Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. On January 1, 2018, we adopted the requirements of ASU 2014-09 using the full retrospective approach as of January 1, 2016. Except where otherwise noted, all amounts and disclosures set forth in this Form 10-K reflect the necessary adjustments required for the adoption of this standard, including the reclassification of prior period balances to conform to current year presentation. See Note 2: "Basis of Presentation and Summary of Significant Accounting Policies" in our consolidated financial statements for additional information.

Overview

Our Business

Hilton is one of the largest and fastest growing hospitality companies in the world, with 5,685 properties comprising 912,960 rooms in 113 countries and territories as of December 31, 2018. Our premier brand portfolio includes: our luxury and lifestyle hotel brands, Waldorf Astoria Hotels & Resorts, Conrad Hotels & Resorts, Canopy by Hilton and our recently launched luxury brand, LXR Hotels & Resorts; our full service hotel brands, Hilton Hotels & Resorts, Curio Collection by Hilton, DoubleTree by Hilton, Tapestry Collection by Hilton and Embassy Suites by Hilton; our focused service hotel brands, Hilton Garden Inn, Hampton by Hilton, Tru by Hilton, Homewood Suites by Hilton, Home2 Suites by Hilton and our recently launched urban-affordable brand, Motto by Hilton; and our timeshare brand, Hilton Grand Vacations. As of December 31, 2018, we had over 85 million members in our award-winning guest loyalty program, Hilton Honors, a 20 percent increase from December 31, 2017.

On January 3, 2017, we completed the spin-offs of Park and HGV. The historical financial results of Park and HGV are reflected in our consolidated financial statements as discontinued operations. See Note 3: "Discontinued Operations" in our consolidated financial statements for additional information.

Segments and Regions

Management analyzes our operations and business by both operating segments and geographic regions. Our operations consist of two reportable segments that are based on similar products or services: (i) management and franchise and (ii) ownership. The management and franchise segment provides services, including hotel management and licensing of our brands. This segment generates its revenue from: (i) management and franchise fees charged to third-party hotel owners; (ii) license fees for the exclusive right to use certain Hilton marks and intellectual property; and (iii) fees for managing our owned and leased hotels. As a manager of hotels, we typically are responsible for supervising or operating the property in exchange for management fees. As a franchisor of hotels, we charge franchise fees in exchange for the use of one of our brand names and related commercial services, such as our reservation system, marketing and information technology services. The ownership segment primarily derives earnings from hotel room sales, food and beverage sales and other services at our owned and leased hotels.

Geographically, management conducts business through three distinct geographic regions: (i) the Americas; (ii) Europe, Middle East and Africa ("EMEA"); and (iii) Asia Pacific. The Americas region includes North America, South America and Central America, including all Caribbean nations. Although the U.S. is included in the Americas, it represented 73 percent of our system-wide hotel rooms as of December 31, 2018; therefore, the U.S. is often analyzed separately and apart from the Americas geographic region overall and, as such, it is presented separately within the analysis herein. The EMEA region includes Europe, which represents the western-most peninsula of Eurasia stretching from Iceland in the west to Russia in the east, and the Middle East and Africa ("MEA"), which represents the Middle East region and all African nations, including the Indian Ocean island nations. Europe and MEA are often analyzed separately and, as such, are presented separately within the analysis herein. The Asia Pacific region includes the eastern and southeastern nations of Asia, as well as India, Australia, New Zealand and the Pacific island nations.

System Growth and Pipeline

Our strategic objectives include the continued expansion of our global footprint and fee-based business. As we enter into new management and franchise contracts, we expand our business with minimal or no capital investment by us as the manager or franchisor, since the capital required to build and maintain hotels is typically provided by the third-party owner of the hotel with whom we contract to provide management or franchise services. Prior to approving the addition of new properties to our management and franchise development pipeline, we evaluate the economic viability of the property based on its geographic

location, the credit quality of the third-party owner and other factors. By increasing the number of management and franchise contracts with third-party owners, we expect to increase overall return on invested capital and cash available for return to stockholders.

As of December 31, 2018, we had more than 2,400 hotels in our development pipeline that we expect to add as open hotels in our system, representing over 364,000 rooms under construction or approved for development throughout 103 countries and territories, including 35 countries and territories where we do not currently have any open hotels. All of the rooms in the development pipeline are within our management and franchise segment. Additionally, 195,000 rooms in the development pipeline were located outside the U.S., and 184,000 rooms, or more than half, were under construction. We do not consider any individual development project to be material to us.

Principal Components and Factors Affecting our Results of Operations

Revenues

Principal Components

We primarily derive our revenues from the following sources:

•

Franchise and licensing fees. Represents fees received in connection with the licensing of our brands. Under our franchise contracts, franchisees typically pay us franchise fees that include: (i) monthly royalty fees, generally based on a percentage of monthly gross room revenue, and, for our full service brands, a percentage of gross food and beverage revenues and other revenues, as applicable, and (ii) application, initiation and other fees for when new hotels enter the system, when there is a change of ownership or when contracts with properties already in our system are extended. We also earn licensing fees from a license agreement with HGV and co-brand credit card arrangements for the use of certain Hilton marks and IP. Consideration to incentivize hotel owners to enter into franchise contracts with us is amortized over the life of the applicable contract as a reduction to franchise and licensing fees.

•

Base and incentive management fees. Represents fees received in connection with the management of hotels. Terms of our management contracts vary, but our fees generally consist of a base fee, which is typically based on a percentage of the hotel's monthly gross revenue and, in some cases, an incentive fee, which is based on hotel operating profits and may be subject to a stated return threshold to the owner, normally measured over a one-calendar year period. Outside of the U.S., our fees are often more dependent on hotel profitability measures, either through a single management fee structure where the entire fee is based on a profitability measure, or because our two-tier fee structure is more heavily weighted toward the incentive fee than the base fee. Consideration to incentivize hotel owners to enter into management contracts with us is amortized over the life of the applicable contract as a reduction to base and other management fees.

•

Owned and leased hotels. Represents revenues derived from hotel operations, including hotel room sales, food and beverage sales and other ancillary goods and services. These revenues are primarily derived from two categories of customers: transient and group. Transient guests are individual travelers who are traveling for business or leisure. Group guests are traveling for group events that reserve rooms for meetings, conferences or social functions sponsored by associations, corporate, social, military, educational, religious or other organizations. Group business usually includes a block of room accommodations, as well as other ancillary services, such as meeting facilities and catering and banquet services. A majority of our food and beverage sales and other ancillary services are provided to customers who are also occupying rooms at our hotels. As a result, occupancy affects all components of our owned and leased hotel revenues.

