-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SvBuQyZ/q5CPUwufcsGqf7752MtVqZQL6pXFkLVQUNdUnFdBX/kiTpvw5/RoSiaM iqog4ST/Cc/RGSrLncOCiQ== 0001104659-08-031803.txt : 20080509 0001104659-08-031803.hdr.sgml : 20080509 20080509151044 ACCESSION NUMBER: 0001104659-08-031803 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20080331 FILED AS OF DATE: 20080509 DATE AS OF CHANGE: 20080509 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PRICELINE COM INC CENTRAL INDEX KEY: 0001075531 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-BUSINESS SERVICES, NEC [7389] IRS NUMBER: 061528493 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-25581 FILM NUMBER: 08817990 BUSINESS ADDRESS: STREET 1: 800 CONNECTICUT AVE CITY: NORWALK STATE: CT ZIP: 06854 BUSINESS PHONE: 2037053000 10-Q 1 a08-13867_110q.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, 2008

 

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  NOo.

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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, 2008:

 

Common Stock, par value $0.008 per share

 

38,518,359

(Class)

 

(Number of Shares)

 

 



 

priceline.com Incorporated

Form 10-Q

 

For the Three Months Ended March 31, 2008

 

PART I - FINANCIAL INFORMATION

3

 

 

Item 1. Unaudited Consolidated Financial Statements

3

 

 

Consolidated Balance Sheets (unaudited) at March 31, 2008 and December 31, 2007

3

Consolidated Statements of Operations (unaudited) For the Three Months Ended March 31, 2008 and 2007

4

Consolidated Statement of Changes in Stockholders’ Equity (unaudited) For the Three Months Ended March 31, 2008

5

Consolidated Statements of Cash Flows (unaudited) For the Three Months Ended March 31, 2008 and 2007

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

51

 

 

Item 4. Controls and Procedures

52

 

 

PART II - OTHER INFORMATION

54

 

 

Item 1. Legal Proceedings

54

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

54

Item 6. Exhibits

55

 

 

SIGNATURES

56

 

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,

 

 

 

2008

 

2007

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

508,235

 

$

385,359

 

Restricted cash

 

2,919

 

1,350

 

Short-term investments

 

41,426

 

122,499

 

Accounts receivable, net of allowance for doubtful accounts of $3,783 and $2,309, respectively

 

97,261

 

70,712

 

Prepaid expenses and other current assets

 

33,757

 

33,080

 

Total current assets

 

683,598

 

613,000

 

 

 

 

 

 

 

Long-term investments

 

7,536

 

2,451

 

Property and equipment, net

 

26,885

 

27,088

 

Intangible assets, net

 

182,841

 

182,748

 

Goodwill

 

295,332

 

287,159

 

Deferred taxes

 

212,784

 

218,519

 

Other assets

 

19,215

 

19,891

 

Total assets

 

$

1,428,191

 

$

1,350,856

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

68,934

 

$

47,708

 

Accrued expenses and other current liabilities

 

55,946

 

59,589

 

Deferred merchant bookings

 

23,948

 

17,750

 

Convertible debt

 

570,077

 

569,796

 

Total current liabilities

 

718,905

 

694,843

 

 

 

 

 

 

 

Deferred taxes

 

46,573

 

46,502

 

Other long-term liabilities

 

14,172

 

13,368

 

Total liabilities

 

779,650

 

754,713

 

 

 

 

 

 

 

Commitments and Contingencies (see Note 14)

 

 

 

 

 

Minority interest

 

19,556

 

17,036

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $0.008 par value; authorized 1,000,000,000 shares, 45,187,287 and 45,117,685 shares issued, respectively

 

347

 

346

 

Treasury stock, 6,673,020 and 6,646,408 shares, respectively

 

(492,379

)

(489,106

)

Additional paid-in capital

 

2,135,791

 

2,124,029

 

Accumulated deficit

 

(1,088,352

)

(1,106,506

)

Accumulated other comprehensive income

 

73,578

 

50,344

 

Total stockholders’ equity

 

628,985

 

579,107

 

Total liabilities and stockholders’ equity

 

$

1,428,191

 

$

1,350,856

 

 

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,

 

 

 

2008

 

2007

 

 

 

 

 

 

 

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

 

$

289,159

 

$

246,011

 

Agency revenues

 

109,932

 

54,511

 

Other revenues

 

4,089

 

867

 

Total revenues

 

403,180

 

301,389

 

Cost of merchant revenues

 

222,077

 

181,672

 

Cost of agency revenues

 

 

 

Cost of other revenues

 

 

 

Total costs of revenues

 

222,077

 

181,672

 

Gross profit

 

181,103

 

119,717

 

Operating expenses:

 

 

 

 

 

Advertising – Offline

 

12,031

 

11,334

 

Advertising – Online

 

57,800

 

31,927

 

Sales and marketing

 

16,333

 

11,410

 

Personnel, including stock-based compensation of $9,939 and $3,166, respectively

 

36,883

 

21,490

 

General and administrative, including net cost of litigation settlement of $54,857 in 2007, and option payroll taxes of $488 and $438, respectively

 

11,789

 

63,875

 

Information technology

 

4,149

 

2,911

 

Depreciation and amortization

 

10,353

 

8,505

 

Total operating expenses

 

149,338

 

151,452

 

Operating income (loss)

 

31,765

 

(31,735

)

Other income (expense):

 

 

 

 

 

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

 

4,172

 

8,203

 

  Interest expense

 

(2,671

)

(2,470

)

  Foreign currency transactions and other

 

(5,084

)

(214

)

Total other income (expense)

 

(3,583

)

5,519

 

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

 

28,182

 

(26,216

)

Income tax (expense) benefit

 

(9,518

)

11,593

 

Equity in income (loss) of investees and minority interests

 

(510

)

(93

)

Net income (loss)

 

18,154

 

(14,716

)

Preferred stock dividend

 

 

(1,555

)

Net income (loss) applicable to common stockholders

 

$

18,154

 

$

(16,271

)

Net income (loss) applicable to common stockholders per basic common share

 

$

0.47

 

$

(0.44

)

Weighted average number of basic common shares outstanding

 

38,224

 

37,191

 

Net income (loss) applicable to common stockholders per diluted common share

 

$

0.37

 

$

(0.44

)

Weighted average number of diluted common shares outstanding

 

49,134

 

37,191

 

 

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, 2008

(In thousands)

 

 

 

 

 

 

 

 

 

Accumulated Other

 

 

 

 

 

 

 

Common Stock

 

Additional

 

Accumulated

 

Comprehensive

 

Treasury Stock

 

 

 

 

 

Shares

 

Amount

 

Paid-in Capital

 

Deficit

 

Income

 

Shares

 

Amount

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2008

 

45,118

 

$

346

 

$

2,124,029

 

$

(1,106,506

)

$

50,344

 

(6,646

)

$

(489,106

)

$

579,107

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income applicable to common stockholders

 

 

 

 

18,154

 

 

 

 

18,154

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss on marketable securities

 

 

 

 

 

(6

)

 

 

(6

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Currency translation adjustment

 

 

 

 

 

23,240

 

 

 

23,240

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

41,388

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercise of stock options and vesting of restricted stock units

 

69

 

1

 

1,365

 

 

 

 

 

1,366

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase of common stock

 

 

 

 

 

 

(27

)

(3,273

)

(3,273

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation

 

 

 

9,847

 

 

 

 

 

9,847

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Excess tax benefit on stock-based compensation

 

 

 

550

 

 

 

 

 

550

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, March 31, 2008

 

45,187

 

$

347

 

$

2,135,791

 

$

(1,088,352

)

$

73,578

 

(6,673

)

$

(492,379

)

$

628,985

 

 

See Notes to Unaudited Consolidated Financial Statements.

 

5



 

priceline.com Incorporated

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

 

 

Three Months Ended
March 31,

 

OPERATING ACTIVITIES:

 

2008

 

2007

 

Net income (loss)

 

$

18,154

 

$

(14,716

)

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

Depreciation

 

3,608

 

2,576

 

Amortization

 

7,017

 

5,929

 

Provision for uncollectible accounts, net

 

1,942

 

1,799

 

Deferred income taxes

 

2,527

 

(12,451

)

Stock-based compensation expense

 

9,939

 

3,166

 

Amortization of debt issuance costs

 

771

 

763

 

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

 

510

 

93

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(25,700

)

(5,104

)

Prepaid expenses and other current assets

 

1,757

 

(25,355

)

Accounts payable, accrued expenses and other current liabilities

 

21,902

 

61,280

 

Other

 

955

 

773

 

Net cash provided by operating activities

 

43,382

 

18,753

 

INVESTING ACTIVITIES:

 

 

 

 

 

Purchase of investments

 

(16,678

)

 

Redemption of investments

 

94,131

 

7,996

 

Acquisitions and other equity investments, net of cash acquired

 

(463

)

 

Additions to property and equipment

 

(2,854

)

(2,217

)

Change in restricted cash

 

(1,536

)

(160

)

Net cash provided by investing activities

 

72,600

 

5,619

 

FINANCING ACTIVITIES:

 

 

 

 

 

Repurchase of common stock

 

(3,273

)

(1,425

)

Proceeds from exercise of stock options

 

1,366

 

7,589

 

Excess tax benefit on stock-based compensation

 

550

 

169

 

Net cash (used in) provided by financing activities

 

(1,357

)

6,333

 

Effect of exchange rate changes on cash and cash equivalents

 

8,251

 

706

 

Net increase in cash and cash equivalents

 

122,876

 

31,411

 

Cash and cash equivalents, beginning of period

 

385,359

 

423,577

 

Cash and cash equivalents, end of period

 

$

508,235

 

$

454,988

 

 

 

 

 

 

 

SUPPLEMENTAL CASH FLOW INFORMATION:

 

 

 

 

 

 

 

 

 

 

 

Cash paid during the period for income taxes

 

$

8,790

 

$

6,645

 

 

 

 

 

 

 

Cash paid during the period for interest

 

$

3,534

 

$

2,958

 

 

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, 2007.

