Amended Form 10-K for Period Ended 12/31/2002

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K/A

(Amendment No. 1)

 

(Mark One)

x   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2002 or

 

¨   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

(for the transition period from to )

 

Commission File No. 000-27429

 


 

EXPEDIA, INC.

(Exact name of registrant as specified in its charter)

 

Washington

 

91-1996083

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

13810 SE Eastgate Way, Suite 400

Bellevue, Washington 98005

(Address of Principal Executive Offices)

 

(425) 564-7200

(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  x    No  ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes  x    No  ¨

 

The aggregate market value of the voting stock held by non-affiliates of the registrant on March 31, 2002 (the date nearest to June 28, 2002 for which information is available to the registrant), based on the closing sale price of the Common Stock on June 28, 2002, as reported on the Nasdaq National Market was approximately $1,162,975,000. Shares of Common Stock held by each current executive officer and director and by each person who is known by the registrant to own 5% or more of the outstanding Common Stock have been excluded from this computation in that such persons may be deemed to be affiliates of the Company. Share ownership information of certain persons known by the Company to own greater than 5% of the outstanding common stock for purposes of the preceding calculation is based solely on information on Schedule 13D or 13G filed with the Commission and is as of March 31, 2002 (the date nearest to June 28, 2002 for which information is available to the registrant). This determination of affiliate status is not a conclusive determination for other purposes.

 

The number of shares outstanding of the registrant’s Common Stock, par value $.01 per share as of February 28, 2003, was approximately 118,520,000 consisting of 49,518,000 of common stock and 69,002,000 of Class B common stock (as adjusted for the 2-for-1 stock split effective March 10, 2003).

 



Our operations are subject to a number of risks. You may find a discussion of those risks under the Caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors that May Impact Future Results of Operations.”

 

This annual report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding our expectations, beliefs, intentions or strategies regarding the future. Forward-looking statements also include statements regarding the extent and timing of our future revenues and expenses and customer demand, statements regarding the deployment of our products and services, and statements regarding our reliance on third parties. Sections which contain numerous forward-looking statements include: Item 1: “Business,” Item 7: “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 7A: “Quantitative and Qualitative Disclosures About Market Risk,” all of which appear later in this annual report.

 

We have based all of our forward-looking statements on information available to us on the date of the annual report on Form 10-K filed on March 31, 2003, and we are not obligated to update any of these forward-looking statements. You should note that our actual results could differ materially from the forward-looking statements.

 

2


 

EXPLANATORY NOTE

 

The purpose of this Form 10-K/A is to amend the Form 10-K filed on March 31, 2003 to:

 

(1)  Include Part III of Form 10-K/A.

 

Expedia has included the information set forth in Items 10, 11, 12 and 13 of Part III hereof which formerly had been contemplated to be incorporated by reference from Expedia’s definitive Proxy Statement for Expedia’s 2003 annual meeting of shareholders to be filed with the Securities and Exchange Commission. The Company has not yet determined a date for the annual meeting of shareholders.

 

(2)  Restate financial statements.

 

In April 2003, the Company became aware of an error in the computation of amortization of stock-based compensation expense for the year ended June 30, 2000, related to stock options granted on the completion of its initial public offering in place of the cancelled unvested Microsoft options. Subsequent periods (year ended June 30, 2001, six-month period ended December 31, 2001, and the year ended December 31, 2002) were affected by the impact of the error.

 

The effect of the restatements for the year ended December 31, 2002, the six-month period ended December 31, 2001, and for the years ended June 30, 2001 and 2000 is as follows (in thousands, except per share amounts):

 

    

Year ended December 31,


  

Six-month period ended December 31,


  

Years ended June 30,


 
    

2002


  

2001


  

2001


    

2000


 

Recognition of stock-based compensation:

                               

As previously reported

  

$

6,562

  

$

5,988

  

$

31,183

 

  

$

60,689

 

    

  

  


  


Restated

  

$

2,884

  

$

4,367

  

$

30,228

 

  

$

70,051

 

    

  

  


  


Net income (loss):

                               

As previously reported

  

$

66,315

  

$

472

  

$

(78,053

)

  

$

(118,315

)

    

  

  


  


Restated

  

$

69,993

  

$

2,093

  

$

(77,098

)

  

$

(127,677

)

    

  

  


  


Basic net income (loss) per common share:

                               

As previously reported

  

$

0.59

  

$

0.00

  

$

(0.83

)

        
    

  

  


        

Restated

  

$

0.62

  

$

0.02

  

$

(0.82

)

        
    

  

  


        

Diluted net income (loss) per common share:

                               

As previously reported

  

$

0.52

  

$

0.00

  

$

(0.83

)

        
    

  

  


        

Restated

  

$

0.55

  

$

0.02

  

$

(0.82

)

        
    

  

  


        

Pro forma basic and diluted net loss per common share:

                               

As previously reported

                         

$

(1.55

)

                           


Restated

                         

$

(1.68

)

                           


 

Selected Financial Data (Item 6), Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 7) and the Consolidated Financial Statements, including the Notes to Consolidated Financial Statements (Item 15), have been revised to reflect the impact of the restatement. For additional information regarding the restatement, see “Note 16 to Consolidated Financial Statements” included in Part IV, Item 15.

 

(3)  Add Exhibit 10.29.

 

Except for the addition of the information in Part III hereof and the addition of Exhibit 10.29, this amendment to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002 amends and restates only those items of the previously filed Form 10-K which have been affected by the restatement. In order to preserve the nature and character of the disclosures set forth in such items as originally filed, no attempt has been made in this amendment to modify or update such disclosures except as required to reflect the effects of the restatement and to make non-substantive revisions to the Notes to the Consolidated Financial Statements.

 

3


 

ITEM 6.    SELECTED FINANCIAL DATA

 

The following selected financial data in this amended report has been restated for all periods presented, except for years ended June 30, 1999 and 1998 (see Note 16 to Consolidated Financial Statements) and should be read together with our financial statements and notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this annual report. In February 2002, Expedia changed its fiscal year from June 30 to December 31. The statement of operations data for the year ended December 31, 2002, the six-month period ended December 31, 2001, and for the years ended June 30, 2001 and 2000 and the balance sheet data as of December 31, 2002 and 2001, are derived from our audited financial statements and are included elsewhere in this annual report. The statement of operations data for the years ended June 30, 1999 and 1998 and the balance sheet data as of June 30, 2001, 2000, 1999, and 1998 are derived from audited financial statements not included herein.

 

    

Year ended December 31,


    

Six-month

period ended

December 31,


    

Years ended June 30,


 
    

2002
(restated)


    

2001
(restated)


    

2001
(restated)


    

2000
(restated)


    

1999


    

1998


 
    

(in thousands, except per share amounts)

 

Statement of Operations Data:

                                                     

Merchant revenues

  

$

339,137

 

  

$

68,423

 

  

$

64,548

 

  

$

10,912

 

  

$

 

 

  

$

 

 

Agency revenues

  

 

231,817

 

  

 

81,545

 

  

 

122,987

 

  

 

59,534

 

  

 

24,677

 

  

 

6,866

 

Advertising and other revenues

  

 

19,644

 

  

 

11,272

 

  

 

34,685

 

  

 

24,185

 

  

 

14,022

 

  

 

6,961

 

    


  


  


  


  


  


Revenues

  

 

590,598

 

  

 

161,240

 

  

 

222,220

 

  

 

94,631

 

  

 

38,699

 

  

 

13,827

 

    


  


  


  


  


  


Cost of merchant revenues

  

 

98,770

 

  

 

19,325

 

  

 

17,567

 

  

 

3,369

 

                 

Cost of agency revenues

  

 

87,771

 

  

 

31,287

 

  

 

53,427

 

  

 

34,136

 

  

 

14,548

 

  

 

8,996

 

Cost of advertising and other revenues

  

 

2,726

 

  

 

1,555

 

  

 

3,280

 

  

 

2,643

 

  

 

1,402

 

  

 

696

 

    


  


  


  


  


  


Cost of revenues

  

 

189,267

 

  

 

52,167

 

  

 

74,274

 

  

 

40,148

 

  

 

15,950

 

  

 

9,692

 

    


  


  


  


  


  


Gross profit

  

 

401,331

 

  

 

109,073

 

  

 

147,946

 

  

 

54,483

 

  

 

22,749

 

  

 

4,135

 

    


  


  


  


  


  


Operating expenses

  

 

255,893

 

  

 

76,887

 

  

 

137,381

 

  

 

96,599

 

  

 

42,351

 

  

 

33,613

 

Operating expenses—non-cash

  

 

24,901

 

  

 

24,176

 

  

 

92,254

 

  

 

87,914

 

                 
    


  


  


  


  


  


Total operating expenses

  

 

280,794

 

  

 

101,063

 

  

 

229,635

 

  

 

184,513

 

  

 

42,351

 

  

 

33,613

 

    


  


  


  


  


  


Income (loss) from operations

  

 

120,537

 

  

 

8,010

 

  

 

(81,689

)

  

 

(130,030

)

  

 

(19,602

)

  

 

(29,478

)

Net interest income and other

  

 

11,276

 

  

 

2,543

 

  

 

4,591

 

  

 

2,353

 

                 

Share of joint venture net loss

  

 

(711

)

  

 

(769

)

                                   

USA merger related expense

  

 

(11,566

)

  

 

(7,691

)

                                   
    


  


  


  


  


  


Income (loss) before provision for income taxes

  

 

119,536

 

  

 

2,093

 

  

 

(77,098

)

  

 

(127,677

)

  

 

(19,602

)

  

 

(29,478

)

Provision for income taxes

  

 

(49,543

)

                                            
    


  


  


  


  


  


Net income (loss)

  

$

69,993

 

  

$

2,093

 

  

$

(77,098

)

  

$

(127,677

)

  

$

(19,602

)

  

$

(29,478

)

    


  


  


  


  


  


Net income (loss) per share:

                                                     

Basic

  

$

0.62

 

  

$

0.02

 

  

$

(0.82

)

                          

Diluted

  

$

0.55

 

  

$

0.02

 

  

$

(0.82

)

                          

Pro forma basic and diluted

                             

$

(1.68

)

  

$

(0.30

)

        

Weighted average number of shares outstanding:

                                                     

Basic

  

 

113,072

 

  

 

102,342

 

  

 

94,420

 

                          

Diluted

  

 

127,972

 

  

 

124,384

 

  

 

94,420

 

                          

Pro forma basic and diluted

                             

 

76,088

 

  

 

66,000

 

        

Balance Sheet Data:

                                                     

Cash and cash equivalents

  

$

218,219

 

  

$

238,374

 

  

$

182,161

 

  

$

60,670

 

  

$

 

 

  

$

 

 

Working capital

  

 

270,945

 

  

 

116,487

 

  

 

96,147

 

  

 

20,122

 

  

 

1,390

 

  

 

4,814

 

Total assets

  

 

859,913

 

  

 

404,555

 

  

 

389,844

 

  

 

273,050

 

  

 

5,756

 

  

 

8,333

 

Deferred merchant bookings

  

 

149,348

 

  

 

52,965

 

  

 

80,326

 

  

 

14,424

 

                 

Unearned revenues

  

 

4,772

 

  

 

1,574

 

  

 

1,545

 

  

 

9,696

 

  

 

6,215

 

  

 

7,963

 

Long-term liabilities, net of current portion

                    

 

1,303

 

  

 

4,557

 

  

 

3,851

 

  

 

5,820

 

Accumulated deficit

                                      

 

(86,764

)

  

 

(67,162

)

Retained deficit

  

 

(128,328

)

  

 

(198,261

)

  

 

(200,327

)

  

 

(123,172

)

                 

Total stockholders’ equity (owner’s net deficit)

  

 

486,006

 

  

 

249,101

 

  

 

230,999

 

  

 

207,496

 

  

 

(1,675

)

  

 

(92

)

 

4


 

ITEM 7.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The information contained in this section has been derived from our consolidated financial statements and should be read together with our consolidated financial statements and related notes included elsewhere in this annual report.

 

As discussed in the explanatory note at the beginning of this report, and also in Note 16 to the Consolidated Financial Statements included in this report, Expedia has restated its consolidated financial statements for the year ended December 31, 2002, the six-month period ended December 31, 2001, and for the years ended June 30, 2001 and 2000. The following discussion has been revised to reflect the results of such restatement. The discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those expressed or implied in these forward-looking statements as a result of various factors, including those set forth at the end of this section under “Factors That May Impact Future Results of Operations.” All share numbers and share prices in the following sections have been adjusted to reflect our 2-for-1 stock split effective March 10, 2003.

 

Critical Accounting Policies and Judgments

 

The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. The SEC has defined a company’s most critical accounting policies as the ones that are most important to the portrayal of the company’s financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, we have identified the critical accounting policies and judgments addressed below. We also have other key accounting policies, which involve the use of estimates, judgments and assumptions. See Note 2 “Summary of Significant Accounting Policies” in our audited consolidated financial statements included elsewhere in this annual report. Although we believe that our estimates and assumptions are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates under different assumptions or conditions.

 

Revenue Recognition

 

We generally recognize revenue from product sales or services rendered when the following four revenue recognition criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable and collectibility is reasonably assured.

 

Merchant revenues are derived from transactions where we are the merchant of record and determine the price to the customer. We have agreements with suppliers for inventory (e.g., air tickets or hotel rooms) that we sell. We do not have purchase obligations for unsold inventory. We present merchant revenues in accordance with Emerging Issues Task Force (EITF) Issue No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent. Based upon our evaluation of our merchant transactions and in accordance with the various indicators identified in EITF No. 99-19, we determined our suppliers assume the majority of the business risks which include providing the service and the risk of unsold inventory. As such, all merchant transactions are recorded at the net amount, which is the amount charged to the customer less the amount to be paid to the supplier. Recognition of merchant revenue occurs on the date the traveler’s usage.

 

We accrue for costs of merchant revenues based on the expected amount to be invoiced to us by our suppliers. If we do not receive an invoice within a certain period of time, typically within six months, or the invoice is less than the accrued amount, we may reverse a portion of the accrued cost, thus, increasing net revenue, after giving consideration to the applicable state escheat laws. We determine the amounts to be reversed into revenues based on our understanding of the escheat laws, our estimates of billings suppliers will send us

 

5


after six months following the travel date, and our analysis of reasons underlying the unbilled amounts. If our judgments regarding these factors were inaccurate, actual revenues could differ from the amount we recognize, directly impacting our results of operations.

 

For our merchant air business, the cost of the airline ticket is paid by us to the airlines via the Airlines Reporting Corporation within a week after the customer purchases the ticket from us. This cost to us is treated as prepaid merchant bookings on the consolidated balance sheet until the flight occurs, when it is then applied against the customer purchase in order to record revenue on a net basis. Cash paid by the customer at the time the reservation is booked for merchant transactions is treated as deferred merchant bookings on the consolidated balance sheet until usage occurs, when it is then applied against the cost in order to record revenue on a net basis.

 

Agency revenues are derived from airline ticket transactions, hotel, cruise, car rental reservations and service fees. We recognize agency revenues on airline ticket transactions when the reservation is made and secured by a credit card. Our revenues from reservation fees are subject to forfeiture in the event of a ticket cancellation. No revenue reserve for cancellations was required prior to June 2002, as airlines paid a separate cancellation fee, higher than the reservation fee cancelled, to agents upon cancellation. However, beginning June 2002, airlines eliminated payment of a cancellation fee to agents such as Expedia. Accordingly, beginning on that date we have been recognizing a cancellation allowance on these revenues based on historical cancellation experience. We recognize agency revenues on hotel, cruise and car rental reservations at the earlier of notification of the amount of the commission from a commission clearinghouse or an individual supplier or on receipt of the commissions. Override commissions are recognized each period based upon the projected and actual attainment of predetermined target sales levels. Where historical financial data is not available to project the target sales levels, we record the override commission upon receipt of the commission from the supplier. We recognize service fees as the services are performed and completed.

 

Advertising revenues are derived from the sales of advertisements on our websites. We generally recognize advertising revenues ratably over the advertising period, depending on the terms of the advertising contract. We also recognize some revenue relating to barter arrangements. The Company has applied EITF 99-17, Accounting for Advertising Barter Transactions, in the valuation and recognition of this revenue. Fees from the licensing of software are another source of revenues. The fixed portion of these license fees are recognized ratably over the lives of the contracts upon delivery of the software. Transaction-based fees are recognized when the relevant transactions occur. We have applied Statement of Position (SOP) 97-2, Software Revenue Recognition, and SOP 98-9, Modification of SOP 97-2, With Respect to Certain Transactions, in the valuation of this revenue.

 

Non-Application of Push Down Basis of Accounting

 

Under the SEC rules, financial statements filed with the SEC of companies following a more than 95% change in ownership have to be restated to reflect the purchaser’s push down basis of accounting. Push-down is not allowed in the event of a less than 70% change in control. If 70% or more, but no more than 95% change in control occurred, application of the push-down basis is at the company’s discretion. Because USA acquired more than 70%, but less than 95% of Expedia’s shares and voting power, Expedia had the choice of whether to apply push-down basis of accounting, and has elected not to do so. If push-down basis were applied, all of Expedia’s assets and liabilities as of the date of its acquisition by USA would have been restated to fair values; and retained earnings and other equity accounts as of the acquisition date would have been eliminated.

 

Capitalized Internal Use Software and Website Development Costs

 

We capitalize certain direct costs incurred in conjunction with developing internal use software in accordance with Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. These costs are being amortized using the straight-line method over their estimated useful lives ranging from three to five years, beginning when the software is ready for use. We also capitalize website development costs in connection with the periodic upgrades to our websites in accordance with EITF 00-2, Accounting for Website Development Costs. These costs are being amortized using the straight-line

 

6


method over a one-year estimated useful life, beginning with the release of the website enhancements to which these costs pertained. Internal use software and website development costs are included in property and equipment assets in the accompanying consolidated balance sheets. The determination of estimated useful lives is sensitive to estimates used. Accordingly, any changes in estimates could have a material impact on the resulting fair values and thus the assessment of impairment.

 

Accounting for Goodwill and Certain Other Intangibles

 

On July 1, 2001, we adopted Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting, and broadens the criteria for recording intangible assets apart from goodwill. SFAS No. 142 requires that purchased goodwill and certain indefinite-lived intangibles no longer be amortized, but instead be tested for impairment at least annually.

