filings.toolsItem 8. Financial Statements and Supplementary Data.
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Item 8. Financial Statements and Supplementary Data.
The following financial information is included on the pages indicated:
MANAGEMENT’S REPORT ON
INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Marriott International, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting and for assessing the effectiveness of internal control over financial reporting. The Company has designed its internal control over financial reporting to provide reasonable assurance on the reliability of financial reporting and the preparation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles.
The Company’s internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the Company’s transactions and dispositions of the Company’s assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of the Company’s management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the consolidated financial statements.
Because of inherent limitations in internal control over financial reporting, such controls may not prevent or detect misstatements. Also, projections of any evaluation of the effectiveness of internal controls to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In connection with the preparation of the Company’s annual consolidated financial statements, management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (the “COSO criteria”).
Based on this assessment, and the existence of a material weakness related to the accounting for our Loyalty Program further described in Part II, Item 9A, management has concluded that, applying the COSO criteria, as of December 31, 2019, the Company’s internal control over financial reporting was not effective to provide reasonable assurance of the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. We have made progress towards remediation and continue to implement our remediation plan. See the “Remediation of Material Weakness” caption in Part II, Item 9A for further information.
Ernst & Young LLP, the independent registered public accounting firm that audited the Company’s consolidated financial statements included in this report, has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting, a copy of which appears on the following page.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of Marriott International, Inc.
Opinion on Internal Control over Financial Reporting
We have audited Marriott International, Inc.’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (the COSO criteria). In our opinion, because of the effect of the material weakness described below on the achievement of the objectives of the control criteria, Marriott International, Inc. (the Company) has not maintained effective internal control over financial reporting as of December 31, 2019, based on the COSO criteria.
A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management’s assessment. Management has identified a material weakness in controls whereby the Company did not have a sufficient complement of resources, including IT and accounting processes and personnel, to perform the ongoing accounting associated with the guest loyalty program.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of Marriott International, Inc. as of December 31, 2019 and 2018, and the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the three fiscal years in the period ended December 31, 2019, and the related notes. This material weakness was considered in determining the nature, timing and extent of audit tests applied in our audit of the 2019 consolidated financial statements, and this report does not affect our report dated February 27, 2020, which expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
| /s/ Ernst & Young LLP |
Tysons, Virginia
February 27, 2020
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of Marriott International, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Marriott International, Inc. (the Company) as of December 31, 2019 and 2018, and the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the three fiscal years in the period ended December 31, 2019, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) and our report dated February 27, 2020 expressed an adverse opinion thereon.
Adoption of New Accounting Standards
As discussed in Note 2 to the financial statements, the Company has changed its method of accounting for leases in fiscal year 2019 due to the adoption of the new leasing standard. The Company adopted the new leasing standard using the modified retrospective approach.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
| Accounting for the Loyalty Program | ||
| Description of the Matter | During 2019 the Company recognized $2,211 million of revenues previously deferred as of December 31, 2018 and had deferred revenue of $5,718 million as of December 31, 2019 associated with the Marriott Bonvoy guest loyalty program (the “Loyalty Program”). As discussed in Note 2 to the financial statements, the Company recognizes revenue for performance obligations relating to Loyalty Program points and free night certificates as they are redeemed and the related performance obligations are satisfied. The Company recognizes a portion of revenue for the Licensed IP performance obligation under the sales-based royalty criteria, with the remaining portion recognized on a straight-line basis over the contract term. Revenue is recognized utilizing complex models based upon the estimated standalone selling price per point and per free night certificate, which includes judgment in making the estimates of variable consideration and breakage of points. Auditing Loyalty Program results is complex due to: (1) the complexity of models and high volume of data used to monitor and account for Loyalty Program results, (2) the material weakness in the Company’s internal control over financial reporting relating to the insufficient complement of resources, including IT and accounting processes and personnel, to perform the ongoing accounting associated with the Loyalty Program and (3) the complexity and judgment of estimating the standalone selling price per Loyalty Program point, including both the estimate of variable consideration under the Company’s co-brand credit card agreements and the estimated breakage of Loyalty Program points which requires the use of specialists. Such estimates are complex given the significant estimation uncertainty associated with projecting future cardholder spending and redemption activity. | |
| How We Addressed the Matter in Our Audit | We obtained an understanding, evaluated the design and tested the operating effectiveness of certain controls over the Company’s process of accounting for the Loyalty Program. We tested controls over management’s review of the assumptions and data inputs utilized in estimating the standalone selling price per Loyalty Program point, as well as the development of the estimated breakage. To test the recognition of revenues and costs associated with the Loyalty Program, we performed audit procedures that included, among others, testing the clerical accuracy and consistency with US GAAP of the accounting model developed by the Company to recognize revenue and costs associated with the Loyalty Program, and testing significant inputs into the accounting model, including the estimated standalone selling price and recognition of points earned and redeemed during the period. Because of the material weakness we expanded our sample sizes selected for substantive testing and performed additional testing over the completeness and accuracy of Loyalty Program data. We involved our actuarial professionals to assist in our testing procedures with respect to the estimate of the breakage of Loyalty Program points. We evaluated management’s methodology for estimating the breakage of Loyalty Program points, and we tested underlying data and actuarial assumptions used in estimating the breakage. We evaluated the reasonableness of management’s assumptions, including projections of cash flows, used to estimate variable consideration under the Company’s co-brand credit cards. |
| Accounting for General & Administrative Expenses and Reimbursed Expenses | ||
| Description of the Matter | During 2019 the Company recognized $938 million of general and administrative expenses and $16,439 million of reimbursed expenses. As discussed in Note 2 to the financial statements, the Company incurs certain expenses that are for the benefit of, and reimbursable from, hotel owners and franchisees. Such amounts are recorded in the period in which the expense is incurred and include judgment with respect to the allocation of certain costs between general & administrative expenses, which are non-reimbursable, and reimbursed expenses. |
| Auditing the classification of general and administrative expenses and reimbursed expenses is complex due to: (1) judgment associated with testing management’s conclusions regarding the allocation of costs between reimbursable and non-reimbursable expenses, (2) the complexity associated with allocating above-property expenses to hotel owners and franchisees due to the high volume of data used to monitor and account for reimbursed expenses and (3) incentives within management’s compensation structure designed to limit the growth in general and administrative expenses. | ||
| How We Addressed the Matter in Our Audit | We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company’s process of accounting for reimbursed expenses, general and administrative expenses, and the process for allocating expenses. For example, we tested management’s controls over the review of the allocation of certain costs to determine if they were reasonably classified. To test the recognition of reimbursed expenses for appropriate classification, we performed audit procedures that included, among others, (1) testing a sample of transactions that were classified within reimbursed expenses in order to evaluate the appropriate accounting treatment and financial statement classification pursuant to the terms of the management and franchise agreements, (2) performed analytical procedures over total reimbursed expenses and general and administrative expenses in order to identify any trends or indicators of material errors in the classification of expenses, (3) tested manual journal entries made to reimbursed expenses and general and administrative expenses and (4) evaluated the methodology of cost allocations, including any material changes to allocations during the period. | |
| Accounting for Acquisitions and Dispositions | ||
| Description of the Matter | As discussed in Note 3 to the financial statements, the Company executed acquisitions and disposals of real estate, including: (1) the acquisition of the remaining interest in two joint ventures that resulted in the recognition of the indefinite-lived intangible brand asset for AC Hotels by Marriott of $156 million and management and franchise agreements of $34 million, (2) the acquisition of the W New York - Union Square for $206 million, (3) the acquisition of Elegant Hotels for $128 million in cash and assumed Elegant’s net debt outstanding of $63 million and (4) the dispositions of The St. Regis New York and the Sheraton Gateway Hotel in Toronto International Airport, resulting in recognition of aggregate gains on the disposition of real estate assets of $134 million recognized within “Gains and other income, net” during 2019. Auditing the accounting for acquisitions and dispositions is complex and judgmental as a result of: (1) the magnitude of acquisitions, real estate dispositions and related gains on disposition recognized during the year, (2) significant estimation involved in estimating the fair value of acquired real estate and intangible assets, including the estimate of the relative fair value of assets acquired and (3) technical accounting complexities associated with each individual acquisition and disposition. For dispositions, such complexities included the determination of whether the sale meets the definition of a business, the appropriate treatment of deferred taxes, and in instances where the Company enters into an agreement to manage or franchise the property subsequent to disposition, whether such agreements are consistent with market value. | |
| How We Addressed the Matter in Our Audit | We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company’s process of accounting for acquisitions and dispositions during the year. For example, we tested management’s controls over the review of the technical accounting conclusions reached. To test the accounting for acquisitions and dispositions we performed audit procedures that included, among others, assessing the technical positions taken by management, vouching of consideration paid in acquisitions and proceeds received in dispositions, testing the estimate of fair value or relative fair value allocation to acquired assets, testing the clerical accuracy of the Company’s gain or loss calculations, and testing the appropriateness of the allocation of deferred taxes to individual asset dispositions. |
| /s/ Ernst & Young LLP |
We have served as the Company’s auditor since 2002.
Tysons, Virginia
February 27, 2020
MARRIOTT INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
Fiscal Years 2019**,** 2018**, and** 2017
($ in millions, except per share amounts)
| December 31, 2019 | December 31, 2018 | December 31, 2017 | |||||||||
| REVENUES | |||||||||||
| Base management fees (1) | $ | 1,180 | $ | 1,140 | $ | 1,102 | |||||
| Franchise fees | 2,006 | 1,849 | 1,586 | ||||||||
| Incentive management fees (1) | 637 | 649 | 607 | ||||||||
| Gross fee revenues | 3,823 | 3,638 | 3,295 | ||||||||
| Contract investment amortization (1) | (62 | ) | (58 | ) | (50 | ) | |||||
| Net fee revenues | 3,761 | 3,580 | 3,245 | ||||||||
| Owned, leased, and other revenue (1) | 1,612 | 1,635 | 1,752 | ||||||||
| Cost reimbursement revenue (1) | 15,599 | 15,543 | 15,455 | ||||||||
| 20,972 | 20,758 | 20,452 | |||||||||
| OPERATING COSTS AND EXPENSES | |||||||||||
| Owned, leased, and other-direct | 1,316 | 1,306 | 1,411 | ||||||||
| Depreciation, amortization, and other (1) | 341 | 226 | 229 | ||||||||
| General, administrative, and other (1) | 938 | 927 | 921 | ||||||||
| Merger-related costs and charges | 138 | 155 | 159 | ||||||||
| Reimbursed expenses (1) | 16,439 | 15,778 | 15,228 | ||||||||
| 19,172 | 18,392 | 17,948 | |||||||||
| OPERATING INCOME | 1,800 | 2,366 | 2,504 | ||||||||
| Gains and other income, net (1) | 154 | 194 | 688 | ||||||||
| Interest expense (1) | (394 | ) | (340 | ) | (288 | ) | |||||
| Interest income (1) | 26 | 22 | 38 | ||||||||
| Equity in earnings (1) | 13 | 103 | 40 | ||||||||
| INCOME BEFORE INCOME TAXES | 1,599 | 2,345 | 2,982 | ||||||||
| Provision for income taxes | (326 | ) | (438 | ) | (1,523 | ) | |||||
| NET INCOME | $ | 1,273 | $ | 1,907 | $ | 1,459 | |||||
| EARNINGS PER SHARE | |||||||||||
| Earnings per share - basic | $ | 3.83 | $ | 5.45 | $ | 3.89 | |||||
| Earnings per share - diluted | $ | 3.80 | $ | 5.38 | $ | 3.84 |
| (1) | See Note 16 for disclosure of related party amounts. |
See Notes to Consolidated Financial Statements.
MARRIOTT INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Fiscal Years 2019**,** 2018**, and** 2017
($ in millions)
| December 31, 2019 | December 31, 2018 | December 31, 2017 | |||||||||
| Net income | $ | 1,273 | $ | 1,907 | $ | 1,459 | |||||
| Other comprehensive (loss) income: | |||||||||||
| Foreign currency translation adjustments | 35 | (391 | ) | 478 | |||||||
| Derivative instrument adjustments and other, net of tax | 2 | 4 | (9 | ) | |||||||
| Reclassification of (gains) losses, net of tax | (7 | ) | 17 | 11 | |||||||
| Total other comprehensive (loss) income, net of tax | 30 | (370 | ) | 480 | |||||||
| Comprehensive income | $ | 1,303 | $ | 1,537 | $ | 1,939 |
See Notes to Consolidated Financial Statements.
