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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Expedia Group is one of the world's largest travel companies. We help knock down the barriers to travel, making it easier, more enjoyable, more attainable and more accessible. We bring the world within reach for customers and partners around the globe. We leverage our platform and technology capabilities across an extensive portfolio of businesses and brands to orchestrate the movement of people and the delivery of travel experiences on both a local and global basis. We make available, on a stand-alone and package basis, travel 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 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, 2017 and 2018 represented years of continuing growth 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. For additional information about our growth strategy for Expedia Group, see the disclosure set forth in Part I, Item 1, Business, under the caption “Growth Strategy.”
Online Travel
Increased usage and familiarity with the internet are driving rapid growth in online penetration of travel expenditures. According to Phocuswright, an independent travel, tourism and hospitality research firm, in 2019, 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 35% to 45% in 2019. These penetration rates increased over the past few years, and are expected to continue growing, which presents an attractive growth opportunity for our business, while also attracting 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 Booking Holdings), trivago (in which Expedia Group 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. In addition, the increasing popularity of the “sharing economy,” accelerated by online penetration, has had a direct impact on the travel and lodging industry. Businesses such as Airbnb, HomeAway (which Expedia acquired in December 2015) and Booking.com (owned by Booking Holdings) have 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 expected to continue to grow as a percentage of the global accommodation market. Furthermore, we see increased interest in the online travel industry from search engine companies as evidenced by recent innovations including direct booking functionality and product enhancements 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. For additional detail regarding the competitive trends and risks we face, see Part I Item 1 Business - "Competition," and Part I, Item 1A, Risk Factors - "We operate in an increasingly competitive global environment.”
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 Group 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 Group 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 and 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. In addition, 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. For more detail, see Part I, Item 1A, Risk Factors - "We rely on the value of our brands, and the cost of maintaining and enhancing our brand awareness are increasing” and “Our international operations involve additional risks and our exposure to these risks will increase as our business expands globally.”
Lodging
Lodging includes hotel accommodations as well as alternative accommodations primarily made available through HomeAway. As a percentage of our total worldwide revenue in 2018, lodging accounted for 69%. Our room night growth has been healthy, with room nights 32% in 2016 (excluding eLong), 16% in 2017 and 13% in 2018. ADRs for rooms booked on Expedia and HomeAway websites increased 5% in 2016 (excluding eLong) due to the acquisition of HomeAway, 3% in 2017 and 5% in 2018.
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. Current occupancy rates for hotels in the United States remain high; however, U.S. hotel supply has continued to grow, which may put additional pressure on ADRs. In some 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. 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 succeeded in adding supply to our global lodging marketplace with more than one million properties on our global websites as of December 31, 2018, including more than 370,000 integrated HomeAway vacation rental listings.
Alternative Accommodations. With our acquisition of HomeAway and all of its brands in December 2015, we expanded into the fast growing alternative accommodations market. HomeAway is a leader in this market and represents an attractive growth opportunity for Expedia Group. 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. HomeAway offers hosts subscription-based listing or pay-per-booking service models. It also generates revenue from a traveler service fee for bookings. As of December 31, 2018, there are over 1.8 million online bookable listings available on HomeAway, with over 370,000 listings also available through Expedia Group's other brands.
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 2017 and into 2018, there was evidence of discounting by the U.S. carriers while currency headwinds and weaker macroeconomic trends put pressure on international results. Starting in the second half of 2018, there has been evidence of modest fare increases, though it remains unclear if this trend will continue. Ticket prices on Expedia Group websites declined 6% in 2016 (excluding eLong), 1% in 2017, and increased 2% in 2018. Based on airline reports, demand for airline tickets seems to be strong, helping increase air revenues globally. There is significant correlation between airline revenues and fuel prices, and fluctuations in fuel prices generally take time to be reflected in air revenues. Given current volatility, it is uncertain whether the recent increases in fuel prices will drive further increases in airfares, particularly when considering planned supply increases through capacity additions. 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 increased 32% in 2016 (excluding eLong), primarily due to the acquisition of Orbitz, 4% in 2017, and 5% in 2018. As a percentage of our total worldwide revenue in 2018, 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 Group Media Solutions, which is responsible for generating advertising revenue on our global online travel brands. In 2018, we generated a total of $1.1 billion of advertising and media revenue, a slight increase from 2017, representing 10% of our total worldwide revenue. In 2018, trivago shifted its operational focus, reducing marketing spend to better balance revenue and profit growth. The lower marketing spend negatively impacted revenue growth, while benefiting profitability. We expect that trend to continue in the first half of 2019.
