Item 1.
Business
General Description of Our Business
Orbitz Worldwide, Inc. is a global online travel company (“OTC”) that uses innovative technology to enable leisure and business travelers to research, plan and book a broad range of travel products and services including hotels, flights, vacation packages, car rentals, cruises, travel insurance, destination services and event tickets. We provide our customers an easy-to-use booking experience across a wide variety of devices. Our global brand portfolio includes Orbitz and CheapTickets in the United States; ebookers in Europe; and HotelClub, which focuses on the Asia Pacific region. We also own and operate Orbitz for Business (“OFB”), which is a corporate travel management company, and the Orbitz Partner Network (“OPN”), which delivers private label travel solutions to a broad range of partners.
History
Orbitz, Inc. was established in early 2000 through a partnership of major airlines, which included American Airlines, Inc., Continental Airlines, Inc., Delta Air Lines, Inc., Northwest Airlines, Inc. and United Air Lines, Inc. Orbitz.com officially launched in June 2001. In November 2004, Orbitz was acquired by Cendant Corporation (“Cendant”), which already owned and operated the HotelClub and CheapTickets brands, and the next year Cendant acquired ebookers Limited.
In August 2006, affiliates of The Blackstone Group and Technology Crossover Ventures acquired Travelport Limited (“Travelport”), a unit of Cendant that included the businesses we now own and operate as well as other travel distribution businesses. In 2007, our businesses were separated from the rest of the Travelport businesses and placed in a newly formed company, Orbitz Worldwide, Inc. Orbitz Worldwide, Inc. was incorporated in Delaware on June 18, 2007, and became a public company in July 2007. Our common stock trades on the New York Stock Exchange under the symbol “OWW.”
At December 31, 2014 and 2013, there were 110,733,276 and 108,372,390 shares of our common stock outstanding, respectively, of which approximately 1% and 48% were beneficially owned by Travelport and the investment funds that indirectly owned Travelport. In the second quarter and early third quarter of 2014, Travelport sold approximately 47.7 million shares, and after its secondary stock offering on July 22, 2014, is no longer considered a related party.
On February 12, 2015, the Company, Expedia, Inc., (“Expedia”), and Xeta, Inc., an indirect wholly owned subsidiary of Expedia (“Merger Sub”) entered into an Agreement and Plan of Merger (the “Merger Agreement”).
The Merger Agreement provides, among other things and subject to the terms and conditions set forth therein, that Merger Sub will be merged with and into the Company (the “Merger”), with the Company surviving the Merger as an indirect wholly owned subsidiary of Expedia. At the effective time of the Merger (the “Effective Time”), each share of common stock of the Company outstanding immediately prior to the Effective Time (other than any shares owned by the Company, Expedia, Merger Sub or Merger Sub’s direct parent or any dissenting shares) will be automatically converted into the right to receive $12.00 in cash, without interest.
The Board of Directors of the Company by a unanimous vote of directors present approved the Merger Agreement and the transactions contemplated thereby, including the Merger. The closing of the Merger is subject to the adoption of the Merger Agreement by the affirmative vote of holders of a majority of the outstanding shares of common stock of the Company. The closing of the Merger is also subject to various customary conditions, including the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and other regulatory clearances, the absence of any governmental order prohibiting the consummation of the transactions contemplated by the Merger Agreement, the accuracy of the representations and warranties contained in the Merger Agreement (subject to certain materiality qualifications) and compliance with the covenants and agreements in the Merger Agreement in all material respects.
The Merger Agreement contains certain termination rights, including the right of the Company to terminate the Merger Agreement to accept a superior proposal (subject to compliance with certain notice and other requirements). The Merger Agreement provides that, in connection with termination of the Merger Agreement by the Company or Expedia upon specified conditions, the Company will be required to pay to Expedia a termination fee of $57.5 million. If the Merger Agreement is terminated as a result of the failure to obtain competition law approvals or a legal prohibition related to competition law matters, a termination fee of $115 million will be payable by Expedia to the Company, subject to certain limitations. In addition, subject to certain exceptions and limitations, the Company or Expedia may terminate the Merger Agreement if the
Merger is not consummated by August 12, 2015 (or as such date may be extended pursuant to the terms of the Merger Agreement).
The remainder of this Annual Report on Form 10-K excludes any impact that results or may result from the Merger Agreement.
Brand Portfolio
Our global consumer brand portfolio is composed of Orbitz.com and CheapTickets (U.S. domestic), and ebookers and HotelClub (international). Our global business brand portfolio consists of Orbitz for Business and the Orbitz Partner Network.
Orbitz (www.orbitz.com)
Orbitz.com is our most well-known brand and offers a full suite of travel products and services, including hotels, flights, vacation packages, car rentals, cruises, travel insurance, destination services and event tickets from suppliers worldwide. Since launching in June 2001, Orbitz.com has been an innovator in the industry having introduced Orbitz Matrix Display, mobile travel alerts and, most recently, the Orbitz Rewards Visa Card. Orbitz.com has maintained its technology leadership by offering a suite of mobile apps and solutions that now drive approximately 35% of its standalone hotel transactions. In October 2013, Orbitz.com launched its Orbitz Rewards loyalty program, which lets customers immediately earn OrbucksSM, the currency of Orbitz rewards, on flights, hotels and vacation packages and instantly redeem those OrbucksSM on future bookings at tens of thousands of hotels worldwide. The program aims to incentivize air bookers to book hotels in addition to their air travel bookings, increasing hotel cross-sell and our share of the customer’s travel spend as customers seek to earn and redeem rewards.
Orbitz members also get exclusive access to “Mobile Steals,” which are exclusive hotel deals in the most popular destinations around the world, available to mobile consumers.
CheapTickets (www.cheaptickets.com)
CheapTickets is an online travel company focused on value-conscious customers. CheapTickets offers customers the ability to search for and book a broad range of travel products and services, including hotels, flights, vacation packages, car rentals, cruises, travel insurance, destination services and event tickets from suppliers worldwide. CheapTickets offers value-oriented promotions such as “Cheap of the Week”® which provide customers with special travel offers on a weekly basis.
ebookers (www.ebookers.com)
ebookers is a pan-European online travel company that offers customers the ability to search for and book a broad range of global travel products and services through websites in Austria, Belgium, Denmark, Finland, France, Germany, Ireland, the Netherlands, Norway, Sweden, Switzerland and the United Kingdom. Customers can book travel products and services, including hotels, flights, vacation packages, car rentals, cruises, travel insurance, destination services and event tickets from suppliers worldwide. ebookers also offers customers the ability to book a full range of travel products from their smartphones and tablets through our mobile sites and our iOS and Android apps. In September 2014, ebookers launched its Bonus+ loyalty program, which lets customers immediately earn Bonus+ cash rewards on flights, hotels and vacation packages and instantly redeem them on future bookings at tens of thousands of hotels worldwide. Similar to the Orbitz Rewards loyalty program, the Bonus+ program aims to incentivize air bookers to book hotels in addition to their air travel bookings, increasing hotel cross-sell and our share of the customer’s travel spend as customers seek to earn and redeem rewards.
HotelClub (www.hotelclub.com)
HotelClub is a global hotel booking website offering members a worldwide selection of hotel properties across more than 170 countries. Through its unique loyalty program, HotelClub Rewards, members earn rewards on each booking made, which can then be redeemed on future hotel bookings. The company operates HotelClub.com and RatesToGo.com and offers services in 35 currencies and 18 languages, including Simplified Chinese, Traditional Chinese, Dutch, English, French, German, Italian, Japanese, Korean, Polish, Portuguese, Russian, Spanish, Swedish and Thai, among others. HotelClub also offers customers the ability to book a full range of travel products from their smartphones and tablets through its mobile sites and its iOS and Android apps.
Orbitz for Business (“OFB”) (www.orbitzforbusiness.com)
Orbitz for Business leverages our technology expertise for corporate travelers, offering a complete portfolio of travel products and services that help corporate customers plan, search and book business travel. In addition to its leading technology, Orbitz for Business delivers customizable, full service, cost-effective travel products and travel management solutions including 24/7 support, expense reporting and policy management tools. Orbitz for Business also offers a mobile web solution that allows business travelers to search for and book flights, hotels and car rentals directly from any web-enabled smartphone. Through partnerships with leading regional corporate travel companies, Orbitz for Business offers its services in over 80 countries to over 1,100 corporate travel clients.
In addition to our customer-facing brands and services, we also generate revenue through other sources, including:
Orbitz Partner Network (“OPN”) (www.orbitzpartnernetwork.com)
Orbitz Partner Network offers a full range of travel solutions to over one thousand partners globally, which include many of the world’s largest airlines, travel companies and financial institutions. Orbitz Partner Network enables our partners to provide a wide range of travel products on their websites under their own brands through solutions ranging from hosted services that can be launched in a matter of weeks to custom developed solutions that are fully tailored to meet the needs of more complex partners. We share net revenue with our partners from transactions booked on their websites. In February 2014, we announced the acquisition of certain assets and contracts of the Travelocity Partner Network (“TPN”), which provides private label technology solutions for bank loyalty programs and online commerce sites. TPN brings us deep technology capabilities and a strong customer base in the bank loyalty market.
Partner Marketing
The Partner Marketing team is responsible for building innovative online marketing and advertising partnerships across our global portfolio of consumer and business travel brands. We generate advertising revenue by providing our partners access to our customer base through a combination of display advertising, performance-based advertising, video production and other marketing programs. Travel companies, convention and visitor bureaus, credit card partners, media, packaged goods and other non-travel advertisers advertise on our websites.
Supplier Relationships and Global Distribution Systems
Supplier Relationships
We work with suppliers to provide our customers with a broad and deep range of highly competitive travel products and services on our websites. We have teams that manage relationships with hotel, air, car rental, cruise, travel insurance and destination services suppliers. Our supplier teams negotiate contracts regarding access to the supplier’s travel inventory and payment for our services, manage supplier relationships and obtain supplier-sponsored promotions.
For hotels, we are focused on offering our customers the ability to book the most relevant hotels at the most competitive prices. To do this, we focus on infrastructure to ensure we have appropriate connectivity with our suppliers, sophisticated sort order algorithms and robust promotional capabilities. Our global hotel services team works closely with hotel chains and independent hotels to increase the number of properties that participate on our websites and to ensure that our customers have access to their best available prices, including prices exclusive to our brands, where possible.
For airlines, we have long-standing relationships with hundreds of airlines, including most major U.S. and international carriers. We work with our suppliers to provide our customers with a highly competitive product offering.
Our suppliers continue to look for ways to decrease their overall distribution costs, which could significantly reduce the net revenue OTCs earn from travel and other travel-related products. As a result, the revenue we and other OTCs earn in the form of mark-ups and commissions from our suppliers is likely to be negatively impacted over the long term as supplier contracts are extended or renegotiated or as we add new suppliers.
Global Distribution Systems
Global distribution systems (“GDS”) provide us access to a comprehensive set of supplier content through a single source. Suppliers, such as airlines and hotels, utilize GDSs to connect their product and service offerings with travel providers, who in turn make these products and services available to travelers for booking. Certain of our businesses utilize GDS services
provided by Amadeus IT Group (“Amadeus”), Sabre Inc. (“Sabre”) and Travelport Worldwide Limited (“Travelport”). Under our GDS service agreements, we receive revenue in the form of an incentive payment for air, car and hotel segments processed through a GDS. These GDS service agreements may contain minimum segment volume commitments and require us to make shortfall payments if we do not process the required minimum number of segments for a given year. As a result, a significant portion of our GDS services are processed by these providers. For the year ended December 31, 2014, we recognized $94.7 million of incentive revenue from GDS providers, which accounted for more than 10% of our net revenue. In February 2014, Orbitz announced that it had entered into new multi-year GDS service agreements with Amadeus, Sabre and Travelport for the provision of technology and travel management solutions. The ability to use multiple GDSs across our business will provide us greater operational flexibility to take advantage of the strengths of each of the providers starting in 2015 as certain exclusivity provisions with Travelport lapse.
Merchant and Retail Models
We generate revenue primarily from the booking of travel products and services on our websites. We provide customers the ability to book travel products and services on both a stand-alone basis and as part of a vacation package, primarily through our merchant and retail business models.
Merchant Model
Our merchant model provides customers the ability to book air travel, hotels, car rentals, destination services and vacation packages. Hotel transactions comprise the majority of our merchant bookings. We generate revenue for our services based on the difference between the total amount the customer pays for the travel product and the negotiated net rate plus estimated taxes that the supplier charges us for that product. Depending upon the brand and the product, we may also earn revenue by charging our customers a service fee for booking their travel reservation. Generally, our net revenue per transaction is higher under the merchant model compared with the retail model. Customers generally pay us for reservations at the time of booking and we pay our suppliers at a later date, which is generally when the customer uses the reservation. However, in the case of merchant air, payment often occurs prior to the consumption date. Initially, we record these customer receipts as accrued merchant payables and either deferred income or net revenue, depending upon the travel product. The timing difference between when we collect money from our customers and when we pay our suppliers increases our operating cash flow and represents a source of liquidity for us.
We recognize net revenue under the merchant model when we have no further obligations to the customer. For merchant air transactions, this is at the time of booking. For merchant hotel transactions and merchant car transactions, net revenue is recognized at the time of check-in or customer pick-up, respectively. The timing of revenue recognition is different for merchant air travel because our primary service to the customer is fulfilled at the time of booking. In the merchant model, we do not take on credit risk with the customer since we are paid via credit card, debit card or certain other electronic payment processors (collectively, “Payment Processors”), while the Payment Processors collects funds from the customer; however, we are subject to charge-backs and fraud risk, which we actively monitor. We are not responsible for the actual delivery of the flight, hotel room or car rental; we take no inventory risk; we have no ability to determine or change the products or services delivered; and the customer chooses the supplier. The Payment Processors transmit payment for the reservation within one to two days of the booking date. The Payment Processors take on the risk of collecting funds from the customer. We are subject to fraud because we may be charged by Payment Processors for fraudulent charges after we remit funds to the supplier. In other instances, the customer may be dissatisfied with some aspect of their travel and contest the charge with the Payment Processors, which could result in a charge-back.
Retail Model
Our retail model provides customers the ability to book air travel, hotels, car rentals and cruises. Air transactions comprise the majority of our retail bookings. Under the retail model, we earn commissions from suppliers for airline tickets, hotel rooms, car rentals and other travel products and services booked on our websites. We generally receive these commissions from suppliers after the customer uses the travel reservation. Depending upon the brand and the product, we may also earn revenue by charging customers a service fee for booking their travel reservation. Generally, our net revenue per transaction is lower under the retail model compared with the merchant model. Airline tickets booked under the retail model contribute substantially to our overall gross bookings and net revenue due to the high volume of airline tickets booked on our websites. We recognize net revenue under the retail model when the reservation is made, is secured by a customer with a credit card, and we have no further obligations to the customer. For air transactions, this is at the time of booking. For hotel transactions and car transactions, net revenue is recognized at the time of check-in or customer pick-up respectively, net of an allowance for cancelled reservations. In the retail model, we do not take on credit risk with the customer; we are not the primary obligor with the customer; we have no latitude in determining pricing; we take no inventory risk; we have no ability to determine or change
the products or services delivered; and the customer chooses the supplier. We are, however, subject to charge-back by airlines for fraudulent transactions.
When customers assemble vacation packages, we may offer the customer the ability to book a combination of travel products that use both the merchant model and the retail model. Vacation packages allow us to make products available to our customers at prices that are generally lower than booking each travel product separately.
Operations and Technology
Systems Infrastructure
We use CenturyLink and Verizon Business co-location services in the United States to host our systems infrastructure for Orbitz, CheapTickets, Orbitz for Business, HotelClub, ebookers and private label partners. CenturyLink and Verizon provide data center management services as well as emergency hands-on support. In addition, we have dedicated staff on-site at each facility.
Systems Platform
Our systems platform enables us to deconstruct the segment feeds from our GDS partners for air flight searches and then reassemble these segments for cost-effective and flexible multi-leg itineraries. The easy-to-use Orbitz Matrix Display allows customers to simultaneously view these various travel options so that they can select the price and supplier that best meet their travel needs. In addition, our vacation packaging technology enables travelers to view multiple combinations of airlines, hotels and other travel products and to assemble a customized vacation package that is generally less expensive than booking each travel product separately.
We have technology operations teams dedicated to ensuring that our websites operate efficiently. These teams monitor our websites, our private label customer websites and the performance and availability of our third-party service providers, as well as coordinate releases of new functionality on our websites. We have product development teams focused on creating new and enhancing existing website functionality. These teams completed the migration of our global consumer brands to one common technology platform in 2012 (the “Global Platform”).
Customer Support
Our customer support platform includes customer self-service, chat, email and call center services to provide our customers with multiple options to enhance the travel experience. We utilize intelligent voice routing and intelligent call management technology to connect customers with the appropriate agent who can best assist them with their particular needs. We utilize third-party vendors domestically and internationally to manage these call centers and customer service centers.
Fraud Prevention System
We use a system of third-party and internally developed fraud prevention tools that we believe enable us to efficiently detect fraudulent bookings. The system automates many functions and prioritizes suspicious transactions for review by fraud analysts within our fraud prevention team.
Marketing
We use a combination of online and traditional offline marketing. Our sales and marketing efforts primarily focus on increasing brand awareness and driving visitors to our websites. Our long-term success will depend on our ability to continue to increase the overall number of booked transactions in a cost-effective manner.
We use various forms of online marketing to drive traffic to our websites including search engine marketing (“SEM”), travel research websites, meta-search travel websites, display advertising, affiliate programs and email marketing. We continue to pursue strategies to improve our online marketing efficiency and have utilized our advanced analytics capabilities to support development, testing and verification of new strategies. These strategies include increasing the amount of traffic coming to our websites through search engine optimization (“SEO”) and customer relationship management (“CRM”), and improving the efficiency of our SEM and travel research spending. We also use traditional broadcast advertising to focus on brand differentiation and to emphasize distinct features of our businesses that we believe are valuable to our customers.
We have dedicated marketing teams that focus on generating leads and building relationships with corporate travel managers and potential private label partners. Our Orbitz for Business sales team includes experienced corporate travel managers who are qualified to assist organizations in choosing between the variety of corporate booking products that we offer.
Intellectual Property
We regard our technology and other intellectual property, including our brands, as a critical part of our business. We protect our intellectual property rights through a combination of copyright, trademark and patent laws and confidentiality procedures. We have a number of trademarks, service marks and trade names that are registered or for which we have pending registration applications or common law rights. We currently hold numerous issued United States patents and pending United States patent applications. We file additional patent applications on new inventions, as appropriate.
Despite these efforts and precautions, we cannot be certain that any of these patent applications will result in issued patents, or that we will receive any effective protection from competition from any trademarks and issued patents. It may be possible for a third-party to copy or otherwise obtain and use our intellectual property without authorization. In that case, legal remedies may not adequately compensate us for the damages caused by unauthorized use.
From time to time, we may be subject to legal proceedings and claims in the ordinary course of our business, including claims of alleged infringement by us of the trademarks, copyrights, patents and other intellectual property rights of third parties. In addition, we may have to initiate lawsuits in the future to enforce our intellectual property rights or determine the validity and scope of proprietary rights claimed by others. Any such litigation, regardless of outcome or merit, could consume a significant amount of financial resources or management time. It could also invalidate or impair our intellectual property rights, or result in significant damages or onerous license terms and restrictions for us. We may even lose our right to use certain intellectual property or business processes. These outcomes could materially harm our business. See Item 3, “Legal Proceedings.”
At the time of the IPO, we entered into a Master License Agreement with Travelport, which grants Travelport licenses to use certain of our intellectual property going forward, including:
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our supplier link technology;
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portions of ebookers’ booking, search and vacation packaging technologies;
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certain of our products and online booking tools for corporate travel;
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portions of our private label vacation packaging technology; and
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our extranet supplier connectivity functionality.
The Master License Agreement generally includes the right to create derivative works and other improvements. Other than the unrestricted use of our supplier link technology, Travelport is generally prohibited from sublicensing these technologies to any third-party for competitive use. However, Travelport and its affiliates are not restricted from using the technologies to compete directly with us.
Regulation
Our business is subject to laws and regulations relating to our revenue generating and marketing activities, including those prohibiting unfair and deceptive advertising or practices, consumer protection and data privacy. Our travel services are subject to regulation and laws governing the offer of travel products and services, including laws requiring us to register as a “seller of travel” in various jurisdictions and to comply with certain disclosure requirements. As an OTC that offers customers the ability to book air travel in the United States, we are also subject to regulation by the Department of Transportation, which has authority to enforce economic regulations and may assess civil penalties or challenge our operating authority. Our services are also subject to federal, foreign, state and local regulations and we may be required to comply with bonding regulations in certain foreign jurisdictions. See Item 1A
Item 1A. Risk Factors
The proposed merger is subject to various closing conditions, including regulatory and stockholder approvals, as well as other uncertainties and there can be no assurances as to whether and when the merger may be completed.
As previously announced, on February 12, 2015, the Company entered into an Agreement and Plan of Merger with Expedia, Inc. and an indirect wholly owned subsidiary of Expedia, under which, subject to the terms and conditions of the Merger Agreement, the Merger Sub will be merged with and into the Company, with the Company surviving the Merger as an indirect wholly owned subsidiary of Expedia. The consummation of the Merger is subject to various customary conditions, including the affirmative vote of holders of a majority of the outstanding shares of common stock of the Company, the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and other regulatory clearances, the absence of any governmental order prohibiting the consummation of the transactions contemplated by the Merger Agreement, the accuracy of the representations and warranties contained in the Merger Agreement and compliance with the covenants and agreements in the Merger Agreement. If these conditions to the closing of the Merger are not fulfilled, then the Merger cannot be consummated. Several of these required closing conditions are not within Orbitz’s control, including regulatory approval, and we cannot predict with certainty whether and when any of the required closing conditions will be satisfied or if another uncertainty may arise. If the Merger does not receive, or timely receive, the required regulatory approvals and clearances, or if another event occurs that delays or prevents the Merger, such delay or failure to complete the Merger may cause uncertainty and other negative consequences that may materially and adversely affect Orbitz’s business, financial position, and results of operations.
We can give you no assurance that the Merger will be consummated, in which case we would not realize the anticipated benefits of having completed the Merger, which may adversely affect us. In addition, under certain circumstances, we may be required to pay a termination fee of up to $57.5 million if the Merger is not consummated.
While the Merger is pending, we will be subject to business uncertainties and contractual restrictions that could materially adversely affect our operations and the future of our business or result in a loss of employees.
Uncertainty about the effect of the Merger on employees, customers and business partners may negatively impact the Company. These uncertainties could cause customers, business partners and other third parties to modify existing business relationships with the Company. Such uncertainty may also cause potential customers and business partners to decide not to pursue business or other relationships with Orbitz. Additionally, these uncertainties may impair our ability to attract and retain key personnel until the Merger is completed as certain employees may experience uncertainty about their future roles. If key or a high number of employees depart because of issues relating to the uncertainty, the perceived difficulty of integration or a desire not to remain with the business, the Company’s business could be negatively impacted. These factors, either individually or collectively, may negatively impact the financial performance of the Company pending the consummation of the merger.
In the event that the pending Merger with Expedia is not completed, the trading price of our common stock and our future business and financial results may be negatively impacted.
As noted above, the conditions to the completion of the Merger with Expedia may not be satisfied. If the Merger with Expedia is not completed for any reason, we would still be liable for significant transaction costs and the focus of our management would have been diverted from seeking other potential opportunities without realizing any benefits of the completed Merger. If we do not complete the Merger, the price of our common stock may decline significantly from the current market price, which may reflect a market assumption that the Merger will be completed.
If the proposed Merger is not completed or we are not otherwise acquired, we may consider other strategic alternatives, which are subject to risks and uncertainties.
If the proposed Merger with Expedia is not completed, our Board of Directors will review and consider various alternatives available to us, including, among others, continuing as a public company with no material changes to our business or capital structure or other alternative transactions. Any alternative transaction may involve various additional risks to our business, including, among others, distraction of our management team and associated expenses similar to those described above in connection with the proposed Merger, our ability to consummate the alternative transaction, the valuation assigned to our business in the alternative transaction, our ability or a potential buyer’s ability to access capital on acceptable terms or at all and other variables that may adversely affect our operations.
The travel industry is highly competitive, and we may not be able to effectively compete in the future.
We operate in the highly competitive travel industry. Our success depends upon our ability to compete effectively against numerous established and emerging competitors, including other OTCs, traditional offline travel companies, suppliers, travel research companies, search engines and meta-search companies, which may have significantly greater financial, marketing, personnel and other resources than we have. Factors affecting our competitive success include price, availability of travel products, ability to package travel products across multiple suppliers, brand recognition, customer service and customer care, fees charged to customers, ease of use, accessibility, reliability and innovation. If we are not able to compete effectively against our competitors, our business and results of operations may be adversely affected.
Online travel companies: We face significant competition from other online travel companies, such as Priceline, Expedia, Faceportal, TripAdvisor and their related brands, as well as other regional competitors such as Odigeo, Bravofly and e-travel.ie in Europe. We compete with offline travel companies for both travelers and the acquisition and retention of supply.
Travel suppliers: Suppliers have increasingly focused on distributing their products through their own websites and driving consumers away from OTCs. Suppliers may offer advantages for customers to book directly, such as member-only fares, bonus miles or loyalty points, which could make their offerings more attractive to customers. Some low-cost airlines distribute their online supply exclusively through their own website and other airlines have stopped providing inventory to certain online channels and attempt to drive customers to book directly on their websites by eliminating or limiting sales of certain airline tickets through third-party distributors. Additionally, airline suppliers are increasingly promoting hotel supply on their websites in connection with airline tickets. Our results of operations could be negatively affected by such increased competitive pressure from suppliers.
Search engines: We also face increasing competition from search engines like Google, Bing and Yahoo!. Search engines have grown in popularity and may offer comprehensive travel planning or shopping capabilities, which may drive more traffic directly to the websites of suppliers or competitors. Google has increased its focus on appealing to travel customers through its launches of Google Places, Google Flights and Google Hotel Price Ads (“HPA”). Google’s efforts around these products, as well as possible future developments, may change or undermine our ability to obtain prominent placement in paid or unpaid search results at a reasonable cost or at all. In addition, we currently license our search functionality, QPX Software, from ITA Software, Inc., a subsidiary of Google.