MARRIOTT INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
Fiscal Years-Ended 2019 and 2018
($ in millions)
| December 31, 2019 | December 31, 2018 | ||||||
| ASSETS | |||||||
| Current assets | |||||||
| Cash and equivalents | $ | 225 | $ | 316 | |||
| Accounts and notes receivable, net (1) | 2,395 | 2,133 | |||||
| Prepaid expenses and other (1) | 252 | 249 | |||||
| Assets held for sale | 255 | 8 | |||||
| 3,127 | 2,706 | ||||||
| Property and equipment, net | 1,904 | 1,956 | |||||
| Intangible assets | |||||||
| Brands | 5,954 | 5,790 | |||||
| Contract acquisition costs and other (1) | 2,687 | 2,590 | |||||
| Goodwill | 9,048 | 9,039 | |||||
| 17,689 | 17,419 | ||||||
| Equity method investments (1) | 577 | 732 | |||||
| Notes receivable, net | 117 | 125 | |||||
| Deferred tax assets | 154 | 171 | |||||
| Operating lease assets | 888 | — | |||||
| Other noncurrent assets (1) | 595 | 587 | |||||
| $ | 25,051 | $ | 23,696 | ||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY | |||||||
| Current liabilities | |||||||
| Current portion of long-term debt | $ | 977 | $ | 833 | |||
| Accounts payable (1) | 720 | 767 | |||||
| Accrued payroll and benefits | 1,339 | 1,345 | |||||
| Liability for guest loyalty program | 2,258 | 2,529 | |||||
| Accrued expenses and other (1) | 1,383 | 963 | |||||
| 6,677 | 6,437 | ||||||
| Long-term debt | 9,963 | 8,514 | |||||
| Liability for guest loyalty program | 3,460 | 2,932 | |||||
| Deferred tax liabilities (1) | 290 | 485 | |||||
| Deferred revenue | 840 | 731 | |||||
| Operating lease liabilities | 882 | — | |||||
| Other noncurrent liabilities (1) | 2,236 | 2,372 | |||||
| Shareholders’ equity | |||||||
| Class A Common Stock | 5 | 5 | |||||
| Additional paid-in-capital | 5,800 | 5,814 | |||||
| Retained earnings | 9,644 | 8,982 | |||||
| Treasury stock, at cost | (14,385 | ) | (12,185 | ) | |||
| Accumulated other comprehensive loss | (361 | ) | (391 | ) | |||
| 703 | 2,225 | ||||||
| $ | 25,051 | $ | 23,696 |
| (1) | See Note 16 for disclosure of related party amounts. |
See Notes to Consolidated Financial Statements.
MARRIOTT INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Years 2019**,** 2018**, and** 2017
($ in millions)
| December 31, 2019 | December 31, 2018 | December 31, 2017 | |||||||||
| OPERATING ACTIVITIES | |||||||||||
| Net income | $ | 1,273 | $ | 1,907 | $ | 1,459 | |||||
| Adjustments to reconcile to cash provided by operating activities: | |||||||||||
| Depreciation, amortization, and other | 403 | 284 | 279 | ||||||||
| Share-based compensation | 187 | 184 | 181 | ||||||||
| Income taxes | (200 | ) | (239 | ) | 887 | ||||||
| Liability for guest loyalty program | 257 | 520 | 298 | ||||||||
| Contract acquisition costs | (195 | ) | (152 | ) | (185 | ) | |||||
| Merger-related charges | 86 | 16 | (124 | ) | |||||||
| Working capital changes | (273 | ) | (76 | ) | (30 | ) | |||||
| Gain on asset dispositions | (147 | ) | (194 | ) | (687 | ) | |||||
| Other | 294 | 107 | 149 | ||||||||
| Net cash provided by operating activities | 1,685 | 2,357 | 2,227 | ||||||||
| INVESTING ACTIVITIES | |||||||||||
| Capital expenditures | (653 | ) | (556 | ) | (240 | ) | |||||
| Dispositions | 395 | 479 | 1,418 | ||||||||
| Loan advances | (30 | ) | (13 | ) | (93 | ) | |||||
| Loan collections | 51 | 48 | 187 | ||||||||
| Other | (47 | ) | (10 | ) | (61 | ) | |||||
| Net cash (used in) provided by investing activities | (284 | ) | (52 | ) | 1,211 | ||||||
| FINANCING ACTIVITIES | |||||||||||
| Commercial paper/Credit Facility, net | 951 | (129 | ) | 60 | |||||||
| Issuance of long-term debt | 1,397 | 1,646 | — | ||||||||
| Repayment of long-term debt | (835 | ) | (397 | ) | (310 | ) | |||||
| Issuance of Class A Common Stock | 7 | 4 | 6 | ||||||||
| Dividends paid | (612 | ) | (543 | ) | (482 | ) | |||||
| Purchase of treasury stock | (2,260 | ) | (2,850 | ) | (3,013 | ) | |||||
| Share-based compensation withholding taxes | (148 | ) | (105 | ) | (157 | ) | |||||
| Other | (8 | ) | — | — | |||||||
| Net cash (used in) provided by financing activities | (1,508 | ) | (2,374 | ) | (3,896 | ) | |||||
| DECREASE IN CASH, CASH EQUIVALENTS, AND RESTRICTED CASH | (107 | ) | (69 | ) | (458 | ) | |||||
| CASH, CASH EQUIVALENTS, AND RESTRICTED CASH, beginning of period (1) | 360 | 429 | 887 | ||||||||
| CASH, CASH EQUIVALENTS, AND RESTRICTED CASH, end of period (1) | $ | 253 | $ | 360 | $ | 429 |
| (1) | The 2019 amounts include beginning restricted cash of $44 million at December 31, 2018, and ending restricted cash of $28 million at December 31, 2019, which we present in the “Prepaid expenses and other” and “Other noncurrent assets” captions of our Balance Sheets. |
See Notes to Consolidated Financial Statements.
MARRIOTT INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
Fiscal Years 2019**,** 2018**, and** 2017
(in millions, except per share amounts)
| Common Shares Outstanding | Total | Class A Common Stock | Additional Paid-in- Capital | Retained Earnings | Treasury Stock, at Cost | Accumulated Other Comprehensive Loss | ||||||||||||||||||||
| 386.1 | Balance at December 31, 2016 | $ | 5,121 | $ | 5 | $ | 5,808 | $ | 6,265 | $ | (6,460 | ) | $ | (497 | ) | |||||||||||
| — | Net income | 1,459 | — | — | 1,459 | — | — | |||||||||||||||||||
| — | Other comprehensive loss | 480 | — | — | — | — | 480 | |||||||||||||||||||
| — | Dividends ($1.29 per share) | (482 | ) | — | — | (482 | ) | — | — | |||||||||||||||||
| 2.2 | Share-based compensation plans | 29 | — | (38 | ) | — | 67 | — | ||||||||||||||||||
| (29.2 | ) | Purchase of treasury stock | (3,025 | ) | — | — | — | (3,025 | ) | — | ||||||||||||||||
| 359.1 | Balance at December 31, 2017 | 3,582 | 5 | 5,770 | 7,242 | (9,418 | ) | (17 | ) | |||||||||||||||||
| — | Adoption of ASU 2016-01 | — | — | — | 4 | — | (4 | ) | ||||||||||||||||||
| — | Adoption of ASU 2016-16 | 372 | — | — | 372 | — | — | |||||||||||||||||||
| — | Net income | 1,907 | — | — | 1,907 | — | — | |||||||||||||||||||
| — | Other comprehensive loss | (370 | ) | — | — | — | — | (370 | ) | |||||||||||||||||
| — | Dividends ($1.56 per share) | (543 | ) | — | — | (543 | ) | — | — | |||||||||||||||||
| 1.5 | Share-based compensation plans | 86 | — | 44 | — | 42 | — | |||||||||||||||||||
| (21.5 | ) | Purchase of treasury stock | (2,809 | ) | — | — | — | (2,809 | ) | — | ||||||||||||||||
| 339.1 | Balance at December 31, 2018 | 2,225 | 5 | 5,814 | 8,982 | (12,185 | ) | (391 | ) | |||||||||||||||||
| — | Adoption of ASU 2016-02 | 1 | — | — | 1 | — | — | |||||||||||||||||||
| — | Net income | 1,273 | — | — | 1,273 | — | — | |||||||||||||||||||
| — | Other comprehensive income | 30 | — | — | — | — | 30 | |||||||||||||||||||
| — | Dividends ($1.85 per share) | (612 | ) | — | — | (612 | ) | — | — | |||||||||||||||||
| 2.2 | Share-based compensation plans | 46 | — | (14 | ) | — | 60 | — | ||||||||||||||||||
| (17.3 | ) | Purchase of treasury stock | (2,260 | ) | — | — | — | (2,260 | ) | — | ||||||||||||||||
| 324.0 | (1) | Balance at December 31, 2019 | $ | 703 | $ | 5 | $ | 5,800 | $ | 9,644 | $ | (14,385 | ) | $ | (361 | ) |
| (1) | Our restated certificate of incorporation authorizes 800 million shares of our common stock, with a par value of $.01 per share and 10 million shares of preferred stock, without par value. At year-end 2019, we had 324 million of these authorized shares of our common stock and no preferred stock outstanding. |
See Notes to Consolidated Financial Statements.
MARRIOTT INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The consolidated financial statements present the results of operations, financial position, and cash flows of Marriott International, Inc. and subsidiaries (referred to in this report as “we,” “us,” “Marriott,” or “the Company”). In order to make this report easier to read, we also refer throughout to (i) our Consolidated Financial Statements as our “Financial Statements,” (ii) our Consolidated Statements of Income as our “Income Statements,” (iii) our Consolidated Balance Sheets as our “Balance Sheets,” (iv) our Consolidated Statements of Cash Flows as our “Statements of Cash Flows,” (v) our properties, brands, or markets in the United States (“U.S.”) and Canada as “North America” or “North American,” and (vi) our properties, brands, or markets in our Caribbean and Latin America, Europe, and Middle East and Africa regions as “Other International,” and together with those in our Asia Pacific segment, as “International.” In addition, references throughout to numbered “Notes” refer to these Notes to Consolidated Financial Statements, unless otherwise stated.
Preparation of financial statements that conform with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements, the reported amounts of revenues and expenses during the reporting periods, and the disclosures of contingent liabilities. Accordingly, ultimate results could differ from those estimates.
The accompanying Financial Statements reflect all normal and recurring adjustments necessary to present fairly our financial position at fiscal year-end 2019 and fiscal year-end 2018 and the results of our operations and cash flows for fiscal years 2019, 2018, and 2017. We have eliminated all material intercompany transactions and balances between entities consolidated in these Financial Statements.
The accompanying Financial Statements also reflect our adoption of ASU 2016-02. See the “New Accounting Standards Adopted” caption in Note 2 for additional information.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Base Management and Incentive Management Fees: For our managed hotels, we have performance obligations to provide hotel management services and a license to our hotel system intellectual property for the use of our brand names. As compensation for such services, we are generally entitled to receive base fees, which are a percentage of the revenues of hotels, and incentives fees, which are generally based on a measure of hotel profitability. Both the base and incentive management fees are variable consideration, as the transaction price is based on a percentage of revenue or profit, as defined in each contract. We recognize base management fees on a monthly basis over the term of the agreement as those amounts become payable. We recognize incentive management fees on a monthly basis over the term of the agreement based on each property’s financial results, as long as we do not expect a significant reversal due to projected future hotel performance or cash flows in future periods.
Franchise Fee and Royalty Fee Revenue: For our franchised hotels, we have a performance obligation to provide franchisees and operators a license to our hotel system intellectual property for use of certain of our brand names. As compensation for such services, we are typically entitled to initial application fees and ongoing royalty fees. Our ongoing royalty fees represent variable consideration, as the transaction price is based on a percentage of certain revenues of the hotels, as defined in each contract. We recognize royalty fees on a monthly basis over the term of the agreement as those amounts become payable. Initial application and relicensing fees are fixed consideration payable upon submission of a franchise application or renewal and are recognized on a straight-line basis over the initial or renewal term of the franchise agreements.
Owned and Leased Hotel Revenue: At our owned and leased hotels, we have performance obligations to provide accommodations and other ancillary services to hotel guests. As compensation for such goods and services, we are typically entitled to a fixed nightly fee for an agreed upon period and additional fixed fees for any ancillary services purchased. These fees are generally payable at the time the hotel guest checks out of the hotel. We generally satisfy the performance obligations over time, and we recognize the revenue from room sales and from other ancillary guest services on a daily basis, as the rooms are occupied and we have rendered the services.
Cost Reimbursements: Under our management and franchise agreements, we are entitled to be reimbursed for certain costs we incur on behalf of the managed, franchised, and licensed properties, with no added mark-up. These costs primarily consist of payroll and related expenses at managed properties where we are the employer of the employees at the properties and
include certain operational and administrative costs as provided for in our contracts with the owners. We are entitled to reimbursement in the period we incur the related reimbursable costs, which we recognize within the “Cost reimbursement revenue” caption of our Income Statements.
Under our management and franchise agreements, hotel owners and franchisees participate in certain centralized programs and services, such as marketing, sales, reservations, and insurance programs. We operate these programs and services for the benefit of our hotel owners. We do not operate these programs and services to generate a profit over the contract term, and accordingly, when we recover the costs that we incur for these programs and services from our hotel owners, we do not seek a mark-up. The amounts we charge for these programs and services are generally a combination of fixed fees and variable fees based on sales or other metrics and are payable on a monthly basis. We recognize revenue within the “Cost reimbursement revenue” caption of our Income Statements when the amounts may be billed to hotel owners, and we recognize expenses within the “Reimbursed expenses” caption as they are incurred. This pattern of recognition results in timing differences between the costs incurred for centralized programs and services and the related reimbursement from hotel owners in our operating and net income. Over the long term, these programs and services are not designed to impact our economics, either positively or negatively. In addition, proceeds from the sale of our interest in Avendra that we expend for the benefit of our hotel owners are included in “Reimbursed expenses.”
Other Revenue: Includes Global Design fees, which we describe below, termination fees, and other property and brand revenues. We generally recognize termination fees when collection is probable, and other revenue as services are rendered. Amounts received in advance are deferred as liabilities.
We provide hotel design and construction review quality assurance (“Global Design”) services to our managed and franchised hotel owners, generally during the period prior to a hotel’s opening or during the period a hotel is converting to a Marriott brand (the “pre-opening period”). As compensation for such services, we may be entitled to receive a one-time fixed fee that is payable during the pre-opening period of the hotel. As these services are not a distinct performance obligation, we recognize the fees on a straight-line basis over the initial term of the management or franchise agreement within the “Owned, leased, and other revenue” caption of our Income Statements.
