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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Expedia, Inc. is an online travel company, empowering business and leisure travelers with the tools and information they need to efficiently research, plan, book and experience travel. We created a global travel marketplace used by a broad range of leisure and corporate travelers, offline retail travel agents and travel service providers. We make available, on a stand-alone and package basis, travel products and services provided by numerous lodging properties, airlines, car rental companies, destination service providers, cruise lines, vacation rental property owners and managers, and other travel product and service companies. We also offer travel and non-travel advertisers access to a potential source of incremental traffic and transactions through our various media and advertising offerings on our transaction-based websites. For additional information about our portfolio of brands, see the disclosure set forth in Part I, Item 1, Business, under the caption “Management Overview.”
All percentages within this section are calculated on actual, unrounded numbers.
Trends
The travel industry, including offline agencies, online agencies and other suppliers of travel products and services, has historically been characterized by intense competition, as well as rapid and significant change. Generally, 2016 and 2017 represented years of continuing improvement for the travel industry. However, political instability, geopolitical conflicts, acts of terrorism, significant fluctuations in currency values, sovereign debt issues, natural disasters and macroeconomic concerns are examples of events that contribute to a somewhat uncertain environment, which could have a negative impact on the travel industry in the future.
Online Travel
Increased usage and familiarity with the internet drove rapid growth in online penetration of travel expenditures. According to Phocuswright, an independent travel, tourism and hospitality research firm, in 2018, over 45% of U.S. and European leisure and unmanaged corporate travel expenditures are expected to occur online. Online penetration rates in the emerging markets, such as Asia Pacific and Latin American regions, are lagging behind that of the United States and Europe, and are estimated to be in the range of 30% to 40%. These penetration rates increased over the past few years, and are expected to continue growing, which has attracted many competitors to online travel. This competition intensified in recent years, and the industry is expected to remain highly competitive for the foreseeable future. In addition to the growth of online travel agencies, airlines and lodging companies aggressively pursued direct online distribution of their products and services. Competitive entrants such as “metasearch” companies, including Kayak.com (owned by The Priceline Group), trivago (in which Expedia owns a majority interest) as well as TripAdvisor, introduced differentiated features, pricing and content compared with the legacy online travel agency companies, as well as various forms of direct or assisted booking tools, the impact of which is currently uncertain. In addition, the increasing popularity of the “sharing economy,” accelerated by online penetration, has had a direct impact on the travel and lodging industry. Players such as Airbnb, HomeAway (which Expedia acquired in December 2015) and Booking.com (owned by The Priceline Group) emerged as the leaders, bringing incremental alternative accommodation and vacation rental inventory to the market. Many other competitors, including vacation rental metasearch players, continue to emerge in this space, which is estimated by analysts to account for approximately $100 billion of annual travel spend and expected to continue to grow as a percentage of the global accommodation market. Furthermore, we saw increased interest in the online travel industry from search engine companies as evidenced by recent innovations including direct booking functionality, as well as licensing deals and proposed and actual acquisitions by companies such as Google. Finally, traditional consumer eCommerce and group buying websites expanded their local offerings into the travel market by adding hotel offers to their websites.
The online travel industry also saw the development of alternative business models and variations in the timing of payment by travelers and to suppliers, which in some cases place pressure on historical business models. In particular, the agency hotel model saw rapid adoption in Europe. Expedia distributes both merchant (Expedia Collect) and agency (Hotel Collect) hotel offerings for our hotel supply partners through both agency-only contracts as well as our hybrid ETP program, which offers travelers the choice of whether to pay Expedia at the time of booking or pay the hotel at the time of stay.
Intense competition also historically led to aggressive marketing efforts by the travel suppliers and intermediaries, and a meaningful unfavorable impact on our overall marketing efficiencies and operating margins. We manage our selling and marketing spending on a brand basis, making decisions in each applicable market that we think are appropriate based on the relative growth opportunity, the expected returns and the competitive environment. In certain cases, particularly in emerging markets, we are pursuing and expect to continue to pursue long-term growth opportunities for which our marketing efficiency is less favorable than that for our consolidated business, but for which we still believe the opportunity to be attractive. The crowded online travel environment is now driving certain secondary and tertiary online travel companies to establish marketing
agreements with global players in order to leverage distribution and technology capabilities while focusing resources on capturing traveler mind share.
In May 2015, Expedia sold its 62.4% equity stake in eLong for approximately $671 million to several purchasers including Ctrip.com International, Ltd (“Ctrip”). Expedia and Ctrip also reached agreement on cooperation for certain travel products in specified geographic markets. The transaction closed on May 22, 2015. Unless otherwise noted, all discussion in the “Trends” and “Growth Strategy” sections refers to results for Expedia, Inc. excluding eLong.
Lodging
Lodging includes hotel accommodations as well as alternative accommodations primarily made available through HomeAway. As a percentage of our total worldwide revenue in 2017, lodging accounted for 68%. Our room night growth has been healthy, with room nights excluding eLong growing 36% in 2015, 32% in 2016, and 16% in 2017. ADRs for rooms booked on Expedia and HomeAway websites excluding eLong declined 5% in 2015, increased 5% in 2016 due to the acquisition of HomeAway, and increased 3% in 2017.
Hotel. We generate the majority of our revenue through the facilitation of hotel reservations (stand-alone and package bookings). Although our relationships with our hotel supply partners remained broadly stable in the past few years, as part of the global rollout of ETP, we reduced negotiated economics in certain instances to compensate for hotel supply partners absorbing expenses such as credit card fees and customer service costs, which has negatively impacted the margin of revenue we earn per booking. In addition, as we continue to expand the breadth and depth of our global hotel offering, in some cases we have reduced our economics in various geographies based on local market conditions. These impacts are due to specific initiatives intended to drive greater global size and scale through faster overall room night growth. Additionally, increased promotional activities such as growing loyalty programs contribute to declines in revenue per room night and profitability.
Since our hotel supplier agreements are generally negotiated on a percentage basis, any increase or decrease in ADRs has an impact on the revenue we earn per room night. Over the course of the last several years, occupancies and ADRs in the lodging industry generally increased on a currency-neutral basis in a gradually improving overall travel environment. However, U.S. dollar-denominated hotel ADRs declined in 2015 and 2016, due to the currency translation impact, and increased in 2017. Current occupancy rates for hotels in the United States remain high; however, U.S. hotel supply growth has been accelerating, which may put additional pressure on ADRs. In international markets, hotel supply is being added at a faster rate as hotel owners and operators try to take advantage of opportunities in faster growing regions such as Asia and certain Latin American markets. Companies like Airbnb, HomeAway and Booking.com also added incremental global supply in the alternative accommodations space. In addition, while the global lodging industry remains very fragmented, there has been consolidation in the hotel space among chains as well as ownership groups. In the meantime, certain hotel chains have been focusing on driving direct bookings on their own websites and mobile applications by advertising lower rates than those available on third-party websites as well as incentives such as loyalty points, increased or exclusive product availability and complimentary Wi-Fi. We have had success adding supply to our marketplace with more than 590,000 properties on our global websites as of December 31, 2017, including more than 150,000 HomeAway vacation rental properties now available on select Brand Expedia, Orbitz, Travelocity, CheapTickets and ebookers websites.
Alternative Accommodations. With our acquisition of HomeAway and all of its brands in December 2015, we expanded into the fast growing $100 billion alternative accommodations market. HomeAway is a leader in this market and represents an attractive growth opportunity for Expedia. HomeAway has been undergoing a transition from a listings-based classified advertising model to an online transactional model that optimizes for both travelers and homeowner and property manager partners, with a goal of increasing monetization and driving growth through investments in marketing as well as in product and technology. In addition, HomeAway rolled out a traveler service fee in the United States and Europe during the first half of 2016, consistent with market practice. The fee is expected to continue to contribute to HomeAway’s revenue growth and help fund marketing investment, programs to better protect travelers and future growth initiatives. Furthermore, HomeAway moved to a single subscription option globally in July 2016. In the first quarter of 2017, HomeAway began integrating Expedia vacation rental properties onto its websites. As of December 31, 2017, there are nearly 1.5 million online bookable listings available on HomeAway.
Air
Significant airline sector consolidation in the United States in recent years generally resulted in lower overall capacity and higher fares, which combined with the significant declines in fuel prices led to record levels of profitability for the U.S. air carriers, further strengthening their position. However, in 2015, 2016 and 2017, there has been evidence of discounting by the U.S. carriers while currency headwinds and weaker macroeconomic trends put pressure on international results. Ticket prices on Expedia websites excluding eLong declined 11% in 2015, 6% in 2016, and 1% in 2017 as short-haul traffic and low cost carriers grew alongside increasingly competitive airline pricing and more recently a volatile fuel pricing environment. We can
encounter pressure on air remuneration as air carriers combine and as certain supply agreements renew, and continue to add airlines to ensure local coverage in new markets.
Air ticket volumes excluding eLong increased 35% in 2015 and 32% in 2016, primarily due to the acquisition of Orbitz, and 4% in 2017. As a percentage of our total worldwide revenue in 2017, air accounted for 8%.
Advertising & Media
Our advertising and media business is principally driven by revenue generated by trivago, a leading hotel metasearch website, in addition to Expedia Media Solutions, which is responsible for generating advertising revenue on our global online travel brands. In 2017, we generated a total of $1.1 billion of advertising and media revenue representing 11% of our total worldwide revenue, up from $807 million in 2016.
