XMEX:PCL N Priceline Group Inc Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q 
(Mark One)
 
ý      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 

For the quarterly period ended March 31, 2012
 
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 ý NO o.
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 ý 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 ý
 
Number of shares of Common Stock outstanding at May 2, 2012:
Common Stock, par value $0.008 per share
 
49,793,087
(Class)
 
(Number of Shares)




priceline.com Incorporated
Form 10-Q
 
For the Three Months Ended March 31, 2012
 
PART I - FINANCIAL INFORMATION
 
 
 
Item 1. Unaudited Consolidated Financial Statements
 
 
Consolidated Balance Sheets (unaudited) at March 31, 2012 and December 31, 2011
Consolidated Statements of Operations (unaudited) For the Three Months Ended March 31, 2012 and 2011
Consolidated Statements of Comprehensive Income (unaudited) For the Three Months Ended March 31, 2012 and 2011
Consolidated Statement of Changes in Stockholders’ Equity (unaudited) For the Three Months Ended March 31, 2012
Consolidated Statements of Cash Flows (unaudited) For the Three Months Ended March 31, 2012 and 2011
Notes to Unaudited Consolidated Financial Statements
 
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
 
Item 4. Controls and Procedures
 
 
PART II - OTHER INFORMATION
 
 
 
Item 1. Legal Proceedings
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 4. Mine Safety Disclosures
Item 6. Exhibits
 
 
SIGNATURES

2



PART I — FINANCIAL INFORMATION
Item 1.  Unaudited Consolidated Financial Statements

priceline.com Incorporated
UNAUDITED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
 
 
 
March 31,
2012
 
December 31,
2011
ASSETS
 
 

 
 

Current assets:
 
 

 
 

Cash and cash equivalents
 
$
1,192,075

 
$
632,836

Restricted cash
 
4,458

 
3,771

Short-term investments
 
2,426,628

 
2,024,827

Accounts receivable, net of allowance for doubtful accounts of $7,214 and $6,103, respectively
 
324,562

 
264,453

Prepaid expenses and other current assets
 
201,740

 
104,202

Deferred income taxes
 
53,599

 
36,755

Total current assets
 
4,203,062

 
3,066,844

Property and equipment, net
 
73,520

 
64,322

Intangible assets, net
 
210,918

 
200,151

Goodwill
 
520,769

 
504,784

Deferred income taxes
 
43,245

 
111,080

Other assets
 
41,313

 
23,490

Total assets
 
$
5,092,827

 
$
3,970,671

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 

 
 

Current liabilities:
 
 

 
 

Accounts payable
 
$
173,984

 
$
146,867

Accrued expenses and other current liabilities
 
298,217

 
222,134

Deferred merchant bookings
 
314,836

 
239,157

Convertible debt (See Note 8)
 
503,192

 
497,640

Total current liabilities
 
1,290,229

 
1,105,798

Deferred income taxes
 
45,720

 
46,990

Other long-term liabilities
 
43,526

 
39,183

Convertible debt (See Note 8)
 
866,569

 

Total liabilities
 
2,246,044

 
1,191,971

 
 
 
 
 
Redeemable noncontrolling interests (See Note 11)
 
183,316

 
127,045

Convertible debt (See Note 8)
 
71,808

 
77,360

 
 
 
 
 
Stockholders’ equity:
 
 

 
 

Common stock, $0.008 par value; authorized 1,000,000,000 shares, 57,972,063 and 57,578,431 shares issued, respectively
 
449

 
446

Treasury stock, 8,180,276 and 7,779,645 shares, respectively
 
(1,057,811
)
 
(803,586
)
Additional paid-in capital
 
2,536,639

 
2,431,279

Accumulated earnings
 
1,163,494

 
1,033,738

Accumulated other comprehensive loss
 
(51,112
)
 
(87,582
)
Total stockholders’ equity
 
2,591,659

 
2,574,295

Total liabilities and stockholders’ equity
 
$
5,092,827

 
$
3,970,671

 
See Notes to Unaudited Consolidated Financial Statements.

3



priceline.com Incorporated
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
 
 
 
Three Months Ended
March 31,
 
 
2012
 
2011
Merchant revenues
 
$
496,409

 
$
454,804

Agency revenues
 
537,627

 
351,422

Other revenues
 
3,211

 
3,094

Total revenues
 
1,037,247

 
809,320

Cost of revenues
 
293,959

 
303,512

Gross profit
 
743,288

 
505,808

Operating expenses:
 
 

 
 

Advertising — Online
 
277,136

 
185,108

Advertising — Offline
 
11,157

 
11,614

Sales and marketing
 
45,537

 
34,778

Personnel, including stock-based compensation of $16,523 and $13,993, respectively
 
100,676

 
75,221

General and administrative
 
40,674

 
25,879

Information technology
 
10,735

 
6,670

Depreciation and amortization
 
15,842

 
12,479

Total operating expenses
 
501,757

 
351,749

Operating income
 
241,531

 
154,059

Other income (expense):
 
 

 
 

Interest income
 
1,098

 
1,421

Interest expense
 
(11,258
)
 
(7,715
)
Foreign currency transactions and other
 
(2,376
)
 
(7,073
)
Total other income (expense)
 
(12,536
)
 
(13,367
)
Earnings before income taxes
 
228,995

 
140,692

Income tax expense
 
(47,179
)
 
(36,679
)
Net income
 
181,816

 
104,013

Less: net loss attributable to noncontrolling interests
 
(154
)
 
(777
)
Net income applicable to common stockholders
 
$
181,970

 
$
104,790

Net income applicable to common stockholders per basic common share
 
$
3.65

 
$
2.12

Weighted average number of basic common shares outstanding
 
49,827

 
49,319

Net income applicable to common stockholders per diluted common share
 
$
3.54

 
$
2.05

Weighted average number of diluted common shares outstanding
 
51,347

 
51,159

 
See Notes to Unaudited Consolidated Financial Statements.


4



priceline.com Incorporated
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
 
Three Months Ended March 31,
 
2012
 
2011
Net income
$
181,816

 
$
104,013

Other comprehensive income, net of tax
 
 
 
Foreign currency translation adjustments (1)
41,455

 
46,042

Unrealized loss on marketable securities (2)
(774
)
 
(584
)
Comprehensive income
222,497

 
149,471

Less: Comprehensive income attributable to redeemable noncontrolling interests (See Note 11)
4,057

 
1,432

Comprehensive income attributable to priceline.com Incorporated
$
218,440

 
$
148,039


(1) Net of tax benefits of $12,962 and $13,084 for three months ended March 31, 2012 and 2011, respectively.

(2) Net of tax benefits of $352 and $206 for the three months ended March 31, 2012 and 2011, respectively.


See Notes to Unaudited Consolidated Financial Statements.


5



priceline.com Incorporated
UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2012
(In thousands)
 
 
 
Common Stock
 
Treasury Stock
 
Additional Paid-In Capital
 
Accumulated Earnings
 
Accumulated Other Comprehensive Loss
 
 
 
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
Total
Balance, December 31, 2011
 
57,579

 
$
446

 
(7,780
)
 
$
(803,586
)
 
$
2,431,279

 
$
1,033,738

 
$
(87,582
)
 
$
2,574,295

Net income applicable to common stockholders
 

 

 

 

 

 
181,970

 

 
181,970

Unrealized loss on marketable securities, net of tax benefit of $352
 

 

 

 

 

 

 
(774
)
 
(774
)
Currency translation adjustments, net of tax benefit of $12,962
 

 

 

 

 

 

 
37,244

 
37,244

Redeemable noncontrolling interests fair value adjustments
 

 

 

 

 

 
(52,214
)
 

 
(52,214
)
Reclassification adjustment for convertible debt in mezzanine
 

 

 

 

 
5,552

 

 

 
5,552

Exercise of stock options and vesting of restricted stock units and/or performance share units
 
393

 
3

 

 

 
1,042

 

 

 
1,045

Issuance of convertible senior notes
 

 

 

 

 
78,086

 

 

 
78,086

Repurchase of common stock
 

 

 
(400
)
 
(254,225
)
 

 

 

 
(254,225
)
Stock-based compensation and other stock-based payments
 

 

 

 

 
16,640

 

 

 
16,640

Excess tax benefit on stock-based compensation
 

 

 

 

 
4,040

 

 

 
4,040

Balance, March 31, 2012
 
57,972

 
$
449

 
(8,180
)
 
$
(1,057,811
)
 
$
2,536,639

 
$
1,163,494

 
$
(51,112
)
 
$
2,591,659

 
See Notes to Unaudited Consolidated Financial Statements.


6



priceline.com Incorporated
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
 
Three Months Ended
March 31,
 
 
2012
 
2011
OPERATING ACTIVITIES:
 
 

 
 

Net income
 
$
181,816

 
$
104,013

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

 
 

Depreciation
 
7,685

 
4,166

Amortization
 
8,157

 
8,313

Provision for uncollectible accounts, net
 
3,998

 
2,812

Deferred income taxes
 
4,804

 
8,260

Stock-based compensation expense and other stock-based payments
 
16,640

 
14,110

Amortization of debt issuance costs
 
895

 
553

Amortization of debt discount
 
7,241

 
5,239

Changes in assets and liabilities:
 
 

 
 

Accounts receivable
 
(58,235
)
 
(56,487
)
Prepaid expenses and other current assets
 
(145,345
)
 
3,307

Accounts payable, accrued expenses and other current liabilities
 
153,239

 
177,763

Other
 
1,485

 
4,170

Net cash provided by operating activities
 
182,380

 
276,219

 
 
 
 
 
INVESTING ACTIVITIES:
 
 

 
 

Purchase of investments
 
(1,301,457
)
 
(472,872
)
Proceeds from sale of investments
 
925,356

 
618,427

Additions to property and equipment
 
(13,697
)
 
(8,279
)
Acquisitions and other equity investments, net of cash acquired
 
(13,286
)
 
(66,204
)
Proceeds from settlement of foreign currency contracts
 
32,183

 

Payments on foreign currency contracts
 

 
(16,005
)
Change in restricted cash
 
(600
)
 
(16
)
Net cash (used in) provided by investing activities
 
(371,501
)
 
55,051

 
 
 
 
 
FINANCING ACTIVITIES:
 
 

 
 

Proceeds from the issuance of convertible debt
 
1,000,000

 

Payment of debt issuance costs
 
(20,327
)
 

Repurchase of common stock
 
(254,225
)
 
(157,262
)
Proceeds from exercise of stock options
 
1,045

 
544

Excess tax benefit on stock-based compensation
 
4,040

 
9,520

Net cash provided by (used in) financing activities
 
730,533

 
(147,198
)
Effect of exchange rate changes on cash and cash equivalents
 
17,827

 
8,035

Net increase in cash and cash equivalents
 
559,239

 
192,107

Cash and cash equivalents, beginning of period
 
632,836

 
358,967

Cash and cash equivalents, end of period
 
$
1,192,075

 
$
551,074

 
 
 
 
 
SUPPLEMENTAL CASH FLOW INFORMATION:
 
 

 
 

Cash paid during the period for income taxes
 
$
173,528

 
$
28,956

Cash paid during the period for interest
 
$
3,912

 
$
3,601

Non-cash fair value increase for redeemable noncontrolling interests
 
$
52,214

 
$
10,355

 
See Notes to Unaudited Consolidated Financial Statements.

