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 June 30, 2004
	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)

 

 

800 Connecticut Avenue

Norwalk, Connecticut 06854

(address of principal executive offices)

(203) 299-8000

(Registrant’s telephone number, including area code)

N/A

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

 

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act. YES x  NO o.

Number of shares of Common Stock outstanding at August 6, 2004:

 

 

priceline.com Incorporated
Form 10-Q
For the Quarter Ended June 30, 2004

PART I—FINANCIAL INFORMATION
Item 1. Consolidated Condensed Financial Statements
Consolidated Balance Sheets (unaudited) at June 30, 2004 and December 31, 2003		3
Consolidated Statements of Operations (unaudited) For the Three and Six Months Ended June 30, 2004 and 2003		4
Consolidated Statement of Changes in Stockholders’ Equity (unaudited) For the Six Months Ended June 30, 2004		5
Consolidated Statements of Cash Flows (unaudited) For the Six Months Ended June 30, 2004 and 2003		6
Notes to Unaudited Consolidated Financial Statements		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		21
Item 3. Quantitative and Qualitative Disclosures About Market Risk		47
Item 4. Controls and Procedures		47
PART II—OTHER INFORMATION
Item 1. Legal Proceedings		48
Item 4. Submission of Matters to a Vote of Security Holders		48
Item 6. Exhibits and Reports on Form 8-K		49
SIGNATURES		50

 

2

PART I—FINANCIAL INFORMATION

Item 1.   Consolidated Condensed Financial Statements

priceline.com Incorporated
CONSOLIDATED BALANCE SHEETS
(unaudited)
(In thousands, except share data)

		June 30,			December 31,
		2004			2003
ASSETS
Current assets:
Cash and cash equivalents		$	156,306		$	93,732
Restricted cash		23,502			22,485
Short-term investments		206,360			151,736
Accounts receivable, net of allowance for doubtful accounts of $1,038 and $794, respectively		23,733			10,782
Prepaid expenses and other current assets		6,156			4,778
Total current assets		416,057			283,513
Property and equipment, net		15,474			16,524
Intangible assets, net		13,570			7,053
Goodwill		32,837			8,779
Other assets		16,674			21,915
Total assets		$	494,612		$	337,784
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	49,380		$	25,061
Accrued expenses		22,414			21,031
Deferred merchant bookings		8,867			—
Other current liabilities		3,340			3,522
Total current liabilities		84,001			49,614
Other long-term liabilities		2,029			1,069
Minority interest		691			—
Long-term debt, net		223,348			124,524
Total liabilities		310,069			175,207
Commitments and Contingencies (See Note 16)
Series B Mandatorily Redeemable Preferred Stock, $0.01 par value per share; 80,000 authorized shares; $1,000 liquidation value per share; 80,000 shares issued; 13,470 and 13,470 shares outstanding, respectively		13,470			13,470
Stockholders’ equity:
Common stock, $0.008 par value per share, authorized 1,000,000,000 shares, issued 41,244,265 and 40,103,374 shares, respectively		315			306
Treasury stock, 2,496,326 shares and 2,496,326 shares, respectively		(350,628		)	(350,628		)
Additional paid-in capital		2,062,613			2,055,607
Deferred compensation		(1,516		)	(1,408		)
Accumulated deficit		(1,539,712		)	(1,555,444		)
Accumulated other comprehensive income		1			674
Total stockholders’ equity		171,073			149,107
Total liabilities and stockholders’ equity		$	494,612		$	337,784

 

See Notes to Unaudited Consolidated Financial Statements.

3

priceline.com Incorporated
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(In thousands, except per share data)

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Merchant revenues		$	249,860		$	236,943		$	466,871		$	435,551
Agency revenues		8,747			1,476			15,195			2,481
Other revenues		782			1,147			1,454			2,021
Total revenues		259,389			239,566			483,520			440,053
Cost of merchant revenues		205,610			199,072			386,367			366,572
Cost of agency revenues		—			—			—			—
Cost of other revenues		—			—			—			—
Total costs of revenues		205,610			199,072			386,367			366,572
Gross profit		53,779			40,494			97,153			73,481
Operating expenses:
Advertising		16,366			10,774			31,771			21,872
Sales and marketing		9,096			7,790			15,802			14,653
Personnel		7,783			7,546			16,018			15,059
General and administrative, including option payroll taxes of $298 and $102 for the three months ended June 30, 2004 and 2003 and $338 and $102 for the six months ended June 30, 2004 and 2003, respectively		4,454			2,744			7,963			5,563
Information technology		2,455			2,604			4,969			4,971
Depreciation and amortization		2,565			2,787			4,785			6,699
Stock based compensation		112			70			218			70
Restructuring charge/(reversal)		(12		)	—			(12		)	—
Warrant costs		—			—			—			6,638
Total operating expenses		42,819			34,315			81,514			75,525
Operating income (loss)		10,960			6,179			15,639			(2,044		)
Other income:
Interest income		1,029			427			2,139			942
Interest expense		(566		)	(22		)	(1,132		)	(45		)
Equity in income (loss) of investees, net		(35		)	1,105			(161		)	1,105
Other		13			—			19			—
Total other income		441			1,510			865			2,002
Net income (loss)		11,401			7,689			16,504			(42		)
Preferred stock dividend		—			—			(772		)	(297		)
Net income (loss) applicable to common stockholders		$	11,401		$	7,689		$	15,732		(339		)
Net income (loss) applicable to common stockholders per basic common share		$	0.30		$	0.20		$	0.42		$	(0.01	)
Weighted average number of basic common shares outstanding		38,076			37,635			37,822			37,556
Net income (loss) applicable to common stockholders per diluted common share		$	0.29		$	0.20		$	0.41		$	(0.01	)
Weighted average number of diluted common shares outstanding		39,932			39,284			37,788			37,556

 

See Notes to Unaudited Consolidated Financial Statements.

4

priceline.com Incorporated
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2004
(unaudited)
(In thousands)

		Common Stock							Additional					Accumulated					Accumulated Other Comprehensive					Treasury Stock					Deferred
		Shares		Amount					Paid-in Capital					Deficit					Income					Shares		Amount			Compensation					Total
Balance, January 1, 2004		40,103			$	306				$	2,055,607				$	(1,555,444	)			$	674			(2,496	)	$	(350,628	)		$	(1,408	)		$	149,107
Net income applicable to common stockholders		—			—					—					15,732					—				—		—				15,732
Unrealized (loss) on marketable securities		—			—					—					—					(728		)		—		—				—				(728		)
Currency translation adjustment		—			—					—					—					55				—		—				—				55
Comprehensive income		—			—					—					—					—				—		—				—				15,059
Issuance of common stock under deferred compensation plan		12			—					326					—					—				—		—				(326		)		—
Amortization of deferred compensation		—			—					—					—					—				—		—				218				218
Issuance of preferred stock dividend		40			1					771					—					—				—		—				—				772
Exercise of options		1,089			8					5,909					—					—				—		—				—				5,917
Balance, June 30, 2004		41,244			$	315				$	2,062,613				$	(1,539,712	)			$	1			(2,496	)	$	(350,628	)		$	(1,516	)		$	171,073

 

See Notes to Unaudited Consolidated Financial Statements.

