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Edited Transcript of SABR earnings conference call or presentation 12-Feb-19 2:00pm GMT

Q4 2018 Sabre Corp Earnings Call

SOUTHLAKE Mar 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Sabre Corp earnings conference call or presentation Tuesday, February 12, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Barry Sievert

Sabre Corporation - SVP of Corporate Communications & IR

* Douglas Elliott Barnett

Sabre Corporation - Executive VP & CFO

* Sean E. Menke

Sabre Corporation - President, CEO & Director

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Conference Call Participants

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* Brian Lee Essex

Morgan Stanley, Research Division - Equity Analyst

* Georgios Kertsos

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* James Edward Schneider

Goldman Sachs Group Inc., Research Division - VP

* Jed Kelly

Oppenheimer & Co. Inc., Research Division - Director and Senior Analyst

* John Peter King

BofA Merrill Lynch, Research Division - Research Analyst

* Mark L. Moerdler

Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst

* Matthew Charles Pfau

William Blair & Company L.L.C., Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the Sabre Fourth Quarter and Full Year 2018 Earnings Conference Call. Please note that today's call is being recorded and is also being broadcast live over the Internet on the Sabre corporate website. This broadcast is the property of Sabre. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of the company is strictly prohibited.

I will now turn the call over to the Senior Vice President of Investor Relations and Corporate Communications, Mr. Barry Sievert. Go ahead, sir.

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Barry Sievert, Sabre Corporation - SVP of Corporate Communications & IR [2]

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Thank you, Joelle, and good morning, everyone. Thanks for joining us for our fourth quarter and full year 2018 earnings call. This morning, we issued an earnings release, which is available on our website at investors.sabre.com. Our slide presentation and today's prepared remarks are also available, during this call, on the Sabre IR web page. A replay of today's call will be available on our website later this morning.

Throughout today's call, we'll be presenting certain non-GAAP financial measures, which have been adjusted to exclude certain items. All references during today's call to EBITDA, EBITDA less capitalized software development, operating income, EPS and net income have been adjusted for these items. The most directly comparable GAAP measures and reconciliations for non-GAAP measures are available in the earnings release and other documents posted on our website at investors.sabre.com.

We'd like to advise you that our comments contain forward-looking statements. These statements include, among others, disclosures of our guidance, including revenue, EBITDA, EBITDA less capitalized software development, operating income, net income, EPS, cash flow and CapEx; our medium-term outlook; our expected segment results; the amounts and effects of changes in capitalization mix and depreciation and amortization; the effects of new or renewed agreements, products and implementations; our expectations of industry trends; and various other forward-looking statements regarding our business. These statements involve risks and uncertainties that may cause actual results to differ materially from the statements made on today's conference call.

Information concerning the risks and uncertainties that could affect our financial results is contained in our SEC filings, including our 2017 Form 10-K and our third quarter 2018 Form 10-Q.

Participating with me on today's call are Sean Menke, our President and Chief Executive Officer; and Doug Barnett, Executive Vice President and Chief Financial Officer. Sean will start us off and provide a review of our strategic and commercial performance and outlook. Doug will offer additional perspective on our financial results and the forward outlook. We will then open the call for your questions.

With that, I'll turn the call over to Sean.

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Sean E. Menke, Sabre Corporation - President, CEO & Director [3]

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Thanks, Barry. Good morning, everyone, and thank you for joining us today.

2018 demonstrates steady continued progress on a strong foundation. Our commitment and execution to the strategy we laid out at the beginning of 2018 resulted in solid financial and operational performance, with high single-digit revenue growth, a 10% increase in earnings per share and a 22% growth in free cash flow.

We augmented our leadership team with skilled technology executives, evolved our go-to-market strategy and made strong progress on our technology evolution. This, along with continued evidence of momentum behind our strategic and commercial initiatives, gives me confidence in our 2019 expectations, including driving a 10% increase in free cash flow, growth that is in line with our Investor Day guidance but off a higher 2018 base.

Before we get into the details, I would like to acknowledge my team members around the world with a sincere thank you. Their collective hard work and effort over the past year have been a major contributor to the progress we have made and make me feel confident about the future.

Now let's take a look at our performance for 2018. In 2018, we delivered strong full year results, well ahead of our original expectations coming into the year. Our solid full year revenue growth was driven by 2 main factors: strong growth in Travel Network, driven by a supportive booking environment; the completion of the Flight Centre migration; increased share at global travel agencies and conversions, including CWT and other new agencies.

The investments we have made in the new Sabre Red 360, the official name of our new Sabre Red Workspace; and the cloud deployment of our shopping complex, are clearly paying off. We gained 120 basis points of global bookings share, leading to full year booking growth of 6.4%, ahead of our expected 4% to 6% coming into the year. Additionally, average booking fee growth was higher than anticipated coming into the year.

We expect continued solid growth in the mid-single digits at Travel Network in 2019 despite expected modest slowing of the global travel economy.

Airline Solutions growth also came in stronger than expected, with over a 5% full year passengers boarded growth on a consistent carrier basis. Our progress in driving strong product health and customer relationships led to a higher rate of renewals and new implementations than we factored into our initial expectations coming into 2018.

One thing that I believe was underappreciated by investors is the concentrated renewal cycle that Airline Solutions went through in 2017 and 2018. We successfully renewed 94% of our total contract value up for renewal over the period. After emerging from this heavy renewal cycle, we have 75% of total Airline Solutions revenue through 2023 under contract. And I am thrilled to report that this morning, we announced we have agreed to extend or expand our long-term alliance with JetBlue, one of Airline Solutions' largest customers. In addition to a PSS renewal, JetBlue will upgrade to the Sabre commercial platform that was announced in the second half of 2018.

