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TRIPADVISOR, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the views of our management regarding current expectations and projections about future events and are based on currently available information. Actual results could differ materially from those contained in these forward-looking statements for a variety of reasons, including, but not limited to, those discussed in our Annual Report on Form 10-K for the year ended December 31, 2013, Part I, Item 1A, "Risk Factors," as well as those discussed elsewhere in this report. Other unknown or unpredictable factors also could have a material adverse effect on our business, financial condition and results of operations. Accordingly, readers should not place undue reliance on these forward-looking statements. The use of words such as "anticipates," "estimates," "expects," "intends," "plans" and "believes," among others, generally identify forward-looking statements; however, these words are not the exclusive means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. These forward-looking statements are inherently subject to uncertainties, risks and changes in circumstances that are difficult to predict. We are not under any obligation to, and do not intend to, publicly update or review any of these forward-looking statements, whether as a result of new information, future events or otherwise, even if experience or future events make it clear that any expected results expressed or implied by those forward-looking statements will not be realized. Please carefully review and consider the various disclosures made in this report and in our other reports filed with the SEC that attempt to advise interested parties of the risks and factors that may affect our business, prospects and results of operations. The information included in this Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our Unaudited Consolidated Financial Statements and the accompanying notes included in this Quarterly Report on Form 10-Q, and the Consolidated Financial Statements and accompanying notes, as well as Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2013. Overview TripAdvisor is the world's largest online travel company. Our mission is to help people around the world plan and have the perfect trip by giving them access to the reviews and opinions of the millions of travelers who make up our global online community. TripAdvisor aggregates reviews and opinions about destinations, accommodations, restaurants and activities throughout the world. Our platform also enables consumers to book hotels, vacation rentals, airline tickets, vacation packages, destination services, restaurant reservations and even cruises. Our branded websites include tripadvisor.com in the United States and localized versions of the website in 41 other countries, including China under the brand daodao.com. Our TripAdvisor-branded websites globally averaged nearly 280 million monthly unique visitors during the quarter ended June 30, 2014, according to Google Analytics. We currently feature over 170 million reviews and opinions on more than 850,000 hotels and accommodations and approximately 640,000 vacation rentals, 2.3 million restaurants and 450,000 attractions in 142,000 destinations throughout the world. Beyond travel-related content, our websites also include links to the websites of our customers, including travel advertisers, allowing travelers to directly book their travel arrangements. In addition to the flagship TripAdvisor brand, we now manage and operate 23 other travel media brands, connected by the common goal of providing comprehensive travel planning resources across the travel sector. Executive Summary At present, our financial results are principally dependent on our ability to grow click-based advertising revenue. We continue to invest in areas of potential click-based revenue growth, including international and mobile initiatives, while also investing in our display-based advertising, Business Listings and Vacation Rentals products. We aim to leverage our position as the largest online travel company to become an increasingly important partner for advertisers-including hoteliers, online travel agencies ("OTA's") and other travel-related service providers-by providing our partners with access to a large audience of highly-qualified, highly-engaged users. The key drivers of our click-based and display-based advertising revenue are described below, as well as a summary of our key growth areas and the current trends impacting our business. 22 --------------------------------------------------------------------------------Key Drivers of Click-Based Advertising Revenue For both the three and six months ended June 30, 2014, 73% of our total revenue came from our core cost-per-click ("CPC")-based lead generation product. For the three and six months ended June 30, 2013, 74% and 76%, respectively, of our total revenue came from our core CPC-based lead generation product. The key drivers of our click-based advertising revenue include the growth in monthly hotel shoppers and revenue per hotel shopper. - Hotel shoppers: Total traffic growth, or growth in monthly visits from unique visitors, is reflective of our overall brand growth. We track and analyze sub-segments of traffic and their correlation to revenue generation and utilize hotel shoppers as an indicator of revenue growth. We use the term "hotel shoppers" to refer to users who view a listing of hotels in a city or visitors who view a specific hotel page. Hotel shoppers tend to be seasonal and also tend to vary based on general economic conditions. Our number of hotel shoppers increased 17% and 14% for the three and six months ended June 30, 2014, respectively, and increased 38% and 37% for the three and six months ended