OWW 09.30.2012 10Q
 


 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q
(Mark One)
 
R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to ____
Commission File Number: 001-33599
ORBITZ WORLDWIDE, INC.
(Exact name of registrant as specified in its charter)
Delaware
 
20-5337455
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
500 W. Madison Street, Suite 1000
 
 
Chicago, Illinois
 
60661
(Address of principal executive offices)
 
(Zip Code)
(312) 894-5000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes R     No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes R     No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
Accelerated filer R
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No R

As of October 31, 2012, 105,051,759 shares of Common Stock, par value $0.01 per share, of Orbitz Worldwide, Inc. were outstanding.





 


Table of Contents

Table of Contents
 
 
Page
 
 
 
 
 
 
4 
 
 
 
 
 
 
 
 
 
 
 


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Forward-Looking Statements

This Quarterly Report on Form 10-Q and its exhibits contain forward-looking statements that are subject to risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different than the results, performance or achievements expressed or implied by the forward-looking statements. Forward-looking statements include statements about our expectations, beliefs, plans, objectives, intentions, assumptions and other statements that are not historical facts. Forward-looking statements can generally be identified by phrases such as “believes,” “expects,” “potential,” “continues,” “may,” “should,” “seeks,” “predicts,” “anticipates,” “intends,” “projects,” “estimates,” “plans,” “could,” “designed,” “should be” and other similar expressions that denote expectations of future or conditional events rather than statements of fact. Forward-looking statements may relate to our operations, financial results, financial condition, business prospects, growth strategy and liquidity. Our actual results could differ materially from those anticipated in forward-looking statements for many reasons, including the factors described in the sections entitled “Risk Factors” in this Quarterly Report on Form 10-Q and in our 2011 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 5, 2012 and “Management's Discussion and Analysis of Financial Condition and Results of Operations” in this Quarterly Report on Form 10-Q and in our 2011 Annual Report on Form 10-K. Accordingly, you should not unduly rely on these forward-looking statements, which speak only as of the date on which they were made. We undertake no obligation to update any forward-looking statements in this Quarterly Report on Form 10-Q.

The use of the words “we,” “us,” “our” and “the Company” in this Quarterly Report on Form 10-Q refers to Orbitz Worldwide, Inc. and its subsidiaries, except where the context otherwise requires or indicates.


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PART I — FINANCIAL INFORMATION

Item 1.
Financial Statements

ORBITZ WORLDWIDE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands, except share and per share data)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Net revenue
$
198,303

 
$
202,924

 
$
589,059

 
$
589,673

Cost and expenses:
 
 
 
 
 
 
 
Cost of revenue
38,203

 
36,095

 
109,704

 
107,906

Selling, general and administrative
57,071

 
67,679

 
194,696

 
204,180

Marketing
62,640

 
61,351

 
197,304

 
189,867

Depreciation and amortization
14,062

 
14,939

 
42,212

 
45,655

Impairment of other assets
1,417

 

 
1,417

 

Total operating expenses
173,393

 
180,064

 
545,333

 
547,608

Operating income
24,910

 
22,860

 
43,726

 
42,065

Other income/(expense):
 
 
 
 
 
 
 
Net interest expense
(8,847
)
 
(9,746
)
 
(28,086
)
 
(30,052
)
Other income/(expense)
3

 
9

 
(41
)
 
377

Total other expense
(8,844
)
 
(9,737
)
 
(28,127
)
 
(29,675
)
Income before income taxes
16,066

 
13,123

 
15,599

 
12,390

Provision for income taxes
1,248

 
1,890

 
2,708

 
3,162

Net income
$
14,818

 
$
11,233

 
$
12,891

 
$
9,228

 
 
 
 
 
 
 
 
Net income per share - basic:
 
 
 
 
 
 
 
Net income per share
$
0.14

 
$
0.11

 
$
0.12

 
$
0.09

Weighted-average shares outstanding
106,127,706

 
104,652,402

 
105,366,429

 
103,906,153

 
 
 
 
 
 
 
 
Net income per share - diluted:
 
 
 
 
 
 
 
Net income per share
$
0.14

 
$
0.11

 
$
0.12

 
$
0.09

Weighted-average shares outstanding
107,256,562

 
105,509,043

 
107,423,416

 
105,492,208





See Notes to Unaudited Condensed Consolidated Financial Statements.


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Table of Contents

ORBITZ WORLDWIDE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(in thousands)

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Net income
$
14,818

 
$
11,233

 
$
12,891

 
$
9,228

Other comprehensive income/(loss) (a):
 
 
 
 
 
 
 
Currency translation adjustment
(5,622
)
 
6,753

 
(6,746
)
 
2,544

Unrealized gain on floating to fixed interest rate swaps
2

 
183

 
194

 
2,092

Other comprehensive income/(loss)
(5,620
)
 
6,936

 
(6,552
)
 
4,636

Comprehensive income
$
9,198

 
$
18,169

 
$
6,339

 
$
13,864


(a)
There was no income tax impact to other comprehensive income/(loss) for the three and nine months ended September 30, 2012 and 2011.


See Notes to Unaudited Condensed Consolidated Financial Statements.


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ORBITZ WORLDWIDE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except share data)
 
September 30, 2012
 
December 31, 2011
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
152,290

 
$
136,171

Accounts receivable (net of allowance for doubtful accounts of $1,147
and $1,108, respectively)
84,542

 
62,377

Prepaid expenses
12,429

 
15,917

Due from Travelport, net
12,652

 
3,898

Other current assets
4,064

 
2,402

Total current assets
265,977

 
220,765

Property and equipment, net
136,190

 
141,702

Goodwill
647,300

 
647,300

Trademarks and trade names
108,402

 
108,194

Other intangible assets, net
2,888

 
4,162

Deferred income taxes, non-current
5,575

 
7,311

Other non-current assets
20,771

 
16,352

Total Assets
$
1,187,103

 
$
1,145,786

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
21,257

 
$
30,937

Accrued merchant payable
296,026

 
238,694

Accrued expenses
122,998

 
120,962

Deferred income
39,462

 
28,953

Term loan, current
21,900

 
32,183

Other current liabilities
5,841

 
2,034

Total current liabilities
507,484

 
453,763

Term loan, non-current
418,130

 
440,030

Tax sharing liability
71,052

 
68,411

Unfavorable contracts
895

 
4,440

Other non-current liabilities
18,571

 
18,617

Total Liabilities
1,016,132

 
985,261

Commitments and contingencies (see Note 7)


 


Shareholders’ Equity:
 
 
 
Preferred stock, $0.01 par value, 100 shares authorized, no shares issued or
     outstanding

 

Common stock, $0.01 par value, 140,000,000 shares authorized, 105,076,996
and 103,814,769 shares issued, respectively
1,051

 
1,038

Treasury stock, at cost, 25,237 shares held
(52
)
 
(52
)
Additional paid-in capital
1,040,187

 
1,036,093

Accumulated deficit
(867,995
)
 
(880,886
)
Accumulated other comprehensive income/(loss) (net of accumulated tax
    benefit of $2,558)
(2,220
)
 
4,332

Total Shareholders’ Equity
170,971

 
160,525

Total Liabilities and Shareholders’ Equity
$
1,187,103

 
$
1,145,786



See Notes to Unaudited Condensed Consolidated Financial Statements.


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ORBITZ WORLDWIDE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
 
Nine Months Ended
September 30,
 
2012
 
2011
Operating activities:
 
 
 
Net income
$
12,891

 
$
9,228

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
42,212

 
45,655

Impairment of other assets
1,417

 

Amortization of unfavorable contract liability
(5,822
)
 
(1,136
)
Non-cash net interest expense
10,625

 
10,900

Deferred income taxes
2,005

 
2,444

Stock compensation
6,233

 
6,793

Changes in assets and liabilities:
 
 
 
Accounts receivable
(21,544
)
 
(6,896
)
Due from Travelport, net
(8,664
)
 
1,458

Accounts payable, accrued expenses and other current liabilities
1,139

 
11,548

Accrued merchant payable
56,579

 
31,012

Deferred income
13,336

 
6,395

Other
(4,322
)
 
(3,528
)
Net cash provided by operating activities
106,085

 
113,873

Investing activities:
 
 
 
Property and equipment additions
(34,841
)
 
(35,740
)
Changes in restricted cash
(5,252
)
 
(3,657
)
Net cash used in investing activities
(40,093
)
 
(39,397
)
Financing activities:
 
 
 
Payments on the term loan
(32,183
)
 
(19,808
)
Employee tax withholdings related to net share settlements of equity-based awards
(2,126
)
 
(1,426
)
Payments on tax sharing liability
(15,408
)
 
(8,847
)
Payments on note payable
(172
)
 
(171
)
Net cash used in financing activities
(49,889
)
 
(30,252
)
Effects of changes in exchange rates on cash and cash equivalents
16

 
(651
)
Net increase in cash and cash equivalents
16,119

 
43,573

Cash and cash equivalents at beginning of period
136,171

 
97,222

Cash and cash equivalents at end of period
$
152,290

 
$
140,795

Supplemental disclosure of cash flow information:
 
 
 
Income tax payments, net
$
1,128

 
$
1,352

Cash interest payments
$
21,078

 
$
20,039



See Notes to Unaudited Condensed Consolidated Financial Statements.


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ORBITZ WORLDWIDE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1.
Basis of Presentation

Description of the Business

Orbitz, Inc. (“Orbitz”) was formed in early 2000 by American Airlines, Inc., Continental Airlines, Inc., Delta Air Lines, Inc., Northwest Airlines, Inc. and United Air Lines, Inc. (the “Founding Airlines”). In November 2004, Orbitz was acquired by Cendant Corporation (“Cendant”), whose online travel distribution businesses included the HotelClub and RatesToGo brands (collectively referred to as “HotelClub”) and the CheapTickets brand. In February 2005, Cendant acquired ebookers Limited, an international online travel brand which currently has operations in 12 countries throughout Europe (“ebookers”).

On August 23, 2006, Travelport Limited (“Travelport”), which consisted of Cendant's travel distribution services businesses, including the businesses that currently comprise Orbitz Worldwide, Inc., was acquired by affiliates of The Blackstone Group (“Blackstone”) and Technology Crossover Ventures. We refer to this acquisition as the “Blackstone Acquisition.”