7



priceline.com Incorporated
Notes to Unaudited Consolidated Financial Statements
 
1.                                      BASIS OF PRESENTATION
 
Priceline.com Incorporated (the "Priceline Group" 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, 2011.
 
The Unaudited Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries, including without limitation, priceline.com International Ltd. ("PIL"), Booking.com B.V. ("Booking.com"), priceline.com Mauritius Company Limited ("Agoda.com"), and its majority-owned interest in TravelJigsaw Holdings Limited (known now as the rentalcars.com business) since its acquisition in May 2010.  All inter-company accounts and transactions have been eliminated in consolidation.  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 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, 2012, the Company adopted the amended accounting guidance issued by the Financial Accounting Standards Board concerning the presentation of comprehensive income. The new guidance requires comprehensive income to be reported in either a single statement or in two consecutive statements reporting net income and other comprehensive income. The Company selected to present two consecutive statements. This amended guidance did not change the items that constitute net income or other comprehensive income, the timing of when other comprehensive income is reclassified to net income, or the earnings per share computation.


2.                                      STOCK-BASED EMPLOYEE COMPENSATION
 
The Company has adopted stock compensation plans which provide for grants of share based compensation as incentives and rewards to encourage employees, officers, and directors to contribute towards the long-term success of the Company.  Stock-based compensation cost included in personnel expenses in the Unaudited Consolidated Statements of Operations was approximately $16.5 million and $14.0 million for the three months ended March 31, 2012 and 2011, respectively.

The cost of stock-based transactions is recognized in the financial statements based upon fair value. The fair value of restricted stock, performance share units and restricted stock units is determined based on the number of units or shares, as applicable, granted and the quoted price of the Company's common stock as of the grant date. Stock-based compensation related to performance share units reflects the estimated probable outcome at the end of the performance period. Fair value is recognized as expense on a straight line basis, net of estimated forfeitures, over the employee requisite service period.
 
During the three months ended March 31, 2012, stock options were exercised for 55,716 shares of common stock with a weighted average exercise price per share of $18.76.  As of March 31, 2012, the aggregate number of stock options outstanding and exercisable was 141,522 shares, with a weighted average exercise price per share of $21.48 and a weighted average remaining term of 2.2 years.

8





The following table summarizes the activity of unvested restricted stock, restricted stock units and performance share units (“Share-Based Awards”) during the three months ended March 31, 2012
Share-Based Awards
 
Shares
 
Weighted Average
 Grant Date Fair Value
Unvested at December 31, 2011
 
799,980

 
$
231.87

Granted
 
90,192

 
$
645.86

Vested
 
(342,221
)
 
$
103.67

Performance Share Units Adjustment
 
323

 
$
464.79

Forfeited
 
(1,309
)
 
$
433.68

Unvested at March 31, 2012
 
546,965

 
$
380.00

 
As of March 31, 2012, there was $132.0 million of total future compensation cost related to unvested share-based awards to be recognized over a weighted-average period of 2.2 years.
 
During the three months ended March 31, 2012, the Company made broad-based grants of restricted stock units of 29,827 shares that generally vest after three years. The share-based awards granted had a total grant date fair value of $19.3 million based upon the grant date fair value per share of $645.86.
  
In addition, during the three months ended March 31, 2012, the Company granted 60,365 performance share units to certain executives.  The performance share units had a total grant date fair value of $39.0 million based upon the grant date fair value per share of $645.86.  The performance share units are payable in shares of the Company’s common stock upon vesting.  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, 2015 in order to receive any shares.  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 to be issued on the vesting date will be determined upon completion of the performance period which ends December 31, 2014.  As of March 31, 2012, the estimated number of probable shares to be issued is a total of 60,365 shares.  If the maximum performance thresholds are met at the end of the performance period, a maximum number of 120,730 total shares could be issued.  If the minimum performance thresholds are not met, 38,611 shares would be issued at the end of the performance period.
 
2011 Performance Share Units

During the year ended December 31, 2011, the Company granted 77,144 performance share units with a grant date fair value of $35.9 million, based on a weighted average grant date fair value per share of $464.79. The actual number of shares will be determined upon completion of the performance period which ends December 31, 2013.

At March 31, 2012, there were 76,122 unvested performance share units outstanding, net of actual forfeitures and vesting. As of March 31, 2012, the number of shares estimated to be issued at the end of the performance period is a total of 152,832 shares. If the maximum thresholds are met at the end of the performance period, a maximum of 162,464 total shares could be issued.

2010 Performance Share Units
 
During the year ended December 31, 2010, the Company granted 110,430 performance share units with a grant date fair value of $26.0 million, based on a weighted average grant date fair value per share of $235.34.  The actual number of shares will be determined upon completion of the performance period which ends December 31, 2012.
 
At March 31, 2012, there were 85,796 unvested performance share units outstanding, net of actual forfeitures and vesting.  As of March 31, 2012, the number of shares estimated to be issued at the end of the performance period is a total of 203,349 shares.  If the maximum performance thresholds are met at the end of the performance period, a maximum of 203,349 total shares could be issued.

9





3.                                      NET INCOME PER SHARE
 
The Company computes basic net income per share by dividing net income by the weighted average number of common shares outstanding during the period.  Diluted net income per share is based upon the weighted average number of common and common equivalent shares outstanding during the period.
 
Common equivalent shares related to stock options, restricted stock, restricted stock units, 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 and 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, at the Company’s option.  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): 
 
 
Three Months Ended
March 31,
 
 
2012
 
2011
Weighted average number of basic common shares outstanding
 
49,827

 
49,319

Weighted average dilutive stock options, restricted stock, restricted stock units and performance share units
 
607

 
1,217

Assumed conversion of convertible debt
 
913

 
623

Weighted average number of diluted common and common equivalent shares outstanding
 
51,347

 
51,159

Anti-dilutive potential common shares
 
2,245

 
1,300

 
Anti-dilutive potential common shares for the three months ended March 31, 2012 includes approximately 2.0 million shares which could be issued under the Company’s convertible debt if the Company experiences substantial increases in its common stock price.  Under the treasury stock method, the convertible debt 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 debt.

In 2006, the Company issued $172.5 million aggregate principal amount of convertible notes due September 30, 2013 (the "2013 Notes"). In 2006, the Company also entered into hedge transactions (the "Conversion Spread Hedges") relating to the potential dilution of the Company's common stock upon conversion of the 2013 Notes at their stated maturity date. Under the Conversion Spread Hedges, the Company is entitled to purchase from Goldman Sachs and Merrill Lynch approximately 4.3 million shares of the Company's common stock (the number of shares underlying the 2013 Notes) at a strike price of $40.38 per share (subject to adjustment in certain circumstances) in 2013, and the counterparties are entitled to purchase from the Company approximately 4.3 million shares of the Company's common stock at a strike price of $50.47 per share (subject to adjustment in certain circumstances) in 2013.

The 2013 Notes were converted prior to maturity. Therefore, upon early conversion of the 2013 Notes, the Company delivered any related conversion premium in shares of stock or a combination of shares or cash. The Conversion Spread Hedges are separate transactions entered into by the Company and are not part of the terms of the 2013 Notes. The Conversion Spread Hedges did not immediately hedge against the associated dilution from early conversions of the 2013 Notes. Because of this timing difference, the number of shares, if any, that the Company receives from the Conversion Spread Hedges can differ materially from the number of shares that it was required to deliver to the holders of the 2013 Notes upon their early conversion. The actual number of shares to be received will depend upon the Company's stock price on the date the Conversion Spread Hedges are exercisable, which coincides with the scheduled maturity of the 2013 Notes.

The Conversion Spread Hedges are outstanding at March 31, 2012. However, since the beneficial impact of the Conversion Spread Hedges was anti-dilutive, it was excluded from the calculation of net income per share.

10





4.                                      INVESTMENTS
 
The following table summarizes, by major security type, the Company’s short-term investments as of March 31, 2012 (in thousands): 
 
 
Cost
 
Gross 
Unrealized 
Gains
 
Gross 
Unrealized
 Losses
 
Fair
 Value
Available for sale securities
 
 

 
 

 
 

 
 

Foreign government securities
 
$
908,136

 
$
34

 
$
(87
)
 
$
908,083

U.S. government securities
 
1,491,837

 
91

 
(205
)
 
1,491,723

U.S. agency securities
 
26,812

 
10

 

 
26,822

Total
 
$
2,426,785

 
$
135

 
$
(292
)
 
$
2,426,628

 
As of March 31, 2012, foreign government securities included investments in debt securities issued by the governments of Germany, the Netherlands, and the United Kingdom. 
 
The following table summarizes, by major security type, the Company’s short-term investments as of December 31, 2011 (in thousands): 
 
 
Cost
 
Gross
 Unrealized
 Gains
 
Gross
 Unrealized
 Losses
 
Fair
 Value
Available for sale securities
 
 

 
 

 
 

 
 

Foreign government securities
 
$
1,073,731

 
$
588

 
$
(133
)
 
$
1,074,186

U.S. government securities
 
922,997

 
353

 
(28
)
 
923,322

U.S. agency securities
 
26,942

 
9

 

 
26,951

U.S. corporate notes
 
205

 
163

 

 
368

Total
 
$
2,023,875

 
$
1,113

 
$
(161
)
 
$
2,024,827

 
As of December 31, 2011, foreign government securities included investments in debt securities issued by government of Germany, the Netherlands, the United Kingdom and France.

There were no material realized gains or losses related to investments for the three months ended March 31, 2012 or 2011.

