UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

 

 

 

Commission File Number: 001-33599

 

ORBITZ WORLDWIDE, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

(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 þ     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. (Check one):

 

 

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

 

As of November 10, 2008, 83,284,999 shares of Common Stock, par value $0.01 per share, of Orbitz Worldwide, Inc. were outstanding.

 

 

Table of Contents

 

 

This Quarterly Report on Form 10-Q contains 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,” “will,” “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 also 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” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Quarterly Report on Form 10-Q and in our 2007 Annual Report on Form 10-K/A filed with the Securities and Exchange Commission on August 28, 2008. Accordingly, you should not unduly rely on these forward-looking statements. We undertake no obligation to publicly revise any forward-looking statement to reflect circumstances or events after the date of this Form 10-Q or to reflect the occurrence of unanticipated events.

 

The use of the words “we,” “us,” “our” and “the Company” refers to Orbitz Worldwide, Inc. and its subsidiaries, except where the context otherwise requires or indicates.

 

 

ORBITZ WORLDWIDE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in millions, except share and per share data)

 

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

ORBITZ WORLDWIDE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in millions, except share data)

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

ORBITZ WORLDWIDE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in millions)

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

ORBITZ WORLDWIDE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (UNAUDITED)
(in millions)

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

ORBITZ WORLDWIDE, INC.
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED)
(in millions)

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

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 CheapTickets, HotelClub and RatesToGo brands. In February 2005, Cendant acquired ebookers Limited, an international online travel brand with operations in 13 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 (“TCV”). We refer to this acquisition as the “Blackstone Acquisition” in this Form 10-Q.

 

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 Travel Acquisition Corporation Pty. Ltd. (“HotelClub”) and the related subsidiaries and affiliates of those businesses. We are the registrant as a result of the completion of our initial public offering (“IPO”) of 34,000,000 shares of our common stock on July 25, 2007. At September 30, 2008 and December 31, 2007, Travelport and its affiliates beneficially owned approximately 58% and 59% 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. Our brand portfolio includes Orbitz, CheapTickets, the Away Network, and Orbitz for Business in the Americas; ebookers in Europe; and HotelClub and RatesToGo based in Sydney, Australia, which has operations globally. We provide customers with the ability to book a comprehensive set of travel products from over 75,000 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 unaudited condensed consolidated financial statements present the accounts of Orbitz, ebookers and HotelClub and the related subsidiaries and affiliates of those businesses, collectively doing business as Orbitz Worldwide, Inc. These entities became wholly owned subsidiaries of ours as part of an intercompany restructuring that was completed on July 18, 2007 (the “Reorganization”) in connection with the IPO. Prior to the IPO, these entities had operated as indirect, wholly-owned subsidiaries of Travelport.

 

Prior to the IPO, we had not operated as an independent standalone company. As a result, our condensed consolidated financial statements for periods in 2007 prior to the IPO consisted of the business-to-consumer travel businesses of Travelport, which were carved out of the Travelport operations.

 

The legal entity of Orbitz Worldwide, Inc. was formed in connection with the Reorganization, and prior to the Reorganization there was no single capital structure upon which to calculate historical earnings (loss) per share information. Accordingly, earnings (loss) per share information is not presented on our condensed consolidated statements of operations for periods prior to the Reorganization.

 

We have prepared the accompanying unaudited condensed consolidated financial statements in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). These financial statements include all adjustments that are, in the opinion of management, necessary for a fair presentation of our financial position and results of operations for the interim periods presented. All such adjustments are of a normal and recurring nature. Certain information and footnote disclosures normally included in financial

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to SEC rules and regulations for interim reporting. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in our 2007 Annual Report on Form 10-K/A filed with the SEC on August 28, 2008.

 

We have reclassified marketing expense for the prior period in our condensed consolidated financial statements to conform to the current period presentation. We stated our marketing expense separately on our condensed consolidated statements of operations in the current period. These amounts were previously included in selling, general and administrative expense.

 

The preparation of our condensed consolidated financial statements in conformity with GAAP requires us to make certain estimates and assumptions. Our estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as of the date of our condensed consolidated financial statements and the reported amounts of revenue and expense during the reporting periods. Actual results could differ from our estimates.

 

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value and expands disclosure about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. However, in February 2008, the FASB issued FASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”), which delayed the effective date of SFAS No. 157 for one year for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. Our adoption of SFAS No. 157 on January 1, 2008 for our financial assets and liabilities did not have a material impact on our consolidated financial position or results of operations. We do not expect the adoption of SFAS No. 157 for our non-financial assets and non-financial liabilities, effective January 1, 2009, to have a material impact on our consolidated financial position or results of operations.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), which provides companies with an option to report selected financial assets and liabilities at fair value. SFAS No. 159’s objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS No. 159 helps to mitigate this type of accounting-induced volatility by enabling companies to report related assets and liabilities at fair value, which would likely reduce the need for companies to comply with detailed rules for hedge accounting. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of their choice to use fair value on their earnings. It also requires companies to display the fair value of those assets and liabilities for which they have chosen to use fair value on the face of the balance sheet. SFAS No. 159 was effective on January 1, 2008. We have chosen not to apply the provisions of SFAS No. 159 to any of our existing financial assets and liabilities.

 

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS No. 141(R)”), which establishes principles and requirements for the reporting entity in a business combination, including recognition and measurement in the financial statements of the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. This statement also establishes disclosure requirements to enable financial statement users to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, and interim periods within those fiscal years. SFAS No. 141(R) will become effective for our fiscal year beginning January 1, 2009. We do not expect the adoption of SFAS No. 141(R) to have an effect on our consolidated financial statements unless we enter into a business combination or reduce our deferred tax valuation allowance that was established in purchase accounting. In connection with the Blackstone Acquisition, we established a deferred income tax valuation allowance of $408 million in purchase accounting. Under the current standard, any reductions in our remaining deferred income tax valuation allowance that was originally established in purchase accounting are recorded through goodwill. Beginning January 1, 2009, these reductions will be recorded through our statement of operations.