 

SFAS No. 142 prescribes a two-phase process for impairment testing of goodwill. The first phase screens for impairment, while the second phase (if necessary) measures the impairment. The first phase should be performed by comparing the fair value of the applicable reporting unit to its carrying value. Impairment adjustments recognized, if any, are recognized as operating expenses. Fair value was determined using a discounted cash flow methodology. We completed our initial and annual impairment analysis as of December 31, 2001 and 2002, respectively, and found no instances of impairment of our recorded goodwill; accordingly, the second testing phase was not necessary. No subsequent indicators of impairment have been noted. The determination of fair values, generally based on either appraised values or discounted estimated future cash flows, is critical to assessing impairment under SFAS No. 142 and requires the use of significant assumptions and estimates. The determination of fair values is sensitive to the assumptions and estimates used. Accordingly, any changes in such assumptions or estimates could have a material impact on the resulting fair values and thus the assessment of impairment. Likewise, any changes in appraised values or discounted estimated future cash flows resulting from future events or performance could result in future impairment charges.

 

Separable intangible assets that have determinable lives continue to be amortized over their useful lives. Intangible assets consist primarily of supplier relationships, distribution agreements, acquired technology, customer lists, trademarks and property manager relationships. As required under SFAS No. 142, we continue to amortize intangible assets with finite lives on a straight-line basis, over their estimated useful lives, ranging from two to ten years and have ceased the amortization prospectively on goodwill and indefinite-lived intangible assets upon adoption of SFAS No. 142.

 

Stock-Based Compensation

 

Through December 31, 2002, we have followed Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and related interpretations, in accounting for employee stock options rather than the alternative fair value accounting method described in SFAS No. 123, Accounting for Stock-Based Compensation. APB No. 25 provides that the compensation expense relative to our employee stock options is measured based on the intrinsic value of the stock options at the time of issuance and is recognized and expensed over the vesting period on an accelerated basis. Any changes in methodology in the recognition of stock based compensation such as using straight-line instead of an accelerated basis could have a material impact on our financial operations. SFAS No. 123 requires companies that continue to follow APB No. 25 to provide pro forma disclosure of the impact of applying the fair value method of SFAS No. 123 in their annual report.

 

Restricted stock is measured at fair value on the date of grant based on the number of shares granted and the quoted price of our common stock. Such value is recognized as an expense ratably over the corresponding employee service period. To the extent restricted stock is forfeited prior to vesting, the corresponding previously recognized expense is reversed as an offset to “unearned stock-based compensation.”

 

7


 

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure. This Statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002 and have been incorporated into these consolidated financial statements and accompanying footnotes. Effective January 1, 2003, we have adopted SFAS No. 123, the fair value based method of accounting for stock-based employee compensation. We expect the adoption of SFAS No. 123 to have a material effect on our financial position and results of operations. See Note 2 in the consolidated financial statements included herein for discussion of the effect on net income (loss) and other related disclosures had we accounted for these plans under SFAS No. 123, “Accounting for Stock-Based Compensation.”

 

Income Taxes

 

We account for income taxes under the liability method. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. We provide a valuation allowance to reduce deferred tax assets to their estimated realizable value.

 

As of December 31, 2002, we had utilized the benefit of all of our net operating loss carryforwards that had been generated through our operations. The remaining net operating loss carryforwards, which are attributable to acquired net operating losses and stock option deductions, will be utilized to reduce income taxes payable. The benefit of the remaining net operating losses will be recorded as an adjustment to goodwill or an increase to equity, when realized.

 

Based on our limited operating history, the difficulty in accurately forecasting long-term future results, the large amount of net operating loss carryforwards for income tax purposes and the expected continuation of tax deductions attributable to stock option deductions, we have applied a valuation allowance equivalent to the expected tax benefit from our net operating loss carryforward and other deferred tax assets. As a result, we have not recorded a benefit for current federal and state income taxes or a related deferred tax asset.

 

A valuation allowance against deferred tax assets is recorded if the realization of income, as defined under SFAS No. 109, Accounting for Income Taxes, from the reversal of deferred tax liabilities is no longer assured within the carryforward periods of our existing deferred tax assets. Such determination includes estimates of expected taxable income and the timing of the reversal of deferred tax liabilities. In the event that actual results differ materially from management’s expectations, the valuation allowance could materially change, directly impacting our financial position and results of operations.

 

Recent Developments

 

On March 19, 2003, Expedia and USA announced that they entered into a merger agreement by which USA would acquire the Expedia shares it does not currently own in a stock-for-stock merger. The Expedia Board of Directors approved the agreement following the unanimous recommendation and approval of an independent Special Committee of the Expedia Board. Under the agreement, Expedia shareholders will receive 1.93875 shares of USA common stock for each share of Expedia stock that they own. In connection with the merger, Expedia warrants and options will be converted into warrants and options to acquire USA common stock. The parties expect that the transaction will generally be tax-free to Expedia shareholders. The merger is subject to certain conditions to closing contained in the merger agreement, which was filed with the SEC on March 19, 2003.

 

8


 

Results of Operations

 

The following table sets forth our results of operations as a percentage of revenues.

 

      

Year ended

December 31,


      

Six-month

period ended

December 31,


      

Years ended June 30,


 
      

2002 (restated)


      

2001 (restated)


      

2001 (restated)


      

2000 (restated)


 

Statement of Operations Data:

                                   

Merchant revenues

    

58

 %

    

42

 %

    

29

 %

    

11

 %

Agency revenues

    

39

 

    

51

 

    

55

 

    

63

 

Advertising and other revenues

    

3

 

    

7

 

    

16

 

    

26

 

      

    

    

    

Revenues

    

100

 

    

100

 

    

100

 

    

100

 

      

    

    

    

Cost of merchant revenues

    

17

 

    

12

 

    

8

 

    

4

 

Cost of agency revenues

    

15

 

    

19

 

    

24

 

    

36

 

Cost of advertising and other revenues

    

1

 

    

1

 

    

1

 

    

2

 

      

    

    

    

Cost of revenues

    

33

 

    

32

 

    

33

 

    

42

 

      

    

    

    

Gross profit

    

67

 

    

68

 

    

67

 

    

58

 

      

    

    

    

Operating expenses:

                                   

Product development

    

6

 

    

8

 

    

11

 

    

22

 

Sales and marketing

    

29

 

    

30

 

    

41

 

    

69

 

General and administrative

    

7

 

    

9

 

    

10

 

    

11

 

Amortization of goodwill

                      

9

 

    

6

 

Amortization of intangible assets

    

4

 

    

12

 

    

19

 

    

13

 

Recognition of stock-based compensation

    

1

 

    

3

 

    

14

 

    

74

 

      

    

    

    

Total operating expenses

    

47

 

    

62

 

    

104

 

    

195

 

      

    

    

    

Income (loss) from operations

    

20

 

    

6

 

    

(37

)

    

(137

)

Net interest income and other

    

2

 

    

2

 

    

2

 

    

2

 

Share of joint venture net loss

                                   

USA merger related expense

    

(2

)

    

(6

)

                 
      

    

    

    

Income (loss) before provision for income taxes

    

20

 

    

2

 

    

(35

)

    

(135

)

Provision for income taxes

    

(8

)

                          
      

    

    

    

Net income (loss)

    

12

 

    

2

 

    

(35

)

    

(135

)

      

    

    

    

 

Year Ended December 31, 2002 and 2001

 

Amounts for the year ended December 31, 2001 included in the following discussion are unaudited and represent the aggregation of the audited amounts for the six-months ended December 31, 2001 with the unaudited amounts reported in the financial statements for the six-months ended June 30, 2001.

 

Revenues

 

    

Year ended December 31,


  

Twelve-month

period ended December 31,


        
    

2002


  

2001


    

% Change


 
    

($ in thousands)

        

Merchant revenues

  

$

339,137

  

$

108,603

    

212

 %

Agency revenues

  

 

231,817

  

 

158,794

    

46

 %

Advertising and other revenues

  

 

19,644

  

 

29,539

    

(33

)%

    

  

        

Revenues

  

$

590,598

  

$

296,936

    

99

 %

    

  

        

 

9


 

Merchant revenues are derived from transactions where we are the merchant of record and determine the price to the customer. We have agreements with suppliers for inventory that we sell. We do not have purchase obligations for unsold inventory. All merchant transactions are recorded at the net amount, which is the amount charged to the customer less the amount to be paid to the supplier.

 

Agency revenues are derived from airline ticket transactions, hotel, cruise, car rental reservations and services fees. Airline ticket transactions represent both airline paid ticketing fees and fees related to the sale of airline tickets. Fees related to the sale of airline tickets also include performance-based revenues from our global distribution partner. In addition, certain contracts with suppliers contain override commission compensation typically related to achieving specific performance targets. We also charge service fees and paper ticket mailing fees to customers. Paper ticket mailing fee revenues are generated by processing and delivering a paper ticket via express mail if the customer chooses not to have an electronic ticket or an electronic ticket is not available. Beginning in December 2002, a service fee is being charged to customers for most airline tickets booked on our U.S. websites. We also generate corporate transaction service fees for providing travel booking services to our corporate customers.

 

Advertising and other revenues are derived from the sales of advertisements on our websites and fees from the licensing of software are another source of revenue.

 

Total revenues for the years ended December 31, 2002 and 2001 were $590.6 million and $296.9 million, respectively, an increase of 99%. Excluding the acquisitions of Classic Custom Vacations (CCV) and Metropolitan during 2002, total revenues for the year ended December 31, 2002 would have been $529.8 million, an increase of 78%. The increase was primarily attributable to the growth in our worldwide merchant hotel business.

 

Merchant revenues for the years ended December 31, 2002 and 2001 were $339.1 million and $108.6 million, respectively, an increase of $230.5 million or 212%. Merchant revenues relating to our North America segment increased by $215.3 million year over year due to an increase in our merchant hotel transactions and the acquisition of CCV in March 2002. Our North America segment generates its revenues from its points-of-sale in the U.S. and Canada. Our North America merchant hotel business increased by $131.2 million year over year as a result of an increased number of hotels available for customers to choose from, increased number of room nights stayed, a slightly higher average daily rate per hotel room due to a shift in mix to higher priced destinations such as Europe, Hawaii, Mexico and the Caribbean, and the customer having the flexibility to purchase merchant hotel rooms as a stand-alone product or combined with other travel products in a package. In addition, CCV, our provider of luxury vacation packages to Mexico, North America, Europe and the Caribbean through a network of travel agents and travel agencies, generated $56.9 million of revenues. All components of CCV’s vacation packages are classified as merchant revenues.

 

Merchant revenues relating to our International segment increased by $15.2 million year over year. The International segment generates its revenues from its points-of-sale in the U.K., Germany, Italy, the Netherlands and France. The increase in revenues is a result of our efforts in past years to expand our international segment through increased promotional and development activities in order to bring more customers to the websites. In addition, we have increased the number of partnerships with new merchant hotels, thereby expanding our available inventory. This resulted in an increased number of room nights booked by our customers. Our revenues have demonstrated strong growth especially in the U.K. where we generate the highest transaction volumes in the international segment. As we continue to gain acceptance internationally we anticipate continued strong growth in our international segment.

 

Agency revenues for the years ended December 31, 2002 and 2001 were $231.8 million and $158.8 million, respectively, an increase of $73.0 million or 46%. Agency revenues relating to our North America segment increased $63.9 million year over year primarily due to an increase in airline ticket transactions and the introduction of corporate travel as part of the acquisition of Metropolitan in July 2002. Our air ticket-related

 

10


revenue increased by $42.2 million due to an increased number of airline tickets sold which was partially offset by a decline in commission per ticket resulting from a decline in commissions paid by airlines. We expect revenues generated from our newly-implemented service fee to have a positive impact on revenue per ticket.

 

Agency revenues relating to the international segment increased $9.1 million year over year due to an increase in marketing and development activities in past years which has resulted in increased airline ticket transactions. As we continue to gain acceptance internationally we anticipate continued strong growth in our international segment.

 

Advertising and other revenues for the years ended December 31, 2002 and 2001 were $19.6 million and $29.5 million, respectively, a decrease of $9.9 million or 33%. The decrease is primarily due to two license agreements ending during the quarter ended June 30, 2001 and the last license agreement ending in the quarter ended September 30, 2002. In addition, advertising revenues have experienced slow growth rates due to the economic slowdown in the current period.

 

Cost of Revenues and Gross Profit

 

    

Year ended December 31,


    

Twelve-month

period ended

December 31,


          
    

2002


    

2001


      

% Change


 
    

($ in thousands)

          

Cost of merchant revenues

  

$

98,770

 

  

$

28,813

 

    

243

 %

Cost of agency revenues

  

 

87,771

 

  

 

61,357

 

    

43

 %

Cost of advertising and other revenues

  

 

2,726

 

  

 

3,245

 

    

(16

)%

    


  


        

Cost of revenues

  

$

189,267

 

  

$

93,415

 

    

103

 %

    


  


        

% of revenues

  

 

33

%

  

 

31

%

        

Gross profit

  

$

401,331

 

  

$

203,521

 

    

97

 %

% of revenues

  

 

68

%

  

 

69

%

        

 

The costs of merchant revenues consist of credit card merchant fees and allocated and direct costs for the operation of our data center and call centers. The costs of agency revenues consist primarily of fees paid to our fulfillment vendors for issuing airline tickets and related customer services, reserves and related payments to the airlines for tickets purchased with fraudulent credit cards, fees paid to our global distribution partners for use of their computer reservation and information services systems and allocated and direct costs for the operation of our data center and call centers. The costs of advertising and other revenues consist mainly of costs related to the employees who are responsible for placing banners and other advertisements on our websites.

 

Cost of revenues for the years ended December 31, 2002 and 2001 were $189.3 million and $93.4 million, respectively, an increase of $95.9 million or 103%. Excluding CCV and Metropolitan, cost of revenues for 2002 would have been $142.9 million, an increase of $49.5 million or 53%.

 

Gross profit for the years ended December 31, 2002 and 2001 were $401.3 million and $203.5 million, respectively, an increase of $197.8 million or 97%. Gross margin decreased from 69% in 2001 to 68.0% in 2002. Excluding CCV and Metropolitan, gross profit for 2002 would have been $386.9 million, an increase of $183.4 million or 90%. Excluding the acquisitions, gross margin for 2002 would have increased to 73.0%. CCV products have a lower gross margin than our other services, since CCV pays commissions to travel agents, which is part of the cost of merchant revenues. Our gross margins increased, excluding CCV, due to high growth rates in our merchant business and reduced costs per transaction at our call centers.

 

Merchant gross margins decreased from 73.5% to 70.9% primarily due to CCV’s commissions paid to travel agents, which is included cost of revenues. Excluding CCV, merchant gross margin for 2002 would have been

 

11


80.3%. Our gross margins excluding CCV increased due to high growth rates in our merchant business, which yields a higher gross profit per transaction compared with the other lines of business, and due to the reduction of telephone calls per air and hotel reservation. This reduction was achieved through website improvements and increased functionality on our websites which enabled our customers to make changes to their itinerary online and navigate through our websites more efficiently, thereby reducing the number of calls and e-mails to our call centers. In addition, we have managed our call center costs more effectively, as we have been able to achieve greater economies of scale.

 

Agency gross margin increased from 61.4% to 62.1%. Gross margin increased due to the reductions in cost per transaction and in the ratio of calls to transactions. The realization of this efficiency has more than made up for the decline in our revenue per airline ticket.

 

Advertising and other gross margin declined from 89.0% to 86.1% as we continued to incur fixed costs associated with advertising revenue while advertising revenues declined. Also, the reduction in licensing revenues which had virtually no associated cost, has negatively impacted margins.

 

Product Development

 

    

Year ended December 31,


    

Twelve-month

period ended December 31,


          
    

2002


    

2001


      

% Change


 
    

($ in thousands)

          

Product development

  

$

36,532

 

  

$

27,202

 

    

34

%

% of revenues

  

 

6

%

  

 

9

%

        

 

Product development expenses consist primarily of payroll and related expenses for website development, maintenance, localization and acquired content. Product development expenses for the years ended December 31, 2002 and 2001 were $36.5 million and $27.2 million, representing 6% and 9% of net revenues, respectively. The increase in absolute dollars is primarily due to additional personnel involved in the development, enhancements, and localization of our websites. This includes deploying new websites for new markets such as corporate travel. In addition, we have provided greater and richer content to travelers to enhance the customers’ buying experience. In October 2002, we acquired Newtrade Technologies, Inc. (Newtrade). A substantial number of Newtrade’s employees are classified as product development.

 

We expect to continue to invest in technology and improvements to our websites, which may include, but are not limited to, hiring additional employees, offering additional website features as well as continuing our international expansion and investment in corporate travel.

 

Sales and Marketing

 

    

Year ended December 31,


    

Twelve-month period ended December 31,


      

% Change


 
    

2002


    

2001


      
    

($ in thousands)

          

Sales and marketing

  

$

172,758

 

  

$

99,740

 

    

73

%

% of revenues

  

 

29

%

  

 

34

%

        

 

Sales and marketing expenses consist of advertising, distribution and public relations expenses as well as personnel-related costs. Our distribution activities relate to associate marketing agreements with various websites such as MSN.com and our WWTE partners. Sales and marketing expenses for the years ended December 31, 2002 and 2001 were $172.8 million and $99.7 million representing 29% and 34% of net revenues, respectively.

 

12


The increase in absolute dollars is due to domestic promotional and distribution activities of $44.3 million. Our promotional activities range from radio to magazine and other paper media advertising which create general brand awareness. We also expanded our distribution channels. In 2001, we served as the travel channel on MSN.com, Microsoft’s online services network and we also had a few WWTE partners, whereby we sell directly on other travel companies’ websites. In 2002, we increased our distribution sources with an increased number of search engine portals as well as WWTE partners.

 

In connection with the USA acquisition of control in February 2002, we received the right to advertising, marketing and promotion time, valued at $15 million for each of the five years after consummation of the merger, on the various media outlets related to USA (including outlets of former USA entertainment businesses, such as the USA Network, that are now part of Vivendi Universal Entertainment). During 2002, we recognized $13.1 million of sales and marketing expense related to these media outlets.

 

General and Administrative

 

    

Year ended December 31,


    

Twelve-month period ended December 31,


      

% Change


 
    

2002


    

2001


      
    

($ in thousands)

          

General and administrative

  

$

46,603

 

  

$

26,764

 

    

74

%

% of revenues

  

 

7

%

  

 

9

%

        

 

General and administrative expenses consist primarily of compensation for personnel to support functions such as our executive leadership, finance, legal and human resources. In addition to people-related costs, other significant expenses include professional fees and depreciation of certain internally developed systems. General and administrative expenses for the years ended December 31, 2002 and 2001 were $46.6 million and $26.8 million, representing 8% and 9% of net revenues, respectively. The increase in absolute dollars is due to additional personnel required to support our business growth and additional personnel from the acquisitions of CCV, Metropolitan and Newtrade. During 2001 and the first six months of 2002, we incurred significant costs related to acquiring hardware and software as we migrated from Microsoft’s systems onto our own. These costs were capitalized and in 2002 we began to depreciate these assets.

