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Booking Holdings Inc. - Quarter Report: 2010 September (Form 10-Q)

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)

 

x

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

 

 

For the quarterly period ended September 30, 2010

 

OR

 

 

o

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

 

 

For the transition period from                    to                   

 

Commission File Number 0-25581

 

PRICELINE.COM INCORPORATED

(Exact name of Registrant as specified in its charter)

 

Delaware

 

06-1528493

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification Number)

 

800 Connecticut Avenue

Norwalk, Connecticut 06854

(address of principal executive offices)

 

(203) 299-8000

(Registrant’s telephone number, including area code)

 

N/A

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

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES x  NO o.

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

 

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

 

Number of shares of Common Stock outstanding at November 2, 2010:

 

Common Stock, par value $0.008 per share

 

49,096,034

(Class)

 

(Number of Shares)

 

 

 



Table of Contents

 

priceline.com Incorporated

Form 10-Q

 

For the Three Months Ended September 30, 2010

 

PART I - FINANCIAL INFORMATION

 

 

 

Item 1.  Consolidated Financial Statements

 

 

 

Consolidated Balance Sheets (unaudited) at September 30, 2010 and December 31, 2009

2

Consolidated Statements of Operations (unaudited) For the Three and Nine Months Ended September 30, 2010 and 2009

3

Consolidated Statement of Changes in Stockholders’ Equity (unaudited) For the Nine Months Ended September 30, 2010

4

Consolidated Statements of Cash Flows (unaudited) For the Nine Months Ended September 30, 2010 and 2009

5

Notes to Unaudited Consolidated Financial Statements

6

 

 

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

27

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

56

 

 

Item 4. Controls and Procedures

57

 

 

 

 

PART II - OTHER INFORMATION

 

 

 

Item 1. Legal Proceedings

58

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

58

Item 6. Exhibits and Reports on Form 8-K

59

 

 

SIGNATURES

60

 

1



Table of Contents

 

PART I — FINANCIAL INFORMATION

Item 1.  Unaudited Consolidated Financial Statements

priceline.com Incorporated

UNAUDITED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

 

 

September 30,
2010

 

December 31,
2009

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

533,121

 

$

202,141

 

Restricted cash

 

1,155

 

1,319

 

Short-term investments

 

941,948

 

598,014

 

Accounts receivable, net of allowance for doubtful accounts of $5,758 and $5,023, respectively

 

248,946

 

118,659

 

Prepaid expenses and other current assets

 

41,631

 

36,828

 

Deferred income taxes

 

73,257

 

65,980

 

Total current assets

 

1,840,058

 

1,022,941

 

 

 

 

 

 

 

Property and equipment, net

 

35,905

 

30,489

 

Intangible assets, net

 

243,243

 

172,080

 

Goodwill

 

453,618

 

350,630

 

Deferred income taxes

 

158,888

 

253,700

 

Other assets

 

14,833

 

4,384

 

Total assets

 

$

2,746,545

 

$

1,834,224

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

112,753

 

$

60,568

 

Accrued expenses and other current liabilities

 

195,936

 

119,521

 

Deferred merchant bookings

 

117,800

 

60,758

 

Income taxes payable

 

79,666

 

8,040

 

Convertible debt (see Note 8)

 

174

 

159,878

 

Total current liabilities

 

506,329

 

408,765

 

 

 

 

 

 

 

Deferred income taxes

 

59,402

 

43,793

 

Other long-term liabilities

 

28,481

 

24,052

 

Convertible debt (see Note 8)

 

471,071

 

 

Total liabilities

 

1,065,283

 

476,610

 

 

 

 

 

 

 

Convertible debt (see Note 8)

 

41

 

35,985

 

Redeemable noncontrolling interests (See Note 11)

 

44,222

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $0.008 par value; authorized 1,000,000,000 shares, 56,498,183 and 52,446,173 shares issued, respectively

 

438

 

405

 

Treasury stock, 7,410,558 and 6,865,119 shares, respectively

 

(636,623

)

(510,970

)

Additional paid-in capital

 

2,355,093

 

2,289,867

 

Accumulated deficit

 

(62,861

)

(454,673

)

Accumulated other comprehensive loss

 

(19,048

)

(3,000

)

Total stockholders’ equity

 

1,636,999

 

1,321,629

 

Total liabilities and stockholders’ equity

 

$

2,746,545

 

$

1,834,224

 

 

See Notes to Unaudited Consolidated Financial Statements.

 

2



Table of Contents

 

priceline.com Incorporated

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Merchant revenues

 

$

494,473

 

$

400,314

 

$

1,309,407

 

$

1,130,169

 

Agency revenues

 

504,010

 

323,188

 

1,034,765

 

647,899

 

Other revenues

 

3,274

 

7,158

 

9,419

 

18,391

 

Total revenues

 

1,001,757

 

730,660

 

2,353,591

 

1,796,459

 

Cost of revenues

 

335,569

 

296,654

 

923,032

 

848,885

 

Gross profit

 

666,188

 

434,006

 

1,430,559

 

947,574

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Advertising — Offline

 

7,773

 

8,474

 

29,684

 

30,293

 

Advertising — Online

 

172,727

 

115,103

 

418,354

 

273,327

 

Sales and marketing

 

33,060

 

24,473

 

85,663

 

63,583

 

Personnel, including stock-based compensation of $21,176, $10,870, $48,550 and $32,727, respectively

 

82,007

 

50,959

 

194,635

 

135,333

 

General and administrative

 

15,730

 

19,367

 

56,224

 

48,881

 

Information technology

 

5,347

 

4,777

 

14,850

 

14,002

 

Depreciation and amortization

 

12,775

 

10,098

 

33,312

 

29,182

 

Total operating expenses

 

329,419

 

233,251

 

832,722

 

594,601

 

Operating income

 

336,769

 

200,755

 

597,837

 

352,973

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

918

 

471

 

2,713

 

1,695

 

Interest expense

 

(8,293

)

(5,911

)

(22,366

)

(19,221

)

Foreign currency transactions and other

 

(10,715

)

(1,220

)

(12,806

)

(1,283

)

Total other income (expense)

 

(18,090

)

(6,660

)

(32,459

)

(18,809

)

 

 

 

 

 

 

 

 

 

 

Earnings before income taxes and equity in income of investees

 

318,679

 

194,095

 

565,378

 

334,164

 

Income tax (expense) benefit

 

(94,119

)

124,887

 

(172,347

)

76,851

 

Equity in income of investees

 

 

 

 

2

 

Net income

 

224,560

 

318,982

 

393,031

 

411,017

 

Less: net income attributable to noncontrolling interests

 

1,580

 

 

1,219

 

 

 

 

 

 

 

 

 

 

 

 

Net income applicable to common stockholders

 

$

222,980

 

$

318,982

 

$

391,812

 

$

411,017

 

Net income applicable to common stockholders per basic common share

 

$

4.59

 

$

7.49

 

$

8.24

 

$

9.84

 

Weighted average number of basic common shares outstanding

 

48,570

 

42,569

 

47,565

 

41,750

 

Net income applicable to common stockholders per diluted common share

 

$

4.41

 

$

6.42

 

$

7.70

 

$

8.42

 

Weighted average number of diluted common shares outstanding

 

50,559

 

49,670

 

50,917

 

48,805

 

 

See Notes to Unaudited Consolidated Financial Statements.

 

3



Table of Contents

 

priceline.com Incorporated

UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2010

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated Other

 

 

 

 

 

Common Stock

 

Treasury Stock

 

Additional

 

Accumulated

 

Comprehensive

 

 

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Paid-in Capital

 

Deficit

 

Loss

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2009

 

52,446

 

$

405

 

(6,865

)

$

(510,970

)

$

2,289,867

 

$

(454,673

)

$

(3,000

)

$

1,321,629

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income applicable to common stockholders

 

 

 

 

 

 

 

 

 

 

 

391,812

 

 

 

391,812

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on marketable securities, net of tax of $166

 

 

 

 

 

 

 

 

 

 

 

 

 

87

 

87

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Currency translation adjustment, net of tax of $7,548

 

 

 

 

 

 

 

 

 

 

 

 

 

(16,135

)

(16,135

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

375,764

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Redeemable noncontrolling interests fair value adjustment

 

 

 

 

 

 

 

 

 

(4,118

)

 

 

 

 

(4,118

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercise of stock options and vesting of stock-based awards

 

594

 

5

 

 

 

 

 

24,618

 

 

 

 

 

24,623

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase of common stock

 

 

 

 

 

(545

)

(125,653

)

 

 

 

 

 

 

(125,653

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation and other stock-based payments

 

 

 

 

 

 

 

 

 

48,628

 

 

 

 

 

48,628

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of senior convertible notes

 

 

 

 

 

 

 

 

 

67,516

 

 

 

 

 

67,516

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reclassification adjustment for convertible debt in mezzanine

 

 

 

 

 

 

 

 

 

3,680

 

 

 

 

 

3,680

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Conversion of debt

 

3,458

 

28

 

 

 

 

 

(80,073

)

 

 

 

 

(80,045

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Excess tax benefit on stock-based compensation

 

 

 

 

 

 

 

 

 

4,975

 

 

 

 

 

4,975

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, September 30, 2010

 

56,498

 

$

438

 

(7,410

)

$

(636,623

)

$

2,355,093

 

$

(62,861

)

$

(19,048

)

$

1,636,999

 

 

See Notes to Unaudited Consolidated Financial Statements.

 

4



Table of Contents

 

priceline.com Incorporated

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

 

 

Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

393,031

 

$

411,017

 

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

 

 

 

 

 

Depreciation

 

12,068

 

10,605

 

Amortization

 

24,193

 

18,577

 

Provision for uncollectible accounts, net

 

5,737

 

3,379

 

Reversal of valuation allowance on deferred tax assets

 

 

(181,874

)

Other deferred income taxes, excluding valuation allowance reversal

 

33,650

 

27,835

 

Stock-based compensation and other stock-based payments

 

48,628

 

32,727

 

Amortization of debt issuance costs

 

2,785

 

1,620

 

Amortization of debt discount

 

14,948

 

14,752

 

Loss (gain) on early extinguishment of debt

 

11,334

 

(2,735

)

Equity in income of investees

 

 

(2

)

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(112,755

)

(73,932

)

Prepaid expenses and other current assets

 

(8,034

)

8,921

 

Accounts payable, accrued expenses and other current liabilities

 

169,898

 

89,827

 

Other

 

1,897

 

2,683

 

Net cash provided by operating activities

 

597,380

 

363,400

 

INVESTING ACTIVITIES:

 

 

 

 

 

Purchase of investments

 

(1,030,011

)

(534,274

)

Proceeds from sale of investments

 

665,925

 

294,618

 

Additions to property and equipment

 

(14,471

)

(9,902

)

Acquisitions and other equity investments, net of cash acquired

 

(110,972

)

 

Proceeds from foreign currency contracts

 

44,564

 

 

Payments on foreign currency contracts

 

(4,283

)

 

Proceeds from redemption of equity investment in pricelinemortgage.com

 

 

8,921

 

Change in restricted cash

 

156

 

1,234

 

Net cash used in investing activities

 

(449,092

)

(239,403

)

FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from the issuance of convertible senior notes

 

575,000

 

 

Payment of debt issuance costs

 

(13,334

)

 

Payments related to conversion of convertible senior notes

 

(295,398

)

(122,047

)

Repurchase of common stock

 

(125,653

)

(14,169

)

Proceeds from the sale of subsidiary shares to noncontrolling interests

 

4,311

 

 

Proceeds from exercise of stock options

 

24,623

 

9,404

 

Excess tax benefit on stock-based compensation

 

4,975

 

1,580

 

Net cash provided by (used in) financing activities

 

174,524

 

(125,232

)

Effect of exchange rate changes on cash and cash equivalents

 

8,168

 

(842

)

Net increase/(decrease) in cash and cash equivalents

 

330,980

 

(2,077

)

Cash and cash equivalents, beginning of period

 

202,141

 

364,550

 

Cash and cash equivalents, end of period

 

$

533,121

 

$

362,473

 

SUPPLEMENTAL CASH FLOW INFORMATION:

 

 

 

 

 

Cash paid during the period for income taxes

 

$

61,568

 

$

60,155

 

Cash paid during the period for interest

 

$

4,639

 

$

4,242

 

Non-cash fair value adjustment for redeemable noncontrolling interests

 

$

4,118

 

$

 

 

See Notes to Unaudited Consolidated Financial Statements

 

5



Table of Contents

 

priceline.com Incorporated

Notes to Unaudited Consolidated Financial Statements

 

1.                                      BASIS OF PRESENTATION

 

Priceline.com Incorporated (“priceline.com” or the “Company”) is responsible for the Unaudited Consolidated Financial Statements included in this document.  The Unaudited Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and include all normal and recurring adjustments that management of the Company considers necessary for a fair presentation of its financial position and operating results.  The Company prepared the Unaudited Consolidated Financial Statements following the requirements of the Securities and Exchange Commission for interim reporting.  As permitted under those rules, the Company condensed or omitted certain footnotes or other financial information that are normally required by GAAP for annual financial statements.  These statements should be read in combination with the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

 

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 loss” in the accompanying Unaudited Consolidated Balance Sheets.  Foreign currency transaction gains and (losses) are included in the Unaudited Consolidated Statements of Operations, principally in “Foreign currency transactions and other.”

 

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 certain provisions of a new accounting standard which defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements.  On January 1, 2009, the Company adopted the remaining provisions of this accounting standard as it relates to nonfinancial assets and liabilities that are not recognized or disclosed at fair value on a recurring basis.  In April 2009, the FASB issued further clarification for determining fair value when the volume and level of activity for an asset or liability had significantly decreased and for identifying transactions that were not conducted in an orderly market.  This clarification of the accounting standard was effective for interim reporting periods after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted this clarification of the standard effective for the three months ended March 31, 2009.  The adoption of the provisions of this new standard did not materially impact the Company’s Unaudited Consolidated Financial Statements.  In January 2010, the accounting requirements for fair value measurements were modified to provide disclosures about transfers into and out of Levels 1 and 2 fair value measurements, separate detail of activity relating to Level 3 fair value measurements, and disclosure by class of asset and liability as opposed to disclosure by the major category of assets and liabilities, which was often interpreted as a line item on the balance sheet.  The accounting guidance also clarified for Level 2 and Level 3 fair value measurements that a description of the valuation techniques and inputs used to measure fair value and a discussion of changes in valuation techniques or inputs, if any, are required for both recurring and nonrecurring fair value measurements.  The Company adopted this 2010 guidance effective with the three months ended March 31, 2010.  See Note 5 for information on fair value measurements.

 

In May 2009, the FASB issued new accounting guidance which required entities to state in their periodic filings the date through which subsequent events were evaluated.  The Company adopted this accounting standard for the six months ended June 30, 2009.  In February 2010, this accounting guidance was amended.  Although the Company is still required to conduct its review of subsequent events until its periodic reports are filed, it is no longer required to specifically state that date in its filings.  This change in guidance also requires an entity to update its evaluation of subsequent events through the date revised financial statements are issued (“revised financial statements” is a new term that incorporates the retrospective adoption of new accounting standards and the correction of an error).

 

6



Table of Contents

 

2.                                      STOCK-BASED COMPENSATION AND OTHER STOCK-BASED PAYMENTS

 

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 included in personnel expenses in the Unaudited Consolidated Statements of Operations was approximately $21.2 million and $10.9 million, and $48.6 million and $32.7 million, for the three and nine months ended September 30, 2010 and 2009, respectively.  Stock-based compensation for the three and nine months ended September 30, 2010 includes charges amounting to $6.4 million and $11.0 million, respectively, representing the cumulative impact of adjusting the estimated probable outcome at the end of the performance period for certain outstanding unvested performance share units.

 

During the nine months ended September 30, 2010, 362,569 options to purchase shares of common stock were exercised with a weighted average exercise price of $67.91, and 157,370 options with a weighted average exercise price of $317.66 were forfeited or expired.  As of September 30, 2010, the aggregate number of stock options outstanding and exercisable was 400,360 shares, with a weighted average exercise price of $23.77 and a weighted average remaining life of 2.8 years.

 

The following table summarizes the activity of unvested restricted stock, restricted stock units and performance share units (“Share-Based Awards”) related to stock-based compensation during the nine months ended September 30, 2010:

 

Share-Based Awards

 

Shares

 

Weighted Average
Grant Date Fair Value

 

 

 

 

 

 

 

Unvested at December 31, 2009

 

1,488,854

 

$

90.82

 

Granted

 

178,681

 

$

236.23

 

Vested

 

(340,833

)

$

53.39

 

Performance Share Units Adjustment

 

229,866

 

$

187.31

 

Forfeited

 

(18,829

)

$

120.56

 

Unvested at September 30, 2010

 

1,537,739

 

$

130.08

 

 

As of September 30, 2010, there was approximately $86.0 million of total future compensation cost related to unvested share-based awards to be recognized over a weighted-average period of 2.0 years.

 

2010 Restricted Stock Units (“RSUs”)

 

During the three months ended September 30, 2010, the Company made grants of 3,486 RSUs with a total grant date fair value of $1.0 million based upon the grant date fair value per share of $289.10.  During the three months ended June 30, 2010, the Company made grants of 3,253 RSUs with a total grant date fair value of $0.7 million based upon the grant date fair value per share of $217.88.  During the three months ended March 31, 2010, the Company made broad-based grants of 61,512 RSUs that had a total grant date fair value of $14.5 million based upon the grant date fair value per share of $235.82.  These share-based awards generally vest after three years.

 

2010 Performance Share Units

 

During the three months ended June 30, 2010, the Company made grants of 2,983 performance share units with a grant date fair value of $0.7 million based on the grant date fair value per share of $217.88.  During the three months ended March 31, 2010, the Company granted 107,447 performance share units with a total grant date fair value of $25.3 million based upon the grant date fair value per share of $235.82.

 

These performance share units are payable in shares of the Company’s common stock upon vesting and are based upon the attainment of certain performance targets.  Subject to certain exceptions for terminations related to a change in control and terminations other than for “cause,” for “good reason” or on account of death or disability, the executive officers must continue their service through March 1, 2013 in order to receive any share units.  Stock-based compensation for performance share units is recorded based on the estimated probable outcome at the end of the performance period.  The actual number of shares will be determined upon completion of the performance period which ends December 31, 2012.

 

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During the three months ended September 30, 2010, the estimated number of probable shares to be issued in connection with performance share units granted in 2010 increased by 51,207 shares.  As of September 30, 2010, the estimated total number of probable shares to be issued is 252,689 shares.  If the maximum performance thresholds are met at the end of the performance period, a maximum number of 268,611 total shares could be issued.

 

2008 Performance Share Units

 

During the three months ended September 30, 2010, the estimated number of probable shares to be issued in connection with the performance share units granted in 2008 increased by 49,735 shares.  As of September 30, 2010, the estimated total number of probable shares to be issued is 284,553 shares.  If the maximum performance thresholds are met at the end of the performance period, a maximum number of 443,214 shares could be issued.  The actual number of shares will be determined in 2011 upon completion of the performance period, which ends December 31, 2010.

 

Other Stock-based Payments

 

In 2010, the Company granted 5,555 RSUs with a total grant date fair value of $1.6 million to an advertising partner.  Expense is amortized over the service period and is charged to offline advertising expense.

 

3.                                      NET INCOME PER SHARE

 

The Company computes basic net income per share by dividing net income applicable to common stockholders 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 and performance share units 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 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.  The convertible notes are included in the calculation of diluted net income per share if their inclusion is dilutive under the treasury stock method.

 

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

 

 

 

For the Three Months
Ended September 30,

 

For the Nine Months
Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of basic common shares outstanding

 

48,570

 

42,569

 

47,565

 

41,750

 

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

 

1,402

 

1,207

 

1,524

 

1,335

 

Assumed conversion of Convertible Senior Notes

 

587

 

5,894

 

1,828

 

5,720

 

Weighted average number of diluted common and common equivalent shares outstanding

 

50,559

 

49,670

 

50,917

 

48,805

 

Anti-dilutive potential common shares

 

2,629

 

3,723

 

2,582

 

4,204

 

 

Anti-dilutive potential common shares for the three and nine months ended September 30, 2010 includes approximately 1.9 million shares for each period, which could be issued under the Company’s convertible debt if the Company’s stock price increases.  Under the treasury stock method, the convertible notes will generally have a dilutive impact on net income per share if the Company’s average stock price for the period exceeds the conversion price for the convertible notes.  The Company has Conversion Spread Hedges outstanding that increase the effective conversion price of the Company’s 0.50% Convertible Senior Notes due 2011 (the “2011 Notes”) and the Company’s 0.75% Convertible Senior Notes due 2013 (the “2013 Notes”) from $40.38 to $50.47 per share from the Company’s perspective and were designed to reduce potential dilution upon conversion of these notes at maturity (see Note 8).  Since the beneficial impact of the Conversion Spread Hedges is anti-dilutive, it is excluded from the calculation of net income per share.  At stock prices above

 

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$50.47, the Company will receive $85 million in value which will be settled in shares.  The actual number of shares to be received will depend upon the Company’s stock price on the date on which the Conversion Spread Hedges are exercisable, which coincides with the scheduled maturity of the 2011 Notes and the 2013 Notes.