 

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS No. 161”), which changes the disclosure requirements for derivative instruments and hedging activities previously identified under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”). SFAS No. 161 provides for enhanced disclosures regarding (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 will become effective for our fiscal year beginning January 1, 2009. We are currently evaluating the impact of the adoption of SFAS No. 161 on our consolidated financial statements.

 

 

In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” we assess the carrying value of goodwill and other indefinite-lived intangible assets for impairment annually, or more frequently whenever events occur and circumstances change indicating potential impairment. We also evaluate the recoverability of our long-lived assets, including our finite-lived intangible assets, when circumstances indicate that the carrying value of those assets may not be recoverable pursuant to SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

 

We assess goodwill for possible impairment using a two-step process. The first step is used to identify if there is potential goodwill impairment. If step one indicates that an impairment may exist, a second step is performed to measure the amount of the goodwill impairment, if any. Goodwill impairment exists when the estimated fair value of goodwill is less than its carrying value.

 

Our indefinite-lived intangible assets include our trademarks and trade names. We assess our trademarks and trade names for impairment by comparing their carrying value to their estimated fair value. Impairment exists when the estimated fair value of the trademark or trade name is less than its carrying value.

 

Our finite-lived intangible assets primarily include our customer and vendor relationships. We assess these assets for impairment by comparing their respective carrying values to expected future cash flows, on an undiscounted basis. If this analysis indicates that the carrying value of these assets is not recoverable, impairment exists. Refer to Note 2 to the Consolidated Financial Statements contained in our 2007 Annual Report on Form 10-K/A for further information on our accounting policy for goodwill, indefinite-lived intangible assets and finite-lived intangible assets.

 

During the three months ended September 30, 2008, in connection with our annual forecasting process, we lowered our long-term earnings forecast in response to changes in the economic environment, including the potential future impact of airline capacity reductions, increased fuel prices and a weakening global economy. These factors, coupled with a prolonged decline in our market capitalization, indicated potential impairment of our goodwill, trademarks and trade names. Additionally, given the current environment, our distribution partners are under increased pressure to reduce their overall costs and could attempt to terminate or renegotiate their agreements with us on more favorable terms to them. These factors indicated that the carrying value of

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

certain of our finite-lived intangible assets, specifically customer relationships, may not be recoverable. As a result, in connection with the preparation of our financial statements for the third quarter of 2008, we performed an interim impairment test of our goodwill, indefinite-lived intangible assets and finite-lived intangible assets.

 

For purposes of testing goodwill for potential impairment, we estimated the fair value of the applicable reporting units to which all goodwill is allocated using generally accepted valuation methodologies, including market and income based approaches, and relevant data available through and as of September 30, 2008. The market approach is a valuation method in which fair value is estimated based on observed prices in actual transactions and on asking prices for similar assets. Under the market approach, the valuation process is essentially that of comparison and correlation between the subject asset and other similar assets. The income approach is a method in which fair value is estimated based on the cash flows that an asset could be expected to generate over its useful life, including residual value cash flows. These cash flows are then discounted to their present value equivalents using a rate of return that accounts for the relative risk of not realizing the estimated annual cash flows and for the time value of money. Variations of the income approach were used to estimate certain of the intangible asset fair values.

 

We further used appropriate valuation techniques to separately estimate the fair values of all of our indefinite-lived intangible assets as of September 30, 2008 and compared those estimates to the respective carrying values. Our indefinite-lived intangible assets are comprised of trademarks and trade names. We used a market or income valuation approach, as described above, to estimate fair values of the relevant trademarks and trade names.

 

We also determined the estimated fair values of certain of our finite-lived intangible assets as of September 30, 2008, specifically certain of our customer relationships whose carrying values exceeded their expected future cash flows on an undiscounted basis. We determined the fair values of these customer relationships by discounting the estimated future cash flows of these assets. We then compared the estimated fair values to the respective carrying values.

 

As a result of this testing, we concluded that the goodwill, trademarks and trade names related to both our domestic and international subsidiaries as well as the customer relationships related to our domestic subsidiaries were impaired. As a result, we recorded a non-cash impairment charge of $297 million during the three months ended September 30, 2008, of which $210 million related to goodwill, $74 million related to trademarks and trade names and $13 million related to customer relationships. This charge is included in the impairment of goodwill and intangible assets expense line item in our condensed consolidated statements of operations.

 

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

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Property and equipment, net, consisted of the following:

 

 

We recorded depreciation and amortization expense related to property and equipment in the amount of $12 million for each of the three months ended September 30, 2008 and September 30, 2007, respectively, and $34 million and $27 million for the nine months ended September 30, 2008 and September 30, 2007, respectively.

 

 

Goodwill and indefinite-lived intangible assets consisted of the following:

 

 

The changes in the carrying amount of goodwill during the nine months ended September 30, 2008 were as follows:

 

 

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Finite-lived intangible assets consisted of the following:

 

 

 

We recorded amortization expense related to finite-lived intangible assets in the amount of $5 million for each of the three months ended September 30, 2008 and September 30, 2007, respectively, and $15 million for each of the nine months ended September 30, 2008 and September 30, 2007, respectively. These amounts are included in depreciation and amortization expense in our condensed consolidated statements of operations.

 

The table below shows estimated amortization expense related to our finite-lived intangible assets over the next five years:

 

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Accrued expenses consisted of the following:

 

 

 

On July 25, 2007, concurrent with the IPO, we entered into a $685 million senior secured credit agreement (“Credit Agreement”) consisting of a seven-year $600 million term loan facility (“Term Loan”) and a six-year $85 million revolving credit facility (“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 (“Alternative Base Rate”). The Term Loan matures in July 2014. At September 30, 2008 and December 31, 2007, $594 million and $599 million was outstanding on the Term Loan, respectively.