11






5.                                      FAIR VALUE MEASUREMENTS
 
Financial assets and liabilities carried at fair value as of March 31, 2012 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
 
$

 
$
908,083

 
$

 
$
908,083

U.S. government securities
 

 
1,491,723

 

 
1,491,723

U.S. agency securities
 

 
26,822

 

 
26,822

Foreign exchange derivatives
 

 
11,723

 

 
11,723

Total assets at fair value
 
$

 
$
2,438,351

 
$

 
$
2,438,351

 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
LIABILITIES:
 
 

 
 

 
 

 
 

Foreign exchange derivatives
 
$

 
$
16,187

 
$

 
$
16,187

Redeemable noncontrolling interests
 

 

 
183,316

 
183,316

Total liabilities at fair value
 
$

 
$
16,187

 
$
183,316

 
$
199,503

 
Financial assets and liabilities carried at fair value as of December 31, 2011 were 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
 
$

 
$
1,074,186

 
$

 
$
1,074,186

U.S. government securities
 

 
923,322

 

 
923,322

U.S. agency securities
 

 
26,951

 

 
26,951

U.S. corporate notes
 

 
368

 

 
368

Foreign exchange derivatives
 

 
60,455

 

 
60,455

Total assets at fair value
 
$

 
$
2,085,282

 
$

 
$
2,085,282

 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
LIABILITIES:
 
 

 
 

 
 

 
 

Foreign exchange derivatives
 
$

 
$
1,107

 
$

 
$
1,107

Redeemable noncontrolling interests
 

 

 
127,045

 
127,045

Total liabilities at fair value
 
$

 
$
1,107

 
$
127,045

 
$
128,152

 
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:
Inputs that are observable, either directly or indirectly.  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.

Investments in U.S. Treasury and foreign government securities are considered “Level 2” fair value measurements as

12



of March 31, 2012 and December 31, 2011 because the Company has access to quoted prices, but does not have visibility to the volume and frequency of trading for all of these investments.  Fair values for U.S. agency securities and U.S. corporate notes are considered “Level 2” fair value measurements because they are obtained from pricing sources for these or comparable instruments. For the Company’s short-term 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. The Company's derivative instruments are typically short-term in nature.
 
The Company considers its redeemable noncontrolling interests to represent a “Level 3” fair value measurement that requires a high degree of judgment to determine fair value.  The fair value of the redeemable noncontrolling interests was determined by industry peer comparable analysis and a discounted cash flow valuation model. See Note 11 for further information on redeemable noncontrolling interests.
 
As of March 31, 2012 and December 31, 2011, the carrying value of the Company’s cash and cash equivalents approximated their fair value and consisted primarily of foreign and U.S. 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 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 debt.
 
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 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 is exposed to adverse movements in currency exchange rates as the financial results of its international operations are translated from local currency into U.S. Dollars upon consolidation.  The Company’s derivative contracts principally address foreign exchange fluctuations for the Euro and British Pound Sterling.  As of March 31, 2012 and December 31, 2011, there were no outstanding derivative contracts.  Foreign exchange gains of $0.6 million for the three months ended March 31, 2012 and foreign exchange losses of $1.8 million for the three months ended March 31, 2011 were recorded in “Foreign currency transactions and other” in the Unaudited Consolidated Statements of Operations.
 
Derivatives associated with foreign currency transaction risks as of March 31, 2012 resulted in a liability of $0.2 million and was recorded in "Accrued expenses and other current liabilities" in the Unaudited Consolidated Balance Sheet. Derivatives associated with foreign currency transaction risks as of December 31, 2011 resulted in a net liability of $0.8 million, with $1.1 million recorded in "Accrued expenses and other current liabilities" and $0.3 million recorded in "Prepaid expense and other current assets" in the Unaudited Consolidated Balance Sheet.   Foreign exchange gains of $2.4 million and $0.1 million for the three months ended March 31, 2012 and 2011, respectively, were recorded in “Foreign currency transactions and other” in the Unaudited Consolidated Statements of Operations.
 
The settlement of derivative contracts resulted in a net cash inflow of $3.4 million for the three months ended March 31, 2012 compared to a net cash outflow of $1.3 million for the three months ended March 31, 2011, and are reported within “Net cash provided by operating activities” on the Unaudited Consolidated Statements of Cash Flows.
 
Derivatives Designated as Hedging Instruments — As of March 31, 2012 and December 31, 2011, the Company had outstanding foreign currency forward contracts for 860 million Euros at both periods to hedge a portion of its net investment in a foreign subsidiary.  These contracts are 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 March 31, 2012 was a net liability of $4.3 million, with $16.0 million liability recorded in "Accrued expenses and other current liabilities" and $11.7 million asset recorded in "Prepaid and other current assets" in the Unaudited Consolidated Balance Sheet. The fair value of these derivatives at December 31, 2011 was an asset of $60.1 million and was reflected in “Prepaid expenses and other current assets” in the

13



Unaudited Consolidated Balance Sheet.  A net cash inflow of $32.2 million for the three months ended March 31, 2012 compared to a net cash outflow of $16.0 million for the three months ended March 31, 2011 were reported within “Net cash (used in) provided by investing activities” on the Unaudited Consolidated Statements of Cash Flows.

 
6.                                      INTANGIBLE ASSETS AND GOODWILL
 
The Company’s intangible assets consist of the following (in thousands): 
 
March 31, 2012
 
December 31, 2011
 
 
 
 
 
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
$
267,998

 
$
(105,563
)
 
$
162,435

 
$
260,288

 
$
(97,114
)
 
$
163,174

 
10 - 13 years
 
12 years
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Technology
23,520

 
(23,289
)
 
231

 
22,982

 
(22,708
)
 
274

 
3 years
 
3 years
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Patents
1,638

 
(1,411
)
 
227

 
1,638

 
(1,399
)
 
239

 
15 years
 
15 years
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Customer lists
20,514

 
(20,243
)
 
271

 
19,923

 
(19,150
)
 
773

 
2 years
 
2 years
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Internet domain names
18,562

 
(1,149
)
 
17,413

 
5,215

 
(625
)
 
4,590

 
2 - 20 years
 
7 years
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trade names
53,649

 
(23,328
)
 
30,321

 
52,272

 
(21,192
)
 
31,080

 
5 - 20 years
 
11 years
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other
345

 
(325
)
 
20

 
345

 
(324
)
 
21

 
3 - 10 years
 
4 years
Total intangible assets
$
386,226

 
$
(175,308
)
 
$
210,918

 
$
362,663

 
$
(162,512
)
 
$
200,151

 
 
 
 
 
Intangible assets with determinable lives are primarily amortized on a straight-line basis.  Intangible asset amortization expense was approximately $8.2 million and $8.3 million for the three months ended March 31, 2012 and 2011, respectively.

The estimated amortization expense for intangible assets for the remainder of 2012, the annual expense for the next five years, and the expense thereafter is expected to be as follows (in thousands): 
2012
$
24,496

2013
31,822

2014
31,746

2015
28,966

2016
26,318

2017
22,502

Thereafter
45,068

 
$
210,918

 
The change in goodwill for the three months ended March 31, 2012 consists of the following (in thousands): 
Balance at December 31, 2011
$
504,784

Acquisition
4,462

Currency translation adjustments
11,523

Balance at March 31, 2012
$
520,769

 
A substantial majority of the Company’s goodwill relates to the acquisition of Booking.com. 

14





7.                                      OTHER ASSETS
 
Other assets at March 31, 2012 and December 31, 2011 consist of the following (in thousands): 
 
 
March 31,
2012
 
December 31,
2011
Deferred debt issuance costs
 
$
27,828

 
$
10,560

Other
 
13,485

 
12,930

Total
 
$
41,313

 
$
23,490

 
Deferred debt issuance costs arose from (i) $1.0 billion aggregate principal amount of 1.0% Convertible Senior Notes, due March 15, 2018, issued in March 2012; (ii) a $1.0 billion revolving credit facility entered into in October 2011; and (iii) the issuance in March 2010 of $575.0 million aggregate principal amount of 1.25% Convertible Senior Notes, due March 15, 2015.  Deferred debt issuance costs are being amortized using the effective interest rate method and the period of amortization was determined at inception of the related debt agreements based upon the stated maturity date.


8.                                      DEBT
 
Revolving Credit Facility

In October 2011, the Company entered into a $1.0 billion five-year unsecured revolving credit facility with a group of lenders. Borrowings under the revolving credit facility will bear interest, at the Company's option, at a rate per annum equal to either (i) the adjusted LIBOR for the interest period in effect for such borrowing plus an applicable margin ranging from 1.00% to 1.50%; or (ii) the greatest of (a) JPMorgan Chase Bank, National Association's prime lending rate, (b) the federal funds rate plus 0.50%, and (c) an adjusted LIBOR for an interest period of one month plus 1.00%, plus an applicable margin ranging from 0.00% to 0.50%. Undrawn balances available under the revolving credit facility are subject to commitment fees at the applicable rate ranging from 0.10% to 0.25%.
 
The revolving credit facility provides for the issuance of up to $100.0 million of letters of credit as well as borrowings of up to $50.0 million on same-day notice, referred to as swingline loans. Borrowings under the revolving credit facility may be made in U.S. Dollars, Euros, British 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 March 31, 2012 and December 31, 2011, there were no borrowings under the facility and there were approximately $1.9 million of letters of credit issued under the facility for both periods.
 
Convertible Debt
 
Convertible debt as of March 31, 2012 consists of the following (in thousands): 
March 31, 2012  
 
Outstanding
 Principal 
Amount
 
Unamortized
 Debt
 Discount
 
Carrying
 Value
1.25% Convertible Senior Notes due March 2015
 
$
575,000

 
$
(71,808
)
 
$
503,192

1.0% Convertible Senior Notes due March 2018
 
1,000,000

 
(133,431
)
 
866,569

Outstanding convertible debt
 
$
1,575,000

 
$
(205,239
)
 
$
1,369,761

 
Convertible debt as of December 31, 2011 consisted of the following (in thousands): 
December 31, 2011
 
Outstanding
 Principal 
Amount
 
Unamortized
 Debt
 Discount
 
Carrying
 Value
1.25% Convertible Senior Notes due March 2015
 
$
575,000

 
$
(77,360
)
 
$
497,640

 
Based upon the closing price of the Company’s common stock for the prescribed measurement period during the three months ended March 31, 2012 and December 31, 2011, the contingent conversion threshold on the 2015 Notes was exceeded.  Therefore, the 2015 Notes were convertible at the option of the holders. Accordingly, the Company reported the

15



carrying value of the 2015 Notes as a current liability as of March 31, 2012 and December 31, 2011. Since these notes are convertible at the option of the holders and the principal amount is required to be paid in cash, the difference between the principal amount and the carrying value is reflected as convertible debt in the mezzanine section on the Company's Unaudited Balance Sheets. Therefore, with respect to the 2015 Notes, the Company reclassified $71.8 million and $77.4 million before tax from additional paid-in capital to convertible debt in the mezzanine section on the Company's Unaudited Consolidated Balance Sheets as of March 31, 2012 and December 31, 2011, respectively. The determination of whether or not the 2015 Notes are convertible must continue to be performed on a quarterly basis. Consequently, the 2015 Notes may not be convertible in future quarters, and therefore may again be classified as long-term debt, if the contingent conversion threshold is not met in such quarters. The contingent conversion threshold on the 2018 Notes was not exceeded at March 31, 2012, and therefore that debt is reported as a non-current liability on the Unaudited Consolidated Balance Sheet.