 

priceline.com Incorporated
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(In thousands)

		Six Months Ended June 30,
		2004			2003
OPERATING ACTIVITIES:
Net income (loss)		$	16,504		$	(42	)
Adjustments to reconcile net income/(loss) to net cash provided by operating activities:
Depreciation		2,294			6,505
Amortization		3,320			194
Provision for uncollectible accounts, net		582			1,680
Warrant costs		—			6,638
Equity in loss (income) of investees, net		161			(1,105		)
Net gain on disposal of property and equipment		(6		)	—
Compensation expense arising from restricted stock awards		218			70
Amortization of debt issuance costs		432			—
Changes in assets and liabilities:
Accounts receivable		(13,036		)	(11,609		)
Prepaid expenses and other current assets		(1,346		)	(1,810		)
Accounts payable and accrued expenses		11,626			6,527
Other		80			919
Net cash provided by operating activities		20,829			7,967
INVESTING ACTIVITIES:
Additions to property and equipment		(2,502		)	(1,588		)
Proceeds from sales of fixed assets		7			—
Maturities of/(investment in) short-term investments/marketable securities, net		(55,352)			1,162
Change in restricted cash and bank certificate of deposit		146			1,379
Equity investment and other acquisitions, net of cash acquired		(3,485		)	(11,686		)
Net cash (used in) investing activities		(61,186		)	(10,733		)
FINANCING ACTIVITIES:
Proceeds from issuance of convertible senior notes		100,000			—
Proceeds from exercise of stock options and warrants		5,917			4,677
Debt issuance costs		(3,055		)	—
Net cash provided by financing activities		102,862			4,677
Effect of exchange rate changes on cash and cash equivalents		69			199
Net increase in cash and cash equivalents		62,574			2,110
Cash and cash equivalents, beginning of period		93,732			67,182
Cash and cash equivalents, end of period		$	156,306		$	69,292
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during period for interest		$	702		$	45

6

See Notes to Unaudited Consolidated Financial Statements.

6

priceline.com Incorporated
Notes to Unaudited Consolidated Financial Statements

1.   BASIS OF PRESENTATION

Priceline.com Incorporated (“priceline.com” or the “Company”) is responsible for the consolidated financial statements included in this document. The 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 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, 2003.

The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiary, priceline.com Europe Holdings N. V., and  it’s majority-owned subsidiary, Travelweb LLC. All significant intercompany accounts and transactions have been eliminated. Investments in affiliates in which the Company does not have control, but has the ability to exercise significant influence, are accounted for by the equity method.

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

2.   ACQUISITION OF TRAVELWEB

In May 2004, Lowestfare.com, a wholly-owned subsidiary of priceline.com Incorporated (the “Company”), acquired 71.4% of the equity interest in Travelweb LLC, a Delaware limited liability company owned by Marriott International, Inc. (“Marriott”), Hilton Hotels Corporation (“Hilton”), Hyatt Corporation (“Hyatt”), Starwood Hotels & Resorts Worldwide, Inc. (“Starwood”), InterContinental Hotels Group (“InterContinental”) and Pegasus Solutions, Inc. (“Pegasus”), or their affiliates. Travelweb is a full-service, automated hotel distribution network founded by Marriott, Hilton, Hyatt, Starwood, Pegasus and InterContinental. The equity interests acquired were all but those held by InterContinental. The Company entered into an agreement with InterContinental whereby the Company may acquire those interests at a future date.

The purchase price for the interests acquired was $20.8 million, which the Company paid in cash; in addition, the Company will potentially pay an earn-out after 12 months of approximately 954,547 shares of its common stock to the sellers in the event certain performance goals are met.

The purchase price for the equity interests in Travelweb was determined through arms’ length negotiations between management of the Company on the one hand and Travelweb members on the other hand. Prior to the acquisition, Lowestfare.com owned 14.3% of the equity interest in Travelweb, and Jeffery Boyd, a director of the Company and its Chief Executive Officer and President, was a member of the board of directors of Travelweb. Jeffery Boyd is also a member of the board of directors of Lowestfare.com and its Chief Executive Officer. All of Travelweb’s founding hotel chains also participate in the Company’s Name Your Own Price^® hotel service.

The acquisition increased Lowestfare.com’s total ownership of Travelweb to 85.7%. The aggregate purchase price for Travelweb to date is $28.2 million, consisting of $20.8 million paid in cash in May 2004, the Company’s pre-acquisition investment in Travelweb and direct acquisition costs.

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The acquisition has been accounted for as a purchase business combination. The Company’s consolidated financial statements and results of operations include the consolidated accounts of Travelweb since the acquisition of the additional 71.4% in May 2004. Prior to the May 2004 acquisition, the Company accounted for its investment in Travelweb under the equity method of accounting. Under the purchase method of accounting, the proportion of the assets acquired and liabilities assumed from Travelweb are recorded at the date of acquisition, at their respective estimated fair values. The acquisition cost, including transaction costs, is allocated to the underlying net assets of Travelweb in proportion to their respective estimated fair values. The Company obtained a preliminary independent valuation of the assets acquired and liabilities assumed, including the identification of intangible assets other than goodwill. The excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill.

In connection with the acquisition, the Company expects to incur costs of approximately $2.5 million for severance and contract terminations related to the acquired business. The Company has identified and notified the affected Travelweb personnel and vendors. Such exiting costs are expected to be paid out in cash and $147,000 was paid as of June 30, 2004.

The proportionate fair value of assets acquired and liabilities assumed amounted to approximately $23.8 million and $19.7 million, respectively. Assets acquired consisted principally of cash and intangible assets. Liabilities assumed consisted principally of accounts payable, accrued expenses and deferred merchant bookings. Goodwill resulting from this transaction amounted to approximately $24.1 million.

