The Priceline Group
Priceline Group Inc. (Form: 10-Q, Received: 05/08/2014 08:47:30)


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, 2014
 
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
 
The Priceline Group Inc.
(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 Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes ý No  o .
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" 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 1, 2014 :
Common Stock, par value $0.008 per share
 
52,432,390
(Class)
 
(Number of Shares)





The Priceline Group Inc.
Form 10-Q
 
For the Three Months Ended March 31, 2014
 
PART I - FINANCIAL INFORMATION
 
 
 
Item 1. Financial Statements
 
 
Consolidated Balance Sheets (unaudited) at March 31, 2014 and December 31, 2013
Consolidated Statements of Operations (unaudited) For the Three Months Ended March 31, 2014 and 2013
Consolidated Statements of Comprehensive Income (unaudited) For the Three Months Ended March 31, 2014 and 2013
Consolidated Statement of Changes in Stockholders' Equity (unaudited) For the Three Months Ended March 31, 2014
Consolidated Statements of Cash Flows (unaudited) For the Three Months Ended March 31, 2014 and 2013
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 1A. Risk Factors
 
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
 
Item 6. Exhibits
 
 
SIGNATURES

2



PART I — FINANCIAL INFORMATION
Item 1.  Financial Statements

The Priceline Group Inc.
UNAUDITED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
 
 
 
March 31,
2014
 
December 31,
2013
ASSETS
 
 

 
 

Current assets:
 
 

 
 

Cash and cash equivalents
 
$
1,288,150

 
$
1,289,994

Restricted cash
 
15,616

 
10,476

Short-term investments
 
5,422,358

 
5,462,720

Accounts receivable, net of allowance for doubtful accounts of $14,237 and $14,116, respectively
 
627,160

 
535,962

Prepaid expenses and other current assets
 
428,123

 
107,102

Deferred income taxes
 
74,533

 
74,687

Total current assets
 
7,855,940

 
7,480,941

Property and equipment, net
 
149,373

 
135,053

Intangible assets, net
 
998,307

 
1,019,985

Goodwill
 
1,771,548

 
1,767,912

Deferred income taxes
 
5,093

 
7,055

Other assets
 
33,423

 
33,514

Total assets
 
$
10,813,684

 
$
10,444,460

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 

 
 

Current liabilities:
 
 

 
 

Accounts payable
 
$
299,411

 
$
247,345

Accrued expenses and other current liabilities
 
561,915

 
545,342

Deferred merchant bookings
 
471,956

 
437,127

Convertible debt (see Note 8)
 
97,707

 
151,931

Total current liabilities
 
1,430,989

 
1,381,745

Deferred income taxes
 
334,631

 
326,425

Other long-term liabilities
 
81,177

 
75,981

Convertible debt (see Note 8)
 
1,753,160

 
1,742,047

Total liabilities
 
3,599,957

 
3,526,198

 
 
 
 
 
Convertible debt (see Note 8)
 
4,318

 
8,533

 
 
 
 
 
Stockholders' equity:
 
 

 
 

Common stock, $0.008 par value; authorized 1,000,000,000 shares, 61,614,457 and 61,265,160 shares issued, respectively
 
478

 
476

Treasury stock, 9,328,998 and 9,256,721 shares, respectively
 
(2,083,867
)
 
(1,987,207
)
Additional paid-in capital
 
4,650,077

 
4,592,979

Accumulated earnings
 
4,549,970

 
4,218,752

Accumulated other comprehensive income
 
92,751

 
84,729

Total stockholders' equity
 
7,209,409

 
6,909,729

Total liabilities and stockholders' equity
 
$
10,813,684

 
$
10,444,460

 
See Notes to Unaudited Consolidated Financial Statements.

3



The Priceline Group Inc.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
 
 
 
Three Months Ended
March 31,
 
 
2014
 
2013
Agency revenues
 
$
1,041,144

 
$
769,928

Merchant revenues
 
526,998

 
528,564

Advertising and other revenues
 
73,660

 
3,520

Total revenues
 
1,641,802

 
1,302,012

Cost of revenues
 
235,331

 
292,347

Gross profit
 
1,406,471

 
1,009,665

Operating expenses:
 
 

 
 

Advertising — Online
 
520,848

 
403,153

Advertising — Offline
 
53,474

 
27,729

Sales and marketing
 
64,311

 
52,263

Personnel, including stock-based compensation of $38,803 and $21,709, respectively
 
194,531

 
134,218

General and administrative
 
72,981

 
50,161

Information technology
 
23,224

 
13,222

Depreciation and amortization
 
38,376

 
19,080

Total operating expenses
 
967,745

 
699,826

Operating income
 
438,726

 
309,839

Other income (expense):
 