Practical Expedients and Exemptions: We do not disclose the amount of variable consideration that we expect to recognize in future periods in the following circumstances:
(1) if we recognize the revenue based on the amount invoiced or services performed;
(2) for sales-based or usage-based royalty promised in exchange for a license of intellectual property; or
(3) if the consideration is allocated entirely to a wholly unsatisfied promise to transfer a distinct service that forms part of a single performance obligation, and the terms of the consideration relate specifically to our efforts to transfer, or to a specific outcome from transferring the service.
We are required to collect certain taxes and fees from customers on behalf of governmental agencies and remit these to the applicable governmental agencies on a periodic basis. We do not include these taxes in determining the transaction price.
Loyalty Program*:*
Loyalty Program members earn points based on the money they spend at our hotels; purchases of timeshare interval, fractional ownership, and residential products; and through participation in travel experiences and affiliated partners’ programs, such as those offered by credit card, car rental, and airline companies. Members can redeem points, which we track on their behalf, for stays at most of our hotels, airline tickets, airline frequent flyer program miles, rental cars, and a variety of other awards. Points cannot be redeemed for cash.
Under our Loyalty Program, we have a performance obligation to provide or arrange for the provision of goods or services for free or at a discount to Loyalty Program members in exchange for the redemption of points earned from past activities. We operate our Loyalty Program as a cross-brand marketing program to participating properties. Our management and franchise agreements require that properties reimburse us for a portion of the costs of operating the Loyalty Program, including costs for marketing, promotion, communication with, and performing member services for Loyalty Program members, with no added mark-up. We receive contributions on a monthly basis from managed, franchised, owned, and leased hotels based on a portion of qualified spend by Loyalty Program members. We recognize these contributions into revenue as the points are redeemed and we provide the related service. The amount of revenue we recognize upon point redemption is impacted by our estimate of the “breakage” for points that members will never redeem. We estimate breakage based on our historical experience and expectations of future member behavior. We recognize revenue net of the redemption cost within our “Cost reimbursement revenue” caption on our Income Statements, as our performance obligation is to facilitate the transaction
between the Loyalty Program member and the managed or franchised property or program partner. We recognize all other Loyalty Program costs as incurred in our “Reimbursed expenses” caption.
We have multi-year agreements for our co-brand credit cards associated with our Loyalty Program. Under these agreements, we have performance obligations to provide a license to the intellectual property associated with our brands and marketing lists (“Licensed IP”) to the financial institution that issues the credit cards, to arrange for the redemption of Loyalty Program points as discussed in the preceding paragraph, and to arrange for the redemption of free night certificates provided to cardholders. We receive fees from these agreements, including fixed amounts that are primarily payable at contract inception, and variable amounts that are paid to us monthly over the term of the agreements, based on: (1) the number of free night certificates issued and redeemed; (2) the number of Loyalty Program points purchased; and (3) the volume of cardholder spend. We allocate those fees among the performance obligations, including the Licensed IP, our Loyalty Program points, and free night certificates provided to cardholders based on their estimated standalone selling prices. The estimation of the standalone selling prices requires significant judgments based upon generally accepted valuation methodologies regarding the value of our Licensed IP, the amount of funding we will receive, and the number of Loyalty Program points and free night certificates we will issue over the term of the agreements. We base our estimates of these amounts on our historical experience and expectation of future cardholder behavior. We recognize the portion of the Licensed IP revenue that meets the sales-based royalty criteria as the credit cards are used and the remaining portion of the Licensed IP revenue on a straight-line basis over the contract term. In our Income Statements, we primarily recognize Licensed IP revenue in the “Franchise fees” caption, and we recognize a portion in the “Cost reimbursement revenue” caption. We recognize the revenue related to the Loyalty Program points as discussed in the preceding paragraph. We recognize the revenue related to the free night certificates when the related service is provided. We recognize revenue net of the redemption cost, as our performance obligation is to facilitate the transaction between the Loyalty Program member and the managed or franchised property.
Contract Balances: We generally receive payments from customers as we satisfy our performance obligations. We record a receivable when we have an unconditional right to receive payment and only the passage of time is required before payment is due. We record deferred revenue when we receive payment, or have the unconditional right to receive payment, in advance of the satisfaction of our performance obligations related to franchise application and relicensing fees, Global Design fees, credit card branding license fees, and our Loyalty Program.
Current and noncurrent deferred revenue increased by $129 million, to $960 million at December 31, 2019 from $831 million at December 31, 2018, primarily as a result of our Global Design, cost reimbursements, and application and relicensing activities described in the “Revenue Recognition” caption above.
Our current and noncurrent Loyalty Program liability increased by $257 million, to $5,718 million at December 31, 2019 from $5,461 million at December 31, 2018, primarily reflecting an increase in points earned by members, partially offset by $2,211 million of revenue recognized in 2019, that was deferred as of December 31, 2018. At each reporting period, we evaluate the estimates used in the recognition of Loyalty Program revenues, including estimates of the breakage of points that members will never redeem and the amount of funding we expect to receive over the life of the agreements with various third parties. In 2019, the updated estimates resulted in a net increase in deferred revenue, and a corresponding net reduction of revenue of approximately $78 million ($58 million net of tax).
Costs Incurred to Obtain and Fulfill Contracts with Customers
We incur certain costs to obtain and fulfill contracts with customers, which we capitalize and amortize on a straight-line basis over the initial, non-cancellable term of the contract. We classify incremental costs of obtaining a contract with a customer in the “Contract acquisition costs and other” caption of our Balance Sheets, the related amortization in the “Contract investment amortization” caption of our Income Statements, and the cash flow impact in the “Contract acquisition costs” caption of our Statements of Cash Flows. We classify certain direct costs to fulfill a contract with a customer in the “Other noncurrent assets” caption of our Balance Sheets, and the related amortization in the “Owned, leased, and other - direct expenses” caption of our Income Statements. We had capitalized costs to fulfill contracts with customers of $351 million at December 31, 2019 and $324 million at December 31, 2018. See Note 10 for information on capitalized costs incurred to obtain contracts with customers.
Real Estate Sales
We recognize a gain or loss on real estate transactions when control of the asset transfers to the buyer, generally at the time the sale closes. In sales transactions where we retain a management contract, the terms and conditions of the management contract are generally comparable to the terms and conditions of the management contracts obtained directly with third-party owners in competitive processes.
Retirement Savings Plan
We contribute to tax-qualified retirement plans for the benefit of U.S. employees who meet certain eligibility requirements and choose to participate in the plans. Participating employees specify the percentage or amount of salary they wish to contribute from their compensation, and the Company typically makes discretionary and certain other matching or supplemental contributions. We recognized compensation costs from Company contributions of $128 million in 2019, $224 million in 2018, and $119 million in 2017.
Non-U.S. Operations
The U.S. dollar is the functional currency of our consolidated and unconsolidated entities operating in the U.S. The functional currency of our consolidated and unconsolidated entities operating outside of the U.S. is generally the principal currency of the economic environment in which the entity primarily generates and expends cash. We translate the financial statements of consolidated entities whose functional currency is not the U.S. dollar into U.S. dollars, and we do the same, as needed, for unconsolidated entities whose functional currency is not the U.S. dollar. We translate assets and liabilities at the exchange rate in effect as of the financial statement date and translate income statement accounts using the weighted average exchange rate for the period. We include translation adjustments from currency exchange and the effect of exchange rate changes on intercompany transactions of a long-term investment nature as a separate component of shareholders’ equity. We report gains and losses from currency exchange rate changes for intercompany receivables and payables that are not of a long-term investment nature, as well as for third-party transactions, currently in operating costs and expenses.
Share-Based Compensation
Our share-based compensation awards primarily consist of restricted stock units (“RSUs”). We measure compensation costs for our share-based payment transactions at fair value on the grant date, and we recognize those costs in our Financial Statements over the vesting period during which the employee provides service in exchange for the award.
Advertising Costs
We expense costs to produce advertising as they are incurred and to communicate advertising as the communication occurs and record such amounts in reimbursed expenses to the extent undertaken on behalf of our owners and franchisees. We recognized advertising costs of $851 million in 2019, $660 million in 2018, and $562 million in 2017.
Income Taxes
We record the amounts of taxes payable or refundable for the current year, as well as deferred tax liabilities and assets for the future tax consequences of events we have recognized in our Financial Statements or tax returns, using judgment in assessing future profitability and the likely future tax consequences of those events. We base our estimates of deferred tax assets and liabilities on current tax laws, rates and interpretations, and, in certain cases, business plans and other expectations about future outcomes. We develop our estimates of future profitability based on our historical data and experience, industry projections, micro and macro general economic condition projections, and our expectations.
We generally recognize the effect of the tax law changes in the period of enactment. Changes in existing tax laws and rates, their related interpretations, and the uncertainty generated by the current economic environment may affect the amounts of our deferred tax liabilities or the valuations of our deferred tax assets over time. Our accounting for deferred tax consequences represents management’s best estimate of future events that can be appropriately reflected in the accounting estimates.
For tax positions we have taken or expect to take in a tax return, we apply a more likely than not threshold, under which we must conclude a tax position is more likely than not to be sustained, assuming that the position will be examined by the appropriate taxing authority that has full knowledge of all relevant information, to continue to recognize the benefit. In determining our provision for income taxes, we use judgment, reflecting our estimates and assumptions, in applying the more likely than not threshold. We recognize accrued interest and penalties for our unrecognized tax benefits as a component of tax expense. See Note 6 for further information.
Cash and Equivalents
We consider all highly liquid investments with an initial maturity of three months or less at date of purchase to be cash equivalents.
Accounts Receivable
Our accounts receivable primarily consist of amounts due from hotel owners with whom we have management and franchise agreements and include reimbursements of costs we incurred on behalf of managed and franchised properties. We generally collect these receivables within 30 days. We record an accounts receivable reserve when losses are probable, based on an assessment of historical collection activity and current business conditions. Our accounts receivable reserve was $76 million at year-end 2019 and $66 million at year-end 2018.
Assets Held for Sale
We consider properties to be assets held for sale when (1) management commits to a plan to sell the property; (2) it is unlikely that the disposal plan will be significantly modified or discontinued; (3) the property is available for immediate sale in its present condition; (4) actions required to complete the sale of the property have been initiated; (5) sale of the property is probable and we expect the completed sale will occur within one year; and (6) the property is actively being marketed for sale at a price that is reasonable given our estimate of current market value. Upon designation of a property as an asset held for sale, we record the property’s value at the lower of its carrying value or its estimated fair value, less estimated costs to sell, and we cease depreciation. See Note 3 for further information.
Goodwill
We test goodwill for potential impairment at least annually in the fourth quarter, or more frequently if an event or other circumstance indicates that we may not be able to recover the carrying amount of the net assets of the reporting unit. In evaluating goodwill for impairment, we may assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. If we bypass the qualitative assessment, or if we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying value, then we perform a quantitative impairment test by comparing the fair value of a reporting unit with its carrying amount.
We calculate the estimated fair value of a reporting unit using a combination of the income and market approaches. For the income approach, we use internally developed discounted cash flow models that include the following assumptions, among others: projections of revenues, expenses, and related cash flows based on assumed long-term growth rates and demand trends; expected future investments to grow new units; and estimated discount rates. For the market approach, we use internal analyses based primarily on market comparables. We base these assumptions on our historical data and experience, third-party appraisals, industry projections, micro and macro general economic condition projections, and our expectations.
We have had no goodwill impairment charges for the last three fiscal years.
Intangibles and Long-Lived Assets
We assess indefinite-lived intangible assets for continued indefinite use and for potential impairment annually, or more frequently if an event or other circumstance indicates that we may not be able to recover the carrying amount of the asset. Like goodwill, we may first assess qualitative factors to determine whether it is more likely than not that the fair value of the indefinite-lived intangible is less than its carrying amount. If the carrying value of the asset exceeds the fair value, we recognize an impairment loss in the amount of that excess.
We test definite-lived intangibles and long-lived asset groups for recoverability when changes in circumstances indicate that we may not be able to recover the carrying value; for example, when there are material adverse changes in projected revenues or expenses, significant underperformance relative to historical or projected operating results, or significant negative industry or economic trends. We also test recoverability when management has committed to a plan to sell or otherwise dispose of an asset group and we expect to complete the plan within a year. We evaluate recoverability of an asset group by comparing its carrying value, including right-of-use assets, to the future net undiscounted cash flows that we expect the asset group will generate. If the comparison indicates that we will not be able to recover the carrying value of an asset group, we recognize an impairment loss for the amount by which the carrying value exceeds the estimated fair value. When we recognize an impairment loss for assets to be held and used, we depreciate the adjusted carrying amount of those assets over their remaining useful life.
We calculate the estimated fair value of an intangible asset or asset group using the income approach or the market approach. We utilize the same assumptions and methodology for the income approach that we describe in the “Goodwill” caption. For the market approach, we use internal analyses based primarily on market comparables and assumptions about market capitalization rates, growth rates, and inflation. See Note 8 and Note 11 for additional information.
Investments
We hold equity interests in ventures established to develop or acquire and own hotel properties or that otherwise support our hospitality operations. We account for these investments as either an equity method investment, a financial asset, or a controlled subsidiary. We apply the equity method of accounting if we have significant influence over the entity, typically when we hold 20 percent of the voting common stock (or equivalent) of an investee but do not have a controlling financial interest. In certain circumstances, such as with investments in limited liability companies or limited partnerships, we apply the equity method of accounting when we own as little as three to five percent. We account for financial assets at fair value if it is readily determinable, or using the fair value alternative method, whereby investments are measured at cost less impairment, adjusted for observable price changes. We consolidate entities that we control.
When we acquire an investment that qualifies for the equity method of accounting, we determine the acquisition date fair value of the identifiable assets and liabilities. If our carrying amount exceeds our proportional share in the equity of the investee, we amortize the difference on a straight-line basis over the underlying assets’ estimated useful lives when calculating equity method earnings attributable to us, excluding the difference attributable to land, which we do not amortize.