•	Other revenues. Represents revenues generated by the incidental support of hotel operations for owned, leased, managed and franchised properties, including our purchasing operations, and other operating income.

•

Other revenues from managed and franchised properties. Represents amounts that are contractually reimbursed to us by property owners, either directly as costs are incurred or indirectly through fees that are billed and collected each month based on the underlying hotel's sales or usage and are related to certain costs and expenses of the related properties. The direct reimbursements by property owners are for payroll and related costs where the property employees are legally our responsibility, and certain other operating costs of the managed and franchised properties' operations. We have no legal responsibility for the employees or the liabilities associated with operating franchised properties. These direct reimbursements have no net effect on operating income (loss) or net income (loss). The monthly fee that hotel franchisees and property owners of hotels we manage pay is based on the underlying hotel's

sales or usage and covers the costs of: (i) advertising and marketing programs; (ii) internet, technology and reservation systems; and (iii) quality assurance program expenses. We are contractually required to use these fees solely for the programs.

Factors Affecting our Revenues

The following factors affect the revenues we derive from our operations:

•

Consumer demand and global economic conditions. Consumer demand for our products and services is closely linked to the performance of the general economy and is sensitive to business and personal discretionary spending levels. Declines in consumer demand due to adverse general economic conditions, risks affecting or reducing travel patterns, lower consumer confidence and adverse political conditions can lower the amount of management and franchise fee revenues we are able to generate from our managed and franchised properties and the revenues and profitability of our owned and leased operations. Further, competition for hotel guests and the supply of hotel services affect our ability to sustain or increase rates charged to customers at our hotels. Also, declines in hotel profitability during an economic downturn directly affect the incentive portion of our management fees, which is based on hotel profitability measures. As a result, changes in consumer demand and general business cycles have historically subjected and could in the future subject our revenues to significant volatility.

•

Contracts with third-party owners and franchisees and relationships with developers. We depend on our long-term management and franchise contracts with third-party owners and franchisees for a significant portion of our management and franchise fee revenues. The success and sustainability of our management and franchise business depends on our ability to perform under our management and franchise contracts and maintain good relationships with third-party owners and franchisees. Our relationships with these third parties also generate new relationships with developers and opportunities for property development that can support our growth. Growth and maintenance of our hotel system and earning fees relating to hotels in development are dependent on the ability of developers and owners to access capital for the development, maintenance and renovation of properties. We believe that we have good relationships with our third-party owners, franchisees and developers and are committed to the continued growth and development of these relationships. These relationships exist with a diverse group of owners, franchisees and developers and are not significantly concentrated with any particular third party.

Expenses

Principal Components

We primarily incur the following expenses:

•

Owned and leased hotels. Reflects the operating expenses of our consolidated owned and leased hotels, including room expense, food and beverage costs, other support costs and property expenses. Room expense includes compensation costs for housekeeping, laundry and front desk staff, as well as supply costs for guest room amenities and laundry. Food and beverage costs include costs for wait and kitchen staff and food and beverage inventory. Other support expenses consist of costs associated with property-level management, utilities, sales and marketing, operating hotel spas, telephones, parking and other guest recreation, entertainment and services. Property expenses include property taxes, repairs and maintenance, rent and insurance.

•

Depreciation and amortization. These are non-cash expenses that primarily consist of amortization of intangible assets that were recorded at their fair value at the time of the October 24, 2007 transaction whereby we became a wholly owned subsidiary of The Blackstone Group L.P., which include management and franchise contracts, leases and our Hilton Honors guest loyalty program intangible, as well as certain proprietary technologies. These expenses also include depreciation of fixed assets, such as buildings and furniture and equipment that are used in corporate operations or at our consolidated owned and leased hotels.

•

General and administrative. Consists primarily of compensation expense for our corporate staff and personnel supporting our business segments, including divisional offices that support our management and franchise segment; professional fees, including consulting, audit and legal fees; travel and entertainment expenses; bad debt expenses for uncollected management, franchise and other fees; and administrative and related expenses.

•	Other expenses. Consists of expenses incurred by our purchasing operations and other ancillary businesses, along with other operating expenses of the business.

•

Other expenses from managed and franchised properties. Represents certain costs and expenses that are contractually reimbursed to us by property owners for payroll and related costs for properties that we manage where the property employees are legally our responsibility, or paid from fees collected from properties for certain other operating costs of the managed and franchised properties' operations, marketing expenses and other expenses associated with our brands and shared services. We are contractually required to use these fees solely for the programs. We have no legal responsibility for the employees or the liabilities associated with operating franchised properties.

Factors Affecting our Costs and Expenses

The following are principal factors that affect the costs and expenses we incur in the course of our operations:

•

Fixed expenses. Many of the expenses associated with owning and leasing hotels are relatively fixed. These expenses include personnel costs, rent, property taxes, insurance and utilities. If we are unable to decrease these costs significantly or rapidly when demand for our hotels and other properties decreases, the resulting decline in our revenues can have an adverse effect on our net cash flow, margins and profits. This effect can be especially pronounced during periods of economic contraction or slow economic growth. Economic downturns generally affect the results of our ownership segment more significantly than the results of our management and franchise segment due to the high fixed costs associated with operating an owned or leased hotel. Employees at some of our owned and leased hotels are parties to collective bargaining agreements that may also limit our ability to make timely staffing or labor changes in response to declining revenues. In addition, any efforts to reduce costs, including the deferral or cancellation of capital improvements, could adversely affect the economic value of our hotels and brands. Additionally, the general and administrative expenses of operating a global business also include fixed personnel costs, rent, property taxes, insurance and utilities. The effectiveness of any cost-cutting efforts related to owning and leasing hotels or corporate operations is limited by the amount of inherent fixed costs. However, we have taken steps to reduce our fixed costs to levels we believe are appropriate to maximize profitability and respond to market conditions, while continuing to optimize the overall customer experience or the value of our hotels or brands.

•

Changes in depreciation and amortization expense. We capitalize costs associated with certain software development projects and, as those projects are completed and placed into service, amortization expense will increase. Additionally, changes in depreciation expense may be driven by renovations of existing hotels, acquisition or development of new hotels, the disposition of existing hotels through sale or closure or changes in estimates of the useful lives of our assets. As we place new assets into service, we will be required to recognize additional depreciation expense on those assets.