Orbitz Worldwide, Inc. was incorporated in Delaware on June 18, 2007 and was formed to be the parent company of the business-to-consumer travel businesses of Travelport, including Orbitz, ebookers and HotelClub and the related subsidiaries and affiliates of those businesses. We are the registrant as a result of the completion of the initial public offering (the “IPO”) of 34,000,000 shares of our common stock on July 25, 2007. At September 30, 2012 and December 31, 2011, Travelport and investment funds that own and/or control Travelport's ultimate parent company beneficially owned approximately 53% and 55% of our outstanding common stock, respectively.

We are a leading global online travel company that uses innovative technology to enable leisure and business travelers to search for and book a broad range of travel products and services. Our brand portfolio includes Orbitz, CheapTickets, The Away Network and Orbitz for Business in the United States; ebookers in Europe; and HotelClub based in Australia, which has operations globally. We provide customers with the ability to book a wide array of travel products and services from suppliers worldwide, including air travel, hotels, vacation packages, car rentals, cruises, travel insurance and destination services such as ground transportation, event tickets and tours.

Basis of Presentation

The accompanying condensed consolidated financial statements of Orbitz Worldwide, Inc. and subsidiaries (the “Company,” “we,” “us,” or “our”) have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and the rules and regulations of the Securities and Exchange Commission (“SEC”) for reporting on Form 10-Q. Certain information and note disclosures normally included in comprehensive annual financial statements presented in accordance with GAAP have been condensed or omitted pursuant to SEC rules and regulations.

 
Management believes that the accompanying condensed consolidated financial statements contain all adjustments, composed of normal recurring adjustments that are, in the opinion of management, necessary to present fairly the Company’s consolidated financial condition, results of operations and cash flows for the periods presented. The results of operations for interim periods are not necessarily indicative of the results that may be expected for the full year. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in our 2011 Annual Report on Form 10-K.

 
The preparation of our condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to matters that require a significant level of judgment or are otherwise subject to an inherent degree of uncertainty. Actual amounts may differ from these estimates.




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ORBITZ WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

2.
Property and Equipment, Net

Property and equipment, net, consisted of the following:
 
September 30, 2012
 
December 31, 2011
 
(in thousands)
Capitalized software
$
313,560

 
$
285,277

Furniture, fixtures and equipment
82,491

 
78,157

Leasehold improvements
13,574

 
13,650

Construction in progress
15,307

 
13,868

Gross property and equipment
424,932

 
390,952

Less: accumulated depreciation
(288,742
)
 
(249,250
)
Property and equipment, net
$
136,190

 
$
141,702


We recorded depreciation expense related to property and equipment in the amount of $13.6 million and $14.3 million for the three months ended September 30, 2012 and 2011, respectively, and $40.9 million and $42.6 million for the nine months ended September 30, 2012 and 2011, respectively.


3.
Accrued Expenses
Accrued expenses consisted of the following:
 
September 30, 2012
 
December 31, 2011
 
(in thousands)
Advertising and marketing
$
34,692

 
$
26,461

Employee costs 
17,684

 
21,220

Customer service costs
12,654

 
8,337

Tax sharing liability (see Note 5)
12,633

 
20,579

Contract exit costs
11,007

 
10,017

Professional fees
7,505

 
6,458

Technology costs
6,548

 
5,406

Customer refunds
5,866

 
5,328

Airline rebates
3,960

 
4,534

Unfavorable contracts (see Note 6)
3,580

 
4,440

Customer incentive costs
3,079

 
2,861

Other
3,790

 
5,321

Total accrued expenses
$
122,998

 
$
120,962



4.
Term Loan and Revolving Credit Facility

On July 25, 2007, we entered into a $685.0 million senior secured credit agreement (the “Credit Agreement”) consisting of a seven-year $600.0 million term loan facility (the “Term Loan”) and a six-year $85.0 million revolving credit facility, which was effectively reduced to a $72.5 million revolving credit facility following the bankruptcy of Lehman Commercial Paper Inc. in October 2008 (the “Revolver”).

Term Loan

The Term Loan bears interest at a variable rate, at our option, of LIBOR plus a margin of 300 basis points or an alternative base rate plus a margin of 200 basis points. The alternative base rate is equal to the higher of the Federal Funds Rate plus one half of 1% and the prime rate (the “Alternative Base Rate”). The principal amount of the Term Loan is payable in quarterly installments of $1.3 million, with the final installment (equal to the remaining outstanding balance) due upon maturity in July 2014. In addition, we are required to make an annual prepayment on the Term Loan in the first quarter of each fiscal

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ORBITZ WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

year in an amount up to 50% of the prior year’s excess cash flow, as defined in the Credit Agreement. Prepayments from excess cash flow are applied, in order of maturity, to the scheduled quarterly Term Loan principal payments. Due to the total excess cash flow payments that we have made, we are not required to make any scheduled principal payments on the Term Loan for the remainder of its term.
The change in the Term Loan during the nine months ended September 30, 2012 was as follows:
 
Amount
 
(in thousands)
Balance at December 31, 2011 (current and non-current)
$
472,213

Prepayment from excess cash flow
(32,183
)
Balance at September 30, 2012 (current and non-current)
$
440,030


Based on our current financial projections for the year ending December 31, 2012, we estimate that we will be required to make a $21.9 million prepayment from excess cash flow in the first quarter of 2013. The amount of prepayment required is subject to change based on actual results, which could differ materially from our financial projections as of September 30, 2012. The potential amount of prepayment from excess cash flow that will be required beyond the first quarter of 2013 is not reasonably estimable as of September 30, 2012.

At September 30, 2012, $100.0 million of the Term Loan had a fixed interest rate as a result of interest rate swaps and $340.0 million had a variable interest rate based on LIBOR, resulting in a blended weighted-average interest rate of 3.3% (see Note 9 - Derivative Financial Instruments).

Revolver

The Revolver provides for borrowings and letters of credit of up to $72.5 million ($42.6 million in U.S. dollars and the equivalent of $29.9 million denominated in Euros and Pounds sterling) and at September 30, 2012 bears interest at a variable rate, at our option, of LIBOR plus a margin of 200 basis points or the Alternative Base Rate plus a margin of 100 basis points. The margin is subject to change based on our total leverage ratio, as defined in the Credit Agreement, with a maximum margin of 250 basis points on LIBOR-based loans and 150 basis points on Alternative Base Rate loans. We incur a commitment fee of 50 basis points on any unused amounts on the Revolver. The Revolver matures in July 2013.

At September 30, 2012 and December 31, 2011, there were no outstanding borrowings under the Revolver and the equivalent of $13.8 million and $10.8 million of outstanding letters of credit issued under the Revolver, respectively (see Note 7 - Commitments and Contingencies). The amount of letters of credit issued under the Revolver reduces the amount available for borrowings. Due to the letters of credit issued under the Revolver, we had $58.7 million and $61.7 million of availability at September 30, 2012 and December 31, 2011, respectively. Commitment fees on unused amounts under the Revolver were $0.1 million for each of the three months ended September 30, 2012 and 2011 and $0.2 million for each of the nine months ended September 30, 2012 and 2011.





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ORBITZ WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

5.
Tax Sharing Liability

We have a liability included in our condensed consolidated balance sheets that relates to a tax sharing agreement between Orbitz and the Founding Airlines. As of September 30, 2012, the estimated remaining payments that may be due under this agreement were approximately $123.9 million. We estimated that the net present value of our obligation to pay tax benefits to the Founding Airlines was $83.7 million and $89.0 million at September 30, 2012 and December 31, 2011, respectively. The change in the tax sharing liability for the nine months ended September 30, 2012 is as follows:
 
Amount
 
(in thousands)
Balance at December 31, 2011 (current and non-current)
$
88,990

Accretion of interest expense (a)
10,103

Cash payments
(15,408
)
Balance at September 30, 2012 (current and non-current)
$
83,685


(a)
We accreted interest expense related to the tax sharing liability of $3.0 million and $3.4 million for the three months ended September 30, 2012 and 2011, respectively, and $10.1 million and $9.9 million for the nine months ended September 30, 2012 and 2011, respectively.

Based upon the estimated timing of future payments we expect to make, the current portion of the tax sharing liability of $12.6 million and $20.6 million was included in accrued expenses in our condensed consolidated balance sheets at September 30, 2012 and December 31, 2011, respectively. The long-term portion of the tax sharing liability of $71.1 million and $68.4 million was reflected as the tax sharing liability in our condensed consolidated balance sheets at September 30, 2012 and December 31, 2011, respectively.


6.
Unfavorable Contracts

In December 2003, we entered into amended and restated airline charter associate agreements (the “Charter Associate Agreements”) with the Founding Airlines as well as with US Airways (the “Charter Associate Airlines”). These agreements pertain to our Orbitz brand, which was owned by the Founding Airlines at the time we entered into the agreements. Under the Charter Associate Agreements, we must pay a portion of the global distribution system (“GDS”) incentive revenue we earn from Worldspan back to the Charter Associate Airlines in the form of a rebate. The rebate payments are required when airline tickets for travel on a Charter Associate Airline are booked through our Orbitz.com and OrbitzforBusiness.com websites utilizing Worldspan.

The rebate structure under the Charter Associate Agreements was considered unfavorable when compared with market conditions at the time of the Blackstone Acquisition. As a result, a net unfavorable contract liability was established on the acquisition date. The amount of this liability was determined based on the discounted cash flows of the expected future rebate payments we would be required to make to the Charter Associate Airlines, net of the fair value of the expected in-kind marketing and promotional support we would receive from the Charter Associate Airlines. The portion of the net unfavorable contract liability related to the expected future rebate payments is amortized as an increase to net revenue, whereas the partially offsetting asset for the expected in-kind marketing and promotional support is amortized as an increase to marketing expense in our condensed consolidated statements of operations, both on a straight-line basis over the remaining contractual term.