We evaluate an investment for impairment when circumstances indicate that we may not be able to recover the carrying value. When evaluating our ventures, we consider loan defaults, significant underperformance relative to historical or projected operating performance, or significant negative industry or economic trends. Additionally, a venture’s commitment to a plan to sell some or all of its assets could cause us to evaluate the recoverability of the venture’s individual long-lived assets and possibly the venture itself. We impair investments we account for using the equity method of accounting when we determine that there has been an “other-than-temporary” decline in the venture’s estimated fair value compared to its carrying value. We perform qualitative assessments for investments we account for using the fair value alternative method and we record any associated impairment when the fair value is less than the carrying value.
Under the accounting guidance for the consolidation of variable interest entities, we analyze our variable interests, including equity investments, loans, and guarantees, to determine if an entity in which we have a variable interest is a variable interest entity. Our analysis includes both quantitative and qualitative reviews. We base our quantitative analysis on the forecasted cash flows of the entity, and our qualitative analysis on our review of the design of the entity, its organizational structure including decision-making ability, and relevant financial agreements. We also use our qualitative analysis to determine if we must consolidate a variable interest entity as its primary beneficiary.
Fair Value Measurements
We have various financial instruments we must measure at fair value on a recurring basis, including certain marketable securities and derivatives. See Note 13 for further information. We also apply the provisions of fair value measurement to various nonrecurring measurements for our financial and nonfinancial assets and liabilities.
Accounting standards define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). We measure our assets and liabilities using inputs from the following three levels of the fair value hierarchy:
Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access at the measurement date.
Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).
Level 3 includes unobservable inputs that reflect our assumptions about what factors market participants would use in pricing the asset or liability. We develop these inputs based on the best information available, including our own data.
Derivative Instruments
We record derivatives at fair value. The designation of a derivative instrument as a hedge and its ability to meet the hedge accounting criteria determine how we reflect the change in fair value of the derivative instrument in our Financial Statements. A derivative qualifies for hedge accounting if, at inception, we expect the derivative will be highly effective in offsetting the underlying hedged cash flows or fair value and we fulfill the hedge documentation standards at the time we enter into the derivative contract. We designate a hedge as a cash flow hedge, fair value hedge, or a hedge of the net investment in non-U.S. operations based on the exposure we are hedging. For the effective portion of qualifying cash flow hedges, we record changes in fair value in accumulated other comprehensive income (“AOCI”). We release the derivative’s gain or loss from AOCI to
match the timing of the underlying hedged items’ effect on earnings. The change in fair value of qualifying fair value hedges as well as changes in fair value of the underlying hedged items to the hedged risks are recorded concurrently in earnings.
We review the effectiveness of our hedging instruments quarterly, recognize current period hedge ineffectiveness immediately in earnings, and discontinue hedge accounting for any hedge that we no longer consider to be highly effective. We recognize changes in fair value for derivatives not designated as hedges or those not qualifying for hedge accounting in current period earnings. Upon termination of cash flow hedges, we release gains and losses from AOCI based on the timing of the underlying cash flows or revenue recognized, unless the termination results from the failure of the intended transaction to occur in the expected time frame. Such untimely transactions require us to immediately recognize in earnings the gains and/or losses that we previously recorded in AOCI.
Changes in interest rates, currency exchange rates, and equity securities expose us to market risk. We manage our exposure to these risks by monitoring available financing alternatives, as well as through development and application of credit granting policies. We also use derivative instruments as part of our overall strategy to manage our exposure to market risks. As a matter of policy, we only enter into transactions that we believe will be highly effective at offsetting the underlying risk, and we do not use derivatives for trading or speculative purposes.
Loan Loss Reserves
We may make senior, mezzanine, and other loans to owners of hotels that we operate or franchise, generally to facilitate the development of a hotel and sometimes to facilitate brand programs or initiatives. We expect the owners to repay the loans in accordance with the loan agreements, or earlier as the hotels mature and capital markets permit. We use metrics such as loan-to-value ratios and debt service coverage, and other information about collateral and from third party rating agencies to assess the credit quality of the loan receivable, both upon entering into the loan agreement and on an ongoing basis as applicable.
On a regular basis, we individually assess loans for impairment. We use internally generated cash flow projections to determine if we expect the loans will be repaid under the terms of the loan agreements. If we conclude that it is probable a borrower will not repay a loan in accordance with its terms, we consider the loan impaired and begin recognizing interest income on a cash basis. To measure impairment, we calculate the present value of expected future cash flows discounted at the loan’s original effective interest rate or the estimated fair value of the collateral. If the present value or the estimated collateral is less than the carrying value of the loan receivable, we establish a specific impairment reserve for the difference.
If it is likely that a loan will not be collected based on financial or other business indicators, including our historical experience, our policy is to charge off the loan in the quarter in which we deem it uncollectible.
Leases
We determine if an arrangement is a lease or contains a lease at the inception of the contract. Our leases generally contain fixed and variable components. The variable components of our leases are primarily based on operating performance of the leased property. Our lease agreements may also include non-lease components, such as common area maintenance, which we combine with the lease component to account for both as a single lease component.
Lease liabilities, which represent our obligation to make lease payments arising from the lease, and corresponding right-of-use assets, which represent our right to use an underlying asset for the lease term, are recognized at the commencement date of the lease based on the present value of fixed future payments over the lease term. We calculate the present value of future payments using the discount rate implicit in the lease, if available, or our incremental borrowing rate.
For operating leases, lease expense relating to fixed payments is recognized on a straight-line basis over the lease term and lease expense relating to variable payments is expensed as incurred. For finance leases, the amortization of the asset is recognized over the shorter of the lease term or useful life of the underlying asset.
Guarantees
We measure and record our liability for the fair value of a guarantee on a nonrecurring basis, that is when we issue or modify a guarantee, using Level 3 internally developed inputs, as described above in this footnote under the caption “Fair Value Measurements.” We base our calculation of the estimated fair value of a guarantee on the income approach or the market approach, depending on the type of guarantee. For the income approach, we use internally developed discounted cash flow and Monte Carlo simulation models that include the following assumptions, among others: projections of revenues and expenses and related cash flows based on assumed growth rates and demand trends; historical volatility of projected performance; the guaranteed obligations; and applicable discount rates. We base these assumptions on our historical data and experience, industry projections, micro and macro general economic condition projections, and our expectations. For the market approach,
we use internal analyses based primarily on market comparable data and our assumptions about market capitalization rates, credit spreads, growth rates, and inflation.
The offsetting entry for the guarantee liability depends on the circumstances in which the guarantee was issued. Funding under the guarantee reduces the recorded liability. In most cases, when we do not forecast any funding, we amortize the liability into income on a straight-line basis over the remaining term of the guarantee. On a quarterly basis, we evaluate all material estimated liabilities based on the operating results and the terms of the guarantee. If we conclude that it is probable that we will be required to fund a greater amount than previously estimated, we record a loss except to the extent that the applicable contracts provide that the advance can be recovered as a loan.
Self-Insurance Programs
We self-insure for certain levels of liability, workers’ compensation, property insurance and employee medical coverage. We accrue estimated costs of these self-insurance programs at the present value of projected settlements for known and incurred but not reported claims. We use a discount rate of three percent to determine the present value of the projected settlements, which we consider to be reasonable given our history of settled claims, including payment patterns and the fixed nature of the individual settlements. We classify the current portion of our self-insurance reserve in the “Accrued expense and other” caption and the noncurrent portion in the “Other noncurrent liabilities” caption of our Balance Sheets. The current portion of our self-insurance reserve was $166 million in 2019 and $126 million in 2018. The noncurrent portion of our self-insurance reserve was $323 million in 2019 and $351 million in 2018.
Pension and Other Postretirement Benefits
We sponsor numerous funded and unfunded domestic and international defined benefit pension plans. All defined benefit plans covering U.S. employees are frozen, meaning that employees do not accrue additional benefits. Certain plans covering non-U.S. employees remain active. We also sponsor the Starwood Retiree Health and Welfare Program, which provides health care and life insurance benefits for certain eligible retired employees.
Legal Contingencies
We are subject to various legal proceedings and claims, the outcomes of which are uncertain. We record an accrual for legal contingencies when we determine that it is probable that we have incurred a liability and we can reasonably estimate the amount of the loss. In making such determinations we evaluate, among other things, the probability of an unfavorable outcome and, when we believe it probable that a liability has been incurred, our ability to make a reasonable estimate of the loss. We review these accruals each reporting period and make revisions based on changes in facts and circumstances.
Business Combinations
We allocate the purchase price of an acquisition to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. We recognize as goodwill the amount by which the purchase price of an acquired entity exceeds the net of the fair values assigned to the assets acquired and liabilities assumed. In determining the fair values of assets acquired and liabilities assumed, we use various recognized valuation methods including the income and market approaches. Further, we make assumptions within certain valuation techniques, including discount rates, royalty rates, and the amount and timing of future cash flows. We record the net assets and results of operations of an acquired entity in our Financial Statements from the acquisition date. We initially perform these valuations based upon preliminary estimates and assumptions by management or independent valuation specialists under our supervision, where appropriate, and make revisions as estimates and assumptions are finalized. We expense acquisition-related costs as we incur them. See Note 3 for additional information.
Asset Acquisitions
Acquisitions that do not meet the definition of a business are accounted for as asset acquisitions. We allocate the cost of the acquisition, including direct and incremental transaction costs, to the individual assets acquired and liabilities assumed on a relative fair value basis. Goodwill is not recognized in an asset acquisition.
New Accounting Standards Adopted
Accounting Standards Update (“ASU”) No. 2016-02 - “Leases” (Topic 842). ASU 2016-02 introduces a lessee model that brings substantially all leases onto the balance sheet. Under the standard, a lessee recognizes on its balance sheet a lease liability and a right-of-use asset for most leases, including operating leases. The new standard also distinguishes leases as either finance leases or operating leases. This distinction affects how leases are measured and presented in the income statement and statement of cash flows. We adopted ASU 2016-02 in the 2019 first quarter using the modified retrospective transition method. Our accounting for finance leases remained substantially unchanged. Adoption of the standard resulted in the recording of $1,013 million of operating lease assets and $1,053 million of operating lease liabilities, as of January 1, 2019. We did not adjust our prior period Balance Sheets. Adoption of the standard did not impact our Income Statements or our Statements of Cash Flows.
When we adopted ASU 2016-02, we applied the package of practical expedients allowed by the standard, and therefore, we did not reassess:
| • | Whether any expired or existing contracts are or contain leases under the new definition; |
| • | The lease classification for any expired or existing leases; or |
| • | Whether previously capitalized costs continue to qualify as initial direct costs. |
NOTE 3. ACQUISITIONS AND DISPOSITIONS
Acquisitions
In 2019, we completed the acquisition of Elegant Hotels Group plc (“Elegant”) for $128 million in cash and assumed Elegant’s net debt outstanding of $63 million, which we subsequently repaid in January 2020. As a result of the transaction, we added seven hotels and a beachfront restaurant on the island of Barbados to our Caribbean and Latin America owned and leased portfolio.
In 2019, we purchased the W New York - Union Square, a North American Full-Service property, for $206 million.
In 2019, we accelerated our option to acquire our partner’s remaining interests in two joint ventures. As a result of the transaction, we recognized an indefinite-lived brand asset for AC Hotels by Marriott of $156 million and management and franchise contract assets, with a weighted-average term of 24 years totaling $34 million.
Dispositions
In 2019, we sold The St. Regis New York and the Sheraton Gateway Hotel in Toronto International Airport, two North American Full-Service properties, and recognized total gains of $134 million in the “Gains and other income, net” caption of our Income Statements. We will continue to operate the hotels under long-term management agreements.
In 2018, we sold the following properties and recognized total gains of $132 million in the “Gains and other income, net” caption of our Income Statements:
| • | The Tremont Chicago Hotel at Magnificent Mile and Le Centre Sheraton Montreal Hotel, two North American Full-Service properties; |
| • | The Westin Denarau Island Resort and The Sheraton Fiji Resort, two Asia Pacific properties; and |
| • | The Sheraton Buenos Aires Hotel & Convention Center and Park Tower, A Luxury Collection Hotel, Buenos Aires, two Caribbean and Latin America properties. |
In 2018, we sold our interest in three equity method investments, whose assets included a plot of land in Italy, the W Hotel Mexico City, and the Royal Orchid Sheraton Hotel & Towers in Bangkok, and we recognized total gains of $42 million in the “Gains and other income, net” caption of our Income Statements. Also in 2018, a Caribbean and Latin America investee sold the JW Marriott Mexico City, and a North American Full-Service investee sold The Ritz-Carlton Toronto, and we recorded our share of the gains of $55 million and $10 million, respectively, in the “Equity in earnings” caption of our Income Statements.
In 2017, we sold the following three North American Full-Service properties:
| • | The Sheraton Centre Toronto Hotel that was owned on a long-term ground lease; |
| • | The Westin Maui that was owned on a long-term ground lease; and |
| • | The Charlotte Marriott City Center and recognized a $24 million gain in the “Gains and other income, net” caption of our Income Statements. |
In 2017, Aramark purchased Avendra LLC, in which we had a 55 percent ownership interest. We recorded a non-recurring pre-tax gain of $659 million in 2017 and $5 million in 2018, which we reflected in the “Gains and other income, net” caption of our Income Statements. After cash paid for income taxes, the gain totaled $425 million. We committed to the owners of the hotels in our system that the benefits derived from Avendra, including any dividends or sale proceeds above our original investment, would be used for the benefit of the hotels in our system. Spending funded by the sale proceeds, which we present in the “Reimbursed expenses” caption of our Income Statements, totaled $118 million ($87 million after-tax) in 2019 and $115 million ($85 million after-tax) in 2018. In conjunction with the sale of Avendra to Aramark, we entered into a new five-year procurement services agreement with Avendra for the benefit of our managed and owned properties in North America.