Seasonality
We generally experience seasonal fluctuations in the demand for our travel 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 services, including merchant and agency hotel, is recognized as 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 or more 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 typically increase marketing 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. As HomeAway has further shifted to a predominately transaction-based business model for vacation rental listings and its booking window elongates, its seasonal trends are 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 reduce our merchant accounts payable and the supplier costs within net 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. Actual revenue could be greater or less than the amounts estimated due to changes in hotel billing practices or changes in traveler behavior.
Deferred Loyalty Rewards
We offer certain internally administered traveler loyalty programs to our customers, such as our Hotels.com Rewards program, our 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 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 Orbucks, 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 defer the relative standalone selling price of earned points, net of expected breakage, as deferred loyalty rewards within deferred merchant bookings on the consolidated balance sheet. In order to estimate the standalone selling price of the underlying services on which points can be redeemed for all loyalty programs, we use an adjusted market assessment approach and consider the redemption values expected from the traveler. We then estimate the number of rewards that will not be redeemed based on historical activity in our members' accounts as well as statistical modeling techniques. Revenue is recognized when we have satisfied our performance obligation relating to the points, that is when the travel service purchased with the loyalty award is satisfied. Both the actual standalone selling price of the underlying services and ultimate redemption rates could differ materially from our estimates due to a number of factors, including fluctuations in reward value, product utilization and divergence from historical member behavior.
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 Act was enacted in December 2017 and the Tax Act significantly changed 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 reduced 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 applied the guidance in SAB 118 when accounting for the enactment date effects of the Tax Act in 2017 and throughout 2018. At
December 31, 2017, we had not completed our accounting for all of the enactment date income tax effects of the Tax Act under Accounting Standards Codification 740, Income Taxes, for the following aspects: one-time transition tax and revaluation of deferred tax balances. As of December 31, 2018, we have now completed our accounting for all of the enactment date income tax effects of the Tax Act. Based on our final analysis, changes in our estimates during 2018 relating to the one-time transition tax and revaluation of deferred tax balances were immaterial. The Tax Act created a new requirement that global intangible low-taxed income (“GILTI”) earned by our foreign subsidiaries must be included in gross U.S. taxable income which we account for in the period incurred (the "period cost method").
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 and Other Taxes. Some states and localities impose taxes (e.g. transient occupancy, accommodation tax, sales tax and/or business privilege tax) on the use or occupancy of hotel accommodations or other traveler services. 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 applicable 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 taxes, nor do we pay 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 taxes. More recently, a limited number of taxing jurisdictions have made similar claims against HomeAway for tax amounts due on the rental amounts charged by owners of vacation rental properties or for taxes on HomeAway’s services. HomeAway is an intermediary between a traveler and a party renting a vacation property and we believe is similarly not liable for such taxes. We are engaged in discussions with tax authorities in various jurisdictions to resolve these issues. Some tax authorities have brought lawsuits or have levied assessments asserting that we are required to collect and remit 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 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 10,000 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 these taxes were established before the emergence of the internet and eCommerce. Certain jurisdictions have enacted, and others may enact, legislation regarding the imposition of taxes on businesses that arrange the booking of hotel or alternative 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 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
Historically, our primary form of employee stock-based compensation was stock option awards. Our employee stock options consist of service based awards, some of which also have market-based vesting conditions. 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, for awards that contain market-based vesting conditions. We amortize the fair value over the remaining explicit vesting term in the case of service-based awards and the longer of the derived service period or the explicit service period for awards with market conditions, 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 15 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 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:
| • | Jefferson Parish, Louisiana Litigation. On January 2, 2019, Jefferson Parish, Louisiana filed a lawsuit in Louisiana state court against a number of online travel companies, including Expedia, Hotels.com, Hotwire, Orbitz and Egencia, alleging claims for declaratory judgment, violation of state and local tax laws, unfair trade practices, breach of fiduciary duty and imposition of a constructive trust. |
| • | Palm Beach County, Florida Litigation. On January 23, 2019, the court granted defendants’ motion for summary judgment, concluding that the defendants are not responsible for tourist development taxes. |
| • | Miami Dade County, Florida Litigation. On October 30, 2018, Miami-Dade County, Florida filed a lawsuit in Florida state court against HomeAway and Expedia for a declaratory judgment and supplemental relief claiming that HomeAway is obligated to collect and remit transient rental taxes imposed by Miami-Dade County. |
| • | Broward County, Florida Litigation. On January 11, 2019, Broward County, Florida filed a lawsuit in Florida state court against HomeAway for a declaratory judgment and supplemental relief claiming that HomeAway is obligated to collect and remit tourist development taxes imposed by Broward County and also seeking enforcement of a subpoena. |
| • | Colorado Department of Revenue Tax Litigation. On January 11, 2019, a number of online travel companies, including Expedia, Hotels.com, Hotwire and Orbitz filed a complaint in Colorado state court appealing tax assessments for state and state-collected local taxes issued by the Colorado Department of Revenue. |
| • | Palm Beach County, Florida Litigation (Ordinance Tax Amendments Challenge). On November 20, 2018, HomeAway filed a lawsuit in Florida state court seeking a declaratory judgment and injunctive relief against Palm Beach County, Florida and its Tax Collector in connection with recently enacted amendments to the County’s tax ordinance. |
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 $46 million as of December 31, 2018 and $43 million as of December 31, 2017.