 

 
 

Interest income
 
1,041

 
874

Interest expense
 
(17,745
)
 
(17,329
)
Foreign currency transactions and other
 
(5,969
)
 
(2,942
)
Total other income (expense)
 
(22,673
)
 
(19,397
)
Earnings before income taxes
 
416,053

 
290,442

Income tax expense
 
84,835

 
46,150

Net income
 
331,218

 
244,292

Less: net income attributable to noncontrolling interests
 

 
21

Net income applicable to common stockholders
 
$
331,218

 
$
244,271

Net income applicable to common stockholders per basic common share
 
$
6.35

 
$
4.89

Weighted average number of basic common shares outstanding
 
52,153

 
49,939

Net income applicable to common stockholders per diluted common share
 
$
6.25

 
$
4.76

Weighted average number of diluted common shares outstanding
 
53,018

 
51,353

 
See Notes to Unaudited Consolidated Financial Statements.


4



The Priceline Group Inc.
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
 
Three Months Ended
March 31,
 
2014
 
2013
Net income
$
331,218

 
$
244,292

Other comprehensive income, net of tax
 
 
 
Foreign currency translation adjustments  (1)
7,914

 
(76,606
)
Unrealized gain on marketable securities (2)
108

 
39

Comprehensive income
339,240

 
167,725

Less: Comprehensive loss attributable to noncontrolling interests (See Note 11)

 
(12,162
)
Comprehensive income attributable to common stockholders
$
339,240

 
$
179,887


(1) Net of tax of $1,137 and $26,898 for the three months ended March 31, 2014 and 2013 , respectively, associated with hedges of foreign denominated net assets. See Note 12.

(2) Net of tax of $49 and $7 for the three months ended March 31, 2014 and 2013 , respectively.


See Notes to Unaudited Consolidated Financial Statements.


5



The Priceline Group Inc.
UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2014
(In thousands)
 
 
 
Common Stock
 
Treasury Stock
 
Additional Paid-In Capital
 
Accumulated Earnings
 
Accumulated Other Comprehensive Income
 
 
 
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
Total
Balance, December 31, 2013
 
61,265

 
$
476

 
(9,257
)
 
$
(1,987,207
)
 
$
4,592,979

 
$
4,218,752

 
$
84,729

 
$
6,909,729

Net income applicable to common stockholders
 

 

 

 

 

 
331,218

 

 
331,218

Foreign currency translation adjustments, net of tax of $1,137
 

 

 

 

 

 

 
7,914

 
7,914

Unrealized gain on marketable securities, net of tax of $49
 

 

 

 

 

 

 
108

 
108

Reclassification adjustment for convertible debt in mezzanine
 

 

 

 

 
4,215

 

 

 
4,215

Exercise of stock options and vesting of restricted stock units and performance share units
 
206

 
1

 

 

 
7,692

 

 

 
7,693

Repurchase of common stock
 

 

 
(72
)
 
(96,660
)
 

 

 

 
(96,660
)
Stock-based compensation and other stock-based payments
 

 

 

 

 
39,412

 

 

 
39,412

Conversion of debt
 
143

 
1

 

 

 
280

 

 

 
281

Excess tax benefit on stock-based compensation
 

 

 

 

 
5,499

 

 

 
5,499

Balance, March 31, 2014
 
61,614

 
$
478

 
(9,329
)
 
$
(2,083,867
)
 
$
4,650,077

 
$
4,549,970

 
$
92,751

 
$
7,209,409

 
See Notes to Unaudited Consolidated Financial Statements.


6



The Priceline Group Inc.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
 
Three Months Ended
March 31,
 
 
2014
 
2013
OPERATING ACTIVITIES:
 
 
 
 
Net income
 
$
331,218

 
$
244,292

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation
 
15,552

 
9,802

Amortization
 
22,824

 
9,278

Provision for uncollectible accounts, net
 
3,671

 
4,216

Deferred income taxes
 
8,828

 
(7,229
)
Stock-based compensation expense and other stock-based payments
 
39,412

 
21,826

Amortization of debt issuance costs
 
1,346

 
1,432

Amortization of debt discount
 
12,412

 
11,120

Loss on early extinguishment of debt
 
3,396

 

Changes in assets and liabilities:
 
 
 
 
Accounts receivable
 
(94,156
)
 
(115,162
)
Prepaid expenses and other current assets
 
(317,812
)
 