 

We have entered into interest rate swaps that effectively convert $500 million of the Term Loan to a fixed interest rate (see Note 13 — Derivative Financial Instruments). At September 30, 2008, $300 million of the Term Loan effectively bears interest at a fixed rate of 8.21%, $100 million of the Term Loan effectively bears interest at a fixed rate of 6.39%, and an additional $100 million of the Term Loan effectively bears interest at a fixed rate of 5.98%, through these interest rate swaps. The remaining $94 million of the Term Loan bears interest at a variable rate of LIBOR plus 300 basis points, or 6.70%, which is based on the one-month LIBOR at September 30, 2008.

 

Revolver

 

The Revolver provides for borrowings and letters of credit of up to $85 million and bears interest at a variable rate, at our option, of LIBOR plus a margin of 250 basis points or an Alternative Base Rate plus a margin of 150 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 also incur a commitment fee of 50 basis points on any unused amounts on the Revolver. The Revolver matures in July 2013.

 

Lehman Commercial Paper Inc. (“LCPI”), which filed for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code on October 5, 2008, holds a $12.5 million commitment, or 14.7% percent, of

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

the $85 million available under the Revolver. LCPI did not fund its pro rata share of our borrowing under the Revolver in September 2008. As a result, total availability under the Revolver has effectively been reduced from $85 million to $72.5 million.

 

At September 30, 2008 and December 31, 2007, $26 million and $1 million was outstanding under the Revolver, respectively. Commitment fees on unused amounts under the Revolver were almost nil for each of the three months ended September 30, 2008 and September 30, 2007, respectively, and almost nil for each of the nine months ended September 30, 2008 and September 30, 2007, respectively.

 

 

We have a liability included in our condensed consolidated balance sheets that relates to a tax sharing agreement between Orbitz and the Founding Airlines. The agreement governs the allocation of tax benefits resulting from a taxable exchange that took place in connection with the Orbitz initial public offering in December 2003 (“Orbitz IPO”). As a result of this taxable exchange, the Founding Airlines incurred a taxable gain. The taxable exchange also caused Orbitz to have additional future tax deductions for depreciation and amortization due to the increased tax basis of its assets. The additional tax deductions for depreciation and amortization may reduce the amount of taxes we are required to pay in future years. For each tax period during the term of the tax sharing agreement, we are obligated to pay the Founding Airlines a significant percentage of the amount of the tax benefit realized as a result of the taxable exchange. The tax sharing agreement commenced upon consummation of the Orbitz IPO and continues until all tax benefits have been utilized.

 

As of September 30, 2008, the estimated remaining payments that may be due under this agreement were approximately $259 million. Payments under the tax sharing agreement are generally due in the second, third and fourth calendar quarters of the year, with two payments due in the second quarter. We estimate that the net present value of our obligation to pay tax benefits to the Founding Airlines was $136 million and $141 million at September 30, 2008 and December 31, 2007, respectively. This estimate is based upon certain assumptions, including our future operating performance and taxable income, the tax rate, the timing of payments, current and projected market conditions and the applicable discount rate, all of which we believe are reasonable. These assumptions are inherently uncertain, however, and actual results could differ from our estimates.

 

The table below shows the changes in the tax sharing liability during the nine months ended September 30, 2008:

 

 

 

Based upon the future payments we expect to make, the current portion of the tax sharing liability of $13 million and $27 million is included in accrued expenses in our condensed consolidated balance sheets at September 30, 2008 and December 31, 2007, respectively. The long-term portion of the tax sharing liability of $123 million and $114 million is reflected as the tax sharing liability in our condensed consolidated balance sheets at September 30, 2008 and December 31, 2007, respectively. At the time of the Blackstone Acquisition,

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Cendant indemnified Travelport and us for amounts due under the tax sharing agreement. As a result, we recorded a receivable of $37 million which is included in other non-current assets in our condensed consolidated balance sheets at September 30, 2008 and December 31, 2007, respectively. We expect to collect this receivable when Cendant receives the tax benefit.

 

The table below shows the estimated payments under our tax sharing liability over the next five years:

 

 

 

In December 2003, we entered into amended and restated airline charter associate agreements, or “Charter Associate Agreements,” with the Founding Airlines as well as US Airways (“Charter Associate Airlines”). These agreements pertain to our Orbitz business, which was owned by the Founding Airlines at the time we entered into the agreements. Under each Charter Associate Agreement, the Charter Associate Airline has agreed to provide Orbitz with information regarding the airline’s flight schedules, published air fares and seat availability at no charge and with the same frequency and at the same time as this information is provided to the airline’s own website or to a website branded and operated by the airline and any of its alliance partners or to the airline’s internal reservation system. The agreement also provides Orbitz with nondiscriminatory access to seat availability for published fares, as well as marketing and promotional support. Under each agreement, the Charter Associate Airline provides us with agreed upon transaction payments when consumers book air travel on the Charter Associate Airline on Orbitz.com. The payments we receive are based on the value of the tickets booked and gradually decrease over time. The agreements expire on December 31, 2013. However, certain of the Charter Associate Airlines may terminate their agreements for any reason or no reason prior to the scheduled expiration date upon thirty days prior notice to us.

 

Under the Charter Associate Agreements, we must pay a portion of the global distribution system (“GDS”) incentive payments earned 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 the Orbitz.com website utilizing Worldspan. The rebate payments are made in part for in-kind marketing and promotional support we receive. However, a portion of the rebate payments are deemed unfavorable because we receive no benefit for these payments.

 

The rebate structure under the Charter Associate Agreements was considered unfavorable when compared to market conditions at the time of Cendant’s acquisition of Orbitz in 2004 and the Blackstone Acquisition in 2006. As a result, an unfavorable contract liability was recorded at its fair value at each acquisition date. The fair value of the unfavorable contract liability was determined using the discounted cash flows of the expected rebates, net of the expected fair value of in-kind marketing support.