Other Items

Effect of foreign currency exchange rate fluctuations

Significant portions of our operations are conducted in functional currencies other than our reporting currency, which is the U.S. dollar ("USD"), and we have assets and liabilities, including those that are intercompany in nature, denominated in a variety of foreign currencies. As a result, we are required to translate those results, assets and liabilities from the functional currency into USD at market-based exchange rates for each reporting period. When comparing our results of operations between periods, there may be material portions of the changes in our revenues or expenses that are derived from fluctuations in exchange rates experienced between those periods. We hedge foreign exchange-based cash flow variability in certain of our foreign currency denominated management and franchise fees using forward contracts.

Seasonality

The hospitality industry is seasonal in nature. The periods during which our properties experience higher or lower levels of demand vary from property to property, depending principally upon their location, type of property and competitive mix within the specific location. Based on historical results, we generally expect our revenues to be lower in the first quarter of each year than in each of the three subsequent quarters.

Key Business and Financial Metrics Used by Management

Comparable Hotels

We define our comparable hotels as those that: (i) were active and operating in our system for at least one full calendar year as of the end of the current period, and open January 1st of the previous year; (ii) have not undergone a change in brand or ownership type during the current or comparable periods reported, excluding the hotels distributed in the spin-offs; and (iii) have not sustained substantial property damage, business interruption, undergone large-scale capital projects or for which comparable results are not available. Of the 5,634 hotels in our system as of December 31, 2018, 4,218 hotels have been classified as comparable hotels. Our 1,416 non-comparable hotels included 197 hotels, or approximately three percent of the total hotels in our system, that were removed from the comparable group during the year because they sustained substantial property damage, business interruption, underwent large-scale capital projects or comparable results were not available.

Occupancy

Occupancy represents the total number of room nights sold divided by the total number of room nights available at a hotel or group of hotels for a given period. Occupancy measures the utilization of our hotels' available capacity. Management uses occupancy to gauge demand at a specific hotel or group of hotels in a given period. Occupancy levels also help us determine achievable average daily rate pricing levels as demand for hotel rooms increases or decreases.

Average Daily Rate ("ADR")

ADR represents hotel room revenue divided by the total number of room nights sold for a given period. ADR measures average room price attained by a hotel, and ADR trends provide useful information concerning the pricing environment and the nature of the customer base of a hotel or group of hotels. ADR is a commonly used performance measure in the industry, and we use ADR to assess pricing levels that we are able to generate by type of customer, as changes in rates charged to customers have a different effect on overall revenues and incremental profitability than changes in occupancy, as described above.

Revenue per Available Room ("RevPAR")

RevPAR is calculated by dividing hotel room revenue by the total number of room nights available to guests for a given period. We consider RevPAR to be a meaningful indicator of our performance as it provides a metric correlated to two primary and key drivers of operations at a hotel or group of hotels, as previously described: occupancy and ADR. RevPAR is also a useful indicator in measuring performance over comparable periods for comparable hotels.

References to RevPAR, ADR and occupancy are presented on a comparable basis and references to RevPAR and ADR are presented on a currency neutral basis, unless otherwise noted. As such, comparisons of these hotel operating statistics for the years ended December 31, 2018 and 2017 use the exchange rates for the year ended December 31, 2018, and comparisons for the years ended December 31, 2017 and 2016 use the exchange rates for the year ended December 31, 2017.

EBITDA and Adjusted EBITDA

EBITDA reflects income (loss) from continuing operations, net of taxes, excluding interest expense, a provision for income taxes and depreciation and amortization.

Adjusted EBITDA is calculated as EBITDA, as previously defined, further adjusted to exclude certain items, including gains, losses, revenues and expenses in connection with: (i) asset dispositions for both consolidated and unconsolidated equity investments; (ii) foreign currency transactions; (iii) debt restructurings and retirements; (iv) furniture, fixtures and equipment ("FF&E") replacement reserves required under certain lease agreements; (v) reorganization costs; (vi) share-based compensation expense; (vii) non-cash impairment losses; (viii) severance, relocation and other expenses; (ix) amortization of contract acquisition costs; (x) the net effect of reimbursable costs included in other revenues and expenses from managed and franchised properties; and (xi) other items.

During the first quarter of 2018, we modified the definition of Adjusted EBITDA to exclude the amortization of contract acquisition costs and the net effect of reimbursable costs included in other revenues and expenses from managed and franchised properties. We believe that excluding these items is useful for the reasons set forth below and have applied the modified definition of Adjusted EBITDA to all periods presented.

We believe that EBITDA and Adjusted EBITDA provide useful information to investors about us and our financial condition and results of operations for the following reasons: (i) these measures are among the measures used by our management team to evaluate our operating performance and make day-to-day operating decisions and (ii) these measures are frequently used by securities analysts, investors and other interested parties as a common performance measure to compare results or estimate valuations across companies in our industry. Additionally, these measures exclude certain items that can vary widely across different industries and among competitors within our industry. For instance, interest expense and the provision for income taxes are dependent on company specifics, including, among other things, capital structure and operating jurisdictions, respectively, and, therefore could vary significantly across companies. Depreciation and amortization, as well as amortization of contract acquisition costs, are dependent upon company policies, including the method of acquiring and depreciating assets and the useful lives that are used. For Adjusted EBITDA, we also exclude items such as: (i) FF&E replacement reserves to be consistent with the treatment of FF&E for owned and leased hotels where it is capitalized and depreciated over the life of the FF&E; (ii) share-based compensation expense, as this could vary widely among companies due to the different plans in place and the usage of them; (iii) the net effect of our cost reimbursement revenues and reimbursed expenses, as we contractually do not operate the related programs to generate a profit over the terms of the respective contracts; and (iv) other items that are not core to our operations and are not reflective of our performance.

EBITDA and Adjusted EBITDA are not recognized terms under U.S. generally accepted accounting principles ("GAAP") and should not be considered as alternatives to net income (loss) or other measures of financial performance or liquidity derived in accordance with GAAP. EBITDA and Adjusted EBITDA have limitations as analytical tools and should not be considered as alternatives, either in isolation or as a substitute, for net income (loss), cash flow or other methods of analyzing our results as reported under GAAP. Some of these limitations are:

•	EBITDA and Adjusted EBITDA do not reflect changes in, or cash requirements for, our working capital needs;

•	EBITDA and Adjusted EBITDA do not reflect our interest expense, or the cash requirements necessary to service interest or principal payments, on our indebtedness;

•	EBITDA and Adjusted EBITDA do not reflect a provision for income taxes or the cash requirements to pay our taxes;

•	EBITDA and Adjusted EBITDA do not reflect historical cash expenditures or future requirements for capital expenditures or contractual commitments;

•	EBITDA and Adjusted EBITDA do not reflect the effect on earnings or changes resulting from matters that we consider not to be indicative of our future operations;

•	although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements; and

•	other companies in our industry may calculate EBITDA and Adjusted EBITDA differently, limiting their usefulness as comparative measures.