Certain jurisdictions, including the states of New York, New Jersey, North Carolina, Minnesota, Oregon, Rhode Island, Maryland, Pennsylvania, Hawaii, Iowa, Massachusetts, the city of New York, and the District of Columbia, have enacted legislation seeking to tax online travel company services as part of sales or other taxes for hotel occupancy and/or car rental. We are currently remitting taxes to a number of jurisdictions, including to the states of New York, New Jersey, South Carolina, North Carolina, Minnesota, Georgia, Wyoming, Oregon, Rhode Island, Montana, Maryland, Kentucky, Maine, New Jersey, Pennsylvania, Hawaii, Iowa, Massachusetts, the city of New York and the District of Columbia, as well as certain other 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 Group companies as well as reimbursement of certain pay-to-play amounts received by Expedia Group companies, see NOTE 16 — 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 City of Los Angeles regarding hotel occupancy taxes and in the United Kingdom regarding the application of value added tax (“VAT”) to our European Union related transactions, may 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, and Egencia. 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, Expedia Partner Solutions, 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 alternative accommodations 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 as well as HomeAway bookings, 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 | ||||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Gross Bookings | |||||||||||||||||
| Core OTA | $ | 80,320 | $ | 72,701 | $ | 66,063 | 10 | % | 10 | % | |||||||
| trivago(1) | — | — | — | N/A | N/A | ||||||||||||
| HomeAway | 11,449 | 8,746 | 5,980 | 31 | % | 46 | % | ||||||||||
| Egencia | 7,958 | 6,963 | 6,368 | 14 | % | 9 | % | ||||||||||
| Total gross bookings | $ | 99,727 | $ | 88,410 | $ | 78,411 | 13 | % | 13 | % | |||||||
| Revenue Margin | |||||||||||||||||
| Core OTA | 10.9 | % | 10.8 | % | 10.7 | % | |||||||||||
| trivago(1) | N/A | N/A | N/A | ||||||||||||||
| HomeAway | 10.2 | % | 10.4 | % | 11.5 | % | |||||||||||
| Egencia | 7.6 | % | 7.5 | % | 7.3 | % | |||||||||||
| Total revenue margin | 11.3 | % | 11.4 | % | 11.2 | % |
| (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. |
The increase in worldwide gross bookings in 2018 and 2017 compared to the prior year periods was primarily due to growth in the Core OTA segment, including growth at Brand Expedia, Hotels.com and Expedia Partner Solutions, as well as growth at HomeAway.
Results of Operations
Revenue
| Year ended December 31, | % Change | ||||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Revenue by Segment | |||||||||||||||||
| Core OTA | $ | 8,760 | $ | 7,881 | $ | 7,084 | 11 | % | 11 | % | |||||||
| trivago (Third-party revenue) | 691 | 752 | 539 | (8 | )% | 40 | % | ||||||||||
| HomeAway | 1,171 | 906 | 689 | 29 | % | 32 | % | ||||||||||
| Egencia | 601 | 521 | 462 | 16 | % | 13 | % | ||||||||||
| Total revenue | $ | 11,223 | $ | 10,060 | $ | 8,774 | 12 | % | 15 | % |
In 2018, revenue increased primarily driven by growth in the Core OTA segment, including growth at Brand Expedia, Expedia Partner Solutions and Hotels.com, as well as growth at HomeAway. In 2017, revenue increased primarily driven by growth in the Core OTA segment, including growth at Brand Expedia and Expedia Partner Solutions, as well as growth at HomeAway and trivago.
| Year Ended December 31, | % Change | ||||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Revenue by Service Type | |||||||||||||||||
| Lodging | $ | 7,712 | $ | 6,851 | $ | 6,021 | 13 | % | 14 | % | |||||||
| Air | 881 | 784 | 778 | 12 | % | 1 | % | ||||||||||
| Advertising and media(1) | 1,092 | 1,073 | 807 | 2 | % | 33 | % | ||||||||||
| Other | 1,538 | 1,352 | 1,168 | 14 | % | 16 | % | ||||||||||
| Total revenue | $ | 11,223 | $ | 10,060 | $ | 8,774 | 12 | % | 15 | % |
| (1) | Includes third-party revenue from trivago as well as our transaction-based websites. |
Lodging revenue increased 13% in 2018 on a 13% increase in room nights stayed driven by growth in Hotels.com, Expedia Partner Solutions and HomeAway. Lodging revenue increased 14% in 2017 primarily due to a 16% increase in room nights stayed driven by growth in Brand Expedia, HomeAway and Expedia Partner Solutions, partially offset by a 2% decline in revenue per room night.
