10-Q 1 a07-13606_210q.htm 10-Q

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q

(Mark One)

x

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

 

 

SECURITIES EXCHANGE ACT OF 1934

 

 

 

 

 

For the quarterly period ended March 31, 2007

 

 

 

 

 

OR

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

 

 

SECURITIES EXCHANGE ACT OF 1934

 

 

 

 

 

For the transition period from           to           

 

Commission File Number 0-25581

PRICELINE.COM INCORPORATED

(Exact name of Registrant as specified in its charter)

Delaware

 

06-1528493

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification Number)

 

800 Connecticut Avenue

Norwalk, Connecticut 06854

(address of principal executive offices)

 

(203) 299-8000

(Registrant’s telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed, since last report)

 

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 o.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

 

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

Number of shares of Common Stock outstanding at May 1, 2007:

Common Stock, par value $0.008 per share

 

37,890,242

(Class)

 

(Number of Shares)

 

 




priceline.com Incorporated

Form 10-Q

For the Three Months Ended March 31, 2007

PART I - FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1. Unaudited Consolidated Financial Statements

 

3

 

 

 

 

 

Consolidated Balance Sheets (unaudited) at March 31, 2007 and December 31, 2006

 

3

 

Consolidated Statements of Operations (unaudited) For the Three Months
Ended March 31, 2007 and 2006

 

4

 

Consolidated Statement of Changes in Stockholders’ Equity (unaudited)

 

 

 

For the Three Months Ended March 31, 2007

 

5

 

Consolidated Statements of Cash Flows (unaudited) For the Three Months

 

 

 

Ended March 31, 2007 and 2006

 

6

 

Notes to Unaudited Consolidated Financial Statements

 

7

 

 

 

 

 

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

 

23

 

 

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

49

 

 

 

 

 

Item 4. Controls and Procedures

 

50

 

 

 

 

 

PART II - OTHER INFORMATION

 

 

 

 

 

 

 

Item 1. Legal Proceedings

 

51

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

51

 

Item 6. Exhibits and Reports on Form 8-K

 

51

 

 

 

 

 

SIGNATURES

 

53

 

 

2




PART I – FINANCIAL INFORMATION

Item 1.   Unaudited Consolidated Financial Statements

priceline.com Incorporated

UNAUDITED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

 

March 31,

 

December 31,

 

 

 

2007

 

2006

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

454,988

 

$

423,577

 

Restricted cash

 

2,624

 

2,459

 

Short-term investments

 

 

7,983

 

Accounts receivable, net of allowance for doubtful accounts of $2,136 and $1,651, respectively

 

52,134

 

48,536

 

Prepaid expenses and other current assets

 

46,007

 

20,534

 

Total current assets

 

555,753

 

503,089

 

 

 

 

 

 

 

Property and equipment, net

 

21,400

 

21,691

 

Intangible assets, net

 

148,261

 

152,925

 

Goodwill

 

228,354

 

226,707

 

Deferred taxes

 

190,947

 

179,392

 

Other assets

 

21,024

 

21,844

 

Total assets

 

$

1,165,739

 

$

1,105,648

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

57,906

 

$

49,032

 

Accrued expenses and other current liabilities

 

96,533

 

46,872

 

Deferred merchant bookings

 

8,769

 

4,768

 

Convertible debt

 

568,980

 

 

Total current liabilities

 

732,188

 

100,672

 

Deferred taxes

 

39,160

 

39,714

 

Other long-term liabilities

 

11,466

 

11,885

 

Minority interest

 

23,218

 

22,486

 

Convertible debt

 

 

568,865

 

Total liabilities

 

806,032

 

743,622

 

 

 

 

 

 

 

Commitments and Contingencies (see Note 14)

 

 

 

 

 

 

 

 

 

 

 

Series B mandatorily redeemable preferred stock, $0.01 par value; 80,000 authorized shares; $1,000 liquidation value per share; 80,000 shares issued and 0 and 13,470 shares outstanding, respectively

 

 

13,470

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $0.008 par value; authorized 1,000,000,000 shares, 44,514,707 and 43,215,712 shares issued, respectively

 

342

 

331

 

Treasury stock, 6,630,313 and 6,603,050 shares, respectively

 

(487,893

)

(486,468

)

Additional paid-in capital

 

2,096,021

 

2,070,379

 

Accumulated deficit

 

(1,278,304

)

(1,262,033

)

Accumulated other comprehensive income

 

29,541

 

26,347

 

Total stockholders’ equity

 

359,707

 

348,556

 

Total liabilities and stockholders’ equity

 

$

1,165,739

 

$

1,105,648

 

 

See Notes to Unaudited Consolidated Financial Statements.

3




priceline.com Incorporated

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

 

 

Three Months Ended
March 31,

 

 

 

2007

 

2006

 

 

 

 

 

 

 

Merchant revenues, including $15,878 excise tax refund in 2007

 

$

246,011

 

$

210,438

 

Agency revenues

 

54,511

 

30,381

 

Other revenues

 

867

 

1,095

 

Total revenues

 

301,389

 

241,914

 

Cost of merchant revenues

 

181,672

 

169,683

 

Cost of agency revenues

 

 

 

Cost of other revenues

 

 

 

Total costs of revenues

 

181,672

 

169,683

 

Gross profit

 

119,717

 

72,231

 

Operating expenses:

 

 

 

 

 

Advertising – Offline

 

11,334

 

9,438

 

Advertising – Online

 

31,927

 

21,861

 

Sales and marketing

 

11,410

 

9,582

 

Personnel, including stock-based compensation of $3,166 and $3,017, respectively

 

21,490

 

16,454

 

General and administrative, including net cost of litigation settlement of $54,857 in 2007, and option payroll taxes of $438 and $89, respectively

 

63,875

 

5,737

 

Information technology

 

2,911

 

2,307

 

Depreciation and amortization

 

8,505

 

7,946

 

Restructuring charge, net

 

 

135

 

Total operating expenses

 

151,452

 

73,460

 

Operating loss

 

(31,735

)

(1,229

)

Other income (expense):

 

 

 

 

 

Interest income, including $2,786 of interest on excise tax refund in 2007

 

8,203

 

1,575

 

Interest expense

 

(2,470

)

(1,498

)

Other

 

(214

)

111

 

Total other income

 

5,519

 

188

 

Loss before income taxes, equity in income (loss) of investees and minority interests

 

(26,216

)

(1,041

)

Income tax benefit

 

11,593

 

741

 

Equity in income (loss) of investees and minority interests

 

(93

)

201

 

Net loss

 

(14,716

)

(99

)

Preferred stock dividend

 

(1,555

)

(865

)

Net loss applicable to common stockholders

 

$

(16,271

)

$

(964

)

Net loss applicable to common stockholders per basic common share

 

$

(0.44

)

$

(0.02

)

Weighted average number of basic common shares outstanding

 

37,191

 

39,380

 

Net loss applicable to common stockholders per diluted common share

 

$

(0.44

)

$

(0.02

)

Weighted average number of diluted common shares outstanding

 

37,191

 

39,380

 

 

See Notes to Unaudited Consolidated Financial Statements.

4




priceline.com Incorporated

UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE THREE MONTHS ENDED MARCH 31, 2007

(In thousands)

 

 

 

Common Stock

 

Additional

 

Accumulated

 

Accumulated Other
Comprehensive 

 

Treasury Stock

 

 

 

 

 

Shares

 

Amount

 

Paid-in Capital

 

 Deficit

 

Income (Loss)

 

Shares

 

Amount

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2007

 

43,216

 

$

331

 

$

2,070,379

 

$

(1,262,033

)

$

26,347

 

(6,603

)

$

(486,468

)

$

348,556

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss applicable to common stockholders

 

 

 

 

(16,271

)

 

 

 

(16,271

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on marketable securities

 

 

 

 

 

143

 

 

 

143

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Currency translation adjustment

 

 

 

 

 

3,051

 

 

 

3,051

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(13,077

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of restricted stock under equity-based compensation plans, net of forfeitures

 

119

 

1

 

(1

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of preferred stock dividend

 

35

 

1

 

1,554

 

 

 

 

 

1,555

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercise of stock options and vesting of restricted stock units

 

389

 

3

 

7,586

 

 

 

 

 

7,589

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase of common stock

 

 

 

 

 

 

(27

)

(1,425

)

(1,425

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation

 

 

 

2,870

 

 

 

 

 

2,870

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercise of warrants

 

756

 

6

 

13,464

 

 

 

 

 

13,470

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Excess tax benefit on stock-based compensation

 

 

 

169

 

 

 

 

 

169

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, March 31, 2007

 

44,515

 

$

342

 

$

2,096,021

 

$

(1,278,304

)

$

29,541

 

(6,630

)

$

(487,893

)

$

359,707

 

 

See Notes to Unaudited Consolidated Financial Statements.

5




priceline.com Incorporated

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

 (In thousands)

 

 

Three Months Ended
March 31,

 

 

 

2007

 

2006

 

OPERATING ACTIVITIES:

 

 

 

 

 

Net loss

 

$

(14,716

)

$

(99

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

Depreciation

 

2,576

 

2,359

 

Amortization

 

5,929

 

5,917

 

Provision for uncollectible accounts, net

 

1,799

 

768

 

Deferred income taxes

 

(12,451

)

(1,217

)

Stock-based compensation expense

 

3,166

 

3,017

 

Amortization of debt issuance costs

 

763

 

369

 

Equity in (income) loss of investee, net, and minority interests

 

93

 

(201

)

Restructuring charge, net

 

 

135

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(5,104

)

(4,197

)

Prepaid expenses and other current assets

 

(25,355

)

(3,346

)

Accounts payable, accrued expenses and other current liabilities

 

61,280

 

17,158

 

Other

 

773

 

(316

)

Net cash provided by operating activities

 

18,753

 

20,347

 

INVESTING ACTIVITIES:

 

 

 

 

 

Purchase of short-term investments

 

 

(27,235

)

Redemption of short-term investments

 

7,996

 

14,478

 

Acquisitions and other equity investments, net of cash acquired

 

 

(1,210

)

Additions to property and equipment

 

(2,217

)

(2,075

)

Change in restricted cash

 

(160

)

1,328

 

Net cash provided by (used in) investing activities

 

5,619

 

(14,714

)

FINANCING ACTIVITIES:

 

 

 

 

 

Repurchase of common stock

 

(1,425

)

(5,616

)

Proceeds from exercise of stock options

 

7,589

 

1,142

 

Excess tax benefit on stock-based compensation

 

169

 

 

Net cash provided by (used in) financing activities

 

6,333

 

(4,474

)

Effect of exchange rate changes on cash and cash equivalents

 

706

 

407

 

Net increase in cash and cash equivalents

 

31,411

 

1,566

 

Cash and cash equivalents, beginning of period

 

423,577

 

80,341

 

Cash and cash equivalents, end of period

 

$

454,988

 

$

81,907

 

SUPPLEMENTAL CASH FLOW INFORMATION:

 

 

 

 

 

Cash paid during the period for income taxes

 

$

6,645

 

$

7

 

Cash paid during the period for interest

 

$

2,958

 

$

1,802

 

 

See Notes to Unaudited Consolidated Financial Statements.

6




priceline.com Incorporated

Notes to Unaudited Consolidated Financial Statements

1.             BASIS OF PRESENTATION

Priceline.com Incorporated (“priceline.com” or the “Company”) is responsible for the Unaudited Consolidated Financial Statements included in this document.  The Unaudited Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and include all normal and recurring adjustments that management of the Company considers necessary for a fair presentation of its financial position and operating results.  The Company prepared the Unaudited Consolidated Financial Statements following the requirements of the Securities and Exchange Commission for interim reporting.  As permitted under those rules, the Company condensed or omitted certain footnotes or other financial information that are normally required by GAAP for annual financial statements.  These statements should be read in combination with the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

The Unaudited Consolidated Financial Statements include the accounts of the Company and its subsidiaries.  All significant intercompany accounts and transactions have been eliminated in consolidation. Investments in affiliates in which the Company does not have control, but has the ability to exercise significant influence, are accounted for by the equity method.

Revenues, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be the same as those for the full year.

2.             STOCK-BASED EMPLOYEE COMPENSATION

The Company has adopted stock compensation plans which provide for grants of share based compensation as incentives and rewards to encourage employees, officers, consultants and directors to contribute towards the long-term success of the Company.  Stock-based compensation cost included in personnel expenses in the Unaudited Consolidated Statements of Operations was approximately $3.2 million and $3.0 million for the three months ended March 31, 2007 and 2006, respectively.  These amounts include stock-based compensation for restricted stock and restricted stock units related to shares of priceline.com International.

During the three months ended March 31, 2007, the Company granted 125,550 shares of restricted stock, 83,740 restricted stock units and 75,750 performance share units.  The share based awards generally vest on the third anniversary of the date of grant and had a total grant date fair value of $14.8 million based upon the grant date fair value per share of $51.93.  The actual number of shares of common stock issued in connection with the performance share units, if any, will be determined at the end of the performance period, assuming there is no accelerated vesting for, among other things, a change in control or termination of employment in certain circumstances, and could range from zero to an additional 75,750 shares over the “target” number of shares if the maximum performance threshold associated with the performance share units is met by the Company.

3.             NET LOSS PER SHARE

The Company computes basic and diluted net income (loss) per share in accordance with SFAS No. 128, “Earnings per Share.” Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is based upon the weighted average number of common and common equivalent shares outstanding during the period.

Common equivalent shares related to stock options, restricted stock, restricted stock units, performance share units and warrants are calculated using the treasury stock method.  Performance share units are included in the weighted average common equivalent shares based on the number of shares that would be issued if the end of the reporting period were the end of the performance period, if the result would be dilutive.

7




The Company’s convertible debt issues  have net share settlement features requiring the Company upon conversion to settle the principal amount of the debt for cash and the conversion premium for cash or shares of the Company’s common stock (See Note 8). Pursuant to EITF 90-19, “Convertible Bonds with Issuer Options to Settle for Cash upon Conversion,” the convertible notes are included in the calculation of diluted net income per share if their inclusion is dilutive under the treasury stock method.

As of March 31, 2007 and 2006, respectively, 17.8 million shares and 11.7 million shares that could potentially dilute earnings per share in the future were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive.  The potentially dilutive share amount at March 31, 2007 includes approximately 14.3 million shares that could be issued under the Company’s convertible debt if the Company experiences substantial increases in its common stock price.  Under the treasury stock method, the convertible notes will generally have a dilutive impact on net income per share if the Company’s average stock price for the period exceeds the conversion price for the convertible notes. As an example, at stock prices of $40 per share, $60 per share and $100 per share, common equivalent shares would include approximately 0.1 million, 4.8 million and 8.6 million equivalent shares, respectively, related to the convertible notes (excluding the offsetting impact of the Convertible Spread Hedges — see Note 8).

4.             RESTRUCTURING

At March 31, 2007, the Company had a restructuring liability of $1.3 million for the estimated remaining costs related to leased property vacated by the Company in 2000. During the first quarter of 2006, the Company recorded a $135,000 restructuring charge based upon a re-evaluation of the estimated disposal costs related to the vacated leased property.  The Company estimates that, based on current available information, the remaining net cash outflows associated with its restructuring related commitments will be paid in 2007-2011. The current portion of the restructuring accrual in the amount of $669,000 is recorded in “Accrued expenses and other current liabilities” and the $582,000 non-current portion is recorded in “Other long-term liabilities” on the Company’s Unaudited Consolidated Balance Sheet.

5.             SHORT-TERM INVESTMENTS

The Company held no marketable securities as of March 31, 2007.  The Company’s marketable securities as of December 31, 2006 were approximately $8.0 million, comprised of U.S. government agency-discount notes.  The securities were sold in the first quarter 2007 with no significant gain or loss.

8




6.             INTANGIBLE ASSETS

The Company’s intangible assets consist of the following (in thousands):

 

 

March 31, 2007

 

December 31, 2006

 

 

 

 

 

 

 

Gross 
Carrying 
Amount

 

Accumulated 
Amortization

 

Net 
Carrying 
Amount

 

Gross 
Carrying 
Amount

 

Accumulated 
Amortization

 

Net 
Carrying 
Amount

 

Amortization 
Period

 

Weighted 
Average 
Useful Life

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supply and distribution agreements

 

$

149,762

 

$

(23,798

)

$

125,964

 

$

151,926

 

$

(24,237

)

$

127,689

 

13 years

 

13 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Technology

 

21,622

 

(14,360

)

7,262

 

21,454

 

(12,571

)

8,883

 

3 years

 

3 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Patents

 

1,489

 

(1,090

)

399

 

1,489

 

(1,076

)

413

 

15 years

 

15 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer lists

 

9,905

 

(8,828

)

1,077

 

9,822

 

(8,049

)

1,773

 

2 – 3 years

 

2 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Internet domain names

 

6,443

 

(859

)

5,584

 

6,443

 

(698

)

5,745

 

10 years

 

10 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trade names

 

10,628

 

(2,752

)

7,876

 

10,515

 

(2,195

)

8,320

 

5 years

 

5 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

326

 

(227

)

99

 

1,107

 

(1,005

)

102

 

3 – 15 years

 

9 years

 

Total intangible assets

 

$

200,175

 

$

(51,914

)

$

148,261

 

$

202,756

 

$

(49,831

)

$

152,925

 

 

 

 

 

 

Intangible assets with determinable lives are primarily amortized on a straight-line basis.  Intangible asset amortization expense was approximately $5.9 million and $5.9 million for the three months ended March 31, 2007 and 2006, respectively.

The annual estimated amortization expense for intangible assets for the remainder of 2007, the next four years and thereafter is expected to be as follows (in thousands):

2007

 

$

16,041

 

2008

 

17,031

 

2009

 

14,748

 

2010

 

14,172

 

2011

 

12,263

 

Thereafter

 

74,006

 

 

 

$

148,261

 

 

7.             OTHER ASSETS

Other assets at March 31, 2007 and December 31, 2006 consist of the following (in thousands):

 

March 31, 2007

 

December 31, 2006

 

Investment in pricelinemortgage.com

 

$

9,593

 

$

9,550

 

Deferred debt issuance costs, net

 

11,136

 

11,899

 

Other

 

295

 

395

 

Total

 

$

21,024

 

$

21,844

 

 

9




Investment in pricelinemortgage.com represents the Company’s 49% equity investment in pricelinemortgage.com and, accordingly, the Company recognizes its pro rata share of pricelinemortgage.com’s operating results, not to exceed an amount that the Company believes represents the investment’s estimated fair value. The Company recognized approximately $43,000 and $11,000 of income from its investment in pricelinemortgage.com in the three months ended March 31, 2007 and 2006, respectively.  The Company earned advertising fees from pricelinemortgage.com of approximately $4,000 and $11,000 in the three months ended March 31, 2007 and 2006, respectively.