June 30, 2013. The deceleration of hotel shopper growth for the three and six months ended June 30, 2014 is primarily due to high hotel shopper growth from search engine optimization ("SEO") in late 2012 and for the three and six months ending June 30, 2013, which provides for a challenging comparative. We continue to focus our efforts on strategies that will increase the number of hotel shoppers, however, hotel shopper trends remain difficult to predict. As our traffic grows and we optimize the hotel shopper experience on our site, the number of pages on which a user can engage with the TripAdvisor brand also grows. We have captured these additional pages in both the three and six months ended June 30, 2014 hotel shopper growth figure and have also updated our historical hotel shopper growth figure for both the three and six months ended June 30, 2013 for comparative purposes. The impact of this change is immaterial to hotel shopper growth and revenue per hotel shopper and did not affect our unaudited consolidated financial statements for any period presented. - Revenue per hotel shopper: Revenue per hotel shopper is a metric we use to analyze how effectively we are able to monetize hotel shoppers based on a combination of user conversion and pricing. User conversion, or clicks per hotel shopper, is a measure of how many hotel shoppers ultimately click on a CPC link that generates revenue for us. User conversion on our site is primarily driven by three factors: merchandising, commerce coverage and choice. We define merchandising as the number and location of ads that are available on a page; we define commerce coverage as whether we have a client who can take an online booking for a particular property; and we define choice as the number of clients available for any given property, allowing the user to shop for the best price. Pricing is the effective CPC that OTA's and hoteliers are willing to pay us for a hotel shopper lead, by participating in a competitive bidding process which determines the CPC price paid. Revenue per hotel shopper increased 11% and 8% for the three and six months ended June 30, 2014, respectively, and decreased 13% and 11% for the three and six months ended June 30, 2013, respectively. Revenue per hotel shopper increased 11% and 8% for the three and six months ended June 30, 2014, largely due to our implementation of hotel metasearch in June of 2013, which, to date, has resulted in relatively higher CPC pricing paid by our partners, due to higher quality clicks being delivered, mainly offset by relatively lower rates of user conversion. In addition, growth in hotel shoppers on smartphones, which have a lower monetization rate than desktops and tablets, and growth in emerging international markets that are currently monetizing at lower levels than our mature markets continue to provide challenges to our growth rate. In summary, our CPC revenue depends on the number of hotel shoppers that are interested in a property, whether there is a commerce link available for that hotel shopper to click on for that property, whether there are several commerce choices available for that property so the hotel shopper has the benefit of pricing and availability from multiple sources and what our partners are willing to pay us for the lead. While hotel shoppers is an important metric, it is but one component of revenue per hotel shopper which is the primary driver of click-based advertising revenue. Key Drivers of Display-Based Advertising Revenue For both the three and six months ended June 30, 2014, 11% of our total revenue came from our display-based advertising product. For the three and six months ended June 30, 2013, 13% and 12%, respectively, of our total revenue came from our display-based advertising product. The key drivers of our display-based advertising revenue include the growth in number of impressions, or the number of times an ad is displayed on our site, and the cost per thousand impressions ("CPM"). Our number of impressions sold increased 11% and 19% for the three and six months ended June 30, 2014, respectively, and increased 32% and 24% for the three and six months ended June 30, 2013, respectively, while pricing increased 4% and 2% for the three and six months ended June 30, 2014, respectively, and decreased 11% and 8% for three and six months ended June 30, 2013, respectively, according to our log files. Key Growth Areas We continue to invest in areas of potential growth, including our mobile and social initiatives, as well as our Business Listings and Vacation Rentals products. 23 -------------------------------------------------------------------------------- Mobile. Mobile is an investment area that is geared towards creating a more complete user experience by reinforcing the TripAdvisor brand when users are in-market. In the quarter ended June 30, 2014, we saw strong mobile user uptake, as aggregate downloads of our TripAdvisor, TripAdvisor City Guides, SeatGuru, Jetsetter and GateGuru mobile apps reached more than 128 million downloads and average monthly unique visitors via smartphone and tablet devices grew over 77% year-over-year from 79 million to 141 million, according to company logs. We believe that travelers will increasingly use mobile devices, including smartphones and tablets, to conduct travel research and planning. Community Engagement. Engaging our community is a core component of our strategic growth plan. We believe that having strong social presence improves engagement on our sites and improves the sites' "stickiness" amongst the users. As a result, we continue to look for ways to leverage Facebook as well as other community features across our platforms. Specifically, we offer Facebook users a more personalized and social travel planning experience that enables travelers to engage with their Facebook friends' reviews and opinions when planning their perfect trip on TripAdvisor. Business Listings. Created in early 2010, our Business Listings product enables hotel and accommodation owners to list pertinent property information on TripAdvisor, bringing them closer to potential customers and thereby increasing direct bookings. In the year ended December 31, 2013, we grew our Business Listings customer base over 38% to 69,000 subscribers, representing approximately 9% of our current hotel and accommodation listings on TripAdvisor branded sites. We continue to expand our sales force and improve features to grow our subscriber base. Vacation Rentals. As of June 30, 2014, we had amassed an inventory of approximately 640,000 properties, up nearly 40% year-over-year, across our TripAdvisor Vacation Rentals, U.S.