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Priceline Group Inc. 10-Q 2007

 

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 September 30, 2007

 

 

 

OR

 

o

 

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

 

 

 

 

 

For the transition period from                    to                   

 

Commission File Number 0-25581

 

PRICELINE.COM INCORPORATED

(Exact name of Registrant as specified in its charter)

 

Delaware

 

06-1528493

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification Number)

 

800 Connecticut Avenue

Norwalk, Connecticut 06854

(address of principal executive offices)

 

(203) 299-8000

(Registrant’s telephone number, including area code)

 

N/A

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

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days. YES    x   . NO   o.

 

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

 

Large accelerated filer  x

 

Accelerated filer  o

 

Non-accelerated filer  o

 

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

 

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

 

Common Stock, par value $0.008 per share

 

38,336,422

(Class)

 

(Number of Shares)

 

 



 

priceline.com Incorporated

Form 10-Q

 

For the Three Months Ended September 30, 2007

 

 

 

Page

 

 

 

PART I - FINANCIAL INFORMATION

 

2

 

 

 

Item 1. Consolidated Financial Statements

 

2

 

 

 

Consolidated Balance Sheets (unaudited) at September 30, 2007 and December 31, 2006

 

2

Consolidated Statements of Operations (unaudited) For the Three and Nine Months
Ended September 30, 2007 and 2006

 

3

Consolidated Statement of Changes in Stockholders’ Equity (unaudited)
For the Nine Months Ended September 30, 2007

 

4

Consolidated Statements of Cash Flows (unaudited) For the Nine Months
Ended September 30, 2007 and 2006

 

5

Notes to Unaudited Consolidated Financial Statements

 

6

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

20

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

46

 

 

 

 

Item 4.

Controls and Procedures

 

47

 

 

 

PART II - OTHER INFORMATION

 

48

 

 

 

Item 1. Legal Proceedings

 

48

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

 

48

Item 6. Exhibits and Reports on Form 8-K

 

49

 

 

 

SIGNATURES

 

50

 

1



 

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)

 

 

 

September 30,

 

December 31,

 

 

 

2007

 

2006

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

423,508

 

$

423,577

 

Restricted cash

 

2,710

 

2,459

 

Short-term investments

 

73,048

 

7,983

 

Accounts receivable, net of allowance for doubtful accounts of $1,641 and $1,651, respectively

 

103,558

 

48,536

 

Prepaid expenses and other current assets

 

26,998

 

20,534

 

Total current assets

 

629,822

 

503,089

 

 

 

 

 

 

 

Long-term investments

 

18,735

 

 

Property and equipment, net

 

25,056

 

21,691

 

Intangible assets, net

 

182,438

 

152,925

 

Goodwill

 

270,807

 

226,707

 

Deferred taxes

 

222,766

 

179,392

 

Other assets

 

21,085

 

21,844

 

Total assets

 

$

1,370,709

 

$

1,105,648

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

59,359

 

$

49,032

 

Accrued expenses and other current liabilities

 

124,576

 

46,872

 

Deferred merchant bookings

 

7,670

 

4,768

 

Convertible debt

 

569,453

 

 

Total current liabilities

 

761,058

 

100,672

 

 

 

 

 

 

 

Deferred taxes

 

47,153

 

39,714

 

Other long-term liabilities

 

12,508

 

11,885

 

Minority interest

 

15,127

 

22,486

 

Convertible debt

 

 

568,865

 

Total liabilities

 

835,846

 

743,622

 

 

 

 

 

 

 

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

 

 

13,470

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $0.008 par value; authorized 1,000,000,000 shares, 44,969,857 and 43,215,712 shares issued, respectively

 

345

 

331

 

Treasury stock, 6,641,992 and 6,603,050 shares, respectively

 

(488,691

)

(486,468

)

Additional paid-in capital

 

2,112,949

 

2,070,379

 

Accumulated deficit

 

(1,139,368

)

(1,262,033

)

Accumulated other comprehensive income

 

49,628

 

26,347

 

Total stockholders’ equity

 

534,863

 

348,556

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

1,370,709

 

$

1,105,648

 

 

See Notes to Unaudited Consolidated Financial Statements.

 

2



 

priceline.com Incorporated

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Merchant revenues, including $395 and $18,592 excise tax refund for the three and nine months ended September 30, 2007, respectively

 

$

275,211

 

$

238,558

 

$

776,131

 

$

699,520

 

Agency revenues

 

139,623

 

73,326

 

292,478

 

159,599

 

Other revenues

 

2,453

 

1,583

 

5,947

 

3,913

 

Total revenues

 

417,287

 

313,467

 

1,074,556

 

863,032

 

 

 

 

 

 

 

 

 

 

 

Cost of merchant revenues

 

214,956

 

189,920

 

595,297

 

561,450

 

Cost of agency revenues

 

 

 

 

 

Cost of other revenues

 

 

 

 

 

Total costs of revenues

 

214,956

 

189,920

 

595,297

 

561,450

 

Gross profit

 

202,331

 

123,547

 

479,259

 

301,582

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Advertising – Offline

 

8,413

 

6,665

 

29,028

 

24,962

 

Advertising – Online

 

53,844

 

34,560

 

129,241

 

86,914

 

Sales and marketing

 

13,093

 

11,204

 

36,027

 

31,494

 

Personnel, including stock-based compensation of $4,127, $3,543, $10,759 and $10,277, respectively

 

27,182

 

21,658

 

72,108

 

56,869

 

General and administrative, including net cost of litigation settlement of $126 and $55,365 for the three and nine months ended September 30, 2007, respectively, and option payroll taxes of $228, $54, $760 and $273, respectively

 

9,241

 

6,643

 

82,893

 

19,638

 

Information technology

 

3,343

 

2,551

 

9,406

 

7,190

 

Depreciation and amortization

 

9,131

 

8,664

 

26,633

 

24,970

 

Restructuring charge, net

 

 

 

 

135

 

Total operating expenses

 

124,247

 

91,945

 

385,336

 

252,172

 

Operating income

 

78,084

 

31,602

 

93,923

 

49,410

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income, including $77 and $3,346 of interest on excise tax refund for the three and nine months ended  September 30, 2007, respectively

 

6,063

 

2,626

 

20,377

 

6,322

 

Interest expense

 

(2,607

)

(1,550

)

(7,560

)

(4,603

)

Other

 

(1,316

)

354

 

(1,862

)

(157

)

Total other income (expense)

 

2,140

 

1,430

 

10,955

 

1,562

 

 

 

 

 

 

 

 

 

 

 

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

 

80,224

 

33,032

 

104,878

 

50,972

 

Income tax benefit

 

26,657

 

18,113

 

23,287

 

13,277

 

Equity in income (loss) of investees and minority interests

 

(2,516

)

(2,328

)

(3,945

)

(3,015

)

Net income

 

104,365

 

48,817

 

124,220

 

61,234

 

Preferred stock dividend

 

 

(1,063

)

(1,555

)

(1,927

)

 

 

 

 

 

 

 

 

 

 

Net income applicable to common stockholders

 

$

104,365

 

$

47,754

 

$

122,665

 

$

59,307

 

Net income applicable to common stockholders per basic common share

 

$

2.76

 

$

1.21

 

$

3.27

 

$

1.50

 

Weighted average number of basic common shares outstanding

 

37,803

 

39,596

 

37,533

 

39,487

 

Net income applicable to common stockholders per diluted common share

 

$

2.27

 

$

1.05

 

$

2.79

 

$

1.34

 

Weighted average number of diluted common shares outstanding

 

45,924

 

46,385

 

43,924

 

46,153

 

 

See Notes to Unaudited Consolidated Financial Statements.