The change in the net unfavorable contract liability for the nine months ended September 30, 2012 is as follows:
 
Amount
 
(in thousands)
Balance at December 31, 2011 (current and non-current)
$
8,880

Amortization (a)
(3,187
)
Other (b)
(1,218
)
Balance at September 30, 2012 (current and non-current)
$
4,475

(a)
We recognized net amortization of $1.0 million ($1.6 million was recorded as an increase to net revenue and $0.6 million was recorded as an increase to marketing expense) for the three months ended September 30, 2012 and $0.2

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ORBITZ WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

million ($1.9 million was recorded as an increase to net revenue and $1.7 million was recorded as an increase to marketing expense) for the three months ended September 30, 2011. We recognized net amortization of $3.2 million ($5.3 million was recorded as an increase to net revenue and $2.1 million was recorded as an increase to marketing expense) for the nine months ended September 30, 2012 and $1.1 million ($5.6 million was recorded as an increase to net revenue and $4.5 million was recorded as an increase to marketing expense) for the nine months ended September 30, 2011.
(b)
For the nine months ended September 30, 2012, we reduced the unfavorable contract liability by $1.2 million due to the negotiation of a new agreement with one of our airline suppliers, which resulted in the termination of the former agreement with this airline. The $1.2 million reduction in the liability was comprised of a $2.6 million non-cash increase to net revenue and a $1.4 million non-cash charge to impair the asset related to the in-kind marketing and promotional support that we expected to receive under the former agreement. The impairment charge was included in the impairment of other assets line item in our condensed consolidated statement of operations for the three and nine months ended September 30, 2012.
The current portion of the liability of $3.6 million and $4.4 million was included in accrued expenses in our condensed consolidated balance sheets at September 30, 2012 and December 31, 2011. The long-term portion of the liability of $0.9 million and $4.4 million was reflected as unfavorable contracts in our condensed consolidated balance sheets at September 30, 2012 and December 31, 2011, respectively.


7.
Commitments and Contingencies

Our commitments as of September 30, 2012 did not materially change from the amounts set forth in our 2011 Annual Report on Form 10-K, except for changes in the timing of future payments on the Term Loan (see Note 4 - Term Loan and Revolving Credit Facility).

Company Litigation

We are involved in various claims, legal proceedings and governmental inquiries related to contract disputes, business practices, intellectual property and other commercial, employment and tax matters.

We are party to various cases brought by consumers and state and local governmental entities in the U.S. involving hotel occupancy or related taxes and our merchant hotel business model. Some of the cases are class actions (some of which have been confirmed on a state-wide basis and some of which are purported), and most of the cases were brought simultaneously against other online travel companies, including Expedia, Travelocity and Priceline. The cases allege, among other things, that we violated the jurisdictions' hotel occupancy tax ordinances. While not identical in their allegations, the cases generally assert similar claims, including violations of local or state occupancy tax ordinances, violations of consumer protection ordinances, conversion, unjust enrichment, imposition of a constructive trust, demand for a legal or equitable accounting, injunctive relief, declaratory judgment, and in some cases, civil conspiracy. The plaintiffs seek relief in a variety of forms, including: declaratory judgment, full accounting of monies owed, imposition of a constructive trust, compensatory and punitive damages, disgorgement, restitution, interest, penalties and costs, attorneys' fees, and where a class action has been claimed, an order certifying the action as a class action. An adverse ruling in one or more of these cases could require us to pay tax retroactively and prospectively and possibly pay penalties, interest and fines. The proliferation of additional cases could result in substantial additional defense costs.

We have also been contacted by several municipalities or other taxing bodies concerning our possible obligations with respect to state or local hotel occupancy or related taxes. The following taxing bodies have issued notices to the Company: the Louisiana Department of Revenue; the Montana Department of Revenue; the Wyoming Department of Revenue; the Kentucky Department of Revenue; an entity representing 84 cities and 14 counties in Alabama; 43 cities in California; the cities of Paradise Valley and Phoenix, Arizona; North Little Rock and Pine Bluff, Arkansas; Aurora, Broomfield, Colorado Springs, Golden, Greenwood Village, Lakewood, Littleton, Loveland, and Steamboat Springs, Colorado; and the counties of Jefferson, Arkansas; Arlington, Texas; Brunswick and Stanly, North Carolina; Duval, Florida; and Davis, Summit, Salt Lake and Weber, Utah. These taxing authorities have not issued assessments, but have requested information to conduct an audit and/or have requested that the Company register to pay local hotel occupancy taxes. On May 17, 2012, the Louisiana Department of Revenue announced that it had suspended its audit of the online travel companies.


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ORBITZ WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Assessments that are administratively final and subject to judicial review have been issued by the cities of Anaheim, San Francisco, Santa Monica and San Diego, California; the city of Denver, Colorado; the counties of Miami-Dade and Broward, Florida; the Indiana Department of Revenue; the Hawaii Department of Taxation; and the Wisconsin Department of Revenue. In addition, the following taxing authorities have issued assessments which are subject to further review by the taxing authorities: the Colorado Department of Revenue; the City of Aurora, Colorado; the Maryland Comptroller; the Texas Comptroller; the West Virginia Department of Revenue; the South Carolina Department of Revenue; the city of Los Angeles, California; the city of Philadelphia, Pennsylvania; the City of Portland, Oregon; and Osceola, Florida. The Company disputes that any hotel occupancy or related tax is owed under these ordinances and is challenging the assessments made against the Company. These assessments range from $250 to approximately $58 million, and total approximately $80 million. Some of these assessments, including a $58 million assessment from the Hawaii Department of Taxation, are not based on historical transaction data. On several occasions, where the Company has received an assessment, it has been required to provide financial security or pay the assessment to the municipality in order to seek judicial review.

The online travel companies, including Orbitz, have prevailed in the large majority of hotel tax cases that have been decided to date. However, there have been two adverse trial court decisions against Orbitz and the other online travel companies, and we estimate that, if affirmed, they could result in a total liability of up to $7 million to the Company. First, related to the City of San Antonio hotel occupancy tax case, in July 2011 the United States District Court for the Western District of Texas issued its findings of fact and conclusions of law in which it held the defendant online travel companies, including Orbitz, liable for hotel occupancy taxes on markup, fees, and breakage revenue, and also imposed penalties and interest. The online travel companies have asked the court to modify its findings of fact and conclusions of law to conform to the Texas Court of Appeals' decision in the City of Houston case, which determined that the online travel companies are not liable under an ordinance that is similar to the ones at issue in the San Antonio class action. The court has not yet ruled on the online travel companies' motion. If the court does not grant the motion, and enters judgment, we intend to appeal. Because we do not believe a loss is probable given the issues pending before the district court, and those issues that would exist on appeal if an adverse judgment is entered, we have not accrued any liability related to this case. Second, in September 2012, the Superior Court of the District of Columbia granted the District's motion for partial summary judgment and denied the online travel companies' motion for summary judgment, finding Orbitz liable for sales tax on hotel reservations dating back to the inception of the merchant model. The Court has not yet determined the amount of damages at issue. Although the Court acknowledged that the District had amended its law in 2011, and that the sales tax law was ambiguous prior to that time, the Court nonetheless found the online travel companies liable for merchant model hotel reservations before the amendment date. Because the Court's finding of ambiguity is inconsistent with a determination that the online travel companies are liable, we plan to appeal and do not believe a loss is probable. Accordingly, we have not accrued any liability relating to the District of Columbia case for the period prior to 2011. Although the Company expects to prevail in both matters, it is possible that we will not prevail, and if that occurs, we estimate that the Company could be required to pay up to approximately $7 million.

In July 2011, Trilegiant Corporation filed an action for breach of contract and declaratory judgment in the Supreme Court of New York against us, alleging that we are obligated to make a series of termination payments arising out of a promotion agreement that we terminated in 2007. In 2007, we accrued the present value of the termination payments, and as of September 30, 2012, we had a remaining accrual totaling $11.7 million, which was included within accrued expenses and other long-term liabilities in our condensed consolidated balance sheet; in 2010, in connection with a dispute with Trilegiant, we ceased making termination payments.

On August 20, 2012, a putative consumer class action was filed in the United States District Court for the Northern District of California against certain hotel chains and the major online travel companies, including Orbitz. The complaint alleges that the hotel chains and several major online travel companies, including Orbitz, have violated the antitrust and consumer protection laws by entering into agreements in which online travel companies agree not to facilitate the reservation of hotel rooms at prices that are less than what the hotel chain offers on its own website. Following the filing of the initial complaint on August 20, 2012, approximately 20 additional putative consumer class action complaints have been filed in federal and state courts across the country. We expect that these cases will be consolidated in a single forum later this year. We do not believe that a loss is probable. We are unable to estimate a range of our potential loss if we do not prevail in this litigation.

We believe that we have meritorious defenses, and we are vigorously defending against these claims, proceedings and inquiries. At September 30, 2012 and December 31, 2011, we had a $1.1 million and $0.9 million accrual related to various legal proceedings, respectively. Litigation is inherently unpredictable and, although we believe we have valid defenses in these matters, unfavorable resolutions could occur. Although we believe it is unlikely that an adverse outcome will result from these proceedings, an adverse outcome could be material to us with respect to earnings or cash flows in any given reporting period.

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ORBITZ WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


During the three and nine months ended September 30, 2012, we recorded a reduction to selling, general and administrative expense of $5.0 million in our condensed consolidated statements of operations related to an insurance reimbursement received for costs incurred to defend our hotel occupancy tax cases. No such reimbursement was received during the nine months ended September 30, 2011, and we will not receive any additional insurance reimbursements in future periods as our related insurance coverage limits have been reached.

Financing Arrangements

We are required to issue letters of credit to support certain suppliers, commercial agreements, leases and non-U.S. regulatory and governmental agencies primarily to satisfy consumer protection requirements. The majority of these letters of credit were issued by Travelport on our behalf under the terms of the Separation Agreement, as amended (the “Separation Agreement”), entered into in connection with the IPO. Travelport is obligated to issue letters of credit on our behalf in an aggregate amount not to exceed $75.0 million (denominated in U.S. dollars) so long as Travelport and its affiliates (as defined in the Separation Agreement) own at least 50% of our voting stock. At September 30, 2012 and December 31, 2011, there were $73.5 million and $74.2 million, respectively, of outstanding letters of credit issued by Travelport on our behalf.

Travelport charges us fees for issuing, renewing or extending letters of credit on our behalf. In February 2012, we made a one-time payment to Travelport of $3.0 million related to fees associated with an amendment to the Travelport credit facility, entered into during 2011, under which Travelport issues letters of credit on our behalf. This payment is subject to a refund provision through September 30, 2013 if Travelport is no longer obligated to provide letters of credit on our behalf or if we obtain our own letter of credit facility. We are recognizing the $3.0 million payment to Travelport over the term of its underlying credit facility, or approximately two and a half years. The expenses related to these fees are included in interest expense in our consolidated statements of operations.