Worldwide air revenue increased 12% in 2018 due to a 5% increase in air tickets sold as well as a 7% increase in revenue per ticket. Air revenue growth for 2018 included an approximately 3% benefit due to an accounting change related to classification of certain fees, which were previously recorded as contra-revenue but now classified as cost of revenue with no net impact to operating income. 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.
Advertising and media revenue increased 2% in 2018 due to continued growth at Expedia Group Media Solutions, offset by declines at trivago. Advertising and media revenue increased 33% in 2017 primarily due to growth at trivago and Expedia Group Media Solutions.
All other revenue, which includes car rental, insurance, destination services and fees related to our corporate travel business, increased by 14% in 2018 and 16% in 2017 primarily due to growth in our travel insurance products and car rental revenue.
In addition to the above segment and product revenue discussion, our revenue by business model is as follows:
| Year ended December 31, | % Change | ||||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Revenue by Business Model | |||||||||||||||||
| Merchant | $ | 5,950 | $ | 5,394 | $ | 4,853 | 10 | % | 11 | % | |||||||
| Agency | 3,010 | 2,687 | 2,425 | 12 | % | 11 | % | ||||||||||
| Advertising and media | 1,092 | 1,073 | 807 | 2 | % | 33 | % | ||||||||||
| HomeAway | 1,171 | 906 | 689 | 29 | % | 32 | % | ||||||||||
| Total revenue | $ | 11,223 | $ | 10,060 | $ | 8,774 | 12 | % | 15 | % |
The increase in merchant revenue in 2018 and 2017 was primarily due to an increase in room nights stayed.
The increase in agency revenue in 2018 and 2017 was primarily due to the growth in agency hotel and air.
HomeAway revenue increased 29% in 2018 compared to 2017 due to growth in transactional revenue of approximately 55% primarily driven by a benefit from the traveler service fee, partially offset by subscription revenue decreasing approximately 20%. 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%.
Cost of Revenue
| Year ended December 31, | % Change | ||||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Customer operations | $ | 874 | $ | 767 | $ | 727 | 14 | % | 5 | % | |||||||
| Credit card processing | 508 | 506 | 508 | — | % | — | % | ||||||||||
| Data center, cloud and other | 583 | 484 | 362 | 21 | % | 34 | % | ||||||||||
| Total cost of revenue | $ | 1,965 | $ | 1,757 | $ | 1,597 | 12 | % | 10 | % | |||||||
| % of revenue | 17.5 | % | 17.5 | % | 18.2 | % |
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 2018, the increase in cost of revenue expense was driven by $107 million of increased customer operations expenses, including higher direct and headcount costs to support the growth of the business as well as impacts of the reclassification of certain air fees from contra-revenue due to the current year accounting change. In addition, data center, cloud and other costs increased $99 million period over period.
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 2018 was $92 million compared to $57 million in 2017 and $4 million in 2016.
Selling and Marketing
| Year ended December 31, | % Change | ||||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Direct costs | $ | 4,670 | $ | 4,360 | $ | 3,530 | 7 | % | 24 | % | |||||||
| Indirect costs | 1,097 | 938 | 837 | 17 | % | 12 | % | ||||||||||
| Total selling and marketing | $ | 5,767 | $ | 5,298 | $ | 4,367 | 9 | % | 21 | % | |||||||
| % of revenue | 51.4 | % | 52.7 | % | 49.8 | % |
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 $469 million during 2018 compared to 2017 driven by an increase of $310 million of direct costs, including online and offline marketing expenses. Expedia Partner Solutions, Brand Expedia, Hotels.com and HomeAway accounted for the majority of the total direct cost increases, partially offset by a decrease at trivago. In addition, higher indirect costs of $159 million also contributed to the increase and were primarily driven by growth in personnel in the lodging supply organization. The decrease in selling and marketing expense as a percentage of revenue in 2018 from 2017 was largely due to leverage on direct costs primarily driven by the ongoing marketing rationalization efforts at trivago.
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, Expedia Partner Solutions and Hotels.com accounted for the majority of the total direct cost increases. In addition, higher indirect costs of $101 million also contributed to the increase and were primarily driven by growth in personnel at Egencia as well as in the lodging supply organization.