Because of these limitations, EBITDA and Adjusted EBITDA should not be considered as discretionary cash available to us to reinvest in the growth of our business or as measures of cash that will be available to us to meet our obligations.

Results of Operations

The hotel operating statistics by region for our system-wide comparable hotels for the year ended December 31, 2018 compared to the year ended December 31, 2017 were as follows:

	Year Ended				Variance
	December 31, 2018				2018 vs. 2017
U.S.
Occupancy	76.3		%		0.4	%	pts.
ADR	$	149.09			1.7	%
RevPAR	$	113.68			2.2	%
Americas (excluding U.S.)
Occupancy	71.6		%		1.6	%	pts.
ADR	$	127.57			3.8	%
RevPAR	$	91.36			6.1	%
Europe
Occupancy	77.0		%		2.1	%	pts.
ADR	$	148.37			4.0	%
RevPAR	$	114.22			6.9	%
MEA
Occupancy	72.5		%		3.3	%	pts.
ADR	$	151.24			(2.9	)%
RevPAR	$	109.60			1.8	%
Asia Pacific
Occupancy	73.4		%		3.0	%	pts.
ADR	$	135.60			2.1	%
RevPAR	$	99.54			6.5	%
System-wide
Occupancy	75.8		%		0.8	%	pts.
ADR	$	147.22			1.9	%
RevPAR	$	111.61			3.0	%

For the year ended December 31, 2018, we experienced system-wide RevPAR growth, largely driven by improved ADR. Growth in our international portfolio outpaced growth in the U.S., with particularly strong trends in the Europe and Asia Pacific regions. Continued strength in Europe was driven primarily by increased ADR, most notably in Turkey, as it continues to recover from political and economic turmoil. Growth in Asia Pacific was primarily attributable to increased occupancy in China resulting from new hotels maturing in our system. In the Americas (excluding U.S.), increases in RevPAR were largely attributable to positive performance in the Caribbean and Canada, driven by increases in ADR. RevPAR grew moderately in MEA, primarily due to increases in occupancy in Egypt. In the U.S., RevPAR experienced its ninth consecutive year of growth, but was also affected by natural and man-made disasters, driving increased occupancy for the year ended December 31, 2017 and softening results and comparisons of growth during the year ended December 31, 2018.

The hotel operating statistics by region for our system-wide comparable hotels for the year ended December 31, 2017 compared to the year ended December 31, 2016 were as follows:

	Year Ended				Variance
	December 31, 2017				2017 vs. 2016
U.S.
Occupancy	76.3		%		0.4	%	pts.
ADR	$	146.78			1.0	%
RevPAR	$	111.93			1.5	%
Americas (excluding U.S.)
Occupancy	71.5		%		2.1	%	pts.
ADR	$	124.47			2.1	%
RevPAR	$	89.04			5.3	%
Europe
Occupancy	75.3		%		3.2	%	pts.
ADR	$	141.20			2.1	%
RevPAR	$	106.37			6.6	%
MEA
Occupancy	67.1		%		5.5	%	pts.
ADR	$	145.16			(5.0	)%
RevPAR	$	97.42			3.6	%
Asia Pacific
Occupancy	72.9		%		4.9	%	pts.
ADR	$	140.36			0.1	%
RevPAR	$	102.39			7.3	%
System-wide
Occupancy	75.5		%		1.2	%	pts.
ADR	$	144.78			0.9	%
RevPAR	$	109.27			2.5	%

For the year ended December 31, 2017, we experienced RevPAR growth across all regions, particularly in Asia Pacific, Europe and the Americas (excluding U.S.). Continued growth in Asia Pacific was primarily driven by high demand in China and Japan attributable to new hotels stabilizing in the system, resulting in increased occupancy. Strong performance in Europe was a result of increases in both occupancy and ADR, largely driven by continued recovery from the geopolitical and economic turmoil in 2016, particularly in Turkey. The RevPAR increase in the Americas (excluding U.S.) was driven by strong performance in Canada and Puerto Rico, which was a result of strong transient and group demand and steady demand resulting from the hurricanes, respectively. MEA experienced RevPAR growth due to increased occupancy, despite declines in ADR due to travel sanctions and increased geopolitical pressures. RevPAR growth in the U.S. was driven by increased demand in certain markets as a result of hurricane relief efforts.

The table below provides a reconciliation of income (loss) from continuing operations, net of taxes, to EBITDA and Adjusted EBITDA:

	Year Ended December 31,
	2018				2017				2016
	(in millions)
Income (loss) from continuing operations, net of taxes	$	769			$	1,089			$	(17	)
Interest expense	371				351				334
Income tax expense (benefit)	309				(336		)		557
Depreciation and amortization	325				336				353
EBITDA	1,774				1,440				1,227
Gain on sales of assets, net	—				—				(8		)
Loss (gain) on foreign currency transactions	11				(3		)		16
Loss on debt extinguishment	—				60				—
FF&E replacement reserves	50				55				55
Share-based compensation expense	127				121				81
Amortization of contract acquisition costs	27				17				16
Net other expenses from managed and franchised properties	85				172				12
Other adjustment items(1)	27				47				85
Adjusted EBITDA	$	2,101			$	1,909			$	1,484

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(1)	Includes adjustments for transaction costs related to the spin-offs for the year ended December 31, 2017; impairment loss for the years ended December 31, 2017 and 2016; and severance and other items for all periods. Transaction costs related to the spin-offs for the year ended December 31, 2016 are included in discontinued operations and, therefore, are excluded from the presentation above.

Revenues

	Year Ended December 31,												Percent Change
	2018				2017				2016				2018 vs. 2017		2017 vs. 2016
	(in millions)
Franchise and licensing fees	$	1,530			$	1,321			$	1,091			15.8		21.1
Base and other management fees	$	321			$	324			$	230			(0.9)		40.9
Incentive management fees	235				222				142				5.9		56.3
Total management fees	$	556			$	546			$	372			1.8		46.8

The addition of new managed and franchised properties to our system and the increases in RevPAR at our comparable managed and franchised hotels yielded increases in management and franchise fees in all periods.