At September 30, 2012 and December 31, 2011, there were the equivalent of $13.8 million and $10.8 million, respectively, of outstanding letters of credit issued under the Revolver, the majority of which were denominated in Pounds sterling (see note 4 - Term Loan and Revolving Credit Facility).

During the third quarter of 2012, we secured a new multi-currency letter of credit facility (the “Facility”) that terminates in September 2015. The Facility provides for the issuance of letters of credit up to $25.0 million. We pay fees of 25 basis points on outstanding letters of credit and incur a commitment fee of 37.5 basis points on any unused amounts of the Facility. The Facility requires cash to be held in a collateral account in an unrestricted subsidiary equal to 1.03 times the outstanding letters of credit amount plus fees. As of September 30, 2012, we had $1.8 million of outstanding letters of credit issued under the Facility which were denominated in Pounds sterling.

At September 30, 2012 and December 31, 2011, there were a total of $89.1 million and $85.0 million of outstanding letters of credit issued under our various arrangements. Total letter of credit fees were $1.6 million and $1.4 million for the three months ended September 30, 2012 and 2011, respectively, and $5.0 million and $4.1 million for the nine months ended September 30, 2012 and 2011, respectively.

In order to comply with certain non-U.S. consumer protection regulations, as well as with the terms of the Facility, and for other general business purposes, we had restricted cash totaling $12.7 million and $7.3 million at September 30, 2012 and December 31, 2011, respectively. Such amounts were included in other non-current assets in our condensed consolidated balance sheets.


8.
Equity-Based Compensation

We issue share-based awards under the Orbitz Worldwide, Inc. 2007 Equity and Incentive Plan, as amended (the “Plan”). The Plan provides for the grant of equity-based awards, including restricted stock, restricted stock units, stock options, stock appreciation rights and other equity-based awards to our directors, officers and other employees, advisors and consultants who are selected by the Compensation Committee of the Board of Directors for participation in the Plan. At our Annual Meeting of Shareholders on June 12, 2012, our shareholders approved an amendment to the Plan, increasing the total number of shares of our common stock available for issuance under the Plan from 21,100,000 shares to 24,100,000 shares, subject to adjustment as provided by the Plan. As of September 30, 2012, 8,482,551 shares were available for future issuance under the plan.


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ORBITZ WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Restricted Stock Units

We granted 1,889,000 restricted stock units (“RSUs”) during the nine months ended September 30, 2012 with a weighted-average grant date fair value per share of $3.61. The fair value of RSUs is amortized on a straight-line basis over the requisite service period, and the majority of these RSUs vest annually over a four-year period.

Performance-Based Restricted Stock Units

We granted 1,425,000 performance-based restricted stock units (“PSUs”) in June 2012 with a fair value per share of $3.65 to certain of our executive officers. The PSUs entitle the executives to receive one share of our common stock for each PSU, subject to the satisfaction of a performance condition. The performance condition requires that the Company's net revenue for fiscal year 2012 equal or exceed a certain threshold, or each PSU will be forfeited. If this performance condition is met, the PSUs will vest annually over a four-year period. As of September 30, 2012, we did not expect that the performance condition will be satisfied.

Non-Employee Directors Deferred Compensation Plan

We granted 301,517 deferred stock units to our non-employee directors during the nine months ended September 30, 2012 with a weighted-average grant date fair value per share of $3.53. These deferred stock units are issued as restricted stock units under the Plan and are immediately vested and non-forfeitable. The entire grant date fair value of deferred stock units is recognized on the date of grant.

Compensation Expense

We recognized total equity-based compensation expense of $1.9 million for the three months ended September 30, 2012 and 2011, and $6.2 million and $6.8 million for the nine months ended September 30, 2012 and 2011, respectively, none of which has provided us with a tax benefit. As of September 30, 2012, a total of $15.4 million of unrecognized compensation costs related to unvested restricted stock units, unvested stock options and unvested PSUs are expected to be recognized over the remaining weighted-average period of 2.9 years.


9.
Derivative Financial Instruments

Interest Rate Hedges

At September 30, 2012, we had the following interest rate swap outstanding that effectively converted $100.0 million of the Term Loan from a variable to a fixed interest rate. We pay a fixed interest rate on the swap and in exchange receive a variable interest rate based on the one-month LIBOR.
Notional Amount
 
Effective Date
 
Maturity Date
 
Fixed Interest
Rate Paid
 
Variable Interest
Rate Received
$100.0 million
 
July 29, 2011
 
July 31, 2013
 
0.68%
 
One-month LIBOR

The following interest rate swaps that effectively converted an additional $200.0 million of the Term Loan from a variable to a fixed interest rate matured in January 2012:
Notional Amount
 
Effective Date
 
Maturity Date
 
Fixed Interest
Rate Paid
 
Variable Interest
Rate Received
$100.0 million
 
January 29, 2010
 
January 31, 2012
 
1.15%
 
One-month LIBOR
$100.0 million
 
January 29, 2010
 
January 31, 2012
 
1.21%
 
Three-month LIBOR

The objective of entering into our interest rate swaps is to protect against volatility of future cash flows and effectively hedge a portion of the variable interest payments on the Term Loan. We determined that these designated hedging instruments qualify for cash flow hedge accounting treatment. Our interest rate swaps are the only derivative financial instruments that we have designated as hedging instruments.


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ORBITZ WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The interest rate swaps were reflected in our condensed consolidated balance sheets at market value. The corresponding market adjustment was recorded to accumulated other comprehensive income (“OCI”). The following table shows the fair value of our interest rate swaps:
 
 
 
Fair Value Measurements as of
 
Balance Sheet Location
 
September 30, 2012
 
December 31, 2011
 
 
 
(in thousands)
Interest rate swaps
Other current liabilities
 
$
392

 
$
275

Interest rate swaps
Other non-current liabilities
 
$

 
$
311


The following table shows the market adjustments recorded during the three months ended September 30, 2012 and 2011:
 
Gain in Other Comprehensive Income
 
(Loss) Reclassified from Accumulated OCI into Interest Expense (Effective Portion)
 
Gain/(Loss) Recognized in Income (Ineffective Portion and the Amount Excluded from Effectiveness Testing)
 
2012
 
2011
 
2012
 
2011
 
2012
 
2011
 
 
 
 
 
(in thousands)
 
 
 
 
Interest rate swaps
$
2

 
$
183

 
$
(104
)
 
$
(558
)
 
$

 
$



The following table shows the market adjustments recorded during the nine months ended September 30, 2012 and 2011:
 
Gain in Other Comprehensive Income
 
(Loss) Reclassified from Accumulated OCI into Interest Expense (Effective Portion)
 
Gain/(Loss) Recognized in Income (Ineffective Portion and the Amount Excluded from Effectiveness Testing)
 
2012
 
2011
 
2012
 
2011
 
2012
 
2011
 
 
 
 
 
(in thousands)
 
 
 
 
Interest rate swaps
$
194

 
$
2,092

 
$
(447
)
 
$
(2,773
)
 
$

 
$


The amount of loss recorded in accumulated other comprehensive income at September 30, 2012 that is expected to be reclassified to interest expense in the next twelve months if interest rates remain unchanged is approximately $0.4 million after-tax.

Foreign Currency Hedges

We enter into foreign currency contracts to manage our exposure to changes in the foreign currency associated with foreign currency receivables, payables, intercompany transactions and borrowings, if any, under the Revolver. We primarily hedge our foreign currency exposure to the Pound sterling and the Australian dollar. As of September 30, 2012, we had foreign currency contracts outstanding with a total net notional amount of $320.6 million, almost all of which matured in October 2012. The foreign currency contracts do not qualify for hedge accounting treatment; accordingly, changes in the fair value of the foreign currency contracts are reflected in net income as a component of selling, general and administrative expense in our condensed consolidated statements of operations.

The following table shows the fair value of our foreign currency hedges:
 
 
 
Fair Value Measurements as of
 
Balance Sheet Location
 
September 30, 2012
 
December 31, 2011
 
 
 
(in thousands)
Asset Derivatives:
 
 
 

 
 

Foreign currency hedges
Other current assets
 
$
265

 
$
991

Liability Derivatives:
 
 
 

 
 

Foreign currency hedges
Other current liabilities
 
$
3,437

 
$
495




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ORBITZ WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following table shows the changes in the fair value of our foreign currency contracts which were recorded as a gain/(loss) in selling, general and administrative expense:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
 
(in thousands)
Foreign currency hedges (a)
$
(4,810
)
 
$
5,506

 
$
(9,680
)
 
$
2,939


(a)
We recorded transaction gains/(losses) associated with the re-measurement and settlement of our foreign denominated assets and liabilities of $4.3 million and $(7.2) million for the three months ended September 30, 2012 and 2011, respectively, and gains/(losses) of $6.8 million and $(7.1) million for the nine months ended September 30, 2012 and 2011, respectively. These transaction gains and losses were included in selling, general and administrative expense in our condensed consolidated statements of operations. The net impact of these transaction gains and losses, together with the gains and losses incurred on our foreign currency hedges, were losses of $0.5 million and $1.7 million for the three months ended September 30, 2012 and 2011, respectively, and $2.8 million and $4.2 million for the nine months ended September 30, 2012 and 2011, respectively.


10.
Net Income per Share

We calculate basic net income per share by dividing the net income for the period by the weighted-average number of shares outstanding during the period. The weighted-average number of shares includes common shares outstanding and deferred stock units, which are immediately vested and non-forfeitable. Diluted net income per share is calculated by dividing the net income for the period by the weighted-average number of common shares outstanding and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares are determined by the application of the treasury stock method.