Growth Strategy
Global Expansion. Our Brand Expedia, Hotels.com, Egencia, and EAN brands operate both domestically and through international points of sale, including in Europe, Asia Pacific, Canada and Latin America. In addition, ebookers offers multi-product online travel reservations in Europe and Wotif Group has a leading portfolio of travel brands, including Wotif.com, Wotif.co.nz, lastminute.com.au, lastminute.com.nz and travel.com.au, focused principally on the Australia and New Zealand markets. Egencia, our corporate travel business, operates in over 65 countries around the world and continues to expand. The HomeAway portfolio has 60 vacation rental websites all around the world. We own a majority share of trivago, a leading metasearch company. Officially launched in 2005, trivago is one of the best known travel brands in Europe and North America. trivago continues to operate independently and grow revenue through global expansion, including aggressive expansion in new countries. In December 2016, trivago successfully completed its initial public offering and trades on the Nasdaq Global Select Market under the symbol "TRVG." In addition, we have commercial agreements in place with Ctrip and eLong in China, Traveloka in Southeast Asia, as well as Decolar.com, Inc. in Latin America, among many others. In conjunction with the commercial arrangements with Traveloka and Decolar, we have also made strategic investments of over $600 million combined in Traveloka in 2017 and Decolar in 2015. In 2017, approximately 38% of our worldwide gross bookings and 45% of worldwide revenue were through international points of sale compared to just 21% for both worldwide gross bookings and revenue in 2005. We have a goal of generating more than two-thirds of our revenue through businesses and points of sale outside of the United States.
In expanding our global reach, we leverage significant investments in technology, operations, brand building, supplier relationships and other initiatives that we have made since the launch of Expedia.com in 1996. Our scale of operations enhances the value of technology innovations we introduce on behalf of our travelers and suppliers. We believe that our size and scale afford the company the ability to negotiate competitive rates with our supply partners, provide breadth of choice and travel deals to our traveling customers through an expanding supply portfolio and create opportunities for new value added offers for our customers such as our loyalty programs. The size of Expedia’s worldwide traveler base makes our websites an increasingly appealing channel for travel suppliers to reach customers. In addition, the sheer size of our user base and search query volume allows us to test new technologies very quickly in order to determine which innovations are most likely to improve the travel research and booking process, and then roll those features out to our worldwide audience in order to drive improvements in conversion.
Product Innovation. Each of our leading brands was a pioneer in online travel and has been responsible for driving key innovations in the space for more than two decades. Each Expedia technology platform is operated by a dedicated technology team, which drives innovations that make researching and shopping for travel increasingly easier and helps customers find and book the best possible travel options. We have made key investments in technology, including significant development of our technical platforms that makes it possible for us to deliver innovations at a faster pace. Improvements in our global platforms for Hotels.com and Brand Expedia continue to enable us to significantly increase the innovation cycle, thereby improving conversion and driving faster growth rates for those brands. In 2013, Expedia signed an agreement to power the technology, supply and customer service platforms for Travelocity-branded websites in the United States and Canada, enabling Expedia to leverage its investments in each of these key areas. During 2014, the Travelocity-branded websites were successfully migrated to the Expedia technology platform. In November 2014, Expedia completed the acquisition of Wotif Group and subsequently converted the Wotif.com website to the Expedia technology platform. In January 2015, we acquired the Travelocity brand and other associated assets from Sabre. The strategic marketing and other related agreements previously entered into were terminated. In September 2015, Expedia acquired Orbitz Worldwide, including all of its brands. The Orbitz, CheapTickets and ebookers websites were migrated to the Expedia technology platform in the first half of 2016, and Orbitz for Business customers were migrated to the Egencia technology platform by July 2016. In December 2015, Expedia acquired HomeAway, Inc., including all of its brands. Additionally, in June 2017, Expedia acquired a majority stake in SilverRail, a leading rail technology distributor. We intend to continue leveraging these investments when launching additional points of sale in new
countries, introducing new website features, adding supplier products and services including new business model offerings, as well as proprietary and user-generated content for travelers.
Channel Expansion. Technological innovations and developments continue to create new opportunities for travel bookings. In the past few years, each of our brands made significant progress creating new mobile websites and mobile applications that are receiving strong reviews and solid download trends, and some of our brands now see more traffic via mobile devices than via traditional PCs. Mobile bookings continue to present an opportunity for incremental growth as they are often completed within one or two days of the travel or stay, which is a much shorter booking window than we historically experienced via more traditional online booking methods. Additionally, our brands implemented new technologies like voice-based search, chatbots and messaging apps as mobile-based options for travelers. In addition, we are seeing significant cross-device usage among our customers, who connect to our websites and apps across multiple devices and platforms throughout their travel planning process. We also believe mobile represents an efficient marketing channel given the opportunity for direct traffic acquisition, increase in share of wallet and in repeat customers, particularly through mobile applications. During 2017, approximately one in three Expedia, Inc. transactions were booked globally on a mobile device.
Seasonality
We generally experience seasonal fluctuations in the demand for our travel products and services. For example, traditional leisure travel bookings are generally the highest in the first three quarters as travelers plan and book their spring, summer and winter holiday travel. The number of bookings typically decreases in the fourth quarter. Because revenue for most of our travel products, including merchant and agency hotel, is recognized when the travel takes place rather than when it is booked, revenue typically lags bookings by several weeks for our hotel business and can be several months for our vacation rental business. Historically, HomeAway has seen seasonally stronger bookings in the first quarter of the year, with the relevant stays occurring during the peak summer travel months. The seasonal revenue impact is exacerbated with respect to income by the nature of our variable cost of revenue and direct sales and marketing costs, which we typically realize in closer alignment to booking volumes, and the more stable nature of our fixed costs. Furthermore, operating profits for our primary advertising business, trivago, have typically been experienced in the second half of the year, particularly the fourth quarter, as selling and marketing costs offset revenue in the first half of the year as we aggressively market during the busy booking period for spring, summer and winter holiday travel. As a result on a consolidated basis, revenue and income are typically the lowest in the first quarter and highest in the third quarter. The continued growth of our international operations, advertising business or a change in our product mix, including the growth of HomeAway, may influence the typical trend of the seasonality in the future, and there may also be business or market driven dynamics that result in short-term impacts to revenue or profitability that differ from the typical seasonal trends. We expect that as HomeAway continues its shift to more of a transaction-based business model for vacation rental listings its seasonal trends will be more pronounced than our other traditional leisure businesses.
Critical Accounting Policies and Estimates
Critical accounting policies and estimates are those that we believe are important in the preparation of our consolidated financial statements because they require that we use judgment and estimates in applying those policies. We prepare our consolidated financial statements and accompanying notes in accordance with generally accepted accounting principles in the United States (“GAAP”). Preparation of the consolidated financial statements and accompanying notes requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the consolidated financial statements as well as revenue and expenses during the periods reported. We base our estimates on historical experience, where applicable, and other assumptions that we believe are reasonable under the circumstances. Actual results may differ from our estimates under different assumptions or conditions.
There are certain critical estimates that we believe require significant judgment in the preparation of our consolidated financial statements. We consider an accounting estimate to be critical if:
| • | It requires us to make an assumption because information was not available at the time or it included matters that were highly uncertain at the time we were making the estimate; and |
| • | Changes in the estimate or different estimates that we could have selected may have had a material impact on our financial condition or results of operations. |
For more information on each of these policies, see NOTE 2 — Significant Accounting Policies, in the notes to consolidated financial statements. We discuss information about the nature and rationale for our critical accounting estimates below.
Accounting for Certain Merchant Revenue
We accrue the cost of certain merchant revenue based on the amount we expect to be billed by suppliers. In certain instances when a supplier invoices us for less than the cost we accrued, we generally recognize those amounts as revenue six months in arrears, net of an allowance, when we determine it is not probable that we will be required to pay the supplier, based on historical experience and contract terms. Actual revenue could be greater or less than the amounts estimated due to changes in hotel billing practices or changes in traveler behavior.
Loyalty Program Accruals
We offer certain internally administered traveler loyalty programs to our customers, such as our Hotels.com Rewards program, our Brand Expedia Expedia+ rewards program and our Orbitz rewards program. Hotels.com Rewards offers travelers one free night at any Hotels.com partner property after that traveler stays 10 nights, subject to certain restrictions. Expedia+ rewards enables participating travelers to earn points on all hotel, flight, package and activities made on over 30 Brand Expedia websites. Orbitz Rewards allows travelers to earn OrbucksSM, the currency of Orbitz Rewards, on flights, hotels and vacation packages and instantly redeem those Orbucks on future bookings at various hotels worldwide. As travelers accumulate points towards free travel products, we record a liability for the estimated future cost of redemptions. The cost of these loyalty points is recorded as a reduction to revenue in our consolidated financial statements. We determine the future redemption obligation based on judgment factors including: (i) the estimated cost of travel products to be redeemed, and (ii) an estimated redemption rate based on the overall accumulation and usage of points towards free travel products, which is determined through current and historical trends as well as statistical modeling techniques. The actual future cost and rate of redemptions could differ materially from our estimates.
Business Combinations
We assign the value of the consideration transferred to acquire a business to the tangible assets and identifiable intangible assets acquired and liabilities assumed on the basis of their fair values at the date of acquisition. Any excess purchase price over the fair value of the net tangible and intangible assets acquired is allocated to goodwill. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions, especially with respect to intangible assets. Critical estimates in valuing certain intangible assets include but are not limited to future expected cash flows from customer relationships and trade names, and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates.
Recoverability of Goodwill and Indefinite and Definite-Lived Intangible Assets
Goodwill. We assess goodwill for impairment annually as of October 1, or more frequently, if events and circumstances indicate impairment may have occurred. In the evaluation of goodwill for impairment, we typically perform a quantitative assessment and compare the fair value of the reporting unit to the carrying value and, if applicable, record an impairment charge based on the excess of the reporting unit's carrying amount over its fair value. Periodically, we may choose to perform a qualitative assessment, prior to performing the quantitative analysis, to determine whether the fair value of the goodwill is more likely than not impaired.
We generally base our measurement of fair value of reporting units on a blended analysis of the present value of future discounted cash flows and market valuation approach with the exception of our standalone publicly traded subsidiary, which is based on market valuation. The discounted cash flows model indicates the fair value of the reporting units based on the present value of the cash flows that we expect the reporting units to generate in the future. Our significant estimates in the discounted cash flows model include: our weighted average cost of capital; long-term rate of growth and profitability of our business; and working capital effects. The market valuation approach indicates the fair value of the business based on a comparison of the Company to comparable publicly traded firms in similar lines of business. Our significant estimates in the market approach model include identifying similar companies with comparable business factors such as size, growth, profitability, risk and return on investment and assessing comparable revenue and operating income multiples in estimating the fair value of the reporting units.