A preliminary list of the estimated fair value and useful lives of acquired identifiable intangible assets with determinable useful lives is as follows:

		($ in thousands)					Useful Lives (months)
Distribution agreement			$	1,618				20
Supply agreements			2,987					32
Customer list			550					24
Other			183					14-26
Total			$	5,338

 

The following unaudited pro forma financial information presents the combined results of operations of the priceline.com and Travelweb as if the acquisition had occurred as of the beginning of the periods presented. These statements include certain one-time purchase accounting entries and are not necessarily indicative of the actual results of operations that might have occurred, nor are they necessarily indicative of expected results in the future.

		Three Months Ended						Six Months Ended
		June 30, 2004			June 30, 2003			June 30, 2004			June 30, 2003
		(unaudited)						(unaudited)
		(in thousands, except per common share amounts)
Revenues		$	261,345		$	244,363		$	490,795		$	447,674
Net income		10,192			5,303			12,523			(4,456		)
Per share amounts:
Net income (loss) per common share—basic		$	.27		$	.14		$	.33		$	(.12	)
Net income (loss) per common share—diluted		$	.26		$	.13		$	.32		$	(.12	)

 

3.   TRAVELWEB REVENUE RECOGNITION AND DEFERRED MERCHANT BOOKINGS

Merchant revenues for Travelweb are derived from transactions where it sells hotel rooms on the Internet at rates which are subject to contractual limitations. Charges for hotel accommodations are billed to customers in advance at the time of booking and are included in Deferred Merchant Bookings until the

8

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customer completes his stay. Such amounts are generally refundable upon cancellation prior to stay. Merchant revenues and accounts payable to the hotel supplier are recognized at the conclusion of the customer’s stay at the hotel. Travelweb records the difference between the selling price and the cost of the hotel room as merchant revenue.

4.   STOCK BASED EMPLOYEE COMPENSATION

The following table summarizes relevant information as to reported results under the Company’s APB Opinion No. 25 method of accounting for stock options with supplemental information as if the fair value recognition provisions of SFAS No. 123, “Accounting for Stock Based Compensation,” had been applied (in thousands, except per share amounts):

		For the Three Months  Ended June 30,						For the Six Months  Ended June 30,
		2004			2003			2004			2003
Net income (loss) applicable to common stockholders, as reported		$	11,401		$	7,689		$	15,732		$	(339	)
Add: Stock based compensation, as reported		112			70			218			70
Deduct: Total stock based compensation determined under fair value based method for all stock based compensation		(2,680		)	(7,218		)	(5,005		)	(14,272		)
Adjusted net income (loss), fair value method for all stock based compensation		$	8,833		$	541		$	10,945		$	(14,541	)
Net income (loss) applicable to common stockholders per basic common share, as reported		$	0.30		$	0.20		$	0.42		$	(0.01	)
Net income (loss) applicable to common stockholders per diluted common share, as reported		$	0.29		$	0.20		$	0.41		$	(0.01	)
Basic income (loss) per share, pro forma		$	0.23		$	0.01		$	0.29		$	(0.39	)
Diluted income (loss) per share, pro forma		$	0.22		$	0.01		$	0.28		$	(0.39	)

 

The fair value of stock options granted was determined on the date of grant using the Black-Scholes option-pricing model, assuming no expected dividends and the following weighted average assumptions:

		For the Three Months Ended June 30,				For the Six Months Ended June 30
		2004		2003		2004		2003
Risk-free interest rate		2.8	%	2.2	%	2.8	%	2.2	%
Expected lives		3 years		3 years		3 years		3 years
Volatility		95	%	97	%	95	%	97	%

 

5.   NET INCOME (LOSS) PER SHARE

The Company computes basic and diluted earnings per share in accordance with SFAS No. 128, “Earnings per Share.”  SFAS No. 128 requires the Company to report both basic earnings per share, which is based on the weighted average number of common shares outstanding, and diluted earnings per share, which is based on the weighted average number of common shares outstanding and all potential dilutive common shares outstanding.

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For purposes of calculating basic and diluted earnings per share, we used the following weighted average shares outstanding (in thousands):

		For the Three Months  Ended June 30,				For the Six Months  Ended June 30,
		2004		2003		2004		2003(1)
Weighted average common shares
Basic		38,076		37,635		37,822		37,556
Diluted		39,932		39,284		38,778		37,556
Potential dilutive common shares		5,068		1,649		4,881		—
Anti-dilutive potential common shares		7,360		5,288		7,504		6,903

(1)          Since the Company incurred a loss for the six months ended June 30, 2003, the inclusion of stock options and warrants in the calculation of weighted average common shares was anti-dilutive; and therefore there was no difference between basic and diluted weighted average shares outstanding.

6.   RECENT ACCOUNTING PRONOUNCEMENTS

In January 2003, the FASB issued FASB Interpretation (“FIN”) No. 46, “Consolidation of Variable Interest Entities”. In December 2003, the FASB issued FIN No. 46 (Revised) (“FIN 46-R”) to address certain FIN 46 implementation issues. As the Company has no variable interest entities, the adoption of these pronouncements had no effect on the Company’s consolidated financial statements.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS 149 amends and clarifies the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS 149 is generally effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The Company has limited involvement with derivative financial instruments and does not use them for trading or speculative purposes. As of June 30, 2004, the Company’s only derivative financial instrument is an interest rate hedge agreement in relation to $45 million of the outstanding borrowings of the Convertible Senior Notes. The adoption of SFAS No. 149 on July 1, 2003, as required, had no impact on the Company’s consolidated financial statements.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company adopted the new standard on July 31, 2003, with no effect on the Company’s consolidated financial statements.

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7.   RESTRUCTURING

At June 30, 2004, the restructuring liability consisted of estimated remaining severance, real estate costs and professional fees related to the Company’s 2000 and 2002 restructuring activities. A roll forward of the Company’s restructuring obligation is as follows (in thousands):

Accrued at January 1, 2004		$	1,555
Currency translation adjustment		6
Disbursed during 2004		(432		)
Accrued at June 30, 2004		$	1,129
At June 30, 2004:
Current portion		$	863
Long-term portion		$	266

 

8.   SHORT-TERM INVESTMENTS

Short-term investments consist of investments with maturities exceeding three months. The Company accounts for marketable securities in accordance with Statement of Financial Accounting Standard (SFAS) No. 115, “Accounting for Certain Investments in Debt and Equity Securities”. All marketable securities are classified as available-for-sale and are reported at fair value with unrealized gains and losses included in “Accumulated Other Comprehensive Income” on the Consolidated Balance Sheet and Statement of Changes in Stockholders’ Equity. The Company recorded an unrealized loss of approximately $728,000 for the six months ended June 30, 2004. The specific-identification method is used to determine the cost of all securities. The marketable securities are presented as current assets in the accompanying Consolidated Balance Sheets, as they are available to meet the short-term working capital needs of the Company.