Travel meta-search engines and content aggregators: Travel meta-search websites and travel research sites that have search functionality, including Kayak.com (a subsidiary of our competitor Priceline), Trivago.com (a subsidiary of our competitor Expedia), and TripAdvisor, aggregate travel search results for a specific itinerary across supplier, travel agent and other websites. If these competitors limit our participation within their results, it could affect our traffic-generating arrangements in a negative manner. For example, our agreement with Kayak.com that provided for exclusivity with respect to some of Kayak’s core search results terminated at the end of 2013 and was not renewed. In addition, some meta-search sites, including Kayak.com, offer users the ability to make reservations directly on their websites, which may reduce the amount of traffic and transactions available to us through referrals from these sites. If additional meta-search sites begin to offer the ability to make reservations directly, that will further affect our ability to generate traffic to our sites.
Other competitors in the broader travel space: We also will continue to face competition from new channels of distribution in the travel industry. Additional sources of competition include large companies that offer online travel services as one part of their business model, such as Amazon and Alibaba, “daily deal” websites, such as Groupon Getaways, or peer-to-peer inventory sources, such as AirBnB and HomeAway. AirBnB and similar websites facilitate the short-term rental of homes and apartments from owners, thereby providing an alternative to hotel rooms. The growth of peer-to-peer inventory sources could affect the demand for our services in facilitating reservations at hotels.
There can be no assurance that we will be able to compete successfully against any current and future competitors or on emerging platforms, or provide differentiated products and services to our customer base. Increasing competition from current and emerging competitors, the introduction of new technologies and the continued expansion of existing technologies, such as meta-search and other search engine technologies, may force us to make changes to our business models, which could affect our financial performance and liquidity. Increased competition has resulted in and may continue to result in reduced margins, as well as loss of customer, transactions and brand recognition.
Our business depends on our supplier and distribution partner relationships. Adverse changes in these relationships or our inability to enter into new relationships could negatively affect our access to travel offerings and reduce our revenue.
We rely significantly on our relationships with hotels, airlines and other suppliers and travel partners. We enter into agreements with these suppliers and travel partners at varying times and of varying duration. As a result, at any given point in time, one or more of these agreements may be approaching expiration or renewal. Moreover, in order to enhance the competitiveness of our offerings, we are constantly seeking to add new suppliers and travel partners. Adverse changes in any of these relationships (whether upon expiration of an agreement or otherwise) or the inability to enter into new relationships could negatively impact the availability and competitiveness of the travel products we offer on our websites and therefore could adversely affect our revenue. If any of our major suppliers or travel partners significantly reduces their business with us for a sustained period of time or completely withdraws from doing business with us, in favor of one of our competitors or to require consumers to purchase services directly from them, it could have a material adverse effect on our business and ability to retain customers.
Our suppliers continue to look for ways to decrease their overall distribution costs, which could significantly reduce the net revenue OTCs earn from travel and other travel-related products. As a result, the revenue we and other OTCs earn in the form of mark-ups and commissions from our suppliers is likely to be negatively impacted over the long term as supplier contracts are extended or renegotiated or as we add new suppliers. In particular, airlines continue to look for ways to decrease their overall costs, including the cost of distributing airline tickets through OTCs and GDSs, and to increase their control over distribution. The airlines have negotiated, and we expect they will continue to attempt to negotiate, terms more favorable to themselves whenever possible. To the extent airlines obtain more favorable terms in their agreements with us (which has been a continuing trend for many years) or in their agreements with the GDSs that we use, or if an airline terminates its agreement with us, the net revenue we earn from the distribution of airline tickets would be negatively impacted, which could have a material adverse effect on our business, results of operations and financial condition. In addition, although we have recently negotiated new GDS service agreements with more favorable terms than our prior GDS contract, there can be no assurance that the revenue we earn in the form of incentive payments from GDS providers will not be negatively impacted in future contract negotiations.
Because we depend on a relatively small number of airlines and car rental companies for a significant portion of our revenue in those areas, our business and results of operations could be adversely affected by further consolidation of suppliers in either of these industries. Further consolidation would force the Company to negotiate with a fewer number of total suppliers for the same number of segments, which would weaken our negotiating position and reduce our ability to negotiate favorable rates on segments. Additionally, further consolidation in the airline industry could result in a reduction in the number of airline tickets available for booking on our websites and increased air fares, which may have a negative impact on demand for travel.
Disruptions or prolonged declines in travel volume, particularly air travel, could adversely affect our business, financial condition and results of operations.
Our revenue is derived from the worldwide travel industry and is directly related to the overall level of travel activity, particularly air travel and hotel volume. Therefore, our revenue is significantly impacted by declines in or disruptions to travel in the United States, Europe and the Asia Pacific region due to factors entirely outside of our control. Factors that could affect travel activity and materially adversely impact our results of operations, business and revenue include:
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deterioration, weakness or uncertainty in the global economy;
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global security issues, political instability, acts or threats of terrorism, regional hostilities or war, and other political issues that could adversely affect travel volume in our key regions;
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health-related concerns, such as epidemics or pandemics;
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natural disasters, such as hurricanes, volcanic eruptions, earthquakes, tsunamis, floods and droughts;
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severe weather conditions, or unusual or unpredictable weather patterns;
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the financial condition of suppliers, particularly those in the airline and hotel industry, and the impact of their financial condition on the cost and availability of air travel and hotel rooms;
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changes in airline distribution policies or increases in airfares;
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changes to regulations governing the airline and travel industry or the imposition of taxes or surcharges by regulatory authorities;
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an increase in fuel prices affecting travel;
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work stoppages or labor unrest at any of the major airlines, airports or major hotel chains;
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travel-related accidents or safety concerns;
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increased airport security that could reduce the convenience of air travel;
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changes in occupancy and room rates achieved by hotels; and
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travelers’ perceptions of the occurrence of or the scope, severity and timing of the factors described above.
If there is a prolonged substantial decrease in travel volumes, particularly for air travel and hotel stays, for these or any other reasons, it would have a material adverse impact on our business, financial condition and results of operations.
We rely on search engines, which may change their business models or search engine algorithms in ways that could have a negative impact on our business.
We use Google and other internet search engines to generate traffic to our websites, principally through the purchase of travel-related keywords. Google and other search engines frequently update and change the logic that determines the placement and display of results of a user’s search. These changes could negatively affect the purchased or algorithmic placement of links to our websites. In addition, a significant amount of traffic is directed to our websites through our participation in pay-per-click and display advertising campaigns on search engines, social networking sites, meta-search sites and content properties. Pricing and operating dynamics for these traffic sources can experience rapid change, both technically and competitively. Moreover, any of these providers could, for competitive or other purposes, alter their search algorithms or results, causing our websites to place lower in search query results. If a major search engine changes its algorithms in a manner that negatively affects the search engine ranking, paid or unpaid, of our websites or that of our third-party distribution partners, or if competitive dynamics impact the costs or effectiveness of search engine optimization, search engine marketing or other traffic generating arrangements in a negative manner, our business and financial performance would be adversely affected, potentially to a material extent.
We rely on third-party service providers who may experience disruptions in the services they provide to us or changes in their businesses, which could have a negative impact on our business.
We are dependent upon third-party systems and service providers, and any disruption or adverse change in their businesses could have a material adverse effect on our business. We rely on certain third-party computer systems, service providers and software companies, including the electronic central reservation systems and GDSs. In particular, our businesses rely on third parties to:
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conduct searches for airfares;
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process hotel room transactions;
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process credit card and other payments; and
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provide computer infrastructure critical to our business.
We currently utilize GDSs to process a significant portion of our bookings. In addition, we rely on a group of business process outsourcing companies located in various countries to provide us with call center and telesales services, back office administrative services such as ticketing fulfillment, hotel rate loading and quality control, information technology services, and financial services. Any interruption in these third-party services could prevent us from operating certain aspects of our business and damage our reputation. For instance, interruption or deterioration in our GDS partners’ products or services could prevent us from searching and booking airline and car rental reservations.
Our success is dependent on our ability to maintain relationships with our technology partners. In the event our arrangements with any of these third parties are impaired or terminated, we may not be able to find an alternative source of systems support on a timely basis or on commercially reasonable terms, which could result in significant additional costs or disruptions to our business. In addition, some of our agreements with third-party service providers can be terminated by those parties on short notice and, in many cases, provide no recourse for service interruptions. A termination or disruption of these services could have a material adverse effect on our business, financial condition and results of operations.
We face risks associated with data security and credit card fraud.
The secure transmission of confidential personal information over the Internet is essential in maintaining customer and supplier confidence in our services. Substantial or ongoing data security breaches, whether instigated internally or externally on our system or on other Internet-based systems, could significantly harm our business. It is possible that a party (whether internal or external) could circumvent our security measures to steal confidential personal information, which could expose us to a risk of loss or litigation and possible liability, and that we may be unsuccessful in implementing our remediation plan to address potential exposures. Data security breaches could also damage our reputation, causing customers, potential customers and suppliers to lose confidence in our data security, which could have a negative effect on the demand for our services. Additionally, we disclose to certain of our third-party service providers, including our GDS providers, our customers’ credit card information in order to process transactions. If such third-party provider incurs a data security breach that causes our customers’ credit card information to be compromised, we could face the same risks as we would to a breach on our own system, including risk of loss and litigation and damage to our reputation. Moreover, it’s possible that public perception concerning security and privacy on the Internet generally could adversely affect customers’ willingness to use the Internet, including our websites, as a means of conducting commercial transactions. Publicized breaches of security affecting other
companies that conduct business over the Internet could cause consumers to be reluctant to use the Internet as a means of conducting commercial transactions and therefore reduce the number of consumers using our websites to book travel.
Additionally, our results of operations have been negatively affected by purchases made using fraudulent credit cards and we may be held liable for accepting fraudulent credit card information as payment for transactions in the future. Fraudulent schemes are becoming increasingly sophisticated and common, and our ability to detect and combat fraudulent schemes may be negatively impacted by the adoption of new payment methods and new technology platforms. If we are unable to effectively combat the use of fraudulent credit cards on our websites or if we otherwise experience increased levels of disputed credit card payments, our results of operations and financial positions could be materially adversely affected.
Our business has significant liquidity requirements.
Our business has significant liquidity requirements. Certain events could have a negative impact on our liquidity, which in turn could affect our ability to take advantage of potential business opportunities, respond to competitive pressures or operate our business as it currently exists, including the following:
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termination of a major supplier’s participation on our websites;
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decline in merchant gross bookings due to deteriorating economic conditions or other factors;
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decline in stand-alone hotel merchant gross bookings due to a shift from the merchant model to the retail model;
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the imposition of holdbacks or reserves by credit card and other payment processors;
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changes to payment terms or other requirements imposed by vendors, suppliers, payment processors, consumer protection organizations, taxing authorities or regulatory agencies, such as requiring us to provide letters of credit, cash reserves, deposits or other forms of financial security or increases in such requirements; and
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lower than anticipated operating cash flows from our operations or other unanticipated events, such as unfavorable outcomes in legal proceedings (including, in the case of hotel occupancy proceedings, certain jurisdictions’ requirements that we provide financial security or pay a deposit to the municipality in order to challenge the assessment in court).
If any of these events occurs in the future, individually or in the aggregate, it could have a material adverse effect on our results of operations, our liquidity and the value of our common stock.
We have a significant amount of indebtedness, which could limit the manner in which we operate our business.
As of December 31, 2014, we had $447.8 million of outstanding borrowings under our Amended Credit Agreement. Our substantial level of indebtedness could:
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impair our ability to obtain additional financing or to obtain such financing on terms acceptable to us for working capital, capital expenditures, acquisitions or general corporate purposes;
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reduce the funds available to us for potential acquisitions, capital expenditures, working capital and general corporate purposes because we are required to use a portion of our cash flows from operations to make debt service payments;
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put us at a competitive disadvantage because we have a higher level of indebtedness than some of our competitors and reduce our flexibility in planning for, or responding to, changing conditions in the economy or our industry, including increased competition; and
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make us more vulnerable to general economic downturns and adverse developments in our business.
The Amended Credit Agreement requires us not to exceed a maximum first lien leverage ratio. If we fail to comply with this covenant and we are unable to obtain a waiver or amendment, our lenders could accelerate the maturity of all amounts outstanding under our term loan and revolving credit facility and could proceed against the collateral securing this indebtedness. If this were to occur, there is no assurance that alternative financing would be available to us or at favorable terms.
In addition, restrictive covenants in our Amended Credit Agreement specifically limit our ability to, among other things:
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incur additional indebtedness or enter into guarantees;
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enter into sale and leaseback transactions;
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make new investments, loans or acquisitions;
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grant or incur liens on our assets;
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sell our assets;
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engage in mergers, consolidations, liquidations or dissolutions;
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engage in transactions with affiliates; and
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make distributions or dividend payments or redeem or repurchase our capital stock.
As a result, we may operate our business differently than if we were not subject to these covenants and restrictions.
Certain of our international subsidiaries have a history of significant operating losses and our inability to improve their scale and profitability could adversely affect our business and results of operations.
We have historically incurred significant operating losses for some of our international subsidiaries and may continue to experience operating losses in the future. As a result, we have made, and may continue to make, significant investments in our international operations by using a portion of the cash flow generated from our domestic operations or funds from other borrowings under our other credit facilities. There can be no assurance that such international subsidiaries will be profitable in the future or that any profits generated by them will be sufficient to recover our investments in them.
The profitability of our international subsidiaries depends to a large extent on the scale of their operations. If we fail to achieve the desired scale, we may not be able to effectively compete in the global marketplace, and our business and results of operations may be adversely affected.
Our international operations are subject to additional risks not usually encountered when doing business in the United States, including foreign exchange risk.
We generated 26% of our net revenue for the year ended December 31, 2014, from our international operations and had employees in over 25 countries. We are subject to certain risks as a result of having international operations and operations in multiple countries generally, including:
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currency exchange rate fluctuations;
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difficulties in staffing and managing operations due to distance, time zones, language and cultural differences, including issues associated with establishing management infrastructure in various countries;
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reduced flexibility in our foreign staffing due to more onerous employment law obligations and restrictions;
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differences and unexpected changes in local regulatory requirements and exposure to local economic conditions;
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limits on our ability to enforce our intellectual property rights;
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preference of local populations for local providers;
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restrictions on the repatriation of non-U.S. investments and earnings back to the United States, including withholding taxes imposed by certain foreign jurisdictions;
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diminished ability to comply with local legal and licensing requirements due to discriminatory practices against business operators based on nationality or place of establishment; and
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diminished ability to legally enforce our contractual rights.
We expect that our exposure to the foregoing risks will increase as we attempt to expand our international operations. To the extent we are not able to effectively mitigate or eliminate these risks, our results of operations could be adversely affected.
Further, our international operations require us to comply with a number of U.S. and international regulations, including, among others, the Foreign Corrupt Practices Act (“FCPA”) and the U.K.’s Bribery Act 2010. Any failure by us to adopt and continue to practice appropriate compliance procedures to ensure that our employees and agents comply with the FCPA and applicable laws and regulations in foreign jurisdictions could result in substantial penalties or restrictions on our ability to conduct business in certain foreign jurisdictions.
We rely on information technology to operate our businesses and maintain our competitiveness, and any failure to adapt to technological developments or industry trends could affect our ability to compete and harm our business.
We depend upon the use of sophisticated information technologies and systems, including technologies and systems utilized for reservations, communications, procurement and administrative systems. Certain of our businesses also utilize third-party fare search solutions and GDSs or other technologies. As our operations grow in both size and scope, we must continuously improve and upgrade our systems and infrastructure to offer our customers enhanced products, services, features and functionality, while maintaining the reliability and integrity of our systems and infrastructure. Our future success depends on our ability to adapt our services and infrastructure to meet rapidly evolving industry standards while continuing to improve the performance and features of our service in response to competitive service and product offerings and the changing demands of the marketplace. In particular, we will need to commit additional financial, operational and technical resources in order to expand our systems and infrastructure to meet any potential increases in business volume.
In addition, we may not be able to maintain our existing systems, obtain new technologies and systems, or replace or introduce new technologies and systems as quickly as our competitors or in a cost-effective manner. We may fail to achieve the benefits anticipated or required from any new technology or system, or we may be unable to devote financial resources to new
technologies and systems in the future. Furthermore, our use of this technology could be challenged by claims that we have infringed upon the patents, copyrights or other intellectual property rights of others. If any of these events occur, our business could suffer.
System interruptions and the lack of redundancy may cause us to lose customers or business opportunities.
We rely on computer and information technology systems to operate our business and process transactions. If we are unable to maintain and improve our information technology systems and infrastructure, we may experience extended system interruptions, which could significantly curtail our ability to conduct business, provide services to our customers and generate revenue. System interruptions may include slow delivery times, unreliable service levels, prolonged or frequent service outages, or insufficient capacity in our systems and the systems of critical third parties on which we rely. In addition to the risks associated with inadequate maintenance or upgrading, our information technologies and systems are vulnerable to damage or interruption from various causes, including:
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power losses, computer systems failure, Internet and telecommunications or data network failures, operator error, losses and corruption of data, and similar events;
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computer viruses, penetration by individuals seeking to disrupt operations or misappropriate information and other physical or electronic breaches of security;
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the failure of third-party systems or services that we rely upon to maintain our own operations; and
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natural disasters, war and acts of terrorism.
Although we have identified and tested redundancy of critical systems and services in an effort to mitigate the above noted risks, it is possible that our disaster recovery planning may not be sufficient in the face of these threats. In addition, we may have inadequate insurance coverage to compensate for losses from a major interruption, and remediation may be costly and have a material adverse effect on our operating results and financial condition. Any extended interruption in our technologies or systems could have a material adverse effect on our business, financial condition and results of operations.
Our business and financial performance could be negatively impacted by adverse tax events.
New sales, use, occupancy or other tax laws, statutes, rules, regulations or ordinances could be enacted at any time. Such enactments could adversely affect our domestic and international business operations and our business and financial performance. Further, existing tax laws, statutes, rules, regulations or ordinances could be interpreted, changed, modified or applied adversely to us. These events could require us to pay additional tax amounts on a prospective or retroactive basis, as well as require us to pay fees, penalties and/or interest for past amounts deemed to be due. In addition, our revenue may decline because we may have to charge more for our services.
New, changed, modified or newly interpreted or applied tax laws could also increase our compliance, operating and other costs, as well as the costs of our products or services. Further, these events could decrease the capital we have available to operate our business. Any or all of these events could adversely impact our business and financial performance.
We and other providers of travel in the online travel industry are currently subject to various lawsuits related to hotel occupancy tax in numerous jurisdictions in the United States, and other jurisdictions may be considering similar lawsuits. An adverse ruling in the existing hotel occupancy tax cases could require us to pay tax retroactively and prospectively, and possibly penalties, interest and/or fees. We have also been contacted by several municipalities or other taxing bodies concerning our possible obligation with respect to local hotel occupancy or related taxes, and certain municipalities have begun audit proceedings and some have issued assessments against us. If we are found to be subject to the hotel occupancy tax ordinance by a taxing authority and we appeal the decision in court, certain jurisdictions may attempt to require us to provide financial security or pay the assessment to the municipality in order to challenge the tax assessment in court. The proliferation of new hotel occupancy tax cases or audit proceedings could result in substantial additional defense costs. These events could also adversely impact our business and financial performance.
Our businesses are regulated and any failure to comply with applicable regulations or any changes in those regulations could adversely affect us.
We operate in a regulated industry both in the United States and internationally. Our business, financial condition and results of operations could be adversely affected by unfavorable changes in or the enactment of new laws, rules and regulations applicable to us, which could decrease demand for our products and services, increase costs or subject us to additional liabilities. Moreover, regulatory authorities have relatively broad discretion to grant, renew and revoke licenses and approvals and to implement regulations. Accordingly, these regulatory authorities could prevent or temporarily suspend us from carrying on some or all of our activities or otherwise penalize us if our practices were found not to comply with the then current
regulatory or licensing requirements or any interpretation of such requirements by the regulatory authority. Our failure to comply with any of these requirements or interpretations could have a material adverse effect on our operations. In addition, the various regulatory regimes to which we are subject may conflict so that compliance with the regulatory requirements in one jurisdiction may create regulatory issues in another.
Because we process, store and use customer information, we are subject to additional risks as a result of governmental regulation and conflicting legal requirements regarding customer information. In the processing of customer transactions, we receive and store a large volume of personally identifiable information. This information is increasingly subject to legislation and regulations in numerous jurisdictions around the world. This legislation and regulation is generally intended to protect the privacy and security of personal information, including credit card information that is collected, processed and transmitted in or from the governing jurisdiction. If domestic or international legislation or regulations are expanded to require changes in our business practices, or if governing jurisdictions interpret or implement their legislation or regulations in ways that negatively affect our business, we could be adversely affected. Travel companies have also been subjected to investigations, lawsuits and adverse publicity due to allegedly improper disclosure of passenger information. As privacy and data protection have become more sensitive issues, we may also become exposed to potential liabilities as a result of differing views on the privacy of travel data. These and other privacy concerns could adversely impact our business, financial condition and results of operations.
Our business is also subject to laws and regulations relating to our revenue generating and marketing activities, including those prohibiting unfair and deceptive advertising or practices. Our travel services are subject to regulation and laws governing the offer of travel products and services, including laws requiring us to register as a “seller of travel” in various jurisdictions and to comply with certain disclosure requirements. As an OTC that offers customers the ability to book air travel in the United States, we are also subject to regulation by the Department of Transportation, which has authority to enforce economic regulations and may assess civil penalties or challenge our operating authority.
We are involved in various legal proceedings and may experience unfavorable outcomes, which could affect our financial position.
We are involved in various legal proceedings, including, but not limited to, actions relating to intellectual property, in particular patent infringement claims against us, tax disputes throughout the United States, employment law and other negligence, breach of contract and fraud claims, which involve claims, in the aggregate, for substantial amounts of money or for other relief or that might necessitate changes to our business or operations. The defense of these actions is both time consuming and expensive. In addition, historically, our insurers have reimbursed us for a significant portion of costs we incurred to defend cases related to use or occupancy tax of hotel accommodations that some states and localities impose (“hotel occupancy tax”). We will not receive any additional insurance reimbursements in future periods as our insurance coverage has now been exhausted. Litigation is inherently unpredictable and unfavorable resolutions could occur. While we generally cannot estimate our range of loss, except for tax matters, if any of these legal proceedings were to result in an unfavorable outcome, it could have a material adverse effect on our business, financial position and results of operations.
We may not be effectively protecting our intellectual property, which would allow competitors to duplicate our products and services. This could make it more difficult for us to compete with them.
Our success and ability to compete depend, in part, upon our technology and other intellectual property, including our brands. Among our significant assets are our software and other proprietary information and intellectual property rights. We rely on a combination of copyright, trademark and patent laws, trade secrets, confidentiality procedures and contractual provisions to protect these assets. However, we have a limited number of patents, and our software and related documentation are protected principally under trade secret and copyright laws, which afford only limited protection, and the laws of some jurisdictions provide less protection for our proprietary rights than the laws of the United States. We have granted Travelport an exclusive license to our supplier link technology, including our patents related to that technology. Under the exclusive license, Travelport has the first right to enforce those patents, and so we will only be able to bring actions to enforce those patents if Travelport declines to do so. Unauthorized use and misuse of our intellectual property could have a material adverse effect on our business, financial condition and results of operations, and the legal remedies available to us may not adequately compensate us for the damages caused by unauthorized use.
Further, intellectual property challenges have been increasingly brought against members of the travel industry. These legal actions have in the past, and might in the future, result in substantial costs and diversion of resources and management attention. In addition, we may need to take legal action in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others, and these enforcement actions could result in the invalidation or other impairment of intellectual property rights we assert.
Our ability to attract, train and retain executives and other qualified employees is critical to our results of operations and future growth.
We depend substantially on the continued services and performance of our key executives, senior management and skilled personnel, particularly our professionals with experience in our industry and our information technology and systems. Any of these individuals may choose to terminate their employment with us at any time. The specialized skills we require can be difficult and time-consuming to acquire and, as a result, these skills are often in short supply. A significant period of time and expense may be required to hire and train replacement personnel when skilled personnel depart the Company. Our inability to hire, train and retain a sufficient number of qualified employees could materially hinder our business by, for example, delaying our ability to bring new products and services to market or impairing the success of our operations or prospects for future growth.
We have granted Travelport perpetual licenses to use certain of our intellectual property, which could facilitate Travelport’s ability to compete with us.
We are party to a Master License Agreement with Travelport under which we and Travelport each have rights to use certain of the other’s intellectual property. The Master License Agreement permits Travelport and its affiliates to use and, in some cases, to sublicense to third parties certain of our intellectual property, including:
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our supplier link technology;
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portions of ebookers’ booking, search and vacation package technologies;
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certain of our products and online booking tools for corporate travel;
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portions of our private label vacation package technology; and
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our extranet supplier connectivity functionality.
Travelport and its affiliates may use these technologies as part of, or in support of, their own products or services, including in some cases to compete directly with us.
The Master License Agreement permits Travelport to sublicense our intellectual property (other than our supplier link technology) to a party that is not an affiliate of Travelport, except that Travelport may not sublicense our intellectual property to a third-party for a use that competes with our business, unless Travelport incorporates or uses our intellectual property with Travelport products or services to enhance or improve Travelport products or services (other than to provide our intellectual property to third parties on a stand-alone basis). Travelport and its affiliates are permitted to use our intellectual property to provide their own products and services to third parties that compete with us. With respect to our supplier link technology, Travelport has an unrestricted license. These Travelport rights could facilitate Travelport’s, its affiliates’ and third parties’ ability to compete with us, which could have a material adverse effect on our business, financial condition and operating results.
Item 1B.
Item 1B.
Unresolved Staff Comments
None.
Item 2.
Item 2.
Properties
Our corporate headquarters are located in leased office space in Chicago, Illinois. We also lease office space for our ebookers brand portfolio in various countries, including the United Kingdom, Finland, France, Germany, India, Ireland, Sweden and Switzerland. In addition, we lease office space for our HotelClub brand portfolio, primarily in Sydney, Australia. We believe that our existing facilities are adequate to meet our current requirements and that additional space will be available as needed to accommodate any further expansion of our business.
