Item 4.
Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of our security holders during the fourth quarter of 2006.
Part II. Item 5.
Item 6.
Selected Financial Data
We have derived the following selected financial data presented below from the consolidated financial statements and related notes. The information set forth below is not necessarily indicative of future results and should be read in conjunction with the consolidated financial statements and related notes and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Our financial statements present our results of operations, financial position, stockholders’ equity and cash flows on a combined basis up through the Spin-Off on August 9, 2005, and on a consolidated basis thereafter.
Beginning January 1, 2004, as part of the integration of our businesses, Hotels.com conformed its merchant hotel business practices to those of our other businesses. As a result, we prospectively commenced reporting revenue for Hotels.com on a net basis. In our selected financial data below, the revenue amounts prior to January 1, 2004 report Hotels.com merchant hotel business revenue on a gross basis. The change in reporting did not affect operating income or net income.
SELECTED FINANCIAL DATA
(1)
Includes Hotels.com revenue amounts on a gross basis. Beginning January 1, 2004, we prospectively commenced reporting revenue for Hotels.com on a net basis.
(2)
Includes stock-based compensation under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Effective January 1, 2003, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation.
Part II. Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Expedia, Inc. is an online travel company, empowering business and leisure travelers with the tools and information they need to efficiently research, plan, book and experience travel. We have created a global travel marketplace used by a broad range of leisure and corporate travelers and offline retail travel agents. We make available, on a stand-alone and package basis, travel products and services provided by numerous airlines, lodging properties, car rental companies, destination service providers, cruise lines and other travel product and service companies. For additional information about our portfolio of brands, see the disclosure set forth in Part I, Item 1, Business, under the caption “Management Overview.”
Trends
The travel industry, which includes travel agencies and travel suppliers has been characterized by rapid and significant change. The U.S. airline sector has experienced significant turmoil in recent years, with several of the largest airlines seeking the protection of Chapter 11 bankruptcy proceedings.
The need to rationalize high fixed cost structures to better compete with low cost carriers offering “no frills” flights at discounted prices, as well as jet fuel inflation have caused the airlines to recently consider a series of merger opportunities to better share fixed costs and reduce redundant flight routes. In addition, carriers have aggressively pursued cost reductions in every aspect of their operations. These cost reduction efforts include distribution costs, which the airlines have pursued by increasing direct distribution through their proprietary websites, as well as seeking to reduce travel agent commissions and overrides. The airlines have also generally successfully reduced their fees with the GDS intermediaries as their contracts with the GDSs expired in mid to late 2006. These reductions impacted offline and online travel agents as large agencies, including Expedia, have historically received a meaningful portion of their air remuneration from GDS providers.
In addition, the U.S. airline industry has experienced increased load factors and ticket prices. At the same time, the airline carriers which participate in the Expedia marketplace have been reducing their relative flight capacities; while the lower cost carriers that are largely replacing this capacity generally do not currently participate in the Expedia marketplace. These trends have affected our ability to obtain inventory in our agency and merchant air businesses, reduced discounts for merchant air tickets and limited supply of merchant air tickets for use in our package travel offerings.
As a result of these industry dynamics and reduced economics stemming from recently negotiated GDS and airline agreements, Expedia’s air revenue per ticket has declined significantly since the fourth quarter of 2004, and we anticipate it will continue to decline further in 2007.
The hotel sector has recently been characterized by robust demand and constrained supply, resulting in increasing occupancy rates and average daily rates (“ADR”). Industry experts expect demand growth to continue to outstrip supply through at least 2007. While increasing ADRs generally have a positive effect on our merchant hotel operations as our remuneration increases proportionally with the room price, higher ADRs can impact underlying demand, and higher occupancies can restrict our ability to obtain merchant hotel room allocation, particularly in high occupancy destinations popular with our travel base, including Orlando, Las Vegas and New York. Higher occupancies also have historically tended to drive lower margins as hotel room suppliers have less need for third-party intermediaries to meet demand. A large number of our contracts with major chain hotel operators are scheduled for renewal in 2007.
Increased usage and familiarity with the internet has driven rapid growth in online penetration of travel expenditures. According to PhoCusWright, an independent travel, tourism and hospitality research firm, in 2006 49% of leisure, unmanaged and corporate travel expenditures occurred online in the United States, compared with 22% of European travel and 12% in the Asia Pacific region. These penetration rates have increased considerably over the past few years, and are expected to continue growing.
In addition to the growth of online travel agencies, airlines and lodging companies have aggressively pursued direct online distribution of their products and services over the last several years, with supplier growth outpacing online growth since 2002. Differentiation among the various website offerings have narrowed in the past several years, and the travel landscape has grown extremely competitive, with the need for competitors to generally differentiate their offerings on a feature other than price.
Strategy
We play a fundamental role in facilitating travel, whether for leisure or business. We are committed to providing our travelers with the best set of resources to serve their travel needs by taking advantage of our critical assets - our brand portfolio, our technologies and continuous innovation, our global reach, and our breadth of product offering. In doing so, we take advantage of our growing base of knowledge about our destinations, suppliers and travelers based on our unique position in the travel value chain.
A discussion of the critical assets that we leverage in achieving our business strategy follows:
Portfolio of Travel Brands. We seek to appeal to the broadest possible range of travelers and suppliers through our collection of industry-leading brands. We target several different demographics, from the value-conscious traveler through our Hotwire brand to luxury travelers seeking a high-touch, customized vacation
package through our Classic Vacations brand. We believe our flagship Expedia brand appeals to the broadest range of travelers, with our extensive product offering and facilitation of single item bookings of discounted product to complex bundling of higher-end travel packages. Our Hotels.com site and its international versions target travelers with premium content about lodging properties, and generally appeal to travelers with shorter booking windows who prefer to drive to their destinations.
Technologies and Continuous Innovation. Expedia has an established tradition of innovation, from Expedia.com’s inception as a division of Microsoft, to our introduction of more recent innovations such as our ThankYou Rewards Network offered in conjunction with Citigroup, Expedia® Fare Alerts, Travel Tickertm by Hotwire®, TripAdvisor’s wikis and ECT’s business intelligence toolset.
We intend to continue to aggressively innovate on behalf of our travelers and suppliers, including our current efforts in building a scaleable, extensible, service-oriented technology platform for our travelers, which will extend across our portfolio of brands. We expect this to result in improved flexibility and faster go-forward innovation. This transition should allow us to improve our site merchandising, browse and search functionality and add significant personalization features. We expect this transition to occur in a phased approach, with portions of our worldwide points of sale migrating to the new platform beginning in 2007. For our suppliers, we have developed proprietary, supplier-oriented technology that streamlines the interaction between some of our websites and hotel central reservation systems, making it easier and more cost-effective for hotels to manage reservations made through our brands. We are planning to offer more streamlined application programming interfaces for our lodging partners in 2007, to enable faster and simpler integration of real-time hotel content.
Global Reach. In 2006, our international gross bookings accounted for approximately 26% of worldwide gross bookings and 28% of revenue. We currently operate over 50 branded points of sale across the globe, including Expedia-branded sites in the United States, Australia, Canada, Denmark, France, Germany, Italy, Japan, the Netherlands, Norway, Sweden and the United Kingdom. Our Hotels.com and TripAdvisor brands also maintain both U.S. points of sale and additional points of sale outside the United States. Lastly, we offer Chinese travelers a wide array of products and services through our majority ownership in eLong.
We intend to continue investing in and growing our existing international points of sale, including the expected launch of an Expedia-branded site in India in 2007. We anticipate launching points of sale in additional countries where we find large travel markets and rapid growth of online commerce.
ECT currently conducts operations in the United States, Belgium, Canada, France, Germany and the United Kingdom. We believe the corporate travel sector represents a large opportunity for Expedia, and we believe we offer a compelling technology solution to small and medium-sized businesses seeking to control travel costs and improve their employees’ travel experiences. We intend to continue investing in and expanding the geographic footprint of our ECT business.
In expanding our global reach, we are leveraging our significant investment in technology, operations, brand building, supplier integration and relationships and other areas since the launch of Expedia.com in 1996. We intend to continue leveraging this investment when launching new countries, introducing website features, adding supplier products and services or adding value-added content for travelers.
Breadth of Product Offering. In general, through our websites, we believe we offer a comprehensive array of innovative travel products and services to travelers. We plan to continue improving and growing these offerings, as well as expand them to our worldwide points of sale over time.
The majority of our revenue comes from transactions involving the sale of airline tickets and the booking of hotel reservations, either as stand-alone products or as part of package transactions. We are working to grow our package business as it results in higher revenue per transaction, and we also seek to continue diversifying our revenue mix beyond core air and hotel products to car rental, destination services, cruise and other product offerings, as well as by increasing the mix of revenue from advertising we derive from our travel partners and suppliers.
Seasonality
We generally experience seasonal fluctuations in the demand for our travel products and services. For example, traditional leisure travel bookings are generally the highest in the first three quarters as travelers plan and book their spring, summer and holiday travel. The number of bookings decreases in the fourth quarter. Because revenue in the merchant business is generally recognized when the travel takes place rather than when it is booked, revenue typically lags bookings by several weeks or longer. As a result, revenue is typically the lowest in the first quarter and highest in the third quarter. The continued growth of our international operations or a change in our product mix may influence the typical trend of our seasonality in the future.
Critical Accounting Policies and Estimates
Critical accounting policies and estimates are those that we believe are important in the preparation of our consolidated financial statements because they require that we use judgment and estimates in applying those policies. We prepare our consolidated financial statements and accompanying notes in accordance with generally accepted accounting principles in the United States (“GAAP”). Preparation of the consolidated financial statements and accompanying notes requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the consolidated financial statements as well as revenue and expenses during the periods reported. We base our estimates on historical experience, where applicable, and other assumption that we believe are reasonable under the circumstances. Actual results may differ from our estimates under different assumptions or conditions.
There are certain critical estimates that we believe require significant judgment in the preparation of our consolidated financial statements. We consider an accounting estimate to be critical if:
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It requires us to make assumption because information was not available at the time or it included matters that were highly uncertain at the time we were making the estimate; and
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Changes in the estimate or different estimates that we could have selected may have had a material impact on our financial condition or results of operations.
For more information on each of these policies, see Note 2 - Significant Accounting Policies, in the notes to consolidated financial statements. We discuss information about the nature and rationale for our critical accounting estimates below.
Accounting for Certain Merchant Revenue
We accrue the cost of certain merchant revenue based on the amount we expect from suppliers’ invoices. In certain instances when a supplier invoices us for less than the cost we accrued, we generally recognize those amounts as revenue six months in arrears, net of an allowance, when we determine it is not probable that we will be required to pay the supplier, based on historical experience and contract terms. Actual revenue could be greater or lower than the amounts estimated due to changes in hotel billing practices or changes in traveler behavior.
Marketing Promotions
We periodically provide incentive offers to our customers to encourage booking of travel products and services, which include inducement offers. Inducement offers include discounts granted at the time of a current purchase to be applied against a future qualifying purchase. We treat inducement offers as a reduction to revenue based on estimated future redemption rates. We allocate the discount amount between the current purchase and the potential future purchase based on our expected relative value of the transactions. We estimate our redemption rates using our historical experience for similar inducement offers, and the amounts we record as a reduction to revenue on current purchases could vary significantly based on the redemption estimates used.
Recoverability of Goodwill and Indefinite and Definite-Lived Intangible Assets
Goodwill. We assess goodwill for impairment annually as of October 1, or more frequently, if events and circumstances indicate impairment may have occurred. The impairment test requires us to estimate the fair value of our reporting units. If the carrying value of the reporting unit exceeds the fair value, the goodwill of the reporting unit is potentially impaired and we proceed to step two of the impairment analysis. In step two of the analysis, we will record an impairment loss equal to the excess of the carrying value of the reporting unit’s goodwill over its implied fair value should such a circumstance arise.
We generally base our measurement of fair value of reporting units on a blended analysis of the present value of future discounted cash flows and market valuation approach. The discounted cash flows model indicates the fair value of the reporting units based on the present value of the cash flows that we expect the reporting units to generate in the future. Our significant estimates in the discounted cash flows model include: our weighted average cost of capital; long-term rate of growth and profitability of our business; working capital effects; and effective income tax rate. The market valuation approach indicates the fair value of the business based on a comparison of the company to comparable firms in similar lines of business that are publicly traded. Our significant estimates in the market approach model include identifying similar companies with comparable business factors such as size, growth, profitability, risk and return on investment and assessing comparable revenue and operating income multiples in estimating the fair value of the reporting units.
We believe the weighted use of discounted cash flows and market approach is the best method for determining the fair value of our reporting units because:
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It excludes the impact of short-term volatility;
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It includes all information available to management, which is generally more than that is available to the external capital markets;
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Both models are the most common valuation methodologies used within the travel industry; and
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The blended use of both models compensate for the inherent risks associated with each model if used on a stand-alone basis.
The use of different estimates or assumptions in determining the fair value of our goodwill may result in different values for these assets, which could result in an impairment.
Indefinite-Lived Intangible Assets. We base our measurement of fair value of indefinite-lived intangible assets, which primarily consist of trade name and trademarks, using the relief-from-royalty method. This method assumes that the trade name and trademarks have value to the extent that their owner is relieved of the obligation to pay royalties for the benefits received from them. This method requires us to estimate the future revenue for the related brands, the appropriate royalty rate and the weighted average cost of capital.
The use of different estimates or assumptions in determining the fair value of our indefinite-lived intangible assets may result in different values for these assets, which could result in an impairment.
Definite-Lived Intangible Assets. We review the carrying value of long-lived assets to be used in operations whenever events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable. Factors that would necessitate an impairment assessment include a significant adverse change in the extent or manner in which an asset is used, a significant adverse change in legal factors or the business climate that could affect the value of the asset, or a significant decline in the observable market value of an asset, among others. If such facts indicate a potential impairment, an impairment loss would only be recorded if the asset’s carrying amount is not recoverable through its undiscounted cash flows. Any impairment would be measured as the difference between the asset’s carrying amount and estimated fair value, determined using appropriate valuation methodologies which would typically include an estimate of discounted cash flows. Our impairment analysis is based on available information and on assumptions and projections that we consider to be reasonable and supportable. This analysis requires us to estimate current and future cash flows
attributable to the group of assets, the time period for which they will be held and used as well as a discount rate to incorporate the time value of money and the risks inherent in future cash flows.
The use of different estimates or assumptions in determining the fair value of our definite-lived intangible assets may result in different values for these assets, which could result in an impairment.
Income Taxes
In accordance with SFAS No. 109, Accounting for Income Taxes, we record income taxes under the liability method. Deferred tax assets and liabilities reflect our estimation of the future tax consequences of temporary differences between the carrying amounts of assets and liabilities for book and tax purposes. We determine deferred income taxes based on the differences in accounting methods and timing between financial statement and income tax reporting. Accordingly, we determine the deferred tax asset or liability for each temporary difference based on the tax rates that we expect will be in effect when we realize the underlying items of income and expense. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent earnings experience by jurisdiction, expectations of future taxable income, and the carryforward periods available to us for tax reporting purposes, as well as other relevant factors. We may establish a valuation allowance to reduce deferred tax assets to the amount we believe is more likely than not to be realized. Due to inherent complexities arising from the nature of our businesses, future changes in income tax law, tax sharing agreements or variances between our actual and anticipated operating results, we make certain judgments and estimates. Therefore, actual income taxes could materially vary from these estimates.
