Confessions of a SpinCo: TripAdvisor’s recent spin-off experience and its impact on employee...

Copyright 2013. Independent Stock Plan Advisors, LLC. All rights reserved.

Confessions of a SpinCo:TripAdvisor’s recent spin-off experience and its impact on employee stock plans

July 19, 2013


Overview TripAdvisor: At a Glance A Fresh Start – Sort Of The Netting Initiative A Shift in Philosophy

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TripAdvisor: At a Glance

TripAdvisor® is the world's largest travel site, enabling travelers to plan and have the perfect trip. TripAdvisor offers trusted advice from real travelers and a wide variety of travel choices and planning features with seamless links to booking tools. TripAdvisor branded sites make up the largest travel community in the world,

with more than 200 million unique monthly visitors, and over 100 million reviews and opinions covering more than 2.5 million accommodations, restaurants, and attractions. The sites operate in 30 countries worldwide, including China under daodao.com. TripAdvisor also includes TripAdvisor for Business, a dedicated division that provides the tourism industry access to millions of monthly TripAdvisor visitors.

Stock Ticker: Nasdaq: TRIP

Market Cap: $8.64 billion

2012 Revenue: $762 million

Index Membership: S&P 500

Founded: 2000

Headquarters: Newton, MA

Employees: ~1,700 worldwide

Global Presence: ~15 countries

Acquired: IAC (2004)

Spin #1: Together w/ all other travel businesses under EXPE (2005)

Spin #2 / IPO: December 2011


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A Fresh Start – Sort of

On December 20, 2011 TripAdvisor was spun-off from Expedia Spin mechanics

o Immediately prior to the spin-off, Expedia effected a 1-for-2 reverse split

o As a result of the reverse split and spin-off, every 2 shares of Expedia were converted into:

• One share of EXPE• One share of TRIP

The Spin


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What happen to equity awards?o Conversion ratios were applied to preserve intrinsic valueo But trailing obligations to non-employees were created by

both EXPE & TRIPEmployee Award Type Result

EXPE Option (vested) EXPE option & TRIP option

EXPE Option (unvested) EXPE option

EXPE RSU (unvested) EXPE RSU

TRIP Option (vested) TRIP option & EXPE option

TRIP Option (unvested) TRIP option

TRIP RSU (unvested) TRIP RSU

The Spin


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IAC’s history of divestitures - with similar spin mechanics - only further complicated the situationo Options settling in TRIP were also held by employees of:

o Options held by TRIP employees settled in stock of the following companies:

• A long, material trail of non-employee / former SpinCo obligations

HSNI IAC EXPE

HSNI IAC TREE TKTM IILG EXPE

THE RESULT

A significant % of TRIP

options were held by non-employees

The Spin


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Administration of non-employee awardso Initially, all SpinCos resided on the same vendor platform

• This permitted sharing of employee indicative data across databases

• Intra-SpinCo reporting was still required to handle ongoing payroll and accounting obligations

o In Q1 2013, TRIP selected a new stock plan vendor

A New Vendor


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A Fresh Start – Sort ofA New Vendor

TRIP’s move to the new vendor offered an opportunity to revisit the challenges and risks presented by administering non-employee equity awards

TRIP proposed that each employer would be responsible for administering the awards of only its own employees

Each employer would administer awards that settle in multiple CUSIPs through their existing recordkeeper


The proposal (in detail)

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Objectives

Simplify participant experience

Enhance independence / controls

Reduce administrative burden

+ -Control all indicative data for employee awards on the same, new vendor platform (tax rates, terms, etc.)

Establish old vendor controls to settle TRIP awards (DWAC)

Receive all payroll reporting from one platform (new vendor)

Establish old vendor reporting to reconcile TRIP awards exercised by SpinCo employees

No need to keep indicative old vendor data feed

Single site / login for TRIP participants

+ -Control all indicative data for employee awards on the same, old vendor platform (tax rates, terms, etc.)

Establish new vendor controls to settle SpinCo awards (DWAC)

Receive all payroll reporting from one platform (old vendor)

Establish new vendor reporting to reconcile SpinCo awards exercised by TripAdvisor employees.

No need create indicative data feed to new vendor

Single site / login for SpinCo participants. No communication needed

TRIP SpinCos

Minimize operational risk


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Trip Data “Before and After”

All TRIP and SpinCo Employees Reside at old vendor

Pre Conversion

TRIP only employees:• TRIP Stock Outstanding and Not

Outstanding• SpinCo Stock: Outstanding and Not

Outstanding

July 1 New Vendor - LIVE

Spin-Co only employees:• TRIP Stock Outstanding and Not

Outstanding

July 1 Old Vendor - LIVE

All TRIP and SpinCo Employees’ Activity through June 28. This data will remain available for employees and corporate to view activity through June 28

July 1 Old Vendor - FROZEN

Going forward – Data from two vendors captures all TRIP Stock

related transactions

Going forward – This database stays static


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The Netting Initiative

In Q1 2013, the Company made a push to be less dilutive (i.e., BOD approved stock buyback program and implemented strict share pool management procedures)o The poster child of which was a “netting” initiative for equity

• With the exception of mobile employees, no one received a free pass. The initiative applied to:

• Outstanding and prospective awards• RSUs and stock options• Exercise costs and taxes• Section 16 officers and rank-and-file employees• Domestic and foreign participants

o The administrative and technical barriers to implementing the netting initiative were numerous


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Net settlement of RSUs is old hat for most administrators Net settlement of stock options is another story

Administrative Considerations

Q: What are net exercises?

A: When a participant tenders a portion of the shares exercised back to the company to cover the exercise price and taxes due

Example

An employee holds an option to purchase 100 shares with an exercise price of $10 per share. The employee exercises the option when the FMV is $25 per share.