 

3



 

priceline.com Incorporated

UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

Accumulated Other

 

 

 

 

 

 

 

 

 

Common Stock

 

Additional

 

Accumulated

 

Comprehensive

 

Treasury Stock

 

 

 

 

 

Shares

 

Amount

 

Paid-in Capital

 

Deficit

 

Income

 

Shares

 

Amount

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2007

 

43,216

 

$

331

 

$

2,070,379

 

$

(1,262,033

)

$

26,347

 

(6,603

)

$

(486,468

)

$

348,556

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income applicable to common stockholders

 

 

 

 

122,665

 

 

 

 

122,665

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss on marketable securities

 

 

 

 

 

(45

)

 

 

(45

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Currency translation adjustment

 

 

 

 

 

23,326

 

 

 

23,326

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

145,946

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

119

 

1

 

(1

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of preferred stock dividend

 

35

 

1

 

1,554

 

 

 

 

 

1,555

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercise of stock options and vesting of restricted stock units

 

843

 

6

 

16,190

 

 

 

 

 

16,196

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase of common stock

 

 

 

 

 

 

(39

)

(2,223

)

(2,223

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation

 

 

 

9,906

 

 

 

 

 

9,906

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercise of warrants

 

756

 

6

 

13,464

 

 

 

 

 

13,470

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of shares related to convertible debt

 

1

 

 

23

 

 

 

 

 

23

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Excess tax benefit on stock-based compensation

 

 

 

1,434

 

 

 

 

 

1,434

 

Balance, September 30, 2007

 

44,970

 

$

345

 

$

2,112,949

 

$

(1,139,368

)

$

49,628

 

(6,642

)

$

(488,691

)

$

534,863

 

 

See Notes to Unaudited Consolidated Financial Statements.

 

4



 

priceline.com Incorporated

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(In thousands)

 

 

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

124,220

 

$

61,234

 

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

 

 

 

 

 

Depreciation

 

8,260

 

7,551

 

Amortization

 

18,373

 

18,439

 

Provision for uncollectible accounts, net

 

2,138

 

2,921

 

Deferred income taxes

 

(49,883

)

(26,106

)

Stock-based compensation expense

 

10,759

 

10,277

 

Amortization of debt issuance costs

 

2,356

 

1,061

 

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

 

3,945

 

3,015

 

Restructuring charges, net

 

 

135

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(53,568

)

(28,491

)

Prepaid expenses and other current assets

 

(4,950

)

(2,150

)

Accounts payable, accrued expenses and other current liabilities

 

26,501

 

31,831

 

Other

 

1,183

 

567

 

Net cash provided by operating activities

 

89,334

 

80,284

 

INVESTING ACTIVITIES:

 

 

 

 

 

Purchase of investments

 

(118,255

)

(111,953

)

Redemption of investments

 

35,202

 

152,119

 

Acquisitions and other equity investments, net of cash acquired

 

 

(3,104

)

Additions to property and equipment

 

(11,011

)

(9,628

)

Change in restricted cash

 

(228

)

4,538

 

Net cash provided by (used in) investing activities

 

(94,292

)

31,972

 

FINANCING ACTIVITIES:

 

 

 

 

 

Repurchase of common stock

 

(2,223

)

(135,625

)

Proceeds from exercise of stock options

 

16,196

 

9,592

 

Proceeds from issuance of Convertible Senior Notes

 

 

300,000

 

Payment of debt issuance costs

 

(1,309

)

(7,900

)

Purchase of Conversion Spread Hedges

 

 

(32,520

)

Purchase of shares held by minority interest

 

(15,013

)

(19,830

)

Excess tax benefit from stock-based compensation

 

1,434

 

68

 

Net cash provided (used in) by financing activities

 

(915

)

113,785

 

Effect of exchange rate changes on cash and cash equivalents

 

5,804

 

2,288

 

Net increase (decrease) in cash and cash equivalents

 

(69

)

228,329

 

Cash and cash equivalents, beginning of period

 

423,577

 

80,341

 

Cash and cash equivalents, end of period

 

$

423,508

 

$

308,670

 

 

 

 

 

 

 

SUPPLEMENTAL CASH FLOW INFORMATION:

 

 

 

 

 

 

 

 

 

 

 

Cash paid during the period for income taxes

 

$

22,111

 

$

10,682

 

 

 

 

 

 

 

Cash paid during the period for interest

 

$

5,847

 

$

3,552

 

 

See Notes to Unaudited Consolidated Financial Statements

 

5



 

priceline.com Incorporated

Notes to Unaudited Consolidated Financial Statements

 

1.                                      BASIS OF PRESENTATION

 

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

 

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

 

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

 

2.                                      STOCK-BASED EMPLOYEE COMPENSATION

 

The Company has adopted stock compensation plans which provide for grants of share based compensation as incentives and rewards to encourage employees, officers, consultants and directors to contribute towards the long-term success of the Company. Stock-based compensation cost included in personnel expenses in the Unaudited Consolidated Statements of Operations was approximately $4.1 million and $3.5 million, and $10.8 million and $10.3 million for the three and nine months ended September 30, 2007 and 2006, respectively. These amounts include stock-based compensation for restricted stock and restricted stock units related to shares of priceline.com International.

 

During the three months ended March 31, 2007, the Company granted 125,550 shares of restricted stock, 83,740 restricted stock units and 75,750 performance share units. The share based awards generally vest on the third anniversary of the date of grant and had a total grant date fair value of $14.8 million based upon the grant date fair value per share of $51.93. The actual number of shares of common stock issued in connection with the performance share units, if any, will be determined at the end of the performance period, assuming there is no accelerated vesting for, among other things, a change in control or termination of employment in certain circumstances, and could range from zero to an additional 75,750 shares over the “target” number of shares if the maximum performance threshold associated with the performance share units is met by the Company. Stock-based compensation related to the performance share units is recorded based upon the probable outcome at the end of the performance period. During the three months ended September 30, 2007, the estimated probable number of shares to be issued at the end of the performance period was increased by 75,750 shares.

 

During the three months ended June 30, 2007, the Company granted 8,070 shares of restricted stock. The share based awards generally vest over four years and had a total grant date fair value of $0.5 million based upon the grant date fair value per share of $56.75.

 

During the three months ended September 30, 2007, the Company granted 2,140 shares of restricted stock. The share based awards generally vest over four years and had a total grant date fair value of $0.16 million based upon the grant date fair value per share of $76.82.

 

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.

 

6



 

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.

 

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

 

Prior to the Company executing an exchange offer in November 2006 that modified certain terms in the 1% Notes and 2.25% Notes, such notes were convertible into a fixed amount of common stock if certain specified conditions were met. Pursuant to EITF 04-08 “Effect of Contingently Convertible Debt on Diluted Earnings per Share”, these convertible notes were included in the calculation of diluted earnings per share if their inclusion was dilutive to earnings per share under the “if-converted” method for the three and nine months ended September 30, 2006.