Deferred debt issuance costs arose from the Company’s issuance of $125 million aggregate principal amount of 1% Notes in August 2003, $100 million aggregate principal amount of 2.25% Notes in June 2004, $172.5 million aggregate principal amount of 0.5% Notes in September 2006 and $172.5 million of aggregate principal amount 0.75% Notes in September 2006.  Deferred debt issuance costs of approximately $4.3 million, $3.8 million, $4.4 million and $4.4 million, respectively, consisting primarily of underwriting commissions and professional service fees, are being amortized using the effective interest rate method over the term of approximately five years, except for the 0.75% Notes, which are amortized over their term of seven years.

8.             CONVERTIBLE DEBT

The Company’s convertible debt is convertible into the Company’s common stock subject to certain conditions. Upon conversion, a holder will receive cash for the principal amount of the note and cash or shares of the Company’s common stock for the conversion value in excess of such principal amount.   Based upon the closing price of the Company’s common stock for the prescribed measurement periods during the quarter ended March 31, 2007, the contingent conversion thresholds on each of the Company’s convertible senior note issues were exceeded.  As a result, the notes are convertible at the option of the holder as of March 31, 2007 and, accordingly, have been classified as a current liability in the Unaudited Consolidated Balance Sheets as of that date.  The convertible debt may be classified as long-term debt in future quarters if the contingent conversion thresholds are not met in such quarters.  Convertible debt consists of the following as of March 31, 2007 and December 31, 2006 (in thousands):

 

 

March 
31, 2007

 

December 
31, 2006

 

$125 million aggregate principal amount of 1.00% Convertible Senior Notes due August 2010

 

$

123,980

 

$

123,865

 

$172.5 million aggregate principal amount of 0.50% Convertible Senior Notes due September 2011

 

172,500

 

172,500

 

$172.5 million aggregate principal amount of 0.75% Convertible Senior Notes due September 2013

 

172,500

 

172,500

 

$100 million aggregate principal amount of 2.25% Convertible Senior Notes due January 2025

 

100,000

 

100,000

 

 

 

$

568,980

 

$

568,865

 

 

The $125 million aggregate principal amount of Convertible Senior Notes due August 1, 2010, with an interest rate of 1.00% (the “1% Notes”) are convertible, subject to certain conditions, into the Company’s common stock at a conversion price of approximately $40.00 per share.  Prior to August 1, 2008, the 1% Notes will be convertible if the closing price of the Company’s common stock for at least 20 trading days in the 30 consecutive trading days ending on the first day of a conversion period is more than 110% of the then current conversion price of the 1% Notes, or after August 1, 2008, if the closing price of the Company’s common stock is more than 110% of the then current conversion price of the 1% Notes.  The 1% Notes are also convertible in certain other circumstances, such as a change in control of the Company.  In addition, the 1% Notes will be redeemable at the Company’s option beginning in 2008, and the holders may require the Company to repurchase the 1% Notes on August 1, 2008 or in certain other circumstances.  In the event that all or substantially all of the Company’s common stock is acquired on or prior to August 1, 2008, in a transaction in which the consideration paid to holders of the Company’s common stock consists of all or substantially all cash, the Company would be required to make additional payments in the form of additional shares of common stock to the holders of 1% Notes in aggregate value

10




ranging from $0 to approximately $18.4 million depending upon the date of the transaction and the then current stock price of the Company. Interest on the 1% Notes is payable on February 1 and August 1 of each year.

In November 2003, the Company entered into an interest rate swap agreement whereby it swapped the fixed 1% interest on its 1% Notes for a floating interest rate based on the 3-month U.S. Dollar LIBOR, minus the applicable margin of 221 basis points, on $45 million notional value of debt.  This agreement expires August 1, 2010.  The Company designated this interest rate swap agreement as a fair value hedge.  The changes in the fair value of the interest rate swap agreement and the underlying debt are recorded as offsetting gains and losses in interest expense in the Consolidated Statement of Operations.  Hedge ineffectiveness was not significant in the quarters ended March 31, 2007 and 2006.  The fair value cost to terminate this swap as of March 31, 2007 and December 31, 2006, was approximately $1.0 million and $1.2 million, respectively, and has been recorded as a credit in accrued expenses and other current liabilities at March 31, 2007, and other long-term liabilities at December 31, 2006, with a related adjustment to the carrying value of debt.

The $172.5 million aggregate principal amount of Convertible Senior Notes due September 30, 2011, with an interest rate of 0.50% (the “2011 Notes”), and $172.5 million aggregate principal amount of Convertible Senior Notes due September 30, 2013, with an interest rate of 0.75% (the “2013 Notes”) are convertible, subject to certain conditions, into the Company’s common stock at a conversion price of approximately $40.38 per share.  The 2011 Notes and the 2013 Notes are convertible, at the option of the holder, prior to June 30, 2011 in the case of the 2011 Notes, and prior to June 30, 2013 in the case of the 2013 Notes, upon the occurrence of specified events, including, but not limited to a change in control, or if the closing sale price of the Company’s common stock for at least 20 trading days in the period of the 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is more than 120% of the applicable conversion price in effect for the notes on the last trading day of the immediately preceding quarter.  In the event that all or substantially all of the Company’s common stock is acquired on or prior to the maturity of the 2011 Notes or the 2013 Notes, in a transaction in which the consideration paid to holders of the Company’s common stock consists of all or substantially all cash, the Company would be required to make additional payments in the form of additional shares of common stock to the holders of the 2011 Notes and the 2013 Notes, collectively, in aggregate value ranging from $0 to approximately $57.5 million depending upon the date of the transaction and the then current stock price of the Company.   As of June 30, 2011, with respect to the 2011 Notes, and as of June 30, 2013, with respect to the 2013 Notes, holders shall have the right to convert all or any portion of such security.  Neither the 2011 Notes nor the 2013 Notes may be redeemed by the Company prior to maturity.  The holders may require the Company to repurchase the 2011 Notes and the 2013 Notes for cash in certain circumstances.  Interest on the 2011 Notes and the 2013 Notes is payable on March 30 and September 30 of each year, starting March 30, 2007.

The Company entered into hedge transactions relating to potential dilution of the Company’s common stock upon conversion of the 2011 Notes and the 2013 Notes (the “Conversion Spread Hedges”).  Under the Conversion Spread Hedges, the Company is entitled to purchase from the counterparties approximately 8.5 million shares of the Company’s common stock (the number of shares underlying the 2011 Notes and the 2013 Notes) at a strike price of $40.38 per share (subject to adjustment in certain circumstances) and the counterparties are entitled to purchase from the Company approximately 8.5  million shares of the Company’s common stock at a strike price of $50.47 per share (subject to adjustment in certain circumstances).   The Conversion Spread Hedges increase the effective conversion price of the 2011 Notes and the 2013 Notes to $50.47 per share from the Company’s perspective and are designed to reduce the potential dilution upon conversion of the 2011 Notes and the 2013 Notes.  If the market value per share of the Company’s common stock at the time of any exercise is above $40.38, the Conversion Spread Hedge will entitle the Company to receive from the counterparties net shares of the Company’s common stock based on the excess of the then current market price of the Company’s common stock over the strike price of the purchased call options.  Holders of the 2011 Notes and the 2013 Notes do not have any rights with respect to the Conversion Spread Hedges.  The Conversion Spread Hedges are separate transactions entered into by the Company with the counterparties, are not part of the terms of the Notes and will not affect the holders’ rights under the 2011 Notes and the 2013 Notes.  The Conversion Spread Hedges are exercisable at dates coinciding with the scheduled maturities of the 2011 Notes and 2013 Notes.

11




The $100 million aggregate principal amount of Convertible Senior Notes due January 15, 2025, with an interest rate of 2.25% (the “2.25% Notes”) are convertible, subject to certain conditions, into the Company’s common stock at a conversion price of approximately $37.95 per share.  The 2.25% Notes will be convertible if, on or prior to January 15, 2020, the closing sale price of our common stock for at least 20 consecutive trading days in the period of 30 consecutive trading days ending on the first day of a conversion period is more than 120% of the then current conversion price of the 2.25% Notes.  The 2.25% Notes are also convertible in certain other circumstances, such as a change in control of the Company.  In the event that all or substantially all of the Company’s common stock is acquired on or prior to January 15, 2010, in a transaction in which the consideration paid to holders of the Company’s common stock consists of all or substantially all cash, the Company would be required to make additional payments in the form of common shares to the holders of the 2.25% Notes of amounts ranging from $0 to $15.6 million depending upon the date of the transaction and the then current stock price of the Company.  In addition, the 2.25% Notes will be redeemable at the Company’s option beginning January 20, 2010, and the holders may require the Company to repurchase the 2.25% Notes on January 15, 2010, 2015 or 2020, or in certain other circumstances.  Interest on the 2.25% Notes is payable on January 15 and July 15 of each year.

9.             TREASURY STOCK

In the fourth quarter of 2005, the Company’s Board of Directors authorized the repurchase of up to $50 million of the Company’s common stock from time to time in the open market or in privately negotiated transactions.  In addition, in the third quarter 2006, the Company’s Board of Directors authorized the repurchase of up to an additional $150 million of the Company’s common stock with a portion of the proceeds from the issuance of the 2011 Notes and the 2013 Notes. The Company’s Board of Directors has also given the Company the general authorization to repurchase shares of its common stock to satisfy employee withholding tax obligations related to stock-based compensation.

Under these programs, the Company repurchased 216,228 shares of its common stock at an aggregate cost of $5.1 million in the three months ended March 31, 2006, at prevailing market prices.  In September 2006, the Company purchased 3.85 million shares of its common stock at an aggregate purchase price of approximately $129.6 million.   Repurchases of 27,263 and 19,847 shares at aggregate costs of $1.4 million and $483,000 were made in the three months ended March 31, 2007and 2006, respectively, to satisfy employee withholding taxes related to stock-based compensation.

The Company may make additional repurchases of shares under its stock repurchase program, depending on prevailing market conditions, alternate uses of capital and other factors.  Whether and when to initiate and/or complete any purchase of common stock and the amount of common stock purchased will be determined in the Company’s complete discretion.  As of March 31, 2007, there were approximately 6.6 million shares of the Company’s common stock held in treasury.

10.          REDEEMABLE PREFERRED STOCK

On January 12, 2007, Delta exercised warrants to purchase 756,199 shares of the Company’s common stock by surrendering 13,470 shares of Series B Preferred Stock, representing all of the remaining outstanding shares of Series B Preferred Stock.  On February 6, 2007, the Company issued a final pro-rated dividend to Delta in the amount of 34,874 shares of common stock, and recorded a non-cash dividend charge of $1.6 million for the three months ended March 31, 2007.

In February 2006, the Company issued Delta Air Lines, Inc. a dividend on the Series B Redeemable Preferred Stock in the amount of 40,240 shares of the Company’s common stock, and recorded a non-cash dividend charge of $865,000 in the three months ended March 31, 2006.

12




11.          GOODWILL

A substantial majority of the Company’s goodwill relates to its acquisitions of Travelweb LLC, Booking.com Limited in 2004 and Booking.com B.V. in 2005.

Change in goodwill for the three months ended March 31, 2007 consists of the following (in thousands):

Balance at January 1, 2007

 

$

226,707

 

Currency translation adjustments

 

1,647

 

Balance at March 31, 2007

 

$

228,354

 

 

12.          TAXES

Income tax benefit includes U.S. and international income taxes, determined using an estimate of the Company’s annual effective tax rate.  A deferred tax liability is recognized for all taxable temporary differences, and a deferred tax asset is recognized for all deductible temporary differences and operating loss and tax credit carryforwards.  A valuation allowance is recognized if it is more likely than not that some portion of the deferred tax asset will not be realized.

The Company recognizes income tax expense related to income generated outside of the United States based upon the applicable tax rates of the foreign countries in which the income is generated.  During the three months ended March 31, 2007 and 2006, the substantial majority of the Company’s foreign-sourced income has been generated in the United Kingdom and the Netherlands. Income tax benefit for the three months ended March 31, 2007 and 2006 differs from the expected tax benefit at the U.S. statutory rate of 35% due to state income taxes and the foreign tax benefit of interest expense on intercompany debt.

The Company has significant deferred tax assets, resulting principally from domestic net operating loss carryforwards (“NOLs”).  As required by SFAS No. 109, “Accounting for Income Taxes,” the Company periodically evaluates the likelihood of the realization of deferred tax assets, and reduces the carrying amount of these deferred tax assets by a valuation allowance to the extent it believes a portion will not be realized. The Company considers many factors when assessing the likelihood of future realization of the deferred tax assets, including its recent cumulative earnings experience by taxing jurisdiction, expectations of future taxable income, the carryforward periods available for tax reporting purposes, and other relevant factors.  The valuation allowance may need to be adjusted in the future if facts and circumstances change, causing a reassessment of the amount of deferred tax assets more likely than not to be realized.  The total deferred tax asset at March 31, 2007 and December 31, 2006 amounted to $203.2 million and $191.7 million, respectively.  The current portion at March 31, 2007 and December 31, 2006 is $12.3 million and is recorded in prepaid expenses and other current assets in the Unaudited Consolidated Balance Sheets.

The Company has recorded a deferred tax liability in the amount of $39.2 million at March 31, 2007, and $39.7 million at December 31, 2006, primarily related to the assignment of estimated fair value to certain purchased identifiable intangible assets associated with the acquisitions of Booking.com Limited and Booking.com B.V.

In July 2006, the FASB issued Interpretation No. 48, “Uncertainty in Income Taxes” (“FIN 48”). FIN 48 applies to all tax positions and clarifies the recognition of tax benefits in the financial statements by providing for a two-step approach of recognition and measurement.  The first step involves assessing whether the tax position is more likely than not to be sustained upon examination based upon its technical merits. The second step involves measurement of the amount to recognize.  Tax positions that meet the more likely than not threshold are measured at the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate finalization with the taxing authority.  The Company adopted FIN 48 effective January 1, 2007.  The adoption of FIN 48 did not have a material impact on the Company’s consolidated results of operations and financial position.  The Company’s Federal and Connecticut tax returns, constituting the returns of the major taxing jurisdictions, are subject to examination by the taxing authorities for all open years as prescribed by applicable statute.  No waivers have been executed that would extend the period subject to examination beyond the period prescribed by statute.

13




13.          MINORITY INTERESTS

In connection with the Company’s acquisitions of Booking.com B.V. in July 2005 and Booking.com Limited in September 2004 and the reorganization of its European operations, key managers of Booking.com B.V. and Booking.com Limited purchased shares of priceline.com International.  In addition, these key managers were granted restricted stock and restricted stock units in priceline.com International shares that vest over time.  As of March 31, 2007, the total minority interest in priceline.com International on a fully diluted basis was approximately 6.4%.

The holders of the minority interest in priceline.com International have the right to put their shares to the Company and the Company has the right to call their shares at a purchase price reflecting the fair market value of the shares at the time of the exercise of the put or call right.  Subject to certain exceptions, (a) certain of the shares are subject to the put and call options in March 2007 and 2008 and (b) certain of the shares are subject to the put and call options in August 2007 and 2008.  In April 2007 (in connection with the March 2007 put and call options), the Company repurchased 92,125 shares underlying minority interest with a carrying value of $3.7 million for an aggregate purchase price of approximately $15.0 million based upon fair value.  As a result of the purchase, the minority interest in priceline.com International was reduced on a fully diluted basis to 5.4%.

All purchased securities and vested granted securities described above can be put by the holders of the securities or called by the Company shortly after the consummation of a “change in control” of the Company.  The aggregate fair value of the minority interest in priceline.com International is estimated to be approximately $97.2 million at March 31, 2007, including unvested restricted stock and restricted stock units.

14.          COMMITMENTS AND CONTINGENCIES

Litigation Related to Hotel Occupancy and Other Taxes

Statewide Putative Class Actions

A number of cities and counties have filed putative class actions on behalf of themselves and other allegedly similarly situated cities and counties within the same respective state against the Company and other defendants, including, but not in all cases, Lowestfare.com Incorporated and Travelweb LLC, both of which are subsidiaries of the Company, and Hotels.com, L.P.; Hotels.com GP, LLC; Hotwire, Inc.; Cheaptickets, Inc.; Travelport, Inc. (f/k/a Cendant Travel Distribution Services Group, Inc.); Expedia, Inc.; Internetwork Publishing Corp. (d/b/a Lodging.com); Maupintour Holding LLC; Orbitz, Inc.; Orbitz, LLC; Site59.com, LLC; Travelocity.com, Inc.; Travelocity.com LP; and Travelnow.com, Inc.  Each complaint alleges, among other things, that the defendants violated each jurisdiction’s respective hotel occupancy tax ordinance with respect to the charges and remittance of amounts to cover taxes under each ordinance.  Each complaint typically seeks compensatory damages, disgorgement, penalties available by law, attorneys’ fees and other relief.  Such actions include:

·      City of Los Angeles v. Hotels.com, Inc., et al.

·      City of Fairview Heights v. Orbitz, Inc., et al.

·      City of Findlay v. Hotels.com, L.P., et al.

·      City of Rome, Georgia, et al., v. Hotels.com, L.P., et al.

·      Pitt County v. Hotels.com, L.P., et al.

·      City of San Antonio, Texas v. Hotels.com, L.P., et al.

·      City of Gallup, New Mexico v. Hotels.com, L.P., et al.

·      Lake County Convention and Visitors Bureau, Inc. and Marshall County v. Hotels.com, L.P., et al.

·      City of Orange, Texas v. Hotels.com, L.P., et al.

·      Leon County and Doris Maloy, Leon County Tax Collector v. Hotels.com, L.P., et al.

·      City of Jacksonville v. Hotels.com, L.P., et al.

·      City of Columbus, et al. v. Hotels.com, L.P., et al.

·      Louisville/Jefferson County Metro Government v. Hotels.com, L.P., et al.

·      County of Nassau, New York v. Hotels.com, LP, et al.

14




A discussion of each of the aforementioned legal proceedings can be found in the section titled “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2006.

The following developments regarding such legal proceedings occurred during or after the quarter ended March 31, 2007:

City of Los Angeles v. Hotels.com, Inc., et al.:  On January 17, 2007, the defendants filed motions to dismiss to the City of Los Angeles’ second amended complaint on all issues other than misjoinder of defendants and claims.  On March 1, 2007, the court denied defendants’ previously-filed demurrers on grounds of improper joinder of defendants and claims.  On March 2, 2007, the City of Los Angeles filed a third amended complaint.  On April 11, 2007, the defendants filed renewed demurrers to the third amended complaint.  On June 11, 2007, the court is scheduled to conduct oral argument on defendants’ demurrers.