We believe the weighted use of discounted cash flows and market approach is the best method for determining the fair value of our reporting units because these are the most common valuation methodologies used within the travel and internet industries; and the blended use of both models compensates for the inherent risks associated with either model if used on a stand-alone basis.
In addition to measuring the fair value of our reporting units as described above, we consider the combined carrying and fair values of our reporting units in relation to the Company’s total fair value of equity plus debt as of the assessment date. Our
equity value assumes our fully diluted market capitalization, using either the stock price on the valuation date or the average stock price over a range of dates around the valuation date, plus an estimated acquisition premium which is based on observable transactions of comparable companies. The debt value is based on the highest value expected to be paid to repurchase the debt, which can be fair value, principal or principal plus a premium depending on the terms of each debt instrument.
Indefinite-Lived Intangible Assets. We base our measurement of fair value of indefinite-lived intangible assets, which primarily consist of trade name and trademarks, using the relief-from-royalty method. This method assumes that the trade name and trademarks have value to the extent that their owner is relieved of the obligation to pay royalties for the benefits received from them. This method requires us to estimate the future revenue for the related brands, the appropriate royalty rate and the weighted average cost of capital.
Definite-Lived Intangible Assets. We review the carrying value of long-lived assets or asset groups to be used in operations whenever events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable. Factors that would necessitate an impairment assessment include a significant adverse change in the extent or manner in which an asset is used, a significant adverse change in legal factors or the business climate that could affect the value of the asset, or a significant decline in the observable market value of an asset, among others. If such facts indicate a potential impairment, we would assess the recoverability of an asset group by determining if the carrying value of the asset group exceeds the sum of the projected undiscounted cash flows expected to result from the use and eventual disposition of the assets over the remaining economic life of the primary asset in the asset group. If the recoverability test indicates that the carrying value of the asset group is not recoverable, we will estimate the fair value of the asset group using appropriate valuation methodologies, which would typically include an estimate of discounted cash flows. Any impairment would be measured as the difference between the asset groups carrying amount and its estimated fair value.
The use of different estimates or assumptions in determining the fair value of our goodwill, indefinite-lived and definite-lived intangible assets may result in different values for these assets, which could result in an impairment or, in the period in which an impairment is recognized, could result in a materially different impairment charge.
Income Taxes
We record income taxes under the liability method. Deferred tax assets and liabilities reflect our estimation of the future tax consequences of temporary differences between the carrying amounts of assets and liabilities for book and tax purposes. We determine deferred income taxes based on the differences in accounting methods and timing between financial statement and income tax reporting. Accordingly, we determine the deferred tax asset or liability for each temporary difference based on the enacted tax rates expected to be in effect when we realize the underlying items of income and expense. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent earnings experience by jurisdiction, expectations of future taxable income, and the carryforward periods available to us for tax reporting purposes, as well as other relevant factors. We may establish a valuation allowance to reduce deferred tax assets to the amount we believe is more likely than not to be realized. Due to inherent complexities arising from the nature of our businesses, future changes in income tax law, tax sharing agreements or variances between our actual and anticipated operating results, we make certain judgments and estimates. Therefore, actual income taxes could materially vary from these estimates.
We record liabilities to address uncertain tax positions we have taken in previously filed tax returns or that we expect to take in a future tax return. The determination for required liabilities is based upon an analysis of each individual tax position, taking into consideration whether it is more likely than not that our tax position, based on technical merits, will be sustained upon examination. For those positions for which we conclude it is more likely than not it will be sustained, we recognize the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with the taxing authority. The difference between the amount recognized and the total tax position is recorded as a liability. The ultimate resolution of these tax positions may be greater or less than the liabilities recorded.
The Tax Cuts and Jobs Act ("the Tax Act") was enacted in December 2017. The Tax Act significantly changes U.S. tax law by, among other things, lowering U.S. corporate income tax rates, implementing a territorial tax system and imposing a one-time transition tax on deemed repatriated earnings of foreign subsidiaries. The Tax Act reduces the U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018. The SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act and allows the registrant to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. We have recognized the provisional impacts related to the one-time transition tax and revaluation of deferred tax balances and included these estimates in our consolidated financial statements for the year ended December 31, 2017. The ultimate impact may materially differ from these provisional amounts, due to, among other things, additional
analysis, changes in interpretations and assumptions we have made, additional regulatory guidance that may be issued, and actions we may take as a result of the Tax Act. In addition, foreign governments may enact tax laws in response to the Tax Act that could result in further changes to global taxation and materially affect our financial position and results of operations. We expect to complete our analysis within the measurement period in accordance with SAB 118.
Other Long-Term Liabilities
Various Legal and Tax Contingencies. We record liabilities to address potential exposures related to business and tax positions we have taken that have been or could be challenged by taxing authorities. In addition, we record liabilities associated with legal proceedings and lawsuits. These liabilities are recorded when the likelihood of payment is probable and the amounts can be reasonably estimated. The determination for required liabilities is based upon analysis of each individual tax issue, or legal proceeding, taking into consideration the likelihood of adverse judgments and the range of possible loss. In addition, our analysis may be based on discussions with outside legal counsel. The ultimate resolution of these potential tax exposures and legal proceedings may be greater or less than the liabilities recorded.
Occupancy Tax. Some states and localities impose a transient occupancy or accommodation tax on the use or occupancy of hotel accommodations. Generally, hotels collect taxes based on the rate paid to the hotel and remit these taxes to the various tax authorities. When a customer books a room through one of our travel services, we collect a tax recovery charge from the customer which we pay to the hotel. We calculate the tax recovery charge by applying the occupancy tax rate supplied to us by the hotels to the amount that the hotel has agreed to receive for the rental of the room by the consumer. In all but a limited number of jurisdictions, we do not collect or remit occupancy taxes, nor do we pay occupancy taxes to the hotel operator, on the portion of the customer payment we retain. Some jurisdictions have questioned our practice in this regard. While the applicable tax provisions vary among the jurisdictions, we generally believe that we are not required to pay such occupancy taxes. We are engaged in discussions with tax authorities in various jurisdictions to resolve this issue. Some tax authorities have brought lawsuits or have levied assessments asserting that we are required to collect and remit occupancy tax. The ultimate resolution in all jurisdictions cannot be determined at this time. Certain jurisdictions may require us to pay tax assessments, including occupancy and other transactional tax assessments, prior to contesting any such assessments.
We have established a reserve for the potential settlement of issues related to hotel occupancy taxes for prior and current periods, consistent with applicable accounting principles and in light of all current facts and circumstances. A variety of factors could affect the amount of the liability (both past and future), which factors include, but are not limited to, the number of, and amount of revenue represented by, jurisdictions that ultimately assert a claim and prevail in assessing such additional tax or negotiate a settlement and changes in relevant statutes.
We note that there are more than 7,000 taxing jurisdictions in the United States, and it is not feasible to analyze the statutes, regulations and judicial and administrative rulings in every jurisdiction. Rather, we have obtained the advice of state and local tax experts with respect to tax laws of certain states and local jurisdictions that represent a large portion of our hotel revenue. Many of the statutes and regulations that impose hotel occupancy taxes were established before the emergence of the internet and eCommerce. Certain jurisdictions have enacted, and others may enact, legislation regarding the imposition of occupancy taxes on businesses that arrange the booking of hotel accommodations. We continue to work with the relevant tax authorities and legislators to clarify our obligations under new and emerging laws and regulations. We will continue to monitor the issue closely and provide additional disclosure, as well as adjust the level of reserves, as developments warrant. Additionally, certain of our businesses are involved in occupancy tax related litigation, which is discussed in Part I, Item 3, Legal Proceedings. Recent occupancy tax developments are also discussed below under the caption “Occupancy and Other Taxes.”
Stock-Based Compensation
Our primary form of employee stock-based compensation is stock option awards. We measure the value of stock option awards on the date of grant at fair value using the appropriate valuation techniques, including the Black-Scholes and Monte Carlo option-pricing models. We amortize the fair value over the remaining term on a straight-line basis. We account for forfeitures as they occur. The pricing models require various highly judgmental assumptions including volatility and expected option term. If any of the assumptions used in the models change significantly, stock-based compensation expense may differ materially in the future from that recorded in the current period.
In addition, we classify certain employee option awards as liabilities when we deem it not probable that the employees holding the awards will bear the risk and rewards of stock ownership for a reasonable period of time. Such options are revalued at the end of each reporting period and upon settlement our total compensation expense recorded from grant date to settlement date will equal the settlement amount.
New Accounting Pronouncements
For a discussion of new accounting pronouncements, see NOTE 2 — Significant Accounting Policies in the notes to consolidated financial statements.
Occupancy and Other Taxes
We are currently involved in sixteen lawsuits brought by or against states, cities and counties over issues involving the payment of hotel occupancy and other taxes. We continue to defend these lawsuits vigorously. With respect to the principal claims in these matters, we believe that the statutes and ordinances at issue do not apply to the services we provide, namely the facilitation of hotel reservations, and, therefore, that we do not owe the taxes that are claimed to be owed. We believe that the statutes and ordinances at issue generally impose occupancy and other taxes on entities that own, operate or control hotels (or similar businesses) or furnish or provide hotel rooms or similar accommodations.
Recent developments include:
| • | City of San Antonio, Texas Litigation. On November 29, 2017, the United States Fifth Circuit Court of Appeals reversed the decision of the district court and held that the amounts charged by the defendants for their services are not subject to tax. The plaintiff municipalities filed petitions for rehearing and en banc review. On February 6, 2018, the Fifth Circuit Court denied those petitions. |
| • | Town of Breckenridge, Colorado Litigation. On January 25, 2018, the Colorado Court of Appeals affirmed the trial court’s decision on all grounds, finding that the defendant online travel companies are not liable for accommodations taxes, that the Town’s sales tax claims were properly dismissed for lack of subject matter jurisdiction and that class certification was properly denied. |
| • | Village of Bedford Park, Illinois Litigation. On November 22, 2017, the United States Seventh Circuit Court of Appeals denied the plaintiffs’ appeal, affirming the district court’s finding of no liability for occupancy taxes in 12 of the 13 plaintiff municipalities, and granted the defendant online travel companies’ appeal, reversing the district court’s finding of liability for occupancy taxes in the Village of Lombard. |
| • | State of New Hampshire Litigation. On November 17, 2017, the plaintiff filed a notice of appeal to the New Hampshire Supreme Court from the trial court’s October 18, 2017 ruling that the defendant online travel companies are not subject to the New Hampshire meals and room tax and that their business practices do not violate the state consumer protection act. |
For additional information on these and other legal proceedings, see Part I, Item 3, Legal Proceedings.