Item 3.
Item 3.
Legal Proceedings
We are involved in various claims, legal proceedings and governmental inquiries related to contract disputes, business practices, intellectual property and other commercial, and tax matters. The following list identifies all litigation matters for which we believe that an adverse outcome could be material to our financial position or results of operations, as well as other matters that may be of particular interest to our stockholders. See Note 9 - Commitments and Contingencies of the Notes to Consolidated Financial Statements.
Litigation Relating to Hotel Occupancy Taxes
Orbitz Worldwide, Inc. and certain of its current and former subsidiaries and affiliates, including Orbitz, Inc., Orbitz, LLC, Trip Network, Inc. (d/b/a Cheaptickets.com), Travelport Inc. (f/k/a Cendant Travel Distribution Services Group, Inc.), and Internetwork Publishing Corp. (d/b/a Lodging.com), are parties to various cases involving municipalities and other governmental entities in the U.S. concerning sales and hotel occupancy taxes and our merchant model for hotel and car rental reservations. Some of the cases are purported class actions, and most of the cases were brought simultaneously against other OTCs, including Expedia, Travelocity and Priceline. The cases allege, among other things, that we violated the jurisdictions’ hotel occupancy tax ordinances, as well as related sales and use taxes. While not identical in their allegations, the cases generally assert similar claims, including violations of local or state occupancy tax ordinances, failure to pay sales or use taxes, and in some cases, violations of consumer protection ordinances, conversion, unjust enrichment, imposition of a constructive trust, demand for a legal or equitable accounting, injunctive relief, declaratory judgment, and civil conspiracy. The plaintiffs seek relief in a variety of forms, including: declaratory judgment, full accounting of monies owed, imposition of a constructive trust, compensatory and punitive damages, disgorgement, restitution, interest, penalties and costs, attorneys’ fees, and where a class action has been claimed, an order certifying the action as a class action. Some of these cases arose from tax assessments or audits by taxing authorities, and Orbitz has brought claims in courts to challenge those assessments. Some of these assessments, including an approximately $58.0 million assessment from the Hawaii Department of Taxation, are not based on historical transaction data. On several occasions, where we have received an assessment, we have been required to provide financial security or pay the assessment to the municipality in order to seek judicial review. Adverse rulings in these cases could require us to pay tax retroactively and prospectively and possibly pay interest, penalties and fines. The proliferation of additional cases could result in substantial additional defense costs.
We dispute that any hotel occupancy or related tax is owed under these ordinances and are challenging the assessments made against us. The following table reflects the hotel tax cases in which we are currently a party:
*
Indicates purported class action filed on behalf of named City or County and other (unnamed) cities, counties, governments or other taxing authorities with similar tax ordinances.
**
Indicates court certified class action on behalf of named City or County and other (unnamed) cities, counties, governments or other taxing authorities with similar tax ordinances.
*** Indicates cases in which class certification has been denied.
† Indicates case relates to alleged non-payment of business license fees in connection with alleged furnishing of hotel rooms.
Procedurally, the cases listed above are at different stages. Eighteen of these cases are pending before their respective trial courts, and no dispositive rulings have been issued. The following cases have reached more advanced stages, as described below:
County of Los Angeles, California: On January 17, 2013, the OTCs and Los Angeles filed cross motions for judgment. On April 18, 2013, the Superior Court for the County of Los Angeles granted the OTCs motion for judgment granting writ of administrative mandamus and denied the City’s cross-motion. On January 21, 2014, the Superior Court entered final judgment on behalf of the OTCs. On March 31, 2014, Los Angeles filed a notice of appeal. Appellate briefing is stayed pending outcome of the appeal in the City of San Diego case.
City of San Diego, California: On May 28, 2010, a hearing officer appointed by the City approved assessments of approximately $1.4 million against the Company. On September 6, 2011, the Superior Court for the State of California for Los Angeles County issued a peremptory writ of mandamus remanding the proceedings to the City’s hearing officer directing him to withdraw his decision. On July 10, 2012, the Court entered judgment on the OTCs consolidated writ of mandate and an order for consent judgment in favor of the OTCs on the City’s Third Amended Complaint. On August 21, 2012, the City filed a notice of appeal. On January 30, 2014, the Court of Appeal of the State of California heard oral argument on San Diego’s appeal. On March 5, 2014, the Court of Appeal affirmed the judgment in favor of the OTCs. On May 6, 2014, the City of San Diego filed a Petition for Review in the California Supreme Court. On July 30, 2014, the California Supreme Court granted San Diego’s Petition for Review. The parties are in the process of briefing the case before the California Supreme Court, and oral argument is expected to occur later this year.
City of Atlanta, Georgia: On July 28, 2014, the Georgia Supreme Court issued an order finding that it lacked jurisdiction to hear the City’s appeal, and dismissed the case. The case is now pending before the Georgia Court of Appeals, and relates to the issue of whether the OTCs are liable for occupancy tax before July 2011. The Court of appeals heard oral argument on January 21, 2015.
City of San Antonio, Texas: On April 4, 2013, the U.S. District Court for the Western District of Texas entered final judgment in favor of plaintiffs. On May 2, 2013, the OTCs filed their renewed motion for judgment as a matter of law, and alternatively, motion for a new trial. On February 21, 2014, the District Court denied the OTCs’ motions for judgment as a matter of law, and motion for new trial. Both parties have sought reconsideration on the issue of penalties in post-judgment motions. The Court still has not ruled on those motions. Once the District Court enters judgment on the parties’ post-judgment motions concerning penalties, the parties will have 30 days to appeal the case to the Fifth Circuit.
Broward County, Florida: On January 12, 2009, Orbitz filed a complaint in the Circuit Court, Second Judicial Circuit, Leon County, Florida, against Broward County and the Florida Department of Revenue in which it contested assessments that had been issued against it. On July 13, 2012, the Circuit Court granted partial summary judgment in favor of the OTCs on their affirmative claims and all of Broward County’s Counterclaims. On February 4, 2013, Broward County filed a notice of appeal. On February 12, 2014, the Florida Court of Appeals affirmed the grant of summary judgment in favor of the OTCs. On February 14, 2014, Broward County filed a motion with the Court of Appeals in which it sought certification of question of great public importance. On February 20, 2014, the Court of Appeals denied Broward County’s motion. On February 24, 2014, Broward County filed a motion to stay pending review, to stay the issuance of mandate, and to enlarge the time to file a motion for rehearing pending ruling by the Florida Supreme Court. Broward County also filed a notice to invoke the discretionary jurisdiction of the Florida Supreme Court. On May 22, 2014 the Florida Supreme Court stayed the action pending resolution of the Leon County Tourist Development Tax case in the Florida Supreme Court.
Wisconsin Department of Revenue: On August 6, 2008 the Wisconsin Department of Revenue issued assessments against Orbitz for the period from January 1, 2001 through December 31, 2006. Orbitz filed a petition for redetermination on October 6, 2008, which was denied. Orbitz appealed to the Wisconsin Tax Appeals Commission on July 6, 2009. On October 7, 2013, both parties filed motions for summary judgment. On May 14, 2014, the Wisconsin Tax Appeals Commission granted Orbitz’s motion for summary judgment and reversed the Department’s assessments. On June 13, 2014, the Wisconsin Department of Revenue filed a Petition for Review in the Circuit Court for Dane County, State of Wisconsin, seeking review of the May 14, 2014 Wisconsin Tax Appeals Commission decision in favor of Orbitz. On December 11, 2014, the Dane County Circuit Court affirmed the Tax Appeals Commission’s decision to grant summary judgment for Orbitz.
Leon County, Florida (Transient Rental Tax): On August 16, 2013, the Florida Court of Appeal for the First District affirmed the trial court’s grant of summary judgment in favor of the OTCs. On August 30, 2013, the County filed a motion for rehearing, rehearing en banc, or certification to the Florida Supreme Court of a Question of Great Public Importance. On October 9, 2013, the Florida Court of Appeal for the First District denied the motion. On October 24, 2013, the County filed a notice to invoke the discretionary jurisdiction of the Florida Supreme Court. The parties have filed jurisdictional briefs, and on
December 31, 2013, the Florida Supreme Court issued an order staying the Transient Rental Tax statute case pending the outcome of Tourist Development Tax case.
Leon County, Florida (Tourist Development Tax): On February 28, 2013, the First District Court of Appeal affirmed the trial court’s summary judgment ruling in favor of the OTCs. On March 15, 2013, the County filed a motion for rehearing en banc, or in the alternative Requesting Certification to the Florida Supreme Court of a Question of Great Public Importance. On April 16, 2013, the Florida Court of Appeals, First District denied plaintiffs’ motion for rehearing en banc, but granted plaintiffs’ request for certification to the Florida Supreme Court. On May 13, 2013, the plaintiffs filed their Petition for Review with the Florida Supreme Court seeking review of the First District Court of Appeal’s opinion affirming the trial court’s summary judgment in favor of the OTCs. On September 10, 2013, the Florida Supreme Court granted plaintiffs’ Petition for Review. On April 30, 2014, the Florida Supreme Court heard oral argument.
City of San Francisco, California: On March 3, 2010, the City of San Francisco issued a final assessment of approximately $3.2 million for the period of January 1, 2000 to September 30, 2008, against various Orbitz entities. On March 31, 2010, Orbitz paid the final assessment pursuant to the City’s “pay to play” requirement. On April 2, 2010, we filed a refund request with the City. On May 14, 2010, the OTCs filed a Complaint for Tax Refund and Declaratory Relief against the City and County of San Francisco seeking a tax refund and declaratory relief. On December 18, 2012, the City of San Francisco issued supplemental final assessments of approximately $1.4 million against Orbitz LLC, Trip Network, Inc. and Internetwork Publishing Corp. On January 2, 2013, these entities paid this assessment pursuant to the City’s “pay to play” requirement. On February 6, 2013, the Superior Court granted the OTCs motion for summary judgment. On October 10, 2013, the Superior Court entered final judgment in favor of the OTCs, ordering San Francisco to issue a refund of $4.0 million to the Orbitz Entities on the first assessment, representing a refund of the principle amount ($3.2 million) and $0.8 million in interest. On November 5, 2013, the Orbitz entities filed a Complaint in the Superior Court for a tax refund and declaratory relief relating to the supplemental final assessment of $1.4 million. On December 9, 2013, the City and County of San Francisco filed a Notice of Appeal. On August 6, 2014, the Court granted the City and County of San Francisco’s motion to stay the appeal pending the California Supreme Court’s resolution of the City of San Diego case.
Montana Department of Revenue: On March 6, 2014, the Montana First Judicial District granted the OTCs’ motions for summary judgment on both accommodations and car rental reservations. On May 5, 2014, the Montana Department of Revenue filed a notice of appeal with the Montana Supreme Court. The parties have fully briefed the appeal and oral argument has been set for April 10, 2015.
Hawaii Department of Taxation: On December 30, 2010, the State of Hawaii Department of Taxation issued a series of “proposed” assessments for the transient accommodations tax and general excise tax totaling approximately $10.2 million against various Orbitz entities. On January 31, 2011, the Department of Revenue issued its Final Notices of Assessments for those same amounts. On March 1, 2011, the OTCs filed their Notice of Appeal to the Tax Appeal Court. On May 8, 2012, the Hawaii Department of Taxation issued additional proposed assessments for the period of January 1, 2000 to December 31, 2011 totaling approximately $48.6 million against the Orbitz entities bringing the total amount of assessments to approximately $58.8 million. On October 22, 2012, the Tax Appeal Court orally denied the Department of Taxation’s motion for partial summary judgment and granted the OTCs motion for partial summary judgment on the transient accommodations tax. On January 11, 2013, the Tax Court of Appeal orally granted in part the Department of Taxation’s motion for summary judgment and denied the OTCs motion as it relates to application of the general excise tax. On February 8, 2013, the OTCs filed a motion for reconsideration. On March 27, 2013, the OTCs filed a mandamus petition and motion to stay the action in the Tax Court pending resolution of the mandamus petition. On May 20, 2013, the Hawaii Department of Taxation issued estimated assessments for the 2012 tax year for merchant model hotel reservations against various Orbitz entities collectively amounting to $16.9 million. On August 15, 2013, the Hawaii Tax Appeal Court entered final judgment disposing of all issues and claims of all parties. On September 11, 2013, the OTCs filed their notice of appeal seeking review of the Hawaii Tax Appeal Court finding that the OTCs are subject to Hawaii’s general excise tax (“GET”). The Department filed a notice of appeal seeking review of the Hawaii Tax Appeal Court finding that the OTCs are not subject to Hawaii’s transient accommodations tax. On December 9, 2013, the Hawaii Department of Taxation issued Notices of Final Assessments collectively totaling $10,254,669.60 on Orbitz, LLC, Trip Network, Inc. and Internetwork Publishing Corp. for General Excise Tax, penalties and interest for rental car transactions during the period of January 1, 2002, through December 31, 2012. On December 16, 2013, the Tax Appeal Court granted the OTCs’ motion to stay their consolidated tax appeals for 2012 GET and TAT Tax Assessments. On December 24, 2013, the Hawaii Supreme Court granted the parties’ application to transfer the matter to the Hawaii Supreme Court. On July 18, 2014, the Hawaii Department of Taxation issued final assessments for merchant hotel and merchant car reservations for the 2013 tax year against Orbitz LLC, Trip Network Inc., and Internetwork Publishing Corporation, collectively in the amount of $14.6 million. The Hawaii Supreme Court heard oral argument on both appeals on October 2, 2014. On December 22, 2014, the Hawaii Tax Court of Appeal granted the OTCs’ motion to stay the 2013 assessments.
Washington D.C.: In September 2012, the Superior Court of the District of Columbia granted the District’s motion for partial summary judgment and denied the OTCs’ motion for summary judgment, finding the companies liable for sales tax on hotel reservations dating back to the inception of the merchant model. On December 6, 2013, the Superior Court of the District of Columbia granted the OTCs’ motion for partial summary judgment on the calculation of sales tax, and denied the District’s motion for partial summary judgment on the same issue. On February 21, 2014, Orbitz entered into a stipulation agreement with the District of Columbia. On February 24, 2014 the Superior Court entered final judgment in favor of the District of Columbia. On March 25, 2014, Orbitz paid a judgment of $3.8 million, an amount that represented the sales tax attributable to Orbitz.com hotel reservations through 2011. This amount is subject to a refund if Orbitz prevails in its appeal. On March 12, 2014, Orbitz filed its notice of appeal, and on March 17, 2014, the District cross-appealed on the issue of whether amounts charged to consumers as a tax recovery charge should have been included in the Supreme Court’s damage calculation. On September 30, 2014, the District of Columbia Court of Appeals heard oral argument in this case.
Nassau County, New York: On September 10, 2014, Supreme Court of the State of New York, Appellate Division, affirmed in part, and reversed in part the trial court’s June 2012 order. The Supreme Court affirmed the trial court’s denial of the OTCs’ motion to dismiss for failure to exhaust administrative remedies, conversion, and unjust enrichment. The Supreme Court reversed the court’s denial of the OTCs’ motion to dismiss Nassau County’s claim for imposition of a constructive trust, and the trial court’s decision to certify a class of municipalities in New York.
City and County of Denver, Colorado: On February 8, 2012, the City’s appointed hearing officer issued his final administrative decision finding the OTCs are subject to Denver’s Lodger’s Tax, and approved an assessment against Orbitz in the amount of $0.6 million. On February 13, 2012, the OTCs filed their notice of intent to appeal the hearing officer’s final administrative decision. On March 30, 2012, the City filed a motion to dismiss the first claim for relief of the OTCs complaint. On July 26, 2012, the District Court denied the City’s motion to dismiss. On October 2, 2012, the OTCs filed their brief supporting their claim for relief. On March 12, 2013, the District Court, Denver, Colorado affirmed in part and reversed in part the Hearing Officer’s February 8, 2012 ruling. The District Court found the Hearing Office did not abuse his discretion in finding that the OTCs fall within the scope of the Lodging Tax statute; however, the District Court found the three year statute of limitations period applied to Denver’s assessments. On April 26, 2013, the OTCs appealed. On May 10, 2013, the City filed its notice of appeal regarding the District Court’s ruling that the three year statute of limitations period applied to Denver’s assessments. On July 3, 2014, the Colorado Court of Appeals reversed in part the District Court’s decision and vacated all tax assessments against the OTCs. On August 14, 2014, the City and County of Denver filed a Petition for Writ of Certiorari to the Colorado Supreme Court. The petition has been fully briefed.
The following legal proceedings relating to hotel occupancy taxes we previously reported were concluded since October 1, 2014:
North Carolina consolidated: On August 19, 2014, the North Carolina Court of Appeals affirmed the trial court’s decision in favor of the OTCs. On December 19, 2014, the North Carolina Supreme Court denied the Counties’ petition for discretionary review.
In addition to the current litigation, the following taxing authorities have issued assessments that are subject to further review by the taxing authorities: the Colorado Department of Revenue; the City of Aurora, Colorado; the Maryland Comptroller; the Texas Comptroller; the City of Portland, Oregon, and Multnomah County, Oregon; and Lake County, Indiana. These assessments collectively total approximately $9.67 million.
Consumer Class Actions
On-Line Travel Company Hotel Booking Antitrust Litigation: On August 20, 2012, a putative consumer class action was filed in the United States District Court for the Northern District of California against certain hotel chains and the major OTCs, including Orbitz. The complaint alleged that the hotel chains and several major OTCs, including Orbitz, violated the antitrust and consumer protection laws by entering into agreements in which OTCs agree not to facilitate the reservation of hotel rooms at prices that are less than what the hotel chain offers on its own website. Following the filing of the initial complaint, several dozen additional putative consumer class action complaints were filed in federal courts across the country. On December 11, 2012, the Judicial Panel on Multidistrict Litigation issued an order consolidating these cases in the United States District Court for the Northern District of Texas. On May 1, 2013, the plaintiffs filed a consolidated amended complaint. On July 1, 2013, the defendants moved to dismiss the Complaint. On December 17, 2013, the District Court heard oral argument on Defendants’ motion to dismiss. On February 16, 2014, the District Court granted the Defendants’ motion to dismiss on all claims without prejudice. On October 27, 2014, the District Court denied Plaintiffs leave to amend their complaint. Plaintiffs did not file a notice of appeal, thereby officially ending the case.
Litigation related to Intellectual Property
Unified Messaging Solutions LLC v. Orbitz, LLC: On March 1, 2012, Unified Messaging Solutions LLC (“UMS”) filed a suit for patent infringement against Orbitz, LLC in the United States District Court for Northern District of Illinois alleging infringement of U.S. Patent Nos. 6,857,074; 7,836,141; 7,895,306; 7,895,313; and 7,934,148. On April 23, 2012, UMS filed an Amended Complaint in which it alleged infringement of only one of the five originally asserted patents (U.S. Patent No. 7,934,148). On June 13, 2014, pursuant to a stipulation by the parties, the Court entered an order dismissing the case. Plaintiff agreed to stipulate that under the district court’s claim construction, Defendants do not infringe Plaintiff’s patents. On June 27, 2014, Plaintiff filed a notice of appeal with the United States Court of Appeals for the Federal Circuit. On September 26, 2014, the Federal Circuit entered an order staying Plaintiff’s appeal, pending the outcome of fee motions by certain defendants.
Ameranth, Inc. v. Orbitz, LLC: On June 29, 2012, Ameranth, Inc. filed a lawsuit against Orbitz, LLC in the United States District Court for the Southern District of California alleging infringement of U.S. Patent Nos. 6,384,850; 6,871,325; and 8,146,077. On October 15, 2013, Orbitz filed petitions with the Patent Trial and Appeal Board (“PTAB”) of the United States Patent and Trademark Office seeking review of the validity of Ameranth’s, asserted patents under the Transitional Program for Covered Business Method (“CBM”) Patents. On November 27, 2013 the Court entered an Order which stayed the case pending a final decision from the PTAB. In March of 2014, the PTAB instituted CBM review of several of the challenged claims in the ’850 and ’325 Patents. A final decision on the validity of the instituted claims is due from the PTAB in March of 2015.
CEATS, Inc. v. Orbitz Worldwide, Inc.: On August 5, 2013, CEATS, Inc. filed a patent infringement suit against Orbitz, Worldwide, Inc. in the United States District Court for the District of Nevada. The plaintiff alleges that Orbitz infringes U.S. Patent Nos. 7,548,867; 7,640,178; 7,660,727; 8,219,448; 8,229,774; and 8,244,561. On July 3, 2014, the United States District Court for the District of Nevada transferred the case to the United States District Court for the Northern District of Illinois. On January 20, 2015, the parties entered into a settlement agreement.
Metasearch Systems, LLC v. Orbitz Worldwide, Inc.: On September 21, 2012, Metasearch Systems, LLC filed a suit for patent infringement against Orbitz Worldwide, Inc. in the United States District Court for the District of Delaware alleging that Orbitz infringes U.S. Patent Nos. 8,239,451; 8,171,079; 8,073,904; 7,490,091; 7,421,468; and 7,277,918. On December 19, 2012, Metasearch filed an Amended Complaint adding allegations of infringement for U.S. Patent No. 8,326,924. Orbitz filed petitions with the Patent Trial and Appeal Board (“PTAB”) of the United States Patent and Trademark Office seeking review of the validity of certain of Metasearch’s, asserted patents under the Transitional Program for Covered Business Method (“CBM”) Patents. The parties filed a Stipulation to stay the case pending the outcome of the CBM proceedings: the first one challenging U.S. Patent No. 8,326,924 (“924 CBM proceeding”) and the second one challenging U.S. Patent Nos. 8,239,451 (“451 CBM proceeding”). On December 3, 2013, the Court entered an Order staying the case pending a decision from the PTAB. On March 20, 2014 and June 18, 2014, the PTAB instituted trial on both the ’924 and ’451 patents, respectively, finding it more likely than not the challenged claims were directed to patent-ineligible subject matter and more likely than not the challenged claims were unpatentable in view of the prior art. The patent owner has filed in both proceedings motions to amend the patent by adding substitute claims. All briefing and oral arguments were completed on December 5, 2014 in the ’924 CBM proceeding, and a final decision from the PTAB is expected by March 20, 2015. Briefing and oral argument will be completed on February 24, 2015 in the ’451 CBM proceeding, and a final decision is expected by June 18, 2015.
Execware LLC v. Orbitz Worldwide, Inc.: On February 21, 2014, Execware LLC filed a patent infringement suit in the United States District Court for the District of Delaware. The plaintiff alleges that Orbitz infringes U.S. patent No. 6,216,139. On May 21, 2014, Orbitz filed a motion to dismiss the Complaint.
Shareholder Litigation
Teamsters Union 25 Health Services & Insurance Plan v. Martin J. Brand et al.: On April 3, 2014, the Teamsters 25 Health Services & Insurance Plan derivatively on behalf of nominal defendant Orbitz Worldwide Inc., filed suit in the Court of Chancery for the State of Delaware against certain current and former members of the Orbitz Board of Directors, Travelport Limited, Travelport LP, Travelport Global Distribution System, B.V., TDS Investor (Luxembourg) S.A.R.L., Waltonville Limited, Travelport Holdings Limited, and the Blackstone Group L.P. With respect to the Orbitz directors, the Complaint alleged that the directors breached their fiduciary duties in relation to a new GDS agreement that was entered into between Orbitz and Travelport in 2014. On June 25, 2014, Plaintiff filed a First Amended Complaint. On November 18, 2014, Plaintiffs filed a Second Amended Complaint. On December 4, 2014, the Defendants moved to dismiss the Second Amended Complaint. Oral argument on Defendants’ motion to dismiss has been scheduled for April 15, 2015.
Delaware Actions relating to Expedia transaction: Since the announcement of the merger on February 12, 2015, six putative shareholder class action lawsuits have been filed against Orbitz and its directors, among other parties, in the Court of Chancery of the State of Delaware. The specific cases are: (i) Irving Feldbaum v. Barney Harford, et al., No. 10692, filed on February 19, 2015; (ii) Tonya Diamond v. Orbitz Worldwide, Inc., et al., No. 10703, filed on February 23, 2015; (iii) Jonathan Shiller v. Orbitz Worldwide, Inc., et al., No. 10704, filed on February 23, 2015; (iv) Suresh Rijhwani v. Barney Harford, et al., No. 10711, filed on February 24, 2015; Mathew Sciababucch v. Orbitz Worldwide, Inc. et al, No. 10726, filed on February 26, 2015; and (vi) Douglas Carlson v. Barney Harford, et al, No. 10736, filed on March 3, 2015. Collectively, we refer to these actions as the “Delaware Actions”. In the Delaware Actions, plaintiffs allege that the individual director defendants breached their fiduciary duties to Orbitz shareholders in negotiating and approving the merger agreement, that the merger consideration negotiated in the merger agreement undervalues Orbitz, that Orbitz shareholders will not receive fair value for their Orbitz common stock in the merger, and that the terms of the merger agreement impose improper deal-protection devices that purportedly preclude competing offers. The complaints further allege that Orbitz, Expedia and Merger Sub aided and abetted the alleged breaches of fiduciary duty by the Orbitz directors. Plaintiffs seek injunctive relief, including enjoining or rescinding the merger, an award of unspecified attorneys' fees, and other relief.
The outcome of the Delaware Actions cannot be predicted with certainty. A preliminary injunction could delay or jeopardize the completion of the merger, and an adverse judgment granting permanent injunctive relief could indefinitely enjoin completion of the merger. Additional lawsuits arising out of or relating to the merger agreement or the merger may be filed in the future. Defendants intend to vigorously defend against these lawsuits
Other Litigation
Trilegiant Corporation v. Orbitz, LLC v. and Trip Network, Inc.: On July 7, 2011, Trilegiant Corporation filed an action for breach of contract and declaratory judgment in the Supreme Court of New York against Orbitz, LLC and Trip Network, Inc. Trilegiant alleges that the defendants are obligated to make a series of termination payments arising out of a marketing agreement that defendants terminated in 2007. In December 2012, Trilegiant moved to dismiss certain of Orbitz’s affirmative defenses. In January 2013, Orbitz moved for summary judgment on all of Trilegiant’s claims, arguing that those claims were barred by the illegality affirmative defense. On October 7, 2013, the Supreme Court of the State of New York denied Orbitz’s motion for summary judgment. Orbitz filed its notice of appeal of that ruling on October 31, 2013. On December 24, 2013, the Supreme Court dismissed the majority of Orbitz’s remaining affirmative defenses. Orbitz filed a notice of appeal of that ruling on January 30, 2014. On August 22, 2014, the Supreme Court rejected Orbitz’s remaining affirmative defenses, and Orbitz appealed that ruling on September 24, 2014. On January 15, 2015, the New York Supreme Court, Appellate Division, First Department heard oral argument on Orbitz’s first two appeals relating to, among others, its impossibility and illegality defenses. On February 19, 2015, the First Department affirmed the Supreme Court’s October 7, 2013 and December 24, 2013 rulings. On February 23, 2015, Orbitz filed its appellate brief relating to the Supreme Court’s August 22, 2014 order.