 

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. The functional currency of the Company’s foreign subsidiaries is generally their respective local currency.  Assets and liabilities are translated into U.S. dollars at the rate of exchange existing at the balance sheet date.  Income statement amounts are translated at the average exchange rates for the period.  Translation gains and losses are included as a component of “accumulated other comprehensive income” in the accompanying Consolidated Balance Sheets.  Foreign currency transaction gains and (losses) are included in the Consolidated Statement of Operations, principally in “foreign currency transactions and other.”

 

From time to time, the Company enters into derivatives with counterparties to minimize the impact of short-term foreign currency fluctuations on consolidated operating results.  Realized and unrealized gains and losses resulting from the derivatives are recognized in the period in which they occur.  As of March 31, 2008, derivatives with notional values of 59.4 million Euros and 2.5 million British Pounds were outstanding.  As of December 31, 2007, derivatives with notional amounts of 16.0 million Euros and 3.7 million British Pounds were outstanding.  Foreign exchange losses in the amount of $5.1 million and $0.3 million were recorded in “foreign currency transactions and other” for the three months ended March 31, 2008 and 2007, respectively, and were principally related to foreign exchange derivative contracts.

 

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.

 

Recent Accounting Pronouncements – On January 1, 2008, the Company adopted Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The adoption of  SFAS No. 157 did not have a material impact on the Company’s consolidated financial statements.  See Note 6 for more information regarding fair value measurements.

 

In February 2008, the FASB issued FASB Staff Position No. SFAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”).  FSP 157-2 defers the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years, and interim periods within those fiscal years, beginning after November 15, 2008. The Company is evaluating the impact of adopting the provisions of FSP 157-2.

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. The standard requires unrealized gains and losses to be included in earnings for items reported using the fair value option.  SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for financial statements issued for fiscal years beginning

 

7



 

after November 15, 2007. The Company did not elect the fair value option described in SFAS No. 159 for financial instruments and certain other items.

 

In December 2007, the FASB issued SFAS No. 141 (R), “Business Combinations” (“SFAS No. 141(R)”). SFAS No. 141(R) requires an entity to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date.  Subsequent changes to the estimated fair value of contingent consideration will be reflected in earnings until the contingency is settled.  SFAS No. 141(R) also requires acquisition-related costs and restructuring costs to be expensed as incurred rather than treated as part of the purchase price. The adoption of SFAS No. 141(R) will change the Company’s accounting treatment for business combinations on a prospective basis beginning January 1, 2009.

 

In April 2008, the FASB issued FASB Staff Position No. FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP FAS 142-3”).  In determining the useful life of acquired intangible assets, FSP FAS 142-3 removes the requirement to consider whether an intangible asset can be renewed without substantial cost of material modifications to the existing terms and conditions and, instead, requires an entity to consider its own historical experience in renewing similar arrangements. FSP FAS 142-3 also requires expanded disclosure related to the determination of intangible asset useful lives.  The FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and may impact any intangible assets the Company acquires.

 

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS No. 160”). SFAS No. 160 changes the accounting and reporting for minority interests, which will be characterized as non-controlling interests and classified as a component of equity. SFAS No. 160 is effective for the Company on a prospective basis in the first quarter of fiscal year 2009. The Company has not yet determined the impact on its consolidated financial statements of adopting SFAS No. 160.

 

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities - an Amendment of FASB Statement 133.” SFAS No. 161 provides new disclosure requirements for an entity’s derivative and hedging activities. SFAS No. 161 is effective for periods beginning after November 15, 2008. The Company has not yet determined the impact on its consolidated financial statements of adopting SFAS No. 161.

 

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 $9.9 million and $3.2 million for the three months ended March 31, 2008 and 2007, 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, 2008, the Company made broad-based grants of 28,558 restricted stock units and 179,402 performance share units.  The restricted stock units generally vest 25% per year over 4 years and the performance share units generally vest on the third anniversary of the date of grant.  The share based awards granted had a total grant date fair value of $24.0 million based upon the weighted average grant date fair value per share of $115.33.  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 applicable performance periods, 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 a minimum of 71,261 shares to maximum of 447,999 shares depending on the actual performance of the Company.  Stock-based compensation related to the performance share units is recorded over the vesting period based upon the estimated probable outcome at the end of the performance period.  During the three months ended March 31, 2008, the estimated probable number of shares to be issued at the end of the performance period was increased by 120,043 shares to an aggregate of 299,445 shares.

 

In December 2007, the Company granted 198,500 performance share units to certain European employees.  The 198,500 represents the “target” number of shares of common stock that will be issued if certain financial performance goals are achieved.  The actual number of shares to be issued will be determined in 2011 upon the

 

8



 

completion 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 a minimum of 97,500 shares to a maximum of 595,500 shares.  Stock-based compensation related to the performance share units is recorded based upon the estimated probable outcome at the end of the performance period.  The estimated probable number of shares to be issued at the end of the performance period was increased by 305,690 shares during 2007 and by an additional 91,310 shares to an aggregate of 595,500 shares in the three months ended March 31, 2008.

 

3.             NET INCOME PER SHARE

 

The Company computes basic and diluted net income per share in accordance with SFAS No. 128, “Earnings per Share.” Basic net income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income 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. The warrants underlying Series B Preferred Stock were considered for inclusion in fully diluted net income per share using the “if-converted” method prior to their exercise in the first quarter 2007.

 

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. 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.

 

A reconciliation of the weighted average number of shares outstanding used in calculating diluted earnings per share is as follows (in thousands):

 

 

 

For the Three Months
Ended March 31,

 

 

 

2008

 

2007

 

 

 

 

 

 

 

Weighted average number of basic common shares outstanding

 

38,224

 

37,191

 

Weighted average dilutive stock options, restricted stock, restricted stock units and performance share units

 

1,734

 

 

Assumed conversion of Convertible Senior Notes

 

9,176

 

 

Weighted average number of diluted common and common equivalent shares outstanding

 

49,134

 

37,191

 

 

 

 

 

 

 

Anti-dilutive potential common shares

 

7,281

 

17,750

 

 

Anti-dilutive potential common shares for the three months ended March 31, 2008 and 2007 includes approximately 5.1 million shares and 14.3 million shares, respectively, that could be issued under the Company’s convertible debt if the Company’s stock price increases. 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, $100 per share, $150 per share and $200 per share, common equivalent shares would include approximately 0.1 million, 8.6 million, 10.5 million and 11.5 million equivalent shares, respectively, related to the convertible notes (excluding the offsetting impact of the Convertible Spread Hedges — see Note 9).

 

9



 

4.             RESTRUCTURING

 

At March 31, 2008 and December 31, 2007, the Company had a restructuring liability of $1.1 million and $1.2 million, respectively, for the estimated remaining costs related to leased property vacated by the Company in 2000.  The Company estimates that, based on current available information, the remaining net cash outflows associated with its restructuring related commitments will be paid in 2008-2011. The current portion of the restructuring accrual in the amount of $0.7 million is recorded in “Accrued expenses and other current liabilities” and the $0.4 million non-current portion is recorded in “Other long-term liabilities” on the Company’s Unaudited Consolidated Balance Sheet.

 

5.             INVESTMENTS

 

The following table summarizes, by major security type, the Company’s short-term investments as of March 31, 2008 (in thousands):

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Market Value

 

 

 

 

 

 

 

 

 

 

 

Commercial Paper

 

$

9,991

 

$

3

 

 

$

9,994

 

 

 

 

 

 

 

 

 

 

 

Corporate Notes

 

8,691

 

 

(6

)

8,685

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

12,446

 

96

 

 

12,542

 

 

 

 

 

 

 

 

 

 

 

Foreign government securities

 

10,225

 

 

(20

)

10,205

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

41,353

 

$

99

 

$

(26

)

$

41,426

 

 

The following table summarizes, by major security type, the Company’s short-term investments as of December 31, 2007 (in thousands):

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Estimated Fair
Value

 

 

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$

31,080

 

$

21

 

$

(18

)

$

31,083

 

 

 

 

 

 

 

 

 

 

 

State government and agency securities

 

79,020

 

 

 

79,020

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

9,461

 

49

 

 

9,510

 

 

 

 

 

 

 

 

 

 

 

Foreign government securities

 

2,898

 

 

(12

)

2,886

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

122,459

 

$

70

 

$

(30

)

$

122,499

 

 

10



 

Long-term investments amounting to approximately $7.5 million and $2.5 million as of March 31, 2008 and December 31, 2007, respectively, were comprised of U.S. government securities and corporate notes with a maturity date greater than one year.  The long-term investments are recorded net of unrealized losses of approximately $0.2 million as of March 31, 2008 and December 31, 2007.  There were no material gains or losses related to investments for the three months ended March 31, 2008 or 2007.

 

6.                                      FAIR VALUE MEASUREMENTS

 

Effective January 1, 2008, the Company adopted SFAS No. 157, which defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date.  The standard describes three levels of inputs that may be used to measure fair value:

 

Level 1: Quoted prices in active markets that are accessible by the Company at the measurement date for identical assets and liabilities.

 

Level 2: These prices are not directly accessible by the Company.  Such prices may be based upon quoted prices in active markets or inputs not quoted on active markets, but corroborated by market data.

 

Level 3: Unobservable inputs are used when little or no market data is available.

 

Financial assets and liabilities carried at fair value as of March 31, 2008 are classified in the table below in the categories described above:

 

Dollars in Millions

 

Level 1

 

Level 2

 

Total

 

Short-term investments

 

$

22,747

 

$

18,679

 

$

41,426

 

Long-term investments

 

5,042

 

2,494

 

7,536

 

Interest rate swap derivative assets

 

 

169

 

169

 

Foreign exchange derivative assets

 

 

422

 

422

 

Total assets at fair value

 

$

27,789

 

$

21,764

 

$

49,553

 

 

 

 

 

 

 

 

 

Foreign exchange derivative liabilities

 

$

 

$

4,609

 

$

4,609

 

Total liabilities at fair value

 

$

 

$

4,609

 

$

4,609

 

 

Fair values for investments in U.S. Treasury and foreign governmental securities are considered “level 1” valuations because the Company has access to quoted prices in active markets as of the measurement date.  Fair values for other investments are considered “level 2” instrument valuations because they are obtained from professional pricing sources for these or comparable instruments, rather than direct observation of quoted prices in active markets.  As of March 31, 2008, we did not have any assets or liabilities without observable market values that would require a high level of judgment to determine fair value (level 3 assets). Our derivative instruments are valued using pricing models. Pricing models take into account the contract terms as well as multiple inputs where applicable, such as interest rate yield curve, option volatility and currency rates. Our derivative instruments are typically short-term in nature.