-based FlipKey (which includes recently acquired Vacation Home Rentals), and European-based Holiday Lettings and Niumba. We offer individual property owners and property managers the ability to list using a subscription-based fee structure or a free-to-list, commission-based option and we believe our highly-engaged and motivated user community creates a competitive advantage for us in this market. Current Trends Affecting Our Business Increasing Competition. The travel review industry and, more generally, the business of collecting and aggregating travel-related resources and information, continue to be increasingly competitive. In recent years, an increasing number of companies, such as search companies Google, Inc. and Baidu.com, Inc. and several large OTA's, have begun to collect and aggregate travel information and resources. We plan to continue to invest in order to remain the leading source of travel reviews as well as continue to enhance our content and user experience. Refer to our Annual Report on Form 10-K for the year ended December 31, 2013 in "-Competition" in Item 1 "Business" section for additional information on our competition. Increasing Use of Internet and Social Media to Access Travel Information. Commerce, information and advertising continue to migrate to the Internet and away from traditional media outlets. We believe that this trend will continue to create strategic growth opportunities, allowing us to attract new consumers and develop unique and effective advertising solutions. Consumers are increasingly using online social media channels, such as Facebook and Twitter, as a means to communicate and exchange information, including travel information and opinions. We have made significant efforts related to social networking in order to leverage the expanding use of this channel and enhance traffic diversification and user engagement. We are also continually adapting our user experience in response to a changing Internet environment and usage trends. For example, in 2012, we invested in building and introducing to users, hotel metasearch functionality for our smartphone platforms and in June of 2013, we completed the process of implementing hotel metasearch functionality on our desktop and tablet platforms. Hotel metasearch functionality provides hotel shoppers with real-time online hotel availability and pricing information from multiple sources without requiring the user to visit another website. Refer to our metasearch discussion in our Annual Report on Form 10-K for the year ended December 31, 2013 under "Improving the Hotel Shopper Experience" in the "Our Strategy" section in Item 1 "Business" for additional information on our hotel metasearch transition. Increasing Mobile Usage. Users are increasingly using smartphone and tablet computing devices to access the Internet. To address these growing user demands, we continue to extend our platform to develop smartphone and tablet applications to deliver travel information and resources. Although the substantial majority of our smartphone users also access and engage with our websites on personal computers and tablets where we display advertising, our users could decide to access our products primarily through smartphone devices. We do display graphic advertising on smartphones, however, our smartphone monetization strategies are still developing, as smartphone monetization is currently less than 20% of desktop monetization while tablets monetize more closely to desktops. Mobile growth and development remains a key strategy and we will continue to invest and innovate in this growing platform to help us maintain and grow our user base, engagement and monetization over the long term. An example of our mobile development efforts is our assisted booking path, or Instant Booking, which we began integrating into smartphone sessions in April 2014. Currently 100% of U.S. iOS and Android smartphone users now see a "Book on TripAdvisor" button. This product feature allows travelers to complete a hotel reservation, powered by our OTA and hotelier partners, while remaining on the TripAdvisor mobile app. 24 --------------------------------------------------------------------------------We believe Instant Booking will optimize the hotel shopping experience for mobile users. The Company also plans to integrate this feature onto desktop and tablets during 2014. Click-Based Advertising Revenue. In recent years, the majority of our revenue growth resulted from higher click-based advertising revenue due to increased traffic on our websites and an increase in the volume of clicks on our advertisers' placements. Although click-based advertising revenue growth has generally been driven by traffic volume, we remain focused on the various factors that could impact revenue growth, including, but not limited to, the growth in hotel shoppers, CPC pricing fluctuations, the overall economy, the ability of advertisers to monetize our traffic, the quality and mix of traffic to our