We intend to defend ourselves vigorously against the claims described above. Litigation is inherently unpredictable and, although we believe we have valid defenses in these matters, unfavorable resolutions could occur. Although we believe it is unlikely that an adverse outcome will result from these proceedings, an adverse outcome could be material to us with respect to our financial position, earnings or cash flows in any given reporting period.
Item 4.
Item 4.
Mine Safety Disclosure
Not Applicable.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock trades on the New York Stock Exchange under the symbol “OWW.” The following table sets forth the high and low sales prices for our common stock for each of the periods presented:
Holders
As of February 25, 2015, there were approximately 30 holders of record of our common stock. Several brokerage firms, banks and other institutions (“nominees”) are listed once on the stockholders of record listing. However, in most cases, the nominees’ holdings represent blocks of our common stock held in brokerage accounts for a number of individual stockholders. Accordingly, the number of beneficial owners of our stock is higher than the number of registered stockholders of record.
Dividends
We did not declare or pay any cash dividends on our common stock during the years ended December 31, 2014 and 2013, and we do not intend to in the foreseeable future. Any future determination to pay dividends will be at the discretion of our Board of Directors and will depend on several factors, including our financial condition, results of operations, capital requirements, restrictions contained in existing and future financing instruments and other factors that our Board of Directors may deem relevant.
Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information as of December 31, 2014 with respect to shares of our common stock that may be issued under our equity compensation plans.
Performance Graph
The following graph shows the total shareholder return through December 31, 2014 of an investment of $100 in cash on December 31, 2009 for our common stock and an investment of $100 in cash on December 31, 2009 for (i) the S&P SmallCap 600 Index and (ii) the Research Data Group (“RDG”) Internet Composite Index.
The RDG Internet Composite Index is an index of stocks representing the Internet industry, including Internet software and services companies and e-commerce companies. Historic stock performance is not necessarily indicative of future stock price performance. All values assume reinvestment of the full amount of all dividends and are calculated as of the last day of each month.
Item 6.
Item 6. Selected Financial Data
The selected financial data presented in the table below is derived from our audited consolidated financial statements. This data is not necessarily indicative of future results and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements and notes thereto included in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.
(a)
During the first quarter of 2011, we changed the classification of expenses for commissions paid to private label partners (“affiliate commissions”) from cost of revenue to marketing expense in our Consolidated Statements of Operations. Affiliate commissions were reclassified from cost of revenue to marketing expense for the year ended December 31, 2010 in the amount of $16 million.
(b)
Net income/(loss) per share may not recalculate due to rounding.
(c)
Defined as current assets less current liabilities.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
EXECUTIVE OVERVIEW
General
As previously noted, the following discussion excludes any impact that may result from the Merger Agreement.
We are a global online travel company that uses innovative technology to enable leisure and business travelers to research, plan and book a broad range of travel products and services including hotels, flights, vacation packages, car rentals, cruises, rail tickets, travel insurance, destination services and event tickets. We provide our customers an easy-to-use booking experience across a wide variety of devices. Our global brand portfolio includes Orbitz.com and CheapTickets in the United States; ebookers in Europe; and HotelClub which focuses on the Asia Pacific region. We also own and operate Orbitz for Business, which is a corporate travel management company, and the Orbitz Partner Network, which delivers private label travel solutions to a broad range of partners.
Industry Trends
Our position in the industry is affected by the industry-wide trends discussed below, as well as a number of factors specific to our global operations and supplier relationships. In addition, the continuing uncertainty about the state of the global economy and regional conflicts and the related pressure on consumer spending cause uncertainty and volatility in the travel market.
Worldwide travel is estimated to be a $1.3 trillion industry in 2014 that has been characterized by rapid and significant transformation driven by changes in demographic trends, globalization and higher consumer discretionary spending. The travel industry continues to benefit from increasing internet usage and higher online and mobile booking penetration rates. We compete in various geographic markets, with our primary markets being the United States, Europe and the Asia Pacific region. Internationally, approximately one third of travel sales are transacted online and the market is highly fragmented, which represents a significant opportunity for us. Phocuswright estimates that online travel bookings will grow approximately 11% annually from $402 billion in 2013 to $492 billion in 2015, with annual growth of approximately 6% in the United States, 8% in Europe and 15% in the Asia Pacific region. (Phocuswright, Global Online Travel Overview, 3rd ed.).
The online travel industry is highly competitive and competition has intensified in recent years. Airlines and hotels have increasingly focused on distributing their products through their own websites, and meta-search and travel research sites have gained in popularity and some of our competitors have acquired or invested in meta-search companies. We have also seen technology companies, such as Google, increase their interest in online travel.
Intense competition in the travel industry has historically led OTCs and travel suppliers to aggressively spend on online marketing. Competition for search engine key words continues to be intense as certain OTCs and travel suppliers increase their marketing spending in this area. Competitive dynamics could cause the cost to acquire traffic to continue to increase.
Over the past few years, fundamentals in the global hotel industry have strengthened. In general, we have seen rising hotel occupancy rates and higher average daily rates for hotel rooms. In addition, we have seen a shift in the business model under which some of our competitors make hotel rooms available to consumers. Our hotel business operates predominantly under the merchant model, however some of our competitors have adopted a retail model, or a model where the traveler can choose to purchase a hotel room under either a retail or merchant model. This could put pressure on the economics of historical business models.
Demand in the air travel industry has strengthened over the past few years driven largely by increased corporate travel demand. The increased corporate travel demand combined with continued discipline by airlines around capacity has resulted in higher airfares. Higher airfares generally put pressure on leisure travel demand, which represents the majority of air bookings through OTCs. Further consolidation of the airline industry could put additional pressure on capacity and airfares in the future.
Suppliers continue to look for ways to decrease overall distribution costs, which could significantly reduce the net revenue OTCs earn from travel and other ancillary travel products. We have encountered, and expect to continue to encounter, pressure on supplier economics as certain supply agreements are renegotiated. We expect that our shift in mix towards hotels and dynamic packaging will positively impact our overall transaction economics over time.
RESULTS OF OPERATIONS
** Not meaningful.
Overall Financial Results
During the year ended December 31, 2014, we reported net income of $17.3 million, compared with net income of $165.1 million in 2013. During the year ended December 31, 2013 we recorded a tax benefit of $165.0 million reflecting the release of $174.4 million in valuation allowance related to our U.S. federal deferred tax assets and during the year ended December 31, 2012 we recorded a $321.2 million charge for the impairment of goodwill and intangible assets.
Domestically, hotel, air, and car transaction volume grew in 2014 and revenue per transaction increased for air, car and vacation packages.
Internationally, we continued to see growth in hotel and vacation package transaction volume at ebookers, partially offset by lower air and vacation package revenue per transaction. HotelClub experienced higher year-over-year hotel transaction volume.
Key Operating Metrics
The table below shows our gross bookings, net revenue, transaction growth and hotel room night growth for the years ended December 31, 2014, 2013 and 2012. Gross bookings, transactions and stayed hotel room nights not only have an impact on our net revenue trends, but these metrics also provide insight to changes in overall travel demand, both industry-wide and specific to our websites. Air gross bookings include only standalone air gross bookings, while non-air gross bookings include gross bookings from hotels, car rentals, vacation packages, cruises, destination services and travel insurance.
(a)
For the years ended December 31, 2014, 2013 and 2012, $94.7 million, $98.7 million and $112.8 million of our total net revenue, respectively, was from incentive payments earned for air, car and hotel segments processed through GDSs.
Gross Bookings
The increase in domestic gross bookings for the year ended December 31, 2014 was driven by higher average booking values for air, hotels, vacation packages and car rentals and higher volume for air, hotels and car rentals. The TPN acquisition contributed approximately 9 percentage points of gross bookings growth for the year ended December 31, 2014. The increase in international gross bookings for the year ended December 31, 2014 was driven primarily by higher volume for air, hotels and vacation packages and higher average booking values for hotels, partially offset by lower average booking values for air and vacation packages.
For the year ended December 31, 2013 compared with the year ended December 31, 2012, the increase in domestic gross bookings was driven primarily by higher airfares, higher average booking values and higher volume for both hotels and vacation packages, and higher average car rental booking values, partially offset by lower air volume. The increase in international gross bookings for the year ended December 31, 2013 was driven primarily by higher airfares, higher hotel and vacation package volume, and higher average booking values for hotels, partially offset by lower air volume.
Net Revenue
Net revenue increased $85.0 million, or 10%, for the year ended December 31, 2014, as compared with the year ended December 31, 2013. Excluding the impact of foreign currency fluctuations, net revenue increased $84.7 million compared with the year ended December 31, 2013.
Hotel. Net revenue from hotel bookings increased $55.7 million or 19% for the year ended December 31, 2014 compared with the year ended December 31, 2013. Excluding the impact of foreign currency fluctuations, net revenue from hotel bookings increased $57.8 million compared with the prior year. Domestic hotel net revenue for the year ended December 31, 2014 increased $47.4 million as compared with the prior year. The increase was due primarily to higher volume. International hotel net revenue increased $8.3 million for the year ended December 31, 2014 as compared with the prior year. Excluding the impact of foreign currency fluctuations, international hotel net revenue increased $10.4 million. The increase was due to higher volume partially offset by lower net revenue per transaction. The TPN acquisition contributed approximately 8 percentage points to hotel net revenue growth for the year ended December 31, 2014.
Net revenue from hotel bookings increased $68.5 million, or 30%, for the year ended December 31, 2013, compared with the year ended December 31, 2012. Excluding the impact of foreign currency fluctuations, net revenue from hotel bookings increased $71.1 million compared with the year ended December 31, 2012. Domestic hotel net revenue for the year ended December 31, 2013 increased $54.5 million as compared with the prior year. The increase was due primarily to higher volume and to a lesser extent, higher net revenue per transaction. International hotel net revenue increased $14.0 million for the year ended December 31, 2013 as compared with the prior year. Excluding the impact of foreign currency fluctuations, international hotel net revenue increased $16.6 million. The increase was due primarily to higher volume.
Air. Net revenue from air bookings increased $7.5 million, or 3%, for the year ended December 31, 2014, as compared with the year ended December 31, 2013. Excluding the impact of foreign currency fluctuations, net revenue from air bookings increased $5.8 million for the year ended December 31, 2014, as compared with the prior year. Domestic air net revenue increased $6.5 million for the year ended December 31, 2014, as compared with the prior year. The increase was due to higher volume, and to a lesser degree, net revenue per transaction. International air net revenue increased by $1.0 million for the year ended December 31, 2014, as compared with the prior year. Excluding the impact of foreign currency fluctuations, international air net revenue decreased $0.7 million. The increase in reported net revenue was due to higher net revenue per transaction and higher volume. The TPN acquisition contributed approximately 9 percentage points to year-over-year standalone air net revenue growth for the year ended December 31, 2014.
Net revenue from air bookings decreased $11.8 million, or 5%, for the year ended December 31, 2013, as compared with the year ended December 31, 2012. Excluding the impact of foreign currency fluctuations, net revenue from air bookings decreased $13.6 million for the year ended December 31, 2013, as compared with the prior year. Domestic air net revenue decreased $5.1 million for the year ended December 31, 2013, as compared with the prior year. The decrease was due primarily to lower transaction volume and the absence of $2.6 million in additional revenue in 2012 resulting from a reduction in an unfavorable contract liability, partially offset by higher net revenue per transaction. The lower domestic transaction volume for the year ended December 31, 2013 was driven primarily by lower OTC channel volume. International air net revenue decreased by $6.7 million for the year ended December 31, 2013, as compared with the prior year. Excluding the impact of foreign currency fluctuations, international air net revenue decreased $8.5 million. The decrease in international air net revenue was due primarily to lower transaction volume, slightly offset by higher net revenue per transaction.
Vacation package. For the year ended December 31, 2014, net revenue from vacation package bookings increased $7.6 million, or 5%, as compared with the year ended December 31, 2013. Excluding the impact of foreign currency fluctuations, net revenue from vacation package bookings increased $7.0 million for the year ended December 31, 2014, as compared with the prior year. Domestic vacation package net revenue increased $4.0 million for the year ended December 31, 2014, as compared with the prior year due primarily to higher net revenue per transaction, partially offset by a slight decrease in volume. International vacation package net revenue increased $3.6 million for the year ended December 31, 2014, as compared with the prior year. Excluding the impact of foreign currency fluctuations, international vacation package net revenue increased $3.0 million. The increase was due primarily to higher volume, partially offset by lower net revenue per transaction. The TPN acquisition contributed approximately 2 percentage points to year-over-year vacation package net revenue growth for the year ended December 31, 2014.
For the year ended December 31, 2013 net revenue from vacation package bookings increased $12.4 million, or 10%, as compared with the prior year. Excluding the impact of foreign currency fluctuations, net revenue from vacation package bookings increased $12.0 million for the year ended December 31, 2013, as compared with the prior year. Domestic vacation package net revenue increased $7.8 million for the year ended December 31, 2013 as compared with the prior year driven
primarily by higher transaction volume, and to a slightly lesser degree, an increase in revenue per transaction. International vacation package net revenue increased $4.6 million for the year ended December 31, 2013, as compared with the prior year. Excluding the impact of foreign currency fluctuations, international vacation package net revenue increased $4.2 million. The increase was due to higher net revenue per transaction and higher volume.
Advertising and media. Advertising and media net revenue increased $4.3 million, or 7%, for the year ended December 31, 2014, compared with the year ended December 31, 2013. Excluding the impact of foreign currency fluctuations, net revenue from advertising and media increased $4.4 million for the year ended December 31, 2014, as compared with the prior year. The increase of $4.3 million was due largely to an increase in pay-per-click and other performance advertising, partially offset by lower display advertising and the shutdown of the Away Network, which occurred in the first quarter of 2013.
Advertising and media net revenue increased $1.0 million, or 2%, on both a reported and constant currency basis for the year ended December 31, 2013, compared with the year ended December 31, 2012. The increase of $1.0 million was driven by $4.6 million of higher display advertising, largely offset by a $3.6 million decrease due to the shutdown of the Away Network.
Other. Other net revenue is composed primarily of net revenue from travel insurance, car bookings, cruise bookings, and attraction and services bookings. Other net revenue increased $10.0 million, or 10%, for the year ended December 31, 2014, compared with the year ended December 31, 2013. Excluding the impact of foreign currency fluctuations, other net revenue increased $9.7 million. The increase was due largely to higher car rental net revenue, and to a lesser extent, higher travel insurance and attractions and services net revenue. The TPN acquisition contributed approximately 5 percentage points to year-over-year other net revenue growth for the year ended December 31, 2014.
Other net revenue decreased $1.8 million, or 2%, for the year ended December 31, 2013, compared with the year ended December 31, 2012. Excluding the impact of foreign currency fluctuations, other net revenue decreased $2.3 million. The decrease was largely driven by lower attractions and services revenue and to a lesser extent, lower cruise revenue.
Costs and Expenses
Cost of Revenue
Our cost of revenue is composed of costs to operate our customer service call centers, credit card and other payment processing fees and other costs, which include customer refunds, fraud and other charge-backs, hosting costs and connectivity and other processing costs.
Cost of revenue increased $25.4 million (a $25.2 million increase excluding the impact of foreign currency fluctuations), including an increase of $25.2 million related to TPN, for the year ended December 31, 2014, compared with the year ended December 31, 2013. This was driven by a $16.0 million increase in customer service costs related to the TPN acquisition, a $6.9 million increase in credit card processing fees reflecting higher merchant volume, and a $5.3 million increase in customer refunds and fraud, partially offset by lower connectivity and processing costs of $1.5 million and lower ticketing costs of $0.4 million.
Cost of revenue increased $6.6 million on both a reported and constant currency basis for the year ended December 31, 2013 compared with the year ended December 31, 2012. The increase in cost of revenue was due primarily to a $13.5 million increase in credit card processing fees driven by higher global hotel volume, partially offset by lower customer refunds and fraud expense of $4.8 million due to efficiencies at the Company’s customer service call centers and lower connectivity and processing costs of $2.3 million.
Selling, General and Administrative
Our selling, general and administrative expense is composed of wages and benefits, contract labor costs, network communications, systems maintenance and equipment costs and other costs, which include professional fees, foreign currency transaction and hedging expense and other administrative costs.
(a)
The amounts presented above for wages and benefits and contract labor are net of amounts capitalized related to software development.
Selling, general and administrative expense decreased $2.2 million (a $2.1 million decrease excluding the impact of foreign currency fluctuations), including an increase of $15.0 million related to TPN, for the year ended December 31, 2014, compared with the year ended December 31, 2013. This decrease was driven primarily by a $7.0 million decrease in professional fees due primarily to litigation related expenses and a $2.3 million decrease in wages and benefits, partially offset by a $2.5 million increase in the fair value of the tax sharing liability attributable to a change in the expected tax rate (see Note 8 -Tax Sharing of the Notes to Consolidated Financial Statements), higher travel costs of $1.6 million, and higher network communications, systems maintenance and equipment costs of $1.0 million and increases in foreign currency expense and facilities expense. Wages and benefits decreased due largely to lower incentive-based compensation of $6.4 million, lower severance expense of $2.0 million, higher capitalized wages and benefits of $2.8 million and lower taxes and commissions. These amounts were partially offset by higher salary and wages of $9.6 million, primarily due to TPN, and other employee benefits.
Selling, general and administrative expense increased $20.2 million (a $21.1 million increase excluding the impact of foreign currency fluctuations) for the year ended December 31, 2013, compared with the year ended December 31, 2012. The increase in expense was primarily driven by a $26.2 million increase in wages and benefits and the absence of an insurance reimbursement of $5.0 million received in 2012 for costs previously incurred to defend our hotel tax cases. The increase in selling, general, and administrative expense was partially offset by a $4.7 million decrease in contract labor costs, a $2.2 million decrease in legal fees, a $1.5 million decrease in employee travel expense, a $1.3 million decrease in network communications costs, and a decrease in other professional fees. Wages and benefits increased due largely to higher incentive-based compensation of $17.8 million, higher stock-based compensation of $3.7 million and lower capitalized wages and benefits of $3.5 million. In addition, lower wages of $6.2 million were largely offset by higher payroll taxes of $2.4 million, higher severance of $2.3 million and higher sales commissions of $1.1 million.
Marketing
Our marketing expense is primarily composed of online marketing costs, such as search engine marketing and travel research; offline marketing costs, such as television, radio and print advertising; and commissions to affiliates, including distribution partners. Our online marketing spending is significantly greater than our offline marketing spending.
Marketing expense increased $42.0 million, or 14%, including an increase of $17.3 million related to TPN, for the year ended December 31, 2014, compared with the year ended December 31, 2013. Excluding the impact of foreign currency fluctuations, marketing expense increased $42.1 million for the year ended December 31, 2014, compared with the year ended December 31, 2013. The increase in marketing expense was due largely to the TPN acquisition, the growth of our private label distribution channel and higher online marketing spend at our consumer sites.
Marketing expense increased $39.5 million (a $39.9 million increase excluding the impact of foreign currency fluctuations) for the year ended December 31, 2013, compared with the year ended December 31, 2012, due largely to the growth of our private label distribution channel which increased affiliate commissions by $23.5 million and increased search engine and other online marketing of $32.7 million, partially offset by lower offline marketing spend of $16.7 million.
Depreciation and Amortization
Depreciation and amortization expense increased $2.4 million (a $2.5 million increase excluding the impact of foreign currency fluctuations), driven primarily by $2.2 million related to TPN, for the year ended December 31, 2014, compared with the year ended December 31, 2013.
Depreciation and amortization expense decreased $1.9 million (a $1.8 million decrease excluding the impact of foreign currency fluctuations) for the year ended December 31, 2013, compared with the year ended December 31, 2012. The decrease in depreciation and amortization expense was due primarily to certain fixed and other assets that were written off in 2012 and in the first quarter of 2013 (see “Impairment” discussion below).
Impairment
As of December 31, 2014 and December 31, 2013, we performed our annual impairment test for goodwill and intangible assets and determined that no impairment existed as of those dates.
As a result of our decision during the first quarter of 2013 to exit the Away Network business, we recorded a $2.6 million non-cash charge for the year ended December 31, 2013 to impair property and equipment associated with that business.
For the year ended December 31, 2012, in connection with our annual impairment test for goodwill and intangible assets, and as a result of lower than expected performance and a decline in expected future cash flows for the Americas reporting unit, we recorded a non-cash impairment charge of $321.2 million, of which $301.9 million related to goodwill, $17.6 million related to trademarks and trade names associated with Orbitz and CheapTickets and $1.6 million related to finite-lived intangible assets. (See Note 5 - Goodwill and Intangible Assets of the Notes to Consolidated Financial Statements).
Net Interest Expense
Net interest expense decreased $8.6 million for the year ended December 31, 2014, compared with the year ended December 31, 2013. The decrease in net interest expense was due to lower letter of credit fees of $3.0 million, lower interest on the term loan of $2.6 million as a result of the amendments to the credit agreement, a decrease in amortization expense for deferred financing costs of $1.7 million, a decrease in non-cash interest expense related to the tax sharing liability of $0.8 million and a decrease in costs related to interest rate swaps. For the year ended December 31, 2014, the weighted average interest rate of the term loan was 57 basis points lower than the same period in 2013 and the average principal balance of the debt outstanding was approximately $1.6 million higher, compared with the same period in 2013.
Net interest expense increased $7.2 million for the year ended December 31, 2013, compared with the year ended December 31, 2012. The increase in net interest expense was due primarily to higher interest rates as a result of the refinancing of our debt that was completed in March 2013 and again in May 2013. Interest expense under our debt agreements increased by $9.4 million largely due to the higher interest rates. The increase in net interest expense was also driven by higher amortization expense for deferred financing costs of $2.2 million and the mark-to-market effect of derivative interest rate contracts of $0.9 million. These increases were partially offset by lower letter of credit fees of $3.7 million and lower non-cash interest expense related to the tax sharing liability of $1.7 million.
See Note 7 - Term Loan and Revolving Credit Facility of the Notes to Consolidated Financial Statements.
Other Income/(Expense)
Other income/(expense) decreased $15.9 million for the year ended December 31, 2014, compared with the year ended December 31, 2013. The decrease in other expense was due to a $2.2 million charge during the year ended December 31, 2014 reflecting the refinancing costs related to the credit agreement, as amended, and the write-off of deferred financing fees, compared with an $18.1 million write-off of deferred financing fees during the year ended December 31, 2013 (See Note 7 - Term Loan and Revolving Credit Facility in the Notes to Consolidated Financial Statements).
Other income/(expense) increased $18.1 million for the year ended December 31, 2013, compared with the year ended December 31, 2012. Due to a favorable interest rate environment and the Company’s performance in the first quarter of 2013, on May 24, 2013 we refinanced the term loan portion of our debt at substantially lower rates than those in the agreement signed on March 25, 2013. The $18.1 million charge reflects the write-off of deferred financing costs related to the March 25, 2013 refinancing and prepayment penalties incurred when the term loans were refinanced on May 24, 2013.
Provision for Income Taxes
We recorded a tax provision of $27.3 million for the year ended December 31, 2014, a tax benefit of $165.0 million for the year ended December 31, 2013, and a tax provision of $3.2 million for the year ended December 31, 2012. The tax provision for the year ended December 31, 2014 was primarily deferred taxes on income from our U.S. operations and certain foreign subsidiaries where we have not established a valuation allowance. The 2014 tax provision was disproportionate to pre-tax book income due to the valuation allowances which still remain with respect to the majority of our non-US operations.
The tax benefit for the year ended December 31, 2013 was due primarily to a release of $174.4 million in valuation allowances related to our U.S. federal deferred tax assets and therefore the book benefit was disproportionate to the amount of pretax book income.
The tax provision for the year ended December 31, 2012 was due primarily to taxes on the income of certain European-based subsidiaries and U.S. state and local income taxes. The tax provision recorded for the year ended December 31, 2012 was disproportionate to the amount of pre-tax net loss incurred primarily because we were not able to recognize any tax benefits on the goodwill and trademark and trade names impairment charges. The provision for income taxes only includes the tax effect of the net income or net loss of certain foreign subsidiaries that had not established a valuation allowance and U.S. state and local income taxes.
As of December 31, 2014, the valuation allowance for our deferred tax assets was $109.2 million, of which $107.3 million related to foreign jurisdictions. We will continue to assess the level of the valuation allowance required and if sufficient positive evidence exists in future periods to support a release of some or all of the valuation allowance, such a release may have a material impact on our results of operations.
Related Party Transactions
For a discussion of certain relationships and related party transactions, see Note 15 - Related Party Transactions of the Notes to Consolidated Financial Statements.
Seasonality
Our businesses experience seasonal fluctuations in the demand for the products and services we offer. The majority of our customers book leisure travel rather than business travel. Gross bookings for leisure travel are generally highest in the first half of the year as customers plan and book their spring and summer vacations. Cash is received upon booking for the majority of transactions on our website, and net revenue for non-air transactions is generally recognized when the travel takes place and typically lags bookings by several weeks or longer. As a result, our cash receipts are generally highest in the first half of the year and our net revenue is typically highest in the second and third quarters. Fluctuations in the travel products our suppliers make available to us for booking the growth of our international operations or a change in our product mix may also affect our seasonality.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Our principal sources of liquidity are our cash flows from operations, our cash and cash equivalents and availability under the Amended Credit Agreement, which includes an $80.0 million revolving credit facility (the “Revolver”) through which our revolving lenders have agreed to issue up to $55.0 million in letters of credit (See Note 7 - Term Loan and Revolving Credit Facility of the Notes to Consolidated Financial Statements). At December 31, 2014, our cash and cash equivalents amounted to $188.5 million. At December 31, 2014, there were no outstanding borrowings or letters of credit issued under the Revolver. Letters of credit that are issued under the Revolver would reduce the amount available for borrowings. Total available liquidity from cash and cash equivalents and the Revolver was $268.5 million at December 31, 2014.