The fair value of the investments is based on the quoted market price of the securities at the balance sheet dates. Investments are considered to be impaired when a decline in fair value is judged to be other than temporary. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded and a new cost basis in the investment is established.

The following table summarizes, by major security type, the Company’s marketable securities as of June 30, 2004 (in thousands):

		Cost			Gross  Unrealized  Gains (Loss)  (net)					Estimated Fair Value
Commercial Paper		$	52,830			$	3			$	52,833
Corporate Notes		19,916				(114		)		19,802
U.S. Government Agency—Securities		76,198				(334		)		75,864
U.S. Government Agency—Discount Notes		50,258				14				50,722
Adjustable Rate Mortgages (ARM’s)		7,633				(44		)		7,589
Total		$	206,835			$	(475	)		$	206,360

 

Contractual maturities of marketable securities classified as available-for-sale as of June 30, 2004 are as follows (in thousands):

		Cost			Estimated  Fair Value
Due within one year		$	116,173		$	116,184
Due between one year and two years		90,662			90,176
Totals		$	206,835		$	206,360

 

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No significant gains or losses were realized for the three and six months ended June 30, 2004.

9.   INTANGIBLE ASSETS

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

					June 30, 2004															December 31, 2003
			Amortization Period		Gross   Carrying   Amount					Accumulated Amortization					Net   Carrying   Amount					Gross   Carrying   Amount				Accumulated Amortization					Net   Carrying   Amount
Intangible assets with determinable lives:
Patents			3-15 years			$	1,435				$	(932	)			$	503				$1,435				$	(896	)			$	539
Technology			3 years			1,200					(250		)			950					1,200				(50		)			1,150
Distribution Agreement			20 Months			1,618					(162		)			1,456					—				—					—
Supplier Agreements			32 Months			2,987					(187		)			2,800					—				—					—
Customer Lists			2 years			550					(73		)			477					—				—					—
Other			1-15 years			636					(217		)			419					528				(224		)			304
Sub total:						8,426					(1,821		)			6,605					3,163				(1,170		)			1,993
Domain names with indefinite lives						6,965					—					6,965					5,060				—					5,060
Total intangible assets:						$	15,391				$	(1,821	)			$	13,570				$8,223				$	(1,170	)			$	7,053

 

12

Intangible assets with determinable lives are primarily amortized on a straight-line basis. Intangible assets amortization expense was approximately $509,000 and $100,000 for the three months ended June 30, 2004 and 2003, respectively and approximately $651,000 and $194,000 for the six months ended June 30, 2004 and 2003.

The estimated amortization expense for the amortizable acquired intangible assets for the remainder of 2004 and years thereafter is expected to be as follows (in thousands):

2004		$	1,603
2005		2,936
2006		1,593
2007		47
2008		47
Thereafter		379
		$6,605

 

10.   OTHER ASSETS

Other assets at June 30, 2004 and December 31, 2003 consist of the following (in thousands):

		June 30, 2004					December 31, 2003
Investment in pricelinemortgage			$	9,834				$	9,421
Investment in Travelweb LLC			—					7,933
Deferred debt issuance costs			6,544					3,921
Other			296					640
Total			$	16,674				$	21,915

 

Investment in pricelinemortgage represents the Company’s 49% equity investment in Priceline Mortgage Company, LLC dba pricelinemortgage and, accordingly, the Company recognizes its pro rata share of pricelinemortgage’s operating results, not to exceed an amount that the Company believes represents the investments’ estimated fair value. The Company recognized approximately $220,000 and $413,000 of income from its investment in pricelinemortgage for the three and six months ended June 30, 2004, respectively, and approximately $1.3 million for each of the three and six months ended June 30, 2003. The Company earned advertising fees from pricelinemortgage of approximately $22,000 and $197,000 for the three months June 30, 2004 and 2003, respectively, and approximately $79,000 and $401,000 for the six months June 30, 2004 and 2003, respectively.

Deferred debt issuance costs arose from the Company’s issuance of $125 million aggregate principal amount of 1% Convertible Senior Notes due August 1, 2010 and the issuance of $100 million aggregate principal amount of 2.25% Convertible Senior Notes due January 15, 2025. Deferred debt issuance costs of originally $7.3 million, consisting primarily of underwriting commissions and professional service fees, are being amortized using the effective interest rate method over approximately five year periods.

11.   CONVERTIBLE DEBT

In August 2003, the Company issued, in a private placement, $125 million aggregate principal amount of Convertible Senior Notes due August 1, 2010, with an interest rate of 1%. The Company used the net proceeds of the offering for general corporate purposes, strategic purposes and working capital requirements. The notes are convertible, subject to certain conditions, into priceline.com’s common stock, par value $0.008 per share, at the option of the holder, at a conversion price of approximately $40.00 per share, subject to adjustment upon the occurrence of specified events. Each $1,000 principal amount of notes will initially be convertible into 25 shares of the Company’s common stock if, on or prior to August 1,

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2008, if the closing price of the Company’s common stock for at least 20 trading days in the 30 consecutive trading days ending on the first day of a conversion period is more than 110% of the then current conversion price of the notes, or after August 1, 2008, the closing price of the Company’s common stock is more than 110% of the then current conversion price of the notes. The notes are also convertible in certain other circumstances, such as a change in control of the Company. In addition, the notes will be redeemable at the Company’s option beginning in 2008, and the holders may require the Company to repurchase the notes on August 1, 2008 or in certain other circumstances. Interest on the notes is payable on February 1 and August 1 of each year.

In November 2003, the Company entered into an interest rate swap agreement whereby it swapped the fixed 1% interest on its Convertible Senior Notes due August 1, 2010 for a floating interest rate based on the 3-month U.S. Dollar LIBOR, minus the applicable margin of approximately 221 basis points, on $45 million notional value of debt. This agreement expires August 1, 2010. The Company designated this interest rate swap agreement as a fair value hedge. The changes in the fair value of the interest rate swap agreement and the underlying debt are recorded as offsetting gains and losses in interest income and expense in the Consolidated Statement of Operations. Hedge ineffectiveness of approximately $78,000 was recorded as a reduction of interest income for the three months ended June 30, 2004. The fair value (cost if terminated) of this swap as of June 30, 2004 was approximately $1.8 million and has been recorded in other long-term liabilities and as an adjustment to the carrying value of debt.