(207,993
)
Accounts payable, accrued expenses and other current liabilities
 
147,608

 
188,112

Other
 
2,705

 
23,423

Net cash provided by operating activities
 
177,004

 
183,117

 
 
 
 
 
INVESTING ACTIVITIES:
 
 
 
 
Purchase of investments
 
(2,612,047
)
 
(1,504,676
)
Proceeds from sale of investments
 
2,652,013

 
1,521,947

Additions to property and equipment
 
(29,731
)
 
(15,051
)
Acquisitions and other equity investments, net of cash acquired
 
(2,633
)
 
(102
)
Payments on foreign currency contracts
 
(43,380
)
 
(17,539
)
Change in restricted cash
 
(5,077
)
 
(581
)
Net cash used in investing activities
 
(40,855
)
 
(16,002
)
 
 
 
 
 
FINANCING ACTIVITIES:
 
 
 
 
Payments related to conversion of senior notes
 
(58,449
)
 

Repurchase of common stock
 
(96,660
)
 
(76,380
)
Proceeds from exercise of stock options
 
7,693

 
965

Excess tax benefit on stock-based compensation
 
5,499

 
4,443

Net cash used in financing activities
 
(141,917
)
 
(70,972
)
Effect of exchange rate changes on cash and cash equivalents
 
3,924

 
(21,282
)
Net (decrease) increase in cash and cash equivalents
 
(1,844
)
 
74,861

Cash and cash equivalents, beginning of period
 
1,289,994

 
1,536,349

Cash and cash equivalents, end of period
 
$
1,288,150

 
$
1,611,210

SUPPLEMENTAL CASH FLOW INFORMATION:
 
 
 
 
Cash paid during the period for income taxes
 
$
367,160

 
$
228,893

Cash paid during the period for interest
 
$
5,821

 
$
9,072

Non-cash fair value increase for redeemable noncontrolling interests
 
$

 
$
42,768

 
See Notes to Unaudited Consolidated Financial Statements.

7



The Priceline Group Inc.
Notes to Unaudited Consolidated Financial Statements
 
1.                                       BASIS OF PRESENTATION
 
On April 1, 2014, the Company changed its name from priceline.com Incorporated to The Priceline Group Inc. The Priceline Group Inc. (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, 2013 .
 
The Unaudited Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries, including KAYAK Software Corporation ("KAYAK") since its acquisition on May 21, 2013. 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 income" on the accompanying Unaudited Consolidated Balance Sheets.  Foreign currency transaction gains and losses are included on 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
 
In July 2013, the Financial Accounting Standards Board ("FASB") issued an accounting update which provides guidance on financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward or a tax credit carryforward exists in the same taxing jurisdiction. Per this guidance, an entity must present the unrecognized tax benefit as a reduction to a deferred tax asset, except when the carryforward is not available as of the reporting date under the governing tax law to settle taxes or the entity does not intend to use the deferred tax asset for this purpose. This amendment does not impact the recognition or measurement of uncertain tax positions or the disclosure reconciliation of gross unrecognized tax benefits. The update is effective for public companies beginning after December 15, 2013. The Company adopted this update in the first quarter of 2014 and this accounting update did not have an impact on the Company's consolidated balance sheet.
In April 2014, the FASB issued an accounting update which amends the definition of a discontinued operation. The new definition limits discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have or will have a major effect on an entity's operations and financial results. The new definition includes an acquired business that is classified as held for sale at the date of acquisition. The accounting update requires new disclosures of both discontinued operations and a disposal of an individually significant component of an entity. The accounting update is effective for annual periods beginning on or after December 15, 2014. Early adoption is permitted but only for disposals that have not been reported in financial statements previously issued.

2.                                       STOCK-BASED EMPLOYEE COMPENSATION
 
Stock-based compensation expense included in personnel expenses in the Unaudited Consolidated Statements of Operations was approximately $38.8 million and $21.7 million for the three months ended March 31, 2014 and 2013 , respectively.

The cost of stock-based transactions is recognized in the financial statements based upon fair value. Fair value is recognized as expense on a straight line basis, net of estimated forfeitures, over the employee requisite service period. The fair value of 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

8



performance share units reflects the estimated probable outcome at the end of the performance period. The fair value of employee stock options assumed in the acquisition of KAYAK was determined using the Black-Scholes model and the market value of the Company's common stock at the merger date.
 