 

4.                                      INVESTMENTS

 

The following table summarizes, by major security type, the Company’s short-term investments as of September 30, 2010 (in thousands):

 

 

 

Cost

 

Gross Unrealized
Gains

 

Gross Unrealized
Losses

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Foreign government securities

 

$

450,328

 

$

59

 

$

(217

)

$

450,170

 

U.S. government securities

 

445,880

 

326

 

 

446,206

 

U.S. agency securities

 

45,531

 

41

 

 

45,572

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

941,739

 

$

426

 

$

(217

)

$

941,948

 

 

The following table summarizes, by major security type, the Company’s short-term investments as of December 31, 2009 (in thousands):

 

 

 

Cost

 

Gross Unrealized
Gains

 

Gross Unrealized
Losses

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Foreign government securities

 

$

397,012

 

$

94

 

$

(35

)

$

397,071

 

U.S. government securities

 

200,940

 

56

 

(53

)

200,943

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

597,952

 

$

150

 

$

(88

)

$

598,014

 

 

Long-term investments amounting to approximately $0.4 million at both September 30, 2010 and December 31, 2009, comprised of corporate notes with a maturity date greater than one year, are included in “Other assets” on the Company’s Unaudited Consolidated Balance Sheets.  There were no material gains or losses related to long-term investments for the three or nine months ended September 30, 2010 or 2009.

 

5.                                      FAIR VALUE MEASUREMENTS

 

Financial assets and liabilities carried at fair value as of September 30, 2010 are classified in the table below in the categories described below (in thousands):

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

ASSETS

 

 

 

 

 

 

 

 

 

Short-term investments

 

 

 

 

 

 

 

 

 

Foreign government securities

 

$

450,170

 

$

 

$

 

$

450,170

 

U.S. government securities

 

446,206

 

 

 

446,206

 

U.S. agency securities

 

 

45,572

 

 

45,572

 

Long-term investments

 

 

424

 

 

424

 

Total assets at fair value

 

$

896,376

 

$

45,996

 

$

 

$

942,372

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

 

 

 

 

Foreign exchange derivatives

 

$

 

$

18,959

 

$

 

$

18,959

 

Redeemable noncontrolling interests

 

 

 

44,222

 

44,222

 

Total liabilities at fair value

 

$

 

$

18,959

 

$

44,222

 

$

63,181

 

 

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Financial assets and liabilities carried at fair value as of December 31, 2009 were classified in the table below in the categories described below (in thousands):

 

 

 

Level 1

 

Level 2

 

Total

 

Short-term investments

 

$

598,014

 

$

 

$

598,014

 

Long-term investments

 

 

359

 

359

 

Foreign exchange derivative assets

 

 

8,047

 

8,047

 

Total assets at fair value

 

$

598,014

 

$

8,406

 

$

606,420

 

 

There are three levels of inputs to measure fair value.  The definition of each input is described below:

 

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

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

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

 

As of September 30, 2010, the Company considers its redeemable noncontrolling interests to represent a “Level 3” fair value measurement that requires a high level of judgment to determine fair value.  The Company estimated such fair value based upon standard valuation techniques using discounted cash flow analysis and industry peer comparable analysis.  See Note 11 for information on the estimated fair value for redeemable noncontrolling interests.

 

For the Company’s investments, a market approach is used for recurring fair value measurements and the valuation techniques use inputs that are observable, or can be corroborated by observable data, in an active marketplace.  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 curves, option volatility and currency rates.  Derivatives are considered “Level 2” fair value measurements.

 

As of September 30, 2010 and December 31, 2009, the carrying value of the Company’s cash and cash equivalents approximated their fair value and consisted primarily of U.S. and foreign government securities and bank deposits.  Other financial assets and liabilities, including restricted cash, accounts receivable, accrued expenses and deferred merchant bookings are carried at cost which also approximates their fair value because of the short-term nature of these items.  See Note 4 for information on the carrying value of investments and Note 8 for the estimated fair value of the Company’s convertible senior notes.

 

In the normal course of business, the Company is exposed to the impact of foreign currency fluctuations.  The Company limits these risks by following established risk management policies and procedures, including the use of derivatives.  The Company’s derivative instruments are typically short-term in nature.  The Company does not use derivatives for trading or speculative purposes.  All derivative instruments are recognized in the Unaudited Consolidated Balance Sheets at fair value.  Gains and losses resulting from changes in the fair value of derivative instruments which are not designated as hedging instruments for accounting purposes are recognized in the Unaudited Consolidated Statements of Operations in the period that the changes occur.  Changes in the fair value of derivatives designated as net investment hedges are recorded as currency translation adjustments to offset a portion of the translation adjustment of the foreign subsidiary’s net assets and are recognized in the Unaudited Consolidated Balance Sheets in “Accumulated other comprehensive loss.”

 

Derivatives Not Designated as Hedging Instruments — The Company’s derivative contracts principally address foreign exchange fluctuation risk for the Euro.  As of September 30, 2010, derivatives with a notional value of 65 million Euros were outstanding and are short-term in nature.  There were no derivative contracts outstanding as of December 31, 2009.  Foreign exchange losses related to derivatives were $6.2 million for the three months ended September 30, 2010 compared to gains of $2.4 million for the nine months ended September 30, 2010.  Foreign exchange losses were $1.7 million and $2.5 million for the three and nine months ended September 30, 2009, respectively. Foreign exchange gains and losses are recorded in “Foreign currency transactions and other” in the Unaudited Consolidated Statement of Operations.  The fair value of derivative liabilities of $2.5 million at September 30, 2010 is recorded in “Accrued expenses and other current liabilities” in the Unaudited Consolidated Balance Sheet.  Net cash inflows of $5.7 million and $7.4 million for contracts that settled for the nine months ended September 30, 2010 and 2009, respectively, were reported within “Net cash provided by operating activities” in the Unaudited Consolidated Statements of Cash Flows.

 

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Derivatives Designated as Hedging Instruments — As of September 30, 2010 and December 31, 2009, the Company had outstanding contracts for 353 million Euros and 183 million Euros, respectively, to hedge a portion of its net investment in a foreign subsidiary.  These contracts were all short-term in nature.  Hedge ineffectiveness is assessed and measured based on changes in forward exchange rates.  The fair value of these derivatives at September 30, 2010 of $16.5 million is a liability recorded in “Accrued expenses and other current liabilities” in the Unaudited Consolidated Balance Sheet.  The fair value of these derivatives at December 31, 2009 of $8.0 million was an asset recorded in “Prepaid expenses and other current assets” in the Unaudited Consolidated Balance Sheet.

 

6.                                      INTANGIBLE ASSETS AND GOODWILL

 

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

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

 

 

 

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Amortization
Period

 

Weighted
Average
Useful Life

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supply and distribution agreements

 

$

267,565

 

$

(72,222

)

$

195,343

 

$

204,117

 

$

(60,587

)

$

143,530

 

10 – 13 years

 

12 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Technology

 

23,884

 

(21,878

)

2,006

 

24,185

 

(20,890

)

3,295

 

3 years

 

3 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Patents

 

1,487

 

(1,233

)

254

 

1,489

 

(1,197

)

292

 

15 years

 

15 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer lists

 

20,616

 

(17,256

)

3,360

 

17,235

 

(15,098

)

2,137

 

2 years

 

2 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Internet domain names

 

6,894

 

(3,202

)

3,692

 

6,517

 

(2,633

)

3,884

 

2 – 10 years

 

10 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trade names

 

47,219

 

(10,477

)

36,742

 

26,855

 

(8,031

)

18,824

 

5 – 20 years

 

12 years

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

5,267

 

(3,421

)

1,846

 

469

 

(351

)

118

 

7 months – 15 years

 

1 year

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total intangible assets

 

$

372,932

 

$

(129,689

)

$

243,243

 

$

280,867

 

$

(108,787

)

$

172,080

 

 

 

 

 

 

Intangible assets with determinable lives are primarily amortized on a straight-line basis.  Intangible asset amortization expense was approximately $10.6 million and $6.4 million for the three months ended September 30, 2010 and 2009, respectively, and approximately $24.2 million and $18.6 million for the nine months ended September 30, 2010 and 2009, respectively.

 

The annual estimated amortization expense for intangible assets for the remainder of 2010, the next five years and thereafter is expected to be as follows (in thousands):

 

2010

 

$

10,010

 

2011

 

32,024

 

2012

 

29,668

 

2013

 

28,390

 

2014

 

28,319

 

2015

 

25,585

 

Thereafter

 

89,247

 

 

 

$

243,243

 

 

A substantial portion of the Company’s intangible assets relate to its Booking.com business.  In addition, purchased identifiable intangibles increased by $94.5 million as a result of the acquisition of TravelJigsaw Holdings Limited in May 2010 (refer to Note 11).

 

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The change in goodwill for the nine months ended September 30, 2010 consists of the following (in thousands):

 

Balance at December 31, 2009

 

$

350,630

 

Acquisition

 

105,313

 

Currency translation adjustments

 

(2,325

)

Balance at September 30, 2010

 

$

453,618

 

 

A substantial majority of the Company’s goodwill relates to its acquisition of Booking.com.  In addition, the acquisition of TravelJigsaw Holdings Limited in May 2010 increased goodwill by $105.3 million (refer to Note 11).  During the three months ended September 30, 2010, the Company performed its annual goodwill impairment testing using standard valuation techniques.  The estimated fair value for Booking.com, as well as the Company’s other reporting units, substantially exceeds their respective carrying values.

 

7.                                      OTHER ASSETS

 

Other assets at September 30, 2010 and December 31, 2009 consist of the following (in thousands):

 

 

 

September 30, 2010

 

December 31, 2009

 

Deferred debt issuance costs

 

$

10,124

 

$

2,235

 

Long-term investments

 

424

 

359

 

Other

 

4,285

 

1,790

 

Total

 

$

14,833

 

$

4,384

 

 

Deferred debt issuance costs arose from (i) the Company’s issuance, in March 2010, of $575.0 million aggregate principal amount of 1.25% Convertible Senior Notes due 2015 (the “2015 Notes”); (ii) a $175.0 million revolving credit facility entered into in September 2007; (iii) the Company’s issuance, in September 2006, of $172.5 million aggregate principal amount of 2011 Notes; and (iv) the Company’s issuance, in September 2006, of $172.5 million aggregate principal amount of 2013 Notes.  Deferred debt issuance costs are being amortized using the effective interest rate method over the term of approximately five years, except for the 2013 Notes, which are amortized over their term of seven years.  The period of amortization for the Company’s 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.

 

Long-term investments amounting to approximately $0.4 million at both September 30, 2010 and December 31, 2009 were comprised of corporate notes with a maturity date greater than one year.

 

Other assets, consisting primarily of supplier and other security deposits, increased $2.5 million during the nine months ended September 30, 2010.  This increase is principally related to the other assets acquired with the acquisition of TravelJigsaw Holdings Limited in May 2010 (see Note 11 for further information on the acquisition).

 

8.                                      DEBT

 

Revolving Credit Facility

 

In September 2007, the Company entered into a $175.0 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 $50.0 million of letters of credit as well as borrowings on same-day notice, referred to as swingline loans, which are available in U.S. Dollars, Euros, Pound Sterling and any other foreign currency agreed to by the lenders. The proceeds of loans made under the facility will be used for working capital and general corporate purposes.  As of September 30, 2010 and December 31, 2009, there were no borrowings outstanding under

 

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the facility, and there were approximately $1.6 million and $2.4 million, respectively, of letters of credit issued under the revolving credit facility.

 

Convertible Debt

 

Convertible debt as of September 30, 2010 consisted of the following (in thousands):

 

September 30, 2010

 

Outstanding
Principal
Amount

 

Unamortized
Debt
Discount

 

Carrying
Value

 

1.25% Convertible Senior Notes due 2015

 

$

575,000

 

$

(103,929

)

$

471,071

 

0.50% Convertible Senior Notes due 2011

 

2

 

 

2

 

0.75% Convertible Senior Notes due 2013

 

213

 

(41

)

172

 

Outstanding convertible debt

 

$

575,215

 

$

(103,970

)

$

471,245

 

 

Convertible debt as of December 31, 2009 consists of the following (in thousands):

 

December 31, 2009

 

Outstanding
Principal
Amount

 

Unamortized
Debt
Discount

 

Carrying
Value

 

0.50% Convertible Senior Notes due 2011

 

$

39,990

 

$

(4,730

)

$

35,260

 

0.75% Convertible Senior Notes due 2013

 

133,000

 

(31,151

)

101,849

 

2.25% Convertible Senior Notes due 2025

 

22,873

 

(104

)

22,769

 

Outstanding convertible debt

 

$

195,863

 

$

(35,985

)

$

159,878

 

 

Based upon the closing price of the Company’s common stock for the prescribed measurement periods during the three months ended September 30, 2010 and December 31, 2009, the contingent conversion thresholds on the 2011 Notes and the 2013 Notes and the 2.25% Convertible Senior Notes due 2025 (the “2025 Notes”) were exceeded.  As a result, the 2011 Notes and the 2013 Notes were convertible at the option of the holder as of September 30, 2010 and December 31, 2009, and the 2025 Notes were convertible at the option of the holder as of December 31, 2009.  Accordingly, the carrying value of the 2011 Notes, the 2013 Notes and the 2025 Notes has been classified as a current liability.  Since the notes are convertible at the option of the holder and the principal amount is required to be paid in cash, the difference between the principal amount and carrying value is reflected as convertible debt in mezzanine on the Company’s Unaudited Consolidated Balance Sheets as of those dates.  The determination of whether or not the notes are convertible must continue to be performed on a quarterly basis.  The contingent conversion thresholds on the 2015 Notes were not exceeded at September 30, 2010, and therefore that debt is reported as a non-current liability.

 

In January 2010, the Company exercised its right to redeem the 2025 Notes; however, all of the holders of the then outstanding Notes tendered their notes for conversion prior to the redemption date, and as a result, none of the 2025 Notes was outstanding as of September 30, 2010.  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 issuance costs to interest expense.  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 three months ended September 30, 2010, $18.9 million aggregate principal amount of the 2011 Notes and $30.9 million aggregate principal amount of the 2013 Notes were converted.  The Company delivered cash of $49.8 million to repay the principal amount and issued 660,196 shares and delivered cash of $72.2 million in satisfaction of the conversion value in excess of the principal amount.  In the nine months ended September 30, 2010, $39.9 million aggregate principal amount of the 2011 Notes, $132.8 million aggregate principal amount of the 2013 Notes and $22.9 million aggregate principal amount of the 2025 Notes were converted.  The Company delivered cash of $195.6 million to repay the principal amount and issued 3,457,785 shares and delivered cash of $99.8 million in satisfaction of the conversion value in excess of the principal amount.  In October 2010, the Company settled $2 thousand principal amount of the 2011 Notes for cash of $2 thousand for the principal amount and issued 43 shares in satisfaction of the conversion value in excess of the principal amount.  As a result, none of the 2011 Notes is currently outstanding.

 

As of September 30, 2010 and December 31, 2009, the estimated market value of the outstanding senior notes was approximately $770 million and $1.1 billion, respectively.  Fair value was estimated based upon actual trades at the end of the reporting period or the most recent trade available as well as the Company’s stock price at the end of the reporting period. 

 

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A substantial portion of the fair value of the Company’s debt in excess of the outstanding principal amount relates to the conversion premium on the bonds.

 

In March 2010, the Company issued in a private placement $575.0 million aggregate principal amount of Convertible Senior Notes due March 15, 2015, with an interest rate of 1.25% (the “2015 Notes”).  The 2015 Notes are convertible, subject to certain conditions, into the Company’s common stock at a conversion price of approximately $303.06 per share.  The 2015 Notes are convertible, at the option of the holder, prior to March 15, 2015 upon the occurrence of specified events, including, but not limited to a change in control, or if the closing sales price of the Company’s common stock for at least 20 consecutive 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 150% of the applicable conversion price in effect for the notes on the last trading day of the immediately preceding quarter. In the event that all or substantially all of the Company’s common stock is acquired on or prior to the maturity of the 2015 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 2015 Notes in aggregate value ranging from $0 to approximately $132.7 million depending upon the date of the transaction and the then current stock price of the Company.  As of December 15, 2014, holders will have the right to convert all or any portion of the 2015 Notes.  The 2015 Notes may not be redeemed by the Company prior to maturity.  The holders may require the Company to repurchase the 2015 Notes for cash in certain circumstances.  Interest on the 2015 Notes is payable on March 15 and September 15 of each year.

 

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 consecutive trading days in the period of the 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is more than 120% of the applicable conversion price in effect for the notes on the last trading day of the immediately preceding quarter.  In October 2010, the Company settled $2 thousand principal amount of the 2011 Notes.  As a result, none of the 2011 Notes is currently outstanding.  Neither the 2011 Notes nor the 2013 Notes were redeemable by the Company prior to maturity.  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 2011 and 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 Hedges 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 Conversion Spread Hedges do not immediately hedge against the associated dilution from conversions of the Notes prior to their stated maturities.  Therefore, upon conversion of the 2011 Notes or the 2013 Notes, the Company has delivered or will be obligated to immediately deliver any related conversion premium in shares of common stock or cash, at its option.  However, the hedging counterparties will not be obligated to deliver the Company shares or cash that would offset the dilution associated with the early conversion activity until 2011 and 2013.  Because of this potential timing difference, the number of shares, if any, that the Company receives from its Conversion Spread Hedges could differ materially from the number of shares, if any, that it is required to deliver to holders of the Notes upon their early conversion.  This difference in timing can potentially make the hedges ineffective, which could negatively impact the Company’s future diluted shares outstanding and diluted earnings per share.

 

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Accounting guidance requires that cash-settled convertible debt, such as the Company’s convertible senior notes, be separated into debt and equity components at issuance and each be assigned a value.  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.  Debt discount is amortized using the effective interest method over the period from origination or modification date through the earlier of the first stated put date or the stated maturity date.

 

The Company estimated the straight debt borrowing rates at debt origination or modification (the 2015 Notes, 2011 Notes and 2013 Notes were structured requiring net cash settlement at issue and the 2025 Notes were modified to provide for net cash settlement in 2006) to be 5.89% for the 2015 Notes, 7.75% for the 2011 Notes and 2025 Notes, and 8.0% for the 2013 Notes.  The yield to maturity was estimated at an at-market coupon priced at par.  The straight debt borrowing rate for the 2025 Notes was based upon an effective maturity date of January 15, 2010 because on that date the 2025 Notes were redeemable and the holders could require the Company to repurchase these notes.

 

The carrying value of the permanent equity component reported in additional paid-in-capital related to the 2015 Notes was a credit of $67.5 million at September 30, 2010, comprised of debt discount after tax of $69.1 million ($115.2 million before tax) partially offset by financing costs after tax of $1.6 million.

 

For the three months ended September 30, 2010 and 2009, the Company recognized interest expense of $7.7 million and $5.4 million, respectively, related to convertible notes.  Interest expense was comprised of $1.7 million and $0.6 million, respectively, for the contractual coupon interest, $5.5 million and $4.5 million, respectively, related to the amortization of debt discount and $0.5 million and $0.3 million, respectively, related to the amortization of debt issuance costs.  In addition, unamortized debt issuance costs written off to interest expense related to debt conversions in the three months ended September 30, 2010 and 2009 amounted to approximately $0.3 million for each period.  The effective interest rate for the three months ended September 30, 2010 and 2009 was 6.5% and 8.4%, respectively.  The remaining debt discount and debt issuance costs are amortized through the stated maturity dates of the respective debt.

 

For the nine months ended September 30, 2010 and 2009, the Company recognized interest expense of $20.2 million and $18.0 million, respectively, related to convertible notes, comprised of $4.0 million and $2.4 million, respectively, for the contractual coupon interest, $15.0 million and $14.8 million, respectively, related to the amortization of debt discount and $1.2 million and $0.8 million, respectively, related to the amortization of debt issuance costs.  In addition, unamortized debt issuance costs written off to interest expense related to debt conversions for the nine months ended September 30, 2010 and 2009 amounted to $1.3 million and $0.6 million, respectively.  The effective interest rate for the nine months ended September 30, 2010 and 2009 was 6.9% and 8.3%, respectively.

 

In addition, if the Company’s convertible debt is redeemed or converted prior to maturity, a gain or loss on extinguishment is recognized.  The gain or loss is the difference between the fair value of the debt component immediately prior to extinguishment and its carrying value.  To estimate the fair value at each conversion date, the Company used an applicable LIBOR rate plus an applicable credit default spread based upon the Company’s credit rating at the respective conversion dates.  As a result of debt conversions during the three months ended September 30, 2010 and 2009, the Company recognized a loss of $3.2 million ($1.9 million after tax) and a loss of $0.4 million ($0.2 million after tax), respectively, in “Foreign currency transactions and other” in the Unaudited Consolidated Statements of Operations.  As a result of debt conversions during the nine months ended September 30, 2010 and 2009, the Company recognized a loss of $11.3 million ($6.8 million after tax) and a gain of $2.7 million ($1.6 million after tax), respectively, in “Foreign currency transactions and other” in the Unaudited Consolidated Statements of Operations.