Technology and Content
| Year ended December 31, | % Change | ||||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Personnel and overhead | $ | 796 | $ | 667 | $ | 600 | 19 | % | 11 | % | |||||||
| Depreciation and amortization of technology assets | 495 | 445 | 362 | 11 | % | 23 | % | ||||||||||
| Other | 326 | 275 | 273 | 18 | % | 1 | % | ||||||||||
| Total technology and content | $ | 1,617 | $ | 1,387 | $ | 1,235 | 17 | % | 12 | % | |||||||
| % of revenue | 14.4 | % | 13.8 | % | 14.1 | % |
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 $230 million for 2018 compared to 2017 primarily due to increased personnel and overhead costs of $129 million on higher headcount investments to develop our eCommerce platform and growth at HomeAway. Depreciation and amortization of technology assets also increased by $50 million. Other costs increased $51 million year-over-year primarily due to higher licensing and maintenance costs to support the growth of our technology platforms as well as higher cloud expenses.
Technology and content expense increased $152 million for 2017 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 2016 amounts related to the trivago employee stock option plan as described in NOTE 9 — Stock-Based Awards and Other Equity Instruments.
Cloud expense in technology and content during 2018 was $48 million, compared to $38 million in 2017 and $35 million in 2016.
General and Administrative
| Year ended December 31, | % Change | ||||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Personnel and overhead | $ | 520 | $ | 453 | $ | 411 | 15 | % | 10 | % | |||||||
| Professional fees and other | 288 | 223 | 267 | 29 | % | (17 | )% | ||||||||||
| Total general and administrative | $ | 808 | $ | 676 | $ | 678 | 20 | % | — | % | |||||||
| % of revenue | 7.2 | % | 6.7 | % | 7.7 | % |
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 increased $132 million in 2018 compared to 2017 primarily related to higher personnel and overhead costs of $67 million resulting from increased headcount at corporate as well as the prior year reversal of approximately $41 million of previously recognized stock-based compensation expense related to the departure of our former CEO in September 2017.
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 $64 million year-over-year, resulting from the 2017 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 $42 million primarily driven by the organic growth of the business.
Amortization and Impairment of Intangible Assets
| Year ended December 31, | % Change | ||||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Amortization of intangible assets | $ | 283 | $ | 275 | $ | 317 | 3 | % | (13 | )% | |||||||
| Impairment of intangible assets | 42 | — | 35 | N/A | N/A |
Amortization of intangible assets increased $8 million in 2018 compared to 2017 primarily due to amortization related to new business acquisitions in the prior year. In 2017, amortization of intangible assets decreased $42 million 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 2017.
In 2018 and in 2016, we recorded an impairment loss of $42 million and $35 million related to indefinite-lived trade names within our Core OTA segment due to changes in estimated future revenue of the related brands.
Impairment of Goodwill
During 2018, we recognized a goodwill impairment charge of $86 million related to a reporting unit within our Core OTA segment. See NOTE 4 — Fair Value Measurements in the notes to the consolidated financial statements for further information.
Legal Reserves, Occupancy Tax and Other
| Year ended December 31, | % Change | |||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | ||||||||||||
| ($ in millions) | ||||||||||||||||
| Legal reserves, occupancy tax and other | $ | (59 | ) | $ | 25 | $ | 27 | N/A | (4 | )% |
Legal reserves, occupancy tax and other primarily consists of increases in our reserves for court decisions and the potential and final settlement of issues related to hotel occupancy and other 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 2018, we received a refund of prepaid pay-to-play payments of $78 million from the City of San Francisco and recorded a related gain in legal reserves, occupancy tax and other, which was partially offset by expense related to changes in our reserve related to hotel occupancy and other taxes for other jurisdictions.
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.
For additional information, see NOTE 16 — Commitments and Contingencies in the notes to the consolidated financial statements.
Restructuring and Related Reorganization Charges
During 2018, we did not recognize any restructuring and related reorganization charges. However, during 2017 and 2016, 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 and $56 million in restructuring and related reorganization charges, respectively.
Operating Income
| Year ended December 31, | % Change | ||||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Operating income | $ | 714 | $ | 625 | $ | 462 | 14 | % | 35 | % | |||||||
| % of revenue | 6.4 | % | 6.2 | % | 5.3 | % |
In 2018, operating income increased primarily due to growth in revenue in excess of operating costs as well as the $78 million gain recognized related to the San Francisco pay-to-play refund in the current year, partially offset by current year impairment charges related to goodwill and intangible assets.
In 2017, operating income increased primarily due to growth in revenue and a decrease in most major expense categories as a percentage of revenue, partially offset by growth in sales and marketing as a percentage of revenue in 2017.