Restricted Stock Units and Performance Share Units

The following table summarizes the activity of unvested restricted stock units and performance share units ("share-based awards") during the three months ended March 31, 2014
Share-Based Awards
 
Shares
 
Weighted Average Grant Date Fair Value
Unvested at December 31, 2013
 
534,319

 
 
$
615.10

 
Granted
 
95,476

 
 
$
1,338.24

 
Vested
 
(180,616
)
 
 
$
469.32

 
Performance Share Units Adjustment
 
25,822

 
 
$
800.59

 
Forfeited
 
(1,438
)
 
 
$
838.94

 
Unvested at March 31, 2014
 
473,563

 
 
$
825.92

 
 
As of March 31, 2014 , there was $262.9 million of total future compensation cost related to unvested share-based awards to be recognized over a weighted-average period of 2.1 years.
 
During the three months ended March 31, 2014 , the Company made broad-based grants of 31,980 restricted stock units that generally vest after three years. These share-based awards had a total grant date fair value of $42.8 million based on a weighted average grant date fair value per share of $1,338.24 .

In addition, during the three months ended March 31, 2014 , the Company granted 63,496 performance share units to executives and certain other employees.  The performance share units had a total grant date fair value of $85.0 million based upon a weighted average grant date fair value per share of $1,338.24 .  The performance share units are payable in shares of the Company's common stock upon vesting. Subject to certain exceptions for terminations other than for "cause," for "good reason" or on account of death or disability, recipients of these performance share units must continue their service through the three year requisite service period in order to receive any shares.  Stock-based compensation related to performance share units reflects 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, 2016, assuming there is no accelerated vesting for, among other things, a termination of employment under certain circumstances.  As of March 31, 2014 , the estimated number of probable shares to be issued is a total of 63,496 shares.  If the maximum performance thresholds are met at the end of the performance period, a maximum number of 126,992 total shares could be issued.  If the minimum performance thresholds are not met, 44,067 shares would be issued at the end of the performance period.
 
2013 Performance Share Units

During the year ended December 31, 2013 , the Company granted 104,865 performance share units with a grant date fair value of $74.4 million , based on a weighted average grant date fair value per share of $709.74 . The actual number of shares to be issued will be determined upon completion of the performance period which ends December 31, 2015.

At March 31, 2014 , there were 103,162 unvested 2013 performance share units outstanding, net of performance share units that were forfeited or vested since the grant date. As of March 31, 2014 , the number of shares estimated to be issued pursuant to these performance share units at the end of the performance period is a total of 194,403 shares. If the maximum thresholds are met at the end of the performance period, a maximum of 225,894 total shares could be issued pursuant to these performance share units. If the minimum performance thresholds are not met, 40,466 shares would be issued at the end of the performance period.


9



2012 Performance Share Units
 
During the year ended December 31, 2012 , the Company granted 60,365 performance share units with a grant date fair value of $39.0 million , based on a weighted average grant date fair value per share of $645.86 .  The actual number of shares to be issued will be determined upon completion of the performance period which ends December 31, 2014.
 
At March 31, 2014 , there were 58,004 unvested 2012 performance share units outstanding, net of performance share units that were forfeited or vested since the grant date.  As of March 31, 2014 , the number of shares estimated to be issued pursuant to these performance share units at the end of the performance period is a total of 99,232 shares.  If the maximum performance thresholds are met at the end of the performance period, a maximum of 116,008 total shares could be issued pursuant to these performance share units. If the minimum performance thresholds are not met, 36,250 shares would be issued at the end of the performance period.

Stock Options - Other than Stock Options Assumed in the Acquisition of KAYAK

The disclosures in this section do not include employee stock options assumed in the acquisition of KAYAK (described below). During the three months ended March 31, 2014 , stock options were exercised for 2,250 shares of common stock with a weighted average exercise price per share of $22.25 and an aggregate intrinsic value of $2.9 million .  As of March 31, 2014 , the aggregate number of shares subject to stock options outstanding and exercisable was 6,750 , with a weighted average exercise price per share of $22.66 , a weighted average remaining term of 1 year and an aggregate intrinsic value of $7.9 million .

Employee Stock Options Assumed in the Acquisition of KAYAK

The Company assumed vested and unvested employee stock options as part of the acquisition of KAYAK on May 21, 2013. The following table summarizes the activity of employee stock options assumed in the acquisition of KAYAK during the three months ended  March 31, 2014
Assumed Employee Stock Options
 
Number of Shares
 
Weighted Average
 Exercise Price
 
Aggregate
 Intrinsic Value (in thousands)
 
Weighted Average Remaining Contractual Term
(in years)
Balance, December 31, 2013
 
128,708

 
 
$
335.83

 
 
$
106,386

 
6.9
Exercised
 
(23,809
)
 
 
$
313.57

 
 
 
 
 
Forfeited
 
(147
)
 