We have established a reserve for the potential settlement of issues related to hotel occupancy and other tax litigation, consistent with applicable accounting principles and in light of all current facts and circumstances, in the amount of $43 million as of December 31, 2017 and $71 million as of December 31, 2016.
Certain jurisdictions, including the states of New York, North Carolina, Minnesota, Oregon, Rhode Island, and Maryland, the city of New York, and the District of Columbia, have enacted legislation seeking to tax online travel company services as part of sales taxes for hotel occupancy. We are currently remitting taxes to a number of jurisdictions, including to the states of New York, South Carolina, North Carolina, Minnesota, Georgia, Wyoming, Oregon, Rhode Island, Montana, Maryland, Kentucky and Maine, the District of Columbia and the city of New York, as well as certain other county and local jurisdictions.
Pay-to-Play
Certain jurisdictions may assert that we are required to pay any assessed taxes prior to being allowed to contest or litigate the applicability of the ordinances. This prepayment of contested taxes is referred to as “pay-to-play.” Payment of these amounts is not an admission that we believe we are subject to such taxes and, even when such payments are made, we continue to defend our position vigorously. If we prevail in the litigation, for which a pay-to-play payment was made, the jurisdiction collecting the payment will be required to repay such amounts and also may be required to pay interest. However, any significant pay-to-play payment or litigation loss could negatively impact our liquidity. For additional information, including significant pay-to-play payments made by Expedia companies, see NOTE 17 — Commitments and Contingencies - Legal Proceedings - Pay-to-Play in the notes to the consolidated financial statements.
Other Jurisdictions. We are also in various stages of inquiry or audit with domestic and foreign tax authorities, some of which, including in the United Kingdom regarding the application of value added tax (“VAT”) to our European Union related transactions, impose a pay-to-play requirement to challenge an adverse inquiry or audit result in court.
Segments
We have four reportable segments: Core OTA, trivago, HomeAway upon its acquisition on December 15, 2015 and Egencia. In addition, eLong was a reportable segment through its disposal on May 22, 2015. Our Core OTA segment provides a full range of travel and advertising services to our worldwide customers through a variety of brands including: Expedia.com and Hotels.com in the United States and localized Expedia and Hotels.com websites throughout the world, Orbitz, CheapTickets, ebookers, EAN, Hotwire.com, Travelocity, Wotif Group, CarRentals.com, Classic Vacations and SilverRail Technologies, Inc. Our trivago segment generates advertising revenue primarily from sending referrals to online travel companies and travel service providers from its hotel metasearch websites. Our HomeAway segment operates an online marketplace for the vacation rental industry. Our Egencia segment provides managed travel services to corporate customers worldwide.
Operating Metrics
Our operating results are affected by certain metrics, such as gross bookings and revenue margin, which we believe are necessary for understanding and evaluating us. Gross bookings represent the total retail value of transactions booked for both agency and merchant transactions, recorded at the time of booking reflecting the total price due for travel by travelers, including taxes, fees and other charges, and are generally reduced for cancellations and refunds. As travelers have increased their use of the internet to book travel arrangements, we have generally seen our gross bookings increase, reflecting the growth in the online travel industry, our organic market share gains and our business acquisitions. Revenue margin is defined as revenue as a percentage of gross bookings.
When HomeAway properties are booked through our Core OTA websites and vice versa, the segments split the third-party revenue for management and segment reporting purposes with the majority of the third-party revenue residing with the website marketing the property or room. The operating metrics, including gross bookings and room nights, are not split but instead generally reside entirely with the website marketing the property or room.
Gross Bookings and Revenue Margin
| Year ended December 31, | % Change | ||||||||||||||||
| 2017 | 2016 | 2015 | 2017 vs 2016 | 2016 vs 2015 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Gross Bookings | |||||||||||||||||
| Core OTA | $ | 72,701 | $ | 66,063 | $ | 54,252 | 10 | % | 22 | % | |||||||
| trivago(1) | — | — | — | N/A | N/A | ||||||||||||
| HomeAway(2) | 8,746 | 5,980 | — | 46 | % | N/A | |||||||||||
| Egencia | 6,963 | 6,368 | 5,427 | 9 | % | 17 | % | ||||||||||
| eLong(3) | — | — | 1,151 | N/A | N/A | ||||||||||||
| Total gross bookings | $ | 88,410 | $ | 78,411 | $ | 60,830 | 13 | % | 29 | % | |||||||
| Revenue Margin | |||||||||||||||||
| Core OTA | 10.8 | % | 10.7 | % | 10.8 | % | |||||||||||
| trivago(1) | N/A | N/A | N/A | ||||||||||||||
| HomeAway(2) | 10.4 | % | 11.5 | % | N/A | ||||||||||||
| Egencia | 7.5 | % | 7.3 | % | 7.4 | % | |||||||||||
| eLong(3) | N/A | N/A | 3.6 | % | |||||||||||||
| Total revenue margin | 11.4 | % | 11.2 | % | 11.0 | % |
| (1) | trivago, which is comprised of a hotel metasearch business that differs from our transaction-based websites, does not have associated gross bookings or revenue margin. However, third-party revenue from trivago is included in revenue used to calculate total revenue margin. |
| (2) | In 2017, we began reporting HomeAway gross bookings along with the historical comparable information for 2016. As we acquired HomeAway on December 15, 2015, we did not report HomeAway gross bookings for 2015. HomeAway gross bookings include on-platform transactions from all HomeAway brands, with the exception of BedandBreakfast.com and TopRural (which, if included would collectively add less than an estimated 2% to gross bookings). On-platform gross bookings for Stayz, Bookabach and Travelmob (which collectively represent less than 10% of total on-platform transactions) represent our best estimates. |
| (3) | Includes results for eLong through its disposal on May 22, 2015. |
The increase in worldwide gross bookings in 2017 as compared to 2016 was primarily due to growth in the Core OTA segment, including growth at Brand Expedia, Hotels.com and EAN, as well as growth at HomeAway. The increase in worldwide gross bookings in 2016 as compared to 2015 was primarily driven by the inorganic impact from acquisitions of 22%, growth in the Core OTA segment, including growth at Brand Expedia and Hotels.com, as well as growth at Egencia.
Revenue margin increased in 2017 as compared to 2016 primarily due to a mix shift to higher margin products, including growth in advertising and media revenue, and the favorable impact of lower air ticket prices, partially offset by lower revenue per room night and lower HomeAway revenue margins. Revenue margin increased in 2016 compared to 2015 primarily due to the favorable impact of lower air ticket prices and a mix shift to higher margin products, including advertising and media revenue. These impacts were partially offset by the inclusion of a higher share of lower margin air gross bookings with the acquisition of Orbitz and lower revenue per room night
Results of Operations
On May 22, 2015, we completed the sale of our 62.4% ownership stake in eLong. The below discussion of the results of operations for 2015 include results for eLong through its disposal on May 22, 2015. Operating expense tables below present total expenses including eLong for 2015 as well as eLong specific amounts included within the consolidated total.
On September 17, 2015, we completed our acquisition of Orbitz. Orbitz was consolidated into our results of operations starting on the acquisition date and we recognized $196 million in revenue and $163 million in operating losses, including restructuring charges of $92 million as well as fees related to the acquisition, from the acquisition date to December 31, 2015.
On December 15, 2015, we completed our acquisition of HomeAway. HomeAway was consolidated into our results of operations starting on the acquisition date and we recognized $20 million in revenue and $14 million in operating loss, including fees related to the acquisition, from the acquisition date to December 31, 2015.
Revenue
| Year ended December 31, | % Change | ||||||||||||||||
| 2017 | 2016 | 2015 | 2017 vs 2016 | 2016 vs 2015 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Revenue by Segment | |||||||||||||||||
| Core OTA | $ | 7,881 | $ | 7,084 | $ | 5,877 | 11 | % | 21 | % | |||||||
| trivago (Third-party revenue) | 752 | 539 | 333 | 40 | % | 62 | % | ||||||||||
| HomeAway | 906 | 689 | 20 | 32 | % | N/A | |||||||||||
| Egencia | 521 | 462 | 400 | 13 | % | 16 | % | ||||||||||
| eLong | — | — | 42 | N/A | N/A | ||||||||||||
| Total revenue | $ | 10,060 | $ | 8,774 | $ | 6,672 | 15 | % | 31 | % |
In 2017, revenue increased primarily driven by growth in the Core OTA segment, including growth at Brand Expedia and EAN, as well as growth at HomeAway and trivago. In 2016, revenue increased primarily driven by 19% of inorganic impact from acquisitions, growth in the Core OTA segment, including growth at Brand Expedia and Hotels.com, as well as growth at trivago.
Lodging revenue, which includes hotel and HomeAway revenue, increased 14% in 2017 primarily due to a 16% increase in room nights stayed driven by growth in Brand Expedia, HomeAway and EAN, partially offset by a 2% decline in revenue per room night. Lodging revenue increased 30% in 2016 primarily due to a 22% (32% excluding eLong) increase in room nights stayed driven by the inorganic impact of acquisitions of HomeAway and Orbitz as well as organic growth in Hotels.com, Brand Expedia and EAN, and a 6% increase (1% decrease excluding eLong) in revenue per room night in 2016. Acquisitions added approximately 21% of inorganic lodging revenue growth in 2016 and 16% of room night growth in 2016.
Worldwide air revenue increased 1% in 2017 due to 4% increase in air tickets sold, partially offset by a 3% decrease in revenue per ticket. Worldwide air revenue increased 37% (39% excluding eLong) in 2016 due to a 29% (32% excluding eLong) increase in air tickets sold and a 6% (5% excluding eLong) increase in revenue per air ticket, driven by new contractual agreements and the addition of Orbitz. Acquisitions added approximately 28% of inorganic air revenue growth in 2016 and 21% of air ticket growth in 2016.