 

At September 30, 2008 and December 31, 2007, the net present value of the unfavorable contract liability was $17 million and $20 million, respectively. The current portion of the liability of $3 million was included in accrued expenses in our condensed consolidated balance sheets at September 30, 2008 and December 31, 2007. The long term portion of the liability of $14 million and $17 million was included in unfavorable

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

contracts in our condensed consolidated balance sheets at September 30, 2008 and December 31, 2007, respectively.

 

This liability is being amortized to revenue in our condensed consolidated statements of operations on a straight-line basis over the remaining contractual term. We recognized revenue for the unfavorable portion of the Charter Associate Agreements in the amount of almost nil for each of the three months ended September 30, 2008 and September 30, 2007, respectively, and $2 million for each of the nine months ended September 30, 2008 and September 30, 2007, respectively.

 

 

Our commitments as of September 30, 2008 did not materially change from the amounts set forth in our 2007 Annual Report on Form 10-K/A.

 

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 within the United States and abroad.

 

We are party to various cases brought by consumers and municipalities and other U.S. governmental entities involving hotel occupancy taxes and our merchant hotel business. Some of the cases are purported class actions and most of the cases were brought simultaneously against other Internet travel companies, including Expedia, Travelocity and Priceline. The cases allege, among other things, that we violated the jurisdictions’ hotel occupancy tax ordinance with respect to the charges and remittance of amounts to cover taxes under the ordinance. 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 City of Baltimore, Maryland, City of New Orleans, Louisiana, the City of Philadelphia, Pennsylvania, the City of Madison, Wisconsin, the City of Phoenix, Arizona, the counties of Mecklenburg, Stanly and Brunswick, North Carolina, the counties of Miami-Dade and Broward, Florida, the cities of Alpharetta, Atlanta, Cartersville, Cedartown, College Park, Columbus, Dalton, East Point, Hartwell, Macon, Rockmart, Rome, Tybee Island and Warner Robins, Georgia, the counties of Augusta-Richmond, Clayton, Cobb, DeKalb, Fulton and Gwinnett, Georgia, the cities of Anaheim, Oakland, Los Angeles, San Francisco and San Diego, California, the cities of Pine Bluff and North Little Rock, Arkansas, the county of Jefferson, Arkansas, the county of Suffolk, New York, state and local tax officials from Arizona, Florida, Wisconsin, Pennsylvania, Hawaii and Indiana, and a third-party on behalf of unnamed municipalities and counties in Alabama, among others, have begun or attempted to pursue formal or informal administrative procedures or audits or stated that they may assert claims against us relating to allegedly unpaid state or local hotel occupancy or related taxes.

 

We believe that we have meritorious defenses and we are vigorously defending against these claims, proceedings and inquiries. We have not recorded any reserves related to these hotel occupancy tax matters.

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

We are party to a breach of contract claim brought by Vanguard Rental USA, Inc. (“Vanguard”) relating to the display of its Alamo Rent a Car and National Car Rental brands on the orbitz.com and cheaptickets.com websites. Although the court granted Vanguard’s motion for preliminary injunction, it has not yet ruled on the merits. We believe that we have meritorious defenses and intend to vigorously defend against these claims. We have not recorded any reserves related to this matter.

 

Litigation is inherently unpredictable and, although we believe we have valid defenses in these matters based upon advice of counsel, unfavorable resolutions could occur. While we cannot estimate our range of loss, an adverse outcome from these unresolved proceedings could be material to us with respect to earnings or cash flows in any given reporting period. We do not believe that the impact of this unresolved litigation would result in a material liability to us in relation to our financial position or liquidity.

 

We are currently seeking to recover insurance reimbursement for costs incurred to defend the hotel occupancy tax cases. We recorded a reduction to selling, general and administrative expense in our condensed consolidated statements of operations for reimbursements received of $1 million and nil for the three months ended September 30, 2008 and September 30, 2007, respectively, and $6 million and nil for the nine months ended September 30, 2008 and September 30, 2007, respectively. The recovery of additional amounts, if any, by us and the timing of receipt of these recoveries is unclear. As such, in accordance with SFAS No. 5, “Accounting for Contingencies,” as of September 30, 2008, we have not recognized a reduction to selling, general and administrative expense in our condensed consolidated statements of operations for the outstanding contingent claims for which we have not yet received reimbursement.

 

Surety Bonds and Bank Guarantees

 

In the ordinary course of business, we obtain surety bonds and bank guarantees, issued for the benefit of a third party, to secure performance of certain of our obligations to third parties. At September 30, 2008 and December 31, 2007, there were $3 million of surety bonds outstanding and $4 million and $6 million of bank guarantees outstanding, respectively.

 

Financing Arrangements

 

We are required to issue letters of credit to certain suppliers and non-U.S. government agencies. Substantially all of these letters of credit were issued by Travelport on our behalf under the terms of the separation agreement entered into in connection with the IPO. The letter of credit fees were $1 million for each of the three months ended September 30, 2008 and September 30, 2007, respectively, and $2 million for each of the nine months ended September 30, 2008 and September 30, 2007, respectively. At September 30, 2008 and December 31, 2007, there were $75 million and $74 million of outstanding letters of credit issued by Travelport on our behalf, respectively (see Note 15 — Related Party Transactions).

 

 

In accordance with FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), we have established a liability for unrecognized tax benefits that management believes to be adequate. The table below shows the changes in this liability during the nine months ended September 30, 2008:

 

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The total amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate is $3 million. We do not expect to make any cash tax payments nor do we expect any statutes of limitations to lapse related to this liability within the next twelve months.

 

We recognize interest and penalties related to unrecognized tax benefits in income tax expense. During the three months and nine months ended September 30, 2008, we recognized interest and penalties of almost nil. As of September 30, 2008 and December 31, 2007, accrued interest and penalties were almost nil.