 

Amortization of Goodwill and Intangible Assets

 

    

Year ended December 31,


    

Twelve-month period ended December 31,


    

% Change


 
    

2002


    

2001


    
    

($ in thousands)

        

Amortization of goodwill

  

$

—  

 

  

$

10,709

 

  

(100

)%

% of revenues

  

 

0

%

  

 

4

%

      

Amortization of intangible assets

  

$

22,017

 

  

$

40,062

 

  

(45

)%

% of revenues

  

 

4

%

  

 

13

%

      

 

Amortization of intangibles relate to our acquisitions of Travelscape and VacationSpot in March 2000, CCV in March 2002, Metropolitan in July 2002 and Newtrade in October 2002. Amortization of intangibles for the years ended December 31, 2002 and 2001 were $22.0 million and $40.1 million, representing 4% and 13% of net revenues, respectively. The portion of Travelscape and VacationSpot intangible assets with estimated useful lives of two years were fully amortized as of March 17, 2002, resulting in a decrease of amortization of intangible assets in 2002. However, the decrease was partially offset by the amortization of CCV’s, Metropolitan’s and Newtrade’s intangible assets.

 

13


 

Amortization of goodwill for the years ended December 31, 2002 and 2001 was $0 and $10.7 million, representing 0% and 4% of net revenues, respectively. In July 2001, we adopted SFAS No. 142 and discontinued amortizing goodwill.

 

Recognition of Stock-Based Compensation

 

    

Year ended December 31,


    

Twelve-month period ended December 31,


      

% Change (restated)


 
    

2002
(restated)


    

2001
(restated)


      
    

($ in thousands)

          

Recognition of stock-based compensation

  

$

2,884

 

  

$

13,785

 

    

(79

)%

% of revenues

  

 

1

%

  

 

5

%

        

 

Upon the completion of our initial public offering, all the unvested options to purchase Microsoft common stock held by Expedia employees were converted to options to purchase Expedia common stock (Expedia Options). These stock option issuances were deemed to be new grants and created non-cash compensation expense for the difference between the option exercise price and the fair market value of the common stock at the date of grant. The starting date for amortization coincided with the initial public offering date of November 10, 1999.

 

Stock-based compensation for the years ended December 31, 2002 and 2001 was  $2.9 million and $13.8 million, representing 2% and 5% of net revenues, respectively. The decrease is due to amortizing the expense utilizing the accelerated method over the vesting period of each individual grant. The accelerated method results in higher amortization amounts during the beginning of the amortization period.

 

Effective January 1, 2003, we adopted SFAS No. 123, the fair value based method of accounting for stock-based employee compensation and we are shifting our equity compensation to include performance units.

 

Net Interest Income and Other

 

    

Year ended December 31,


      

Twelve-month period ended December 31,


      

% Change


 
    

2002


      

2001


      
    

($ in thousands)

          

Net interest income and other

  

$

11,276

 

    

$

4,324

 

    

161

%

% of revenues

  

 

2

%

    

 

1

%

        

 

Net interest income and other for the years ended December 31, 2002 and 2001 were $11.3 million and $4.3 million, representing 2% and 1% of net revenues, respectively. The increase was due to a growing cash balance and the investment in marketable securities consisting of high-quality, short-to intermediate term agency securities which yielded higher returns. We increased interest income despite the decline in interest rates.

 

USA Merger Related Expense

 

    

Year ended December 31,


      

Twelve-month period ended December 31,


      

% Change


 
    

2002


      

2001


      
    

($ in thousands)

          

USA merger & related expenses

  

$

11,566

 

    

$

7,691

 

    

50

%

% of revenues

  

 

2

%

    

 

3

%

        

 

14


 

USA merger related expenses for the years ended December 31, 2002 and 2001 were $11.6 million and $7.7 million, representing 2% and 3% of net revenues, respectively. USA merger related expense included the costs incurred in connection with USA acquiring a controlling interest in Expedia in February 2002. In addition, we incurred costs related to USA’s proposal in June 2002 of an exchange offer whereby USA would seek to acquire all of our publicly held shares.

 

Provision for Income Taxes

 

    

Year ended December 31,


      

Twelve-month period ended December 31,


      

% Change


 
    

2002


      

2001


      
    

($ in thousands)

          

Provision for income taxes

  

$

49,543

 

    

$

  —

 

    

100

%

% of revenues

  

 

8

%

    

 

0

%

        

 

The provision for income taxes for the years ended December 31, 2002 and 2001 were $49.5 million and $0, representing 8% and 0% of net revenues, respectively.

 

At December 31, 2002, we had net operating loss carryforwards of approximately $262.0 million for federal income tax purposes. The net operating loss carryforwards will begin to expire in 2017. Approximately $31.0 million of the loss carryforwards are from acquired companies, the utilization of which, in each carryforward year, may be limited by the Internal Revenue Code. At December 31, 2002, we had utilized the benefit of all our net operating loss carryforwards other than those generated by stock compensation tax deductions. The remaining net operating loss carryforwards, will be utilized to reduce income taxes payable. The benefit of the remaining net operating losses will be recorded as an adjustment to goodwill or an increase to additional paid-in capital, when realized.

 

Six-Month Periods Ended December 31, 2001 and 2000

 

Amounts for the six-month period ended December 31, 2000 included in the following discussion were included in the transition financial statements for the six-months ended December 31, 2001 and are unaudited.

 

Revenues

 

    

Six-month period ended December 31,


    

% Change


 
    

2001


  

2000


    
    

($ in thousands)

        

Merchant revenues

  

$

68,423

  

$

24,368

    

181

 %

Agency revenues

  

 

81,545

  

 

45,738

    

78

 %

Advertising and other revenues

  

 

11,272

  

 

16,418

    

(31

)%

    

  

        

Revenues

  

$

161,240

  

$

86,524

    

86

 %

    

  

        

 

Merchant revenues increased significantly as a result of the growth in our Expedia Special Rate (ESR) hotel business as we continued to add new available inventory both domestically and internationally. ESR bookings represented a majority of all hotel gross bookings. In September 2001, we introduced other destination services such as sightseeing tours, show tickets and theme park passes as part of the vacation packages products. The introduction of Expedia Bargain Fares (EBF) in March 2001 provided customers the date and price of the airline ticket up front while not disclosing the airline or flight times until after the purchase.

 

15


 

Growth in agency revenues occurred as Internet commerce, especially travel sales, continued to gain acceptance and our customer base continued to grow substantially. In addition, our agency business continued to generate greater revenues per transaction.

 

In December 2000, we launched our packages business which significantly increased both merchant and agency revenues. This product offering enabled customers to customize their trip by selecting their itinerary, airline, hotel, car rentals and the destination product and services of choice all for one packaged price. The introduction of our Expert Searching and Pricing (ESP) engine in January 2001 not only provided customers with more choice and control in choosing their travel itineraries but also enabled us to succeed in selling more vacation packages and in merchandising a wide range of inventory types.

 

The increase in agency and merchant revenues was partially offset by the decrease in advertising and licensing-related revenue for the six-month period ended December 31, 2001, compared with the same period in 2000. This was due to two license agreements ending during the quarter ended June 30, 2001. In addition, advertising revenues declined due to the weakening market for advertising, and Internet advertising in particular.

 

Cost of Revenues and Gross Profit

 

    

Six-month period ended December 31,


      

% Change


 
    

2001


    

2000


      
    

($ in thousands)

          

Cost of merchant revenues

  

$

19,325

 

  

$

8,079

 

    

139

 %

Cost of agency revenues

  

 

31,287

 

  

 

23,357

 

    

34

 %

Cost of advertising and other revenues

  

 

1,555

 

  

 

1,590

 

    

(2

)%

    


  


        

Cost of revenues

  

$

52,167

 

  

$

33,026

 

    

58

 %

    


  


        

% of revenues

  

 

32

%

  

 

38

%

        

Gross profit

  

$

109,073

 

  

$

53,498

 

    

104

 %

% of revenues

  

 

68

%

  

 

62

%

        

 

Cost of merchant revenues increased significantly as a result of the introduction of our vacation packages business in December 2000 and our EBF business in March 2001. The vacations packages consist of a combination of agency and merchant transactions.

 

Cost of agency revenues increased due to the increase in fulfillment costs related to the increase in the number of transactions processed and costs related to providing our express mailing service, which was introduced during the quarter ended December 31, 2000. Partially offsetting the increase in agency costs was a decrease in expenses related to fraudulent and lost tickets.

 

Cost of advertising and other revenues decreased as advertising and other revenues declined. There were minimal costs associated with the licensing business, therefore, we generated strong profit margin on this business.

 

The increase in gross margin percentage was due to increased transaction volumes, which created economies of scale, and due to the growth in merchant business, which yielded a higher gross profit per transaction compared to the agency business. In addition, our agency business continued to generate increased revenues per transaction.

 

16


 

Product Development

 

    

Six-month period ended December 31,


      

% Change


 
    

2001


    

2000


      
    

($ in thousands)

          

Product development

  

$

13,652

 

  

$

11,132

 

    

23

%

% of revenues

  

 

8

%

  

 

13

%

        

 

The increase in product development expenses were primarily due to an increased number of personnel involved in the ongoing development and enhancement of our websites and supporting infrastructure and systems. The increase was partially offset by the capitalization of website development and internally developed software costs which exceeded the amortization of these costs.

 

Sales and Marketing

 

    

Six-month period ended December 31,


      

% Change


 
    

2001


    

2000


      
    

($ in thousands)

          

Sales and marketing

  

$

48,358

 

  

$

38,777

 

    

25

%

% of revenues

  

 

30

%

  

 

45

%

        

 

The increase in sales and marketing expenses were primarily due to increased promotional and distribution activities intended to bring additional customers to our websites. Our promotional activities ranged from radio to magazine and other print media advertising, and also include domestic television ads. Our distribution activities related to marketing agreements with various internet websites such as MSN.

 

During the quarter ended September 30, 2001, we redirected visitors from the Travelscape.com and LVRS.com websites to the Expedia.com website. This enabled our domestic brand awareness advertising to be focused on the Expedia.com website, which in turn enabled us to gain greater marketing efficiencies for the six-month period ended December 31, 2001, compared with the same period in 2000. Although sales and marketing costs increased, the significant increase in revenues resulted in the large decrease in sales and marketing costs as a percentage of revenues.

 

General and Administrative

 

    

Six-month period ended December 31,


          
    

2001


    

2000


      

% Change


 
    

($ in thousands)

          

General and administrative

  

$

14,877

 

  

$

10,653

 

    

40

%

% of revenues

  

 

9

%

  

 

12

%

        

 

General and administrative expenses increased in absolute terms but decreased as a percentage of revenues. The increased growth and greater complexity in our business required additional support and overhead. We continued to hire employees, to perform functions that were previously performed less expensively via a services agreement with Microsoft.

 

17


 

Amortization of Goodwill and Intangible Assets

 

    

Six-month period ended December 31,


        
    

2001


    

2000


    

% Change


 
    

($ in thousands)

        

Amortization of goodwill

  

$

—  

 

  

$

9,576

 

  

(100

)%

% of revenues

  

 

0

%

  

 

11

%

      

Amortization of intangible assets

  

$

19,809

 

  

 

21,488

 

  

(8

)%

% of revenues

  

 

12

%

  

 

25

%

      

 

Amortization of intangibles related to our acquisitions of Travelscape® and VacationSpot in March 2002. In adopting SFAS No. 142 in July 2001, we discontinued amortizing goodwill and we reclassified $4.1 million of “acquired workforce” from intangible asset to goodwill.

 

Recognition of Stock-Based Compensation

 

    

Six-month period ended December 31,


          
    

2001 (restated)


    

2000 (restated)


      

% Change (restated)


 
    

($ in thousands)

          

Recognition of stock-based compensation

  

$

4,367

 

  

$

20,809

 

    

(79

)%

% of revenues

  

 

3

%

  

 

24

%

        

 

The decrease in stock-based compensation related to amortizing the expense utilizing the accelerated method over the vesting period of the individual. This resulted in higher amortization amounts during the beginning of the amortization period. In addition, stock option forfeitures due to departing employees also decreased the recognition of stock-based compensation.

 

Net Interest Income and Other

 

    

Six-month period ended December 31,


          
    

2001


    

2000


      

% Change


 
    

($ in thousands)

          

Net interest income and other

  

$

2,543

 

  

$

2,810

 

    

(10

)%

% of revenues

  

 

2

%

  

 

3

%

        

 

We generated cash flow from operations of $76.9 million for the six-month period ended December 31, 2001. However, a large decline in interest rates caused interest income to decrease during the six-month period ended December 31, 2001, compared with the same period in 2000, even with the significantly higher invested balances.

 

Years Ended June 30, 2001 and 2000

 

Revenues

 

    

Years ended June 30,


        
    

2001


  

2000


    

% Change


 
    

($ in thousands)

        

Merchant revenues

  

$

64,548

  

$

10,912

    

492

%

Agency revenues

  

 

122,987

  

 

59,534

    

107

%

Advertising and other revenues

  

 

34,685

  

 

24,185

    

43

%

    

  

        

Revenues

  

$

222,220

  

$

94,631

    

135

%

    

  

        

 

18


 

Agency revenues increased due to increases in the volume of transactions on our websites. With the acquisition of Travelscape in March 2000 and the introduction of our ESR business in June 2000, we significantly increased our merchant revenues. The introduction of the vacation packages business in December 2000 also increased our agency and merchant revenues.

 

Cost of Revenues and Gross Profit

 

    

Years ended June 30,


      

% Change


 
    

2001


    

2000


      
    

($ in thousands)

          

Cost of merchant revenues

  

$

17,567

 

  

$

3,369

 

    

421

%

Cost of agency revenues

  

 

53,427

 

  

 

34,136

 

    

57

%

Cost of advertising and other revenues

  

 

3,280

 

  

 

2,643

 

    

24

%

    


  


        

Cost of revenues

  

$

74,274

 

  

$

40,148

 

    

85

%

    


  


        

% of revenues

  

 

33

%

  

 

42

%

        

Gross profit

  

$

147,946

 

  

$

54,483

 

    

172

%

% of revenues

  

 

67

%

  

 

58

%

        

 

Cost of agency revenues increased due to the increased number of transactions to be processed. Partially offsetting the increase in agency costs were a decrease in expenses related to fraudulent credit card charges and expense related to lost paper tickets. The cost of merchant revenues increased significantly as a result of the acquisition of Travelscape in March 2000 and the introductions of our ESR business in June 2000 and our vacation packages business in December 2000. The increase in gross margin was due to increased transaction volumes which created economies of scale, and the growth in merchant business which yielded a higher gross profit per transaction compared to the agency business.

 

Product Development

 

    

Years ended June 30,


          
    

2001


    

2000


      

% Change


 
    

($ in thousands)

          

Product development

  

$

24,682

 

  

$

20,391

 

    

21

%

% of revenues

  

 

11

%

  

 

22

%

        

 

Product development expenses decreased due to the capitalization of $5.5 million of costs related to website development while only $1.5 million of related expense was amortized during the year ended June 30, 2001. Excluding the impact of this capitalization and amortization, expense would have increased 41% from the prior year. A significant portion of the increase related to the development of the ESP engine.

 

Sales and Marketing

 

    

Years ended June 30,


          
    

2001


    

2000


      

% Change


 
    

($ in thousands)

          

Sales and marketing

  

$

90,159

 

  

$

65,701

 

    

37

%

% of revenues

  

 

41

%

  

 

69

%

        

 

The increase in sales and marketing expenses was primarily attributable to increased promotional activities, intended to bring additional customers to our websites. In addition, the acquisitions of Travelscape and VacationSpot in March 2000 increased our sales and marketing expense, as the year ended June 30, 2001 was the first year to fully include the results of these companies.

 

19


 

General and Administrative

 

    

Years ended June 30,


          
    

2001


    

2000


      

% Change


 
    

($ in thousands)

          

General and administrative

  

$

22,540

 

  

$

10,507

 

    

115

%

% of revenues

  

 

10

%

  

 

11

%

        

 

General and administrative expenses increased in absolute terms but decreased as a percentage of revenues. We continued to hire employees to perform functions that were not previously necessary when we were an operating unit of Microsoft and functions previously performed under our services agreement with Microsoft were brought in house. In addition, the acquisitions of Travelscape and VacationSpot in March 2000 increased our general and administrative expenses, as the year ended June 30, 2001 was the first year to fully include the results of operations.

 

Amortization of Goodwill and Intangible Assets

 

    

Years ended June 30,


          
    

2001


    

2000


      

% Change


 
    

($ in thousands)

          

Amortization of goodwill

  

$

20,285

 

  

$

5,502

 

    

269

%

% of revenues

  

 

9

%

  

 

6

%

        

Amortization of intangible assets

  

$

41,741

 

  

$

12,361

 

    

238

%

% of revenues

  

 

19

%

  

 

13

%

        

 

Amortization of goodwill and intangibles increased as this was the first full year of amortization related to our acquisitions of Travelscape and VacationSpot.

 

Recognition of Stock-Based Compensation

 

    

Years ended June 30,


          
    

2001 (restated)


    

2000 (restated)


      

% Change (restated)


 
    

($ in thousands)

          

Recognition of stock-based compensation

  

$

30,228

 

  

$

70,051

 

    

(57

)%

% of revenues

  

 

14

%

  

 

74

%

        

 

The decrease in the recognition of stock-based compensation related to amortizing the expense utilizing the accelerated method over the vesting period of the individual. This resulted in higher amortization amounts during the beginning of the amortization period. In addition, stock option forfeitures due to departing employees also decreased the recognition of stock-based compensation.

 

20


 

Quarterly Unaudited Results of Operations

 

The quarterly operating results have been restated for all periods presented as discussed in the explanatory note at the beginning of this report and Note 16 to the Consolidated Financial Statements included in this amended report.

 

The following table sets forth our unaudited quarterly results of operations, in dollars and as a percentage of revenues, for the periods presented. The unaudited quarterly results include the results of operations of Travelscape.com, Inc. and VacationSpot.com, Inc. from March 18, 2000, CCV from March 9, 2002, Metropolitan from July 13, 2002, and Newtrade from October 28, 2002.

 

We have prepared this unaudited information on the same basis as the audited financial statements. This information includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the quarters presented. The operating results in any quarter are not necessarily indicative of the results that may be expected for any future period and you should not rely on them as such.