websites, and the quality and mix of traffic from our advertising placements to advertisers, as well as advertisers' evolving approach to transaction attribution models and return on investment targets. We monitor and regularly respond to changes in these factors in order to strategically improve our user experience, customer satisfaction and monetization in this dynamic environment. For example, in order to improve user experience, we introduced metasearch functionality to our hotel shoppers as discussed above. Segment We have one operating and reportable segment. The segment is determined based on how our chief operating decision maker manages our business, makes operating decisions, evaluates operating performance and allocates resources. The chief operating decision maker for the Company is our Chief Executive Officer. Employees As of June 30, 2014, we had 2,356 employees. Of these employees, 1,235 were based in the United States. We believe we have good relationships with our employees, including relationships with employees represented by international works councils or other similar organizations. Seasonality Expenditures by travel advertisers tend to be seasonal. Traditionally, our strongest quarter has been the third quarter, which is a key travel research period, with the weakest quarter historically being the fourth quarter. However, adverse economic conditions or continued growth of our international operations with differing holiday peaks may influence the typical trend of our seasonality in the future. Critical Accounting Policies and Estimates Critical accounting policies and estimates are those that we believe are important in the preparation of our consolidated financial statements because they require that management use judgment and estimates in applying those policies. We prepare our consolidated financial statements and accompanying notes in accordance with GAAP. Preparation of the consolidated financial statements and accompanying notes requires that management 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. Management bases its estimates on historical experience, where applicable and other assumptions that it believes are reasonable under the circumstances. Actual results may differ from 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. There have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. New Accounting Pronouncements For a discussion of new accounting pronouncements, see "Note 2- Significant Accounting Policies," in the Notes to the Unaudited Consolidated Financial Statements in this Quarterly Report on Form 10-Q. We are an "issuer" (as defined in Section 2(a) of the Sarbanes-Oxley Act of 2002), and, as such, are required to comply with all new and revised accounting standards applicable to public companies. 25 -------------------------------------------------------------------------------- Results of Operations Selected Financial Data (in millions, except per share amounts) Three months ended Six months ended June 30, June 30, 2014 2013 % Change 2014 2013 % Change Revenue $ 323 $ 247 31 % $ 604 $ 477 27 % Costs and expenses: Cost of revenue (1) 9 4 125 % 17 8 113 % Selling and marketing (2) 127 83 53 % 228 162 41 % Technology and content (2) 41 32 28 % 79 61 30 % General and administrative (2) 32 25 28 % 58 48 21 % Depreciation 11 7 57 % 21 13 62 % Amortization of intangible assets 3 2 50 % 5 3 67 % Total costs and expenses: 223 153 46 % 408 295 38 % Operating income 100 94 6 % 196 182 8 % Other income (expense): Interest expense (2 ) (2 ) 0 % (4 ) (5 ) (20 )% Interest income and other, net - (2 ) (100 )% - (3 ) (100 )% Total other expense, net (2 ) (4 ) (50 )% (4 ) (8 ) (50 )% Income before income taxes 98 90 9 % 192 174 10 % Provision for income taxes (30 ) (23 ) 30 % (56 ) (45 ) 24 % Net income $ 68 $ 67 1 % $ 136 $ 129 5 % Earnings per share attributable to common stockholders: Basic $ 0.48 $ 0.47 2 % $ 0.95 $ 0.90 6 % Diluted $ 0.47 $ 0.46 2 % $ 0.93 $ 0.89 4 % Weighted average common shares outstanding: Basic 143 144 (1 )% 143 143 0 % Diluted 146 146 0 % 146 145 1 % Other Financial Data: Adjusted EBITBA (3) $ 129 $ 113 14 % $ 251 $ 222 13 % (1) Excludes amortization as follows: Amortization of website development costs included in depreciation $ 7 $ 5 $ 13 $ 9 (2) Includes stock-based compensation as follows: Selling and marketing $ 3 $ 2 $ 6 $ 5 Technology and content $ 6 $ 4 $ 12 $ 10 General and administrative $ 6 $ 4 $ 11 $ 9 (3) See "Adjusted EBITDA" below for more information. Adjusted EBITDA To provide investors with additional information regarding our financial results, we have disclosed Adjusted EBITDA, which is a non-GAAP financial measure, in our Quarterly Report on Form 10-Q. We have provided a reconciliation below of Adjusted EBITDA to net income, the most directly comparable GAAP financial measure. A "non-GAAP financial measure" refers to a numerical measure of a company's historical or future financial performance, financial position, or cash flows that excludes (or includes) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP in such company's financial statements. 