As of March 31, 2012 and December 31, 2011, the estimated market value of the outstanding convertible debt was approximately $2.4 billion and $0.9 billion, respectively, and was considered a "Level 2" fair value measurement (see Note 5). 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.  A substantial portion of the market value of the Company’s debt in excess of the outstanding principal amount relates to the conversion premium on the bonds.
 
Description of Senior Notes
 
In March 2012 , the Company issued in a private placement $1.0 billion aggregate principal amount of Convertible Senior Notes due March 15, 2018, with an interest rate of 1.0% (the "2018 Notes"). The Company paid $20.3 million in debt issuance costs during the three months ended March 31, 2012, related to this offering. The 2018 Notes are convertible, subject to certain conditions, into the Company's common stock at a conversion price of approximately $944.61 per share. The 2018 Notes are convertible, at the option of the holder, prior to March 15, 2018, upon the occurrence of specific 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 trading days in the period of 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 2018 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 2018 Notes in aggregate value ranging from $0 to approximately $344.0 million depending upon the date of the transaction and the then current stock price of the Company. As of December 15, 2017, holders will have the right to convert all or any portion of the 2018 Notes. The 2018 Notes may not be redeemed by the Company prior to maturity.  The holders may require the Company to repurchase the 2018 Notes for cash in certain circumstances.  Interest on the 2018 Notes is payable on March 15 and September 15 of each year.

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 Company paid $13.3 million in debt issuance costs during the year ended December 31, 2010, related to this offering.  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 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.
 
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 a value to be assigned to each.  The value assigned to the debt component is the estimated fair value, as of the issuance date, of a similar bond without the conversion feature.  The difference between the bond cash proceeds and this estimated fair value, representing the value assigned to the equity component, is recorded as a debt discount.  Debt discount is amortized using the effective interest method over the period from origination date through the stated maturity date.  The Company estimated the straight debt borrowing rates at debt origination to be 5.89%

16



for the 2015 Notes and 3.5% for the 2018 Notes.  The yield to maturity was estimated at an at-market coupon priced at par.

Debt discount after tax of $80.9 million ($135.2 million before tax) partially offset by financing costs associated with the equity component of convertible debt of $2.8 million were recorded in additional paid-in capital related to the 2018 Notes at March 31, 2012. The Company reclassified $71.8 million before tax and $77.4 million before tax out of additional paid-in capital to the mezzanine section in the Company's Unaudited Consolidated Balance Sheets at March 31, 2012 and December 31, 2011, respectively, related to the 2015 Notes.
 
For the three months ended March 31, 2012 and 2011, the Company recognized interest expense of $10.6 million and $7.5 million, respectively, related to convertible notes.  Interest expense related to convertible notes was comprised of $2.6 million and $1.8 million, respectively, for the contractual coupon interest, $7.2 million and $5.2 million, respectively, related to the amortization of debt discount and $0.8 million and $0.5 million, respectively, related to the amortization of debt issuance costs.  The effective interest rate for the three months ended March 31, 2012 and 2011 was 5.7% and 6.3%, respectively.
 
 
9.                               TREASURY STOCK
 

In the first quarter of 2012, the Company's Board of Directors authorized a one-time purchase of the Company's common stock up to $200.0 million concurrent with the issuance of the 2018 Notes. The Company repurchased 263,913 shares in the first quarter of 2012 for an aggregate cost of $166.2 million.

As of March 31, 2012, the Company has a remaining amount from all authorizations granted by the Board of Directors of $459.2 million to purchase its common stock.  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’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 136,718 shares and 346,904 shares at aggregate costs of $88.0 million and $157.3 million in the three months ended March 31, 2012 and 2011, respectively, to satisfy employee withholding taxes related to stock-based compensation.
 
As of March 31, 2012, there were approximately 8.2 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 months ended March 31, 2012 and 2011, 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 months ended March 31, 2012 and 2011 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. 
 
Effective January 1, 2010, the Netherlands modified its corporate income tax law related to income generated from qualifying “innovative” activities (“Innovation Box Tax”).  Earnings that qualify for the Innovation Box Tax will effectively be taxed at the rate of 5% rather than the Dutch statutory rate of 25%.  Booking.com obtained a ruling from the Dutch tax authorities in February 2011 confirming that a portion of its earnings (“qualifying earnings”) is eligible for Innovation Box Tax treatment.   The ruling from the Dutch tax authorities is valid from January 1, 2010 through December 31, 2013 (the “Initial Period”).  In this ruling, the Dutch tax authorities require that the Innovation Box Tax benefit be phased in over a multi-year period.  The benefit is fully phased in starting in 2012. The amount of qualifying earnings expressed as a percentage of the total pretax earnings in the Netherlands will vary depending upon the level of total pretax earnings that is achieved in any given year.

17



 
In order to be eligible for Innovation Box Tax treatment, Booking.com must, among other things, apply for and obtain a research and development (“R&D”) certificate from a Dutch governmental agency every six months confirming that the activities that Booking.com intends to be engaged in over the subsequent six month period are “innovative.”  The R&D certificate is current but should Booking.com fail to secure such a certificate in any future period — for example, because the governmental agency does not view Booking.com’s new or anticipated activities as “innovative” — or should this agency determine that the activities contemplated to be performed in a prior year were not performed as contemplated or did not comply with the agency’s requirements, Booking.com may lose its certificate and, as a result, the Innovation Box Tax benefit may be reduced or eliminated.

Booking.com intends to reapply for continued Innovation Box Tax treatment in future periods. There can be no assurance that Booking.com’s application will be accepted, or that the amount of qualifying earnings or applicable tax rates will not be reduced at that time.  In addition, there can be no assurance that the tax law will not change in 2012 and/or future years resulting in a reduction or elimination of the tax benefit.
 
The Company currently estimates that its consolidated effective tax rate for 2012 will be lower by approximately four to six percentage points compared to what it would be if the Company did not have the benefit of the Innovation Box Tax. The Innovation Box Tax reduced the Company's consolidated effective tax rate for 2011 by approximately four percentage points.
 
The Company has significant deferred tax assets, resulting principally from domestic net operating loss carryforwards (“NOLs”) for U.S. federal income tax purposes generated from operating losses and equity-related transactions, including equity-based compensation and stock warrants. The NOLs mainly expire 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 ("IRC Section 382") and is also dependent on the Company’s ability to generate sufficient future taxable income. IRC 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 IRC 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.  It was determined that ownership changes, as defined in IRC 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, 2011, it was estimated that the remaining effect of IRC Section 382 will generally limit the total cumulative amount of net operating loss available to offset future taxable income to approximately $1.2 billion. Pursuant to IRC 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 March 31, 2012 and December 31, 2011 amounted to $96.8 million and $147.8 million, net of the valuation allowance recorded, respectively.
 
The Company has recorded a non-current deferred tax liability in the amount of $45.7 million and $47.0 million million at March 31, 2012 and December 31, 2011, respectively, primarily related to the assignment of estimated fair value to certain purchased identifiable intangible assets associated with various international acquisitions.
 
As an international corporation providing hotel reservation services available around the world, the Company is subject to income taxes as well as non-income based taxes, in both the United States and various foreign jurisdictions.  Significant judgment is required in determining the Company’s worldwide provision for income taxes and other tax liabilities.  Although the Company believes that its tax estimates are reasonable, there is no assurance that the final determination of tax audits or tax disputes will not be different from what is reflected in the Company’s historical income tax provisions and accruals.  To date, we have been audited in several taxing jurisdictions with no significant impact on the Company's financial position, results of operations or cash flows.  The Internal Revenue Service initiated an audit of our 2009 and 2010 federal income tax returns in the third quarter of 2011 and such audit is on-going.

18





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 (collectively, “TravelJigsaw” now known as the rentalcars.com business), a Manchester, UK-based international rental car reservation service.
 
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 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 have been or will be, as the case may be, subject to the put and call options in each of 2011, 2012 and 2013, respectively, during specified option exercise periods.  In April 2012 and April 2011, in connection with the exercise of March 2012 and March 2011 call and put options, PIL purchased a portion of the shares underlying redeemable noncontrolling interests for an aggregate purchase price of approximately $61.1 million and $13.0 million, respectively.  As a result of the April 2012 purchase, the redeemable noncontrolling interests in TravelJigsaw Holdings Limited were reduced from 19.0% to 12.7%.
 
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 Company’s Unaudited Consolidated Balance Sheets in the mezzanine section in “Redeemable noncontrolling interests.”
 
A reconciliation of redeemable noncontrolling interests for the three months ended March 31, 2012 is as follows (in thousands): 
 
2012
Balance, December 31, 2011
$
127,045

Net loss attributable to redeemable noncontrolling interests
(154
)
Fair value adjustments (1)
52,214

Currency translation adjustments
4,211

Balance, March 31, 2012
$
183,316

 
(1)          The fair value of the redeemable noncontrolling interests was determined by industry peer comparable analysis and a discounted cash flow valuation model.

A reconciliation of redeemable noncontrolling interests for the three months ended March 31, 2011 is as follows (in thousands):
 
2011
Balance, December 31, 2010
$
45,751

Net loss attributable to redeemable noncontrolling interests
(777
)
Fair value adjustments (1)
10,355

Currency translation adjustments
2,209

Balance, March 31, 2011
$
57,538


(1)          The fair value of the redeemable noncontrolling interests was determined by industry peer comparable analysis and a discounted cash flow valuation model.