 

We have computed the tax provision for the period ended September 30, 2008 in accordance with the provisions of FASB Interpretation No. 18, “Accounting for Income Taxes in Interim Periods” and Accounting Principles Board Opinion No. 28, “Interim Financial Reporting.” We recognized an income tax provision in tax jurisdictions which had pre-tax income for the period ended September 30, 2008 and are expected to generate pre-tax book income during the remainder of fiscal year 2008. We recognized an income tax benefit in tax jurisdictions which incurred pre-tax losses for the period ended September 30, 2008 if the tax jurisdictions are expected to be able to realize these losses during the remainder of fiscal year 2008 or are expected to recognize a deferred tax asset related to such losses at December 31, 2008.

 

We recorded a tax benefit during the three and nine months ended September 30, 2008 related to certain of our international subsidiaries. The amount of the tax benefit recorded during the three and nine months ended September 30, 2008 is disproportionate to the amount of pre-tax net loss incurred during each of these periods primarily because we are not able to realize any tax benefits on the goodwill impairment charge recorded during the third quarter of 2008.

 

 

We currently 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 (the “Compensation Committee”) for participation in the Plan. At our Annual Meeting of Shareholders on May 8, 2008, our shareholders approved an amendment to the Plan, increasing the number of shares of our common stock available for issuance under the Plan from 6,100,000 shares to 15,100,000 shares, subject to adjustment as provided in the Plan. As of September 30, 2008, 6,643,900 shares were available for future issuance under the Plan.

 

Stock Options

 

The table below summarizes the option activity under the Plan during the nine months ended September 30, 2008:

 

 

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

The exercise price of stock options granted under the Plan is equal to the fair market value of the underlying stock on the date of grant. Stock options generally expire seven to ten years from the grant date. The stock options granted at the time of the IPO as additional compensation to our employees who previously held equity awards under Travelport’s long-term incentive plan vest quarterly over a three-year period. All other stock options granted vest annually over a four-year period. The fair value of stock options on the date of grant is amortized on a straight-line basis over the requisite service period.

 

The fair value of stock options granted under the Plan is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted average assumptions for stock options granted during the nine months ended September 30, 2008 are outlined in the following table. Expected volatility is based on implied volatilities for publicly traded options and historical volatility for comparable companies over the estimated expected life of the stock options. The expected life represents the period of time the stock options are expected to be outstanding and is based on the “simplified method,” as defined in SEC Staff Accounting Bulletin No. 110, “Share-Based Payments.” The risk-free interest rate is based on yields on U.S. Treasury strips with a maturity similar to the estimated expected life of the stock options. We use historical turnover to estimate employee forfeitures.

 

 

Based on the above assumptions, the weighted average grant date fair value of stock options granted during the nine months ended September 30, 2008 was $2.54.

 

Restricted Stock Units

 

The table below summarizes activity regarding unvested restricted stock units under the Plan for the nine months ended September 30, 2008:

 

 

 

The restricted stock units granted at the time of the IPO upon conversion of unvested equity-based awards previously held by our employees under Travelport’s long-term incentive plan vest quarterly over a three-year period. All other restricted stock units cliff vest at the end of either a two-year or three-year period, or vest annually over a three-year or four-year period. The fair value of restricted stock units on the date of grant is amortized on a straight-line basis over the requisite service period.

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The total number of restricted stock units that vested during the nine months ended September 30, 2008 and the total fair value thereof was 221,878 restricted stock units and $3 million, respectively.

 

Restricted Stock

 

There was no significant restricted stock activity for the nine months ended September 30, 2008.

 

Performance-Based Restricted Stock Units

 

On June 19, 2008, the Compensation Committee approved a grant of performance-based restricted stock units (“PSUs”) under the Plan to certain of our executive officers. The PSUs entitle the executives to receive a certain number of shares of our common stock based on the Company’s satisfaction of certain financial and strategic performance goals, including net revenue growth, adjusted EBITDA margin improvement and the achievement of specified technology milestones during fiscal years 2008, 2009 and 2010 (the “Performance Period”). The performance conditions also provide that if the Company’s aggregate adjusted EBITDA during the Performance Period does not equal or exceed a certain threshold, each PSU award will be forfeited. Based on the achievement of the performance conditions during the Performance Period, the final settlement of the PSU awards will range between 0 and 1662/3% of the target shares underlying the PSU awards based on a specified objective formula approved by the Compensation Committee. The PSUs will vest within 75 days of the end of the Performance Period.

 

The target number of shares underlying the PSUs that were granted to certain executive officers during the nine months ended September 30, 2008 totaled 249,108 shares and had a grant date fair value of $6.28 per share. As of September 30, 2008, the Company expects that none of the PSUs will vest.

 

As of September 30, 2008, $32 million of unrecognized compensation costs related to unvested stock options, unvested restricted stock units, unvested PSUs and unvested restricted stock are expected to be recognized over the remaining weighted-average period of 2.58 years.

 

Non-Employee Directors Deferred Compensation Plan

 

During the nine months ended September 30, 2008, a total of 171,724 deferred stock units were granted to our non-employee directors at a weighted average grant date fair value of $5.92 per share. The deferred stock units are issued as restricted stock units under the Plan and are immediately vested and non-forfeitable. The deferred stock units entitle the non-employee director to receive one share of our common stock for each deferred stock unit on the date that is 200 days immediately following the non-employee director’s retirement or termination of service from the board of directors, for any reason. The entire grant date fair value of deferred stock units is expensed on the date of grant.

 

Compensation Expense

 

We recognized total equity-based compensation expense of $4 million for each of the three months ended September 30, 2008 and September 30, 2007, respectively, and $12 million and $4 million for the nine months ended September 30, 2008 and September 30, 2007, respectively, none of which has provided us a tax benefit.

 

 

Interest Rate Hedges

 

On July 25, 2007, we entered into two interest rate swaps that effectively convert $300 million of the Term Loan from a variable to a fixed interest rate. The first swap has a notional amount of $100 million and matures on December 31, 2008. The second swap has a notional amount of $200 million and matures on

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

December 31, 2009. We pay a fixed rate of 5.21% on both swaps and in exchange receive a variable rate based on the three-month LIBOR.