 

   

Dec. 31, 2002

(restated)


   

Sept. 30, 2002

(restated)


   

Jun. 30, 2002

(restated)


   

Mar. 31, 2002

(restated)


   

Dec. 31, 2001

(restated)


   

Sept. 30, 2001

(restated)


   

Jun. 30, 2001

(restated)


   

Mar. 31, 2001

(restated)


 
   

(in thousands, except per share amounts)

 

Merchant revenues

 

$

97,307

 

 

$

98,453

 

 

$

85,727

 

 

$

57,650

 

 

$

34,321

 

 

$

34,102

 

 

$

25,886

 

 

$

14,294

 

Agency revenues

 

 

62,781

 

 

 

62,495

 

 

 

54,800

 

 

 

51,741

 

 

 

42,266

 

 

 

39,279

 

 

 

43,900

 

 

 

33,349

 

Advertising and other revenues

 

 

3,824

 

 

 

4,854

 

 

 

4,351

 

 

 

6,615

 

 

 

5,175

 

 

 

6,097

 

 

 

8,688

 

 

 

9,579

 

   


 


 


 


 


 


 


 


Revenues

 

 

163,912

 

 

 

165,802

 

 

 

144,878

 

 

 

116,006

 

 

 

81,762

 

 

 

79,478

 

 

 

78,474

 

 

 

57,222

 

   


 


 


 


 


 


 


 


Cost of merchant revenues

 

 

28,082

 

 

 

29,561

 

 

 

26,334

 

 

 

14,793

 

 

 

9,816

 

 

 

9,509

 

 

 

6,409

 

 

 

3,079

 

Cost of agency revenues

 

 

23,237

 

 

 

24,574

 

 

 

20,457

 

 

 

19,503

 

 

 

15,310

 

 

 

15,977

 

 

 

15,850

 

 

 

14,220

 

Cost of advertising and other revenues

 

 

696

 

 

 

585

 

 

 

597

 

 

 

848

 

 

 

754

 

 

 

801

 

 

 

904

 

 

 

786

 

   


 


 


 


 


 


 


 


Cost of revenues

 

 

52,015

 

 

 

54,720

 

 

 

47,388

 

 

 

35,144

 

 

 

25,880

 

 

 

26,287

 

 

 

23,163

 

 

 

18,085

 

   


 


 


 


 


 


 


 


Gross profit

 

 

111,897

 

 

 

111,082

 

 

 

97,490

 

 

 

80,862

 

 

 

55,882

 

 

 

53,191

 

 

 

55,311

 

 

 

39,137

 

   


 


 


 


 


 


 


 


Operating expenses:

                                                               

Product development

 

 

10,343

 

 

 

9,310

 

 

 

8,152

 

 

 

8,727

 

 

 

6,443

 

 

 

7,209

 

 

 

7,261

 

 

 

6,289

 

Sales and marketing

 

 

47,503

 

 

 

49,206

 

 

 

41,213

 

 

 

34,836

 

 

 

22,287

 

 

 

26,071

 

 

 

26,599

 

 

 

24,783

 

General and administrative

 

 

14,269

 

 

 

12,548

 

 

 

11,545

 

 

 

8,241

 

 

 

8,696

 

 

 

6,181

 

 

 

6,647

 

 

 

5,240

 

Amortization of goodwill

                                                 

 

5,921

 

 

 

4,788

 

Amortization of intangible assets

 

 

4,538

 

 

 

4,493

 

 

 

4,218

 

 

 

8,768

 

 

 

9,905

 

 

 

9,904

 

 

 

9,509

 

 

 

10,744

 

Recognition of stock-based
compensation

 

 

337

 

 

 

366

 

 

 

575

 

 

 

1,606

 

 

 

1,493

 

 

 

2,874

 

 

 

3,249

 

 

 

6,169

 

   


 


 


 


 


 


 


 


Total operating expenses

 

 

76,990

 

 

 

75,923

 

 

 

65,703

 

 

 

62,178

 

 

 

48,824

 

 

 

52,239

 

 

 

59,186

 

 

 

58,013

 

   


 


 


 


 


 


 


 


Income (loss) from operations

 

 

34,907

 

 

 

35,159

 

 

 

31,787

 

 

 

18,684

 

 

 

7,058

 

 

 

952

 

 

 

(3,875

)

 

 

(18,876

)

Net interest income and other

 

 

3,701

 

 

 

2,407

 

 

 

2,485

 

 

 

2,683

 

 

 

1,214

 

 

 

1,329

 

 

 

215

 

 

 

1,566

 

Share of joint venture net loss

 

 

(193

)

 

 

(120

)

 

 

(151

)

 

 

(247

)

 

 

(769

)

                       

USA merger related expense

 

 

(729

)

 

 

(977

)

         

 

(9,860

)

 

 

(1,350

)

 

 

(6,341

)

               
   


 


 


 


 


 


 


 


Income (loss) before provision for income taxes

 

 

37,686

 

 

 

36,469

 

 

 

34,121

 

 

 

11,260

 

 

 

6,153

 

 

 

(4,060

)

 

 

(3,660

)

 

 

(17,310

)

Provision for income taxes

 

 

(15,436

)

 

 

(15,434

)

 

 

(14,059

)

 

 

(4,614

)

                               
   


 


 


 


 


 


 


 


Net income (loss), restated

 

$

22,250

 

 

$

21,035

 

 

$

20,062

 

 

$

6,646

 

 

$

6,153

 

 

$

(4,060

)

 

$

(3,660

)

 

$

(17,310

)

   


 


 


 


 


 


 


 


Net income (loss), previously reported

 

$

21,435

 

 

$

20,069

 

 

$

19,096

 

 

$

5,715

 

 

$

5,222

 

 

$

(4,750

)

 

$

(4,350

)

 

$

(17,618

)

   


 


 


 


 


 


 


 


Net income (loss) per common share, restated:

                                                               

Basic

 

$

0.19

 

 

$

0.18

 

 

$

0.18

 

 

$

0.06

 

 

$

0.06

 

 

$

(0.04

)

 

$

(0.04

)

 

$

(0.18

)

   


 


 


 


 


 


 


 


Diluted

 

$

0.17

 

 

$

0.17

 

 

$

0.15

 

 

$

0.05

 

 

$

0.05

 

 

$

(0.04

)

 

$

(0.04

)

 

$

(0.18

)

   


 


 


 


 


 


 


 


Net income (loss) per common share, previously reported:

                                                               

Basic

 

$

0.18

 

 

$

0.18

 

 

$

0.17

 

 

$

0.05

 

 

$

0.05

 

 

$

(0.05

)

 

$

(0.04

)

 

$

(0.18

)

   


 


 


 


 


 


 


 


Diluted

 

$

0.17

 

 

$

0.16

 

 

$

0.15

 

 

$

0.05

 

 

$

0.04

 

 

$

(0.05

)

 

$

(0.04

)

 

$

(0.18

)

   


 


 


 


 


 


 


 


Weighted average number of shares outstanding:

                                                               

Basic

 

 

116,414

 

 

 

114,406

 

 

 

112,884

 

 

 

108,558

 

 

 

104,020

 

 

 

100,638

 

 

 

98,028

 

 

 

95,582

 

   


 


 


 


 


 


 


 


Diluted

 

 

129,612

 

 

 

125,522

 

 

 

129,692

 

 

 

122,848

 

 

 

123,890

 

 

 

100,638

 

 

 

98,028

 

 

 

95,582

 

   


 


 


 


 


 


 


 


 

21


 

      

Dec. 31, 2002


      

Sept. 30, 2002


      

Jun. 30, 2002


      

Mar. 31, 2002


      

Dec. 31, 2001


      

Sept. 30, 2001


      

Jun. 30, 2001


      

Mar. 31, 2001


 
      

(restated)

      

(restated)

      

(restated)

      

(restated)

      

(restated)

      

(restated)

      

(restated)

      

(restated)

 

Revenues

    

100

 %

    

100

 %

    

100

 %

    

100

 %

    

100

 %

    

100

 %

    

100

 %

    

100

 %

Cost of revenues

    

32

 

    

33

 

    

33

 

    

30

 

    

32

 

    

33

 

    

30

 

    

32

 

      

    

    

    

    

    

    

    

Gross profit

    

68

 

    

67

 

    

67

 

    

70

 

    

68

 

    

67

 

    

70

 

    

68

 

      

    

    

    

    

    

    

    

Operating expenses:

                                                                       

Product development

    

6

 

    

5

 

    

6

 

    

8

 

    

8

 

    

9

 

    

9

 

    

11

 

Sales and marketing

    

28

 

    

29

 

    

28

 

    

30

 

    

27

 

    

33

 

    

34

 

    

43

 

General and administrative

    

9

 

    

8

 

    

8

 

    

7

 

    

11

 

    

8

 

    

8

 

    

9

 

Amortization of goodwill

                                                          

8

 

    

8

 

Amortization of intangible assets

    

3

 

    

3

 

    

3

 

    

8

 

    

12

 

    

13

 

    

12

 

    

20

 

Recognition of stock-based compensation

                               

1

 

    

2

 

    

4

 

    

4

 

    

11

 

      

    

    

    

    

    

    

    

Total operating expenses

    

46

 

    

45

 

    

45

 

    

54

 

    

60

 

    

67

 

    

75

 

    

102

 

      

    

    

    

    

    

    

    

Income (loss) from operations

    

22

 

    

22

 

    

22

 

    

16

 

    

8

 

             

(5

)

    

(34

)

Net interest income and other

    

2

 

    

1

 

    

2

 

    

2

 

    

1

 

    

2

 

             

3

 

Share of joint venture net loss

                                        

(1

)

                          

USA merger related expense

             

(1

)

             

(8

)

    

(1

)

    

(8

)

                 
      

    

    

    

    

    

    

    

Income (loss) before provision for income taxes

    

24

 

    

22

 

    

24

 

    

10

 

    

7

 

    

(6

)

    

(5

)

    

(31

)

Provision for income taxes

    

(9

)

    

(9

)

    

(10

)

    

(4

)

                                   
      

    

    

    

    

    

    

    

Net income (loss)

    

15

 

    

13

 

    

14

 

    

6

 

    

7

 

    

(6

)

    

(5

)

    

(31

)

      

    

    

    

    

    

    

    

 

Liquidity and Capital Resources

 

Our principal sources of liquidity are our cash, cash equivalents and marketable securities. Our cash, cash equivalents and marketable securities balances were $584.0 million and $238.4 million at December 31, 2002 and 2001, respectively.

 

The increases in cash flow are driven by our increase in net income, coupled with the fact that certain of our expenses are non-cash transactions, working capital cash flows from our merchant business and the economies of scale we have been able to realize on our cost structure. Net cash provided by operating activities was $327.3 million, $76.9 million and $63.5 million, during the year ended December 31, 2002, the six-month period ended December 31, 2001, and the year ended June 30, 2001, respectively. Net cash used in operating activities was $30.9 million during the year ended June 30, 2000.

 

The changes in working capital from our merchant business have been a significant source of cash. In our merchant business, we receive cash from customers on hotel and air bookings before the stay or flight has occurred. These amounts are classified on our balance sheet as deferred merchant bookings. The payment to the suppliers related to these bookings is not made until approximately one week after booking for air travel and, for all other merchant bookings, after the customer’s use and subsequent billing from the supplier. Therefore, especially for the hotel business, which is the majority of our merchant bookings, there is a significant period of time from the receipt of the cash from the customers to the payment to the suppliers. For the year ended December 31, 2002 the growth in net merchant bookings has contributed $55.7 million to our positive cash flow. The significant growth in customers’ bookings has contributed to positive cash flow. In addition, certain of our 2002 expenses are non-cash transactions, such as the USA contributed marketing expense of $13.1 million, the provision for income taxes of $49.5 million and depreciation and amortization of $38.6 million also contributed to the increase in cash flows from operations. Cancellations and reduced bookings caused by the terrorist attacks on September 11, 2001, resulted in a net cash outflow from the change in deferred and prepaid merchant bookings of $5.9 million for the six-month period ended December 31, 2001 as a declining-bookings environment can have a significant negative effect on our working capital and cash.

 

Net cash used in investing activities during the year ended December 31, 2002, the six-month period ended December 31, 2001 and the years ended June 30, 2001 was $444.2 million, $23.3 million and $11.8 million, respectively. Net cash provided by investing activities was $9.9 million for the year ended June 30, 2000. In

 

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June 2002, we began investing in certain marketable securities, which consist of high-quality short to intermediate term agency securities. These investments are intended to provide additional interest income while at the same time ensuring liquidity and safety of the principal. During the year ended December 31, 2002, we purchased $475.1 million and sold $112.9 million of such investments.

 

During the year ended December 31, 2002, we paid total net cash of $59.6 million to acquire CCV, Metropolitan, and Newtrade. Additional investing activities consisted primarily of capital expenditures, which totaled $22.0 million, $12.5 million, $17.0 million and $5.2 million during the year ended December 31, 2002, the six-month period ended December 31, 2001, and the years ended June 30, 2001 and 2000, respectively. We anticipate continued growth of capital spending associated with website development, additional systems and infrastructure, and office space expansion.

 

Net cash provided by financing activities during the year ended December 31, 2002, the six-month period ended December 31, 2001, and the years ended June 30, 2001 and 2000 was $96.7 million, $2.6 million, $69.9 million and $81.4 million, respectively. As part of the CCV acquisition, we issued 1,873,630 shares of common stock to USA at a price of $25.08 in a private placement, raising approximately $47.0 million.

 

During the year ended December 31, 2002 and for the six-month period ended December 31, 2001, we incurred costs of $11.6 million and $7.7 million, respectively, associated with the February 2002 USA acquisition of control and the June 2002 USA proposed exchange offer. These costs relate to our financial advisory, accounting, legal and tax advisory fees. In August 2002, USA made a capital contribution of $20.0 million in cash in lieu of its contractual commitment to deliver to Expedia an option to acquire from USA all of the outstanding equity of National Leisure Group, Inc.

 

Stock option exercises by employees and directors were a source of cash totaling $37.0 million, $11.6 million, $7.9 million and $1.6 million for the year ended December 31, 2002, the six-month period ended December 31, 2001 and the years ended June 30, 2001 and 2000, respectively. We anticipate a substantial number of stock options to become vested going forward. If these options are exercised they will also affect operating results, as we incur payroll tax expenses on the taxable portion of employees’ gains upon exercise. These expenses are recognized in the cost of revenues, product development, sales and marketing, and general and administrative line items of our consolidated financial statements.

 

On February 5, 2003, we announced the authorization of a plan to repurchase up to $200.0 million of our common stock through a stock repurchase program. Pursuant to this program as of February 28, 2003, we have repurchased approximately 816,000 shares of our common stock for $25.0 million, at prices ranging from $29.68 to $31.47 per share.

 

Associated with the USA acquisition of control, we issued to our shareholders and optionholders 12.6 million warrants to purchase our common stock, with an exercise price of $26 per share. No cash was received as part of this issuance. Because these warrants are tradable and do not expire until February 2009, we do not anticipate a significant inflow of cash from the exercises of these warrants in the next 12 months. For the year ended December 31, 2002, proceeds from exercise of warrants were approximately $61,000.

 

As of December 31, 2002 and 2001, we had two letter of credit facilities in the combined amounts of $35.0 million and $17.0 million, respectively. A substantial amount of the letter of credit is issued to hotel properties to secure payment for the potential purchase of hotel rooms. These letter of credit facilities previously required full collateralization for issued letters of credit with restricted deposits. However, as of December 31, 2002, one credit facility for $20.0 million was amended to release the pledge of restricted deposits in exchange for standard liquidity, capital and financial covenants. As of December 31, 2002 and 2001, we had $16.3 million and $9.1 million, respectively, of outstanding letters of credit drawn against these facilities. No claims have been made against any letters of credit. As of December 31, 2002, we were in compliance with all financial covenants.

 

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During 2002, we provided bank guarantees to government regulatory authorities in the U.K. and Germany in order to operate our vacation packages business in those respective countries. As of December 31, 2002, we had bank guarantees in the amount of $9.7 million.

 

The terrorist activities of September 11, 2001, and the uncertainty caused by the current economic, political and transportation climates may affect future demand for our products and services. As previously discussed, a significant amount of operating cash flow is from increased deferred merchant bookings and the period between receipt of cash from the customer and payment to non-air merchant suppliers. In a time of flat or declining merchant bookings, we would expect to experience a related decrease in operating cash flow, or negative operating cash flows. We believe that our financial situation would enable us to absorb a significant potential downturn in business. As a result, we anticipate being able to meet our operating cash needs without any need for additional funding. We intend to continue to invest in marketable securities with maturities of three years or less in order to ensure liquidity and safety of principal.

 

Leases

 

Our headquarters are located in Bellevue, Washington in leased space consisting of approximately 165,000 square feet. The leases for this space expire from 2003 to 2009. Expedia also leases space in Tacoma, Washington for a call center and has small sales offices in Ft. Lauderdale, Florida, New York City, New York and Washington, D.C. Travelscape, Inc., a subsidiary of Expedia, is headquartered in Las Vegas, Nevada. Travelscape leases office space consisting of approximately 65,000 square feet in Las Vegas, Nevada. As a result of its acquisition of the assets of Classic Custom Vacation in March 2002, Expedia also leases office space consisting of 39,000 square feet in San Jose, California and warehouse space in Post Falls, Idaho. As a result of its acquisition of the assets of Metropolitan Travel in July, 2002, Expedia also leases office space consisting of approximately 17,000 square feet in downtown Seattle, Washington and office space in Kirkland, Washington.

 

We also lease office space for our international operations in Brussels, Belgium; Toronto, Canada; Montreal, Canada; London, England; Milan, Italy; Munich, Germany; Amsterdam, The Netherlands; and Sydney, Australia.

 

Acquisitions

 

USA

 

Acquisition of Control.    On February 4, 2002, USA Interactive acquired Microsoft’s controlling stake in Expedia. Immediately prior to the USA acquisition of control, we recapitalized our common shares to create a new class of common shares, Class B common shares, par value $.01 per share, which are entitled to approximately 15 votes per share, provided that no Expedia shareholder or group of shareholders can generally hold more than 94.9% of Expedia’s total outstanding voting power. Under the terms of the transaction agreements governing the USA acquisition of control, each of our shareholders had the option, with respect to each common share it owned, to elect to either (1) retain its Expedia share and in addition receive warrants to acquire additional Expedia shares or (2) exchange its Expedia share for a package of USA securities consisting of USA common stock, USA cumulative convertible redeemable preferred stock and warrants to acquire USA common stock.

 

Pursuant to the terms of the USA acquisition of control, Microsoft beneficially owned approximately 66% of our common stock prior to the merger, and elected to exchange all of its Expedia common stock for USA securities. As a result, upon closing of the USA acquisition of control, Microsoft no longer holds any Expedia securities. Expedia shareholders who elected not to receive USA securities in the transaction retained their Expedia shares and received 0.1920 of a new Expedia warrant for each Expedia share held. In addition, certain optionholders were also issued warrants. Each warrant entitles the holder to purchase one share of Expedia common stock for $26 through February 4, 2009. In addition, the warrants issued to optionholders are subject to

 

24


the same vesting schedule as the options in respect of which the warrants were issued. We issued approximately 12.6 million warrants to holders of Expedia’s common shares and stock options. The Expedia warrants trade on NASDAQ under the symbol “EXPEW.” Of these warrants, approximately 7.8 million were issued to common stockholders. Theses warrants were valued at market value as of the date of the grant and were recorded as capital distributions.