The following table presents the weighted-average shares outstanding used in the calculation of net income per share:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Weighted-Average Shares Outstanding
2012
 
2011
 
2012
 
2011
Basic
106,127,706

 
104,652,402

 
105,366,429

 
103,906,153

Diluted effect of:
 
 
 
 
 
 
 
Restricted stock units
954,959

 
855,477

 
1,631,050

 
1,542,629

Performance-based restricted stock units
173,578

 
1,164

 
425,668

 
43,426

Stock options
319

 

 
269

 

Diluted
107,256,562

 
105,509,043

 
107,423,416

 
105,492,208


The following equity awards were not included in the diluted net income/loss per share calculation because they would have had an antidilutive effect:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Antidilutive Equity Awards
2012
 
2011
 
2012
 
2011
Stock options
2,863,480

 
3,684,245

 
3,094,930

 
3,684,245

Restricted stock units
2,120,750

 
1,311,488

 
1,166,502

 
1,311,488

Performance-based restricted stock units
1,578,500

 
1,065,250

 
577,281

 
1,065,250

Total
6,562,730

 
6,060,983

 
4,838,713

 
6,060,983




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ORBITZ WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

11.
Related Party Transactions

Related Party Transactions with Travelport and its Subsidiaries

We had amounts due from Travelport of $12.7 million and $3.9 million at September 30, 2012 and December 31, 2011, respectively. Amounts due to or from Travelport are generally settled on a net basis.

The following table summarizes the related party transactions with Travelport and its subsidiaries, reflected in our condensed consolidated statements of operations:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
 
(in thousands)
Net revenue (a)
$
22,655

 
$
26,482

 
$
78,875

 
$
87,302

Cost of revenue
$
14

 
$
173

 
$
155

 
$
566

Selling, general and administrative expense
$
64

 
$
98

 
$
199

 
$
799

Interest expense (b)
$
1,554

 
$
1,287

 
$
4,830

 
$
3,915


(a)
Net revenue for the nine months ended September 30, 2011 included incremental GDS incentive revenue recognized through June 1, 2011 under the February 2011 Letter Agreement with Travelport. The Letter Agreement provided for increased segment incentives payable from Travelport during the temporary absence of American Airlines' ticketing authority on certain of our websites, which was reinstated on June 1, 2011.
(b)
Interest expense relates to letters of credit issued on our behalf by Travelport (see Note 7 - Commitments and Contingencies).

Related Party Transactions with Other Affiliates of Blackstone

In the course of conducting business, we have entered into various agreements with other affiliates of Blackstone. For example, we have agreements with certain hotel management companies that are affiliates of Blackstone and that provide us with access to their inventory. We also purchase services from certain Blackstone affiliates such as telecommunications and advertising. In addition, various Blackstone affiliates utilize our partner marketing programs and corporate travel services. We believe that these agreements have been executed on terms comparable to those available from unrelated third parties.

The following table summarizes the related party balances with other affiliates of Blackstone, reflected in our condensed consolidated balance sheets:
 
September 30, 2012
 
December 31, 2011
 
(in thousands)
Accounts receivable
$
380

 
$
374

Accounts payable
$
218

 
$
4,647

Accrued merchant payable
$
724

 
$
6,022

Accrued expenses
$
35

 
$


The following table summarizes the related party transactions with other affiliates of Blackstone, reflected in our condensed consolidated statements of operations:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
 
(in thousands)
Net revenue
$
2,734

 
$
6,474

 
$
11,546

 
$
17,698

Cost of revenue
$

 
$

 
$

 
$
15,144

Selling, general and administrative expense
$
140

 
$
175

 
$
527

 
$
2,195

Marketing
$

 
$

 
$

 
$
70


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ORBITZ WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


12.
Fair Value Measurements

The following table shows the fair value of our assets and liabilities that are required to be measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011, which are classified as cash and cash equivalents, other current assets, other current liabilities and other non-current liabilities in our condensed consolidated balance sheets.
 
Fair Value Measurements as of
 
September 30, 2012
 
December 31, 2011
 
Total
 
Quoted prices in
active markets
(Level 1)
 
Significant
other
observable
inputs
(Level 2)
 
Significant unobservable
inputs
(Level 3)
 
Total
 
Quoted prices in
active markets
(Level 1)
 
Significant
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Assets:
(in thousands)
Money market funds
$
16,005

 
$
16,005

 
$

 
$

 
$
36,002

 
$
36,002

 
$

 
$

Foreign currency hedge assets
$
265

 
$
265

 
$

 
$

 
$
991

 
$
991

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency hedge liabilities
$
3,437

 
$
3,437

 
$

 
$

 
$
495

 
$
495

 
$

 
$

Interest rate swap liabilities
$
392

 
$

 
$
392

 
$

 
$
586

 
$

 
$
586

 
$


We value our foreign currency hedges based on the difference between the foreign currency contract rate and widely available foreign currency rates as of the measurement date. Our foreign currency hedges are short-term in nature, generally maturing within 30 days. We value our interest rate swaps using valuations that are calibrated to the initial trade prices. Using a market-based approach, subsequent valuations are based on observable inputs to the valuation model including interest rates, credit spreads and volatilities.

Fair Value of Financial Instruments

For certain of our financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, accrued merchant payable and accrued expenses, the carrying value approximates or equals fair value due to their short-term nature.

The carrying value of the Term Loan was $440.0 million at September 30, 2012, compared with a fair value of $432.3 million. At December 31, 2011, the carrying value of the Term Loan was $472.2 million, compared with a fair value of $415.5 million. The fair values were determined based on quoted market ask prices, which is classified as a Level 2 measurement.


13.
Income Taxes

We have established a liability for unrecognized tax benefits of $3.8 million and $3.4 million at September 30, 2012 and December 31, 2011, respectively, that management believes to be adequate. The total amount of unrecognized benefits that, if recognized, would affect our effective tax rate was $1.1 million and $0.7 million at September 30, 2012 and December 31, 2011. During the next twelve months, we anticipate a reduction to this liability due to the lapsing of statutes of limitations of approximately $0.1 million, all of which would affect our effective tax rate.

In computing the tax provision for the three and nine months ended September 30, 2012, we recognized an income tax provision in tax jurisdictions in which we had pre-tax income for the period and are expecting to generate pre-tax book income during the remainder of fiscal year 2012. We recognized an income tax benefit in tax jurisdictions in which we incurred pre-tax losses for the three and nine months ended September 30, 2012 and are expecting to be able to realize the benefits associated with these losses during the remainder of fiscal year 2012 or are expecting to recognize a deferred tax asset related to such losses at December 31, 2012. We recognized no income tax benefit in tax jurisdictions in which we incurred pre-tax losses for the three and nine months ended September 30, 2012 and are neither expecting to be able to realize the benefits associated with these losses during the remainder of fiscal year 2012 nor expecting to recognize a deferred tax asset related to such losses at December 31, 2012.

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Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our condensed consolidated financial statements included elsewhere in this report and our 2011 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 5, 2012.

EXECUTIVE OVERVIEW

General

We are a leading global online travel company (“OTC”) that uses innovative technology to enable leisure and business travelers to search for and book a broad range of travel products and services. Our brand portfolio includes Orbitz, CheapTickets, The Away Network and Orbitz for Business in the United States; ebookers in Europe; and HotelClub and RatesToGo (collectively referred to as “HotelClub”) based in Australia, which have operations globally. We provide customers with the ability to book a wide array of travel products and services from suppliers worldwide, including air travel, hotels, vacation packages, car rentals, cruises, travel insurance and destination services such as ground transportation, event tickets and tours. Our mission is to unlock the joy of travel by becoming the travel expert for the world, where our customers easily find and book personalized travel options.
Industry Trends
The online travel industry is highly competitive, and our position in the industry is affected by the industry-wide trends discussed below, as well as a number of factors specific to our global operations and supplier relationships. In addition, the presence of high unemployment rates and related pressure on consumer spending, as well as perceived uncertainty about the state of the global economy, particularly in Europe, cause uncertainty and volatility in the travel market.
Over the past few years, fundamentals in the global hotel industry have strengthened. However, while we have generally seen growth in average daily rates for hotels, during 2012 we have seen the deceleration of these growth rates on a global basis, driven in part by macroeconomic conditions in Europe.
Demand in the air travel industry has also strengthened over the past few years, but this has been driven largely by increased corporate travel, resulting in higher airfares. In addition, while air capacity for major air suppliers was up slightly during the second half of 2011, we are seeing a slight decline in capacity in 2012.
Our suppliers continue to look for ways to decrease their overall distribution costs, which could significantly reduce the net revenue OTCs earn from travel and other ancillary travel products. We have encountered, and expect to continue to encounter, pressure on supplier economics as certain supply agreements are renegotiated. As a result, the net revenue we and other OTCs earn in the form of incentive payments from global distribution systems (“GDSs”) or in the form of mark-ups and commissions from our suppliers are likely to be impacted over the long term.
Intense competition in the travel industry has historically led OTCs and travel suppliers to aggressively spend on online marketing. Competition for search engine key words continues to be intense as certain OTCs and travel suppliers increase their marketing spending in this area. In addition, as meta-search engines continue to expand their presence in the online travel market, competition will intensify and could increase the cost to acquire traffic. In addition, last year Google launched Google Flights, which directs consumers to suppliers' websites for potential booking of travel and to OTC sites only on a limited basis; if this search-engine site gains popularity, the cost to acquire traffic could also increase.