 

9.                                      TREASURY STOCK

 

In the first quarter of 2010, the Company’s Board of Directors authorized an additional repurchase of up to $500 million of the Company’s common stock from time to time in the open market or in privately negotiated transactions, including the approval to purchase up to $100 million from the proceeds from the issuance of the 2015 Notes.  During the three months ended June 30, 2010, the Company repurchased 32,487 shares of its common stock at an aggregate cost of approximately $6.1 million.  The Company repurchased 428,950 shares of its common stock at an aggregate cost of approximately $100.0 million in the three months ended March 31, 2010.

 

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.  The Company repurchased 84,002 shares and 163,557 shares at aggregate costs of $19.6 million and $14.2 million in the nine months ended September 30, 2010 and 2009, 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 programs, 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.  The Company has a remaining authorization of $459.2 million to purchase its common stock.  As of September 30, 2010, there were approximately 7.4 million shares of the Company’s common stock held in treasury.

 

10.                               INCOME TAXES

 

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

 

The Company recognizes income tax expense related to income generated outside of the United States based upon the applicable tax rates and tax laws of the foreign countries in which the income is generated.  During the three and nine months ended September 30, 2010 and 2009, 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, 2010 differs from the expected tax expense at the U.S. statutory rate of 35%, primarily due to lower foreign tax rates, partially offset by state income taxes and certain non-deductible expenses.  Income tax expense for the three and nine months ended September 30, 2009 differs from the expected tax expense at the U.S. statutory rate of 35%, principally because it includes a benefit of $181.9 million resulting from the reversal of the remaining valuation allowance on the deferred tax assets related to net operating losses (“NOLs”) generated from the Company’s domestic operating losses, and to a lesser extent, lower foreign tax rates, partially offset by state income taxes and certain non-deductible expenses.

 

The Company has significant deferred tax assets, resulting principally from domestic NOLs.  At December 31, 2009, the Company had approximately $2.8 billion of NOLs for U.S. federal income tax purposes, comprised of $0.8 billion of NOLs generated from operating losses and approximately $2.0 billion of NOLs generated from equity-related transactions, including equity-based compensation and stock warrants, mainly expiring from December 31, 2019 to December 31, 2021.  The utilization of these NOLs is subject to limitation under Section 382 of the Internal Revenue Code and is also dependent on the Company’s ability to generate sufficient future taxable income.  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.  As of December 31, 2009, 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 $1.4 billion, comprised of $0.8 billion of NOLs generated from operating losses which have been fully reflected in the Unaudited Consolidated Financial Statements and $0.6 billion of NOLs generated from equity-related transactions. In accordance with accounting guidance, tax benefits related to equity transactions will be recognized as a credit to additional paid-in capital if and when they are realized by reducing the Company’s current income tax liability.  Pursuant to Section 382, subsequent ownership changes could further limit this amount.

 

The Company periodically evaluates the likelihood of the realization of deferred tax assets, and reduces the carrying amount of these deferred tax assets by a valuation allowance to the extent it believes a portion will not be realized.  The Company considers many factors when assessing the likelihood of future realization of the deferred tax assets, including its recent cumulative earnings experience by taxing jurisdiction, expectations of future income, the carryforward periods available for tax reporting purposes, and other relevant factors.  The deferred tax asset at September 30, 2010 and December 31, 2009 amounted to $232.1 million and $319.7 million, net of the valuation allowance recorded, respectively.

 

The Company has recorded a non-current deferred tax liability in the amount of $59.4 million and $43.8 million at September 30, 2010 and December 31, 2009, respectively, primarily related to the assignment of estimated fair value to certain purchased identifiable intangible assets associated with various acquisitions.

 

The Company does not have any significant uncertain tax positions as of September 30, 2010 and December 31, 2009.

 

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11.                               REDEEMABLE NONCONTROLLING INTERESTS

 

On May 18, 2010, the Company, through its wholly-owned subsidiary, Priceline.com International Limited (“PIL”), paid $108.5 million, net of cash acquired, to purchase a controlling interest of the outstanding equity of TravelJigsaw Holdings Limited and its operating subsidiary, TravelJigsaw Limited, a Manchester, U.K.-based multinational car hire reservation service (collectively, “TravelJigsaw”).

 

Certain key members of TravelJigsaw’s management team retained a noncontrolling ownership interest in TravelJigsaw Holdings Limited.  In addition, certain key members of the management team of Booking.com purchased a 3% ownership interest in TravelJigsaw from PIL in June 2010 (together with TravelJigsaw management’s investment, the “Redeemable Shares”).  The holders of the Redeemable Shares will have the right to put their shares to PIL and PIL will have the right to call the shares in each case at a purchase price reflecting the fair value of the Redeemable Shares at the time of exercise.  Subject to certain exceptions, one-third of the Redeemable Shares will be subject to the put and call options in each of 2011, 2012 and 2013, respectively, during specified option exercise periods.

 

Redeemable noncontrolling interests are measured at fair value, both at the date of acquisition and subsequently at each reporting period.  The redeemable noncontrolling interests are reported on the Unaudited Consolidated Balance Sheet in mezzanine equity in “Redeemable noncontrolling interests.”

 

A reconciliation of redeemable noncontrolling interests for the nine months ended September 30, 2010 is as follows (in thousands):

 

 

 

2010

 

 

 

 

 

Balance, December 31, 2009

 

$

 

Fair value at acquisition (1)

 

29,520

 

Sale of subsidiary shares at fair value(2)

 

4,311

 

Net income attributable to noncontrolling interests

 

1,219

 

Fair value adjustment (3)

 

4,118

 

Currency translation adjustments

 

5,054

 

Balance, September 30, 2010

 

$

44,222

 

 


(1)          The fair value was determined based on the price paid at acquisition.

(2)          The Company retained a controlling interest after the sale of the subsidiary shares.

(3)          The estimated fair value adjustment was based upon standard valuation techniques using discounted cash flow analysis and industry peer comparable analysis.

 

12.                               COMPREHENSIVE INCOME AND ACCUMULATED OTHER COMPREHENSIVE LOSS

 

Comprehensive income for the three months ended September 30, 2010 was $298.6 million comprised of net income applicable to common stockholders of $223.0 million and favorable currency translation adjustments of $75.8 million partially offset by unrealized losses on investments of $0.2 million,  For the comparable period in 2009, comprehensive income was $334.9 million comprised of $319.0 million of net income, favorable currency translation adjustments of $15.8 million, and unrealized gains on investments of $0.1 million.

 

Comprehensive income for the nine months ended September 30, 2010 was $375.8 million comprised of net income applicable to common stockholders of $391.8 million and an unrealized gain on marketable securities of $0.1 million, partially offset by unfavorable currency translation adjustments of $16.1 million.  For the comparable period in 2009, comprehensive income was $456.2 million, comprised of $411.0 million of net income and favorable currency translation adjustments of $45.3 million, partially offset by an unrealized loss on marketable securities of $0.1 million.

 

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The table below provides the balances for each classification of accumulated other comprehensive loss as of September 30, 2010 and December 31, 2009 (in thousands):

 

 

 

September 30,
2010

 

December 31,
2009

 

Foreign currency translation adjustments (1)

 

$

(19,359

)

$

(3,224

)

Net unrealized gain on investment securities (2)

 

311

 

224

 

Accumulated other comprehensive loss

 

$

(19,048

)

$

(3,000

)

 


(1)          Includes net gains from fair value adjustments at September 30, 2010 and December 31, 2009 associated with net investment hedges of $11.2 million after tax ($18.7 million before tax) and $1.8 million after tax ($3.0 million before tax), respectively.  The remaining balance in currency translation adjustments excludes income taxes due to the Company’s practice and intention to reinvest the earnings of its foreign subsidiaries in those operations.

(2)          The unrealized gain before tax at September 30, 2010 was $0.5 million.

 

13.                               COMMITMENTS AND CONTINGENCIES

 

Litigation Related to Hotel Occupancy and Other Taxes

 

The Company and certain third-party defendants are currently involved in approximately fifty lawsuits brought by or against states, cities and counties over issues involving the payment of hotel occupancy and other taxes (i.e., state and local sales tax) and its “merchant” hotel business.  The Company is also involved in two consumer lawsuits relating to, among other things, the payment of hotel occupancy taxes and service fees.  In addition, over sixty municipalities or counties, and at least eight states, have initiated audit proceedings (including proceedings initiated by more than forty municipalities in California), issued proposed tax assessments or started inquiries relating to the payment of hotel occupancy and other taxes (i.e., state and local sales tax).  Additional state and local jurisdictions are likely to assert that the Company is subject to, among other things, hotel occupancy and other taxes (i.e., state and local sales tax) and could seek to collect such taxes, retroactively and/or prospectively.

 

With respect to the principal claims in these matters, the Company believes that the ordinances at issue do not apply to the service it provides, namely the facilitation of reservations, and, therefore, that the Company does not owe the taxes that are claimed to be owed.  Rather, the Company believes that the ordinances at issue generally impose hotel occupancy and other taxes on entities that own, operate or control hotels (or similar businesses) or furnish or provide hotel rooms or similar accommodations.  In addition, in many of these matters, municipalities have typically asserted claims for “conversion” — essentially, that the Company has collected a tax and wrongfully “pocketed” those tax dollars — a claim that the Company believes is without basis and has vigorously contested.  The municipalities that are currently involved in litigation and other proceedings with the Company, and that may be involved in future proceedings, have asserted contrary positions and will likely continue to do so.

 

In connection with some of the tax audits and assessments, the Company may be required to pay any assessed taxes, which amounts may be substantial, prior to being allowed to contest the assessments and the applicability of the ordinances in judicial proceedings.  This requirement is commonly referred to as “pay to play” or “pay first.”  For example, the City of San Francisco assessed the Company approximately $3.4 million (an amount that includes interest and penalties) relating to hotel occupancy taxes, which it paid in July 2009.  Payment of these amounts, if any, is not an admission that the Company believes it is subject to such taxes and, even if such payments are made, the Company intends to continue to assert its position vigorously.  The Company has successfully argued against a “pay first” requirement asserted in another California proceeding.

 

Litigation is subject to uncertainty and there could be adverse developments in these pending or future cases and proceedings.  For example, in October 2009, a jury in a San Antonio class action found that the Company and the other online travel companies that are defendants in the lawsuit “control” hotels for purposes of the local hotel occupancy tax ordinances at issue and are, therefore, subject to the requirements of those ordinances.  An unfavorable outcome or settlement of pending litigation is likely to encourage the commencement of additional litigation, audit proceedings or other regulatory inquiries.  In addition, an unfavorable outcome or settlement of these actions or proceedings could result in substantial

 

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liabilities for past and/or future bookings, including, among other things, interest, penalties, punitive damages and/or attorney fees and costs.  There have been, and will continue to be, substantial ongoing costs, which may include “pay first” payments, associated with defending the Company’s position in pending and any future cases or proceedings.  An adverse outcome in one or more of these unresolved proceedings could have a material adverse effect on the Company’s business and results of operations and could be material to its earnings or cash flow in any given operating period.

 

To the extent that any tax authority succeeds in asserting that the Company has a tax collection responsibility, or the Company determines that it has one, with respect to future transactions, the Company may collect any such additional tax obligation from its customers, which would have the effect of increasing the cost of hotel room reservations to its customers and, consequently, could make the Company’s hotel service less competitive (i.e., versus the websites of other online travel companies or hotel company websites) and reduce hotel reservation transactions; alternatively, the Company could choose to reduce the compensation for its services on “merchant” hotel transactions.  Either step could have a material adverse effect on the Company’s business and results of operations.

 

In many of the judicial and other proceedings initiated to date, municipalities seek not only historical taxes that are claimed to be owed on the Company’s gross profit, but also, among other things, interest, penalties, punitive damages and/or attorney fees and costs.  Any liability associated with hotel occupancy tax matters is not constrained to the Company’s liability for tax owed on its historical gross profit, but may also include, among other things, penalties, interest and attorneys’ fees.  To date, the majority of the taxing jurisdictions in which the Company facilitates the sale of hotel reservations have not asserted that taxes are due and payable on the Company’s U.S. “merchant” hotel business.  With respect to municipalities that have not initiated proceedings to date, it is possible that they will do so in the future or that they will seek to amend their tax statutes and seek to collect taxes from the Company only on a prospective basis.  As a result of this litigation and other attempts by jurisdictions to levy similar taxes, the Company has established a reserve for the potential resolution of issues related to hotel occupancy and other taxes in the amount of approximately $23 million as of September 30, 2010 (which includes, among other things, amounts related to the litigation in San Antonio).  The reserve is based on the Company’s reasonable estimate, and the ultimate resolution of these issues may be less or greater, potentially significantly, than the liabilities recorded.

 

From time to time, the Company has settled, and may in the future agree to settle, claims pending in these matters.  Since June 30, 2010, the Company has reached an agreement in principle with the respective plaintiffs resolving the claims for purported back taxes in Mayor & City Council of Baltimore v. priceline.com, Inc., et al., as well as three individual cases that had been previously consolidated for pretrial purposes, City of Charleston, South Carolina v. Hotel.com, et al.; Town of Mount Pleasant, South Carolina v. Hotels.com, et al.; and City of North Myrtle Beach, South Carolina v. Hotels.com, LP, et al.  Also, as part of each of the agreements in principle, plaintiffs have agreed to not assert claims based on the ordinance at issue in the respective action for a period of time, ranging from two to four years.  For the City of Baltimore, as discussed below, the agreement was finalized and dismissal followed shortly thereafter.  For the City of Charleston, Town of Mount Pleasant, and City of North Myrtle Beach cases, the agreement was finalized by October 25, 2010 and dismissal is expected shortly.  The settlement amounts in these cases are not material to the Company’s results of operations for the three months ended September 30, 2010.

 

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 the Company’s subsidiaries, 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.

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

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

·                  County of Nassau, New York 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.

 

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·                  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.

·                  County of Monroe, Florida v. Priceline.com, Inc. et al.

·                  County of Genesee, Michigan, et al. v. Hotels.com L.P. et al.

·                  Pine Bluff Advertising and Promotion Commission, Jefferson County, Arkansas, et al. v. Hotels.com, LP, et al.

·                  County of Lawrence, Pennsylvania v. Hotels.com, L.P., et al.

 

A discussion of each of the legal proceedings listed above can be found in the section titled “Legal Proceedings” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, and in the section titled “Commitments and Contingencies” in each of the Company’s Quarterly Reports on Form 10-Q for the three months ended March 1, 2010 and for the three months ended June 30, 2010.

 

The following developments regarding such legal proceedings occurred during or after the three months ended September 30, 2010:

 

City of Rome, Georgia, et al., v. Hotels.com, L.P., et al.:  The parties were unable to resolve the case in mediation.  The Company expects plaintiffs to seek class certification and move forward with the litigation.

 

City of Gallup, New Mexico v. Hotels.com, L.P., et al.:  On March 1, 2010, the court denied plaintiffs’ motion for partial summary judgment.  Plaintiffs moved for reconsideration on March 9, 2010 and that motion was denied on October 7, 2010.

 

The City of Goodlettsville, Tennessee, et al. v. priceline.com Incorporated, et al.:  The court granted plaintiff’s motion for class certification on April 20, 2010.  Notice of the pendency of the class action was sent to class members in June 2010.  The opt out period expired July 23, 2010, and the only city to opt out of the class was South Fulton.  The parties are currently conducting discovery.

 

County of Monroe, Florida v. Priceline.com, Inc. et al.:  The court granted class certification on March 15, 2010.  The opt-out period expired on May 24, 2010.  As of the opt-out date, the following counties opted-out of the Monroe class action:  Alachua, Bay, Brevard, Broward, Charlotte, Escambia, Flagler, Gulf, Hillsborough, Lee, Leon, Manatee, Marion, Nassau, Okaloosa, Orange, Palm Beach, Pasco, Pinellas, Polk, St. Johns, Seminole, Volusia, Wakulla and Walton.

 

The parties to the lawsuit signed a settlement agreement resolving the claims asserted by the remaining class members in the action.  As part of the agreement, the remaining class members have agreed to not assert claims based on the tourist development tax ordinances at issue in the action for a period of three years.  On September 3, 2010, the court entered an order preliminarily approving the class settlement agreement and establishing deadlines for, among other things, class members to object to the terms of the settlement or request exclusion from the class.  One additional county, Gilchrist, opted out of the class because it had no alleged tax amounts at issue.  A fairness hearing is currently scheduled for January 6, 2011.

 

County of Genesee, Michigan, et al. v. Hotels.com L.P. et al.:     Defendants filed a notice of plaintiffs’ failure to timely file a motion for class certification on May 14, 2010.  Plaintiffs have elected not to pursue class certification.  On September 10, 2010, plaintiffs filed a motion for partial summary disposition.  The parties are currently conducting discovery.

 

Pine Bluff Advertising and Promotion Commission, Jefferson County, Arkansas, et al. v. Hotels.com, LP, et al.:  Defendants filed a motion to dismiss the complaint for failure to exhaust administrative remedies.  The court held a hearing on the motion to dismiss on August 27, 2010.  The parties are awaiting a decision on the motion.

 

County of Lawrence, Pennsylvania v. Hotels.com, L.P., et al.:  Defendants filed preliminary objections to the complaint on March 9, 2010.  The plaintiff then filed an amended complaint on March 26, 2010 and Defendants moved to dismiss on April 15, 2010.  After full briefing and oral argument, on October 25, 2010 the Court dismissed the action on the grounds that plaintiff failed to exhaust administrative remedies.

 

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

 

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Actions Filed on Behalf of Individual States, Cities and Counties

 

Several states, 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 the Company’s subsidiaries, 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 Findlay, Ohio 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. Hotels.com, et al.

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

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

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

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

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

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

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

·                  Horry County, South Carolina, 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, North Carolina v. Hotels.com, LP, et al.

·                  City of Baltimore, Maryland v. Priceline.com Inc., et al.

·                  County Commissioners of Worcester, Maryland v. Priceline.com Inc., et al.

·                  City of Bowling Green, Kentucky v. Hotels.com L.P., et al.

·                  St. Louis County, Missouri v. Prestige Travel, Inc. et al.

·                  Village of Rosemont, Illinois v. Priceline.com, Inc., et al.

·                  Anne Gannon, in her capacity as Palm Beach County Tax Collector, on behalf of Palm Beach County v. Hotel.com LP, et al.

·                  Brevard County, Florida v. Priceline.com, Inc., et al.

·                  Leon County, Florida, et al. v. Expedia, Inc., et al. (2 separate proceedings).

·                  City of Birmingham, Alabama, et al. v. Orbitz, Inc., et al.

·                  Town of Hilton Head Island, South Carolina v. Hotels.com, L.P., et al.

·                  City of Santa Monica v. Hotels.com, LP, et al.

·                  Baltimore County, Maryland v. Priceline.com, Inc., et al.

·                  Hamilton County, Ohio, et al. v. Hotels.com, L.P., et al.

 

A discussion of each of the legal proceedings listed above can be found in the section titled “Legal Proceedings” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, and in the section titled “Commitments and Contingencies” in each of the Company’s Quarterly Reports on Form 10-Q for the three months ended March 1, 2010 and for the three months ended June 30, 2010.  In addition to the matters listed above, on August 23, 2010, Hamilton County, Ohio, Cuyahoga County, Ohio, and Erie County, Ohio commenced the action Hamilton County, Ohio, et al. v. Hotels.com, L.P., et al., naming priceline.com, Inc., Travelweb, LLC, and Lowestfare.com, Inc. as defendants.  Also, the State of Oklahoma has filed the lawsuit State of Oklahoma v. Priceline.com, Inc. et al., against the Company, Travelweb LLC and other online travel companies alleging that the Company and other defendants have failed to appropriately pay state taxes.

 

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The following developments regarding such legal proceedings occurred during or after the three months ended September 30, 2010:

 

City of Findlay, Ohio v. Hotels.com, L.P., et al. and City of Columbus, et al. v. Hotels.com, L.P., et al.:  Defendants filed a motion for summary judgment on May 10, 2010.  On June 14, 2010, Plaintiffs filed a response to the motion for summary judgment, a cross motion for summary judgment and a motion to certify questions of law to the Ohio Supreme Court.  Defendants opposed the motion to certify on July 1, 2010.  On July 12, 2010, defendants filed a reply in support of their motion for summary judgment and in opposition to plaintiffs’ motion for summary judgment.  The motions have not yet been decided.

 

City of San Diego, California v. Hotels.com L.P., et al.:  On May 28, 2010, the administrative hearing officer appointed by the City issued a ruling holding the Company and other online travel companies liable for transient occupancy tax.  Specifically, the hearing officer’s decision held the Company liable for a total of $2.1 million in transient occupancy taxes and penalties.  The hearing officer rejected the City’s attempt to impose interest and certain penalties.  On August 4, 2010, the Company and the other online travel company defendants filed their Verified Petition and Cross-Complaint challenging Hearing Officer’s Ruling in the Los Angeles Superior Court.  The City has stated that it intends to file an amended complaint.