The remaining worldwide revenue, other than lodging and air discussed above, which includes advertising and media, car rental, destination services and fees related to our corporate travel business, increased by 23% in 2017 and 35% in 2016
primarily due to growth in advertising and media revenue as well as growth in our travel insurance and car rental products, including an inorganic contribution from Orbitz in 2016.
In addition to the above segment and product revenue discussion, our revenue by business model is as follows:
| Year ended December 31, | % Change | ||||||||||||||||
| 2017 | 2016 | 2015 | 2017 vs 2016 | 2016 vs 2015 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Revenue by Business Model | |||||||||||||||||
| Merchant | $ | 5,394 | $ | 4,852 | $ | 4,204 | 11 | % | 15 | % | |||||||
| Agency | 2,687 | 2,425 | 1,882 | 11 | % | 29 | % | ||||||||||
| Advertising and media(1) | 1,073 | 807 | 566 | 33 | % | 43 | % | ||||||||||
| HomeAway | 906 | 689 | 20 | 32 | % | N/A | |||||||||||
| Total revenue | $ | 10,060 | $ | 8,774 | $ | 6,672 | 15 | % | 31 | % |
| (1) | Includes third-party revenue from trivago as well as our transaction-based websites. |
The increase in merchant revenue in 2017 and 2016 was primarily due to the increase in merchant hotel revenue driven by an increase in room nights stayed.
The increase in agency revenue in 2017 and 2016 was primarily due to the growth in agency hotel for both periods as well as agency air in 2016.
The increase in advertising and media revenue in 2017 and 2016 was primarily due to continued growth in trivago and Expedia Media Solutions.
HomeAway revenue increased 32% in 2017 compared to 2016 primarily due to growth in transactional revenue of 115% driven by a benefit from the traveler service fee, partially offset by subscription revenue decreasing approximately 30%. The large increase in 2016 compared to 2015 was due to our acquisition of HomeAway in December 2015.
Cost of Revenue
| Year ended December 31, | % Change | ||||||||||||||||
| 2017 | 2016 | 2015 | 2017 vs 2016 | 2016 vs 2015 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Customer operations | $ | 767 | $ | 727 | $ | 569 | 5 | % | 28 | % | |||||||
| Credit card processing | 506 | 508 | 451 | — | % | 13 | % | ||||||||||
| Data center, cloud and other | 484 | 362 | 290 | 34 | % | 25 | % | ||||||||||
| Total cost of revenue(1) | $ | 1,757 | $ | 1,597 | $ | 1,310 | 10 | % | 22 | % | |||||||
| % of revenue | 17.5 | % | 18.2 | % | 19.6 | % | |||||||||||
| (1) Includes the following eLong amounts: | $ | — | $ | — | $ | 37 | N/A | N/A |
Cost of revenue primarily consists of (1) customer operations, including our customer support and telesales as well as fees to air ticket fulfillment vendors, (2) credit card processing, including merchant fees, fraud and chargebacks, and (3) other costs, primarily including data center and cloud costs to support our websites, supplier operations, destination supply, and stock-based compensation.
In 2017, the increase in cost of revenue expense was driven by $122 million of higher data center, cloud and other costs, including a $37 million increase in depreciation expense primarily data center related, as well as $40 million of increased customer operations expenses. Cloud expense in cost of revenue during 2017 was $57 million compared to $4 million in 2016.
In 2016, the increase in cost of revenue expense was driven by $158 million of increased customer operations expenses, $72 million of higher data center, cloud and other costs, as well as $57 million of higher net credit card processing costs related to growth of our merchant bookings. Acquisitions added approximately 18% of year-on-year cost of revenue growth for 2016.
Selling and Marketing
| Year ended December 31, | % Change | ||||||||||||||||
| 2017 | 2016 | 2015 | 2017 vs 2016 | 2016 vs 2015 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Direct costs | $ | 4,360 | $ | 3,530 | $ | 2,718 | 24 | % | 30 | % | |||||||
| Indirect costs | 938 | 837 | 663 | 12 | % | 26 | % | ||||||||||
| Total selling and marketing(1) | $ | 5,298 | $ | 4,367 | $ | 3,381 | 21 | % | 29 | % | |||||||
| % of revenue | 52.7 | % | 49.8 | % | 50.7 | % | |||||||||||
| (1) Includes the following eLong amounts: | $ | — | $ | — | $ | 54 | N/A | N/A |
Selling and marketing expense primarily relates to direct costs, including traffic generation costs from search engines and internet portals, television, radio and print spending, private label and affiliate program commissions, public relations and other costs. The remainder of the expense relates to indirect costs, including personnel and related overhead in our various brands and global supply organization as well as stock-based compensation costs.
Selling and marketing expenses increased $931 million during 2017 compared to 2016 driven by an increase of $830 million of direct costs, including online and offline marketing expenses. trivago, Brand Expedia, EAN and Hotels.com accounted for the majority of the total direct cost increases. In addition, higher indirect costs of $101 million also contributed to the increase and were primarily driven by growth in personnel at Egencia as well as in the lodging supply organization.
Selling and marketing expenses increased $986 million during 2016 compared to 2015 driven by an increase of $812 million of direct costs, including online and offline marketing expenses. trivago, Brand Expedia and Hotels.com as well as the added costs from our acquisitions of HomeAway and Orbitz accounted for the majority of the total direct cost increase. In addition, higher indirect costs of $174 million also contributed to the increase and were driven by additional personnel due to an accelerated pace of hiring in the lodging supply organization in the first half of the year and additional headcount at HomeAway and Orbitz. Acquisitions added approximately 14% of year-on-year selling and marketing growth for 2016.
Technology and Content
| Year ended December 31, | % Change | ||||||||||||||||
| 2017 | 2016 | 2015 | 2017 vs 2016 | 2016 vs 2015 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Personnel and overhead | $ | 667 | $ | 600 | $ | 415 | 11 | % | 45 | % | |||||||
| Depreciation and amortization of technology assets | 445 | 362 | 265 | 23 | % | 36 | % | ||||||||||
| Other | 275 | 273 | 150 | 1 | % | 82 | % | ||||||||||
| Total technology and content(1) | $ | 1,387 | $ | 1,235 | $ | 830 | 12 | % | 49 | % | |||||||
| % of revenue | 13.8 | % | 14.1 | % | 12.4 | % | |||||||||||
| (1) Includes the following eLong amounts: | $ | — | $ | — | $ | 11 | N/A | N/A |
Technology and content expense includes product development and content expense, as well as information technology costs to support our infrastructure, back-office applications and overall monitoring and security of our networks, and is principally comprised of personnel and overhead, depreciation and amortization of technology assets including hardware, and purchased and internally developed software, and other costs including cloud expense, licensing and maintenance expense and stock-based compensation.
Technology and content expense increased $152 million for 2017 compared to 2016 primarily due to increased depreciation and amortization of technology assets of $83 million year-over-year. Personnel and overhead costs also increased $67 million on higher headcount. Other costs increased $2 million year-over-year primarily due to higher licensing and maintenance to support the growth of our technology platforms, partially offset by lower stock-based compensation of $9 million, including the impact of prior year amounts related to the trivago employee stock option plan as described in NOTE 10 — Stock-Based Awards and Other Equity Instruments. Cloud expense in technology and content during 2017 was $38 million, compared to $35 million in 2016.
Technology and content expense increased $405 million for 2016 compared to 2015 primarily due to increased personnel and overhead costs of $185 million to support key technology projects primarily in Brand Expedia Group, the corporate
technology function and trivago, as well as the addition of HomeAway personnel and overhead costs. Depreciation and amortization of technology assets also increased $97 million year-over-year. Other costs increased $123 million year-over-year primarily due to expansion into the cloud computing environment and higher licensing and maintenance to support the growth of our technology platforms as well as higher stock-based compensation of $37 million, including amounts related to the trivago employee stock option plan. Acquisitions added approximately 20% to year-on-year technology and content growth for 2016.
General and Administrative
| Year ended December 31, | % Change | ||||||||||||||||
| 2017 | 2016 | 2015 | 2017 vs 2016 | 2016 vs 2015 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Personnel and overhead | $ | 453 | $ | 411 | $ | 330 | 10 | % | 24 | % | |||||||
| Professional fees and other | 223 | 267 | 244 | (17 | )% | 10 | % | ||||||||||
| Total general and administrative(1) | $ | 676 | $ | 678 | $ | 574 | — | % | 18 | % | |||||||
| % of revenue | 6.7 | % | 7.7 | % | 8.6 | % | |||||||||||
| (1) Includes the following eLong amounts: | $ | — | $ | — | $ | 23 | N/A | N/A |
General and administrative expense consists primarily of personnel-related costs, including our executive leadership, finance, legal and human resource functions as well as fees for external professional services including legal, tax and accounting, and other costs including stock-based compensation.
General and administrative expense decreased $2 million in 2017 compared to 2016 primarily related to a decrease in professional fees and other on lower stock-based compensation of $63 million year-over-year, resulting from the current year reversal of approximately $41 million of previously recognized stock-based compensation expense related to the departure of our former CEO as well as the absence of certain 2016 stock-based compensation charges related to trivago, partially offset by an increase in professional fees. In addition, personnel and overhead expenses also increased $42 million primarily driven by the organic growth of the business.
General and administrative expense increased $104 million in 2016 compared to 2015 due primarily to higher personnel and overhead expenses of $81 million driven by the organic growth of the business and the inorganic addition of HomeAway and Orbitz. In addition, stock-based compensation increased $28 million year-over-year, which included increases related to trivago as well as in general employee stock-based compensation that were partially offset by the absence of eLong related stock-based compensation in 2016. Acquisitions added approximately 7% of year-on-year general and administrative growth for 2016, which reflects the addition of a full year of expenses for HomeAway and Orbitz, partially offset by higher acquisition-related expenses in 2015.