Planned Disposition
In 2018, we purchased the Sheraton Phoenix Downtown, formerly the Sheraton Grand Phoenix, a North American Full-Service property that we manage, for $255 million. In the 2020 first quarter, we sold this hotel for $268 million. We determined that the carrying values of those assets exceeded their fair values, based on the agreed-upon selling price. Consequently, we recorded a charge of $15 million for the expected disposal loss in the “Depreciation, amortization, and other” caption of our Income Statements, which represents the amount by which the carrying values exceeded the fair values, less our anticipated cost to sell. At year-end 2019, we held $248 million of assets classified as “Assets held for sale” related to the Sheraton Phoenix Downtown and $8 million of liabilities associated with those assets, which we recorded in the “Accrued expenses and other” caption of our Balance Sheets. We will continue to operate the hotel under a long-term management agreement.
NOTE 4. EARNINGS PER SHARE
The table below illustrates the reconciliation of the earnings and number of shares used in our calculations of basic and diluted earnings per share, the latter of which uses the treasury stock method in order to calculate the dilutive effect of the Company’s potential common stock:
| (in millions, except per share amounts) | 2019 | 2018 | 2017 | ||||||||
| Computation of Basic Earnings Per Share | |||||||||||
| Net income | $ | 1,273 | $ | 1,907 | $ | 1,459 | |||||
| Shares for basic earnings per share | 332.7 | 350.1 | 375.2 | ||||||||
| Basic earnings per share | $ | 3.83 | $ | 5.45 | $ | 3.89 | |||||
| Computation of Diluted Earnings Per Share | |||||||||||
| Net income | $ | 1,273 | $ | 1,907 | $ | 1,459 | |||||
| Shares for basic earnings per share | 332.7 | 350.1 | 375.2 | ||||||||
| Effect of dilutive securities | |||||||||||
| Share-based compensation | 2.8 | 4.1 | 4.7 | ||||||||
| Shares for diluted earnings per share | 335.5 | 354.2 | 379.9 | ||||||||
| Diluted earnings per share | $ | 3.80 | $ | 5.38 | $ | 3.84 |
NOTE 5. SHARE-BASED COMPENSATION
RSUs and PSUs
We granted RSUs in 2019 to certain officers and key employees, and those units vest generally over four years in equal annual installments commencing one year after the grant date. We also granted performance-based RSUs (“PSUs”) in 2019 to certain executive officers, which are earned, subject to continued employment and the satisfaction of certain performance conditions based on achievement of pre-established targets for gross room openings, active Marriott Bonvoy loyalty member growth, and adjusted operating income growth over, or at the end of, a three-year performance period.
We had deferred compensation costs for RSUs of approximately $176 million at year-end 2019 and $167 million at year-end 2018. The weighted average remaining term for RSUs outstanding at year-end 2019 was two years.
The following table provides additional information on RSUs for the last three fiscal years:
| 2019 | 2018 | 2017 | |||||||||
| Share-based compensation expense (in millions) | $ | 177 | $ | 170 | $ | 172 | |||||
| Weighted average grant-date fair value (per RSU) | $ | 117 | $ | 132 | $ | 85 | |||||
| Aggregate intrinsic value of distributed RSUs (in millions) | $ | 276 | $ | 294 | $ | 322 |
The following table presents the changes in our outstanding RSUs, including PSUs, during 2019 and the associated weighted average grant-date fair values:
| Number of RSUs (in millions) | Weighted Average Grant-Date Fair Value (per RSU) | |||||
| Outstanding at year-end 2018 | 4.8 | $ | 90 | |||
| Granted | 1.7 | 117 | ||||
| Distributed | (2.3 | ) | 79 | |||
| Forfeited | (0.1 | ) | 112 | |||
| Outstanding at year-end 2019 | 4.1 | $ | 106 |
Other Information
At year-end 2019, we had 29 million remaining shares authorized under the Marriott and Starwood Hotels & Resorts Worldwide, LLC, formerly known as Starwood Hotels & Resorts Worldwide, Inc. (“Starwood”) stock plans.
NOTE 6. INCOME TAXES
The components of our earnings before income taxes for the last three fiscal years consisted of:
| ($ in millions) | 2019 | 2018 | 2017 | ||||||||
| U.S. | $ | 549 | $ | 1,311 | $ | 2,153 | |||||
| Non-U.S. | 1,050 | 1,034 | 829 | ||||||||
| $ | 1,599 | $ | 2,345 | $ | 2,982 |
Our provision for income taxes for the last three fiscal years consists of:
| ($ in millions) | 2019 | 2018 | 2017 | |||||||||
| Current | -U.S. Federal | $ | (272 | ) | $ | (169 | ) | $ | (1,253 | ) | ||
| -U.S. State | (57 | ) | (94 | ) | (152 | ) | ||||||
| -Non-U.S. | (161 | ) | (284 | ) | (178 | ) | ||||||
| (490 | ) | (547 | ) | (1,583 | ) | |||||||
| Deferred | -U.S. Federal | 141 | 10 | 61 | ||||||||
| -U.S. State | 39 | (6 | ) | (33 | ) | |||||||
| -Non-U.S. | (16 | ) | 105 | 32 | ||||||||
| 164 | 109 | 60 | ||||||||||
| $ | (326 | ) | $ | (438 | ) | $ | (1,523 | ) |
Unrecognized Tax Benefits
The following table reconciles our unrecognized tax benefit balance for each year from the beginning of 2017 to the end of 2019:
| ($ in millions) | Amount | ||
| Unrecognized tax benefit at beginning of 2017 | $ | 421 | |
| Change attributable to tax positions taken in prior years | 12 | ||
| Change attributable to tax positions taken during the current period | 87 | ||
| Decrease attributable to settlements with taxing authorities | (28 | ) | |
| Decrease attributable to lapse of statute of limitations | (1 | ) | |
| Unrecognized tax benefit at year-end 2017 | 491 | ||
| Change attributable to tax positions taken in prior years | 37 | ||
| Change attributable to tax positions taken during the current period | 148 | ||
| Decrease attributable to settlements with taxing authorities | (53 | ) | |
| Unrecognized tax benefit at year-end 2018 | 623 | ||
| Change attributable to tax positions taken in prior years | (13 | ) | |
| Change attributable to tax positions taken during the current period | 13 | ||
| Decrease attributable to settlements with taxing authorities | (54 | ) | |
| Unrecognized tax benefit at year-end 2019 | $ | 569 |
Our unrecognized tax benefit balances included $498 million at year-end 2019, $497 million at year-end 2018, and $385 million at year-end 2017 of tax positions that, if recognized, would impact our effective tax rate. It is reasonably possible that we will settle $207 million of unrecognized tax benefits within the next twelve months. This includes $179 million related to U.S. federal issues that are currently in appeals and $28 million related to state and non-U.S. audits we expect to resolve in 2020. We recognize accrued interest and penalties for our unrecognized tax benefits as a component of tax expense. Related interest totaled $28 million in 2019, $3 million in 2018, and $24 million in 2017.
We file income tax returns, including returns for our subsidiaries, in various jurisdictions around the world. The U.S. Internal Revenue Service (“IRS”) has examined our federal income tax returns, and as of year-end 2019, we have settled all issues for tax years through 2013 for Marriott and through 2009 for Starwood. Our Marriott 2014 and 2015 tax year audits are substantially complete, and our Marriott 2016 through 2018 tax year audits are currently ongoing. Starwood is currently under audit by the IRS for years 2010 through 2016. Various foreign, state, and local income tax returns are also under examination by the applicable taxing authorities.
Deferred Income Taxes
Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases, as well as from net operating loss and tax credit carry-forwards. We state those balances at the enacted tax rates we expect will be in effect when we pay or recover the taxes. Deferred income tax assets represent amounts available to reduce income taxes we will pay on taxable income in future years. We evaluate our ability to realize these future tax deductions and credits by assessing whether we expect to have sufficient future taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings, and available tax planning strategies to utilize these future deductions and credits. We establish a valuation allowance when we no longer consider it more likely than not that a deferred tax asset will be realized.
The following table presents the tax effect of each type of temporary difference and carry-forward that gave rise to significant portions of our deferred tax assets and liabilities as of year-end 2019 and year-end 2018:
| ($ in millions) | At Year-End 2019 | At Year-End 2018 | |||||
| Deferred Tax Assets | |||||||
| Employee benefits | $ | 267 | $ | 261 | |||
| Net operating loss carry-forwards | 680 | 494 | |||||
| Accrued expenses and other reserves | 162 | 160 | |||||
| Receivables, net | 11 | 12 | |||||
| Tax credits | 41 | 24 | |||||
| Loyalty Program | 249 | 133 | |||||
| Deferred income | 70 | 56 | |||||
| Lease liabilities | 261 | — | |||||
| Other | 15 | 13 | |||||
| Deferred tax assets | 1,756 | 1,153 | |||||
| Valuation allowance | (616 | ) | (428 | ) | |||
| Deferred tax assets after valuation allowance | 1,140 | 725 | |||||
| Deferred Tax Liabilities | |||||||
| Joint venture interests | (55 | ) | (59 | ) | |||
| Property and equipment | (82 | ) | (85 | ) | |||
| Intangibles | (895 | ) | (876 | ) | |||
| Right-of-use assets | (229 | ) | — | ||||
| Self-insurance | (15 | ) | (19 | ) | |||
| Deferred tax liabilities | (1,276 | ) | (1,039 | ) | |||
| Net deferred taxes | $ | (136 | ) | $ | (314 | ) |
Our valuation allowance is attributable to non-U.S. and U.S. state net operating loss carry forwards. During 2019, our valuation allowance increased primarily due to net operating losses in Luxembourg.
At year-end 2019, we had approximately $24 million of tax credits that will expire through 2029 and $16 million of tax credits that do not expire. We recorded $10 million of net operating loss benefits in 2019 and $10 million in 2018. At year-end 2019, we had approximately $3,319 million of primarily state and foreign net operating losses, of which $1,951 million will expire through 2039.
Reconciliation of U.S. Federal Statutory Income Tax Rate to Actual Income Tax Rate
The following table reconciles the U.S. statutory tax rate to our effective income tax rate for the last three fiscal years:
| 2019 | 2018 | 2017 | ||||||
| U.S. statutory tax rate | 21.0 | % | 21.0 | % | 35.0 | % | ||
| U.S. state income taxes, net of U.S. federal tax benefit | 1.6 | 2.5 | 3.1 | |||||
| Non-U.S. income | (3.3 | ) | (1.0 | ) | (7.3 | ) | ||
| Change in valuation allowance | 3.4 | 2.6 | 2.0 | |||||
| Change in uncertain tax positions | 1.9 | 1.0 | 2.2 | |||||
| Change in U.S. tax rate | 0.0 | (1.7 | ) | (5.5 | ) | |||
| Transition Tax on foreign earnings | (0.3 | ) | 0.1 | 22.8 | ||||
| Tax on asset dispositions | (0.7 | ) | (2.9 | ) | (0.2 | ) | ||
| Excess tax benefits related to equity awards | (3.2 | ) | (1.8 | ) | (2.4 | ) | ||
| Other, net | 0.0 | (1.1 | ) | 1.4 | ||||
| Effective rate | 20.4 | % | 18.7 | % | 51.1 | % |
The non-U.S. income tax benefit presented in the table above includes tax-exempt income in Hong Kong, a tax rate incentive in Singapore, a deemed interest deduction in Switzerland, and tax-exempt income earned from certain operations in Luxembourg, which collectively represented 8.0% in 2019, 3.4% in 2018, and 6.2% in 2017. We included the impact of these
items in the foreign tax rate differential line above because we consider them to be equivalent to a reduction of the statutory tax rates in these jurisdictions. Pre-tax income in Switzerland, Singapore, Hong Kong, and Luxembourg totaled $642 million in 2019, $432 million in 2018, and $576 million in 2017.
The non-U.S. income tax benefit also includes U.S. income tax expense on non-U.S. operations, which represents 2.0% in 2019 and 1.4% in 2018. We included the impact of this tax in the non-U.S. income line above because we consider this tax to be an integral part of the foreign taxes.
Other Information
We paid cash for income taxes, net of refunds of $526 million in 2019, $678 million in 2018, and $636 million in 2017.
Tax Cuts and Jobs Act of 2017
The U.S. Tax Cuts and Jobs Act of 2017 (the “2017 Tax Act”) was enacted on December 22, 2017. In 2017, we recorded a provisional estimated tax benefit of $153 million related to the change in the U.S. tax rate, and a provisional estimated Deemed Repatriation Transition Tax (“Transition Tax”) expense of $745 million. In 2018, we completed our analyses of all impacts of the 2017 Tax Act and recognized an additional tax benefit of $41 million. Substantially all of our unremitted foreign earnings that had not been previously taxed have now been subjected to U.S. taxation under the Transition Tax. In 2018, we recorded a charge of $29 million for state tax liability on unremitted accumulated earnings and continue to update the state tax liability on unremitted accumulated earnings. It is not practical at this time to determine the income tax liability related to any remaining undistributed earnings or additional basis differences not subject to the Transition Tax. We account for U.S. tax on Global Intangible Low-Taxed Income in the period incurred.
NOTE 7. COMMITMENTS AND CONTINGENCIES
Guarantees
We issue guarantees to certain lenders and hotel owners, chiefly to obtain long-term management and franchise contracts. The guarantees generally have a stated maximum funding amount and a term of three to ten years. The terms of guarantees to lenders generally require us to fund if cash flows from hotel operations are inadequate to cover annual debt service or to repay the loan at maturity. The terms of the guarantees to hotel owners generally require us to fund if the hotels do not attain specified levels of operating profit. Guarantee fundings to lenders and hotel owners are generally recoverable out of future hotel cash flows and/or proceeds from the sale or refinancing of hotels. We also enter into project completion guarantees with certain lenders in conjunction with hotels that we or our joint venture partners are building.