Adjusted EBITDA by Segment
| Year ended December 31, | % Change | ||||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Core OTA | $ | 2,305 | $ | 2,057 | $ | 1,956 | 12 | % | 5 | % | |||||||
| trivago | 16 | 5 | 35 | 186 | % | (84 | )% | ||||||||||
| HomeAway | 288 | 202 | 175 | 43 | % | 15 | % | ||||||||||
| Egencia | 107 | 95 | 81 | 13 | % | 18 | % | ||||||||||
| Unallocated overhead costs (Corporate) | (746 | ) | (646 | ) | (631 | ) | (15 | )% | (3 | )% | |||||||
| Total Adjusted EBITDA(1) | $ | 1,970 | $ | 1,713 | $ | 1,616 | 15 | % | 6 | % |
(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 18 — 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 Group, Inc. for the periods presented above.
Core OTA Adjusted EBITDA increased $248 million during 2018, primarily due to an increase in revenue combined with a decrease in selling and marketing as a percentage of revenue in the current period. Adjusted EBITDA increased $101 million during 2017, primarily due to an increase of $797 million in revenue, partially offset by an increase in online marketing expense mostly at Brand Expedia, Expedia Partner Solutions and Hotels.com, and including an increase in online spend at trivago.
trivago Adjusted EBITDA increased $11 million during 2018. Beginning late in the second quarter of 2018, trivago started focusing on improved profitability and made significant reductions in its advertising spend as a result of this increased focus on reducing operating expenditures. trivago Adjusted EBITDA declined $30 million during 2017. The deterioration was largely driven by a sudden change in advertiser 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.
HomeAway Adjusted EBITDA increased $86 million during 2018 due to an increase of $265 million in revenue, partially offset by higher operating expenses from planned investments in performance-based marketing as well as continued investing in both customer and supplier facing products, and HomeAway's migration to the cloud. 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 2017, HomeAway 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.
Egencia Adjusted EBITDA increased $12 million during 2018 primarily due to an increase in revenue of $80 million as a result of adding new corporate clients and room night growth, partially offset by investments in customer service and product to
further differentiate Egencia. Egencia Adjusted EBITDA increased $14 million in 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.
Unallocated overhead costs increased $100 million during 2018 primarily due to higher general and administrative personnel and overhead costs as well as higher technology and content expense to support investments in our eCommerce platform. Unallocated overhead costs increased $15 million during 2017 primarily due to higher general and administrative professional fees as well as personnel and overhead costs, partially offset by lower technology and content expense as we lapped over an accelerated pace of technology hiring in 2016.
Interest Income and Expense
| Year ended December 31, | % Change | ||||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Interest income | $ | 71 | $ | 34 | $ | 20 | 108 | % | 73 | % | |||||||
| Interest expense | (190 | ) | (182 | ) | (173 | ) | 5 | % | 5 | % |
Interest income increased in 2018 compared to 2017 primarily due to interest income recognized on the San Francisco pay-to-play refund mentioned above of $19 million as well as higher invested balances and to a lesser extent higher rates of return. Interest income increased in 2017 compared to 2016 primarily due to higher invested balances and to a lesser extent higher rates of return.
Interest expense increased in 2018 compared to 2017 primarily as a full year of interest on the $1 billion senior unsecured notes issued in September 2017, partially offset by lower interest expense due to the August 2018 maturity of our $500 million senior unsecured notes. 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.
As of December 31, 2018, 2017 and 2016, our senior unsecured notes indebtedness totaled $3.7 billion, $4.2 billion and $3.2 billion, respectively.
Other, Net
Other, net is comprised of the following:
| Year ended December 31, | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| (In millions) | |||||||||||
| Foreign exchange rate gains (losses), net | $ | 3 | $ | (46 | ) | $ | (15 | ) | |||
| Losses on minority equity investments, net | (111 | ) | (14 | ) | (12 | ) | |||||
| Other | (2 | ) | — | (5 | ) | ||||||
| Total other, net | $ | (110 | ) | $ | (60 | ) | $ | (32 | ) |
During 2018, the losses on minority equity investments, net related to fair value changes in our investment in Despegar, a publicly traded company, partially offset by $33 million of gains related to minority investments without readily determinable fair values for which recently observable and orderly transactions for similar investments occurred during the year. See NOTE 2 — Significant Accounting Policies – Recently Adopted Accounting Policies – Recognition and Measurement of Financial Instruments for more information on the related new accounting guidance for minority equity investments adopted in 2018.
Provision for Income Taxes
| Year ended December 31, | % Change | ||||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||
| ($ in millions) | |||||||||||||||||
| Provision for income taxes | $ | 87 | $ | 45 | $ | 16 | 94 | % | 196 | % | |||||||
| Effective tax rate | 18.1 | % | 10.9 | % | 5.5 | % |
Our effective tax rate for 2018 was lower than the 21% federal statutory rate primarily 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 stock-based payments and foreign-derived intangible income ("FDII"). The net increase in our effective rate for 2018 compared to 2017 was primarily driven by the Tax Act, the 2018 non-deductible goodwill impairments as discussed in NOTE 4 — Fair Value Measurements in the notes to the consolidated financial statements and a decrease in the excess tax benefits related to stock-based payments.