 

In connection with the USA acquisition of control, all of the shares of the merger subsidiary, which were all held by USA, were converted into a number of shares of Expedia Class B common stock equal to the number of Expedia common shares that were exchanged for the package of USA securities. As a result, USA owns all of the outstanding shares of Expedia Class B common stock (approximately 69,002,000 shares), representing approximately 64% of Expedia’s then outstanding shares, and 94.9% of the voting interest in Expedia. Since USA acquired less than 95% voting interest in Expedia, we elected to account for the USA transaction as a recapitalization. Accordingly, the purchase price paid by USA to acquire our common shares does not have an impact on our consolidated financial statements.

 

Due to its controlling interest in Expedia, USA generally has the ability to control the outcome of any matter submitted for the vote or consent of our shareholders, except where a separate vote of the holders of common shares is required by Washington law. In addition, USA also controls Expedia’s board of directors, which, immediately after the closing of the merger transaction, was expanded from seven to thirteen board members. The current Expedia Board consists of seven USA appointees and includes four independent board members that are not employees of Expedia.

 

In connection with the USA acquisition of control, we received the right to advertising, marketing and promotion time, valued at $15 million for each of the five years after consummation of the merger, on the various media outlets related to USA (including outlets of former USA entertainment businesses such as USA Network that are now part of Vivendi Universal Entertainment). The use of this asset is being accounted for as sales and marketing expense and a capital contribution by USA to Expedia. In addition, we received a two-year option to purchase a one-third interest in a new television channel to be developed by USA. The exercise price of the option will equal one-third of USA’s cost, plus interest, up to the date of exercise. There will be no accounting recognition of the option until the option is exercised, if ever. Finally, USA made a capital contribution of $20 million in lieu of its contractual commitment to deliver to Expedia an option to acquire from USA all of the outstanding equity of National Leisure Group, Inc.

 

Private Placement.    On February 20, 2002, we issued 1,873,630 common shares to USA for approximately $47 million in cash. The proceeds from this sale were used by us in connection with the Classic Custom Vacations transaction to pay off the approximately $47 million of outstanding debt of Classic Vacation Group, Inc.

 

Exchange Offer and Merger.    On June 3, 2002, USA announced its intention to commence an exchange offer whereby USA would acquire all our publicly held shares. On October 10, 2002, USA announced that it was ending the proposed exchange offer process. On March 19, 2003, we announced that we entered into a merger agreement with USA whereby USA would acquire all our publicly held shares it does not currently own in a stock-for-stock merger.

 

Classic Custom Vacations Acquisition

 

On March 9, 2002, we acquired substantially all of the assets of CCV, a subsidiary of Classic Vacation Group, Inc. (CVG), a publicly traded corporation, for an aggregate purchase price of approximately $48.6 million, plus the assumption of approximately $30.0 million in net liabilities. CCV provides luxury vacation packages to Mexico, North America, Europe and the Caribbean through a network of travel agents and travel agencies. In connection with the asset acquisition, in February 2002 we paid off the outstanding debt of

 

25


CVG for approximately $47.0 million in cash, using the proceeds from the sale of 1,873,630 shares of common stock to USA. On March 9, 2002, we purchased the assets of CCV for approximately $1.6 million in cash.

 

Metropolitan Acquisition

 

On July 13, 2002, we acquired substantially all of the assets of Metropolitan Travel, Inc. (Metropolitan), a closely held Seattle-based corporate travel agency. Metropolitan provides corporate travel services to over 230 corporate clients. This acquisition was part of our expansion into the corporate travel business.

 

Newtrade Acquisition

 

On October 28, 2002, we acquired substantially all of the assets of Newtrade Technologies, Inc. (Newtrade), a Montreal-based developer of software and information distribution services that help hotels deliver their rates and availability to the market more efficiently. We anticipate using Newtrade’s technology to enable our merchant hotel partners to improve their quality of connectivity and give hotels greater flexibility and control over their information distribution and inventory.

 

Related Party Transactions

 

USA

 

In connection with the USA acquisition of control, we received the right to advertising, marketing and promotion time, valued at $15 million for each of the five years after the consummation date on the various media outlets related to USA. The total amount due under this arrangement was recorded as “contribution receivable from parent” within the statement of changes in stockholders’ equity and comprehensive income. During the year ended December 31, 2002, we recorded $13.1 million under this arrangement as sales and marketing expense.

 

In August 2002, USA made a cash capital contribution of $20.0 million to Expedia in lieu of offering Expedia a two-year option to acquire from USA all of the outstanding equity of National Leisure Group, Inc. We have recorded the transaction as a capital contribution from USA.

 

During 2002, USA reimbursed us for certain professional fees related to the delay in the USA acquisition of control in the amount of $0.3 million. We have recorded this amount as a capital contribution from USA.

 

Ticketmaster

 

We entered into an agreement with Ticketmaster, Inc. (Ticketmaster), a subsidiary of USA, on March 19, 2002, to create a new gateway channel on Citysearch.com’s website. This is a content area that provides site visitors with Citysearch’s local content and enables them to plan and book trips using an Expedia.com booking tool with the availability of some Ticketmaster event tickets within Expedia’s customer-built trips. Revenues generated through the gateway channel are shared based on an agreed-upon transaction fee paid by us to Ticketmaster. The transaction fees paid in connection with this agreement during the year ended December 31, 2002 were $0.3 million.

 

Hotels.com

 

As Hotels.com and Expedia have a common controlling shareholder, we previously have said that we would explore areas where we might work together with Hotels.com in a way that would benefit all Expedia customers and stockholders. Although we consider Hotels.com to be a direct competitor, there have been instances where, fully consistent with our existing contractual agreements, we have worked cooperatively with Hotels.com, and we anticipate that we will continue to explore such possibilities in the future.

 

26


 

Microsoft

 

Our financial statements prior to October 1, 1999 reflect certain allocated corporate support costs from Microsoft. Such allocations and charges are based on a percentage of total corporate costs for the services provided, based on factors such as headcount, revenue, gross asset value, or the specific level of activity directly related to such costs. Management believes that the allocation methods used were reasonable and reflective of our proportionate share of such expenses.

 

Subsequent to October 1, 1999, we had entered into a number of agreements with Microsoft to facilitate our operations. On February 4, 2002, Microsoft ceased being a related party as we were acquired by USA Networks, Inc. (now USA Interactive).

 

TCV and Microsoft

 

On August 25, 2000, we issued 6,022,586 shares of common stock and warrants to purchase an additional 1,204,518 shares of our common stock to TCV IV, L.P. and TCV IV Strategic Partners, L.P. (collectively, TCV) in exchange for approximately $50.0 million in cash. As a result of the investment, the founding general partner of Technology Crossover Ventures and managing member of Technology Crossover Management IV, L.L.C. (which is the general partner of TCV) became a director of Expedia. On that same date, we issued 1,204,516 shares of common stock and warrants to purchase an additional 240,904 shares of our common stock to Microsoft in exchange for approximately $10.0 million in cash. In September 2001 and February 2002, TCV and Microsoft net exercised their 1,204,518 and 240,904 shares of common stock warrants in non-cash transactions, respectively, and received 669,040 shares and 168,064 shares of common stock, respectively, representing the number of shares purchased based on the in-the-money value of the warrants.

 

Recent Accounting Pronouncements

 

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure. This Statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002 and have been incorporated into these consolidated financial statements and accompanying footnotes. Effective January 1, 2003, we have adopted SFAS No. 123, the fair value based method of accounting for stock-based employee compensation described in SFAS No. 123.

 

In November 2002, the FASB issued Interpretation 45 (FIN 45), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 will change current practice in the accounting for and disclosure of guarantees. Under FIN 45, guarantees are broadly defined to include, among others, product warranties, indemnification provisions, and standby letters of credit. Guarantees meeting the characteristics described in FIN 45 are required to be initially recorded at fair value, which is different from the general current practice of recording a liability only when a loss is probable and reasonably estimable, as those terms are defined in SFAS 5, Accounting for Contingencies. FIN 45 also requires a guarantor to make new disclosures for virtually all guarantees even when the likelihood of the guarantor’s having to make payments under the guarantee is remote. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002, while the initial recognition and initial measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements have been incorporated into these consolidated financial statements and accompanying footnotes. Effective January 1, 2003, we have adopted the initial recognition and

 

27


initial measurement provisions of FIN 45 and believe that the application of FIN 45 will not have a material effect on our consolidated financial position or results of operations.

 

EITF 02-16, Accounting by a Reseller for Cash Consideration Received from a Vendor. This EITF release provides guidance on the following issues. (1) The circumstances under which cash consideration received from a vendor by a reseller should be considered (a) an adjustment of the prices of the vendor’s products or services and, therefore, characterized as a reduction of cost of sales when recognized in the reseller’s income statement, (b) an adjustment to a cost incurred by the reseller and, therefore, characterized as a reduction of that cost when recognized in the reseller’s income statement, or (c) a payment for assets or services delivered to the vendor and, therefore, characterized as revenue when recognized in the reseller’s income statement. (2) If a vendor offers a customer a rebate or refund of a specified amount of cash consideration that is payable only if the customer completes a specified cumulative level of purchases or remains a customer for a specified time period, when the customer should recognize the rebate and how the customer should measure the amount of the offer. Consensuses reached are effective for arrangements entered into after December 31, 2002 and November 21, 2002, respectively. Effective January 1, 2003, we have adopted consensus one of this release and believe that the application of EITF 02-16 will not have a material effect on our consolidated financial position or results of operations.

 

Factors That May Impact Future Results of Operations

 

While management is optimistic about our long-term prospects, an investment in our securities involves a high degree of risk. Investors evaluating Expedia and our business should carefully consider the factors described below and all other information contained in our annual report on Form 10-K before purchasing our securities. Any of the following factors could materially impact our business, operating results and financial condition. Additional factors and uncertainties not currently known to us or that we currently consider immaterial could also harm our business, operating results and financial condition. Investors could lose all or part of their investment as a result of these factors.

 

Failure to complete the merger with USA could negatively impact the price of our common stock

 

On March 19, 2003, Expedia and USA announced that they entered into a merger agreement by which USA would acquire the outstanding Expedia shares it does not already own. If our proposed merger with USA is not completed for any reason, the price of our common stock may decline to the extent that the current market price of our common stock reflects a market assumption that the merger will be completed. We will also be required to pay costs incurred in connection with the merger, such as our legal, accounting and financial advisory fees, even if the merger is not completed.

 

We believe that as a result of the announcement of the merger with USA the price of our common stock will be based in large part on the price of USA common stock; the price of USA’s common stock may be affected by factors different from those affecting the price of our common stock

 

Prior to the completion of the merger, we expect that our common stock will trade in tandem with USA common stock given the fixed exchange ratio for the merger. USA’s business differs somewhat from our business, and USA’s results of operations and the price of USA’s common stock may be affected by factors different from those that affect our results of operations and the price of our common stock before the announcement of the merger. Please see USA’s public filings with the Commission, including the risk factors contained in USA’s most recent Annual Report on Form 10-K.

 

USA exercises significant control over Expedia

 

At December 31, 2002, USA owned approximately 60% of our outstanding common equity and 94.9% of our total voting power. As a result, USA generally has the ability to control the outcome of any matter submitted

 

28


for the vote or consent of our shareholders, except where a separate vote of the holders of our common shares is required by Washington law. In addition, USA controls our board of directors. USA generally will not be restricted with regard to its ability to control the election of our directors, to cause the amendment of our articles of incorporation or bylaws, or generally to exercise a controlling influence over our business and affairs.

 

Conflicts of interest may arise between USA and Expedia, which may be resolved in a manner that adversely affects our business, financial condition or results of operations

 

Conflicts of interest may arise between us, on the one hand, and USA and its other affiliates, on the other hand, in areas relating to past, ongoing and future relationships, including corporate opportunities, potential acquisitions or financing transactions, sales or other dispositions by USA of its interest in Expedia and the exercise by USA of its ability to control our management and affairs. Conflicts, disagreements or other disputes between Expedia and USA may arise and may be resolved in a manner that adversely affects our business, financial condition or results of operations.

 

For instance, USA is engaged in a diverse range of media, electronic and online commerce businesses, including businesses that offer services that overlap with ours, such as Hotels.com. While USA encourages its operating units to cooperate with each other and Expedia may benefit from being able to better serve its customers through such cooperation, Expedia also could lose business to such other USA operating units. In addition, USA or its affiliates may acquire additional businesses that may conflict or overlap with our business interests. Our amended and restated articles of incorporation include provisions which provide that (1) neither USA nor any of its affiliates will have any duty to refrain from engaging in the same or similar activities or lines of business of Expedia, thereby potentially diverting business from us, and (2) neither USA nor any of its affiliates will have any duty to communicate or offer corporate opportunities to us and none of them will be liable for breach of any fiduciary duty to us, as a shareholder of Expedia or otherwise, in connection with such opportunities, provided that the procedures provided for in our articles of incorporation are followed.

 

Our directors, officers and former officers may have interests in USA and its subsidiaries that could create potential conflicts of interest

 

Ownership interests of directors or officers of Expedia in USA common stock, or ownership of directors or officers of USA in Expedia common shares or service as both a director or officer of Expedia and a director, officer or employee of USA, could create or appear to create potential conflicts of interest when directors and officers are faced with decisions that could have different implications for Expedia and USA. Barry Diller, chairman of the board of directors of USA, is also chairman of the board of directors of Expedia. A majority of our board of directors are also directors, officers or employees of USA. In addition, interlocking relationships may exist between certain members of our board of directors and members of the boards of directors of other USA subsidiaries that provide services that overlap ours, including Hotels.com, and important suppliers of ours that also have strong business relationships with our direct competitors. On February 5, 2003, we announced that Richard Barton would resign as our President and Chief Executive Officer effective March 31, 2003 and join the board of directors of USA.

 

Declines or disruptions in the travel industry, such as those caused by terrorism, war, bankruptcies or general economic downturns, could reduce our revenues

 

We depend on the stability of the travel industry and the viability of travel suppliers. Our business is highly sensitive to economic conditions as well as issues that impact travel safety. We could experience a protracted decrease in demand for our travel services due to fears regarding acts of terrorism, breakouts of war, military responses to acts of terrorism and increased costs and reduced operations by airlines due, in part, to new security directives adopted by the Federal Aviation Administration. This decrease in demand, depending on its scope and duration—which we cannot predict at this time—together with any future issues impacting travel safety, could significantly impact our long-term results of operations or financial condition. In addition, in connection with

 

29


certain events, such as terrorist activity or war, that have the effect of disrupting the existing travel plans of a significant number of our customers, we may incur additional costs if we decide to provide relief to customers by not charging cancellation fees or by refunding the price of tickets that are not used.

 

Some major airlines, most notably US Airways and the parent company of United Airlines, have sought bankruptcy protection and others may consider bankruptcy relief. As a result of bankruptcy or other financial difficulties, these airlines may reduce their fleets and the number of available flights, which could result in lower travel bookings volumes for us. The financial difficulties facing the airlines increase the risk that airlines may not perform on our contracts with them, including the risk we may not be paid for services provided to them. We have also paid merchant air suppliers for tickets in advance of travel. These amounts are classified as prepaid merchant bookings on our balance sheet. Should a supplier go out of business, we may be responsible for fulfilling the travel plans of our customers by purchasing tickets on another carrier, which could involve a substantial cost. As a result of airline bankruptcies we may incur additional customer service costs, face potential liability to customers for tickets that are not honored by the bankrupt airline, and we may lose revenue from hotel bookings that are associated with the purchase of tickets from the bankrupt airline.

 

Other adverse trends or events that tend to reduce travel and may reduce our revenues include:

 

    political instability;

 

    regional hostilities;

 

    price escalation in the airline industry or other travel-related industries;

 

    increased occurrence of travel-related accidents;

 

    airline or other travel-related strikes;

 

    increased airport security that could reduce the convenience of air travel;

 

    escalation of fuel prices might make travel more expensive and less desirable to consumers;

 

    strikes within the travel industry could reduce availability of inventory and increase costs to consumers; and

 

    bad weather

 

The seasonality of our business may make quarter-to-quarter comparisons of our financial results a poor indication of our performance; the seasonality of our business may place increased strain on our operations

 

Our business experiences seasonal fluctuations, reflecting seasonal trends for the products and services offered by our websites. For example, traditional leisure travel supplier and agency bookings typically are highest in the first two calendar quarters of the year as consumers plan and purchase their spring and summer travel and then the number of bookings flattens in the last two calendar quarters of the year. These factors could cause our revenues to fluctuate from quarter to quarter. Our results may also be affected by seasonal fluctuations in the inventory made available to us by our travel suppliers. For instance, during seasonal periods when demand is high, suppliers may impose blackouts for their inventory that prohibit us from selling their inventory during such periods.

 

We believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance as a result of this seasonality. Our historical growth has tended to mask the effects of seasonality on our operating results, and to the extent our rate of growth slows in the future these effects may become more pronounced.

 

If too many customers access our Web sites within a short period of time during our peak seasons, we may experience system interruptions that make our web sites unavailable or prevent us from efficiently fulfilling

 

30


orders, which may reduce the attractiveness of our products and services. In addition, we may be unable to hire adequate staff to operate our business during these peak periods.

 

Because our results of operations are difficult to predict, they may fluctuate substantially from the estimates of securities analysts or from our published budgets

 

In the event that our operating results fall below the expectations of securities analysts or investors, the trading price of our common shares may decline significantly. Factors that may cause us to fail to meet the expectations of securities analysts or investors include the following:

 

    our inability to obtain travel inventory on satisfactory terms from our travel suppliers;

 

    decreases in commission rates from airlines or increases in the costs of acquiring merchant travel inventory;

 

    the ability of our competitors to offer new or enhanced websites, services or products or similar services or products with lower prices;

 

    our inability to obtain new customers at reasonable cost, retain existing customers or encourage repeat purchases;

 

    decreases in the number of visitors to our websites or our inability to convert visitors to our websites into customers;

 

    our inability to adequately maintain, upgrade and develop our websites, the systems that we use to process customers’ orders and payments or our computer network;

 

    our inability to retain existing airlines, hotels, rental car companies and other suppliers of travel services or to obtain new travel suppliers;

 

    fluctuating gross margins due to a changing mix of revenues;

 

    the termination of existing relationships with key service providers or our failure to develop new ones;

 

    the amount and timing of operating costs relating to expansion of our operations;

 

    economic conditions specific to the Internet, online commerce and the travel industry; and

 

    a decrease in overall travel spending due to terrorism, war, economic recession, bad weather or other external factors.