Including new development and ownership type transfers, we added, on a net basis, 829 managed and franchised properties from January 1, 2017 to December 31, 2018 and 744 managed and franchised properties from January 1, 2016 to December 31, 2017, providing an additional 144,149 rooms and 133,921 rooms, respectively, to our management and franchise segment. As new hotels stabilize in our system, we expect the fees received from such hotels to increase as they are part of our system for full periods.

Franchise and licensing fees increased as a result of increases in RevPAR at our comparable franchised hotels of 2.3 percent and 2.0 percent during the years ended December 31, 2018 and 2017, respectively, due to increases in ADR of 1.6 percent and 0.9 percent, respectively, as well as increased occupancy of 0.5 percentage points and 0.8 percentage points, respectively. Franchise and licensing fees also increased during the years ended December 31, 2018 and 2017 as a result of net increases in licensing and other fees of $112 million and $148 million, respectively.

On a comparable basis, management fees increased during the years ended December 31, 2018 and 2017 as a result of increases in RevPAR at our managed hotels of 4.4 percent and 3.4 percent, respectively, due to increased occupancy of 1.7 percentage points and 2.4 percentage points, respectively, and, for the year ended December 31, 2018, increased ADR of 2.1 percent. For the year ended December 31, 2018, the increase in management fees was partially offset by a decrease in base and other management fees that was the result of termination fees recognized during the year ended December 31, 2017.

	Year Ended December 31,											Percent Change
	2018				2017				2016			2018 vs. 2017		2017 vs. 2016
	(in millions)
Owned and leased hotels	$	1,484			$	1,432			1,434			3.6		(0.1)

The changes in owned and leased hotel revenues during the years ended December 31, 2018 and 2017 primarily included an increase of $21 million and a decrease of $41 million, respectively, resulting from foreign currency exchange rates and, on a currency neutral basis, increases of $48 million and $41 million, respectively, related to our comparable owned and leased hotels.

The increases in revenues at our comparable owned and leased hotels were primarily the result of improved performance due to increases in RevPAR of 5.3 percent and 4.8 percent during the years ended December 31, 2018 and 2017, respectively, driven by increases in ADR of 3.8 percent and 3.2 percent, respectively, and occupancy growth of 1.1 percentage points and 1.2 percentage points, respectively. These increases were partially offset by decreases in revenues, on a currency neutral basis, at our non-comparable owned and leased hotels, of which $18 million and $5 million, respectively, were due to lease terminations and, for the year ended December 31, 2017, the disposal of a property, which were only partially offset by increases in revenues from a property that opened in 2017.

	Year Ended December 31,												Percent Change
	2018				2017				2016				2018 vs. 2017		2017 vs. 2016
	(in millions)
Other revenues	$	98			$	105			$	82			(6.7)		28.0

Other revenues decreased during the year ended December 31, 2018 and increased during the year ended December 31, 2017, primarily as a result of $28 million and $9 million of recoveries from the settlement of a claim by Hilton to a third party related to our defined benefit plans that were recognized during the years ended December 31, 2017 and 2016, respectively. The decrease during the year ended December 31, 2018 was partially offset by an increase in revenues from our purchasing operations due to increased volume.

Operating Expenses

	Year Ended December 31,												Percent Change
	2018				2017				2016				2018 vs. 2017		2017 vs. 2016
	(in millions)
Owned and leased hotels	$	1,332			$	1,269			$	1,279			5.0		(0.8)

The changes in owned and leased hotel expenses during the years ended December 31, 2018 and 2017 primarily included an increase of $20 million and a decrease of $40 million, respectively, resulting from foreign currency exchange rates and, on a currency neutral basis, increases of $51 million and $39 million, respectively, related to our comparable owned and leased hotels.

The increases in expenses at our comparable owned and leased hotels were primarily due to increased variable operating costs related to occupancy growth and, for the year ended December 31, 2018, increased contingent rent expense resulting from improved performance. The currency neutral increases during the years ended December 31, 2018 and 2017 were partially offset by decreases in owned and leased hotel expenses at our non-comparable owned and leased hotels, of which, $13 million and $6 million, respectively, were due to lease terminations and, for the year ended December 31, 2017, the disposal of a property, which were only partially offset by increases in expenses from a property that opened in 2017. Additionally, the changes included a $4 million refund of rent related to a lease termination that was recognized in 2017.

	Year Ended December 31,												Percent Change
	2018				2017				2016				2018 vs. 2017		2017 vs. 2016
	(in millions)
Depreciation and amortization	$	325			$	336			$	353			(3.3)		(4.8)
General and administrative	443				439				409				0.9		7.3
Other expenses	51				56				66				(8.9)		(15.2)

The decreases in depreciation and amortization expenses during the years ended December 31, 2018 and 2017 were primarily the result of decreases in amortization expense, driven by certain capitalized software costs being fully amortized during the years ended December 31, 2018 and 2017, respectively. Additionally, the decrease in depreciation and amortization expense during the year ended December 31, 2018 included a $5 million decrease in depreciation expense, primarily related to our leased hotels as a result of a lease termination and assets being fully depreciated in 2017.

The increases in general and administrative expenses during the years ended December 31, 2018 and 2017 were primarily the result of increases in payroll and compensation costs, including share-based compensation, which, for the year ended December 31, 2017, was largely driven by an increase in retirement eligible participants resulting in the acceleration of expense recognition, as well as additional expense recognized from a special equity grant to certain participants in connection with the spin-offs. These increases were partially offset by decreases in severance costs related to the 2015 sale and continued management of the Waldorf Astoria New York of $8 million and $10 million, respectively. Additionally, for the year ended December 31, 2017, there were $18 million of costs associated with the spin-offs, while similar costs for the year ended December 31, 2016 were included in discontinued operations.

Other expenses decreased during the year ended December 31, 2018 as a result of impairment losses and costs for the settlement of the claim relating to our defined benefit plans being recognized during the year ended December 31, 2017. These decreases were partially offset by an increase in expenses from our purchasing operations. The decrease in other expenses during the year ended December 31, 2017 was primarily a result of decreased impairment losses of $11 million.

Non-operating Income and Expenses

	Year Ended December 31,												Percent Change
	2018				2017				2016				2018 vs. 2017		2017 vs. 2016
	(in millions)
Interest expense	$	(371	)		$	(351	)		$	(334	)		5.7		5.1
Gain (loss) on foreign currency transactions	(11		)		3				(16		)		NM(1)		NM(1)
Loss on debt extinguishment	—				(60		)		—				NM(1)		NM(1)
Other non-operating income, net	28				29				22				(3.4)		31.8
Income tax benefit (expense)	(309		)		336				(557		)		NM(1)		NM(1)

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(1)	Fluctuation in terms of percentage change is not meaningful.