 

As of March 31, 2008, the carrying value of our cash and cash equivalents approximated their fair value and consisted primarily of bank deposits and AAA-rated U.S. Treasury money market funds.

 

11



 

7.             INTANGIBLE ASSETS AND GOODWILL

 

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

 

 

 

March 31, 2008

 

December 31, 2007

 

 

 

 

 

 

 

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

 

$

199,156

 

$

(39,711

)

$

159,445

 

$

191,612

 

$

(34,684

)

$

156,928

 

13 years

 

13 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Technology

 

20,040

 

(15,142

)

4,898

 

27,865

 

(21,191

)

6,674

 

3 years

 

3 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Patents

 

1,489

 

(1,142

)

347

 

1,489

 

(1,133

)

356

 

15 years

 

15 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer lists

 

12,802

 

(11,301

)

1,501

 

12,280

 

(10,546

)

1,734

 

2 – 3 years

 

2 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Internet domain names

 

6,453

 

(1,504

)

4,949

 

6,453

 

(1,343

)

5,110

 

10 years

 

10 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trade names

 

16,117

 

(4,689

)

11,428

 

15,317

 

(4,007

)

11,310

 

5 – 20 years

 

15 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

1,344

 

(1,071

)

273

 

1,725

 

(1,089

)

636

 

1 – 15 years

 

7 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total intangible assets

 

$

257,401

 

$

(74,560

)

$

182,841

 

$

256,741

 

$

(73,993

)

$

182,748

 

 

 

 

 

 

Intangible assets with determinable lives are primarily amortized on a straight-line basis.  Intangible asset amortization expense was approximately $7.0 million and $5.9 million for the three months ended March 31, 2008 and 2007, respectively.

 

The annual estimated amortization expense for intangible assets for the remainder of 2008, the next four years and thereafter is expected to be as follows (in thousands):

 

2008

 

$

17,403

 

2009

 

19,183

 

2010

 

17,518

 

2011

 

17,207

 

2012

 

17,098

 

Thereafter

 

94,432

 

 

 

$

182,841

 

 

A substantial majority of the Company’s goodwill relates to its acquisitions of Booking.com Limited in 2004, Booking.com B.V. in 2005 and subsequent purchases of the minority interest in their parent company, priceline.com International.  The change in goodwill for the three months ended March 31, 2008 consists of the following (in thousands):

 

Balance at January 1, 2008

 

$

287,159

 

Adjustment to purchase price

 

463

 

Currency translation adjustments

 

7,710

 

Balance at March 31, 2008

 

$

295,332

 

 

12



 

8.             OTHER ASSETS

 

Other assets at March 31, 2008 and December 31, 2007 consist of the following (in thousands):

 

 

 

March 31, 2008

 

December 31, 2007

 

Investment in pricelinemortgage.com

 

$

9,140

 

$

9,229

 

Deferred debt issuance costs, net

 

9,261

 

10,032

 

Other

 

814

 

630

 

Total

 

$

19,215

 

$

19,891

 

 

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 $89,000 of losses and approximately $43,000 of income from its investment in pricelinemortgage.com for the three months ended March 31, 2008 and 2007, respectively.  The Company earned advertising fees from pricelinemortgage.com of approximately $2,000 and $4,000 in the three months ended March 31, 2008 and 2007, 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, $172.5 million of aggregate principal amount 0.75% Notes in September 2006 and a $175 million revolving credit facility in September 2007.  Deferred debt issuance costs 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.

 

9.             DEBT

 

Revolving Credit Facility

 

In September 2007, the Company entered into a $175 million five-year revolving credit facility with a group of lenders, which is secured, subject to certain exceptions, by a first-priority security interest on substantially all of the Company’s assets and related intangible assets located in the United States. In addition, the Company’s obligations under the revolving credit facility are guaranteed by substantially all of the assets and related intangible assets of the Company’s material direct and indirect domestic and foreign subsidiaries. Borrowings under the revolving credit facility will bear interest, at the Company’s option, at a rate per annum equal to the greater of (a) JPMorgan Chase Bank, National Association’s prime lending rate and (b) the federal funds rate plus ½ of 1%, plus an applicable margin ranging from 0.25% to 0.75%; or at an adjusted LIBOR for the interest period in effect for such borrowing plus an applicable margin ranging from 1.25% to 1.75%. Undrawn balances available under the revolving credit facility are subject to commitment fees at the applicable rate ranging from 0.25% to 0.375%.

 

The revolving credit facility provides for the issuance of up to $50 million of letters of credit as well as borrowings on same-day notice, referred to as swingline loans, which are available in U.S. dollars, Euros, Pounds Sterling and any other foreign currency agreed to by the lenders. The Company may request that an additional $100 million be added to the revolving credit facility or to enter into one or more tranches of additional term loans. The proceeds of loans made under the facility could be used for working capital or general corporate purposes. As of March 31, 2008, there were no borrowings outstanding under the facility and the Company has issued approximately $14.7 million of letters of credit under the revolving credit facility.

 

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 three months ended

 

13



 

March 31, 2008 and December 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, 2008 and December 31, 2007 and, accordingly, have been classified as a current liability amounting to approximately $570 million in the Unaudited Consolidated Balance Sheet as of that date.  As of March 31, 2008, the estimated fair value of the Convertible Senior Notes was approximately $1.78 billion.  If the note holders were to convert, the Company would deliver approximately $570 million in cash to repay the principal amount of the notes and would deliver cash or shares of common stock, at its option, to satisfy the conversion value in excess of the principal amount.  In 2007, approximately $50,000 and $23,000 of the 2.25% Notes and 1% Notes, respectively, were converted.  In April 2008, the Company received notices of conversion from the holders of approximately $41 million aggregate principal amount of the 1% Notes.  Convertible debt consists of the following as of March 31, 2008 and December 31, 2007 (in thousands):

 

 

 

March 31,
2008

 

December 31,
2007

 

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

 

$

125,127

 

$

124,846

 

$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

 

99,950

 

99,950

 

 

 

 

 

 

 

 

 

$

570,077

 

$

569,796

 

 

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 ranging from $0 to approximately $16.2 million depending upon the date of the transaction and the then current stock price of the Company. No additional payments are due at stock prices in excess of $100 per share.  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 Unaudited Consolidated Statement of Operations. Hedge ineffectiveness was not significant in the three months ended March 31, 2008 and 2007. The fair value of the swap as of March 31, 2008 is an asset of approximately $0.2 million and is recorded in prepaid expenses and other current assets, and as of December 31, 2007, is a liability of approximately $0.1 million, recorded in accrued expenses and other current liabilities with a related adjustment to the carrying value of debt.

 

14



 

In 2006, the Company issued in a private placement $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”).  The 2011 Notes and 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.  No additional payments are due at stock prices in excess of $100 per share.  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.

 

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.

 

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 $13.4 million depending upon the date of the transaction and the then current stock price of the Company. Based on the stock price at March 31, 2008, the Company would be required to make $0.1 million in additional payments.  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,

 

15



 

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.

 

10.          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, repurchases of 26,612 and 27,263 shares at aggregate costs of $3.3 million and $1.4 million were made in the three months ended March 31, 2008 and 2007, 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, 2008, there were approximately 6.7 million shares of the Company’s common stock held in treasury.

 

11.          REDEEMABLE PREFERRED STOCK

 

In the three months ended March 31, 2007, Delta Airlines, Inc. 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, and the Company issued a final pro-rated dividend to Delta Airlines, Inc. in the amount of 34,874 shares of common stock, resulting in a non-cash dividend charge of $1.6 million.  The exercise of the warrant was a non-cash transaction.

 

12.          TAXES

 

Income tax expense 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, 2008 and 2007, the substantial majority of the Company’s foreign-sourced income has been generated in the United Kingdom and the Netherlands. Income tax (expense) benefit for the three months ended March 31, 2008 and 2007 differs from the expected tax (expense) benefit at the U.S. statutory rate of 35% primarily due to lower foreign tax rates and the foreign tax benefit of interest expense on intercompany debt, partially offset by state income taxes.

 

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 income, the carryforward periods available for tax reporting purposes, and other relevant factors.  The deferred tax asset at March 31, 2008 and December 31, 2007 amounted to $227.8 million and $232.6 million, respectively.  The current

 

16



 

portion at March 31, 2008 and December 31, 2007 amounting to $15 million and $14 million, respectively, is recorded in prepaid expenses and other current assets in the Unaudited Consolidated Balance Sheet.  It is more likely than not that the remaining deferred tax assets will not be realized and, accordingly, a valuation allowance remains against those assets.  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.

 

Section 382 imposes limitations on the availability of a company’s net operating losses after a more than 50 percentage point ownership change occurs.  The Section 382 limitation is based upon certain conclusions pertaining to the dates of ownership changes and the value of the Company on the dates of the ownership changes.  As a result of a study, it was determined that ownership changes, as defined in Section 382, occurred in 2000 and 2002.  The amount of the Company’s net operating losses incurred prior to each ownership change is limited based on the value of the Company on the respective dates of ownership change.  It is estimated that the effect of Section 382 will generally limit the total cumulative amount of net operating loss available to offset future taxable income to approximately $1.6 billion.  Pursuant to Section 382, subsequent ownership changes could further limit this amount.

 

The Company has recorded a deferred tax liability in the amount of $46.6 million and $46.5 million at March 31, 2008 and December 31, 2007, respectively, primarily related to the assignment of estimated fair value to certain purchased identifiable intangible assets associated with the acquisitions of Booking.com Limited, Booking.com B.V. and Agoda Company, Ltd.