As has been announced in the market, we did have 3 losses for SabreSonic customers, Pakistan, Bangkok and Philippine Airlines, that will impact the Airline Solutions growth rate in 2019. But looking ahead at 2019, in the medium term, our number of contracts up for renewal is much lower while we believe one of our competitors will face a much heavier renewal cycle. This gives us the opportunity to shift from playing defense to playing offense. With the introduction of our new innovations in the Sabre commercial platform, we are excited about our prospects for winning and reinvigorating strong growth in Airline Solutions going forward.

Although Hospitality Solutions revenue growth was a bit lower than originally expected, the recurring SynXis software and services revenue growth was in the very high single digits. Furthermore, Hospitality Solutions had its best sales year ever, with particular strength over the back half of the year, providing a healthy foundation for the years ahead. We expect 2019 to be a strong year for the core hospitality business, with reported growth expected to be between 7% and 9%. We expect double-digit growth from our new and most of our existing customers. However, a few of our large customers are in the process of being acquired by large hoteliers, which we expect to dampen reported growth for the year.

And in what I consider to be a key metric, free cash flow, we delivered $441 million in 2018, up 22% year-over-year, well ahead of our initial expectations. We expect continued strong growth of approximately 10% in free cash flow in 2019 as we continue to gain scale in our investments.

In 2019, we expect continued solid growth in the metrics that are key to our investors, with expectations for mid-single-digit revenue growth and free cash flow growth of about 10% to approximately $485 million. And as Doug will discuss in a moment, our underlying expectations for the business are largely consistent with the medium-term guidance we gave in March of 2018, off the higher base of our 2018 results.

We've made tremendous progress against our technology initiatives in 2018. In 2019, we expect total technology expense growth to begin to moderate. However, under new technology leadership, we are making great progress in refining our technology road map to help drive accelerated results. This progression in the business, particularly as it relates to the sequencing of our continued cloud migration and mainframe offload and our transition to full adoption and maturity of agile development methods, is expected to drive a meaningful reduction in the percentage in technology spend that is capitalized in 2019.

There are 4 key points to keep in mind about this mix shift. First, we are making great progress against our technology initiatives. Efficiencies we are gaining are allowing increased investments in the migration, platform development and innovation even as our expectations for total technology spend growth over the medium term have been reduced from 3% to 4% discussed at last year's Investor Day to expected 1% growth over the medium term going forward.

Second, this shift will have a significant impact on our near-term reported earnings as our P&L is temporarily burdened by both the increased portion of technology spend that is expensed in the current period and the depreciation and amortization from previous capitalization.

Third, over the medium term, we expect this shift to lower levels of capitalization of total technology cost to remain relatively stable to 2019 levels. However, we expect depreciation and amortization to decline significantly over the next few years for earnings to roughly normalize to previous expectations by 2021.

Fourth, our technology transformation is already driving great efficiency, stability, security and flexibility. We expect that benefits will continue to accrue over the coming years, resulting in further enhanced competitive position and efficiency that will allow us to rotate increasing investments into innovation to drive stronger growth in the years ahead. Doug will provide more detail in a moment, but you need to remember this shift in capitalization mix itself has no impact on our expectation for total technology spend, and importantly, it has zero impact on a key metric, free cash flow.

As I mentioned, we are making great progress on our technology initiatives. Our cloud migration is going well. We are already seeing significant benefits from the work that has been completed. We continue to expect to complete our transition to a cloud-first infrastructure by the end of 2023, with significant performance, stability and efficiency benefits that are expected to continue to accumulate as the transition work continues.

Already in 2018, we signed strategic agreements with AWS and Microsoft Azure. We established cloud landing zones across North America, Europe and Asia Pacific; began consolidating small legacy data centers around the globe; built automation tools for deploying cloud infrastructure; increased the percentage of our total open systems footprint by 1.6 points. Over 89% of all our processing power is now on open system versus less than 11% on the mainframe. Within our open systems' footprint, we migrated important open-systems applications to the cloud that increased our open systems' cloud footprint by 19 percentage points. Over 50% of our open systems' processing power is now in the cloud.

Two years ago, our shopping complex was entirely hosted in our Tulsa data center. We now have deployed our shopping complex to a multisite configuration, leveraging public and private cloud environments. And most recently, for a 24-hour period, we successfully completed a test to shift our shopping complex to operate entirely in the cloud. As a result of our initiatives, our hosting costs were 6% lower in 2018 than they otherwise would have been under our historical infrastructure even as total compute volumes increased over 30%.

In 2019, we expect continued growth in compute volumes but even greater savings, with hosting costs 10% lower than they would have been under our historical infrastructure. As a reminder, we expect $100 million of annual cost benefits beginning in 2024, concurrent with the expiration of our DXC contract. And based on this progress I have described, we have even greater confidence in reaching that objective.

Let me put it in simple terms why we feel good about where our technology investment is going. If you look at our compute cost today, it's roughly $0.5 billion. About 40% of that is in mainframe, even though the mainframe is only 11% of our total compute power. There is a clear path to cost savings, which is why we are so focused on accelerating the completion of our technology evolution.

Included among the list of applications now running in production in the cloud are: shopping and schedule updater; Sabre Red 360 for some of our largest customers; AirCentre and AirVision products, including digital experience and check-in; Revenue Optimizer; dynamic availability; planning and scheduling and distributed availability; all Hospitality Solutions, including the new SynXis Property Hub and SynXis booking engine. In addition to cost benefits, shifting our applications and platform to the cloud brings processing closer to customers, reducing response times.

Cloud migration also increases our security and leading system stability. In 2018, we saw 0 major stability incidents compared to 5 in 2017. We also saw more than a 30% reduction across all other stability incidents, and our average time to recovery was significantly reduced, which also reduced our service level agreements or SLA payments significantly. We fully expect continued improvement in these metrics in 2019 and the years ahead as we continue to mature our global cloud footprint and get into some of the heavier lifting of our mainframe offload efforts around ticketing, PNR and check-in.

With that, I'll turn the call over to Doug to get into more of the financial details and expectations going forward.