 

On May 1, 2008, we entered into a third interest rate swap that effectively converts an additional $100 million of the Term Loan from a variable to a fixed interest rate. The swap was effective on May 30, 2008, has a notional amount of $100 million and matures on May 31, 2011. We pay a fixed rate of 3.39% on the swap and in exchange receive a variable rate based on the three-month LIBOR.

 

On September 12, 2008, we entered into a fourth interest rate swap that effectively converts an additional $100 million of the Term Loan from a variable to a fixed interest rate. The swap was effective on September 30, 2008, has a notional amount of $100 million and matures on September 30, 2010. We pay a fixed rate of 2.98% on the swap and in exchange receive a variable rate based on the one-month LIBOR.

 

The objective of entering into our interest rate swaps is to protect against volatility of future cash flows and effectively hedge the variable interest payments on the Term Loan. We determined that these designated hedging instruments qualify for cash flow hedge accounting treatment under SFAS No. 133.

 

The interest rate swaps are reflected in our condensed consolidated balance sheets at market value. At September 30, 2008 and December 31, 2007, $4 million and $6 million of the total market value of the swaps, respectively, represented a liability, of which almost nil and $1 million was included in other current liabilities and $4 million and $5 million was included in other non-current liabilities in our condensed consolidated balance sheets, respectively. At September 30, 2008 and December 31, 2007, almost nil and nil of the total market value of the swaps, respectively, represented an asset, which was included in other non-current assets in our condensed consolidated balance sheets. The corresponding market adjustment was recorded to accumulated other comprehensive income. There was no hedge ineffectiveness recorded during the three or nine months ended September 30, 2008 and September 30, 2007.

 

Foreign Currency Hedges

 

We enter into foreign currency forward contracts (“forward contracts”) from time to time to manage exposure to changes in the foreign currency associated with foreign receivables, payables, intercompany transactions and forecasted earnings. As of September 30, 2008, we have forward contracts outstanding with a total net notional amount of $83 million, which matured in October 2008. The forward contracts do not qualify for hedge accounting treatment under SFAS No. 133. Accordingly, changes in the fair value of the forward contracts are recorded in net income, as a component of selling, general and administrative expense in our condensed consolidated statements of operations. We recognized gains (losses) related to foreign currency forward contracts of $3 million and $(1) million for the three months ended September 30, 2008 and September 30, 2007, respectively, and $2 million and $(2) million for the nine months ended September 30, 2008 and September 30, 2007, respectively. The total market value of forward contracts at September 30, 2008 and December 31, 2007 represented an asset of $1 million and almost nil, respectively, which was included in other current assets in our condensed consolidated balance sheets.

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

The following table presents the calculation of basic and diluted loss per share:

 

 

 

 

The following equity awards are not included in the diluted loss per share calculation above because they would have had an antidilutive effect:

 

 

 

Related Party Transactions with Travelport and its Subsidiaries

 

The following table summarizes the related party balances with Travelport and its subsidiaries as of September 30, 2008 and December 31, 2007, reflected in our condensed consolidated balance sheets. We net settle amounts due to and from Travelport.

 

 

We also purchased assets of $1 million from Travelport and its subsidiaries during the nine months ended September 30, 2008 which are included in property and equipment, net in our condensed consolidated balance sheet at September 30, 2008.

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The following table summarizes the related party transactions with Travelport and its subsidiaries for the three months and nine months ended September 30, 2008 and September 30, 2007, reflected in our condensed consolidated statements of operations:

 

 

 

The tables above reflect amounts resulting from agreements with Travelport and its subsidiaries, including our transition services agreement, master license agreement, equipment, services and use agreements, intercompany notes payable, GDS service agreement, hotel sourcing and franchise agreement and corporate travel agreement. In addition, prior to the IPO, our condensed consolidated statements of operations reflect an allocation from Travelport of both general corporate overhead expenses and direct billed expenses incurred on our behalf.

 

On January 1, 2008, our new Master Supply and Services Agreement with GTA (the “GTA Agreement”) became effective. Under this agreement, we pay GTA a contract rate for hotel and destination services inventory it makes available to us for booking on our websites. The contract rate exceeds the prices at which suppliers make their inventory available to GTA for distribution and is based on a percentage of the rates GTA makes such inventory available to its other customers. We are also subject to additional fees if we exceed certain specified booking levels. The initial term of the GTA Agreement expires on December 31, 2010. Under this agreement, we are restricted from providing access to hotels and destination services content to certain of GTA’s clients until December 31, 2010.

 

In May 2008, we amended the separation agreement with Travelport that was entered into in connection with the IPO. The amendment, among other things, clarifies how Travelport’s aggregate ownership of our voting stock is determined for all purposes of the separation agreement. In addition, Travelport agreed to continue to issue letters of credit on our behalf through at least March 31, 2009 and thereafter so long as Travelport and its affiliates own at least 50% of our voting stock, in an aggregate amount not to exceed $75 million (denominated in U.S. dollars). Travelport charges us a fee for issuing, renewing or extending letters of credit on our behalf. This fee is included in interest expense in our condensed consolidated statements of operations. At September 30, 2008 and December 31, 2007, there were $75 million and $74 million of letters of credit issued by Travelport on our behalf, respectively (see Note 10 — Commitments and Contingencies).

 

Related Party Transactions with Affiliates of Blackstone and TCV

 

The following table summarizes the related party balances with affiliates of Blackstone and TCV as of September 30, 2008 and December 31, 2007, reflected in our condensed consolidated balance sheets:

 

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The following table summarizes the related party transactions with affiliates of Blackstone and TCV for the three months and nine months ended September 30, 2008 and September 30, 2007, reflected in our condensed consolidated statements of operations:

 

 

The tables above reflect amounts resulting from agreements entered into in the normal course of conducting business with these affiliates. We believe that these agreements have been executed on terms comparable to those of unrelated third parties. 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 and TCV affiliates such as telecommunications and advertising. In addition, various Blackstone and TCV affiliates utilize our partner marketing programs and corporate travel services.