26 -------------------------------------------------------------------------------- We define Adjusted EBITDA as net income (loss) plus: (1) provision for income taxes; (2) other (income) expense, net; (3) depreciation of property and equipment, including amortization of internal use software and website development; (4) amortization of intangible assets; (5) stock-based compensation; and (6) non-recurring expenses. Adjusted EBITDA is the primary metric by which management evaluates the performance of its business and on which internal budgets are based. In particular, the exclusion of certain expenses in calculating Adjusted EBITDA facilitates operating performance comparisons on a period-to-period basis. We believe that by excluding certain non-cash expenses, such as stock-based compensation and non-recurring expenses, Adjusted EBITDA corresponds more closely to the cash that 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. Our use of Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results reported in accordance with GAAP. Some of these limitations are: - Adjusted EBITDA does not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments; - Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs; - Adjusted EBITDA does not reflect the interest expense, or cash requirements necessary to service interest or principal payments on our debt; - Adjusted EBITDA does not consider the potentially dilutive impact of stock-based compensation; - although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements; - Adjusted EBITDA does not reflect tax payments that may represent a reduction in cash available to us; and - other companies, including companies in our own industry, may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure. Because of these limitations, you should consider Adjusted EBITDA alongside other financial performance measures, including various cash flow metrics, net income and our other GAAP results. The following table is a reconciliation of Adjusted EBITDA to net income, the most directly comparable financial measure calculated and presented in accordance with GAAP, for the periods presented: Three months ended Six months ended June 30, June 30, 2014 2013 2014 2013 (in millions) (in millions) Adjusted EBITDA $ 129 $ 113 $ 251 $ 222 Depreciation (1) (11 ) (7 ) (21 ) (13 ) Amortization of intangible assets (3 ) (2 ) (5 ) (3 ) Stock-based compensation (15 ) (10 ) (29 ) (24 ) Other expense, net (2 ) (4 ) (4 ) (8 ) Provision for income taxes (30 ) (23 ) (56 ) (45 ) Net income $ 68 $ 67 $ 136 $ 129 (1) Includes amortization of internal use software and website development costs. Revenue We derive substantially all of our revenue through the sale of advertising, primarily through click-based advertising and, to a lesser extent, display-based advertising. In addition, we earn revenue through a combination of subscription-based offerings related to our Business Listings, subscription and free-to-list commission-based offerings from our Vacation Rentals products, transaction revenue from selling room nights, online restaurant reservations revenue from newly-acquired Lafourchette, and other revenue including, among other things, content licensing. 27 -------------------------------------------------------------------------------- Three months ended Six months ended June 30, June 30, 2014 2013 % Change 2014 2013 % Change (in millions) (in millions) Click-based advertising $ 235 $ 183 28 % $ 442 $ 362 22 % Display-based advertising 37 31 19 % 69 56 23 % Subscription, transaction and other 51 33 55 % 93 59 58 % Total revenue $ 323 $ 247 31 % $ 604 $ 477 27 % Revenue increased $76 million and $127 million during the three and six months ended June 30, 2014, respectively, when compared to the same periods in 2013, primarily due to an increase in click-based advertising revenue of $52 million and $80 million, respectively. The primary driver of the increase in click-based advertising revenue was an increase in hotel shoppers of 17% and 14%, respectively, and an increase in revenue per hotel shopper of 11% and 8% for the three and six months ended June 30, 2014. Display-based advertising increased by $6 million and $13 million during the three and six months ended June 30, 2014, respectively, primarily as a result of a 11% and 19% increase in the number of impressions sold, due to increased sales productivity, and an increase in pricing by 4% and 2%, coupled with worldwide growth particularly in emerging markets when compared to the same periods in 2013, respectively. Subscription, transaction and other revenue increased by $18 million and $34 million during the three and six months ended June 30, 2014, respectively, primarily due to growth in our Business Listings and Vacation Rentals products. The following table presents our revenue by geographic region which reflects how we measure our business internally. Revenue by geography is based on the location of our websites: Three months ended Six months ended June 30, June 30, 2014 2013 % Change 2014 2013 % Change (in millions) (in millions) Revenue by geographic region: North America (1) $ 161 $ 134 20 % $ 307 $ 255 20 % EMEA (2) 107 73 47 % 197 145 36 % APAC (3) 42 30 40 % 77 57 35 % LATAM (4) 13 10 30 % 23 20 15 % Total $ 323 $ 247 31 % $ 604 $ 477 27 % (1) United States and Canada* (2) Europe, Middle East and Africa (3) Asia-Pacific (4) Latin America * Included in international revenue for discussion purposes. International revenue increased $51 million or 42% and $80 million or 34% during the three and six months ended June 30, 2014, respectively, compared to the same periods in 2013. International revenue represented 53% and 52% of total revenue during the three and six months ended June 30, 2014, respectively, and represented 49% of total revenue during both the three and six months ended June 30, 2013. The increase in international revenue, in absolute dollars and as a percentage of total revenue, is primarily due to additional investment in international expansion and growth in international hotel shoppers. Cost of Revenue Cost of revenue consists of expenses that are closely correlated or directly related to revenue generation, including direct costs, such as ad serving fees, flight search fees, transaction fees and data center costs. In addition, cost of revenue includes personnel and overhead expenses, including salaries, benefits, stock-based compensation and bonuses for certain customer support personnel who are directly involved in revenue generation. 