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 well as excess tax benefits related to stock-based payments. The net increase in our effective rate for 2017 compared to 2016 was primarily due to one-time tax benefits in 2016 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.
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 tax benefits from the adoption of new accounting guidance related 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.
For additional information including additional information on the impacts of the Tax Act, see NOTE 10 — 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 Group, Inc. 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 Group, Inc. to Adjusted EBITDA is as follows:
| Year ended December 31, | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| (In millions) | |||||||||||
| Net income attributable to Expedia Group, Inc. | $ | 406 | $ | 378 | $ | 282 | |||||
| Net loss attributable to non-controlling interests | (8 | ) | (6 | ) | (21 | ) | |||||
| Provision for income taxes | 87 | 45 | 16 | ||||||||
| Total other expense, net | 229 | 208 | 185 | ||||||||
| Operating income | 714 | 625 | 462 | ||||||||
| Gain (loss) on revenue hedges related to revenue recognized | 25 | 8 | 13 | ||||||||
| Restructuring and related reorganization charges, excluding stock-based compensation | — | 17 | 43 | ||||||||
| Legal reserves, occupancy tax and other | (59 | ) | 25 | 27 | |||||||
| Stock-based compensation | 203 | 149 | 242 | ||||||||
| Amortization of intangible assets | 283 | 275 | 317 | ||||||||
| Impairment of goodwill | 86 | — | — | ||||||||
| Impairment of intangible assets | 42 | — | 35 | ||||||||
| Depreciation | 676 | 614 | 477 | ||||||||
| Adjusted EBITDA | $ | 1,970 | $ | 1,713 | $ | 1,616 |
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 $2.5 billion and $3.3 billion at December 31, 2018 and 2017, and our $2 billion revolving credit facility, which is essentially untapped and expires in May 2023.
As of December 31, 2018, the total cash and cash equivalents and short-term investments held outside the United States was $1.2 billion ($1.0 billion in wholly-owned foreign subsidiaries and $220 million in majority-owned subsidiaries). The amount of undistributed earnings in foreign subsidiaries where the foreign subsidiary has or will invest undistributed earnings indefinitely outside of the United States, and for which future distributions could be taxable, was $104 million as of December 31, 2018. The unrecognized deferred tax liability related to the U.S. federal income tax consequences of these earnings was $22 million as of December 31, 2018.
The revolving credit facility, which was amended in 2018 to increase the borrowing capacity to $2 billion, extend the expiration to May 2023, and reduce the interest rate on loans under the facility (as disclosed herein), bears interest based on the Company’s credit ratings with the applicable interest rate on drawn amounts at LIBOR plus 125 basis points and the commitment fee on undrawn amounts at 17.5 basis points as of December 31, 2018. The facility contains various restrictive covenants, including a maximum permissible leverage ratio and a minimum permissible interest coverage ratio. As of December 31, 2018, the maximum permissible leverage ratio and the minimum interest coverage were 4.00 to 1.00 and 2.75 to 1.00, respectively.
Our credit ratings are periodically reviewed by rating agencies. As of December 31, 2018, 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, 2018, we were in compliance with the covenants and conditions in our revolving credit facility and outstanding debt, which was comprised of $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 $1 billion of registered senior unsecured notes due in February 2028 that bear interest at 3.8% ("the 3.8%
Notes"). In August 2018, our $500 million in registered senior unsecured notes that bore interest at 7.456% matured and the balance was repaid.
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 Partner Solutions 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 become the merchant of record on more of its transactions.
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, 2018, we had a deficit in our working capital of $2.9 billion, compared to a deficit of $2.3 billion as of December 31, 2017. The change in the deficit was primarily due to investing and financing activities, including capital expenditures and purchase of treasury stock, partially offset by operating cash flows.
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 our cloud computing expenses have increased and are expected to continue 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 full year 2019 to increase over 2018 spending levels. For the new headquarters, we expect to spend approximately $900 million. Of the total, approximately $30 million was spent in 2016, approximately $70 million in 2017 and approximately $190 million in 2018. During 2019 and 2020, we expect to spend $425 to $475 million and $135 to $185 million, respectively. However, the timing of spend could shift as we progress toward completion of the project and total spend estimates could increase due to impacts from any additional tariffs.