Pitt County v. Hotels.com, L.P., et al.:  On March 29, 2007, the court denied defendants’ motion to dismiss the complaint.  On April 13, 2007, the defendants moved for reconsideration of that decision or, in the alternative, interlocutory appeal.  The parties are currently conducting discovery.

City of San Antonio, Texas v. Hotels.com, L.P., et al.:  On March 21, 2007, the court denied defendants’ motion to dismiss the City of San Antonio’s amended complaint.  The parties are currently conducting discovery and the City of San Antonio’s motion for class certification is pending.

City of Gallup, New Mexico v. Hotels.com, L.P., et al.:  On April 18, 2007, the City of Gallup moved to dismiss this action voluntarily and without prejudice.  The Court granted that motion and the action was dismissed the same day.

Leon County and Doris Maloy, Leon County Tax Collector v. Hotels.com, L.P., et al.:  Following limited discovery on issue of jurisdiction, on February 21, 2007, the parties jointly stipulated to dismissal of the action without prejudice.

City of Jacksonville v. Hotels.com, L.P., et al.:  On April 12, 2007, the defendants withdrew their previously filed motion to stay the action and filed a motion to dismiss the City of Jacksonville’s complaint.  That motion is being briefed.

County of Nassau, New York v. Hotels.com, LP, et al.:  On January 31, 2007, the defendants moved to dismiss the County of Nassau’s complaint.  That motion is being briefed.

In addition to those cases discussed in the section titled “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2006, the following additional legal proceedings were filed during or after the quarter ended March 31, 2007:

City of Fayetteville v. Hotels.com, L.P., et al.:  On February 28, 2007, a putative class action complaint was filed in the Circuit Court of Washington County, Arkansas by the City of Fayetteville, Arkansas on behalf of itself and a putative class of Arkansas cities, counties and townships that have enacted uniform hotel taxes on lodging.  In addition to the claim for hotel taxes, the complaint also asserted claims for a declaratory judgment, conversion, unjust enrichment, and a constructive trust.  The Company has been served with the complaint and the defendants are scheduled to respond to the complaint by motion or answer on or before May 31, 2007.

The Company intends to defend vigorously against the claims in all of these proceedings.

Actions Filed on Behalf of Individual Cities and Counties

Several cities, counties, municipalities and other political subdivisions across the country have filed actions relating to the collection of hotel occupancy taxes against the Company and other defendants, including, but not in all cases, Lowestfare.com Incorporated and Travelweb LLC, both of which are subsidiaries of the Company, and

15




Hotels.com, L.P.; Hotels.com GP, LLC; Hotwire, Inc.; Cheaptickets, Inc.; Cendant Travel Distribution Services Group, Inc.; Expedia, Inc.; Internetwork Publishing Corp. (d/b/a Lodging.com); Maupintour Holding LLC; Orbitz, Inc.; Orbitz, LLC; Site59.com, LLC; Travelocity.com, Inc.; Travelocity.com LP; and Travelnow.com, Inc.  In each, the complaint alleges, among other things, that each of these defendants violated each jurisdiction’s respective hotel occupancy tax ordinance with respect to the charges and remittance of amounts to cover taxes under each ordinance.  Each complaint typically seeks compensatory damages, disgorgement, penalties available by law, attorneys’ fees and other relief.  Such actions include:

·      City of Chicago, Illinois v. Hotels.com, L.P., et al.

·      City of San Diego, California, v. Hotels.com L.P., et al.

·      City of Atlanta, Georgia v. Hotels.com L.P., et al.

·      City of Charleston, South Carolina v. Hotel.com, et al.

·      Town of Mount Pleasant, South Carolina v. Hotels.com, et al.

·      City of North Myrtle Beach, South Carolina v. Hotels.com, LP, et al.

·      Miami-Dade County and Ian Yorty, Miami-Dade County Tax Collector v. Internetwork Publishing Corp., et al.

·      Wake County v. Hotels.com, LP, et al.

·      Cumberland County v. Hotels.com, LP, et al.

·      City of Branson v. Hotels.com, LP., et al.

·      Dare County v. Hotels.com, LP, et al.

·      Buncombe County v. Hotels.com, LP, et al.

·      Horry County, et al. v. Hotels.com, LP, et al.

·      City of Myrtle Beach, South Carolina v. Hotels.com, LP, et al.

A discussion of each of the aforementioned legal proceedings can be found in the section titled “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2006.

The following developments regarding such legal proceedings occurred during or after the quarter ended March 31, 2007:

City of San Diego, California v. Hotels.com, Inc., et al.:  On January 17, 2007, the defendants filed motions to dismiss to the City of San Diego’s complaint on all issues other than misjoinder of defendants and claims.  On March 1, 2007, the court denied defendants’ previously-filed motions to dismiss on grounds of improper joinder of defendants and claims.  On March 8, 2007, the City of San Diego filed an amended complaint.  On April 11, 2007, the defendants filed renewed motions to dismiss to the amended complaint.  On June 11, 2007, the court is scheduled to conduct oral argument on defendants’ motions to dismiss.

City of Atlanta, Georgia v. Hotels.com L.P., et al.:  On January 10, 2007, the City of Atlanta filed a notice of appeal from the court’s December 12, 2006 order dismissing the action for the City’s failure to exhaust administrative remedies, which the City has indicated that it intends to pursue.  That appeal is being briefed.

City of Charleston, South Carolina v. Hotel.com, et al.:  On April 23, 2007, the court granted plaintiff’s motion for leave to amend its complaint to assert claims arising under the South Carolina Unfair Trade Practices Act.

Town of Mount Pleasant, South Carolina v. Hotels.com, et al.:  On April 23, 2007, the court granted plaintiff’s motion for leave to amend its complaint to assert claims arising under the South Carolina Unfair Trade Practices Act.

Miami-Dade County and Ian Yorty, Miami-Dade County Tax Collector v. Internetwork Publishing Corp., et al.:  Following a January 17, 2007 hearing on the defendants’ motion to dismiss, on January 18, 2007, the plaintiffs filed a motion to dismiss this action voluntarily and it was dismissed.  On February 26, 2007, the County served notices of audit on the Company and Lowestfare.com Incorporated.  On March 22, 2007, the County served

16




an estimated assessment against both companies.  The parties are currently discussing the procedures for any further audit.

Wake County v. Hotels.com, LP, et al.; Cumberland County v. Hotels.com, LP, et al.; City of Branson v. Hotels.com, LP., et al.; and Dare County v. Hotels.com, LP, et al.:  On January 19, 2007, the defendants moved to dismiss the Wake County action based on plaintiff’s failure to state a claim.  On January 26, 2007, Dare County filed its complaint.  On February 1, 2007, Buncombe County filed its complaint.  On February 12, 2007, the defendants moved to dismiss the Cumberland County action based on plaintiff’s failure to state a claim.  On April 4, 2007, these four cases were consolidated for pre-trial purposes and all four cases are now pending before the North Carolina Business Court.  The defendants anticipate that they will move to dismiss the Dare County and Buncombe County actions on May 7, 2007, and that all four motions will be briefed at that time.

City of Branson v. Hotels.com, LP., et al.:  On April 23, 2007, the defendants moved to dismiss the complaint.  That motion is being briefed.

Horry County, et al. v. Hotels.com, LP, et al.:  On February 2, 2007, Horry County filed its complaint.  On April 30, 2007, the defendants moved to dismiss the complaint.  That motion is being briefed.

City of Myrtle Beach, South Carolina v. Hotels.com, LP, et al.: On February 2, 2007, the City of Myrtle Beach filed its complaint.  On April 23, 2007, the defendants moved to dismiss the complaint.  That motion is being briefed.

In addition to those cases discussed in the section titled “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2006, the following additional legal proceedings were filed during or after the quarter ended March 31, 2007:

City of Houston, Texas v. Hotels.com, LP., et al.:  On March 5, 2007, the City of Houston, Texas filed a complaint in the District Court of Harris County, Texas.  In addition to the claim for violation of the Houston hotel occupancy tax ordinance, the complaint also asserted claims for conversion, constructive trust, civil conspiracy, and a legal accounting.  On April 30, 2007, the defendants filed special exceptions to the complaint.

We have also been informed by counsel to the plaintiffs in certain of the aforementioned actions that various, undisclosed municipalities or taxing jurisdictions may file additional cases against the Company, Lowestfare.com Incorporated and Travelweb LLC in the future.  In the first quarter 2006, the Company became aware of an opinion by the City Attorney of the City of Madison, Wisconsin that online travel companies were subject to the City of Madison, Wisconsin’s hotel occupancy tax.  Since that time, City officials have expressed an interest in filing suit against the Company, but neither the Company nor any of its subsidiaries has been served with or otherwise received any complaint brought on behalf of the City of Madison.

The Company intends to defend vigorously against the claims in all of these proceedings.

Consumer Class Actions

Two class actions brought by consumers against the Company are pending.

·      Marshall, et al. v. priceline.com, Inc.

·      Bush, et al. v. Cheaptickets, Inc., et al.

A discussion of each of the aforementioned legal proceedings can be found in the section titled “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2006.

The Company intends to defend vigorously against the claims in all of the aforementioned proceedings.

17




Other Possible Actions

At various times the Company has also received inquiries or proposed tax assessments from municipalities and other taxing jurisdictions relating to its charges and remittance of amounts to cover state and local hotel occupancy and other related taxes.  The City of New Orleans, Louisiana, the City of Philadelphia, Pennsylvania, and state tax officials from Wisconsin, Pennsylvania, and Indiana, among others, have begun formal or informal administrative procedures or stated that they may assert claims against the Company relating to allegedly unpaid state or local hotel occupancy or related taxes.  In addition, the State of New Jersey Department of Taxation has begun an audit related to the state’s Corporation Business Tax.  The Company is unable at this time to predict whether any such proceedings or assertions will result in litigation.

The Company intends to defend vigorously against the claims in all of the aforementioned proceedings.

Litigation Related to Securities Matters

On March 16, March 26, April 27, and June 5, 2001, respectively, four putative class action complaints were filed in the U.S. District Court for the Southern District of New York naming priceline.com, Inc., Richard S. Braddock, Jay Walker, Paul Francis, Morgan Stanley Dean Witter & Co., Merrill Lynch, Pierce, Fenner & Smith, Inc., BancBoston Robertson Stephens, Inc. and Salomon Smith Barney, Inc. as defendants (01 Civ. 2261, 01 Civ. 2576, 01 Civ. 3590 and 01 Civ. 4956).  Shives et al. v. Bank of America Securities LLC et al., 01 Civ. 4956, also names other defendants and states claims unrelated to the Company.  The complaints allege, among other things, that priceline.com and the individual defendants violated the federal securities laws by issuing and selling priceline.com common stock in priceline.com’s March 1999 initial public offering without disclosing to investors that some of the underwriters in the offering, including the lead underwriters, had allegedly solicited and received excessive and undisclosed commissions from certain investors.  By Orders of Judge Mukasey and Judge Scheindlin dated August 8, 2001, these cases were consolidated for pre-trial purposes with hundreds of other cases, which contain allegations concerning the allocation of shares in the initial public offerings of companies other than priceline.com, Inc.  By Order of Judge Scheindlin dated August 14, 2001, the following cases were consolidated for all purposes:  01 Civ. 2261; 01 Civ. 2576; and 01 Civ. 3590.  On April 19, 2002, plaintiffs filed a Consolidated Amended Class Action Complaint in these cases.  This Consolidated Amended Class Action Complaint makes similar allegations to those described above but with respect to both the Company’s March 1999 initial public offering and the Company’s August 1999 second public offering of common stock.  The named defendants are priceline.com, Inc., Richard S. Braddock, Jay S. Walker, Paul E. Francis, Nancy B. Peretsman, Timothy G. Brier, Morgan Stanley Dean Witter & Co., Goldman Sachs & Co., Merrill Lynch, Pierce, Fenner & Smith, Inc., Robertson Stephens, Inc. (as successor-in-interest to BancBoston), Credit Suisse First Boston Corp. (as successor-in-interest to Donaldson Lufkin & Jenrette Securities Corp.), Allen & Co., Inc. and Salomon Smith Barney, Inc.  Priceline, Richard Braddock, Jay Walker, Paul Francis, Nancy Peretsman, and Timothy Brier, together with other issuer defendants in the consolidated litigation, filed a joint motion to dismiss on July 15, 2002.  On November 18, 2002, the cases against the individual defendants were dismissed without prejudice and without costs.  In addition, counsel for plaintiffs and the individual defendants executed Reservation of Rights and Tolling Agreements, which toll the statutes of limitations on plaintiffs’ claims against those individuals.  On February 19, 2003, Judge Scheindlin issued an Opinion and Order granting in part and denying in part the issuer’s motion.  None of the claims against the Company were dismissed.  On June 26, 2003, counsel for the plaintiff class announced that they and counsel for the issuers had agreed to the form of a Memorandum of Understanding (the “Memorandum”) to settle claims against the issuers.  The terms of that Memorandum provide that class members will be guaranteed $1 billion in recoveries by the insurers of the issuers and that settling issuer defendants will assign to the class members certain claims that they may have against the underwriters.  Issuers also agree to limit their abilities to bring certain claims against the underwriters.  If recoveries in excess of $1 billion are obtained by the class from any non-settling defendants, the settling defendants’ monetary obligations to the class plaintiffs will be satisfied; any amount recovered from the underwriters that is less than $1 billion will be paid by the insurers on behalf of the issuers.  The Memorandum, which is subject to the approval of each issuer, was approved by a special committee of the priceline.com Board of Directors on Thursday, July 3, 2003.  Thereafter, counsel for the plaintiff class and counsel for the issuers agreed to the form of a Stipulation and Agreement of Settlement with Defendant Issuers and Individuals (“Settlement Agreement”).  The Settlement Agreement implements the Memorandum and contains the same material provisions.  On June 11, 2004, a special committee of the priceline.com Board of Directors authorized the Company’s counsel to

18




execute the Settlement Agreement on behalf of the Company.  The Settlement Agreement is subject to final approval by the Court and the process to obtain that approval is still pending.

Subsequent to the Company’s announcement on September 27, 2000, that revenues for the third quarter 2000 would not meet expectations, it was served with putative class action complaints that were assigned to Judge Dominic J. Squatrito.  On September 12, 2001, Judge Squatrito ordered that these cases be consolidated under the Master File No. 3:00cv1884 (DJS), and he designated lead plaintiffs and lead plaintiffs’ counsel.  On October 29, 2001, plaintiffs served a Consolidated Amended Complaint.  On February 5, 2002, Amerindo Investment Advisors, Inc., who was one of the lead plaintiffs in the consolidated action, made a motion for leave to withdraw as lead plaintiff.  The Court granted that motion on May 30, 2002.  On February 28, 2002, the Company filed a motion to dismiss the Consolidated Amended Complaint.  On October 7, 2004, the Court issued a Memorandum of Decision granting, in part, and denying, in part, the Company’s motion.  An initial scheduling order was entered by the Court on November 2, 2004.  Plaintiffs filed a motion for class certification on January 7, 2005 and the Company filed its opposition to that motion.  On April 4, 2006, the Court issued a Memorandum of Decision granting, in part, and denying, in part, the plaintiffs’ motion.  The Court certified a class and approved five of the six proposed class representatives.  On May 4, 2006, the case was transferred to Judge Christopher F. Droney.  Plaintiffs filed a motion for an order approving the proposed notice of class certification on May 5, 2006 and the Company filed its response to that motion.  On May 18, 2006, the case was transferred to Judge Alfred V. Covello.  On October 30, 2006, the Court issued an Order setting forth a partial schedule, designating December 31, 2007 as the deadline for the completion of discovery.

19




 

On May 3, 2007, the Company entered into a Stipulation and Agreement of Settlement (“Settlement Agreement”) to settle the shareholder class action.  The Settlement Agreement is contingent upon the satisfaction of various conditions, including, without limitation, preliminary approval by the Court and final approval by the Court after notice to the class and a hearing.  There can be no assurance that the Settlement Agreement will be approved by the Court.  Under the terms of the Settlement Agreement, the class will receive $80 million in return for a release, with prejudice, of all claims against the Company and the individual defendants that are related to the purchase of the Company’s securities by class members during the class period.  The Company’s insurance carriers will fund $30 million of the settlement.  As a result, the Company incurred a first quarter 2007 net charge of approximately $54.9 million representing its share of the cost to settle the litigation and cover related expenses. The settlement is subject to approval by the Court after notice to the class.  The Company can terminate the Settlement Agreement if more than a certain percentage of class members opt out of the settlement.  Should the Settlement Agreement be terminated or fail to get final approval by the Court, the Company intends to defend vigorously against this action.  In the absence of a settlement, the Company is unable to predict the outcome of this litigation.

In addition, on November 1, 2000 the Company was served with a complaint that purported to be a shareholder derivative action against its Board of Directors and certain of its current and former executive officers, as well as the Company (as a nominal defendant).  The complaint alleged breach of fiduciary duty and waste of corporate assets.  The action is captioned Mark Zimmerman v. Richard Braddock, J. Walker, D. Schulman, P. Allaire, R. Bahna, P. Blackney, W. Ford, M. Loeb, N. Nicholas, N. Peretsman, and priceline.com Incorporated, 18473-NC (Court of Chancery of Delaware, County of New Castle, State of Delaware).  On February 6, 2001, all defendants moved to dismiss the complaint for failure to make a demand upon the Board of Directors and failure to state a cause of action upon which relief can be granted.  Pursuant to a stipulation by the parties, an amended complaint was filed on June 21, 2001.  Defendants renewed their motion to dismiss on August 20, 2001, and plaintiff served

20




his opposition to that motion on October 26, 2001.  Defendants filed their reply brief on January 7, 2002.  On December 20, 2002, the Court granted defendants’ motion without prejudice.  On April 25, 2003, a second amended complaint, adding H. Miller, was filed and a motion seeking leave of court to file the second amended complaint was filed on July 28, 2003.  That motion was fully briefed, and oral argument took place on May 9, 2005. Immediately following oral argument, the Court dismissed three of the four counts in the second amended complaint.  All of the counts against defendants Allaire, Bahna, Blackney, Ford, Loeb, Miller, Peretsman and Schulman have now been dismissed.  On September 8, 2005, the Court granted plaintiff leave to file the second amended complaint as to the one remaining count.  Defendants filed a motion requesting that the Court certify its September 8, 2005 order for interlocutory appeal to the Delaware Supreme Court, and the Court granted that motion on October 6, 2005.  On October 17, 2005, the Delaware Supreme Court accepted the interlocutory appeal.  The appeal was fully briefed, and oral argument took place on February 22, 2006.  In an Order dated April 3, 2006, the Delaware Supreme Court stated that the appeal now is to be scheduled for oral argument and determination by the Court en banc without further briefing.  The en banc argument took place on June 28, 2006.  On September 12, 2006, the Delaware Supreme Court decided in favor of the Company and the Delaware action was thereafter dismissed with prejudice by stipulation.