28 -------------------------------------------------------------------------------- Three months ended Six months ended June 30, June 30, 2014 2013 2014 vs 2013 2014 2013 2014 vs 2013 (in millions) (in millions) Direct costs $ 8 $ 4 100 % $ 15 $ 8 88 % Personnel and overhead 1 - 100 % 2 - 100 % Total cost of revenue $ 9 $ 4 125 % $ 17 $ 8 113 % % of revenue 2.8 % 1.6 % 2.8 % 1.7 % Cost of revenue increased $5 million and $9 million during the three and six months ended June 30, 2014 when compared to the same periods in 2013, primarily due to increased data center costs, driven by higher site traffic; increased merchant credit card and transaction fees, driven by additional costs from our 2013 business acquisitions and free-to-list growth in our vacation rental products; and customer support costs. Selling and Marketing Sales and marketing expenses primarily consist of direct costs, including search engine marketing ("SEM") other traffic acquisition costs, syndication costs and affiliate program commissions, brand advertising and public relations. In addition, our indirect sales and marketing expense consists of personnel and overhead expenses, including salaries, commissions, benefits, stock-based compensation and bonuses for sales, sales support, customer support and marketing employees. Three months ended Six months ended June 30, June 30, 2014 2013 % Change 2014 2013 % Change (in millions) (in millions) Direct costs $ 89 $ 52 71 % $ 153 $ 103 49 % Personnel and overhead 38 31 23 % 75 59 27 % Total selling and marketing $ 127 $ 83 53 % $ 228 $ 162 41 % % of revenue 39.3 % 33.6 % 37.7 % 34.0 % Direct selling and marketing costs increased $37 million and $50 million during the three and six months ended June 30, 2014 when compared to the same periods in 2013, primarily due to increased SEM costs, other traffic acquisition costs, and offline advertising costs partially offset by a decrease in spending in social media. The primary driver of the increase in our offline advertising costs is related to our new television campaign that was launched in May 2014 and have spent $10 million and $11 million for the three and six months ended June 30, 2014, respectively. Personnel and overhead costs increased $7 million and $16 million during the three and six months ended June 30, 2014, respectively, when compared to the same periods in 2013. This is primarily due to an increase in headcount to support business growth, including international expansion and employees joining us through recent business acquisitions, and also increased stock-based compensation costs. Technology and Content Technology and content expenses consist of personnel and overhead expenses, including salaries, benefits, stock-based compensation and bonuses for salaried employees and contractors engaged in the design, development, testing, content support, and maintenance of our websites. Other costs include licensing, maintenance expense, and technology hardware. Three months ended Six months ended June 30, June 30, 2014 2013 % Change 2014 2013 % Change (in millions) (in millions) Personnel and overhead $ 35 $ 30 17 % $ 67 $ 57 18 % Other 6 2 200 % 12 4 200 % Total technology and content $ 41 $ 32 28 % $ 79 $ 61 30 % % of revenue 12.7 % 13.0 % 13.1 % 12.8 % 29 -------------------------------------------------------------------------------- Technology and content costs increased $9 million and $18 million during the three and six months ended June 30, 2014, respectively, when compared to the same periods in 2013. This was primarily due to increased personnel costs from increased headcount to support business growth, including international expansion and enhanced site features, as well as additional personnel costs related to employees joining us through recent business acquisitions. General and Administrative General and administrative expense consists primarily of personnel and related overhead costs, including executive leadership, finance, legal and human resource functions and stock-based compensation as well as professional service fees and other fees including audit, legal, tax and accounting, and other costs including bad debt expense and our charitable foundation costs. Three months ended Six months ended June 30, June 30, 2014 2013 % Change 2014 2013 % Change (in millions) (in millions) Personnel and overhead $ 23 $ 15 53 % $ 41 $ 31 32 % Professional service fees and other 9 10 (10 %) 17 17 0 % Total general and administrative $ 32 $ 25 28 % $ 58 $ 48 21 % % of revenue 9.9 % 10.1 % 9.6 % 10.1 % General and administrative costs increased $7 million and $10 million during the three and six months ended June 30, 2014, respectively, when compared to the same periods in 2013. This increase resulted primarily from increased personnel costs and office rental costs related to an increase in headcount to support our business operations. Depreciation Three months ended Six months ended June 30, June 30, 2014 2013 2014 2013 (in millions) (in millions) Depreciation $ 11 $ 7 $ 21 $ 13 % of revenue 3.4 % 2.8 % 3.5 % 2.7 % Depreciation expense increased $4 million and $8 million during the three and six months ended June 30, 2014, respectively, when compared to the same periods in 2013, primarily due to increased amortization related to website development costs. Amortization of Intangible Assets Three months ended Six months ended June 30, June 30, 2014 2013 2014 2013 (in millions) (in millions) Amortization of intangible assets $ 3 $ 2 $ 5 $ 3 % of revenue 0.9 % 0.8 % 0.8 % 0.6 % Amortization of intangible assets did not materially change during the three and six months ended June 30, 2014 when compared to the same periods in 2013. 