Amortization and Impairment of Intangible Assets
| Year ended December 31, | % Change | ||||||||||||||||
| 2017 | 2016 | 2015 | 2017 vs 2016 | 2016 vs 2015 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Amortization of intangible assets | $ | 275 | $ | 317 | $ | 156 | (13 | )% | 103 | % | |||||||
| Impairment of intangible assets | — | 35 | 7 | N/A | N/A |
Amortization of intangible assets decreased $42 million in 2017 compared to 2016 primarily due to the completion of amortization related to certain intangible assets, partially offset by $11 million of amortization related to new business acquisitions in the current year. In 2016, amortization increased $161 million primarily due to amortization related to new business acquisitions in the prior year, partially offset by the completion of amortization related to certain intangible assets.
In 2016 and 2015, we recorded impairment losses of $35 million and $7 million related to indefinite-lived trade names within our Core OTA segment due to changes in estimated future revenues of the related brands.
Legal Reserves, Occupancy Tax and Other
| Year ended December 31, | % Change | |||||||||||||||
| 2017 | 2016 | 2015 | 2017 vs 2016 | 2016 vs 2015 | ||||||||||||
| ($ in millions) | ||||||||||||||||
| Legal reserves, occupancy tax and other | $ | 25 | $ | 26 | $ | (105 | ) | (4 | )% | N/A |
Legal reserves, occupancy tax and other consists of increases in our reserves for court decisions and the potential and final settlement of issues related to hotel occupancy taxes, expenses recognized related to monies paid in advance of occupancy and other tax proceedings (“pay-to-play”) as well as certain other legal reserves.
During 2017, the expense primarily related to changes in our reserve related to hotel occupancy and other taxes.
During 2016, we recognized approximately $12 million for amounts expected to be paid in advance of litigation related to merchant car rental transactions in connection with Hawaii's general excise tax litigation. The remaining expense in 2016 related to changes in our reserve related to hotel occupancy and other taxes.
During 2015, we received a refund of prepaid pay-to-play payments of $132 million from the State of Hawaii in connection with the general excise tax litigation. In addition, during 2015, we recorded a $24 million benefit in legal reserves, occupancy tax and other for the recovery of costs related to occupancy tax litigation matters. These gains were partially offset by charges for changes in our reserve related to hotel occupancy and other taxes.
For additional information, see NOTE 17 — Commitments and Contingencies in the notes to the consolidated financial statements.
Restructuring and Related Reorganization Charges
In connection with activities to centralize and optimize certain operations as well as migrate technology platforms in the prior years, primarily related to previously disclosed acquisitions, we recognized $17 million, $56 million and $105 million in restructuring and related reorganization charges during 2017, 2016 and 2015. The charges were primarily related to employee severance and benefits, including severance amounts under pre-existing written plans and contracts Orbitz had with its employees and incremental retention compensation for existing employees as well as stock-compensation charges for acceleration of replacement awards pursuant to certain employee agreements. Based on current plans, which are subject to change, and excluding any possible future acquisition integrations, we do not expect to incur material restructuring charges in 2018.
For additional information, see NOTE 15 — Restructuring and Related Reorganization Charges in the notes to the consolidated financial statements.
Operating Income
| Year ended December 31, | % Change | ||||||||||||||||
| 2017 | 2016 | 2015 | 2017 vs 2016 | 2016 vs 2015 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Operating income | $ | 625 | $ | 462 | $ | 414 | 35 | % | 12 | % | |||||||
| % of revenue | 6.2 | % | 5.3 | % | 6.2 | % |
In 2017, operating income increased primarily due to growth in revenue and a decrease in most major expense categories as a percentage of revenue, partially offset by growth in sales and marketing as a percentage of revenue in 2017.
In 2016, operating income increased primarily due to higher growth in revenue and the absence of eLong operating losses, partially offset by increased costs and expenses, including growth in technology and content expense in excess of revenue growth, higher amortization of intangible assets as well as the comparative impact of the 2015 Hawaii pay-to-play gain of $132 million.
Included in our consolidated operating income for 2015 are operating losses for eLong through its disposition date of May 22, 2015 of $86 million.
Adjusted EBITDA by Segment
| Year ended December 31, | % Change | ||||||||||||||||
| 2017 | 2016 | 2015 | 2017 vs 2016 | 2016 vs 2015 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Core OTA | $ | 2,069 | $ | 1,966 | $ | 1,600 | 5 | % | 23 | % | |||||||
| trivago | 5 | 35 | 3 | (84 | )% | N/A | |||||||||||
| HomeAway | 202 | 175 | 4 | 15 | % | N/A | |||||||||||
| Egencia | 94 | 81 | 68 | 17 | % | 18 | % | ||||||||||
| eLong | — | — | (62 | ) | N/A | N/A | |||||||||||
| Unallocated overhead costs (Corporate) | (657 | ) | (641 | ) | (510 | ) | (3 | )% | (26 | )% | |||||||
| Total Adjusted EBITDA(1) | $ | 1,713 | $ | 1,616 | $ | 1,103 | 6 | % | 46 | % |
(1) Adjusted EBITDA is a non-GAAP measure. See "Definition and Reconciliation of Adjusted EBITDA" below for more information.
Adjusted EBITDA is our primary segment operating metric. See NOTE 19 — Segment Information in the notes to the consolidated financial statements for additional information on intersegment transactions, unallocated overhead costs and for a reconciliation of Adjusted EBITDA by segment to net income (loss) attributable to Expedia, Inc. for the periods presented above.
Core OTA Adjusted EBITDA increased $103 million and $366 million during 2017 and 2016, primarily due to an increase of $797 million and $1.2 billion in revenue, partially offset by an increase in online marketing expense mostly at Brand Expedia, EAN and Hotels.com, and including an increase in online spend at trivago. The acquisition of Orbitz contributed to $264 million to the increase in Core OTA Adjusted EBITDA for 2016.
trivago Adjusted EBITDA declined $30 million during 2017. The deterioration was largely driven by a sudden change in advertising bidding at the end of the second quarter of 2017 resulting in a sharp decline in revenue growth. Marketing spend, in particular pre-committed television spend, could not be adjusted to an optimal level timely enough and resulted in the declining profitability. trivago Adjusted EBITDA increased $32 million during 2016, primarily due to an increase of $288 million in revenue driven by continued global expansion and market share gains, including $83 million in intersegment revenue growth from Core OTA. Revenue growth during 2016 was partially offset by higher online and offline marketing expense.
HomeAway Adjusted EBITDA increased $27 million during 2017 due to an increase of $217 million in revenue, partially offset by higher selling and marketing and technology and content expense. During the current year, HomeAway has continued to invest in offline and online brand marketing to bring more demand to its supply base and in growing its product and technology teams. The increase during 2016 was due to our acquisition of the company in December 2015.
Egencia Adjusted EBITDA increased $13 million during 2017 primarily due to an increase in revenue of $59 million as a result of adding new corporate clients and room night growth as well as scale efficiencies, partially offset by investments in sales, product and technology. Egencia Adjusted EBITDA increased $13 million in 2016 primarily due to the addition of Orbitz for Business.
Unallocated overhead costs increased $16 million during 2017 primarily due to higher general and administrative professional fees as well as personnel and overhead costs, partially offset by lower technology and content expense as we lap over an accelerated pace of technology hiring in the prior year. Unallocated overhead costs increased $131 million during 2016 primarily due to increased technology and content expense to support key corporate technology projects as well as higher general and administrative personnel and overhead costs. The acquisition of Orbitz contributed $27 million to the increase in unallocated overhead costs for 2016.
Interest Income and Expense
| Year ended December 31, | % Change | ||||||||||||||||
| 2017 | 2016 | 2015 | 2017 vs 2016 | 2016 vs 2015 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Interest income | $ | 34 | $ | 20 | $ | 17 | 73 | % | 18 | % | |||||||
| Interest expense | (182 | ) | (173 | ) | (126 | ) | 5 | % | 37 | % |
Interest income increased in 2017 compared to 2016 primarily due to higher invested balances and to a lesser extent higher rates of return. Interest income increased in 2016 compared to 2015 primarily due to higher rates of return, partially offset by lower invested balances.
Interest expense increased in 2017 compared to 2016 primarily as a result of additional interest on the $1 billion senior unsecured notes issued in September 2017. Interest expense increased in 2016 compared to 2015 primarily as a result of additional interest on the Euro 650 million of senior unsecured notes issued in June 2015 and the $750 million senior unsecured notes issued in December 2015.
As of December 31, 2017, our senior unsecured notes indebtedness totaled $4.2 billion. As of December 31, 2016 and 2015, our indebtedness totaled $3.2 billion.
Gain on Sale of Business
On May 22, 2015, we completed the sale of our 62.4% ownership stake in eLong, Inc. for approximately $671 million (or $666 million net of costs to sell and other transaction expenses) to several purchasers, including Ctrip.com International, Ltd. As a result of the sale, we recognized a pre-tax gain of $509 million ($395 million after tax) during 2015 included in gain on sale of business in our consolidated statement of operations.
Other, Net
Other, net is comprised of the following:
| Year ended December 31, | |||||||||||
| 2017 | 2016 | 2015 | |||||||||
| ($ in millions) | |||||||||||
| Foreign exchange rate gains (losses), net | $ | (46 | ) | $ | (15 | ) | $ | 25 | |||
| Non-controlling interest basis adjustment | 2 | — | 77 | ||||||||
| Loss on investments, net | (14 | ) | (12 | ) | — | ||||||
| Other | (3 | ) | (5 | ) | 11 | ||||||
| Total other, net | $ | (61 | ) | $ | (32 | ) | $ | 113 |
Provision for Income Taxes
| Year ended December 31, | % Change | ||||||||||||||||
| 2017 | 2016 | 2015 | 2017 vs 2016 | 2016 vs 2015 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Provision for income taxes | $ | 45 | $ | 15 | $ | 203 | 196 | % | (92 | )% | |||||||
| Effective tax rate | 10.9 | % | 5.5 | % | 21.9 | % |
Our effective tax rate for 2017 was lower than the 35% federal statutory rate due to earnings in foreign jurisdictions outside of the United States, predominately Switzerland, where our statutory income tax rate is lower, as well as excess tax benefits related to share-based payments. The net increase in our effective rate for 2017 compared to 2016 was primarily due to one-time tax benefits in the prior year period including release of a valuation allowance and return to provision true-ups, as well as an increase in losses generated in foreign jurisdictions at tax rates below the 35% federal statutory rate. The effects of the provisional income inclusion for the deemed repatriation transition tax pursuant to the Tax Act were negated by the benefit of the provisional remeasurement of our net deferred tax liability.