 

City of Atlanta, Georgia v. Hotels.com L.P., et al.:  Defendants filed a motion for summary judgment and plaintiff filed a motion for summary judgment and for a preliminary injunction on March 1, 2010.  On July 22, 2010, the court granted in part each motion.  The court granted defendants’ motion for summary judgment dismissing plaintiff’s claim for declaratory judgment, expressly finding that defendants are not innkeepers or operators under the ordinance and statute at issue.  At the same time, the court found that under the “merchant” model, defendants have undertaken an obligation to collect these taxes and granted plaintiff’s request for an injunction, prospectively enjoining defendants to collect and remit occupancy tax to the City of Atlanta.  In addition, the court held that the amount on which defendants must collect and remit such taxes is the rate charged to customers, which includes not only the amount paid to hotels for occupancy, but also defendants’ respective margins, i.e., compensation for reservation facilitation services.  The court denied plaintiff’s claims for unjust enrichment, money had and received, constructive trust, and for an equitable accounting.  The court also denied defendants’ constitutional claims.  The Company intends to comply with the judge’s order.  The City and the other defendants are appealing the court’s decision.

 

City of Charleston, South Carolina v. Hotel.com, et al., Town of Mount Pleasant, South Carolina v. Hotels.com, et al., City of North Myrtle Beach, South Carolina v. Hotels.com, LP, et al.:  The Company and other online travel company defendants reached principle settlement agreement with each plaintiff in these consolidated cases resolving their claims.  As part of the agreement, the respective plaintiff in each case has agreed to not assert claims based on the ordinances at issue in the action for a period of two years.   Dismissal of the action is expected shortly.

 

City of Houston, Texas v. Hotels.com, LP., et al.:  On November 23, 2009, defendants moved for summary judgment on all of plaintiffs’ claims.  The court granted the motion in its entirety and dismissed the action with prejudice on January 19, 2010.  The court denied plaintiffs’ motion for a new trial on March 29, 2010.  Plaintiffs filed a notice of appeal on April 14, 2010, and the matter is now pending before the Fourteenth Circuit Court of Appeals, Houston.  The parties completed briefing submissions on October 21, 2010 and are awaiting an argument date.

 

City of Baltimore, Maryland v. Priceline.com, Inc., et al.:  The Company and the City signed a final agreement resolving the claims for purported back taxes.  As part of the agreement, the City of Baltimore agreed not to assert claims based on the ordinance at issue in the action for a period of four years.  On October 1, 2010, the Court issued an order of dismissal, which included a stipulation of dismissal with prejudice.

 

County Commissioners of Worcester, Maryland v. Priceline.com, Inc., et al.:  The parties signed a final agreement resolving the claims for purported back taxes.  As part of the agreement, the County of Worcester agreed to not assert claims based on the ordinance at issue in the action for a period of four years.  On June 25, 2010, the Court issued an Order of Dismissal Due To Settlement.  A Stipulation of Dismissal, with prejudice, was filed on July 26, 2010.

 

City of Bowling Green, Kentucky v. Hotels.com LP et al.:  The court granted defendants motion to dismiss the complaint on April 8, 2010.  Plaintiff filed a notice of appeal on April 30, 2010.  Briefing on the appeal is currently ongoing.

 

St. Louis County, Missouri v. Prestige Travel, Inc. et al.:  On July 12, 2010, the court denied defendants’ motion to dismiss.  The defendants filed a motion for reconsideration based primarily on a recent clarification of the current statutory scheme by the Missouri legislative and executive branches.  The court granted the motion for consideration and dismissed the

 

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case with prejudice on September 8, 2010.  On September 27, 2010, the plaintiff appealed the court’s order dismissing the case.

 

Brevard County, Florida v. Priceline.com Inc., et al.: The parties reached an agreement in principle to resolve the matter at mediation on October 29, 2010 and are currently finalizing the agreement.  As part of the agreement in principle, plaintiff has agreed to not assert claims based on the ordinance at issue in the action for three years.

 

Leon County, Florida, et al. v. Expedia, Inc., et al.:  Defendants filed a motion to dismiss the complaint on January 19, 2010.  On February 9, 2010, Plaintiffs amended their complaint and filed a one count declaratory action.  Defendants filed answers and affirmative defenses to that amended complaint on March 17, 2010.  Plaintiffs filed a second amended complaint on April 6, 2010, which defendants answered on May 3, 2010.  On July 15, 2010 the plaintiffs filed with the court an unopposed motion to add five more counties as plaintiffs to the action.  The plaintiffs in this matter now consist of 17 Florida counties, including Leon County, Florida, and certain individual tax collectors for some of the counties.  The parties are currently conducting discovery.

 

Leon County, Florida v. Expedia, Inc. et al.:  Plaintiff filed an amended complaint on March 9, 2010 and defendants filed a motion to dismiss the amended complaint on March 24, 2010.  The Court denied defendants’ motion to dismiss on September 1, 2010.  Defendants filed an answer to the complaint on September 21, 2010.

 

City of Birmingham, Alabama, et al. v. Orbitz, Inc., et al.:  Defendants moved to dismiss the complaint on February 19, 2010.  The court denied the motion on April 1, 2010.  The court ordered expedited and limited discovery, with a discovery deadline of May 28, 2010.  Defendants moved for summary judgment on July 19, 2010. A hearing is currently scheduled for February 4, 2011.

 

Baltimore County v. Priceline.com et al:  On August 20, the Company filed a motion to dismiss the Complaint for failure to state a claim of action.  Briefing on the matter was completed on October 29, 2010.

 

City of Santa Monica, California v. Expedia, Inc., et al.:  On June 25, 2010, the City of Santa Monica, California filed a complaint in the Superior Court of the State of California, County of Los Angeles—West District.  At a hearing conducted on August 31, 2010, the Court granted the online travel company defendants’ motion to coordinate the Santa Monica action with other similar actions already pending in the Los Angeles Superior Court.  On October 8, 2010, the defendants moved to dismiss the City’s complaint.  On October 18, 2010, the City filed a motion to strike the motion because Defendants did not “pay first” the asserted tax liability prior to moving to dismiss.  Briefing is currently ongoing, and a hearing on the motion to strike is set for November 17, 2010.

 

In addition, the following new actions were filed during or after the three months ended September 30, 2010:

 

Hamilton County, Ohio, et al. v. Hotels.com, L.P., et al.:  On August 23, 2010, Hamilton County, Ohio, Cuyahoga County, Ohio and Erie County, Ohio filed a complaint in the Hamilton County Court of Common Pleas.  In addition to a claim that defendants have violated the local accommodations tax ordinances, the complaint asserts claims for unjust enrichment, money had and received, conversion, constructive trust, breach of contract, and declaratory judgment.  Defendants removed the action to federal court (Southern District of Ohio) on the basis of diversity jurisdiction.  The defendants filed on October 29, 2010, a motion to transfer venue to the Northern District of Ohio.  After the court rules on the motion to transfer venue, the defendants will respond to the complaint.

 

State of Oklahoma v. Priceline.com, Inc. et al.: On November 2, 2010, the State of Oklahoma filed a lawsuit in the District Court of Oklahoma County, Oklahoma, against the Company, Travelweb LLC, Lowestfare.com, Inc. and other online travel companies, alleging that the defendants failed to properly remit taxes to the state of Oklahoma under the Oklahoma Sales Tax Code.  The Complaint asserts claims for declaratory and injunctive relief, damages, penalties and interest.

 

State of Florida v. Expedia, Inc., et al.:  On November 1, 2010, the Office of the Attorney General of the State of Florida added the Company as a defendant in this action, originally filed in 2009 against other online travel companies.  The complaint asserts one claim, a violation of the state Deceptive and Unfair Trade Practices Act, insofar as the company does not collect and remit the state transient rentals tax.

 

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

 

Judicial Actions Relating to Assessments Issued by Individual Cities and Counties

 

Five judicial actions relating to assessments issued by individual cities and counties were pending during the three months ended September 30, 2010.

 

·                  Priceline.com Inc. v. Indiana Dept. of Revenue.

·                  Priceline.com, Inc., et al. v. Broward County, Florida.

 

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·                  Priceline.com, Inc., et al. v. City of Anaheim, California, et al.

·                  Priceline.com Inc., et al. v. City of San Francisco, California, et al.

·                  Priceline.com, Inc. v. Miami-Dade County, Florida, et al.

 

A discussion of each of the legal proceedings listed above can be found in the section titled “Legal Proceedings” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, and in the section titled “Commitments and Contingencies” in each of the Company’s Quarterly Reports on Form 10-Q for the three months ended March 1, 2010 and for the three months ended June 30, 2010.

 

The following developments regarding such legal proceedings occurred during or after the three months ended September 30, 2010:

 

Priceline.com Inc. et al. v. City of Anaheim, California, et al.:  On February 1, 2010, the court granted the online travel companies’ motion for judgment to set aside the hearing officer’s determination and denied the City’s competing application to dismiss the complaint.  On April 7, 2010, the Court denied the City’s motion for reconsideration of the February 1, 2010 order, but granted the City leave to amend its complaint.  On August 30, 2010, the Court granted the online travel companies’ motion to dismiss the City’s amended complaint, and denied the online travel companies’ motion for judgment on the pleadings with respect to their claim for declaratory relief.  The parties are completing administrative tasks, and the Company anticipates the Court will enter final judgment in favor of the online travel companies within the next few months.

 

Priceline.com Inc., et al. v. City of San Francisco, California, et al.:  The Company, together with other online travel companies filed a Consolidated/Amended Complaint on May 14, 2010.  On June 18, 2010, the City and County filed a cross-complaint against the online travel company parties, asserting claims for the transient occupancy tax as well as claims for injunctive relief, conversion, constructive trust, breach of fiduciary duty, fraudulent concealment, money had and received, and other claims under the Municipal Code.  The online travel companies answered the Cross-Complaint on July 23, 2010.  The parties are presently conducting discovery.

 

Priceline.com, Inc. v. Miami-Dade County, Florida, et al.:  The Company filed a motion to dismiss Miami-Dade’s counterclaims and a motion to strike Miami-Dade’s affirmative defenses on February 26, 2010.   In late May, 2010, Miami-Dade County declined to opt-out of the Monroe County class action (discussed above) and on June 2, 2010, the court entered an order staying this action pending a final determination of the Monroe County action.  Under the proposed settlement in Monroe County, claims asserted by Miami-Dade County under the tourist development tax will be resolved and dismissed in this action.  However, the proposed settlement in Monroe County would not resolve claims relating to the convention development tax.

 

Priceline.com, Inc. v. Broward County, Florida:  Plaintiff filed amended counterclaims.  Defendants filed a motion to dismiss the amended counterclaims.  A hearing on defendants’ motion to dismiss plaintiff’s amended counterclaims is set for January 10, 2011.

 

The Company intends to prosecute vigorously its claims in these actions.

 

Consumer Class Actions

 

Two purported class actions brought by consumers against the Company were pending during the three months ended September 30, 2010.

 

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

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

 

A discussion of each of the legal proceedings listed above can be found in the section titled “Legal Proceedings” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

 

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The following developments regarding such legal proceedings occurred during or after the three months ended September 30, 2010:

 

Marshall, et al. v. priceline.com, Inc.:  The court granted the Company’s motion for summary judgment, and denied plaintiff’s competing motion for summary judgment, on March 8, 2010. On October 14, 2010, the Delaware Supreme Court affirmed the judgment of the lower court on the basis of and for the reasons set forth in the March 8, 2010 decision.

 

Chiste, et al. v. priceline.com Inc., et al.: The parties appeared for a status conference on October 26, 2010.  At the conference, the Court indicated that a decision on the pending motion to dismiss would be issued shortly.

 

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.  Among others, the City of Philadelphia, Pennsylvania, the City of Phoenix, Arizona (on behalf of itself and 12 other Arizona cities), the City of St. Louis, Missouri, and the City of Denver, Colorado, the County of Osceola and state tax officials from Florida, Louisiana, Montana, New Mexico, Pennsylvania, Texas, West Virginia, Wisconsin, and Wyoming 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.  Since late 2008, the Company has received audit notices from more than forty cities in the state of California.  The Company is engaged in audit proceedings in each of those cities.  The Company has also been contacted for audit by five counties in the state of Utah.  The Company received notices of assessment from Osceola County, Florida dated August 27, 2010.

 

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 the Company and the individual defendants violated the federal securities laws by issuing and selling priceline.com common stock in its 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.  After extensive negotiations, the parties reached a comprehensive settlement on or about March 30, 2009.  On April 2, 2009, plaintiffs filed a Notice of Motion for Preliminary Approval of Settlement.  On June 9, 2009, the court granted the motion and scheduled the hearing for final approval for September 10, 2009.  The settlement, previously approved by a special committee of the Company’s Board of Directors, compromised the claims against the Company for approximately $0.3 million. The court issued an order granting final approval of the settlement on October 5, 2009.  Notices of appeal of the Court’s order have been filed with the Second Circuit.  All but one of the appeals has been resolved.  The remaining appeal is still pending.

 

From time to time, the Company has been, and expects 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 the Company’s business objectives and could adversely affect its business, results of operations, financial condition and cash flows.

 

The Company intends to defend vigorously against the claims in all of the proceedings described in this Note 13.  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 Unaudited Consolidated Balance Sheets and provisions recorded have not been material to its consolidated results of operations.  The Company is unable to estimate the potential maximum range of loss.

 

Contingent Purchase Price

 

In connection with our acquisition of Agoda in 2007, contingent consideration of up to $141.6 million is payable in 2011 if Agoda achieves specified “gross bookings” and earnings targets for the period of January 1, 2008 through December 

 

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31, 2010.  Based upon our current estimates, we anticipate a payment for contingent consideration of approximately $50 million to $70 million.

 

OFT Inquiry

 

In September 2010, the United Kingdom’s Office of Fair Trading (“OFT”), the competition authority in the U.K., announced it was conducting a formal early stage investigation into suspected breaches of competition law in the hotel online booking sector and had written to a number of parties in the industry to request information.  Specifically, the investigation focuses upon whether there are agreements or concerted practices between hotels and online travel companies and/or hotel room reservation “wholesalers” relating to the fixed or minimum resale prices of hotel room reservations.  In September 2010, Booking.com B.V. and priceline.com Incorporated, on behalf of Booking.com, received a Notice of Inquiry from the OFT; the Company and Booking.com are cooperating with the OFT’s investigation.  The Company is unable at this time to predict the outcome of the OFT’s investigation and the impact, if any, on the Company’s business and results of operations.

 

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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 Unaudited Consolidated 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. Internationally, we offer our customers hotel room reservations in 100 countries and 38 languages.  In May 2010, we acquired TravelJigsaw, a rental car reservation service based in the U.K. that operates primarily under the Car Hire 3000 brand.  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.

 

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 international brands Booking.com, Agoda and TravelJigsaw.  Our principal goal is to be the leading worldwide online hotel reservation service.  Our business is driven primarily by international results.  During the nine months ended September 30, 2010, our international business — the significant majority of which is currently generated by Booking.com — represented approximately 69% of our gross bookings (an operating and statistical metric referring to the total dollar value, generally inclusive of all taxes and fees, of all travel services purchased by our customers), and approximately 82% of our consolidated operating income.  Given that the business of our international operations is primarily comprised of hotel reservation services, commissions earned in connection with the reservation of hotel room nights represents a substantial majority of our gross profit.

 

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 Name Your Own Price® and retail travel services and, consequently, gross profit has become an increasingly important measure of evaluating growth in our business.  At present, we derive substantially all of our gross profit from the following sources:

 

·                  Commissions earned from price-disclosed hotel room reservations, rental cars, cruises and other travel services;

 

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

 

·                  Transaction gross profit and customer processing fees from our price-disclosed merchant hotel room service and our price-disclosed merchant rental car 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 gross profit derived primarily from selling advertising on our websites.

 

The worldwide recession negatively affected the broad travel market and, as a result, our business.  Since the onset of the worldwide recession, hotel operators have reported significant decreases in occupancy rates (a common metric that measures hotel customer usage) and average daily rates (“ADRs”) in the United States, Europe and Asia.  While these trends have recently shown signs of improvement, unemployment remains at historically high levels and consumer spending remains pressured.  There can be no assurance that the worldwide recession will not worsen or continue or that the worldwide recession will not have further negative impact on the travel industry and, as a result, our business.

 

Over the last several years we have experienced strong growth in the number of hotel room nights booked through our hotel reservation services.  However, given the sheer size of our hotel reservation business, we believe it is highly likely that our year-over-year room night growth rates will generally decelerate on a quarterly sequential basis.  For example, in the first quarter of 2010, we experienced a mild deceleration in year-over-year hotel room night reservation growth as compared

 

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to the year-over-year growth rate in the fourth quarter of 2009.  The unit growth rate decelerated further in the second quarter of 2010 due in part to (1)  travel disruptions caused by the April 2010 eruption of a volcano in Iceland, (2) general uncertainty about the European economy and (3) substantial increases in airfares, which can negatively impact overall travel demand.  In the third quarter of 2010, our year-over-year hotel room night reservation growth accelerated as the volcanic activity subsided, macroeconomic concerns in Europe abated and airfare increases moderated.  Additionally, an increasing amount of our business from a destination and point-of-sale perspective is conducted in markets that we have entered more recently and are growing faster than our overall growth rate, such as Asia-Pacific and South America.  Ongoing efforts to improve the experience for customers on our web site and to add hotel supply also contributed to the strong performance in the third quarter of 2010.  As our business grows in size, it becomes increasingly more difficult to maintain high growth rates and, therefore, we believe that our year-on-year room night growth rates will generally decelerate on a sequential basis in future periods.

 

Large, established Internet search engines with substantial resources and expertise in developing online commerce and facilitating Internet traffic are creating — and intend to further create — inroads into online travel, both in the U.S. and internationally.  For example, Google recently announced that it has entered into an agreement to acquire ITA Software, Inc., a major flight information software company, which could allow Google to pursue the creation of new flight search tools which will enable users to find flight information on the Internet without using a service like ours.  Google has also invested in HomeAway, a vacation home rental service.  In addition, Google has launched a travel “meta-search” site to show searchers specific hotels and rates in addition to text advertisements, and Microsoft has launched Bing Travel, a “meta-search” site, which searches for airfare and hotel reservations online and predicts the best time to purchase them.  “Meta-search” sites leverage their search technology to aggregate travel search results for the searcher’s specific itinerary across supplier, travel agent and other websites and, in many instances, compete directly with us for customers.  These initiatives, among others, illustrate Google’s and Bing’s clear intention to more directly appeal to travel consumers by showing consumers more detailed travel search results, including specific information for travelers’ own itineraries, which could lead to suppliers or others gaining a larger share of Google’s or Bing’s traffic or may ultimately lead to search engines maintaining transactions within their own websites.  If Google, as the single largest search engine in the world, or Bing, or other leading search engines refer significant traffic to these or other travel services that they develop in the future, it could result in, among other things, more competition from supplier websites and higher customer acquisition costs for third-party sites such as ours and could have a material adverse effect on our business, results of operations and financial condition.

 

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 and Asia 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 and factors have enabled us to become the top online hotel service provider in the world.

 

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 Booking.com and Agoda utilize online search and affiliate marketing as the principal means of generating traffic to their websites, our online advertising expense has increased significantly over recent years, a trend we expect to continue throughout the remainder of 2010.  In addition, and as discussed in more detail below, 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 of Booking.com, Agoda and TravelJigsaw 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 $531.0 million and $1.1 billion to our revenues for the three and nine months ended September 30, 2010, respectively, which compares to $316.9 million and $629.1 million for the three and nine months ended September 30, 2009, respectively (year-over-year growth of approximately 68% and 70%, respectively).  Revenue attributable to our international operations increased on a local currency basis by approximately 80% and 77% in the three and nine months ended September 30, 2010, respectively, compared to the same periods in 2009.  In the first quarter of 2010, the U.S. Dollar was weaker against the Euro

 

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and the British Pound Sterling, relative to the first quarter of 2009, which benefitted the growth rates of our Euro and British Pound Sterling denominated gross bookings, gross profit and net income as expressed in U.S. Dollars.  In the second and third quarters of 2010 and through October 2010, the U.S. Dollar was stronger against the Euro and British Pound Sterling relative to the same periods in 2009, which negatively impacts such growth rates.

 

In early 2010, Greece and certain other European Union countries with high levels of sovereign debt had difficulty refinancing that debt and central bank intervention was required, causing significant devaluation of the Euro relative to other currencies, such as the U.S. Dollar, and concerns that sovereign defaults could lead to devaluation or abandonment of the common currency.  Sovereign debt issues could lead to further significant, and potentially longer-term, devaluation of the Euro against the U.S. Dollar, which would adversely impact our Euro-denominated net assets, gross bookings, revenues, operating expenses, and net income as expressed in U.S. Dollars.  Furthermore, governmental austerity measures aimed at reducing deficits could impair the economic recovery and adversely affect travel demand.

 

From time to time, we enter into derivative instruments to minimize the impact of short-term currency fluctuations on our consolidated operating results.  Such derivative instruments are short term in nature and not designed to hedge against currency fluctuation that could impact our foreign currency denominated gross bookings, revenue or gross profit.  See Note 5 to the Unaudited Consolidated Financial Statements for additional information on our derivative contracts.