The increases in interest expense were primarily due to the issuances of the 4.625% Senior Notes due 2025 (the "2025 Senior Notes") and the 4.875% Senior Notes due 2027 (the "2027 Senior Notes") in March 2017 and, for the year ended December 31, 2018, the issuance of the 5.125% Senior Notes due 2026 (the "2026 Senior Notes") in April 2018. The increase during the year ended December 31, 2017 also related to the issuance of the 4.250% Senior Notes due 2024 in August 2016 and the reclassification of losses from accumulated other comprehensive loss resulting from interest rate swaps dedesignated in 2016. These increases were partially offset by decreases in interest expense due to the March 2017 repayment of the 5.625% Senior Notes due 2021 (the "2021 Senior Notes") and the March 2017 refinancing of the senior secured term loan facility (the "Term Loans"), which reduced the interest rate on this borrowing. Additionally, for the year ended December 31, 2018, interest expense decreased due to the April 2018 partial repayment of the Term Loans and the reclassification of gains from accumulated other comprehensive loss resulting from the interest rate swap settled in 2018. See Note 9: "Debt" and Note 11: "Derivative Instruments and Hedging Activities" in our consolidated financial statements for additional information on our indebtedness and interest rate swaps, respectively.

The net gain and losses on foreign currency transactions for all periods were primarily related to changes in foreign currency rates on our short-term cross-currency intercompany loans. The changes were predominantly related to loans denominated in the Australian dollar ("AUD"), the British pound and the euro ("EUR").

The loss on debt extinguishment related to the repayment of the 2021 Senior Notes and included a redemption premium of $42 million and the accelerated recognition of $18 million of unamortized debt issuance costs during the year ended December 31, 2017.

Other non-operating income, net decreased during the year ended December 31, 2018 and increased during the year ended December 31, 2017 due to a $7 million gain that was recognized in 2017 related to an amendment of one of our capital leases. Additionally, for the year ended December 31, 2018, as a result of the partial repayments of the Term Loans in April and December 2018, we accelerated the recognition of deferred financing costs and discount driving a $6 million decrease, which was partially offset by a combined $12 million gain related to the refinancing and early repayment of a loan we issued that financed the construction of a hotel that we manage.

On December 22, 2017, H.R.1, known as the Tax Cuts and Jobs Act of 2017 (the "TCJ Act") was signed into law, which permanently reduced the corporate income tax rate from a graduated 35 percent to a flat 21 percent rate and imposed a one-time transition tax in 2017 on earnings of foreign subsidiaries that were previously deferred. The increase in income tax expense during the year ended December 31, 2018 was the result of a one-time benefit recorded during the year ended December 31, 2017 related to the TCJ Act, as well as an increase in income from continuing operations before incomes taxes, partially offset by the decrease in the annual effective tax rate as a result of the TCJ Act. The income tax benefit during the year ended December 31, 2017 was primarily due to a benefit of $600 million for the estimated impact of the transition tax and the remeasurement of deferred tax assets and liabilities and other tax liabilities based on the rates at which they are expected to reverse in the future. This benefit was partially offset by an increase in tax expense attributable to an increase in income from continuing operations before income taxes compared to the year ended December 31, 2016. See Note 14: "Income Taxes" in our consolidated financial statements for additional information.

Segment Results

We evaluate our business segment operating performance using operating income. Refer to Note 19: "Business Segments" in our consolidated financial statements for a reconciliation of segment operating income to income from continuing operations before income taxes and additional information on the evaluation of the performance of our segments using operating income. The following table sets forth revenues and operating income by segment:

	Year Ended December 31,												Percent Change
	2018				2017				2016				2018 vs. 2017		2017 vs. 2016
	(in millions)
Revenues:
Management and franchise(1)	$	2,157			$	1,927			$	1,521			11.9		26.7
Ownership	1,484				1,432				1,434				3.6		(0.1)
Segment revenues	3,641				3,359				2,955				8.4		13.7
Amortization of contract acquisition costs	(27		)		(17		)		(16		)		58.8		6.3
Other revenues	98				105				82				(6.7)		28.0
Other revenues from managed and franchised properties	5,238				4,727				3,597				10.8		31.4
Intersegment fees elimination(1)	(44		)		(43		)		(42		)		2.3		2.4
Total revenues	$	8,906			$	8,131			$	6,576			9.5		23.6
Operating Income(1):
Management and franchise	$	2,157			$	1,927			$	1,521			11.9		26.7
Ownership	108				120				113				(10.0)		6.2
Segment operating income	$	2,265			$	2,047			$	1,634			10.6		25.3

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(1)	Includes management, royalty and IP fees charged to our ownership segment by our management and franchise segment, which were eliminated in our consolidated financial statements.

Management and franchise segment revenues and operating income increased $230 million and $406 million during the years ended December 31, 2018 and 2017, respectively, as a result of the net addition of managed and franchised properties to our system, increases in RevPAR at our comparable managed and franchised hotels of 2.9 percent and 2.4 percent, respectively, and increases in licensing fees. Refer to "—Revenues" for further discussion of the increases in revenues from our managed and franchised properties.

The changes in ownership segment revenues were the result of foreign currency exchange rates and increases in revenues from our comparable owned and leased hotels due to increases in RevPAR, as well as net decreases in revenues from our non-comparable owned and leased hotels. Ownership operating income decreased during the year ended December 31, 2018 as a result of the increase in owned and leased hotel expenses, partially offset by an increase in segment revenues. Ownership operating income increased during the year ended December 31, 2017 primarily as a result of a decrease in owned and leased hotel expenses. Refer to "—Revenues" and "—Operating Expenses" for further discussion of the changes in revenues and operating expenses at our owned and leased hotels.

Liquidity and Capital Resources

Overview

As of December 31, 2018, we had total cash and cash equivalents of $484 million, including $81 million of restricted cash and cash equivalents. The majority of our restricted cash and cash equivalents balance related to cash collateral on our self-insurance programs.