On November 7, 2003, the Company was served with a complaint that purported to be a shareholder derivative action against its Board of Directors and certain of its current and former executive officers, as well as the Company (as a nominal defendant).  The complaint alleged, among other things, breach of fiduciary duty, waste of corporate assets and misappropriation of corporate information.  The claims in the complaint appear to be substantially repetitive of the claims pending in the derivative action in Delaware which is described above.  The action is captioned Don Powell v. Richard S. Braddock, Jay S. Walker, Daniel H. Schulman, Paul A. Allaire, Ralph M. Bahna, Paul J. Blackney, William E. Ford, Marshall Loeb, N. J. Nicholas, Jr., Nancy B. Peretsman, and Heidi G. Miller and priceline.com Incorporated (Superior Court, Judicial District of Stamford/Norwalk, State of Connecticut).  On January 28, 2004, defendants Blackney, Nicholas, Peretsman and Loeb moved to dismiss the complaint for lack of personal jurisdiction.  On January 29, 2004, defendant Miller moved to dismiss the complaint for lack of personal jurisdiction and for insufficient service of process.  On February 27, 2004, defendants Braddock, Walker, Schulman, Allaire, Bahna, Blackney, Loeb, Nicholas, Peretsman, Miller and priceline.com moved to dismiss the complaint for lack of subject matter jurisdiction and defendants Braddock and Schulman also moved to dismiss the complaint for lack of personal jurisdiction and insufficient service of process.  At a hearing on May 3, 2004, the Court stated that it would not rule on the pending motions until the pending motions in the Delaware action described above are decided.  The Court conducted a subsequent status conference on January 10, 2005, at which it requested that the parties report back no later than March 15, 2005 on the status of the Delaware derivative suit.  On March 15, 2005, the parties informed the Court in writing that the oral argument in the Delaware case had been postponed until May 9, 2005, and that the parties would contact the Court with a status report after that hearing was held.  The Delaware Court dismissed three of the four counts in the second amended complaint in the Delaware derivative suit.  All of the counts against the defendants Allaire, Bahna, Blackney, Ford, Loeb, Miller, Peretsman and Schulman have now been dismissed.  The parties in the Connecticut action advised the Connecticut Court of the Delaware Court’s ruling by letter dated June 6, 2005.  The Delaware Court subsequently granted plaintiff leave to file the second amended complaint as to the one remaining count.  Defendants sought an interlocutory appeal of the Delaware Court’s order, and the Delaware Supreme Court accepted that appeal.  The parties in the Connecticut action advised the Connecticut Court of those developments by letter dated November 3, 2005.  Following the September 12, 2006 decision by the Delaware Supreme Court and the subsequent dismissal of the Delaware derivative action, plaintiffs in the Connecticut action executed a Withdrawal of their case on January 30, 2007.

Airline Excise Tax Refund

The online travel industry recently received guidance in the form of a ruling from the Internal Revenue Service that the fee earned by online intermediaries in connection with the facilitation of the purchase of airline tickets is not subject to Federal Excise Tax.  Due to the prior lack of clear guidance related to the application of federal excise taxes to amounts earned by online travel intermediaries, the Company historically remitted such taxes on the amounts it earned for facilitating the purchase of airline tickets.  The tax at issue was on the amounts earned by the Company and was not added to the ticket price paid by its customers.  Accordingly, the Company sought refunds of the taxes it paid while the on-line travel industry pursued clarification on the issue.  In response to this ruling, the Company has discontinued remitting tax on these amounts.  The Company received notices from the

21




Internal Revenue Service in March 2007 approving refund claims in the amount of $15.9 million, plus interest of $2.8 million and, therefore, the Company recorded the refund receivable in prepaid and other current assets as of March 31, 2007, with corresponding amounts recorded in revenue and interest income.  The Company received notices in April 2007 approving refund claims of an additional amount of approximately $3 million, including estimated accrued interest and therefore expects to record this refund in the second quarter of 2007.

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

The following discussion should be read in conjunction with our financial statements, including the notes to those statements, included elsewhere in this Form 10-Q, and the Section entitled “Special Note Regarding Forward Looking Statements” in this Form 10-Q.  As discussed in more detail in the Section entitled “Special Note Regarding Forward Looking Statements,” this discussion contains forward-looking statements, which involve risks and uncertainties.  Our actual results may differ materially from the results discussed in the forward-looking statements.  Factors that might cause those differences include, but are not limited to, those discussed in “Risk Factors.”

Overview

General.  We are a leading online travel company that offers our customers a broad range of travel services, including airline tickets, hotel rooms, car rentals, vacation packages, cruises and destination services.  We offer our customers a unique choice: the ability to purchase travel services in a traditional, price-disclosed manner or the opportunity to use our unique Name Your Own Price® service, which allows our customers to make offers for travel services at discounted prices.  At present, we derive substantially all of our revenues from the following sources:

·          Transaction revenues from our Name Your Own Price® airline ticket, hotel room and rental car services, as well as our vacation packages service;

·          Commissions earned from the sale of price-disclosed hotel rooms, rental cars, cruises and other travel services;

·          Customer processing fees charged in connection with the sale of both Name Your Own Price® and price-disclosed airline tickets, hotel rooms and rental cars services;

·          Transaction revenue from our price-disclosed hotel room service;

·          Global distribution system (“GDS”) reservation booking fees related to both our Name Your Own Price® airline ticket, hotel room and rental car services, and price-disclosed airline tickets and rental car services; and

·          Other revenues derived primarily from selling advertising on our websites.

Trends.  The online sale of travel services has been one of the fastest growing sectors of the Internet since the late 1990s.  While the online market for travel services continues to experience significant annualized growth, we believe that the domestic market share of third-party distributors, like priceline.com, has declined over the recent past and that the growth of the domestic online market for travel services has slowed.  We believe the decline in market share is attributable, in part, to a concerted initiative by travel suppliers to direct customers to their own websites in an effort to reduce distribution expenses and establish more direct control over their pricing.  In addition, airlines and hotel chains have generally experienced year-over-year increases in load factors (a common metric that measures airplane customer usage) and occupancy rates (a common metric that measures hotel customer usage), respectively, which leaves them with less excess inventory to provide third party intermediaries like priceline.com.  Notwithstanding these trends, we continue to believe that the market for online travel services is an attractive market with continued opportunity for growth, in particular, in certain international markets.

Because we believe that an opportunity for growth exists in certain international markets, and since prior to the fourth quarter of 2004 substantially all of our revenue was generated in the U.S., we have taken steps to expand the markets we serve.  In September 2004, we acquired Booking.com Limited (formerly known as Active Hotels Ltd.), a U.K. based online hotel service.  Booking.com Limited gives us a strong presence in the U.K.’s online hotel market.  Furthermore, in July 2005, we acquired Amsterdam-based Booking.com B.V. (formerly known as Bookings B.V.), one of Europe’s leading Internet hotel reservation services, with offices primarily in Amsterdam, Barcelona, Berlin, Capetown, Dubai, Loule, Paris, Rome, Vienna and Warsaw.  All of our European operations, which are substantially comprised of Booking.com Limited and Booking.com B.V., are majority-owned by us.  A minority interest in our European business is held by our European managers responsible for that business.  We work with a range of chain-owned and independently owned hotels across Europe and in major cities around the world to provide hotel reservations on various websites in multiple languages.

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Our European operations represented approximately 52% of our gross bookings in the three months ended March 31, 2007, and were a substantial contributor to our consolidated operating income during that period and we expect that throughout the remainder of 2007 they will represent a growing percentage of our total gross bookings and operating income.  As our European operations have become more meaningful contributors to our results, we have seen, and expect to continue to see, changes in certain of our operating expenses and other financial metrics.  For example, because our European operations utilize online affiliate and search marketing as principal means of generating traffic to their websites, our online advertising expense has increased significantly since our acquisition of those companies, a trend we expect to continue throughout the remainder of 2007.  In addition, and as discussed in more detail below, since the acquisitions of Booking.com Limited and Booking.com B.V., we have seen the effects of seasonal fluctuation on our results change as a result of different revenue recognition policies that apply to our European hotel service (as well as our domestic retail hotel and rental car services) and the increased importance of European hotel bookings to our results of operations.

The financial prospects of our domestic business have been and continue to be significantly dependent upon the sale of leisure airline tickets and, as a result, the health of our domestic business has been impacted by the health of the airline industry.  In recent years, most domestic airlines, and many of our major suppliers, experienced significant losses.  Those losses were compounded by competition from low-cost carriers and high fuel prices.  As a result of these and other factors, many of the major airlines deeply discounted retail airline tickets to maintain market share, simplified fare structures by removing restrictions associated with certain airline tickets and reduced their total capacity to increase load factors.  Those actions had a detrimental effect on our overall airline business and, in particular, our Name Your Own Price® airline ticket service, which is negatively impacted by (1) increased load factors as airlines have less excess inventory to provide to third party intermediaries in general, and to lower yielding “opaque” services, in particular, like our Name Your Own Price® service, and (2) deep retail discounting because it hurts our value proposition and makes users less willing to accept the trade-offs associated with the Name Your Own Price® service, for what has become, in many cases, modest fare savings.

We rely on fees paid to us by global distribution systems, or GDSs, for travel bookings made through GDSs for a portion of our gross profit and a substantial portion of our operating income. We rebate certain GDS costs to certain suppliers (e.g., airlines, hotels, etc.) in exchange for contractual considerations such as those relating to pricing and availability, and expect to continue to do so in the future.  During 2006, most agreements between GDSs and the major domestic airlines expired, and most airlines have negotiated new agreements with reduced distribution costs for the airlines that went into effect on or around September 1, 2006.  The structure of these new agreements, along with airline pressure on third-party travel intermediaries, such as us, to operate under the new structures, require us to reduce our aggregate compensation and book through lower cost channels to receive airlines’ full content and avoid airline service fees.  We have entered into new agreements with a number of airlines to obtain access to airline content, and are in continuing discussions with others to obtain similar access.  If we were denied access to airlines’ full content or had to incur service fees on our airline tickets, it could have a material adverse effect on our business, results of operations and financial condition.

Additionally, some travel suppliers are encouraging third-party travel intermediaries, such as us, to develop technology to bypass the traditional GDSs, such as enabling direct connections to the travel suppliers or using alternative global distribution methods recently developed by new entrants to the global distribution marketplace, such as G2 Switchworks Corp.  Such new entrants propose using technology that is less complex than traditional global distribution systems, and that enables the distribution of airline tickets in a manner that is more cost-effective to the airline suppliers.  To this end, in the first quarter 2006, we entered into an agreement with G2 Switchworks for the provision of GDS services.  In addition, to further reduce our dependence on Worldspan, L.P., in the first quarter 2006, we entered into an agreement for the provision of GDS services with Sabre Inc.  Development of the technology to connect to such alternative GDSs, or to enable direct connections to travel suppliers, requires the use of information technology resources and could cause us to incur additional operating expenses, increase the frequency/duration of system problems and delay other projects.  Furthermore, our contractual obligations to Worldspan, L.P., which expire on December 31, 2007, may limit our ability to pursue the most financially attractive GDS options during the term of our agreement with Worldspan, L.P.

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As a result of the continued decline in sales of Name Your Own Price® airline tickets over the last several years, we have taken and expect to continue to take steps to diversify our revenue among “non-opaque” services, such as allowing our customers to purchase price-disclosed retail airline, hotel, rental car and other travel services, which we believe will help broaden our customer appeal.

We intend to continue to execute on our strategy of diversifying our service offerings and markets, through both continued internal development of services and, if appropriate, acquisitions.  As a result of the diversification described above, the growth rates for our “agency” businesses, which are generally comprised of our price-disclosed retail services, have, over the recent past, significantly exceeded the growth rates for our “merchant” businesses, which are comprised primarily of our slower-growing Name Your Own Price® services.

We believe that our success will depend in large part on our ability to maintain profitability, primarily from our leisure travel business, to continue to promote the priceline.com brand in the United States and the Booking.com brand in Europe and, over time, to offer other travel services and further expand into international markets. Factors beyond our control, such as the outbreak of an epidemic or pandemic disease; natural disasters such as hurricanes, tsunamis or earthquakes; terrorist attacks, hostilities in the Middle East or elsewhere; or the liquidation of major domestic airlines now in bankruptcy, the bankruptcy of an additional carrier or the withdrawal from our system of a major airline (or the consolidation of our major airline suppliers) or hotel supplier, could adversely affect our business and results of operations and impair our ability to effectively implement all or some of the initiatives described above.  We intend to continue to invest in marketing and promotion, technology and personnel within parameters consistent with attempts to improve operating results.  We also intend to broaden the scope of our business, and to that end, we explore strategic alternatives from time to time in the form of, among other things, mergers and acquisitions.  Our goal is to improve volume and sustain gross margins in an effort to maintain profitability. The uncertain environment described above makes the prediction of future results of operations difficult, and accordingly, we cannot provide assurance that we will sustain revenue growth and profitability.

Seasonality.  Prior to introducing a retail travel option to our customers, substantially all of our business was conducted under the Name Your Own Price® system and accordingly, because those services are generally non-refundable in nature, we recognize travel revenue at the time a booking is generated.  However, we recognize revenue generated from our retail hotel services, including our European operations, at the time that the customer checks out of the hotel.  As a result, a meaningful amount of retail hotel bookings generated earlier in the year, as customers plan and reserve their spring and summer vacations, will not be recognized until future quarters. From a cost perspective, however, we expense the substantial majority of our advertising activities as they are incurred, which is typically in the quarter in which bookings are generated.  Therefore, as our retail hotel business continues to grow, we expect our quarterly results to become increasingly impacted by these seasonal factors.

Recent Accounting Pronouncements.  In July 2006, the FASB issued Interpretation No. 48, “Uncertainty in Income Taxes” (“FIN 48”).  FIN 48 applies to all tax positions and clarifies the recognition of tax benefits in the financial statements by providing for a two-step approach of recognition and measurement. The first step involves assessing whether the tax position is more likely than not to be sustained upon examination based upon its technical merits. The second step involves measurement of the amount to recognize.  Tax positions that meet the more likely than not threshold are measured at the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate finalization with the taxing authority.  We adopted FIN 48 on January 1, 2007. The adoption of FIN 48 did not have a material impact on our consolidated results of operations and financial position.

Recent Developments.  On May 3, 2007, we agreed to settle the securities class action litigation that was filed against us in 2000 (described in Note 14 to the Unaudited Consolidated Financial Statements).  Under the terms of the settlement agreement, the class will receive $80 million in return for a release, with prejudice, of all claims against us and the individual defendants that are related to the purchase of our securities by class members during the class period.  Our insurance carriers will fund $30 million of the settlement.  As a result, we incurred a first quarter 2007 net charge of approximately $54.9 million representing our share of the cost to settle the litigation and cover related expenses, with a related tax benefit in the amount of $21.9 million.  The settlement agreement is contingent upon various conditions, including preliminary approval by the Court and final approval after notice to the class and a hearing.  There can be no assurance that the settlement agreement will be approved by the Court.  We can terminate the settlement agreement if more than a

25




certain percentage of class members opt out of the settlement.

We received notices from the Internal Revenue Service in March and April that our refund requests for excise taxes paid on merchant airline tickets had been approved for payment.  As a result, we recorded in the first quarter 2007 approximately $15.9 million in revenue and approximately $2.8 million in related accrued interest representing the amounts approved in the March IRS notice, with a related income tax expense in the amount of $7.5 million.  We expect to record an additional amount of approximately $3 million of income in the second quarter 2007 related to the April notice, including estimated accrued interest.

Results of Operations

Three Months Ended March 31, 2007 compared to the Three Months Ended March 31, 2006

Operating Metrics

Our financial results are driven by certain operating metrics that encompass the selling activity generated by our travel services.  Specifically, sales of airline tickets, hotel room nights and rental car days capture the volume of units purchased by our customers.  Gross Bookings capture the total dollar value inclusive of taxes and fees of all travel services purchased by our customers.

The number of airline tickets, hotel room nights and rental car days sold through our websites and the related gross bookings were as follows:

 

 

Gross
Bookings

 

Airline
Tickets

 

Hotel
Room
Nights

 

Rental
Car Days

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 2007

 

$

998 million

 

639,000

 

6.0 million

 

2.0 million

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 2006

 

$

747 million

 

728,000

 

4.2 million

 

1.6 million

 

 

Gross bookings increased by 33.7% for the three months ended March 31, 2007, compared to the same period in 2006.  The increase was driven primarily by an increase of 47.9% in “agency” bookings for the three months ended March 31, 2007, which was primarily attributable to growth in our European operations, and the increased sale of retail rental cars, which was partially offset by a decrease in the sale of agency airline tickets.  Merchant gross bookings increased by 8.1% for the three months ended March 31, 2007, over the same period in 2006.  The increase was primarily due to an increase in merchant gross bookings relating to our Name Your Own Price® hotel service and an increase in the sale of Name Your Own Price® rental car days, partially offset by a decrease in gross bookings of our Name Your Own Price® airline ticket service due to a decline in average fares.

Airline tickets sold decreased by 12.2% for the three months ended March 31, 2007, compared to the same period in 2006, primarily due to a decrease in the sale of retail airline tickets, partially offset by an increase in the sale of Name Your Own Price® airline tickets.

Hotel room nights sold increased by 43.4% for the three months ended March 31, 2007, compared to the same period in 2006, primarily due to growth in our hotel room nights sold through our European operations and our Name Your Own Price® hotel service.  This increase was partially offset by a decline in our domestic retail merchant hotel service due to the previously discussed expiration of our agreement with Orbitz whereby Orbitz generated bookings of retail merchant hotel rooms using our booking engine and our negotiated rates in return for a commission.

Rental car days sold increased by 23.6% for the three months ended March 31, 2007, compared to the same period in 2006, due to increases in sales of our Name Your Own Price® and retail rental car services.

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Revenues

We classify our revenue into three categories:

·      Merchant revenues are derived from transactions where we are the merchant of record and are responsible for, among other things, collecting receipts from our customers, selecting suppliers and remitting payments to our suppliers.  Merchant revenues include (1) transaction revenues representing the selling price of Name Your Own Price® airline tickets, hotel rooms, rental cars and price-disclosed vacation packages; (2) transaction revenues representing the amount charged to a customer, less the amount charged by suppliers in connection with the hotel rooms provided through our merchant price-disclosed hotel service; (3) customer processing fees charged in connection with the sale of Name Your Own Price® airline tickets, hotel rooms and rental cars and merchant price-disclosed hotels; and (4) ancillary fees, including GDS reservation booking fees related to certain of the aforementioned transactions.

·      Agency revenues are derived from travel related transactions where we are not the merchant of record and where the prices of our services are determined by third parties. Agency revenues include travel commissions, customer processing fees and GDS reservation booking fees related to certain of the aforementioned transactions and are reported at the net amounts received, without any associated cost of revenue.