 

 

We adopted SFAS No. 157 on January 1, 2008. Under this standard, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The standard outlines a valuation framework and creates a fair value hierarchy in order to increase the consistency and comparability of fair value measurements and the related disclosures. In accordance with FSP 157-2, we will defer the adoption of SFAS No. 157 for our non-financial assets and non-financial liabilities, except those items recognized or disclosed at fair value on an annual or more frequently recurring basis, until January 1, 2009. Under SFAS No. 159, companies may choose to measure many financial instruments and certain other items at fair value. We did not elect the fair value measurement option under SFAS No. 159 for any of our financial assets or liabilities (see Note 2 — Recently Issued Accounting Pronouncements).

 

We have derivative financial instruments that must be measured under the new fair value standard. We currently do not have non-financial assets and non-financial liabilities that are required to be measured at fair value on a recurring basis. SFAS No. 157 establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

 

In accordance with the fair value hierarchy described above, the following table shows the fair value of our financial assets and liabilities that are required to be measured at fair value as of September 30, 2008,

 

ORBITZ WORLDWIDE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

which are classified as other current assets, other non-current assets, other current liabilities and other non-current liabilities in our condensed consolidated balance sheets:

 

 

 

We value our interest rate hedges using valuations that are calibrated to the initial trade prices. Subsequent valuations are based on observable inputs to the valuation model including interest rates, credit spreads and volatilities.

 

We value our foreign currency hedges based on the difference between the foreign currency forward contract rate and widely available foreign currency forward rates as of the measurement date. Our foreign currency hedges consist of forward contracts that are short-term in nature, generally maturing within 30 days.

 

 

On November 10, 2008, we announced that we will reduce our U.S. workforce by approximately 10 percent by the end of the year and will reduce other operating expenses in response to weakening demand in the travel industry as well as current economic conditions. In connection with the workforce reduction, we estimate that we will incur total expenses of $2 million to $3 million relating to severance benefits and other termination-related costs, all of which will be cash expenditures. We expect to record these charges in the fourth quarter of 2008.

 

The following discussion should be read in conjunction with our condensed consolidated financial statements included elsewhere in this report and our 2007 Annual Report on Form 10-K/A filed with the Securities and Exchange Commission on August 28, 2008.

 

OVERVIEW

 

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. Our brand portfolio includes Orbitz, CheapTickets, the Away Network, and Orbitz for Business in the Americas; ebookers in Europe; and HotelClub and RatesToGo based in Sydney, Australia, which have operations globally. We provide customers with the ability to book a comprehensive set of travel products, from over 75,000 suppliers worldwide, including air travel, hotels, vacation packages, car rentals, cruises, travel insurance and destination services such as ground transportation, event tickets and tours.

 

We generate revenue through multiple sources, including our retail model, merchant model, incentive payments, advertising, and white label and hosting businesses. Through our retail model, we earn fees and commissions from travel suppliers for airline tickets, hotel rooms, car rentals and other travel products and services booked on our websites. Through our merchant model, we generate revenue for our services based on the difference between the total amount the customer pays for the travel product and the negotiated net rate plus estimated taxes that the supplier charges for that product. Under both the retail and merchant models, we also earn revenue by charging customers a service fee for booking airline tickets and certain other travel products. In addition, we receive incentive payments for each segment of travel that is processed through a global distribution system (“GDS”).

 

We generate advertising revenue through our partner marketing programs. These programs provide direct access to our customer base through a combination of display advertising, performance-based advertising and other marketing programs. Our white label and hosting businesses enable us to earn revenue by licensing our technology platform to, or hosting websites on behalf of, third-party partners.

 

We continue to focus on the execution of our strategic plan, including increasing non-air revenue, growing our international brands and improving our operational efficiency through investing in our new technology platform. We are a leader in air travel, the largest online travel segment. This leadership position has enabled us to drive growth in non-air categories, specifically hotels and dynamic vacation packages. Dynamic vacation packages are vacation packages that include different combinations of travel products. These non-air categories generally have higher margins, and we believe these categories will present significant growth opportunities for us.

 

We believe that there are substantial growth opportunities in regions outside of the U.S. for our international brands. We experienced growth in our international gross bookings of 13% during the three months ended September 30, 2008 as compared to the three months ended September 30, 2007 and 22% during the nine months ended September 30, 2008 as compared to the nine months ended September 30, 2007, excluding the impact of fluctuations in foreign exchange rates and the results of Travelbag, an offline U.K. travel business that we sold in July 2007.

 

We believe our new technology platform will enhance our ability to drive growth internationally and improve our operational efficiency. Our new platform will support our brand portfolio in the Americas and Europe as well as our white label partnerships. In 2007, we launched the new technology platform for our ebookers brand in the U.K. and Ireland. During the nine months ended September 30, 2008, we launched our ebookers brand in Belgium, Austria, the Netherlands, Germany, Switzerland and Spain onto the platform. By late 2008, we expect to launch our remaining ebookers websites onto the platform. We believe the new technology platform and other technology enhancements we are making will:

 

 

 

We have already realized benefits from the new platform. The platform allows us to offer a broader range of hotels to customers for booking. As a result, the number of hotels on our websites that have migrated to the new platform has tripled to over 75,000 hotels globally. We expect to see further improvements in the hotels available for booking on these websites as our global hotel supply team continues to expand our relationships with hotel suppliers. We have made significant improvements in the hotel and dynamic packaging booking path. We have also experienced operational efficiencies and eliminated many of the manual processes required under the old platform. We expect these improvements, combined with the anticipated centralization of certain business functions and the retirement of the old platform, to lower our operating costs at ebookers over time.

 

As part of our strategy to grow our dynamic packaging and hotel businesses, we have significantly increased the number of hotel market managers on our global hotel supply team, particularly in Europe and Asia Pacific. With these additional resources in place, we have signed a substantial number of new direct hotel contracts, and we are beginning to realize the benefits of developing these relationships.