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Douglas Elliott Barnett, Sabre Corporation - Executive VP & CFO [4]

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Thank you, Sean. Turning to Q4 results. Revenue growth was solid, up 5% year-over-year. Over the period, recurring revenues represented 93% of total revenue versus 95% in the prior year. EBITDA grew 4%, reflecting revenue growth and lower corporate costs, partially offset by increased Travel Network incentives.

Operating income increased 2% year-over-year, which includes an $8 million increase in depreciation and amortization. Earnings per share increased 6%, driven by operating income growth and a lower tax rate due to the impact of U.S. tax reform. And as expected, in the quarter, free cash flow declined 26% to $110 million due to working capital timing. Full year free cash flow of $441 million represents growth of 22% and was more than $50 million above our initial expectations of approximately $390 million for the year.

Looking a bit closer at Travel Network in Q4. Total revenue growth of 7.5% supported an increase in operating income of 2% for the quarter. Bookings grew 4% in the quarter, and average booking fee increased 3% in the quarter. About half of the average booking fee growth was driven by the positive impact from customer pricing at specific carriers experimenting with different distribution strategies in Europe.

Travel Network operating margin decline of 130 basis points in the quarter was driven by 3 points of margin decline from incentive fee growth; and approximately 150 basis points of negative impact from higher technology operating expenses, all due to lower third-party service credits; partially offset by a 2-point benefit from the increase in average booking fee and a 1 point benefit from headcount-related and other expense leverage from cost saving initiatives.

Taking a closer look at incentive fee growth in the quarter, about half of the increase was from new commercial deals and agency conversions, and half was due to normal incentive growth, consistent with historic growth in the low to mid-single digits, including the impact of agency consolidation. For the full year, Travel Network revenue increased 10% to reach $2.8 billion.

Full year operating margin of 26.9% was a bit below the prior year, reflecting incentive fee growth and lower third-party service credits. As previously mentioned, we expect incentive fee growth to revert to historical normal growth rates in the low to mid-single digits beginning in the second quarter of 2019.

Total bookings increased more than 4% in the quarter, a bit of a slowdown versus prior quarters as we started to anniversary the positive year-over-year impact of the Flight Centre migration. Our geographic mix and strong share gain, driven by increased share at large travel management companies, including the implementation of our strategic agreement with CWT and other new agency conversions, more than offset the deceleration in overall market growth, driven by macroeconomic factors impacting EMEA and Latin America.

Within our total bookings, air bookings grew 5% and lodging, ground and sea bookings grew 1%. Within lodging, ground and sea, higher-value hotel bookings grew double digits, partially offset by a decline in lower-margin rail bookings. Full year bookings growth of over 6% was driven by a supportive macro environment and global share gain.

Q4 bookings growth was supported by an increase of 9% in Asia Pacific, driven by agency conversions and solid market growth. This was a bit slower than previous quarters as we started to anniversary the positive year-over-year impact of the Flight Centre migration. Bookings increased 6% in North America, driven by increased share at large global travel management companies, including our expanded strategic agreement with CWT. EMEA bookings grew faster than the market at 2%. Bookings declined in Latin America due to unfavorable macroeconomic factors in the region.

In total, global bookings share increased 110 basis points in the fourth quarter to 37.1%. Full year global share reached 37.5%, an increase of 120 basis points.

At Airline Solutions, revenues declined as expected due to the negative impact related to the adoption of ASC 606. The impact of adopting ASC 606 drove a $7 million decrease in revenue in the quarter, net of upfront revenue recognition from license fee implementations and renewals. Excluding this impact, revenues increased 2% in the quarter. SabreSonic revenue declined 1% in the quarter with the completion of the SabreSonic implementation at LATAM in Q2 and consistent carrier growth offset by a modest decline in SabreSonic PB rate.

AirVision and AirCentre declined mid-single digits in the quarter due to the impact of ASC 606, and professional services revenues increased in the quarter. The decline in Airline Solutions' operating income includes a negative impact of ASC 606 and lower third-party service credits. Excluding the impacts of ASC 606 and lower third-party service credits, operating margin declined 100 basis points in the quarter.

Full year Airline Solutions revenue growth of 1% exceeded our expectations coming into the year for revenue to decline mid-single digits. We more than offset large headwinds from the Southwest Airlines' demigration in mid-2017 and ASC 606 adoption with organic growth, new implementations and renewals. Excluding the impacts of Southwest Airlines and ASC 606, the full year revenue increased more than 5%.

As expected, the full year Airline Solutions operating income and margin decline includes the negative impacts of the Southwest demigration, ASC 606 and the decrease in third-party service credits. Excluding the impacts of ASC 606 and the decline in third-party service credits, operating income growth was 10% and operating margin increased 90 basis points.

Passengers boarded increased more than 6% in the quarter. On a consistent carrier basis, passengers boarded increased 3%, a deceleration versus historical growth rates due to a year-over-year decline at a large carrier in Asia Pacific. If this particular carrier had continued to grow at first half growth rates, total PB growth would have been 10% and PB growth on a consistent carrier basis would have been 7% in the quarter. Full year passengers boarded increased 8% excluding the impact of Southwest Airlines, reflecting 5% consistent carrier growth and the completion of the SabreSonic implementation at LATAM in Q2.

At Hospitality Solutions, Q4 SynXis software and services revenue increased 8% while digital marketing services revenue declined $2 million in the quarter, driving overall revenue growth of 4%. Hospitality Solutions' operating margins expanded 30 basis points in the quarter due to the mix shift towards higher-margin recurring revenue and cost reduction initiatives, partially offset by a 10% increase in D&A.

Full year SynXis software and services revenue increased 11%. And although digital marketing services revenue declined, the mix shift towards higher-margin recurring revenue and cost reduction initiatives drove 33% growth in full year operating income.

In Q4 2018, total technology spend was $243 million. As a reminder, this includes the costs that we incur, whether capitalized or expensed, for hosting, third-party software and R&D. Total technology spend was up 3% in the quarter. This increase was due to $10 million lower third-party hosting service provider credits in Q4 2018 versus 2017.