Other Long-Term Liabilities
Various Legal and Tax Contingencies. We record liabilities to address potential exposures related to business and tax positions we have taken that have been or could be challenged by taxing authorities. In addition, we record liabilities associated with legal proceedings and lawsuits. These liabilities are recorded when the likelihood of payment is probable and the amounts can be reasonably estimated. The determination for required liabilities is based upon analysis of each individual tax issue, or legal proceeding, taking into consideration the likelihood of adverse judgments and the range of possible loss. In addition, our analysis may be based on discussions with outside legal counsel. The ultimate resolution of these potential tax exposures and legal proceedings may be greater or less than the liabilities recorded.
Occupancy Tax. Some states and localities impose a transient occupancy or accommodation tax, or a form of sales tax, on the use or occupancy of hotel accommodations. Generally, hotels charge taxes based on the room rate paid to the hotel and remit these taxes to the various tax authorities. When a customer books a room through one of our travel services, we collect a tax recovery charge from the customer which we pay to the hotel. We do not collect or remit occupancy taxes, nor do we pay occupancy taxes to the hotel operator on the portion of the customer payment we retain. Some jurisdictions have questioned our practice in this regard. While the applicable tax provisions vary among the jurisdictions, we generally believe that we are not required to collect and remit such occupancy taxes. We are engaged in discussions with tax authorities in various jurisdictions to resolve this issue. Some tax authorities have brought lawsuits asserting that we are required to collect and remit occupancy tax. The ultimate resolution in all jurisdictions cannot be determined at this time.
We have established a reserve for the potential settlement of issues related to hotel occupancy taxes for prior and current periods, consistent with applicable accounting principles and in light of all current facts and circumstances. A variety of factors could affect the amount of the liability (both past and future), which factors include, but are not limited to, the number of, and amount of revenue represented by, jurisdictions that ultimately assert a claim and prevail in assessing such additional tax or negotiate a settlement and changes in relevant statutes.
We note that there are more than 7,000 taxing jurisdictions in the United States, and it is not feasible to analyze the statutes, regulations and judicial and administrative rulings in every jurisdiction. Rather, we have obtained the advice of state and local tax experts with respect to tax laws of certain states and local jurisdictions that represent a large portion of our hotel revenue. Many of the fundamental statutes and
regulations that impose these taxes were established before the growth of the internet and e-commerce. It is possible that some jurisdictions may introduce new legislation regarding the imposition of occupancy taxes on businesses that arrange the booking of hotel accommodations. We continue to work with the relevant tax authorities and legislators to clarify our obligations under new and emerging laws and regulations. We will continue to monitor the issue closely and provide additional disclosure, as well as adjust the level of reserves, as developments warrant. Additionally, certain of our businesses are involved in occupancy tax related litigation which is discussed in Part I, Item 3, Legal Proceedings.
Stock-Based Compensation
We record stock-based compensation expense net of estimated forfeitures. In determining the estimated forfeiture rates for stock-based awards, we periodically conduct an assessment of the actual number of equity awards that have been forfeited to date as well as those expected to be forfeited in the future. We consider many factors when estimating expected forfeitures, including the type of award, the employee class and historical experience. The estimate of stock awards that will ultimately be forfeited requires significant judgment and to the extent that actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period such estimates are revised. In 2005, we recognized significant changes in estimates related to our forfeiture rate.
New Accounting Pronouncements
For a discussion of new accounting pronouncements, see Note 2 - Significant Accounting Policies, in the notes to consolidated financial statements.
Operating Metrics
Our operating results are affected by certain metrics that represent the selling activities generated by our travel products and services. As travelers have increased their use of the internet to book their travel arrangements, we have seen our gross bookings increase, reflecting the growth in the online travel industry and our business acquisitions. Gross bookings represent the total retail value of transactions booked for both agency and merchant transactions, recorded at the time of booking reflecting the total price due for travel, including taxes, fees and other charges, and are generally not reduced for cancellations and refunds.
Operating Metrics Reclassifications
For the years ended December 31, 2005 and 2004, we adjusted allocations for certain points of sale to conform to the current period presentation. The allocation adjustment impacted domestic and international gross bookings, revenue and revenue margin but did not impact gross bookings, revenue or revenue margin on a consolidated basis.
The increase in domestic and international gross bookings for 2006 compared to 2005 was 6% and 26% and would have been 5% and 29% under our prior allocation method. The change in domestic and international revenue for 2006 compared to 2005 was flat and an increase of 24% and would have been a decrease of 3% and an increase of 36% under our prior allocation method. The change in domestic and international revenue margin for 2006 compared to 2005 was a decrease of 76 basis points and 19 basis points and would have been a decrease of 103 basis points and an increase of 75 basis points under the prior allocation method.
The allocation adjustment did not have an impact on the change in domestic and international gross bookings for 2005 compared to 2004. The increase in domestic and international revenue for 2005 compared to 2004 was 7% and 50% versus 8% and 48% under our prior allocation method. The decline in domestic and international revenue margin for 2005 compared to 2004 was 100 basis points and 4 basis points versus 90 basis points and 21 basis points under the prior allocation method.
Gross Bookings and Revenue Margin
Gross bookings increased $1.6 billion, or 10%, in 2006 compared to 2005, and $2.8 billion, or 22%, in 2005 compared to 2004. Gross bookings represent the total retail value of transactions recorded for both agency and merchant transactions, recorded at the time of booking. In 2006, domestic gross bookings increased 6% and international gross bookings increased 26% compared to 2005. In 2005, domestic gross bookings increased 15% and international gross bookings increased 50% compared to 2004. The increases in 2006 and 2005 were primarily due to increases in transaction volumes.
Revenue margin, which is defined as revenue as a percentage of gross bookings, decreased 59 basis points in 2006 compared to 2005. In 2006, revenue margin decreased 76 basis points in our domestic operations and 19 basis points in our international operations. The decline in worldwide revenue margin was primarily due to the decline in air revenue per ticket, coupled with an increase in average worldwide airfares of 9% for 2006 compared to 2005, as our remuneration generally does not vary with the price of the ticket. Revenue margin decreased 80 basis points in 2005 compared to 2004. The decrease was primarily due to a decrease in air revenue per ticket and hotel margins. In 2005, revenue margin decreased 100 basis points in our domestic operations and 4 basis points in our international operations.
Results of Operations
Reclassifications
For the years ended December 31, 2005 and 2004, we reclassified stock-based compensation expense to the same operating expense line items as cash compensation paid to employees in accordance with SEC Staff Accounting Bulletin No. 107.
Revenue
In 2006, the increase in revenue was primarily driven by increased worldwide merchant hotel revenue, partially offset by a decline in our domestic air revenue. In 2006, domestic revenue growth remained flat and international revenue increased by 24% compared to 2005.
Worldwide merchant hotel revenue increased 13% in 2006 compared to 2005 primarily due to a 10% increase in room nights stayed, including rooms delivered as a component of vacation packages, as well as a 2% increase in revenue per room night. Revenue per room night increased due to a 6% increase in worldwide ADRs, partially offset by a decrease in hotel raw margins (defined as hotel net revenue as a percentage of hotel gross revenue). Our merchant hotel raw margins decreased in 2006 and 2005 as hotel room suppliers have taken advantage of higher occupancies and the efficacy of their own online distribution to negotiate more favorable terms.
Worldwide air revenue decreased 14% in 2006 compared to 2005 due to a 13% decrease in revenue per air ticket and a 2% decrease in air tickets sold. The decrease in revenue per air ticket reflects decreased compensation from air carriers and GDS providers. The decrease in air tickets sold reflects the reduction in relative capacity of carriers participating in our marketplace and continued challenges in obtaining merchant air inventory in light of record industry load factors. Lesser availability of merchant air inventory also impacted our packages revenue, which grew only 1% in 2006 compared to 2005.
Other revenue, which includes car rental, destination services, cruise and advertising, increased by 7% in 2006 compared to 2005 primarily due to an increase in advertising revenue.
In 2005, the increase in revenue was primarily due to increases in worldwide merchant hotel business, worldwide air revenue, growth in our car rental business and acquisitions. Worldwide merchant hotel revenue increased 10% in 2005 compared to 2004. The increase was primarily due to a 9% increase in room nights and a 1% increase in revenue per room night. The increase in revenue per room night was primarily due to a 7% increase in ADRs, partially offset by a contraction in hotel raw margins.
Worldwide air revenue increased 5% in 2005 compared to 2004. Year-over-year, air tickets sold increased by 17%, partially offset by an 11% decrease in revenue per air ticket. The increase in air tickets sold is primarily due to the growth in domestic ticket sales while the decrease in revenue per air ticket resulted from less inventory allocation and lower discounting of merchant air tickets, as the industry experienced high load factors. Our packages revenue grew 16% in 2005 compared to 2004.
Other revenue increased by 57% in 2005 compared to 2004 primarily due to acquisitions and growth in the car rental business. International revenue increased by 50% in 2005 compared to 2004, primarily due to our acquisitions and continued growth from international websites.
Cost of Revenue and Gross Profit
Cost of revenue primarily consists of (1) costs of our data and call centers, including telesales, (2) credit card merchant fees, (3) fees paid to fulfillment vendors for processing airline tickets and related customer services, (4) costs paid to suppliers for certain destination inventory, (5) reserves and related payments to airlines for tickets purchased with fraudulent credit cards and (6) stock-based compensation.
The cost of revenue increase in 2006 compared to 2005 was primarily due to higher costs associated with the increase in transaction volumes. The cost of revenue increase in 2005 compared to 2004 was primarily due to costs associated with an increase in transaction volumes and acquisitions, partially offset by lower stock-based compensation. Our 2005 stock-based compensation expense included a benefit related to changes in estimated forfeiture rates and capitalization of software development costs, partially offset by a modification charge on stock option awards related to the Spin-Off.
The year over year increases in gross profit are primarily due to the increases in revenue. Gross margin increased in 2006 compared to 2005 primarily due to the increased mix of merchant hotel revenue, which has a higher gross margin than our overall business.
Selling and Marketing
Selling and marketing expense relates to direct advertising and distribution expense, including television, radio and print spending, as well as traffic generation from internet portals, search engines, and our private label and affiliate programs. The remainder of the expense relates to indirect costs, including stock-based
compensation costs and market manager staffing in our Partner Services Group (“PSG”) and destination services.
In 2006, the increase in selling and marketing expenses was primarily due to growth in indirect PSG and destination services staffing costs. Direct selling and marketing expense grew 7% in 2006.
In 2005, the increase in selling and marketing expense was primarily due to growth in personnel costs, including costs associated with the PSG team expansion and destination services staffing assumed in our acquisitions, partially offset by a decrease in offline marketing spend for certain businesses, keyword search efficiencies and a decrease in stock-based compensation costs. Selling and marketing expense in 2004 includes a favorable adjustment for the reversal of $6.4 million associated with the resolution of a contractual dispute.
We expect absolute amounts spent on selling and marketing to increase in 2007. The direction of selling and marketing expense as a percentage of revenue in 2007 will primarily depend on our ability to drive efficiencies as well as geographic and product mix.
General and Administrative
General and administrative expense consists primarily of (1) personnel-related costs for support functions that include our executive leadership, finance, legal, tax and human resource functions, (2) stock-based compensation costs and (3) fees for external professional services including legal, tax and accounting.
In 2006, the increase in general and administrative expense was primarily due to an increase in our headcount and accompanying compensation resulting from our being a stand-alone public company for the full year as well as increased legal expenses, partially offset by a decrease in stock-based compensation expense. Stock-based compensation expense decreased in 2006 compared to 2005 primarily due to stock options that are completing their vesting cycles. We expect general and administrative expense to increase in absolute dollars but decrease as a percentage of revenue for 2007 versus 2006 as we have largely completed our overhead additions as a stand-alone public company.
In 2005, the increase in general and administrative expense was primarily due to acquisitions, an increase in our use of professional services and costs to build our executive teams and supporting staff levels largely in connection with being a stand-alone public company. In addition, we incurred one-time expenses specifically related to the Spin-Off. These increases were partially offset by a decrease in stock-based compensation.
Technology and Content
Technology and content expense consists of expenses for customizing our websites, amortization of website and internal software development costs, localization of our websites, and product development expenses such as personnel-related costs, including stock-based compensation.
The year-over-year expense increases were primarily due to growth in personnel-related expenses in our software development and engineering teams as we increase our level of website innovation, net of the capitalization of software development efforts that we began placing into service in the fourth quarter of 2006 and will continue to place into service in early 2007. The increase in 2005 was partially offset by a decrease in stock-based compensation costs.
Given our historical and ongoing investments in our enterprise data warehouse, new platform, geographic expansion, data centers, redundancy, call center technology, site merchandising, content management, site monitoring, networking, corporate travel, supplier integration and other initiatives, as well as the incremental amortization of capitalized software placed into service in late 2006 and into 2007, we expect technology and content expense to increase in absolute dollars and as a percentage of revenue for both 2007 and 2008.
Amortization of Intangible Assets
In 2006, amortization of intangibles expense decreased compared to 2005 as some of our intangible assets were fully amortized. In 2005, amortization of intangibles expense was flat compared to 2004, because the amortization of intangibles related to new business acquisitions was offset by the decrease in amortization related to intangibles that were fully amortized.
For additional information about our acquisitions, see Note 3 - Business Acquisitions, in the notes to consolidated financial statements.
Impairment of Intangible Asset
Based on lower than expected revenue growth in 2006, we determined that our indefinite lived trade name intangible asset related to Hotwire might be impaired during the third quarter of 2006. Accordingly, we performed a valuation of that asset and determined that its carrying amount exceeded its fair value and recognized an impairment charge of $47.0 million.
Amortization of Non-Cash Distribution and Marketing
Amortization of non-cash distribution and marketing expense consists mainly of advertising from Universal Television contributed to us by IAC at Spin-Off. We use this advertising without any cash cost.
In 2006, we had substantially utilized all media time we received from IAC in conjunction with the Spin-Off, with an original value of $17.1 million. In 2005, the decrease in amortization of non-cash distribution and marketing expense compared to 2004 was due to a decline in the amount of television advertising that we used.
Operating Income
In 2006, the decrease in operating income was primarily due to the impairment charge of $47.0 million and higher selling and marketing and general and administrative expenses. These increases were partially offset by an increase in gross profit, lower amortization expense related to intangible assets and lower stock-based compensation.
In 2005, the increase in operating income was primarily due to increased revenue, which contributed to a higher gross profit, and a decrease in stock-based compensation due to changes in the estimated forfeiture rates used to determine stock-based compensation, partially offset by an increase in selling and marketing, general and administrative, and technology and content expense as discussed above. In 2005, operating income included a $79.7 million decrease to stock-based compensation expense mainly due the benefit of $44.7 million related to changes in estimated forfeiture rates and capitalization of software development costs, partially offset by a modification charge on stock option awards related to the Spin-Off. Operating income was favorably impacted in 2004 by a $12.1 million net reserve adjustment primarily related to the reversal of an air excise tax reserve and the resolution of a contractual dispute.
Operating Income Before Amortization (“OIBA”)
In 2006, the decrease in OIBA was primarily due to higher operating expenses, partially offset by higher revenue and the improvement in gross margin.
In 2005, the increase in OIBA was primarily due to increases in revenue that contributed to a higher gross profit, partially offset by increases in higher operating expenses.
Definition of OIBA
We provide OIBA as a supplemental measure to GAAP. We define OIBA as operating income plus: (1) amortization of non-cash distribution and marketing expense, (2) stock-based compensation expense, (3) amortization of intangible assets and goodwill and intangible asset impairment, if applicable and (4) certain one-time items, if applicable.
OIBA is the primary operating metric used by which management evaluates the performance of our business, on which internal budgets are based, and by which management is compensated. Management believes that investors should have access to the same set of tools that management uses to analyze our results. This non-GAAP measure should be considered in addition to results prepared in accordance with GAAP, but should not be considered a substitute for, or superior to, GAAP. We endeavor to compensate for the limitation of the non-GAAP measure presented by also providing the comparable GAAP measures, GAAP financial statements, and descriptions of the reconciling items and adjustments, to derive the non-GAAP measure. We present a reconciliation of this non-GAAP financial measure to GAAP below.
OIBA represents the combined operating results of Expedia, Inc.’s businesses, taking into account depreciation, which we believe is an ongoing cost of doing business, but excluding the effects of other non-cash expenses that may not be indicative of our core business operations. We believe this measure is useful to investors for the following reasons:
•
it corresponds more closely to the cash operating income generated from our core operations by excluding significant non-cash operating expenses;
•
it aids in forecasting and analyzing future operating income as stock-based compensation, non-cash distribution and marketing expenses and intangible assets amortization, assuming no subsequent acquisitions, are likely to decline going forward; and
•
it provides greater insight into management decision making at Expedia, as OIBA is our primary internal metric for evaluating the performance of our business.
OIBA has certain limitations in that it does not take into account the impact of certain expenses to our consolidated statements of income, including stock-based compensation, non-cash payments to partners, acquisition-related accounting and certain one-time items, if applicable. Due to the high variability and
difficulty in predicting certain items that affect net income, such as tax rates, stock price and interest rates, we are unable to provide a reconciliation to net income on a forward-looking basis without unreasonable efforts.
Reconciliation of OIBA to Operating Income and Net Income
The following table presents a reconciliation of OIBA to operating income and net income for the years ended December 31, 2006, 2005 and 2004:
Interest Income
Prior to the Spin-Off, the intercompany receivable balances were subject to a cash management arrangement with IAC. Since we extinguished our intercompany receivable balances with IAC at Spin-Off with a non-cash distribution to IAC, we no longer receive interest income from IAC. The increase in interest income in 2005 compared to 2004 was due to the growth in our intercompany receivable balances with IAC, as well as an increase in the interest rates earned on these balances.
Other interest income increased in 2006 compared to 2005 primarily due to higher cash balances, which resulted from operating cash flow and the $500.0 million senior unsecured notes (the “Notes”) that we issued in August 2006.
Interest Expense
In 2006, interest expense increased compared to 2005 due to interest expense related to the Notes. We expect interest expense to continue to increase for 2007 as a result of the Notes.
Write-off of Long-Term Investment
In 2005, we received information regarding the deteriorating financial condition of our long-term investment in a leisure travel company and we determined that it was not likely we would recover any of our investment because the decline in its value was determined to be other-than-temporary. As a result, we recorded a loss related to this impairment of $23.4 million. In 2006, we sold our investment for nil consideration.
Other, net
In 2006, other, net primarily includes net gains of $8.1 million in the fair value changes in and the settlement of derivative instruments related to the Ask Jeeves Notes and certain stock warrants as well as net gains of $10.4 million from the fluctuation of exchange rates on foreign denominated assets and liabilities of U.S. dollar functional subsidiaries.
In 2005, other, net primarily includes an unrealized loss of $6.0 million in the fair value changes in derivative instruments related to the Ask Jeeves Notes and certain stock warrants. In 2004, other, net was primarily due to losses of $7.5 million from the fluctuation of exchange rates.
Provision for Income Taxes
In 2006, our effective tax rate was affected by state taxes, valuation allowance on certain foreign losses, and non-taxable gains related to our derivative liabilities.
In 2005 and 2004, our effective tax rate was higher than the 35% statutory rate primarily due to state taxes and an increase in the valuation allowance related to foreign operating losses. In addition, in 2005, our effective tax rate was affected by non-deductible stock-based compensation expense, unrealized losses on derivative instruments and loss from the write-off of our long-term investment.
During 2006, we utilized all of our federal net operating losses and expect to be a full U.S. cash taxpayer going forward. For additional information about income taxes, see Note 10 - Income Taxes, in the notes to consolidated financial statements.
Segment Operating Results
In the first quarter of 2006, we began reporting two segments; North America and Europe. The change from a single reportable segment is a result of the reorganization of our business. We determined our segments based on how our chief operating decision makers manage our business, make operating decisions and evaluate operating performance. Our primary operating metric for evaluating segment performance is OIBA (defined above). We have not reported segment information for the years ended December 31, 2005 and 2004, as it is not practicable to do so. For additional information about our segment results, see Note 16 - Segment Information, in the notes to consolidated financial statements.
Financial Position, Liquidity and Capital Resources
Our principal sources of liquidity are cash flows generated from operations, our cash and cash equivalents balances which were $853.3 million and $297.4 million at December 31, 2006 and 2005, and our $1.0 billion
revolving credit facility, of which $948 million was available to us as of December 31, 2006 representing the total of the facility less $52 million of outstanding stand-by letters of credit (“LOC”). As of December 31, 2006, we were in compliance with our financial covenants consisting of leverage and minimum net worth related to the facility.
Under the merchant model, we receive cash from travelers at the time of booking and we record these amounts on our consolidated balance sheets as deferred merchant bookings. We pay our suppliers related to these bookings generally within two weeks after completing the transaction for air travel and, for all other merchant bookings, which is primarily our merchant hotel business, after the travelers’ use and subsequent billing from the supplier. Therefore there is generally a greater time from the receipt of cash from the traveler to the payment to the supplier, and this operating cycle represents a working capital source of cash to us. As long as the merchant hotel business continues to grow and our business model does not change, we expect that changes in working capital will positively impact operating cash flows. If this business declines relative to our other businesses, or if there are changes to the model which compress the time between receipts of cash from travelers to payments to suppliers, our working capital benefits could be reduced, as was the case to a certain degree in 2006 as we increased the efficiency of our supplier payment process.
Seasonal fluctuations in our merchant hotel bookings affect the timing of our annual cash flows. During the first half of the year, hotel bookings have traditionally exceeded stays, resulting in much higher cash flow related to working capital. During the second half of the year, this pattern reverses. While we expect the impact of seasonal fluctuations to continue, merchant hotel growth rates or model changes as discussed above may affect working capital, which might counteract or intensify the anticipated seasonal fluctuations.
As of December 31, 2006, we had a deficit in our working capital of $217.4 million, compared to a deficit of $848.0 million as of December 31, 2005. The 2005 deficit resulted from the $2.5 billion of net intercompany receivable balances we extinguished through a non-cash distribution to IAC upon our Spin-Off on August 9, 2005.
We anticipate continued investment in the development and expansion of our operations. These investments include but are not limited to improvements to infrastructure, which include our enterprise data warehouse investment, servers, networking equipment and software, release improvements to our software code and continuing efforts to build a scaleable, extensible, service-oriented technology platform that will extend across our portfolio of brands. We expect portions of our worldwide points of sale to migrate to the new platform beginning in 2007. Capital expenditures are expected to increase 5% to 15% in 2007. Our future capital requirements may include capital needs for acquisitions or expenditures in support of our business strategy. In the event we have acquisitions, this may reduce our cash balance and increase our debt. Legal risks and challenges to our business strategy may also negatively affect our cash balance.
Our cash flows are as follows:
In 2006, net cash provided by operating activities decreased by $241.7 million primarily due to an increase in tax payments and a decrease in cash flows from operating income as well as a reduced benefit from working capital. We made tax payments of $126.1 million, an increase of $115.7 million over 2005, reducing cash provided by operations due primarily to IAC’s payment of taxes on behalf of Expedia prior to our becoming an independent public company after which point we became responsible for our tax obligations.
In 2005, net cash provided by operating activities increased by $67.0 million primarily due to an increase in cash flows from operating income, partially offset by tax payments of $10.4 million, an increase of $12.3 million from 2004, reducing cash provided by operations.
Cash used in investing activities decreased by $687.8 million in 2006 primarily due to the absence of transfers to IAC of $757.2 million, partially offset by net cash used in acquisitions and a $40.3 million increase in capital expenditures in the current period in part due to capitalized software costs incurred for the development of our enterprise data warehouse and other improvements to our technology infrastructure. In 2005, cash used in investing activities decreased by $131.1 million from 2004 primarily due to a $515.5 million decrease in transfers to IAC and reduction of cash acquisitions as well as the decrease in marketable securities proceeds in 2005 compared to 2004.
Cash provided by financing activities decreased in 2006 due to $295.7 million of treasury stock activity primarily related to open market share repurchases and the $230.0 million repayment of our revolving credit facility, which was initially borrowed in 2005, partially offset by the net proceeds of $495.3 million from the Notes issuance in 2006. In 2005, cash provided by financing activities decreased due to withholding taxes for stock option exercises of $86.6 million that we paid on behalf of our senior executive in exchange for surrendering a portion of his vested shares to treasury, and 2005 distributions to IAC versus 2004 contributions from IAC, partially offset by an increase in short-term borrowings of $230.7 million and proceeds from the exercise of stock option exercises of $29.1 million.
During the third quarter of 2006, we issued $500.0 million Notes for net proceeds of $495.3 million. The Notes are due August 2018 and bear a fixed interest rate of 7.456% with interest payable semi-annually in February and August of each year, beginning in February 2007. The Notes are repayable in whole or in part on August 15, 2013, at the option of the Note holders, and are redeemable in whole or in part at any time at our option. As of December 31, 2006, we were in compliance with all related covenants.
During the second and third quarters of 2006, we repurchased, in open market trades at an average per share price of $14.42, 20 million shares of our common stock for a total cost of $288 million.
We reclassified certain foreign exchange effects on our cash balances from operating activities to effect of foreign exchange rate changes for the periods presented. The effect of foreign exchange on our cash balances denominated in foreign currency in 2006 showed a net increase of $50.7 million from 2005 due to the benefit of foreign currency appreciation during that time period versus our reporting currency, as well as the increase in our cash balances.
On January 19, 2007, we completed a tender offer pursuant to which we acquired 30 million tendered shares of our common stock at a purchase price of $22.00 per share, for a total cost of $660 million plus fees and expenses relating to the tender offer. These shares represent approximately 9.8% of the shares of common stock outstanding and 9.0% of the total number of shares of common stock and Class B common stock outstanding as of December 31, 2006. We paid for the tendered shares with cash on-hand and by drawing $150 million on our revolving credit facility.
As of February 15, 2007, we have Board of Directors authorization for additional share repurchases of up to 20 million outstanding shares of our common stock. There is no fixed termination date for the repurchases.
In our opinion, available cash, funds from operations and available borrowings will provide sufficient capital resources to meet our foreseeable liquidity needs.
Contractual Obligations and Commercial Commitments
Our contractual obligations and commercial commitments are as follows:
•
Our Notes include interest payments through maturity in 2018.
•
We have obligations related to the Ask Jeeves Notes. As a result of the Spin-Off, when holders of IAC’s Ask Jeeves Notes convert their notes, they will receive shares of both IAC and Expedia common stock. Under the terms of the Spin-Off, we are obligated to issue shares of our common stock to IAC
for delivery to the holders of the Ask Jeeves Notes, or pay cash in equal value, in lieu of issuing such shares, at our option. The Ask Jeeves Notes are due June 1, 2008; upon maturity of these notes, our obligation to satisfy demands for conversion ceases.
•
The operating leases are for office space and related office equipment. We account for these leases on a monthly basis. Certain leases contain periodic rent escalation adjustments and renewal options. Operating lease obligations expire at various dates with the latest maturity in 2014.
•
Our purchase obligations represent the minimum obligations we have under agreements with certain of our vendors. These minimum obligations are less than our projected use for those periods. Payments may be more than the minimum obligations based on actual use. In addition, if certain obligations are met by our counterparties, our obligations will increase.
•
Guarantees and LOCs are commitments that represent funding responsibilities that may require our performance in the event of third-party demands or contingent events. These commitments consist of stand-by LOCs and guarantees. We use our stand-by LOCs to secure payment for hotel room transactions to particular hotel properties. The outstanding balance of our stand-by LOCs directly reduces the amount available to us from our revolving credit facility. In addition, we provide a guarantee to the aviation authority of one country to protect against potential non-delivery of our packaged travel services sold within that country. This country holds all travel agents and tour companies to the same standard.
The following table presents our material contractual obligations and commercial commitments as of December 31, 2006:
Other than the items described above, we do not have any off-balance sheet arrangements as of December 31, 2006.
Certain Relationships and Related Party Transactions
For a discussion of certain relationships and related party transactions, see Note 15 - Related Party Transactions, in the notes to consolidated financial statements.
Part II. Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Market Risk Management
Market risk is the potential loss from adverse changes in interest rates, foreign exchange rates and market prices. Our exposure to market risk includes our Notes, our revolving credit facility, derivative instruments, cash and cash equivalents, merchant accounts payable and deferred merchant bookings denominated in foreign currencies. We manage our exposure to these risks through established policies and procedures. Our objective is to mitigate potential income statement, cash flow and market exposures from changes in interest and foreign exchange rates.
Interest Rate Risk
In August 2006, we issued $500.0 million Notes with a fixed rate of 7.456%. As a result, if market rates decline, our required payments will exceed those based on market rates. The fair value of our Notes was approximately $520 million as of December 31, 2006 based on the quoted market price. A 50 basis point increase or decrease in interest rates would decrease or increase the fair value of our Notes by approximately $20 million.
In July 2005, we entered into a $1.0 billion revolving credit facility. The revolving credit facility bears interest based on our financial leverage and as of December 31, 2006 was equal to LIBOR plus 0.50%. As a result, we may be susceptible to fluctuations in interest rates if we do not hedge the interest rate exposure arising from any borrowings under our revolving credit facility. As of December 31, 2005, our outstanding borrowing under the revolving credit facility was $230.0 million, which we fully repaid during 2006. No borrowings were outstanding under the revolving credit facility as of December 31, 2006. In 2007, we paid for the 30 million tendered shares, in part, by drawing on our revolving credit facility. As of February 15, 2007, the outstanding balance on the credit facility was $150 million.
We did not experience any significant impact from changes in interest rates for the years ended December 31, 2006 or 2005.
Foreign Exchange Risk
We conduct business in certain international markets, primarily in Australia, Canada, China and the European Union. Because we operate in international markets, we have exposure to different economic climates, political arenas, tax systems and regulations that could affect foreign exchange rates. Our primary exposure to foreign currency risk relates to transacting in foreign currency and recording the activity in U.S. dollars. Changes in exchange rates between the U.S. dollar and these other currencies will result in transaction gains or losses, which we recognize in our consolidated statements of income. To the extent practicable, we minimize this exposure by maintaining natural hedges between our current assets and current liabilities in similarly denominated foreign currencies.
Future net transaction gains and losses are inherently difficult to predict as they are reliant on how the multiple currencies in which we transact fluctuate in relation to the U.S. dollar, the relative composition and denomination of the current assets and liabilities each period, and our ability to maintain natural offsets of such exposures. During 2006 we recorded net foreign exchange rate gains of $10.4 million; and during 2005 and 2004 we recorded net foreign exchange rate losses of $0.6 million and $7.5 million.
As we increase our operations in international markets, our exposure to fluctuations in foreign currency exchange rates increases. The economic impact to us of foreign currency exchange rate movements is linked to variability in real growth, inflation, interest rates, governmental actions and other factors. These changes, if material, could cause us to adjust our financing and operating strategies.
As foreign currency exchange rates fluctuate, translation of the income statements of our international businesses into U.S. dollars affects year-over-year comparability of operating results. Historically, we have not hedged foreign exchange risks; we periodically review our strategy for hedging foreign exchange risks. Our goal in managing our foreign exchange risk is to reduce to the extent practicable our potential exposure to the changes that exchange rates might have on our earnings, cash flows and financial position.
We use cross-currency swaps to hedge against the change in value of certain intercompany loans denominated in currencies other than the lending subsidiaries’ functional currency. For additional information about our cross-currency swaps, see Note 7 - Derivative Instruments, in the notes to consolidated financial statements.
Equity Price Risk
We do not maintain any minority investments in equity securities as part of our marketable securities investment strategy. Thus, our equity price risk primarily relates to fluctuations in our stock price, which affects our derivative liabilities related to outstanding Ask Jeeves Notes. We base the fair value of these derivative instruments primarily on the changes in the market price of our common stock.
In 2006, certain of these notes were converted at fair value for $80.8 million of common stock, or 3.5 million shares. As additional notes are converted, the value of the derivative liability will be reduced and our equity price risk will decrease accordingly. The conversion of the Ask Jeeves Notes during 2006, reduced our obligation to issue our common stock from 4.3 million shares as of December 31, 2005, to 0.8 million shares as of December 31, 2006.
As of December 31, 2006, each $1.00 fluctuation in our common stock will result in approximately $0.8 million of change in the aggregate fair value of our Ask Jeeves Notes derivative liability. An increase in our common stock price will result in a charge to our consolidated statements of income and a decrease in our common stock price will result in a credit. The Ask Jeeves Notes are due June 1, 2008; upon maturity of these notes, our obligation to satisfy demands for conversion ceases.
For additional information about the Ask Jeeves Notes, see Note 7 - Derivative Instruments, in the notes to consolidated financial statements.
Part II. Item 8.
Item 9B.
Other Information
None.
Part III.
We are incorporating by reference the information required by Part III of this report on Form 10-K from our proxy statement relating to our 2007 annual meeting of stockholders, which will be filed with the Securities and Exchange Commission within 120 days after the end of our fiscal year ended December 31, 2006.
Item 10
Item 10
Directors and Executive Officers of the Registrant
Item 11
Item 11
Executive Compensation
Item 12
Item 12
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13
Item 13
Certain Relationships and Related Transactions
Item 14
Item 14
Principal Accountant Fees and Services
Part IV. Item 15.
Item 15.
Exhibits, Consolidated Financial Statements and Financial Statement Schedules
(a)(1) Consolidated Financial Statements and (2) Financial Statement Schedules
We have filed the consolidated financial statements and consolidated financial statement schedule listed in the Index to Consolidated Financial Statements, Schedules and Exhibits on page as a part of this report.
(b)(3) Exhibits
The exhibits listed below are filed as part of this Annual Report on Form 10-K.
*
Reflects management contracts and management and director compensatory plans.
(1)
Incorporated by reference to Expedia, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005.
(2)
Incorporated by reference to Expedia, Inc.’s Current Report on Form 8-K, filed on August 15, 2005.
(3)
Incorporated by reference to Expedia, Inc.’s Registration Statement on Form S-4/A (File No. 333-124303-01), filed on June 13, 2005.
(4)
Incorporated by reference to Expedia, Inc.’s Registration Statement on Form 8-A/A, filed on August 22, 2005.
(5)
Incorporated by reference to Expedia, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006.
(6)
Incorporated by reference to Expedia, Inc.’s Registration Statement on Form S-8 (File No. 333-127324) filed on August 9, 2005.
(7)
Incorporated by reference to Expedia, Inc.’s Current Report on Form 8-K, filed on December 20, 2005.
(8)
Incorporated by reference to Expedia, Inc.’s Current Report on Form 8-K, filed on July 14, 2005.
(9)
Incorporated by reference to Expedia, Inc.’s Schedule TO (File No. 005-80935), filed on December 11, 2006.
(10)
Incorporated by reference to Expedia, Inc.’s Amendment No. 3 to Schedule TO (File No. 005-80935), filed on December 22, 2006.
(11)
Incorporated by reference to Expedia, Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005.
(12)
Incorporated by reference to Expedia, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006.
Signatures
Pursuant to the requirements of the Section 13 or 15(d) Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
Expedia, Inc.
By:
/s/ DARA KHOSROWSHAHI
Dara Khosrowshahi
Chief Executive Officer
February 28, 2007
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on February 28, 2007.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS
Report of Ernst & Young LLP, Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Expedia, Inc.
We have audited the accompanying consolidated balance sheets of Expedia, Inc. as of December 31, 2006 and 2005, and the related consolidated statements of income, shareholders’ equity and comprehensive income, and cash flows for each of the two years in the period ended December 31, 2006. 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 conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Expedia, Inc. at December 31, 2006 and 2005, and the consolidated results of its operations and its cash flows for each of the two years in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 2 to the financial statements, in 2006 the Company adopted Statement of Financial Accounting Standard No. 123 (revised 2004), Share-Based Payment, effective January 1, 2006.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Expedia, Inc.’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2007 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Seattle, Washington
February 26, 2007
Report of Ernst & Young LLP, Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Expedia, Inc.
We have audited the accompanying combined statements of income, stockholders’ equity and comprehensive income, and cash flows of Expedia, Inc. for the year ended December 31, 2004. 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 audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the combined results of operations and cash flows of Expedia, Inc. for the year ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
/s/ Ernst & Young LLP
New York, New York
April 18, 2005,
except for 2004 combining financial information in Note 19, as to which the date is
January 22, 2007
Consolidated Financial Statements
EXPEDIA, INC.
CONSOLIDATED STATEMENTS OF INCOME
See notes to consolidated financial statements.
EXPEDIA, INC.
CONSOLIDATED BALANCE SHEETS
See notes to consolidated financial statements.
EXPEDIA, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
We have 846 shares of preferred stock outstanding as of December 31, 2006 and 2005.
See notes to consolidated financial statements.
EXPEDIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements.
Expedia, Inc.
Notes to Consolidated Financial Statements
NOTE 1 - Organization and Basis of Presentation
Description of Business
Expedia, Inc. and its subsidiaries provide travel products and services to leisure and corporate travelers in the United States and abroad. These travel products and services are offered through a diversified portfolio of brands including: Expedia, Hotels.com, Hotwire.com, our private label programs (Worldwide Travel Exchange and Interactive Affiliate Network), Classic Vacations, Expedia Corporate Travel (“ECT”), eLong, Inc. (“eLong”) and TripAdvisor. In addition, many of these brands have related international points of sale. We refer to Expedia, Inc. and its subsidiaries collectively as “Expedia,” the “Company,” “us,” “we” and “our” in these consolidated financial statements.
Spin-Off from IAC/InterActiveCorp
On December 21, 2004, IAC/InterActiveCorp (“IAC”) announced its plan to separate into two independent public companies to allow each company to focus on its individual strategic objectives. We refer to this transaction as the “Spin-Off.” A new company, Expedia, Inc., was incorporated under Delaware law in April 2005, to hold substantially all of IAC’s travel and travel-related businesses (“Expedia Businesses”).
On August 9, 2005, the Spin-Off of the Expedia Businesses from IAC was completed. Shares of Expedia, Inc. began trading on The Nasdaq Stock Market, Inc. (“NASDAQ”) under the symbol “EXPE.” In conjunction with the Spin-Off, we completed the following transactions: (1) transferred to IAC all cash in excess of $100 million, excluding the cash and cash equivalents held by eLong; (2) extinguished all intercompany receivable balances from IAC, which totaled $2.5 billion by recording a non-cash distribution to IAC; (3) recorded a non-cash contribution from IAC of a joint ownership interest in an airplane, with a value of $17.4 million; (4) recorded a non-cash contribution of media time, with a value of $17.1 million; (5) recorded derivative liabilities for the stock warrants and Ask Jeeves Convertible Subordinated Notes (“Ask Jeeves Notes”) with a fair value of $101.6 million; (6) recorded a modification of stock-based compensation awards of $5.4 million; and (7) recapitalized the invested equity balance with common stock, Class B common stock and preferred stock, whereby holders of IAC stock received shares of Expedia stock based on a formula or cash ($50 per share plus accrued and unpaid dividends).
Basis of Presentation
The accompanying consolidated financial statements include Expedia, Inc., our wholly-owned subsidiaries, and entities we control, or in which we have a variable interest and are the primary beneficiary of future cash profits or losses. We record our investments in entities that we do not control, but over which we have the ability to exercise significant influence, using the equity method. We record our investments in entities over which we do not have the ability to exercise significant influence using the cost method. We have eliminated significant intercompany transactions and accounts.
These consolidated financial statements present our results of operations, financial position, change in stockholders’ equity and comprehensive income, and cash flows on a combined basis through the Spin-Off on August 9, 2005, and on a consolidated basis thereafter. We have prepared the combined financial statements from the historical results of operations and historical bases of the assets and liabilities with the exception of income taxes. We have computed income taxes using our stand-alone tax rate.
We believe that the assumptions underlying our consolidated financial statements are reasonable. However, these consolidated financial statements do not present our future financial position, the results of our future operations and cash flows, nor do they present what our historical financial position, results of operations and cash flows would have been prior to Spin-Off had we been a stand-alone company.
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
Seasonality
We generally experience seasonal fluctuations in the demand for our travel products and services. For example, traditional leisure travel bookings are generally the highest in the first three quarters as travelers plan and book their spring, summer and holiday travel. The number of bookings decreases in the fourth quarter. Because revenue in the merchant business is generally recognized when the travel takes place rather than when it is booked, revenue typically lags bookings by several weeks or longer. As a result, revenue is typically the lowest in the first quarter and highest in the third quarter.
NOTE 2 - Significant Accounting Policies
Consolidation
Our consolidated financial statements include the accounts of Expedia, Inc., our wholly-owned subsidiaries, and entities for which we control a majority of the entity’s outstanding common stock. We record minority interest in our consolidated financial statements to recognize the minority ownership interest in our consolidated subsidiaries. Minority interests in the earnings and losses of consolidated subsidiaries represent the share of net income or loss allocated to members or partners in our consolidated entities, which includes the minority interest share of net income or loss from eLong.
In addition, we hold variable interests in certain affiliated entities of eLong in order to meet the laws and regulations of the People’s Republic of China, which restricts foreign investment in the air-ticketing, travel agency, internet content provision and advertising businesses. Through a series of agreements with affiliated Chinese entities, eLong is the primary beneficiary of future cash losses or profits by contractual right. As such, although we do not own capital stock of the Chinese affiliates, we consolidate their results.
We have eliminated significant intercompany transactions and accounts in our consolidated financial statements.
Accounting Estimates
We use estimates and assumptions in the preparation of our consolidated financial statements in accordance with accounting principles generally accepted in the United States (“GAAP”). Our estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of our consolidated financial statements. These estimates and assumptions also affect the reported amount of net income during any period. Our actual financial results could differ significantly from these estimates. The significant estimates underlying our consolidated financial statements include revenue recognition, recoverability of long-lived and intangible assets and goodwill, income taxes, occupancy tax, stock-based compensation and accounting for derivative instruments.
Reclassifications
We have reclassified prior period financial statements to conform to the current period presentation.
In our consolidated statements of cash flows for the years ended December 31, 2005 and 2004, we reclassified net foreign exchange gains and losses on cash of U.S. functional subsidiaries held in foreign currencies from operating cash flows to effect of exchange rate changes on cash and cash equivalents to appropriately reflect foreign currency impacts on cash and cash equivalents for the periods presented.
In our consolidated statements of income for the years ended December 31, 2005 and 2004, we reclassified stock-based compensation expense to the same operating expense line items as cash compensation paid to employees in accordance with SEC Staff Accounting Bulletin (“SAB”) No. 107.
In our consolidated balance sheet as of December 31, 2005, we reclassified $19.7 million from accounts payable, other, to accounts payable, merchant ($19.3 million) and other current liabilities ($0.4 million).
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Revenue Recognition
We recognize revenue when it is earned and realizable based on the following criteria: persuasive evidence that an arrangement exists, services have been rendered, the price is fixed or determinable and collectibility is reasonably assured.
We also evaluate the presentation of revenue on a gross versus a net basis through application of Emerging Issues Task Force No. (“EITF”) 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent. The consensus of this literature is that the presentation of revenue as “the gross amount billed to a customer because it has earned revenue from the sale of goods or services or the net amount retained (that is, the amount billed to a customer less the amount paid to a supplier) because it has earned a commission or fee” is a matter of judgment that depends on the relevant facts and circumstances. In making an evaluation of this issue, some of the factors that should be considered are: whether we are the primary obligor in the arrangement (strong indicator); whether we have general inventory risk (before customer order is placed or upon customer return) (strong indicator); and whether we have latitude in establishing price. The guidance clearly indicates that the evaluations of these factors, which at times can be contradictory, are subject to significant judgment and subjectivity. If the conclusion drawn is that we perform as an agent or a broker without assuming the risks and rewards of ownership of goods, revenue should be reported on a net basis. For our primary revenue models, discussed below, we have determined net presentation is appropriate for the majority of revenue transactions.
We offer travel products and services on a stand-alone and package basis primarily through two business models: the merchant model and the agency model.
Under the merchant model, we facilitate the booking of hotel rooms, airline seats, car rentals and destination services from our travel suppliers and we are the merchant of record for such bookings.
Under the agency model, we act as the agent in the transaction, passing reservations booked by the traveler to the relevant travel provider. We receive commissions or ticketing fees from the travel supplier and/or traveler. For agency airline, hotel and car transactions, we also receive fees from global distribution systems partners that control the computer systems through which these reservations are booked.
Merchant Hotel. Our travelers pay us for merchant hotel transactions prior to departing on their trip, generally when they book the reservation. We record the payment in deferred merchant bookings until the stay occurs, at which point we record the revenue. In certain non-refundable, non-changeable transactions where we have no significant post-delivery obligations, we record revenue when the traveler completes the transaction on our website, less a reserve for chargebacks and cancellations based on historical experience. Amounts received from customers are presented net of amounts paid to suppliers. In certain instances when a supplier invoices us for less than the cost we accrued, we generally recognize those amounts as revenue six months in arrears, net of an allowance, when we determine it is not probable that we will be required to pay the supplier, based on historical experience and contract terms.
We generally contract in advance with lodging providers to obtain access to room allotments at wholesale rates. Certain contracts specifically identify the number of potential rooms and the negotiated rate of the rooms to which we may have access over the terms of the contracts, which generally range from one to three years. Other contracts are not specific with respect to the number of rooms and the rates of the rooms to which we may have access over the terms of the contracts. In either case we may return unbooked hotel room allotments with no obligation to the lodging providers within a period specified in each contract. For hotel rooms that are cancelled by the traveler after the specified period of time, we charge the traveler a cancellation fee or penalty that is at least equal to the amount a hotel may invoice us for the cancellation.
Merchant Air. Generally, we determine the ticket price for merchant air transactions. We pay the cost of the airline ticket generally within two weeks after booking. We record cash paid by the traveler as deferred merchant bookings and the cost of the airline ticket as prepaid merchant bookings. When the flight occurs, we
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record the difference between the deferred merchant bookings and the prepaid merchant bookings as revenue on a net basis.
When we have nonrefundable and generally noncancelable merchant air transactions, with no significant post-delivery obligations, we record revenue upon booking. We record a reserve for chargebacks and cancellations at the time of the transaction based on historical experience.
Agency Air, Hotel, Car and Cruise. Our agency revenue comes from airline ticket transactions, certain hotel transactions as well as cruise and car rental reservations. We record agency revenue on air transactions when the traveler books the transaction, as we have no significant post-delivery obligations. We record agency revenue on hotel reservations, cruise and car rental reservations either on an accrual basis for payments from a commission clearinghouse, or on receipt of commissions from an individual supplier. We record an allowance for cancellations and chargebacks on this revenue based on historical experience.
Click-Through Fees. We record revenue from click-through fees charged to our travel partners for traveler leads sent to the travel partners’ websites. We record revenue from click-through fees after the traveler makes the click-through to the related travel partners’ websites.
Advertising. We record advertising revenue ratably over the advertising period or upon delivery of advertising impressions, depending on the terms of the advertising contract.
Other. We record revenue from all other sources either upon delivery or when we provide the service.
Cash and Cash Equivalents
Our cash and cash equivalents include cash and liquid financial instruments with maturities of 90 days or less when purchased.
Accounts Receivable
Accounts receivable are generally due within thirty days and are recorded net of an allowance for doubtful accounts. We consider accounts outstanding longer than the contractual payment terms as past due. We determine our allowance by considering a number of factors, including the length of time trade accounts receivable are past due, previous loss history, a specific customer’s ability to pay its obligations to us, and the condition of the general economy and industry as a whole.
Property and Equipment
We record property and equipment at cost, net of accumulated depreciation and amortization. We also capitalize certain costs incurred related to the development of internal use software in accordance with Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, and EITF No. 00-02, Accounting for Website Development Costs. We capitalize costs incurred during the application development stage related to the development of internal-use software. We expense costs incurred related to the planning and post-implementation phases of development as incurred.
We compute depreciation using the straight-line method over the estimated useful lives of the assets, which is three years for computer equipment and capitalized software development, and range from three to five years for furniture and other equipment. We amortize leasehold improvement using the straight-line method, over the shorter of the estimated useful life of the improvement or the remaining term of the lease.
In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 143, Accounting for Asset Retirement Obligations, we establish assets and liabilities for the present value of estimated future costs to return certain of our leased facilities to their original condition. Such assets are depreciated over the lease period into operating expense, and the recorded liabilities are accreted to the future value of the estimated restoration costs.
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Notes to Consolidated Financial Statements - (Continued)
Goodwill and Indefinite-Lived Intangible Assets
Goodwill is assigned to reporting units that are expected to benefit from the synergies of the business combination as of the acquisition date. We assess goodwill and indefinite-lived intangible assets, neither of which is amortized, for impairment annually as of October 1 or more frequently if events and circumstances indicate impairment may have occurred.
In the evaluation of goodwill for impairment, we first compare the fair value of the reporting unit to the carrying value. If the carrying value of the reporting unit exceeds the fair value, the goodwill of the reporting unit is potentially impaired and we proceed to step two of the impairment analysis. In step two of the analysis, we will record an impairment loss equal to the excess of the carrying value of the reporting unit’s goodwill over its implied fair value should such a circumstance arise.
In the evaluation of indefinite-lived intangible assets, an impairment charge is recorded for the excess of the carrying value of indefinite-lived intangible assets over their fair value.
We generally base our measurement of fair value of reporting units on a blended analysis of the present value of estimated future discounted cash flows and market valuation approach, which compares revenue and operating income multiples for companies of similar industry and/or size. Our analysis is based on available information and on assumptions and projections that we consider to be reasonable and supportable. The discounted cash flow analysis considers the likelihood of possible outcomes and is based on our best estimates of projected future cash flows. We base our measurement of fair value of indefinite-lived intangible assets, which primarily consist of trade name and trademarks, using the relief-from-royalty method. This method assumes that the trade name and trademarks have value to the extent that their owner is relieved of the obligation to pay royalties for the benefits received from them.
Intangible Assets with Definite Lives and Other Long-Lived Assets
Intangible assets with definite lives and other long-lived assets are carried at cost and are amortized on a straight-line basis over their estimated useful lives of two to ten years. We review the carrying value of long-lived assets to be used in operations whenever events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable. Factors that would necessitate an impairment assessment include a significant adverse change in the extent or manner in which an asset is used, a significant adverse change in legal factors or the business climate that could affect the value of the asset, or a significant decline in the observable market value of an asset, among others. If such facts indicate a potential impairment, an impairment loss would only be recorded if the asset’s carrying amount is not recoverable through its undiscounted cash flows. Any impairment would be measured as the difference between the asset’s carrying amount and estimated fair value, determined using appropriate valuation methodologies which would typically include an estimate of discounted cash flows.
Assets held for sale, to the extent we have any, are reported at the lower of cost or fair value less costs to sell.
Investments
We record investments, which are non-marketable, using the cost basis when we do not have the ability to exercise significant influence over the investee and generally when our ownership in the investee is less than 20%. We record investments using the equity method when we have the ability to exercise significant influence over the investee.
At December 31, 2006 and 2005, we had a joint venture with Société Nationale des Chemins de Fer Français (“SNCF”), the state-owned railway group in France, which operates www.voyages-sncf.com, an online site for e-tourism in France. The investment is recorded under the equity method of accounting. At December 31, 2006 and 2005, SNCF owned 50.1% and we owned 49.9% of the joint venture.
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We periodically evaluate the recoverability of investments and record a write-down if a decline in value is determined to be other-than-temporary. This evaluation resulted in the write-off of an investment in 2005. See Note 13 - Other Income (Expense).
Income Taxes
In accordance with SFAS No. 109, Accounting for Income Taxes, we record income taxes under the liability method. Deferred tax assets and liabilities reflect our estimation of the future tax consequences of temporary differences between the carrying amounts of assets and liabilities for book and tax purposes. We determine deferred income taxes based on the differences in accounting methods and timing between financial statement and income tax reporting. Accordingly, we determine the deferred tax asset or liability for each temporary difference based on the tax rates that we expect will be in effect when we realize the underlying items of income and expense. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent earnings experience by jurisdiction, expectations of future taxable income, and the carryforward periods available to us for tax reporting purposes, as well as other relevant factors. We may establish a valuation allowance to reduce deferred tax assets to the amount we believe is more likely than not to be realized. Due to inherent complexities arising from the nature of our businesses, future changes in income tax law, tax sharing agreements or variances between our actual and anticipated operating results, we make certain judgments and estimates. Therefore, actual income taxes could materially vary from these estimates.
Occupancy Tax
Some states and localities impose a transient occupancy or accommodation tax, or a form of sales tax, on the use or occupancy of hotel accommodations. Generally, hotels charge taxes based on the room rate paid to the hotel and remit these taxes to the various tax authorities. When a customer books a room through one of our travel services, we collect a tax recovery charge from the customer which we pay to the hotel. We do not collect or remit occupancy taxes, nor do we pay occupancy taxes to the hotel operator on the portion of the customer payment we retain. Some jurisdictions have questioned our practice in this regard. While the applicable tax provisions vary among the jurisdictions, we generally believe that we are not required to collect and remit such occupancy taxes. We are engaged in discussions with tax authorities in various jurisdictions to resolve this issue. Some tax authorities have brought lawsuits asserting that we are required to collect and remit occupancy tax. The ultimate resolution in all jurisdictions cannot be determined at this time. We have established a reserve for the potential settlement of issues related to hotel occupancy taxes.
Derivative Instruments
Derivative instruments are carried at fair value on our consolidated balance sheets.
We have designated cross currency swap agreements as cash flow hedges of certain inter-company loan agreements denominated in currencies other than the lending subsidiaries’ functional currency (the “hedged items”). The hedges have been determined to be highly effective, at designation and on an ongoing basis. As such, we record the total change in the fair value of the hedges in other comprehensive income (“OCI”) each period, and concurrently reclassify a portion of the gain or loss to other, net to perfectly offset gains or losses related to transactional remeasurement of the hedged items.
We report the change in the fair value of derivative instruments that do not qualify for hedge accounting treatment in other, net in our consolidated statements of income. We do not hold or issue financial instruments for speculative or trading purposes. For additional information about derivative instruments, see Note 7 - Derivative Instruments.
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Notes to Consolidated Financial Statements - (Continued)
Foreign Currency Translation and Transaction Gains and Losses
Our operations outside of the United States use the related local currency as their functional currency. We translate revenue and expense at average rates of exchange during the period. We translate assets and liabilities at the rates of exchange as of the consolidated balance sheet dates and include foreign currency translation gains and losses as a component of accumulated OCI. Due to the nature of our operations and our corporate structure, we also have subsidiaries that have significant transactions in foreign currencies other than their functional currency. We record transaction gains and losses in our consolidated statements of income related to the recurring remeasurement and settlement of such transactions. To the extent practicable, we attempt to minimize this exposure by maintaining natural hedges between our current assets and current liabilities of similarly denominated foreign currencies.
Debt Issuance Costs
We defer costs we incur to issue debt and amortize these costs to interest expense over the term of the debt or, when the debt can be redeemed at the option of the holders, over the term of the redemption option.
Marketing Promotions
We periodically provide incentive offers to our customers to encourage booking of travel products and services. Generally, our incentive offers are as follows:
Current Discount Offers. These promotions include dollar off discounts to be applied against current purchases. We record the discounts as reduction in revenue at the date we record the corresponding revenue transaction.
Inducement Offers. These promotions include discounts granted at the time of a current purchase to be applied against a future qualifying purchase. We treat inducement offers as a reduction to revenue based on estimated future redemption rates. We allocate the discount amount between the current purchase and the potential future purchase based on our expected relative value of the transactions. We estimate our redemption rates using our historical experience for similar inducement offers.
Concession Offers. These promotions include discounts to be applied against a future purchase to maintain customer satisfaction. Upon issuance, we record these concession offers as a reduction to revenue based on estimated future redemption rates. We estimate our redemption rates using our historical experience for concession offers.
Advertising Expense
We incur advertising expense consisting of offline costs, including television and radio advertising, and online advertising expense to promote our brands. We expense the production costs associated with advertisements in the period in which the advertisement first takes place. We expense the costs of communicating the advertisement (e.g., television airtime) as incurred each time the advertisement is shown. For the years ended December 31, 2006, 2005, and 2004, our advertising expense was $427.2 million, $425.2 million and $452.9 million. As of December 31, 2006 and 2005, we had $12.6 million and $19.3 million of prepaid marketing expenses included in prepaid expenses and other current assets on our consolidated balance sheets.
Stock-Based Compensation
Effective January 1, 2006, we began accounting for stock-based compensation under the modified prospective method provisions of SFAS No. 123(R), Share-Based Payment, and related guidance. Under SFAS 123(R), we continue to measure and amortize the fair value for all share-based payments consistent with our past practice under SFAS 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting
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for Stock-Based Compensation - Transition and Disclosure. As a result, the adoption of SFAS 123(R) did not have a material impact on our financial position.
We measure and amortize the fair value of restricted stock units, stock options and warrants as follows:
Restricted Stock Units. Restricted stock units (“RSU”) are stock awards that are granted to employees entitling the holder to shares of common stock as the award vests, typically over a five-year period. We measure the value of RSUs at fair value based on the number of shares granted and the quoted price of our common stock at the date of grant. We amortize the fair value, net of estimated forfeitures, as stock-based compensation expense over the vesting term on a straight-line basis. We record RSUs that may be settled by the holder in cash, rather than shares, as a liability and we remeasure these instruments at fair value at the end of each reporting period. Upon settlement of these awards, our total compensation expense recorded over the vesting period of the awards will equal the settlement amount, which is based on our stock price on the settlement date.
Performance-based RSUs vest upon achievement of certain company-based performance conditions. On the date of grant, we assess whether it is probable that the performance targets will be achieved, and if assessed as probable, we determine the fair value of the performance-based award based on the fair value of our common stock at that time. We record compensation expense for these awards over the estimated performance period using the accelerated method under Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans - an interpretation of Accounting Principles Board Opinion No. 15 and 25. At each reporting period, we reassess the probability of achieving the performance targets and the performance period required to meet those targets. The estimation of whether the performance targets will be achieved and of the performance period required to achieve the targets requires judgment, and to the extent actual results or updated estimates differ from our current estimates, the cumulative effect on current and prior periods of those changes will be recorded in the period estimates are revised, or the change in estimate will be applied prospectively depending on whether the change affects the estimate of total compensation cost to be recognized or merely affects the period over which compensation cost is to be recognized. The ultimate number of shares issued and the related compensation expense recognized will be based on a comparison of the final performance metrics to the specified targets.
Stock Options and Warrants. We measure the value of stock options and warrants issued or modified, including unvested options assumed in acquisitions, on the grant date (or modification or acquisition dates, if applicable) at fair value, using the Black-Scholes option valuation model. We amortize the fair value, net of estimated forfeitures, over the remaining vesting term on a straight-line basis.
Estimates of fair value are not intended to predict actual future events or the value ultimately realized by employees who receive these awards, and subsequent events are not indicative of the reasonableness of our original estimates of fair value. In determining the estimated forfeiture rates for stock-based awards, we periodically conduct an assessment of the actual number of equity awards that have been forfeited to date as well as those expected to be forfeited in the future. We consider many factors when estimating expected forfeitures, including the type of award, the employee class and historical experience. The estimate of stock awards that will ultimately be forfeited requires significant judgment and to the extent that actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period such estimates are revised. For additional information about the changes in estimated forfeiture rates, see Note 9 - Stock-Based Awards and Other Equity Instruments.
We have calculated an additional paid-in capital (“APIC”) pool pursuant to the provisions of SFAS 123(R). The APIC pool represents the excess tax benefits related to stock-based compensation that are available to absorb future tax deficiencies. We include only those excess tax benefits that have been realized in accordance with SFAS No. 109, Accounting for Income Taxes. If the amount of future tax deficiencies is greater than the available APIC pool, we will record the excess as income tax expense in our consolidated statements of
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income. In 2006, we recorded tax deficiencies of $11.6 million against the APIC pool; as a result, such deficiencies did not affect our results of operations. Excess tax benefits or tax deficiencies are a factor in the calculation of diluted shares used in computing dilutive earnings per share. The adoption of SFAS 123(R) did not have a material impact on our dilutive shares.
Prior to our adoption of SFAS 123(R), we recorded cash retained as a result of tax benefit deductions relating to stock-based compensation in operating activities in our consolidated statements of cash flows, along with other tax cash flows, in accordance with the provisions of the EITF No. 00-15, Classification in the Statement of Cash Flows of the Income Tax Benefit Received by a Company upon Exercise of a Nonqualified Employee Stock Option. SFAS 123(R) supersedes EITF 00-15, amends SFAS No. 95, Statement of Cash Flows, and requires that, upon adoption, we present the tax benefit deductions relating to excess stock-based compensation deductions as a financing activity in our consolidated statements of cash flows. In 2006, we reported $1.3 million of tax benefit deductions as a financing activity that previously would have been reported as an operating activity.
Earnings Per Share
We compute basic earnings per share by taking net income available to common shareholders divided by the weighted average number of common and Class B common shares outstanding during the period excluding restricted stock and stock held in escrow. Diluted earnings per share include the potential dilution that could occur from stock-based awards and other stock-based commitments using the treasury stock or the as if converted methods, as applicable. For additional information on how we compute earnings per share, see Note 12 - Earnings Per Share.
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents and restricted cash and cash equivalents reported on our consolidated balance sheets approximate fair value as we maintain them with various high-quality financial institutions or in short-term duration high-quality debt securities. The accounts and notes receivable are short-term in nature and are generally settled shortly after the sale. We maintain the carrying amounts of the derivative liabilities created in the Spin-Off at fair value, which is based upon appropriate valuation methodologies.
Certain Risks and Concentrations
Our business is subject to certain risks and concentrations including dependence on relationships with travel suppliers, primarily airlines and hotels, dependence on third-party technology providers, exposure to risks associated with online commerce security and credit card fraud. We are highly dependent on our relationships with six major airlines in the United States. We also depend on global distribution system partners and third-party service providers for certain fulfillment services.
Financial instruments, which potentially subject us to concentration of credit risk, consist primarily of cash and cash equivalents. We maintain some cash and cash equivalents balances with financial institutions that are in excess of Federal Deposit Insurance Corporation insurance limits.
Contingent Liabilities
We have a number of regulatory and legal matters outstanding, as discussed further in Note 14 - Commitments and Contingencies. Periodically, we review the status of all significant outstanding matters to assess the potential financial exposure. When (i) it is probable that an asset has been impaired or a liability has been incurred and (ii) the amount of the loss can be reasonably estimated, we record the estimated loss in our consolidated statements of income. We provide disclosure in the notes to the consolidated financial statements for loss contingencies that do not meet both these conditions if there is a reasonable possibility that
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a loss may have been incurred. Significant judgment is required to determine the probability that a liability has been incurred and whether such liability is reasonably estimable. We base accruals made on the best information available at the time which can be highly subjective. The final outcome of these matters could vary significantly from the amounts included in the accompanying consolidated financial statements.
New Accounting Pronouncements
Presentation of Taxes in the Income Statement. In June 2006, the FASB reached a consensus on EITF Issue No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation). EITF 06-3 indicates that the income statement presentation on either a gross basis or a net basis of the taxes within the scope of the issue is an accounting policy decision that should be disclosed. EITF 06-3 is effective for interim and annual periods beginning after December 15, 2006. We present the taxes within the scope of EITF 06-3 on a net basis.
Accounting for Uncertainty in Income Taxes. In July 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109, which clarifies the accounting for uncertainty in tax positions. FIN 48 prescribes guidance related to the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 requires that we recognize in our financial statements the impact of a tax position, if that position is more likely than not to be sustained upon an examination, based on the technical merits of the position. FIN 48 must be applied to all existing tax positions upon initial adoption. The cumulative effect of applying FIN 48 at adoption, if any, is to be reported as an adjustment to opening retained earnings for the year of adoption. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. We are in the process of determining the impact, if any, of this interpretation on our results from operations and financial position.
Fair Value Measurements. In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS 157 only applies when another standard requires or permits assets or liabilities to be measured at fair value and does not require any new fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. We are in the process of determining the impact, if any, of this statement on our results from operations, financial position or cash flows.
NOTE 3 - Business Acquisitions
eLong. In August 2004, we purchased a 30% ownership interest in eLong, a publicly-traded Cayman Island company, whose principal business is the operation of an internet-based travel business in the People’s Republic of China, for approximately $59.0 million in cash, and were concurrently issued a warrant to allow us to acquire additional shares, with an exercise price of approximately $6.21 per share of common stock, or $108 million.
In January 2005, we exercised the warrant resulting in an aggregate purchase price of $170.6 million, including our initial investment, exercise of the warrant and related transaction costs, a total ownership position of 59% and voting rights of approximately 96%. From August 2004 to the warrant exercise the investment was accounted for under the equity method, and from the warrant exercise forward we have consolidated the operating results of eLong. As of December 31, 2006, our ownership interest in eLong was 55%.
eLong’s American Depositary Shares (“ADS”) trade on the NASDAQ under the symbol “LONG.” Each ADS is equivalent to two shares of eLong common stock.
TripAdvisor. In April 2004 and July 2005, we acquired 94.1% and an additional 1%, respectively, of TripAdvisor, a travel search engine and directory that enables consumers to research their travel and
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destination place through the internet. The aggregate purchase price for our acquisition in April 2004 was $219.3 million. In 2006, we purchased the remaining 4.9% minority ownership in TripAdvisor for $18.3 million in cash.
Egencia. In April 2004, we acquired 91.4% of the ownership of Egencia (renamed ECT-Europe), an online corporate travel agency in France, for an aggregate purchase price of $65.7 million. In April 2006, we acquired the remaining 8.6% minority ownership interest in Egencia for $3.3 million in cash and recorded a $3.1 million liability that will be paid in cash through April 2008.
NOTE 4 - Property and Equipment, Net
Our property and equipment consists of the following:
As of December 31, 2006 and 2005, our recorded capitalized software development costs, net of accumulated amortization, were $92.4 million and $49.5 million. For the years ended December 31, 2006, 2005 and 2004, we recorded amortization of capitalized software development costs of $28.3 million, $38.6 million and $24.0 million.
NOTE 5 - Goodwill and Intangible Assets, Net
The following table presents our goodwill and intangible assets as of December 31, 2006 and 2005:
We perform our annual assessment of possible impairment of goodwill and indefinite lived intangible assets as of October 1, or more frequently if events and circumstances indicate that impairment may have occurred. We performed our annual impairment assessment for goodwill and intangible assets as of October 1, 2006 and had no impairments.
Our indefinite lived intangible assets relate principally to trade names and trademarks acquired in various acquisitions. Based on lower than expected year-to-date revenue growth, we determined that our indefinite lived trade name intangible asset related to Hotwire might be impaired during the third quarter of 2006. Accordingly, we performed a valuation of that asset and determined that its carrying amount exceeded its fair
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value and recognized an impairment charge of $47.0 million in “Impairment of intangible asset” in our consolidated statements of income. We based our measurement of fair value of the trade name intangible asset using the relief-from-royalty method. This method assumes that a trade name has value to the extent that its owner is relieved of the obligation to pay royalties for the benefits received therefrom.
The following table presents the changes in goodwill:
As of December 31, 2006 and 2005, approximately 80% of our goodwill was assigned to our North American segment and approximately 17% to our European segment.
In 2006, the additions to goodwill relate primarily to the remaining purchase of TripAdvisor and Egencia shares and other miscellaneous business acquisitions. The deductions from goodwill primarily relate to the income tax benefit realized pursuant to the exercise of stock options assumed in business acquisitions that were vested at the transaction date and are treated as a reduction in purchase price when the deductions are realized.
In 2005, the additions to goodwill relate to new acquisitions, primarily eLong, as well as adjustments to the carrying value of goodwill based upon the finalization of the valuation of intangible assets and their related deferred tax impacts, and the deductions from goodwill relate to the income tax benefit realized pursuant to the exercise of stock options assumed in business acquisitions that were vested at the transaction date and are treated as a reduction in purchase price when the deductions are realized.
The following table presents the components of our intangible assets with definite lives as of December 31, 2006 and 2005.
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Amortization expense was $110.8 million, $126.1 million and $125.1 million for the years ended December 31, 2006, 2005 and 2004. The estimated future amortization expense related to intangible assets with definite lives as of December 31, 2006, assuming no subsequent impairment of the underlying assets, is as follows:
NOTE 6 - Debt
Short-term Borrowings
In July 2005, we entered into a $1.0 billion five-year unsecured revolving credit facility with a group of lenders, which was effective as of the Spin-Off, and is unconditionally guaranteed by certain Expedia subsidiaries. The facility bears interest based on our financial leverage, which as of December 31, 2006 and 2005, was equal to LIBOR plus .50%. The annual fee to maintain the facility is 0.1% on the unused portion of the facility, or approximately $1.0 million if all of the facility is unused. The facility also contains financial covenants consisting of a leverage ratio and a minimum net worth requirement. As of December 31, 2006, we were in compliance with our financial covenants which relate to leverage and minimum net worth.
The amount of stand-by letters of credit (“LOC”) issued under the facility reduces the amount available to us. As of December 31, 2006, and December 31, 2005, there was $52.0 million and $53.2 million of outstanding stand-by LOCs issued under the facility. As of December 31, 2005, we had $230.0 million outstanding under the facility, which we fully repaid during the quarter ended March 31, 2006. The $230.0 million carrying amount of the short-term borrowing approximates its fair value as of December 31, 2005. As of December 31, 2006, there was no amount outstanding under the facility.
On January 19, 2007, we completed a tender offer for 30 million common shares and paid for the tendered shares acquired, in part, by drawing on our revolving credit facility. As of February 15, 2007, the outstanding balance on the credit facility was $150 million, not including the stand-by LOCs also issued under the facility. For additional information about the tender offer, see Note 11 - Stockholders’ Equity.
Long-term Debt
In August 2006, we privately placed $500.0 million of senior unsecured notes due 2018 (the “Notes”). The Notes bear a fixed rate interest of 7.456% with interest payable semi-annually in February and August of each year, beginning in February 2007. The amount of accrued interest related to the Notes was $13.4 million as of December 31, 2006. The Notes are repayable in whole or in part on August 15, 2013, at the option of the holders of such Notes, at 100% of the principal amount plus accrued interest. We may redeem the Notes in accordance with the terms of the agreement, in whole or in part at any time at our option.
On February 14, 2007, we commenced an offer to exchange the Notes for registered notes having substantially the same financial terms and covenants as the privately placed notes. The offer will expire, unless extended, on March 15, 2007.
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
The fair value of our Notes was approximately $520 million as of December 31, 2006 based on the quoted market price.
The Notes are senior unsecured obligations guaranteed by certain domestic Expedia subsidiaries and rank equally in right of payment with all of our existing and future unsecured and unsubordinated obligations. For further information, see Note 19 - Guarantor and Non-Guarantor Supplemental Financial Information.
The Notes include covenants that limit our ability to (i) incur liens, (ii) enter into sale and leaseback transactions and (iii) merge, consolidate or sell substantially all of our assets. As of December 31, 2006, we were in compliance with all covenants.
NOTE 7 - Derivative Instruments
The fair values of the derivative financial instruments generally represent the estimated amounts we would expect to receive or pay upon termination of the contracts as of the reporting date. Components of our derivative liabilities balance are as follows:
Ask Jeeves Notes
As a result of the Spin-Off, we assumed certain obligations to IAC related to IAC’s Ask Jeeves Notes. When holders of the Ask Jeeves Notes convert their notes, they will receive shares of both IAC and Expedia common stock. Under the terms of the Spin-Off, we are obligated to issue shares of our common stock to IAC for delivery to the holders of the Ask Jeeves Notes, or pay cash in equal value, in lieu of issuing such shares, at our option. This obligation represents a derivative liability on our consolidated balance sheet because it is not indexed solely to shares of our common stock. We record the fair value of this derivative obligation on our consolidated balance sheets with any changes in fair value recorded in our consolidated statements of income. The estimated fair value of this liability fluctuates primarily based on changes in the price of our common stock.
In 2006 and 2005, certain of these notes were converted and we released approximately 3.5 million and 37,000 shares of our common stock from escrow with a fair value of $80.8 million and $0.9 million to satisfy the conversion requirements. In 2006 and 2005, we recognized a net unrealized gain (loss) of $8.1 million and $(6.0) million related to these Ask Jeeves Notes.
As of December 31, 2006, we estimate that we could be required to release from escrow up to 0.8 million shares of our common stock (or pay cash in equal value, in lieu of issuing such shares, at our option). The Ask Jeeves Notes are due June 1, 2008; upon maturity of these notes, our obligation to satisfy demands for conversion ceases.
Cross-Currency Swaps
We enter into cross-currency swaps to hedge against the change in value of certain intercompany loans denominated in currencies other than the lending subsidiaries’ functional currency.
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
In November 2003, we entered into a swap with a notional amount of Euro 39.0 million that matures in October 2013. Under the terms of this swap, we pay Euro at a rate of the three-month EURIBOR plus 0.50% on Euro 39.0 million and we receive 4.90% interest on $46.4 million in U.S. dollars.
In April 2004, we entered into a swap with a notional amount of Euro 38.2 million that matures in April 2014. Under the terms of this swap, we pay Euro at a rate of the six-month EURIBOR plus 0.90% on Euro 38.2 million and we receive 5.47% interest on $45.9 million in U.S. dollars.
Upon maturity, these cross-currency swap agreements call for the exchange of notional amounts. These swaps have been designated as cash flow hedges and are re-measured at fair value each reporting period. The hedges have been determined to be perfectly effective, at designation and on an ongoing basis. As such, we record the total change in the fair value of the hedges in OCI each period, and concurrently reclassify a portion of the gain or loss to other income (expense), net to perfectly offset gains or losses related to transactional remeasurement of the hedged items. We are not able to predict future gains or losses due to remeasurement of the hedged items, or the equivalent reclassifications of the gains or losses on the hedges from accumulated OCI to earnings. There was no ineffectiveness related to these cash flow hedges for the years ended December 31, 2006, 2005 and 2004.
In addition, as of December 31, 2006, we had $14.1 million of cash held by counterparties as collateral for our cross-currency swaps, which is classified in long-term investments and other assets on our consolidated balance sheet.
Stock Warrants
In connection with prior transactions, IAC assumed a number of stock warrants that were adjusted to become exercisable into IAC common stock and subsequent to the Spin-Off, also in our common stock. As of December 31, 2006, there are approximately 42,700 of these stock warrants outstanding with expiration dates through May 2010. Each stock warrant represents the right to receive the number of shares of IAC common stock and Expedia common stock that the stock warrant holder would have received had the holder exercised the stock warrant immediately prior to the Spin-Off. Under the terms of the Spin-Off between IAC and Expedia, we assumed the obligation to deliver our common stock to the stock warrant holders upon exercise and will receive a portion of the proceeds from exercise. This obligation represents a derivative instrument that we record at fair value on our consolidated balance sheets with any changes in value recorded in our consolidated statements of income. The estimated fair value of this liability fluctuates based on changes in the price of our common stock.
NOTE 8 - Employee Benefit Plans
Our U.S. employees are generally eligible to participate in a retirement and savings plan that qualifies under Section 401(k) of the Internal Revenue Code. Participating employees may contribute up to 16% of their pretax salary, but not more than statutory limits. We contribute fifty cents for each dollar a participant contributes in this plan, with a maximum contribution of 3% of a participant’s earnings. Our contribution vests with the employee after the employee completes two years of service. Participating employees have the option to invest in our common stock, but there is no requirement for participating employees to invest their contribution or our matching contribution in our common stock. We also have various defined contribution plans for our international employees. Our contributions to these benefit plans was $8.0 million, $6.0 million and $4.1 million for the years ended December 31, 2006, 2005 and 2004.
NOTE 9 -
Stock-Based Awards and Other Equity Instruments
Pursuant to the 2005 Expedia, Inc. Stock and Annual Incentive Plan, we may grant restricted stock, restricted stock awards (“RSA”), RSUs, stock options and other stock-based awards to directors, officers, employees and consultants. As of December 31, 2006, we had approximately 7.1 million shares of common
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
stock reserved for new stock-based awards under the 2005 Stock and Annual Incentive Plan. We issue new shares to satisfy the exercise or release of stock-based awards.
As described below in “Modification of Stock-Based Compensation Awards,” certain stock options, restricted stock, RSUs and other equity based awards granted to our employees, officers, directors and consultants by IAC prior to the Spin-Off were converted into awards based on our common stock in connection with the Spin-Off. For the period from January 1, 2005 to August 8, 2005, and for the year ended December 31, 2004, IAC allocated to us stock-based compensation expense that was attributable to our employees.
RSUs, which are stock awards that are granted to employees entitling the holder to shares of our common stock as the award vests, are our primary form of stock-based award. We record RSUs that will settle in cash as a liability and we remeasure them to fair value at the end of each reporting period. These awards that settle in cash and the resulting liability are insignificant. Our RSUs generally vest over five years, but may accelerate in certain circumstances, including changes in control.
We have fully vested stock warrants with expiration dates through February 2012 outstanding, certain of which trade on the NASDAQ under the symbols “EXPEW” and “EXPEZ.” Each stock warrant is exercisable for a certain number of shares of our common stock or a fraction thereof.
The following table presents a summary of RSU awards from August 9, 2005 through December 31, 2006:
Included in RSUs outstanding at December 31, 2006 are approximately one million RSUs to certain senior executives, whereby future vesting is tied to achievement of performance targets. The total fair value of shares vested and released during the years ended December 31, 2006 and 2005 was $31.9 million and $3.3 million.
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
The following table presents a summary of our stock warrants (equivalent shares) from December 31, 2005 through December 31, 2006:
The following table presents a summary of our stock option transactions from August 9, 2005 through December 31, 2006:
The aggregate intrinsic value of outstanding options shown in the table above represents the total pretax intrinsic value at December 31, 2006, based on our the closing stock price of $20.98 as of the last trading date. The total intrinsic value of stock options exercised was $34.7 million and $213.2 million for the years ended December 31, 2006 and 2005. Since the Spin-off on August 9, 2005, we have not granted options. The expected to vest balance as of December 31, 2006 is equal to the outstanding balance at that date.
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
The following table presents a summary of our stock options outstanding and exercisable at December 31, 2006:
In 2006, 2005 and 2004, we recognized stock-based compensation expense of $80.3 million, $91.7 million and $171.4 million. In 2005, we recorded a cumulative benefit from the change in estimated forfeiture rates of approximately $43.4 million, which reduced the stock-based compensation expense. The total income tax benefit related to stock-based compensation expense was $27.0 million, $31.3 million and $64.5 million for 2006, 2005 and 2004.
Cash received from stock-based award exercises for the year ended December 31, 2006 was $35.3 million. Our employees that held vested stock options prior to the Spin-Off received vested stock options in both Expedia and IAC. As these stock options are exercised, we receive a tax deduction. Total current income tax benefits realized during the year ended December 31, 2006 associated with the exercise of IAC and Expedia stock-based awards held by our employees were $34.3 million, of which we recorded approximately $16.9 million as a reduction of goodwill.
As of December 31, 2006, there was approximately $145 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to unvested stock-based awards, which is expected to be recognized in expense over a weighted-average period of 1.7 years.
Modification of Stock-Based Awards
In connection with the Spin-Off, all existing IAC stock-based awards, which included RSUs, stock options and warrants, were converted as follows:
•
each vested stock option to purchase shares of IAC common stock converted into an option to purchase shares of IAC common stock and an option to purchase shares of Expedia common stock,
•
each unvested stock option to purchase shares of IAC common stock converted into a stock option to purchase shares of common stock of the applicable company for which the employee worked following the Spin-Off,
•
all RSUs converted into RSUs of the applicable company for which the employee worked following the Spin-Off, and
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
•
each vested and unvested warrant converted into a warrant to purchase shares of IAC common stock and a warrant to purchase shares of Expedia common stock.
The adjustments to the number of shares subject to each option and the option exercise prices were based on the relative market capitalization of IAC and Expedia following the Spin-Off. These modifications resulted in a one- time expense of $5.4 million due to the increase in the estimated fair value of vested stock options. Expenses related to incremental value due to modification of warrants, RSUs and unvested stock options were not material.
NOTE 10 - Income Taxes
The following table presents a summary of our U.S. and foreign income (loss) before income taxes and minority interest:
The following table presents a summary of our income tax expense components:
For all periods presented, we have computed current and deferred tax expense using our stand-alone effective tax rate. As of December 31, 2006, our current income tax payable represents amounts that we will pay to the Internal Revenue Service and other tax authorities based on our taxable income.
For the period January 1, 2005 through the Spin-Off date, we were a member of the IAC consolidated tax group. Accordingly, IAC filed a federal income tax return and certain state income tax returns on a combined basis with us for that period. IAC paid the entire combined income tax liability related to these filings. As such, our estimated income tax liability for this period was transferred to IAC upon Spin-Off and is not included in income taxes payable at December 31, 2005. Under the terms of the Tax Sharing Agreement, IAC can make certain elections in preparation of these tax returns, which may change the amount of income taxes we owe for the period after the Spin-Off. We intend to record such changes as adjustments to stockholders’
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
equity in accordance with EITF No. 94-10, Accounting by a Company for the Income Tax Effects of Transactions Among or With its Shareholders under FASB Statement 109.
We reduced our current income tax payable by $34.3 million, $50.6 million and $120.8 million for the years ended December 31, 2006, 2005 and 2004, for tax deductions attributable to stock-based compensation. For 2006 and 2005, we recorded $16.9 million and $25.3 million of the related income tax benefits of this stock-based compensation as a reduction of goodwill.
The tax effect of cumulative temporary differences and net operating losses that give rise to our deferred tax assets and deferred tax liabilities as of December 31, 2006 and 2005 are as follows:
At December 31, 2006, we had state and foreign net operating loss carryforwards (“NOLs”) of approximately $43.0 million and $49.0 million. If not utilized, the state NOLs will expire at various times between 2007 and 2025, $46.8 million foreign NOLs can be carried forward indefinitely, and $2.2 million foreign NOLs will expire at various times between 2007 and 2011.
At December 31, 2006, we had a valuation allowance of approximately $24.2 million related to the portion of tax operating loss carryforwards and other items for which it is more likely than not that the tax benefit will not be realized. This amount represented a decrease of approximately $1.3 million over the amount recorded as of December 31, 2005 and was primarily attributable to a reduction of state NOLs, offset by an increase in foreign operating losses. The tax benefit for approximately $3.5 million of the valuation allowance recorded at December 31, 2006 will be recorded as a reduction of goodwill if recognized in future years.
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
A reconciliation of total income tax expense to the amounts computed by applying the statutory federal income tax rate to income before income taxes and minority interest is as follows:
By virtue of the previously filed separate company and consolidated income tax returns filed with IAC, we are routinely under audit by federal, state, local and foreign authorities. These audits include questioning the timing and the amount of deductions and the allocation of income among various tax jurisdictions. Annual tax provisions include amounts considered sufficient to pay assessments that may result from the examination of prior year returns; however, the amount ultimately paid upon resolution of issues raised may differ from the amount provided. Differences between our contingent tax liabilities and the amounts actually owed are recorded in the period they become known.
In addition, we have a tax allocation agreement with Microsoft Corporation (“Microsoft”) as well as the Tax Sharing Agreement with IAC. For additional information about these agreements, see Note 15 - Related Party Transactions.
NOTE 11 - Stockholders’ Equity
Common Stock and Class B Common Stock
Our authorized common stock consists of 1.6 billion shares of common stock with par value of $0.001 per share, and 400 million shares of Class B common stock with par value of $0.001 per share. Both classes of common stock qualify for and would share equally in dividends, if declared by our Board of Directors, and generally vote together on all matters. Common stock is entitled to one vote per share and Class B common stock is entitled to 10 votes per share. Holders of common stock, voting as a single, separate class are entitled to elect 25% of the total number of directors. Class B common stockholders may, at any time, convert their shares into common stock, on a one for one share basis. Upon conversion, the Class B common stock is retired and is not available for reissue. In the event of liquidation, dissolution, distribution of assets or winding-up of Expedia, Inc., the holders of both classes of common stock have equal rights to receive all the assets of Expedia, Inc. after the rights of the holders of the preferred stock have been satisfied.
Preferred Stock
Our preferred stock has a face value of $22.23 per share; each share is entitled to an annual dividend of 1.99%. Each preferred stockholder is entitled to two votes per share. Preferred stockholders may, at certain times through 2017, elect to have their shares redeemed or elect to convert their shares into common stock based upon formulas described in the related Certificate of Designations of Series A Cumulative Convertible Preferred Stock of Expedia, Inc. Beginning February 4, 2012, we may redeem the preferred stock for cash or common stock. On February 4, 2022, all outstanding shares of preferred stock automatically convert into common stock.
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
Share Repurchases
During 2006, we completed the repurchase of 20 million shares of our common stock for a total cost of $288 million, representing an average price of $14.42 per share including transaction costs. All shares were repurchased in the open market at prevailing market prices.
In addition, our Board of Directors authorized additional share repurchases of up to 20 million outstanding shares of our common stock during 2006. As of February 15, 2007, we have not made any share repurchases under this authorization. There is no fixed termination date for the repurchase.
On January 19, 2007, we completed a tender offer pursuant to which we acquired 30 million tendered shares of our common stock at a purchase price of $22.00 per share, for a total cost of $660 million plus fees and expenses relating to the tender offer. These shares represent approximately 9.8% of the shares of common stock outstanding and 9.0% of the total number of shares of common stock and Class B common stock outstanding as of December 31, 2006. We paid for the tendered shares, in part, by drawing on our revolving credit facility.
Accumulated Other Comprehensive Income (Loss)
The following table presents the components of accumulated other comprehensive income (loss), net of tax:
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
Other Comprehensive Income
The following table presents the changes in the components of OCI, net of taxes:
In October 2004, eLong completed an initial public offering (“IPO”) of its shares. As a result of the IPO, our warrant became subject to the mark-to-market provisions of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. As such, we recorded an unrealized gain of $27.2 million, net of deferred taxes of $16.4 million, related to the warrant in other comprehensive income in 2004. We reversed the unrealized gain in January 2005 upon exercise of our warrant.
NOTE 12 - Earnings Per Share
Basic Earnings Per Share
Basic earnings per share was calculated for the year ended December 31, 2006 using the weighted average number of common and Class B common shares outstanding during the period excluding restricted stock and stock held in escrow. We have 846 shares of preferred stock outstanding, the impact of which on our earnings per share calculation is immaterial.
For the year ended December 31, 2005, we computed basic earnings per share using the number of shares of common stock and Class B common stock outstanding immediately following the Spin-Off, as if such shares were outstanding for the entire period prior to the Spin-Off, plus the weighted average of such shares outstanding following the Spin-Off. For the year ended December 31, 2004, we computed basic earnings per share using the number of shares of common stock and Class B common stock outstanding immediately following the Spin-Off, as if such shares were outstanding for the entire period.
Diluted Earnings Per Share
For the years ended December 31, 2006 and 2005, we computed diluted earnings per share using (i) the number of shares of common stock and Class B common stock used in the basic earnings per share calculation
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
as indicated above (ii) if dilutive, the incremental common stock that we would issue upon the assumed exercise of stock options and stock warrants and the vesting of restricted stock units using the treasury stock method, and (iii) the shares we are contractually obligated to issue associated with the Ask Jeeves Notes, if converted, and other stock-based commitments.
For the year ended December 31, 2004, we computed diluted earnings per share using (i) the number of shares of common stock and Class B common stock used in the basic earnings per share calculation as indicated above, and (ii) if dilutive, the incremental common stock that we would issue upon exercise of potentially dilutive stock-based commitments if the terms of the agreement under which the commitments were issued obligate us to issue the instrument as of the Spin-Off. Some of the stock warrant agreements meet this requirement, but options to purchase common stock and other potentially dilutive items do not. Warrants meeting this requirement were included in our diluted earnings per share calculation for the year ended December 31, 2004, based on the number of days they were outstanding at Spin-Off. We treated all other securities as if they were granted as of the Spin-Off.
The following table presents our basic and diluted earnings per share:
NOTE 13 - Other Income (Expense)
Other, net
The following table presents the components of other, net:
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
Write-off of Long-term Investment
In 2005, we received information regarding the deteriorating financial condition of our long-term investment in a leisure travel company and we determined that it was not likely we would recover any of our investment because the decline in its value was determined to be other-than-temporary. As a result, we recorded a loss related to this impairment of $23.4 million in write-off of long-term investment in our consolidated statements of income. In 2006, we sold our investment for nil consideration.
NOTE 14 - Commitments and Contingencies
Letters of Credit, Purchase Obligations and Guarantees
We have commitments and obligations that include purchase obligations, guarantees and LOCs, which could potentially require our payment in the event of demands by third parties or contingent events. The following table presents these commitments and obligations as of December 31, 2006:
Our purchase obligations represent the minimum obligations we have under agreements with certain of our vendors. These minimum obligations are less than our projected use for those periods. Payments may be more than the minimum obligations based on actual use. In addition, if certain obligations are met by our counterparties, our obligations will increase.
We have guarantees primarily related to a specific country aviation authority for the potential non-delivery, by us, of packaged travel sold in that country. The authority also requires that a portion of the total amount of packaged travel sold be bonded.