 

Domestic Trends.  Competition in domestic online travel remains intense and traditional online travel companies are creating new promotions and consumer value features in an effort to gain competitive advantage.  In June 2007, we eliminated processing fees for our price-disclosed airline ticket service, and in April 2008, we reduced processing fees for our domestic price-disclosed merchant hotel room service.  As a result, since those dates, we had a pricing advantage against other major online travel agents with respect to these travel services.  Starting in March 2009, Expedia and Travelocity also eliminated air booking fees, and in April 2009, Orbitz followed.  As a result, we no longer have the price advantage that we have had against our major competitors on price-disclosed airline tickets since June 2007.  Similarly, in April 2009, each of Expedia and Orbitz reduced booking fees on hotel room reservations, and we therefore no longer have a price advantage over those companies on price-disclosed merchant hotel room reservations.  In addition, in May 2009, Orbitz announced a price guarantee program under which a customer who books a prepaid hotel stay will receive money back from Orbitz if another Orbitz customer books the exact same stay in terms of room type, travel dates and number of travelers.  In addition, in October 2009, Travelocity announced the waiver of its cancellation and change fees for hotel and vacation packages, as well as an expanded hotel guarantee, under which consumers who book a hotel room and then find a lower published rate for the same room anytime before the day of check-in are eligible to receive a refund of the difference.  Our business may be adversely impacted as a result of no longer having a price advantage over our direct competitors in the U.S., and we may be adversely impacted by future promotional initiatives by our competitors.  Traffic obtained through online advertising has increased as a percentage of total demand.  In addition, the elimination of processing fees on retail airline tickets by our major competitors, coupled with the recent significant year over year increases in retail air fares, has led consumers to engage in increased shopping behavior before making a purchase.  Increased shopping behavior reduces our advertising efficiency and effectiveness as traffic obtained through online advertising becomes less likely to result in a purchase on our web site.  Therefore, online advertising expenses for our priceline.com U.S. business have increased at a faster rate than gross profit, a trend which we expect to continue.

 

In March 2009, Travelocity launched an opaque price-disclosed hotel booking service that allows customers to book rooms at a discount because, similar to our Name Your Own Price® hotel booking service, the name of the hotel is not disclosed until after purchase.  At this point, the number of hotels available through Travelocity’s opaque hotel service is limited.  However, Travelocity has experience with offering opaque price-disclosed hotel room reservations in Europe through its site, lastminute.com, and it is likely that it will use such experience to grow the number of opaque hotel room reservations it makes available.  Additionally, Expedia recently began making opaque hotel rooms available on its principal website under the name “Expedia Unpublished.”  Expedia has access to a large, established base of opaque-participating hotels through its subsidiary, Hotwire.  If Expedia or Travelocity are successful in growing their opaque hotel service, our share of the discount hotel market in the U.S. could decrease.  In addition, we would have to compete with Expedia and Travelocity for access to hotel room supply and there is no guarantee that we would be able to maintain successfully our current level of opaque hotel supply.  If Expedia’s or Travelocity’s opaque hotel service is successful, they may try to offer opaque airline tickets and/or rental cars, each of which would expose us to similar competitive risks as the opaque hotel service.

 

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 last several years 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 (1) a concerted initiative by travel suppliers to direct customers to their own websites in an effort to reduce distribution expenses

 

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and establish more direct control over their pricing, and (2) a price advantage in that the suppliers generally do not charge a processing fee.  However, with the recent elimination and reduction of processing and other fees by all of the major online travel companies, we believe that the domestic market share of third party distributors stabilized and potentially increased during 2009 and the first nine months of 2010.

 

Domestic airlines have recently reduced capacity and increased fares.  In addition, the threat of carrier bankruptcies and the emerging prospect of industry consolidation, as evidenced by the recent mergers of United Air Lines with Continental Airlines and Delta Air Lines with Northwest Airlines, as well as the recently announced future acquisition of AirTran by Southwest Airlines, could lead to additional decreases in capacity and further reduce the amount of airline tickets available to us.  Significant increases in average airfares thus far in 2010 may adversely impact travel demand.  Reduced airline capacity and demand negatively impact our priceline.com air business, which in turn has negative repercussions on our priceline.com hotel and rental car businesses.  Recent decreases in rental car fleets have led to decreases in rental car availability, which has negatively impacted our Name Your Own Price® rental car service.  In addition, Avis is currently in discussions to acquire the Dollar-Thrifty Automotive Group.  The merger or acquisition of the Dollar-Thrifty Automotive Group by Avis or another rental car company could result in a decrease of rental car inventory available to our rental car service.  In January 2010, Toyota recalled over 8 million vehicles due to faulty accelerator pedals, leading to further strain on rental car companies’ fleets and increased retail rental car rates.  As a result of these challenges, we experienced a decline in Name Your Own Price® airline tickets and rental car days during the nine months ended September 30, 2010 compared to the same period in 2009.  Nevertheless, 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 in the U.S. 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 Booking.com, Agoda and TravelJigsaw brands internationally and the priceline.com brand in the United States, and, over time, to offer other travel services and further expand into other international markets. Factors beyond our control, such as worldwide recession, terrorist attacks, unusual weather patterns, including natural disasters such as hurricanes, tsunamis, volcanic eruptions (such as the April 2010 eruption of a volcano in Iceland) or earthquakes and other weather phenomena, travel related health concerns including pandemics and epidemics such as Influenza H1N1, avian bird flu and SARS, political instability, regional hostilities, increases in fuel prices, imposition of taxes or surcharges by regulatory authorities, travel related accidents 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, in early 2010, civil unrest in Thailand, a key market for our Agoda business and the Asian business of Booking.com, negatively impacted booking volumes in this market at the time.  In addition, clashes involving Thai security forces, anti-government demonstrators and groups supporting the government resulted in violence in various locations in Bangkok, causing the temporary relocation of Agoda’s Thailand-based operations.  Thailand has experienced disruptive civil unrest in prior years as well and continued or future civil or political unrest could further disrupt Agoda’s Thailand-based business and operations.

 

We intend to continue to invest in marketing and promotion, technology and personnel within parameters consistent with attempts to improve operating results.  We also intend to broaden the scope of our business, and to that end, we explore strategic alternatives from time to time in the form of, among other things, mergers and acquisitions. Our goal is to improve volume and sustain gross margins in an effort to maintain profitability. The uncertain environment described above makes the prediction of future results of operations difficult, and accordingly, we cannot provide assurance that we will sustain revenue growth and profitability.

 

Seasonality.  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 Booking.com and Agoda, 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. In addition, revenue generated by TravelJigsaw transactions is recognized when the customer returns the rental car.  From a cost perspective, however, we expense the substantial

 

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majority of our advertising activities as they are incurred, which is typically in the quarter in which bookings are generated.  Therefore, if our retail hotel business continues to grow, we expect our quarterly results to become increasingly impacted by these seasonal factors.

 

Results of Operations

 

Three and Nine Months Ended September 30, 2010 compared to the Three and Nine Months Ended September 30, 2009

 

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, generally inclusive of taxes and fees, of all travel services booked by our customers, and is widely used in the travel business.  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 night reservations, rental car days and airline tickets sold through our domestic and international operations for the three and nine months ended September 30, 2010 and 2009 were as follows (numbers may not total due to rounding):

 

 

 

Three Months Ended September 30,
(in millions)

 

 

 

Nine Months Ended September 30,
(in millions)

 

 

 

 

 

2010

 

2009

 

Change

 

2010

 

2009

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Domestic

 

$

1,121

 

$

999

 

12.2

%

$

3,264

 

$

2,814

 

16.0

%

International

 

2,885

 

1,724

 

67.3

%

7,116

 

4,231

 

68.2

%

Total

 

$

4,006

 

$

2,723

 

47.1

%

$

10,381

 

$

7,046

 

47.3

%

 

Gross bookings increased by 47.1% and 47.3% for the three and nine months ended September 30, 2010, respectively, compared to the same periods in 2009, principally due to 54.1% and 52.8% growth in hotel room night reservations, respectively.  The 67.3% increase in international gross bookings was primarily attributable to growth in international hotel room night reservations for Booking.com and Agoda (growth on a local currency basis was approximately 78%).  International gross bookings for the three and nine months ended September 30, 2010 also includes $86 million and $130 million, respectively, of TravelJigsaw gross bookings since its acquisition in May 2010.  Domestic gross bookings increased by 12.2% the three months ended September 30, 2010, compared to the same period in 2009, primarily due to growth in price-disclosed hotel and Name Your Own Price® hotel and rental car gross bookings.  Domestic gross bookings increased 16.0% for the nine months ended September 30, 2010, compared to the same period in 2009, primarily due to increases in price-disclosed and Name Your Own Price® hotel room night reservations and increases in average airline fares, partially offset by a decline in Name Your Own Price® rental car days, and price-disclosed rental car days.

 

Gross bookings resulting from hotel room night reservations, rental car days and airline tickets sold through our agency and merchant models for the three and nine months ended September 30, 2010 and 2009 were as follows:

 

 

 

Three Months Ended September 30,
(in millions)

 

 

 

Nine Months Ended September 30,
(in millions)

 

 

 

 

 

2010

 

2009

 

Change

 

2010

 

2009

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Agency

 

$

3,168

 

$

2,131

 

48.7

%

$

8,225

 

$

5,425

 

51.6

%

Merchant

 

838

 

592

 

41.4

%

2,156

 

1,620

 

33.1

%

Total

 

$

4,006

 

$

2,723

 

47.1

%

$

10,381

 

$

7,046

 

47.3

%

 

Agency gross bookings increased 48.7% and 51.6% for the three and nine months ended September 30, 2010, respectively, compared to the same periods in 2009, due to growth in the sale of Booking.com hotel room night reservations and an increase in average airline fares.  Merchant gross bookings increased 41.4% and 33.1% for the three and nine months ended September 30, 2010, respectively, compared to the same periods in 2009, due to the inclusion of gross bookings from TravelJigsaw, which was acquired in May 2010 and increases in the sale of Agoda merchant price-disclosed hotel room night

 

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reservations, Name Your Own Price® and priceline.com merchant price-disclosed hotel room night reservations, and for the three months ended September 30, 2010, an increase in Name Your Own Price® rental car days.

 

 

 

Hotel Room
Nights

 

Rental
Car Days

 

Airline
Tickets

 

 

 

 

 

 

 

 

 

Three Months ended September 30, 2010

 

27.5 million

 

5.1 million

 

1.5 million

 

Three Months ended September 30, 2009

 

17.9 million

 

2.6 million

 

1.5 million

 

Nine Months ended September 30, 2010

 

70.8 million

 

12.4 million

 

4.6 million

 

Nine Months ended September 30, 2009

 

46.3 million

 

8.9 million

 

4.6 million

 

 

Hotel room night reservations increased by 54.1% and 52.8% for the three and nine months ended September 30, 2010, respectively, over the same periods in 2009, due primarily to an increase in the sale of Booking.com agency room night reservations, as well as an increase in the sale of Agoda price-disclosed room night reservations, priceline.com price-disclosed room night reservations and Name Your Own Price® room night reservations.

 

Rental car days sold increased by 97.3% and 40.0% for the three and nine months ended September 30, 2010, respectively, over the same periods in 2009, due primarily to the inclusion of rental car days sold by TravelJigsaw, which we acquired in May 2010, and for the three months ended September 30, 2010, due to an increase in Name Your Own Price® rental car days.

 

Airline tickets sold decreased by 4.6% for the three months ended September 30, 2010, compared to the same period in 2009, due to a decline in the sale of both price-disclosed and Name Your Own Price® airline tickets.  Airline tickets sold were flat for the nine months ended September 30, 2010, compared to the same period in 2009, as a decline in Name Your Own Price® airline tickets was partially offset by a slight increase in price-disclosed airline tickets.

 

Revenues

 

We classify our revenue into three categories:

 

·                  Merchant revenues are derived from transactions where we are the merchant of record and therefore charge the customer’s credit card for the travel services provided.  Merchant revenues include (1) transaction revenues representing the selling price of Name Your Own Price® hotel room reservations, 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 (a) the hotel room reservations provided through our merchant price-disclosed hotel service in the U.S. and at Agoda, and (b) the rental car reservations provided through our merchant semi-opaque rental car service at TravelJigsaw (which allows customers to see the price of the reservation prior to purchase, but not the identity of the supplier); (3) customer processing fees charged in connection with the sale of Name Your Own Price® airline tickets, hotel room reservations and rental cars and merchant price-disclosed hotel reservations; and (4) ancillary fees, including GDS reservation booking fees related to certain of the services listed above.

 

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

 

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

 

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Three Months Ended
September 30,

 

 

 

Nine Months Ended
September 30,

 

 

 

 

 

($000)

 

%

 

($000)

 

%

 

 

 

2010

 

2009

 

Change

 

2010

 

2009

 

Change

 

Merchant Revenues

 

$

494,473

 

$

400,314

 

23.5

%

$

1,309,407

 

$

1,130,169

 

15.9

%

Agency Revenues

 

504,010

 

323,188

 

55.9

%

1,034,765

 

647,899

 

59.7

%

Other Revenues

 

3,274

 

7,158

 

(54.3

)%

9,419

 

18,391

 

(48.8

)%

Total Revenues

 

$

1,001,757

 

$

730,660

 

37.1

%

$

2,353,591

 

$

1,796,459

 

31.0

%

 

Merchant Revenues

 

Merchant revenues for the three and nine months ended September 30, 2010 increased 23.5% and 15.9%, respectively, compared to the same periods in 2009, primarily due to an increase in the sale of Name Your Own Price® hotel room night reservations, the inclusion of TravelJigsaw since its acquisition in May 2010, and Agoda and priceline.com merchant price-disclosed hotel room night reservations.  Name Your Own Price® rental car days increased during the three months ended September 30, 2010, but decreased slightly during the nine months ended September 30, 2010, as compared to the same respective periods in 2009.

 

Agency Revenues

 

Agency revenues for the three and nine months ended September, 2010 increased 55.9% and 59.7%, respectively, compared to the same periods in 2009, primarily as a result of growth in the business of Booking.com.

 

Other Revenues

 

Other revenues consist primarily of advertising.  Other revenues for the three and nine months ended September 30, 2010 decreased 54.3% and 48.8%, respectively, compared to the same periods in 2009, primarily as a result of the termination of a relationship with a post-transaction online advertising partner in September 2009.

 

Cost of Revenues and Gross Profit

 

 

 

Three Months Ended
September 30,

 

 

 

Nine Months Ended
September 30,

 

 

 

 

 

($000)

 

%

 

($000)

 

%

 

 

 

2010

 

2009

 

Change

 

2010

 

2009

 

Change

 

Cost of Revenues

 

$

335,569

 

$

296,654

 

13.1

%

$

923,032

 

$

848,885

 

8.7

%

% of Merchant Revenues

 

67.9

%

74.1

%

 

 

70.5

%

75.1

%

 

 

 

Cost of Revenues

 

For the three and nine months ended September 30, 2010, cost of revenues consisted primarily of charges from the suppliers for: (1) the cost of Name Your Own Price® hotel room reservations, net of applicable taxes, (2) the cost of Name Your Own Price® rental cars, net of applicable taxes; and (3) the cost of Name Your Own Price® airline tickets, net of the federal air transportation tax, segment fees and passenger facility charges imposed in connection with the sale of airline tickets.  Cost of revenues for the three and nine months ended September 30, 2010 increased by 13.1% and 8.7%, respectively, compared to the same periods in 2009, due primarily to the increase in merchant revenue discussed above.  Merchant price-disclosed hotel revenues in the U.S. and for Agoda and merchant semi-opaque rental car reservations for TravelJigsaw are recorded in merchant revenues net of the amounts paid to suppliers and therefore, there is no associated cost of revenues for merchant price-disclosed hotel revenues.  Cost of revenues as a percentage of their associated merchant revenues decreased primarily due to the increase in merchant price-disclosed hotel revenues, which are recorded on a “net” basis.

 

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

 

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Gross Profit

 

 

 

Three Months Ended
September 30,

 

 

 

Nine Months Ended
September 30,

 

 

 

 

 

($000)

 

%

 

($000)

 

%

 

 

 

2010

 

2009

 

Change

 

2010

 

2009

 

Change

 

Gross Profit

 

$

666,188

 

$

434,006

 

53.5

%

$

1,430,559

 

$

947,574

 

51.0

%

Gross Margin

 

66.5

%

59.4

%

 

 

60.8

%

52.7

%

 

 

 

Total gross profit for the three and nine months ended September 30, 2010 increased by 53.5% and 51.0%, respectively, compared to the same periods in 2009, primarily as a result of increased revenue discussed above.  Total gross margin (gross profit expressed as a percentage of total revenue) increased during the three and nine months ended September 30, 2010, compared to the same periods in 2009, because Name Your Own Price® revenues, which are recorded “gross” with a corresponding cost of revenue, represented a smaller percentage of total revenues compared to retail, price-disclosed revenues which are primarily recorded “net” with no corresponding cost of revenues.  Because Name Your Own Price® transactions are reported “gross” and retail transactions are primarily recorded on a “net” basis, we believe that gross profit has become an increasingly important measure of evaluating growth in our business.  Our international operations accounted for approximately $529.8 million and $1.1 billion of our gross profit for the three and nine months ended September 30, 2010, respectively, which compares to $316.0 million and $626.5 million for the same periods in 2009, respectively.  Gross profit attributable to our international operations increased, on a local currency basis, by approximately 80% and 77% in the three and nine months ended September 30, 2010, respectively, compared to the same periods in 2009.

 

Operating Expenses

 

Advertising

 

 

 

Three Months Ended
September 30,

 

 

 

Nine Months Ended
September 30,

 

 

 

 

 

($000)

 

%

 

($000)

 

%

 

 

 

2010

 

2009

 

Change

 

2010

 

2009

 

Change

 

Offline Advertising

 

$

7,773

 

$

8,474

 

(8.3

)%

$

29,684

 

$

30,293

 

(2.0

)%

% of Total Gross Profit

 

1.2

%

2.0

%

 

 

2.1

%

3.2

%

 

 

Online Advertising

 

$

172,727

 

$

115,103

 

50.1

%

$

418,354

 

$

273,327

 

53.1

%

% of Total Gross Profit

 

25.9

%

26.5

%

 

 

29.2

%

28.8

%

 

 

 

Offline advertising expenses consist primarily of: (1) the expenses associated with domestic television, print and radio advertising; and (2) the cost for creative talent, production costs and agency fees for television, print and radio advertising.  For the three and nine months ended September 30, 2010, offline advertising expenses decreased compared to the same period in 2009, due to decreased television and print advertising.  Online advertising expenses primarily consist of the costs of (1) search engine keyword purchases; (2) affiliate programs; (3) banner and pop-up advertisements; and (4) e-mail campaigns.  For the three and nine months ended September 30, 2010, online advertising expenses increased over the same periods in 2009, primarily to support increased gross bookings for Booking.com, Agoda and priceline.com, as well as the inclusion of online advertising expense for TravelJigsaw since its acquisition in May 2010.

 

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Sales and Marketing

 

 

 

Three Months Ended
September 30,

 

 

 

Nine Months Ended
September 30,

 

 

 

 

 

($000)

 

%

 

($000)

 

%

 

 

 

2010

 

2009

 

Change

 

2010

 

2009

 

Change

 

Sales and Marketing

 

$

33,060

 

$

24,473

 

35.1

%

$

85,663

 

$

63,583

 

34.7

%

% of Total Gross Profit

 

5.0

%

5.6

%

 

 

6.0

%

6.7

%

 

 

 

Sales and marketing expenses consist primarily of (1) credit card processing fees associated with merchant transactions; (2) fees paid to third-party service providers that operate the call centers for our priceline.com U.S. business; (3) provisions for credit card chargebacks; and (4) provisions for bad debt primarily related to agency hotel commission receivables.  For the three and nine months ended September 30, 2010, sales and marketing expenses, which are substantially variable in nature, increased over the same periods in 2009, primarily due to increased credit card processing fees, call center costs and bad debt provision associated with increased gross booking volumes.

 

Personnel

 

 

 

Three Months Ended
September 30,

 

 

 

Nine Months Ended
September 30,

 

 

 

 

 

($000)

 

%

 

($000)

 

%

 

 

 

2010

 

2009

 

Change

 

2010

 

2009

 

Change

 

Personnel

 

$

82,007

 

$

50,959

 

60.9

%

$

194,635

 

$

135,333

 

43.8

%

% of Total Gross Profit

 

12.3

%

11.7

%

 

 

13.6

%

14.3

%

 

 

 

Personnel expenses consist of compensation to our personnel, including salaries, bonuses, taxes, employee health benefits and stock-based compensation. For the three and nine months ended September 30, 2010, personnel expenses increased over the same periods in 2009, due primarily to increased headcount to support the growth of our business, higher bonus accruals reflecting our strong operating performance, and the inclusion of TravelJigsaw since its acquisition in May 2010.  Stock-based compensation expense was approximately $21.2 million and $10.9 million for the three months ended September 30, 2010 and 2009, respectively, and approximately $48.6 million and $32.7 million for the nine months ended September 30, 2010 and 2009, respectively.  Stock-based compensation for the three and nine months ended September 30, 2010 includes charges amounting to $6.4 million and $11.0 million, respectively, representing the cumulative impact of adjusting the estimated probable outcome at the end of the performance period for certain outstanding unvested performance share units.