In June 2004, the Company issued, in a private placement, $100 million aggregate principal amount of Convertible Senior Notes due January 15, 2025, with an interest rate of 2.25%. The Company used the net proceeds of the offering for general corporate purposes, strategic purposes and working capital requirements. The notes are convertible, subject to certain conditions, into priceline.com’s common stock, par value $0.008 per share, at the option of the holder, at a conversion price of approximately $37.95 per share, subject to adjustment upon the occurrence of specified events. Each $1,000 principal amount of notes will initially be convertible into 26.3505 shares of the Company’s common stock if, on or prior to January 15, 2025, certain conditions occur. The notes are also convertible in certain other circumstances, such as a change in control of the Company. In the event substantially all of the Company’s common stock is acquired prior to January 15, 2010, for substantially all cash, the Company could be required to make additional payments to the holders of amounts ranging from $0 to $19.1 million depending upon the date of the transaction and the then current stock price of the Company. In addition, the notes will be redeemable at the Company’s option beginning January 20, 2010, and the holders may require the Company to repurchase the notes on January 15, 2010, 2015 and 2020, or in certain other circumstances. Interest on the notes is payable on January 15 and July 15 of each year.

12.   TREASURY STOCK

On July 31, 2002, the Company’s Board of Directors authorized the repurchase of up to $40 million of the Company’s common stock from time to time in the open market or in privately negotiated transactions. As part of the stock repurchase program, the Company purchased 897,953 shares of its common stock for its treasury during the period ended December 31, 2002 at an aggregate cost of approximately $11.8 million and purchased an additional 690,000 shares of its common stock for its treasury during the year ended December 31, 2003 at an aggregate cost of approximately $12.2 million. All shares were purchased at prevailing market prices.

The Company may continue or, from time to time, commence or suspend repurchases of shares under its stock repurchase program, depending on prevailing market conditions, alternate uses of capital and other factors. Whether and when to initiate and/or complete any purchase of common stock and the amount of common stock purchased will be determined in the Company’s complete discretion.

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As of June 30, 2004, there were approximately 2.5 million shares of the Company’s common stock held in treasury.

13.   REDEEMABLE PREFERRED STOCK

In February 2004 and 2003, the Company issued Delta Air Lines, Inc. a dividend on the Series B Redeemable Preferred Stock in the amount of 40,240 shares of the Company’s common stock. As a result, the Company recorded a non-cash dividend of approximately $772,000 and $297,000 in the first quarter of 2004 and 2003, respectively.

14.   MARRIOTT WARRANTS

In March 2003, in connection with the renewal of a marketing agreement with Marriott International, Inc., (“Marriott”) the Company issued Marriott 833,333 warrants to purchase shares of the Company’s common stock at an exercise price of $9.84 per share. The warrants, which are not transferable, are fully vested, non-forfeitable, and will be exercisable no earlier than three years from the date of issuance (subject to certain limited exceptions in the event of a reorganization, recapitalization, merger or consolidation involving priceline.com). In connection with the issuance of the warrants, the Company recorded a charge of approximately $6.6 million in the first quarter of 2003 determined by using an option pricing model.

15.   TAXES

For the six months ended June 30, 2004 and 2003, the Company has recorded no provision for income taxes due to cumulative losses through 2002 and the availability of previously fully reserved net operating losses which have been utilized to offset the income tax provision.

16.   COMMITMENTS AND CONTINGENCIES

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

Subsequent to the Company’s announcement on September 27, 2000 that revenues for the third quarter 2000 would not meet expectations, it was served with the following putative class action complaints:

Weingarten v. priceline.com Incorporated
and Jay S. Walker
3:00 CV 1901 (District of Connecticut).

Twardy v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 1884 (District of Connecticut).

Berdakina v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 1902 (District of Connecticut).

Mazzo v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 1924 (District of Connecticut).

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Fialkov v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 1954 (District of Connecticut).

Ayach v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 2062 (District of Connecticut).

Zia v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 1968 (District of Connecticut).

Mazzo v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 1980 (District of Connecticut).

Bazag v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 2122 (District of Connecticut).

Breier v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 2146 (District of Connecticut).

Farzam et al. v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 2176 (District of Connecticut).

Caswell v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 2169 (District of Connecticut).

Howard Gunty Profit Sharing Plan v. priceline.com Inc.
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 1917 (District of Connecticut).

Cerelli v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 1918 (District of Connecticut).

Mayer v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 1923 (District of Connecticut).

Anish v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 1948 (District of Connecticut).

Atkin v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 1994 (District of Connecticut).

Lyon v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 2066 (District of Connecticut).

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Kwan v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 2069 (District of Connecticut).

Krim v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 2083 (District of Connecticut).

Karas v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 2232 (District of Connecticut).

Michols v. priceline.com Inc.,
Richard S. Braddock, Daniel H. Schulman and Jay S. Walker
3:00 CV 2280 (District of Connecticut).

All of these cases have been assigned to Judge Dominick J. Squatrito. On September 12, 2001, Judge Squatrito ordered that these cases be consolidated under the Master File No. 3:00cv1884 (DJS), and he designated lead plaintiffs and lead plaintiffs’ counsel. On October 29, 2001, plaintiffs served a Consolidated Amended Complaint. On February 5, 2002, Amerindo Investment Advisors, Inc., who is one of the lead plaintiffs in the consolidated action, made a motion for leave to withdraw as lead plaintiff. The court has yet to rule on that motion. On February 28, 2002, the Company filed a motion to dismiss the Consolidated Amended Complaint. That motion has been fully briefed. The Court has yet to rule on that motion. On July 26 and August 1, 2002, the Court issued scheduling orders concerning pretrial proceedings. The Company intends to defend vigorously against this action. The Company is unable to predict the outcome of these suits or reasonably estimate a range of possible loss, if any.

In addition, on November 1, 2000 the Company was served with a complaint that purported to be a shareholder derivative action against its Board of Directors and certain of its current and former executive officers, as well as the Company (as a nominal defendant). The complaint alleged breach of fiduciary duty and waste of corporate assets. The action is captioned Mark Zimmerman v. Richard Braddock, J. Walker, D. Schulman, P. Allaire, R. Bahna, P. Blackney, W. Ford, M. Loeb, N. Nicholas, N. Peretsman, and priceline.com Incorporated, 18473-NC (Court of Chancery of Delaware, County of New Castle, State of Delaware). On February 6, 2001, all defendants moved to dismiss the complaint for failure to make a demand upon the Board of Directors and failure to state a cause of action upon which relief can be granted. Pursuant to a stipulation by the parties, an amended complaint was filed on June 21, 2001. Defendants renewed their motion to dismiss on August 20, 2001, and plaintiff served his opposition to that motion on October 26, 2001. Defendants filed their reply brief on January 7, 2002. On December 20, 2002, the Court granted defendants’ motion without prejudice. On April 25, 2003, a second amended complaint, adding H. Miller, was filed and a motion seeking leave of court to file the second amended complaint was filed on July 28, 2003. That motion has been fully briefed. The Court has yet to rule on the motion. The Company intends to defend vigorously against this action. The Company is unable to predict the outcome of the suit or reasonably estimate a range of possible loss, if any.