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12.                              ACCUMULATED OTHER COMPREHENSIVE LOSS
 
The table below provides the balances for each classification of accumulated other comprehensive loss as of March 31, 2012 and December 31, 2011 (in thousands): 
 
 
March 31,
2012
 
December 31,
2011
Foreign currency translation adjustments, net of tax (1)
 
$
(51,068
)
 
$
(88,312
)
Net unrealized (loss) gain on marketable securities, net of tax (2)
 
(44
)
 
730

Accumulated other comprehensive loss
 
$
(51,112
)
 
$
(87,582
)
 
(1)          Includes net gains from fair value adjustments at March 31, 2012 of $27.0 million after tax ($46.9 million before tax) and net gains from fair value adjustments at December 31, 2011 of $46.2 million after tax ($79.1 million before tax) associated with net investment hedges (See Note 5).  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 loss before tax at March 31, 2012 was $0.1 million and the unrealized gain before tax at December 31, 2011 was $1.0 million.
 

13.                               COMMITMENTS AND CONTINGENCIES
 
Litigation Related to Hotel Occupancy and Other Taxes
 
The Company and certain third-party defendant online travel companies are currently involved in approximately forty lawsuits, including certified and putative class actions, 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 the Company’s “merchant” hotel business.  The Company’s subsidiaries Lowestfare.com LLC and Travelweb LLC are named in some but not all of these cases.  Generally, 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 law.  Each complaint typically seeks compensatory damages, disgorgement, penalties available by law, attorneys’ fees and other relief.  The Company is also involved in one consumer lawsuit relating to, among other things, the payment of hotel occupancy taxes and service fees.  In addition, approximately sixty municipalities or counties, and at least six 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 it 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 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.  From time to time, the Company has found it expedient to settle, and may in the future agree to settle, claims pending in these matters without conceding that the claims at issue are meritorious or that the claimed taxes are in fact due to be paid.
 
In connection with some of these 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 the Company 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.

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 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.  The court has not yet entered a final judgment in that case.  The Company intends to vigorously pursue an appeal of the judgment in that case, once it has been entered, on legal and factual grounds.
 
An unfavorable outcome or settlement of pending litigation may 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 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 the Company’s earnings, financial position 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 such a responsibility, 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 action 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.  Therefore, 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 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.
 
Reserve for Hotel Occupancy and Other Taxes
 
As a result of this litigation and other attempts by jurisdictions to levy similar taxes, the Company has established an accrual for the potential resolution of issues related to hotel occupancy and other taxes in the amount of approximately $33 million at both March 31, 2012 and December 31, 2011 (which includes, among other things, amounts related to the litigation in San Antonio). The accrual is based on the Company's estimate of the probable cost of resolving these issues. The actual cost may be less or greater, potentially significantly, than the liabilities recorded. An estimate for a reasonably possible loss or range of loss in excess of the amount accrued cannot be reasonably made.
 
Developments in and after the Quarter Ended March 31, 2012
 
In the quarter ending March 31, 2012, three new actions commenced. State of Mississippi v. Priceline.com, Inc., et al., (Hinds County Chancery Court)(filed January 2012), a putative class action filed on behalf of residents of the state of Mississippi, asserts violation of the state's hotel occupancy tax and also asserts claims under Mississippi's consumer protection statute. The Company intends to vigorously defend these claims. In Expedia Inc. et al v. City of Portland (Circuit Court of the State of Oregon for the County of Multnomah) (filed February 17, 2012), the Company filed a declaratory action seeking a declaration that the plaintiffs are not subject to local occupancy tax after the City of Portland and Multnomah County issued audit notices to the Company and other online travel companies. Defendant City of Portland filed a motion to dismiss on March 30, 2012. In Expedia, Inc., et al. v. City and County of Denver, et al, (District Court for Denver) (filed March 2012), the Company and other online travel companies are seeking review of the administrative hearing officer's decision.

On April 19, 2012, in Leon County, et al. v. Expedia, Inc., et al. (2d Judicial Cir. Ct. for Leon County, Florida), the Florida Second Judicial Circuit Court orally denied the Counties' motion for summary judgment and granted a motion for summary judgment in favor of the defendants, dismissing the action. The Company expects the Counties to file a notice of appeal once the trial court enters its final judgment. In City of Goodlettsville, Tennessee, et al. v. priceline.com Incorporated, et

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al. (U.S. District Court for the Middle District of Tennessee), a certified class action on behalf of Tennessee cities and counties, the court granted summary judgment in favor of defendants on February 21, 2012. On April 13, 2012, in City of Birmingham, Alabama, et al. v. Orbitz, Inc., et al. (Circuit Court of Jefferson County, Alabama), the Alabama Supreme Court affirmed summary judgment in favor of the defendants on claims by several Alabama cities. On February 17, 2012, in City of Bowling Green, Kentucky v. Hotels.com LP et al. (Warren Cir. Ct., Kentucky, Div. 1; filed in March 2009); (Commonwealth of Kentucky Court of Appeals; appeal filed in April 2010), the Kentucky Supreme Court declined to hear Bowling Green's appeal so the Court of Appeal's ruling affirming the lower court's dismissal of the case stands. In City of Branson, Missouri v. Hotels.com, LP., et al. (Circuit Court of Greene County, Missouri), the trial granted defendants' motion to dismiss on January 31, 2012. Plaintiff has filed a notice of appeal. On March 8, 2012, the Company received notice that the New Mexico Taxation and Revenue Department completed its audit and administrative review of priceline.com's state and local sales and use tax and concluded that priceline.com did not owe the tax.

In addition to these developments, a discussion of the remaining legal proceedings listed below 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, 2011. The Company intends to vigorously defend against the claims in all of the proceedings described below.

Statewide Class Actions and Putative Class Actions

Such actions include:

City of Los Angeles, California v. Hotels.com, Inc., et al. (California Superior Court, Los Angeles County; filed in December 2004)
City of Rome, Georgia, et al. v. Hotels.com, L.P., et al. (U.S. District Court for the Northern District of Georgia; filed in November 2005)
City of San Antonio, Texas v. Hotels.com, L.P., et al. (U.S. District Court for the Western District of Texas; filed in May 2006)
City of Gallup, New Mexico v. Hotels.com, L.P., et al. (U.S. District Court for the District of New Mexico; filed in July 2007)
Pine Bluff Advertising and Promotion Commission, Jefferson County, Arkansas, et al. v. Hotels.com, LP, et al. (Circuit Court of Jefferson County, Arkansas; filed in September 2009)
County of Lawrence, Pennsylvania v. Hotels.com, L.P., et al. (Court of Common Pleas of Lawrence County, Pennsylvania; filed Nov. 2009); (Commonwealth Court of Pennsylvania; appeal filed in November 2010)
Elizabeth McAllister, et al. v. Hotels.com L.P., et al., (Circuit Court of Saline County, Arkansas; filed February in 2011)
Town of Breckenridge, Colorado v. Colorado Travel Company, LLC, et al. (District Court for Summit County, Colorado; filed in July 2011)
County of Nassau v. Expedia, Inc., et al. (Supreme Court of Nassau County, New York; filed in September 2011)

Actions Filed on Behalf of Individual Cities, Counties and States

Such actions include:

City of Findlay, Ohio v. Hotels.com, L.P., et al. (U.S. District Court for the Northern District of Ohio; filed in October 2005); (U.S. Court of Appeals for the Sixth Circuit; appeal filed in December 2010); and City of Columbus, Ohio, et al. v. Hotels.com, L.P., et al. (U.S. District Court for the Southern District of Ohio; filed in August. 2006); (U.S. District Court for the Northern District of Ohio) (U.S. Court of Appeals for the Sixth Circuit; appeal filed in December 2010)
City of Chicago, Illinois v. Hotels.com, L.P., et al. (Circuit Court of Cook County Illinois; filed in November 2005)
City of San Diego, California v. Hotels.com L.P., et al. (California Superior Court, San Diego County; filed in September 2006) (Superior Court of California, Los Angeles County)
City of Atlanta, Georgia v. Hotels.com L.P., et al. (Superior Court of Fulton County, Georgia; filed in March 2006); (Court of Appeals of the State of Georgia; appeal filed in January 2007); (Georgia Supreme Court; further appeal filed in December 2007)
Wake County, North Carolina v. Hotels.com, LP, et al. (General Court of Justice, Superior Court Division, Wake County, North Carolina; filed in November 2006); Dare County, North Carolina v. Hotels.com, LP, et al. (General Court of Justice, Superior Court Division, Dare County, North Carolina; filed in January 2007); Buncombe County, North Carolina v. Hotels.com, LP, et al. (General Court of Justice, Superior Court

22



Division, Buncombe County, North Carolina; filed in February 2007); Mecklenburg County, North Carolina v. Hotels.com LP, et al. (General Court of Justice, Superior Court Division, Mecklenburg County, North Carolina; filed in January 2008)
City of Branson, Missouri v. Hotels.com, LP., et al. (Circuit Court of Greene County, Missouri; filed in December 2006); (Missouri Court of Appeals; appeal filed February 2012)
City of Houston, Texas v. Hotels.com, LP., et al. (District Court of Harris County, Texas; filed in March 2007); (Texas 14th Court of Appeals; appeal filed in April 2010); (Texas Supreme Court; petition for review filed in January 2012)
The Village of Rosemont, Illinois v. Priceline.com, Inc., et al. (U.S. District Court for the Northern District of Illinois; filed in July 2009)
Leon County, et al. v. Expedia, Inc., et al. (Second Judicial Circuit Court for Leon County, Florida; filed Nov. 2009); Leon County v. Expedia, Inc. et al. (Second Judicial Circuit Court for Leon County, Florida; filed in December 2009)
Baltimore County, Maryland v. Priceline.com, Inc., et al. (U.S. District Court for the District of Maryland; filed in May 2010)
City of Santa Monica v. Expedia, Inc., et al. (California Superior Court, Los Angeles County; filed in June 2010)
Hamilton County, Ohio, et al. v. Hotels.com, L.P., et al. (U.S. District Court for the Northern District Of Ohio; filed in August 2010)
State of Florida Attorney General v. Expedia, Inc., et al. (Circuit Court - Second Judicial Circuit, Leon County, Florida; filed in November 2010)
Montana Department of Revenue v. Priceline.com, Inc., et al. (First Judicial District Court of Lewis and Clark County, Montana; filed in November 2010)
Montgomery County, Maryland v. Priceline.com, Inc., et al. (United States District Court for the District of Maryland; filed in December 2010)
District of Columbia v. Expedia, Inc., et al. (Superior Court of District of Columbia; filed in March 2011)
Volusia County, et al. v. Expedia, Inc., et al. (Circuit Court for Volusia County, Florida; filed in April 2011)
State of Mississippi v. Priceline.com Inc., et al., (Chancery Court of Hinds County, Mississippi; filed in January 2012)

The Company has also been informed by counsel to the plaintiffs in certain of the aforementioned actions that various, undisclosed municipalities or taxing jurisdictions may file additional cases against the Company, Lowestfare.com LLC and Travelweb LLC in the future.