 
$
452.45

 
 
 
 
 
Balance, March 31, 2014
 
104,752

 
 
$
340.73

 
 
$
89,161

 
6.7
Vested and exercisable as of March 31, 2014
 
72,009

 
 
$
268.68

 
 
$
66,479

 
6.0
Vested and exercisable as of March 31, 2014 and expected to vest thereafter, net of estimated forfeitures
 
103,203

 
 
$
337.72

 
 
$
88,153

 
6.7

The aggregate intrinsic value of employee stock options assumed in the acquisition of KAYAK that were exercised during the three months ended March 31, 2014 was $23.6 million . During the three months ended March 31, 2014 , assumed unvested employee stock options vested for 9,478 shares of common stock with a fair value of $4.1 million .

For the three months ended March 31, 2014 , the Company recorded stock-based compensation expense of $4.1 million for the KAYAK unvested assumed employee stock options. As of March 31, 2014 , there was $12.7 million of total future compensation costs related to these KAYAK unvested assumed employee stock options to be recognized over a weighted-average period of 2.1 years.


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.

10



 
Common equivalent shares related to stock options, restricted stock units and performance share units are calculated using the treasury stock method.  Performance share units are included in the weighted average common equivalent shares based on the number of shares that would be issued if the end of the reporting period were the end of the performance period, if the result would be dilutive.
 
The Company's convertible debt issues have net share settlement features requiring the Company upon conversion to settle the principal amount of the debt for cash and the conversion premium for cash or shares of the Company's common stock, 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,
 
 
2014
 
2013
Weighted average number of basic common shares outstanding
 
52,153

 
49,939

Weighted average dilutive stock options, restricted stock units and performance share units
 
317

 
351

Assumed conversion of Convertible Senior Notes
 
548

 
1,063

Weighted average number of diluted common and common equivalent shares outstanding
 
53,018

 
51,353

Anti-dilutive potential common shares
 
2,069

 
2,196

 
Anti-dilutive potential common shares for the three months ended March 31, 2014 include approximately 1.7 million shares that could be issued under the Company's outstanding convertible notes, if the Company experiences substantial increases in its common stock price.  Under the treasury stock method, the convertible notes will generally have a dilutive impact on net income per share if the Company's average stock price for the period exceeds the conversion price for the convertible notes.


4.                                       INVESTMENTS
 
The following table summarizes, by major security type, the Company's short-term investments as of March 31, 2014 (in thousands): 
 
 
Cost
 
Gross 
Unrealized 
Gains
 
Gross 
Unrealized
  Losses
 
Fair
  Value
Available for sale securities
 
 

 
 

 
 

 
 

Foreign government securities
 
$
3,823,066

 
$
242

 
$
(328
)
 
$
3,822,980

U.S. government securities
 
1,599,045

 
354

 
(21
)
 
1,599,378

Total
 
$
5,422,111

 
$
596

 
$
(349
)
 
$
5,422,358

 
As of March 31, 2014 , 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, 2013 (in thousands): 
 
 
Cost
 
Gross
  Unrealized
  Gains
 
Gross
  Unrealized
  Losses
 
Fair
  Value
Available for sale securities
 
 

 
 

 
 

 
 

Foreign government securities
 
$
4,019,530

 
$
233

 
$
(356
)
 
$
4,019,407

U.S. government securities
 
1,443,083

 
250

 
(20
)
 
1,443,313

Total
 
$
5,462,613

 
$
483

 
$
(376
)
 
$
5,462,720

 

11



There were no realized gains or losses related to investments for the three months ended March 31, 2014 and 2013 .


5.                                       FAIR VALUE MEASUREMENTS
 
Financial assets and liabilities carried at fair value as of March 31, 2014 are classified in the tables below in the categories described below (in thousands): 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
ASSETS:
 
 

 
 

 
 

 
 

Short-term investments
 
 

 
 

 
 

 
 

Foreign government securities
 
$

 
$
3,822,980

 
$

 
$
3,822,980

U.S. government securities
 

 
1,599,378

 

 
1,599,378

Foreign exchange derivatives
 

 
3,344

 

 
3,344

Total assets at fair value
 
$

 
$
5,425,702

 
$

 
$
5,425,702

 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
LIABILITIES:
 
 

 
 

 
 

 
 

Foreign exchange derivatives
 
$

 
$
78,603

 
$

 
$
78,603

 
Financial assets and liabilities carried at fair value as of December 31, 2013 are classified in the tables below in the categories described below (in thousands):
 
 
Level 1
 
Level 2
 
Level 3
 
Total
ASSETS:
 
 