 

General and Administrative

 

 

 

Three Months Ended
September 30,

 

 

 

Nine Months Ended
September 30,

 

 

 

 

 

($000)

 

%

 

($000)

 

%

 

 

 

2010

 

2009

 

Change

 

2010

 

2009

 

Change

 

General and Administrative

 

$

15,730

 

$

19,367

 

(18.8

)%

$

56,224

 

$

48,881

 

15.0

%

% of Total Gross Profit

 

2.4

%

4.5

%

 

 

3.9

%

5.2

%

 

 

 

General and administrative expenses consist primarily of: (1) fees for outside professionals, including litigation expenses; (2) occupancy expenses; and (3) personnel related expenses such as recruiting, training and travel expenses.  General and administrative expenses for the three and nine months ended September 30, 2010 included a favorable adjustment of approximately $2.7 million in connection with the resolution of certain franchise tax and sales and use tax issues related to our corporate headquarters location.  General and administrative expenses for the same periods in 2009 included a charge of $3.7 million related to a judgment in a lawsuit involving hotel occupancy taxes.  Excluding these items, general and administrative expenses increased during the three and nine months ended September 30, 2010, over the same period in 2009, due to professional fees incurred in the second quarter 2010 related to the acquisition of TravelJigsaw, additional fees for outside professionals, including litigation expenses primarily related to hotel occupancy and other tax proceedings, increased

 

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personnel-related expenses and occupancy expenses to support the growth in our Booking.com and Agoda operations, and the inclusion of TravelJigsaw since its acquisition in May 2010.

 

Information Technology

 

 

 

Three Months Ended
September 30,

 

 

 

Nine Months Ended
September 30,

 

 

 

 

 

($000)

 

%

 

($000)

 

%

 

 

 

2010

 

2009

 

Change

 

2010

 

2009

 

Change

 

Information Technology

 

$

5,347

 

$

4,777

 

11.9

%

$

14,850

 

$

14,002

 

6.1

%

% of Total Gross Profit

 

0.8

%

1.1

%

 

 

1.0

%

1.5

%

 

 

 

Information technology expenses consist primarily of: (1) system maintenance and software license fees; (2) outsourced data center costs relating to our domestic and international data centers; (3) data communications and other expenses associated with operating our Internet sites; and (4) payments to outside consultants. For the three and nine months ended September 30, 2010, information technology expenses increased compared to the same periods in 2009, due primarily to growth in our worldwide operations.

 

Depreciation and Amortization

 

 

 

Three Months Ended
September 30,

 

 

 

Nine Months Ended
September 30,

 

 

 

 

 

($000)

 

%

 

($000)

 

%

 

 

 

2010

 

2009

 

Change

 

2010

 

2009

 

Change

 

Depreciation and Amortization

 

$

12,775

 

$

10,098

 

26.5

%

$

33,312

 

$

29,182

 

14.2

%

% of Total Gross Profit

 

1.9

%

2.3

%

 

 

2.3

%

3.1

%

 

 

 

Depreciation and amortization expenses consist of:  (1) amortization of intangible assets with determinable lives; (2) amortization of internally developed and purchased software, (3) depreciation of computer equipment; and (4) depreciation of leasehold improvements, office equipment and furniture and fixtures.  For the three and nine months ended September 30, 2010, depreciation and amortization expense increased from the same periods in 2009, primarily due to acquisition-related amortization in connection with our acquisition of TravelJigsaw.

 

Other Income (Expense)

 

 

 

Three Months Ended
September 30,

 

 

 

Nine Months Ended
September 30,

 

 

 

 

 

($000)

 

%

 

($000)

 

%

 

 

 

2010

 

2009

 

Change

 

2010

 

2009

 

Change

 

Interest Income

 

$

918

 

$

471

 

94.9

%

$

2,713

 

$

1,695

 

60.1

%

Interest Expense

 

(8,293

)

(5,911

)

40.3

%

(22,366

)

(19,221

)

16.4

%

Foreign Currency Transactions and Other

 

(10,715

)

(1,220

)

878.3

%

(12,806

)

(1,283

)

898.1

%

Total

 

$

(18,090

)

$

(6,660

)

171.6

%

$

(32,459

)

$

(18,809

)

72.6

%

 

For the three and nine months ended September 30, 2010, interest income on cash and marketable securities increased over the same periods in 2009, primarily due to an increase in the average balance invested.  Interest expense increased for the three and nine months ended September 30, 2010, as compared to the same periods in 2009, primarily due to an increase in the average outstanding debt.  “Foreign currency transactions and other” includes foreign exchange losses of $6.2 million and gains of $2.4 million for the three and nine months ended September 30, 2010, respectively, and foreign exchange losses of $1.7 million and $2.5 million for the three and nine months ended September 30, 2009, respectively, related to foreign exchange derivative contracts.  Foreign exchange losses on transactions were approximately $1.3 million and $3.9 million for the three and nine months ended September 30, 2010, respectively, compared to foreign exchange gains of $0.8 million and losses of $1.5 million for the three and nine months ended September 30, 2009, respectively.  In addition,

 

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losses of $3.2 million and $11.3 million were incurred for the three and nine months ended September 30, 2010, respectively, resulting from convertible debt conversions, compared to a loss of $0.4 million and a gain of $2.7 million for the three and nine months ended September 30, 2009, respectively.

 

Income Taxes

 

 

 

Three Months Ended
September 30,

 

 

 

Nine Months Ended
September 30,

 

 

 

 

 

($000)

 

%

 

($000)

 

%

 

 

 

2010

 

2009

 

Change

 

2010

 

2009

 

Change

 

Income Tax (Expense) Benefit

 

$

(94,119

)

$

124,887

 

(175.4

)%

$

(172,347

)

$

76,851

 

(324.3

)%

 

Our effective tax rate for the three and nine months ended September 30, 2010 was 29.5% and 30.5%, respectively, and differs from the expected tax provision at the U.S. statutory tax rate of 35%, principally due to lower foreign tax rates, partially offset by state income taxes and certain non-deductible expenses.  The income tax benefit for the three and nine months ended September 30, 2009 included a benefit of $181.9 million, resulting from the reversal in September 2009 of the remaining valuation allowance on the deferred tax assets related to net operating loss carryforwards (“NOLs”) generated from our domestic operating losses.  Excluding the aforementioned $181.9 million benefit in 2009, the effective income tax rates for the nine months ended September 30, 2010 decreased over the same periods in 2009, primarily due to a higher percentage of foreign income which is taxed at lower rates.

 

Due to our domestic net operating loss carryforwards, we do not expect to make payments on our U.S. income for the foreseeable future, except for U.S. federal alternative minimum tax and state income taxes.  However, we expect to pay foreign taxes on our foreign income.  We expect that Booking.com, Agoda and TravelJigsaw will grow their pretax income at higher rates than the U.S. over the long term and, therefore, it is our expectation that our cash tax payments will increase as Booking.com and Agoda generate an increasing share of our pretax income.

 

In 2009, the Netherlands modified its tax law related to income generated from qualifying “innovative” activities carried out in the Netherlands (“Innovation Box Tax”).  The new law became effective January 1, 2010.   Earnings that qualify for Innovation Box Tax will be taxed at the rate of 5% rather than the Dutch statutory rate of 25.5%.  Booking.com received confirmation from the Dutch tax authorities in June 2010 that it is eligible to apply for Innovation Box Tax.  Booking.com is discussing with the Dutch tax authorities what percentage of its earnings, if any, will qualify for Innovation Box Tax treatment.  The discussions will also determine the time period over which any benefit received under the Innovation Box Tax will be phased in.

 

Equity in Income of Investees

 

 

 

Three Months Ended
September 30,

 

 

 

Nine Months Ended
September 30,

 

 

 

 

 

($000)

 

%

 

($000)

 

%

 

 

 

2010

 

2009

 

Change

 

2010

 

2009

 

Change

 

Equity in Income of Investees

 

n/a

 

$

 

n/a

 

n/a

 

$

2

 

n/a

 

 

Equity in income of investees for the three and nine months ended September 30, 2009 represented our pro rata share of pricelinemortgage.com’s net results. In July 2009, pricelinemortgage.com was dissolved, and we received $8.9 million in cash for our 49% equity investment in pricelinemortgage.com. We do not expect the dissolution of our investment in pricelinemortgage.com to materially impact future periods.

 

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Noncontrolling Interests

 

 

 

Three Months Ended
September 30,

 

 

 

Nine Months Ended
September 30,

 

 

 

 

 

($000)

 

%

 

($000)

 

%

 

 

 

2010

 

2009

 

Change

 

2010

 

2009

 

Change

 

Noncontrolling Interests

 

$

1,580

 

n/a

 

n/a

 

$

1,219

 

n/a

 

n/a

 

 

Noncontrolling interests for the three and nine months ended September 30, 2010, represents the proportionate share of the net income of TravelJigsaw Holdings Limited for the three months ended September 30, 2010 and the period of May 18, 2010 through September 30, 2010, respectively, applicable to the noncontrolling interests (refer to Note 11 of the Unaudited Consolidated Financial Statements).

 

Liquidity and Capital Resources

 

As of September 30, 2010, we had $1.5 billion in cash, cash equivalents and short-term investments.  Approximately $0.8 billion of our cash and cash equivalents and short-term investments are held by our international subsidiaries and are denominated primarily in Euros and, to a lesser extent, in British Pound Sterling. Cash equivalents and short-term investments are primarily comprised of highly liquid, investment-grade debt securities.

 

In March 2010, we issued in a private placement $575.0 million aggregate principal amount of convertible senior notes due 2015, with an interest rate of 1.25%.  Interest on these notes is payable in March and September of each year.  The net proceeds may be used for general corporate purposes, which may include repurchasing shares of priceline.com common stock from time to time, repaying outstanding debt and corporate acquisitions.  As discussed below, concurrent with this debt offering, we repurchased approximately $100 million of our outstanding common stock.  See Note 8 to our Unaudited Consolidated Financial Statements for further details on these notes.

 

In March 2010, our Board of Directors authorized an additional repurchase of up to $500 million of our common stock from time to time in open market or privately negotiated transactions, including the approval to purchase up to $100 million of our common stock from the proceeds of, and concurrently with, the offering of the notes discussed above.  We repurchased 461,437 shares of our common stock at an aggregate cost of $106.1 million during the nine months ended September 30, 2010.  As of September 30, 2010, we have a remaining authorization to repurchase $459.2 million of our common stock.  We may from time to time make additional repurchases of our common stock, depending on prevailing market conditions, alternate uses of capital and other factors.

 

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

 

Net cash provided by operating activities for the nine months ended September 30, 2010, was $597.4 million, resulting from net income of $393.0 million, net favorable changes in working capital of $51.0 million, and a net favorable impact of $153.4 million for non-cash items not affecting cash flows.  Non-cash items include deferred income taxes, stock-based compensation expense, depreciation and amortization, primarily from acquisition-related intangible assets, amortization of debt discount and loss on conversions of our convertible notes.  The changes in working capital for the nine months ended September 30, 2010, were related to a $169.9 million increase in accounts payable, accrued expenses and other current liabilities, partially offset by a $112.8 million increase in accounts receivable.  The increase in these working capital balances was primarily related to seasonality and increases in business volume as well as the timing of income tax payments.  Our bookings and revenues are generally higher in the third quarter of the year than in the fourth quarter of the year which results in higher accounts receivable, deferred merchant bookings, accounts payable and accrued expenses at September 30, 2010 compared to December 31, 2009.

 

Net cash provided by operating activities for the nine months ended September 30, 2009, was $363.4 million, resulting from net income of $411.0 million and net favorable changes in working capital of $27.5 million, partially offset by a net unfavorable impact of $75.1 million for non-cash items not affecting cash flows.  Non-cash items include the benefit of $181.9 million from the reversal of the remaining valuation allowance on our deferred tax assets related to NOLs generated from our domestic operating losses, stock-based compensation expense, depreciation and amortization, primarily from acquisition-related intangible assets, amortization of debt discount and gain on conversions of our convertible notes.  The

 

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Table of Contents

 

changes in working capital for the nine months ended September 30, 2009, were related to an $89.8 million increase in accounts payable, accrued expenses and other current liabilities and an $8.9 million decrease in prepaid expenses and other current assets partially offset by a $73.9 million increase in accounts receivable.  The increase in these working capital balances was primarily related to seasonality and increases in business volume.

 

Net cash used in investing activities was $449.1 million for the nine months ended September 30, 2010.  Investing activities were affected by $364.1 million net purchase of marketable securities and a payment of $111.0 million for acquisitions and other equity investments, net of cash acquired, partially offset by $40.3 million net proceeds from foreign currency forward contracts.  Net cash used in investing activities was $239.4 million for the nine months ended September 30, 2009, and investing activities were affected by $239.6 million net purchase of securities, $8.9 million received in connection with the dissolution of pricelinemortgage.com and a reduction in restricted cash of $1.2 million.  Cash invested in purchases of property and equipment was $14.5 million and $9.9 million for the nine months ended September 30, 2010 and 2009, respectively.

 

Net cash provided by financing activities was approximately $174.5 million for the nine months ended September 30, 2010.  The cash provided by financing activities during the nine months ended September 30, 2010 was primarily related to proceeds from the issuance of convertible senior notes with an aggregate principal amount of $575.0 million, $24.6 million of proceeds from the exercise of employee stock options, $5.0 million of excess tax benefits from stock-based compensation and proceeds of $4.3 million from the sale of subsidiary shares to noncontrolling interests, partially offset by $295.4 million paid upon the conversion of senior notes, $125.7 million of treasury stock purchases and $13.3 million of debt issuance costs.  Net cash used in financing activities was approximately $125.2 million for the nine months ended September 30, 2009.  The cash used in financing activities during the nine months ended September 30, 2009 was primarily related to $122.0 million of principal paid upon the conversion of senior notes, $14.2 million of treasury stock purchases, partially offset by $9.4 million of proceeds from the exercise of employee stock options and $1.6 million of excess tax benefits from stock-based compensation.

 

In connection with our acquisition of Agoda in 2007, contingent consideration of up to $141.6 million is payable in 2011 if Agoda achieves specified “gross bookings” and earnings targets for the period of January 1, 2008 through December 31, 2010.  Based upon our current estimates, we anticipate a payment for contingent consideration of approximately $50 million to $70 million.

 

In September 2007, we entered into a $175.0 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 our assets and related intangible assets located in the United States.  In addition, our obligations under the revolving credit facility are guaranteed by substantially all of the assets and related intangible assets of our material direct and indirect domestic and foreign subsidiaries.  Borrowings under the revolving credit facility will bear interest, at our option, at a rate per annum equal to the greater of (a) JPMorgan Chase Bank, National Association’s prime lending rate and (b) the federal funds rate plus ½ of 1%, plus an applicable margin ranging from 0.25% to 0.75%; or at an adjusted LIBOR for the interest period in effect for such borrowing plus an applicable margin ranging from 1.25% to 1.75%.  Undrawn balances available under the revolving credit facility are subject to commitment fees at the applicable rate ranging from 0.25% to 0.375%.

 

The revolving credit facility provides for the issuance of up to $50.0 million of letters of credit as well as borrowings on same-day notice, referred to as swingline loans, which are available in U.S. Dollars, Euros, British Pounds Sterling and any other foreign currency agreed to by the lenders. The proceeds of loans made under the facility will be used for working capital and general corporate purposes.  As of September 30, 2010, there were no borrowings outstanding under the facility and we have issued approximately $1.6 million of letters of credit under the revolving credit facility.

 

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

 

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Table of Contents

 

Contingencies

 

A number of jurisdictions have initiated lawsuits against us related to, among other things, the payment of hotel occupancy and other taxes (i.e., state and local sales tax).  In addition, a number of municipalities have initiated audit proceedings, issued proposed tax assessments or started inquiries relating to the payment of hotel occupancy and other taxes.  To date, the majority of taxing jurisdictions in which the Company facilitates the making of hotel room reservations have not asserted that taxes are due and payable on the Company’s U.S. “merchant” hotel business.  With respect to jurisdictions that have not initiated proceedings to date, it is possible that they will do so in the future or that they will seek to amend their tax statutes and seek to collect taxes from the Company only on a prospective basis.  See Note 13 to the Unaudited Consolidated Financial Statements for a description of these pending cases and proceedings and Risk Factors — Adverse application of state and local tax laws could have an adverse effect on our business and results of operations.

 

We are vigorously defending against these claims and proceedings.  However, litigation is subject to uncertainty and there could be adverse developments in these pending or future cases and proceedings.  An unfavorable outcome or settlement of these actions or proceedings could result in substantial liabilities for past and/or future bookings, including, among other things, interest, penalties, punitive damages and/or attorney fees and costs, which could have a material adverse effect on our cash flows in any given operating period.  Also, there have been, and will continue to be, ongoing costs associated with defending our position in pending and any future cases or proceedings.

 

As a result of this litigation and other attempts by jurisdictions to levy similar taxes, the Company has established a reserve which amounted to approximately $23 million as of September 30, 2010 and $21 million as of December 31, 2009.  The reserve is based on the Company’s reasonable estimate, and the ultimate resolution of these issues may be less or greater than the liabilities recorded.  The Company believes that even if it were to suffer adverse determinations in the near term in more of the pending proceedings than currently anticipated given results to date, because of the Company’s available cash, it would not have a material impact on the Company’s liquidity.

 

Off-Balance Sheet Arrangements

 

As of September 30, 2010, we did not have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.

 

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Table of Contents

 

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

 

Sections of this Form 10-Q including, in particular, our Management’s Discussion and Analysis of Financial Condition and Results of Operations above, contain forward-looking statements.  These forward-looking statements reflect the views of our management regarding current expectations and projections about future events and are based on currently available information and current foreign currency exchange rates.  These forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict; therefore, actual results may differ materially from those expressed, implied or forecasted in any such forward-looking statements.

 

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

 

Risk Factors

 

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

 

Booking.com and Agoda face risks related to their growth rate and expansion.

 

Throughout 2007, 2008, 2009 and to date in 2010, our international operations experienced significant year-over-year growth in their gross bookings (an operating and statistical metric referring to the total dollar value, generally inclusive of all taxes and fees, of all travel services purchased by our customers) and hotel room night reservations.  This growth rate has contributed significantly to our growth in revenue, gross profit and earnings per share.  Over time, Booking.com and Agoda will experience a decline in their growth rate as the absolute level of their gross bookings and unit sales grow larger.  Other factors may also slow the growth rates of the Booking.com and Agoda businesses, including, for example, the impact of the worldwide recession, any strengthening of the U.S. Dollar versus the Euro, declines in hotel average daily rates (“ADRs”), increases in cancellations, travel market conditions and the competitiveness of the market.  A decline in Booking.com and Agoda’s growth rate could have a negative impact on our future revenue and earnings per share growth rates and, as a consequence, our stock price.

 

The strategy of Booking.com, Agoda and TravelJigsaw involves rapid expansion into regions around the world, including Europe, Asia, North America, South America and elsewhere, many of which have different customs, different levels of customer acceptance of the Internet and different legislation, regulatory environments, tax laws and levels of political stability.  In addition, compliance with foreign legal, regulatory or tax requirements will place demands on our time and resources, and we may nonetheless experience unforeseen and potentially adverse legal, regulatory or tax consequences.  If Booking.com, Agoda and TravelJigsaw are unsuccessful in rapidly expanding into other countries, our business, results of operations and financial condition would be adversely affected.

 

We are dependent on the travel industry.

 

Our financial prospects are significantly dependent upon our sale of travel services.  Travel, including hotel room reservations, rental car reservations and airline tickets, is dependent on discretionary spending levels. As a result, sales of travel services tend to decline during general economic downturns and recessions.  Accordingly, the current worldwide recession has led to a weakening in the fundamental demand for our services and an increase in the number of customers who cancel existing travel reservations with us.  In addition, unforeseen events beyond our control, such as terrorist attacks, unusual weather patterns, including natural disasters such as hurricanes, tsunamis or earthquakes and other weather phenomena such as the recent volcanic ash cloud that grounded European air travel for several days in April 2010, travel related health concerns including pandemics and epidemics such as H1N1 influenza (swine flu), avian bird flu and SARS, political instability, regional hostilities, increases in fuel prices, imposition of taxes or surcharges by regulatory authorities and travel related accidents, also may adversely affect the travel industry and our business and results of operations.  Further,

 

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work stoppages or labor unrest at any of the major airlines could materially adversely affect the airline industry and, as a consequence, have a material adverse effect on our business, results of operations and financial condition.

 

For example, in early 2010, civil unrest in Thailand, a key market for our Agoda business and the Asian business of Booking.com, negatively impacted booking volumes in this market at the time.  In addition, clashes involving Thai security forces, anti-government demonstrators and groups supporting the government resulted in violence in various locations in Bangkok, causing the temporary relocation of Agoda’s Thailand-based operations.  Thailand has experienced disruptive civil unrest in prior years as well and continued or future civil or political unrest could further disrupt Agoda’s Thailand-based business and operations.