The total -- the amount of total technology expense running through our income statement in Q4 2018 went up by $2 million or 1%. Remember, this refers to our total technology spend less capitalized software development plus amortization of previous capitalization. Although total technology expense running through our P&L increased only modestly at the Sabre level in the quarter, more pressure was felt in the individual business unit segments with a substantial offset at the corporate line due to investment project mix.

For the full year, total technology spend increased 6%. As a reminder, our third-party hosting service provider credits, which are related to hitting volume minimums, stepped down from $58 million in 2017 to approximately $15 million in 2018 and go away in 2019. Therefore, about 75% of the year-over-year increase in total technology spend was due to these lower service credits. These service provider credits impact both EBITDA and free cash flow. Excluding the decline in third-party service credits, total technology spend increased 2%, much lower than revenue growth of 7.5%.

As we mentioned on previous earnings calls, the costs supporting our cloud migration are not capitalized. This, along with a shift in development mix, resulted in a 260 basis point decline in capitalization mix for the full year. And year-over-year, there was a $9 million decline in capitalized software development. Although neutral to free cash flow, this shift impacts operating income and EBITDA and is what we have been discussing all year referred to as the CapEx/OpEx rotation.

Finally, the increase in amortization of previous capitalization resulted in a $36 million headwind to 2018 operating income. This, of course, is neutral to both EBITDA and free cash flow. Excluding the third-party hosting service provider credits, the decline in capitalization mix and the increase in amortization, full year operating margin would have increased 100 basis points from 18% in 2017 to 19% in 2018.

Full year free cash flow generation of $441 million was ahead of expectations and represents growth of 22% year-over-year. Our cash flow supported the continued strengthening of our balance sheet, with leverage declining to 2.6x as of year-end.

We repurchased 1.1 million shares under our share repurchase authorization in 2018 for approximately $26 million in aggregate. Including dividends, we returned $180 million to shareholders in 2018. We have $365 million remaining under our share repurchase authorization. As we have said, we expect to repurchase enough shares to offset dilution from equity plans while maintaining flexibility to be opportunistic beyond that.

All right. Let's level set and review the medium-term guidance provided at our Investor Day in March last year: mid- to single-digit (sic - see slide 24, "Mid-to-high single digit") revenue growth, with Travel Network and Airline Solutions growing in line with or above global travel growth or about mid-single digits and double-digit growth in Hospitality Solutions; relatively stable operating margin; 10% EPS growth over the medium term, with mid- to high single-digit EPS growth specifically in 2019; and free cash flow growth of 10%.

So how are we tracking against that in 2019? Largely in line with expectations, excluding the impact of the lower capitalization mix and an increase in depreciation and amortization that I will explain shortly. Off a higher base year than we anticipated last March given our strong 2018 performance, in 2019, before these impacts, we expect total Sabre revenue growth of 4% to 6% to $4.005 billion to $4.085 billion; EBITDA growth of 2% to 6% to $1.15 billion to $1.19 billion; operating income growth of 2% to 8% to $715 million to $755 million; net income growth of 1% to 10% to $430 million to $470 million; EPS growth of 1% to 10% to $1.56 to $1.70; and free cash flow growth of 10% to approximately $485 million.

Taking a closer look at the segment level. At Travel Network, we expect full year 2019 revenue growth of 4% to 6%, driven by bookings growth of the same amount. Although we expect recent booking fee trends to continue through Q1, we expect full year booking fee to be roughly flat as we fully anniversary both the favorable mix impact of the Flight Centre conversion and favorable pricing at specific carriers in EMEA beginning in Q2. We expect incentive fee growth to normalize to historical growth rates in the low to mid-single digits beginning in Q2.

At Airline Solutions, as you know and has been announced, growth in 2019 will be impacted by the attrition of certain PSS customers. The demigration of Pakistan, Bangkok and Philippine Airlines is expected to reduce our full year 2019 revenue growth by approximately $30 million. And because of this, we expect full year revenue growth of 1% to 3%. Excluding the impact of these customer attritions, expected revenue growth would have been 5% to 7%, in line with or better than Investor Day expectations.

As Sean mentioned, we have successfully navigated a very significant renewal cycle with our existing Airline Solutions customers, which gives us confidence in 2019 and the medium term.

At Hospitality Solutions, we expect 7% to 9% revenue growth for full year 2019. Hospitality Solutions had its strongest sales year ever in 2018. However, the impact of customer consolidation in the hospitality space is expected to reduce our full year 2019 revenue by $10 million as the acquired brands are migrated onto the larger hoteliers' existing technology platforms. Excluding this impact, the core business is expected to grow 11% to 13%, in line with Investor Day expectations. So as we look at 2019, we believe our business is solid and in line with our prior guidance.

Now I want to take a moment to explain 2 items that will impact our reported 2019 earnings. First, we are taking significant steps in our technology evolution in 2019 and, as a result, expect the capitalized portion of our total technology spend to be lower. As we have stated on the past several earnings calls, the costs supporting our cloud migration are not capitalized under GAAP. This, combined with the acceleration of our mainframe offload and our transition to full adoption and maturity of agile development methods, is expected to reduce the percentage of technology spend that is capitalized in 2019 with an equal and offsetting increase in the percent of technology spend that is expensed as incurred.

The important thing is to remember this change in capitalization mix has no impact on free cash flow. Additionally, it has no impact on total technology spend, which we expect to grow in line with our previous expectations of 3% to 4%, slower than revenue in 2019 as we continue to gain scale. 1 percentage point of this cost growth is driven by the contractual decline in third-party hosting service provider credits from $15 million in 2018 to 0 in 2019. We are committed to continuing to report and provide clarity into our total technology spend just like we have these past 2 quarters.