·      Other revenues are derived primarily from advertising on our websites.

We continue to experience a shift in the mix of our travel business from a business historically focused exclusively on the sale of domestic point-of-sale travel services to a business that includes the sale of European point-of-sale hotel services.  Because our domestic services include merchant Name Your Own Price® travel services, which are reported on a “gross” basis, while both our domestic and European retail travel services are primarily recorded on a “net” basis, revenue increases and decreases are impacted by changes in the mix of the sale of merchant and retail travel services and, consequently, gross profit has become an increasingly important measure of evaluating growth in our business.  Our European operations contributed approximately $48 million and $22 million to our revenues for the three months ended March 31, 2007, and 2006, respectively.  Approximately $2.2 million of this increase is due to fluctuations in currency exchange rates.

 

Three Months Ended
March 31,

 

 

 

 

 

($000)

 

 

 

 

 

2007

 

2006

 

Change

 

 

 

 

 

 

 

 

 

Merchant Revenues

 

$

246,011

 

$

210,438

 

16.9

%

Agency Revenues

 

54,511

 

30,381

 

79.4

%

Other Revenues

 

867

 

1,095

 

(20.8

)%

Total Revenues

 

$

301,389

 

$

241,914

 

24.6

%

 

Merchant Revenues

Merchant revenue for the three months ended March 31, 2007 increased by 16.9%, compared to the same period in 2006, primarily due to the inclusion of the excise tax refund of $15.9 million.  In addition, there was an increase in revenue related to the sale of Name Your Own Price® hotel room nights and rental car days, partially offset by a decrease in revenue due to a decline in average fares of our Name Your Own Price® airline ticket service.  We received notices from the Internal Revenue Service in March and April that our refund requests for excise taxes paid on merchant airline tickets had been approved for payment.  As a result, we recorded in the first quarter approximately $15.9 million in revenue and approximately $2.8 million in related accrued interest representing the

27




amounts approved in the March IRS notice.  We expect to record an additional amount of approximately $3 million of income in the second quarter 2007 related to the April notice, including estimated accrued interest.

Agency Revenues

Agency revenues for the three months ended March 31, 2007 increased 79.4%, compared to the same period in 2006, primarily as a result of growth in our European operations which contributed $47.0 million and $21.4 million of agency revenue for the three months ended March 31, 2007 and 2006, respectively.

Other Revenues

Other revenues during the three months ended March 31, 2007 consisted primarily of advertising revenues and fees for referring customers to pricelinemortgage.com for home financing services.  Other revenues for the three months ended March 31, 2007 decreased 20.8% compared to the same period in 2006, primarily due to lower online advertising revenue as a result of the restructuring of an advertising partner relationship in 2006.

Cost of Revenues and Gross Profit

 

Three Months Ended
March 31,

 

 

 

 

 

($000)

 

 

 

 

 

2007

 

2006

 

Change

 

 

 

 

 

 

 

 

 

Cost of Merchant Revenues

 

$

181,672

 

$

169,683

 

7.1

%

% of Merchant Revenues

 

73.8

%

80.6

%

 

 

Cost of Agency Revenues

 

 

 

 

% of Agency Revenues

 

0.0

%

0.0

%

 

 

Cost of Other Revenues

 

 

 

 

% of Other Revenues

 

0.0

%

0.0

%

 

 

Total Cost of Revenues

 

$

181,672

 

$

169,683

 

7.1

%

% of Revenues

 

60.3

%

70.1

%

 

 

 

Cost of Revenues

During the three months ended March 31, 2007, cost of revenues increased 7.1%, compared to the same period in 2006, due primarily to an increase in merchant revenues in the same period.  Cost of revenues entirely reflect Name Your Own Price® transactions, whose revenues are recorded “gross” with a corresponding cost of revenue while retail transactions are recorded “net” with no corresponding cost of revenues.

Cost of Merchant Revenues

For the three months ended March 31, 2007, cost of merchant revenues consisted primarily of: (1) the cost of opaque hotel rooms from our suppliers, net of applicable taxes, (2) the cost of opaque airline tickets from our suppliers, net of the federal air transportation tax, segment fees and passenger facility charges imposed in connection with the sale of airline tickets; and (3) the cost of opaque rental cars from our suppliers, net of applicable taxes.  Cost of merchant revenues for the three months ended March 31, 2007 increased 7.1%, compared to the same period in 2006, due primarily to an increase in merchant revenues in the same period.  Merchant price-disclosed hotel revenues are recorded at their net amounts, which are amounts received less amounts paid to suppliers and therefore, there are no associated costs of merchant price-disclosed hotel revenues.

28




Cost of Agency Revenues

Agency revenues are recorded at their net amount, which are amounts received less amounts paid to suppliers, if any, and therefore, there are no costs of agency revenues.

Cost of Other Revenues

For the three months ended March 31, 2007 and 2006, there were no costs of other revenues.

Gross Profit

Total gross profit for the three months ended March 31, 2007 increased by 65.7% compared to the same period in 2006, due to comparable increases in both agency and merchant gross profit.  Total gross margin (gross profit expressed as a percentage of total revenue) increased during the three months ended March 31, 2007, compared to the same period in 2006, because Name Your Own Price® transactions, whose revenues are recorded “gross” with a corresponding cost of revenue, represented a smaller percentage of transactions compared to retail, price-disclosed transactions which are primarily recorded “net” with no corresponding cost of revenues.  Gross margin was also positively impacted by the $15.9 million excise tax refund recorded in merchant revenue in the three months ended March 31, 2007.  Because Name Your Own Price® transactions are reported “gross” and retail transactions are primarily recorded on a “net” basis, we believe that gross profit has become an increasingly important measure of evaluating growth in our business.  Gross profit for our European operations was $47.1 million and $21.6 million for the three months ended March 31, 2007 and 2006, respectively.

 

Three Months Ended
March 31,

 

 

 

 

 

($000)

 

 

 

 

 

2007

 

2006

 

Change

 

 

 

 

 

 

 

 

 

Merchant Gross Profit

 

$

64,339

 

$

40,755

 

57.9

%

Merchant Gross Margin

 

26.2

%

19.4

%

 

 

Agency Gross Profit

 

54,511

 

30,381

 

79.4

%

Agency Gross Margin

 

100.0

%

100.0

%

 

 

Other Gross Profit

 

867

 

1,095

 

(20.8

)%

Other Gross Margin

 

100.0

%

100.0

%

 

 

Total Gross Profit

 

$

119,717

 

$

72,231

 

65.7

%

Total Gross Margin

 

39.7

%

29.9

%

 

 

 

Merchant Gross Profit

Merchant gross profit consists of merchant revenues less the cost of merchant revenues. For the three months ended March 31, 2007, merchant gross profit increased from the same period in 2006, due primarily to an excise tax refund of $15.9 million included in merchant revenue.  In addition, there was an increase in gross profit related to the sale of Name Your Own Price® hotel room nights and rental car days.  The contribution to merchant gross profit from Name Your Own Price® airline ticket sales during the three months ended March 31, 2007 was negatively impacted by a decrease in net GDS fees per ticket as compared to the same period in 2006.

Agency Gross Profit

Agency gross profit consists of agency revenues, which are recorded net of agency costs, if any.  For the three months ended March 31, 2007, agency gross profit increased over the same period in 2006, primarily as a result of growth in our European operations.

29




Other Gross Profit

During the three months ended March 31, 2007, other gross profit decreased from the same period in 2006 primarily due to lower online advertising revenues as a result of the restructuring of an advertising partner relationship in 2006.

Operating Expenses

Advertising

 

Three Months Ended
March 31,

 

 

 

 

 

($000)

 

 

 

 

 

2007

 

2006

 

Change

 

 

 

 

 

 

 

 

 

Offline Advertising

 

$

11,334

 

$

9,438

 

20.1

%

% of Total Gross Profit

 

9.5

%

13.1

%

 

 

Online Advertising

 

$

31,927

 

$

21,861

 

46.0

%

% of Total Gross Profit

 

26.7

%

30.3

%

 

 

 

Offline advertising expenses consist primarily of: (1) the expenses associated with domestic television and radio advertising; and (2) agency fees, the cost for creative talent and production costs for television and radio commercials. For the three months ended March 31, 2007, offline advertising expenses were higher than in the same period in 2006, primarily as a result of increased television advertising during the quarter.  Online advertising expenses primarily consist of the costs of (1) search engine keyword purchases; (2) affiliate programs; (3) banner and other advertisements; and (4) e-mail campaigns.  For the three months ended March 31, 2007, online advertising expenses increased over the same period in 2006, primarily due to an increase in online advertising expenses to support the growth of our European operations, which rely primarily on online advertising to drive their businesses, partially offset by the elimination of advertising fees paid under our agreement with Orbitz, which expired on December 31, 2006, and the imposition of higher efficiency requirements on other online spend.

Sales and Marketing

 

Three Months Ended
March 31,

 

 

 

 

 

($000)

 

 

 

 

 

2007

 

2006

 

Change

 

 

 

 

 

 

 

 

 

Sales and Marketing

 

$

11,410

 

$

9,582

 

19.1

%

% of Total Gross Profit

 

9.5

%

13.3

%

 

 

Sales and marketing expenses consist primarily of (1) credit card processing fees associated with merchant transactions; (2) fees paid to third-party service providers that operate our call centers; (3) provisions for uncollectible hotel commissions; and (4) provisions for credit card chargebacks.  For the three months ended March 31, 2007, sales and marketing expenses, which are substantially variable in nature, increased compared to the same period in 2006, primarily due to increased gross booking volumes.

30




Personnel

 

Three Months Ended
March 31,

 

 

 

 

 

($000)

 

 

 

 

 

2007

 

2006

 

Change

 

 

 

 

 

 

 

 

 

Personnel

 

$

21,490

 

$

16,454

 

30.6

%

% of Total Gross Profit

 

18.0

%

22.8

%

 

 

 

Personnel expenses consist of compensation to our personnel, including salaries, bonuses, taxes, employee health benefits and stock-based compensation. For the three months ended March 31, 2007, personnel expenses increased over the same period in 2006, primarily due to increased personnel expenses associated with head count growth of our European operations and increased employee performance bonus expense.  Stock-based compensation expense was approximately $3.2 million and $3.0 million for the three months ended March 31, 2007 and 2006, respectively.

General and Administrative

 

Three Months Ended
March 31,

 

 

 

 

 

($000)

 

 

 

 

 

2007

 

2006

 

Change

 

 

 

 

 

 

 

 

 

General and Administrative

 

$

63,875

 

$

5,737

 

1,013.4

%

% of Total Gross Profit

 

53.4

%

7.9

%

 

 

 

General and administrative expenses consist primarily of: (1) fees for outside professionals, including litigation expenses; (2) occupancy expenses; and (3) business insurance. General and administrative expenses increased during the three months ended March 31, 2007, over the same period in 2006, due to a $54.9 million expense related to a litigation settlement, additional fees for outside professionals and expenses related to pending litigation, and increased general and administrative expenses associated with the growth of our European operations.  The $54.9 million represents our net cost of the litigation settlement, including related expenses. Under the terms of the litigation settlement agreement, the class will receive $80 million in return for a release, with prejudice, of all claims against us and the individual defendants that are related to the purchase of our securities by class members during the class period.  Our insurance carriers will fund $30 million of the settlement.

Information Technology

 

Three Months Ended
March 31,

 

 

 

 

 

($000)

 

 

 

 

 

2007

 

2006

 

Change

 

 

 

 

 

 

 

 

 

Information Technology

 

$

2,911

 

$

2,307

 

26.2

%

% of Total Gross Profit

 

2.4

%

3.2

%

 

 

 

Information technology expenses consist primarily of: (1) system maintenance and software license fees; (2) data communications and other expenses associated with operating our Internet sites; and (3) payments to outside consultants. For the three months ended March 31, 2007, the increase in information technology expenses was primarily associated with the growth of our European operations.

31




Depreciation and Amortization

 

Three Months Ended
March 31,

 

 

 

 

 

($000)

 

 

 

 

 

2007

 

2006

 

Change

 

 

 

 

 

 

 

 

 

Depreciation and Amortization

 

$

8,505

 

$

7,946

 

7.0

%

% of Total Gross Profit

 

7.1

%

11.0

%

 

 

 

Depreciation and amortization expenses consist of:  (1) amortization of intangible assets with determinable lives; (2) amortization of internally developed and purchased software, (3) depreciation of computer equipment; and (4) depreciation of leasehold improvements, office equipment and furniture and fixtures.  For the three months ended March 31, 2007, depreciation and amortization expense increased from the same period in 2006, primarily as a result of increased depreciation and amortization related to investment in our European operations.

Restructuring Charge

 

Three Months Ended
March 31,

 

 

 

 

 

($000)

 

 

 

 

 

2007

 

2006

 

Change

 

 

 

 

 

 

 

 

 

Restructuring Charge

 

$

 

$

135

 

(100.0

)%

 

In the three months ended March 31, 2006, we recorded a restructuring charge of approximately $135,000, related to vacated leased property.

Interest

 

Three Months Ended
March 31,

 

 

 

 

 

($000)

 

 

 

 

 

2007

 

2006

 

Change

 

 

 

 

 

 

 

 

 

Interest Income

 

$

8,203

 

$

1,575

 

420.8

%

Interest Expense

 

(2,470

)

(1,498

)

64.9

%

Total

 

$

5,733

 

$

77

 

7,345.5

%

 

For the three months ended March 31, 2007, interest income on cash and marketable securities increased over the same period in 2006, primarily due to $2.8 million of accrued interest on our excise tax refund, higher prevailing interest rates and significantly higher cash balances in the three months ended March 31, 2007.  Interest expense increased for the three months ended March 31, 2007 over the same period in 2006, due primarily to an increase in debt balances in 2006, as well as an increase in prevailing interest rates on the variable portion of the interest rate swap agreement related to our 1% Convertible Senior Notes.

32




Taxes

 

Three Months Ended
March 31,

 

 

 

 

 

($000)

 

 

 

 

 

2007

 

2006

 

Change

 

 

 

 

 

 

 

 

 

Income tax benefit

 

$

11,593

 

$

741

 

1,464.5

%

 

Income tax benefit for the three months ended March 31, 2007 and 2006 differs from the expected tax benefit at the U.S. statutory tax rate of 35% due to state income taxes and the foreign tax benefit of interest expense on intercompany debt.  Due to our significant net operating loss carryforwards, we do not expect to pay significant cash taxes on our U.S. federal taxable income tax for the foreseeable future.  We expect to make cash payments for U.S. alternative minimum tax and for certain international taxes.

Equity in Income (Loss) of Investees and Minority Interests

 

Three Months Ended
March 31,

 

 

 

 

 

($000)

 

 

 

 

 

2007

 

2006

 

Change

 

 

 

 

 

 

 

 

 

Equity in Income (Loss) of Investees and Minority Interests

 

$

(93

)

$

201

 

(146.3

)%

 

Equity in income of investees and minority interests for the three months ended March 31, 2007 and 2006, represented (1) minority interests associated with the ownership of priceline.com International that is held by certain managers of that business; and (2) equity in income (loss) of investees, principally comprised of our pro rata share of pricelinemortgage.com’s net results.  The change in equity in income of investees and minority interests for the three months ended March 31, 2007 compared to the same period in 2006 was primarily due to an increase in the minority interest in the earnings of priceline.com International, partially offset by an increase in earnings from our investment in pricelinemortgage.com.

Liquidity and Capital Resources

As of March 31, 2007, we had $455 million in cash and cash equivalents. We generally invest excess cash to make such funds readily available for operating purposes.  Cash equivalents are primarily comprised of highly liquid, high quality, investment grade debt instruments.

All of our merchant transactions are structured such that we collect cash up front from our customers and then we pay most of our suppliers at a subsequent date.  We therefore tend to experience significant swings in supplier payables depending on the absolute level of our cost of revenue during the last few weeks of every quarter.  This can cause volatility in working capital levels and impact cash balances more or less than our operating income would indicate.

Net cash provided by operating activities was $18.8 million and $20.3 million for the three months ended March 31, 2007 and 2006, respectively.  The decrease in operating cash flow in 2007 as compared to 2006 is due primarily to a $6.6 million increase in income taxes paid and a $5.5 million increase in performance bonuses paid to our European employees.  The increase in income taxes paid relates to our European operations and is due to timing of payments as well as higher taxes as a result of increased earnings. Net cash provided by operating activities for the three months ended March 31, 2007 was $18.8 million, resulting from $31.6 million of positive changes in working capital and $1.9 million of non-cash items included in net loss, partly offset by a net loss of $14.7 million.  The changes in working capital for the three months ended March 31, 2007, were primarily related to a $62.3

33




million increase in accounts payable, accrued expenses and other current liabilities, partly offset by a $5.1 million increase in accounts receivable and a $25.4 million increase in prepaid expenses and other current assets.  The increase in accounts payable, accrued expenses and other current liabilities is primarily due to an accrual in the amount of $54.9 million recorded in the three months ended March 31, 2007 related to the settlement of securities litigation described in Note 14 to our Unaudited Consolidated Financial Statements. The remainder of the increase is attributable to accounts payable and deferred merchant bookings.  Increases in accounts receivable, accounts payable and deferred merchant bookings were primarily due to increases in revenues and related cost of revenues attributable to increased hotel and rental car transactions.  The increase in prepaid expenses and other current assets is related to an $18.7 million excise tax refund receivable recorded in March 2007.  Non-cash items were primarily associated with stock-based compensation expense, the deferred income tax benefit, depreciation and amortization of property and equipment and intangible assets, primarily those acquired in our acquisitions of Travelweb, Booking.com Ltd. and Booking.com B.V.  Net cash provided by operating activities for the three months ended March 31, 2006 was $20.3 million, resulting from $9.3 million of positive changes in working capital and $11.1 million of non-cash items included in net loss, partly offset by a net loss of $99,000.  The changes in working capital for the three months ended March 31, 2006, were primarily related to a $17.2 million increase in accounts payable and accrued expenses, partly offset by a $4.2 million increase in accounts receivable.  The increases in accounts receivable and accounts payable were primarily due to increases in revenues and related cost of revenues attributable to increased hotel, vacation package and rental car transactions.  Non-cash items were primarily associated with stock-based compensation expense, the deferred income tax benefit, depreciation and amortization of property and equipment and intangible assets, primarily those acquired in our acquisitions of Travelweb, Booking.com Ltd. and Booking.com B.V.