 

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, 2008, the total aggregate minority interest in priceline.com International on a fully diluted basis was approximately 3.3%.

 

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 were subject to the put and call options in March 2008 and (b) certain of the shares are subject to the put and call options in August 2008.  In April 2008, in connection with the March 2008 put and call options, the Company repurchased 62,020 shares underlying minority interest with a carrying value of $3.7 million for an aggregate purchase price of approximately $30.5 million based upon fair value.  As a result of the April 2008 purchase, the minority interest in priceline.com International was reduced on a fully diluted basis to 2.6%.  The purchases have been accounted for as step acquisitions and accordingly, the excess of the purchase price over the carrying value is recorded as an increase of intangible assets, deferred taxes and goodwill.

 

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 remaining minority interest in priceline.com International is estimated to be approximately $154 million at March 31, 2008.

 

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 LLC 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 Rome, Georgia, et al., v. Hotels.com, L.P., et al.

 

17



 

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

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

·                  Lake County Convention and Visitors Bureau, Inc. and Marshall County 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.

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

·                  City of Jefferson, Missouri v. Hotels.com, LP, et al.

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

 

A discussion of each of the legal proceedings listed above can be found in the section titled “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2007.

 

The following developments regarding such legal proceedings occurred during or after the quarter ended March 31, 2008:

 

Louisville/Jefferson County Metro Government v. Hotels.com, L.P., et al.:  On February 20, 2008, the Lexington-Fayette Urban County Government (“Lexington”) filed a motion to intervene in this action as an additional plaintiff, which the defendants did not oppose.  On March 20, 2008, Lexington’s motion was granted, and its intervening complaint was filed on April 16, 2008.  Lexington’s intervening complaint makes substantially the same claims asserted by the Louisville/Jefferson County Metro Government, except it does not seek to represent a class.  The defendants are scheduled to answer or otherwise respond to Lexington’s complaint on or before May 16, 2008.  On March 21, 2008, the Louisville/Jefferson County Metro Government filed an unopposed motion to amend its complaint to withdraw its allegations relating to the proposed certification of a class of Kentucky cities, counties and townships that have enacted transient room taxes, and to make certain other changes to the alleged facts.  That motion is pending.

 

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

 

Actions Filed on Behalf of Individual Cities

 

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 LLC and Travelweb LLC, both of which are subsidiaries of the Company, and 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 Fairview Heights v. Orbitz, Inc., et al.

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

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

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

·                  Wake 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.

 

18



 

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

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

·                  City of Houston, Texas v. Hotels.com, LP, et al.

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

·                  City of Madison v. Expedia, Inc., et al.

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

 

A discussion of each of the legal proceedings listed above can be found in the section titled “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2007.

 

The following developments regarding such legal proceedings occurred during or after the quarter ended March 31, 2008:

 

City of Fairview Heights v. Orbitz, Inc., et al.:  On March 31, 2008, the court denied the motion for class certification filed by the City of Fairview Heights.  Thus, the City of Fairview Heights will now proceed as the sole plaintiff.  The parties are presently conducting discovery.

 

City of Findlay v. Hotels.com, L.P., et al. and City of Columbus, et al. v. Hotels.com, L.P., et al.:  On November 6, 2007, the City of Columbus case was consolidated with the City of Findlay case for pre-trial purposes.  On February 19, 2008, the cities of Columbus, Dayton and Findlay moved to amend their respective complaints to drop all class action allegations and to add nine additional Ohio cities and townships as plaintiffs.  That motion was granted on February 28, 2008, and the plaintiffs’ first amended consolidated complaint was filed that day.  Thus, the plaintiffs will now proceed solely on their own behalf, and not on behalf of a putative class of Ohio cities, counties and townships that have enacted occupancy or excise taxes on lodging.  On March 26, 2008, the defendants moved to dismiss the first amended consolidated complaint.  That motion is pending.

 

City of North Myrtle Beach, South Carolina v. Hotels.com, LP, et al.:  On January 29, 2008, the City of North Myrtle Beach moved to amend its complaint to assert claims arising under the South Carolina Unfair Trade Practices Act.  That motion is pending.  The parties are currently conducting discovery.

 

Horry County, et al. v. Hotels.com, LP, et al.:  On March 18, 2008, the court denied the defendants’ motion to dismiss.  The parties are presently conducting discovery.

 

City of Myrtle Beach, South Carolina v. Hotels.com, LP, et al.:  On March 18, 2008, the court denied the defendants’ motion to dismiss.  The parties are presently conducting discovery.

 

City of Houston, Texas v. Hotels.com, LP., et al.:  On January 22, 2008, the plaintiffs filed a second amended petition.  On February 4, 2008, the Company and the defendants filed renewed special exceptions to the petition and moved to dismiss the action.  On March 13, 2008, the court granted the defendants’ special exceptions and dismissed the action.  On April 14, 2008, the plaintiffs filed a motion for a new trial, and a hearing on that motion is presently scheduled for May 9, 2008.

 

Mecklenburg County v. Hotels.com LP, et al.:  On March 26, 2008, the Company and the other defendants moved to dismiss the complaint.  That motion is pending.

 

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 LLC and Travelweb LLC in the future.  Some municipalities or taxing jurisdictions have sent the Company and/or its subsidiaries tax notices or demands, including Brunswick County and Stanly County, North Carolina; Jefferson County, Arkansas; City of North Little Rock, Arkansas; and the Pine Bluff Advertising and Promotion Commission.

 

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

 

19



 

Consumer Class Actions

 

Two purported 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 legal proceedings listed above can be found in the section titled “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2007.

 

The following developments regarding such legal proceedings occurred during or after the quarter ended March 31, 2008:

 

Marshall, et al. v. priceline.com, Inc.:  On February 1, 2008, two of the four plaintiffs voluntarily dismissed their claims against the Company.  On February 29, 2008, the remaining plaintiffs moved for leave to amend their complaint to assert additional claims for breach of contract and the implied duty of good faith and fair dealing alleging that the Company included a hidden fee within its room rate charge.  The Company opposed the plaintiffs’ motion for leave to amend, which is presently scheduled for hearing on May 7, 2008.

 

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

 

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; Miami-Dade County, Florida; Broward County, Florida; the City of Anaheim, California; 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.  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 proceedings described above.

 

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

 

20



 

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.com, 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 execute the Settlement Agreement on behalf of the Company.  The Settlement Agreement was submitted to the Court for approval.  Subsequently, the Second Circuit reversed the District Court’s granting of class certification in certain of the related class actions.  As a result, the parties entered into a stipulation and order dated June 25, 2007 which terminated the Settlement Agreement.  The Company intends to vigorously defend against the claims in all of these proceedings.

 

 On May 3, 2007, the Company entered into a Stipulation and Agreement of Settlement (“Settlement Agreement”) to settle a class action lawsuit brought after its announcement that third quarter 2000 revenues would not meet expectations.  Under the terms of the Settlement Agreement, the class received $80 million in return for a release, with prejudice, of all claims against the Company and the individual defendants (the “Settling Defendants”) that are related to the purchase of the Company’s securities by class members during the class period.  The Company’s insurance carriers funded $30 million of the settlement.  As a result, the Company recorded 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 Company will continue to assess the risks of the potential financial impact of these matters, and to the extent appropriate, it will reserve for those estimates of liabilities.

 

Other Litigation

 

On January 6, 1999, we received notice that a third party patent applicant and patent attorney, Thomas G. Woolston, purportedly had filed in December 1998 with the United States Patent and Trademark Office a request to declare an interference between a patent application filed by Woolston and our U.S. Patent 5,794,207.  We are currently awaiting information from the Patent Office regarding whether it will initiate an interference proceeding.

 

From time to time, we have been and expect to continue to be subject to legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of third party intellectual property rights.  Such claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources, divert management’s attention from our business objectives and could adversely affect our business, results of operations, financial condition and cash flows.

 

21



 

Airline Excise Tax Refund

 

The online travel industry received guidance in the fourth quarter of 2006 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.  The Company received notices from the 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.

 

Contingent Purchase Price

 

On November 6, 2007, the Company and a newly-formed, indirect wholly-owned subsidiary of the Company, acquired 100% of the total issued share capital of  Agoda Company, Ltd. (“Agoda”) and AGIP LLC (“AGIP,” and together with Agoda, the “Agoda Companies”).  The purchase price for the acquisition, including acquisition costs, consists of an initial purchase price payable by the Company in cash of approximately $16 million and up to an additional $141.6 million in cash, which is payable by the Company if the Agoda Companies achieve the maximum “gross bookings” and earnings targets from January 1, 2008 through December 31, 2010. 

 

On December 21, 2007, the Company acquired 100% of the total issued share capital of an online advertising company for approximately $4.1 million in cash, including acquisition costs.  In addition, the Company could be required to pay an additional amount of up to $3.8 million in each of the years 2008, 2009 and 2010, if the acquired company achieves certain performance targets.

 

The contingent consideration related to these acquisitions, if any, will be recorded as additional purchase price when the contingency is resolved.

 

22



 

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 hotel rooms, car rentals, airline tickets, vacation packages, cruises and destination services.  In the United States, 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.  Internationally, we offer our customers hotel room reservations in 60 countries and 22 languages.

 

We launched our business in the United States in 1998 under the priceline.com brand and have since expanded our operations to include, among others, the brands Booking.com and Active Hotels in Europe and Agoda in Asia.  Our goal is to be the leading worldwide online hotel reservation service.  At present, we derive substantially all of our revenues from the following sources:

 

·                              Transaction revenues from our Name Your Own Price® hotel room, rental car services and airline ticket, 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 hotel rooms and Name Your Own Price® airline tickets and rental cars services.  Priceline eliminated processing fees for its price-disclosed airline ticket service in June 2007;

 

·                              Transaction revenue from our price-disclosed merchant 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.