Same Day Sale Net Exercise

Shares exercised 100 100

Shared tendered to company 0 55*

Shares sold on open market 100 0

Shares issued 100 45

* EXERCISE COST (100 shares exercised x $10 price) / $25 FMV = 40 shares TAXES [($15 per share spread x 100 shares exercised) * 25% tax rate] / $25 FMV = 15 shares

55%fewer shares

issued


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TripAdvisor was fortunate that the netting initiative was launched immediately prior to its vendor search

Relatively few vendors were able to preserve the pre-initiative user experience (i.e., the ability to exercise and immediately sell the shares)

Given that fewer shares are on the table, increased vendor fees are a possibility

Administrative Considerations

TripAdvisor Guiding PrincipalParticipants would not view the initiative as a “take away”

TAKE AWAY #1:

TAKE AWAY #2:


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The Netting InitiativeTechnical Considerations An oversimplified view of the world

XYZ Inc.

Tax Authorities

Employee


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The Netting InitiativeTechnical Considerations

Accounting ruleso US GAAP (ASC 718-10)

• The risk− If shares withheld, there’s a risk

of triggering variable accounting for the entire award

− If cash withheld, similar risk is not present

• Can the risk be avoided?− Yes - fixed accounting can be

preserved if withholding occurs at a rate that does not exceed the “minimum statutory rate”

CashEmployee Cuts A Check

Employer Withholds From Next Paycheck

Employer / Employee Sells Shares

SharesEmployer Withholds Shares

Minimum Statutory Rate

Different Methodologies Beget Different Accounting Considerations


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The Netting InitiativeTechnical Considerations Accounting rules

o US GAAP (ASC 718-10)• Why do we care?

− Your finance team likely fought long and hard to ensure “fixed” accounting – and the predictability it brings.

Charge to earnings = fair value determined via option pricing model

Award is revalued each year (or quarter) from grant to settlement; the additional charge (or credit) is marked-to-market

Subsequent stock appreciation / depreciation will increase / decrease the charge to earnings

Grant Settlement

Charge to Earnings

1 2 3 4 5 6 8 9 1070

$0

$10

$20

$30StockPrice

Years

ASC 718 ACCOUNTING TREATMENT OF

LIABILITY INSTRUMENTS

Charge to earnings = fair value determined via option pricing model Charge is fixed at grant and recognized ratably over vesting period Subsequent stock appreciation / depreciation will not increase /

decrease the charge to earnings

1 2 3 4 5 6 8 9 1070

$0

$10

$20

$30StockPrice

YearsIssuance Settlement

ASC 718ACCOUNTING TREATMENT OF EQUITY INSTRUMENTS

Charge to Earnings


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Tax Lawso How do we determine the “minimum statutory rate”?

• In the US− Includes federal, state and local taxes (including payroll taxes)− Federal

Supplemental withholding rates (25% / 39.6%) generally accepted as satisfying the accounting requirements

FICA / Medicare withholding is also required− States

Only some have supplemental rates If no supplemental rate exists, then treat like the foreign

countries


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• Outside the US− Most companies will have withholding requirements in 1/3 to

1/2 of the countries in which they make grants And the list may be growing!

− Very few countries have supplemental or flat withholding rates that apply to equity compensation


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• Outside the US (continued)− Most countries require companies to withhold at individual

rates depending on: The employee’s marginal tax bracket Various deductions / exemptions / martial status, etc Social tax wage caps often applied on a monthly basis

− This means that withholding rates vary by individual and may vary during the course of the year

o Expats• Industry advocates requested that FASB allow “hypo” tax for

expatriates to be withheld in shares – FASB declined


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Tax Lawso Example

• German employee earning €100,000 annually exercises an option on January 1st vs. August 1st - What rate is the minimum statutory rate?

0%

14%

42%

45%

€ 0 – 8,130

€ 8,131– 52,882

€ 52,882 – 250,730

€ 250,731 and over

Tax Base

Rate


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TripAdvisor’s Challengeo RSUs

• Taxable events are more visible, more predictable• It’s comparatively “easier” to get actual rates because of the ability

to plan aheado Options

• Exercises are more arbitrary, more real-time• Requires a fire drill to determine an employee’s actual rate


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TripAdvisor’s Solution Pre-Code Actual Individual Rates on a Monthly Basis

Pros Cons

Avoid the accounting issue Requires substantial real-time maintenance of individual rates

No local true-up required Requires close coordination with local payroll

Settles employee out of transaction quickly Inherent risk of error

Consistent with the industry standard approach More challenging for broad-based population

Relatively labor-intensive; advance population of tax rates prior to vesting


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Legalo Does the plan allow net exercises?o Can the requirement be imposed retroactively?

• May not be necessary if option agreements defer to the plan


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A Shift in Philosophy

Equity under the old regimeo An Exercise in Selectivity

Equity post-spino Broad-Based Eligibility

Award Type Recipients Participation Rate % of Awards GrantedStock options NEOs and select members of management team ~25% of employees ~99%RSUs NEOs and select members of management team ~1% of employees ~1%

Award Type Recipients Participation Rate % of Awards GrantedStock options NEOs and select members of management team ~10% of employees ~34%RSUs All employees 100% of employees ~66%


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A Shift in Philosophy

Drivers of changeo Desire to better align employee interests with those of

shareholderso Competitive pressures to attract and retain top talento Desire to grow ownership in friendly hands


Contact Information:

Yoon ParkTripAdvisor, Inc.Director of Global Compensation and EquityEmail: [email protected]: 617-670-6717

Geoff HammelISP Advisors LLCManaging DirectorEmail: [email protected]: 215-GET-ISPA (215-438-4772)

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