 

We depend on our relationships with travel suppliers and distribution partners and adverse changes in these relationships could affect our inventory of travel offering and our transaction revenue

 

Our business relies on our relationships with our travel suppliers and distribution partners. Adverse changes in any of these relationships could reduce the amount of inventory that we are able to offer through our websites. We depend on travel suppliers to enable us to offer our customers comprehensive access to travel services and products. Consistent with industry practices, we currently have few agreements with our travel suppliers obligating them to provide inventory for us to sell through our websites. It is possible that travel suppliers may choose not to make their inventory of services and products available through our distribution channels. Travel suppliers could elect to sell exclusively through other sales and distribution channels or to restrict our access to their inventory. We also depend on travel suppliers for advertising revenues. If our travel suppliers chose not to make their services and products available to us, or not to advertise with us or if we are unable to negotiate acceptable terms with our suppliers, it could significantly decrease the amount or breadth or depth of our inventory of available travel offerings. Of particular note is Orbitz, the airline direct-distribution website owned by American Airlines, Continental Airlines, Delta Air Lines, Northwest Airlines and United Air Lines, and Travelweb, an online distributor of hotel rooms owned by Hilton, Hyatt, Mariott, Six Continents and Starwood. Additionally, American Airlines, United Airlines, Northwest Airlines, Continental Airlines, US Airways Group

 

31


and America West Airlines own a website known as “Hotwire,” which offers unpublished special fares on certain carriers. If a substantial number of our suppliers choose to restrict their special inventory solely to the distribution channels that they own, such action may have a material adverse affect on our business.

 

In addition to the impact on our supply, we may experience an adverse impact on our business due to the declining financial health of many of our travel suppliers. We may experience accounts receivable collections issues and this may result in the recording of bad debts expense or in some cases, a reduction in revenues.

 

Efforts by our suppliers to reduce distribution costs, such as a decline in commission rates and fees or the elimination of commissions, could reduce our revenues and margins

 

A portion of our revenues depends on the commissions and fees paid by travel suppliers for bookings made through our travel service. Generally, we do not have written commission agreements with our hotel suppliers. We generally negotiate commissions and fees with our other travel suppliers. Recently, airlines have cut or eliminated commission levels to travel agents. We cannot assure you that airlines, hotel chains or other travel suppliers will not reduce current industry commission rates further or eliminate commissions entirely, either of which could reduce our revenues and margins.

 

A portion of our revenues depends on payments from our Global Distribution System (GDS) partners as consideration for fees received by them from suppliers for transactions generated through one of our five distribution channels. Generally, we have written agreements with respect to these payments from our GDS partners. Nevertheless, there can be no assurance that our GDS partners will not reduce these payments or will not eliminate them entirely over time, either of which could reduce our revenues and margins. In this regard, on November 12, 2002, the Department of Transportation issued a Notice of Proposed Rulemaking regarding its existing rules governing certain GDS’s known as airline computer reservation systems. These proposed rules expressly seek to give airlines more flexibility in bargaining with the companies that run these computer reservation systems. To the extent that these proposed rules become final, any of our GDS partners could negotiate to receive less compensation from an airline, which in turn could cause that GDS partner to reduce the segment fee payments that it will pay Expedia for sales of the relevant airline’s tickets.

 

The current downturn in the airline industry has also caused our airline travel suppliers and our GDS partners to focus on reducing all costs. Airlines have reduced or eliminated commission payments to certain travel agents, airlines and GDS in an effort to reduce distribution costs. Future efforts to further reduce such payments could adversely impact our revenues. It is possible that we may be unable to reach distribution agreements with one or more major airlines in the future, which could result in flights on such airlines not being available on our websites. It is also possible that we may be subject to terms that adversely impact our margins on air travel revenue.

 

Similarly, many of our hotel partners face challenging market conditions brought on by reduced demand, pricing softness and lower occupancy levels. In response to these challenges, our hotel partners are increasingly focused on maintaining profitability by controlling expenses, including distribution costs. As a result, we may from time to time be asked by a certain hotel partner to renegotiate commercial terms of our agreement with them. We treat each of these conversations on a case by case basis in consideration of a variety of economic factors and with equal emphasis on maintaining healthy long-term relationship with our hotel partners going forward.

 

We compete with a variety of companies with respect to each product or service we offer

 

These competitors include:

 

    Internet travel agents such as Travelocity.com, Orbitz.com and American Express Interactive, Inc.;

 

    local, regional, national and international traditional travel agencies;

 

32


 

    consolidators and wholesalers of airline tickets, hotels and other travel products, including Hotwire.com, Cheaptickets.com and Priceline.com;

 

    airlines, hotels, rental car companies, cruise operators and other travel service providers, whether working individually or collectively, some of which are suppliers to our websites; and

 

    operators of travel industry reservation databases, such as Sabre and Pegasus.

 

In addition, some of the services provided by other USA companies such as Hotels.com are similar to ours and to that extent, business could be diverted away from Expedia.

 

In addition to the traditional travel agency channel, many travel suppliers also offer their travel services as well as third-party travel services directly to consumers through their own websites or by telephone. These travel suppliers include many suppliers with which we do business. As the demand for online travel services grows, we believe that travel suppliers, traditional travel agencies, travel industry information providers and other companies will increase their efforts to develop services that compete with our services by selling inventory from a wide variety of suppliers. We cannot assure you that our online operations will compete successfully with any current or future competitors online or offline.

 

Because we participate in an intensely competitive market place against a variety of well-capitalized, scaled offline and online travel distributors, we believe that maintaining and enhancing the Expedia brand is a critical. Our brand is a central piece of our efforts to attract and expand our online traffic as well as compete with traditional travel agencies and other travel service providers. The vast number of travel service providers that offer competing services increases the importance of maintaining and enhancing our brand recognition. Promotion of the Expedia brand will depend largely on our success in providing a high-quality experience supported by a high level of customer service. Some of our competitors may be able to secure services and products from travel suppliers on more favorable terms. In addition, the introduction of new technologies and the expansion of existing technologies may increase competitive pressures. Increased competition may result in reduced operating margins, as well as loss of market share and brand recognition. We cannot assure you that we will be able to compete successfully against current and future competitors. Competitive pressures faced by us could have a material adverse effect on our business, operating results and financial condition.

 

Interruptions in service from third parties could impair the quality of our service

 

We rely on third-party computer systems and third-party service providers, including the computerized global distribution systems of the airline, hotel and car rental industries to make airline ticket, hotel room and car rental reservations and credit card verifications and confirmations.

 

Currently, a majority of our transactions are processed through two GDS partners: Worldspan, L.P. and Pegasus Solutions, Inc. We rely on TRX, Inc. and PeopleSupport, Inc. to provide a significant portion of our telephone and e-mail customer support, as well as to print and deliver airline tickets as necessary. Any interruption in these third-party services or deterioration in their performance could impair the quality of our service. If our arrangement with any of these third parties is terminated, we may not find an alternate source of systems support on a timely basis or on commercially reasonable terms. In particular, any migration from the Worldspan system could require a substantial commitment of time and resources and harm our business.

 

We rely on a third party to provide our hosting services. We do not maintain fully redundant systems or alternative providers of hosting services. As a result, a system interruption or shutdown at the hosting facility that we use could result in lengthy interruptions in our services. Our business interruption insurance may not be sufficient to compensate us for losses that may occur.

 

33


 

Our success depends on maintaining the integrity of our systems and infrastructure

 

In order to be successful, we must continue to provide reliable, real-time access to our systems for our customers and suppliers. As our operations continue to grow in both size and scope, domestically and internationally, we will need to improve and upgrade our systems and infrastructure to offer an increasing number of customers and travel suppliers enhanced products, services, features and functionality. The expansion of our systems and infrastructure will require us to commit substantial financial, operational and technical resources before the volume of business increases, with no assurance that the volume of business will increase. Consumers and suppliers will not tolerate a service hampered by slow delivery times, unreliable service levels or insufficient capacity, any of which could have a material adverse effect on our business, operating results and financial condition.

 

In this regard, our operations face the risk of systems failures. Our systems and operations are vulnerable to damage or interruption from fire, flood, power loss, telecommunications failure, break-ins, earthquake and similar events. We do not currently have a back-up data center. Our business interruption insurance may not adequately compensate us for losses that may occur. The occurrence of a natural disaster or unanticipated problems at our facilities in Washington or Travelscape’s facilities in Nevada could cause interruptions or delays in our business, loss of data or render us unable to process reservations. In addition, the failure of our computer and communications systems to provide the data communications capacity required by us, as a result of human error, natural disaster or other operational disruptions could result in interruptions in our service. The occurrence of any or all of these events could adversely affect our reputation, brand and business.

 

Our business is exposed to risks associated with online commerce security and credit card fraud

 

Consumer concerns over the security of transactions conducted on the Internet or the privacy of users may inhibit the growth of the Internet and online commerce. To transmit confidential information such as customer credit card numbers securely, we rely on encryption and authentication technology. Unanticipated events or developments could result in a compromise or breach of the systems we use to protect customer transaction data. Furthermore, our servers may also be vulnerable to viruses transmitted via the Internet. While we proactively check for intrusions into our infrastructure, a new and undetected virus could cause a service disruption.

 

To date, our results have been impacted due to accounting reserves we record for reservations placed on our website with fraudulent credit card data. We record these reserves because, under current credit card practices and the rules of the Airline Reporting Corporation, we may be held liable for fraudulent credit card transactions on our websites and other payment disputes with customers. We have put additional anti-fraud measures in place above and beyond our existing credit card verification procedures; however, a failure to control fraudulent credit card transactions adequately could further adversely affect our business.

 

Rapid technological changes may render our technology obsolete or decrease the competitiveness of our services

 

To remain competitive, we must continue to enhance and improve the functionality and features of our websites. The Internet and the online commerce industry are rapidly changing. In particular, the online travel industry is characterized by increasingly complex systems and infrastructures. If competitors introduce new services embodying new technologies, or if new industry standards and practices emerge, our existing websites and proprietary technology and systems may become obsolete. Our future success will depend on our ability to do the following:

 

    enhance our existing services;

 

    develop and license new services and technologies that address the increasingly sophisticated and varied needs of our prospective customers and suppliers; and

 

    respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis.

 

34


 

Developing our websites and other proprietary technology entails significant technical and business risks. We may use new technologies ineffectively or we may fail to adapt our websites, transaction-processing systems and network infrastructure to customer requirements or emerging industry standards. If we face material delays in introducing new services, products and enhancements, our customers and suppliers may forego the use of our services and use those of our competitors.

 

Our international operations involve risks relating to travel patterns and practices and Internet-based commerce

 

We operate in the U.K., Germany, Canada, France, the Netherlands and Italy and intend to expand our operations to other countries. In order to achieve widespread acceptance in each country we enter, we believe that we must tailor our services to the unique customs and cultures of that country. Learning the customs and cultures of various countries, particularly with respect to travel patterns and practices, is a difficult task and our failure to do so could slow our growth in those countries.

 

In addition, we face additional risks in operating internationally, such as:

 

    delays in the development of the Internet as a broadcast, advertising and commerce medium in international markets;

 

    difficulties in managing operations due to distance, language and cultural differences, including issues associated with establishing management systems infrastructures in individual foreign markets;

 

    unexpected changes in regulatory requirements;

 

    tariffs and trade barriers and limitations on fund transfers;

 

    difficulties in staffing and managing foreign operations;

 

    potential adverse tax consequences;

 

    exchange rate fluctuations;

 

    increased risk of piracy and limits on our ability to enforce our intellectual property rights; and

 

    for those operations where we have physical offices, increased risk of terrorism, political instability and war.

 

Any of these factors could harm our business. We do not currently hedge our foreign currency exposures.

 

Our success depends in large part on the continuing efforts of a few individuals and our ability to continue to attract, retain and motivate highly skilled employees

 

We depend substantially on the continued services and performance of our senior management. These individuals may not be able to fulfill their responsibilities adequately and may not remain with us. The loss of the services of any executive officers or other key employees could hurt our business. A large number of our senior executives are significantly vested in their current stock options which vest according to time-based criteria. As a result, they will be less likely to remain with us solely to achieve vesting of the remaining unvested portion of their stock options.

 

As of December 31, 2002, we employed a total of 1,699 employees. In order to achieve our anticipated growth, we will need to hire additional qualified employees. If we do not succeed in attracting new employees and retaining and motivating our current personnel, our business will be adversely affected.

 

35


 

We may be found to have infringed on intellectual property rights of others that could expose us to substantial damages and restrict our operations

 

We could face claims that we have infringed the patents, copyrights or other intellectual property rights of others. In addition, we may be required to indemnify travel suppliers for claims made against them. Any claims against us could require us to spend significant time and money in litigation, delay the release of new products or services, pay damages, develop new intellectual property or acquire licenses to intellectual property that is the subject of the infringement claims. These licenses, if required, may not be available on acceptable terms or at all. As a result, intellectual property claims against us could have a material adverse effect on our business, operating results and financial condition.

 

Our websites rely on intellectual property, and we cannot be sure that this intellectual property is protected from copy or use by others, including potential competitors

 

We regard much of our content and technology as proprietary and try to protect our proprietary technology by relying on trademarks, copyrights, trade secret laws and confidentiality agreements with consultants. In connection with our license agreements with third parties, we seek to control access to and distribution of our technology, documentation and other proprietary information. Even with all of these precautions, it is possible for someone else to copy or otherwise obtain and use our proprietary technology without our authorization or to develop similar technology independently. Effective trademark, copyright and trade secret protection may not be available in every country in which our services are made available through the Internet, and policing unauthorized use of our proprietary information is difficult and expensive. We cannot be sure that the steps we have taken will prevent misappropriation of our proprietary information. This misappropriation could have a material adverse effect on our business. In the future, we may need to go to court to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. This litigation might result in substantial costs and diversion of resources and management attention.

 

We currently license from third parties, including our former parent Microsoft, some of the technologies incorporated into our websites. As we continue to introduce new services that incorporate new technologies, we may be required to license additional technology from Microsoft and others. We cannot be sure that these third-party technology licenses will continue to be available on commercially reasonable terms, if at all.

 

Evolving government regulation could impose taxes or other burdens on our business, which could increase our costs or decrease demand for our products

 

We rely upon generally available interpretations of tax laws and regulations in the countries and locales in which we operate and for which we provide travel inventory. We cannot be sure that these interpretations are accurate nor that the responsible taxing authority is in agreement with our views. The imposition of additional taxes could cause us to have to pay taxes that we currently do not collect or pay or increase the costs of our products or services or increase our costs of operations.

 

We are currently conducting an on-going review and interpretation of the tax laws in various states and jurisdictions relating to state and local sales and hotel occupancy taxes. We are also monitoring the effect of value added taxes in certain foreign jurisdictions in which we operate. The current business practice is that the hotels collect and remit these taxes to the various tax authorities. Consistent with this practice, we recover the taxes from customers and remit the taxes to the hotel operators for payment to the appropriate tax authorities. Several jurisdictions have stated that they may take the position that the tax is also applicable to the gross profit on merchant hotel transactions. We have not paid nor agreed to pay such taxes but have established a reserve for potential payment.

 

Federal legislation imposing limitations on the ability of states to tax Internet-based sales was enacted in 1998. The Internet Tax Freedom Act, which was extended by the Internet Non-Discrimination Act, exempts specific types of sales transactions conducted over the Internet from multiple or discriminatory state and local

 

36


taxation through November 1, 2003. If this legislation is not renewed when it terminates, state and local governments could impose additional taxes on Internet-based sales and these taxes could decrease the demand for our products or increase our costs of operations.

 

In addition, despite the federal statute, state and local tax authorities may seek to establish that Expedia has nexus in the traditional sense or acts as a hotel operator. These jurisdictions could rule that Expedia is subject to sales and occupancy taxes and seek to collect taxes on certain forms of revenue, either retroactively or prospectively or both.

 

 

37


PART III

 

ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

 

a)   Executive Officers

 

Information regarding our Executive Officers required by Item 10 of Part III is set forth in Item 1 of Part I “Business—Executive Officers.”

 

b)   Directors

 

The following is a current list of the Board of Directors of Expedia.

 

Name


  

Age


  

Capacity


Michael Adler

  

39

  

Director

Erik C. Blachford

  

36

  

President, Chief Executive Officer and Director

Thomas C. Breitling

  

33

  

Director

Anne M. Busquet

  

53

  

Director

Barry Diller

  

61

  

Chairman of the Board

David Ellen

  

38

  

Director

Jay C. Hoag (1)(2)

  

44

  

Director

Reed Hundt (1)(2)

  

55

  

Director

Victor Kaufman

  

59

  

Director

Dara Khosrowshahi

  

33

  

Director

Gregory B. Maffei (1)(2)

  

42

  

Director

Daniel Marriott

  

34

  

Director

Gregory S. Stanger

  

38

  

Senior Vice President, Chief Financial Officer and Director


(1)   Member of the Compensation Committee
(2)   Member of the Audit Committee

 

Michael Adler has served as a director of Expedia since September 2002. Mr. Adler has served as the Vice President of Financial Analysis and Operational Reporting at USA Interactive (“USA”) since February 2002. He joined USA in May 2001 as Senior Vice President, Finance and Administration, for USA’s Information and Services Group. He has also served as Chief Financial Officer of Styleclick, Inc. (“Styleclick”), a majority owned subsidiary of USA, since April 2002, and as Chief Executive Officer, Chief Operating Officer and a member of the Styleclick Board of Directors since May 2002. Prior to joining USA, Mr. Adler held a number of positions, including Chief Financial Officer and General Counsel for SchoolSports, Inc. from September 1999 to April 2001 and Vice President and General Counsel for Cheyenne Software, Inc. from 1993 to 1996, both in New York. Prior to that, Mr. Adler practiced law with Feldman, Waldman & Kline in San Francisco.

 

Erik C. Blachford joined Expedia in 1995. He has served in various capacities at Expedia and prior to his current position of President and Chief Executive Officer effective April 1, 2003, he was President of Expedia North America. Previously, he served as General Manager at Kroll Travel Watch, a travel information services division of Kroll Associates Inc. from 1994 to 1995. Prior to that, he held various marketing and new product development positions at Butterfield & Robinson Travel Inc. between 1989 and 1992.