Our known short-term liquidity requirements primarily consist of funds necessary to pay for operating and other expenditures, including costs associated with the management and franchising of hotels, corporate expenses, payroll and compensation costs, taxes and compliance costs, interest payments on our outstanding indebtedness, contract acquisition costs and capital expenditures for renovations and maintenance at the hotels within our ownership segment. Our long-term liquidity requirements primarily consist of funds necessary to pay for scheduled debt maturities, capital improvements to the hotels within our ownership segment, commitments to owners in our management and franchise segment, dividends as declared, share repurchases and corporate capital and information technology expenditures.

We finance our business activities primarily with existing cash and cash generated from our operations. We believe that this cash will be adequate to meet anticipated requirements for operating and other expenditures, including corporate expenses, payroll and related benefits, taxes and compliance costs and other commitments for the foreseeable future. The objectives of our cash management policy are to maintain the availability of liquidity and minimize operational costs. Further, we have an investment policy that is focused on the preservation of capital and maximizing the return on new and existing investments and returning available capital to stockholders through dividends and share repurchases.

We and our affiliates may from time to time purchase our outstanding debt through open market purchases, privately negotiated transactions or otherwise. Purchases or retirement of debt, if any, will depend on prevailing market conditions, liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.

During the years ended December 31, 2018 and 2017, we repurchased 23.5 million and 13.5 million shares of our common stock for $1.7 billion and $891 million, respectively, which we funded with borrowings and available cash.

Sources and Uses of Our Cash and Cash Equivalents

The following table summarizes our net cash flows:

	Year Ended December 31,												Percent Change
	2018				2017				2016(1)				2018 vs. 2017		2017 vs. 2016
	(in millions)
Net cash provided by operating activities	$	1,255			$	849			$	1,310			47.8		(35.2)
Net cash used in investing activities	(131		)		(147		)		(423		)		(10.9)		(65.2)
Net cash used in financing activities	(1,300		)		(1,724		)		(44		)		(24.6)		NM(2)

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(1)	Includes the cash flows from operating activities, investing activities and financing activities of Hilton, Park and HGV.

(2)	Fluctuation in terms of percentage change is not meaningful.

Operating Activities

Cash flows from operating activities were primarily generated from management and franchise fee revenue and operating income from our owned and leased hotels and, for the year ended December 31, 2016, sales of timeshare units.

The $406 million increase in net cash provided by operating activities during the year ended December 31, 2018 was primarily the result of improved operating results from our management and franchise business, including net growth in

properties, as well as a decrease in net cash paid for income taxes of $238 million. The increase was partially offset by an increase in contract acquisition costs.

The $461 million decrease in net cash provided by operating activities during the year ended December 31, 2017 was primarily the result of a decrease in operating income from our owned and leased properties and sales of timeshare units as a result of the spin-offs.

Investing Activities

For the years ended December 31, 2018, 2017 and 2016, net cash used in investing activities consisted primarily of capital expenditures for property and equipment and capitalized software costs. Our capital expenditures for property and equipment primarily consisted of expenditures related to our corporate facilities and the renovation of hotels in our ownership segment which, for the year ended December 31, 2016, included those hotels owned by Park following completion of the spin-offs. Our capitalized software costs related to various systems initiatives for the benefit of both our hotel owners and our overall corporate operations. Additionally, during the year ended December 31, 2018, these expenditures were offset by the receipt of the repayment of a loan we issued that financed the construction of a hotel that we manage.

Financing Activities

The $424 million decrease in net cash used in financing activities during the year ended December 31, 2018 was primarily attributable to the transfer of cash in connection with the spin-offs during 2017 and the issuance of the $1.5 billion 2026 Senior Notes during the year ended December 31, 2018. These decreases were partially offset by the $800 million repayment of the Term Loans, as well as $1.9 billion of capital returned to our stockholders, which includes dividends and share repurchases, during the year ended December 31, 2018 compared to $1.1 billion of capital returned during the year ended December 31, 2017.

The $1,680 million increase in net cash used in financing activities during the year ended December 31, 2017 was primarily the result of cash transferred in connection with the spin-offs and an increase of $809 million in capital returned to stockholders. In addition, during the year ended December 31, 2017, we received $1.5 billion in proceeds from the issuance of the 2025 Senior Notes and 2027 Senior Notes, which we used with available cash to repay in full our 2021 Senior Notes, including a redemption premium of $42 million.

Debt and Borrowing Capacity

As of December 31, 2018, our total indebtedness, excluding unamortized deferred financing costs and discount, was approximately $7.4 billion. For additional information on our total indebtedness, debt issuances and repayments and guarantees on our debt, refer to Note 9: "Debt" and Note 23: "Condensed Consolidating Guarantor Financial Information" in our consolidated financial statements.

Our senior secured revolving credit facility (the "Revolving Credit Facility") provides for $1.0 billion in borrowings, including the ability to draw up to $150 million in the form of letters of credit. As of December 31, 2018, we had $63 million of letters of credit outstanding, leaving us with a borrowing capacity of $937 million. The maturities of the letters of credit were within one year as of December 31, 2018, and the majority of them related to our self-insurance programs. Subsequent to December 31, 2018, we drew a net $100 million under the Revolving Credit Facility.

If we are unable to generate sufficient cash flow from operations in the future to service our debt, we may be required to reduce capital expenditures, issue additional equity securities or draw on our senior secured revolving credit facility. Our ability to make scheduled principal payments and to pay interest on our debt depends on our future operating performance, which is subject to general conditions in or affecting the hospitality industry that may be beyond our control.

Contractual Obligations

The following table summarizes our significant contractual obligations as of December 31, 2018:

	Payments Due by Period
	Total				Less Than 1 Year				1-3 Years				3-5 Years				More Than 5 Years
	(in millions)
Long-term debt(1)	$	9,111			$	325			$	651			$	3,745			$	4,390
Capital leases	312				30				60				58				164
Operating leases	1,681				206				357				253				865
Purchase commitments	224				60				100				37				27
Total contractual obligations	$	11,328			$	621			$	1,168			$	4,093			$	5,446

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(1)	Includes principal, as well as estimated interest payments. For our variable-rate debt, we have assumed a constant 30-day LIBOR rate of 2.51 percent as of December 31, 2018.

The total amount of unrecognized tax benefits as of December 31, 2018 was $318 million. This amount is excluded from the table above because these unrecognized tax benefits are uncertain and subject to the findings of the taxing authorities in the jurisdictions where we are subject to taxation. It is possible that the amount of the liability for unrecognized tax benefits could change. Refer to Note 14: "Income Taxes" in our consolidated financial statements for additional information.