 

Over the last several years, our business has transitioned from one driven primarily by domestic results to one driven primarily by international results.  Prior to 2004, substantially all of our revenues were generated within the United States.  In September 2004, we acquired Booking.com Limited, a U.K.-based online hotel service, in July 2005, we acquired Booking.com B.V., a Netherlands-based online hotel service, and in November 2007, we acquired Agoda Company, Ltd. (“Agoda”) and AGIP LLC (“AGIP,” and together with Agoda, the “Agoda Companies”), an online hotel service with operations in Singapore and Thailand.  During the three months ended March 31, 2008, our international business – the significant majority of which is currently generated by our European operations – represented approximately 59.0% of our gross bookings, and contributed more than half of our consolidated operating income during that period.  We expect that throughout 2008 and beyond, our international business will represent a growing percentage of our total gross bookings and operating income.

 

While the sale of leisure airline tickets, rental cars and vacation packages remain important parts of our business, revenue earned in connection with the reservation of hotel room nights has come to represent a substantial majority of our gross profit.  Internationally and domestically, the hotel market has been characterized in recent years by robust demand and limited supply, leading to increased occupancy rates, and in turn, increased average

 

23



 

daily rates (“ADRs”).  Recently, however, we have seen a general decrease in occupancy rates and a slowing in the growth of ADRs.  While lower occupancy rates have historically resulted in hotel suppliers increasing their distribution of merchant hotel rooms through third-party intermediaries such as us, our remuneration for agency and merchant hotel transactions changes proportionately with room price, and therefore, lower ADRs generally have a negative effect on our hotel business and a negative effect on our gross profit.

 

International Trends.  The size of the travel market outside of the United States is substantially greater than that within the United States.  Historically, Internet adoption rates and e-commerce adoption rates of international consumers have trailed those of the United States.  However, international consumers are rapidly moving to online means for purchasing travel.  Accordingly, recent international online travel growth rates have substantially exceeded and are expected to continue to exceed the growth rates within the United States.  In addition, the base of hotel suppliers in Europe is particularly fragmented compared to that in the United States, where the hotel market is dominated by large hotel chains.  We believe online reservation systems like ours may be more appealing to small chains and independent hotels more commonly found outside of the United States.  We believe these trends have enabled us to become the top hotel service provider in Europe, and will allow us to successfully expand our service offerings internationally beyond Europe.

 

As our international operations have become significant contributors to our results and international hotel bookings have become of increased importance to our earnings, we have seen, and expect to continue to see, changes in certain of our operating expenses and other financial metrics.  For example, because our international operations utilize online affiliate and search marketing as the 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 2008 and beyond.  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 fluctuations on our operating results change as a result of different revenue recognition policies that apply to our price-disclosed services (including our international hotel service) as compared to our Name Your Own Price® services.

 

Another impact of the growing importance that our international operations represent to our business is our increased exposure to foreign currency exchange risk.  Because we are conducting a significant and growing portion of our business outside the United States and are reporting our results in U.S. dollars, we face exposure to adverse movements in currency exchange rates as the financial results of our international operations are translated from local currency into U.S. dollars upon consolidation.  Our international operations contributed approximately $104.2 million to our revenues for the three months ended March 31, 2008, which compares to approximately $47.9 million for the same period in 2007.  Approximately $8.8 million of this increase is due to fluctuations in currency exchange rates, compared to $2.2 million for the three months ended March 31, 2007.  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.  Similarly, our net assets, net revenues, operating expenses, and net income will decrease if the U.S. dollar strengthens against local currency.

 

Domestic Trends.  While the online market for travel services continues to experience 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 supply to provide third party intermediaries like priceline.com.  Recent decreases in domestic airline capacity and the emerging prospect of industry consolidation, as evidenced by the recent merger agreement between Delta Air Lines and Northwest Airlines, could further reduce the amount of airline tickets available to us.  Notwithstanding these trends, we continue to believe that the market for domestic online travel services is an attractive market with continued opportunity for growth.

 

24



 

Recently, significant attention has been given to the state of the United States economy and concern has been expressed regarding certain recessionary trends.  Recently reported April 2008 airline industry data showed reductions in domestic traffic, and hotels have reported decreases in occupancy rates and revenue per available room night.   We do not believe that our first quarter 2008 financial results were impacted by a slowdown in the United States economy, and we believe that our brands and services are attractive to consumers and suppliers in times of economic stress.  There can be no assurance, however, that our business would not be adversely affected if current economic conditions continue or worsen.

 

We also 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 operating income.  Connectivity to a GDS does not guarantee us access to the content of a travel supplier such as an airline or hotel company.  We have agreements with a number of suppliers to obtain access to content, and are in continuing discussions with others to obtain similar access.  If we were denied access to a suppliers’ full content or had to incur service fees in order to access or book such content, our results could suffer.

 

We believe that our success will depend in large part on our ability to maintain profitability, primarily from our hotel business, to continue to promote the priceline.com brand in the United States, the Booking.com brand internationally, the Agoda brand in Asia and, over time, to offer other travel services and further expand into other 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 withdrawal from our system of a major hotel supplier or airline, 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. In addition, we currently do not have operations in geographic areas such as South America, and therefore may consider strategic alternatives in those areas.  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.  Our Name Your Own Price® services are non-refundable in nature, and accordingly, we recognize travel revenue at the time a booking is generated.  However, we recognize revenue generated from our retail hotel services, including our international 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 as revenue 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.

 

Results of Operations

 

Three Months Ended March 31, 2008 compared to the Three Months Ended March 31, 2007

 

Operating Metrics

 

Our financial results are driven by certain operating metrics that encompass the selling activity generated by our travel services.  Specifically, sales of hotel room nights, rental car days and airline tickets 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.  International gross bookings reflect gross bookings generated principally by websites owned by, operated by, or dedicated to providing gross bookings for our international brands and operations, and domestic gross bookings reflect gross bookings generated principally by websites owned by, operated by, or dedicated to providing gross bookings by our domestic operations, in each case without regard to the location of the travel or the customer purchasing the travel.

 

25



 

Gross bookings resulting from hotel room nights, rental car days and airline tickets sold through our domestic and international operations for the three months ended March 31, 2008 and 2007 were as follows:

 

 

 

Three Months Ended March 31,

 

 

 

 

 

2008

 

2007

 

Change

 

 

 

 

 

 

 

 

 

Domestic

 

$

721 million

 

$

479 million

 

50.6

%

International

 

1,038 million

 

520 million

 

99.7

%

Total

 

$

1,759million

 

$

998million

 

76.1

%

 

Gross bookings resulting from hotel room nights, rental car days and airline tickets sold through our agency and merchant models for the three months ended March 31, 2008 and 2007 were as follows:

 

 

 

Three Months Ended March 31,

 

 

 

 

 

2008

 

2007

 

Change

 

 

 

 

 

 

 

 

 

Agency

 

$

1,370 million

 

$

711 million

 

92.8

%

Merchant

 

389 million

 

288 million

 

34.9

%

Total

 

$

1,759 million

 

$

998 million

 

76.1

%

 

Gross bookings increased by 76.1% for the three months ended March 31, 2008, compared to the same period in 2007.  The increase was primarily attributable to 99.7% growth in our international gross bookings, virtually all of which relates to retail hotel room night sales (including the $128 million favorable impact of foreign currency exchange rates).  Domestic gross bookings increased by 50.6%, primarily due to growth in the sale of retail airline tickets due to the elimination of booking fees in June of 2007, Name Your Own Price® hotel room nights and Name Your Own Price® rental car days.

 

Agency gross bookings increased 92.8% for the three months ended March 31, 2008, compared to the same period in 2007, due to growth in our international hotel operations and in the sale of retail airline tickets due to the elimination of booking fees in June of 2007.  Merchant gross bookings increased 34.9% for the three months ended March 31, 2008, compared to the same period in 2007, due to an increase in the sale of Name Your Own Price® hotel room nights, the inclusion of room nights sold by Agoda, which was acquired in November 2007, Name Your Own Price® rental car days and merchant price-disclosed hotel room nights.

 

Three Months 
Ended

 

Hotel Room 
Nights

 

Rental 
Car Days

 

Airline 
Tickets

 

 

 

 

 

 

 

 

 

March 31, 2008

 

9.4 million

 

2.6 million

 

1.2 million

 

 

 

 

 

 

 

 

 

March 31, 2007

 

6.0 million

 

2.0 million

 

0.6 million

 

 

Hotel room nights sold increased by 57.4% for the three months ended March 31, 2008, over the same period in 2007, primarily due to an increase in the sale of agency room nights in connection with our international operations, an increase in the sale of Name Your Own Price® hotel room nights in the United States and the inclusion of room nights sold by Agoda, which was acquired in November 2007.

 

Rental car days sold increased by 30.4% for the three months ended March 31, 2008, over the same period in 2007, due to increases in sales of both our Name Your Own Price® and price-disclosed rental car services.

 

Airline tickets sold increased by 83.0% for the three months ended March 31, 2008, over the same period in 2007.  The increase in the number of airline tickets sold in the three months ended March 31, 2008, compared to the same period in 2007, was primarily attributable to an increase in the sale of price-disclosed airline tickets due to our elimination of booking fees in June 2007 and increased marketing support.

 

26



 

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® hotel rooms, rental cars and airline tickets 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. In June 2007, we eliminated processing fees on the priceline.com price-disclosed airline ticket service.

 

·                  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 significant sales of international point-of-sale hotel services, a significant majority of which are currently generated in Europe.  Because our domestic services include merchant Name Your Own Price® travel services, which are reported on a “gross” basis, while both our domestic and international 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 international operations contributed approximately $104.2 million to our revenues for the three months ended March 31, 2008, which compares to $47.9 million for the same period in 2007.  Approximately $8.8 million of this increase is due to fluctuations in currency exchange rates, compared to $2.2 million for the three months ended March 31, 2007.

 

 

 

Three Months Ended 
March 31,

 

Change

 

 

 

($000)

 

 

 

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

Merchant Revenues

 

$

289,159

 

$

246,011

 

17.5

%

Agency Revenues

 

109,932

 

54,511

 

101.7

%

Other Revenues

 

4,089

 

867

 

371.6

%

Total Revenues

 

$

403,180

 

$

301,389

 

33.8

%

 

Merchant Revenues

 

Merchant revenues for the three months ended March 31, 2008 increased 17.5% compared to the same period in 2007, primarily due to an increase in the sale of Name Your Own Price® hotel room nights and Name Your Own Price® rental car days, merchant price-disclosed airline tickets and the inclusion of room nights sold by Agoda,

 

27



 

which was acquired in November 2007.  The increase was partially offset by the impact of excise tax refunds of $15.9 million recorded in merchant revenues in the three months ended March 31, 2007, as more fully discussed in Note 14 to our Unaudited Consolidated Financial Statements.