 

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

 

 

 

For the Three Months
Ended September 30,

 

For the Nine Months
Ended September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Net income applicable to common stockholders

 

$

104,365

 

$

47,754

 

$

122,665

 

$

59,307

 

Interest expense on convertible senior notes

 

 

762

 

 

2,323

 

 

 

$

104,365

 

$

48,516

 

$

122,665

 

$

61,630

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of basic common shares outstanding

 

37,803

 

39,596

 

37,533

 

39,487

 

 

 

 

 

 

 

 

 

 

 

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

 

1,359

 

1,029

 

1,386

 

906

 

 

 

 

 

 

 

 

 

 

 

Assumed conversion of convertible senior notes

 

6,762

 

5,760

 

5,005

 

5,760

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of diluted common and common equivalent shares outstanding

 

45,924

 

46,385

 

43,924

 

46,153

 

 

 

 

 

 

 

 

 

 

 

Anti-dilutive potential common shares

 

9,328

 

3,885

 

11,058

 

4,008

 

 

Anti-dilutive potential common shares for the three and nine months ended September 30, 2007 includes approximately 7.5 million shares and 9.3 million shares, respectively, that could be issued under the Company’s convertible debt if the Company experiences substantial increases in its common stock price. Under the treasury stock method, the convertible notes will generally have a dilutive impact on net income per share if the Company’s average stock price for the period exceeds the conversion price for the convertible notes. As an example, at stock prices of $40 per share, $60 per share, $80 per share and $100 per share, common equivalent shares would include approximately 0.1 million, 4.8 million, 7.2 million and 8.6 million equivalent shares, respectively, related to the convertible notes (excluding the offsetting impact of the Convertible Spread Hedges — see Note 8).

 

4.                                      RESTRUCTURING

 

At September 30, 2007, the Company had a restructuring liability of $1.2 million for the estimated remaining costs related to leased property vacated by the Company in 2000. During the first quarter of 2006, the Company recorded a $135,000 restructuring charge based upon a re-evaluation of the estimated disposal costs related to the vacated leased property. The Company estimates that, based on current available information, the remaining net cash outflows associated with its restructuring related commitments will be paid in 2007-2011. The current portion of the restructuring accrual in the amount of $697,000 is recorded in “Accrued expenses and other current liabilities” and the $504,000 non-current portion is recorded in “Other long-term liabilities” on the Company’s Unaudited Consolidated Balance Sheet.

 

7



 

5.                                      INVESTMENTS

 

The following table summarizes, by major security type, the Company’s short-term investments as of September 30, 2007 (in thousands):

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized Loss

 

Estimated Fair
Value

 

Asset backed obligations

 

$

1,320

 

$

 

$

(2

)

$

1,318

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

34,724

 

15

 

(3

)

34,735

 

 

 

 

 

 

 

 

 

 

 

Corporate notes

 

26,488

 

 

(6

)

26,483

 

 

 

 

 

 

 

 

 

 

 

Government agency notes

 

10,514

 

7

 

(9

)

10,512

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

73,046

 

$

22

 

$

(20

)

$

73,048

 

 

The Company’s short-term investments as of December 31, 2006 were approximately $8.0 million, comprised of U.S. government agency notes. Contractual maturities of marketable securities classified as available-for-sale as of September 30, 2007 and December 31, 2006, are all within one year. No material gains or losses were realized for the three months or nine months ended September 30, 2007 and 2006.

 

Long-term investments amounting to $18.7 million as of September 30, 2007 were comprised of government agency and corporate notes with a maturity date greater than one year. There were no material gains or losses related to long-term investments for the three or nine month ended September 30, 2007 and 2006.  The Company did not have any long-term investments at December 31, 2006.

 

6.                                      INTANGIBLE ASSETS AND GOODWILL

 

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

 

 

 

September 30, 2007

 

December 31, 2006

 

 

 

 

 

 

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Amortization
Period

 

Weighted
Average
Useful Life

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supply and distribution agreements

 

$

190,142

 

$

(31,186

)

$

158,956

 

$

151,926

 

$

(24,237

)

$

127,689

 

13 years

 

13 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Technology

 

25,294

 

(19,379

)

5,915

 

21,454

 

(12,571

)

8,883

 

3 years

 

3 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Patents

 

1,489

 

(1,119

)

370

 

1,489

 

(1,076

)

413

 

15 years

 

15 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer lists

 

12,243

 

(10,214

)

2,029

 

9,822

 

(8,049

)

1,773

 

2 — 3 years

 

2 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Internet domain names

 

6,443

 

(1,181

)

5,262

 

6,443

 

(698

)

5,745

 

10 years

 

10 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trade names

 

12,957

 

(3,549

)

9,408

 

10,515

 

(2,195

)

8,320

 

5 — 20 years

 

15 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

729

 

(231

)

498

 

1,107

 

(1,005

)

102

 

3 — 15 years

 

9 years

 

Total intangible assets

 

$

249,297

 

$

(66,859

)

$

182,438

 

$

202,756

 

$

(49,831

)

$

152,925

 

 

 

 

 

 

Intangible assets with determinable lives are primarily amortized on a straight-line basis. Intangible asset amortization expense was approximately $6.1 million and $6.4 million for the three months ended September 30, 2007 and 2006, respectively, and approximately $18.4 million for the nine months ended September 30, 2007 and 2006, respectively.

 

8



 

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

 

2007

 

$

6,643

 

2008

 

21,951

 

2009

 

17,324

 

2010

 

15,724

 

2011

 

15,724

 

Thereafter

 

105,072

 

 

 

$

182,438

 

 

A substantial majority of the Company’s goodwill relates to its acquisitions of Travelweb LLC and Booking.com Limited in 2004 and Booking.com B.V. in 2005. The change in goodwill for the nine months ended September 30, 2007 consists of the following (in thousands):

 

Balance at January 1, 2007

 

$

226,707

 

Purchase of minority interest

 

33,220

 

Currency translation adjustments

 

10,880

 

Balance at September 30, 2007

 

$

270,807

 

 

7.                                      OTHER ASSETS

 

Other assets at September 30, 2007 and December 31, 2006 consist of the following (in thousands):

 

 

 

September 30, 2007

 

December 31, 2006

 

Investment in pricelinemortgage.com

 

$

9,414

 

$

9,550

 

Deferred debt issuance costs, net

 

10,852

 

11,899

 

Other

 

819

 

395

 

Total

 

$

21,085

 

$

21,844

 

 

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 $113,000 and $136,000 of losses from its investment in pricelinemortgage.com in the three and nine months ended September 30, 2007, respectively. The Company recognized approximately $39,000 and $63,000 of losses from its investment in pricelinemortgage.com in the three and nine months ended September 30, 2006, respectively. The Company earned advertising fees from pricelinemortgage.com of approximately $8,000 and $16,000 in the nine months ended September 30, 2007 and 2006, respectively.