The capitalization mix of our total technology spend in 2018 was 26%, and we expect the capitalization mix to decrease to approximately 9% to 10% in 2019. We estimate that this will result in approximately $175 million more of our technology spend being expensed immediately with a corresponding $175 million reduction in CapEx. This capitalization mix change is expected to reduce our full year 2019 EPS by $0.51.

Second, as we accelerate our technology evolution, more products have been placed into service than anticipated in the medium-term guidance we issued last March. We now expect a $25 million increase related to the accelerated frequency of products placed into service as new leadership and methods have increased our innovation velocity versus our previous expectations for 2019. This is expected to result in an EPS reduction of $0.07 versus our previous 2019 expectations. So in total, the impact of the capitalization mix change and increased D&A are expected to reduce our full year EPS by $0.58 versus our 2019 expectations from a year ago.

To reiterate, there is no impact to free cash flow. The estimated quarterly impact of these items in 2019 is included in the appendix of today's presentation, which is available on our website. Because of this reduction in capitalization mix and in order to have a comparable earnings measure year-over-year, we are introducing a new metric, EBITDA less capitalized software development.

We believe EBITDA less capitalized software development is a useful metric to analyze the underlying operational performance of our business because it reflects total development spend and does not benefit from the amount that is capitalized. It normalizes for the impact of changes in capitalization mix across periods for better comparability. We will provide this metric in our quarterly reporting in 2019.

As I just explained, in 2019, we estimate the change in capitalization mix and increase in depreciation and amortization will negatively impact our reported results as follows: lower EBITDA by $175 million, lower CapEx also by $175 million, lower operating income by $200 million and lower EPS by $0.58. Our 2019 guidance, inclusive of the shift in capitalization mix and increased depreciation and amortization expense, which is how we expect to talk about our 2019 financial results, is the following: revenue, EBITDA less capitalized software development and free cash flow are consistent with my previous comments as the capitalization mix change and increased D&A have no impact on these metrics; EBITDA of $975 million to $1.015 billion; operating income of $515 million to $555 million; net income of $270 million to $310 million; and EPS of $0.98 to $1.12. This guidance incorporates expectations for approximately $460 million of depreciation and amortization, $170 million in interest expense, a tax rate of approximately 20%, flat share count at 278 million shares and total CapEx of $130 million to $150 million in the year.

So what does this mean for our medium term from 2019 through 2022? For the core business, nothing has changed. Our revenue growth expectations are the same, and our expectations for key -- for free cash flow are the same or better. There's obviously a near-term P&L impact from the shift to less capitalization and increased expensed R&D over the period, but this effect is transitory as D&A from previous capitalization quickly burns down. We expect our capitalization mix to remain relatively consistent with 2019 levels over the medium term and expect depreciation and amortization to decline by $150 million between 2019 and 2022, helping to drive a full recovery of operating income and EPS to previously expected levels by 2021.

We currently expect D&A to total approximately $460 million, $420 million, $340 million and $310 million for each year from 2019 through 2022.

Looking at a consolidated view of our updated medium-term guidance metrics compared with what we stated last March at our Investor Day, we continue to expect a mid- to high single-digit revenue compounded annual growth rate over the 2019 through 2022 medium-term period. Our cloud migration, mainframe offload and rapid adoption of agile development methods are expected to deliver significant efficiencies and lower our compute costs. As a result of the benefits we expect from these efforts and the work being done in 2019, we now expect even better efficiencies than at Investor Day last year, although from the 2019 base.

We now expect total technology spend growth of 1% over the medium term. This is better than our previous expectations for medium-term total technology spend growth of 3% to 4%. The amount of technology expense hitting the income statement, which includes amortization of previous capitalization, was 27% of revenue in 2018. We expect this to step up to about 31% in 2019 and then rapidly decline to the low 20 percents over the medium term. You can see this reflected in our expectations for EBITDA less capitalized software development growth, which we expect to accelerate to high single-digit compounded annual growth rate over the medium term.

Our previous expectations were for roughly stable operating margins and for operating income to grow relatively in line with revenue growth over the medium term. Although we expect operating margin to dip in 2019, from this base, we expect operating margin to expand significantly over the medium term off the new 2019 base as we gain leverage in total technology spend and depreciation and amortization declines. By 2021, we expect full operating margin recovery to our previous Investor Day expectations with continued margin expansion into 2022. Accordingly, we now expect 20% to 25% compound annual growth rate in operating income from 2019 through 2022.

Moving down the income statement. As mentioned, we also expect full EPS recovery by 2021. This incorporates expectations of 25% to 30% medium-term EPS growth off the lower 2019 base.

Getting to the metric that I think matters the most. We now expect low double-digit growth in free cash flow off of a 2019 base of approximately $485 million. This reflects solid revenue growth and the leverage we are gaining in total technology spend. This is better than previous Investor Day expectations for 10% growth.

As a reminder, we expect to become a full U.S. cash taxpayer in 2020, resulting in approximately $40 million to $50 million of additional cash taxes over 2019. And as a result, we expect more modest growth in free cash flow in 2020. In terms of the tax receivable agreement or TRA, we now expect to put it behind us a year earlier than expected at Investor Day. Due to the changes driven by U.S. tax reform, we expect to pay out the remaining balance under the TRA in 2020.

With that, I'd like to turn the call back to Sean.

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Sean E. Menke, Sabre Corporation - President, CEO & Director [5]

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Thanks, Doug. Strong full year results prove we're progressing well against our strategy. Its continued evidence of momentum behind our strategic and commercial initiatives gives me great confidence in our 2019 and medium-term expectations. I look forward to continuing to share our progress over the quarters to come. I want to once again thank you for joining our call today and for your continued interest in Sabre.

And with that, I will ask the operator to open up the call for your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Mark Moerdler with Bernstein Research.