 

We are dependent on certain suppliers.

 

During the three months ended September 30, 2010, Name Your Own Price® hotel room night reservations from our five largest hotel suppliers accounted for approximately 65.7% of total Name Your Own Price® hotel room night reservations, and sales of airline tickets from our five largest and two largest airline suppliers accounted for approximately 80.6% and 41.1% of total airline tickets sold, respectively. As a result, we are currently substantially dependent upon the continued participation of these suppliers in our system in order to maintain and continue to grow our total gross profit.

 

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

 

During the recent worldwide recession, the hotel industry experienced a significant decrease in occupancy rates and ADRs, and an increase in reservation cancellation rates.  While lower occupancy rates have historically resulted in hotel suppliers increasing their distribution of hotel room reservations 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.

 

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

 

With respect to our airline suppliers, the airline industry has experienced a shift in market share from full-service carriers to low-cost carriers that focus primarily on discount fares to leisure destinations and we expect this trend to continue.  Some low-cost carriers, such as Southwest, have not historically distributed their tickets through us or other third-party intermediaries.  In addition, certain airlines have significantly limited or eliminated sales of airline tickets through opaque channels, preferring to consistently show the lowest available price on their own website.  Since the start of the worldwide recession, domestic airline capacity has been significantly reduced, which reduces the number of airline tickets available to our customers.  Thus far in 2010, airlines have significantly increased their average fares compared to the same period in 2009, which could adversely impact travel demand.  Reduced airline capacity and lower travel demand negatively impact our priceline.com air business, which in turn has negative repercussions on our priceline.com hotel and rental car businesses, and could have a material adverse effect on our business, results of operations and financial condition.  Conversely, decreased airfares can adversely impact our Name Your Own Price® airline tickets sales by reducing the amount of absolute dollar savings as compared to retail airline tickets.

 

We could be adversely affected by changes in the airline industry, and, in many cases, we will have no control over such changes or their timing.  Recently, there has been an emerging prospect of domestic airline industry consolidation, as evidenced by mergers of United Air Lines with Continental Airlines and Delta Air Lines with Northwest Airlines, as well as the recently announced future acquisition of AirTran by Southwest Airlines.  If one of our major airline suppliers merges or consolidates with, or is acquired by, another company that either does not participate in the priceline.com system or that participates on substantially lower levels, the surviving company may elect not to participate in our system or to participate at

 

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lower levels than the previous supplier.  For example, in September 2010, Southwest Airlines announced that it entered into an agreement to acquire AirTran.  AirTran has participated in our Name Your Own Price® system on only a limited basis, but Southwest Airlines has never participated.  In fact, Southwest Airlines does not currently distribute airline tickets through any online travel agent or permit its fares to appear in comparative fare displays. If AirTran fares are taken out of the online marketplace as a result of this acquisition, those fares would no longer be available to us.  Similarly, United Air Lines has historically participated in our Name Your Own Price® system at a high level, while Continental Airlines has historically participated at a much lower level.  We cannot predict the effects that the acquisition of AirTran by Southwest Airlines or the merger of United Air Lines with Continental Airlines will have on our business.

 

In addition, in the event that one of our major suppliers voluntarily or involuntarily declares bankruptcy and is subsequently unable to successfully emerge from bankruptcy, and we are unable to replace such supplier, our business would be adversely affected.  For example, in April 2008, Aloha Airlines and ATA Airlines each ceased operations and we experienced an increase in credit card chargebacks from customers with tickets on those airlines.  To the extent major U.S. airlines that participate in our system declare bankruptcy or cease operations, they may be unable or unwilling to honor tickets sold for their flights.  Our policy in such event is to direct customers seeking a refund or exchange to the airline, and not to provide a remedy ourselves. Because we are the merchant-of-record on sales of Name Your Own Price® airline tickets to our customers, however, we could experience a significant increase in demands for refunds or credit card chargebacks from customers, which could materially adversely affect our operations and financial results. In addition, because Name Your Own Price® customers do not choose their airlines, hotels or rental car companies, the bankruptcy of a major airline, hotel or rental car company, or even the possibility of such a bankruptcy, could discourage customers from using our Name Your Own Price® system to book travel.

 

In November 2010, American Airlines informed Orbitz that it intends to terminate its participation in the Orbitz service, effective December 1, 2010.  This is consistent with an effort on the part of American Airlines to reduce distribution costs, including GDS payments that ultimately inure in part to the benefit of online travel agents such as us, by requiring such online travel agents to connect directly to American Airlines’ systems in order to access its content.  American Airlines’ termination of its distribution arrangement with Orbitz could be indicative of the airlines in general becoming more aggressive toward requiring online travel agents to implement direct connections.  Development and implementation of the technology to enable direct connections to travel suppliers could cause us to incur additional operating expenses, increase the frequency/duration of system problems and delay other projects. In addition, any migration toward direct connections would reduce the compensation we receive from GDSs.

 

The loss of any major airline participant in our Name Your Own Price® system could result in other major airlines electing to terminate their participation in the Name Your Own Price® system, which would further negatively impact our business, results of operations and financial condition.  In addition, fewer independent suppliers reduces opacity and competition among suppliers.  In such event, if we are unable to divert sales to other suppliers, our business, results of operations and financial condition may be adversely affected.

 

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

 

United Airlines prohibits certain travel agents from using United’s merchant processing system for retail credit card transactions.  When accepting credit cards for payment, such agents must use their own merchant accounts and settle with United with cash.  By requiring such agents to act as merchant of record, United passes the credit card processing costs onto the travel agent.  United has not informed us that we must cease using United’s merchant processing system for credit card transactions, however, if United or another airline changes its policy with respect to us and requires us to act as merchant of record for retail airline ticket transactions, we will incur additional credit card processing costs and increased chargeback activity and expense, including chargeback expense in connection with the bankruptcy of any such airline.

 

Avis is currently in discussions to acquire the Dollar-Thrifty Automotive Group.  The merger or acquisition of the Dollar-Thrifty Automotive Group by Avis or another rental car company could result in a decrease of rental car inventory available to our rental car service. If another major rental car supplier merges or consolidates with, or is acquired by, another company that either does not participate in the priceline.com system or that participates on substantially lower levels, the surviving company may elect not to participate in our system or to participate at lower levels than the previous supplier.  The loss of any rental car supplier participant in our Name Your Own Price® system could result in other rental car suppliers electing to terminate or reduce their participation in the Name Your Own Price® system, which would negatively impact our business, results of operations and financial condition.  Similarly, industry consolidation and any resulting reduction in rental car capacity would limit the amount of availability for TravelJigsaw’s rental car service. Furthermore, many major rental car companies are highly leveraged and the worldwide recession creates the potential for severe financial difficulty, including without limitation, the inability of a rental car company to refinance its debt, restructure its operations or emerge from a bankruptcy, any of which could lead to a reduction in rental car supply made available to us.  In addition, fewer independent suppliers reduces opacity and

 

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competition among suppliers.  In such event, if we are unable to divert sales to other suppliers, our business, results of operations and financial condition may be adversely affected.

 

In addition, recent decreases in rental car fleets have led to decreases in rental car availability, which has negatively impacted our Name Your Own Price® rental car service. In January 2010, Toyota recalled over 8 million vehicles due to faulty accelerator pedals, leading to further strain on rental car companies’ fleets and increased retail rental car rates.  If the industry is faced with a shortage of vehicles, rental car companies may further reduce the number of car reservations they distribute through our service or increase the negotiated rates at which they are willing to provide car reservations.  In addition, rental car companies rely on auto manufacturers to provide new vehicles for their fleet.  Rental car companies have also historically relied on auto manufacturers and the wholesale used car market to dispose of their fleets of cars.  The worldwide recession has led to questions about the long term viability of the major U.S. auto manufacturers and is 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.  Tight credit markets can negatively affect the used car market, making it difficult for auto manufacturers and rental car suppliers to dispose of their fleets.  If the rental car industry is faced with excess supply, rental car companies may lower retail rental car rates, which could be beneficial to our retail rental car business, but detrimental to our Name Your Own Price® business.  Retail rental car rates decreased during the three months ended September 30, 2010 compared to the same period in 2009.  Because rental car days are typically less expensive than airline tickets or hotel room night reservations, a reduction in retail rental car rates has a disproportionately adverse effect on sales of Name Your Own Price® rental car days since customers may be less likely to accept the trade-offs associated with that service.  Any disruption in the supply of vehicles or the ability to dispose of vehicles by car rental companies could impact their ability to match their fleet supply with demand, which could adversely impact our business.

 

We are exposed to fluctuations in currency exchange rates.

 

As a result of the growth of Booking.com and Agoda, and the acquisition of TravelJigsaw, we are conducting a significant portion of our business outside the United States and are reporting our results in U.S. Dollars.  As a result, we face exposure to adverse movements in currency exchange rates as the financial results of our international operations are translated from local currency (principally the Euro and the British Pound Sterling) into U.S. Dollars upon consolidation.  Our international operations contributed approximately $531.0 million and $1.1 billion to our revenues for the three and nine months ended September 30, 2010, respectively, which compares to $316.9 million and $629.1 million for the three and nine months ended September 30, 2009, respectively (year-over-year growth of approximately 68% and 70%, respectively).  Revenue attributable to our international operations increased on a local currency basis by approximately 80% and 77% in the three and nine months ended September 30, 2010, compared to the same periods in 2009. Booking.com, Agoda and TravelJigsaw also face foreign exchange risk as their foreign-denominated revenues, expenses, receivables and payables are translated into their respective functional currencies.

 

In the first quarter of 2010, the U.S. Dollar was weaker against the Euro and the British Pound Sterling, relative to the first quarter of 2009, which benefitted the growth rates of our Euro and British Pound Sterling denominated gross bookings, gross profit and net income as expressed in U.S. Dollars.  In the second and third quarters of 2010 and throughout October 2010, the U.S. Dollar was stronger against the Euro and British Pound Sterling relative to the same periods in 2009, which negatively impacts such growth rates.

 

In early 2010, Greece and certain other European Union countries with high levels of sovereign debt had difficulty refinancing that debt and central bank intervention was required, causing significant devaluation of the Euro relative to other currencies, such as the U.S. Dollar, and concerns that sovereign defaults could lead to devaluation or abandonment of the common currency.  Sovereign debt issues could lead to further significant, and potentially longer-term, devaluation of the Euro against the U.S. Dollar, which would adversely impact our Euro-denominated net assets, gross bookings, revenues, operating expenses, and net income as expressed in U.S. Dollars.  Furthermore, governmental austerity measures aimed at reducing deficits could impair the economic recovery and adversely affect travel demand.

 

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

 

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

 

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We currently or potentially compete with a variety of companies with respect to each service we offer. With respect to our travel services, these competitors include, but are not limited to:

 

·                  Internet travel services such as Expedia, Hotels.com, Hotwire and Venere, which are owned by Expedia; Travelocity, lastminute.com and Zuji, which are owned by the Sabre Group; Orbitz.com, Cheaptickets, ebookers, HotelClub and RatesToGo, which are currently owned by Orbitz Worldwide; laterooms and asiarooms owned by Tui Travel; and Gullivers, octopustravel, Superbreak, hotel.de, Hotel Reservation Service, AutoEurope, Holiday Auto, Car Trawler, Ctrip, Rakuten and Wotif;

 

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

 

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

 

·                  traditional travel agencies, wholesalers and tour operators;

 

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

 

·                  operators of travel industry reservation databases such as Galileo, Travelport, Amadeus and Sabre.

 

Certain of our major competitors have matched our elimination and/or reduction of processing fees associated with some of our travel services.  In June 2007, we eliminated processing fees for our price-disclosed airline ticket service, and in April 2008, we reduced processing fees for our priceline.com price-disclosed merchant hotel room service.  As a result, since those dates, we had a pricing advantage against other major online travel agents with respect to these travel services.  Starting in March 2009, Expedia and Travelocity also eliminated air booking fees, and in April 2009, Orbitz followed.  As a result, we no longer have the price advantage that we have had against our major competitors on price-disclosed airline tickets since June 2007.  Similarly, in April 2009, each of Expedia and Orbitz reduced booking fees on hotel room reservations, and we therefore no longer have a price advantage over those companies on price-disclosed merchant hotel room reservations.  In addition, in May 2009, Orbitz announced a price guarantee program under which a customer who books a prepaid hotel stay will receive money back from Orbitz if another Orbitz customer books the exact same stay in terms of room type, travel dates and number of travelers.  In addition, in October 2009, Travelocity announced the waiver of its cancellation and change fees for hotel and vacation packages, as well as an expanded hotel guarantee, under which consumers who book a hotel room and then find a lower published rate for the same room anytime before the day of check-in are eligible to receive a refund of the difference.  Our business may be adversely impacted as a result of no longer having a price advantage over our direct competitors in the U.S., and we may be adversely impacted by future promotional initiatives by our competitors.

 

In addition, in March 2009, Travelocity launched an opaque price-disclosed hotel booking service that allows customers to book rooms at a discount because, similar to our Name Your Own Price® hotel booking service, the name of the hotel is not disclosed until after purchase.  At this point, the number of hotels available through Travelocity’s opaque hotel service is limited.  However, Travelocity has experience with offering opaque price-disclosed hotel room reservations in Europe through its site, lastminute.com, and it is likely that it will use such experience to grow the number of opaque hotel room reservations it makes available.  Additionally, Expedia recently began making opaque hotel rooms available on its principal website under the name “Expedia Unpublished.”  Expedia has access to a large, established base of opaque-participating hotels through its subsidiary, Hotwire.  If Expedia or Travelocity are successful in growing their opaque hotel service, our share of the discount hotel market in the U.S. could decrease.  In addition, we would have to compete with Expedia and Travelocity for access to hotel room supply and there is no guarantee that we would be able to maintain successfully our current level of opaque hotel supply.  If Expedia’s or Travelocity’s opaque hotel service is successful, it may try to offer opaque airline tickets and/or rental cars, each of which would expose us to similar competitive risks as the opaque hotel service.

 

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

 

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Large, established Internet search engines with substantial resources and expertise in developing online commerce and facilitating Internet traffic are creating — and intend to further create — inroads into online travel, both in the U.S. and internationally.  For example, Google recently announced that it has entered into an agreement to acquire ITA Software, Inc., a major flight information software company, which could allow Google to pursue the creation of new flight search tools which will enable users to find flight information on the Internet without using a service like ours.  Google has also invested in HomeAway, a vacation home rental service.  In addition, Google has launched a travel “meta-search” site to show searchers specific hotels and rates in addition to text advertisements, and Microsoft has launched Bing Travel, a “meta-search” site, which searches for airfare and hotel reservations online and predicts the best time to purchase them.  “Meta-search” sites leverage their search technology to aggregate travel search results for the searcher’s specific itinerary across supplier, travel agent and other websites and, in many instances, compete directly with us for customers.  These initiatives, among others, illustrate Google’s and Bing’s clear intention to more directly appeal to travel consumers by showing consumers more detailed travel search results, including specific information for travelers’ own itineraries, which could lead to suppliers or others gaining a larger share of Google’s or Bing’s traffic or may ultimately lead to search engines maintaining transactions within their own websites.  If Google, as the single largest search engine in the world, or Bing, or other leading search engines refer significant traffic to these or other travel services that they develop in the future, it could result in, among other things, more competition from supplier websites and higher customer acquisition costs for third-party sites such as ours and could have a material adverse effect on our business, results of operations and financial condition.

 

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

 

·                  marketing and promotional campaigns;

·                  attracting traffic to their websites;

·                  attracting and retaining key employees;

·                  securing vendors and supply; and

·                  website and systems development.

 

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

 

Adverse application of state and local tax laws could have an adverse effect on our business and results of operation.

 

A number of jurisdictions have initiated lawsuits against on-line travel companies, including us, related to, among other things, the payment of hotel occupancy and other taxes (i.e., state and local sales tax).  In addition, a number of municipalities have initiated audit proceedings, issued proposed tax assessments or started inquiries relating to the payment of hotel occupancy and other taxes.  Please see Note 13 to the Unaudited Consolidated Financial Statements for a description of these pending cases and proceedings.  Additional state and local jurisdictions are likely to assert that we are subject to, among other things, hotel occupancy and other taxes (i.e., state and local sales tax) and could seek to collect such taxes, either retroactively or prospectively, or both.

 

In connection with some hotel occupancy tax audits and assessments, we may be required to pay any assessed taxes, which amounts may be substantial, prior to being allowed to contest the assessments and the applicability of the ordinances in judicial proceedings.  This requirement is commonly referred to as “pay to play” or “pay first.”  Payment of these amounts, if any, is not an admission that we believe that we are subject to such taxes and, even if such payments are made, we intend to continue to assert our position vigorously.

 

Litigation is subject to uncertainty and there could be adverse developments in these pending or future cases and proceedings.  For example, in October 2009, a jury in a San Antonio class action found that we and the other online travel companies that are defendants in the lawsuit “control” hotels for purposes of the local hotel occupancy tax ordinances at issue and are, therefore, subject to the requirements of those ordinances.  An unfavorable outcome or settlement of pending litigation is likely to encourage the commencement of additional litigation, audit proceedings or other regulatory inquiries.  In addition, an unfavorable outcome or settlement of these actions or proceedings could result in substantial liabilities for past

 

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and/or future bookings, including, among other things, interest, penalties, punitive damages and/or attorney fees and costs.  There have been, and will continue to be, substantial ongoing costs, which may include “pay to play” payments, associated with defending our position in pending and any future cases or proceedings. An adverse outcome in one or more of these unresolved proceedings could have a material adverse effect on our business and results of operations and could be material to our earnings or cash flows in any given operating period.

 

To the extent that any tax authority succeeds in asserting that we have a tax collection responsibility, or we determine that we have one, with respect to future transactions, we may collect any such additional tax obligation from our customers, which would have the effect of increasing the cost of hotel room reservations to our customers and, consequently, could make our hotel service less competitive (i.e., versus the websites of other online travel companies or hotel company websites) and reduce hotel reservation transactions; alternatively, we could choose to reduce the compensation for our services on “merchant” hotel transactions.  Either step could have a material adverse effect on our business and results of operations.

 

In many of the judicial and other proceedings initiated to date, municipalities seek not only historical taxes that are claimed to be owed on our gross profit, but also, among other things, interest, penalties, punitive damages and/or attorney fees and costs.  The October 2009 jury verdict in the San Antonio litigation and the related proceedings to determine, among other things, the amount of penalties, interest and attorney’s fees that could be owed by us illustrate that any liability associated with hotel occupancy tax matters is not constrained by our liability for tax owed on our historical gross profit.

 

We will continue to assess the risks of the potential financial impact of additional tax exposure, and to the extent appropriate, we will reserve for those estimates of liabilities.

 

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

 

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

 

Our results may also be affected by seasonal fluctuations in the supply made available to us by airlines, hotels and rental car suppliers.

 

Our revenues and operating results may continue to vary significantly from quarter to quarter because of these factors. As a result, quarter-to-quarter comparisons of our revenues and operating results may not be meaningful.  For example, over the last several years we have experienced strong growth in the number of hotel room nights booked through our hotel reservation services.  However, given the sheer size of our hotel reservation business, we believe it is highly likely that our year-over-year room night growth rates will generally decelerate on a quarterly sequential basis.  For example, in the first quarter of 2010, we experienced a mild deceleration in year-over-year hotel room night reservation growth as compared to the year-over-year growth rate in the fourth quarter of 2009.  The unit growth rate decelerated further in the second quarter of 2010 due in part to (1)  travel disruptions caused by the April 2010 eruption of a volcano in Iceland, (2) general uncertainty about the European economy and (3) substantial increases in airfares, which can negatively impact overall travel demand.  In the third quarter of 2010, our year-over-year hotel room night reservation growth accelerated as the volcanic activity subsided, macroeconomic concerns in Europe abated and airfare increases moderated.

 

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

 

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Our stock price is highly volatile.

 

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

 

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

·                  quarterly variations in our operating results;

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

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

·                  changes in our capital structure;

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

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

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

·                  changes in the status of our intellectual property rights;

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

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

·                  occurrences of a significant security breach;

·                  additions or departures of key personnel; and

·                  stock market price and volume fluctuations.

 

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

 

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

 

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

 

Our business could be negatively affected by changes in search engine algorithms and dynamics or termination of traffic-generating arrangements.

 

We utilize Internet search engines and other travel demand aggregation websites, principally through the purchase of travel-related keywords, to generate traffic to our websites.  Booking.com and Agoda, in particular, rely to a significant extent upon Google to generate business and, to a much lesser extent, other search engines and other travel demand aggregation websites.  Search engines such as Google frequently update and change the logic which determines the placement and display of results of a user’s search, such that the placement of links to our sites, and particularly those of Booking.com, Agoda and their affiliates, can be negatively affected.  In a similar way, a significant amount of Booking.com and Agoda’s business is directed to our own websites through participation in pay-per-click advertising campaigns on Internet search engines whose pricing and operating dynamics can experience rapid change commercially, technically and competitively.  In addition, we purchase web traffic from a number of sources, including some operated by our competitors,

 

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in the form of pay-per-click arrangements that can be terminated with little or no notice.  If one or more of such arrangements is terminated, or if a major search engine, such as Google, changes its algorithms in a manner that negatively affects the search engine ranking of our brands or our third-party distribution partners or changes its pricing, operating or competitive dynamics in a negative manner, our business, results of operations and financial condition would be adversely affected.