30 --------------------------------------------------------------------------------Interest Expense Interest expense primarily consists of interest incurred, commitment fees and debt issuance cost amortization related to our Credit Agreement and Chinese Credit Facilities. Three months ended Six months ended June 30, June 30, 2014 2013 2014 2013 (in millions) (in millions) Interest expense $ (2 ) $ (2 ) $ (4 ) $ (5 ) Interest expense did not materially change during the three and six months ended June 30, 2014 when compared to the same periods in 2013. Refer to "Note 8- Debt" in the Notes to our Unaudited Consolidated Financial Statements in this Quarterly Report on Form 10-Q for additional information on our outstanding borrowing facilities. Interest Income and Other, Net Interest income and other, net primarily consists of interest earned and amortization of discounts and premiums on our marketable securities, and net foreign exchange gains and losses. Three months ended Six months ended June 30, June 30, 2014 2013 2014 2013 (in millions) (in millions) Interest income and other, net $ - $ (2 ) $ - $ (3 ) Interest income and other, net decreased during the three and six months ended June 30, 2014, respectively, when compared to the same periods in 2013, primarily due to the fluctuation of foreign exchange rates. Our interest income is primarily due to investing in marketable securities. Refer to "Note 4- Financial Instruments" in the Notes to our Unaudited Consolidated Financial Statements in this Quarterly Report on Form 10-Q for additional information on our current investment portfolio as of June 30, 2014. Provision for Income Taxes Three months ended Six months ended June 30, June 30, 2014 2013 2014 2013 (in millions) (in millions) Provision for income taxes $ 30 $ 23 $ 56 $ 45 Effective tax rate 30.6 % 25.6 % 29.2 % 25.9 % For the three and six months ended June 30, 2014, the effective tax rate is less than the federal statutory tax rate primarily due to earnings in jurisdictions outside the United States, where our effective tax rate is lower, which was partially offset by state income taxes, non-deductible stock compensation and accruals on uncertain tax positions. The change in the effective tax rate for 2014 compared to the 2013 rate was primarily due to a change in jurisdictional earnings and certain discrete items. Related Party Transactions For information on our relationship with Liberty Interactive Corporation, refer to "Note 15- Related Party Transactions" in the Notes to our Unaudited Consolidated Financial Statements in this Quarterly Report on Form 10-Q. Stock-Based Compensation Refer to "Note 4- Stock-Based Awards and Other Equity Instruments" in the Notes to our Unaudited Consolidated Financial Statements in this Quarterly Report on Form 10-Q for further information on current year equity award activity, including the issuance of 490,508 primarily service based non-qualified stock options with a weighted average grant-date fair value per option of $47.25 and 512,884 RSU's with a weighted average grant-date fair value of $96.00 during the six months ended June 30, 2014. 31 --------------------------------------------------------------------------------Liquidity and Capital Resources The following section explains how we have generated and used our cash historically, describes our current capital resources and discusses our future financial commitments. Sources and Uses of Cash Our cash flows from operating, investing and financing activities, as reflected in the unaudited consolidated statements of cash flows, are summarized in the following table: Six months ended June 30, 2014 2013 (in millions) Net cash provided by (used in): Operating activities $ 267 $ 133 Investing activities (10 ) (256 ) Financing activities (24 ) (43 ) Our current principal sources of liquidity are cash flows generated from operations, our existing cash, cash equivalents and short and long term available-for-sale marketable securities, and available borrowings under our credit facilities discussed in "Note 8 - Debt" in the Notes to our Unaudited Consolidated Financial Statements in this Quarterly Report on Form 10-Q. As of June 30, 2014 and December 31, 2013, we had $721 million and $670 million, respectively, of cash, cash equivalents and short and long-term available-for-sale marketable securities. As of June 30, 2014 approximately $434 million of our cash, cash equivalents and short and long-term marketable securities are held by our international subsidiaries, primarily in the United Kingdom, and are related to earnings we intend to reinvest permanently outside the United States. Cumulative undistributed earnings of foreign subsidiaries that we intend to indefinitely reinvest outside of the United States totaled approximately $575 million as of June 30, 2014. Should we distribute, or be treated under certain U.S. tax rules as having distributed, the earnings of foreign subsidiaries in the form of dividends or otherwise, we may be subject to U.S. income taxes. Determination of the amount of any unrecognized deferred income tax liability on this temporary difference is not practicable because of the complexities of the hypothetical calculation. Cash held is primarily denominated in U.S. dollars. As of June 30, 2014, $199 million was available under our Revolving Credit Facility representing the total $200 million facility less $1 million of outstanding letters of credit. There are currently no outstanding borrowings under the Revolving Credit Facility. The Revolving Credit Facility bears interest at LIBOR plus 150 basis points, or the Eurocurrency Spread, or the alternate base rate ("ABR") plus 50 basis points, and undrawn amounts are currently subject to a commitment fee of 22.5 basis points, as of June 30, 2014. In addition we have approximately $17 million available under our Chinese Credit Facilities, which currently bear interest at a rate based on 100% of the People's Bank of China's base rate, which was 5.6% as of June 30, 