We require letters of credit and similar instruments to support certain supplier and commercial agreements, lease obligations and to comply with non-U.S. regulatory and governmental regulations. At December 31, 2014 and December 31, 2013, we had $101.3 million and $112.9 million, respectively, of outstanding letters of credit and similar instruments. In addition, we may continue to be required to provide financial security or pay deposits to municipalities in order to challenge assessments in court for hotel tax proceedings, which could negatively affect our cash flow and liquidity. For further details on our letters of credit, see Note 9 - Commitments and Contingencies of the Notes to Consolidated Financial Statements.
Currently, except for the availability under the Revolver, most of our letters of credit and similar instruments require cash collateral support, which is recorded as Restricted Cash on our Consolidated Balance Sheets. We believe we have adequate letter of credit availability to support our expected requirements for the foreseeable future.
Under our merchant model, customers generally pay us for reservations at the time of booking and we pay our suppliers at a later date, which is generally when the customer uses the reservation, except in the case of payment for merchant air which generally occurs prior to the consumption date. Initially, we record these customer receipts as accrued merchant payables and either deferred income or net revenue, depending upon the travel product. The timing difference between when cash is collected from our customers and when payments are made to our suppliers improves our operating cash flow and represents a source of liquidity for us.
Seasonal fluctuations in our business also affect the timing of our cash flows. Gross bookings are generally highest in the first half of the year as customers plan and book their spring and summer vacations. As a result, our cash receipts are generally highest in the first half of the year. We generally have net cash outflows during the second half of the year since cash payments to suppliers typically exceed the cash inflows from new merchant reservations. While we expect this seasonal cash flow pattern to continue, changes in our business model could affect the timing, seasonal nature, or amount of our cash flows.
As of December 31, 2014 we had a working capital deficit of $258.0 million compared with a deficit of $314.7 million as of December 31, 2013, a decrease of $56.7 million. The decreased deficit in the year ended December 31, 2014, as compared with December 31, 2013, was due largely to growth in the business, the timing of cash receipts and payments, decreased restricted cash of $21.0 million, all partially offset by an increase in the current portion of the term loan of $12.4 million and the $10.0 million payment made in 2014 to acquire certain TPN assets.
We generated positive cash flow from operations for each of the years ended December 31, 2010 through December 31, 2014 despite experiencing net losses in most of these periods, and we expect annual cash flow from operations to remain positive in the foreseeable future. We generally use this cash flow to fund our operations, make principal and interest payments on our debt, finance capital expenditures, cash collateralize letters of credit and meet our other cash operating needs. For the year ending December 31, 2015, we expect our capital expenditures to be between $57 million and $63 million, a portion of which is discretionary in nature. We do not intend to declare or pay any cash dividends on our common stock.
With respect to both our short- and long-term liquidity needs, we currently believe that cash flow generated from operations, cash on hand, and borrowing availability under the Revolver will provide sufficient liquidity to fund our operating activities, capital expenditures and other obligations. See Note 7 - Term Loan and Revolving Credit Facility of the Notes to Consolidated Financial Statements. See Part I Item 1A. Risk Factors: “Our business has significant liquidity requirements” for a discussion of certain events that could have a negative impact on our liquidity. We may be required to, or choose to, provide financial security or pay deposits to municipalities in order to challenge assessments in court for hotel tax proceedings, which could negatively affect our cash flow and liquidity.
Cash Flows
Our net cash flows from operating, investing and financing activities were as follows:
Operating Activities
Cash provided by operating activities consists of our net income or loss, adjusted for non-cash items such as depreciation, amortization, changes in unrealized gains and losses, impairment of intangible assets and stock-based compensation, and changes in various working capital accounts, principally accounts receivable, deferred income, accrued merchant payables, accounts payable and accrued expenses.
We generated cash flow from operations of $149.5 million for the year ended December 31, 2014, compared with $153.2 million for the year ended December 31, 2013. Cash flow from operations for the year ended December 31, 2014 was affected by higher pretax income of $44.5 million, which was more than offset by the effects of changes in working capital accounts, the effect of foreign exchange contracts and exchange rates on other assets and liabilities.
We generated cash flow from operations of $153.2 million for the year ended December 31, 2013, compared with $107.1 million for the year ended December 31, 2012. The increase in cash flow from operations was largely due to increased merchant payables of $38.7 million as a result of the growth in global merchant hotel transactions and an increase in accounts payable, accrued expenses and other current liabilities of $25.8 million, partially offset by the majority of the $18.1 million deferred financing fees paid and expensed in 2013 related to the refinancing of the term loan.
Investing Activities
Cash flow used in investing activities was $43.8 million for the year ended December 31, 2014, a decrease of $89.5 million from $133.3 million for the year ended December 31, 2013. This change from the prior year was due primarily to a lower use related to restricted cash of $111.3 million in the year ended December 31, 2014, as compared with the prior year period, partially offset by the acquisition of certain assets of TPN for $10.0 million and higher capital spending of $11.8 million. The impact related to restricted cash was due largely to the one-time impact in 2013 of increases in restricted cash to replace letters of credit previously issued by Travelport.
Cash flow used in investing activities increased to $133.3 million for the year ended December 31, 2013 from $63.8 million for the year ended December 31, 2012. This increase from the prior year was due to an increase in restricted cash balances of $94.0 million in the year ended December 31, 2013, partially offset by lower capital spending of $7.7 million, as compared with the prior year. The increase in restricted cash was due largely to increases in restricted cash to collateralize letters of credit and similar instruments primarily to replace letters of credit previously issued by Travelport and under the 2007 Revolver. These letters of credit are used to support certain supplier and commercial agreements, fulfill lease obligations and comply with non-U.S. regulatory and governmental regulations.
Financing Activities
Cash flow used in financing activities decreased to $23.4 million for the year ended December 31, 2014 from $35.0 million for the year ended December 31, 2013. This decrease was due primarily to lower tax sharing liability payments of $2.4 million and lower net repayments on our term loans of $16.9 million in the year ended December 31, 2014 compared with the prior year. Specifically, in 2014, we had a net cash outflow of $2.2 million in connection with the refinancing of the term loan
under our 2007 Credit Agreement (see Note 7 - Term Loans and Revolving Credit Facility of the Notes to Consolidated Financial Statements) and scheduled principal payments pursuant to the senior secured credit agreement compared with $19.1 million in 2013. In addition, we had a $6.9 million decrease in proceeds received from the exercise of stock options 2014, as compared with the prior year.
Cash flow used in financing activities decreased to $35.0 million for the year ended December 31, 2013, from $50.0 million for the year ended December 31, 2012. This decrease was due primarily to lower net repayments on our term loans in the year ended December 31, 2013 compared with the previous year. Specifically, during the year ended December 31, 2013, we had a net cash outflow of $19.1 million for net principal reductions in connection with the refinancing of the term loan borrowings under our 2007 Credit Agreement, excess cash flow payment and scheduled maturity payments of the senior secured credit agreement, while during the year ended December 31, 2012, we had a $32.2 million excess cash flow payment on our term loan. In addition, we had a $3.0 million increase in net proceeds related to the exercise of employee stock options and employee tax withholdings for equity based awards in the year ended December 31, 2013, as compared with the prior year.
Financing Arrangements
On April 15, 2014, we entered into an amendment (the “Second Amendment”) to the $515.0 million senior secured credit agreement entered into on March 25, 2013, as refinanced and amended on May 24, 2013 (the “Credit Agreement”), composed of a 7-year, $450.0 million term loan maturing April 15, 2021 (the “Term Loan”) and a 5-year $80.0 million revolving credit facility maturing April 15, 2019 (the “Revolver”). The proceeds of the Term Loan were used to repay approximately $439.9 million of term loans outstanding under the Credit Agreement, pay certain fees and expenses incurred with the Second Amendment and for general corporate purposes. The term loans under the Credit Agreement, which were repaid, had original principal amounts of $100.0 million maturing September 25, 2017 and $350.0 million maturing March 25, 2019.
Following the Second Amendment, the $530.0 million senior secured credit facility (the “Amended Credit Agreement”) consists of the Term Loan and the Revolver. Among other things, the Second Amendment reduced the financial maintenance covenants, increased certain baskets, and added certain exceptions under certain negative covenants in the Credit Agreement.
The Term Loans and the Revolver bear interest at a variable rate, at our option, of the Eurocurrency Rate or the Base Rate, plus a margin. The Amended Credit Agreement requires us not to exceed a maximum first lien leverage ratio of 5.00 to 1, as defined in the Amended Credit Agreement. As of December 31, 2014, we were in compliance with the financial covenant and other conditions of the Amended Credit Agreement and expect to be in compliance for the foreseeable future.
The Term Loan and Revolver are both secured by substantially all of our and our domestic subsidiaries’ tangible and intangible assets, including a pledge of 100% of the outstanding capital stock or other equity interests of substantially all of our direct and indirect domestic subsidiaries and 65% of the capital stock or other equity interests of certain of our foreign subsidiaries, subject to certain exceptions. The Term Loan and Revolver are also guaranteed by substantially all of our domestic subsidiaries.
The Credit Agreement contains various customary restrictive covenants that limit our ability to, among other things:
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incur additional indebtedness or enter into guarantees;
•
enter into sale or leaseback transactions;
•
make investments, loans or acquisitions;
•
grant or incur liens on our assets;
•
sell our assets;
•
engage in mergers, consolidations, liquidations or dissolutions;
•
engage in transactions with affiliates; and
•
make any distribution or dividend payment, or redeem or repurchase our capital stock.
The Term Loan is payable in quarterly installments of $1.125 million, beginning September 30, 2014, with the final installment of the remaining outstanding balance due at the applicable maturity date with respect to such Term Loan. In addition, we are required, subject to certain exceptions, to make payments on the Term Loan: (a) annually in the first quarter of each fiscal year in an amount of 50% (which percentage will be reduced to 25% and 0% subject to achieving certain leverage ratios) of the prior year’s excess cash flow, as defined in the Credit Agreement; (b) in an amount of 100% of net cash proceeds from asset sales subject to certain reinvestment rights; and (c) in an amount of 100% of net cash proceeds of any issuance of
debt other than debt permitted to be incurred under the Amended Credit Agreement. The first excess cash flow payment is due in the first quarter of 2015 for the period from January 1, 2014 to December 31, 2014. Based on our financial results for the year ended December 31, 2014, we will be required to make a $25.9 million prepayment. Prepayments from excess cash flow are applied, in order of maturity, to the scheduled quarterly Term Loan principal payments. As a result, we will not be required to make any scheduled principal payments on the Term Loan until 2020. The potential amount of prepayment from excess cash flow that will be required beyond the first quarter of 2015 is not reasonably estimable as of December 31, 2014.
Financial Obligations
Commitments and Contingencies
We are involved in various claims, legal proceedings and governmental inquiries related to contract disputes, business practices, antitrust, intellectual property and other commercial, employment and tax matters. We believe that we have meritorious defenses, and we are vigorously defending against these claims, proceedings and inquiries (see Note 9 - Commitments and Contingencies of the Notes to Consolidated Financial Statements).
Litigation is inherently unpredictable and, although we believe we have valid defenses in these matters, unfavorable resolutions could occur. We generally cannot estimate our range of loss, except to the extent taxing authorities have issued assessments against us. Although we believe it is unlikely that a materially adverse outcome will result from these proceedings, an adverse outcome could be material to us with respect to earnings or cash flows in any given reporting period.
Contractual Obligations
The following table summarizes our future contractual obligations as of December 31, 2014:
(a)
The amounts shown in the table above represent future payments under the Term Loan (see Note 7 - Term Loan and Revolving Credit Facility of the Notes to Consolidated Financial Statements). However, the timing of the future payments shown in the table above could change as we are required to make an annual prepayment on the Term Loan in the first quarter of each fiscal year in an amount up to 50% of the prior year’s excess cash flow, as defined in the Credit Agreement. Based on our cash flow for the year ended December 31, 2014, we are required to make a prepayment on the Term Loan of $25.9 million in the first quarter of 2015. The potential amount of prepayments from excess cash flow that will be required beyond the first quarter of 2015 is not reasonably estimable as of December 31, 2014. As a result, the table above excludes prepayments that could be required from excess cash flow beyond the first quarter of 2015.
(b)
Represents estimated interest payments on the variable portion of the Term Loan based on the one-month LIBOR as of December 31, 2014 and fixed interest payments under interest rate swaps.
(c)
In February 2014, the Company entered into an agreement with Travelport for the provision of GDS services (“New Travelport GDS Service Agreement”), replacing our prior Travelport GDS service agreement (“Travelport GDS Service Agreement”). Under the New Travelport GDS Service Agreement, Orbitz was subject to certain exclusivity obligations for segments booked during 2014 in certain markets as defined in the agreement. However, beginning January 1, 2015, the Company is no longer subject to exclusivity obligations. Under the New Travelport GDS Service Agreement beginning in 2015, we are obligated to provide certain levels of volume over the contract period and may be subject to pay shortfall payments in certain cases if we fail to meet volume commitments. The agreement terminates on December 31, 2018.
In February 2014, the Company entered into an agreement with Amadeus to provide GDS services. This contract requires the Company to meet certain minimum annual booking requirements beginning in 2016 through the end of the contract at December 31, 2019.
(d)
Represents payments in connection with the tax sharing agreement with the Founding Airlines (see Note 8 - Tax Sharing Liability of the Notes to Consolidated Financial Statements).
(e)
Excluded from the above table are $3.3 million of liabilities for uncertain tax positions for which the period of settlement is not currently determinable.
Other Commercial Commitments and Off-Balance Sheet Arrangements
In the ordinary course of business, we obtain surety bonds and bank guarantees, issued for the benefit of third parties, to secure performance of certain of our obligations (see Note 9 - Commitments and Contingencies of the Notes to Consolidated Financial Statements).
We are also required to issue letters of credit to certain suppliers and non-U.S. regulatory and government agencies.
CRITICAL ACCOUNTING POLICIES
The preparation of our consolidated financial statements and related notes in conformity with generally accepted accounting principles requires us to make judgments, estimates and assumptions that affect the amounts reported therein. An accounting policy is considered to be critical if it meets the following two criteria:
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the policy requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made; and
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different estimates that reasonably could have been used or changes in the estimates that are reasonably likely to occur from period to period would have a material impact on our consolidated financial statements.
We believe that the estimates and assumptions used when preparing our consolidated financial statements were the most appropriate at that time. However, events that are outside of our control cannot be predicted and, as such, they cannot be contemplated in evaluating such estimates and assumptions. We have discussed these estimates with our Audit Committee of the Board of Directors.
Presented below are those accounting policies that we believe require subjective and complex judgments that could potentially affect our reported results. Although we believe these policies to be the most critical, other accounting policies also have a significant effect on our consolidated financial statements and certain of these policies may also require the use of estimates and assumptions (see Note 2 - Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements).
Revenue Recognition
Merchant revenues are from transactions where we are the merchant of record and have the ability to determine the price charged to the customer. We have agreements with suppliers that provide our customers the ability to book their supply (for example, air tickets or hotel rooms) that we sell through our sites. We present merchant revenues on a net basis in accordance with Accounting Standards Codification (“ASC”) 605-45, Revenue Recognition - Principal Agent Considerations. Based upon evaluation of our merchant transactions and in accordance with the various indicators identified in the ASC, we concluded that our suppliers assume the majority of the business risks, including the risk of unsold air tickets or hotel rooms. As such, we recognize revenues for merchant transactions at the net amount, which is the amount charged to the customer less the amount to be paid to the supplier.
We accrue for the cost of merchant hotel and merchant car transactions based on amounts we expect to be invoiced by suppliers. Based on our historical experience and contract terms, we reverse a portion of the accrued cost, which increases net revenue, when we determine it is not probable that we will be required to pay the supplier. Actual amounts could be greater or less than the amounts estimated due to changes in supplier billing practices or changes in traveler behavior.
The Company issues credits in the form of points related to its loyalty programs. The value of points earned by loyalty program members is included in accrued liabilities and recorded as a reduction of revenue at the time the points are earned,
based on the percentage of points that are projected to be redeemed. The determination of the redemption rate of the loyalty program requires the use of assumptions and estimates.
Impairment of Long-Lived Assets, Goodwill and Indefinite-Lived Intangible Assets
Long-Lived Assets
We evaluate the recoverability of our long-lived assets, including property and equipment and finite-lived intangible assets, when circumstances indicate that the carrying value of those assets may not be recoverable. This analysis is performed by comparing the carrying values of the assets to the current and expected future cash flows to be generated from these assets, on an undiscounted basis. If this analysis indicates that the carrying value of an asset is not recoverable, the carrying value is reduced to fair value through an impairment charge in our Consolidated Statements of Operations. The evaluation of long-lived assets for impairment requires assumptions about operating strategies and estimates of future cash flows. An estimate of future cash flows requires us to assess current and projected market conditions as well as operating performance. A variation of the assumptions used could lead to a different conclusion regarding the recoverability of an asset and could have a significant effect on our consolidated financial statements.
Goodwill and Indefinite-Lived Intangible Assets
We assess the carrying value of goodwill and other indefinite-lived intangible assets for impairment annually or more frequently whenever events occur and circumstances change indicating potential impairment. We perform our annual impairment testing of goodwill and other indefinite-lived intangible assets as of December 31.
We assess goodwill for possible impairment using a two-step process. The first step identifies if there is potential goodwill impairment. If the step one analysis indicates that impairment may exist, a step two analysis is performed to measure the amount of the goodwill impairment, if any. Application of the goodwill impairment test requires management’s judgment, including identifying reporting units, assigning assets and liabilities to reporting units and determining the fair value of each reporting unit. We estimate the fair value of our reporting units to which goodwill is allocated using generally accepted valuation methodologies, including market and income based approaches, and relevant data available through and as of the testing date. Under the market approach, the valuation process is essentially that of comparison and correlation between the subject asset and other similar assets. The income approach is a method in which fair value is estimated based on the cash flows that an asset could be expected to generate over its useful life, including residual value cash flows. These cash flows are then discounted to their present value equivalents using a rate of return that accounts for the relative risk of not realizing the estimated annual cash flows and for the time value of money. Variations of the income approach are used to estimate certain of the intangible asset fair values.
Our trademarks and trade names are indefinite-lived intangible assets. We test these assets for impairment by comparing their carrying values to their estimated fair values. If the estimated fair values are less than the carrying amounts of the intangible assets, then the carrying values are reduced to fair value through an impairment charge recorded in our Consolidated Statements of Operations. We use an income valuation approach to estimate fair values of the relevant trademarks and trade names.
Our testing for impairment involves estimates of our future cash flows, which requires us to assess current and projected market conditions as well as operating performance. Our estimates may differ from actual cash flows due to changes in our operating performance, capital structure or capital expenditure needs as well as changes to general economic and travel industry conditions. We must also make estimates and judgments in the selection of a discount rate that reflects the risk inherent in those future cash flows. The impairment analysis may also require certain assumptions about other businesses with limited financial histories. A variation of the assumptions used could lead to a different conclusion regarding the fair value of an asset and could have a significant effect on our consolidated financial statements. We use the income approach to estimate the fair value of all reporting units and use the market approach to corroborate this estimate. Pursuant to our policy, we performed the annual impairment test as of December 31, 2014 and determined that no impairment of goodwill or indefinite-lived intangible assets existed as of that date as the fair value of the reporting units and the indefinite-lived intangible assets exceeded the carrying values.
Occupancy Taxes
We are involved in a number of lawsuits brought by states, cities and counties over issues involving the payment of hotel occupancy or similar taxes. We do not believe that we are liable for these taxes, generally imposed on entities that own, operate or control hotels or provide hotel rooms or similar accommodations. We accrue for potential losses in those circumstances that
we believe a loss is probable and for which we are able to develop a reasonable estimate of any such loss. The ultimate resolution of these lawsuits or contingencies may differ substantially from our estimates.
Income Taxes
Our provision for income taxes is determined using the asset and liability method. Under this method, deferred tax assets and liabilities are calculated based upon the temporary differences between the financial statement and income tax bases of assets and liabilities using the combined federal and state effective tax rates that are applicable to us in a given year. The deferred tax assets are recorded net of a valuation allowance when, based on the weight of available evidence, we believe it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. Increases to the valuation allowance are recorded as increases to the provision for income taxes. The realization of the deferred tax assets, net of a valuation allowance, is primarily dependent on estimated future taxable income, as well as the consideration of other factors. We currently have a valuation allowance for our deferred tax assets of $109.2 million, of which $107.3 million relates to foreign jurisdictions. On a quarterly basis, we assess the level of valuation allowance required; if sufficient positive evidence exists in future periods to support a release of some or all of the valuation allowance, such a release may have a material impact on our results of operations.
Tax Sharing Liability
We have a liability included in our Consolidated Balance Sheets that relates to a tax sharing agreement between Orbitz and the Founding Airlines (see Note 8 - Tax Sharing Liability of the Notes to Consolidated Financial Statements for further details). We use discounted cash flows in calculating and recognizing the tax sharing liability. We review the calculation of the tax sharing liability on a quarterly basis and make revisions to our estimated timing of payments when appropriate. We also assess whether there are any significant changes, such as changes in the amount of payments and tax rates that could materially affect the present value of the tax sharing liability.
The valuation of the tax sharing liability requires us to make certain estimates in projecting the quarterly depreciation and amortization benefit we expect to receive, as well as the associated effective income tax rates. The estimates require certain assumptions as to our future operating performance and taxable income, the tax rate, the timing of tax payments, current and projected market conditions, and the applicable discount rate. A variation of the assumptions used could lead to a different conclusion regarding the carrying value of the tax sharing liability and could have a significant effect on our consolidated financial statements.
Internal Use Software
We capitalize the costs of software developed for internal use. Capitalization commences when the preliminary project stage of the application has been completed and it is probable that the project will be completed and used to perform the function intended. Amortization commences when the software is placed into service. The determination of costs to be capitalized and the useful life of the software require us to make estimates and judgments.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Risk
Our international operations are subject to risks typical of international operations, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures and foreign exchange rate volatility. Accordingly, our future results could be materially adversely impacted by changes in these or other factors.
Transaction Exposure
We use foreign currency contracts to manage our exposure to changes in foreign currency exchange rates associated with our foreign currency denominated receivables, payables and intercompany transactions. We primarily hedge our foreign currency exposure to the Pound sterling, Euro, Swiss franc and Australian dollar. We do not engage in trading, market making or speculative activities in the derivatives markets. The foreign currency contracts utilized by us do not qualify for hedge accounting treatment and, as a result, any fluctuations in the value of these foreign currency contracts are recognized in Selling, general and administrative expense in our Consolidated Statements of Operations as incurred. The fluctuations in the value of these foreign currency contracts do, however, largely offset the impact of changes in the value of the underlying risk that they are intended to economically hedge. At December 31, 2014 and 2013, we had foreign currency contracts with net notional values equivalent to $190.3 million and $282.7 million, respectively.
Translation Exposure
Foreign exchange rate fluctuations may adversely impact our financial position as the assets and liabilities of our foreign operations are translated into U.S. dollars in preparing our Consolidated Balance Sheets. The effect of foreign exchange rate fluctuations on our Consolidated Balance Sheets at December 31, 2014 and 2013 was a net translation gain of $9.7 million and $3.0 million, respectively. This gain is recognized as an adjustment to shareholders’ equity through Accumulated other comprehensive income.
Interest Rate Risk
The Term Loan and the Revolver bear interest at a variable rate based on LIBOR or an alternative base rate. We limit interest rate risk associated with the Term Loan using interest rate swaps with a combined notional amount of $200.0 million at December 31, 2014 to hedge fluctuations in LIBOR (see Note 12 - Derivative Financial Instruments of the Notes to Consolidated Financial Statements). We do not engage in trading, market making or speculative activities in the derivatives markets.
Sensitivity Analysis
We assess our market risk based on changes in foreign currency exchange rates and interest rates utilizing a sensitivity analysis that measures the potential impact on earnings, fair values and cash flows based on a hypothetical 10% change (increase and decrease) in foreign currency rates and interest rates. We used December 31, 2014 market rates to perform a sensitivity analysis separately for each of our market risk exposures. The estimates assume instantaneous, parallel shifts in interest rate yield curves and exchange rates. We determined, through this analysis, that the potential decrease in net current assets from a hypothetical 10% adverse change in quoted foreign currency exchange rates would be $4.9 million at December 31, 2014 compared with $7.5 million at December 31, 2013. There are inherent limitations in the sensitivity analysis, primarily due to assumptions that foreign exchange rate movements are linear and instantaneous.
The effect of a hypothetical 10% adverse change in market rates of interest on interest expense would be $0 at both December 31, 2014 and December 31, 2013, which represents the effect on annual interest expense related to the unhedged portion of the Term Loan. The hedged portion of the Term Loan is not materially affected by changes in market rates of interest as it has effectively been converted to a fixed interest rate through interest rate swaps. Although our Term Loan bears interest at variable rate plus a margin at December 31, 2014, the current variable rate based on LIBOR is below the minimum rate that would be required to alter the rate under the Credit Agreement.
Item 8.
Item 8.
Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Orbitz Worldwide, Inc.
Chicago, Illinois
We have audited the accompanying consolidated balance sheets of Orbitz Worldwide, Inc. and subsidiaries (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income/ (loss), shareholders’ equity/(deficit), and cash flows for each of the three years in the period ended December 31, 2014. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule 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, such consolidated financial statements present fairly, in all material respects, the financial position of Orbitz Worldwide, Inc. and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2014, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 9, 2015 expressed an unqualified opinion on the Company’s internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Chicago, Illinois
March 9, 2015
ORBITZ WORLDWIDE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
See Notes to Consolidated Financial Statements
ORBITZ WORLDWIDE, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
(in thousands)
See Notes to Consolidated Financial Statements
ORBITZ WORLDWIDE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
See Notes to Consolidated Financial Statements
ORBITZ WORLDWIDE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See Notes to Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(in thousands)
See Notes to Consolidated Financial Statements
ORBITZ WORLDWIDE, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY/(DEFICIT)
(in thousands, except share data)
See Notes to Consolidated Financial Statements
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.