Our LOCs consist of stand-by LOCs, underwritten by a group of lenders, which we primarily issue to certain hotel properties to secure our payment for hotel room transactions. There were no claims made against any stand-by LOCs during the years ended December 31, 2006 and 2005.
Lease Commitments
We have contractual obligations in the form of operating leases for office space and related office equipment for which we record the related expense on a monthly basis. Certain leases contain periodic rent escalation adjustments and renewal options. Rent expense related to such leases is recorded on a straight-line basis. Operating lease obligations expire at various dates with the latest maturity in 2014. For the years ended December 31, 2006, 2005 and 2004, we recorded rental expense of $29.7 million, $26.0 million and $23.6 million.
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
The following table presents our estimated future minimum rental payments under operating leases with noncancelable lease terms that expire after December 31, 2006:
Legal Proceedings
In the ordinary course of business, we are a party to various lawsuits. In the opinion of management, we do not expect these lawsuits to have a material impact on the liquidity, results of operations, or financial condition of Expedia. We also evaluate other potential contingent matters, including value-added tax, federal excise tax, transient occupancy or accommodation tax and similar matters. We do not believe that the aggregate amount of liability that could be reasonably possible with respect to these matters would have a material adverse affect on our financial results.
Securities Related Class Action Litigations. While we are not a party to the securities litigation filed against IAC, under the terms of our Separation Agreement with IAC, we have generally agreed to bear a portion of the costs and liabilities, if any, associated with any securities law litigation relating to conduct prior to the Spin-Off of the businesses or entities that comprise Expedia following the Spin-Off. This case arises out of IAC’s August 4, 2004, announcement of its earnings for the second quarter of 2004.
Litigation relating to the IAC/Hotels.com merger agreement announced April 10, 2003, is pending in Delaware. The principal claim in these actions is that the defendants breached their fiduciary duty to the plaintiffs by entering into or approving the merger agreement.
Hotels.com is also a party to a securities class action and a shareholder derivative suit relating to Hotels.com’s guidance for the fourth quarter of 2002. The principal claim in these actions is that the defendants violated federal securities laws by making misstatements of material facts, failing to disclose material information, and trading in the company’s securities while in possession of material, non-public information. In 2004, the court dismissed virtually all of the plaintiffs’ claims with prejudice in the securities class action. In the shareholder derivative suit, on March 7, 2005, the district court issued orders staying the case until further notice and directing that the case be administratively closed pending a decision in the appeal of the action discussed above. The case remains administratively closed.
Litigation Relating to Hotel Occupancy Taxes. Expedia and certain of its businesses are parties to consumer and municipality litigation involving hotel occupancy taxes.
NOTE 15 - Related Party Transactions
Expenses Allocated from IAC
Prior to Spin-Off, our operating expenses include allocations from IAC for accounting, treasury, legal, tax, corporate support, human resource functions and internal audit. Expenses allocated from IAC were $5.0 million for the period from January 1, 2005 to August 8, 2005, and $7.5 million for the year ended December 31, 2004. We recorded the expense allocation from IAC in general and administrative expense in our consolidated statements of income.
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
Additional allocations from IAC prior to the Spin-Off related to stock-based compensation expense attributable to our employees. Stock-based compensation expense allocated from IAC was $56.5 million for the period from January 1, 2005 to August 8, 2005, and $171.4 million for the year ended December 31, 2004.
Interest Income from IAC
The interest income from IAC/InterActiveCorp recorded in our consolidated statements of income for the years ended December 31, 2005 and 2004 arose from intercompany receivable balances from IAC. The interest income from IAC ceased upon Spin-Off on August 9, 2005.
Relationship Between IAC and Expedia, Inc. after the Spin-Off
In connection with the Spin-Off, we entered into various agreements with IAC, a related party due to common ownership, to provide for an orderly transition and to govern our ongoing relationships with IAC. These agreements include the following:
•
a Separation Agreement that sets forth the arrangements between IAC and Expedia with respect to the principal corporate transactions necessary to complete the Spin-Off, and a number of other principles governing the relationship between IAC and Expedia following the Spin-Off;
•
a Tax Sharing Agreement that governs the respective rights, responsibilities and obligations of IAC and Expedia after the Spin-Off with respect to tax liabilities and benefits, tax attributes, tax contests and other matters regarding income taxes, other taxes and related tax returns;
•
an Employee Matters Agreement that governs a wide range of compensation and benefit issues, including the allocation between IAC and Expedia of responsibility for the employment and benefit obligations and liabilities of each company’s current and former employees (and their dependents and beneficiaries); and
•
a Transition Services Agreement that governs the provision of transition services from IAC to Expedia.
In addition, in conjunction with the Spin-Off, we entered into a joint ownership and cost sharing agreement with IAC, under which IAC transferred to us 50% ownership in an airplane, which is available for use by both companies. We share equally in capital costs; operating costs are pro-rated based on actual usage. In May 2006, the airplane was placed in service and is being depreciated over 10 years. As of December 31, 2006, the net basis in our ownership interest was $19.7 million recorded in long-term investments and other assets on our consolidated balance sheets. In 2006, operating and maintenance costs for the airplane were $0.6 million. We had $0.3 million in related accounts payable as of December 31, 2006.
Commercial Agreements with IAC
Since the Spin-Off, we have continued to work with some of IAC’s businesses pursuant to a variety of commercial relationships. These commercial agreements generally include (i) distribution agreements, pursuant to which certain subsidiaries of IAC distribute their respective products and services via arrangements with Expedia, and vice versa, (ii) services agreements, pursuant to which certain subsidiaries of IAC provide Expedia with various services and vice versa and (iii) office space lease agreements. The distribution agreements typically involve the payment of fees, usually on a fixed amount-per-transaction, revenue share or commission basis, from the party seeking distribution of the product or service to the party that is providing the distribution.
In 2006, we received $1.9 million from IAC businesses, and paid $31.3 million to IAC businesses. From August 9, 2005 to December 31, 2005, we received $0.8 million from IAC businesses and paid $10.7 million to IAC businesses. Amounts receivable from IAC businesses, which are included in accounts and notes receivable, totaled $0.6 million as of December 31, 2005. Amounts payable to IAC businesses, which are
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
included in accounts payable, other, totaled $1.1 million as of December 31, 2006, and $3.6 million as of December 31, 2005.
Other Transactions with IAC
In the fourth quarter of 2006, eLong sold one of its businesses to a subsidiary of IAC for a sale price of $14.6 million of which we received $13.2 million in cash in 2006.
Agreements with Microsoft Corporation
We have various agreements with Microsoft, which is the beneficial owner of more than 5% of our outstanding common stock, including an agreement that maintains our presence as the provider of travel shopping services on MSN.com and several international MSN websites and, in 2004, a data center services agreement. Total fees we paid with respect to these agreements were $26.5 million, $20.0 million and $12.6 million for the years ended December 31, 2006, 2005 and 2004.
Prior to November 1999, Microsoft owned 100% of our outstanding common stock. Concurrent with our separation from them, we entered into a tax allocation agreement whereby we must pay Microsoft for a portion of the tax savings resulting from the exercise of certain stock options when we realize the tax savings on our tax return. We recorded $36.3 million in other long-term liabilities on our consolidated balance sheets as of December 31, 2005 related to this agreement. As of December 31, 2006, we realized $6.0 million of tax savings on our tax return, and remitted an equivalent amount to Microsoft during the fourth quarter of 2006. As of December 31, 2006, we reclassified the remaining $30.3 million to other current liabilities from other long-term liabilities, which we anticipate paying by the end of 2007.
NOTE 16 - Segment Information
In the first quarter of 2006, we began reporting two segments: North America and Europe. The change from a single reportable segment is a result of the reorganization of our business. We determined our segments based on how our chief operating decision makers manage our business, make operating decisions and evaluate operating performance. Our primary operating metric for evaluating segment performance is “Operating Income Before Amortization” (defined below), which includes allocations of certain expenses, primarily cost of revenue and facilities, to the segments. We base the allocations primarily on transaction volumes and other usage metrics; this methodology is periodically evaluated and may change. We do not allocate certain expenses to reportable segments such as partner services, product development, accounting, human resources and legal. We include these expenses in Corporate and Other.
Our North America segment provides a full range of travel services to customers in the United States, Canada and Mexico. This segment operates through a variety of brands including Expedia, Hotels.com, Hotwire.com TripAdvisor and Classic Vacations. Our Europe segment provides travel services primarily through localized Expedia websites in the United Kingdom, Denmark, France, Germany, Italy, the Netherlands, Norway and Sweden, as well as localized versions of Hotels.com in various European countries.
Corporate and Other includes ECT, Expedia Asia Pacific and unallocated corporate functions and expenses. ECT provides travel products and services to corporate customers in North America and Europe. Expedia Asia Pacific provides online travel information and reservation services primarily in Australia, the People’s Republic of China and Japan, whose site launched in November 2006. In addition, we record amortization of intangible assets and any related impairment, as well as stock-based compensation expense in Corporate and Other.
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
The following table presents our segment information for the year ended December 31, 2006. We have not reported segment information for the years ended December 31, 2005 and 2004, as it is not practicable to do so. In addition, as a significant portion of our property and equipment is not allocated to our operating segments, we do not report the assets or related depreciation expense as it would not be meaningful, nor do we regularly provide such information to our chief operating decision makers.
Definition of Operating Income Before Amortization (“OIBA”)
We provide OIBA as a supplemental measure to GAAP. We define OIBA as operating income plus: (1) amortization of non-cash distribution and marketing expense, (2) stock-based compensation expense, (3) amortization of intangible assets and goodwill and intangible asset impairment, if applicable and (4) certain one-time items, if applicable.
OIBA is the primary operating metric used by which management evaluates the performance of our business, on which internal budgets are based, and by which management is compensated. Management believes that investors should have access to the same set of tools that management uses to analyze our results. This non-GAAP measure should be considered in addition to results prepared in accordance with GAAP, but should not be considered a substitute for, or superior to, GAAP. We endeavor to compensate for the limitation of the non-GAAP measure presented by also providing the comparable GAAP measures, GAAP financial statements, and descriptions of the reconciling items and adjustments, to derive the non-GAAP measure. We present a reconciliation of this non-GAAP financial measure to GAAP below.
OIBA represents the combined operating results of Expedia, Inc.’s businesses, taking into account depreciation, which we believe is an ongoing cost of doing business, but excluding the effects of other non-cash expenses that may not be indicative of our core business operations. We believe this measure is useful to investors for the following reasons:
•
it corresponds more closely to the cash operating income generated from our core operations by excluding significant non-cash operating expenses;
•
it aids in forecasting and analyzing future operating income as stock-based compensation, non-cash distribution and marketing expenses and intangible assets amortization, assuming no subsequent acquisitions, are likely to decline going forward; and
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
•
it provides greater insight into management decision making at Expedia, as OIBA is our primary internal metric for evaluating the performance of our business.
OIBA has certain limitations in that it does not take into account the impact of certain expenses to our consolidated statements of income, including stock-based compensation, non-cash payments to partners, acquisition-related accounting and certain one-time items, if applicable. Due to the high variability and difficulty in predicting certain items that affect net income, such as tax rates, stock price and interest rates, we are unable to provide a reconciliation to net income on a forward-looking basis without unreasonable efforts.
Reconciliation of OIBA to Operating Income and Net Income
The following table presents a reconciliation of OIBA to operating income and net income for the years ended December 31, 2006, 2005 and 2004:
Geographic Information
We maintain operations in the United States, Australia, Belgium, Canada, China, France, Germany, Italy, Japan, Mexico, the Netherlands, Spain, the United Kingdom and other international territories. The following table presents revenue by geographic area, the United States and all other countries, for the years ended December 31, 2006, 2005 and 2004:
We have revised the 2005 and 2004 revenue allocations between the United States and all other countries to reflect the current revenue allocations for certain points of sale in 2006. There was no impact on total consolidated revenue as a result of these changes.
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
The following table presents property and equipment, net by geographic area, the United States and all other countries, as of December 31, 2006 and 2005:
NOTE 17 - Valuation and Qualifying Accounts
We accrue the cost associated with purchases made on our website related to the use of fraudulent credit cards “charged-back” due to payment disputes and cancellation fees. The following table presents the changes in the valuation and qualifying accounts.
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
NOTE 18 - Quarterly Financial Information (Unaudited)
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
NOTE 19 - Guarantor and Non-Guarantor Supplemental Financial Information
Condensed consolidating financial information of Expedia, Inc. (the “Parent”), our subsidiaries that are guarantors of the Notes (the “Guarantor Subsidiaries”), and our subsidiaries that are not guarantors of the Notes (the “Non-Guarantor Subsidiaries”) is shown below. The Notes are guaranteed by certain of our wholly-owned domestic subsidiaries and rank equally in right of payment with all of our existing and future unsecured and unsubordinated obligations. The guarantees are full, unconditional, joint and several. In this financial information, the Parent and Guarantor Subsidiaries account for investments in their wholly-owned subsidiaries using the equity method.
CONDENSED CONSOLIDATING STATEMENT OF INCOME
Year Ended December 31, 2006
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
CONDENSED CONSOLIDATING STATEMENT OF INCOME
Year Ended December 31, 2005
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
CONDENSED COMBINING STATEMENT OF INCOME
Year Ended December 31, 2004
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
CONDENSED CONSOLIDATING BALANCE SHEET
December 31, 2006
CONDENSED CONSOLIDATING BALANCE SHEET
December 31, 2005
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Year Ended December 31, 2006
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Year Ended December 31, 2005
Expedia, Inc.
Notes to Consolidated Financial Statements - (Continued)
CONDENSED COMBINING STATEMENT OF CASH FLOWS
Year Ended December 31, 2004
Index to Exhibits
*
Reflects management contracts and management and director compensatory plans.
(1)
Incorporated by reference to Expedia, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005.
(2)
Incorporated by reference to Expedia, Inc.’s Current Report on Form 8-K, filed on August 15, 2005.
(3)
Incorporated by reference to Expedia, Inc.’s Registration Statement on Form S-4/A (File No. 333-124303-01), filed on June 13, 2005.
(4)
Incorporated by reference to Expedia, Inc.’s Registration Statement on Form 8-A/A, filed on August 22, 2005.
(5)
Incorporated by reference to Expedia, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006.
(6)
Incorporated by reference to Expedia, Inc.’s Registration Statement on Form S-8 (File No. 333-127324) filed on August 9, 2005.
(7)
Incorporated by reference to Expedia, Inc.’s Current Report on Form 8-K, filed on December 20, 2005.
(8)
Incorporated by reference to Expedia, Inc. Current Report on Form 8-K, filed on July 14, 2005.
(9)
Incorporated by reference to Expedia, Inc.’s Schedule TO (File No. 005-80935), filed on December 11, 2006.
(10)
Incorporated by reference to Expedia, Inc.’s Amended No. 3 to Schedule TO (File No. 005-80935), filed on December 22, 2006.
(11)
Incorporated by reference to Expedia, Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005.
(12)
Incorporated by reference to Expedia, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006.