 

Thomas C. Breitling has served as a director of Expedia since February 2002. Since December 2001, Mr. Breitling has served as the President and Chief Executive Officer of Breitling Ventures, a private investment firm. Mr. Breitling was the President of Travelscape, Inc., a wholly owned subsidiary of Expedia, from March 2000 to December 2001. Prior to that, Mr. Breitling co-founded Travelscape.com, Inc. and served as its Chief Operating Officer from March 1998 through March 2000, the closing of the acquisition of Travelscape by Expedia. In 1993, Mr. Breitling joined Las Vegas Reservation Systems, Inc., the precursor of Travelscape.com, Inc., and served as its Vice President until he co-founded Travelscape in March 1998.

 

38


 

Anne M. Busquet has been a director of Expedia since January 2003. Since 1999, Ms. Busquet has served as a director of USA, the parent company of Expedia. Ms. Busquet is President of USA’s Travel Services group, and was formerly President of AMB Advisors, LLC, an independent consulting firm. Previously, she was at American Express for 23 years in diverse executive positions. She was President, Interactive Services and New Businesses Division of American Express from July 2000 to April 2001. She was President of American Express Relationship Services Division from October 1995 to July 2000 and Executive Vice President of American Express’ Consumer Card Group since November 1993. Ms. Busquet has an MBA from Columbia University and a Bachelor’s of Science degree in Hotel Administration from Cornell University. Ms. Busquet also serves as a director of Hotels.com.

 

Barry Diller has served as Chairman of the Board of Directors of Expedia since February 2002. Since August 1995, Mr. Diller has been a director and the Chairman and Chief Executive Officer of USA (or its predecessors), the parent company of Expedia. He was Chairman of the Board and Chief Executive Officer of QVC, Inc. from December 1992 through December 1994. From 1984 to 1992, Mr. Diller served as the Chairman of the Board and Chief Executive Officer of Fox, Inc. Prior to joining Fox, Inc., Mr. Diller served for 10 years as Chairman of the Board and Chief Executive Officer of Paramount Pictures Corporation. Mr. Diller also serves as a director of Hotels.com, The Washington Post Company and The Coca-Cola Company. He also serves on the Board of the Museum of Television and Radio, Conservation International and 13/WNET. In addition, Mr. Diller is a member of the Board of Councilors for the University of Southern California’s School of Cinema-Television, the New York University Board of Trustees, the Tisch School of the Arts Dean’s Council and the Executive Board for the Medical Sciences of University of California, Los Angeles.

 

David Ellen has served as a director of Expedia since September 2002. Mr. Ellen has served as Deputy General Counsel for USA since July 2001 and is a director of Hotels.com. Prior to joining USA, Mr. Ellen served as General Counsel at Eureka Broadband Corporation from March 2000 to June 2001. He also previously served as senior counsel at Cablevision Systems Corporation from September 1997 to March 2000, as well as special counsel at the Federal Communications Commission from November 1995 to July 1997. Mr. Ellen was a law clerk for Judge (now Justice) Ruth Bader Ginsburg on the U.S. Court of Appeals for the D.C. Circuit, for Judge (now Justice) Stephen Breyer on the U.S. Court of Appeals for the First Circuit, and for Justice Sandra Day O’Connor on the U.S. Supreme Court.

 

Jay C. Hoag has served as a director of Expedia since August 2000. Since June 1995, Mr. Hoag has been a General Partner of Technology Crossover Ventures, a venture capital firm. Mr. Hoag serves on the Board of Directors of eLoyalty Corporation, Netflix, Inc., Altiris, Inc. and a privately held company.

 

Reed Hundt has served as a director of Expedia since March 2002. Since 1998, Mr. Hundt has served as Senior Advisor on information industries to McKinsey & Company, a worldwide management consulting firm. Mr. Hundt has also been special advisor to the Blackstone Group, a private equity firm, since 2000, and a venture partner at Benchmark Capital, a venture capital firm that specializes in investments in high-tech companies, since 1999. From 1993 to 1997, Mr. Hundt served as Chairman of the FCC. Prior to his position as Chairman of the FCC, Mr. Hundt was a partner at the law firm of Latham & Watkins in Washington, D.C. Mr. Hundt also serves as a director of Allegiance Telecom, Inc. and Intel Corp.

 

Victor Kaufman has served as a director of Expedia since February 2002. Mr. Kaufman has been Vice Chairman of USA since October 1999. Previously, Mr. Kaufman served in the Office of the Chairman for USA since January 1997 and as Chief Financial Officer of USA since November 1997. Prior to that time, he served as Chairman and Chief Executive Officer of Savoy Pictures Entertainment, Inc. (“Savoy”) since March 1992 and as a director of Savoy since February 1992. Mr. Kaufman was the founding Chairman and Chief Executive Officer of Tri-Star Pictures, Inc. from 1983 until December 1987, at which time he became President and Chief Executive Officer of Tri-Star’s successor company, Columbia Pictures Entertainment, Inc. He resigned from these positions at the end of 1989 following the acquisition of Columbia by Sony USA, Inc. Mr. Kaufman joined Columbia in 1974 and served in a variety of senior positions at Columbia and its affiliates prior to the founding of Tri-Star. Mr. Kaufman also serves as a director of USA and Hotels.com.

 

39


 

Dara Khosrowshahi has served as a director of Expedia since February 2002. Mr. Khosrowshahi has been Executive Vice President and Chief Financial Officer of USA since January 2002 and had previously been Executive Vice President, Operations and Strategic Planning of USA since July 2000. From August 1999 to July 2000, Mr. Khosrowshahi served as President, USA Networks Interactive, a division of USA. Mr. Khosrowshahi joined USA in 1998 as Vice President of Strategic Planning, and was later promoted to Senior Vice President in May 1999. Prior to joining USA, Mr. Khosrowshahi worked at Allen & Company Incorporated from 1991 to 1998 where he served as Vice President from 1995 to 1998. Mr. Khosrowshahi also serves as a director of BET.com and Hotels.com.

 

Gregory B. Maffei has served as a director of Expedia since 1999 and served as Chairman of the Board of Directors of Expedia from 1999 to February 2002. Mr. Maffei also serves as Chairman and Chief Executive Officer of 360networks Corporation, and has served as CEO since 2000. From 1997 until January 2000, he was the Senior Vice President, Finance & Administration and Chief Financial Officer of Microsoft. Previously, Mr. Maffei has held a number of positions at Microsoft, including Vice President of Corporate Development, Treasurer, and Director, Business Development & Investments. Prior to joining Microsoft in 1993, he was with Citicorp Venture Capital and Dillon Read. Mr. Maffei serves as a director of aQuantive and Starbucks Coffee Company.

 

Daniel Marriott has served as a director of Expedia since February 2002. Mr. Marriott has served as Senior Vice President, Strategic Planning for USA since March 2002. Prior to this, he served as Executive Vice President, Corporate Strategy and Development of Ticketmaster from January 2000 to March 2002 and also served concurrently as President of Citysearch since October 2001. Prior to holding such positions, Mr. Marriott served as Executive Vice President, Business Development of Ticketmaster from February 1999 to December 1999 and Executive Vice President, Product Development and Marketing of Ticketmaster from August 1997 to January 1999. Prior to joining Ticketmaster, Mr. Marriott was employed by PepsiCo for approximately seven years, most recently in the position of Senior Product Manager for PepsiCo’s Frito-Lay division. Mr. Marriott also serves as a director of Hotels.com.

 

Gregory S. Stanger has served as a director of Expedia since February 2002. Mr. Stanger joined Expedia in 1999 as Vice President and Chief Financial Officer. Prior to joining Expedia, he served as Senior Director, Corporate Development at Microsoft from 1998 to 1999. Mr. Stanger held various positions in Microsoft’s corporate development department from 1993 to 1998, and elsewhere within Microsoft’s finance organization from 1991 to 1993. Prior to joining Microsoft, Mr. Stanger worked in investment banking with PaineWebber from 1987 to 1989. Mr. Stanger also serves as a director of drugstore.com, Inc.

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Under Section 16(a) of the Securities Exchange Act of 1934, as amended, Expedia’s directors, executive officers and any persons holding more than ten percent of Expedia’s common stock are required to report to the SEC and Nasdaq their initial ownership of Expedia’s stock and any subsequent changes in that ownership. Based on a review of Forms 3, 4 and 5 under the Securities Exchange Act furnished to Expedia, Expedia believes that during the year ended December 31, 2002, Expedia’s directors, officers and holders of more than 10% of Expedia’s common stock filed all Section 16(a) reports on a timely basis.

 

40


 

ITEM 11.    EXECUTIVE COMPENSATION

 

EXECUTIVE OFFICER COMPENSATION

 

Summary Compensation Table

 

The following table discloses compensation for the year ended December 31, 2002, six-month period ended December 31, 2001 and fiscal years ended June 30, 2001 and 2000 by our Named Executive Officers. The amounts in the following table have been adjusted for the two-for-one stock split effected on March 10, 2003. Annual compensation includes amounts deferred at the officer’s election.

 

Name and Principal Position


  

Year


      

Salary ($)


  

Bonus ($)(2)


  

Restricted Stock Awards ($)(6)


  

Shares Underlying Options (#)(3)


    

All Other Compensation ($)


 

Richard N. Barton

  

2002

 

    

$

253,814

  

$

277,917

  

$

1,362,750

  

750,000

(7)

  

$

—  

 

President, Chief Executive Officer and Director

  

    (4

)

    

 

102,917

  

 

56,250

         

250,000

 

  

 

—  

 

  

2001

 

    

 

183,333

  

 

166,500

         

450,000

 

  

 

—  

 

  

2000

 

    

 

161,078

  

 

64,500

         

200,000

 

  

 

—  

 

Erik C. Blachford

  

2002

 

    

 

157,831

  

 

154,500

         

140,000

(8)

  

 

—  

 

President, Expedia North America

  

    (4

)

    

 

79,483

  

 

69,500

         

100,000

 

  

 

—  

 

  

2001

 

    

 

127,400

  

 

90,000

         

130,000

 

  

 

—  

 

  

2000

 

    

 

109,750

  

 

22,400

         

177,750

 

  

 

—  

 

Simon J. Breakwell

  

2002

 

    

 

187,917

  

 

141,474

         

35,000

(9)

  

 

—  

 

Senior Vice President and Managing Director, Expedia Europe

  

    (4

)

    

 

89,079

  

 

68,561

         

50,000

 

  

 

121,084

(5)

  

2001

 

    

 

162,505

  

 

70,000

         

126,000

 

  

 

109,995

 

  

2000

 

    

 

121,042

  

 

36,000

         

63,482

 

  

 

—  

 

Ronald Letterman(1)

  

2002

 

    

 

198,515

  

 

325,000

         

50,000

 

  

 

—  

 

Senior Vice President and President, Classic Custom Vacations

                                             
                                             

Gregory S. Stanger

  

2002

 

    

 

161,893

  

 

142,500

  

 

545,100

  

135,000

(10)

  

 

—  

 

Senior Vice President, Chief Financial Officer and Director

  

    (4

)

    

 

80,612

  

 

67,500

         

100,000

 

  

 

—  

 

  

2001

 

    

 

141,069

  

 

90,000

         

136,000

 

  

 

—  

 

  

2000

 

    

 

124,904

  

 

31,772

         

101,572

 

  

 

—  

 


(1)   Mr. Letterman became an executive officer of the Company on March 9, 2002, when Expedia acquired substantially all of the assets of Classic Custom Vacations.

 

(2)   Reflects bonuses earned during each respective period.

 

(3)   The amounts stated for 2000 reflect: (i) the number of Expedia options received by each Named Executive officer in exchange for Microsoft options granted in that fiscal year; plus (ii) the number of Expedia options received by each Named Executive Officer in that fiscal year.

 

(4)   For the six-month period ended December 31, 2001.

 

(5)   Expenses paid by the Company in connection with the executive’s relocation.

 

(6)   Reflects restricted stock awards of 50,000 and 20,000 (as adjusted for our 2:1 stock split) granted to Richard N. Barton and Gregory S. Stanger, respectively, pursuant to an employment agreement signed in February 2002. Values are based on the closing market price of Expedia stock on the date of grant. Vesting on these restricted awards is 100% in February 2005. As of March 31, 2003, Richard Barton resigned and forfeited his restricted stock awards. The value of the outstanding restricted stock at year end, based on the closing price of the restricted stock on December 31, 2002, was $1,673,250 for Mr. Barton and $669,300 for Mr. Stanger.

 

41


 

(7)   Excludes options to purchase 200,000 shares of USA common stock granted to Mr. Barton on February 4, 2002. Excludes warrants to purchase 438,018 shares of Expedia common stock granted to Mr. Barton on February 4, 2002 in connection with the USA acquisition of control.

 

(8)   Excludes options to purchase 30,000 shares of USA common stock granted to Mr. Blachford on February 4, 2002. Excludes warrants to purchase 93,366 shares of Expedia common stock granted to Mr. Blachford on February 4, 2002 in connection with the USA acquisition of control.

 

(9)   Excludes options to purchase 30,000 shares of USA common stock granted to Mr. Breakwell on February 4, 2002. Excludes warrants to purchase 54,960 shares of Expedia common stock granted to Mr. Breakwell on February 4, 2002 in connection with the USA acquisition of control.

 

(10)   Excludes options to purchase 100,000 shares of USA common stock granted to Mr. Stanger on February 4, 2002. Excludes warrants to purchase 178,254 shares of Expedia common stock granted to Mr. Stanger on February 4, 2002 in connection with the USA acquisition of control.

 

 

Compensation Pursuant to Stock Options

 

The following table provides information as of December 31, 2002 on option grants in the year ended December 31, 2002 to the Named Executive Officers. The amounts in the following table have been adjusted for the two-for-one stock split effective on March 10, 2003.

 

    

Options Grants for Year Ended December 31, 2002


    

Individual Grants


  

Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Option Term (3)


    

Number of Securities Underlying Options Granted (#)(1)


    

Percentage of Total Options Granted to Employees (2)


  

Exercise Price ($/Share)


  

Expiration Date


  

Name


                

5% ($)


  

10% ($)


Richard N. Barton(4)

  

750,000

    

12.4%

  

$

27.26

  

2/04/2012

  

$

12,855,392

  

$

32,578,088

Erik C. Blachford(5)

  

100,000

    

1.7%

  

 

21.67

  

1/16/2009

  

 

881,983

  

 

2,055,396

    

40,000

    

0.7%

  

 

29.03

  

7/09/2012

  

 

730,272

  

 

1,850,654

Simon J. Breakwell(6)

  

35,000

    

0.6%

  

 

29.03

  

7/09/2012

  

 

638,988

  

 

1,619,322

Ronald Letterman

  

30,000

    

0.5%

  

 

29.03

  

7/09/2012

  

 

547,704

  

 

1,387,990

    

20,000

    

0.3%

  

 

32.00

  

3/11/2012

  

 

402,493

  

 

1,019,995

Gregory S. Stanger(7)

  

100,000

    

1.7%

  

 

27.26

  

2/04/2012

  

 

1,714,052

  

 

4,343,745

    

35,000

    

0.6%

  

 

29.03

  

7/09/2012

  

 

638,988

  

 

1,619,322


(1)   The amounts in this column reflect the number of Expedia options received by each Named Executive Officer in the year ended December 31, 2002. All of the above stock options were granted pursuant to the 2001 Stock Plan. The options vest over a four-year period with one-quarter of the option vesting on the first anniversary of the date of grant and the remaining options vesting in monthly intervals thereafter. The exercise prices were based on the fair market value of the shares determined in accordance with the plan. Options terminate ten years after the date of grant or three months following termination of the optionee’s employment (twelve months in the case of a termination due to death or disability), whichever occurs earlier.

 

(2)   The amounts in this column represent grants made in the year ended December 31, 2002; we granted to our employees options covering approximately 6,054,000 shares of our common stock.

 

(3)   The dollar amounts under these columns result from calculating 5% and 10% assumed appreciation rates and, therefore, are not intended to forecast possible future appreciation, if any, of the price of Company common stock.

 

(4)  

Excludes options to purchase 200,000 shares of USA common stock granted to Mr. Barton on February 4, 2002. Such options (a) represent 7.7% of the total options to purchase USA common stock granted to employees of USA and its subsidiaries in 2002, (b) have a per share exercise price of $28.83 and (c) expire on February 4,

 

42


 

2012. The potential realizable value of these options at assumed annual rates of USA stock price appreciation for the option term of 5% and 10% would be $3,626,206 and $9,189,519, respectively. Excludes warrants to purchase 438,018 shares of Expedia common stock granted to Mr. Barton on February 4, 2002 in connection with the USA acquisition of control. Such warrants (a) have a per share exercise price of $26 and (b) expire on February 4, 2009. The potential realizable value of these warrants at assumed annual rates of Expedia stock price appreciation for the warrant term of 5% and 10% would be $4,636,250 and $10,804,434, respectively.

 

(5)   Excludes options to purchase 30,000 shares of USA common stock granted to Mr. Blachford on February 4, 2002. Such options (a) represent 1.1% of the total options to purchase USA common stock granted to employees of USA and its subsidiaries in 2002, (b) have a per share exercise price of $28.83 and (c) expire on February 4, 2012. The potential realizable value of these options at assumed annual rates of USA stock price appreciation for the option term of 5% and 10% would be $543,931 and $1,378,428, respectively. Excludes warrants to purchase 93,366 shares of Expedia common stock granted to Mr. Blachford on February 4, 2002 in connection with the USA acquisition of control. Such warrants (a) have a per share exercise price of $26 and (b) expire on February 4, 2009. The potential realizable value of these warrants at assumed annual rates of Expedia stock price appreciation for the warrant term of 5% and 10% would be $988,243 and $2,303,026, respectively.

 

(6)   Excludes options to purchase 30,000 shares of USA common stock granted to Mr. Breakwell on February 4, 2002. Such options (a) represent 1.1% of the total options to purchase USA common stock granted to employees of USA and its subsidiaries in 2002, (b) have a per share exercise price of $28.83 and (c) expire on February 4, 2012. The potential realizable value of these options at assumed annual rates of USA stock price appreciation for the option term of 5% and 10% would be $543,931 and $1,378,428, respectively. Excludes warrants to purchase 54,960 shares of Expedia common stock granted to Mr. Breakwell on February 4, 2002 in connection with the USA acquisition of control. Such warrants (a) have a per share exercise price of $26 and (b) expire on February 4, 2009. The potential realizable value of these warrants at assumed annual rates of Expedia stock price appreciation for the warrant term of 5% and 10% would be $581,730 and $1,355,679, respectively.

 

(7)   Excludes options to purchase 100,000 shares of USA common stock granted to Mr. Stanger on February 4, 2002. Such options (a) represent 3.8% of the total options to purchase USA common stock granted to employees of USA and its subsidiaries in 2002, (b) have a per share exercise price of $28.83 and (c) expire on February 4, 2012. The potential realizable value of these options at assumed annual rates of USA stock price appreciation for the option term of 5% and 10% would be $1,813,103 and $4,594,760, respectively. Excludes warrants to purchase 178,254 shares of Expedia common stock granted to Mr. Stanger on February 4, 2002 in connection with the USA acquisition of control. Such warrants (a) have a per share exercise price of $26 and (b) expire on February 4, 2009. The potential realizable value of these warrants at assumed annual rates of Expedia stock price appreciation for the warrant term of 5% and 10% would be $1,886,749 and $4,396,928, respectively.