The decrease in the effective rate for 2016 compared to 2015 was primarily due to tax benefits from the adoption of new accounting guidance relating to stock-based compensation and the release of valuation allowances in the United Kingdom and Germany on cumulative foreign net operating losses for which it is more likely than not the tax benefit will be realized. As a
result of lower pre-tax earnings in 2016, the impacts of these benefits create a significant effect on our effective tax rate. Our effective tax rate for 2016 was lower than the 35% federal statutory rate due to earnings in foreign jurisdictions outside of the United States as well as the same factors impacting the year-over-year effective tax rate comparison.
Our effective rate for 2015 was lower than the 35% federal statutory rate due to earnings in foreign jurisdictions outside of the United States as well as the sale of eLong, which had a U.S. effective rate of less than 35%.
For additional information including additional information on the impacts of the Tax Act, see NOTE 11 — Income Taxes in the notes to the consolidated financial statements.
Definition and Reconciliation of Adjusted EBITDA
We report Adjusted EBITDA as a supplemental measure to U.S. generally accepted accounting principles ("GAAP"). Adjusted EBITDA is among the primary metrics by which management evaluates the performance of the business and on which internal budgets are based. Management believes that investors should have access to the same set of tools that management uses to analyze our results. This non-GAAP measure should be considered in addition to results prepared in accordance with GAAP, but should not be considered a substitute for or superior to GAAP. Adjusted EBITDA has certain limitations in that it does not take into account the impact of certain expenses to our consolidated statements of operations. We endeavor to compensate for the limitation of the non-GAAP measure presented by also providing the most directly comparable GAAP measure and a description of the reconciling items and adjustments to derive the non-GAAP measure. Adjusted EBITDA also excludes certain items related to transactional tax matters, which may ultimately be settled in cash, and we urge investors to review the detailed disclosure regarding these matters included above, in the Legal Proceedings section, as well as the notes to the financial statements. The non-GAAP financial measure used by the Company may be calculated differently from, and therefore may not be comparable to, similarly titled measures used by other companies.
Adjusted EBITDA is defined as net income (loss) attributable to Expedia adjusted for (1) net income (loss) attributable to non-controlling interests; (2) provision for income taxes; (3) total other expenses, net; (4) stock-based compensation expense, including compensation expense related to certain subsidiary equity plans; (5) acquisition-related impacts, including (i) amortization of intangible assets and goodwill and intangible asset impairment, (ii) gains (losses) recognized on changes in the value of contingent consideration arrangements, if any, and (iii) upfront consideration paid to settle employee compensation plans of the acquiree, if any; (6) certain other items, including restructuring; (7) items included in legal reserves, occupancy tax and other; (8) that portion of gains (losses) on revenue hedging activities that are included in other, net that relate to revenue recognized in the period; and (9) depreciation.
The above items are excluded from our Adjusted EBITDA measure because these items are noncash in nature, or because the amount and timing of these items is unpredictable, not driven by core operating results and renders comparisons with prior periods and competitors less meaningful. We believe Adjusted EBITDA is a useful measure for analysts and investors to evaluate our future on-going performance as this measure allows a more meaningful comparison of our performance and projected cash earnings with our historical results from prior periods and to the results of our competitors. Moreover, our management uses this measure internally to evaluate the performance of our business as a whole and our individual business segments. In addition, we believe that by excluding certain items, such as stock-based compensation and acquisition-related impacts, Adjusted EBITDA corresponds more closely to the cash operating income generated from our business and allows investors to gain an understanding of the factors and trends affecting the ongoing cash earnings capabilities of our business, from which capital investments are made and debt is serviced.
The reconciliation of net income attributable to Expedia, Inc. to Adjusted EBITDA is as follows:
| Year ended December 31, | |||||||||||
| 2017 | 2016 | 2015 | |||||||||
| (In thousands) | |||||||||||
| Net income attributable to Expedia, Inc. | $ | 377,964 | $ | 281,848 | $ | 764,465 | |||||
| Net loss attributable to non-controlling interests | (6,605 | ) | (20,563 | ) | (41,717 | ) | |||||
| Provision for income taxes | 45,405 | 15,315 | 203,214 | ||||||||
| Total other expense, net | 208,374 | 185,102 | (512,396 | ) | |||||||
| Operating income | 625,138 | 461,702 | 413,566 | ||||||||
| Gain (loss) on revenue hedges related to revenue recognized | 6,323 | 12,746 | 43,597 | ||||||||
| Restructuring and related reorganization charges, excluding stock-based compensation | 16,738 | 43,217 | 72,122 | ||||||||
| Legal reserves, occupancy tax and other | 25,412 | 26,498 | (104,587 | ) | |||||||
| Stock-based compensation | 149,350 | 242,417 | 178,068 | ||||||||
| Amortization of intangible assets | 275,445 | 317,141 | 156,458 | ||||||||
| Impairment of intangible assets | — | 34,890 | 7,207 | ||||||||
| Depreciation | 614,099 | 477,061 | 336,680 | ||||||||
| Adjusted EBITDA | $ | 1,712,505 | $ | 1,615,672 | $ | 1,103,111 |
Financial Position, Liquidity and Capital Resources
Our principal sources of liquidity are cash flows generated from operations; our cash and cash equivalents and short-term investment balances, which were $3.3 billion and $1.9 billion at December 31, 2017 and 2016, and our $1.5 billion revolving credit facility, which is essentially untapped. As of December 31, 2017, the total cash and cash equivalents and short-term investments held outside the United States was $1.6 billion ($1.3 billion in wholly-owned foreign subsidiaries and $315 million in majority-owned subsidiaries), for which the amount available to be repatriated is still being determined. We believe any amount repatriated would not incur significant additional taxes. Additionally, we expect to pay minimal taxes for the 2017 mandatory repatriation required by the Tax Act due to the use of our existing net operating loss and tax credit carryforwards.
In September 2017, we privately placed $1 billion of senior unsecured notes that are due in February 2028 and bear interest at 3.8%. In January 2018, we completed an offer to exchange these notes for registered notes having substantially the same financial terms and covenants as the original notes (the unregistered and registered notes collectively, the "3.8% Notes"). The 3.8% Notes were issued at 99.747% of par resulting in a discount, which is being amortized over their life. Interest is payable semi-annually in arrears in February and August of each year, beginning February 15, 2018. We used or expect to use the net proceeds of this offering for general corporate purposes, which may include, but are not limited to, the repayment, prepayment, redemption or repurchase of our indebtedness (including, but not limited to, our 7.456% senior notes due 2018) as well as working capital, capital expenditures and acquisitions.
As of December 31, 2017, we maintained a $1.5 billion revolving credit facility with a February 2021 maturity date. The facility contains various restrictive covenants, including a maximum permissible leverage ratio and a minimum permissible interest coverage ratio, and interest payable under the facility is based on the Company’s credit ratings. As of December 31, 2017, the maximum permissible leverage ratio and the minimum interest coverage were both 3.25 to 1.00, the applicable interest rate on drawn amounts was LIBOR plus 137.5 basis points and the commitment fee on undrawn amounts was 17.5 basis points.
Our credit ratings are periodically reviewed by rating agencies. As of December 31, 2017, Moody’s rating was Ba1 with an outlook of “stable,” S&P’s rating was BBB- with an outlook of “stable” and Fitch’s rating was BBB- with an outlook of “stable.” Changes in our operating results, cash flows, financial position, capital structure, financial policy or capital allocations to share repurchase, dividends, investments and acquisitions could impact the ratings assigned by the various rating agencies. Should our credit ratings be adjusted downward, we may incur higher costs to borrow and/or limited to access to capital markets, which could have a material impact on our financial condition and results of operations.
As of December 31, 2017, we were in compliance with the covenants and conditions in our revolving credit facility and outstanding debt, which was comprised of $500 million in registered senior unsecured notes due in August 2018 that bear
interest at 7.456% (the “7.456% Notes”), $750 million in registered senior unsecured notes due in August 2020 that bear interest at 5.95% (the “5.95% Notes”), $500 million in registered senior unsecured notes due in August 2024 that bear interest at 4.5% (the “4.5% Notes”), Euro 650 million of registered senior unsecured notes due in June 2022 that bear interest at 2.5% (the "2.5% Notes"), $750 million of registered senior unsecured notes due in February 2026 that bear interest at 5.0% ("the 5.0% Notes") and the 3.8% Notes.
Under the merchant model, we receive cash from travelers at the time of booking and we record these amounts on our consolidated balance sheets as deferred merchant bookings. We pay our airline suppliers related to these merchant model bookings generally within a few weeks after completing the transaction, but we are liable for the full value of such transactions until the flights are completed. For most other merchant bookings, which is primarily our merchant hotel business, we generally pay after the travelers’ use and, in some cases, subsequent billing from the hotel suppliers. Therefore, generally we receive cash from the traveler prior to paying our supplier, and this operating cycle represents a working capital source of cash to us. As long as the merchant hotel business grows, we expect that changes in working capital related to merchant hotel transactions will positively impact operating cash flows. However, we are using both the merchant model and the agency model in many of our markets. If the merchant hotel model declines relative to our other business models that generally consume working capital such as agency hotel, managed corporate travel, advertising or certain Expedia Affiliate Network relationships, or if there are changes to the merchant model, supplier payment terms, or booking patterns that compress the time period between our receipt of cash from travelers and our payment to suppliers, such as with mobile bookings via smartphones, our overall working capital benefits could be reduced, eliminated or even reversed. Our future working capital benefits could also be impacted by HomeAway's continued shift to more of a transactional model from a subscription model.
As our ETP program continues to expand, and depending on relative traveler and supplier adoption rates and customer payment preferences, among other things, the scaling up of ETP has and will continue to negatively impact near term working capital cash balances, cash flow, relative liquidity during the transition, and hotel revenue margins.