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Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [2]

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Appreciate all the detail given all the complexity that's going on. I have 2 questions that hopefully help a little bit in clarity. The first is just to confirm. Can you drill into the updated medium-term outlook where the adjusted operating income, margin, EPS are now growing off of a lower 2019 base? If we compare it back to 2018, how should we think about these metrics? Obviously, you're saying margins will improve longer term. What happens to the other parts of the story? And then a follow-up.

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Douglas Elliott Barnett, Sabre Corporation - Executive VP & CFO [3]

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Yes. Obviously, the impact of a capitalization mix shift as well as the incremental amortization negatively impact all of the reported metrics for 2019. What will happen though, as we burn down through -- the amortization and depreciation begins to decline by the $150 million that we've talked about, those metrics will get back to the same levels as what we've talked about back in Investor Day a year ago.

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Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [4]

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Okay. That helps. When we -- the ASC 606 had a negative impact. Can you give more information on when we lap that or when it reverses?

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Douglas Elliott Barnett, Sabre Corporation - Executive VP & CFO [5]

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Yes. Obviously, we don't expect a need to talk about that in 2019. It did impact us negatively by about $12 million and mainly at the AS group in 2018.

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Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [6]

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So by -- it's completely out of the story by the end of...

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Douglas Elliott Barnett, Sabre Corporation - Executive VP & CFO [7]

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That is correct. Yes, you won't see us reference ASC 606 anymore in 2019.

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Operator [8]

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And our next question comes from John King with Merrill Lynch.

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John Peter King, BofA Merrill Lynch, Research Division - Research Analyst [9]

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First one was going to be on the Airline Solutions side. Obviously, great to see the JetBlue renewal. I think in the press release, you referred to some modernization of the platform. So maybe you could give a bit of background as to how that ties up with, I guess, some of the modernization that's going on in Sabre. Is that essentially the exact same thing? Or what are you -- what have you signed up on there? And maybe generally, on the renewals that you've signed, obviously, it sounds like you've done a good job on that in general. What kind of pricing are you seeing? I noticed that you're calling out slightly lower pricing on SabreSonic, but that may simply be mix. So interested in what you're seeing on a like-for-like basis. And I've got a follow-up.

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Sean E. Menke, Sabre Corporation - President, CEO & Director [10]

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Okay. Perfect, John, and thanks for joining us today. First on the JetBlue piece is one, and I think this is a testament to the organization and the transformation that we have been going through if you look at the modernization of the technology, making sure that we're providing the capabilities to not only JetBlue but also customers around the world. And as we announced on the back half of the year, the airline digital commercial platform and the evolution that's taking place there, it was very key as it related to us renewing that relationship with JetBlue and the confidence that they have in this management team to be able to deliver.

And it does go back to really things that we have been doing over the last couple of years, focusing on stability and product health that really translates into this. So that was a big driver in that renewal, but also, it's at the forefront of essentially campaigns that we're involved in. And that actually transcends into the other renewals that we've had over the really last year, 1.5 years.

If you look at your second question relative to the renewals, if you read into the guidance that Doug provided, there has been a little pressure on the PB side of the equation. The other thing that we look at is the opportunity to expand the portfolio of products, because there are certain products that are actually contracted with that. But if you look beyond, in what we're doing within Airline Solution and looking at how the model is continuing to shift to retailing, distribution and fulfillment, we do believe that there is a significant amount of opportunity.

And Intelligence Exchange is an example of that, that we can continue to grow share of wallet with those customers. So very important for us to lock those deals up, as you would imagine, as we stated. That essentially locks up 75% of our revenue through 2023, and I'm pretty invigorated about our opportunity to go out and compete for more business.

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John Peter King, BofA Merrill Lynch, Research Division - Research Analyst [11]

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That's helpful. And then the follow-up was actually one on a similar topic around the -- some of the clients that you've lost. I mean, I guess, as you took over, Sean, the business has come out of quite a lot of disruption on the operating side. You had quite a few outages; 0, it sounds like, in 2018, which is a great result relative to, I think, where you had been. So I'm just wondering, kind of was that a big driver for some of the clients that potentially left you? Were there economic considerations for some of them? Why were you leaving those clients? And what do you expect to be -- when do you expect, I suppose, the better operating performance to flow through into these -- to conversion of pipeline into deals?

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Sean E. Menke, Sabre Corporation - President, CEO & Director [12]

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Yes. So a couple of things on that, John, and thanks for that question. When you look at the stability piece of this -- and this goes back to really what we were dealing with in 2016 and 2017 and the things that we have worked through. And as I went through in my prepared comments, where we are is just night and day right now. I just -- we are just running an amazing operation right now. I couldn't be prouder of the organization. When I look at the 3 carriers that attrited away from us, I wish I was in my seat a year before that because there's no doubt in my mind the efforts that we've taken over the last couple of years would have paid off there.

And as I've mentioned to you and others as we've had these discussions, is if you're not healthy, customers are going to react to that. And 2 of those carriers specifically, I think we made great headwinds with the executive management teams, but you also have to understand that they have frontline employees that they listen to. And it was the decision that they needed to make a transition, and I'm respectful of that. And as we look at the future, this is why I'm so confident in what's taking place right now. We have just tackled a number of these issues that we were dealing with in the past, and we've set ourselves up for some great days ahead.

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Operator [13]

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And our next question comes from Matt Pfau with William Blair.

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Matthew Charles Pfau, William Blair & Company L.L.C., Research Division - Analyst [14]

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I just wanted to dig in a bit into the hospitality business. And acquisitions in that market are quite frequent, and so I think when you would have given -- guidance would have anticipated some level of consolidation. So was -- is the amount of consolidation you're seeing greater than you would have anticipated? And how do you sort of factor in some of the mid- and small-sized hoteliers that you deal with getting consolidated in the future?

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Sean E. Menke, Sabre Corporation - President, CEO & Director [15]

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Yes, yes, yes. Very good question. So if you look at the normal attrition rate that we have, in '19, it's actually higher. So we're seeing this actually jump up specifically to [2] transactions that we see taking place. If I look at sort of the broader context on hospitality and look at essentially where we were in '17 and '18, and it goes back to the question that John had more on the Airline Solutions side, but we did have stability issues and we had an issue that related to a data breach.