 

Agency Revenues

 

Agency revenues for the three months ended March 31, 2008 increased 101.7% compared to the same period in 2007, primarily as a result of growth in our international operations, which contributed $99.1 million of agency revenue for the three months ended March 31, 2008, and $47.0 million of agency revenue for the same period in 2007. Approximately $8.8 million of this increase is due to fluctuations in currency exchange rates.

 

Other Revenues

 

Other revenues during the three months ended March 31, 2008 consisted primarily of advertising revenues.  Other revenues for the three months ended March 31, 2008 increased 371.6%, compared to the same period in 2007, primarily as a result of higher online advertising revenues due to new advertising partner relationships initiated in 2007.

 

Cost of Revenues and Gross Profit

 

 

 

Three Months Ended 
March 31,

 

Change

 

 

 

($000)

 

 

 

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

Cost of Merchant Revenues

 

$

222,077

 

$

181,672

 

22.2

%

% of Merchant Revenues

 

76.8

%

73.8

%

 

 

Cost of Agency Revenues

 

 

 

 

% of Agency Revenues

 

0.0

%

0.0

%

0.0

%

Cost of Other Revenues

 

 

 

 

% of Other Revenues

 

0.0

%

0.0

%

0.0

%

Total Cost of Revenues

 

$

222,077

 

$

181,672

 

22.2

%

% of Revenues

 

55.1

%

60.3

%

 

 

 

Cost of Revenues

 

During the three months ended March 31, 2008, cost of revenues entirely reflect merchant 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, 2008, 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, 2008 increased 22.2%, compared to the same period in 2007, due primarily to the increase in merchant revenue discussed above.  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, 2008 and 2007, there were no costs of other revenues.

 

Gross Profit

 

Total gross profit for the three months ended March 31, 2008 increased by 51.3% compared to the same period in 2007, primarily as a result of increased revenue.  Total gross margin (gross profit expressed as a percentage of total revenue) increased during the three months ended March 31, 2008, compared to the same period in 2007, 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.  In the three months ended March 31, 2007, gross profit and gross margin were positively impacted by the $15.9 million excise tax refund recorded in merchant revenue (see Note 14 to our Unaudited Consolidated Financial Statements).  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.

 

 

 

Three Months Ended 
March 31,

 

Change

 

 

 

($000)

 

 

 

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

Merchant Gross Profit

 

$

67,082

 

$

64,339

 

4.3

%

Merchant Gross Margin

 

23.2

%

26.2

%

 

 

Agency Gross Profit

 

109,932

 

54,511

 

101.7

%

Agency Gross Margin

 

100.0

%

100.0

%

 

 

Other Gross Profit

 

4,089

 

867

 

371.6

%

Other Gross Margin

 

100.0

%

100.0

%

 

 

Total Gross Profit

 

$

181,103

 

$

119,717

 

51.3

%

Total Gross Margin

 

44.9

%

39.7

%

 

 

 

Merchant Gross Profit

 

Merchant gross profit consists of merchant revenues less the cost of merchant revenues. For the three months ended March 31, 2008, merchant gross profit increased from the same period in 2007, primarily due to an increase in merchant revenue.  Merchant gross margin decreased for the three months ended March 31, 2008 compared to the same period in 2007 because merchant gross margin for the three months ended March 31, 2007 was positively affected by the excise tax refund of $15.9 million included in merchant revenue and merchant gross profit (see Note 14 to our Unaudited Consolidated Financial Statements).  Excluding the excise tax refund, merchant gross margin increased, primarily because Name Your Own Price® transactions, whose revenues are recorded “gross” with a corresponding cost of revenue, represented a smaller percentage of transactions in the three months ended March 31, 2008, when compared to merchant price-disclosed hotel transactions, which are recorded “net” with no corresponding cost of revenues.

 

29



 

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, 2008, agency gross profit increased over the same period in 2007, primarily as a result of growth in bookings for retail agency hotel room nights for our international operations.

 

Other Gross Profit

 

During the three months ended March 31, 2008, other gross profit increased from the same period in 2007 primarily as a result of higher online advertising revenues due to new advertising partner relationships initiated in 2007.

 

Operating Expenses

 

Advertising

 

 

 

Three Months Ended 
March 31,

 

Change

 

 

 

($000)

 

 

 

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

Offline Advertising

 

$

12,031

 

$

11,334

 

6.1

%

% of Total Gross Profit

 

6.6

%

9.5

%

 

 

Online Advertising

 

$

57,800

 

$

31,927

 

81.0

%

% of Total Gross Profit

 

31.9

%

26.7

%

 

 

 

Offline advertising expenses consist primarily of: (1) the expenses associated with domestic television, radio and print advertising; and (2) the cost for creative talent, production costs and agency fees for television, radio and print advertising. For the three months ended March 31, 2008, offline advertising expenses were higher than in the same period in 2007 primarily as a result of increased print advertising related to our “Negotiator” advertising campaign, partially offset by a decrease in radio advertising.  Online advertising expenses primarily consist of the costs of (1) search engine keyword purchases; (2) affiliate programs; (3) banner and pop-up advertisements; and (4) e-mail campaigns.  For the three months ended March 31, 2008, online advertising expenses increased over the same period in 2007, primarily due to an increase in online advertising expenses to support significantly increased retail agency hotel room nights booked by our international operations, which rely primarily on online advertising, in particular keyword purchases and payments to affiliate advertisers, to support their businesses.

 

Sales and Marketing

 

 

 

Three Months Ended 
March 31,

 

Change

 

 

 

($000)

 

 

 

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

Sales and Marketing

 

$

16,333

 

$

11,410

 

43.1

%

% of Total Gross Profit

 

9.0

%

9.5

%

 

 

 

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; and (3) provisions for credit card chargebacks.  For the three months ended March 31, 2008, sales and marketing expenses, which are substantially variable in nature, increased over the same period in 2007, primarily due to increased gross booking volumes.

 

30



 

Personnel

 

 

 

Three Months Ended 
March 31,

 

Change

 

 

 

($000)

 

 

 

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

Personnel

 

$

36,883

 

$

21,490

 

71.6

%

% of Total Gross Profit

 

20.4

%

18.0

%

 

 

 

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, 2008, personnel expenses increased over the same period in 2007, primarily due to increased stock-based compensation expense, personnel expenses associated with head count growth of our international operations and increased employee performance bonus expense.  Stock-based compensation expense was approximately $9.9 million for the three months ended March 31, 2008 and $3.2 million, for the three months ended March 31, 2007.

 

General and Administrative

 

 

 

Three Months Ended 
March 31,

 

Change

 

 

 

($000)

 

 

 

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

General and Administrative

 

$

11,789

 

$

63,875

 

(81.5

)%

% of Total Gross Profit

 

6.5

%

53.4

%

 

 

 

General and administrative expenses consist primarily of: (1) fees for outside professionals, including litigation expenses; (2) occupancy expenses; and (3) personnel related expenses. General and administrative expenses decreased during the three months ended March 31, 2008, over the same period during 2007, due to a $54.9 million expense related to a litigation settlement in 2007, partially offset by additional fees for outside professionals, expenses related to pending litigation and increased travel expenses associated with the growth of our international operations.

 

Information Technology

 

 

 

Three Months Ended 
March 31,

 

Change

 

 

 

($000)

 

 

 

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

Information Technology

 

$

4,149

 

$

2,911

 

42.5

%

% of Total Gross Profit

 

2.3

%

2.4

%

 

 

 

Information technology expenses consist primarily of: (1) outsourced data center costs relating to our domestic and international data centers; (2) system maintenance and software license fees; (3) data communications and other expenses associated with operating our Internet sites; and (4) payments to outside consultants. For the three months ended March 31, 2008, the increase in information technology expenses compared to the same period in 2007 was primarily associated with the growth of our international operations.

 

31



 

Depreciation and Amortization

 

 

 

Three Months Ended 
March 31,

 

Change

 

 

 

($000)

 

 

 

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

Depreciation and Amortization

 

$

10,353

 

$

8,505

 

21.7

%

% of Total Gross Profit

 

5.7

%

7.1

%

 

 

 

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, 2008, depreciation and amortization expense increased from the same period in 2007, primarily as a result of increased depreciation and amortization related to investment in our international operations.

 

Other Income (Expense)

 

 

 

Three Months Ended 
March 31,

 

Change

 

 

 

($000)

 

 

 

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

Interest Income

 

$

4,172

 

$

8,203

 

(49.1

)%

Interest Expense

 

(2,671

)

(2,470

)

8.1

%

Foreign Currency Transactions and Other

 

(5,084

)

(214

)

NM

 

Total

 

(3,583

)

$

5,519

 

NM

 

 

For the three months ended March 31, 2008, interest income on cash and marketable securities decreased over the same period in 2007, as lower prevailing interest rates and investments in higher quality, lower yielding securities more than offset higher cash and marketable securities balances.  In addition, interest income for the three months ended March 31, 2007 included approximately $2.8 million of interest received on our excise tax refund.  Interest expense increased for the three months ended March 31, 2008 over the same period in 2007, due primarily to commitment fees related to the $175 million revolving credit facility that we entered into in September 2007.  Foreign currency transactions and other expense increased to $5.1 million in the three months ended March 31, 2008, compared to $0.2 million for the three months ended March 31, 2007, due to foreign exchange losses principally related to foreign exchange derivative contracts.