Judicial Actions Relating to Assessments Issued by Individual Cities, Counties and States

The Company may seek judicial review of assessments issued by an individual city or county. Currently pending actions seeking such a review include:

Priceline.com, Inc., et al. v. Broward County, Florida (Circuit Court - Second Judicial Circuit, Leon County, Florida; filed in January 2009)
Priceline.com Inc., et al. v. City of Anaheim, California, et al. (California Superior Court, County of Orange; filed in February 2009); (California Superior Court, County of Los Angeles)
Priceline.com, Inc. v. Indiana Department of State Revenue (Indiana Tax Court; filed in March 2009)
Priceline.com, Inc., et al. v. City of San Francisco, California, et al. (California Superior Court, County of San Francisco; filed in June 2009); (California Superior Court, County of Los Angeles)
Priceline.com, Inc. v. Miami-Dade County, Florida, et al. (Eleventh Judicial Circuit Court for Miami Dade, County, Florida; filed in December 2009)
Priceline.com Incorporated, et al. v. Osceola County, Florida, et al. (Circuit Court of the Second Judicial Circuit, in and For Leon County, Florida; filed in January 2011)
In the Matter of the Tax Appeal of priceline.com Inc., In the Matter of the Tax Appeal of Lowestfare.com LLC and In the Matter of the Tax Appeal of Travelweb LLC  (Tax Appeal Court of the State of Hawaii; filed in March 2011)
Expedia, Inc. et al. v. City of Portland (Circuit Court for Multnomah County, Oregon, filed in February 2012)
Expedia, Inc., et al. v. City and County of Denver, et al. (District Court for Denver County, Colorado, filed in March 2012)

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

23




Consumer Class Actions

In Chiste, et al. v. priceline.com Inc., et al. (United States District Court for the Southern District of New York; filed in December 2008) the court granted the Company's motion to dismiss all claims against it except the breach of fiduciary claim, which, on June 21, 2011, the court ordered transferred to Illinois. On July 11, 2011, the case was transferred to the United States District Court for the Northern District of Illinois for resolution of the remaining claim, which was consolidated under Peluso v. Orbitz.com, et al., 11 Civ. 4407 on July 14, 2011. On July 13, 2011, plaintiffs filed notices of appeal of the court's orders in the Southern District of New York. On July 26, 2011, the Peluso court granted plaintiff's motion to voluntarily dismiss the claim against the Company in the Northern District of Illinois. The consolidated action, Peluso, however, remains pending. On August 5, 2011, the Company moved to dismiss the appeal. On December 6, 2011, the Court of Appeals for the Second Circuit dismissed the appeal.

The Company intends to defend vigorously against the claims in all of the on-going 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 the Company’s 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 Paradise Valley, Arizona; the City of Portland and County of Multnomah, Oregon, and state tax officials from Arkansas, Florida, Louisiana, Maryland, Ohio, 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, thirteen cities in the state of Utah, and by the City of St. Louis, Missouri. 
 
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 consolidated balance sheets and provisions recorded have not been material to the Company’s consolidated results of operations or cash flows.  The Company is unable to estimate the potential maximum range of loss.
 
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 the Company’s business, results of operations, financial condition and cash flows.
 
OFT Inquiry

In September 2010, the United Kingdom's Office of Fair Trading (the “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, financial condition and results of operations.



24



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
 
We are a leading online travel company that offers our customers hotel room reservations at over 235,000 hotels worldwide through the Booking.com, priceline.com and Agoda.com brands. In the United States, we also offer our customers reservations for car rentals, airline tickets, vacation packages, destination services and cruises through the priceline.com brand. We offer car rental reservations worldwide through rentalcars.com (formerly known as TravelJigsaw), which we acquired in May 2010.
 
We launched our business in the United States in 1998 under the priceline.com brand and have since expanded our operations to include the Booking.com, Agoda.com and rentalcars.com companies.  Our principal goal is to serve our customers with worldwide leadership in online hotel and rental car reservations.  Our business is driven primarily by international results. During the year ended December 31, 2011, our international business (the significant majority of which is generated by Booking.com) represented approximately 78% 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 88% of our consolidated operating income. Given that the business of our international operations is primarily comprised of hotel reservation services, gross profit earned in connection with the reservation of hotel room nights represents a substantial majority of our gross profit.

Our priceline.com brand in the United States offers merchant Name Your Own Price® travel services (sometimes referred to as "opaque" travel services), which are recorded in revenue on a "gross" basis and have associated cost of revenue. Retail, or price-disclosed, travel services offered by both our U.S. and international brands are recorded in revenue on a "net" basis and have no associated cost of revenue. Therefore, revenue increases and decreases are impacted by changes in the mix of our revenues between Name Your Own Price® and retail travel services. Gross profit reflects the net margin earned for both our Name Your Own Price® and retail travel services. 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 price-disclosed merchant hotel room and rental car reservation services;

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

Global distribution system ("GDS") reservation booking fees related to both our Name Your Own Price® airline ticket, hotel room reservation 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.

Over the last several years we have experienced strong growth in the number of hotel room night reservations booked through our hotel reservation services. We believe this growth is the result of, among other things, the broader shift of travel purchases from offline to online, the high growth of travel overall in emerging markets such as Asia-Pacific and South America, and the continued innovation and execution by our teams around the world to build hotel supply, content and distribution and to improve the customer experience on our websites. We experienced exceptionally strong year-over-year growth during 2011. However, given the sheer size of our hotel reservation business, we believe it is highly likely that our year-over-year growth rates will generally decelerate on a quarterly sequential basis in the future. During the first quarter of 2012, we experienced deceleration in year-over-year hotel room night reservation growth as compared to the year-over-year growth rate in the fourth quarter of 2011. We expect to experience further deceleration in growth rates throughout 2012 and beyond.


25



In addition, many governments around the world, including the United States and certain European governments, are operating at very large financial deficits. Governmental austerity measures aimed at reducing deficits have created political challenges and could impair the economic recovery and adversely affect travel demand. Weak economic growth and elevated unemployment rates in the economies of such countries could cause, contribute to, or be indicative of, deteriorating macro-economic conditions. Recently, we have experienced volatility in the growth rates for transactions booked and cancellations for our international business. We have also observed a decline in transaction growth rates and weaker trends in hotel average daily rates ("ADRs") for certain southern European countries, likely due to the impact of weak economic conditions and sovereign debt concerns. This volatility makes it more difficult to predict longer-term trends and the future impact of macro-economic weakness on our business. Finally, higher oil prices are contributing to higher airline ticket prices and are likely to adversely impact consumer discretionary funds available to be spent on travel.

Large, established Internet search engines with substantial resources and expertise in developing online commerce and facilitating Internet traffic are creating - and we believe intend to further create - inroads into online travel, both in the United States and internationally. For example, Google launched "Hotel Finder," a utility that allows users to search and compare hotel accommodations based on parameters set by the user and recently began placing Hotel Finder at the top of hotel-related search advertisements. Google also recently launched a new flight search tool that enables users to find fares, schedules and availability directly on Google and excludes online travel agent ("OTA") participation within the search results. In addition, Microsoft launched Bing Travel, 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. Furthermore, certain suppliers limit OTA participation within the meta-search results. Some meta-search sites, such as Kayak.com, which offers its users the ability to make hotel reservations directly on its website, may evolve into more traditional online travel sites. These initiatives, among others, illustrate a 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 search 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.

Several major hotel companies, including Choice Hotels International, Hilton Worldwide, Hyatt, InterContinental Hotels Group, Wyndham Hotel Group and Marriott, have launched Room Key, a hotel search engine that competes directly with our hotel room night reservations services around the world. The hotel companies that own Room Key have a stated goal of driving demand directly to their brand web sites, thus reducing the share received by online travel agencies. They may also attempt to improve their competitive position by offering lower room rates, better room availability or additional features or amenities through Room Key than are available through services like ours. If Room Key is successful, our share of the online hotel room night reservation market could be negatively affected in the United States and around the world and our business could suffer.

Over the recent past, there has been a proliferation of new channels through which hotels can offer hotel room reservations.  For example, hotels are increasingly offering hotel room reservations through “daily deal” websites such as Groupon and Living Social, which sell coupons to customers at a substantial discount.  In 2011, Expedia, one of our largest competitors, entered into a partnership with Groupon to sell hotel room reservations to Groupon customers under the “Groupon Getaways” brand name. New entrants, such as BackBid, GuestMob and Tingo, have developed new and differentiated offerings that endeavor to provide savings on hotel rooms to consumers and that compete directly with us.  If any of these new services are successful, we may experience less demand for our services and are likely to face more competition for access to the limited supply of discounted hotel room rates.  

While the vast majority of online hotel bookings are generated through typical desktop and laptop computers, an increasing number of our hotel bookings are being made through mobile websites and applications.  Our major competitors and certain new market entrants are offering mobile applications that provide proprietary last-minute discounts for hotel bookings and other functionality. A number of our brands have made significant progress creating new hotel mobile products, which have received strong reviews and solid download trends.  While we believe that mobile bookings present an opportunity for incremental growth, if we are unable to continue to rapidly innovate and create new and differentiated mobile products, we could lose market share to new entrants and traditional competitors. 

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.

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Accordingly, recent international online travel growth rates have substantially exceeded, and are expected to continue to exceed, the growth rates within the United States. We expect that over the long-term, international online travel growth rates will follow a similar trend to that experienced in 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. Our growth has primarily been generated by our international hotel reservation service brands, Booking.com and Agoda.com. Booking.com, our most significant brand, currently includes over 210,000 hotels and accommodations on its website as compared to about 135,000 hotels and accommodations last year (updated hotel and accommodation counts are available on the Booking.com website). Booking.com has added hotels and accommodations over the past year in its core European market as well as higher-growth markets such as North America (which is a newer market for Booking.com), Asia-Pacific and South America. An increasing amount of our business from both a destination and point-of-sale perspective is conducted in these newer markets which are growing faster than our overall growth rate. We believe that the opportunity to continue to grow our business exists for the markets in which we operate. We believe these trends and factors have enabled us to become the top online hotel reservation service provider in the world as measured by room nights booked.

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.com utilize online search, price comparison and travel research websites, 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 2012 and beyond. In addition, certain newer markets in which we operate that are in earlier stages of development have lower operating margins compared to more mature markets, which could have a negative impact on our overall margins as these markets increase in size over time. Also, we intend to continue to invest in adding hotels and accommodations to our websites. Many of these newer properties we add, especially in highly penetrated markets, may have fewer rooms or lower ADRs, and may appeal to a smaller subset of customers (for example, hostels and bed and breakfasts) and therefore may also negatively impact our margins over time.