 

Aggregated Option Exercises and Option Values

 

The following table provides information regarding Expedia stock options exercised by the Named Executive Officers during the year ended December 31, 2002 and exercisable and unexercisable Expedia stock options held by them as of December 31, 2002. The “value realized” figures are based on the fair market value of Expedia’s common stock at the exercise date, minus the per share exercise price, multiplied by the number of options exercised. The “value of unexercised in-the-money options” figures in the right hand column are based on the fair market value of Expedia’s common stock at December 31, 2002, of $33.47 per share, minus the per share exercise price of the applicable option, multiplied by the number of shares issuable upon exercise of the option. The amounts in the following table have been adjusted for the two-for-one stock split effected on March 10, 2003.

 

43


 

Name


  

Shares Acquired on Exercise (#)


  

Value Realized ($)


  

Number of Securities Underlying Unexercised Options at 12/31/02 (#)


  

Value of Unexercised In-the-Money Options at 12/31/02 ($)


        

Exercisable


  

Unexercisable


  

Exercisable


  

Unexercisable


Richard N. Barton(1)

  

743,838

  

$

22,495,773

  

260,896

  

2,076,610

  

$

6,359,662

  

$

39,551,218

Erik C. Blachford(2)

  

136,314

  

 

4,053,849

  

99,410

  

390,566

  

 

2,386,059

  

 

6,613,690

Simon J. Breakwell(3)

  

—  

  

 

—  

  

119,582

  

201,676

  

 

3,318,114

  

 

3,954,683

Ronald Letterman

  

—  

  

 

—  

  

—  

  

50,000

  

 

—  

  

 

162,355

Gregory S. Stanger(4)

  

207,600

  

 

6,001,027

  

490,984

  

414,824

  

 

13,822,853

  

 

6,990,273


(1)   Excludes options to purchase 200,000 shares of USA common stock granted to Mr. Barton on February 4, 2002, none of which were excercisable as of December 31, 2002. The USA options at December 31, 2002 were not in-the-money. Excludes warrants to purchase 438,018 shares of Expedia common stock granted to Mr. Barton on February 4, 2002 in connection with the USA acquisition of control, of which warrants to purchase 183,308 shares of Expedia common stock were exercisable at December 31, 2002 and warrants to purchase 254,710 shares of Expedia common stock were unexercisable as of December 31, 2002. None of such warrants were exercised in 2002. The values of the exercisable and unexercisable in-the-money Expedia warrants at December 31, 2002 were $1,369,311 and $1,902,684, respectively.

 

(2)   Excludes options to purchase 30,000 shares of USA common stock granted to Mr. Blachford on February 4, 2002, none of which were excercisable as of December 31, 2002. The USA options at December 31, 2002 were not in-the-money. Excludes warrants to purchase 93,366 shares of Expedia common stock granted to Mr. Blachford on February 4, 2002 in connection with the USA acquisition of control, of which warrants to purchase 45,542 shares of Expedia common stock were exercisable at December 31, 2002 and warrants to purchase 47,824 shares of Expedia common stock were unexercisable as of December 31, 2002. None of such warrants were exercised in 2002. The values of the exercisable and unexercisable in-the-money Expedia warrants at December 31, 2002 were $340,199 and $357,245, respectively.

 

(3)   Excludes options to purchase 30,000 shares of USA common stock granted to Mr. Breakwell on February 4, 2002, none of which were excercisable as of December 31, 2002. The USA options at December 31, 2002 were not in-the-money. Excludes warrants to purchase 54,960 shares of Expedia common stock granted to Mr. Breakwell on February 4, 2002 in connection with the USA acquisition of control, of which warrants to purchase 27,474 shares of Expedia common stock were exercisable at December 31, 2002 and warrants to purchase 27,486 shares of Expedia common stock were unexercisable as of December 31, 2002. None of such warrants were exercised in 2002. The values of the exercisable and unexercisable in-the-money Expedia warrants at December 31, 2002 were $205,231 and $205,320, respectively.

 

(4)   Excludes options to purchase 100,000 shares of USA common stock granted to Mr. Stanger on February 4, 2002, none of which were excercisable as of December 31, 2002. The USA options at December 31, 2002 were not in-the-money. Excludes warrants to purchase 178,254 shares of Expedia common stock granted to Mr. Stanger on February 4, 2002 in connection with the USA acquisition of control, of which warrants to purchase 126,048 shares of Expedia common stock were exercisable at December 31, 2002 and warrants to purchase 52,206 shares of Expedia common stock were unexercisable as of December 31, 2002. None of such warrants were exercised in 2002. The values of the exercisable and unexercisable in-the-money Expedia warrants at December 31, 2002 were $941,579 and $389,979, respectively.

 

44


 

Director Compensation

 

During the year ended December 31, 2002, each non-employee director received a fee of $10,000 paid in quarterly increments for his or her services on our board of directors and $1,000 for each board meeting and committee meeting attended. Each committee chairperson also received an additional fee of $2,500 paid in quarterly increments. In addition, non-employee directors received 30,000 options upon their initial election to the Board and 20,000 options annually thereafter. All options were granted under the 2001 Stock Plan, had an exercise price equal to the fair market value of our common stock on the date of grant, and vest over a four-year period. Directors who are also our employees did not receive any additional compensation for their service as directors.

 

Beginning in fiscal 2003, each non-employee director will receive an annual fee of $27,000 payable in equal quarterly installments for his or her services on our board of directors, $2,000 for each board meeting attended and $1,500 for each committee meeting attended. Each committee chairperson will also receive an additional annual fee of $5,000 payable in equal quarterly installments. In addition, non-employee directors will receive 15,000 options and 6,000 restricted stock units upon their initial election to the Board and 10,000 options and 4,000 restricted stock units annually on the date of the Company’s annual meeting of shareholders at which the director is re-elected.

 

Compensation Committee Interlocks and Insider Participation in Compensation Decisions

 

Messrs. Hoag, Hundt and Maffei served as members of the Company’s Compensation Committee during 2002. There are no compensation committee interlocks between the members of our Compensation Committee and any other entity.

 

Employment Contracts and Change-in-Control Arrangements

 

Resignation Agreement with Richard Barton.    On February 5, 2003, we entered into a Resignation Agreement with Mr. Barton pursuant to which Mr. Barton agreed to resign from Expedia in all positions effective March 31, 2003. This agreement provides that Mr. Barton will be paid promptly after March 31, 2003 any accrued but unpaid base salary and any compensation previously earned but deferred by Mr. Barton that has not yet been paid. It also provides that, in consideration for a general release of claims by Mr. Barton and other good and valuable consideration, Mr. Barton’s Expedia stock options and other Expedia equity awards that would have vested pursuant to their normal vesting schedule during 2003 had Mr. Barton remained employed by Expedia through the end of 2003 will vest on March 31, 2003 and, in the case of vested Expedia stock options, shall remain exercisable until March 31, 2004. Mr. Barton’s vested Expedia warrants will remain exercisable through their scheduled expiration date.

 

Employment Agreement with Richard Barton.    Effective as of February 4, 2002, we entered into an employment agreement with Mr. Barton setting forth the material terms of his employment. Pursuant to the agreement, Mr. Barton served as Chief Executive Officer of Expedia and served as a member of our Board of Directors. This employment agreement was superceded by the Resignation Agreement described above, other than the restrictive covenants described below.

 

Compensation.    Mr. Barton’s agreement provides for an annual base salary of $266,000 and eligibility to receive an annual bonus of 200% of his salary, payable 50% in cash and 50% in Expedia stock options based on achieving agreed-upon Expedia budget goals. $133,000 of the cash portion of Mr. Barton’s bonus is guaranteed.

 

On the effective date of the agreement, Mr. Barton received (i) a grant of options to purchase 100,000 shares of USA’s common stock at an exercise price of $28.83 and (ii) a grant of options to purchase 750,000 shares of our common stock at an exercise price of $27.26. Such options have a ten-year term and will vest in four equal annual installments commencing on the first anniversary of the effective date contingent upon Mr. Barton’s continued employment with Expedia. Mr. Barton also received an initial grant of 50,000 restricted shares of our

 

45


common stock, vesting contingent upon Mr. Barton’s continued employment with Expedia through the third anniversary of the effective date of the agreement. Mr. Barton will be evaluated for future option grants in a manner consistent with similarly situated executives of USA and its subsidiaries.

 

While employed by Expedia, Mr. Barton participated in welfare, health and life insurance and pension benefit and incentive programs adopted by Expedia on the same basis as similarly situated executives of Expedia, USA and their respective subsidiaries.

 

Severance.    Upon a termination of Mr. Barton’s employment by Expedia without “cause” or by Mr. Barton for “good reason” (as each term is defined in the agreement), we will continue to pay Mr. Barton his salary for the remainder of the term, as well as pay any earned, but unpaid, base salary and will pay Mr. Barton his deferred compensation balance. We will also pay Mr. Barton the pro rata portion of his annual bonus following the end of the fiscal year of his termination of employment (based upon satisfaction of performance goal formulas). In addition, he will immediately vest in all options and such options will remain exercisable for one year following his date of termination of employment. Although Mr. Barton is not obligated to mitigate any severance amounts, such amounts will be reduced by any compensation earned by Mr. Barton in the event that Mr. Barton becomes employed during the remainder of the term.

 

Change in Control.    The agreement provides that upon a change in control of Expedia, all of Mr. Barton’s Expedia options (and the USA options granted on the effective date) and other Expedia equity compensation will vest immediately, and such options will remain exercisable for one year from the date of the change in control, notwithstanding any termination of employment.

 

Restrictive Covenants.    Mr. Barton is bound by a covenant not to compete with our business (or any of our subsidiaries or affiliates) during the term of his employment and for two years after termination of employment for any reason; but if the non-compete period extends beyond the severance period (under circumstances in which Mr. Barton had been entitled to severance pay), we will pay Mr. Barton $100,000 per year (pro rated on a monthly basis) to the extent we determine to continue the non-compete period beyond the period in which Mr. Barton is eligible to receive severance. In addition, Mr. Barton will be bound by a two-year covenant not to solicit our employees or customers (or any of our subsidiaries or affiliates) and a confidentiality covenant.

 

Employment Agreement with Gregory Stanger.    Effective as of February 4, 2002, we entered into an employment agreement with Mr. Stanger setting forth the material terms of his employment. The agreement has a three-year term.

 

Compensation.    Mr. Stanger will receive an annual base salary of $175,000 and will be eligible to receive an annual bonus of 100% of his salary, payable 50% in cash and 50% in Expedia stock options based on achieving agreed-upon Expedia budget goals.

 

On the effective date of the agreement, Mr. Stanger received an initial grant of options to purchase 100,000 shares of our common stock at an exercise price of $27.26. Such options have a ten-year term and will vest in four equal annual installments commencing on the first anniversary of the effective date of the agreement contingent upon Mr. Stanger’s continued employment with us. Mr. Stanger also received a grant of 20,000 restricted shares of our common stock, vesting contingent upon Mr. Stanger’s continued employment with us through the third anniversary of the effective date.

 

Mr. Stanger participates in welfare, health and life insurance and pension benefit and incentive programs adopted by Expedia on the same basis as similarly situated executives of Expedia, USA and their respective subsidiaries.

 

Severance.    Upon a termination of Mr. Stanger’s employment by us without “cause” or by Mr. Stanger for “good reason” (as each term is defined in the agreement), we will continue to pay Mr. Stanger his salary for the

 

46


remainder of the term, as well as pay his earned, but unpaid, base salary and will pay Mr. Stanger his deferred compensation balance. In addition, Mr. Stanger will automatically and immediately vest in all of his then-outstanding equity-based compensation awards granted on or prior to August 2, 2001, and such options shall remain exercisable for one year following his date of termination of employment. Mr. Stanger is obligated to use reasonable best efforts to mitigate any severance payable to him.

 

Change in Control.    The agreement generally provides that upon a change in control of Expedia, all of Mr. Stanger’s Expedia options granted prior to August 2, 2001 and other Expedia equity compensation will vest immediately, and such options will remain exercisable for one year from the date of the change in control, notwithstanding any termination of employment.

 

Restrictive Covenants.    Pursuant to the agreement, Mr. Stanger is bound by covenants not to compete with our businesses (or our subsidiaries or affiliates) and not to solicit our employees or customers (or our subsidiaries or affiliates) during the term of his employment and for two years after termination of employment for any reason. In addition, Mr. Stanger agreed not to divulge or disclose any confidential information of Expedia or our affiliates.

 

Employment Agreements with Simon Breakwell.    We also entered into employment agreements with Mr. Breakwell, effective as of February 7, 2002. This agreement has a term of three years.

 

Compensation.    The base salary provided to Mr. Breakwell pursuant to the employment agreement is £124,800. Unless otherwise agreed by us and USA, the base salary is subject to further review and may be increased at the discretion of our Chief Executive Officer, any such increases to be approved by our compensation committee. The executive is also eligible to receive discretionary annual bonuses.

 

Mr. Breakwell is entitled to participate in company stock option grants after August 2, 2001 (except that such options will not accelerate and vest upon termination without cause or resignation with good reason).

 

Mr. Breakwell participates in welfare, health, and life insurance and pension benefits and incentive programs adopted by Expedia on the same basis as similarly situated executives of Expedia.

 

Severance.    Under the agreements, upon a termination of the Mr. Breakwell’s employment by us without “cause” or a resignation by Mr. Breakwell with “good reason” (as each term is defined in the agreement), Mr. Breakwell will be entitled to: (a) the acceleration and immediate vesting of all unvested Expedia options granted to him on or prior to August 2, 2001, and any attendant warrants granted in connection with the merger; and (b) receive the salary, target bonus and welfare benefits (and any other damages to which he would be entitled) for the remainder of the term, less an offset equal to any amounts earned during the term from other employment, with no obligation to mitigate.

 

Restrictive Covenants.    As a condition to entering into the agreements, Mr. Breakwell agreed to a non-compete for a period of one year from the date of termination for any reason. The non-compete applies to general online travel providers. Mr. Breakwell also agreed to a one-year non-solicitation covenant and a standard confidentiality covenant.

 

Employment Agreement with Ronald Letterman.    Effective as of January 2002, we entered into an employment agreement with Mr. Letterman setting forth the material terms of his employment. The agreement has a two-year term.

 

Compensation.    Mr. Letterman will receive an annual base salary of $225,000 and will be paid a guaranteed bonus of $150,000 for each of calendar years 2002 and 2003. In addition, Mr. Letterman will be eligible to receive an annual bonus based on the achievement of certain performance criteria, at a target amount of 40% of Mr. Letterman’s base salary (the amount actually awarded to range from 0% to 200% of the target amount).

 

47


 

Mr. Letterman was awarded options to purchase 20,000 shares of our common stock pursuant to the agreement. In addition, we agreed to reimburse Mr. Letterman for reasonable out-of-pocket expenses actually incurred by Mr. Letterman in performing his duties, a car allowance of $1,500 per month and, for calendar year 2002, an aggregate amount of up to $20,000 in face value of airline tickets or rental car credits.

 

Mr. Letterman participates in welfare, health and life insurance and pension benefit and incentive programs adopted by Expedia on the same basis as similarly situated executives of Expedia.

 

Severance.    Upon a termination of Mr. Letterman’s employment by us without “cause” or by Mr. Letterman for “good reason” (as each term is defined in the agreement), Mr. Letterman will be entitled to receive: his base salary through the second anniversary of the effective date of the agreement or a twelve-month period following his termination, whichever is longer, each guaranteed bonus, to the extent not already paid, and benefits during the twelve-month period following the termination to the extent that he does not receive any such benefits from a subsequent employer during that period.

 

Restrictive Covenants.    Pursuant to the agreement, Mr. Letterman is bound by covenants not compete with our businesses (or our subsidiaries or affiliates) and not to solicit our employees or customers (or our subsidiaries or affiliates) during the term of his employment and for one year after termination of employment for any reason. In addition, Mr. Letterman agreed not to divulge or disclose any confidential information of Expedia or our affiliates.

 

Employment Agreement with Erik C. Blachford.    Effective as of April 1, 2003, we entered into an amended and restated employment agreement with Mr. Blachford setting forth the material terms of his employment. Pursuant to the agreement, Mr. Blachford serves as President and Chief Executive Officer of Expedia and serves as a member of our Board of Directors for the three year term of the agreement. Mr. Blachford maintains a right to serve as of member of our Board so long as he is employed as Chief Executive Officer of Expedia and Expedia remains a publicly-traded company.

 

Compensation.    Mr. Blachford’s agreement provides for an annual base salary of $275,000 and eligibility to receive an annual bonus with a target of 100% of his salary. Mr. Blachford’s annual bonus will not be less than $137,500 and for the portion of the term from January 1, 2006 until March 31, 2006, Mr. Blachford’s annual bonus will not be less than $34,375.

 

Under the employment agreement, on March 17, 2003, Mr. Blachford received a non-qualified stock option to purchase 253,000 shares of Expedia’s common stock at an exercise price of $39.38. On the first anniversary of the grant date, one-fourth of the options will vest, and  1/48 of the option will vest on each monthly anniversary of the grant date thereafter, subject to Mr. Blachford’s continued employment with Expedia. The option has a ten-year term. On the effective date of the agreement, Mr. Blachford received an initial grant of 102,000 restricted stock units of Expedia common stock which will vest subject to certain performance conditions and Mr. Blachford’s continued employment with Expedia. If such performance conditions are met, restrictions on the restricted stock units will lapse in four equal installments on each of the first four anniversaries of March 31, 2003, subject to Mr. Blachford’s continued employment with Expedia. In addition, Mr. Blachford will receive a grant of 50,000 restricted stock units of USA’s common stock on the later of (i) April 1, 2003 and (ii) the earlier of (a) the date the Audit Committee of the Expedia Board approves the grant and (b) the date Expedia is no longer publicly traded. The USA restricted stock units will be subject to performance conditions set out by the Compensation Committee of USA. If such performance conditions are met, restrictions on the restricted stock units will lapse on March 31, 2006, subject to Mr. Blachford’s continued employment with Expedia. Mr. Blachford will be evaluated for future option grants in a manner consistent with similarly situated executives of USA and its subsidiaries.

 

Under the employment agreement, Mr. Blachford is eligible to participate in welfare, health and life insurance and pension benefit and incentive programs adopted by Expedia on the same basis as similarly situated executives of Expedia, USA and their respective subsidiaries.

 

48 <