 

In addition, Booking.com and Agoda rely on various third party distribution channels (i.e., affiliates) to distribute hotel room reservations.  Should one or more of such third parties cease distribution of Booking.com and Agoda reservations, or suffer deterioration in its search engine ranking, due to changes in search engine algorithms or otherwise, the business of Booking.com and Agoda could be negatively affected.

 

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

 

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

 

We cannot guarantee that our existing security measures will prevent security breaches or attacks. A party (whether internal, external, an affiliate or unrelated third party) that is able to circumvent our security systems could steal customer information or transaction data, proprietary information or cause significant interruptions in our operations. For instance, from time to time, we have experienced “denial-of-service” type attacks on our system that have made portions of our websites slow or unavailable for periods of time.  We may need to expend significant resources to protect against security breaches or to address problems caused by breaches, and reductions in website availability and response time could cause loss of substantial business volumes during the occurrence of any such incident.  These issues are likely to become more difficult as we expand the number of places where we operate and as the tools and techniques used in such attacks become more advanced.  Security breaches could result in negative publicity, damage our reputation, expose us to risk of loss or litigation and possible liability and subject us to regulatory penalties and sanctions. Security breaches could also cause customers and potential customers to lose confidence in our security, which would have a negative effect on the value of our brand.  Our insurance policies carry low coverage limits, and would likely not be adequate to reimburse us for losses caused by security breaches.

 

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

 

We also face risks associated with security breaches affecting third parties conducting business over the Internet. Consumers generally are concerned with security and privacy on the Internet, and any publicized security problems could inhibit the growth of the Internet and, therefore, the priceline.com service as a means of conducting commercial transactions.  Additionally, security breaches at third parties such as supplier or distributor systems upon which we rely could result in negative publicity, damage our reputation, expose us to risk of loss or litigation and possible liability and subject us to regulatory penalties and sanctions.  Some of our business is conducted with third party marketing affiliates, which may generate travel reservations through our infrastructure or through other systems.  A security breach at such a third party could be perceived by consumers as a security breach of our systems and could result in negative publicity, damage our reputation, expose us to risk of loss or litigation and possible liability and subject us to regulatory penalties and sanctions.  In addition, such third parties may not comply with applicable disclosure requirements, which could expose us to liability.

 

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

 

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regulations are expanded to require changes in our business practices or if governing jurisdictions interpret or implement their legislation or regulations in ways that negatively affect our business, results of operations and financial condition.

 

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

 

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

 

Our performance is largely dependent on the talents and efforts of highly skilled individuals. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization.  In particular, the contributions of certain key senior management in the U.S., Europe and Asia are critical to the overall management of the Company.  In addition, because our European senior management’s noncontrolling ownership interest was repurchased in September 2008, it may become more difficult to retain these senior managers.  We cannot ensure that we will be able to retain the services of any members of our senior management or other key employees, the loss of whom could harm our business.

 

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

 

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

 

We have rapidly and significantly expanded our international operations and anticipate expanding further to pursue growth of our service offerings and customer base. For example, the number of our employees worldwide has grown from less than 700 in the first quarter of 2007, to over 3,100 as of September 30, 2010, which growth is almost entirely comprised of hires by or for our international operations.  Such expansion increases the complexity of our business and places a significant strain on our management, operations, technical performance, financial resources and internal financial control and reporting functions.

 

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

 

Capacity constraints and system failures could harm our business.

 

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

 

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We depend upon Chase Paymentech to process our U.S. credit card transactions; Global Collect and others to process Agoda credit card transactions; and Wright Express to provide credit card numbers which we use as a payment mechanism for priceline.com U.S. merchant hotel transactions. If any of these providers were wholly or partially compromised, our cash flows could be disrupted until such a time as a replacement process could be put in place with a different vendor.  As we add complexity to our systems infrastructure by adding new suppliers and distribution, our total system availability could decline and our results could suffer.

 

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

 

We do not have a completely formalized disaster recovery plan in every geographic region in which we conduct business.  In the event of certain system failures, we may not be able to switch to back-up systems immediately and the time to full recovery could be prolonged.  Like many online businesses, we have experienced system failures from time to time. In addition to placing increased burdens on our engineering staff, these outages create a significant amount of user questions and complaints that need to be addressed by our customer support personnel. Any unscheduled interruption in our service could result in an immediate loss of revenues that can be substantial and may cause some users to switch to our competitors. If we experience frequent or persistent system failures, our reputation and brand could be permanently harmed. We have been taking steps to increase the reliability and redundancy of our systems. These steps are expensive, may reduce our margins and may not be successful in reducing the frequency or duration of unscheduled downtime.

 

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

 

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

 

·                  unanticipated disruptions in service;

·                  slower response times;

·                  decreased customer service and customer satisfaction; or

·                  delays in the introduction of new services,

 

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

 

Companies that we have acquired, such as our Booking.com, Agoda and TravelJigsaw, and that we may acquire in the future, may present known or unknown capacity/stability or other types of system challenges.  The process of enhancing infrastructure to attain improved capacity/scalability and other system characteristics may be time consuming and expensive and may require resources and expertise that are difficult to obtain.  Such acquisitions increase potential downtime, customer facing problems and compliance problems.  Failure to successfully make any such improvements to such infrastructures could expose us to potential capacity, stability, and system problems that would have an adverse impact on our business, results of operations and financial condition.

 

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

 

Due to our domestic net operating loss carryforwards, we do not expect to make payments on our U.S. income for the foreseeable future, except for U.S. federal alternative minimum tax and state income taxes.  However, we expect to pay foreign taxes on our foreign income.  We expect that Booking.com and Agoda will grow their pretax income at higher rates than the U.S. over the long term and, therefore, it is our expectation that our cash tax payments will increase as Booking.com and Agoda generate an increasing share of our pretax income.

 

Acquisitions could result in operating difficulties.

 

As part of our business strategy, we acquired Booking.com Limited in September 2004, Booking.com B.V. in July 2005, Agoda in November 2007 and TravelJigsaw in May 2010.  We may enter into additional business combinations and acquisitions in the future.  Acquisitions may result in dilutive issuances of equity securities, use of our cash resources, incurrence of debt and amortization of expenses related to intangible assets acquired.  In addition, the process of integrating an acquired company, business or technology may create unforeseen operating difficulties and expenditures.  The acquisitions of Booking.com B.V., Booking.com Limited, Agoda and TravelJigsaw were accompanied by a number of risks, including, without limitation:

 

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

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

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

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

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

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

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

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

 

We may experience similar risks in connection with any future acquisitions. We may not be successful in addressing these risks or any other problems encountered in connection with the acquisitions of Booking.com B.V., Booking.com Limited, Agoda or TravelJigsaw, or that we could encounter in future acquisitions, which would harm our business or cause us to fail to realize the anticipated benefits of our acquisitions.  As of September 30, 2010, we had approximately $657.3 million assigned to the intangible assets and goodwill of Booking.com B.V., Booking.com Limited, Agoda and TravelJigsaw, and therefore, the occurrence of any of the risks identified above could result in a material adverse impact, including an impairment of these assets, which could cause us to have to record a charge for impairment.  Any such charge could adversely impact our operating results, which would likely cause our stock price to decline significantly.

 

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

 

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

 

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

 

We believe that maintaining and expanding the priceline.com and Booking.com and Agoda brands, and other owned brands, including Active Hotels, Lowestfare.com, Rentalcars.com, Breezenet.com, MyTravelGuide.com, Travelweb, hotelroom.com, TravelJigsaw and Car Hire 3000, are important aspects of our efforts to attract and expand our user and advertiser base.  As our larger competitors spend increasingly more on advertising, we are required to spend more in order to maintain our brand recognition.  In addition, we have spent considerable money and resources to date on the establishment and maintenance of the priceline.com and Booking.com and Agoda brands, and we will continue to spend money on, and devote resources to advertising, marketing and other brand building efforts to preserve and enhance consumer awareness of our brands. We may not be able to successfully maintain or enhance consumer awareness of these brands, and, even if we are successful in our branding efforts, such efforts may not be cost-effective. If we are unable to maintain or enhance customer awareness of our brands in a cost-effective manner, our business, results of operations and financial condition would be adversely affected.

 

We are exposed to various counterparty risks.

 

We are party to derivative instruments to hedge our exposure to potential dilution upon conversion of certain of our convertible senior notes.  The counterparties to our Conversion Spread Hedges are Goldman Sachs and Merrill Lynch.  Under the Conversion Spread Hedges, we are entitled to purchase from the counterparties approximately 8.5 million shares of our common stock (the number of shares underlying the 2011 Notes and the 2013 Notes) at a strike price of $40.38 per share (subject to adjustment in certain circumstances) and the counterparties are entitled to purchase from us approximately 8.5 million shares of our common stock at a strike price of $50.47 per share (subject to adjustment in certain circumstances).  The Conversion Spread Hedges increase the effective conversion price of the 2011 Notes and the 2013 Notes to $50.47 per share from our 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 our common stock at maturity is above $40.38, the Conversion Spread Hedge will entitle us to receive from the counterparties net shares of our common stock based on the excess of the then current market price of our common stock over the strike price of the hedge (up to $50.47).  If any of the counterparties to these derivative instruments were to liquidate, declare bankruptcy or otherwise cease operations, it may not satisfy its obligations under these derivative instruments.  In such event, our fully diluted share count would be increased, which would negatively impact our fully diluted earnings per share.

 

We will be subject to increased income taxes in the event that our foreign cash balances are remitted to the United States.

 

As of September 30, 2010, we held approximately $0.8 billion of cash and short-term liquid investments outside of the United States.  To date, we have used our foreign cash to reinvest in our foreign operations.  It is our current expectation to make further investments in our foreign operations with our foreign cash.  If our foreign cash balances continue to grow and our ability to reinvest those balances diminishes, it will become increasingly likely that we will repatriate some of our foreign cash balances to the United States.  In such event, we would likely be subject to additional income tax expenses in the United States with respect to our unremitted foreign earnings.  We would not incur an increase in tax payments unless we repatriate the cash and no longer have net operating loss carryforwards available to offset the taxable income.

 

In addition, on February 1, 2010, U.S. President Barack Obama proposed significant changes to the U.S. international tax laws that would limit U.S. deductions for interest expense related to un-repatriated foreign-source income and modify the U.S. foreign tax credit rules, some of which were enacted in August 2010.  We cannot determine whether all of these proposals will be enacted into law or what, if any, changes may be made to such proposals prior to their being enacted into law.  If the U.S. tax laws change in a manner that increases our tax obligation, our results could suffer.

 

Regulatory and legal uncertainties could harm our business.

 

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

 

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In addition, the strategy of Booking.com and Agoda involves rapid expansion into regions around the world, including Europe, Asia, North America, South America and elsewhere, many of which have different legislation, regulatory environments, tax laws and levels of political stability.  In September 2010, the United Kingdom’s Office of Fair Trading (“OFT”), the competition authority in the U.K., announced it was conducting a formal early stage investigation into suspected breaches of competition law in the hotel online booking sector and had written to a number of parties in the industry to request information.  Specifically, the investigation focuses upon whether there are agreements or concerted practices between hotels and online travel companies and/or hotel room reservation “wholesalers” relating to the fixed or minimum resale prices of hotel room reservations.  In September 2010, Booking.com B.V. and priceline.com Incorporated, on behalf of Booking.com, received a Notice of Inquiry from the OFT; we and Booking.com are cooperating with the OFT’s investigation.  We are unable at this time to predict the outcome of the OFT’s investigation and the impact, if any, on our business and results of operations.  Compliance with foreign legal, regulatory or tax requirements will place demands on our time and resources, and we may nonetheless experience unforeseen and potentially adverse legal, regulatory or tax consequences.

 

We face risks related to our intellectual property.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

·                  legislative or judicial action will not directly or indirectly affect the scope and validity of any of our patent rights.

 

There has been recent discussion in the press regarding the examination and issuance of so called “business method” patents. As a result, the United States Patent and Trademark Office has indicated that it intends to intensify the review process applicable to such patent applications. The new procedures are not expected to have a direct effect on patents already granted. We cannot anticipate what effect, if any, the new review process will have on our pending patent applications.  In addition, there has been recent discussion in various federal court proceedings regarding the patentability and validity of so called “business method” patents. The Court of Appeals for the Federal Circuit, in a recent order in In re Bilski, has questioned whether it should review its earlier decision affirming the patentability of so-called business method patents in State Street Bank v. Signature Financial.   We cannot anticipate what effect, if any, any new federal court decision will have on our issued patents or pending patent applications.

 

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

 

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

 

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

 

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

 

In addition, in the event that one of our major suppliers voluntarily or involuntarily declares bankruptcy, we could experience an increase in credit card chargebacks from customers with travel reservations with such supplier.  For example, airlines that participate in our system and declare bankruptcy or cease operations may be unable or unwilling to honor tickets sold for their flights.  Our policy in such event is to direct customers seeking a refund or exchange to the airline, and not to provide a remedy ourselves. Because we are the merchant-of-record on sales of Name Your Own Price® airline tickets to our customers, however, we could experience a significant increase in demands for refunds or credit card chargebacks from customers, which could materially adversely affect our operations and financial results.  For example, in April 2008, Aloha Airlines and ATA Airlines each ceased operations and we experienced an increase in credit card chargebacks from customers with tickets on those airlines.

 

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

 

In recent years, the amount of profit we make per airline ticket sold has declined and could continue to decline as we, among other things, experience pressure from suppliers to reduce our profit, strive to remain competitive with other online travel agencies and continue to be subject to reduction of global distribution system, or GDS, fees paid to us.  Historically, we have relied on fees paid to us by GDSs for travel bookings made through GDSs for a portion of our gross profit and a substantial portion of our operating income. We rebate certain GDS costs to certain suppliers (e.g., airlines, hotels, etc.) in exchange for contractual considerations such as those relating to pricing and availability, and expect to continue to do so in the future.  Suppliers put pressure on us to reduce our aggregate compensation and book through lower cost channels to receive full content and avoid penalties.  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 full content or had to impose service fees on our services, it could have a material adverse effect on our business, results of operations and financial condition.

 

Additionally, some travel suppliers are encouraging third-party travel intermediaries, such as us, to develop technology to bypass the traditional GDSs, such as enabling direct connections to the travel suppliers or using alternative global distribution methods.  Development of the technology to connect to such alternatives, or to enable direct connections to travel suppliers, requires the use of information technology resources and could cause us to incur additional operating expenses, increase the frequency/duration of system problems and delay other projects.

 

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

 

We are a party to the legal proceedings described in Note 13 to the Unaudited Consolidated Financial Statements.  The defense of the actions described in Note 13 may increase our expenses and an adverse outcome in any of such actions could have a material adverse effect on our business and results of operations.

 

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Item 3.    Quantitative and Qualitative Disclosures About Market Risk

 

We did not experience any material changes in interest rate exposures during the three months ended September 30, 2010.  Based upon economic conditions and leading market indicators at September 30, 2010, we do not foresee a significant adverse change in interest rates in the near future.

 

However, we performed a sensitivity analysis to determine the impact a change in interest rates would have on the fair value of our available for sale investments assuming an adverse change of 100 basis points.  A hypothetical 100 basis points (1.0%) increase in interest rates would have resulted in a decrease in the fair values of our investments as of September 30, 2010 of approximately $3.4 million.  These hypothetical losses would only be realized if we sold the investments prior to their maturity.

 

As of September 30, 2010, the outstanding principal amount of our debt is approximately $575 million.  We estimate that the fair value of such debt was approximately $770 million as of September 30, 2010.  A substantial portion of the fair value of our debt in excess of the outstanding principal amount is related to the conversion premium on the bonds.

 

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

 

From time to time, we enter into foreign exchange derivative contracts to minimize the impact of short-term foreign currency fluctuations on our consolidated operating results. Our derivative contracts principally address foreign exchange fluctuation risk for the Euro.  As of September 30, 2010, derivatives with a notional value of 65 million Euros are outstanding for derivative contracts that are not designated as hedging instruments.  As of December 31, 2009, there were no outstanding contracts for derivatives not designated as hedging instruments.  Foreign exchange losses of $6.2 million and $1.7 million for the three months ended September 30, 2010 and 2009, respectively, were recorded in “Foreign currency transactions and other” related to foreign exchange derivative contracts.  The fair value of derivative liabilities of $2.5 million at September 30, 2010 is recorded in “Accrued expenses and other current liabilities” in the Unaudited Consolidated Balance Sheet.  A hypothetical 10% strengthening of the foreign exchange rates relative to the U.S. Dollar, with all other variables held constant, would have resulted in a derivative liability balance of approximately $11 million.

 

As of September 30, 2010, we had outstanding forward currency and option contracts with a notional value of 353 million Euros, compared to forward currency contracts as of December 31, 2009 of 183 million Euros to hedge a portion of our net investment in a foreign subsidiary.  These contracts are all short-term in nature.  Mark-to-market adjustments on these net investment hedges are recorded as currency translation adjustments.  The fair value of these derivatives at September 30, 2010 of $16.5 million is a liability recorded in “Accrued expenses and other current liabilities” in the Unaudited Consolidated Balance Sheet.  A hypothetical 10% strengthening of the foreign exchange rates relative to the U.S. Dollar, with all other variables held constant, would have resulted in a derivative liability balance of approximately $51 million.  See Note 5 to the Unaudited Consolidated Financial Statements for further detail on our derivative instruments.

 

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

 

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Item 4.    Controls and Procedures

 

Under the supervision and with the participation of the Company’s principal executive officer and its principal financial officer, the Company conducted an evaluation of its disclosure controls and procedures, as such term is defined under Exchange Act Rule 13a-15(e).  Based on this evaluation, the Company’s principal executive officer and its principal financial officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

 

In May 2010, we acquired TravelJigsaw and, as a result of that acquisition, we intend to undertake a review of its internal controls and, if necessary, make any changes that we believe to be appropriate to those internal controls as we integrate TravelJigsaw’s business with ours.

 

There was no change in the Company’s internal control over financial reporting during the three months ended September 30, 2010 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II - OTHER INFORMATION

 

Item 1.    Legal Proceedings

 

A description of material legal proceedings to which we are a party is contained in Note 13 to our Unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for the three months ended September 30, 2010.

 

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

 

The following table sets forth information relating to repurchases of our equity securities during the three months ended September 30, 2010:

 

ISSUER PURCHASES OF EQUITY SECURITIES

 

Period

 

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

 

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

 

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

 

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

 

July 1, 2009 – July 31, 2009

 

 

 

 

$
$
$

44,866,000
20,447,000
393,917,000

(1)
(2)
(3)

 

 

 

 

 

 

 

 

 

 

August 1, 2009 – August 31, 2009

 

778

(4)

$

296.45

 

 

 

$
$
$

44,866,000
20,447,000
393,917,000

(1)
(2)
(3)

 

 

 

 

 

 

 

 

 

 

September 1, 2009 – September 30, 2009

 

 

 

 

$
$
$

44,866,000
20,447,000
393,917,000

(1)
(2)
(3)

 

 

 

 

 

 

 

 

 

 

Total

 

778

 

$

296.45

 

 

$

459,230,000

 

 


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

 

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

 

(3)          Pursuant to a stock repurchase program announced on March 4, 2010, whereby the Company was authorized to repurchase up to $500,000,000 of its common stock.

 

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

 

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Table of Contents

 

Item 6.  Exhibits

 

The exhibits listed below are filed as part of this Quarterly Report on Form 10-Q.

 

Exhibit
Number

 

Description

 

 

 

31.1

 

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

31.2

 

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

32.1

 

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

32.2

 

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

101

 

The following materials from the Company’s Quarterly Report on Form 10-Q for the three months ended September 30, 2010 are furnished herewith, formatted in XBRL (Extensible Business Reporting Language): (i) Unaudited Consolidated Balance Sheets, (ii) Unaudited Consolidated Statements of Operations, (iii) Unaudited Consolidated Statements of Cash Flows, and (iv) Notes to Unaudited Consolidated Financial Statements, tagged as blocks of text.

 

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Table of Contents

 

SIGNATURES

 

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

 

 

 

PRICELINE.COM INCORPORATED
                       (Registrant)

 

 

 

 

 

 

Date: November 9, 2010

By:

/s/ Daniel J. Finnegan

 

 

Name:

Daniel J. Finnegan

 

 

Title:

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

 

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Table of Contents

 

Exhibit Index

 

Exhibit
Number

 

Description

 

 

 

31.1

 

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

31.2

 

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

32.1

 

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

32.2

 

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

101

 

The following materials from the Company’s Quarterly Report on Form 10-Q for the three months ended September 30, 2010 are furnished herewith, formatted in XBRL (Extensible Business Reporting Language): (i) Unaudited Consolidated Balance Sheets, (ii) Unaudited Consolidated Statements of Operations, (iii) Unaudited Consolidated Statements of Cash Flows, and (iv) Notes to Unaudited Consolidated Financial Statements, tagged as blocks of text.

 

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