2014. Historically, the cash we generate from operations has been sufficient to fund our working capital requirements, capital expenditures and to meet our long term debt obligations and other financial commitments. Management believes that our cash and cash equivalents and available for sale marketable securities, combined with expected cash flows generated by operating activities and available cash from our credit facilities will be sufficient to fund our ongoing working capital requirements, capital expenditures, business growth initiatives, meet our long term debt obligations and other financial commitments, fund our new corporate lease obligations, share repurchases and fund any potential acquisitions for at least the next twelve months. However, if during that period or thereafter, we are not successful in generating sufficient cash flow from operations or in raising additional capital, including refinancing or incurring additional debt, when required in sufficient amounts and on terms acceptable to us, we may be required to reduce our planned capital expenditures and scale back the scope of our business growth initiatives, either of which could have a material adverse effect on our future financial condition or results of operations. Operating Activities For the six months ended June 30, 2014, net cash provided by operating activities increased by $134 million or 101% when compared to the same period in 2013, primarily due to an increase in working capital movements of $123 million mainly related to an increase in operating cash flow from deferred merchant payables of $63 million, described below, with the remaining increase related to the timing of customer receipts, income tax payments, vendor payments and growth in our business. 32 -------------------------------------------------------------------------------- We receive cash from travelers at the time of booking related to our vacation rental and transaction-based businesses and we record these amounts, net of commissions, on our consolidated balance sheets as deferred merchant payables. We pay the hotel or vacation rental owners after the travelers' use and subsequent billing from the hotel or vacation rental owners. Therefore, we receive cash from the traveler prior to paying the hotel or vacation rental owners, and this operating cycle represents a working capital source of cash to us. As long as our transaction-based businesses grow, we currently expect that changes in working capital related to these transactions will positively impact our annual operating cash flows, although seasonal fluctuations in travel expenditures can affect the timing of our annual cash flows and therefore cash flows can fluctuate quarter to quarter. Investing Activities For the six months ended June 30, 2014, net cash used in investing activities decreased by $246 million when compared to the same period in 2013, primarily due to a net decrease in cash used for the purchases, sales and maturities of our marketable securities of $385 million and cash paid for acquisitions of businesses of $31 million in 2013, both of which were partially offset by cash paid for acquisitions of businesses in 2014 of $152 million and an increase in capital expenditures of $18 million in 2014 when compared against 2013. Financing Activities For the six months ended June 30, 2014, net cash used in financing activities decreased by $19 million when compared to the same period in 2013 primarily due to an increase of $9 million in excess tax benefits related to stock compensation, a $15 million repayment of our outstanding borrowings on our Chinese Credit Facilities in 2013, and payments of $34 million for common stock share repurchases under our authorized share repurchase program in 2013. This was offset by a reduction in proceeds from the exercise of our stock options of $18 million in 2014, due to the introduction in the third quarter of 2013 of the net share settlement of our stock options and an increase in payments of minimum withholding taxes related to net share settlement of equity awards of $17 million in 2014, and a $3 million repayment of our outstanding borrowings on our Chinese Credit Facilities in 2014. Contractual Obligations, Commercial Commitments and Off-Balance Sheet Arrangements There have been no material changes outside the normal course of business to our contractual obligations and commercial commitments since December 31, 2013. Refer to "Contractual Obligations, Commercial Commitments and Off-Balance Sheet Arrangements" in Item 7-Management's Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2013. As of June 30, 2014, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K of the SEC, that have, or are reasonably likely to have, a current or future effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources. Contingencies In the ordinary course of business, we and our subsidiaries are parties to legal proceedings and claims involving alleged infringement of third-party intellectual property rights, defamation, and other claims. Rules of the SEC require the description of material pending legal proceedings, other than ordinary, routine litigation incident to the registrant's business, and advise that proceedings ordinarily need not be described if they primarily involve damages claims for amounts (exclusive of interest and costs) not individually exceeding 10% of the current assets of the registrant and its subsidiaries on a consolidated basis. In the judgment of management, none of the pending litigation matters that we and our subsidiaries are defending involves or is likely to involve amounts of that magnitude. There may be claims or actions pending or threatened against us of which we are currently not aware and the ultimate disposition of which could have a material adverse effect on us. |