Our cash flows are as follows:
| Year ended December 31, | $ Change | ||||||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||||
| (In millions) | |||||||||||||||||||
| Cash provided by (used in) operations: | |||||||||||||||||||
| Operating activities | $ | 1,975 | $ | 1,845 | $ | 1,549 | $ | 130 | $ | 296 | |||||||||
| Investing activities | (559 | ) | (1,581 | ) | (718 | ) | 1,022 | (863 | ) | ||||||||||
| Financing activities | (1,489 | ) | 688 | (691 | ) | (2,177 | ) | 1,379 | |||||||||||
| Effect of foreign exchange rate changes on cash and cash equivalents | (139 | ) | 147 | (35 | ) | (286 | ) | 182 |
In 2018, net cash provided by operating activities increased by $130 million primarily due to higher operating income after adjusting for impacts of depreciation, amortization, and impairments and a refund of "pay-to-play" hotel occupancy tax amounts, partially offset by a decrease in benefits from working capital changes, including lower merchant liability benefits
and higher cash paid for taxes. In 2017, net cash provided by operating activities increased by $296 million primarily due to increased benefits from working capital changes driven mostly from a change in merchant liabilities.
In 2018, $1,022 million less cash was used in investing activities primarily due to net sales of investments of $334 million in the current year compared to net purchases of investments of $715 million in the prior year and higher cash used for acquisitions in 2017, partially offset by higher current year capital expenditures primarily related to our new corporate headquarters. In 2017, cash used in investing activities increased by $863 million due to net purchase of investments of $715 million in 2017 compared to cash provided by net sales of investments of $16 million in 2016 and an increase of cash used for acquisitions of $168 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 2017.
Cash used in financing activities in 2018 primarily included cash paid to acquire shares of $923 million, including the repurchased shares under the authorizations discussed below, the $500 million long-term debt repayment and a $186 million cash dividend payment, partially offset by $166 million of proceeds from the exercise of options and employee stock purchase plans. Cash provided by financing activities in 2017 primarily included $990 million of net proceeds from the issuance of 3.8% Notes 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 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.
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, during 2015 authorized a repurchase of up to 10 million shares of our common stock, and during 2018 authorized a repurchase of up to 15 million shares of our common stock for a total of 85 million shares. Shares repurchased under the authorized programs were as follows:
| Year ended December 31, | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| Number of shares repurchased | 7.7 million | 2.3 million | 4.0 million | ||||||||
| Average price per share | $ | 117.02 | $ | 127.04 | $ | 109.64 | |||||
| Total cost of repurchases (in millions)(1) | $ | 903 | $ | 294 | $ | 436 |
| (1) | Amount excludes transaction costs. |
As of December 31, 2018, 12.2 million shares remain authorized for repurchase under the 2018 authorization with no fixed termination date for the repurchases.
Our common stock dividend was $1.24 per share for 2018, $1.16 per share for 2017 and $1.00 per share for 2016. See NOTE 12 — Stockholders’ Equity in the notes to consolidated financial statements for a detail of the quarterly dividend payments by year. In addition, in February 2019, the Executive Committee, acting on behalf of the Board of Directors, declared a quarterly cash dividend of $0.32 per share of outstanding common stock payable on March 27, 2019 to the stockholders of record as of the close of business on March 7, 2019. Future declarations of dividends are subject to final determination by our Board of Directors.
Foreign exchange rate changes resulted in a reduction of our cash balances denominated in foreign currency in 2018 of $139 million reflecting net depreciations in foreign currencies during 2018. Foreign exchange rate changes resulted in increases in our cash balances denominated in foreign currency in 2017 of $147 million reflecting net appreciations in foreign currencies during 2017. Foreign exchange rate changes resulted in reduction in our cash balances denominated in foreign currency in 2016 of $35 million reflecting net depreciations in foreign currencies during 2016.
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, 2018:
| 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) | $ | 4,723 | $ | 161 | $ | 1,028 | $ | 959 | $ | 2,575 | |||||||||
| Property leases (2) | 919 | 156 | 235 | 167 | 361 | ||||||||||||||
| Purchase obligations (3) | 683 | 352 | 266 | 65 | — | ||||||||||||||
| Guarantees (4) | 59 | 59 | — | — | — | ||||||||||||||
| Letters of credit (4) | 28 | 13 | 11 | — | 4 | ||||||||||||||
| Total(5) | $ | 6,412 | $ | 741 | $ | 1,540 | $ | 1,191 | $ | 2,940 |
| (1) | Our 5.95% Notes, 2.5% Notes, 4.5% Notes, 5.0% and 3.8% Notes include interest payments through maturity in 2020, 2022, 2024, 2026 and 2028 respectively, based on the stated fixed rates. For the 2.5% Notes, the December 31, 2018 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) | Property leases include operating leases for office space and related office equipment as well as leases that have been accounted for as build-to-suit lease arrangements. We account for these leases on a monthly basis. Certain leases contain periodic rent escalation adjustments and renewal options. 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, $15 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 $230 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, 2018.
Certain Relationships and Related Party Transactions
For a discussion of certain relationships and related party transactions, see NOTE 17 — Related Party Transactions in the notes to the consolidated financial statements.
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