We present the maximum potential amount of our future guarantee fundings and the carrying amount of our liability for our debt service, operating profit, and other guarantees (excluding contingent purchase obligations) for which we are the primary obligor at year-end 2019 in the following table:
| ($ in millions) Guarantee Type | Maximum Potential Amount of Future Fundings | Recorded Liability for Guarantees | |||||
| Debt service | $ | 53 | $ | 6 | |||
| Operating profit | 231 | 142 | |||||
| Other | 15 | 3 | |||||
| $ | 299 | $ | 151 |
Our liability at year-end 2019 for guarantees for which we are the primary obligor is reflected in our Balance Sheets as $16 million of “Accrued expenses and other” and $135 million of “Other noncurrent liabilities.”
Our guarantees listed in the preceding table include $3 million of debt service guarantees, $114 million of operating profit guarantees, and $5 million of other guarantees that will not be in effect until the underlying properties open and we begin to operate the properties or certain other events occur.
In conjunction with financing obtained for specific projects or properties owned by us or joint ventures in which we are a party, we may provide industry standard indemnifications to the lender for loss, liability, or damage occurring as a result of the actions of the other joint venture owner or our own actions.
Contingent Purchase Obligation
Sheraton Grand Chicago. We granted the owner a one-time right, exercisable in 2022, to require us to purchase the leasehold interest in the land and the hotel for $300 million in cash (the “put option”). If the owner exercises the put option, we have the option to purchase, at the same time the put transaction closes, the fee simple interest in the underlying land for an additional $200 million in cash. We account for the put option as a guarantee, and our recorded liability at year-end 2019 was $57 million.
We concluded that the entity that owns the Sheraton Grand Chicago hotel is a variable interest entity. We did not consolidate the entity because we do not have the power to direct the activities that most significantly impact the entity’s economic performance. Our maximum exposure to loss related to the entity is equal to the difference between the purchase price and the fair value of the hotel at the time that the put option is exercised, plus the maximum funding amount of an operating profit guarantee that we provided for the hotel.
Commitments
At year-end 2019, we had various purchase commitments for goods and services in the normal course of business, primarily for programs and services for which we are reimbursed by third-party owners, totaling $276 million. We expect to purchase goods and services subject to these commitments as follows: $116 million in 2020, $97 million in 2021, and $63 million in 2022.
Letters of Credit
At year-end 2019, we had $145 million of letters of credit outstanding (all outside the Credit Facility, as defined in Note 9), most of which were for our self-insurance programs. Surety bonds issued as of year-end 2019 totaled $160 million, most of which state governments requested in connection with our self-insurance programs.
Data Security Incident
Description of Event
On November 30, 2018, we announced a data security incident involving unauthorized access to the Starwood reservations database (the “Data Security Incident”). Working with leading security experts, we determined that there was unauthorized access to the Starwood network since 2014 and that an unauthorized party had copied information from the Starwood reservations database and taken steps towards removing it. The Starwood reservations database is no longer used for business operations.
Expenses and Insurance Recoveries
We recorded $148 million of expenses, partially offset by $84 million of accrued insurance recoveries related to the Data Security Incident in 2019, and $28 million of expenses, partially offset by $25 million of accrued insurance recoveries, related to the Data Security Incident in 2018. We received insurance recoveries of $58 million in 2019. Expenses in 2019 primarily included the accrual for the loss contingency related to the Proposed ICO Fine discussed below, along with customer care and legal costs, and expenses in 2018 primarily included costs to investigate the Data Security Incident and customer care costs. We recognize insurance recoveries when they are probable of receipt and present them in our Income Statements in the same caption as the related expense, up to the amount of total expense incurred in prior and current periods. We present expenses and insurance recoveries related to the Data Security Incident in either the “Reimbursed expenses” or “Merger-related costs and charges” captions of our Income Statements.
Litigation, Claims, and Government Investigations
Following our announcement of the Data Security Incident, approximately 100 lawsuits were filed by consumers and others against us in U.S. federal, U.S. state and Canadian courts related to the incident. All but one of the U.S. cases have been consolidated and transferred to the U.S. District Court for the District of Maryland, pursuant to orders of the U.S. Judicial Panel on Multidistrict Litigation (the “MDL”). The plaintiffs in the U.S. and Canadian cases, who generally purport to represent various classes of consumers, generally claim to have been harmed by alleged actions and/or omissions by the Company in connection with the Data Security Incident and assert a variety of common law and statutory claims seeking monetary damages, injunctive relief, costs and attorneys’ fees, and other related relief. Among the U.S. cases consolidated in the MDL proceeding is a putative class action lawsuit that was filed against us and certain of our current officers and directors on December 1, 2018, alleging violations of the federal securities laws in connection with statements regarding our cybersecurity systems and controls, and seeking certification of a class of affected persons, unspecified monetary damages, costs and attorneys’ fees, and other related relief. The MDL proceeding also includes two shareholder derivative complaints that were filed on February 26,
2019 and March 15, 2019, respectively, against the Company, certain of its officers and certain of the members of our Board of Directors, alleging, among other claims, breach of fiduciary duty, corporate waste, unjust enrichment, mismanagement and violations of the federal securities laws, and seeking unspecified monetary damages and restitution, changes to the Company’s corporate governance and internal procedures, costs and attorneys’ fees, and other related relief. A third shareholder derivative complaint was filed in the Delaware Court of Chancery on December 3, 2019 against the Company and certain of its officers and certain current and former members of our Board of Directors, alleging claims and seeking relief generally similar to the claims made and relief sought in the other two derivative cases. This case will not be consolidated with the MDL proceeding. We dispute the allegations in the lawsuits described above and are vigorously defending against such claims. We have filed motions to dismiss several of these cases, some of which have been denied, but the cases generally remain at an early stage. There has been some consolidation of the Canadian cases, with five cases now pending across five provinces, and we expect there could be further consolidation in the future. In addition, in April 2019, we received a letter purportedly on behalf of a shareholder of the Company (also one of the named plaintiffs in the putative securities class action described above) demanding that our Board of Directors take action against the Company’s current and certain former officers and directors to recover damages for alleged breaches of fiduciary duties and related claims arising from the Data Security Incident. The Board of Directors has constituted a demand review committee to investigate the claims made in the demand letter, and the committee has retained independent counsel to assist with the investigation. The committee’s investigation is ongoing.
In addition, numerous U.S. federal, U.S. state and foreign governmental authorities are investigating, or otherwise seeking information and/or documents related to, the Data Security Incident and related matters, including Attorneys General offices from all 50 states and the District of Columbia, the Federal Trade Commission, the Securities and Exchange Commission, certain committees of the U.S. Senate and House of Representatives, the Information Commissioner’s Office in the United Kingdom (the “ICO”) as lead supervisory authority in the European Economic Area, and regulatory authorities in various other jurisdictions. In July 2019, the ICO issued a formal notice of intent under the U.K. Data Protection Act 2018 proposing a fine in the amount of £99 million against the Company in relation to the Data Security Incident (the “Proposed ICO Fine”). In late August 2019, we submitted a written response to the ICO vigorously defending our position, and we have continued to engage with the ICO regarding the Data Security Incident and Proposed ICO Fine. We mutually agreed with the ICO to an extension of the regulatory process until June 1, 2020 and the ICO proceeding is ongoing. In the 2019 second quarter, we recorded an accrual in the full amount of the Proposed ICO Fine for this loss contingency, and in the 2019 fourth quarter, we reduced the accrual to $65 million based on the ongoing proceeding. We present the accrual in the “Accrued expenses and other” caption of our Balance Sheets and the related expense in the “Merger-related costs and charges” caption of our Income Statements.
While we believe it is reasonably possible that we may incur additional losses associated with the above described proceedings and investigations, it is not possible to estimate the amount of loss or range of loss, if any, in excess of the amounts already incurred that might result from adverse judgments, settlements, fines, penalties or other resolution of these proceedings and investigations based on the current stage of these proceedings and investigations, the absence of specific allegations as to alleged damages, the uncertainty as to the certification of a class or classes and the size of any certified class, if applicable, and/or the lack of resolution of significant factual and legal issues.
NOTE 8. LEASES
We enter into operating and finance leases primarily for hotels, offices, and equipment. Most leases have initial terms of up to 20 years, and contain one or more renewals at our option, generally for five- or 10-year periods. We have generally not included these renewal periods in the lease term as it is not reasonably certain that we will exercise the renewal option.
The following table details the composition of lease expense at year-end 2019:
| ($ in millions) | 2019 | |||
| Operating lease cost | $ | 185 | ||
| Variable lease cost | 113 |
In the 2019 fourth quarter, we recorded impairment charges of $78 million and $21 million in the “Depreciation, amortization, and other” caption of our Income Statements to reduce the carrying amount of the Renaissance New York Times Square Hotel lease right-of-use asset and property and equipment, including leasehold improvements, respectively. We determined that we may not be able to fully recover the carrying amount of this North American Full-Service hotel lease after evaluating the assets for recovery due to declines in market performance and future cash flow projections. We estimated the fair value using an income approach reflecting internally developed Level 3 discounted cash flows that included, among other things, our expectations of future cash flows based on historical experience and projected growth rates, usage estimates and demand trends. Additionally, during the year ended 2019, we recorded an expense of $34 million in the “Merger-related costs
and charges” caption of our Income Statements due to the impairment of a legacy-Starwood office building accounted for as a finance lease.
The following table presents our future minimum lease payments at year-end 2019:
| ($ in millions) | Operating Leases | Finance Leases | |||||
| 2020 | $ | 173 | $ | 13 | |||
| 2021 | 171 | 13 | |||||
| 2022 | 165 | 13 | |||||
| 2023 | 115 | 13 | |||||
| 2024 | 107 | 14 | |||||
| Thereafter | 579 | 151 | |||||
| Total minimum lease payments | $ | 1,310 | $ | 217 | |||
| Less: Amount representing interest | 298 | 60 | |||||
| Present value of minimum lease payments | $ | 1,012 | $ | 157 | |||
| Current (1) | 130 | 6 | |||||
| Noncurrent (2) | 882 | 151 | |||||
| $ | 1,012 | $ | 157 |
| (1) | Operating leases are recorded in the “Accrued expenses and other” and finance leases are recorded in the “Current portion of long-term debt” captions of our Balance Sheets. |
| (2) | Operating leases are recorded in the “Operating lease liabilities” and finance leases are recorded in the “Long-term debt” captions of our Balance Sheets. |
At year-end 2019, we had entered into an agreement that we expect to account for as an operating lease with a 20-year term for our new headquarters office, which is not reflected in our Balance Sheets or in the table above as the lease has not commenced.
The following table presents additional information about our lease obligations at year-end 2019:
| Operating leases | Finance leases | |||||
| Weighted Average Remaining Lease Term (in years) | 11 | 14 | ||||
| Weighted Average Discount Rate | 4.8 | % | 4.4 | % |
The following table presents supplemental cash flow information for 2019:
| ($ in millions) | 2019 | ||
| Cash paid for amounts included in the measurement of lease liabilities: | |||
| Operating cash outflows for operating leases | $ | 176 | |
| Operating cash outflows for finance leases | 7 | ||
| Financing cash outflows for finance leases | 6 | ||
| Lease assets obtained in exchange for lease obligations: | |||
| Operating leases | 89 |
NOTE 9. LONG-TERM DEBT
We provide detail on our long-term debt balances, net of discounts, premiums, and debt issuance costs, in the following table at year-end 2019 and 2018:
| ($ in millions) | At Year-End 2019 | At Year-End 2018 | |||||
| Senior Notes: | |||||||
| Series K Notes, interest rate of 3.0%, face amount of $600, matured March 1, 2019 (effective interest rate of 4.4%) | $ | — | $ | 600 | |||
| Series L Notes, interest rate of 3.3%, face amount of $350, maturing September 15, 2022 (effective interest rate of 3.4%) | 349 | 349 | |||||
| Series M Notes, interest rate of 3.4%, face amount of $350, maturing October 15, 2020 (effective interest rate of 3.6%) | 349 | 349 | |||||
| Series N Notes, interest rate of 3.1%, face amount of $400, maturing October 15, 2021 (effective interest rate of 3.4%) | 398 | 397 | |||||
| Series O Notes, interest rate of 2.9%, face amount of $450, maturing March 1, 2021 (effective interest rate of 3.1%) | 449 | 448 | |||||
| Series P Notes, interest rate of 3.8%, face amount of $350, maturing October 1, 2025 (effective interest rate of 4.0%) | 346 | 345 | |||||
| Series Q Notes, interest rate of 2.3%, face amount of $750, maturing January 15, 2022 (effective interest rate of 2.5%) | 747 | 745 | |||||
| Series R Notes, interest rate of 3.1%, face amount of $750, maturing June 15, 2026 (effective interest rate of 3.3%) | 744 | 743 | |||||
| Series T Notes, interest rate of 7.2%, face amount of $181, matured December 1, 2019 (effective interest rate of 2.3%) | — | 188 | |||||
| Series U Notes, interest rate of 3.1%, face amount of $291, maturing February 15, 2023 (effective interest rate of 3.1%) | 291 | 291 | |||||
| Series V Notes, interest rate of 3.8%, face amount of $318, maturing March 15, 2025 (effective interest rate of 2.8%) | 332 | 335 | |||||
| Series W Notes, interest rate of 4.5%, face amount of $278, maturing October 1, 2034 (effective interest rate of 4.1%) | 291 | 292 | |||||
| Series X Notes, interest rate of 4.0%, face amount of $450, maturing April 15, 2028 (effective interest rate of 4.2%) | 444 | 443 | |||||
| Series Y Notes, floating rate, face amount of $550, maturing December 1, 2020 (effective interest rate of 2.5% at December 31, 2019) | 549 | 547 | |||||
| Series Z Notes, interest rate of 4.2%, face amount of $350, maturing December 1, 2023 (effective interest rate of 4.4%) | 347 | 347 | |||||
| Series AA Notes, interest rate of 4.7%, face amount of $300, maturing December 1, 2028 (effective interest rate of 4.8%) | 297 | 297 | |||||
| Series BB Notes, floating rate, face amount of $300, maturing March 8, 2021 (effective interest rate of 2.5% at December 31, 2019) | 299 | — | |||||
| Series CC Notes, interest rate of 3.6%, face amount of $550, maturing April 15, 2024 (effective interest rate of 3.9%) | 564 | — | |||||
| Series DD Notes, interest rate of 2.1%, face amount of $550, maturing October 3, 2022 (effective interest rate of 2.4%) | 543 | — | |||||
| Commercial paper | 3,197 | 2,245 | |||||
| Credit Facility | — | — | |||||
| Finance lease obligations | 157 | 163 | |||||
| Other | 247 | 223 | |||||
| $ | 10,940 | $ | 9,347 | ||||
| Less: Current portion of long-term debt | (977 | ) | (833 | ) | |||
| $ | 9,963 | $ | 8,514 |
All our long-term debt is recourse to us but unsecured, other than debt assumed in our acquisition of Elegant which we paid off in January 2020. All the Senior Notes shown in the table above are our unsecured and unsubordinated obligations, which rank equally with our other Senior Notes and all other unsecured and unsubordinated indebtedness that we have issued or will issue from time to time, and are governed by the terms of an indenture, dated as of November 16, 1998, between us and The Bank of New York Mellon (formerly The Bank of New York), as trustee. With the exception of the floating rate Series Y
Notes and Series BB Notes, we may redeem some or all of each series of the Senior Notes before maturity under the terms provided in the applicable form of Senior Note.