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RESULTS OF OPERATIONS
 
Three Months Ended September 30,
 
Increase/ (Decrease)
 
Nine Months Ended September 30,
 
Increase/ (Decrease)
 
2012
 
2011
 
$
 
%
 
2012
 
2011
 
$
 
%
 
(in thousands)
 
 
 
(in thousands)
 
 
Net revenue
$
198,303

 
$
202,924

 
$
(4,621
)
 
(2
)%
 
$
589,059

 
$
589,673

 
$
(614
)
 
 %
Cost and expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of revenue
38,203

 
36,095

 
2,108

 
6
 %
 
109,704

 
107,906

 
1,798

 
2
 %
Selling, general and administrative
57,071

 
67,679

 
(10,608
)
 
(16
)%
 
194,696

 
204,180

 
(9,484
)
 
(5
)%
Marketing
62,640

 
61,351

 
1,289

 
2
 %
 
197,304

 
189,867

 
7,437

 
4
 %
Depreciation and amortization
14,062

 
14,939

 
(877
)
 
(6
)%
 
42,212

 
45,655

 
(3,443
)
 
(8
)%
Impairment of other assets
1,417

 

 
1,417

 
**

 
1,417

 

 
1,417

 
**

Total operating expenses
173,393

 
180,064

 
(6,671
)
 
(4
)%
 
545,333

 
547,608

 
(2,275
)
 
 %
Operating income
24,910

 
22,860

 
2,050

 
9
 %
 
43,726

 
42,065

 
1,661

 
4
 %
Other income/(expense):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest expense
(8,847
)
 
(9,746
)
 
899

 
(9
)%
 
(28,086
)
 
(30,052
)
 
1,966

 
(7
)%
Other income/(expense)
3

 
9

 
(6
)
 
(67
)%
 
(41
)
 
377

 
(418
)
 
**

Total other expense
(8,844
)
 
(9,737
)
 
893

 
(9
)%
 
(28,127
)
 
(29,675
)
 
1,548

 
(5
)%
Income before income taxes
16,066

 
13,123

 
2,943

 
22
 %
 
15,599

 
12,390

 
3,209

 
26
 %
Provision for income taxes
1,248

 
1,890

 
(642
)
 
(34
)%
 
2,708

 
3,162

 
(454
)
 
(14
)%
Net income
$
14,818

 
$
11,233

 
$
3,585

 
32
 %
 
$
12,891

 
$
9,228

 
$
3,663

 
40
 %

** Not meaningful.

Overall Financial Results
In February 2012, we completed a multi-year initiative to bring all of our consumer brands onto a common global technology platform, with the successful migration of the remaining air, car and dynamic packages paths of Orbitz.com. With this migration project behind us, we have increased our focus on technology innovation and growth. The completion of this migration effort has created opportunities for us to enhance efficiency, site performance and the consumer experience in 2012 and beyond.

During the third quarter of 2012, we reported net income of $14.8 million, compared with $11.2 million in the third quarter of 2011. Our overall results were impacted by certain external factors, including economic challenges in Europe, a stronger U.S. dollar and declining domestic air travel in the OTC channel. In addition, we experienced air operational issues for our domestic leisure brands during the quarter that impacted both our air and hotel performance. We have addressed these issues and have since seen an improvement in performance.

Domestically, hotel and vacation package transaction volumes continued to grow in the third quarter. In addition, air volume declined in the quarter due to a combination of lower U.S. OTC channel volume, the operational issues noted above and changes we made with respect to certain revenue management strategies in the third quarter of 2011.

Internationally, in the third quarter of 2012 we continued to see growth in hotel and vacation package transaction volumes at ebookers; however, performance was affected by unfavorable foreign currency fluctuations and the weak macroeconomic conditions in Europe. In addition, HotelClub experienced improving hotel transaction performance in the quarter.


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Table of Contents

Net Revenue

The table below shows our gross bookings, net revenue, transaction growth and hotel room night growth for the three and nine months ended September 30, 2012 and 2011. Gross bookings, transactions and stayed hotel room nights not only impact our net revenue trends, but these metrics also provide insight into changes in overall travel demand, both industry-wide and on our websites. Air gross bookings are comprised of stand-alone air gross bookings, while non-air gross bookings include gross bookings from hotels, car rentals, vacation packages, cruises, destination services and travel insurance.
 
 
Three Months Ended September 30,
 
Increase/
(Decrease)
 
Nine Months Ended September 30,
 
Increase/
(Decrease)
 
 
2012
 
2011
 
$
 
%
 
2012
 
2011
 
$
 
%
 
 
(in thousands)
 
 
 
(in thousands)
 
 
Gross bookings:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Domestic:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Air (a)
 
$
1,486,923

 
$
1,671,058

 
$
(184,135
)
 
(11
)%
 
$
5,089,100

 
$
5,249,942

 
$
(160,842
)
 
(3
)%
Non-air (b)
 
600,875

 
579,885

 
$
20,990

 
4
 %
 
1,890,674

 
1,791,666

 
99,008

 
6
 %
Total domestic gross bookings
 
2,087,798

 
2,250,943

 
(163,145
)
 
(7
)%
 
6,979,774

 
7,041,608

 
(61,834
)
 
(1
)%
International:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Air (c)
 
335,014

 
355,077

 
(20,063
)
 
(6
)%
 
1,091,024

 
1,097,987

 
(6,963
)
 
(1
)%
Non-air (d)
 
227,684

 
244,130

 
(16,446
)
 
(7
)%
 
692,918

 
682,912

 
10,006

 
1
 %
Total international gross bookings
 
562,698

 
599,207

 
(36,509
)
 
(6
)%
 
1,783,942

 
1,780,899

 
3,043

 
 %
Total gross bookings
 
$
2,650,496

 
$
2,850,150

 
$
(199,654
)
 
(7
)%
 
$
8,763,716

 
$
8,822,507

 
$
(58,791
)
 
(1
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net revenue:
 
 
 
 
 
 

 
 

 
 
 
 
 
 

 
 

Air
 
$
61,917

 
$
63,850

 
$
(1,933
)
 
(3
)%
 
$
201,474

 
$
205,872

 
$
(4,398
)
 
(2
)%
Hotel
 
61,189

 
59,094

 
2,095

 
4
 %
 
166,549

 
159,479

 
7,070

 
4
 %
Vacation package
 
33,384

 
32,393

 
991

 
3
 %
 
100,026

 
91,730

 
8,296

 
9
 %
Advertising and media
 
14,347

 
14,310

 
37

 
 %
 
41,077

 
40,624

 
453

 
1
 %
Other
 
27,466

 
33,277

 
(5,811
)
 
(17
)%
 
79,933

 
91,968

 
(12,035
)
 
(13
)%
Total net revenue (e)
 
$
198,303

 
$
202,924

 
$
(4,621
)
 
(2
)%
 
$
589,059

 
$
589,673

 
$
(614
)
 
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net revenue:
 
 
 
 
 
 

 
 

 
 
 
 
 
 

 
 

Domestic
 
$
142,297

 
$
142,214

 
$
83

 
 %
 
$
424,713

 
$
418,573

 
$
6,140

 
1
 %
International
 
56,006

 
60,710

 
(4,704
)
 
(8
)%
 
164,346

 
171,100

 
(6,754
)
 
(4
)%
Total net revenue (e)
 
$
198,303

 
$
202,924

 
$
(4,621
)
 
(2
)%
 
$
589,059

 
$
589,673

 
$
(614
)
 
 %
Transaction and hotel room night growth/(decline):
 
 
 
 
 
 
 
 
 
 
 
 
Booked transactions
 
(7
)%
 
(7
)%
 
 
 
 
 
(3
)%
 
(8
)%
 
 
 
 
Stayed hotel room nights
 
 %
 
(1
)%
 
 
 
 
 
2
 %
 
(1
)%
 
 
 
 

(a)
The decrease in domestic air gross bookings for the three and nine months ended September 30, 2012 was driven primarily by lower transaction volume, partially offset by higher air fares.
(b)
The increase in domestic non-air gross bookings for the three and nine months ended September 30, 2012 was due primarily to higher hotel and vacation package volume.
(c)
For the three and nine months ended September 30, 2012, international air gross bookings were impacted by unfavorable foreign currency fluctuations in the European market as compared with the prior-year periods. For the three months ended September 30, 2012, unfavorable foreign currency fluctuations and lower transaction volume were partially offset by higher air pricing. For the nine months ended September 30, 2012, unfavorable foreign currency fluctuations were partially offset by higher air pricing and higher transaction volume.
(d)
For the three and nine months ended September 30, 2012, international non-air gross bookings were impacted by unfavorable foreign currency fluctuations in the European market as compared with the prior-year periods. For the three months ended September 30, 2012, unfavorable foreign currency fluctuations were partially offset by higher pricing. For the nine months ended September 30, 2012, higher pricing and higher transaction volume were partially offset by unfavorable foreign currency fluctuations.

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(e)
For the three months ended September 30, 2012 and 2011, $28.1 million and $29.9 million of our total net revenue, respectively, was from incentive payments earned for air, car and hotel segments processed through GDSs. For the nine months ended September 30, 2012 and 2011, $90.6 million and $97.2 million of our total net revenue, respectively, was from incentive payments earned for air, car and hotel segments processed through GDSs.

Net revenue decreased $4.6 million for the three months ended September 30, 2012 compared with the three months ended September 30, 2011, and it decreased $0.6 million for the nine months ended September 30, 2012 as compared with the nine months ended September 30, 2011. Excluding unfavorable foreign exchange fluctuations, revenue increased by $0.3 million and $8.8 million, respectively, for the three and nine months ended September 30, 2012 from the comparable prior-year periods.

Air.  Net revenue from air bookings decreased $1.9 million and $4.4 million for the three and nine months ended September 30, 2012, respectively, as compared with the three and nine months ended September 30, 2011. Excluding the impact of foreign currency fluctuations, net revenue from air bookings decreased $0.2 million and $0.4 million for the three and nine months ended September 30, 2012, respectively, from the comparable prior-year periods.

Domestic air net revenue decreased $0.4 million and $1.6 million for the three and nine months ended September 30, 2012, respectively, as compared with the three and nine months ended September 30, 2011. These decreases were due primarily to lower transaction volume and, for the nine-month period, the absence in 2012 of the incremental incentive revenue earned per segment processed through Travelport GDSs from December 2010 through June 1, 2011. The lower domestic transaction volume for the three and nine months ended September 30, 2012 was driven primarily by lower U.S. OTC channel volume and changes we made with respect to certain revenue management strategies. Additionally, for the third quarter, air volume declined due to certain operational issues, which have since been resolved. The lower volume was partially offset by higher net revenue per airline ticket, primarily resulting from these revenue management strategies, and the recognition of $2.6 million due to a reduction in our unfavorable contract liability resulting from the negotiation of a new agreement with one of our airline suppliers (see Note 6 - Unfavorable Contracts of the Notes to the Consolidated Financial Statements).

International air net revenue decreased by $1.5 million for the three months ended September 30, 2012 as compared with the three months ended September 30, 2011 (an increase of $0.2 million excluding the impact of foreign currency fluctuations). International air net revenue decreased by $2.8 million for the nine months ended September 30, 2012 as compared with the nine months ended September 30, 2011 (an increase of $1.2 million, excluding the impact of foreign currency fluctuations). On a constant currency basis, the increase in international air net revenue for the third quarter of 2012 was due primarily to higher revenue per ticket, partially offset by lower transaction volume. For the nine months ended September 30, 2012, the increase in international air net revenue was driven primarily by higher transaction volume.