Organization and Basis of Presentation
Description of the Business
Orbitz, Inc. was established in early 2000 by American Airlines, Inc., Continental Airlines, Inc., Delta Air Lines, Inc., Northwest Airlines, Inc. and United Air Lines, Inc. (the “Founding Airlines”). In November 2004, Orbitz was acquired by Cendant Corporation (“Cendant”), whose online travel distribution businesses included the HotelClub and RatesToGo brands (collectively referred to as “HotelClub”) and the CheapTickets brand. In February 2005, Cendant acquired ebookers Limited, an international online travel brand which currently has operations in 8 countries throughout Europe (“ebookers”).
On August 23, 2006, Travelport Limited (“Travelport”), which consisted of Cendant’s travel distribution services businesses, including the businesses that currently comprise Orbitz Worldwide, Inc., was acquired by affiliates of The Blackstone Group and Technology Crossover Ventures.
Orbitz Worldwide, Inc. was incorporated in Delaware on June 18, 2007 and was formed to be the parent company of the business-to-consumer travel businesses of Travelport, including Orbitz.com, ebookers and HotelClub and the related subsidiaries and affiliates of those businesses. We are the registrant as a result of the completion of the initial public offering (the “IPO”) of 34.4 million shares of our common stock on July 25, 2007. On April 15, 2013, following the completion of the Travelport refinancing plan, Orbitz Worldwide, Inc. is no longer a “controlled company” as defined in Section 303A of the New York Stock Exchange listing rules. In the second quarter and early third quarter of 2014, Travelport sold approximately 47.7 million shares, and after its secondary stock offering on July 22, 2014, is no longer considered a related party. At December 31, 2014 and 2013, Travelport and the investment funds that indirectly owned Travelport, beneficially owned approximately 1% and 48% of our outstanding common stock, respectively.
We are a global online travel company (“OTC”) that uses innovative technology to enable leisure and business travelers to research, plan and book a broad range of travel products and services including hotels, flights, vacation packages, car rentals, cruises, rail tickets, travel insurance, destination services and event tickets. We provide our customers an easy-to-use booking experience across a wide variety of devices. Our global brand portfolio includes Orbitz.com and CheapTickets in the United States; ebookers in Europe; and HotelClub, which focuses on the Asia Pacific region. We also own and operate Orbitz for Business, which is a corporate travel management company, and the Orbitz Partner Network, which delivers private label travel solutions to a broad range of partners.
Basis of Presentation
The accompanying consolidated financial statements present the accounts of Orbitz.com, ebookers and HotelClub and the related subsidiaries and affiliates of those businesses, collectively doing business as Orbitz Worldwide, Inc. These entities became wholly-owned subsidiaries of ours as part of an intercompany restructuring that was completed on July 18, 2007 in connection with the IPO. Prior to the IPO, these entities had operated as indirect, wholly-owned subsidiaries of Travelport.
As further discussed in Note 18 - “Subsequent Events”, the Company entered into an agreement on February 12, 2015, that, if consummated, would result in the Company becoming an indirect wholly-owned subsidiary of Expedia, Inc. The accompanying consolidated financial statements do not reflect any effects that would result if the agreement is consummated.
2.
Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”). All intercompany balances and transactions have been eliminated in the consolidated financial statements.
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Use of Estimates
The preparation of our consolidated financial statements and related notes in conformity with GAAP requires us to make certain estimates and assumptions. Our estimates and assumptions affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to matters that require a significant level of judgment or are otherwise subject to an inherent degree of uncertainty.
Our significant estimates include elements of revenue recognition, the realization of deferred tax assets, amounts that may be due under the tax sharing agreement, impairment of long-lived assets, goodwill and indefinite-lived intangible assets, costs to be capitalized as well as the useful life of capitalized software, and contingent liabilities, including taxes related to hotel occupancy. Actual amounts may differ from these estimates.
Foreign Currency Translation
Balance sheet accounts of our operations outside of the United States are translated from foreign currencies into U.S. dollars at the exchange rates as of the Consolidated Balance Sheet dates. Revenues and expenses are translated at average exchange rates during the period. Foreign currency translation gains or losses are included in accumulated other comprehensive income (loss) in shareholders’ equity. Gains and losses resulting from foreign currency transactions, which are denominated in currencies other than the entity’s functional currency, are included in our Consolidated Statements of Operations.
Revenue Recognition
We recognize revenue when it is earned and realizable, when persuasive evidence of an arrangement exists, services have been rendered, the price is fixed or determinable, and collectability is reasonably assured. We have two primary types of contractual arrangements with our vendors, which we refer to herein as the “merchant” and “retail” models. Under both the merchant and retail models, we record revenue earned net of all amounts paid to our suppliers.
We provide customers the ability to book air travel, hotels, car rentals and other travel products and services through our various websites. These travel products and services are made available to our customers for booking on a stand-alone basis or as part of a vacation package.
Under the merchant model, we generate revenue for our services based on the difference between the total amount the customer pays for the travel product and the negotiated net rate plus estimated taxes that the supplier charges us for that product. Customers generally pay us for reservations at the time of booking. Initially, we record these customer receipts as accrued merchant payables and either deferred income or net revenue, depending on the travel product. In the merchant model we do not take on credit risk with the customer since we are paid via a credit card, debit card or certain other electronic payment processors (collectively “Payment Processors”), while the cardholder’s Payment Processors collects funds from the customer. However we are subject to charge-backs and fraud risk, which we monitor closely; we have the ability to determine the price; we are not responsible for the actual delivery of the flight, hotel room or car rental; we take no inventory risk; we have no ability to determine or change the products or services delivered; and the customer chooses the supplier. Transaction related taxes are recorded net of any amounts received from customers.
Under the merchant model we receive payment for a reservation from a customer via the Payment Processors. The Payment Processors transmit payment for the reservation within one to two days of the booking date. The Payment Processors take on the risk of collecting funds from the customer. We are subject to fraud because we may be charged by the Payment Processors for fraudulent charges after we remit funds to the supplier. In other instances, the customer may be dissatisfied with some aspect of their travel and contest the charges with the Payment Processors, which could result in a charge-back.
We recognize net revenue under the merchant model when we have no further obligations to the customer. For merchant air transactions, this is at the time of booking. For merchant hotel transactions and merchant car transactions, net revenue is recognized at the time of check-in or customer pick-up, respectively. The timing of revenue recognition is different for merchant air travel because our primary service to the customer is fulfilled at the time of booking.
We accrue for the cost of merchant hotel and merchant car transactions based on amounts we expect to be invoiced by suppliers. If we do not receive an invoice within a certain period of time, generally within six months, or the invoice received is less than the accrued amount, we reverse a portion of the accrued cost when we determine it is not probable that we will be
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
required to pay the supplier, based on our historical experience and contract terms. This results in an increase in net revenue and a decrease to the accrued merchant payable.
Under the retail model, we pass reservations booked by our customers to the travel supplier for a commission. In the retail model: we do not take on credit risk with the customer; we are not the primary obligor with the customer; we have no latitude in determining pricing; we take no inventory risk; we have no ability to determine or change the products or services delivered; and the customer chooses the supplier.
We recognize net revenue under the retail model when the reservation is made, secured by a customer with a credit card and we have no further obligations to the customer. For air transactions, this is at the time of booking. For hotel transactions and car transactions, net revenue is recognized at the time of check-in or customer pick-up, respectively, net of an allowance for cancelled reservations. The timing of recognition is different for retail hotel and retail car transactions than for retail air travel because unlike air travel where the reservation is secured by a customer’s Payment Processors at booking, car rental bookings and hotel bookings are not secured by a customer’s credit card until the pick-up date and check-in date, respectively. Allowances for cancelled reservations primarily relate to cancellations that do not occur through our websites, but instead occur directly through the supplier of the travel product. The amount of the allowance is determined based on our historical experience. The majority of commissions earned under the retail model are based upon contractual agreements.
Vacation packages offer customers the ability to book a combination of travel products. For example, travel products booked in a vacation package may include a combination of air travel, hotel and car rental reservations. We recognize net revenue for the entire package when the customer uses the reservation, which generally occurs on the same day for each travel product included in the vacation package.
Under both the merchant and retail models, we may, depending upon the brand and the travel product, charge our customers a service fee for booking their travel reservation. We recognize revenue for service fees at the time we recognize the net revenue for the corresponding travel product. We also may receive override commissions from suppliers if we meet certain contractual volume thresholds. These commissions are recognized when the amount of the commissions becomes fixed or determinable, which is generally upon notification by the respective travel supplier.
We utilize global distribution systems (“GDS”) services from various providers. Under our GDS service agreements, we earn revenue in the form of an incentive payment for air, car and hotel segments that are processed through a GDS. Revenue is recognized for these incentive payments at the time the travel reservation is processed through the GDS, which is generally at the time of booking.
The Company issues credits in the form of points related to its loyalty programs. The value of points earned by loyalty program members is included in accrued liabilities and recorded as a reduction of revenue at the time the points are earned, based on the percentage of points that are projected to be redeemed.
We also generate other revenue, which is primarily composed of revenue from advertising, including sponsoring links on our websites, and travel insurance. Advertising revenue is derived primarily from the delivery of advertisements on our websites and is recognized either at the time of display of each individual advertisement, or ratably over the advertising delivery period, depending on the terms of the advertising contract. Revenues generated from sponsoring links are recognized upon notification from the alliance partner that a transaction has occurred. Travel insurance revenue is recognized when the reservation is made, secured by a customer with a credit card and we have no further obligations to the customer, which for travel insurance is at the time of booking.
Cost of Revenue
Cost of revenue is primarily composed of direct costs incurred to generate revenue, including costs to operate our customer service call centers, credit card processing fees and other costs, which include customer refunds and charge-backs, connectivity and other processing costs. These costs are generally variable in nature and are primarily driven by transaction volume.
Marketing Expense
Marketing expense is primarily composed of online marketing costs, such as search and banner advertising and affiliate commissions, and offline marketing costs, such as television, radio and print advertising. Online advertising expense is
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
recognized based on the terms of the individual agreements, based on the ratio of actual impressions to contracted impressions, pay-per-click, or on a straight-line basis over the term of the contract. Offline marketing expense is recognized in the period in which it is incurred. Our online marketing costs are significantly greater than our offline marketing costs.
Income Taxes
Our provision for income taxes is determined using the asset and liability method. Under this method, deferred tax assets and liabilities are calculated based upon the temporary differences between the financial statement and income tax bases of assets and liabilities using the combined federal and state or foreign effective tax rates that are applicable to us in a given year. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The deferred tax assets are recorded net of a valuation allowance when, based on the weight of available evidence, we believe it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. The realization of the deferred tax assets, net of a valuation allowance, is primarily dependent on estimated future taxable income. A change in our estimate of future taxable income may require an increase or decrease to the valuation allowance.
Derivative Financial Instruments
We measure derivatives at fair value and recognize them in our Consolidated Balance Sheets as assets or liabilities, depending on our rights or obligations under the applicable derivative contract. For our derivatives designated as fair value hedges, if any, the changes in the fair value of both the derivative instrument and the hedged item are recorded in earnings. For our derivatives designated as cash flow hedges, the effective portions of changes in fair value of the derivative are reported in other comprehensive income and are subsequently reclassified into earnings when the hedged item affects earnings. Changes in fair value of derivative instruments not designated as hedging instruments, and ineffective portions of hedges, are recognized in earnings in the current period.
We manage interest rate exposure by utilizing interest rate swaps to achieve a desired mix of fixed and variable rate debt. As of December 31, 2014, we have two interest rate swaps outstanding that effectively convert $200.0 million of the term loan from a variable to a fixed interest rate (see Note 12 - Derivative Financial Instruments). We pay a fixed interest rate on the notional amount and in exchange receive a variable interest rate based on the one-month LIBOR rate.
We have entered into foreign currency contracts to manage exposure to changes in foreign currencies associated with receivables, payables and intercompany transactions. These foreign currency contracts did not qualify for hedge accounting treatment. As a result, the changes in fair values of the foreign currency contracts were recorded in selling, general and administrative expense in our Consolidated Statements of Operations.
We do not enter into derivative instruments for speculative or trading purposes. We require that the hedges or derivative financial instruments be effective in managing the interest rate risk or foreign currency risk exposure that they are designated to hedge. Hedges that qualify for hedge accounting are formally designated as such at the inception of the contract. When the terms of an underlying transaction are modified, or when the underlying hedged item ceases to exist, resulting in some ineffectiveness, the change in the fair value of the derivative instrument will be included in earnings. Additionally, any derivative instrument used for risk management that becomes ineffective is marked-to-market each period. We believe that our credit risk has been mitigated by entering into these agreements with major financial institutions. Net interest differentials to be paid or received under our interest rate swaps are included in interest expense as incurred or earned.
Concentration of Credit Risk
Our cash and cash equivalents and foreign exchange contracts are potentially subject to concentration of credit risk. We maintain cash and cash equivalent balances with financial institutions that are in excess of Federal Deposit Insurance Corporation insurance limits or that are deposited in foreign institutions.
Additionally, we employ forward foreign exchange contracts to hedge our exposure to foreign currency fluctuations. At the maturity of these forward contracts, the counterparties are obligated to pay settlement values.
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Cash and Cash Equivalents
We consider cash and highly liquid investments, such as money market funds, with an original maturity of three months or less to be cash and cash equivalents. Cash and cash equivalents are stated at cost, which approximates or equals fair value due to their short-term nature.
Allowance for Doubtful Accounts
Our accounts receivable are reflected in our Consolidated Balance Sheets net of an allowance for doubtful accounts. We provide for estimated bad debts based on our assessment of our ability to realize receivables, considering historical collection experience, the general economic environment and specific customer information. When we determine that a receivable may not be collectible, bad debt is recognized. Bad debt expense is recorded in selling, general and administrative expense in our Consolidated Statements of Operations. We recorded bad debt expense of $0.8 million and $0.6 million for the years ended December 31, 2014 and 2013, respectively.
Property and Equipment, Net
Property and equipment is recorded at cost, net of accumulated depreciation. We depreciate property and equipment over their estimated useful lives using the straight-line method. The estimated useful lives by asset category are:
Asset Category
Estimated Useful Life
Leasehold improvements
Shorter of asset’s useful life or non-cancellable lease term
Capitalized software
3 - 10 years
Furniture, fixtures and equipment
3 - 7 years
We capitalize the costs of software developed for internal use when the preliminary project stage of the application has been completed and it is probable that the project will be completed and used to perform the function intended. Depreciation commences when the software is placed into service.
We evaluate the recoverability of the carrying value of our long-lived assets, including property and equipment and finite-lived intangible assets, when circumstances indicate that the carrying value of those assets may not be fully recoverable. This analysis is performed by comparing the carrying values of the assets to the expected undiscounted future cash flows to be generated from these assets, including estimated sales proceeds when appropriate. If this analysis indicates that the carrying value of an asset is not recoverable, the carrying value is reduced to fair value through an impairment charge in our Consolidated Statements of Operations.
Annually, we write off the cost and accumulated depreciation of any assets that are no longer in service.
Goodwill, Trademarks and Other Intangible Assets
Goodwill represents the excess of the purchase price over the estimated fair value of the underlying assets acquired and liabilities assumed in the acquisition of a business. We assign goodwill to reporting units that are expected to benefit from the business combination as of the acquisition date. Goodwill is not subject to amortization.
Our indefinite-lived intangible assets include our trademarks and trade names, which are not subject to amortization. Our finite-lived intangible assets primarily include our customer and vendor relationships and are amortized over their estimated useful lives, generally 4 to 8 years, using the straight-line method. Our intangible assets relate to the acquisition of entities accounted for using the purchase method of accounting and are estimated by management based on the fair value of assets acquired.
We assess the carrying value of goodwill and other indefinite-lived intangible assets for impairment annually or more frequently whenever events occur and circumstances change indicating potential impairment. We perform our annual impairment testing of goodwill and other indefinite-lived intangible assets as of December 31.
We assess goodwill for possible impairment using a two-step process. The first step identifies if there is potential goodwill impairment. If the step one analysis indicates that impairment may exist, a step two analysis is performed to measure the amount of the goodwill impairment, if any. Goodwill impairment exists when the estimated fair value of goodwill is less
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
than its carrying value. If impairment exists, the carrying value of the goodwill is reduced to fair value through an impairment charge in our Consolidated Statements of Operations.
For purposes of goodwill impairment testing, we estimate the fair value of our reporting units to which goodwill is allocated using generally accepted valuation methodologies, including market and income based approaches, and relevant data available through and as of the testing date. The market approach is a valuation method in which fair value is estimated based on observed prices in actual transactions and on asking prices for similar assets. Under the market approach, the valuation process is essentially that of comparison and correlation between the subject asset and other similar assets. The income approach is a method in which fair value is estimated based on the cash flows that an asset could be expected to generate over its useful life, including residual value cash flows. These cash flows are then discounted to their present value equivalents using a rate of return that accounts for the relative risk of not realizing the estimated annual cash flows and for the time value of money. Variations of the income approach are used to estimate certain of the intangible asset fair values.
We assess our trademarks and trade names for impairment by comparing their carrying values to their estimated fair values. Impairment exists when the estimated fair value of the trademark or trade name is less than its carrying value. If impairment exists, then the carrying value is reduced to fair value through an impairment charge in our Consolidated Statements of Operations. We use an income based valuation approach to estimate fair values of the relevant trademarks and trade names.
Restricted Cash
In order to collateralize letters of credit and similar instruments, as well as for other general business purposes, we have funds deposited as restricted cash.
Tax Sharing Liability
We have a liability included in our Consolidated Balance Sheets that relates to a tax sharing agreement between Orbitz and the Founding Airlines. The agreement governs the allocation of tax benefits resulting from a taxable exchange that took place in connection with the Orbitz initial public offering in December 2003 (the “Orbitz IPO”). As a result of this taxable exchange, the Founding Airlines incurred a taxable gain. The taxable exchange caused Orbitz to have additional future tax deductions for depreciation and amortization due to the increased tax basis of its assets. The additional tax deductions for depreciation and amortization may reduce the amount of taxes we are required to pay in future years. For each tax period during the term of the tax sharing agreement, we are obligated to pay the Founding Airlines a significant percentage of the amount of the tax benefit realized as a result of the taxable exchange. The tax sharing agreement commenced upon consummation of the Orbitz IPO and continues until all tax benefits have been utilized.
We use discounted cash flows in calculating and recognizing the tax sharing liability. We review the calculation of the tax sharing liability on a quarterly basis and make revisions to our estimated timing of payments when appropriate. We also assess whether there are any significant changes, such as changes in the amount of payments and tax rates that could materially affect the present value of the tax sharing liability. Although the expected gross remaining payments that may be due under this agreement were $96.2 million as of December 31, 2014, the timing and amount of payments may change. Any changes in timing of payments are recognized prospectively as accretions to the tax sharing liability in our Consolidated Balance Sheets and non-cash interest expense in our Consolidated Statements of Operations. Any changes in the estimated amount of payments, including changes to tax rates, are recognized in Selling, general and administrative expense in our Consolidated Statements of Operations.
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Equity-Based Compensation
We measure equity-based compensation cost at fair value and recognize the corresponding compensation expense over the service period during which awards are expected to vest. Performance-based compensation is amortized on a graded basis over the requisite service period of each vesting tranche. We include equity-based compensation in Selling, general and administrative expense in our Consolidated Statements of Operations. The fair value of restricted stock and restricted stock units is determined based on the average of the high and low price of our common stock on the date of grant. The fair value of stock options is determined on the date of grant using the Black-Scholes valuation model. The fair value of the restricted stock subject to market-based conditions is determined on the date of grant using a Monte Carlo simulation for sampling random outcomes. The amount of equity-based compensation expense recorded each period is net of estimated forfeitures based on historical forfeiture rates.
Hotel Occupancy Taxes
Some states and localities impose a tax on the use or occupancy of hotel accommodations (“hotel occupancy tax”). Generally, hotels collect hotel occupancy tax based on the amount of money they receive for renting their hotel rooms and remit the tax to the appropriate taxing authorities. Using the travel services our websites offer, customers are able to make hotel room reservations. While applicable tax laws vary among different taxing jurisdictions, we generally believe that these laws do not require us to collect and remit hotel occupancy tax on the compensation that we receive for our travel services. Some tax authorities have initiated lawsuits or administrative proceedings asserting that we are required to collect and remit hotel occupancy tax on the amount of money we receive from customers for facilitating their reservations and are more frequently addressing the taxability of fees by online travel companies through new legislation. The ultimate resolution of these lawsuits and proceedings in all jurisdictions cannot be determined at this time. We establish an accrual for legal proceedings (tax or otherwise) when we determine that a loss is both probable and can be reasonably estimated. See Note 9 - Commitments and Contingencies.
Recently Issued Accounting Pronouncements
In May 2014, the FASB issued a new financial accounting standard on revenue from contracts with customers, ASU No. 2014-09, “Revenue from Contracts with Customers”. The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance. The accounting standard is effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2016. Early adoption is not permitted. The Company is currently assessing the impact of this ASU on its consolidated financial statements.
In August 2014, the FASB issued ASU No. 2014-15, “Presentation of Financial Statements - Going Concern”. ASU 2014-15 provides guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and sets rules for how this information should be disclosed in the financial statements. ASU 2014-15 is effective for annual periods ending after December 15, 2016 and interim periods thereafter. Early adoption is permitted. The Company does not expect the adoption of ASU 2014-15 to have an impact on its consolidated financial condition and results of operations.
3. Acquisitions
On February 19, 2014, the Company entered into an asset sale and purchase agreement with Travelocity.com LP (“Travelocity”) for certain assets and contracts of the Travelocity Partner Network (“TPN”), which provides private label travel technology solutions for bank loyalty programs and online commerce sites. On February 28, 2014, the Company closed the transaction for cash consideration of $10.0 million with the potential for additional consideration of up to $10.0 million payable if post-acquisition revenue targets for 2014 and 2015 are achieved in excess of agreed amounts (“Earn-Out”). The companies also entered into a transition services agreement, under which Travelocity will provide the Company various services and support, which expires no later than 24 months from the contract date. The Company may, at its sole discretion, terminate one or more of the services under the agreement with 15 days’ notice to Travelocity at which time the parties will have no further obligation with respect to such terminated services. It has been determined that the transition services agreement is unfavorable as compared with market conditions as of the purchase date and a net unfavorable contract liability of approximately $0.8 million has been established, of which $0.5 million remains at December 31, 2014. Transaction costs were incurred in connection with this acquisition of approximately $0.8 million and $0.4 million for the years ended December 31, 2014 and
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2013, respectively, and are included in Selling, general and administrative expenses in our Consolidated Statements of Operations for those periods.
The acquisition was accounted for pursuant to ASC 805, Business Combinations, which requires the acquired assets and liabilities to be recorded at fair value as of the acquisition date. The Company generally used the income approach to estimate fair values. Cash flows utilized in the valuation were discounted to their present value using a rate of return that includes the relative risk of cash flows and the time value of money.
The fair value of the estimated Earn-Out was calculated based on various levels of revenue thresholds for each year and by assigning an expected probability of reaching each level and the corresponding payment. The Company does not expect that any Earn-Out will be payable.
The following table summarizes the purchase price and the allocation of the purchase price:
The amounts of TPN’s revenue and pre-tax loss included in the Consolidated Statements of Operations for the year ended December 31, 2014 were $51.9 million and $7.8 million, respectively. The revenue and earnings of the combined entity had the acquisition date been January 1, 2014 and January 1, 2013 are not available as the related business was not reported separately from that of Travelocity.
Our acquired finite-lived customer relationship assets will be amortized over their estimated useful lives of 5 years, using a straight-line basis. The property and equipment will be amortized over their estimated useful lives of 1.5 years.
4.
Property and Equipment, Net
Property and equipment, net, consisted of the following:
We recorded depreciation expense related to property and equipment in the amount of $57.2 million, $54.4 million and $55.3 million for the years ended December 31, 2014, 2013 and 2012, respectively.
There were no assets subject to capital leases at December 31, 2014 or 2013.
In 2014, we evaluated property and equipment that has become fully depreciated (see Note 2 - Summary of Significant Accounting Policies) and wrote-off $85.1 million of fully depreciated assets that were no longer in service.
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As a result of our decision during the first quarter of 2013 to exit the Away Network business, we recorded a $2.6 million non-cash charge to impair property and equipment associated with that business. This charge was included in Impairment of property and equipment and other assets in our Consolidated Statement of Operations.
5.
Goodwill and Intangible Assets
The changes in the carrying amount of goodwill during the years ended December 31, 2014 and 2013 were as follows:
Trademarks and trade names, which are not subject to amortization, totaled $89.9 million and $90.4 million as of December 31, 2014 and 2013, respectively.
Impairment of Goodwill and Trademarks and Trade Names
We estimate the fair value of our reporting units to which goodwill is allocated using generally accepted valuation methodologies, including market and income based approaches, and relevant data available through and as of December 31. We use the income based approach to estimate the fair value of our reporting units that have goodwill balances and use the market approach to corroborate these estimates. We considered the market approach from a reasonableness standpoint by comparing the multiples of guideline companies with the implied multiples from the income based approach, and we also consider our market capitalization to assess reasonableness of the income based approach valuations. The key assumptions we use in determining the estimated fair value of our reporting units are the terminal growth rates, forecasted cash flows and the discount rates.
At December 31 we used an income based valuation approach to separately estimate the fair values of all of our trademarks and trade names and compared those estimates to the respective carrying values. The key assumptions we use in determining the estimated fair value of our trademarks and trade names are the terminal growth rates, forecasted revenues, assumed royalty rates and discount rates. Significant judgment is required to select these inputs based on observed market data.
There were no impairment charges in 2014 and 2013.
In connection with our annual impairment test as of December 31, 2012, and as a result of lower than expected performance and future cash flows for the Americas reporting unit, we recorded a non-cash impairment charge of $319.5 million during the year ended December 31, 2012, of which $301.9 million was related to the goodwill of the Americas reporting unit and $17.6 million was related to the trademarks and trade names associated with Orbitz and CheapTickets. These charges were included in Impairment of goodwill and intangible assets in our Consolidated Statements of Operations.