Net cash provided by (used in) investing activities was $5.6 million and $(14.7 million) for the quarter ended March 31, 2007 and 2006, respectively. We had approximately $8.0 million of investments sales and maturities for the three months ended March 31, 2007.  Excess cash of $12.8 million was used to invest in short-term investments, net of redemptions, for the three months ended March 31, 2006. During the three months ended March 31, 2006, we invested $1.2 million in acquisitions, respectively.  Cash invested in purchases of property and equipment was $2.2 million and $2.1 million for the three months ended March 31, 2007 and 2006, respectively.

Net cash provided by (used in) financing activities was approximately $6.3 million and ($4.4 million) for the three months ended March 31, 2007 and 2006, respectively.  The cash provided by financing activities was primarily related to $7.6 million of proceeds from the exercise of employee stock options, partially offset by $1.4 million of stock repurchases during the three months ended March 31, 2007.  During the three months ended March 31, 2006, the cash used in financing activities was primarily related to $5.6 million of stock repurchases, offset by $1.1 million of proceeds from the exercise of employee stock.

As more fully discussed in Note 13 to the Unaudited Consolidated Financial Statements, as of March 31, 2007, the total minority interest in priceline.com International on a fully diluted basis was approximately 6.4%.  The aggregate fair value of the minority interest in priceline.com International is estimated to be approximately $97.2 million at March 31, 2007, including unvested restricted stock and restricted stock units.  We expect the future fair value of the minority interest to grow based upon expected continued strong performance of the European business.

Based upon the closing price of our common stock for the prescribed measurement periods during the three months ended March 31, 2007, the contingent conversion thresholds on each of our convertible senior note issues were exceeded.  As a result, the notes are convertible at the option of the holder as of March 31, 2007 and, accordingly, have been classified as a current liability in the Unaudited Consolidated Balance Sheets as of that date.  We believe it is highly unlikely that a significant portion of the Notes would be converted prior to maturity because the market value of the Notes exceeds the value that holders of the Notes would receive upon conversion.  However, if holders elect to convert, we would be required to settle the principal amount of the Notes in cash and the conversion premium in cash or shares of common stock.  We would likely fund the repayment with existing cash and cash equivalents, short-term investments, common stock issuances and/or additional borrowings.

34




We believe that our existing cash balances and liquid resources will be sufficient to fund our operating activities, capital expenditures and other obligations through at least the next twelve months. However, if during that period or thereafter, we are not successful in generating sufficient cash flow from operations or in raising additional capital when required in sufficient amounts and on terms acceptable to us, we may be required to reduce our planned capital expenditures and scale back the scope of our business plan, either of which could have a material adverse effect on our future financial condition or results of operations. If additional funds were raised through the issuance of equity securities, the percentage ownership of our then current stockholders would be diluted.  There are no assurances that we will generate sufficient cash flow from operations in the future, that revenue growth or sustained profitability will be realized or that future borrowings or equity sales will be available in amounts sufficient to make anticipated capital expenditures, finance our strategies or repay our indebtedness.

Off-Balance Sheet Arrangements.

As of March 31, 2007, we did not have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

Sections of this Form 10-Q including, in particular, our Management’s Discussion and Analysis of Financial Condition and Results of Operations above, contain forward-looking statements.  These forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict; therefore, actual results may differ materially from those expressed, implied or forecasted in any such forward-looking statements.

Expressions of future goals and expectations or similar expressions including, without limitation, “may,” “will,” “should,” “could,” “expects,” “does not currently expect,” “plans,” “anticipates,” “intends,” “believes,” “estimates,” “predicts,” “potential,” “targets,” or “continue,” reflecting something other than historical fact are intended to identify forward-looking statements.  The factors described below in the section entitled “Factors That May Affect Future Results” could cause our actual results to differ materially from those described in the forward-looking statements.  Unless required by law, we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.  However, readers should carefully review the reports and documents we file from time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.

Risk Factors

The following risk factors and other information included in this Quarterly Report should be carefully considered.  The risks and uncertainties described below are not the only ones we face.  Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations.  If any of the following risks occur, our business, financial condition, operating results and cash flows could be materially adversely affected.

Our European operations’ business model exposes us to certain risks that we have not traditionally experienced in the hotel business.

Our European operations distribute hotel rooms primarily through a retail model, whereby the customer secures a reservation by providing credit card details, but we are not compensated by the hotel property until such customer checks out of the hotel property.  This requires our European operations to pursue collection of commissions relating to hotel room reservations from the hotel properties after the customer has completed his or her stay.  We do not have extensive experience in collecting commissions from hotel properties and failure to sustain an adequate collection rate could negatively impact the business of our European operations.

35




Throughout 2006, our European operations grew their gross bookings in excess of 100% on an annualized basis.  This growth rate has contributed significantly to our growth in revenue, gross profit and earnings per share.  We believe that this growth rate has also been a significant driver in the increase in our stock price over the last year.  We expect our European operations to experience a significant decline in their growth rate in future years because of the sheer size of their business.  Other factors could also cause slowing growth rates in the European business, including travel market conditions, changes in hotel inventory pricing or availability and the competitiveness of the market.  A decline in our European operations’ growth rate could have a negative impact on our future revenue and earnings per share growth rates and, as a consequence, our stock price.

In addition, our European operations rely heavily on various third parties to distribute hotel room reservations, and our European operations’ distribution channels are concentrated among a number of third parties.  Should one or more of such third parties cease distribution of our European operations’ reservations, or suffer deterioration in its search engine ranking, due to changes in search engine algorithms or otherwise, the business of our European operations could be negatively affected.  Similarly, a significant amount of our European business is directed to our own websites through participation in pay-per-click advertising campaigns on Internet search engines whose pricing and operating dynamics can experience rapid change both technically and competitively.  We have experienced increased competition and increased costs associated with our advertising campaigns.  If a major search engine changes its pricing, operating or competitive dynamics in a negative manner, our business, results of operations and financial condition would be adversely affected.

The strategy of our European operations involves rapid expansion into other European countries, many of which have different customs, different levels of customer acceptance of the Internet and different legislation, regulatory environments and tax schemes.  Compliance with foreign legal, regulatory or tax requirements will place demands on our time and resources, and we may nonetheless experience unforeseen and potentially adverse legal, regulatory or tax consequences.  If our European operations are unsuccessful in rapidly expanding into other European countries, our business, results of operations and financial condition would be adversely affected.

We are dependent on the leisure travel industry and certain travel suppliers.

Our financial prospects are significantly dependent upon our sale of leisure airline tickets and other travel services.  Leisure travel, including the sale of leisure airline tickets and hotel rooms, is dependent on personal discretionary spending levels. As a result, sales of leisure travel services tend to decline during general economic downturns and recessions. In addition, unforeseen events, such as terrorist attacks, political instability, regional hostilities, increases in fuel prices, imposition of taxes or surcharges by regulatory authorities, travel related accidents, travel related health concerns and unusual weather patterns also may adversely affect the leisure travel industry. As a result, our business also is likely to be affected by those events. Further, work stoppages or labor unrest at any of the major airlines could materially and adversely affect the airline industry and, as a consequence, have a material adverse effect on our business, results of operations and financial condition.

During the three months ended March 31, 2007, sales of airline tickets from our five largest and two largest airline suppliers accounted for approximately 85.5% and 46.3% of total airline tickets sold, respectively, and Name Your Own Price® hotel room nights from our five largest hotel suppliers accounted for approximately 33.3% of total Name Your Own Price® hotel room nights sold. As a result, we are currently substantially dependent upon the continued participation of these suppliers in our system in order to maintain and continue to grow our total gross profit.

Our arrangements with the airline and hotel suppliers that participate in our system – either Name Your Own Price® or price-disclosed service – generally do not require them to provide any specific quantity of airline tickets or hotel rooms, or to make tickets or rooms available for any particular route, in any geographic area or at any particular price.  During the course of our business, we are in continuous dialogue with our major suppliers about the nature and extent of their participation in our system. The significant reduction on the part of any of our major suppliers of their participation in our system for a sustained period of time or their complete withdrawal could have a material adverse effect on our business, results of operations and financial condition.

36




With respect to our airline suppliers, the airline industry has experienced a shift in market share from full-service carriers to low-cost carriers that focus primarily on discount fares to leisure destinations and we expect this trend to continue.  Some low-cost carriers, such as Southwest and JetBlue, have not historically distributed their tickets through us or other third-party intermediaries.  In addition, certain airlines have significantly limited or eliminated sales of airline tickets through opaque channels, preferring to consistently show the lowest available price on their own website.  In addition, effective January 1, 2007, Continental Airlines ceased participation in our airline ticket service.  If one or more participating airlines were to further limit or eliminate discounting through opaque channels, it could have a material adverse effect on our business, results of operations and financial condition.

Due to our dependence on the airline industry, we could be severely affected by changes in that industry, and, in many cases, we will have no control over such changes or their timing.  Several major U.S. airlines are struggling financially and have either filed for reorganization under the United States Bankruptcy Code or discussed publicly the risks of bankruptcy.  One of our largest airline suppliers, Northwest Airlines, is currently operating under the protection of federal bankruptcy laws, and others, Delta Air Lines and United Airlines have recently emerged from bankruptcy. If a supplier in bankruptcy liquidates or does not emerge from bankruptcy and we are unable to replace such supplier as a participant in priceline.com, our business would be adversely affected. In addition, in the event that another of our major suppliers voluntarily or involuntarily declares bankruptcy and is subsequently unable to successfully emerge from bankruptcy, and we are unable to replace such supplier, our business would be adversely affected.  To the extent other major U.S. airlines that participate in our system declare bankruptcy, they may be unable or unwilling to honor tickets sold for their flights. Our policy in such event would be to direct customers seeking a refund or exchange to the airline, and not to provide a remedy ourselves. Because we are the merchant-of-record on sales of Name Your Own Price® airline tickets to our customers, however, we could experience a significant increase in demands for refunds or credit card charge backs from customers, which could materially and adversely affect our operations and financial results. In addition, because Name Your Own Price® customers do not choose the airlines on which they are to fly, the bankruptcy of a major U.S. airline or even the possibility of a major U.S. airline declaring bankruptcy could discourage customers from using our Name Your Own Price® system to book airline tickets.

If one of our major airline suppliers merges or consolidates with, or is acquired by, another company that either does not participate in the priceline.com system or that participates on substantially lower levels, the surviving company may elect not to participate in our system or to participate at lower levels than the previous supplier.  For example, in September 2005, US Airways and America West merged.  US Airways was a meaningful participant in our Name Your Own Price® system, but America West participated on a very limited basis.  The resulting entity participates in our Name Your Own Price® system, but at much lower levels than US Airways’ historical participation.  The loss of any major airline participant in our Name Your Own Price® system could result in other major airlines electing to terminate their participation in the Name Your Own Price® system, which would further negatively impact our business, results of operations and financial condition.  In addition, fewer independent suppliers reduces opacity and competition among suppliers.  In such event, if we are unable to divert sales to other suppliers, our business, results of operations and financial condition may be adversely affected.

In addition, given the concentration of the airline industry, particularly in the domestic market, our competitors could exert pressure on other airlines not to supply us with tickets. Moreover, the airlines may attempt to establish their own buyer driven commerce service or participate or invest in other similar services.

With respect to our hotel suppliers, improving economic conditions are creating increased demand for hotel rooms and some hotels may reduce the amount of inventory they sell through our service or increase the negotiated rates at which they are willing to provide inventory.  If hotel occupancy rates improve to the point that our hotel suppliers no longer place the same value on our distribution systems, such suppliers may reduce the amount of inventory they make available through priceline.com and/or our European operations.  Similarly, while not dependent on certain hotel chains, the growth rates of our European operations are dependent upon increasing levels of well-priced, demand-based supply from their portfolio of hotel partners.

Many hotels use merchant arrangements with companies like ours to dispose of excess hotel room inventory at wholesale rates. If hotels experience increased demand for rooms, they might reduce the amount of room inventory they make available through our merchant price-disclosed hotel service.  The recent improvement in

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occupancy rates discussed above could cause hotels to reduce the amount of inventory they make available through our merchant price-disclosed hotel service.

In addition, certain hotels have begun initiatives to reduce margins received by third party intermediaries on retail merchant transactions, which is the primary method we employ to distribute retail hotel room reservations in the United States.  Many hotels distribute room inventory through their own websites and therefore might increase negotiated rates for merchant rate inventory sold through our merchant price-disclosed hotel service, decreasing the margin available to us.  While our merchant price-disclosed hotel agreements with our leading hotel suppliers provide for specified discounts, if one or more participating hotels were to require us to limit our merchant margins, upon contract renewal or otherwise, it could have a material adverse effect on our business, results of operations and financial condition.

Intense competition could reduce our market share and harm our financial performance.

We compete with both online and traditional sellers of the services we offer. The market for the services we offer is intensely competitive, and current and new competitors can launch new sites at a relatively low cost. In addition, the major online travel companies with which we compete have significantly greater financial resources and capital than we do.  We may not be able to effectively compete with industry conglomerates such as Travelport, Sabre or Expedia, each of which have access to significantly greater and more diversified resources than we do.

We currently or potentially compete with a variety of companies with respect to each service we offer. With respect to our travel services, these competitors include:

·      Internet travel services such as Expedia, Hotels.com and Hotwire, which are owned by Expedia; Travelocity and lastminute.com, which are owned by the Sabre Group; Orbitz.com, Cheaptickets, Gullivers.com, ebookers plc, octopustravel and Flairview, which are currently owned by Travelport, a subsidiary of the Blackstone Group, laterooms and hotelopia owned by First Choice plc, and Superbreak, Venere, hotel.de and Hotel Reservation Service;

·      travel suppliers such as airlines, hotel companies and rental car companies, many of which have their own branded websites to which they drive business;

·      large online portal and search companies, such as AOL (including AOL Travel), Yahoo! (including Yahoo! Travel) and Google;

·      traditional travel agencies;

·      online travel search sites such as SideStep.com, Mobissimo.com, FareChase.com, Kayak.com (sometimes referred to as “meta-search”) and travel research sites that have search functionality, such as TripAdvisor, Travelzoo and Cheapflights.com; and

·      operators of travel industry reservation databases such as Galileo, Worldspan, L.P., Amadeus and Sabre.

Many airline, hotel and rental car suppliers, including suppliers with which we conduct business, are focusing on driving online demand to their own websites in lieu of third-party distributors such as us.  Certain suppliers have attempted to charge additional fees to customers who book airline reservations through an online channel other than their own website.  Furthermore, many low cost airlines, which are having increasing success in the marketplace, distribute their inventory exclusively through their own websites.  Suppliers who sell on their own websites typically do not charge a processing fee, and, in some instances, offer advantages such as bonus miles or loyalty points, which could make their offerings more attractive to consumers than models like ours.

We potentially face competition from a number of large Internet companies and services that have expertise in developing online commerce and in facilitating Internet traffic, including Amazon.com, AOL, MSN, Google.com and Yahoo!, which compete with us either directly or indirectly through affiliations with other e-commerce or off-line companies.  We also compete with “meta-search” companies, which are companies that leverage their search technology to aggregate travel search results across supplier, travel agent and other websites.  For example, Yahoo! owns FareChase.com, a travel search-engine that searches for fares and hotel rates at travel supplier and third-party

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websites, and refers traffic to those sites, and AOL is party to a marketing and technology agreement, and holds a minority interest in, Kayak.com, another leading meta-search company.  Other established search engine companies as well as start-ups are attempting to enter the online travel marketplace in this manner.  If Yahoo!, Google or other portals decide to refer significant traffic to travel search engines, it could result in more competition from supplier websites and higher customer acquisition costs for third-party sites such as ours.  Competition from these and other sources could have a material adverse effect on our business, results of operations and financial condition.

Many of our current and potential competitors, including Internet directories, search engines and large traditional retailers, have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing, personnel, technical and other resources than priceline.com. Some of these competitors may be able to secure products and services on more favorable terms than we can. In addition, many of these competitors may be able to devote significantly greater resources to:

·      marketing and promotional campaigns;

·      attracting traffic to their websites;

·      attracting and retaining key employees;

·      securing vendors and inventory; and

·      website and systems development.

Increased competition could result in reduced operating margins, loss of market share and damage to our brand. There can be no assurance that we will be able to compete successfully against current and future competitors or that competition will not have a material adverse effect on our business, results of operations and financial condition.

Our business could be negatively affected by changes in search engine algorithms and dynamics.

We utilize Internet search engines, principally through the purchase of travel-related keywords, to generate traffic to our websites.  Our European operations, in particular, rely to a significant extent upon third-party distribution partners that derive substantial business from search engines such as Google.  Search engines such as Google frequently update and change the logic which determines the placement and display of results of a user’s search, such that the placement of links to our sites, and particularly those of our European operations and their affiliates, can be negatively affected.  In a similar way, a significant amount of our European business is directed to our own websites through participation in pay-per-click advertising campaigns on Internet search engines whose pricing and operating dynamics can experience rapid change commercially, technically and competitively.  If a major search engine, such as Google, changes its algorithms in a manner that further negatively affects the search engine ranking of our brands or our third-party distribution partners or changes its pricing, operating or competitive dynamics in a negative manner, our business, results of operations and financial condition would be adversely affected.

We are exposed to fluctuations in currency exchange rates.

As a result of our acquisitions of our European operations, we are conducting a significant and growing portion of our business outside the United States and are reporting our results in U.S. dollars.  As a result, we face exposure to adverse movements in currency exchange rates.  The results of operations of our European operations are exposed to foreign exchange rate fluctuations as the financial results of our European operations are translated from local currency into U.S. dollars upon consolidation.  If the U.S. dollar weakens against the local currency, the translation of these foreign-currency-denominated balances will result in increased net assets, net revenues, operating expenses, and net income or loss.  Similarly, our net assets, net revenues, operating expenses, and net income or loss will decrease if the U.S. dollar strengthens against local currency. Additionally, transactions denominated in currencies other than the functional currency may result in gains and losses that may adversely impact our results of operations.

Our outstanding convertible senior notes could result in substantial shareholder dilution.

Our convertible senior notes are convertible into shares of our common stock if certain specified conditions are met.  Upon conversion, the holder will receive cash for the principal amount of the note and cash or shares of our common stock or a combination of cash and shares of our common stock for the conversion value in excess of such principal amount.  If our stock trades above the conversion prices of the outstanding convertible notes, our diluted share count will increase by the net number of shares that would become issuable to the holders of our outstanding convertible notes and, as a consequence, have a dilutive impact on net income per share.  As an example, at stock prices of $40 per share, $60 per share and $100 per share, our diluted share count would include approximately 0.1 million, 4.8 million and 8.6 million equivalent shares, respectively, related to the conversion premium on our convertible debt (excluding the offsetting impact of the Conversion Spread Hedges described in Note 8 to the Unaudited Consolidated Financial Statemetns).  The Conversion Spread Hedges increase the effective conversion price of the 2011 Notes and the 2013 Notes from $40.38 to $50.47 per share, and reduce the dilution upon conversion of the 2011 Notes and the 2013 Notes.  Since the impact of the Conversion Spread Hedges is anti-dilutive it is excluded from the calculation of net income per share under GAAP until they are exercised upon maturity.