 

Deferred debt issuance costs arose from the Company’s issuance of $125 million aggregate principal amount of 1% Notes in August 2003, $100 million aggregate principal amount of 2.25% Notes in June 2004, $172.5 million aggregate principal amount of 0.5% Notes in September 2006, $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



 

8.                                      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 $50.0 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 $100.0 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 will be used for working capital and general corporate purposes. As of September 30, 2007 there were no amounts outstanding under the 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 September 30, 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 September 30, 2007 and, accordingly, have been classified as a current liability in the Unaudited Consolidated Balance Sheets as of that date. The convertible debt may be classified as long-term debt in future quarters if the contingent conversion thresholds are not met in such quarters. Convertible debt consists of the following as of September 30, 2007 and December 31, 2006 (in thousands):

 

 

 

September 30,
2007

 

December 31,
2006

 

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

 

$

124,453

 

$

123,865

 

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

 

172,500

 

172,500

 

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

 

172,500

 

172,500

 

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

 

100,000

 

100,000

 

 

 

 

 

 

 

 

 

$

569,453

 

$

568,865

 

 

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

 

10



 

from $0 to approximately $16.5 million depending upon the date of the transaction and the then current stock price of the Company. Interest on the 1% Notes is payable on February 1 and August 1 of each year.

 

In November 2003, the Company entered into an interest rate swap agreement whereby it swapped the fixed 1% interest on its 1% Notes for a floating interest rate based on the 3-month U.S. Dollar LIBOR, minus the applicable margin of 221 basis points, on $45 million notional value of debt. This agreement expires August 1, 2010. The Company designated this interest rate swap agreement as a fair value hedge. The changes in the fair value of the interest rate swap agreement and the underlying debt are recorded as offsetting gains and losses in interest expense in the Unaudited Consolidated Statement of Operations. Hedge ineffectiveness was not significant in the three or nine months ended September 30, 2007 and 2006. The fair value cost to terminate this swap as of September 30, 2007 and December 31, 2006, was approximately $0.5 million and $1.2 million, respectively, and has been recorded in accrued expenses and other current liabilities at September 30, 2007, and other long-term liabilities at December 31, 2006, with a related adjustment to the carrying value of debt.

 

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

 

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

 

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%

 

11



 

Notes of amounts ranging from $0 to $14.7 million depending upon the date of the transaction and the then current stock price of the Company. In addition, the 2.25% Notes will be redeemable at the Company’s option beginning January 20, 2010, and the holders may require the Company to repurchase the 2.25% Notes on January 15, 2010, 2015 or 2020, or in certain other circumstances. Interest on the 2.25% Notes is payable on January 15 and July 15 of each year.

 

In the third quarter 2007, the Financial Accounting Standards Board (“FASB”) issued for comment a proposed 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”) that would significantly impact the accounting for convertible debt. The FSP would require cash settled convertible debt, such as the Company’s $570 million aggregate principal amount of convertible senior notes that are currently outstanding, to be separated into debt and equity components at issuance and a value to be assigned to each. The value assigned to the debt component would be the estimated fair value, as of the issuance date, of a similar bond without the conversion feature. The difference between the bond cash proceeds and this estimated fair value would be recorded as a debt discount and amortized to interest expense over the life of the bond. Although FSP APB 14-a would have no impact on the Company’s actual past or future cash flows, it would require the Company to record a significant amount of non-cash interest expense as the debt discount is amortized. As a result, there would be a material adverse impact on the Company’s results of operations and earnings per share. In addition, if the Company’s convertible debt is redeemed or converted prior to maturity, any unamortized debt discount would result in a loss on extinguishment. FSP APB 14-a, if approved, will become effective January 1, 2008, and require retrospective application.

 

9.                                      TREASURY STOCK

 

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

 

Under these programs, the Company repurchased approximately 4.1 million shares of its common stock at an aggregate cost of $135.7 million in the nine months ended September 30, 2006, at prevailing market prices. Repurchases of 38,942 and 35,147 shares at aggregate costs of $2.2 million and $0.9 million were made in the nine months ended September 30, 2007 and 2006, respectively, to satisfy employee withholding taxes related to stock-based compensation.

 

The Company may make additional repurchases of shares under its stock repurchase program, depending on prevailing market conditions, alternate uses of capital and other factors. Whether and when to initiate and/or complete any purchase of common stock and the amount of common stock purchased will be determined in the Company’s complete discretion. As of September 30, 2007, there were approximately 6.6 million shares of the Company’s common stock held in treasury.

 

10.                               REDEEMABLE PREFERRED STOCK

 

In the first quarter of 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.

 

11.                               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 and nine months ended September 30, 2007 and 2006, the substantial majority of the Company’s foreign-sourced income has been generated in the United Kingdom and the Netherlands. Income tax expense for the three and nine months ended September 30, 2007 and 2006

 

12



 

differs from the expected tax benefit at the U.S. statutory rate of 35% due to reversal of a portion of the deferred tax valuation allowance, state income taxes, lower foreign tax rates and the foreign tax benefit of interest expense on intercompany debt.

 

The Company has significant deferred tax assets, resulting principally from domestic net operating loss carryforwards (“NOLs”). As required by SFAS No. 109, “Accounting for Income Taxes,” the Company periodically evaluates the likelihood of the realization of deferred tax assets, and reduces the carrying amount of these deferred tax assets by a valuation allowance to the extent it believes a portion will not be realized. The Company considers many factors when assessing the likelihood of future realization of the deferred tax assets, including its recent cumulative earnings experience by taxing jurisdiction, expectations of future taxable income, the carryforward periods available for tax reporting purposes, and other relevant factors. In the third quarter of 2007, management concluded that based upon current operating results and projected future results, it is more likely than not that additional deferred tax assets will be realized. Accordingly, the Company recorded a non-cash tax benefit of $47.9 million resulting from the reversal of a portion of its valuation allowance on its deferred tax assets. It is the Company’s belief that it is more likely than not that its remaining deferred tax assets will not be realized and, accordingly, a valuation allowance remains against those assets. In the third quarter of 2006, the Company also recorded a $28.1 million non-cash tax benefit resulting from a $43.7 million reversal of a portion of its valuation allowance on its deferred tax assets. The total deferred tax asset at September 30, 2007 and December 31, 2006 amounted to $236.2 million and $191.7 million, respectively. The current portion is $13.5 million and $12.3 million at September 30, 2007 and December 31, 2006, respectively, and is recorded in prepaid expenses and other current assets in the Unaudited Consolidated Balance Sheet. The valuation allowance may need to be adjusted in the future if facts and circumstances change, causing a reassessment of the amount of deferred tax assets more likely than not to be realized.

 

The Company has recorded a deferred tax liability in the amount of $47.2 million at September 30, 2007, and $39.7 million at December 31, 2006, primarily related to the assignment of estimated fair value to certain purchased identifiable intangible assets associated with the acquisitions of Booking.com Limited and Booking.com B.V.

 

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

 

The Company’s U.K., Netherlands, U.S. Federal and Connecticut income tax returns, constituting the returns of the major taxing jurisdictions, are subject to examination by the taxing authorities for all open years as prescribed by applicable statute. No waivers have been executed that would extend the period subject to examination beyond the period prescribed by statute.

 

12.                               MINORITY INTEREST

 

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 international 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.

 

The holders of the minority interest in priceline.com International have the right to put their shares to the Company and the Company has the right to call their shares at a purchase price reflecting the fair market value of the shares at the time of the exercise of the put or call right. Subject to certain exceptions, (a) certain of the shares are subject to the put and call options in March 2007 and 2008 and (b) certain of the shares are subject to the put and call options in August 2007 and 2008. In April 2007 (in connection with the March 2007 put and call options), the Company repurchased 92,125 shares underlying minority interest with a carrying value of $3.7 million for an aggregate purchase price of approximately $15.0 million based upon fair value. In October 2007 (in connection with the August 2007 put and call options), the Company repurchased 197,538 shares underlying minority interest with a carrying value of $9.9 million for an aggregate purchase price of approximately $61.0 million based upon fair value. Accordingly, the Company has accrued this repurchase obligation at September 30, 2007 and reflected the obligation in accrued expenses and other liabilities. The repurchase will be reflected in the consolidated statement of cash flows during the fourth quarter of 2007. After giving effect to these purchases, the minority interest in priceline.com International is reduced on a fully diluted basis to 3.3%.

 

13



 

All purchased securities and vested granted securities described above can be put by the holders of the securities or called by the Company shortly after the consummation of a “change in control” of the Company. The aggregate fair value of the minority interest in priceline.com International subject to future puts or calls is estimated to be approximately $97.1 million at September 30, 2007, including unvested restricted stock and restricted stock units.

 

13.                               COMMITMENTS AND CONTINGENCIES

 

Litigation Related to Hotel Occupancy and Other Taxes

 

Statewide Putative Class Actions

 

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

 

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

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

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

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

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

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

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

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

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

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

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

                  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 aforementioned legal proceedings can be found in the section titled “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2006 and/or in the section titled “Commitments and Contingencies” of our Quarterly Reports on Form 10-Q for the three months ended March 31, 2007 or June 30, 2007.

 

The following developments regarding such legal proceedings occurred during or after the three months ended September 30, 2007:

 

City of Los Angeles v. Hotels.com, Inc., et al.:  On July 27, 2007, the court sustained the defendants’ demurrers and dismissed the City’s third amended complaint without prejudice to re-filing upon the exhaustion of the City’s mandatory administrative procedures for tax collection, and stayed the action pending such exhaustion. The City is presently conducting those administrative procedures.

 

City of Fairview Heights v. Orbitz, Inc., et al.:  On August 1, 2007, the City of Fairview Heights moved for class certification. That motion is being briefed. The parties are currently conducting discovery.

 

Pitt County v. Hotels.com, L.P., et al.:  On August 13, 2007, the court granted defendants’ motion for reconsideration of the court’s prior order denying the defendants’ motion to dismiss, and dismissed the action in its entirety. On September 6, 2007, Pitt County filed a notice of appeal of that decision to the United States Court of Appeals for the Fourth Circuit. The appeal is currently being briefed.

 

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City of San Antonio, Texas v. Hotels.com, L.P., et al.:  On September 7, 2007, the defendants filed a motion for reconsideration of the court’s March 21, 2007 order denying the defendants’ motion to dismiss. On October 1, 2007, the court denied the defendants’ motion for reconsideration. The City of San Antonio’s motion for class certification remains pending.

 

City of Orange, Texas v. Hotels.com, L.P., et al.:  On September 5, 2007, the Magistrate Judge issued a report and recommendation that the defendants’ motion to dismiss the complaint be granted and the complaint dismissed. On September 21, 2007, the court adopted that report and recommendation and dismissed the case with prejudice. The City of Orange did not appeal that dismissal.

 

City of Jacksonville v. Hotels.com, L.P., et al.:  On August 21, 2007, the court granted defendants’ motion to dismiss the complaint for the City of Jacksonville’s failure to exhaust its mandatory administrative procedures for tax collection. On September 10, 2007, the City of Jacksonville moved for a stay of proceedings pending the outcome of that administrative process. That motion is pending.

 

City of Columbus, et al. v. Hotels.com, L.P., et al.:  On July 10, 2007, the United States District Court for the Southern District of Ohio transferred the case to the United States District Court for the Northern District of Ohio. On July 23, 2007, the court in the Northern District of Ohio granted defendants’ motion to dismiss the plaintiffs’ Consumer Sales Practices Act claims and denied defendants’ motion to dismiss the remaining claims, adopting the reasoning of the court’s opinion on the motion to dismiss in the City of Findlay case. On August 31, 2007, the defendants answered the complaint. On November 5, 2007, the parties jointly moved to consolidate the City of Columbus action with the City of Findlay action for pre-trial purposes, and that motion was granted on November 6, 2007.

 

Louisville/Jefferson County Metro Government v. Hotels.com, L.P., et al.:  On August 10, 2007, the court denied the defendants’ motion to dismiss. On September 13, 2007, the defendants answered. On October 26, 2007, the defendants filed a motion for reconsideration of the court’s order denying the defendants’ motion to dismiss, or, in the alternative, certification of interlocutory appeal to the Kentucky Supreme Court or the United States Court of Appeals for the Sixth Circuit. That motion is being briefed.

 

City of Fayetteville v. Hotels.com, L.P., et al.:  On July 24, 2007, the City of Fayetteville filed an amended complaint correcting the names of certain defendants. On August 7, 2007, the defendants moved to dismiss the amended complaint. That motion is pending.

 

County of Nassau, New York v. Hotels.com, LP, et al.:  On August 17, 2007, the court granted the defendants’ motion to dismiss the complaint for the County of Nassau’s failure to exhaust its mandatory administrative procedures for tax collection. On September 12, 2007, the County of Nassau filed a notice of appeal of that order to the United States Court of Appeals for the Second Circuit. The appeal is currently being briefed.

 

City of Jefferson, Missouri v. Hotels.com, LP, et al.:  On November 5, 2007, the defendants moved to dismiss the complaint. That motion is being briefed.

 

In addition to those cases discussed in the section titled “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2006 or in the section titled “Commitments and Contingencies” of our Quarterly Reports on Form 10-Q for the three months ended March 31, 2007 or June 30, 2007, the following additional legal proceeding was filed during or after the three months ended September 30, 2007:

 

City of Gallup, New Mexico v. Hotels.com, L.P., et al.:  On July 6, 2007, a putative class action was filed in the United States District Court for the District of New Mexico by the City of Gallup on behalf of itself and a putative class of New Mexico taxing authorities that have enacted lodgers’ taxes. The complaint asserts claims for violation of the New Mexico Lodger’s Tax Act and municipal ordinances. On August 27, 2007, the defendants answered the City of Gallup’s complaint.

 

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

 

Actions Filed on Behalf of Individual Cities and Counties

 

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

 

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

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

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

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

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

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

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

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

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

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

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

 

A discussion of each of the aforementioned legal proceedings can be found in the section titled “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2006 and/or in the section titled “Commitments and Contingencies” of our Quarterly Reports on Form 10-Q for the three months ended March 31, 2007 or June 30, 2007.

 

The following developments regarding such legal proceedings occurred during or after the three months ended September 30, 2007:

 

City of Findlay v. Hotels.com, L.P., et al.:  On August 2, 2007, the City of Findlay filed a motion seeking leave to amend its complaint to withdraw its allegations seeking to assert claims on behalf of a state-wide class of Ohio cities, counties and townships that have enacted occupancy or excise taxes on lodging. On August 15, 2007, the court granted that motion and an amended complaint withdrawing those class allegations was filed. On September 4, 2007, the defendants answered the amended complaint. On November 5, 2007, the parties jointly moved to consolidate the City of Findlay action with the City of Columbus action for pre-trial purposes, and that motion was granted on November 6, 2007.

 

City of Chicago, Illinois v. Hotels.com, L.P., et al.:  On September 27, 2007, the court denied the defendants’ motion to dismiss. On November 2, 2007, the defendants answered the complaint. The parties are currently conducting discovery.

 

City of San Diego, California v. Hotels.com, Inc., et al.: On July 27, 2007, the court sustained the defendants’ demurrers and dismissed the City’s third amended complaint without prejudice to re-filing upon the exhaustion of the City’s mandatory administrative procedures for tax collection, and stayed the action pending such exhaustion. The City is presently conducting those administrative procedures.

 

City of Atlanta, Georgia v. Hotels.com L.P., et al.:  On October 26, 2007, the Georgia Court of Appeals affirmed the order of the Georgia Superior Court dismissing the City of Atlanta’s action for the City’s failure to exhaust its administrative procedures for tax collection.  On November 5, 2007, the City moved for reconsideration of the October 26, 2007 opinion.

 

City of Charleston, South Carolina v. Hotel.com, et al.:  On June 4, 2007, the defendants moved to dismiss the amended complaint. On November 5, 2007, the court denied that motion. The parties are currently conducting discovery.

 

Town of Mount Pleasant, South Carolina v. Hotels.com, et al.:  On June 4, 2007, the defendants moved to dismiss the amended complaint. On November 5, 2007, the court denied that motion. The parties are currently conducting discovery.

 

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City of North Myrtle Beach, South Carolina v. Hotels.com, LP, et al.:  On August 28, 2007, the City of North Myrtle Beach withdrew its motion to remand the action to state court. On September 12, 2007, the court conducted oral argument on the defendants’ motion to dismiss the complaint, and on September 30, 2007, it denied that motion. On October 15, 2007, the defendants answered the complaint.

 

Wake County v. Hotels.com, LP, et al.; Cumberland County v. Hotels.com, LP, et al.; Buncombe County v. Hotels.com, LP, et al; and Dare County v. Hotels.com, LP, et al.:  On July 18, 2007, the court conducted oral argument on all four of the motions to dismiss in these consolidated actions. Those motions remain pending.

 

City of Branson v. Hotels.com, LP, et al.:  On August 30, 2007, the court heard oral argument on the defendants’ motion to dismiss the complaint. That motion is pending.

 

City of Houston, Texas v. Hotels.com, LP., et al.:  On July 5, 2007, the court denied in part and granted in part the defendants’ special exceptions to the complaint. The court denied the special exceptions relating to the adequacy of the plaintiff’s allegations, but granted the special exceptions requiring the plaintiff to state with specificity the maximum amount of damages claimed.  On October 2, 2007, the City of Houston filed an amended complaint adding the Harris County Sports Authority as a plaintiff. On October 15, 2007, the defendants filed special exceptions to the amended complaint. Those special exceptions will be heard by the court on November 9, 2007.

 

City of Oakland, California v. Hotels.com, L.P., et al.:  On September 18, 2007, the defendants moved to dismiss the complaint. On November 6, 2007, the court granted the defendants’ motion and dismissed the City of Oakland’s complaint with prejudice for the City’s failure to exhaust its mandatory administrative procedures for tax collection.

 

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

 

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

 

Consumer Class Actions

 

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

 

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

 

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 Anaheim, California, the City of New Orleans, Louisiana, the City of Philadelphia, Pennsylvania, and state tax officials from Wisconsin, Pennsylvania, and Indiana, among others, have begun formal or informal administrative procedures or stated that they may assert claims against the Company relating to allegedly unpaid state or local hotel occupancy or related taxes. In addition, the State of New Jersey Department of Taxation has begun an audit related to the state’s Corporation Business Tax. The Company is unable at this time to predict whether any such proceedings or assertions will result in litigation.

 

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

 

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Litigation Related to Securities Matters

 

On March 16, March 26, April 27, and June 5, 2001, respectively, four putative class action complaints were filed in the U.S. District Court for the Southern District of New York naming priceline.com, Inc., Richard S. Braddock, Jay Walker, Paul Francis, Morgan Stanley Dean Witter & Co., Merrill Lynch, Pierce, Fenner & Smith, Inc., BancBoston Robertson Stephens, Inc. and Salomon Smith Barney, Inc. as defendants (01 Civ. 2261, 01 Civ. 2576, 01 Civ. 3590 and 01 Civ. 4956). Shives et al. v. Bank of America Securities LLC et al., 01 Civ. 4956, also names other defendants and states claims unrelated to the Company. The complaints allege, among other things, that priceline.com and the individual defendants violated the federal securities laws by issuing and selling priceline.com common stock in priceline.com’s March 1999 initial public offering without disclosing to investors that some of the underwriters in the offering, including the lead underwriters, had allegedly solicited and received excessive and undisclosed commissions from certain investors. By Orders of Judge Mukasey and Judge Scheindlin dated August 8, 2001, these cases were consolidated for pre-trial purposes with hundreds of other cases, which contain allegations concerning the allocation of shares in the initial public offerings of companies other than priceline.com, Inc. By Order of Judge Scheindlin dated August 14, 2001, the following cases were consolidated for all purposes:  01 Civ. 2261; 01 Civ. 2576; and 01 Civ. 3590. On April 19, 2002, plaintiffs filed a Consolidated Amended Class Action Complaint in these cases. This Consolidated Amended Class Action Complaint makes similar allegations to those described above but with respect to both the Company’s March 1999 initial public offering and the Company’s August 1999 second public offering of common stock. The named defendants are priceline.com, Inc., Richard S. Braddock, Jay S. Walker, Paul E. Francis, Nancy B. Peretsman, Timothy G. Brier, Morgan Stanley Dean Witter & Co., Goldman Sachs & Co., Merrill Lynch, Pierce, Fenner & Smith, Inc., Robertson Stephens, Inc. (as successor-in-interest to BancBoston), Credit Suisse First Boston Corp. (as successor-in-interest to Donaldson Lufkin & Jenrette Securities Corp.), Allen & Co., Inc. and Salomon Smith Barney, Inc. Priceline, Richard Braddock, Jay Walker, Paul Francis, Nancy Peretsman, and Timothy Brier, together with other issuer defendants in the consolidated litigation, filed a joint motion to dismiss on July 15, 2002. On November 18, 2002, the cases against the individual defendants were dismissed without prejudice and without costs. In addition, counsel for plaintiffs and the individual defendants executed Reservation of Rights and Tolling Agreements, which toll the statutes of limitations on plaintiffs’ claims against those individuals. On February 19, 2003, Judge Scheindlin issued an Opinion and Order granting in part and denying in part the issuer’s motion. None of the claims against the Company were dismissed. On June 26, 2003, counsel for the plaintiff class announced that they and counsel for the issuers had agreed to the form of a Memorandum of Understanding (the “Memorandum”) to settle claims against the issuers. The terms of that Memorandum provide that class members will be guaranteed $1 billion in recoveries by the insurers of the issuers and that settling issuer defendants will assign to the class members certain claims that they may have against the underwriters. Issuers also agree to limit their abilities to bring certain claims against the underwriters. If recoveries in excess of $1 billion are obtained by the class from any non-settling defendants, the settling defendants’ monetary obligations to the class plaintiffs will be satisfied; any amount recovered from the underwriters that is less than $1 billion will be paid by the insurers on behalf of the issuers. The Memorandum, which is subject to the approval of each issuer, was approved by a special committee of the priceline.com Board of Directors on Thursday, July 3, 2003. Thereafter, counsel for the plaintiff class and counsel for the issuers agreed to the form of a Stipulation and Agreement of Settlement with Defendant Issuers and Individuals (“Settlement Agreement”). The Settlement Agreement implements the Memorandum and contains the same material provisions. On June 11, 2004, a special committee of the priceline.com Board of Directors authorized the Company’s counsel to 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 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 2007 net charge of approximately $55.4 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.

 

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 recorded refunds received in the amount of $18.6 million in revenue, plus $3.3 million of interest income during the nine months ended September 30, 2007.

 

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14.                               SUBSEQUENT EVENTS

 

On November 6, 2007, the Company, through a newly-formed, indirect wholly-owned subsidiary, entered into an Equity Purchase Agreement with the shareholders of Agoda Company, Ltd. (“Agoda”) and membership interest holders of AGIP LLC (“AGIP,” and together with Agoda, the “Agoda Companies”). Pursuant to the agreement, the Company acquired all of the outstanding shares and convertible debt of Agoda and all of the outstanding membership interests of AGIP. The purchase price for the acquisition consists of an initial purchase price payable by the Company in cash of $15.1 million, subject to a post-closing net working capital adjustment and a portion of which is being held in escrow to secure certain indemnification and other obligations of the sellers under the agreement, and up to an additional $141.6 million in cash, which is payable to certain of the sellers (the “Earnout Participants”) if the Agoda Companies achieve certain performance targets from January 1, 2008 through December 31, 2010 (the “Earnout Amount”). The Earnout Amount, if any, or any portion thereof, is payable in 2011, or a later date following the expiration of a period in which the Earnout Participants may give notice to the Company of a disagreement with respect to the Earnout Amount or if there is a dispute between the Earnout Participants and the Company as to the Earnout Amount. Under certain circumstances, if there are disruptions in the Asian travel market during 2010, then the date in which the Earnout Amount, if any, or any portion thereof, is payable to the Earnout Participants is extended to a date not earlier than April 2, 2012. There can be no assurance that the Agoda Companies will achieve the performance targets, and depending on whether and the extent to which such targets are achieved by the Agoda Companies, the Company may be obligated to pay all, a portion or none of the Earnout Amount to the Earnout Participants.

 

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

 

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

 

Overview
 

General. We are a leading online travel company that offers our customers a broad range of travel services, including airline tickets, hotel rooms, car rentals, vacation packages, cruises and destination services. 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 16 languages.

 

We launched our business in the United States in 1998 under the priceline.com brand and have since expanded our operations to include the brands Lowestfare.com, Travelweb, Breezenet, Rentalcars.com and MyTravelGuide in the United States and Booking.com in Europe. Our goal is to be the top online discount travel agent in the United States, through our Name Your Own Price® and price-disclosed services, and the top online hotel distributor internationally, through Booking.com. At present, we derive substantially all of our revenues from the following sources:

 

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

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

                  Customer processing fees charged in connection with the sale of both Name Your Own Price® and price-disclosed airline tickets, hotel rooms and rental cars services. Priceline eliminated processing fees for its price-disclosed airline ticket service in June 2007;

                  Transaction revenue from our price-disclosed hotel room service;

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

                  Other revenues derived primarily from selling advertising on our websites.

 

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

 

Because we believe that an opportunity for growth exists in certain international markets, and since prior to the fourth quarter of 2004 substantially all of our revenue was generated in the U.S., we have taken steps to expand the markets we serve. In September 2004, we acquired Booking.com Limited (formerly known as Active Hotels Ltd.), a U.K. based online hotel service. Booking.com Limited gives us a strong presence in the U.K.’s online hotel market. Furthermore, in July 2005, we acquired Amsterdam-based Booking.com B.V. (formerly known as Bookings B.V.), one of Europe’s leading Internet hotel reservation services, with offices primarily in Amsterdam, Barcelona, Berlin, Cape Town, Dubai, Loule, Munich, New York, Paris, Rome, Singapore, Stockholm, Vienna and Warsaw. All of our international operations, which as of September 30, 2007, were substantially comprised of Booking.com Limited and Booking.com B.V., are majority-owned by us. A minority interest in our international business as of September 30, 2007, is held by former shareholders of Booking.com B.V. and Booking.com Limited, including certain European-based managers responsible for that business. We work with a range of chain-owned and independently owned hotels across Europe and in major cities around the world to provide hotel reservations on various websites in multiple languages.

 

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Our international business — the significant majority of which is currently generated in Europe — represented approximately 55.1% of our gross bookings in the first nine months of 2007, and was a substantial contributor to our consolidated operating income during that period. We expect that throughout the remainder of 2007 and beyond, our international business will represent a growing percentage of our total gross bookings and operating income. As our international operations have become more meaningful contributors to our results, we have seen, and expect to continue to see, changes in certain of our operating expenses and other financial metrics. For example, because our 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 the remainder of 2007 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 fluctuation on our operating results change as a result of different revenue recognition policies that apply to our international hotel service (as well as our domestic retail hotel and rental car services) and the increased importance of international hotel bookings to our results of operations.

 

The financial prospects of our domestic business have historically been significantly dependent upon the sale of leisure airline tickets and, as a result, the health of our domestic business has been impacted by the health of the airline industry. While the sale of leisure airline tickets remains an important part of our business, revenue earned in connection with the domestic reservation of hotel room nights has come to represent a substantial majority of our domestic gross profit. The domestic hotel market has been characterized in recent years by robust demand and limited supply, leading to increased occupancy rates, and in turn, increased average daily rates (“ADRs”). Because our remuneration for agency hotel transactions increases proportionately with room price, increased ADRs generally have a positive effect on our agency hotel business. Higher ADRs, however, can also negatively affect consumer demand, and higher occupancy rates can lead hotels to restrict our access to merchant hotel availability, particularly in high occupancy destinations popular with our travel base. Higher occupancy rates also have historically tended to drive lower margins as hotel suppliers have less need to distribute through third-party intermediaries such as us.

 

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 a substantial portion of our 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 leisure travel business, to continue to promote the priceline.com brand in the United States and the Booking.com brand in Europe and, over time, to offer other travel services and further expand into international markets. Factors beyond our control, such as the outbreak of an epidemic or pandemic disease; natural disasters such as hurricanes, tsunamis or earthquakes; terrorist attacks, hostilities in the Middle East or elsewhere; or the liquidation of major domestic airlines now in bankruptcy, the bankruptcy of an additional carrier or the withdrawal from our system of a major airline (or the consolidation of our major airline suppliers) or hotel supplier, could adversely affect our business and results of operations and impair our ability to effectively implement all or some of the initiatives described above. We intend to continue to invest in marketing and promotion, technology and personnel within parameters consistent with attempts to improve operating results. We also intend to broaden the scope of our business, and to that end, we explore strategic alternatives from time to time in the form of, among other things, mergers and acquisitions. In addition, we currently do not operate 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. Prior to introducing a retail travel option to our customers, substantially all of our business was conducted under the Name Your Own Price® system and accordingly, because those services are generally non-refundable in nature, we recognize travel revenue at the time a booking is generated. However, we recognize revenue generated from our retail hotel services, including our 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 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

 

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these seasonal factors.

 

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

 

In addition, during the third quarter 2007, FASB issued for comment a proposed 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”) that would significantly impact the accounting for convertible debt. The FSP would require 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 equity components at issuance and a value to be assigned to each. The value assigned to the debt component would be the estimated fair value, as of the issuance date, of a similar bond without the conversion feature. The difference between the bond cash proceeds and this estimated fair value would be recorded as a debt discount and amortized to interest expense over the life of the bond. Although FSP APB 14-a would have no impact on our actual past or future cash flows, it would require us to record a significant amount of non-cash interest expense as the debt discount is amortized. As a result, there would be a material adverse impact on our results of operations and earnings per share. In addition, if our convertible debt is redeemed or converted prior to maturity, any unamortized debt discount would result in a loss on extinguishment. FSP APB 14-a, if approved, will become effective January 1, 2008, and require retrospective application.

 

Recent Developments. On November 6, 2007, we entered into an Equity Purchase Agreement, through a newly-formed, indirect wholly-owned subsidiary, with the shareholders of Agoda Company, Ltd. (“Agoda”) and membership interest holders of AGIP LLC (“AGIP,” and together with Agoda, the “Agoda Companies”). Pursuant to the agreement, we acquired all of the outstanding shares and convertible debt of Agoda and all of the outstanding membership interests of AGIP. The purchase price for the acquisition consists of an initial purchase price payable by us in cash of $15.1 million, subject to a post-closing net working capital adjustment and a portion of which is being held in escrow to secure certain indemnification and other obligations of the sellers under the agreement, and up to an additional $141.6 million in cash, which is payable to certain of the sellers (the “Earnout Participants”) if the Agoda Companies achieve certain performance targets from January 1, 2008 through December 31, 2010 (the “Earnout Amount”). The Earnout Amount, if any, or any portion thereof, is payable in 2011, or a later date following the expiration of a period in which the Earnout Participants may give notice to us of a disagreement with respect to the Earnout Amount or if there is a dispute between the Earnout Participants and us as to the Earnout Amount. Under certain circumstances, if there are disruptions in the Asian travel market during 2010, then the date in which the Earnout Amount, if any, or any portion thereof, is payable to the Earnout Participants is extended to a date not earlier than April 2, 2012. There can be no assurance that the Agoda Companies will achieve the performance targets, and depending on whether and the extent to which such targets are achieved by the Agoda Companies, we may be obligated to pay all, a portion or none of the Earnout Amount to the Earnout Participants.

 

Results of Operations

 

Three and Nine Months Ended September 30, 2007 compared to the Three and Nine Months Ended September 30, 2006

 

Operating Metrics

 

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

 

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

 

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Gross
Bookings

 

Airline
Tickets

 

Hotel
Room
Nights

 

Rental
Car Days

 

 

 

 

 

 

 

 

 

 

 

Three Months ended September 30, 2007

 

$1.4 billion

 

819,000

 

8.0 million

 

2.3 million

 

 

 

 

 

 

 

 

 

 

 

Three Months ended September 30, 2006

 

$0.9 billion

 

666,000

 

5.2 million

 

2.0 million

 

 

 

 

 

 

 

 

 

 

 

Nine Months ended September 30, 2007

 

$3.6 billion

 

2.1 million

 

21.2 million

 

6.6 million

 

 

 

 

 

 

 

 

 

 

 

Nine Months ended September 30, 2006

 

$2.6 billion

 

2.2 million

 

14.4 million

 

5.7 million

 

 

Gross bookings increased by 54.0% and 40.6% for the three and nine months ended September 30, 2007, respectively, compared to the same periods in 2006. The increase was driven primarily by an increase of 73.7% and 58.1% in “agency” bookings for the three and nine months ended September 30, 2007, respectively, which was primarily attributable to growth in our international operations, which was partially offset by a decrease in domestic agency room-nights. In addition, an approximately 5% increase in international hotel room night unit prices in the three months ended September 30, 2007 compared to the same period in 2006, contributed to the growth in bookings for our international operations. Currency exchange rate fluctuations contributed approximately $58 million and $148 million, respectively, of the increase in gross bookings for the three and nine months ended September 30, 2007, compared to the same periods in 2006. Merchant gross bookings increased by 15.0% and 7.3% for the three and nine months ended September 30, 2007, respectively, compared to the same periods in 2006. The increase was primarily due to an increase in merchant gross bookings relating to our Name Your Own Price® hotel and rental car services, partially offset by a decrease in the sale of Name Your Own Price® airline tickets.

 

Airline tickets sold increased by 23.0% for the three months ended September 30, 2007, over the same period in 2006, due to an increase in the sale of retail airline tickets, partially offset by a decrease in the sale of Name Your Own Price® airline tickets. Airline tickets sold decreased by 3.1% for the nine months ended September 30, 2007, over the same period in 2006, primarily due to a decrease in the sale of Name Your Own Price® airline tickets, partially offset by an increase in the sale of retail airline tickets.

 

Hotel room nights sold increased by 52.0% and 47.1% for the three and nine months ended September 30, 2007, respectively, over the same periods in 2006, primarily due to growth in our hotel room nights sold through our international operations and our Name Your Own Price® hotel service.

 

Rental car days sold increased by 14.4% for the three months ended September 30, 2007, over the same period in 2006, due to an increase in sales of Name Your Own Price® rental car days, partially offset by a decrease in the sale of retail rental car days. Rental car days sold increased by 16.8% for the nine months ended September 30, 2007, over the same period in 2006, due to increases in sales of Name Your Own Price® and retail rental car days.

 

Revenues

 

We classify our revenue into three categories:

 

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

 

                  Agency revenues are derived from travel related transactions where we are not the merchant of record and where the prices of our services are determined by third parties. Agency revenues include travel commissions, customer processing fees and GDS reservation booking fees related to certain of the aforementioned

 

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transactions and are reported at the net amounts received, without any associated cost of revenue. Priceline eliminated processing fees for its price-disclosed airline ticket service in June 2007.

 

                  Other revenues are derived primarily from advertising on our websites.

 

We continue to experience a shift in the mix of our travel business from a business historically focused exclusively on the sale of domestic point-of-sale travel services to a business that includes the sale of 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 $131.8 million and $270.1 million to our revenues for the three and nine months ended September 30, 2007, respectively, which compares to $65.0 million and $134.5 million for the same periods in 2006, respectively. Approximately $2.8 million and $3.7 million, respectively, of this increase is due to fluctuations in currency exchange rates.

 

 

 

Three Months Ended
September 30,

 

 

 

Nine Months Ended
Sepetmber 30,

 

 

 

 

 

($ 000)

 

%

 

($ 000)

 

%

 

 

 

2007

 

2006

 

Change

 

2007

 

2006

 

Change

 

Merchant Revenues

 

$

275,211

 

$

238,558

 

15.4

%

$

776,131

 

$

699,520

 

11.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Agency Revenues

 

139,623

 

73,326

 

90.4

%

292,478

 

159,599

 

83.3

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Revenues

 

2,453

 

1,583

 

55.0

%

5,947

 

3,913

 

52.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Revenues

 

$

417,287