And the one thing that we focused on that has dampened the growth is our focus on what we're doing within the digital exchange business and deciding to pull back on that a little bit and focusing more on strategic customers on a broader portfolio. When you look at just SynXis, CRS and the PMS, there has been a lot of work put into those and they're very healthy products in what's happening. So the other thing that the team has done in this period is they've aggressively focused on just managing expense, and you saw that in the margin improvement.

Where I'd begin to gain more confidence as we go into that cycle is what I outlined and Doug outlined as it related to sales, typically on the back half of the year. The team really did step up, and we're seeing that momentum carry forward into the first quarter of this year. So like I mentioned, it's higher attrition than what we've historically seen, but the level of engagement that we have across the board at the enterprise level as well as large independents makes me feel comfortable where we are. And again, very similar to Airline Solutions, I think the teams have done a good job to position us to continue to gain momentum into the midterm.

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Douglas Elliott Barnett, Sabre Corporation - Executive VP & CFO [16]

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And Matt, I might add the attrition rate we have forecast in 2019 is double what we've seen historically, to give you some perspective.

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Operator [17]

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And our next question comes from Jim Schneider with Goldman Sachs.

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James Edward Schneider, Goldman Sachs Group Inc., Research Division - VP [18]

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I wonder if you could maybe talk a little bit, and I apologize if I missed it, about the progression in airline capacity you see as we get to the back half of this year and beginning of 2020. Even based on what you see now, how much trimming are you expecting? And how does it kind of vary across regions?

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Sean E. Menke, Sabre Corporation - President, CEO & Director [19]

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Yes. So let me give you sort of how we've assessed the year. So we're seeing some moderation in capacity across all regions in 2019, and we've modeled about a 4% growth on a year-over-year basis. We continue to see APAC growing at a significant rate. That's more on the low-cost carrier side. There's definitely delineation between low-cost carrier growth and full-service carrier growth. I think in our modeling, we have full-service carriers growing in the range of about 3% or so. And with that taking place, that does dampen sort of the GDS booking side of the equation. When we look into 2020 right now, it's just really based on, Jim, just historical sort of growth rate and then what we're seeing sort of in the marketplace and just trying to continue to monitor what's happening. But the primary focus right now is what we see in 2019.

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James Edward Schneider, Goldman Sachs Group Inc., Research Division - VP [20]

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And then maybe just a quick follow-up related to the Hospitality Solutions. Understanding fully the consolidation headwinds you're seeing this year, when would you expect that to sort of get -- lap that and get back to a more normalized growth rate? And what would you kind of hazard a guess as to what that normalized rate might be?

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Douglas Elliott Barnett, Sabre Corporation - Executive VP & CFO [21]

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Yes. We would expect that to get back to normal in 2020 and beyond.

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James Edward Schneider, Goldman Sachs Group Inc., Research Division - VP [22]

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And at what rate?

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Douglas Elliott Barnett, Sabre Corporation - Executive VP & CFO [23]

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Similar, about half the attrition rate we would expect to get back to normal attrition rates in 2020. Remember, it's doubling in 2020 -- in 2019.

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Operator [24]

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And our next question comes from Brian Essex with Morgan Stanley.

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Brian Lee Essex, Morgan Stanley, Research Division - Equity Analyst [25]

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Sean, I was maybe wondering if you could, one, offer an update on Farelogix, where does that stand in the process. And then kind of as a follow-up related to that, just looking at the pipeline of deals coming up for renewal. You guys, as you've mentioned, seem pretty well solidified over the next 2 to 3 years, but there are about a dozen-or-so Amadeus deals coming up for renewal. There are probably 15-plus Navitaire deals coming up for renewal. How might that position you to be more competitive in some of those competitor deals coming up for renewal over the next 2 to 3 years?

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Sean E. Menke, Sabre Corporation - President, CEO & Director [26]

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Thanks for the question, Brian, and thanks for joining us this morning. So let me start with Farelogix. So as expected, we did receive a second request from the Department of Justice, and we're working with them to go through that process. We're estimating that the deal will actually close in the mid-part of the year. And as we continue to articulate and we've had really good engagement really across the board with airlines and agencies that, as we continue to look at the model evolving, and this is a big part of what I've really spoken with airline executives as well as agency executives, is we see what's taking place. There has been a model that has worked over a number of years, but there's this desire, as I often say, behind door #2 of how do you continue to evolve. And the Farelogix acquisition allows us to really put our money where our mouth is relative to making sure that we're continuing to evolve in the marketplace.

And so that really leads into your second question on how does that position us to compete in the marketplace. And this is, again, where, when I look at where we're positioned and what we've done over the last 2 years, Brian, I'm extremely excited because this is one that, when we think about our strategy of retailing, distribution and fulfillment, you have to think about it from the supply side and our customers on the supply side, not only on the airlines but the hotels, and how are we allowing them through our technology -- and this really does get into the Airline Solutions piece of the business. It also leans on what we're doing -- would like to do with Farelogix, with getting that deal closed, is that it really allows you to move in to offer an order management.

And as I often tell people, just think of it as sort of a number of ingredients that essentially you can create bundled products and do things that are a little bit differently that flow into the distribution world. And in flowing into the distribution world, as I've stated, it's not about indirect versus direct. It's just about distribution and helping our customers sell their products and services because they've invested hundreds of millions of dollars in that. And if everybody begins to connect the dots, you can see how -- what we've done really with the new Sabre Red Workspace, Sabre 360 and essentially, the ability to make sure that we're displaying products for the agencies that is very similar to the way that it's done through Airline.com allows us to essentially sell those products.