Off-Balance Sheet Arrangements

Our off-balance sheet arrangements as of December 31, 2018 included letters of credit of $63 million and performance guarantees with possible cash outlays of approximately $36 million, for which we accrued $12 million as of December 31, 2018 for estimated probable exposure. Additionally, we enter into purchase commitments in the normal course of business for which we are reimbursed by the owners of our managed and franchised hotels to operate our marketing, sales and brand programs. These obligations have minimal or no net effect on our future cash flows. See Note 20: "Commitments and Contingencies" in our consolidated financial statements for additional information.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements, the reported amounts of revenues and expenses during the reporting periods and the related disclosures in the consolidated financial statements and accompanying footnotes. We believe that of our significant accounting policies, which are described in Note 2: "Basis of Presentation and Summary of Significant Accounting Policies" in our consolidated financial statements, the following accounting policies are critical because they involve a higher degree of judgment, and the estimates required to be made were based on assumptions that are inherently uncertain. As a result, these accounting policies could materially affect our financial position, results of operations, cash flows and related disclosures. On an ongoing basis, we evaluate these estimates and judgments based on historical experiences and various other factors that are believed to reflect the current circumstances. While we believe our estimates, assumptions and judgments are reasonable, they are based on information presently available. Actual results may differ significantly from these estimates due to changes in judgments, assumptions and conditions as a result of unforeseen events or otherwise, which could have a material effect on our financial position or results of operations.

Management has discussed the development and selection of the following critical accounting policies and estimates with the audit committee of the board of directors.

Property and Equipment

We evaluate the carrying value of our property and equipment for potential impairment by comparing the expected undiscounted future cash flows to the net carrying value of the assets if we determine there are indicators of impairment.

As part of the process described above, we exercise judgment to:

•	determine if there are indicators of impairment present. Factors we consider when making this determination include assessing the overall effect of trends in the hospitality industry and the general economy and regional performance and expectations, historical experience, capital costs and other asset-specific information;

•	determine the projected undiscounted future cash flows when indicators of impairment are present. Judgment is required when developing projections of future revenues and expenses based on estimated growth rates over the expected useful life of the asset group. These estimated growth rates are based on historical operating results, as well as various internal projections and external sources; and

•

determine the asset fair value when required. In determining the fair value, we often use internally-developed discounted cash flow models. Assumptions used in the discounted cash flow models include estimating cash flows, which may require us to adjust for specific market conditions, as well as capitalization rates, which are based on location, property or asset type, market-specific dynamics and overall economic performance. The discount rate takes into account our weighted average cost of capital according to our capital structure and other market specific considerations.

We had $367 million of property and equipment, net as of December 31, 2018. Changes in estimates and assumptions used in our impairment testing of property and equipment could result in future impairment losses, which could be material.

Hilton Honors

Hilton Honors records a point redemption liability for amounts received from participating hotels and program partners in an amount equal to the estimated cost per point of the future redemption obligation. We engage outside actuaries to assist in determining the fair value of the future award redemption obligation using statistical formulas that project future point redemptions based on factors that require judgment, including an estimate of "breakage" (points that will never be redeemed), an estimate of the points that will eventually be redeemed and the cost of the points to be redeemed. The cost of the points to be redeemed includes further estimates of available room nights, occupancy rates, room rates and any devaluation or appreciation of points based on changes in reward prices or changes in points earned per stay. Any amounts received from participating hotels and program partners in excess of the actuarial determined cost per point are recorded as deferred revenues and recognized as revenue upon point redemption.

In addition to the Hilton Honors fees we receive from hotel owners to operate the program, we earn fees from co-brand credit card arrangements for the use of our IP license and the issuance of Hilton Honors points. The allocation of the overall fees from the co-brand credit card arrangements between the IP license and the Hilton Honors points is based on their estimated standalone selling prices. The estimated standalone selling price of the IP license is determined using a relief-from-royalty method using statistical formulas based on factors that require significant judgment, including estimates of credit card usage, an appropriate royalty rate and a discount rate to be applied to the projected cash flows. The estimated standalone selling price of the future reward redemptions under the co-brand credit card arrangements is calculated using a discounted cash flow analysis with the same assumptions related to the point redemption liability as discussed above, adjusted for an appropriate margin.

As of December 31, 2018, we had a $1,669 million liability for guest loyalty program, including $700 million reflected as a current liability, and deferred revenues of $471 million, including $186 million reflected as a current liability. Changes in the estimates used in developing our breakage rate or other expected future program operations could result in material changes to our liability for guest loyalty program and deferred revenues.

Income Taxes

See Note 14: "Income Taxes" in our consolidated financial statements for discussion on the effects of the TCJ Act.

We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying values and the tax basis of assets and liabilities using currently enacted tax rates. We regularly review our deferred tax assets to assess their potential realization and establish a valuation allowance for portions of such assets that we believe will not be ultimately realized. In performing this review, we make estimates and assumptions regarding projected future taxable income, the expected timing of reversals of existing temporary differences and the implementation of tax planning strategies. A change in these assumptions may increase or decrease our valuation allowance resulting in an increase or decrease in our effective tax rate, which could materially affect our consolidated financial statements.

We use a prescribed more-likely-than-not recognition threshold for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return if there is uncertainty in income taxes recognized in the consolidated financial statements. When determining the amount of tax benefit to be recognized, we assume, among other items, the position will be examined, the examiner will have all relevant information and the evaluation of the position should be based on its technical merits. Further, estimates based on the tax position’s technical merits and amounts we would ultimately accept in a negotiated settlement with the tax authorities are used to measure the largest amount of benefit that is greater than 50 percent likely of being realized upon settlement. Changes to these assumptions and estimates can lead to an additional income tax benefit (expense), which can materially affect our consolidated financial statements.

Legal Contingencies

We are subject to various legal proceedings and claims, the outcomes of which are subject to significant uncertainty. An estimated loss from a loss contingency will be accrued by a charge to income if it is probable and the amount of the loss can be reasonably estimated. Significant judgment is required when we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially affect our consolidated financial statements.

Consolidations

We use judgment when evaluating whether we have a controlling financial interest in an entity, including the assessment of the importance of rights and privileges of the partners based on voting rights, as well as financial interests in an entity that are not controllable through voting interests. If an entity in which we hold an interest is considered to be a VIE, we use judgment determining whether we are the primary beneficiary, and then consolidate those VIEs for which we have determined we are the primary beneficiary. If the entity in which we hold an interest does not meet the definition of a VIE, we evaluate whether we have a controlling financial interest through our voting interest in the entity. Changes to judgments used in evaluating our partnerships and other investments could materially affect our consolidated financial statements.