Another impact of the growing importance of Booking.com, Agoda.com and rentalcars.com 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. A strengthening of the Euro increases our Euro-denominated net assets, gross bookings, gross profit, operating expenses, and net income as expressed in U.S. Dollars, while a weakening of the Euro decreases our Euro-denominated net assets, gross bookings, gross profit, operating expenses, and net income as expressed in U.S. Dollars. Greece, Ireland, Portugal and certain other European Union countries with high levels of sovereign debt have had difficulty refinancing their debt. Concern around devaluation or abandonment of the Euro common currency, or that sovereign default risk may be more widespread and could include the United States, has led to significant volatility in the exchange rate between the Euro, the U.S. Dollar and other currencies. We generally enter into derivative instruments to minimize the impact of short-term currency fluctuations on our consolidated operating results. However, 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). For example, while revenue from our international operations grew on a local currency basis by approximately 65% for the three months ended March 31, 2012, compared to the same period in 2011, as a result of the negative impact of currency exchange rates, revenue from our international operations as reported in U.S. Dollars grew 59% year-over-year.

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 a competitive advantage. In particular, the competition to provide "opaque" hotel services to consumers, an area in which priceline.com has been a leader, has become more intense over the recent past. For example, in the fourth quarter of 2010, Expedia began making opaque hotel room reservations available on its principal website under the name "Expedia Unpublished Rates" and has been supporting the initiative with a national television advertising campaign as well as funding steeper discounts through lower margins. New entrants, including BackBid, GuestMob and Tingo, endeavor to provide savings on hotel rooms. In addition, in 2009, Travelocity launched an opaque price-disclosed hotel booking service. As with our Name Your Own Price® hotel booking service, for these services, the name of the hotel is not disclosed until after purchase. We believe these new offerings, in particular Expedia Unpublished Rates, have adversely impacted the market share and year-over-year growth rate for our opaque hotel service, which experienced a modest decline in room night reservations in the first quarter of 2012 compared to the same period in 2011. These and other competitors could also launch opaque rental car services, which could negatively impact our Name Your Own Price® rental car service. In addition, hotels are increasingly offering discounted hotel room reservations

27



through "daily deal" websites such as Groupon and Living Social. If Expedia or Travelocity are successful in growing their opaque hotel service, and/or "daily deal" websites are successful in garnering a sizable share of discounted hotel bookings, we may have less consumer demand for our opaque hotel service over time and we are likely to face more competition for access to the limited supply of discounted hotel room rates. As a result, we believe our share of the discount hotel market in the United States could further decrease.

We believe that for a number of reasons, including the recent significant year-over-year increase in retail airfares, consumers are engaging in increased shopping behavior before making a travel purchase than they engaged in previously. Increased shopping behavior reduces our advertising efficiency and effectiveness because traffic becomes less likely to result in a purchase on our website, and such traffic is more likely to be obtained through paid online advertising channels than through free direct channels.

While demand for online travel services in the United States continues to experience annualized growth, we believe that the domestic market share of third-party distributors is impacted in part by a concerted initiative by travel suppliers to direct customers to their own websites in an effort to reduce distribution expenses and establish more direct control over their pricing. The launch of Room Key discussed above is demonstrative of such efforts. In addition, certain suppliers have attempted to charge additional fees to customers who book airline reservations through an online channel other than their own website. 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.

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. For example, in 2011, we enabled a direct connection with American Airlines. During 2011, American Airlines content was temporarily unavailable on Expedia and Orbitz due to disputes related to enabling a direct connection. We believe that this is consistent with an effort on the part of American Airlines, and the airline industry in general, to reduce distribution costs and could be indicative of the airlines in general becoming more aggressive in requiring online travel agents to implement direct connections. Development and implementation of the technology to enable additional 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 additional migration toward direct connections would reduce the compensation we receive from GDSs.

Domestic airlines have reduced capacity and increased fares since the latter part of 2009, a trend which may continue. Decreases in capacity reduce the amount of airline tickets available, while significant increases in average airfares over the last two years have adversely impacted leisure 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. Our rental car business is further impacted by decreases in rental car fleets, which has negatively impacted our Name Your Own Price® rental car service. We expect continued variability in the breadth and depth of discounted airline tickets and rental car rates made available to us in the future, depending on market conditions from time to time.

Seasonality. A meaningful amount of retail gross bookings are generated early in the year, as customers plan and reserve their spring and summer vacations in Europe and North America. However, we do not recognize associated revenue until future quarters when the travel occurs. From a cost perspective, we expense the substantial majority of our advertising activities as they are incurred, which is typically in the quarter in which bookings are generated. As a result, we typically experience our highest levels of profitability in the second and third quarters of the year, which is when we experience the highest levels of booking and travel consumption for the year for our North American and European businesses. However, we experience the highest levels of booking and travel consumption for our Asia-Pacific and South American businesses in the first and fourth quarters. Therefore, if these businesses continue to grow faster than our North American and European businesses, our operating results for the first and fourth quarters of the year may become more significant over time as a percentage of full year operating results. In addition, 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.com, at the time that the customer checks out of the hotel. Therefore, if our retail hotel business continues to grow, we expect our quarterly results to become increasingly impacted by these seasonal factors.

Other Factors. 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.com and rentalcars.com 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, higher oil prices, terrorist attacks, unusual

28



weather patterns, natural disasters such as earthquakes, hurricanes, tsunamis, floods, volcanic eruptions (such as the April 2010 eruption of a volcano in Iceland), travel related health concerns including pandemics and epidemics such as Influenza H1N1, avian bird flu and SARS, political instability, regional hostilities, 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 2011, Japan was struck by a major earthquake, tsunami and nuclear emergency. Japan is an important source of travel demand for Agoda.com, and these crises had an adverse impact on travel demand originating in Japan and demand for Japanese destinations. In October 2011, severe flooding in Thailand, a key market for our Agoda.com business and the Asian business of Booking.com, negatively impacted booking volumes and cancellation rates in this market. In addition, in early 2010, Thailand experienced disruptive civil unrest, which caused the temporary relocation of Agoda.com's Thailand-based operations. Future natural disasters or civil or political unrest could further disrupt our business and operations.

We intend to continue to invest in marketing and promotion, technology and personnel within parameters consistent with attempts to improve long-term 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 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 gross profit growth and profitability.

Results of Operations
 
Three Months Ended March 2012 compared to the Three Months Ended March 31, 2011
 
Operating 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 travel destination or the location of the customer purchasing the travel.

Gross bookings resulting from hotel room night reservations, rental car days and airline tickets reserved through our domestic and international operations for the three months ended March 31, 2012 and 2011 were as follows (numbers may not total due to rounding): 
 
 
Three Months Ended March 31,
 (in millions)
 
 
 
 
2012
 
2011
 
Change
Domestic
 
$
1,260

 
$
1,129

 
11.7
%
International
 
5,451

 
3,536

 
54.2
%
Total
 
$
6,712

 
$
4,665

 
43.9
%
 
Gross bookings increased by 43.9% for the three months ended March 31, 2012, compared to the same period in 2011, principally due to 47.0% growth in hotel room night reservations, partly offset by slower growth rates for our non-hotel businesses.  The 54.2% increase in international gross bookings (growth on a local currency basis was approximately 58%) was attributable to growth in international hotel room night reservations for our Booking.com and Agoda.com businesses, as well as higher average daily rates charged for hotel stays and growth in international rental car reservations for our rentalcars.com business.  Domestic gross bookings increased by 11.7% for the three months ended March 31, 2012, compared to the same period in 2011, primarily due to growth in price-disclosed airline ticket reservations, hotel room night reservations and rental car day reservations, and Name Your Own Price®  rental car day reservations.  Higher average daily rates (“ADRs”) drove growth in gross bookings related to our Name Your Own Price® hotel business despite a modest year-over-year decline in Name Your Own Price® hotel room night reservations in the three months ended March 31, 2012. Name Your Own Price® airline ticket reservations decreased significantly in the three months ended March 31, 2012, compared to the same period in 2011, due to the limited availability of discounted airline capacity.

29



 
Gross bookings resulting from reservations of hotel room nights, rental car days and airline tickets made through our agency and merchant models for the three months ended March 31, 2012 and 2011 were as follows: 
 
 
Three Months Ended March 31,
 (in millions)
 
 
 
 
2012
 
2011
 
Change
Agency
 
$
5,528

 
$
3,781

 
46.2
%
Merchant
 
1,184

 
884

 
34.0
%
Total
 
$
6,712

 
$
4,665

 
43.9
%
 
Agency gross bookings increased 46.2% for the three months ended March 31, 2012, compared to the same period in 2011, due to growth in Booking.com hotel room night reservations.  Our U.S. priceline.com business also experienced growth in reservations of agency price-disclosed hotel room nights, airline tickets and rental car days.  Merchant gross bookings increased 34.0% for the three months ended March 31, 2012, compared to the same period in 2011, due to an increase in the sale of Agoda.com hotel room night reservations, rentalcars.com rental car day reservations, priceline.com merchant price-disclosed hotel room night reservations and Name Your Own Price® rental car day reservations.  Higher ADRs drove growth in gross bookings related to our Name Your Own Price® hotel business despite a modest year-over-year decline in Name Your Own Price® hotel room night reservations in the three months ended March 31, 2012. Name Your Own Price® airline ticket reservations decreased significantly in the three months ended March 31, 2012, compared to the same period in 2011, due to the limited availability of discounted airline capacity.
 
 
Hotel Room 
Nights
 
Rental
 Car Days
 
Airline
 Tickets
 
 
 
 

 
 

 
 

 
Three Months ended March 31, 2012
 
45.9
 million
 
6.9
 million
 
1.6
 million
 
 
 
 

 
 

 
 

 
Three Months ended March 31, 2011
 
31.2
 million
 
4.9
 million
 
1.6
 million
 
 
Hotel room night reservations increased by 47.0% for the three months ended March 31, 2012, compared to the same period in 2011, principally due to an increase in Booking.com, Agoda.com and priceline.com price-disclosed hotel room night reservations, partially offset by a modest decline in Name Your Own Price® hotel room night reservations.  Booking.com, our most significant brand, currently includes over 210,000 hotels on its website as compared to about 135,000 hotels last year (updated hotel counts are available on the Booking.com website).  Booking.com has added hotels over the past year in its core European market as well as higher-growth markets such as North America (which is a newer market for Booking.com), Asia-Pacific and South America.  An increasing amount of our business from a destination and point-of-sale perspective is conducted in these newer markets which are growing faster than our overall growth rate.  Our U.S. priceline.com agency hotel reservations benefited from the integration of hotels from the Booking.com extranet on the priceline.com website.
 