Finite-Lived Intangibles
The changes in the carrying amounts of finite-lived intangible assets during the years ended December 31, 2014 and 2013 were as follows:
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(a) Intangible assets acquired in 2014 relate to our purchase of certain TPN assets. See Note 3 - Acquisitions.
Finite-lived intangible assets consisted of the following:
For the years ended December 31, 2014, 2013 and 2012, we recorded amortization expense related to finite-lived intangible assets in the amount of $0.3 million, $0.7 million and $1.7 million, respectively. These amounts were included in depreciation and amortization expense in our Consolidated Statements of Operations.
The table below shows the estimated amortization expense related to our finite-lived intangible assets over their remaining useful lives:
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6. Accrued Expenses
Accrued expenses consisted of the following:
(a)
In connection with the early termination of an agreement with Trilegiant Corporation (now Affinion Group) in 2007, we accrued termination payments for the period from January 1, 2008 to December 31, 2016. At December 31, 2014 and 2013, the liability’s carrying value of $11.7 million was included in our Consolidated Balance Sheets, $11.6 million of which was included in Accrued expenses and $0.1 million of which was included in Other non-current liabilities at December 31, 2014, and $11.4 million of which was included in Accrued expenses and $0.3 million of which was included in Other non-current liabilities at December 31, 2013.
7.
Term Loan and Revolving Credit Facility
On April 15, 2014, we entered into an amendment (the “Second Amendment”) to the $515.0 million senior secured credit agreement entered into on March 25, 2013, as refinanced and amended on May 24, 2013 (the “Credit Agreement”), composed of a 7-year, $450.0 million term loan maturing April 15, 2021 (the “Term Loan”) and a 5-year $80.0 million revolving credit facility maturing April 15, 2019 (the “Revolver”). The proceeds of the Term Loan were used to repay approximately $439.9 million of term loans outstanding under the Credit Agreement, pay certain fees and expenses incurred with the Second Amendment and for general corporate purposes. The term loans under the Credit Agreement, which were repaid, had original principal amounts of $100.0 million maturing September 25, 2017 and $350.0 million maturing March 25, 2019. Interest rates on these tranches were the Eurocurrency Rate plus 3.50% per annum, or the Base Rate plus 2.50% per annum and the Eurocurrency Rate plus 4.75% per annum or the Base Rate plus 3.75% per annum, respectively.
Following the Second Amendment, the $530.0 million senior secured credit facility (the “Amended Credit Agreement”) consists of the Term Loan and the Revolver. Among other things, the Second Amendment reduced the financial maintenance covenants, increased certain baskets and added certain exceptions under certain negative covenants in the Credit Agreement.
Term Loan
The Term Loan bears interest at a variable rate, at our option, of the Eurocurrency Rate plus a margin of 3.50% per annum, or the Base Rate plus 2.50% per annum. The Eurocurrency Rate is equal to the LIBOR rate as determined by the British Bankers Association (adjusted for any applicable statutory reserves as defined in the Amended Credit Agreement) and with respect to the Term Loan shall not be less than 1.00% per annum. The Base Rate for any day is equal to the greater of (a) the Fed Funds Rate in effect plus 0.5%, (b) the Credit Suisse AG prime rate and (c) the one-month Eurocurrency Rate plus 1.00%.
The principal amount of the Term Loan is payable in quarterly installments of $1.125 million beginning September 30, 2014, with the final installment of the remaining outstanding balance due at the applicable maturity date with respect to such Term Loan. In addition, we are required, subject to certain exceptions, to make payments on the Term Loan (a) annually in the first quarter of each fiscal year in an amount of 50% (which percentage will be reduced to 25% and 0% subject to achieving
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
certain first lien leverage ratios) of the prior year’s excess cash flow, as defined in the Amended Credit Agreement, (b) in an amount of 100% of net cash proceeds from asset sales subject to certain reinvestment rights, and (c) in an amount of 100% of net cash proceeds of any issuance of debt other than debt permitted to be incurred under the Amended Credit Agreement.
Based on our excess cash flow for the year ended December 31, 2014, we are required to make a $25.9 million prepayment in the first quarter of 2015. Prepayments from excess cash flow are applied, in order of maturity, to the scheduled quarterly Term Loan payments. As a result, we will not be required to make any scheduled principal payments on the Term Loan until 2020.
The changes in term loans during the years ended December 31, 2014 and 2013 were as follows:
At December 31, 2014, $200.0 million of the Term Loan had a fixed interest rate as a result of interest rate swaps and $247.8 million had a variable rate based on LIBOR, resulting in a blended interest rate of 4.94%, excluding the impact of the amortization of debt issuance costs (see Note 12 - Derivative Financial Instruments).
The table below shows the aggregate maturities of the Term Loans over the remaining term of the Amended Credit Agreement, excluding any mandatory prepayments that could be required under the Term Loan beyond the first quarter of 2015. The potential amount of prepayment from excess cash flow that will be required beyond the first quarter of 2015 is not reasonably estimable as of December 31, 2014.
Revolver
The Revolver provides for borrowings and letters of credit up to $80.0 million, through which we are allowed to issue up
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
to $55.0 million in letters of credit. The Revolver bears interest at a variable rate, at our option, of the Eurocurrency Rate plus a margin of 3.00% per annum or the Base Rate plus a margin of 2.00% per annum. We pay a letter of credit fee in the amount of the Eurocurrency Rate on all outstanding letters of credit and we incur a facility fee of 0.50% per annum on all loans, letters of credit and any unused amounts on the Revolver. At December 31, 2014 there were no outstanding borrowings or letters of credit issued under the Revolver.
Amended Credit Agreement Terms
The Term Loan and Revolver are both secured by substantially all of our domestic subsidiaries’ tangible and intangible assets, including a pledge of 100% of the outstanding capital stock or other equity interests of substantially all of our direct and indirect domestic subsidiaries and 65% of the capital stock or other equity interests of certain of our foreign subsidiaries, subject to certain exceptions. The Term Loan and Revolver are also guaranteed by substantially all of our domestic subsidiaries.
The Amended Credit Agreement contains various customary restrictive covenants that limit our ability to, among other things: incur additional indebtedness or enter into guarantees; enter into sale/leaseback transactions; make investments, loans or acquisitions; grant or incur liens on our assets; sell our assets; engage in mergers, consolidations, liquidations or dissolutions; engage in transactions with affiliates; and make restricted payments.
The Amended Credit Agreement requires us not to exceed a maximum first lien leverage ratio, as defined in the Amended Credit Agreement, of 5.00 to 1. As of December 31, 2014, we were in compliance with the financial covenants of the Amended Credit Agreement.
We incurred an aggregate of $6.7 million of debt issuance costs to obtain the Amended Credit Agreement in April 2014 and due to the nature and terms of the Second Amendment, the entire amount was capitalized and is included in Other non-current assets in the Consolidated Balance Sheet. The capitalized debt issuance costs will be amortized to interest expense over the contractual terms of the Term Loan and Revolver. Due to the extinguishment of the term loan of the Credit Agreement, unamortized debt issuance costs of $2.2 million related to the Credit Agreement were expensed during the year ended December 31, 2014, and included in Other expense in the Consolidated Statements of Operations.
2007 Credit Agreement
On March 25, 2013, we used proceeds from the issuance of term loans and existing cash on hand to pay in full the amount outstanding relating to the $685.0 million senior secured credit agreement entered into on July 25, 2007 (the “2007 Credit Agreement”), which included a term loan facility and a revolving credit facility. Upon repayment, the 2007 Credit Agreement was terminated and there are no borrowings or letters of credit outstanding.
8.
Tax Sharing Liability
We have a liability included in our Consolidated Balance Sheets that relates to a tax sharing agreement between Orbitz and the Founding Airlines. The agreement governs the allocation of tax benefits resulting from a taxable exchange that took place in connection with the Orbitz IPO in December 2003. As a result of this taxable exchange, the Founding Airlines incurred a taxable gain. The taxable exchange caused Orbitz to have additional future tax deductions for depreciation and amortization due to the increased tax basis of its assets. The additional tax deductions for depreciation and amortization may reduce the amount of taxes we are required to pay in future years. For each tax period while the tax sharing agreement is in effect, we are obligated to pay the Founding Airlines a significant percentage of the amount of the tax benefit realized as a result of the taxable exchange. The tax sharing agreement commenced upon consummation of the Orbitz IPO and continues until all tax benefits have been utilized.
As of December 31, 2014, the estimated remaining payments that may be due under this agreement were approximately $96.2 million. We estimated that the net present value of our obligation to pay tax benefits to the Founding Airlines was $78.4 million and $80.2 million at December 31, 2014 and 2013, respectively. This estimate was based upon certain assumptions, including our future taxable income, the tax rate, the timing of tax payments, current and projected market conditions, and the applicable discount rate, all of which we believe are reasonable. These assumptions are inherently uncertain, however, and actual amounts may differ from these estimates.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The changes in the tax sharing liability for the years ended December 31, 2014 and 2013 were as follows:
(a) We accreted interest expense related to the tax sharing liability of $10.1 million and $10.8 million for the years ended December 31, 2014 and 2013, respectively. Due to a tax rate change in one of our tax jurisdictions, the net present value of the amount we expect to pay to the Founding Airlines increased by approximately $2.5 million during the year ended December 31, 2014, and the related charge is recorded in Selling, general and administrative expenses in the Consolidated Statement of Operations.
Based upon the estimated timing of future payments we expect to make, the current portion of the tax sharing liability of $17.1 million and $18.7 million was included in Accrued expenses in our Consolidated Balance Sheets at December 31, 2014 and 2013, respectively. The long-term portion of the tax sharing liability of $61.3 million and $61.5 million was reflected as the tax sharing liability in our Consolidated Balance Sheets at December 31, 2014 and 2013, respectively. Our estimated payments under the tax sharing agreement are as follows:
9.
Commitments and Contingencies
The following table summarizes the timing of our commitments as of December 31, 2014:
(a)
These operating leases are primarily for facilities and equipment and represent non-cancellable leases. Certain leases contain periodic rent escalation adjustments and renewal options. Our operating leases expire at various dates, with the latest maturing in 2023. For the years ended December 31, 2014, 2013 and 2012, we recorded rent expense in the amount of $7.3 million, $6.8 million and $6.2 million, respectively. As a result of a subleasing arrangement that we have entered into, we are expecting approximately $1.0 million in sublease income through 2017.
(b)
In February 2014, the Company announced that it has entered into an agreement with Travelport for the provision of GDS services (“New Travelport GDS Service Agreement”). Beginning January 1, 2015, the Company will no longer be subject to exclusivity obligations. Under the New Travelport GDS Service Agreement beginning in 2015, we are obligated to provide certain levels of volume over the contract period and may be subject to pay shortfall payments in certain cases if we fail to meet volume commitments. The agreement terminates on December 31, 2018.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In February 2014, the Company entered into an agreement with Amadeus IT Group, S.A. to provide GDS services. This contract requires the Company to meet certain minimum annual booking requirements beginning in 2016 through the end of the contract at December 31, 2019.
In addition to the commitments shown above, we are required to make principal payments on the Term Loan (see Note 7 - Term Loan and Revolving Credit Facility). We also expect to make approximately $96.2 million of payments in connection with the tax sharing agreement with the Founding Airlines (see Note 8 - Tax Sharing Liability). Also excluded from the above table are $3.3 million of liabilities for uncertain tax positions for which the period of settlement is not currently determinable.
Company Litigation
We are involved in various claims, legal proceedings and governmental inquiries related to contract disputes, business practices, intellectual property and other commercial, employment and tax matters. We believe that we have meritorious defenses, and we are vigorously defending against these claims, proceedings and inquiries. As of December 31, 2014, and December 31, 2013, we had accruals of $4.3 million and $5.5 million related to various legal proceedings, respectively. Litigation is inherently unpredictable and, although we believe we have valid defenses in these matters, unfavorable resolutions could occur. Below, we have provided relevant information on these matters.
We are party to various cases brought by municipalities and other state and local governmental entities in the U.S. concerning hotel occupancy or related taxes and our merchant model for hotel and car rental reservations. Most of the cases were brought simultaneously against other OTCs, including Expedia, Travelocity and Priceline. Certain of these cases are class actions, some of which have been confirmed on a state-wide basis and some which are purported. The cases allege, among other things, that we violated the jurisdictions’ hotel occupancy tax ordinances, as well as related sales and use taxes. While not identical in their allegations, the cases generally assert similar claims, including violations of local or state occupancy tax ordinances, failure to pay sales or use tax, and in some cases, violations of consumer protection ordinances, conversion, unjust enrichment, imposition of a constructive trust, demand for a legal or equitable accounting, injunctive relief, declaratory judgment, and civil conspiracy. The plaintiffs seek relief in a variety of forms, including: declaratory judgment, full accounting of monies owed, imposition of a constructive trust, compensatory and punitive damages, disgorgement, restitution, interest, penalties and costs, attorneys’ fees, and where a class action has been claimed, an order certifying the action as a class action. An adverse ruling in one or more of these cases could require us to pay tax retroactively and prospectively and possibly pay interest, penalties and fines. The proliferation of additional cases could result in substantial additional defense costs.
We have also been contacted by several municipalities or other taxing bodies concerning our possible obligations with respect to state or local hotel occupancy or related taxes. We received tax assessments which range from $0.02 million to approximately $58.8 million, and collectively exceed approximately $116.0 million. The following taxing bodies have issued notices to the Company: 43 cities in California; the following cities in Colorado: Broomfield, Colorado Springs, Durango, Frisco, Glendale, Glenwood Springs, Golden, Grand Junction, Greeley, Greenwood Village, Lafayette, Lakewood, Littleton, Loveland, Silverthorne and Steamboat Springs; Arlington, Texas; Brunswick and Stanly, North Carolina; the following counties in Utah: Davis, Summit, Salt Lake and Weber; the Arizona Department of Revenue; the New Mexico Department of Revenue; the Ohio Department of Taxation; Paradise Valley, Arizona; St. Louis, Missouri; various Alabama Municipalities; the Louisiana Department of Revenue; the Maine Department of Revenue; and the Vermont Department of Taxation. These taxing authorities have not issued assessments, but have requested information to conduct an audit and/or have requested that the Company register to pay local hotel occupancy taxes.
The following taxing authorities have issued assessments which are not final and are subject to further review by such taxing authorities: the Colorado Department of Revenue; the City of Aurora, Colorado; the Maryland Comptroller; the Texas Comptroller; the City of Portland, Oregon, and Multnomah County, Oregon; and Lake County, Indiana. These assessments range from $0.02 million to approximately $5.8 million, and total approximately $9.67 million.
In addition, the Hawaii Department of Taxation has issued final assessments for merchant model hotel reservations in the amount of $16.9 million for the taxable year 2012, and for merchant model hotel reservations and rental car transactions in the amount of $14.6 million for the taxable year 2013. Additionally, on December 9, 2013, the Hawaii Department of Taxation issued final assessments for rental car transactions in the amount of $3.4 million against each of three Orbitz entities for the period of January 1, 2002, through December 31, 2012. Based on Hawaii’s past merchant model hotel assessments, Orbitz believes that Hawaii’s rental car assessments represent an aggregate of $3.4 million total against the Orbitz entities for the time
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period. None of the final assessments issued for the taxable years 2012 and 2013 were based on historical transaction data, and each are still subject to review by the Hawaii Tax Appeal Court. These 2012 and 2013 assessments are in addition to the $58.8 million final assessment for merchant model hotel reservations previously issued by the Hawaii Department of Taxation for 2011 and prior years, more than $30.0 million of which was rejected by the Hawaii Tax Appeal Court.
Assessments or declaratory rulings that are administratively final and subject to judicial review have been issued by the cities of San Francisco, Los Angeles, and San Diego, California; the city of Denver, Colorado; the counties of Miami-Dade, Broward and Osceola, Florida; and the Indiana Department of Revenue. These assessments and declaratory rulings range from $0.2 million to approximately $3.2 million, and total approximately $10.8 million. Trial courts rejected the assessments in San Francisco, Los Angeles and San Diego, California and Broward County, Florida. The Colorado Court of Appeals reversed the assessments against the OTCs in the City of Denver case. Collectively, the amounts of the assessments and declaratory rulings not rejected or reversed (the counties of Osceola and Miami-Dade and the Indiana Department of Revenue) amount to approximately $2.0 million.
The OTCs, including Orbitz, have prevailed in the large majority of hotel tax cases that have been decided to date, having obtained favorable judgments in more than two dozen cases. However, there have been certain adverse lower court decisions against Orbitz and the other OTCs that, if affirmed, could result in significant liability to the Company.
First, in July 2011, related to the City of San Antonio hotel occupancy tax case, the United States District Court for the Western District of Texas issued its findings of fact and conclusions of law in which it held the defendant OTCs, including Orbitz, liable for hotel occupancy taxes on markup, fees and breakage revenue, and also imposed penalties and interest. On April 4, 2013, the court entered judgment against Orbitz in the amount of approximately $4.3 million and post-judgment motions are still pending. The OTCs, including Orbitz, intend to appeal once the pending motions are ruled upon by the court. Because we do not believe a loss is probable given the numerous issues that exist on appeal, we have not accrued any liability related to this case.
Second, in September 2012, the Superior Court of the District of Columbia granted the District’s motion for partial summary judgment and denied the OTCs’ motion for summary judgment, finding the companies liable for sales tax on hotel reservations dating back to the inception of the merchant model. Although the court acknowledged that the District had amended its law in 2011, and that the sales tax law was ambiguous prior to that time, the court nonetheless found the OTCs liable for merchant model hotel reservations before that date. Because we believe that the court’s finding of liability was the result of a misapplication of the law, we do not believe a loss is probable relating to the pre-amendment case and have appealed. Accordingly, we have not accrued any liability relating to the District of Columbia case for the period prior to July 2011. On March 25, 2014, Orbitz paid a judgment of $3.8 million, which represents the sales tax attributable to Orbitz.com’s hotel reservations through December 31, 2011. This amount is subject to a refund if Orbitz prevails in its appeal. The District of Columbia Court of Appeals heard oral argument on September 30, 2014. Although the Company expects to prevail on the issue of whether it is liable for sales tax before July 2011, it is possible that we will not prevail, and if that occurs, the amount of the judgment that we have not expensed is approximately $3.7 million. Additionally, the District of Columbia has cross-appealed the Superior Court’s denial of the District’s argument that amounts charged to consumers as a tax recovery charge should have been included in the Superior Court’s damage calculation. Although we do not believe that Orbitz is likely to be liable for tax on the tax recovery charge, it is possible that the Court of Appeals could determine that it is, and if that occurs, Orbitz’s additional liability could exceed $0.95 million.
Third, in January 2013, the Tax Court of Appeals in Hawaii ruled that the OTCs are subject to Hawaii’s general excise tax. The court also determined that the “splitting provision” contained in the Hawaii general excise tax statute, which limits application of the tax to only the amounts that travel agents receive for their services, does not apply to the transactions at issue. On March 19, 2013, the court issued an order in which it also imposed “failure to file” and “failure to pay” penalties on the OTCs. On August 15, 2013, the Hawaii Tax Appeal court ruled that the OTCs were required to pay interest on penalties, and entered final judgment disposing of all issues and claims of all parties. On September 11, 2013, the OTCs filed their notice of appeal. Under Hawaii law, in order to appeal, Orbitz was required to pay the total amount of the final judgment to Hawaii prior to appealing the court’s order. Accordingly, Orbitz made payments to Hawaii of $16.9 million in April 2013, and approximately $9.2 million to Hawaii in September 2013. These amounts reflected a determination of Orbitz’s liability for general excise tax (both on the amounts that it receives for its services and the amounts that the hotels receive for the rental of their rooms), interest, penalties and interest on penalties through the tax year 2011. Although Orbitz disagrees with the court’s rulings on general excise tax and has appealed them, we have recorded an expense of $4.2 million in light of the decision. The $4.2 million represents the amount Orbitz estimates it would owe if the court had correctly applied the general excise tax splitting provision on merchant reservations through December 31, 2012 and a 25% failure to file penalty imposed on that figure. Orbitz
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
has not reserved for the remainder of the ruling because it believes that the general excise tax splitting provision plainly applies to the transactions in question, and that the award of “failure to pay” penalties is entirely unsupported by the record in the case, and that interest on penalties should not have been awarded. Although we believe that it is not probable that Orbitz ultimately will be liable for more than $4.2 million as a result of the court’s order, it is possible that Orbitz will not prevail, and if it does not, the amount of any final award of general excise tax, penalties and interest against Orbitz could exceed $26.0 million. It is also possible that the State of Hawaii could prevail in its cross-appeal on the issue of whether the transient accommodations tax applies to the OTCs’ merchant model hotel transactions. The OTCs’ appeal on the Tax Court of Appeals’ ruling on General Excise Tax, and Hawaii’s cross-appeal on the Tax Court of Appeals’ determination that the OTCs are not subject to Hawaii’s transient accommodations tax, are currently pending before the Hawaii Supreme Court. The Hawaii Supreme Court heard oral argument on both appeals on October 2, 2014.
In an unrelated matter, Trilegiant Corporation filed an action for breach of contract and declaratory judgment in the Supreme Court of New York against us, alleging that we are obligated to make a series of termination payments arising out of a promotion agreement that we terminated in 2007. In 2007, we accrued the present value of the termination payments and in 2010 we ceased making termination payments due to a dispute with Trilegiant. On October 2, 2013, the Court denied Orbitz’s motion for summary judgment on one of its affirmative defenses, and on December 24, 2013, the court rejected most of our remaining defenses. On August 22, 2014, the court denied Orbitz’s remaining affirmative defenses. As of December 31, 2014, we had an accrual totaling $13.5 million, which includes $1.8 million for potential interest. The parties have a dispute as to the rate of prejudgment interest. Trilegiant has asserted an applicable rate of 9%, and as of October 2014, was seeking approximately $3.1 million in interest. Although we believe we will prevail on this issue, it is possible that the Court will determine that the higher rate of interest applies, and if it does, we estimate that we would owe approximately $3.6 million in interest.
We cannot estimate our aggregate range of loss in the cases for which we have not recorded an accrual, except to the extent taxing authorities have issued assessments against us. Although we believe it is unlikely that an adverse outcome will result from these proceedings, an adverse outcome could be material to us with respect to our financial position, earnings or cash flows in any given reporting period.
Surety Bonds and Bank Guarantees
In the ordinary course of business, we obtain surety bonds and bank guarantees, to secure performance of certain of our obligations to third parties. At December 31, 2014 and 2013, there were $7.5 million and $6.7 million of surety bonds outstanding, respectively, of which $5.3 million and $6.2 million were secured by cash collateral or letters of credit, respectively. At December 31, 2014 and 2013, there were $25.3 million and $24.7 million of bank guarantees outstanding, respectively. All bank guarantees were secured by restricted cash at December 31, 2014 and 2013.
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Financing Arrangements
We are required to issue letters of credit to support certain suppliers, commercial agreements, leases and non-U.S. regulatory and governmental agencies primarily to satisfy consumer protection requirements. We believe we have access to sufficient letter of credit availability to meet our short-term and long-term requirements through a combination of the restricted cash balance currently used to collateralize letters of credit or similar instruments, cash from our balance sheet which can be used to support letters of credit and similar instruments and our $80.0 million Revolver through which we are allowed to issue up to $55.0 million in letters of credit.
The following table shows the amount of letters of credit and similar instruments outstanding by facility, as well as the amounts of our restricted cash balances:
Total letter of credit fees were $0.3 million, $4.2 million, and $7.0 million for the years ended December 31, 2014, 2013, and 2012, respectively.
10.
Income Taxes
Pre-tax income/(loss) for U.S. and non-U.S. operations consisted of the following:
The provision/(benefit) for income taxes consisted of the following:
As of December 31, 2014 and 2013, our U.S. federal, state and foreign income taxes receivable/(payable) was $0.0 million and $(0.2) million, respectively.
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The tax provision for the year ended December 31, 2014 was primarily deferred taxes on income from our U.S. operations and certain foreign subsidiaries where we have not established a valuation allowance. The 2014 tax provision was disproportionate to pre-tax book income due to the valuation allowances which still remain with respect to the majority of our non-US operations.
The tax benefit for the year ended December 31, 2013 was due primarily to a release of $174.4 million in valuation allowances related to our U.S. federal deferred tax assets and therefore the benefit was disproportionate to the amount of pretax book income.
The tax provision for the year ended December 31, 2012 was due primarily to taxes on the income of certain European-based subsidiaries and U.S. state and local income taxes. The tax provision recorded for the year ended December 31, 2012 was disproportionate to the amount of pre-tax net loss incurred during the period primarily because we were not able to realize any tax benefits on the goodwill and trademark and trade names impairment charges. The provision for income taxes only includes the tax effect of the income or loss of certain foreign subsidiaries that had not established a valuation allowance and U.S. state and local income taxes.
We currently have a valuation allowance of $109.2 million against certain deferred tax assets, of which $107.3 million relates to foreign jurisdictions. We will continue to assess the level of the valuation allowance required; if sufficient positive evidence exists in future periods to support a release of some or all of the valuation allowance, such a release would likely have a material impact on our results of operations. With respect to the valuation allowance established against our non-U.S.-based deferred tax assets, a significant item of objective negative evidence evaluated in our determination was cumulative losses incurred over the three-year period ended December 31, 2014. This objective evidence limited our ability to consider other subjective evidence such as future income projections.
Our effective income tax rate differs from the U.S. federal statutory rate as follows:
**Not meaningful due to the low level of pre-tax income and release of U.S. valuation allowance of $174.4 million in 2013.
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Current and non-current deferred income tax assets and liabilities in various jurisdictions are composed of the following:
(a)
The current portion of the deferred income tax asset at December 31, 2014 and 2013 is included in Other current assets in our Consolidated Balance Sheets.
The net deferred tax assets at December 31, 2014 and 2013 amounted to $146.3 million and $171.8 million, respectively. These net deferred tax assets largely relate to temporary tax to book differences and net operating loss carryforwards, the realization of which is, in management’s judgment, more likely than not. We have assessed the likelihood of realization based on our expectations of future taxable income, carry-forward periods available and other relevant factors.
As of December 31, 2014, we had U.S. federal and state net operating loss carry-forwards of approximately $119.6 million and $109.0 million, respectively, which expire between 2021 and 2034. In addition, we had $424.6 million of non-U.S. net operating loss carry-forwards, most of which do not expire. Additionally, we had $4.4 million of U.S. federal and state income tax credit carry-forwards which expire between 2027 and 2034 and $1.1 million of U.S. federal income tax credits which have no expiration date. No provision has been made for U.S. federal or non-U.S. deferred income taxes on approximately $16.5 million of accumulated and undistributed earnings of foreign subsidiaries at December 31, 2014. A provision has not been established because it is our present intention to reinvest the undistributed earnings indefinitely in those foreign operations. The determination of the amount of unrecognized U.S. federal or non-U.S. deferred income tax liabilities for unremitted earnings at December 31, 2014 is not practicable. As of December 31, 2014, we have established a deferred income tax liability on $2.0 million of accumulated and undistributed earnings in anticipation of the liquidation of an inactive foreign subsidiary next year.
We have established a liability for unrecognized tax benefits. Once established, unrecognized tax benefits are adjusted if more accurate information becomes available, or a change in circumstance or an event occurs necessitating a change to the liability. Given the inherent complexities of the business and that we are subject to taxation in a substantial number of jurisdictions, we routinely assess the likelihood of additional assessment in each of the taxing jurisdictions.
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The table below shows the changes in the liability for unrecognized tax benefits during the years ended December 31, 2014, 2013 and 2012:
The total amount of unrecognized benefits that, if recognized, would affect our effective tax rate was $3.3 million, $3.5 million and $0.9 million at December 31, 2014, 2013 and 2012. During the next twelve months, we anticipate no reduction to this liability due to the lapsing of statutes of limitations.
We recognize interest and penalties related to unrecognized tax benefits in income tax expense. We recognized interest and penalties of $0, during each of the years ended December 31, 2014, 2013 and 2012. Accrued interest and penalties were $0.7 million and $0.7 million at December 31, 2014 and 2013, respectively.
We file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. A number of years may elapse before an uncertain tax position, for which we have unrecognized tax benefits, is audited and finally resolved. We adjust these unrecognized tax benefits, as well as the related interest and penalties, in light of changing facts and circumstances. Settlement of any particular position could require the use of cash. Favorable resolution could result in a reduction to our effective income tax rate in the period of resolution.
The number of years with open tax audits varies depending on the tax jurisdiction. Our major taxing jurisdictions include the United States (federal and state), the United Kingdom (federal) and Australia (federal). With limited exceptions, we are no longer subject to income tax examinations by tax authorities for years before 2010.
With respect to periods prior to the Blackstone Acquisition, we are only required to take into account income tax returns for which we or one of our subsidiaries is the primary taxpaying entity, namely separate state returns and non-U.S. returns. Uncertain tax positions related to U.S. federal and state combined and unitary income tax returns filed are only applicable in the post-acquisition accounting period. We and our domestic subsidiaries currently file a consolidated income tax return for U.S. federal income tax purposes.
11.
Equity-Based Compensation
We issue share-based awards under the Orbitz Worldwide, Inc. 2007 Equity and Incentive Plan, as amended (the “Plan”). The Plan provides for the grant of equity-based awards, including restricted stock, restricted stock units, stock options, stock appreciation rights and other equity-based awards to our directors, officers and other employees, advisors and consultants who are selected by the Compensation Committee of the Board of Directors for participation in the Plan. There are 25,600,000 shares of common stock available for issuance under the Plan, subject to adjustment as provided by the Plan. As of December 31, 2014, 4,291,197 shares were available for future issuance under the plan.
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Restricted Stock Units
The table below summarizes activity regarding unvested restricted stock units under the Plan during the year ended December 31, 2014:
(a)
We issued 1,159,060 shares of common stock in connection with the vesting of restricted stock units during the year ended December 31, 2014, which is net of the number of shares retained (but not issued) by us in satisfaction of minimum tax withholding obligations associated with the vesting.
The fair value of restricted stock units that vested during the years ended December 31, 2014, 2013 and 2012 was $6.3 million, $4.6 million and $4.4 million, respectively. The weighted-average grant date fair value of restricted stock units granted during the years ended December 31, 2014, 2013 and 2012 was $8.86, $4.07 and $3.31 per unit, respectively. The fair value of restricted stock units on the date of grant is amortized on a straight-line basis over the requisite service period of four years.
Performance-Based and Market-Based Restricted Stock Units
The table below summarizes activity regarding unvested performance-based and market-based restricted stock units (“PSUs”) under the Plan during the year ended December 31, 2014:
a.
We granted 136,815 performance-based restricted stock units with a fair value per share of $9.72 and 273,630 market-based restricted stock units with a fair value per share of between $11.89 and $16.32 (“PSUs”) in March 2014 to certain of our executive officers. The PSUs entitle the executives to receive one share of our common stock for each PSU earned, subject to the satisfaction of the performance and market conditions. Each metric will be equally weighted, with the ability to earn between 25% to 200% of target based on a straight-line interpolation of the criteria. The performance-based condition requires that the Company attain certain performance metrics for the three-year period ended December 31, 2016 and the market-based conditions require that the Company achieve a certain absolute shareholder return and a certain relative shareholder return at the conclusion of the three-year measurement period. If the minimum performance criteria are not met, each PSU will be forfeited. If the minimum conditions are met, the PSUs earned will cliff vest on the third anniversary of the grant date. The fair value of the PSUs subject to market-based conditions was measured using a Monte Carlo simulation for sampling random outcomes.
As of December 31, 2014, we expect that the performance-based condition PSUs granted in 2014 will be satisfied at approximately 60% of their target level. The fair value of the market-based PSUs is being amortized on a straight-line basis over the requisite service period of each vesting tranche.
The weighted-average grant date fair value of PSUs that vested during the years ended December 31, 2014, 2013 and 2012 was $2.7 million, $1.6 million and $0.8 million, respectively. The weighted-average grant date fair value of
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
PSUs granted during the years ended December 31, 2014, 2013 and 2012 was $12.64, $3.34 and $2.40 per unit, respectively.
Stock Options
The table below summarizes the stock option activity under the Plan during the year ended December 31, 2014:
The exercise price of stock options granted under the Plan is equal to the fair market value of the underlying stock on the date of grant. Stock options generally expire seven to ten years from the grant date. Stock options vest either annually over a four-year period, or 25% of the options vest after one year and the remaining awards vest ratably on a monthly basis for the three years that follow. The fair value of stock options on the date of grant is amortized on a straight-line basis over the requisite service period. There were no stock options granted in 2014, 2013 or 2012.
During the years ended December 31, 2014, 2013 and 2012, the total fair value of options that vested during the period was $0.7 million, $1.1 million and $1.3 million, respectively. In addition, the intrinsic value of options exercised was $0.3 million, $3.1 million, and $0 for the years ended December 31, 2014, 2013 and 2012, respectively.
Non-Employee Directors Deferred Compensation Plan
We have a deferred compensation plan that enables our non-employee directors to defer the receipt of certain compensation earned in their capacity as non-employee directors. Eligible directors may elect to defer up to 100% of their annual retainer fees (which are paid by us on a quarterly basis). In addition, 100% of the annual equity granted to non-employee directors is deferred under the Plan.
We grant deferred stock units (“DSUs”) annually to each participating director. The DSUs are issued as restricted stock units under the Plan and are immediately vested and non-forfeitable. The DSUs entitle the non-employee director to receive one share of our common stock for each deferred stock unit following the director’s retirement or termination of service from the Board of Directors. For all awards granted prior to 2011, the DSUs are distributed 200 days immediately following such termination date and for all awards granted in 2011 or later, the DSUs are distributed immediately at termination. The entire grant date fair value of deferred stock units is expensed on the date of grant.
The table below summarizes the deferred stock unit activity under the Plan during the year ended December 31, 2014:
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The weighted-average grant date fair value for deferred stock units granted during the years ended December 31, 2014, 2013 and 2012 was $7.94, $7.79 and $3.47, respectively.
Compensation Expense
We recognized total equity-based compensation expense of $12.2 million, $12.9 million and $7.6 million for the years ended December 31, 2014, 2013 and 2012, respectively, none of which has provided us with a tax benefit due to existence of net operating losses. As of December 31, 2014, a total of $20.1 million of unrecognized compensation costs related to unvested restricted stock units, unvested stock options and unvested PSUs are expected to be recognized over the remaining weighted-average period of 2.8 years.
12.
Derivative Financial Instruments
Interest Rate Hedges
At December 31, 2014, we had the following interest rate swaps outstanding that effectively converts $200.0 million of the term loan from a variable to a fixed interest rate. We pay a fixed interest rate on the notional amount and in exchange receive a variable interest rate based on the one-month LIBOR rate. The Company does not use derivatives for speculative or trading purposes.
We entered into interest rate derivative contracts to protect against volatility of future cash flows of the variable interest payments related to our term loan. These derivative contracts are economic hedges and are not designated as cash flow hedges. We mark-to-market instruments not designated as hedges and record the changes in the fair value of these items in Net interest expense in the Company’s Consolidated Statements of Operations and recognize the unrealized gain or loss in Other non-current assets or liabilities. Unrealized losses of $1.7 million and $1.2 million were recognized at December 31, 2014 and 2013, respectively.
The following table summarizes the location and fair value of our interest rate derivative instruments on the Company’s Consolidated Balance Sheets.
Interest rate swaps previously designated as hedging instruments were terminated in conjunction with the termination of our credit agreement in March 2013. Interest rate swaps designated as hedging instruments were reflected in our Consolidated Balance Sheets at market value. The corresponding market adjustment related to the hedging instrument was recorded to Accumulated other comprehensive income (“AOCI”).
The following table shows the market adjustments recorded during the years ended December 31, 2014, 2013 and 2012:
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Foreign Currency Hedges
We enter into foreign currency contracts to manage our exposure to changes in the foreign currency associated with foreign currency receivables, payables and intercompany transactions. We primarily hedge our foreign currency exposure to the Pound sterling, Euro, Swiss Franc and the Australian dollar. As of December 31, 2014, we had foreign currency contracts outstanding with a total net notional amount of $190.3 million, all of which subsequently matured in early 2015. The foreign currency contracts do not qualify for hedge accounting treatment; accordingly, changes in the fair value of the foreign currency contracts are reflected in net income as a component of Selling, general and administrative expense in our Consolidated Statements of Operations.
The following table shows the fair value of our foreign currency hedges:
The following table shows the changes in the fair value of our foreign currency contracts which were recorded as a gain/(loss) in Selling, general and administrative expense:
(a)
We recorded transaction gains/(losses) associated with the re-measurement and settlement of our foreign denominated assets and liabilities of $(12.9) million, $(9.3) million and $6.7 million for the years ended December 31, 2014, 2013 and 2012, respectively. These transaction gains and losses were included in Selling, general and administrative expense in our Consolidated Statements of Operations. The net impact of these transaction gains and losses, together with the gains/(losses) incurred on our foreign currency hedges, were losses of $6.1 million, $5.4 million and $4.7 million for the years ended December 31, 2014, 2013 and 2012, respectively.
The tables below show the gross and net information related to derivatives eligible for offset in the Consolidated Balance Sheets as of December 31, 2014 and 2013. The gross asset amount of the derivative listed below is the maximum loss the Company would incur if the counterparties failed to meet their obligation.
13. Employee Benefit Plans
We sponsor a defined contribution savings plan for employees in the United States that provides certain of our eligible employees an opportunity to accumulate funds for retirement. We also sponsor similar HotelClub and ebookers defined contribution savings plans. After employees have attained one year of service, we match the contributions of participating employees on the basis specified by the plans, up to a maximum of 3% of participant compensation. We recorded total expense related to these plans in the amount of $5.3 million, $4.9 million and $4.8 million for the years ended December 31, 2014, 2013 and 2012, respectively.
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
14.
Net Income/(Loss) per Share
We calculate basic net income/(loss) per share by dividing the net income/(loss) for the period by the weighted-average number of shares outstanding during the period. The weighted-average number of shares includes common shares outstanding and deferred stock units, which are immediately vested and non-forfeitable. Diluted net income/(loss) per share is calculated by dividing the net income/(loss) for the period by the weighted-average number of common shares outstanding and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares are determined by the application of the treasury stock method.
The following table presents the weighted-average shares outstanding used in the calculation of net income/(loss) per share:
The following equity awards were not included in the diluted net income/(loss) per share calculation because they would have had an antidilutive effect:
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
15.
Related Party Transactions
Related Party Transactions with Travelport and its Subsidiaries
We had amounts due from Travelport of $15.5 million and $12.3 million at December 31, 2014 and 2013, respectively. Amounts due to or from Travelport are generally settled on a net basis.
At December 31, 2013, 48% of the shares of our common stock outstanding were beneficially owned by Travelport and the investment funds that indirectly own Travelport. In the second quarter and early third quarter of 2014, Travelport sold a majority of its shares of our common stock and after its secondary common stock offering on July 22, 2014, beneficially owns less than 1% of shares of our common stock as of December 31, 2014 and is no longer considered a related party (see Note 1 - Organization and Basis of Presentation in the Notes to Consolidated Financial Statements).
The following table summarizes the related party transactions with Travelport and its subsidiaries through July 22, 2014, reflected in our Consolidated Statements of Operations:
(a)
Net revenue includes incentive revenue for segments processed through Galileo and Worldspan, both of which are subsidiaries of Travelport. This incentive revenue accounted for more than 10% of our total net revenue in 2012.
(b)
Interest expense relates to letters of credit issued on our behalf by Travelport.
Master License Agreement
We entered into a Master License Agreement with Travelport at the time of the IPO. Pursuant to this agreement, Travelport licenses certain of our intellectual property and pays us fees for related maintenance and support services. The licenses include our supplier link technology; portions of ebookers’ booking, search and vacation package technologies; certain of our products and online booking tools for corporate travel; portions of our private label vacation package technology; and our extranet supplier connectivity functionality.
The Master License Agreement granted us the right to use a corporate online booking product developed by Travelport. We have entered into a value added reseller license with Travelport for this product.
GDS Service Agreement
In connection with the IPO, we entered into the Travelport GDS Service Agreement, which terminated in February 2014. The Travelport GDS Service Agreement was structured such that we earned incentive revenue for each air, car and hotel segment that was processed through the Travelport GDSs. This agreement required that we process a certain minimum number of segments for our domestic brands through the Travelport GDSs each year. Our domestic brands were required to process a total of 27.8 million and 31.4 million segments through the Travelport GDSs during the years ended December 31, 2013 and 2012, respectively. Of the required number of segments, 16.0 million segments were required to be processed each year through Worldspan, and 11.8 million and 15.4 million segments were required to be processed through Galileo during the years ended December 31, 2013 and 2012, respectively. We were not subject to these minimum volume thresholds to the extent that we processed all eligible segments through the Travelport GDS.
In February 2014, the Company entered into an agreement with Travelport for the provision of GDS services, which terminated and replaced our prior Travelport GDS service agreement (the “New Travelport GDS Service Agreement”). Under the New Travelport GDS Service Agreement, Orbitz was obligated in 2014 to use only Travelport GDSs for all air and car segments booked on its domestic agencies and was subject to certain other exclusivity obligations for its segments booked in
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Europe and other markets as defined in the New Travelport GDS Service Agreement. The Company was required to pay a fee for each segment not booked through Travelport GDSs in 2014 subject to exclusivity obligations discussed above. However, beginning January 1, 2015, the Company is no longer subject to exclusivity obligations. Under the New Travelport GDS Service Agreement, beginning in 2015, we are obligated to provide certain levels of volume over the contract period and may be subject to pay shortfall payments in certain cases if we fail to meet volume commitments. The agreement terminates on December 31, 2018.
No payments were required to be made to Travelport related to the minimum segment requirements for our domestic and European brands for the years ended December 31, 2014, 2013 and 2012.
Corporate Travel Agreement
We provide corporate travel management services to Travelport and its subsidiaries.
16.
Fair Value Measurements
The following table shows the fair value of our assets and liabilities that are required to be measured at fair value on a recurring basis as of December 31, 2014 and 2013, which are classified as Other current assets, Other current liabilities and Other non-current liabilities in our Consolidated Balance Sheets.
We value our foreign currency hedges based on the difference between the foreign currency contract rate and widely available foreign currency rates as of the measurement date. Our foreign currency hedges are short-term in nature, generally maturing within 30 days. We value our interest rate swaps using valuations that are calibrated to the initial trade prices. Using a market-based approach, subsequent valuations are based on observable inputs to the valuation model including interest rates, credit spreads and volatilities.
Fair Value of Financial Instruments
For certain of our financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, accrued merchant payable and accrued expenses, the carrying value approximates or equals fair value due to their short-term nature.
The carrying value of the Term Loan was $447.8 million at December 31, 2014, compared with a fair value of $442.2 million. At December 31, 2013, the carrying value of the Term Loan was $443.3 million, compared with a fair value of $446.8 million. The fair values were determined based on quoted market ask prices, which is classified as a Level 2 measurement.
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
17.
Segment Information
We determine operating segments based on how our chief operating decision maker manages the business, including making operating decisions deciding how to allocate resources and evaluating operating performance. We operate in one segment and have one reportable segment.
We maintain operations in the United States, United Kingdom, Australia, Germany, Sweden, France, Finland, Ireland, Switzerland and other international territories. The table below presents net revenue by geographic area: the United States and all other countries.
The table below presents property and equipment, net, by geographic area.
18.
Subsequent Events
As previously announced, on February 12, 2015, the Company, Expedia, Inc., (“Expedia”), and Xeta, Inc., an indirect wholly owned subsidiary of Expedia (“Merger Sub”) entered into an Agreement and Plan of Merger (the “Merger Agreement”).
The Merger Agreement provides, subject to the terms and conditions set forth therein, that Merger Sub will be merged with and into the Company (the “Merger”) among other things and, with the Company surviving the Merger as an indirect wholly owned subsidiary of Expedia. At the effective time of the Merger (the “Effective Time”), each share of common stock of the Company outstanding immediately prior to the Effective Time (other than any shares owned by the Company, Expedia, Merger Sub or Merger Sub’s direct parent or any dissenting shares) will be automatically converted into the right to receive $12.00 in cash, without interest.
The Board of Directors of the Company by a unanimous vote of directors present approved the Merger Agreement and the transactions contemplated thereby, including the Merger. The closing of the Merger is subject to the adoption of the Merger Agreement by the affirmative vote of holders of a majority of the outstanding shares of common stock of the Company. The closing of the Merger is also subject to various customary conditions, including the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and other regulatory clearances, the absence of any governmental order prohibiting the consummation of the transactions contemplated by the Merger Agreement, the accuracy of the representations and warranties contained in the Merger Agreement (subject to certain materiality qualifications) and compliance with the covenants and agreements in the Merger Agreement in all material respects.
The Merger Agreement contains certain termination rights, including the right of the Company to terminate the Merger Agreement to accept a superior proposal (subject to compliance with certain notice and other requirements). The Merger Agreement provides that, in connection with termination of the Merger Agreement by the Company or Expedia upon specified conditions, the Company will be required to pay to Expedia a termination fee of $57.5 million. If the Merger Agreement is terminated as a result of the failure to obtain competition law approvals or a legal prohibition related to competition law matters, a termination fee of $115.0 million will be payable by Expedia to the Company, subject to certain limitations. In addition, subject to certain exceptions and limitations, the Company or Expedia may terminate the Merger Agreement if the
ORBITZ WORLDWIDE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Merger is not consummated by August 12, 2015 (or as such date may be extended pursuant to the terms of the Merger Agreement).
19.
Quarterly Financial Data (Unaudited)
The following tables present certain unaudited consolidated quarterly financial information.
(a)
During the three months ended March 31, 2013, we reversed $157.5 million in valuation allowance related to deferred tax assets (see Note 10 - Income Taxes).
Schedule II - Valuation and Qualifying Accounts
(a)
Relates to the release of the valuation allowance on U.S. deferred tax assets.
(b)
Represents foreign currency translation adjustments to the valuation allowances, reclassification adjustments between our gross deferred tax assets and the corresponding valuation allowance and the effects of a U.K. tax rate change.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures under Rules 13a-15(e) of the Exchange Act are those controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Pursuant to Rule 13a-15(e) under the Exchange Act, our management evaluated the effectiveness of the design and operation of our disclosure controls and procedures with the participation of our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”). Based on that evaluation, our management concluded that, as of December 31, 2014, our disclosure controls and procedures were effective. We view our internal control over financial reporting as an integral part of our disclosure controls and procedures.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the fiscal quarter ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Annual Report on Internal Control over Financial Reporting
Internal control over financial reporting is the process designed by, or under the supervision of, our CEO and CFO, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with generally accepted accounting principles, and includes those policies and procedures that:
1.
Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
2.
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of our financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
3.
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.
A material weakness is defined within the Public Company Accounting Oversight Board’s Auditing Standard No. 5 as a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. As of December 31, 2014, our management conducted an assessment of the effectiveness of our internal control over financial reporting using the criteria in Internal Control - Integrated Framework (2013), established by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, our management has concluded that our internal control over financial reporting was effective as of December 31, 2014.
On February 28, 2014, the Company closed on its acquisition of certain assets and contracts of the Travelocity Partner Network (“TPN”). TPN is included in the Company’s 2014 consolidated financial statements and represents approximately 5.6% of consolidated net revenue. Due to integration efforts, a separate balance sheet for TPN is no longer maintained. The
Company has excluded TPN from its annual assessment of, and conclusion on, the effectiveness of the Company’s internal control over financial reporting.
Deloitte & Touche LLP, our independent registered public accounting firm, has audited the financial statements contained in this Annual Report on Form 10-K and issued an opinion on the effectiveness of our internal control over financial reporting, which report is included herein.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Orbitz Worldwide, Inc.
Chicago, Illinois
We have audited the internal control over financial reporting of Orbitz Worldwide, Inc. and subsidiaries (the “Company”) as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. As described in Management’s Annual Report on Internal Control over Financial Reporting, management excluded from its assessment the internal control over financial reporting at Travelocity Partner Network, which was acquired on February 28, 2014 and whose financial statements constitute 5.6% of consolidated net revenue for the year ended December 31, 2014. Accordingly, our audit did not include the internal control over financial reporting at Travelocity Partner Network. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2014, of the Company and our report dated March 9, 2015 expressed an unqualified opinion on those financial statements and financial statement schedule.
/s/ DELOITTE & TOUCHE LLP
Chicago, Illinois
March 9, 2015
Item 9B.
Item 9B.
Other Information
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
Certain information required by Item 401 of Regulation S-K will be included under the caption “Proposal 1 - Election of Directors” in the 2015 Proxy Statement, and that information is incorporated by reference herein. The information required by Item 405 of Regulation S-K will be included under the caption “Corporate Governance - Section 16(a) Beneficial Ownership Reporting Compliance” in the 2015 Proxy Statement, and that information is incorporated by reference herein.
Information regarding our executive officers is included in Part I of this Form 10-K under the heading “Executive Officers of the Registrant,” and that information is incorporated by reference herein.
The information required by Item 407(c)(3) of Regulation S-K will be included under the caption “Corporate Governance - Director Selection Procedures,” and the information required under Items 407(d)(4) and (d)(5) of Regulation S-K will be included under the caption “Corporate Governance - Committees of the Board of Directors - Audit Committee” in the 2015 Proxy Statement, and that information is incorporated by reference herein.
Code of Business Conduct
We have adopted the Orbitz Worldwide, Inc. Code of Ethics and Business Conduct (the “Code of Business Conduct”) which applies to all of our directors and employees, including our chief executive officer, chief financial officer and principal accounting officer. In addition, we have adopted a Code of Ethics for our chief executive officer and senior financial officers. The Code of Business Conduct and the Code of Ethics are available on the corporate governance page of our Investor Relations website at www.orbitz-ir.com. Amendments to, or waivers from, the Code of Business Conduct applicable to these senior executives will be posted on our website and provided to you without charge upon written request to Orbitz Worldwide, Inc., Attention: Corporate Secretary, 500 W. Madison Street, Suite 1000, Chicago, Illinois 60661.
Item 11.
Item 11.
Executive Compensation
The information required by Item 402 of Regulation S-K will be included under the captions “Executive Compensation,” “Summary Compensation Table” and “Director Compensation” in the 2015 Proxy Statement, and that information is incorporated by reference herein.
The information required by Items 407(e)(4) and (e)(5) of Regulation S-K will be included under the captions “Corporate Governance - Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report” in the 2015 Proxy Statement, and that information is incorporated by reference herein.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by Item 201(d) of Regulation S-K is included in Item 5, “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.” The information required by Item 403 of Regulation S-K will be included under the caption “Security Ownership” in the 2015 Proxy Statement, and that information is incorporated by reference herein.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
The information required by Item 404 of Regulation S-K will be included under the caption “Certain Relationships and Related Person Transactions” in the 2015 Proxy Statement, and that information is incorporated by reference herein.
The information required by Item 407(a) of Regulation S-K will be included under the caption “Corporate Governance - Independence of Directors” in the 2015 Proxy Statement, and that information is incorporated by reference herein.
Item 14.
Item 14.
Principal Accounting Fees and Services
The information concerning principal accounting fees and services and the information required by Item 14 will be included under the caption “Fees Incurred for Services of Deloitte & Touche LLP” and “Approval of Services Provided by Independent Registered Public Accounting Firm” in the 2015 Proxy Statement, and that information is incorporated by reference herein.
PART IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules
(a)(1)
Financial Statements: The following financial statements are included in Item 8 herein:
(a)(2)
Financial Statement Schedules: The following financial statement schedule is included in Item 8 herein:
All other schedules are omitted because they are either not required, are not applicable, or the information is included in the consolidated financial statements and notes thereto.
(a)(3)
Exhibits: See the Exhibit Index included in this Form 10-K and is incorporated by reference herein.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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 and on the dates indicated.
EXHIBIT INDEX
†
Portions of this exhibit have been omitted pursuant to a request for confidential treatment filed separately with the SEC.
*
Indicates a management contract or compensatory plan or arrangement.
#
XBRL (Extensible Business Reporting Language) information is furnished and not filed herewith, is not a part of a registration statement or Prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.