In the 2019 fourth quarter, we issued $550 million aggregate principal amount of 2.125 percent Series DD Notes due October 3, 2022 (the “Series DD Notes”). We will pay interest on the Series DD Notes in April and October of each year, commencing in April 2020. In connection with the offering, we entered into interest rate swap agreements, which have the economic effect of converting the Series DD Notes into floating rate debt with a variable interest rate of one-month LIBOR (the London Interbank Offered Rate) plus 0.754 percent. We received net proceeds of approximately $545 million from the offering of the Series DD Notes, after deducting the underwriting discount and estimated expenses, which were made available for general corporate purposes, which may include working capital, capital expenditures, acquisitions, stock repurchases, or repayment of outstanding commercial paper or other borrowings.
In the 2019 second quarter, we amended and restated our multicurrency revolving credit agreement (the “Credit Facility”) to extend the maturity date of the Credit Facility and increase the aggregate amount of available borrowings to up to $4.5 billion. The available borrowings support our commercial paper program and general corporate needs. Borrowings under the Credit Facility generally bear interest at LIBOR plus a spread, based on our public debt rating. We also pay quarterly fees on the Credit Facility at a rate based on our public debt rating. While any outstanding commercial paper borrowings and/or borrowings under our Credit Facility generally have short-term maturities, we classify the outstanding borrowings as long-term based on our ability and intent to refinance the outstanding borrowings on a long-term basis. The Credit Facility expires on June 28, 2024.
In the 2019 first quarter, we issued $300 million aggregate principal amount of LIBOR plus 0.650 percent Series BB Notes due March 8, 2021 (the “Series BB Notes”) and $550 million aggregate principal amount of 3.600 percent Series CC Notes due April 15, 2024 (the “Series CC Notes”). We pay interest on the Series BB Notes in March, June, September, and December of each year, which commenced in June 2019, and we pay interest on the Series CC Notes in April and October of each year, which commenced in October 2019. In connection with the offering, we entered into interest rate swap agreements, which have the economic effect of converting the Series CC Notes into floating rate debt with a variable interest rate of one-month LIBOR plus 1.1205 percent. We received net proceeds of approximately $841 million from the offering of the Series BB Notes and Series CC Notes, after deducting the underwriting discount and estimated expenses, which were made available for general corporate purposes, which may include working capital, capital expenditures, acquisitions, stock repurchases, or repayment of outstanding commercial paper or other borrowings.
The following table presents future principal payments, net of discounts, premiums, and debt issuance costs, for our debt at year-end 2019:
| Debt Principal Payments ($ in millions) | Amount | ||
| 2020 | $ | 977 | |
| 2021 | 1,164 | ||
| 2022 | 1,657 | ||
| 2023 | 694 | ||
| 2024 | 3,783 | ||
| Thereafter | 2,665 | ||
| Balance at year-end 2019 | $ | 10,940 |
We paid cash for interest, net of amounts capitalized, of $348 million in 2019, $290 million in 2018, and $234 million in 2017.
NOTE 10. INTANGIBLE ASSETS AND GOODWILL
The following table details the composition of our intangible assets at year-end 2019 and 2018:
| ($ in millions) | At Year-End 2019 | At Year-End 2018 | |||||
| Definite-lived Intangible Assets | |||||||
| Costs incurred to obtain contracts with customers | $ | 1,588 | $ | 1,347 | |||
| Contracts acquired in business combinations and other | 1,972 | 1,983 | |||||
| 3,560 | 3,330 | ||||||
| Accumulated amortization | (808 | ) | (674 | ) | |||
| 2,752 | 2,656 | ||||||
| Indefinite-lived Intangible Brand Assets | 5,889 | 5,724 | |||||
| $ | 8,641 | $ | 8,380 |
We capitalize direct costs that we incur to obtain management, franchise, and license agreements. We amortize these costs on a straight-line basis over the initial term of the agreements, ranging from 15 to 30 years.
For acquired definite-lived intangible assets, we recorded amortization expense of $105 million in 2019, $111 million in 2018, and $116 million in 2017 in the “Depreciation, amortization, and other” caption of our Income Statements. For these assets, we estimate that our aggregate amortization expense will be $102 million for each of the next five fiscal years.
The following table details the carrying amount of our goodwill at year-end 2019 and 2018:
| ($ in millions) | North American Full-Service | North American Limited-Service | Asia Pacific | Other International | Total Goodwill | ||||||||||||||
| Balance at year-end 2018 | $ | 3,566 | $ | 1,755 | $ | 1,862 | $ | 1,856 | $ | 9,039 | |||||||||
| Foreign currency translation | 10 | 7 | 2 | (10 | ) | 9 | |||||||||||||
| Balance at year-end 2019 | $ | 3,576 | $ | 1,762 | $ | 1,864 | $ | 1,846 | $ | 9,048 |
NOTE 11. PROPERTY AND EQUIPMENT
The following table presents the composition of our property and equipment balances at year-end 2019 and 2018:
| ($ in millions) | At Year-End 2019 | At Year-End 2018 | |||||
| Land | $ | 684 | $ | 591 | |||
| Buildings and leasehold improvements | 1,100 | 1,275 | |||||
| Furniture and equipment | 1,225 | 1,439 | |||||
| Construction in progress | 196 | 168 | |||||
| 3,205 | 3,473 | ||||||
| Accumulated depreciation | (1,301 | ) | (1,517 | ) | |||
| $ | 1,904 | $ | 1,956 |
We record property and equipment at cost, including interest and real estate taxes we incur during development and construction. We capitalize the cost of improvements that extend the useful life of property and equipment when we incur them. These capitalized costs may include structural costs, equipment, fixtures, floor, and wall coverings. We expense all repair and maintenance costs when we incur them. We compute depreciation using the straight-line method over the estimated useful lives of the assets (generally three to 40 years), and we amortize leasehold improvements over the shorter of the asset life or lease term. Our gross depreciation expense totaled $346 million in 2019, $256 million in 2018, and $231 million in 2017 (of which $121 million in 2019, $147 million in 2018, and $126 million in 2017 was included in the “Reimbursed expenses” caption of our Income Statements). Fixed assets attributed to operations located outside the U.S. were $695 million in 2019 and $533 million in 2018.
In the 2019 fourth quarter, we recorded impairment charges to reduce the carrying amount of the Renaissance New York Times Square Hotel property and equipment, including leasehold improvements, and right-of-use asset as discussed in Note 8.
NOTE 12. NOTES RECEIVABLE
The following table presents the expected future principal payments, net of reserves and unamortized discounts, as well as interest rates for our notes receivable at year-end 2019:
| Notes Receivable Principal Payments ($ in millions) | Amount | ||
| 2020 | $ | 9 | |
| 2021 | 32 | ||
| 2022 | 28 | ||
| 2023 | 2 | ||
| 2024 | 8 | ||
| Thereafter | 47 | ||
| Balance at year-end 2019 | $ | 126 | |
| Weighted average interest rate at year-end 2019 | 5.6% | ||
| Range of stated interest rates at year-end 2019 | 0-9% |
At year-end 2019, our recorded investment in impaired senior, mezzanine, and other loans was $20 million, and we had a $12 million allowance for credit losses, leaving $8 million of exposure to our investment in impaired loans. At year-end 2018, our recorded investment in impaired senior, mezzanine, and other loans was $45 million, and we had a $25 million allowance for credit losses, leaving $20 million of exposure to our investment in impaired loans. Our average investment in impaired senior, mezzanine, and other loans totaled $33 million during 2019, $70 million during 2018, and $84 million during 2017.
NOTE 13. FAIR VALUE OF FINANCIAL INSTRUMENTS
We believe that the fair values of our current assets and current liabilities approximate their reported carrying amounts. We present the carrying values and the fair values of noncurrent financial assets and liabilities that qualify as financial instruments, determined under current guidance for disclosures on the fair value of financial instruments, in the following table:
| At Year-End 2019 | At Year-End 2018 | ||||||||||||||
| ($ in millions) | Carrying Amount | Fair Value | Carrying Amount | Fair Value | |||||||||||
| Senior, mezzanine, and other loans | $ | 117 | $ | 112 | $ | 125 | $ | 116 | |||||||
| Total noncurrent financial assets | $ | 117 | $ | 112 | $ | 125 | $ | 116 | |||||||
| Senior Notes | $ | (6,441 | ) | $ | (6,712 | ) | $ | (5,928 | ) | $ | (5,794 | ) | |||
| Commercial paper | (3,197 | ) | (3,197 | ) | (2,245 | ) | (2,245 | ) | |||||||
| Other long-term debt | (174 | ) | (179 | ) | (184 | ) | (182 | ) | |||||||
| Other noncurrent liabilities | (196 | ) | (196 | ) | (153 | ) | (153 | ) | |||||||
| Total noncurrent financial liabilities | $ | (10,008 | ) | $ | (10,284 | ) | $ | (8,510 | ) | $ | (8,374 | ) |
We estimate the fair value of our senior, mezzanine, and other loans by discounting cash flows using risk-adjusted rates, both of which are Level 3 inputs.
We estimate the fair value of our other long-term debt, excluding leases, using expected future payments discounted at risk-adjusted rates, which are Level 3 inputs. We determine the fair value of our Senior Notes using quoted market prices, which are directly observable Level 1 inputs. As discussed in Note 9, even though our commercial paper borrowings generally have short-term maturities of 30 days or less, we classify outstanding commercial paper borrowings as long-term based on our ability and intent to refinance them on a long-term basis. As we are a frequent issuer of commercial paper, we use pricing from recent transactions as Level 2 inputs in estimating fair value. At year-end 2019 and year-end 2018, we determined that the carrying value of our commercial paper approximated fair value due to the short maturity. Our other noncurrent liabilities largely consist of guarantees. As we note in the “Guarantees” caption of Note 2, we measure our liability for guarantees at fair value on a nonrecurring basis, which is when we issue or modify a guarantee using Level 3 internally developed inputs. At year-end 2019 and year-end 2018, we determined that the carrying values of our guarantee liabilities approximated their fair values based on Level 3 inputs.
See the “Fair Value Measurements” caption of Note 2 for more information on the input levels we use in determining fair value.
NOTE 14. ACCUMULATED OTHER COMPREHENSIVE LOSS
The following table details the accumulated other comprehensive loss activity for 2019, 2018, and 2017:
| ($ in millions) | Foreign Currency Translation Adjustments | Derivative Instrument and Other Adjustments | Accumulated Other Comprehensive Loss | ||||||||
| Balance at year-end 2016 | $ | (503 | ) | $ | 6 | $ | (497 | ) | |||
| Other comprehensive (loss) income before reclassifications (1) | 478 | (9 | ) | 469 | |||||||
| Reclassification of losses (gains), net of tax | 2 | 9 | 11 | ||||||||
| Net other comprehensive (loss) income | 480 | — | 480 | ||||||||
| Balance at year-end 2017 | $ | (23 | ) | $ | 6 | $ | (17 | ) | |||
| Other comprehensive (loss) income before reclassifications (1) | (391 | ) | 4 | (387 | ) | ||||||
| Reclassification of losses (gains), net of tax | 11 | 6 | 17 | ||||||||
| Net other comprehensive (loss) income | (380 | ) | 10 | (370 | ) | ||||||
| Adoption of ASU 2016-01 | — | (4 | ) | (4 | ) | ||||||
| Balance at year-end 2018 | $ | (403 | ) | $ | 12 | $ | (391 | ) | |||
| Other comprehensive (loss) income before reclassifications (1) | 35 | 2 | 37 | ||||||||
| Reclassification of losses (gains), net of tax | — | (7 | ) | (7 | ) | ||||||
| Net other comprehensive (loss) income | 35 | (5 | ) | 30 | |||||||
| Balance at year-end 2019 | $ | (368 | ) | $ | 7 | $ | (361 | ) |
| (1) | Other comprehensive (loss) income before reclassifications for foreign currency translation adjustments includes gains (losses) on intra-entity foreign currency transactions that are of a long-term investment nature of $6 million for 2019, $14 million for 2018, and $(147) million for 2017. |
NOTE 15. BUSINESS SEGMENTS
We are a diversified global lodging company with operations in the following reportable business segments:
| • | North American Full-Service, which includes our Luxury and Premium properties located in the U.S. and Canada; |
| • | North American Limited-Service, which includes our Select properties located in the U.S. and Canada; and |
| • | Asia Pacific, which includes all properties in our Asia Pacific region. |
The following operating segments do not meet the applicable accounting criteria for separate disclosure as reportable business segments: Caribbean and Latin America, Europe, and Middle East and Africa. We present these operating segments together as “Other International” in the tables below.
We evaluate the performance of our operating segments using “segment profits” which is based largely on the results of the segment without allocating corporate expenses, income taxes, indirect general, administrative, and other expenses, or merger-related costs and charges. We assign gains and losses, equity in earnings or losses from our joint ventures, and direct general, administrative, and other expenses to each of our segments. “Unallocated corporate” represents a portion of our revenues, including license fees we receive from our credit card programs and fees from vacation ownership licensing agreements, revenues and expenses for our Loyalty Program, general, administrative, and other expenses, merger-related costs and charges, equity in earnings or losses, and other gains or losses that we do not allocate to our segments.
Our President and Chief Executive Officer, who is our “chief operating decision maker”, monitors assets for the consolidated company, but does not use assets by operating segment when assessing performance or making operating segment resource allocations.
In January 2020, we modified our reportable segment structure as a result of a change in the way management intends to evaluate results and allocate resources within the Company. Beginning with the first quarter of 2020, we will present the following three reportable business segments:
-
North America, which includes all properties in our North America region;
-
Asia Pacific, which includes all properties in our Asia Pacific region; and
-
Europe, Middle East, and Africa, which includes all properties in these regions.
Our Caribbean and Latin America segment will be combined with the “Unallocated corporate” caption.
Segment Revenues
The following tables present our revenues disaggregated by segment and major revenue stream for the last three fiscal years:
| 2019 | |||||||||||||||||||
| ($ in millions) | North American Full-Service | North American Limited-Service | Asia Pacific | Other International | Total | ||||||||||||||
| Gross fee revenues | $ | 1,299 | $ | 966 | $ | 477 | $ | 555 | $ | 3,297 | |||||||||
| Contract investment amortization | (35 | ) | (13 | ) | (2 | ) | (12 | ) | (62 | ) | |||||||||
| Net fee revenues | 1,264 | 953 | 475 | 543 | 3,235 | ||||||||||||||
| Owned, leased, and other revenue | 581 | 134 | 178 | 663 | 1,556 | ||||||||||||||
| Cost reimbursement revenue | 11,610 | 2,291 | 536 | 1,149 | 15,586 | ||||||||||||||
| Total segment revenue | $ | 13,455 | $ | 3,378 | $ | 1,189 | $ | 2,355 | $ | 20,377 | |||||||||
| Unallocated corporate | 595 | ||||||||||||||||||
| Total revenue | $ | 20,972 |
| 2018 | |||||||||||||||||||
| ($ in millions) | North American Full-Service | North American Limited-Service | Asia Pacific | Other International | Total | ||||||||||||||
| Gross fee revenues | $ | 1,255 | $ | 903 | $ | 479 | $ | 518 | $ | 3,155 | |||||||||
| Contract investment amortization | (33 | ) | (12 | ) | (2 | ) | (11 | ) | (58 | ) | |||||||||
| Net fee revenues | 1,222 | 891 | 477 | 507 | 3,097 | ||||||||||||||
| Owned, leased, and other revenue | 593 | 128 | 182 | 668 | 1,571 | ||||||||||||||
| Cost reimbursement revenue | 11,257 | 2,198 | 459 | 1,091 | 15,005 | ||||||||||||||
| Total segment revenue | $ | 13,072 | $ | 3,217 | $ | 1,118 | $ | 2,266 | $ | 19,673 | |||||||||
| Unallocated corporate | 1,085 | ||||||||||||||||||
| Total revenue | $ | 20,758 |
| 2017 | |||||||||||||||||||
| ($ in millions) | North American Full-Service | North American Limited-Service | Asia Pacific | Other International | Total | ||||||||||||||
| Gross fee revenues | $ | 1,202 | $ | 842 | $ | 431 | $ | 476 | $ | 2,951 | |||||||||
| Contract investment amortization | (25 | ) | (11 | ) | (1 | ) | (13 | ) | (50 | ) | |||||||||
| Net fee revenues | 1,177 | 831 | 430 | 463 | 2,901 | ||||||||||||||
| Owned, leased, and other revenue | 697 | 132 | 191 | 685 | 1,705 | ||||||||||||||
| Cost reimbursement revenue | 11,035 | 2,256 | 433 | 1,140 | 14,864 | ||||||||||||||
| Total segment revenue | $ | 12,909 | $ | 3,219 | $ | 1,054 | $ | 2,288 | $ | 19,470 | |||||||||
| Unallocated corporate | 982 | ||||||||||||||||||
| Total revenue | $ | 20,452 |
Revenues attributed to operations located outside the U.S. were $4,400 million in 2019, $4,246 million in 2018, and $3,830 million in 2017.
Segment Profits
| ($ in millions) | 2019 | 2018 | 2017 | ||||||||
| North American Full-Service | $ | 1,148 | $ | 1,153 | $ | 1,238 | |||||
| North American Limited-Service | 852 | 786 | 827 | ||||||||
| Asia Pacific | 369 | 456 | 361 | ||||||||
| Other International | 435 | 570 | 420 | ||||||||
| Unallocated corporate | (837 | ) | (302 | ) | 386 | ||||||
| Interest expense, net of interest income | (368 | ) | (318 | ) | (250 | ) | |||||
| Income taxes | (326 | ) | (438 | ) | (1,523 | ) | |||||
| Net income | $ | 1,273 | $ | 1,907 | $ | 1,459 |
Segment profits attributed to operations located outside the U.S. were $982 million in 2019, $1,155 million in 2018, and $837 million in 2017. The 2019 segment profits consisted of $369 million from Asia Pacific, $272 million from Europe, $118 million from Caribbean and Latin America, $45 million from the Middle East and Africa, and $178 million from other locations.
Depreciation, Amortization, and Other
| ($ in millions) | 2019 | 2018 | 2017 | ||||||||
| North American Full-Service | $ | 199 | $ | 82 | $ | 82 | |||||
| North American Limited-Service | 19 | 15 | 14 | ||||||||
| Asia Pacific | 25 | 26 | 32 | ||||||||
| Other International | 71 | 70 | 71 | ||||||||
| Unallocated corporate | 27 | 33 | 30 | ||||||||
| $ | 341 | $ | 226 | $ | 229 |
Capital Expenditures
| ($ in millions) | 2019 | 2018 | 2017 | ||||||||
| North American Full-Service | $ | 270 | $ | 290 | $ | 21 | |||||
| North American Limited-Service | 17 | 15 | 10 | ||||||||
| Asia Pacific | 2 | 6 | 12 | ||||||||
| Other International | 164 | 40 | 42 | ||||||||
| Unallocated corporate | 200 | 205 | 155 | ||||||||
| $ | 653 | $ | 556 | $ | 240 |
NOTE 16. RELATED PARTY TRANSACTIONS
Equity Method Investments
We have equity method investments in entities that own properties for which we provide management services and receive fees. In addition, in some cases we provide loans, preferred equity, or guarantees to these entities.
The following tables present financial data resulting from transactions with these related parties:
Income Statement Data
| ($ in millions) | 2019 | 2018 | 2017 | ||||||||
| Base management fees | $ | 21 | $ | 25 | $ | 28 | |||||
| Incentive management fees | 8 | 12 | 15 | ||||||||
| Contract investment amortization | (2 | ) | (2 | ) | (2 | ) | |||||
| Owned, leased, and other revenue | — | — | 2 | ||||||||
| Cost reimbursement revenue | 233 | 332 | 356 | ||||||||
| Depreciation, amortization, and other | (2 | ) | (2 | ) | (3 | ) | |||||
| General, administrative, and other | (2 | ) | — | (1 | ) | ||||||
| Reimbursed expenses | (236 | ) | (337 | ) | (356 | ) | |||||
| Gains and other income, net | 2 | 51 | 658 | ||||||||
| Interest expense | 3 | — | — | ||||||||
| Interest income | — | — | 4 | ||||||||
| Equity in earnings | 13 | 103 | 40 |
Balance Sheet Data
| ($ in millions) | At Year-End 2019 | At Year-End 2018 | |||||
| Current assets | |||||||
| Accounts and notes receivable, net | $ | 16 | $ | 31 | |||
| Prepaid expenses and other | 1 | 1 | |||||
| Intangible assets | |||||||
| Contract acquisition costs and other | 29 | 32 | |||||
| Equity method investments | 577 | 732 | |||||
| Other noncurrent assets | 3 | 10 | |||||
| Current liabilities | |||||||
| Accounts payable | (1 | ) | (4 | ) | |||
| Accrued expenses and other | (3 | ) | (16 | ) | |||
| Deferred tax liabilities | (37 | ) | (20 | ) | |||
| Other noncurrent liabilities | (3 | ) | (11 | ) |
Undistributed earnings attributable to our equity method investments represented approximately $11 million of our consolidated retained earnings at year-end 2019.
Summarized Financial Information for Investees
The following tables present summarized financial information for the entities in which we have equity method investments:
| ($ in millions) | 2019 | 2018 | 2017 | ||||||||
| Sales | $ | 815 | $ | 932 | $ | 1,176 | |||||
| Net income | 80 | 221 | 222 |
| ($ in millions) | At Year-End 2019 | At Year-End 2018 | |||||
| Assets (primarily composed of hotel real estate managed by us) | $ | 2,555 | $ | 2,724 | |||
| Liabilities | 1,691 | 1,843 |
The carrying amount of our equity method investments was $577 million at year-end 2019 and $732 million at year-end 2018. This value exceeded our share of the book value of the investees' net assets by $311 million at year-end 2019 and $419 million at year-end 2018, primarily due to the value that we assigned to land, contracts, and buildings owned by the investees.
Other Related Parties
We received management fees of approximately $12 million in 2019, $13 million in 2018, and $13 million in 2017, plus reimbursement of certain expenses, from our operation of properties owned by JWM Family Enterprises, L.P., which is beneficially owned and controlled by J.W. Marriott, Jr., Deborah Marriott Harrison, and other members of the Marriott family.
NOTE 17. RELATIONSHIP WITH MAJOR CUSTOMER
Host Hotels & Resorts, Inc., formerly known as Host Marriott Corporation, and its affiliates (“Host”) owned or leased 60 lodging properties at year-end 2019 and 74 at year-end 2018 that we operated or franchised. Over the last three years, we recognized revenues, including cost reimbursement revenue, of $2,406 million in 2019, $2,542 million in 2018, and $2,671 million in 2017 from those lodging properties, and included those revenues in our North American Full-Service and North American Limited-Service reportable business segments, and our Caribbean and Latin America and Europe operating segments.
Host was also a partner in certain unconsolidated partnerships that own lodging properties that we operate under long-term agreements. We recognized revenues, including cost reimbursement revenue, of $123 million in 2018 and $114 million in 2017 from those lodging properties, and included those revenues in our North American Full-Service reportable business segment and our Europe operating segment. We did not recognize any revenues in 2019 related to these lodging properties as Host was not affiliated with these lodging properties during 2019.
SUPPLEMENTARY DATA
QUARTERLY FINANCIAL DATA – UNAUDITED
| ($ in millions, except per share data) | 2019 | ||||||||||||||||||
| First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Fiscal Year | |||||||||||||||
| Revenues | $ | 5,012 | $ | 5,305 | $ | 5,284 | $ | 5,371 | $ | 20,972 | |||||||||
| Operating income | $ | 510 | $ | 409 | $ | 607 | $ | 274 | $ | 1,800 | |||||||||
| Net income | $ | 375 | $ | 232 | $ | 387 | $ | 279 | $ | 1,273 | |||||||||
| Basic earnings per share (1) | $ | 1.10 | $ | 0.70 | $ | 1.17 | $ | 0.85 | $ | 3.83 | |||||||||
| Diluted earnings per share (1) | $ | 1.09 | $ | 0.69 | $ | 1.16 | $ | 0.85 | $ | 3.80 |
| ($ in millions, except per share data) | 2018 | ||||||||||||||||||
| First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Fiscal Year | |||||||||||||||
| Revenues | $ | 5,009 | $ | 5,409 | $ | 5,051 | $ | 5,289 | $ | 20,758 | |||||||||
| Operating income | $ | 530 | $ | 818 | $ | 596 | $ | 422 | $ | 2,366 | |||||||||
| Net income | $ | 420 | $ | 667 | $ | 503 | $ | 317 | $ | 1,907 | |||||||||
| Basic earnings per share (1) | $ | 1.17 | $ | 1.89 | $ | 1.45 | $ | 0.93 | $ | 5.45 | |||||||||
| Diluted earnings per share (1) | $ | 1.16 | $ | 1.87 | $ | 1.43 | $ | 0.92 | $ | 5.38 |
| (1) | The sum of the earnings per share for the four quarters may differ from annual earnings per share due to the required method of computing the weighted average shares in interim periods. |
Previous: Item 7A. Quantitative and Qualitative Disclosures About Market Risk. · Next: Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.