Hotel.  Net revenue from hotel bookings increased $2.1 million or 4%, and $7.1 million or 4%, for the three and nine months ended September 30, 2012, respectively, compared with the three and nine months ended September 30, 2011. Excluding the impact of foreign currency fluctuations, net revenue from hotel bookings increased $3.0 million and $8.6 million for the three and nine months ended September 30, 2011.

For the three and nine months ended September 30, 2012, domestic hotel net revenue increased $2.8 million and $10.0 million as compared with the three and nine months ended September 30, 2011, respectively. These increases were due primarily to higher net revenue per room night.

International hotel net revenue decreased $0.7 million and $2.9 million for the three and nine months ended September 30, 2012, respectively, as compared with the three and nine months ended September 30, 2011 (an increase of $0.2 million and a decrease of $1.4 million, respectively, excluding the impact of foreign currency fluctuations). For the three months ended September 30, 2012, the increase on a constant currency basis was due to growth in stayed room nights at ebookers and higher net revenue per room night, partially offset by lower stayed room nights at HotelClub. The decrease on a constant currency basis for the nine months ended September 30, 2012 was due to lower stayed room nights at HotelClub, partially offset by growth in stayed room nights at ebookers and higher net revenue per room night.

Vacation package.  As compared with the three and nine months ended September 30, 2011, net revenue from vacation package bookings increased $1.0 million or 3%, and $8.3 million or 9%, for the three and nine months ended September 30, 2012, respectively. Excluding the impact of foreign currency fluctuations, net revenue from vacation package bookings increased $2.1 million and $10.1 million for the three and nine months ended September 30, 2012, as compared with the three and nine months ended September 30, 2011.


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Table of Contents

Domestic vacation package net revenue increased by $0.5 million and $4.9 million for the three and nine months ended September 30, 2012, respectively, as compared with the three and nine months ended September 30, 2011, driven primarily by increased transaction volume, partially offset by a shift in package mix to lower margin packages.

International vacation package net revenue increased $0.5 million and $3.4 million for the three and nine months ended September 30, 2012, respectively, as compared with the three and nine months ended September 30, 2011 (an increase of $1.6 million and $5.2 million, respectively, excluding the impact of foreign currency fluctuations). These increases were due primarily to higher transaction volume for ebookers.
 
Advertising and media.  Advertising and media net revenue remained flat and increased $0.5 million or 1%, for the three and nine months ended September 30, 2012, respectively, compared with the three and nine months ended September 30, 2011. The increase for the nine-month period was driven by higher display advertising.

Other.  Other net revenue is comprised primarily of net revenue from travel insurance, car bookings, cruise bookings, and destination services. Other net revenue decreased $5.8 million, or 17%, for the three months ended September 30, 2012 compared with the three months ended September 30, 2011 (a decrease of $4.8 million excluding the impact of foreign currency), and $12.0 million or 13%, for the nine months ended September 30, 2012 compared with the nine months ended September 30, 2011 (a decrease of $10.3 million excluding the impact of foreign currency). The decreases were primarily driven by lower international car revenue, due largely to lower pricing, and lower insurance revenue. Insurance revenue decreased year-over-year due to a new regulation issued by the Department of Transportation effective in January 2012 that no longer allows for the travel insurance option to be pre-selected, which reduced the attachment rate for insurance products. In addition, for the nine-month period, revenue from hosting services decreased from the prior-year period due to the termination of our last hosting agreement in July 2011.

Costs and Expenses

Cost of Revenue

Our cost of revenue is comprised of costs to operate our customer service call centers, credit card processing fees and other costs, which include customer refunds and charge-backs, hosting costs and connectivity and other processing costs.
 
 
Three Months Ended September 30,
 
Increase/
(Decrease)
 
Nine Months Ended September 30,
 
Increase/
(Decrease)
 
 
2012
 
2011
 
$
 
%
 
2012
 
2011
 
$
 
%
Cost of revenue:
 
(in thousands)
 
 
 
(in thousands)
 
 
Customer service costs
 
$
16,299

 
$
13,766

 
$
2,533

 
18
 %
 
$
43,111

 
$
41,697

 
$
1,414

 
3
 %
Credit card processing fees
 
11,913

 
12,389

 
(476
)
 
(4
)%
 
36,121

 
36,782

 
(661
)
 
(2
)%
Other
 
9,991

 
9,940

 
51

 
1
 %
 
30,472

 
29,427

 
1,045

 
4
 %
Total cost of revenue
 
$
38,203

 
$
36,095

 
$
2,108

 
6
 %
 
$
109,704

 
$
107,906

 
$
1,798

 
2
 %

Cost of revenue increased $2.1 million (a $2.9 million increase excluding the impact of foreign currency fluctuations) for the three months ended September 30, 2012 compared with the three months ended September 30, 2011, due primarily to a $2.5 million increase in customer service costs to support the growth in our private label distribution channel, partially offset by a $0.5 million decrease in credit card processing fees.

Cost of revenue increased $1.8 million (a $3.5 million increase excluding the impact of foreign currency fluctuations) for the nine months ended September 30, 2012 compared with the nine months ended September 30, 2011, due primarily to a $1.4 million increase in customer services costs and a $1.1 million increase in customer refunds and charge-backs, partially offset by a $0.7 million decrease in credit card processing fees.


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Table of Contents

Selling, General and Administrative

Our selling, general and administrative expense is comprised of wages and benefits, contract labor costs, network communications, systems maintenance and equipment costs and other costs, which include professional fees, foreign currency transaction and hedging and other administrative costs.
 
 
Three Months Ended September 30,
 
Increase/
(Decrease)
 
Nine Months Ended September 30,
 
Increase/
(Decrease)
 
 
2012
 
2011
 
$
 
%
 
2012
 
2011
 
$
 
%
Selling, general and
     administrative:
 
(in thousands)
 
 
 
(in thousands)
 
 
Wages and benefits (a)
 
$
33,420

 
$
36,291

 
$
(2,871
)
 
(8
)%
 
$
109,212

 
$
114,184

 
$
(4,972
)
 
(4
)%
Contract labor (a)
 
6,861

 
7,311

 
(450
)
 
(6
)%
 
20,499

 
19,989

 
510

 
3
 %
Network communications, systems
     maintenance and equipment
 
7,335

 
6,765

 
570

 
8
 %
 
21,111

 
19,458

 
1,653

 
8
 %
Other
 
9,455

 
17,312

 
(7,857
)
 
(45
)%
 
43,874

 
50,549

 
(6,675
)
 
(13
)%
Total selling, general, and
     administrative
 
$
57,071

 
$
67,679

 
$
(10,608
)
 
(16
)%
 
$
194,696

 
$
204,180

 
$
(9,484
)
 
(5
)%

(a)
The amounts presented above for wages and benefits and contract labor are net of amounts capitalized related to software development.

Selling, general and administrative expense decreased $10.6 million (a $9.1 million decrease excluding the impact of foreign currency fluctuations) for the three months ended September 30, 2012 compared with the three months ended September 30, 2011. This decrease was driven primarily by a $5.3 million decrease in professional fees, a $2.9 million decrease in wages and benefits, a $1.2 million decrease in foreign currency losses and hedging costs and a $0.5 million decrease in contract labor costs, partially offset by a $0.6 million increase in network communications, systems maintenance and equipment costs. The decrease in professional fees was due primarily to a $5.0 million insurance reimbursement received for costs previously incurred to defend our hotel occupancy tax cases. No such reimbursement was received during the three or nine months ended September 30, 2011, and we will not receive any additional insurance reimbursements in future periods as our related insurance coverage limits have been reached. Wages and benefits and contract labor costs decreased due to cost savings achieved from the migration of HotelClub to the global platform and lower incentive compensation.

Selling, general and administrative expense decreased $9.5 million ($6.4 million excluding the impact of foreign currency fluctuations) for the nine months ended September 30, 2012 compared with the nine months ended September 30, 2011. The decrease in expense was primarily driven by a $5.0 million decrease in wages and benefits, a $4.1 million decrease in professional fees, and a $1.4 million decrease in foreign currency losses and hedging costs, partially offset by a $1.7 million increase in network communications, systems maintenance and equipment costs. Wages and benefits and contract labor costs decreased due to the centralization of our finance function in our European operations in 2011,cost savings achieved from the migration of HotelClub to the global platform and lower incentive compensation. The decrease in professional fees was due primarily to a $5.0 million insurance reimbursement received for costs previously incurred to defend our hotel occupancy tax cases.

Marketing

Our marketing expense is primarily comprised of online marketing costs, such as search engine marketing, travel research and affiliates, and offline marketing costs, such as television, radio and print advertising. Our online marketing spending is significantly greater than our offline marketing spending. Marketing expense increased $1.3 million ($3.1 million excluding the impact of foreign currency fluctuations) for the three months ended September 30, 2012 compared with the three months ended September 30, 2011, and $7.4 million ($11.1 million excluding the impact of foreign currency fluctuations) for the nine months ended September 30, 2012 compared with the nine months ended September 30, 2011. The year-over-year increase in marketing expense for the three-month period was due primarily to growth of our private label distribution channel, partially offset by lower online marketing spend. The increase in marketing expense for the nine-month period year-over-year was due primarily to higher global online marketing spend as well as growth of our private label distribution channel, offset partially by a decline in offline marketing.


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Table of Contents

Depreciation and Amortization

Depreciation and amortization expense decreased $0.9 million, both reported and excluding the impact of foreign currency fluctuations, for the three months ended September 30, 2012 compared with the three months ended September 30, 2011. Depreciation and amortization expense decreased $3.4 million, both reported and excluding the impact of foreign currency fluctuations, for the nine months ended September 30, 2012 compared with the nine months ended September 30, 2011. The decreases in depreciation and amortization expense were due primarily to certain fixed and other assets that became fully depreciated and amortized in 2011.

Impairment of Other Assets

In the three months ended September 30, 2012, we reduced the unfavorable contract liability by $1.2 million due to the negotiation of a new agreement with one of our airline suppliers, resulting in the termination of the former agreement with this airline. The $1.2 million reduction in the liability was comprised of a $2.6 million non-cash increase to net revenue (see Air Revenue discussion above) and a $1.4 million non-cash charge to impair the asset related to the in-kind marketing and promotional support that we expected to receive under the agreement (see Note 6 - Unfavorable Contracts of the Notes to the Condensed Consolidated Financial Statements).