On March 16, March 26, April 27, and June 5, 2001, respectively, four putative class action complaints were filed in the U.S. District Court for the Southern District of New York naming priceline.com, Inc., Richard S. Braddock, Jay Walker, Paul Francis, Morgan Stanley Dean Witter & Co., Merrill Lynch, Pierce, Fenner & Smith, Inc., BancBoston Robertson Stephens, Inc. and Salomon Smith Barney, Inc. as defendants (01 Civ. 2261, 01 Civ. 2576, 01 Civ. 3590 and 01 Civ. 4956). Shives et al. v. Bank of America Securities LLC et al., 01 Civ. 4956, also names other defendants and states claims unrelated to the Company. The complaints allege, among other things, that priceline.com and the individual defendants violated the federal securities laws by issuing and selling priceline.com common stock in priceline.com’s March 1999 initial public offering without disclosing to investors that some of the underwriters in the

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

On November 7, 2003, the Company was served with a complaint that purported to be a shareholder derivative action against its Board of Directors and certain of its current and former executive officers, as well as the Company (as a nominal defendant). The complaint alleged, among other things, breach of fiduciary duty, waste of corporate assets and misappropriation of corporate information. The claims in the complaint appear to be substantially repetitive of the claims pending in the derivative action in Delaware described above. The action is captioned Don Powell v. Richard S. Braddock, Jay S. Walker, Daniel H. Schulman, Paul A. Allaire, Ralph M. Bahna, Paul J. Blackney, William E. Ford, Marshall Loeb, N. J. Nicholas, Jr., Nancy B. Peretsman, and Heidi G. Miller and priceline.com Incorporated (Superior Court, Judicial District of Stamford/Norwalk, State of Connecticut). On January 28, 2004, defendants Blackney, Nicholas, Peretsman and Loeb moved to dismiss the complaint for lack of personal jurisdiction. On January 29, 2004, defendant Miller moved to dismiss the complaint for lack of personal jurisdiction and for insufficient service of process. On February 27, 2004, defendants Braddock, Walker, Schulman, Allaire,

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Bahna, Blackney, Loeb, Nicholas, Peretsman, Miller and priceline.com moved to dismiss the complaint for lack of subject matter jurisdiction and defendants Braddock and Schulman also moved to dismiss the complaint for lack of personal jurisdiction and insufficient service of process. At a hearing on May 3, 2004, the Court stated that it would not rule on the pending motions until the pending motions in the Delaware action described above are decided. The Court also scheduled a status conference for September 13, 2004. The Company intends to defend vigorously against this action. The Company is unable to predict the outcome of this suit or reasonably estimate a range of possible loss, if any.

On November 24, 2003, the Company was served with a complaint for patent infringement captioned IMX, Inc. v. E-Loan, Inc., InteractiveCorp, LendingTree, Inc. and priceline.com Incorporated. The complaint alleges, among other things, that the Company has infringed, induced others to infringe and/or committed acts of contributory infringement of U.S. Patent number 5,995,947 entitled “Interactive Mortgage and Loan Information and Real-Time Trading Systems.”  The complaint seeks injunctive relief; unspecified money damages; an order directing defendants to pay IMX’s costs and attorneys’ fees; and an award of pre-and post-judgment interest. The Company intends to defend vigorously against this action. On January 23, 2004, the Company answered the complaint, denying IMX’s allegations, and filed a counterclaim, which seeks a declaration that the patent-in-suit is invalid and/or that the Company does not infringe any claim of the patent and that it does not contribute to or induce the infringement of any claim of the patent. The case is currently in discovery. The Court has set a trial date of January 9, 2006. The Company is unable at this time to predict the outcome of this suit or reasonably estimate a range of possible loss, if any.

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 by it. Such claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources and could adversely affect the Company’s business, results of operations, financial condition and cash flows.

Uncertainty regarding payment of sales and hotel occupancy and other related taxes—The Company reviews and interprets, on an ongoing basis, the tax laws in various states and other jurisdictions relating to the payment of state and local hotel occupancy and other related taxes. In connection with its review, the Company has met and had discussions with taxing authorities in certain jurisdictions but the ultimate resolution in any particular jurisdiction cannot be determined at this time. Currently, hotels collect and remit hotel occupancy and related taxes to the various tax authorities based on the amounts collected by the hotels. Consistent with this practice, the Company recovers the taxes on the underlying cost of the hotel room night from customers and remits the taxes to the hotel operators for payment to the appropriate tax authorities. Several jurisdictions have indicated that they may take the position that sales or hotel occupancy tax is applicable to the differential between the price paid by a customer for the Company’s service and the cost to the Company of the underlying room. Historically, the Company has not collected taxes on this differential. Some state and local jurisdictions could assert that the Company is subject to hotel occupancy taxes on this differential and could seek to collect such taxes, either retroactively or prospectively or both. Such actions may result in substantial liabilities for past sales and could have a material adverse effect on the Company’s business and results of operations. To the extent that any tax authority succeeds in asserting that such a tax collection responsibility exists, it is likely that, with respect to future transactions, the Company would collect any such additional tax obligation from its customers, which would have the effect of increasing the cost of hotel room nights to the Company’s customers and, consequently, could reduce its hotel sales. The Company will continue to assess the risks of the potential financial impact of additional tax exposure, and to the extent appropriate, it will reserve for those estimates of liabilities.

19

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

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

Overview

General.   We are a leading online travel company that offers our customers a broad range of travel products, including airline tickets, hotel rooms, car rentals, vacation packages and cruises. Our unique Name Your Own Price^® system—which allows our customers to make offers for travel products at prices they set—enables our customers to use the Internet to save money on travel products and services while enabling sellers, which include many of the major domestic airline, hotel and rental car companies, to generate incremental revenue. In 2003, we complemented our Name Your Own Price^® product offering by giving our customers the ability to purchase certain travel products in a more traditional, price-disclosed manner. At present, we derive substantially all of our revenues from the following sources:

·        Transaction revenues from the sale of Name Your Own Price^® airline tickets, hotel rooms and rental cars;

·        Reservation booking fees from Worldspan, L.P. in connection with the sale of Name Your Own Price^®airline tickets, hotel rooms and rental cars;

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

·        Processing fees, Worldspan reservation booking fees and travel commissions, principally related to the sale of price disclosed airline tickets, hotel rooms, rental cars, cruises and other travel services; and

·        Other revenues derived primarily from advertising on our websites and fees for referring customers to affiliates and others.