 
 

 
 

 
 

Short-term investments
 
 

 
 

 
 

 
 

Foreign government securities
 
$

 
$
4,019,407

 
$

 
$
4,019,407

U.S. government securities
 

 
1,443,313

 

 
1,443,313

Foreign exchange derivatives
 

 
292

 

 
292

Total assets at fair value
 
$

 
$
5,463,012

 
$

 
$
5,463,012

 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
LIABILITIES:
 
 

 
 

 
 

 
 

Foreign exchange derivatives
 
$

 
$
122,091

 
$

 
$
122,091

 
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 foreign government and U.S. Treasury securities are considered "Level 2 " valuations 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.  For the Company's investments, a market approach is used for recurring fair value measurements and the valuation techniques use inputs that are observable, or can be corroborated by observable data, in an active marketplace. 
 
The Company's derivative instruments are valued using pricing models.  Pricing models take into account the contract terms as well as multiple inputs where applicable, such as interest rate yield curves, option volatility and currency rates. Derivatives are considered "Level 2 " fair value measurements. The Company's derivative instruments are typically short-term in nature.

12



 
As of March 31, 2014 and December 31, 2013 , 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, accounts payable, 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 Senior Convertible Notes.
 
In the normal course of business, the Company is exposed to the impact of foreign currency fluctuations.  The Company limits these risks by following established risk management policies and procedures, including the use of derivatives.  The Company does not use derivatives for trading or speculative purposes.  All derivative instruments are recognized on 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 on 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 international subsidiary's net assets and are recognized on the Unaudited Consolidated Balance Sheets in "Accumulated other comprehensive income."
 
Derivatives Not Designated as Hedging Instruments — The Company is exposed to adverse movements in currency exchange rates as the operating results of its international operations are translated from local currency into U.S. Dollars upon consolidation.  The Company's derivative contracts principally address short-term foreign exchange fluctuations for the Euro and British Pound Sterling versus the U.S. Dollar.  As of March 31, 2014 and December 31, 2013 , there were no outstanding derivative contracts associated with foreign currency translation risk.  Foreign exchange losses of $0.3 million for the three months ended March 31, 2014 compared to foreign exchange gains of $0.4 million for the three months ended March 31, 2013 were recorded in "Foreign currency transactions and other" in the Unaudited Consolidated Statements of Operations.
 
The Company also enters into foreign currency forward contracts to hedge its exposure to the impact of movements in currency exchange rates on its transactional balances denominated in currencies other than the functional currency. Foreign exchange derivatives outstanding as of March 31, 2014 associated with hedging these risks resulted in a net asset of $0.2 million , with $0.4 million recorded in "Prepaid expenses and other current assets" and $0.2 million recorded in "Accrued expenses and other current liabilities" on the Unaudited Consolidated Balance Sheet. Foreign exchange derivatives outstanding as of December 31, 2013 associated with hedging these risks resulted in a net liability of $0.5 million , with $0.6 million recorded in "Accrued expenses and other current liabilities" and $0.1 million recorded in "Prepaid expenses and other current assets" on the Unaudited Consolidated Balance Sheet.  Foreign exchange gains of $0.6 million for the three months ended March 31, 2014 compared to foreign exchange losses of $3.2 million for the three months ended March 31, 2013 were recorded related to these derivatives in "Foreign currency transactions and other" in the Unaudited Consolidated Statements of Operations.
 
The settlement of derivative contracts not designated as hedging instruments resulted in a net cash inflow of $0.2 million for the three months ended March 31, 2014 compared to a net cash outflow of $2.8 million for the three months ended March 31, 2013 , 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, 2014 and December 31, 2013 , the Company had outstanding foreign currency forward contracts with a notional value of 3.0 billion Euros as of both dates, 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, 2014 was a net liability of $75.5 million , with $78.4 million recorded in "Accrued expenses and other current liabilities" and $2.9 million recorded in "Prepaid expenses and other current assets" on the Unaudited Consolidated Balance Sheet. The fair value of these derivatives at December 31, 2013 was a net liability of $121.3 million , with $121.5 million recorded in "Accrued expenses and other current liabilities" and $0.2 million recorded in "Prepaid expenses and other current assets" on the Unaudited Consolidated Balance Sheet.  Net cash outflows of $43.4 million and $17.5 million for the three months ended March 31, 2014 and 2013 , respectively, were reported within "Net cash used in investing activities" on the Unaudited Consolidated Statements of Cash Flows.