Seasonal fluctuations in our merchant hotel bookings affect the timing of our annual cash flows. During the first half of the year, hotel bookings have traditionally exceeded stays, resulting in much higher cash flow related to working capital. During the second half of the year, this pattern reverses and cash flows are typically negative. While we expect the impact of seasonal fluctuations to continue, merchant hotel growth rates, changes to the model or booking patterns, changes in the relative mix of merchant hotel transactions compared with transactions in our working capital consuming businesses, including ETP, as well as the transformation of the HomeAway vacation rental listing business, may counteract or intensify the anticipated seasonal fluctuations.
As of December 31, 2017, we had a deficit in our working capital of $2.3 billion, compared to a deficit of $2.7 billion as of December 31, 2016. The change in the deficit was primarily due to operating cash flows as well as proceeds from the 3.8% Notes issued in September 2017, partially offset by investing activities, including capital expenditures and cash paid for acquisitions.
We continue to invest in the development and expansion of our operations. Ongoing investments include but are not limited to improvements in infrastructure, which include our servers, networking equipment and software, release improvements to our software code, platform migrations and consolidation and search engine marketing and optimization efforts. In addition, in 2016, we began our expansion into the cloud computing environment. While we expect our cloud computing expenses to increase significantly over the next few years they are expected to result in lower overall capital expenditures related to our data centers over time. Our future capital requirements may include capital needs for acquisitions (including purchases of non-controlling interest), share repurchases, dividend payments or expenditures in support of our business strategy; thus reducing our cash balance and/or increasing our debt. Excluding capital expenditures associated with the build out of our new corporate headquarters, we expect total capital expenditures for 2018 to increase over 2017 spending levels. Our current estimates for the new headquarters total approximately $700 to $900 million, with final estimates contingent on completion of design plans and final determination of completed office space required in the initial build out. Of the total approximately $30 million was spent in 2016 and approximately $70 million in 2017. We plan to make significant progress on our corporate headquarters building in the coming year, spending approximately $230 million in 2018 followed by nearly $450 million in 2019, when we expect to begin to move into the campus.
Our cash flows are as follows:
| Year ended December 31, | $ Change | ||||||||||||||||||
| 2017 | 2016 | 2015 | 2017 vs 2016 | 2016 vs 2015 | |||||||||||||||
| (In millions) | |||||||||||||||||||
| Cash provided by (used in) operations: | |||||||||||||||||||
| Operating activities | $ | 1,799 | $ | 1,564 | $ | 1,368 | $ | 235 | $ | 196 | |||||||||
| Investing activities | (1,582 | ) | (718 | ) | (2,371 | ) | (864 | ) | 1,653 | ||||||||||
| Financing activities | 688 | (691 | ) | 1,404 | 1,379 | (2,095 | ) | ||||||||||||
| Effect of foreign exchange rate changes on cash and cash equivalents | 146 | (35 | ) | (127 | ) | 181 | 92 |
In 2017, net cash provided by operating activities increased by $235 million primarily due to increased benefits from working capital changes driven mostly from a change in deferred merchant bookings. In 2016, net cash provided by operating activities increased by $196 million primarily due to higher operating income after adjusting for impacts of depreciation and amortization, partially offset by a decrease in benefits from working capital adjustments and a net refund of hotel occupancy and other taxes in 2015.
In 2017, cash used in investing activities increased by $864 million due to net purchase of investments of $715 million in the current year compared to cash provided by net sales of investments of $16 million in the prior year and an increase of cash used for acquisitions of $170 million in 2017. These increases were partially offset by $6 million cash inflow in the 2017 due to the net settlement of foreign currency forwards compared to $53 million cash outflow in 2016 as well as lower capital expenditures of $39 million in the current year. In 2016, cash used in investing activities decreased by $1.7 billion primarily due to a decrease of cash used for acquisitions of $2.1 billion, partially offset by a decrease in net proceeds related to the sale of eLong of $457 million in 2015.
Cash provided by financing activities in 2017 primarily included $990 million of net proceeds from the issuance of 3.8% Notes in September 2017 as well as $229 million of proceeds from the exercise of options and employee stock purchase plans, partially offset by cash paid to acquire shares of $312 million, including the repurchased shares under the authorizations discussed below, and a $176 million cash dividend payment. Cash used in financing activities in 2016 primarily included cash paid to acquire shares of $456 million, the repayment of $401 million of HomeAway Convertible Notes and $150 million cash dividend payment, partially offset by $215 million of net proceeds from the initial public offering of trivago as well as $141 million of proceeds from the exercise of options and employee stock purchase plans. Cash provided by financing activities in 2015 primarily included $700 million of net proceeds from the issuance of 2.5% Notes in June 2015, $741 million in net proceeds from the issuance of the 5.0% Notes in December 2015, $120 million of proceeds from the exercise of options and employee stock purchase plans as well as the issuance of treasury stock, and $91 million in excess tax benefit on equity awards, of which approximately $47 million related to the excess tax benefit associated with the stock options exercised by our Chairman and Senior Executive. These financing inflows were offset in part by $85 million of withholding taxes for stock option exercises paid on behalf of our Chairman and Senior Executive in exchange for surrendering a portion of his vested shares, which were concurrently cancelled, as well as cash paid to acquire shares of $61 million primarily under the repurchase authorizations discussed below, and $109 million cash dividend payments.
During 2012, 2010, and 2006, our Board of Directors, or the Executive Committee, acting on behalf of the Board of Directors, authorized a repurchase of up to 20 million outstanding shares of our common stock during each of the respective years and during 2015 authorized a repurchase of up to 10 million shares of our common stock for a total of 70 million shares. Shares repurchased under the authorized programs were as follows:
| Year ended December 31, | |||||||||||
| 2017 | 2016 | 2015 | |||||||||
| Number of shares repurchased | 2.3 million | 4.0 million | 0.5 million | ||||||||
| Average price per share | $ | 127.04 | $ | 109.64 | $ | 85.27 | |||||
| Total cost of repurchases (in millions)(1) | $ | 294 | $ | 436 | $ | 45 |
| (1) | Amount excludes transaction costs. |
As of December 31, 2017, 4.9 million shares remain authorized for repurchase under the 2015 authorization with no fixed termination date for the repurchases.
Our common stock dividend was $1.16 per share for 2017, $1.00 per share for 2016 and $0.84 per share for 2015. See NOTE 13 — Stockholders’ Equity in the notes to consolidated financial statements for a detail of the quarterly dividend payments by year. In addition, in February 2018, the Executive Committee, acting on behalf of the Board of Directors, declared a quarterly cash dividend of $0.30 per share of outstanding common stock payable on March 28, 2018 to the stockholders of record as of the close of business on March 8, 2018. Future declarations of dividends are subject to final determination by our Board of Directors.
The effect of foreign exchange on our cash balances denominated in foreign currency in 2017 showed a net change of $181 million reflecting net appreciations in foreign currencies in 2017 compared to net depreciations in 2016. The effect of foreign exchange on our cash balances denominated in foreign currency in 2016 showed a net change of $92 million reflecting lower depreciations in foreign currencies in 2016 compared to 2015.
In our opinion, available cash, funds from operations and available borrowings will provide sufficient capital resources to meet our foreseeable liquidity needs. There can be no assurance, however, that the cost of availability of future borrowings, including refinancing, if any, will be available on terms acceptable to us.
Contractual Obligations and Commercial Commitments
The following table presents our material contractual obligations and commercial commitments as of December 31, 2017:
| By Period | |||||||||||||||||||
| Total | Less than 1 year | 1 to 3 years | 3 to 5 years | More than 5 years | |||||||||||||||
| (In millions) | |||||||||||||||||||
| Senior notes debt (1) | $ | 5,462 | $ | 699 | $ | 1,074 | $ | 1,015 | $ | 2,674 | |||||||||
| Operating leases (2) | 850 | 139 | 225 | 152 | 334 | ||||||||||||||
| Purchase obligations (3) | 410 | 257 | 153 | — | — | ||||||||||||||
| Guarantees (4) | 135 | 120 | 15 | — | — | ||||||||||||||
| Letters of credit (4) | 42 | 26 | 11 | — | 5 | ||||||||||||||
| Total(5) | $ | 6,899 | $ | 1,241 | $ | 1,478 | $ | 1,167 | $ | 3,013 |
| (1) | Our 7.456% Notes, 5.95% Notes, 2.5% Notes, 4.5% Notes, 5.0% and 3.8% Notes include interest payments through maturity in 2018, 2020, 2022, 2024, 2026 and 2028 respectively, based on the stated fixed rates. For the 2.5% Notes, the December 31, 2017 Euro exchange rate was used to convert the Euro 650 million to U.S. Dollars and calculate the related U.S. Dollar interest payments. |
| (2) | The operating leases are for office space and related office equipment. We account for these leases on a monthly basis. Certain leases contain periodic rent escalation adjustments and renewal options. Operating lease obligations expire at various dates with the latest maturity in 2031. |
| (3) | Our purchase obligations represent the minimum obligations we have under agreements with certain of our vendors and marketing partners. These minimum obligations are less than our projected use for those periods. Payments may be more than the minimum obligations based on actual use. |
| (4) | Guarantees and LOCs are commitments that represent funding responsibilities that may require our performance in the event of third-party demands or contingent events. We use our stand-by LOCs primarily for certain regulatory purposes as well as to secure payment for hotel room transactions to particular hotel properties. Of the outstanding balance of our stand-by LOCs, $14 million directly reduces the amount available to us from our revolving credit facility. The LOC amounts in the above table represent the amount of commitment expiration per period. In addition, we provide a guarantee to the aviation authorities of certain foreign countries to protect against potential non-delivery of our packaged travel services sold within those countries. These countries hold all travel agents and tour companies to the same standard. Our guarantees also include bonds relating to tax assessments that we are contesting and certain surety bonds related to various company performance obligations. |
| (5) | Excludes $160 million of net unrecognized tax benefits for which we cannot make a reasonably reliable estimate of the amount and period of payment. |
Other than the items described above, we do not have any off-balance sheet arrangements as of December 31, 2017.
Certain Relationships and Related Party Transactions
For a discussion of certain relationships and related party transactions, see NOTE 18 — Related Party Transactions in the notes to the consolidated financial statements.
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