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The unit profitability of our airline ticket business has declined and could continue to decline, as we may be subject to, among other things, competitive pressure and loss or reduction of global distribution system fees.

In recent quarters, the amount of profit we make per airline ticket sold has declined and could continue to decline as we, among other things, experience pressure from suppliers to reduce our profit, strive to remain competitive with other online travel agencies and continue to be subject to reduction of global distribution system, or GDS, fees paid to us. Historically, we have relied on fees paid to us by GDSs for travel bookings made through GDSs for a portion of our gross profit and a substantial portion of our operating income. We rebate certain GDS costs to certain suppliers (e.g., airlines, hotels, etc.) in exchange for contractual considerations such as those relating to pricing and availability, and expect to continue to do so in the future.  During 2006, most agreements between GDSs and the major domestic airlines expired, and most airlines have negotiated new agreements with reduced distribution costs for the airlines that went into effect on or around September 1, 2006.  The structure of these new agreements, along with airline pressure on us to operate under the new structures, requires us to reduce our aggregate compensation and book through lower cost channels to receive airlines’ full content and avoid airline service fees.  We have entered into new agreements with a number of airlines to obtain access to airline content, and are in continuing discussions with others to obtain similar access.  If we were denied access to airlines’ full content or had to impose service fees on our airline tickets, it could have a material adverse effect on our business, results of operations and financial condition.

Additionally, some travel suppliers are encouraging third-party travel intermediaries, such as us, to develop technology to bypass the traditional GDSs, such as enabling direct connections to the travel suppliers or using alternative global distribution methods recently developed by new entrants to the global distribution marketplace, such as G2 Switchworks Corp.  Such new entrants propose using technology that is less complex than traditional global distribution systems, and that enables the distribution of airline tickets in a manner that is more cost-effective to the airline suppliers.  To this end, in the first quarter 2006, we entered into an agreement with G2 Switchworks for the provision of GDS services.  In addition, to further reduce our dependence on Worldspan, L.P., in the first quarter 2006, we entered into an agreement for the provision of GDS services with Sabre Inc.  Development of the technology to connect to such alternative GDSs, or to enable direct connections to travel suppliers, requires the use of information technology resources and could cause us to incur additional operating expenses, increase the frequency/duration of system problems and delay other projects.  Furthermore, our contractual obligations to Worldspan, L.P., which expire on December 31, 2007, may limit our ability to pursue the most financially attractive GDS options during the term of our agreement with Worldspan, L.P.

Our growth cannot be assured. Even if we do experience growth, we cannot assure you that we will grow profitably.

Our business strategies are dependent on the growth of our business. For us to achieve significant growth, consumers and travel suppliers must continue to accept our website as a valuable commercial tool. Consumers who have historically purchased travel services using traditional commercial channels, such as local travel agents and calling suppliers directly, must instead purchase these services on our website. Similarly, travel suppliers will also need to accept or expand their use of our website and view our website as an efficient and profitable channel of distribution for their travel products. Our ability to enhance awareness of the priceline.com brands and offer services that will attract and retain a significant number of new consumers and travel suppliers is not certain, and therefore, our growth may be limited.

Acquisitions could result in operating difficulties.

As part of our business strategy, in September 2004, we acquired Booking.com Limited (formerly known as Active Hotels Ltd.) and, in July 2005, Booking.com B.V. (formerly known as Bookings.com B.V.).  We may enter into additional business combinations and acquisitions in the future.  Acquisitions may result in dilutive issuances of equity securities, use of our cash resources, incurrence of debt and amortization of expenses related to intangible assets acquired.  In addition, the process of integrating an acquired company, business or technology may create unforeseen operating difficulties and expenditures.  The acquisitions of Booking.com B.V. and Booking.com Limited were accompanied by a number of risks, including, without limitation:

·      the need to implement or remediate controls, procedures and policies appropriate for a larger public company at companies that prior to the acquisitions may have lacked such controls, procedures and policies;

·      the difficulty of assimilating the operations and personnel of Booking.com Limited and Booking.com B.V., which are principally located in Cambridge, England, and Amsterdam, The Netherlands, respectively, with and into our operations, which are headquartered in Norwalk, Connecticut;

·      the potential disruption of our ongoing business and distraction of management;

·      the difficulty of incorporating acquired technology and rights into our services and unanticipated expenses related to such integration;

·      the failure to further successfully develop acquired technology resulting in the impairment of amounts currently capitalized as intangible assets;

·      the impairment of relationships with customers of Booking.com B.V. and Booking.com Limited or our own customers as a result of any integration of operations;

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·      the impairment of relationships with employees of Booking.com B.V. and Booking.com Limited or our own business as a result of any integration of new management personnel;

·      the potential unknown liabilities associated with Booking.com B.V. and Booking.com Limited.

We may experience similar risks in connection with any future acquisitions. We may not be successful in addressing these risks or any other problems encountered in connection with the acquisitions of Booking.com B.V. and Booking.com Limited or that we could encounter in future acquisitions, which would harm our business or cause us to fail to realize the anticipated benefits of our acquisitions.  As of March 31, 2007, we had approximately $331 million assigned primarily to the intangible assets and goodwill of Booking.com B.V. and Booking.com Limited, and therefore, the occurrence of any of the aforementioned risks could result in a material adverse impact, including a material impairment of these assets, which could cause us to have to write-down goodwill.  Any such write-down of goodwill could adversely impact our operating results, which would cause our stock price to decline significantly.

We may not be able to keep up with rapid technological and other changes.

The markets in which we compete are characterized by rapidly changing technology, evolving industry standards, consolidation, frequent new service and product announcements, introductions and enhancements and changing consumer demands. We may not be able to keep up with these rapid changes. In addition, these market characteristics are heightened by the emerging nature of the Internet and the apparent need of companies from many industries to offer Internet based products and services. As a result, our future success will depend on our ability to adapt to rapidly changing technologies, to adapt our services to evolving industry standards and to continually improve the performance, features and reliability of our service in response to competitive service and product offerings and the evolving demands of the marketplace. In addition, the widespread adoption of new Internet, networking or telecommunications technologies or other technological changes could require us to incur substantial expenditures to modify or adapt our services or infrastructure.

External or internal security breaches could harm our business.

The secure transmission of confidential information over the Internet is essential in maintaining consumer and supplier confidence in the priceline.com services. Substantial or ongoing security breaches whether instigated internally or externally on our system or other Internet based systems could significantly harm our business. We currently require customers who use certain of our services to guarantee their offers with their credit card, either online or, in some instances, through our toll-free telephone service. It is possible that advances in computer circumvention capabilities, new discoveries or other developments could result in a compromise or breach of customer transaction data.

We incur substantial expense to protect against and remedy security breaches and their consequences. However, we cannot guarantee that our security measures will prevent security breaches. A party (whether internal, external, an affiliate or unrelated third party) that is able to circumvent our security systems could steal customer information or transaction data, proprietary information or cause significant interruptions in our operations. For instance, several major websites have experienced significant interruptions as a result of improper direction of

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excess traffic to those sites, and computer viruses have substantially disrupted e-mail and other functionality in a number of countries, including the United States. Security breaches also could damage our reputation and expose us to a risk of loss or litigation and possible liability. Security breaches could also cause customers and potential customers to lose confidence in our security, which would have a negative effect on the value of our brand.  Our insurance policies carry low coverage limits, which may not be adequate to reimburse us for losses caused by security breaches.

Companies that we have acquired, such as our European operations, and that we may acquire in the future, may employ security and networking standards at levels we find unsatisfactory.  The process of enhancing infrastructure to attain improved security and network standards may be time consuming and expensive and may require resources and expertise that are difficult to obtain.  Such acquisitions increase the number of potential vulnerabilities, and can cause delays in detection of an attack, as well as the timelines of recovery from any given attack. Failure to raise any such standards that we find unsatisfactory could expose us to security breaches that would have an adverse impact on our business, results of operations and financial condition.

We also face risks associated with security breaches affecting third parties conducting business over the Internet. Consumers generally are concerned with security and privacy on the Internet, and any publicized security problems could inhibit the growth of the Internet and, therefore, the priceline.com service as a means of conducting commercial transactions.  Additionally, security breaches at the third-party, supplier or distributor systems upon which we rely could result in negative publicity.

Our processing, storage, use and disclosure of personal data could give rise to liabilities as a result of governmental regulation, conflicting legal requirements or differing views of personal privacy rights.

In our processing of travel transactions, we receive and store a large volume of personally identifiable data.  This data is increasingly subject to legislation and regulations in numerous jurisdictions around the world, including the Commission of the European Union through its Data Protection Directive and variations of that directive in the member states of the European Union.  This government action is typically intended to protect the privacy of personal data that is collected, processed and transmitted in or from the governing jurisdiction.  We could be adversely affected if legislation or regulations are expanded to require changes in our business practices or if governing jurisdictions interpret or implement their legislation or regulations in ways that negatively affect our business, results of operations and financial condition.

In addition, in the aftermath of the terrorist attacks of September 11, 2001 in the United States, government agencies have been contemplating or developing initiatives to enhance national and aviation security, including the Transportation Security Administration’s Computer-Assisted Passenger Prescreening System, known as CAPPS II.  These initiatives may result in conflicting legal requirements with respect to data handling.  As privacy and data protection has become a more sensitive issue, we may also become exposed to potential liabilities as a result of differing views on the privacy of travel data.  Travel businesses have also been subjected to investigations, lawsuits and adverse publicity due to allegedly improper disclosure of passenger information.  These and other privacy developments that are difficult to anticipate could adversely impact our business, results of operations and financial condition.

We rely on the value of the priceline.com and Booking.com brands, along with others, and the costs of maintaining and enhancing our brand awareness are increasing.

We believe that maintaining and expanding the priceline.com brand, and other owned brands, including Booking.com, Lowestfare.com, Rentalcars.com, Breezenet.com, MyTravelGuide.com and Travelweb, are important aspects of our efforts to attract and expand our user and advertiser base.  As our larger competitors spend increasingly more on advertising, we are required to spend more in order to maintain our brand recognition.  Promotion of the priceline.com brand will depend largely on our success in satisfying our customers. In addition, we have spent considerable money and resources to date on the establishment and maintenance of the priceline.com brands, and we will continue to spend money on, and devote resources to advertising, marketing and other brand building efforts to preserve and enhance consumer awareness of the priceline.com brands. We may not be able to successfully maintain or enhance consumer awareness of the priceline.com brands, and, even if we are successful in

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our branding efforts, such efforts may not be cost-effective. If we are unable to maintain or enhance customer awareness of the priceline.com brands in a cost-effective manner, our business, results of operations and financial condition would be adversely affected.

Our financial results will be materially impacted by payment of cash income taxes in the future.

We commenced recording a U.S. tax provision in the third quarter of 2005 upon recording the reversal of a portion of our valuation allowance on our deferred tax assets. Due to our significant net operating loss carryforwards, we do not expect to pay cash taxes on our U.S. federal taxable income tax for the foreseeable future. We expect to make cash payments for U.S. alternative minimum tax and for certain international taxes. We expect that in 2008 and beyond, our European operations will grow their pretax income at higher rates than the U.S. and therefore it is our expectation that our cash tax rate and cash tax payments will increase as our European business generates an increasing share of our pretax income.

We may be unable to generate sufficient cash to repay or repurchase our $570 million Convertible Senior Notes.

As of March 31, 2007, we have $570 million of convertible senior notes outstanding comprised of 2006 1% Notes in an aggregate principal amount of $125 million, 2006 2.25% Notes in an aggregate principal amount of $100 million, 2011 Notes in an aggregate principal amount of $172.5 million and 2013 Notes in an aggregate principal amount of $172.5 million (collectively, the “Notes”).  The holders of the 2006 1% Notes may require us to repurchase the notes on August 1, 2008, the holders of the 2006 2.25% Notes may require us to repurchase the notes on January 15, 2010, 2015 or 2020, and the holders of the 2011 Notes and the 2013 Notes may require us to repurchase the notes upon certain designated events.  The Notes also become convertible if certain specified conditions are met, including if our stock price exceeds contingent conversion levels for a specified period.  Based upon the closing price of the Company’s common stock for the prescribed measurement periods during the three months ended March 31, 2007, the contingent conversion thresholds for each of the Notes were exceeded.  As a result, the Notes are convertible at the option of the holder as of March 31, 2007, and, accordingly, have been classified as a current liability in the Unaudited Consolidated Balance Sheets as of that date.  We believe it is highly unlikely that a significant portion of the Notes would be converted prior to maturity because the market value of the Notes exceeds the value that holders of the Notes would receive upon conversion.  However, if holders elect to convert, we would be required to settle the principal amount of the Notes in cash and the conversion premium in cash or shares of common stock.  We would likely fund the repayment with existing cash and cash equivalents, short-term investments, common stock issuances and/or additional borrowings. It is possible that we may not have sufficient funds or may be unable to arrange for additional financing which would cause us to be in default under our indentures and our business, results of operations and financial condition would be adversely affected.

We face risks related to our intellectual property.

We regard our intellectual property as critical to our success, and we rely on trademark, copyright and patent law, trade secret protection and confidentiality and/or license agreements with our employees, customers, partners and others to protect our proprietary rights. If we are not successful in protecting our intellectual property, it could have a material adverse effect on our business, results of operations and financial condition.

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While we believe that our issued patents and pending patent applications help to protect our business, there can be no assurance that:

·      any patent can be successfully defended against challenges by third parties;

·      pending patent applications will result in the issuance of patents;

·      competitors or potential competitors of priceline.com will not devise new methods of competing with us that are not covered by our patents or patent applications;

·      because of variations in the application of our business model to each of our services, our patents will be effective in preventing one or more third parties from utilizing a copycat business model to offer the same service in one or more categories;

·      new prior art will not be discovered which may diminish the value of or invalidate an issued patent;

·      a third party will not have or obtain one or more patents that prevent us from practicing features of our business or require us to pay for a license to use those features; or

·      our operations do not or will not infringe valid, enforceable patents of third parties.

There has been recent discussion in the press regarding the examination and issuance of so called “business method” patents. As a result, the United States Patent and Trademark Office has indicated that it intends to intensify the review process applicable to such patent applications. The new procedures are not expected to have a direct effect on patents already granted. We cannot anticipate what effect, if any, the new review process will have on our pending patent applications.

We pursue the registration of our trademarks and service marks in the U.S. and internationally. However, effective trademark, service mark, copyright and trade secret protection may not be available in every country in which our services are made available online. We have licensed in the past, and expect to license in the future, certain of our proprietary rights, such as trademarks or copyrighted material, to third parties. These licensees may take actions that might diminish the value of our proprietary rights or harm our reputation.

From time to time, in the ordinary course of our business, we have been subject to, and are currently subject to, legal proceedings and claims relating to the intellectual property rights of others, and we expect that third parties will continue to assert intellectual property claims, in particular patent claims, against us, particularly as we expand the complexity and scope of our business.  We endeavor to defend our intellectual property rights diligently, but intellectual property litigation is extremely expensive and time consuming, and has and is likely to continue to divert managerial attention and resources from our business objectives.  Successful infringement claims against us could result in significant monetary liability or prevent us from operating our business, or portions of our business.  In addition, resolution of claims may require us to obtain licenses to use intellectual property rights belonging to third parties, which may be expensive to procure, or possibly to cease using those rights altogether.  Any of these events could have a material adverse effect on our business, results of operations or financial condition.

Capacity constraints and system failures could harm our business.

We rely on certain third party computer systems and third party service providers, including the computerized central reservation systems of the airline, hotel and rental car industries to satisfy demand for airline tickets, hotel room and rental car reservations. In particular, our travel business is substantially dependent upon the computerized reservation systems of operators of global distribution systems for the travel industry. Any interruption in these third party services systems or deterioration in their performance could prevent us from booking airline, hotel and rental car reservations and have a material adverse effect on our business. Our agreements with some third party service providers are terminable upon short notice and often do not provide recourse for service interruptions. In the event our arrangement with any of such third parties is terminated, we may not be able to find an alternative source of systems support on a timely basis or on commercially reasonable terms and, as a result, it could have a material adverse effect on our business, results of operations and financial condition.

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We also depend upon Paymentech to process our credit card transactions. If Paymentech was wholly or partially compromised, our cash flows could be disrupted until such a time as a replacement process could be put in place with a different vendor.  As we add complexity to our systems infrastructure by adding new supplier and distribution, our total system availability could decline and our results could suffer.

A substantial amount of our computer hardware for operating our services is currently located at the facilities of SAVVIS in New Jersey, AT&T in New York City, IX EUROPE in London, England, TrueServer BV and Redbus Interhouse in the Netherlands. These systems and operations are vulnerable to damage or interruption from human error, floods, fires, power loss, telecommunication failures and similar events. They are also subject to break-ins, sabotage, intentional acts of vandalism and similar misconduct. Despite any precautions we may take, the occurrence of a natural disaster or other unanticipated problems at the SAVVIS facility, the AT&T facility, the IX EUROPE facility or the Redbus Interhouse facility could result in lengthy interruptions in our services. In addition, the failure by SAVVIS, Verizon, AT&T, IX EUROPE, Verizon Business B.V. or TrueServer BV to provide our required data communications capacity could result in interruptions in our service. Any system failure that causes an interruption in service or decreases the responsiveness of the priceline.com service could impair our reputation, damage our brand name and have a material adverse effect on our business, results of operations and financial condition.

Our communications infrastructure and, in some cases, the electrical power supply for our production systems, is provided by vendors such as AT&T, Verizon, IX EUROPE, Verizon Business B.V., TrueServer BV and Verizon.  If they are unable, for any reason, to support the communications infrastructure and electrical power they provide us, instabilities in our systems could increase until such time as we were able to replace their services.

Like many online businesses, we have experienced system failures from time to time. For example, in May 2001, our primary website was interrupted for a period of 12 hours. In addition to placing increased burdens on our engineering staff, these outages create a significant amount of user questions and complaints that need to be addressed by our customer support personnel. Any unscheduled interruption in our service could result in an immediate loss of revenues that can be substantial and may cause some users to switch to our competitors. If we experience frequent or persistent system failures, our reputation and brand could be permanently harmed. We have been taking steps to increase the reliability and redundancy of our system. These steps are expensive, may reduce our margins and may not be successful in reducing the frequency or duration of unscheduled downtime.

We use both internally developed systems and third-party systems to operate the priceline.com service, including transaction processing, order management and financial systems. If the number of users of our services increases substantially, or if critical third-party systems stop operating as designed, we will need to significantly expand and upgrade our technology, transaction processing systems, financial and accounting systems and other infrastructure. We do not know whether we will be able to upgrade our systems and infrastructure to accommodate such conditions in a timely manner, and, depending on the third-party systems affected, our transactional, financial and accounting systems could be impacted for a meaningful amount of time before repair.