 

Taxes

 

 

 

Three Months Ended 
March 31,

 

Change

 

 

 

($000)

 

 

 

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

Income tax (expense) benefit

 

$

(9,518

)

$

11,593

 

(182.1

)%

 

We have income tax expense for the three months ended March 31, 2008, because we have pretax income for that period and we have a tax benefit for the three months ended March 31, 2007, because we had a pretax loss for that period.  Income tax (expense) benefit for the three months ended March 31, 2008 and 2007 differs from the

 

32



 

expected tax provision at the U.S. statutory tax rate of 35% principally due to lower foreign tax rates and the foreign tax benefit of interest expense on intercompany debt, partially offset by state income taxes.  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 international income taxes and U.S. alternative minimum tax.

 

Equity in Income (Loss) of Investees and Minority Interests

 

 

 

Three Months Ended 
March 31,

 

Change

 

 

 

($000)

 

 

 

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

Equity in Income (Loss) of Investees and Minority Interests

 

$

(510

)

$

(93

)

448.4

%

 

Equity in income (loss) of investees and minority interests for the three months ended March 31, 2008 and 2007, represented (1) minority interests associated with the ownership of priceline.com International that is held by former shareholders of Booking.com B.V. and Booking.com Limited, including certain European-based managers of that business; and (2) equity in income (loss) of investees, comprised of our pro rata share of pricelinemortgage.com’s net results.  The change versus the prior year was primarily due to an increase in the minority interest in the earnings of priceline.com International.

 

Liquidity and Capital Resources

 

As of March 31, 2008, we had $549.7 million in cash, cash equivalents and short-term investments.  Cash equivalents are primarily comprised of U.S. Treasury money market accounts.  Short-term investments are primarily comprised of U.S. and foreign government securities and highly liquid, investment grade corporate 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 for the three months ended March 31, 2008, was $43.4 million, resulting from net income of $18.2 million, non-cash items not affecting cash flows of $26.3 million offset by $1.1 million of negative changes in working capital.  The changes in working capital for the three months ended March 31, 2008, were primarily related to a $23.9 million increase in accounts receivable, prepaid expenses and other current assets, partially offset by a $22.8 million increase in accounts payable, accrued expenses and other current liabilities.  The increase in accounts receivable is primarily due to significant revenue growth and the seasonality of our domestic business.  We do not believe there has been any significant change in credit risk regarding our accounts receivable.  The increase in accounts payable, accrued expenses and other current liabilities is primarily due to increased accounts payable and deferred merchant bookings for our domestic business resulting from growth in merchant bookings as well as seasonality, partly offset by a decrease in accrued expenses resulting from payment of 2007 performance bonuses in the first quarter of 2008.  Non-cash items were primarily associated with stock-based compensation expense and  depreciation and amortization, primarily related to acquisition-related intangible assets.

 

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 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

33



 

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 investing activities was $72.6 million for the three months ended March 31, 2008.  Investing activities were affected by $77.5 million of net redemptions of investments for the three months ended March 31, 2008, partially offset by a $1.5 million increase in restricted cash related to our international operations and equity investments of $0.5 million.  Net cash provided by investing activities was $5.6 million for the three months ended March 31, 2007. We had approximately $8.0 million of investments sales and maturities for the three months ended March 31, 2007.  Cash invested in purchases of property and equipment was $2.9 million and $2.2 million for the three months ended March 31, 2008 and 2007, respectively.

 

Net cash used in financing activities was approximately $1.4 million for the three months ended March 31, 2008.  The cash used in financing activities during the three months ended March 31, 2008 was primarily related to $3.3 million of treasury stock purchases, partially offset by $1.4 million of proceeds from the exercise of employee stock options and $0.5 million of excess tax benefits from stock-based compensation.  Net cash provided by financing activities was approximately $6.3 million for the three months ended March 31, 2007.  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.

 

As more fully discussed in Note 13 to the Unaudited Consolidated Financial Statements, the total minority interest in priceline.com International on a fully diluted basis is approximately 3.3% at March 31, 2008.  The remaining outstanding minority interest in priceline.com International is subject to puts and call options that are exercisable in 2008 and its aggregate fair value is estimated to be approximately $154 million at March 31, 2008, including unvested restricted stock and restricted stock units.  In April 2008, in connection with the March 2008 put and call options, we repurchased 62,020 shares underlying minority interest with a carrying value of $3.7 million for an aggregate purchase price of $30.5 million based upon fair value.  We expect the future fair value of the minority interest to grow based upon expected continued strong performance of the international business.

 

Based upon the closing price of our common stock during the measurement periods provided for by our convertible debt during the three months ended March 31, 2008, the contingent conversion thresholds on each of our convertible senior note issues were exceeded.  As a result, all of our outstanding notes (aggregate principal amount $570 million) are convertible at the option of the holder as of March 31, 2008 and, accordingly, have been classified as a current liability in the Unaudited Consolidated Balance Sheet as of that date.  While many factors contribute to the likelihood that the holders of the notes will elect to convert all or a portion of the notes, as the price of our common stock increases, the likelihood of conversion also increases.  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 at our option.  We would likely fund the repayment with existing cash and cash equivalents, short-term investments (totaling approximately $549.7 million at March 31, 2008), borrowings under our revolving credit facility, common stock issuances and/or additional borrowings.  In April 2008, the Company received notices of conversion from holders of approximately $41 million aggregate principal value of the 1% Notes.

 

In September 2007, we entered into a $175 million five-year revolving credit facility with a group of lenders, which is secured, subject to certain exceptions, by a first-priority security interest on substantially all of our assets and related intangible assets located in the United States.  In addition, our obligations under the revolving credit facility are guaranteed by substantially all of the assets and related intangible assets of our material direct and indirect domestic and foreign subsidiaries.  Borrowings under the revolving credit facility will bear interest, at our option, at a rate per annum equal to the greater of (a) JPMorgan Chase Bank, National Association’s prime lending

 

34



 

rate and (b) the federal funds rate plus ½ of 1%, plus an applicable margin ranging from 0.25% to 0.75%; or at an adjusted LIBOR for the interest period in effect for such borrowing plus an applicable margin ranging from 1.25% to 1.75%.  Undrawn balances available under the revolving credit facility are subject to commitment fees at the applicable rate ranging from 0.25% to 0.375%.

 

The revolving credit facility provides for the issuance of up to $50 million of letters of credit as well as borrowings on same-day notice, referred to as swingline loans, which are available in U.S. dollars, Euros, Pounds Sterling and any other foreign currency agreed to by the lenders. The Company may request that an additional $100 million be added to the revolving credit facility or to enter into one or more tranches of additional term loans. The proceeds of loans made under the facility could be used for working capital or general corporate purposes. As of March 31, 2008, there were no borrowings outstanding under the facility and the Company has issued approximately $14.7 million of letters of credit under the revolving credit facility.

 

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, 2008, 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.

 

35



 

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 “Risk Factors” 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 international operations’ business model exposes us to certain risks that we have not traditionally experienced in the U.S. hotel business.

 

Throughout 2006, 2007 and the three months ended March 31, 2008, our international operations experienced significant growth in their gross bookings.  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 international operations to experience a significant decline in their growth rate in future years as the absolute level of their gross bookings grows larger.  Other factors could also cause slowing growth rates in the international business, including changes in foreign currency exchange rates (for example, the strengthening of the U.S. dollar versus the Euro), travel market conditions, changes in hotel pricing or availability (for example, decreases in hotel “ADRs”), the competitiveness of the market and macro economic weakness (for example, the impact of U.S. recessionary trends abroad).  A decline in our international 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 international operations rely heavily on various third parties to distribute hotel room reservations, and our international operations’ distribution channels are concentrated among a number of third parties.  Should one or more of such third parties cease distribution of our international operations’ reservations, or suffer deterioration in its search engine ranking, due to changes in search engine algorithms or otherwise, the business of our international operations could be negatively affected.  Similarly, a significant amount of our international 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 international operations involves rapid expansion into countries in Europe, including eastern Europe, Asia and elsewhere, 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,

 

36



 

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 international operations are unsuccessful in rapidly expanding into other international countries, our business, results of operations and financial condition would be adversely affected.

 

Our international operations currently distribute hotel rooms primarily through a retail model whereby we earn a commission from the hotel property when the customer checks out of the hotel.  This requires our international operations to pursue collection of commissions relating to hotel room reservations from the hotel after the customer has completed his or her stay.  We do not have extensive experience in collecting commissions from hotels in many of our international markets and failure to sustain an adequate collection rate could negatively impact the business of our international operations.

 

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

 

Our financial prospects are significantly dependent upon our sale of leisure travel services.  Leisure travel, including the sale of hotel rooms and leisure airline tickets, 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 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, 2008, Name Your Own Price® hotel room nights from our five largest hotel suppliers accounted for approximately 36.6% of total Name Your Own Price® hotel room nights sold, and sales of airline tickets from our five largest and two largest airline suppliers accounted for approximately 75.3% and 37.3% of total airline tickets sold, respectively. 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 hotel and airline 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.

 

With respect to our hotel suppliers, increased demand for hotel rooms may reduce the number of hotel rooms they distribute through our service or increase the negotiated rates at which they are willing to provide availability.  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 number of hotel rooms they make available through priceline.com and/or our international operations.  Similarly, while not dependent on certain hotel chains, the growth rates of our international 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 rooms at wholesale rates. If hotels experience increased demand for rooms, they might reduce the number of rooms they make available through our merchant price-disclosed hotel service.  Increases in occupancy rates generally cause hotels to reduce the number of hotel rooms 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 rooms through their own websites and therefore might increase

 

37



 

negotiated rates for merchant rate hotel rooms 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.

 

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, 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.  Certain airlines have also reduced their domestic capacity, which could reduce the number of airline tickets available to our customers.  If one or more participating airlines were to further limit or eliminate discounting through opaque channels and/or further reduce capacity, 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.  Recently, there has been an emerging prospect of domestic airline industry consolidation, as evidenced by the recent merger agreement between Delta Air Lines and Northwest Airlines.  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.

 

In addition, in the event that one 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. In April 2008, Aloha Airlines and ATA Airlines each ceased operations and we experienced an increase in credit card chargebacks from customers with tickets on those airlines.  To the extent major U.S. airlines that participate in our system declare bankruptcy or cease operations, they may be unable or unwilling to honor tickets sold for their flights. Our policy in such event is 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.