13



6.                                       INTANGIBLE ASSETS AND GOODWILL
 
The Company's intangible assets at March 31, 2014 and December 31, 2013 consisted of the following (in thousands): 
 
March 31, 2014
 
December 31, 2013
 
 
 
 
 
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
$
582,301

 
$
(170,319
)
 
$
411,982

 
$
581,742

 
$
(160,499
)
 
$
421,243

 
10 - 20 years
 
16 years
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Technology
93,709

 
(32,926
)
 
60,783

 
93,322

 
(29,271
)
 
64,051

 
2 - 5 years
 
5 years
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Patents
1,623

 
(1,490
)
 
133

 
1,623

 
(1,478
)
 
145

 
15 years
 
15 years
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Internet domain names
46,243

 
(13,968
)
 
32,275

 
45,799

 
(12,112
)
 
33,687

 
2 - 20 years
 
8 years
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trade names
548,417

 
(55,287
)
 
493,130

 
548,243

 
(47,388
)
 
500,855

 
5 - 20 years
 
19 years
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other
141

 
(137
)
 
4

 
141

 
(137
)
 
4

 
3 - 10 years
 
3 years
Total intangible assets
$
1,272,434

 
$
(274,127
)
 
$
998,307

 
$
1,270,870

 
$
(250,885
)
 
$
1,019,985

 
 
 
 
 
Intangible assets with determinable lives are amortized on a straight-line basis.  Intangible asset amortization expense was approximately $22.8 million and $9.3 million for the three months ended March 31, 2014 and 2013 , respectively.

The amortization expense for intangible assets for the remainder of 2014 , the annual expense for the next five years, and the expense thereafter is expected to be as follows (in thousands): 
2014
$
68,139

2015
87,821

2016
84,596

2017
80,466

2018
64,456

2019
55,597

Thereafter
557,232

 
$
998,307

 
The change in goodwill for the three months ended March 31, 2014 consists of the following (in thousands): 
Balance at December 31, 2013
$
1,767,912

Acquisitions
1,885

Currency translation adjustments
1,751

Balance at March 31, 2014
$
1,771,548

 
A substantial portion of the intangibles and goodwill relates to the acquisition of the KAYAK business in May 2013.




14



7.                                       OTHER ASSETS
 
Other assets at March 31, 2014 and December 31, 2013 consisted of the following (in thousands): 
 
 
March 31,
2014
 
December 31,
2013
Deferred debt issuance costs
 
$
15,119

 
$
16,465

Security deposits
 
10,611

 
10,617

Other
 
7,693

 
6,432

Total
 
$
33,423

 
$
33,514

 
Deferred debt issuance costs arose from (i) the $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 ; (iii) the Company's issuance, in March 2010 , of the $575.0 million aggregate principal amount of 1.25% Convertible Senior Notes, due March 15, 2015 , and (iv) the $1.0 billion aggregate principal amount of 0.35% Convertible Senior Notes, due June 15, 2020 , issued in May 2013.  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 dates. Unamortized debt issuance costs written off to interest expense in the three months ended  March 31, 2014  related to early conversion of convertible debt amounted to  $0.3 million . Security deposits principally relate to the Company's leased office spaces.


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 Pounds Sterling and any other foreign currency agreed to by the lenders. The proceeds of loans made under the facility will be used for working capital and general corporate purposes. As of March 31, 2014 and December 31, 2013 , there were no borrowings under the facility and there were approximately $2.2 million of letters of credit issued under the facility for both dates.
 
Convertible Debt
 
Convertible debt as of March 31, 2014 consisted of the following (in thousands): 
March 31, 2014
 
Outstanding
  Principal 
Amount
 
Unamortized
  Debt
  Discount
 
Carrying
  Value
1.25% Convertible Senior Notes due March 2015
 
$
102,025

 
$
(4,318
)
 
$
97,707

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

 
(91,377
)
 
908,623

0.35% Convertible Senior Notes due June 2020
 
1,000,000

 
(155,463
)
 
844,537

Outstanding convertible debt
 
$
2,102,025

 
$
(251,158
)
 
$
1,850,867

 

15



Convertible debt as of December 31, 2013 consisted of the following (in thousands): 
December 31, 2013
 
Outstanding
  Principal 
Amount
 
Unamortized
  Debt
  Discount
 
Carrying
  Value
1.25% Convertible Senior Notes due March 2015
 
$
160,464

 
$
(8,533
)
 
$
151,931

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

 
(96,797
)
 
903,203

0.35% Convertible Senior Notes due June 2020
 
1,000,000

 
(161,156
)
 
838,844

Outstanding convertible debt
 
$
2,160,464

 
$
(266,486
)
 
$
1,893,978

 
Based upon the closing price of the Company's common stock for the prescribed measurement period during the three months ended March 31, 2014 and December 31, 2013 , the contingent conversion threshold on the 2015 Notes (as defined below) was exceeded.  Therefore, the 2015 Notes were convertible at the option of the holders. Accordingly, the Company reported the carrying value of the 2015 Notes as a current liability as of March 31, 2014 and December 31, 2013 . 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 Consolidated Balance Sheets. Therefore, with respect to the 2015 Notes, the Company reclassified $4.3 million and $8.5 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, 2014 and December 31, 2013 , 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.