Trends.   Our overall financial prospects have been and continue to be significantly dependent upon our sale of leisure airline tickets and, as a result, the health of our business has been directly related to the health of the airline industry. While the domestic airline industry has experienced significant revenue declines since September of 2001, the online travel sector, overall, continues to grow, and we believe the opportunity exists for us to broaden our participation in that growth. Nonetheless, most domestic airlines, and many of our major suppliers, have experienced, and continue to experience, significant losses, which have been compounded by competition from low-cost carriers and uncertainty regarding our domestic economy. As a result, many of the major airlines have deeply discounted retail airline tickets to maintain market share. These actions have had, and continue to have, a detrimental effect on our Name Your Own Price^® airline ticket business, which represents a significant portion of our total airline ticket revenues. Deep retail discounting by the airlines negatively affects demand for our Name Your Own Price^® airline ticket product because it hurts our value proposition and makes users less willing to accept the trade-offs associated with our product. In addition, decreased airline capacity hurts our business by reducing the levels of inventory available to us and increasing our cost of inventory. Customer offer prices have not kept pace with the increase in our cost of inventory and are, therefore, lower in proportion to our average cost of supply, which has, for the better part of the last two years, materially and negatively affected the number of Name Your Own Price^® tickets we sell.

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In an effort to counter some of the trends described above, we have taken a number of initiatives to diversify our product offerings to lessen our reliance on the sale of Name Your Own Price^® airline tickets. For example, we have taken and expect to continue to take steps to diversify our revenue among non-opaque products, such as retail travel products, which we believe have helped broaden our customer appeal. To this end, in the fourth quarter of 2003, we began offering customers the ability to purchase airline tickets at disclosed, retail prices. In addition, in May 2004, as discussed in more detail below, Lowestfare.com, the Company’s wholly-owned subsidiary, acquired all of the equity interest in Travelweb LLC owned by Marriott, Hilton, Hyatt, Starwood Hotels and Pegasus Solutions, and entered into an agreement whereby we may acquire all of the equity interest held by InterContinental Hotels Group at a future date. We intend to use inventory from Travelweb to launch a price disclosed hotel product in the first half of 2005. Our intent is to provide customers maximum flexibility by allowing them to select a retail itinerary or to make use of the Name Your Own Price^® product.

We believe that the results of the launch of our retail airline ticket product, and the related marketing effort, have been positive and we believe we are making progress towards stabilizing and growing total unit sales of airline tickets, which, as discussed above, declined significantly over the past two years. The launch of a retail airline product has had a positive effect on the overall number of airline tickets we sell. While some customers presented with a display of low disclosed prices may opt to select such a ticket or make a lower offer for a Name Your Own Price^® ticket, we believe the gross profit contribution from the increased sale of retail airline tickets has, to date, more than offset any loss in the number of Name Your Own Price^® tickets sold.

In addition, over the past two years, we have invested in and focused our marketing efforts on our non-airline travel products, including, in particular, our hotel business. To this end, in May 2004, our wholly-owned subsidiary, Lowestfare.com Incorporated, acquired all of the equity interest in Travelweb LLC owned by Marriott, Hilton, Hyatt, Starwood Hotels and Pegasus Solutions, and entered into an agreement whereby we may acquire all of the equity interest held by InterContinental Hotels Group at a future date, at which time Travelweb will become a wholly-owned subsidiary of Lowestfare.com. Travelweb LLC is a full-service automated hotel distribution network, which we intend to use to expand and grow our retail hotel business. See Note 2 to our Unaudited Consolidated Financial Statements.

We also intend to continue to develop our other non-air business, in particular our rental car and vacation package businesses, for which demand remains relatively strong, and continue to evaluate and implement ways to improve the number of airline tickets we sell. In May 2004, we launched a new retail rental car search and booking engine on RentalCars.com and intend to implement that functionality on other URLs that we own. In addition, in the second quarter of 2004, we implemented a new feature on our vacation packages path which allows customers to choose between an opaque or a disclosed flight itinerary. It is too early to determine what impact, if any, the new features of our rental car and vacation package products will have on our business results.

With respect to pricelinemortgage, interest rates have increased from recent lows and this has resulted in a slowdown in home refinancings and a reduction in the number of loans that pricelinemortgage originates. A reduction in loan originations negatively affects the results of pricelinemortgage and if this trend continues, our investment in pricelinemortgage could be significantly impacted. See Note 10 to our Unaudited Consolidated Financial Statements.

Further terrorist attacks, hostilities in the Middle East, the liquidation of a major domestic airline now in bankruptcy, the bankruptcy of an additional carrier or the withdrawal from our system of a major airline or hotel supplier, could adversely affect our business and results of operations and impair our ability to effectively implement all or some of the initiatives described above.

Other.   A number of travel suppliers, particularly airlines, have indicated publicly that, as part of an effort to reduce distribution costs, they intend to reduce their dependence over time on what they view to

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be “expensive” distribution channels such as global distribution systems (GDSs). A number of travel suppliers have reached agreements with travel distributors that require rebates of all or part of the fees received from the GDS. Additionally, travel suppliers are encouraging distributors, such as us, to develop technology enabling direct connections to bypass the GDS. Development of direct connection technology would require the use of information technology resources and could cause us to incur additional operating expenses and delay other projects. We have been and believe that we will continue to be under significant pressure from travel suppliers to rebate all or part of the travel booking fees we receive from Worldspan, L.P., our GDS and to use direct connection technology. To the extent that we are required to rebate travel booking fees we currently receive from our GDS to travel suppliers, and are unable to recover such amounts by charging customers, it could have an adverse effect on our business, results of operations and financial condition.

We believe that our success will depend in large part on our ability to maintain profitability, primarily from our leisure travel business, to continue to promote the priceline.com brand and, over time, to offer other travel products and services on our website. 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.

Financial Presentation

Starting with the fourth quarter 2003, we began reporting our metrics in a new format that provides greater visibility into the operations of our retail businesses. We now combine merchant and agency unit bookings (which are explained in detail in the lead-in to “Results of Operations,” below) for air, hotel and rental car services. The format change reflects the increased importance of agency unit sales to our operating results and gives a better view into the full scale of our operating activities. In connection with this change in format, we stopped presenting “bind rate” and other related customer metrics since we believe such data, which reflects sales of opaque products only, no longer presents a complete view of our financial results or business trends.