Due to macroeconomic uncertainty and other factors, we cannot assure that goodwill, indefinite-lived intangible assets and finite-lived assets will not be impaired in future periods.

Net Interest Expense

Net interest expense decreased $0.9 million for the three months ended September 30, 2012 compared with the three months ended September 30, 2011, and $2.0 million for the nine months ended September 30, 2012 compared with the nine months ended September 30, 2011. The year-over-year decreases in net interest expense for the three- and nine-month periods were due primarily to lower effective interest rates on the Term Loan (including related interest rate hedges) and, to a lesser extent, lower average debt outstanding during 2012, partially offset by higher letter of credit fees. In the three-month period, the decrease was also driven by lower non-cash interest expense related to the tax sharing liability.

Provision for Income Taxes

We recorded a tax provision of $1.2 million and $1.9 million for the three months ended September 30, 2012 and 2011, respectively, and $2.7 million and $3.2 million for the nine months ended September 30, 2012 and 2011, respectively. The tax provisions were due primarily to taxes on the income of certain European-based subsidiaries and U.S. state and local income taxes. The decrease in tax expense for the three and nine months ended September 30, 2012 compared with the prior-year periods was due to a decrease in pretax earnings in certain foreign jurisdictions and a decrease in U.S. earnings subject to state and local income taxes.

As of September 30, 2012, the valuation allowance for our deferred tax assets was $302.3 million, of which $192.1 million relates to U.S. jurisdictions. We have maintained full valuation allowances in all jurisdictions that had previously established a valuation allowance. We will continue to assess the level of the valuation allowance required; if sufficient positive evidence exists in future periods to support a release of some or all of the valuation allowance, such a release would likely have a material impact on our results of operations.

Related Party Transactions

For a discussion of certain relationships and related party transactions, see Note 11 - Related Party Transactions of the Notes to Condensed Consolidated Financial Statements.

Seasonality

Our businesses experience seasonal fluctuations in the demand for the products and services we offer. The majority of our customers book leisure travel rather than business travel. Gross bookings for leisure travel are generally highest in the first half of the year as customers plan and book their spring and summer vacations. Cash is received upon booking for the majority of transactions booked on our websites, and net revenue for non-stand-alone air transactions is generally recognized when the travel takes place and typically lags bookings by several weeks or longer. As a result, our cash receipts are generally highest in the first half of the year and our net revenue is typically highest in the second and third quarters. Our seasonality may also be affected by fluctuations in the travel products our suppliers make available to us for booking, the growth of our international

26

Table of Contents

operations or a change in our product mix.


LIQUIDITY AND CAPITAL RESOURCES
Liquidity

Our principal sources of liquidity are our cash flows from operations, cash and cash equivalents and availability under the senior secured credit agreement, which includes a $72.5 million revolving credit facility (the “Revolver”). See Note 4 - Term Loan and Revolving Credit Facility of the Notes to Condensed Consolidated Financial Statements. At September 30, 2012 and December 31, 2011, our cash and cash equivalents balances were $152.3 million and $136.2 million, respectively. The amount of letters of credit issued under the Revolver reduces the amount available for borrowings. Due to the letters of credit issued under the Revolver, we had $58.7 million and $61.7 million of availability at September 30, 2012 and December 31, 2011, respectively. Total available liquidity from cash and cash equivalents and the Revolver was $211.0 million and $197.9 million at September 30, 2012 and December 31, 2011, respectively.

We require letters of credit to support certain suppliers, commercial agreements, leases and non-U.S. regulatory and governmental agencies. At September 30, 2012 and December 31, 2011, we had $89.1 million and $85.0 million of outstanding letters of credit. The majority of these letters of credit have been issued by Travelport on our behalf. For further details on our letters of credit, see Note 7 - Commitments and Contingencies of the Notes to Condensed Consolidated Financial Statements.

Under our merchant model, customers generally pay us for reservations at the time of booking, and we pay our suppliers at a later date, which is generally when the customer uses the reservation, except in the case of payment for merchant air which generally occurs prior to the consumption date. Initially, we record these customer receipts as accrued merchant payables and either deferred income or net revenue, depending upon the travel product. The timing difference between when cash is collected from our customers and when payments are made to our suppliers improves our operating cash flow and represents a source of liquidity for us.

Seasonal fluctuations in our business also affect the timing of our cash flows. Gross bookings are generally highest in the first half of the year as customers plan and purchase their spring and summer vacations. As a result, our cash receipts are generally highest in the first half of the year. We generally have net cash outflows during the second half of the year since cash payments to suppliers typically exceed the cash inflows from new merchant reservations. While we expect this seasonal cash flow pattern to continue, changes in our business model could affect the timing or seasonal nature of our cash flows.

As of September 30, 2012, we had a working capital deficit of $241.5 million compared with a deficit of $233.0 million as of December 31, 2011. Over time, we expect to reduce this deficit through growth in our business, in particular our global hotel business, and thereby generating positive cash flow from operations.

We generated positive cash flow from operations for the years ended December 31, 2008 through December 31, 2011 and for the nine months ended September 30, 2012 despite experiencing net losses in most of these periods, and we expect annual cash flow from operations to remain positive in the foreseeable future. We generally use this cash flow to fund our operations, make principal and interest payments on our debt, finance capital expenditures and meet our other cash operating needs. For the year ending December 31, 2012, we expect our capital expenditures to be between $46 million and $50 million, a portion of which is discretionary in nature. We do not intend to declare or pay any cash dividends on our common stock in the foreseeable future.

With respect to both our short- and long-term liquidity needs, we currently believe that cash flow generated from operations, cash on hand and borrowing availability under the Revolver through its maturity in July 2013 will provide sufficient liquidity to fund our operating activities, capital expenditures and other obligations. In the future, if we require more liquidity than is available to us from our available cash and under the Revolver, if we are unable to refinance or extend the Revolver beyond its July 2013 maturity date, or if we are unable to refinance or repay the Term Loan by its July 2014 maturity date, we may need to raise additional funds through debt or equity offerings, which may not be available to us on favorable terms or at all.

Our liquidity could be reduced as a result of the termination of a major airline's participation on our websites or a change in their distribution strategy; a decline in merchant gross bookings resulting from changes in our merchant business model; changes to payment terms or other requirements imposed by vendors, suppliers or regulatory agencies, such as requiring us to provide letters of credit, cash reserves, or other forms of financial security or increases in such requirements; lower than anticipated operating cash flows; or other unanticipated events, such as unfavorable outcomes in our legal proceedings,

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including in the case of hotel occupancy tax proceedings, certain jurisdictions' requirements that we provide financial security or pay an assessment to the municipality in order to challenge the assessment in court. If we require additional letters of credit, or if Travelport is no longer required or able to issue letters of credit on our behalf, we would be required to issue these letters of credit under the Revolver or our $25.0 million letter of credit facility or to establish cash reserves/collateral, which would reduce our liquidity and cash available to grow our business.

Cash Flows

Our net cash flows from operating, investing and financing activities were as follows:
 
 
Nine Months Ended September 30,
 
 
2012
 
2011
 
 
(in thousands)
Beginning cash and cash equivalents
 
$
136,171

 
$
97,222

Cash provided by/(used in):
 
 

 
 

Operating activities
 
106,085

 
113,873

Investing activities
 
(40,093
)
 
(39,397
)
Financing activities
 
(49,889
)
 
(30,252
)
Effect of changes in exchange rates on cash and cash equivalents
 
16

 
(651
)
Net increase in cash and cash equivalents
 
16,119

 
43,573

Ending cash and cash equivalents
 
$
152,290

 
$
140,795


Operating Activities

Cash provided by operating activities consists of our net income, adjusted for non-cash items such as depreciation, amortization and stock-based compensation, and changes in various working capital accounts, principally accounts receivable, deferred income, accrued merchant payables, accounts payable and accrued expenses.

We generated cash flow from operations of $106.1 million for the nine months ended September 30, 2012 compared with $113.9 million for the nine months ended September 30, 2011. The decrease in cash flow from operations was primarily due to the timing of cash receipts and payments and lower booking volume on our websites during the period.

Investing Activities

Cash flow used in investing activities increased to $40.1 million for the nine months ended September 30, 2012 from $39.4 million for the nine months ended September 30, 2011. This increase from the prior year was due primarily to establishing higher levels of restricted cash balances in the nine months ended September 30, 2012 as compared with the comparable prior-year period.

Financing Activities

Cash flow used in financing activities increased to $49.9 million for the nine months ended September 30, 2012 from $30.3 million for the nine months ended September 30, 2011. The increase was due to a higher excess cash flow payment made on the Term Loan and higher payments on the tax sharing liability during the nine months ended September 30, 2012, as compared with the prior-year period.

Financing Arrangements

On July 25, 2007, we entered into a $685.0 million senior secured credit agreement (the “Credit Agreement”) consisting of a seven-year $600.0 million term loan facility (the “Term Loan”) and a six-year $85.0 million revolving credit facility, which was effectively reduced to the $72.5 million Revolver. The Term Loan and the Revolver bear interest at variable rates, at our option, of LIBOR or an alternative base rate plus a margin. At September 30, 2012 and December 31, 2011, $440.0 million and $472.2 million of borrowings were outstanding on the Term Loan, respectively. At September 30, 2012 and December 31, 2011, there were no outstanding borrowings under the Revolver. In addition, at September 30, 2012 and December 31, 2011, there were the equivalent of $13.8 million and $10.8 million of outstanding letters of credit issued under the Revolver, respectively, the majority of which were denominated in Pounds sterling. The amount of letters of credit issued under the Revolver reduces the amount available to us for borrowings. The Credit Agreement requires us to maintain a minimum fixed

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charge coverage ratio and not exceed a maximum total leverage ratio, each as defined in the Credit Agreement. We are required to maintain a minimum fixed charge coverage ratio of 1 to 1 and not exceed a maximum total leverage ratio of 3.0 to 1 for the remainder of the Credit Agreement. As of September 30, 2012, we were in compliance with all covenants and conditions of the Credit Agreement.

In addition, we are required to make an annual prepayment on the Term Loan in the first quarter of each fiscal year in an amount up to 50% of the prior year’s excess cash flow, as defined in the Credit Agreement. Based on our excess cash flow for the year ended