If our systems cannot be expanded to cope with increased demand or fails to perform, we could experience:

·      unanticipated disruptions in service;

·      slower response times;

·      decreased customer service and customer satisfaction; or

·      delays in the introduction of new products and services,

any of which could impair our reputation, damage the priceline.com brand and materially and adversely affect our revenues.  While we do maintain redundant systems and hosting services for some of our business, it is possible that we could experience an interruption in our business, and we do not carry business interruption insurance sufficient to compensate us for losses that may occur.

Companies that we have acquired, such as our European operations, and that we may acquire in the future, may present known or unknown capacity/stability or other types of system challenges.  The process of enhancing

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infrastructure to attain improved capacity/scalability and other system characteristics may be time consuming and expensive and may require resources and expertise that are difficult to obtain.  Such acquisitions increase potential downtime, customer facing problems and compliance problems.  Failure to successfully make any such improvements to such infrastructures could expose us to potential capacity, stability, and system problems that would have an adverse impact on our business, results of operations and financial condition.

We have integrated our entire European hotel offerings into a single back-office extranet system operated by Booking.com B.V., in order to allow customers of both Booking.com B.V. and Booking.com Limited to access hotels which may have previously been available only through either Booking.com B.V. or Booking.com Limited.  Because all of our European operations’ hotel offerings are therefore on one platform, in the event that the extranet operated by Booking.com B.V. experiences a system failure, our European operations could be unable to generate hotel bookings, which would have a material adverse effect on our business, results of operations and financial condition.  In addition, in the second quarter of 2006, we started to implement a new financial accounting system at Booking.com B.V., which is expected to improve efficiency and support growth.  The financial accounting system is new to us, however, and as it continues to be developed and refined, it could present unforeseen technical or other issues, including without limitation, systems failures, any of which would place further demands on our European technology and business resources and could adversely impact our European operations.

We recently began utilizing the services of both G2 Switchworks and Sabre Inc. to search for and book some of the airline tickets we make available to consumers.  We believe that this arrangement provides us with the opportunity to access favorable GDS economics with respect to a certain portion of our airline ticket business.  As discussed above, G2 Switchworks is a new entrant to the GDS marketplace and receives its search technology from ITA Software, a third party.  If our access to G2 Switchworks search services becomes limited or unavailable due to technical problems on the part of G2 Switchworks, issues between G2 Switchworks and ITA, or any other reason beyond our control, we would not be able to utilize our most efficient channel for those airline ticket bookings, and our business, results of operations and financial condition could suffer.

If we lose our key personnel or cannot recruit additional personnel, our business may suffer.

We depend on the continued services and performance of our executive officers and other key personnel, both in the United States and Europe. These individuals have acquired specialized knowledge and skills with respect to priceline.com and our domestic and European operations. We do not have “key person” life insurance policies. Our ability to retain key employees could be materially adversely affected by the decline in the market price of our common stock, limitations on our ability to pay cash compensation that is equivalent to cash paid by traditional businesses or, in some instances, larger or better capitalized competitors, and limitations imposed by our employee benefit plans on our ability to issue additional equity incentives. If we do not succeed in attracting new employees or retaining and motivating current and future employees or executive officers, our business could suffer significantly.

Uncertainty regarding state and local taxes.

We file tax returns in such states as required by law based on principles applicable to traditional businesses. In addition, we pay sales and other taxes, including hotel occupancy taxes, to suppliers related to travel services sold through the priceline.com service.  We believe that this practice is consistent with the tax laws of all jurisdictions. On an ongoing basis, we conduct a review and interpretation of the tax laws in various states and other jurisdictions relating to the payment of state and local hotel occupancy and other related taxes.  In connection with our review, we have met and had discussions with taxing authorities in certain jurisdictions but the ultimate resolution in any particular jurisdiction cannot be determined at this time.  Currently, hotels collect and remit hotel occupancy and related taxes to the various tax authorities based on the amounts collected by the hotels. Consistent with this practice, we recover the taxes on the underlying cost of the hotel room night from customers and pay that amount to the hotel operators for payment to the appropriate tax authorities.  As discussed in Note 14 to our Unaudited Consolidated Financial Statements, several jurisdictions have initiated lawsuits indicating the position that sales or hotel occupancy tax is applicable to the differential between the price paid by a customer utilizing our service and the cost of the underlying room.  Additionally, certain municipalities and other taxing jurisdictions have begun formal or informal administrative procedures or stated that they may assert claims against us relating to allegedly unpaid state or local hotel occupancy or related taxes.  Historically, we have not collected taxes on this differential.

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Additional state and local jurisdictions could assert that we are subject to sales or hotel occupancy taxes on this differential and could seek to collect such taxes, either retroactively or prospectively or both. A number of proposals have been made at state and local levels that could impose additional taxes on the sale of products and services through the Internet or the income derived from these sales. Such actions may result in substantial tax liabilities for past and/or future sales and could have a material adverse effect on our business and results of operations. To the extent that any tax authority succeeds in asserting that any such tax collection responsibility exists, it is likely that, with respect to future transactions, we would collect any such additional tax obligation from our customers, which would have the effect of increasing the cost of hotel room nights to our customers and, consequently, could reduce our hotel sales. We will continue to assess the risks of the potential financial impact of additional tax exposure, and to the extent appropriate, we will reserve for those estimated liabilities.

Current economic conditions in the United States are triggering active consideration on ways to generate additional tax revenues by the federal, state and local governments. We cannot predict what changes in tax law or interpretations of such laws may be adopted or assure that such changes or interpretations would not materially impact our business.

Our business is exposed to risks associated with credit card fraud and charge backs.

To date, our results have been negatively impacted by purchases made using fraudulent credit cards. Because we act as the merchant-of-record in a majority of our transactions, we may be held liable for accepting fraudulent credit cards on our website as well as other payment disputes with our customers. Additionally, we are held liable for accepting fraudulent credit cards in certain retail transactions when we do not act as merchant of record.  Accordingly, we calculate and record an allowance for the resulting credit card charge backs.  If we are unable to combat the use of fraudulent credit cards on our website, our business, results of operations and financial condition could be materially adversely affected.

Fluctuations in our financial results make quarterly comparisons and financial forecasting difficult.

Our revenues and operating results have varied significantly from quarter to quarter because our business experiences seasonal fluctuations, which reflect seasonal trends for the travel services offered by our websites. Traditional leisure travel bookings in the United States are higher in the second and third calendar quarters of the year as consumers take spring and summer vacations. In the first and fourth quarters of the calendar year, demand for travel services in the United States generally declines and the number of bookings flattens.  Travel revenues in Europe, on the other hand, have been higher in the third and fourth quarters than in the first and second quarters.  Furthermore, prior to introducing a retail travel option to our customers, substantially all of our business was conducted under the Name Your Own Price® system and accordingly, because those services are non-refundable in nature, we recognize travel revenue at the time a booking was generated.  We recognize revenue generated from our retail hotel service, however, including our European operations, at the time that the customer checks out of the hotel.  As a result, we have seen and expect to continue to see, that a meaningful amount of retail hotel bookings generated earlier in the year, as customers plan and reserve their spring and summer vacations, will not be recognized until future quarters.  This could result in a disproportionate amount of our annual earnings being recognized in later quarters.

Our results may also be affected by seasonal fluctuations in the inventory made available to us by airlines, hotels and rental car suppliers. Our revenues and operating results may continue to vary significantly from quarter to quarter because of these factors. As a result, quarter-to-quarter comparisons of our revenues and operating results may not be meaningful. In addition, due to our limited operating history, a relatively new and unproven business model and an uncertain environment in the travel industry, it may be difficult to predict our future revenues or results of operations.

Because of these fluctuations and uncertainties, our operating results may fail to meet the expectations of securities analysts and investors. If this happens, the trading price of our common stock would almost certainly be materially adversely affected.

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Our stock price is highly volatile.

The market price of our common stock is highly volatile and is likely to continue to be subject to wide fluctuations in response to factors such as the following, some of which are beyond our control:

·      quarterly variations in our operating results;

·      operating results that vary from the expectations of securities analysts and investors;

·      changes in expectations as to our future financial performance, including financial estimates by securities analysts and investors;

·      changes in our capital structure;

·      changes in market valuations of other Internet or online service companies;

·      announcements of technological innovations or new services by us or our competitors;

·      announcements by us or our competitors of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;

·      loss of a major supplier participant, such as an airline or hotel chain;

·      changes in the status of our intellectual property rights;

·      lack of success in the expansion of our business model geographically;

·      announcements by third parties of significant claims or proceedings against us or adverse developments in pending proceedings;

·      additions or departures of key personnel; and

·      stock market price and volume fluctuations.

Sales of a substantial number of shares of our common stock could adversely affect the market price of our common stock by introducing a large number of sellers to the market. Given the volatility that exists for our shares, such sales could cause the market price of our common stock to decline significantly. In addition, fluctuations in our stock price and our price-to-earnings multiple may have made our stock attractive to momentum, hedge or day-trading investors who often shift funds into and out of stocks rapidly, exacerbating price fluctuations in either direction, particularly when viewed on a quarterly basis.

The trading prices of Internet company stocks in general, including ours, have experienced extreme price and volume fluctuations. To the extent that the public’s perception of the prospects of Internet or e-commerce companies is negative, our stock price could decline further, regardless of our results. Other broad market and industry factors may decrease the market price of our common stock, regardless of our operating performance. Market fluctuations, as well as general political and economic conditions, such as a recession or interest rate or currency rate fluctuations, also may decrease the market price of our common stock.  Negative market conditions could adversely affect our ability to raise additional capital.

We are defendants in a number of securities class action litigations. In the past, securities class action litigation often has been brought against a company following periods of volatility in the market price of its securities. To the extent our stock price declines or is volatile, we may in the future be the target of additional litigation. This additional litigation could result in substantial costs and divert management’s attention and resources.

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We are party to legal proceedings which, if adversely decided, could materially adversely affect us.

We are a party to the legal proceedings described in Note 14 to our Unaudited Consolidated Financial Statements.  The defense of the actions described in Note 14 may increase our expenses and an adverse outcome in any of such actions could have a material adverse effect on our business, results of operations and financial condition.

Regulatory and legal uncertainties could harm our business.

The products and services we offer through the priceline.com service are regulated by federal and state governments. Our ability to provide such products and services is and will continue to be affected by such regulations. The implementation of unfavorable regulations or unfavorable interpretations of existing regulations by courts or regulatory bodies could require us to incur significant compliance costs, cause the development of the affected markets to become impractical and otherwise have a material adverse effect on our business, results of operations and financial condition.  See “Uncertainty regarding state and local taxes.”

Item 3.    Quantitative and Qualitative Disclosures About Market Risk

We manage our exposure to interest rate risk and foreign currency risk through internally established policies and procedures and, when deemed appropriate, through the use of derivative financial instruments. We use an interest rate swap agreement to manage interest risk and forward contracts to manage foreign currency risk.  Additional information regarding our interest rate hedge is contained within “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates – Derivative Financial Instruments” Annual Report on Form 10-K for the year ended December 31, 2006.

The objective of our policies is to mitigate potential income statement, cash flow and fair value exposures resulting from possible future adverse fluctuations in rates. We evaluate our exposure to market risk by assessing the anticipated near-term and long-term fluctuations in interest rates and foreign exchange rates. This evaluation includes the review of leading market indicators, discussions with financial analysts and investment bankers regarding current and future economic conditions and the review of market projections as to expected future rates. We utilize this information to determine our own investment strategies as well as to determine if the use of derivative financial instruments is appropriate to mitigate any potential future market exposure that we may face. Our policy does not allow speculation in derivative instruments for profit or execution of derivative instrument contracts for which there are no underlying exposures. We do not use financial instruments for trading purposes and are not a party to any leveraged derivatives.

We did not experience any material changes in interest rate exposures during the three months ended March 31, 2007.  Based upon economic conditions and leading market indicators at March 31, 2007, we do not foresee a significant adverse change in interest rates in the near future.

As of March 31, 2007, the carrying value of our debt is $568.9 million.  We estimate that the fair market value of our debt was $800 million as of March 31, 2007.

As of March 31, 2007, we held an interest rate swap agreement on $45 million notional value of our fixed rate debt.  The fair value cost to terminate this swap as of March 31, 2007 was approximately $1.0 million.  A 10% adverse fluctuation in the 3-month LIBOR rate as of March 31, 2007, would increase the cost to terminate the interest rate swap by approximately $242,000.  Any increase or decrease in the fair value of our interest rate sensitive derivative instruments would be substantially offset by a corresponding decrease or increase in the fair value of the hedged underlying debt.

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As a result of the acquisitions of our European operations, we are conducting a significant and growing portion of our business outside the United States through subsidiaries with Euros and British pounds as their functional currency.  As a result, we face exposure to adverse movements in currency exchange rates as the financial results of our European operations are translated from local currency into U.S. dollars upon consolidation.  If the U.S. dollar weakens against the local currency, the translation of these foreign-currency-denominated balances will result in increased net assets, net revenues, operating expenses, and net income or loss.  Similarly, our net assets, net revenues, operating expenses, and net income or loss will decrease if the U.S. dollar strengthens against local currency. Additionally, foreign exchange rate fluctuations on transactions denominated in currencies other than the functional currency result in gains and losses that are reflected in our Unaudited Consolidated Statement of Operations.  Our European operations are subject to risks typical of international business, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility.

As of March 31, 2007, contracts with notional values of 29.2 million Euros and 3.6 million British Pounds were outstanding to minimize the impact of short-term foreign currency fluctuations on our consolidated operating results.  We may enter into additional forward contracts or other economic hedges in the future.

Additionally, fixed rate investments are subject to unrealized gains and losses due to interest rate volatility.  To the extent that changes in interest rates and currency exchange rates affect general economic conditions, we would also be affected by such changes.

Item 4.    Controls and Procedures

Prior to filing this report, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures.  Based on this evaluation, our principal executive officer and principal financial officer concluded that as of March 31, 2007, our disclosure controls and procedures were effective in timely alerting them to material information required to be included in our periodic SEC reports.

In addition, we reviewed our internal controls and there have been no significant changes in our internal controls or in other factors that could significantly affect those controls to the date of their last evaluation.  In the course of this evaluation, we modify and refine our internal processes as conditions warrant.

In July 2005, we acquired Booking.com B.V., and as a result of that acquisition, we have undertaken a review of their internal controls and intend to make changes, if necessary, that we believe to be appropriate to those internal controls as we integrate its business with ours. In addition, in the second quarter of 2006, we started to implement a new financial accounting system at Booking.com B.V., which is expected to improve efficiency and support growth. The implementation, development and refinement of this financial accounting system is expected to occur in phases through the remainder of 2007 and will likely affect the processes that constitute the Company’s internal control over financial reporting.  As we further integrate Booking.com B.V.’s business and continue with the system implementation, we will continue to review its internal controls and may take further steps to ensure that its internal controls are effective and integrated appropriately.

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PART II - OTHER INFORMATION

Item 1.    Legal Proceedings

A description of material legal proceedings to which we are a party is contained in Note 14 to our Unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for the three months ended March 31, 2007.

Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds

The following table sets forth information relating to repurchases of our equity securities during the three months ended March 31, 2007:

 

ISSUER PURCHASES OF EQUITY SECURITIES

 

 

Period

 

(a) Total Number of
Shares (or Units)
Purchased

 

(b) Average Price Paid
per Share (or Unit)

 

(c) Total Number of
Shares (or Units) 
Purchased as Part of
Publicly Announced 
Plans or Programs

 

(d) Maximum Number
(or Approximate Dollar
Value) of Shares (or
Units) that May Yet Be
Purchased Under the 
Plans or Programs

 

January 1, 2007 –

 

 

 

 

$

44,866,000

(1)

January 31, 2007

 

 

 

 

$

20,447,000

(2)

 

 

 

 

 

 

 

 

 

 

February 1, 2007 –

 

 

 

 

$

44,866,000

(1)

February 28, 2007

 

 

 

 

$

20,447,000

(2)

 

 

 

 

 

 

 

 

 

 

March 1, 2007 –

 

27,263

(3)

$

52.27

 

 

$

44,866,000

(1)

March 31, 2007

 

 

 

 

$

20,447,000

(2)

Total

 

27,263

 

$

52.27

 

 

$

65,313,000

 

 

Item 6.    Exhibits and Reports on Form 8-K

(a)           Exhibits

Exhibit
Number

 

Description

 

 

 

12.1

 

Calculation of Ratio of Earnings to Fixed Charges and Preferred Dividends.

31.1

 

Certification of the Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

 

Certification of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1

 

Certification of Chief Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

 

Certification of Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 


(1)    Pursuant to a stock repurchase program announced on November 2, 2005, whereby the Company was authorized to repurchase up to $50,000,000 of its common stock.

(2)    Pursuant to a stock repurchase program announced on September 21, 2006, whereby the Company was authorized to repurchase up to $150,000,000 of its common stock.

(3)    Pursuant to a general authorization, not publicly announced, whereby the Company is authorized to repurchase shares of its common stock to satisfy employee withholding tax obligations related to stock-based compensation.

 

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(b)           Reports on Form 8-K

On January 18, 2007, we filed a report on Form 8-K in connection with the exercise of certain warrants by Delta Airlines, Inc.; on February 5, 2007, we filed a report on Form 8-K in connection with the promotion of Christopher L. Soder to the position of President, North American Travel; on February 13, 2007, we filed (“furnished” with respect to certain information) a report on Form 8-K in connection with the company’s fourth quarter 2006 and full-year 2006 earnings; on February 13, 2007, we furnished a report on Form 8-K in connection with a presentation to be given by Jeffery H. Boyd and Robert J. Mylod at the Merrill Lynch Internet Software and Services Conference; on February 23, 2007, we filed a report on Form 8-K in connection with certain changes to the our director compensation; on March 5, 2007, we filed a report on Form 8-K in connection with compensatory arrangements of certain officers; and on March 12, 2007, we furnished a report on Form 8-K in connection with a presentation to be given by Jeffery H. Boyd at the JPMorgan Global Internet Conference.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

PRICELINE.COM INCORPORATED

 

(Registrant)

 

 

 

 

 

 

Date: May 10, 2007

By:

/s/ Robert J. Mylod Jr.

 

 

 

Name:

Robert J. Mylod Jr.

 

 

Title:

Chief Financial Officer

 

 

(On behalf of the Registrant and
as principal financial officer)

 

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Exhibit Index

Exhibit
Number

 

Description

12.1

 

Calculation of Ratio of Earnings to Fixed Charges and Preferred Dividends.

31.1

 

Certification of the Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

 

Certification of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1

 

Certification of Chief Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

 

Certification of Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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