Rental car day reservations increased by 40.6% for the three months ended March 31, 2012, compared to the same period in 2011, due primarily to an increase in rental car day reservations for our rentalcars.com business, priceline.com price-disclosed and Name Your Own Price® rental car days.
 
Airline ticket reservations increased by 4.9% for the three months ended March 31, 2012, compared to the same period in 2011, due to an increase in price-disclosed airline ticket reservations partially offset by a decrease in Name Your Own Price® airline ticket reservations.
 
Revenues
 
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 United States and at Agoda.com, and (b) the rental car reservations provided through our merchant semi-opaque rental car service at rentalcars.com, 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

30



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, GDS reservation booking fees related to certain of the services listed above and customer processing fees 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 selling advertising on our websites.
 
 
 
Three Months Ended
March 31,
 
 
 
 
$000
 
 
 
 
2012
 
2011
 
Change
Merchant Revenues
 
$
496,409

 
$
454,804

 
9.1
%
Agency Revenues
 
537,627

 
351,422

 
53.0
%
Other Revenues
 
3,211

 
3,094

 
3.8
%
Total Revenues
 
$
1,037,247

 
$
809,320

 
28.2
%
 
Merchant Revenues
 
Merchant revenues for the three months ended March 31, 2012 increased 9.1%, compared to the same period in 2011, primarily due to increases in Agoda.com price-disclosed hotel room night reservations, rental car day reservations for our rentalcars.com business, priceline.com Name Your Own Price® rental car reservations, and priceline.com price-disclosed hotel room night reservations, partially offset by a decline in Name Your Own Price®  airline ticket reservations and Name Your Own Price® hotel room night reservations. Merchant revenue growth over the prior year period was substantially lower than merchant gross bookings growth because Name Your Own Price® revenues, which are recorded “gross” with a corresponding cost of revenue, represented a smaller percentage of total merchant revenues compared to other merchant revenues, which are primarily recorded “net” with no corresponding cost of revenues.  For this reason, our merchant revenues are disproportionately affected by our Name Your Own Price® business. 
 
Agency Revenues
 
Agency revenues for the three months ended March 31, 2012 increased 53.0%, compared to the same period in 2011, primarily as a result of growth in the business of Booking.com.  Our U.S. agency hotel room reservations benefited from the integration of hotels from the Booking.com extranet on the priceline.com website.
 
Other Revenues
 
Other revenues during the three months ended March 31, 2012 consisted primarily of advertising revenues.  Other revenues for the three months months ended March 31, 2012 increased 3.8% compared to the same periods in 2011.
 
Cost of Revenues and Gross Profit 
 
 
Three Months Ended
March 31,
 
 
 
 
$000
 
 
 
 
2012
 
2011
 
Change
Cost of Revenues
 
$
293,959

 
$
303,512

 
(3.1
)%
% of Merchant Revenues
 
59.2
%
 
66.7
%
 
 

 
Cost of Revenues
 
For the three months ended March 31, 2012, cost of revenues consisted primarily of: (1) the cost of Name Your Own Price® hotel room reservations from our suppliers, net of applicable taxes, (2) the cost of Name Your Own Price® rental cars from our suppliers, 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 months ended March 31, 2012 decreased by 3.1%, compared to the same period in 2011, primarily due to

31



a decrease in opaque airline ticket reservations and Name Your Own Price® hotel room night reservations. Merchant price-disclosed hotel room and car rental reservations 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 and the addition of rentalcars.com merchant revenue, all of 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.
 
Gross Profit 
 
 
Three Months Ended
March 31,
 
 
 
 
$000
 
 
 
 
2012
 
2011
 
Change
Gross Profit
 
$
743,288

 
$
505,808

 
47.0
%
Gross Margin
 
71.7
%
 
62.5
%
 
 

 
Total gross profit for the three months ended March 31, 2012 increased by 47.0% compared to the same period in 2011, 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 months ended March 31, 2012 compared to the same period in 2011, 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 $616.6 million of our gross profit for the three months ended March 31, 2012, which compares to $388.2 million for the same period in 2011.  Gross profit attributable to our international operations increased, on a local currency basis, by approximately 65% for the three months ended March 31, 2012 compared to the same period in 2011.
 
Operating Expenses
 
Advertising 
 
 
Three Months Ended
March 31,
 
 
 
 
$000
 
 
 
 
2012
 
2011
 
Change
Online Advertising
 
$
277,136

 
$
185,108

 
49.7
 %
% of Total Gross Profit
 
37.3
%
 
36.6
%
 
 
Offline Advertising
 
$
11,157

 
$
11,614

 
(3.9
)%
% of Total Gross Profit
 
1.5
%
 
2.3
%
 
 

 
Online advertising expenses primarily consist of the costs of (1) search engine keyword purchases; (2) referrals from meta-search and travel research websites; (3) affiliate programs; (4) banner and pop-up advertisements; and (5) e-mail campaigns. For the three months ended March 31, 2012, online advertising expenses increased over the same period in 2011, primarily to support increased hotel room night reservations for Booking.com and Agoda.com, increased rental car day reservations for rentalcars.com and increased travel reservations for priceline.com. Online advertising as a percentage of gross profit increased for the three months ended March 31, 2012, compared to the same period in 2011. The increase is driven primarily by brand mix rather than a change in the fundamental efficiency of our advertising by brand. Our international operations are growing faster than our priceline.com business in the United States, and spend a higher percentage of gross profit on online advertising, a trend which we expect to continue. Furthermore, we are obtaining an increasing share of traffic through online advertising, a trend which we also expect to continue. We generally recognize advertising expense as incurred, but recognize the gross profit for price-disclosed hotel room and rental car reservations when the travel is completed.


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Offline advertising expenses are related to our domestic television, print and radio advertising for priceline.com. For the three months ended March 31, 2012, offline advertising decreased compared to the same period in 2011.
 
Sales and Marketing 
 
 
Three Months Ended
March 31,
 
 
 
 
$000
 
 
 
 
2012
 
2011
 
Change
Sales and Marketing
 
$
45,537

 
$
34,778

 
30.9
%
% of Total Gross Profit
 
6.1
%
 
6.9
%
 
 

 
Sales and marketing expenses consist primarily of (1) credit card processing fees associated with merchant transactions; (2) fees paid to third-parties that provide call center, website content translations and other services; (3) provisions for credit card chargebacks; and (4) provisions for bad debt, primarily related to agency hotel commission receivables. For the three months ended March 31, 2012, sales and marketing expenses, which are substantially variable in nature, increased over the same period in 2011, primarily due to increased gross booking volumes as well as expenses related to increased content translations. Our U.S. merchant business benefited from the impact of reduced credit card processing fees resulting from Durbin Amendment to the Dodd-Frank Financial Reform and Consumer Protection Act (which amendment caps the interchange fee for debit card transactions and went into effect on October 1, 2011), partially offset by the impact of higher costs for our Agoda.com business resulting from increases in foreign currency transactions and increased cancellation rates. Sales and marketing expenses as a percentage of gross profit is typically higher for our merchant business because it incurs credit card processing fees. Our merchant business grew more slowly than our agency business, and as a result, sales and marketing expenses as a percentage of total gross profit for the three months ended March 31, 2012 declined compared to the same period in 2011.
 
Personnel 
 
 
Three Months Ended
March 31,
 
 
 
 
$000
 
 
 
 
2012
 
2011
 
Change
Personnel
 
$
100,676

 
$
75,221

 
33.8
%
% of Total Gross Profit
 
13.5
%
 
14.9
%
 
 

 
Personnel expenses consist of compensation to our personnel, including salaries, bonuses, payroll taxes, employee health benefits and stock-based compensation. For the three months ended March 31, 2012, personnel expenses increased over the same period in 2011, due primarily to increased headcount to support the growth of our international businesses. Stock-based compensation expense was approximately $16.5 million for the three months ended March 31, 2012 compared to $14.0 million for the three months ended March 31, 2011.
 
General and Administrative 
 
 
Three Months Ended
March 31,
 
 
 
 
$000
 
 
 
 
2012
 
2011
 
Change
General and Administrative
 
$
40,674

 
$
25,879

 
57.2
%
% of Total Gross Profit
 
5.5
%
 
5.1
%
 
 

 
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 increased during the three months ended March 31, 2012, over the same period in 2011, due to expansion of our office capacity worldwide to support continued growth in our international operations. General and administrative expenses for the three months ended March 31, 2012 includes a charge of approximately $3 million related to certain leased space that was vacated in connection with the relocation of Booking.com's headquarters to a new location in Amsterdam. Additionally, we have had higher recruiting, training and travel expenses related to increased headcount at Booking.com, Agoda.com and rentalcars.com.
 

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Information Technology 
 
 
Three Months Ended
March 31,
 
 
 
 
 
$000
 
 
 
 
 
2012
 
2011
 
Change
 
Information Technology
 
$
10,735

 
$
6,670

 
60.9
%
 
% of Total Gross Profit
 
1.4
%
 
1.3
%
 
 

 
 
Information technology expenses consist primarily of: (1) outsourced data center costs relating to our domestic and international data centers; (2) system maintenance and software license fees; (3) data communications and other expenses associated with operating our Internet sites; and (4) payments to outside consultants. For the three months ended March 31, 2012, the increase in information technology expenses compared to the same period in 2011 was due primarily to growth in our worldwide operations.
 
Depreciation and Amortization 
 
 
Three Months Ended
March 31,
 
 
 
 
$000
 
 
 
 
2012
 
2011
 
Change
Depreciation and Amortization
 
$
15,842

 
$
12,479

 
26.9
%
% of Total Gross Profit
 
2.1
%
 
2.5
%
 
 

 
Depreciation and amortization expenses consist of: (1) amortization of intangible assets with determinable lives; (2) depreciation on computer equipment; (3) amortization of internally developed and purchased software; and (4) depreciation of leasehold improvements, office equipment and furniture and fixtures. For the three months ended March 31, 2012, depreciation expense increased from the same period in 2011 due principally to capital expenditures for additional data center capacity and office build outs to support growth and geographic expansion, principally related to our Booking.com brand. We expect future capital expenditures to also be higher than prior historical levels as we continue to invest to support business growth.
 
Other Income (Expense)
 
 
Three Months Ended
March 31,
 
 
 
 
$000