Recent Accounting Pronouncements

See Note 5 to our Unaudited Consolidated Financial Statements for a full description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.

In July 2004, the Emerging Issues Task Force (“EITF”) of the Financial Accounting Standards Board published for comment a draft abstract entitled “The Effect of Contingently Convertible Debt on Diluted Earnings per Share.” Contingently convertible debt instruments are generally convertible into common shares of an issuer after the common stock price has exceeded a predetermined threshold for a specified period of time (the “market price contingency”). The draft abstract reflects the EITF’s tentative conclusion that shares issuable upon conversion of contingently convertible debt should be included in diluted earnings per share computations regardless of whether the market price contingency contained in the debt instrument has been met. Currently, we exclude the potential dilutive effect of the conversion feature from diluted earnings per share until the market price contingency is met. The EITF intends to consider the issue further in September 2004, at which time it may reach a final consensus. If the EITF adopts a final consensus, it is expected that the consensus would be effective for reporting periods ending after December 15, 2004, and prior period earnings per share amounts presented for comparative purposes would be restated to conform to the consensus.

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In August 2003, we issued $125 million of Convertible Senior Notes due 2010 and in June 2004 we issued $100 million of Convertible Senior Notes due January 2025. Both of these Note issues are “contingently convertible debt” within the meaning of the EITF’s draft abstract. As a result, if the EITF reaches a consensus that shares issuable upon conversion of contingently convertible debt should be included in diluted earnings per share, we would be required to include in our diluted earnings per share calculations 3,125,000 shares of priceline.com common stock retroactive to August 2003, and another 2,635,046 shares retroactive to June 2004, which would in each case reduce our reported diluted earnings per share.

Results of Operations

Three and Six Months Ended June 30, 2004 compared to the Three and Six Months Ended June 30, 2003

We classify our revenue into three categories:

·       Merchant revenues are derived from transactions where we are the merchant of record and determine the price to be paid by the customer. Merchant revenues include the selling price of the airline ticket, hotel room and rental car and are reported on a gross basis, except in the case of Travelweb. See Note 3 to our Unaudited Consolidated Financial Statements.

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

·       Other revenues derived primarily from advertising on our websites and fees we earn for referring customers to pricelinemortgage for home financing services and from AIG for travel related insurance.

During the three months ended June 30, 2004, we experienced an increase in total revenue over the corresponding period in 2003 of $19.8 million primarily due to significant growth in sales of agency airline tickets and growth in our hotel, rental car and vacation package products. We continue to experience a shift in our airline ticket business mix from a primarily merchant opaque model to include a growing number of retail, price disclosed tickets. Because the sale of merchant airline tickets are reported gross and retail airline tickets are recorded on a net basis, airline ticket revenue increases and decreases are impacted by changes in merchant and retail sales mix and gross profit has become an important measure of evaluating growth in our business. Additionally, our acquisition of Travelweb, LLC during the second quarter contributed to the increase in total revenues.

The number of airline tickets, hotel room nights and rental car days sold were as follows:

		Airline Tickets		Hotel Room Nights		Rental Car Days
Three Months ended June 30, 2004		819,000		2.0 million		1.4 million
Three Months ended June 30, 2003		513,000		1.5 million		867,000
Six Months ended June 30, 2004		1.4 million		3.7 million		2.6 million
Six Months ended June 30, 2003		996,000		2.7 million		1.5 million

 

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Revenues

		Three Months Ended June 30,						% Change				Six Months Ended June 30,						% Change
		2004			2003							2004			2003
		($000)										($000)
Merchant Revenues		$	249,860		$	236,943			5.4	%		$	466,871		$	435,551			7.2	%
Agency Revenues		8,747			1,476				492.6	%		15,195			2,481				512.5	%
Other Revenues		782			1,147				(31.8	%)		1,454			2,021				(28.1	%)
Total Revenues		$	259,389		$	239,566			8.3	%		$	483,520		$	440,053			9.9	%

 

Merchant Revenues

Merchant revenues for the three and six months ended June 30, 2004 and 2003, consisted primarily of:  (1) transaction revenues representing the selling price of Name Your Own Price^® airline tickets, hotel rooms, rental cars and vacation packages; (2) customer processing fees charged in connection with the sale of Name Your Own Price^® airline tickets, hotel rooms and rental cars and (3) ancillary fees, including Worldspan, L.P. reservation booking fees related to merchant transactions only.

The $12.9 million increase in merchant revenue for the three months ended June 30, 2004 compared to the same period in 2003 was primarily attributable to growth in our Name Your Own Price^® hotel, vacation package and rental car products as well as merchant revenue generated through our majority owned subsidiary Travelweb, LLC, which more than made up for year over year declines in our Name Your Own Price airline ticket service. We believe that the increase in hotel room nights sold during the three months ended June 30, 2004 compared to the same period in 2003 was principally driven by our continued marketing emphasis on our hotel business over the course of the last 18 months, the competitive room inventory and pricing we receive from our hotel partners and the growth of our vacation package business. We believe the increase in rental car days sold during the three months ended June 30, 2004 compared to the same period in 2003 was primarily driven by, among other things, an increase in visits to our website as a result of our advertising (including increased visits created by links on rentalcars.com and breezenet.com, which we acquired in 2003) and favorable rental car inventory and pricing.

Merchant airline revenue, and the number of merchant airline tickets sold, in the second quarter 2004 decreased over the same period in 2003. We believe that the decrease in the number of merchant airline tickets sold—and the corresponding effect that decrease had on our overall merchant revenues during the three months ended June 30, 2004—continued to be due primarily to low retail airline ticket prices and the availability of retail tickets on our website. In particular, we believe that lower retail pricing causes customers who might normally be willing to make the trade­offs associated with our Name Your Own Price^® airline product in exchange for savings off of higher retail rates to purchase travel products at the lower retail rates or from “low-cost” carriers without having to make any trade-offs.

Agency Revenues

Agency revenues for the three and six months ended June 30, 2004 and 2003 consisted primarily of: (1) processing fees and third-party supplier commissions related to the sale of travel products including the sale of price disclosed airline tickets, cruises and other travel services; and (2) ancillary fees, including GDS reservation booking fees related to price-disclosed transactions. Agency revenues for the three months ended June 30, 2004 increased by approximately $7.3 million or 493% from the same period a year ago, primarily as a result of our increased focus on the retail airline ticket business, driven primarily by new advertising campaigns focused on our retail airline ticket product, and rental car business, including the aforementioned acquisitions, and the resulting increase in travel commissions, GDS and processing fees earned.

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