 

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 rental car suppliers, increased utilization (a common metric that measures rental car customer usage) may reduce the number of car reservations they distribute through our service or increase the negotiated rates at which they are willing to provide car reservations.  Like airline and hotel suppliers, rental car companies are focused on selling rental car reservations through their own sites, which reduces the amount of rental car reservations available to us.  Furthermore, if one of our major rental car suppliers merges or consolidates with, or

 

38



 

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.  Finally, because rental car days are typically less expensive than airline tickets or hotel room nights, a reduction in retail rental car rates has a disproportionately adverse effect on sales of Name Your Own Price® rental car days since customers may be less likely to accept the trade-offs associated with that service.

 

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 Orbitz Worldwide, 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, but are not limited to:

 

·                  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, ebookers, HotelClub and RatesToGo, which are currently owned by Orbitz Worldwide; laterooms and asiarooms owned by Tui Travel, and Gullivers, octopustravel, Superbreak, Venere, hotel.de, Hotel Reservation Service and Wotif;

 

·                  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 Mobissimo.com, FareChase.com, Kayak.com and Kayak.com’s recent acquisition, SideStep.com (each 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, Travelport., 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, several low cost airlines, which are having increasing success in the marketplace, distribute their tickets 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 websites, and refers traffic to those sites, and AOL is party to a marketing and technology agreement with, and holds a minority interest in, Kayak.com, another leading meta-search company.  Other established search engine

 

39



 

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.  In addition, because we advertise on certain meta-search sites, a loss of business for competitive reasons could result.  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 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 supply; 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 international operations, in particular, rely to a significant extent upon Google to generate business and, to a much lesser extent, other search engines.  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 international operations and their affiliates, can be negatively affected.  In a similar way, a significant amount of our international 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 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 international 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 as the financial results of our international operations are translated from local currency into U.S. dollars upon consolidation.  For example, our international operations contributed approximately $104.2 million to our revenues for the three months ended March 31, 2008, which compares to $47.9 million for the same period in 2007. Approximately $8.8 million of this increase is due to fluctuations in currency exchange rates.  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.

 

40



 

We may be unable to generate sufficient cash to meet future debt, purchase of minority interest and earnout obligations.

 

As of March 31, 2008, we have $570 million of convertible senior notes outstanding. Based upon the closing price of our common stock during the measurement periods provided for by our convertible debt during the three months ended March 31, 2008, the contingent conversion thresholds for each of the notes were exceeded.  As a result, all of our outstanding notes are convertible at the option of the holder as of March 31, 2008, and, accordingly, have been classified as a current liability in the Unaudited Consolidated Balance Sheet as of that date.  While many factors contribute to the likelihood that the holders of the notes will elect to convert all or a portion of the notes, as the price of our common stock increases, the likelihood of conversion also increases.  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.  In April 2008, we received notices of conversion from the holders of approximately $41 million aggregate principal amount of notes.

 

In connection with our acquisitions of Booking.com B.V. in July 2005 and Booking.com Limited in September 2004 and the reorganization of our international operations, key managers of Booking.com B.V. and Booking.com Limited purchased shares of priceline.com International.  The holders of the remaining minority interest in priceline.com International have the right to put their shares to us in August 2008 at a purchase price reflecting the fair market value of the shares at the time of the exercise of the put right (see Note 13 to our Unaudited Consolidated Financial Statements).  The estimated aggregate fair value of the minority interest in priceline.com International subject to put rights is estimated to be approximately $154 million at March 31, 2008, including unvested restricted stock and restricted stock units.

 

Pursuant to the purchase agreement relating to our acquisition of the Agoda Companies, we may be required to pay, in 2011, certain shareholders of the Agoda Companies an earnout of up to $141.6 million in cash if the Agoda Companies achieve certain performance targets from January 1, 2008 through December 31, 2010.

 

We would likely fund these obligations with existing cash and cash equivalents, short-term investments, borrowings under our revolving credit facility, 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 or revolving credit facility and/or in breach of purchase agreement obligations relating to priceline.com International or the Agoda Companies, and our business, results of operations and financial condition would be adversely affected.

 

Recent recessionary trends could be indicative of an economic downturn that would adversely affect our business.

 

Our results of operations could be adversely affected by economic downturns. Leisure travel is dependent in large part on discretionary spending activities that decrease during periods of economic slowdown.  Recently reported April 2008 airline industry data showed reductions in domestic traffic, and hotels have reported decreases in occupancy rates and revenue per available room night.  If recent recessionary trends and currency devaluation observed in the United States lead to an economic downturn, our results of operations and financial condition could suffer.  Moreover, if such problems in the United States economy spread to Europe or other economies, our results of operations and financial condition would be further adversely affected.

 

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

 

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

 

41



 

circumvention capabilities, new discoveries or other developments, including our own acts or omissions, 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, including websites operated by us, have experienced interruptions, which could be significant, as a result of improper direction of excessive 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 result in negative publicity, damage our reputation, expose us to risk of loss or litigation and possible liability and subject us to regulatory penalties. 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, and would likely not be adequate to reimburse us for losses caused by security breaches.

 

Companies that we have acquired, such as our international 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 of, among other things, personal customer data and credit card information 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, damage our reputation, expose us to risk of loss or litigation and possible liability and subject us to regulatory penalties.

 

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, such as 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.

 

42



 

We rely on the performance of highly skilled personnel and, if we are unable to retain or motivate key personnel or hire, retain and motivate qualified personnel, our business would be harmed.

 

Our performance is largely dependent on the talents and efforts of highly skilled individuals. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization.  In particular, the contributions of certain key senior management in the U.S. and Europe are critical to the overall management of the company.  In addition, because the value of company equity grants and, in the case of our European senior management, their minority ownership interest, which is subject to repurchase in August of 2008, has increased substantially as our share price has increased, it may become more difficult to retain these senior managers over time as they realize the value of these equity interests.  We cannot ensure that we will be able to retain the services of any members of our senior management or other key employees, the loss of whom could harm our business.

 

In addition, competition for well-qualified employees in all aspects of our business, including software engineers and other technology professionals, is intense both in the U.S. and abroad.  With the recent success of our international business and the increased profile of the Booking.com business and brand, competitors have increased their efforts to hire our international employees.  Further, as we continue to grow our international operations, we are seeking to rapidly hire a wide range of employees in different – and often constrained – job markets.  Our continued ability to compete effectively depends on our ability to attract new employees and to retain and motivate existing employees.  If we do not succeed in attracting well-qualified employees or retaining and motivating existing employees, our business would be adversely affected. We do not maintain any key person life insurance policies.

 

Our expansion places a significant strain on our management, technical, operational and financial resources.

 

We have rapidly and significantly expanded our international operations and anticipate expanding further to pursue growth of our service offerings and customer base. For example, the number of our employees worldwide has grown from less than 700 in the first quarter of 2007, to approximately 1,324 as of March 31, 2008, which growth is almost entirely comprised of hires by our international operations.  Such expansion increases the complexity of our business and places a significant strain on our management, operations, technical performance, financial resources and internal financial control and reporting functions.

 

There can be no assurance that we will be able to manage our expansion effectively.  Our current and planned personnel, systems, procedures and controls may not be adequate to support and effectively manage our future operations, especially as we employ personnel in multiple geographic locations.  We may not be able to hire, train, retain, motivate and manage required personnel, which may limit our growth, damage our reputation, negatively affect our financial performance, and harm our business.

 

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 and domestic hotel room and rental car reservations. In particular, our domestic 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.

 

We also depend upon Paymentech to process our U.S. credit card transactions. If Paymentech were 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 suppliers and distribution, our total system availability could decline and our results could suffer.

 

43



 

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, Equinix Europe Ltd. in London, England, Global Switch Amsterdam B.V. and TelecityRedbus 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 any disruption of service due to any such misconduct, natural disaster or other unanticipated problems at the SAVVIS facility, the AT&T facility, the Equinix Europe Ltd. facility or the TelecityRedbus and Global Switch Amsterdam B.V. facility could result in lengthy interruptions in our services. In addition, the failure by SAVVIS, Verizon, AT&T, Equinix Europe Ltd., Colt Telecom Group Limited, Verizon Business B.V., or TrueServer B.V. 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 our services could impair our reputation, damage our brand name and have a material adverse effect on our business, results of operations and financial condition.

 

We do not have a completely formalized disaster recovery plan in every geographic region in which we conduct business.  In the event of certain system failures, we may not be able to switch to back-up systems immediately and the time to full recovery could be prolonged.  Like many online businesses, we have experienced system failures from time to time. 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 systems. 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 services,

 

any of which could impair our reputation, damage our brands 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 international 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 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.

 

44



 

We have integrated the majority of our international agency 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 international operations’ agency hotel offerings are therefore on one platform, in the event that the extranet operated by Booking.com B.V. experiences a system failure, our international operations could be unable to generate hotel bookings, which would have a material adverse effect on our business, results of operations and financial condition.

 

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 reversing 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 the remainder of 2008 and beyond, our international 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 international business generates an increasing share of our pretax income.

 

Uncertainty regarding state and local taxes.

 

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 collect a tax recovery charge on the underlying cost of the hotel room night from customers and are billed by the hotel operators for taxes the hotel operators pay to the appropriate tax authorities.  As discussed above, several jurisdictions have initiated lawsuits indicating the position that sales tax or hotel occupancy tax is applicable to the differential between the price paid by a customer for our service and the amount charged by the hotel for the underlying room.  Historically, we have not collected taxes on this differential.  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.  Such actions may result in substantial liabilities for past and/or future sales and could have a material adverse effect 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 reservations to our customers and, consequently, could reduce hotel reservation transactions.  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 estimates of 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.

 

The Financial Accounting Standards Board is expected to make accounting rule changes that will significantly impact the accounting for our convertible debt.

 

The Financial Accounting Standards Board (“FASB”) is expected in May 2008 to issue FASB Staff Position No. APB 14-a, “Accounting for Convertible Debt Instruments that May be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP APB 14-a”).  The FSP requires cash settled convertible debt, such as our $570 million aggregate principal amount of convertible senior notes that are currently outstanding, to be separated into debt and