 

Industry Trends

 

The economic and industry outlook has deteriorated significantly for the fourth quarter of 2008 and into 2009, as many economists predict that the U.S., and possibly the global economy, may be in a prolonged recession. The weakening economy has lowered consumer confidence which, in turn, could result in changes to consumer spending patterns, including reduced spending on travel.

 

The current economic environment has already begun to impact the travel industry, particularly the domestic airline industry. As a result of higher fuel prices, airlines have raised ticket prices and implemented capacity reductions. We believe that capacity reductions and higher airline ticket prices will negatively impact demand for air travel. Lower demand for air travel could impact the net revenue that online travel companies (“OTCs”) generate from the booking of airline tickets and in turn, impact net revenue generated from the booking of other travel products, such as hotels and car rentals. Potential bankruptcies and consolidation in the airline industry could also result in capacity reductions that could further increase ticket prices and reduce the number of seats available for booking on OTCs’ websites.

 

U.S. airlines are also under increased pressure to reduce their overall costs, including costs of distributing air travel through OTCs and GDSs. As a result, our distribution partners could attempt to terminate or renegotiate their agreements with us on more favorable terms to them, which could reduce the revenue we generate from those agreements. In addition, any pressure placed on GDSs by the airlines may result in an attempt by the GDSs to pass additional costs to us.

 

In September 2008, fundamentals in the U.S. hotel industry also weakened. Hotel occupancy rates and average daily rates (“ADRs”) declined in September for the first time in several years, and we expect this trend to continue well into 2009. A deterioration of ADRs would negatively impact the net revenue that OTCs earn per hotel booking.

 

While we do not believe that our consolidated results of operations for the first nine months of 2008 were significantly impacted by the economic and industry conditions described above, we expect them to negatively impact our gross bookings and net revenue growth in the fourth quarter of 2008 and into 2009.

 

Despite the macroeconomic environment, internet usage and online travel bookings continue to increase worldwide. Online travel booking rates are highest in the U.S. and have grown on a year-over-year basis. Suppliers, including airlines, hotels and car rental companies, have continued to focus their efforts on direct sale of their products through their own websites, further promoting the migration of customers to online

booking. In the current environment, suppliers’ websites are believed to be taking market share domestically from both OTCs and traditional offline travel companies.

 

We believe that the rate of growth of online travel bookings in the domestic market has slowed as this market has matured. Much of the initial rapid growth experienced in the online travel industry was driven by consumers shifting from purchasing travel through traditional offline channels to purchasing travel through online channels. Accordingly, we believe that growth rates in the domestic online travel market may more closely follow the growth rates of the overall travel industry.

 

Internationally, the online travel industry continues to benefit from rapidly increasing Internet usage and growing acceptance of online booking. We expect international growth rates for the online travel industry to continue to outpace growth rates of the overall travel industry. As a result, we believe OTCs will increasingly generate a larger percentage of their growth from outside of the U.S. The hotel-only business models have had particular success in delivering high growth rates in international markets. Our international brands, including ebookers, HotelClub and RatesToGo, provide us with growth opportunities outside of the U.S. However, competitive pressures combined with a weakening global economy have slowed and may continue to slow our international growth rates.

 

In the U.S., the booking of air travel has become increasingly driven by price. As a result, we believe that OTCs will continue to focus on differentiating themselves from supplier websites by offering customers the ability to selectively combine travel products such as air, car, hotel and destination services into dynamic vacation packages. Dynamic packaging and other non-air categories generally have higher margins, and we foresee significant growth potential for OTCs for these types of services.

 

OTCs generally charge a booking fee in connection with the booking of airline tickets and certain other travel products. We charge a service fee on many of our websites, and in exchange, provide our customers with a set of comparison shopping tools, access to extensive travel products and a wide range of services, including coverage from our OrbitzTLC customer care platform. Certain OTCs have reduced or eliminated booking fees on retail airline tickets and hotel rooms, which has created uncertainty around the sustainability of booking fees. We will continue to monitor the competitive environment and regularly evaluate our fee structure.

 

OTCs make significant investments in marketing through both online and traditional offline channels. Key areas of online marketing include search engine marketing, display advertising, affiliate programs and email marketing. Online marketing costs have been rising in the U.S. over time, and competition for search-engine key words has intensified in the past year. Increasing competition from supplier websites and the growing significance of search and meta-search sites has contributed to the increase in online marketing costs. If this trend continues, these rising costs could result in lower margins or declining transaction growth rates for OTCs. We are actively pursuing tactics to optimize the results of our online marketing efforts by increasing the value from existing traffic and by acquiring additional traffic that is more targeted and cost effective. These tactics include pay-per-click optimization and search optimization efforts, loyalty programs and email marketing that target customers with offers that correspond to their particular interests.

 

Despite the increase in online marketing costs, the continued growth of search and meta-search sites as well as Web 2.0 features creates new opportunities for OTCs to add value to the customer experience and generate advertising revenue. Web 2.0 is a term used to describe content features such as social networks, blogs, user reviews, videos and podcasts. We believe that the ability of OTCs to incorporate Web 2.0 features on their websites can create value for customers, suppliers and third-party partners while simultaneously creating new revenue streams.

 

RESULTS OF OPERATIONS

 

Key Operating Metrics

 

Our operating results are affected by certain key metrics that represent overall transaction activity. Gross bookings and net revenue are two key metrics. Gross bookings is defined as the total amount paid by a consumer for transactions booked under both the retail and merchant models. Net revenue is defined as

commissions and fees generated through our retail and merchant models as well as advertising revenue and certain other fees and commissions.

 

Gross bookings provide insight into changes in overall travel activity levels, changes in industry-wide online booking activity, and more specifically, changes in the number of bookings through our websites. We follow net revenue trends for our various brands, geographies and product categories to gain insight into the performance of our business across these categories. Both metrics are important in determining the ongoing growth of our business.

 

The table below shows our gross bookings and net revenue for the three and nine months ended September 30, 2008 and September 30, 2007: