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Priceline.com 10-Q 2008
UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, 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, 2008
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-25581
PRICELINE.COM INCORPORATED (Exact name of Registrant as specified in its charter)
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, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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 October 31, 2008:
priceline.com Incorporated
For the Three Months Ended September 30, 2008
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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)
See Notes to Unaudited Consolidated Financial Statements.
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priceline.com Incorporated UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)
See Notes to Unaudited Consolidated Financial Statements.
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priceline.com Incorporated UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (In thousands)
See Notes to Unaudited Consolidated Financial Statements.
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priceline.com Incorporated CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (In thousands)
See Notes to Unaudited Consolidated Financial Statements
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priceline.com Incorporated Notes to Unaudited Consolidated Financial Statements
Priceline.com Incorporated (“priceline.com” or the “Company”) is responsible for the Unaudited Consolidated Financial Statements included in this document. The Unaudited Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and include all normal and recurring adjustments that management of the Company considers necessary for a fair presentation of its financial position and operating results. The Company prepared the Unaudited Consolidated Financial Statements following the requirements of the Securities and Exchange Commission for interim reporting. As permitted under those rules, the Company condensed or omitted certain footnotes or other financial information that are normally required by GAAP for annual financial statements. These statements should be read in combination with the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.
The Unaudited Consolidated Financial Statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Investments in affiliates in which the Company does not have control, but has the ability to exercise significant influence, are accounted for by the equity method. The functional currency of the Company’s foreign subsidiaries is generally the respective local currency. Assets and liabilities are translated into U.S. dollars at the rate of exchange existing at the balance sheet date. Income statement amounts are translated at the average exchange rates for the period. Translation gains and losses are included as a component of “accumulated other comprehensive income” in the accompanying Unaudited Consolidated Balance Sheets. Foreign currency transaction gains and (losses) are included in the Unaudited Consolidated Statement of Operations, principally in “foreign currency transactions and other.”
From time to time, the Company enters into derivatives with counterparties to minimize the impact of short-term foreign currency fluctuations on consolidated operating results. Realized and unrealized gains and losses resulting from the derivatives are recognized in the period in which they occur. As of September 30, 2008, derivatives with a notional value of 23.1 million Euros and 4.0 million British Pounds were outstanding. These derivatives expire on December 31, 2008, and the Company has no foreign exchange hedges currently in place past that date. As of December 31, 2007, derivatives with notional amounts of 16.0 million Euros and 3.7 million British Pounds were outstanding. Foreign exchange gains of $4.1 million and losses of $1.8 million for the three months ended September 30, 2008 and 2007, respectively, and losses of $0.9 million and $2.4 million for the nine months ended September 30, 2008 and 2007, respectively, were recorded in “Foreign currency transactions and other,” and were principally related to foreign exchange derivative contracts.
Revenues, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be the same as those for the full year.
Recent Accounting Pronouncements – On January 1, 2008, the Company adopted Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The adoption of SFAS No. 157 did not have a material impact on the Company’s consolidated financial statements. See Note 6 for more information regarding fair value measurements.
In February 2008, the FASB issued FASB Staff Position No. SFAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”). FSP 157-2 defers the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years, and interim periods within those fiscal years, beginning after November 15, 2008. The Company is evaluating the impact of adopting the provisions of FSP 157-2.
In May 2008, the FASB issued FASB Staff Position No. APB 14-1, “Accounting for Convertible Debt Instruments that May be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP APB 14-1”). FSP APB 14-1 requires cash settled convertible debt, such as our convertible senior notes, 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 is 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, representing the value assigned to the equity component, is recorded as a debt discount and amortized to interest expense over the life of the bond. In addition, if our convertible debt is redeemed or converted prior to maturity and the fair value of the debt component immediately prior to extinguishment exceeds the carrying value it will result in a loss on extinguishment. Although FSP APB 14-1 will have no impact on our actual past or future cash flows, it will require us to
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record a significant amount of non-cash interest expense as the debt discount is amortized and may result in losses on extinguishment that would not have occurred under previous GAAP. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and must be applied on a retrospective basis. The Company is evaluating the impact of this new standard, but expects that it will have a material adverse impact on our results of operations and earnings per share.
In June 2008, FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock.” This Issue addresses the determination of whether an instrument (or an embedded feature) is indexed to an entity’s own stock. The EITF will be effective for years beginning after December 15, 2008. The Company is evaluating the impact of adopting the provisions of this EITF.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. The standard requires unrealized gains and losses to be included in earnings for items reported using the fair value option. SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company did not elect the fair value option described in SFAS No. 159 for financial instruments and certain other items.
In December 2007, the FASB issued SFAS No. 141 (R), “Business Combinations” (“SFAS No. 141(R)”). SFAS No. 141(R) requires an entity to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. Subsequent changes to the estimated fair value of contingent consideration will be reflected in earnings until the contingency is settled. SFAS No. 141(R) also requires acquisition-related costs and restructuring costs to be expensed as incurred rather than treated as part of the purchase price. The adoption of SFAS No. 141(R) will change the Company’s accounting treatment for business combinations on a prospective basis beginning January 1, 2009.
In April 2008, the FASB issued FASB Staff Position No. FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP FAS 142-3”). In determining the useful life of acquired intangible assets, FSP FAS 142-3 removes the requirement to consider whether an intangible asset can be renewed without substantial cost of material modifications to the existing terms and conditions and, instead, requires an entity to consider its own historical experience in renewing similar arrangements. FSP FAS 142-3 also requires expanded disclosure related to the determination of intangible asset useful lives. The FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and may impact any intangible assets the Company acquires in future transactions.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS No. 160”). SFAS No. 160 changes the accounting and reporting for minority interests, which will be characterized as non-controlling interests and classified as a component of equity. SFAS No. 160 is effective for the Company on a prospective basis in the first quarter of fiscal year 2009. The Company has not yet determined the impact on its consolidated financial statements of adopting SFAS No. 160.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities - an Amendment of FASB Statement 133.” SFAS No. 161 provides new disclosure requirements for an entity’s derivative and hedging activities. SFAS No. 161 is effective for periods beginning after November 15, 2008. The Company has not yet determined the impact on its consolidated financial statements of adopting SFAS No. 161.
2. STOCK-BASED EMPLOYEE COMPENSATION
The Company has adopted stock compensation plans which provide for grants of share based compensation as incentives and rewards to encourage employees, officers, consultants and directors to contribute towards the long-term success of the Company. Stock-based compensation cost included in personnel expense in the Unaudited Consolidated Statements of Operations was approximately $10.1 million, $4.1 million, $29.1 million and $10.8 million for the three and nine months ended September 30, 2008 and 2007, respectively. These amounts include stock-based compensation for restricted stock and restricted stock units related to shares of priceline.com International Limited (see Note 13 for additional information).
During the three months ended March 31, 2008, the Company made broad-based grants of 28,558 restricted stock units and 179,402 performance share units. The restricted stock units generally vest 25% per year over 4 years and the performance share units generally vest on the third anniversary of the date of grant. The share based awards granted had a total grant date fair value of $24.0 million based upon the weighted average grant date fair value per share of $115.33. The actual number of shares of common stock issued in connection with the performance share units will be determined at the end
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of the applicable performance periods, assuming there is no accelerated vesting for, among other things, a change in control or termination of employment in certain circumstances, and could range from a minimum of 71,261 shares to a maximum of 447,999 shares depending on the actual performance of the Company. Stock-based compensation related to the performance share units is recorded over the vesting period based upon the estimated probable outcome at the end of the performance period. During the three months ended March 31, 2008, the estimated probable number of shares to be issued at the end of the performance period was increased by 120,043 shares to an aggregate of 299,445 shares.
During the three months ended June 30, 2008, the Company granted 8,830 restricted stock units. The share based awards generally vest over four years or on the third anniversary of the date of grant and had a total grant date fair value of $1.2 million based upon the weighted average grant date fair value per share of $134.83.
During the three months ended September 30, 2008, the Company granted 58,840 restricted stock units. The share based awards vest over periods ranging from 31 to 48 months and had a total grant date fair value of $5.9 million based upon the weighted average grant date fair value per share of $100.82.
In December 2007, the Company granted 198,500 performance share units to certain European employees. The 198,500 represents the “target” number of shares of common stock that will be issued if certain financial performance goals are achieved. The actual number of shares to be issued will be determined in 2011 upon the completion of the performance period, assuming there is no accelerated vesting for, among other things, a change in control or termination of employment in certain circumstances, and could range from a minimum of 97,500 shares to a maximum of 595,500 shares. Stock-based compensation related to the performance share units is recorded based upon the estimated probable outcome at the end of the performance period. The estimated probable number of shares to be issued at the end of the performance period was increased by 305,690 shares during 2007 and by an additional 91,310 shares to an aggregate of 595,500 shares in the three months ended March 31, 2008.
3. NET INCOME PER SHARE
The Company computes basic and diluted net income per share in accordance with SFAS No. 128, “Earnings per Share.” Basic net income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per share is based upon the weighted average number of common and common equivalent shares outstanding during the period.
Common equivalent shares related to stock options, restricted stock, restricted stock units, performance share units and warrants are calculated using the treasury stock method. Performance share units are included in the weighted average common equivalent shares based on the number of shares that would be issued if the end of the reporting period were the end of the performance period, if the result would be dilutive. The warrants underlying Series B Preferred Stock were considered for inclusion in fully diluted net income per share using the “if-converted” method prior to their exercise in the first quarter 2007.
The Company’s convertible debt issues have net share settlement features requiring the Company upon conversion to settle the principal amount of the debt for cash and the conversion premium for cash or shares of the Company’s common stock. Pursuant to EITF 90-19, “Convertible Bonds with Issuer Options to Settle for Cash upon Conversion,” the convertible notes are included in the calculation of diluted net income per share if their inclusion is dilutive under the treasury stock method.
A reconciliation of the weighted average number of shares outstanding used in calculating diluted earnings per share is as follows (in thousands):
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Anti-dilutive potential common shares for the three and nine months ended September 30, 2008 includes approximately 4.4 million shares and 3.0 million shares, respectively, that could be issued under the Company’s convertible debt if the Company’s stock price increases. Under the treasury stock method, the remaining outstanding 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, $100 per share and $150 per share, common equivalent shares would include approximately 0.1 million, 4.0 million, 5.9 million, 7.1 million and 8.6 million equivalent shares, respectively, related to the remaining outstanding convertible notes (excluding the offsetting impact of the Convertible Spread Hedges — see Note 9). The Conversion Spread Hedges increase the effective conversion price of the Company’s Convertible Senior Notes due September 30, 2011 and September 30, 2013 from $40.38 to $50.47 per share from the Company’s perspective and are expected to reduce potential dilution upon conversion of the Convertible Senior Notes at maturity. Since the beneficial impact of the Conversion Spread Hedges is anti-dilutive it is excluded from the calculation of net income per share.
4. RESTRUCTURING
At September 30, 2008 and December 31, 2007, the Company had a restructuring liability of $1.0 million and $1.2 million, respectively, for the estimated remaining costs related to leased property vacated by the Company in 2000. The Company estimates that, based on current available information, the remaining net cash outflows associated with its restructuring related commitments will be paid in 2008-2011. The current portion of the restructuring accrual in the amount of $0.7 million is recorded in “Accrued expenses and other current liabilities” and the $0.3 million non-current portion is recorded in “Other long-term liabilities” on the Company’s Unaudited Consolidated Balance Sheet.
5. INVESTMENTS
The following table summarizes, by major security type, the Company’s short-term investments as of September 30, 2008 (in thousands):
The following table summarizes, by major security type, the Company’s short-term investments as of December 31, 2007 (in thousands):
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Long-term investments amounting to approximately $14.3 million and $2.5 million as of September 30, 2008 and December 31, 2007, respectively, were comprised of U.S. government securities and corporate notes with a maturity date greater than one year. During the three months ended September 30, 2008, the Company recorded an other-than-temporary impairment in the value of a corporate note included in long-term investments in the amount of $0.8 million. The loss is recorded in “Foreign currency transactions and other” in the consolidated statement of operations. The long-term investments are recorded net of unrealized gains of approximately $0.1 million as of September 30, 2008, and unrealized losses of approximately $0.2 million as of December 31, 2007. Except as disclosed above, there were no material gains or losses related to investments for the three or nine month periods ended September 30, 2008 or 2007.
6. FAIR VALUE MEASUREMENTS
Effective January 1, 2008, the Company adopted SFAS No. 157, which defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The standard describes three levels of inputs that may be used to measure fair value:
Financial assets and liabilities carried at fair value as of September 30, 2008 are classified in the table below in the categories described above:
Fair values for investments in U.S. Treasury and foreign governmental securities are considered “level 1” valuations because the Company has access to quoted prices in active markets as of the measurement date. Fair values for other investments are considered “level 2” instrument valuations because they are obtained from professional pricing sources for these or comparable instruments, rather than direct observation of quoted prices in active markets. As of September 30, 2008, the Company did not have any “level 3” assets or liabilities without observable market values that would require a high level of judgment to determine fair value. The Company’s derivative instruments are valued using pricing models. Pricing models take into account the contract terms as well as multiple inputs where applicable, such as interest rate yield curve, option volatility and currency rates. Our derivative instruments are typically short-term in nature.
As of September 30, 2008, the carrying value of our cash and cash equivalents approximated their fair value and consisted primarily of AAA-rated U.S. Treasury money market funds, foreign governmental securities, AAA rated corporate debt money market funds and bank deposits.
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7. INTANGIBLE ASSETS AND GOODWILL
The Company’s intangible assets consist of the following (in thousands):
Intangible assets with determinable lives are primarily amortized on a straight-line basis. Intangible asset amortization expense was approximately $7.4 million and $6.1 million for the three months ended September 30, 2008 and 2007, respectively, and approximately $21.8 million and $18.4 million for the nine months ended September 30, 2008 and 2007, respectively.
The annual estimated amortization expense for intangible assets for the remainder of 2008, the next four years and thereafter is expected to be as follows (in thousands):
A substantial majority of goodwill relates to the acquisitions of Booking.com Limited in 2004, Booking.com B.V. in 2005 and subsequent purchases of the minority interest in their parent company, priceline.com International. The change in goodwill for the nine months ended September 30, 2008 consists of the following (in thousands):
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8. OTHER ASSETS
Other assets at September 30, 2008 and December 31, 2007, consist of the following (in thousands):
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. The Company recognized approximately $97,000 and $263,000 of losses from its investment in pricelinemortgage.com in the three and nine months ended September 30, 2008, respectively. 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 earned an insignificant amount of advertising fees from pricelinemortgage.com in the three and nine months ended September 30, 2008 and 2007.
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. The period of amortization for our debt issue costs was determined at inception of the related debt agreements to be the stated maturity date or the first stated put date, if applicable.
9. DEBT
Revolving Credit Facility
In September 2007, the Company entered into a $175 million five-year committed revolving credit facility with a group of lenders, which is secured, subject to certain exceptions, by a first-priority security interest on substantially all of the Company’s assets and related intangible assets located in the United States. In addition, the Company’s obligations under the revolving credit facility are guaranteed by substantially all of the assets and related intangible assets of the Company’s material direct and indirect domestic and foreign subsidiaries. Borrowings under the revolving credit facility will bear interest, at the Company’s option, at a rate per annum equal to the greater of (a) JPMorgan Chase Bank, National Association’s prime lending rate and (b) the federal funds rate plus ½ of 1%, plus an applicable margin ranging from 0.25% to 0.75%; or at an adjusted LIBOR for the interest period in effect for such borrowing plus an applicable margin ranging from 1.25% to 1.75%. Undrawn balances available under the revolving credit facility are subject to commitment fees at the applicable rate ranging from 0.25% to 0.375%.
The revolving credit facility provides for the issuance of up to $50 million of letters of credit as well as borrowings on same-day notice, referred to as swingline loans, which are available in U.S. dollars, Euros, Pounds Sterling and any other foreign currency agreed to by the lenders. The Company may request that an additional $100 million be added to the revolving credit facility or to enter into one or more tranches of additional term loans. The proceeds of loans made under the facility could be used for working capital or general corporate purposes. As of September 30, 2008, there were no borrowings outstanding under the facility and the Company has issued approximately $5.8 million of letters of credit under the revolving credit facility.
Convertible Debt
The Company’s convertible debt is convertible into the Company’s common stock subject to certain conditions. Based upon the closing price of the Company’s common stock for the prescribed measurement periods during the three months ended September 30, 2008 and December 31, 2007, the contingent conversion thresholds on each of the Company’s convertible senior note issues were exceeded. As a result, the notes are convertible at the option of the holder as of September 30, 2008 and December 31, 2007 and, accordingly, have been classified as a current liability in the Unaudited Consolidated Balance Sheet as of those dates. However, contingencies continue to exist regarding the holders’ ability to convert such notes in future quarters. The determination of whether or not the notes are convertible must continue to be performed on a quarterly basis. Consequently, the convertible debt may not be convertible in future quarters, and therefore may again be
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classified as long-term debt, if the contingent conversion thresholds are not met in such quarters. In cases where holders decide to convert prior to the maturity date or first stated put date, the Company writes off the proportionate amount of remaining debt issue costs. If the note holders exercise their option to convert, the Company would deliver cash to repay the principal amount of the notes and would deliver cash or shares of common stock, at its option, to satisfy the conversion value in excess of the principal amount.
In the nine months ended September 30, 2008, approximately $100.5 million aggregate principal amount of the 1% Notes, $1.9 million aggregate principal amount of 2011 Notes and $30,000 of the 2.25% Notes were converted. The Company delivered cash of $102.4 million to repay the principal amount and issued 1,655,715 shares in satisfaction of the conversion value in excess of the principal amount. The Company also received notices of conversion from the holders of approximately $24.5 million of the 1% Notes, which represents the entire remaining outstanding principal amount of 1% Notes, and which were settled in the fourth quarter of 2008. In addition, the Company also received notices of conversion from the holders of approximately $36.0 million of the 2011 Notes and $14.0 million of the 2013 Notes, all of which are expected to be settled in the fourth quarter of 2008. In August 2008, the Company exercised its right to redeem the 1% Notes, however, the holders of all of the then-outstanding 1% Notes tendered their notes for conversion prior to the redemption date. In 2007, $50,000 and $23,000 of the 2.25% Notes and 1% Notes, respectively, were converted. Debt issuance costs written off in the nine months ended September 30, 2008 related to converted debt amounted to approximately $0.1 million. As of September 30, 2008, the estimated market value of the outstanding senior notes was approximately $805 million. Substantially all of the market value of the Company’s debt in excess of the carrying value relates to conversion premium on the bonds. Convertible debt consists of the following as of September 30, 2008 and December 31, 2007 (in thousands):
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 were 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 was 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. Both of these conditions have been met and, as discussed above, holders of all the outstanding 1% Notes have tendered their 1% Notes for conversion. 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. In May 2008, the Company terminated the swap agreement and received a payment in the amount of $0.1 million representing the estimated fair value, including net accrued interest. Hedge ineffectiveness was not significant in the nine months ended September 30, 2008 and 2007. The fair value of the swap as of December 31, 2007 was a liability of approximately $0.1 million and was recorded in accrued expenses and other current liabilities with a related adjustment to the carrying value of debt.
In 2006, the Company issued in a private placement $172.5 million aggregate principal amount of Convertible Senior Notes due September 30, 2011, with an interest rate of 0.50% (the “2011 Notes”), and $172.5 million aggregate principal amount of Convertible Senior Notes due September 30, 2013, with an interest rate of 0.75% (the “2013 Notes”). The 2011 Notes and the 2013 Notes are convertible, subject to certain conditions, into the Company’s common stock at a conversion price of approximately $40.38 per share. The 2011 Notes and the 2013 Notes are convertible, at the option of the holder, prior to June 30, 2011 in the case of the 2011 Notes, and prior to June 30, 2013 in the case of the 2013 Notes, upon the occurrence of specified events, including, but not limited to a change in control, or if the closing sale price of the Company’s common stock for at least 20 trading days in the period of the 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is more than 120% of the applicable conversion price in effect for
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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 $57.2 million depending upon the date of the transaction and the then current stock price of the Company. No additional payments are due at stock prices in excess of $100 per share. 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.
In 2006, 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 Goldman Sachs and Merrill Lynch 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) in 2011and 2013, 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) in 2011 and 2013. 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 maturity 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 hedge (up to $50.47). Holders of the 2011 Notes and the 2013 Notes do not have any rights with respect to the Conversion Spread Hedges. The Conversion Spread Hedges are separate transactions entered into by the Company with the counterparties, are not part of the terms of the Notes and will not affect the holders’ rights under the 2011 Notes and the 2013 Notes. The Conversion Spread Hedges are exercisable at dates coinciding with the scheduled maturities of the 2011 Notes and 2013 Notes.
The $100 million aggregate principal amount of Convertible Senior Notes due January 15, 2025, with an interest rate of 2.25% (the “2.25% Notes”) are convertible, subject to certain conditions, into the Company’s common stock at a conversion price of approximately $37.95 per share. The 2.25% Notes will be convertible if, on or prior to January 15, 2020, the closing sale price of our common stock for at least 20 consecutive trading days in the period of 30 consecutive trading days ending on the first day of a conversion period is more than 120% of the then current conversion price of the 2.25% Notes. The 2.25% Notes are also convertible in certain other circumstances, such as a change in control of the Company. In the event that all or substantially all of the Company’s common stock is acquired on or prior to January 15, 2010, in a transaction in which the consideration paid to holders of the Company’s common stock consists of all or substantially all cash, the Company would be required to make additional payments in the form of common shares to the holders of the 2.25% Notes of amounts ranging from $0 to $11.5 million depending upon the date of the transaction and the then current stock price of the Company. Based on the stock price at September 30, 2008, the Company would be required to make $1.5 million in additional payments. In addition, the 2.25% Notes will be redeemable at the Company’s option beginning January 20, 2010, and the holders may require the Company to repurchase the 2.25% Notes on January 15, 2010, 2015 or 2020, or in certain other circumstances. Interest on the 2.25% Notes is payable on January 15 and July 15 of each year.
10. TREASURY STOCK
In the fourth quarter of 2005, the Company’s Board of Directors authorized the repurchase of up to $50 million of the Company’s common stock from time to time in the open market or in privately negotiated transactions. In addition, in the third quarter 2006, the Company’s Board of Directors authorized the repurchase of up to an additional $150 million of the Company’s common stock with a portion of the proceeds from the issuance of the 2011 Notes and the 2013 Notes. As of September 30, 2008, $65.3 million of the Company’s common stock remains eligible for purchase under these authorizations. 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 36,439 and 38,942 shares at an aggregate cost of $4.3 million and $2.2 million in the nine months ended September 30, 2008 and 2007, respectively, to satisfy employee withholding taxes related to stock-based compensation.
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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, 2008, there were approximately 6.7 million shares of the Company’s common stock held in treasury.
11. REDEEMABLE PREFERRED STOCK
In January 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. In the three months ended March 31, 2007, the Company issued a final pro-rated dividend to Delta Airlines, Inc. in the amount of 34,874 shares of common stock, resulting in a non-cash dividend charge of $1.6 million. The exercise of the warrant was a non-cash transaction.
12. INCOME TAXES
Income tax expense includes U.S. federal and state 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, 2008 and 2007, the substantial majority of the Company’s foreign-sourced income has been generated in the Netherlands and the United Kingdom. Income tax expense for the three and nine months ended September 30, 2008 and 2007 differs from the expected tax expense at the U.S. statutory rate of 35% primarily due to lower foreign tax rates and the foreign tax benefit of interest expense on intercompany debt, partially offset by state income taxes and certain non-deductible stock-based compensation expense, and for the three and nine months ended September 30, 2007, a non-cash tax benefit of $47.9 million, as discussed more fully below.
The Company has significant deferred tax assets, resulting principally from domestic net operating loss carryforwards (“NOLs”). As required by SFAS No. 109, “Accounting for Income Taxes,” the Company periodically evaluates the likelihood of the realization of deferred tax assets, and reduces the carrying amount of these deferred tax assets by a valuation allowance to the extent it believes a portion will not be realized. The Company considers many factors when assessing the likelihood of future realization of the deferred tax assets, including its recent cumulative earnings experience by taxing jurisdiction, expectations of future income, the carryforward periods available for tax reporting purposes, and other relevant factors. In the three months ended September 30, 2007, management concluded that based upon recent operating results and projected future results, it was more likely than not that additional deferred tax assets would be realized. Accordingly, the Company recorded a non-cash tax benefit of $47.9 million in the three months ended September 30, 2007, resulting from the reversal of a portion of its valuation allowance on its deferred tax assets. Despite robust growth in the Company’s domestic earnings during 2008, the valuation allowance has not been reduced due to inherent uncertainty regarding the potential impact of the current global financial crisis and economic downturn on the Company’s future operating results. The valuation allowance may need to be adjusted in the future if facts and circumstances change, causing a reassessment of the amount of deferred tax assets more likely than not to be realized.
Section 382 imposes limitations on the availability of a company’s net operating losses after a more than 50 percentage point ownership change occurs. The Section 382 limitation is based upon certain conclusions pertaining to the dates of ownership changes and the value of the Company on the dates of the ownership changes. As a result of a study, it was determined that ownership changes, as defined in Section 382, occurred in 2000 and 2002. The amount of the Company’s net operating losses incurred prior to each ownership change is limited based on the value of the Company on the respective dates of ownership change. It is estimated that the effect of Section 382 will generally limit the total cumulative amount of net operating loss available to offset future taxable income to approximately $1.6 billion. Pursuant to Section 382, subsequent ownership changes could further limit this amount.
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In connection with the Company’s acquisitions of Booking.com B.V. in July 2005 and Booking.com Limited in September 2004 and the reorganization of its European operations, key managers of Booking.com B.V. and Booking.com Limited purchased shares of priceline.com International. In addition, these key managers were granted restricted stock and restricted stock units in priceline.com International shares that vested over time.
The holders of the minority interest in priceline.com International had the right to put their shares to the Company and the Company had 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, the shares were subject to the put and call options in March and August 2008. In April 2008, in connection with the March 2008 put and call options, the Company repurchased 62,020 shares underlying minority interest with a carrying value of $3.6 million for an aggregate purchase price of approximately $30.4 million based upon fair value. In September 2008, in connection with the August 2008 put and call options, the Company repurchased all of the remaining outstanding 253,693 shares underlying minority interest with a carrying value of $17.4 million for an aggregate purchase price of approximately $123.2 million based upon fair value. As a result of the September 2008 purchase, there is no longer any minority interest in priceline.com International. The purchases have been accounted for as step acquisitions and accordingly, the excess of the purchase price over the carrying value is recorded as an increase of intangible assets, deferred taxes and goodwill based upon preliminary estimated values.
14. COMMITMENTS AND CONTINGENCIES
Litigation Related to Hotel Occupancy and Other Taxes
Statewide Class Actions and Putative Class Actions
A number of cities and counties have filed class actions or putative class actions on behalf of themselves and other allegedly similarly situated cities and counties within the same respective state against the Company and other defendants, including, but not in all cases, Lowestfare.com LLC and Travelweb LLC, both of which are subsidiaries of the Company, and Hotels.com, L.P.; Hotels.com GP, LLC; Hotwire, Inc.; Cheaptickets, Inc.; Travelport, Inc. (f/k/a Cendant Travel Distribution Services Group, Inc.); Expedia, Inc.; Internetwork Publishing Corp. (d/b/a Lodging.com); Maupintour Holding LLC; Orbitz, Inc.; Orbitz, LLC; Site59.com, LLC; Travelocity.com, Inc.; Travelocity.com LP; and Travelnow.com, Inc. Each complaint alleges, among other things, that the defendants violated each jurisdiction’s respective hotel occupancy tax ordinance with respect to the charges and remittance of amounts to cover taxes under each ordinance. Each complaint typically seeks compensatory damages, disgorgement, penalties available by law, attorneys’ fees and other relief. Such actions include:
· City of Los Angeles v. Hotels.com, Inc., et al. · City of Rome, Georgia, et al. v. Hotels.com, L.P., et al. · Pitt County v. Hotels.com, L.P., et al. · City of San Antonio, Texas v. Hotels.com, L.P., et al. · Lake County Convention and Visitors Bureau, Inc. and Marshall County v. Hotels.com, L.P., et al. · Louisville/Jefferson County Metro Government v. Hotels.com, L.P., et al. · County of Nassau, New York v. Hotels.com, LP, et al. · City of Fayetteville v. Hotels.com, L.P., et al. · City of Jefferson, Missouri v. Hotels.com, LP, et al. · City of Gallup, New Mexico v. Hotels.com, L.P., et al. · City of Jacksonville v. Hotels.com, L.P., et al. · The City of Goodlettsville, Tennessee, et al. v. priceline.com Incorporated, et al. · The Township of Lyndhurst, New Jersey v. priceline.com Incorporated, et al.
A discussion of each of the legal proceedings listed above can be found in the section titled “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2007 and/or in the section titled “Commitments and Contingencies” of our Quarterly Reports on Form 10-Q for the three months ended March 31, 2008 and June 30, 2008.
The following developments regarding such legal proceedings occurred during or after the quarter ended September 30, 2008:
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City of San Antonio, Texas v. Hotels.com, L.P., et al.: On July 3, 2008, the United States Court of Appeals for the Fifth Circuit denied the defendants’ petition for interlocutory review of the class certification decision. On August 12, 2008, the court granted plaintiff’s motion for leave to amend its complaint to add equitable claims of unjust enrichment, money had and received, and for a constructive trust. Plaintiff amended its complaint on August 13, 2008 and the defendants answered the amended complaint on August 27, 2008. The parties are presently conducting discovery.
Lake County Convention and Visitors Bureau, Inc. and Marshall County v. Hotels.com, L.P., et al.: On July 14, 2008, the court denied the defendants’ motion to dismiss the complaint. On July 28, 2008, the defendants answered the complaint. The parties are presently conducting discovery.
Louisville/Jefferson County Metro Government, et al. v. Hotels.com, L.P., et al.: On September 30, 2008, the court granted the defendants’ motion for reconsideration of its prior order denying the defendants’ motion to dismiss the claims brought by the Louisville/Jefferson County Metro Government, and dismissed all of that plaintiff’s claims. The court also granted the defendants’ motion to dismiss the claims brought by the Lexington-Fayette Urban County Government. The court dismissed all claims against the defendants with prejudice. Both plaintiffs have filed notices of appeal to the U.S. Court of Appeals for the Sixth Circuit.
City of Fayetteville v. Hotels.com, L.P., et al.: On June 30, 2008, the court issued a letter opinion indicating it would grant the defendants’ motion to dismiss the complaint. On July 25, 2008, the court issued an order dismissing the complaint.
City of Jefferson, Missouri v. Hotels.com, LP, et al.: On July 21, 2008, the defendants answered the complaint.
City of Jacksonville v. Hotels.com, L.P., et al.: On July 1, 2008, the City of Jacksonville filed a first amended complaint. The proposed first amended complaint asserts only a declaratory judgment claim related to the defendants’ alleged liability for tourist development taxes and/or convention development taxes. On July 15, 2008, the defendants moved to dismiss and to strike the amended complaint. On July 30, 2008, the plaintiff filed a motion to amend its complaint. Those motions are pending.
The City of Goodlettsville, Tennessee, et al. v. priceline.com Incorporated, et al.: On August 7, 2008, the defendants moved to dismiss the complaint. That motion is pending. On Oct. 2, 2008, the City of Brentwood, Tennessee voluntarily dismissed its claims, and the case will proceed with the City of Goodlettsville as the sole plaintiff.
The Township of Lyndhurst, New Jersey v. priceline.com Incorporated, et al.: On August 19, 2008, the defendants moved to dismiss the complaint. That motion is pending.
The Company intends to defend vigorously against the claims in all of the proceedings described above.
Actions Filed on Behalf of Individual Cities 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 LLC and Travelweb LLC, both of which are subsidiaries of the Company, and Hotels.com, L.P.; Hotels.com GP, LLC; Hotwire, Inc.; Cheaptickets, Inc.; Cendant Travel Distribution Services Group, Inc.; Expedia, Inc.; Internetwork Publishing Corp. (d/b/a Lodging.com); Maupintour Holding LLC; Orbitz, Inc.; Orbitz, LLC; Site59.com, LLC; Travelocity.com, Inc.; Travelocity.com LP; and Travelnow.com, Inc. In each, the complaint alleges, among other things, that each of these defendants violated each jurisdiction’s respective hotel occupancy tax ordinance with respect to the charges and remittance of amounts to cover taxes under each ordinance. Each complaint typically seeks compensatory damages, disgorgement, penalties available by law, attorneys’ fees and other relief. Such actions include:
· City of Fairview Heights v. Orbitz, Inc., et al. · City of Findlay v. Hotels.com, L.P., et al. · City of Chicago, Illinois v. Hotels.com, L.P., et al. · City of San Diego, California v. Hotels.com L.P., et al. · City of Atlanta, Georgia v. Hotels.com L.P., et al. · City of Charleston, South Carolina v. Hotel.com, et al. · Town of Mount Pleasant, South Carolina v. Hotels.com, et al. · City of Columbus, et al. v. Hotels.com, L.P., et al.
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· City of North Myrtle Beach, South Carolina v. Hotels.com, LP, et al. · Wake County v. Hotels.com, LP, et al. · City of Branson v. Hotels.com, LP, et al. · Dare County v. Hotels.com, LP, et al. · Buncombe County v. Hotels.com, LP, et al. · 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. · Mecklenburg County v. Hotels.com, LP, et al.
A discussion of each of the legal proceedings listed above can be found in the section titled “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2007 and/or in the section titled “Commitments and Contingencies” of our Quarterly Reports on Form 10-Q for the three months ended March 31, 2008 and June 30, 2008.
The following developments regarding such legal proceedings occurred during or after the quarter ended September 30, 2008:
City of Atlanta, Georgia v. Hotels.com L.P., et al.: On September 8, 2008, the Georgia Supreme Court heard the plaintiff’s appeal from the October 26, 2007 decision of the Georgia Court of Appeals affirming the dismissal of this action.
City of North Myrtle Beach, South Carolina v. Hotels.com, LP, et al.: On August 1, 2008, the plaintiff filed an amended complaint asserting claims arising under the South Carolina Unfair Trade Practices Act. On August 15, 2008, the defendants answered the amended complaint. The parties are currently conducting discovery.
Horry County, et al. v. Hotels.com, LP, et al.: On August 14, 2008, the defendants moved to dismiss the plaintiff’s declaratory judgment claims, and that motion was denied on September 17, 2008. The parties are presently conducting discovery.
City of Myrtle Beach, South Carolina v. Hotels.com, LP, et al.: On August 14, 2008, the defendants moved to dismiss the plaintiff’s declaratory judgment claims, and that motion was denied on September 17, 2008. The parties are presently conducting discovery.
City of Oakland, California v. Hotels.com, L.P., et al.: The plaintiff’s appeal to the U.S. Court of Appeals for the Ninth Circuit remains pending. On July 16, 2008, the Company and Lowestfare.com LLC received audit notices from the City. On August 4, 2008, the Company and Lowestfare.com LLC responded and requested a hearing before the City’s Business Tax Board of Review. That hearing request remains pending.
We have also been informed by counsel to the plaintiffs in certain of the aforementioned actions that various, undisclosed municipalities or taxing jurisdictions may file additional cases against the Company, Lowestfare.com LLC and Travelweb LLC in the future. Some municipalities or taxing jurisdictions have sent the Company and/or its subsidiaries tax notices or demands, including Brunswick County and Stanly County, North Carolina; Jefferson County, Arkansas; City of North Little Rock, Arkansas; and the Pine Bluff Advertising and Promotion Commission.
The Company intends to defend vigorously against the claims in all of the proceedings described above.
Consumer Class Actions
Two purported class actions brought by consumers against the Company were pending during the three months ended September 30, 2008.
· Marshall, et al. v. priceline.com, Inc. · Bush, et al. v. Cheaptickets, Inc., et al.
A discussion of each of the legal proceedings listed above can be found in the section titled “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2007 and/or in the section titled “Commitments and Contingencies” of our Quarterly Reports on Form 10-Q for the three months ended March 31, 2008 and June 30, 2008.
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The following developments regarding such legal proceedings occurred during or after the quarter ended September 30, 2008:
Marshall, et al. v. priceline.com, Inc.: On August 28, 2008, the court granted plaintiffs’ motion for leave to amend their complaint to assert additional claims for breach of contract and the implied duty of good faith and fair dealing alleging that the Company included a hidden fee within its room rate charge. The plaintiffs filed their second amended complaint on September 12, 2008, and the Company answered that complaint on September 26, 2008. The parties are presently conducting discovery.
Bush, et al. v. Cheaptickets, Inc., et al.: On July 11, 2008, the plaintiffs proposed a draft second amended complaint that withdraws claims against certain defendants, including the Company, but not others. The Company has not opposed the proposed amendments. This action was dismissed against the Company without prejudice on August 6, 2008.
The Company intends to defend vigorously against the claims in all of the proceedings described above.
Administrative Proceedings and 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 Philadelphia, Pennsylvania; Miami-Dade County, Florida; Broward County, Florida; Suffolk County, New York; the City of Anaheim, California; the City of Phoenix, Arizona; the City of San Francisco, California; and state tax officials from Wisconsin, Pennsylvania, Hawaii 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. Broward County, Florida, the City of Anaheim, California and the City of San Francisco, California have each issued assessments from which the Company has appealed or intends to appeal. Those administrative appeals are pending. The Company is unable at this time to predict whether any such proceedings or assessments will result in litigation.
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.com, Richard Braddock, Jay Walker, Paul Francis, Nancy Peretsman, and Timothy Brier, together with other issuer defendants in the consolidated litigation, filed a joint motion to dismiss on July 15, 2002. On November 18, 2002, the cases against the individual defendants were dismissed without prejudice and without costs. In addition, counsel for plaintiffs and the individual defendants executed Reservation of Rights and Tolling Agreements, which toll the statutes of limitations on plaintiffs’ claims against those individuals. On February 19, 2003, Judge Scheindlin issued an Opinion and Order granting in part and denying in part the issuer’s motion. None of the claims against the Company were dismissed. On June 26, 2003, counsel for the plaintiff class announced that they and counsel for the issuers had agreed to the form of a Memorandum of Understanding (the “Memorandum”) to settle claims against the issuers. The terms of that Memorandum provide that class members will be guaranteed $1 billion in recoveries by the insurers of the issuers and that settling issuer defendants will assign to the class members certain claims that they may have against the underwriters. Issuers also agree to limit their abilities to bring certain claims against the underwriters. If recoveries in excess of $1 billion are
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obtained by the class from any non-settling defendants, the settling defendants’ monetary obligations to the class plaintiffs will be satisfied; any amount recovered from the underwriters that is less than $1 billion will be paid by the insurers on behalf of the issuers. The Memorandum, which is subject to the approval of each issuer, was approved by a special committee of the priceline.com Board of Directors on Thursday, July 3, 2003. Thereafter, counsel for the plaintiff class and counsel for the issuers agreed to the form of a Stipulation and Agreement of Settlement with Defendant Issuers and Individuals (“Settlement Agreement”). The Settlement Agreement implements the Memorandum and contains the same material provisions. On June 11, 2004, a special committee of the priceline.com Board of Directors authorized the Company’s counsel to execute the Settlement Agreement on behalf of the Company. The Settlement Agreement was submitted to the Court for approval. Subsequently, the Second Circuit reversed the District Court’s granting of class certification in certain of the related class actions. As a result, the parties entered into a stipulation and order dated June 25, 2007 which terminated the Settlement Agreement. The Company intends to vigorously defend against the claims in all of these proceedings.
On May 3, 2007, the Company entered into a Stipulation and Agreement of Settlement (“Settlement Agreement”) to settle a class action lawsuit brought after its announcement that third quarter 2000 revenues would not meet expectations. Under the terms of the Settlement Agreement, the class received $80 million in return for a release, with prejudice, of all claims against the Company and the individual defendants (the “Settling Defendants”) that are related to the purchase of the Company’s securities by class members during the class period. The Company’s insurance carriers funded $30 million of the settlement. As a result, the Company recorded a net charge in the six months ended June 30, 2007 of approximately $55.2 million representing its share of the cost to settle the litigation and cover related expenses.
The Company intends to defend vigorously against the claims in all of the proceedings described in this Note 14. The Company has accrued for certain legal contingencies where it is probable that a loss has been incurred and the amount can be reasonably estimated. Except as disclosed, such amounts accrued are not material to the Company’s consolidated balance sheets and provisions recorded have not been material to the consolidated results of operations. The Company is unable to estimate the potential maximum range of loss.
From time to time, we have been and expect to continue to be subject to legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of third party intellectual property rights. Such claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources, divert management’s attention from our business objectives and could adversely affect our business, results of operations, financial condition and cash flows.
Other Matters
On January 6, 1999, we received notice that a third party patent applicant and patent attorney, Thomas G. Woolston, purportedly had filed in December 1998 with the United States Patent and Trademark Office a request to declare an interference between a patent application filed by Woolston and our U.S. Patent 5,794,207. We are currently awaiting information from the Patent Office regarding whether it will initiate an interference proceeding.
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 revenue 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.
Contingent Purchase Price
On November 6, 2007, the Company and a newly-formed, indirect wholly-owned subsidiary of the Company, acquired 100% of the total issued share capital of Agoda Company, Ltd. (“Agoda”) and AGIP LLC (“AGIP,” and together with Agoda, the “Agoda Companies”). The purchase price for the acquisition, including acquisition costs, consists of an initial purchase price payable by the Company in cash of approximately $16 million and up to an additional $141.6 million in cash, which is payable by the Company if the Agoda Companies achieve the maximum “gross bookings” and earnings targets from January 1, 2008 through December 31, 2010.
On December 21, 2007, the Company acquired 100% of the total issued share capital of an online advertising
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company for approximately $4.1 million in cash, including acquisition costs. In addition, the Company could be required to pay an additional amount of up to $3.8 million in each of the years 2008, 2009 and 2010, if the acquired company achieves certain performance targets.
The contingent consideration related to these acquisitions, if any, will be recorded as additional purchase price when the contingency is resolved.
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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 hotel rooms, car rentals, airline tickets, vacation packages, cruises and destination services. In the United States, we offer our customers a unique choice: the ability to purchase travel services in a traditional, price-disclosed manner or the opportunity to use our unique Name Your Own Price® service, which allows our customers to make offers for travel services at discounted prices. Internationally, we offer our customers hotel room reservations in 60 countries and 22 languages.
We launched our business in the United States in 1998 under the priceline.com brand and have since expanded our operations to include, among others, the brands Booking.com and Active Hotels in Europe and Agoda in Asia. Our principal goal is to be the leading worldwide online hotel reservation service. At present, we derive substantially all of our revenues from the following sources:
· Transaction revenues from our Name Your Own Price® hotel room, rental car services and airline ticket, as well as our vacation packages service;
· Commissions earned from the sale of price-disclosed hotel rooms, rental cars, cruises and other travel services;
· Customer processing fees charged in connection with the sale of both Name Your Own Price® and price-disclosed hotel rooms and Name Your Own Price® airline tickets and rental cars services. We eliminated processing fees for our price-disclosed airline ticket service in June 2007;
· Transaction revenue from our price-disclosed merchant hotel room service;
· Global distribution system (“GDS”) reservation booking fees related to both our Name Your Own Price® airline ticket, hotel room and rental car services, and price-disclosed airline tickets and rental car services; and
· Other revenues derived primarily from selling advertising on our websites.
Over the last several years, our business has transitioned from one driven primarily by domestic results to one driven primarily by international results. Prior to 2004, substantially all of our revenues were generated within the United States. In September 2004, we acquired Booking.com Limited, a U.K.-based online hotel service, in July 2005, we acquired Booking.com B.V., a Netherlands-based online hotel service, and in November 2007, we acquired Agoda Company, Ltd. (“Agoda”) and AGIP LLC (“AGIP,” and together with Agoda, the “Agoda Companies”), an online hotel service with operations in Singapore and Thailand. During each of the three and nine month periods ended September 30, 2008, our international business – the significant majority of which is currently generated by our European operations – represented approximately 60% of our gross bookings (an operating and statistical metric referring to the total dollar value, inclusive of all taxes and fees, of all travel services purchased by our customers), and contributed more than two-thirds of our consolidated operating income. Given that our international business is primarily comprised of hotel reservation services, revenue earned in connection with the reservation of hotel room nights has come to represent a substantial majority of our gross profit.
Economic turmoil in the United States and Europe is negatively affecting the broad travel market and, as a result, our business. Most recently, global economic and financial market conditions have worsened markedly, creating uncertainty for consumers and pressuring consumer spending on travel. For example, we have recently observed decreases in occupancy rates (a common metric that measures hotel customer usage) and average daily rates (“ADRs”) in both the United States and Europe. We believe that the positive trends impacting our domestic and international business overshadowed these negative influences in the first nine months of 2008. However, market conditions have worsened significantly recently, with particular deterioration in September that continued into early November. We
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believe macro economic turmoil and these weakening travel market trends, including, without limitation, decreased consumer demand, further deterioration in ADRs and increases in cancellations, have had a negative impact on our business, particularly in Europe and will continue to have a negative impact in the near term. We cannot predict the magnitude or duration of this downturn, but our current limited visibility does not suggest any near-term improvement.
The hotel market has, until recently, been characterized by robust demand and limited supply, leading to increased occupancy rates, and in turn, increased ADRs. However, the hotel industry has recently experienced a general decrease in occupancy rates, and we have experienced slowing demand growth, an increase in reservation cancellation rates and declining ADRs – trends in which we do not anticipate any near-term improvement. While lower occupancy rates have historically resulted in hotel suppliers increasing their distribution of hotel rooms through third-party intermediaries such as us, our remuneration for hotel transactions changes proportionately with room price, and therefore, lower ADRs generally have a negative effect on our hotel business and a negative effect on our gross profit.
We believe the current worldwide economic downturn and lower ADRs are also responsible for the increase in the number of hotel cancellations, particularly at our international operations. Our international operations distribute hotel rooms primarily through an agency model where reservations are generally cancellable, as opposed to merchant models operated by us (principally in the U.S.) and our competition and through which reservations are generally not cancellable without penalty. As ADRs decline, customers who have existing reservations may cancel those reservations and rebook at a lower rate, and in times of economic stress, travelers are more likely to cancel their vacation plans outright. While decreasing ADRs and an uncertain economic environment make it relatively more attractive for consumers to make a cancellable agency reservation than a pre-paid reservation, our agency business will likely have higher cancellation rates compared to companies who offer predominantly merchant model hotel rooms.
International Trends. The size of the travel market outside of the United States is substantially greater than that within the United States. Historically, Internet adoption rates and e-commerce adoption rates of international consumers have trailed those of the United States. However, international consumers are rapidly moving to online means for purchasing travel. Accordingly, recent international online travel growth rates have substantially exceeded and are expected to continue to exceed the growth rates within the United States. In addition, the base of hotel suppliers in Europe is particularly fragmented compared to that in the United States, where the hotel market is dominated by large hotel chains. We believe online reservation systems like ours may be more appealing to small chains and independent hotels more commonly found outside of the United States. We believe these trends have enabled us to become the top online hotel service provider in Europe, and will allow us to successfully expand our service offerings internationally beyond Europe.
As our international operations have become significant contributors to our results and international hotel bookings have become of increased importance to our earnings, we have seen, and expect to continue to see, changes in certain of our operating expenses and other financial metrics. For example, because our international operations utilize online affiliate and search marketing as the principal means of generating traffic to their websites, our online advertising expense has increased significantly since our acquisition of those companies, a trend we expect to continue through the remainder of 2008 and beyond. In addition, and as discussed in more detail below, since the acquisitions of Booking.com Limited and Booking.com B.V., we have seen the effects of seasonal fluctuations on our operating results change as a result of different revenue recognition policies that apply to our price-disclosed services (including our international hotel service) as compared to our Name Your Own Price® services.
Another impact of the growing importance that our international operations represent to our business is our increased exposure to foreign currency exchange risk. Because we are conducting a significant and growing portion of our business outside the United States and are reporting our results in U.S. dollars, we face exposure to adverse movements in currency exchange rates as the financial results of our international operations are translated from local currency (principally the Euro and the British Pound Sterling) into U.S. dollars upon consolidation. Our international operations contributed approximately $223.7 million and $492.3 million to our revenues for the three and nine months ended September 30, 2008, respectively, which compares to $131.8 million and $270.1 million for the same periods in 2007, respectively. Approximately $8.6 million and $31.8 million, respectively, of this increase is due to fluctuations in currency exchange rates. As a result, our year-over-year revenue growth in the three and nine months ended September 30, 2008, was approximately 63.2% and 70.5%, respectively, on a local currency basis compared to approximately 69.7% and 82.3%, respectively, after giving effect to currency fluctuations. The U.S. dollar has generally weakened since we acquired Booking.com B.V. in July 2005, and as a result, the year over year growth rates in our international results, when reported in U.S. dollars, have been positively impacted by changes in foreign exchange rates. However, the U.S. dollar has recently strengthened significantly against the Euro and the British Pound Sterling, which results in decreased net assets, revenues, operating expenses, and net income, and in October 2008, for the first time since our acquisition of Booking.com B.V., the foreign exchange impact was negative rather than positive. Accordingly, it will become increasingly difficult for us to grow our gross bookings, revenues and earnings on a dollar-denominated basis during the fourth quarter of 2008 and beyond. If the U.S. dollar weakens against the local currency, the translation of our foreign-currency-denominated balances will result in increased net assets, gross bookings, revenues, operating expenses, and net income. The impact of short-term currency fluctuations on our income for the three months ended September 30, 2008, was minimized by certain derivatives we held. These derivatives expire on December 31, 2008, and we have no foreign exchange hedges currently in place past that date. Furthermore, our derivative instruments do not hedge against fluctuation in our gross bookings.
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Domestic Trends. While demand for online travel services continues to experience annualized growth, we believe that the domestic market share of third-party distributors, like priceline.com, has declined over the recent past and that the growth of the domestic online market for travel services has slowed. We believe the decline in market share is attributable, in part, to a concerted initiative by travel suppliers to direct customers to their own websites in an effort to reduce distribution expenses and establish more direct control over their pricing.
In addition, airlines have generally experienced year-over-year increases in load factors (a common metric that measures airplane customer usage), which leaves them with less excess supply to provide third party intermediaries like priceline.com. Recent decreases in domestic airline capacity and the emerging prospect of industry consolidation, as evidenced by the recent merger agreement between Delta Air Lines and Northwest Airlines, could further reduce the amount of airline tickets available to us. In addition, major airline carriers began significant reductions in U.S. capacity in September 2008. These reductions are expected to result in increased fares and lower traveler demand. Higher fares and lower traveler demand could negatively impact our domestic air business, which could in turn negatively impact our domestic hotel and rental car businesses. In addition, current domestic economic conditions are partially responsible for a change in the arrangements between rental car companies and automobile manufacturers. Where manufacturers have historically supplied cars to rental car companies under a lease or another arrangement whereby the manufacturer would buy the car back when it is taken out of the fleet, manufacturers have begun to require the rental car companies purchase the cars for their fleets, which shifts the burden of risk of selling the car to the rental car company. Because of the recent economic turmoil, rental car companies have struggled to sell such cars, and as a result, they are faced with excess supply. This, along with an intensely competitive environment, leads to lower retail rental car rates, which in turn, are beneficial to our retail rental car business, but detrimental to our Name Your Own Price® business. Notwithstanding these trends, we continue to believe that the market for domestic online travel services is an attractive market with continued opportunity for growth.
We also rely on fees paid to us by global distribution systems, or GDSs, for travel bookings made through GDSs for a portion of our gross profit and operating income. Connectivity to a GDS does not guarantee us access to the content of a travel supplier such as an airline or hotel company. We have agreements with a number of suppliers to obtain access to content, and are in continuing discussions with others to obtain similar access. If we were denied access to a suppliers’ full content or had to incur service fees in order to access or book such content, our results could suffer.
We believe that our success will depend in large part on our ability to maintain profitability, primarily from our hotel business, to continue to promote the priceline.com brand in the United States, the Booking.com brand internationally, the Agoda brand in Asia and, over time, to offer other travel services and further expand into other international markets. Factors beyond our control, such as terrorist attacks, political instability, regional hostilities, increases in fuel prices, global economic slowdown, imposition of taxes or surcharges by regulatory authorities, travel related accidents, travel related health concerns, unusual weather patterns, including natural disasters such as hurricanes, tsunamis or earthquakes; or the withdrawal from our system of a major hotel supplier or airline, could adversely affect our business and results of operations and impair our ability to effectively implement all or some of the initiatives described above. For example, recent civil unrest during the peak booking season in Thailand, a key market for our Agoda business, is negatively impacting booking volumes. We intend to continue to invest in marketing and promotion, technology and personnel within parameters consistent with attempts to improve operating results. We also intend to broaden the scope of our business, and to that end, we explore strategic alternatives from time to time in the form of, among other things, mergers and acquisitions. In addition, we currently do not have operations in geographic areas such as South America, and therefore may consider strategic alternatives in those areas. Our goal is to improve volume and sustain gross margins in an effort to maintain profitability. The uncertain environment described above makes the prediction of future results of operations difficult, and accordingly, we cannot provide assurance that we will sustain revenue growth and profitability.
Seasonality. Our Name Your Own Price® services are generally non-refundable in nature, and accordingly, we recognize travel revenue at the time a booking is generated. However, we recognize revenue generated from our retail hotel services, including our international operations, at the time that the customer checks out of the hotel. As a result, a meaningful amount of retail hotel bookings generated earlier in the year, as customers plan and reserve their spring and summer vacations, will not be recognized as revenue until future quarters. From a cost perspective, however, we expense the substantial majority of our advertising activities as they are incurred, which is typically in the quarter in which bookings are generated. Therefore, as our retail hotel business continues to grow, we expect our quarterly results to become increasingly impacted by these seasonal factors.
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Results of OperationsThree and Nine Months Ended September 30, 2008 compared to the Three and Nine Months Ended September 30, 2007
Operating and Statistical Metrics
Our financial results are driven by certain operating metrics that encompass the booking activity generated by our travel services. Specifically, reservations of hotel room nights, rental car days and airline tickets capture the volume of units purchased by our customers. Gross bookings is an operating and statistical metric that captures the total dollar value inclusive of taxes and fees of all travel services booked by our customers. International gross bookings reflect gross bookings generated principally by websites owned by, operated by, or dedicated to providing gross bookings for our international brands and operations, and domestic gross bookings reflect gross bookings generated principally by websites owned by, operated by, or dedicated to providing gross bookings by our domestic operations, in each case without regard to the location of the travel or the customer purchasing the travel.
Gross bookings resulting from hotel room nights, rental car days and airline tickets sold through our domestic and international operations for the three and nine months ended September 30, 2008 and 2007 were as follows (numbers may not total due to rounding):
Gross bookings resulting from hotel room nights, rental car days and airline tickets sold through our agency and merchant models for the three and nine months ended September 30, 2008 and 2007 were as follows (numbers may not total due to rounding):
Gross bookings increased by 47.4% and 63.3% for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. The increase in the three and nine month periods was primarily attributable to growth of 58.6% and 76.7%, respectively, in our international gross bookings, virtually all of which relates to retail hotel room night sales (including the $110 million and $401 million favorable impact of foreign currency exchange rates in the three and nine month periods ended September 30, 2008, respectively). Domestic gross bookings increased in the three and nine months ended September 30, 2008, by 32.8% and 46.9%, respectively, primarily due to growth in the sale of retail airline tickets, Name Your Own Price® hotel room nights, price-disclosed hotel room nights and Name Your Own Price® airline tickets.
Agency gross bookings increased 53.8% and 73.3% for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007, due to growth in our international hotel operations and in the sale of retail airline tickets. Merchant gross bookings increased 28.3% and 35.4% for the three and nine months ended September 30, 2008, respectively, compared to the same periods in 2007, due to an increase in the sale of Name Your Own Price® hotel room nights, the inclusion of room nights sold by Agoda, which was acquired in November 2007, domestic merchant price-disclosed hotel room nights and Name Your Own Price® airline tickets. Agoda gross bookings amounted to $32.4 million and $81.2 million for the three and nine months ended September 30, 2008, respectively.
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Hotel room nights sold increased by 43.6% and 49.7% for the three and nine months ended September 30, 2008, respectively, over the same periods in 2007, primarily due to an increase in the sale of agency room nights in connection with our international operations, an increase in the sale of Name Your Own Price® and price-disclosed hotel room nights in the United States and the inclusion of room nights sold by Agoda, which was acquired in November 2007.
Rental car days sold were flat for the three months ended September 30, 2008 due to increases in sales of price-disclosed rental cars being offset by decreases in sales of Name Your Own Price® rental cars. Rental car days sold increased by 17.3% for the nine months ended September 30, 2008, over the same period in 2007, due to increases in sales of both our price-disclosed and Name Your Own Price® rental car services.
Airline tickets sold increased by 44.8% and 73.3% for the three and nine months ended September 30, 2008, respectively, over the same periods in 2007, due primarily to an increase in the sale of price-disclosed airline tickets due in part to our elimination of processing fees in June 2007 and increased marketing support.
Revenues
We classify our revenue into three categories:
· Merchant revenues are derived from transactions where we are the merchant of record and are responsible for, among other things, collecting receipts from our customers, selecting suppliers and remitting payments to our suppliers. Merchant revenues include (1) transaction revenues representing the selling price of Name Your Own Price® hotel rooms, rental cars and airline tickets and price-disclosed vacation packages; (2) transaction revenues representing the amount charged to a customer, less the amount charged by suppliers in connection with the hotel rooms provided through our merchant price-disclosed hotel service; (3) customer processing fees charged in connection with the sale of Name Your Own Price® airline tickets, hotel rooms and rental cars and merchant price-disclosed hotels; and (4) ancillary fees, including GDS reservation booking fees related to certain of the aforementioned transactions.
· Agency revenues are derived from travel related transactions where we are not the merchant of record and where the prices of our services are determined by third parties. Agency revenues include travel commissions, customer processing fees and GDS reservation booking fees related to certain of the aforementioned transactions and are reported at the net amounts received, without any associated cost of revenue. In June 2007, we eliminated processing fees on the priceline.com price-disclosed airline ticket service.
· Other revenues are derived primarily from advertising on our websites.
We continue to experience a shift in the mix of our travel business from a business historically focused exclusively on the sale of domestic point-of-sale travel services to a business that includes significant sales of international point-of-sale hotel services, a significant majority of which are currently generated in Europe. Because our domestic services include merchant Name Your Own Price® travel services, which are reported on a “gross” basis, while both our domestic and international retail travel services are primarily recorded on a “net” basis, revenue increases and decreases are impacted by changes in the mix of the sale of merchant and retail travel services and, consequently, gross profit has become an increasingly important measure of evaluating growth in our business. Our international operations contributed approximately $223.7 million and $492.3 million to our revenues for the three and nine months ended September 30, 2008, respectively, which compares to $131.8 million and $270.1 million for the same periods in 2007, respectively. Approximately $8.6 million and $31.8 million, respectively, of this increase is due to favorable fluctuations in currency exchange rates. Agoda
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accounted for approximately $4.2 million and $11.7 million of the revenue attributable to our international operations for the three and nine months ended September 30, 2008, respectively.
Merchant Revenues
Merchant revenues for the three and nine months ended September 30, 2008 increased 17.7% and 22.3%, respectively, compared to the same periods in 2007, primarily due to an increase in the sale of Name Your Own Price® hotel room nights and airline tickets and the inclusion of revenues generated by Agoda, which was acquired in November 2007. In the three and nine months ended September 30, 2007, merchant revenues were positively impacted by the excise tax refund of $0.4 million and $18.6 million, respectively (see Note 14 to our Unaudited Consolidated Financial Statements). Our international operations contributed approximately $5.6 million and $15.0 million to our merchant revenues for the three and nine months ended September 30, 2008, respectively, which compares to $1.0 million and $2.8 million for the same periods in 2007, respectively. Agoda contributed approximately $4.2 million and $11.7 million of the merchant revenue attributable to our international operations for the three and nine months ended September 30, 2008, respectively.
Agency Revenues
Agency revenues for the three and nine months ended September 30, 2008 increased 66.6% and 76.4%, respectively, compared to the same periods in 2007, primarily as a result of growth in our international operations, which contributed $218.1 million and $130.8 million of agency revenue for the three months ended September 30, 2008 and 2007, respectively, and $477.3 million and $267.3 million of agency revenue for the nine months ended September 30, 2008 and 2007, respectively. Approximately $8.6 million and $31.9 million of the increase over the three and nine months ended September 30, 2007, respectively, is due to favorable fluctuations in currency exchange rates.
Other Revenues
Other revenues during the three and nine months ended September 30, 2008 consisted primarily of advertising. Other revenues for the three and nine months ended September 30, 2008 increased 104.4% and 128.7%, respectively, compared to the same periods in 2007, primarily as a result of higher online advertising revenues due to new advertising partner relationships initiated in 2007 and the revenue generated by an online advertising company acquired in December 2007.
Cost of Revenues and Gross Profit
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