But the most important piece of that I sort of really focus on, and this does get into the PSS side of the equation, is the more confusing you make selling of the product on the front end, guess what, the passenger service system, you have to make sure that you're capable of delivering that. And as we looked at our entire strategy -- and this is why, as I travel the world and the team travels the world meeting with airlines, even on the hospitality side, they truly understand that we're looking at the entire picture, that we're looking at "How does revenue optimization change? How do things have to happen for agencies on the back end?" So our ability to communicate that, Brian, and our ability to actually push back and say these are the things that you need to think about, I think it would definitely put us at a different level relative to what people thought about Sabre a couple of years ago and actually how we're helping transform the business.

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Operator [27]

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And our next question comes from Georgios Kertsos with Berenberg.

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Georgios Kertsos, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [28]

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I have, I guess, a bit of a high-level question. You mentioned essentially some cost savings -- compute cost power savings from the shift to cloud. I was just curious to ask what you're actually seeing in the market. Are those costs essentially captured internally? Or are we also looking at a part of those costs being transferred to clients in terms of more competitive pricing?

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Douglas Elliott Barnett, Sabre Corporation - Executive VP & CFO [29]

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Right now, those costs are being captured internally, and they enable us to self-fund the whole technology transformation that we're going through. So they're critical for us to be able to effectuate our technology evolution. So captured internally right now.

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Georgios Kertsos, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [30]

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Okay, clear. And just a quick follow-up then, if I may. On the -- can you just give a little bit more color, if you can, on the incentive fee dynamics? I mean, are there any clear trends by geography perhaps or anything along those lines? How are you expecting that to sort of evolve in the next couple of years?

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Sean E. Menke, Sabre Corporation - President, CEO & Director [31]

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So as we mentioned in our prepared comments, what we saw in 2018 -- and this is an important note, too. We talked about -- I'd be remiss if I didn't mention this. I talked about the amount of business that we locked up on Airline Solutions. What we saw -- if you go back to really 2016 and 2017, we went through a cycle of a number of renewals of major OTAs as well as TMCs, and then we ended up winning Flight Centre as well. And what we saw throughout really 2018 is that, yes, we had higher incentive rates, but it actually began to reduce throughout the year. And as we look into 2019, as Doug had mentioned, we get back to normalized rates -- historic normalized rates in the second quarter. When we look into the future, here's the balance and what I have focused on with the team, and this is the important piece. Technology is an important driver today. It's unbelievably important. And what I find taking place specifically with conversations with agencies today, they're wanting to understand the technology evolution. This is why Farelogix is important. It's why we're going down this path of how do we make sure that we look at the model that has been around for a long period of time and a model that's evolving. And in doing that, it's our responsibility to work with the suppliers as well as the agencies to make sure that the content is there and there's an understanding of that taking place. And with that, I think you're going to find that there's some more balanced conversation that is not incentive-led. It's going to be very technology-led as well.

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Operator [32]

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(Operator Instructions) Our next question comes from Jed Kelly with Oppenheimer.

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Jed Kelly, Oppenheimer & Co. Inc., Research Division - Director and Senior Analyst [33]

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Just a question on the guidance. How much of a factor did you build in a cushion for the current macro environment versus prior years? And then on hospitality, how much is this -- some of the attrition coming from competition? And then can you give us an update on the Booking.com integration?

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Douglas Elliott Barnett, Sabre Corporation - Executive VP & CFO [34]

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Sure. Let me talk about first the macro cushion that you talk about. We've actually factored in a similar level of cushion to what we would have had coming into 2018, similar to what we're doing in 2019. So no real material changes year-over-year.

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Sean E. Menke, Sabre Corporation - President, CEO & Director [35]

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And Jed, on that, if you go back just relative to the way we modeled sort of the capacity growth that does flow through into expected booking growth as well, the other thing that we had the tailwind last year was really the conversion -- the Flight Centre conversion still happening as well as CWT in the marketplace. On the hospitality side, the acquisitions have been more in -- haven't really been a loss. It's gone into -- it's just gone into the platforms of the acquiring hotelier. So it hasn't been that it's gone from us to another. It's just based on the acquirer putting them on their platform. And then, on your last question on the Booking.com, so up to this point, within the Sabre Red Workspace, there is what's called a Red app. And where we are right now is the bookings are taking place through that Red app, so it's sort of an add-on. The important piece, and this is really being rolled out through 2019, is when you look at the content services for lodging of the platform that we have been developing, it's more -- it flows into that, essentially, display that does not only booking, but it does other rates that are out there that gets into the booking floor much better. So we should see some more ramp-up taking place in 2019. The one thing that -- if we looked at the hospitality booking growth in 2018, it was actually up 11%. If you looked at the non-air components, there wasn't significant amount of growth, and that was actually due to the lower-margin rail that was coming off. But we actually saw some really good booking growth. As you know, those are higher margin, and the focus that we have, and this gets into just the broader picture, is that the ability to get the attachment rate higher to air also helps us out.

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Douglas Elliott Barnett, Sabre Corporation - Executive VP & CFO [36]

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And Jed, I just wanted to add one other thing to you with regards to cushion coming into the year. Obviously, with all the renewals that we now have at AS and particularly JetBlue today, we're in a significantly different risk profile today with regards to the Airline Solutions business than we were coming into 2018.

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Jed Kelly, Oppenheimer & Co. Inc., Research Division - Director and Senior Analyst [37]

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And then just one more question. When you called out modest slowing in the global travel economy, is that more business or more leisure-weighted?

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Sean E. Menke, Sabre Corporation - President, CEO & Director [38]

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I mean, the business has a -- if I look at business, business has trended relatively the same. I think it's just a mix that we're seeing right now.

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Operator [39]

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With that, I would like to turn the call back to Mr. Menke for closing remarks. Mr. Menke?

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Sean E. Menke, Sabre Corporation - President, CEO & Director [40]

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Great. Thank you. And once again, thank you again for joining us for the call this morning. We appreciate the interest and support and look forward to continuing to share our progress and results as we look ahead. Thanks again, guys.

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Operator [41]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a wonderful day.