If the note holders exercise their option to convert, the Company delivers cash to repay the principal amount of the notes and delivers shares of common stock or cash, at its option, to satisfy the conversion value in excess of the principal amount.  In cases where holders decide to convert prior to the maturity date, the Company writes off the proportionate amount of remaining debt issuance costs to interest expense. For the three months ended March 31, 2014 , the Company paid $58.4 million to satisfy the aggregate principal amount due and issued 142,896 shares of its common stock in satisfaction of the conversion value in excess of the principal amount for debt converted prior to maturity. As of May 1, 2014, the Company had received early conversion notices that will be settled in the second quarter of 2014 for an aggregate principal amount of approximately $59 million and will issue shares of its common stock to satisfy the conversion value in excess of the principal amount associated with the 1.25% Convertible Senior Notes due March 2015.

The contingent conversion thresholds on the 2018 Notes (as defined below) and the 2020 Notes (as defined below) were not exceeded at March 31, 2014 or December 31, 2013 , and therefore these Notes are reported as a non-current liability on the Unaudited Consolidated Balance Sheets.

As of March 31, 2014 and December 31, 2013 , the estimated market value of the outstanding convertible senior notes was approximately $3.0 billion and $3.1 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 convertible senior notes.

Description of Senior Notes
 
In May 2013, the Company issued in a private placement $1.0 billion aggregate principal amount of Convertible Senior Notes due June 15, 2020, with an interest rate of 0.35% (the "2020 Notes"). The 2020 Notes were issued with an initial discount of $20.0 million . The Company paid $1.0 million in debt issuance costs during the year ended December 31, 2013, related to this offering. The 2020 Notes are convertible, subject to certain conditions, into the Company's common stock at a conversion price of approximately $1,315.10 per share. The 2020 Notes are convertible, at the option of the holder, prior to June 15, 2020, 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 2020 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 2020 Notes in an aggregate value ranging from $0 to approximately $397 million depending upon the date of the transaction and the then current stock

16



price of the Company. As of March 15, 2020, holders will have the right to convert all or any portion of the 2020 Notes. The 2020 Notes may not be redeemed by the Company prior to maturity.  The holders may require the Company to repurchase the 2020 Notes for cash in certain circumstances.  Interest on the 2020 Notes is payable on June 15 and December 15 of each year.

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 $20.9 million in debt issuance costs during the year ended December 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 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 associated with the 2015 Notes for the year ended December 31, 2010 .  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. 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 each be assigned a value.  The value assigned to the debt component is the estimated fair value, as of the issuance date, of a similar bond without the conversion feature.  The difference between the bond cash proceeds and this estimated fair value, representing the value assigned to the equity component, is recorded as a debt discount.  Debt discount is amortized using the effective interest method over the period from the origination date through the stated maturity date.  The Company estimated the straight debt borrowing rates at debt origination to be 5.89% for the 2015 Notes, 3.50% for the 2018 Notes, and 3.13% for the 2020 Notes.  The yield to maturity was estimated at an at-market coupon priced at par.

Debt discount after tax of $92.4 million ( $154.3 million before tax) and financing costs associated with the equity component of convertible debt of $0.1 million after tax were recorded in additional paid-in capital related to the 2020 Notes at June 30, 2013. Debt discount after tax of $80.9 million ( $135.2 million before tax) and financing costs associated with the equity component of convertible debt of $2.8 million after tax were recorded in additional paid-in capital related to the 2018 Notes at March 31, 2012. Debt discount after tax of $69.1 million ( $115.2 million before tax) and financing costs associated with the equity component of convertible debt of $1.6 million after tax were recorded in additional paid-in-capital related to the 2015 Notes at March 31, 2010. The Company reclassified $4.3 million before tax and $8.5 million before tax out of additional paid-in capital to the mezzanine section in the Company's Unaudited Consolidated Balance Sheets at March 31, 2014 and December 31, 2013 , respectively, related to the 2015 Notes.

For the three months ended March 31, 2014 and 2013 , the Company recognized interest expense of $17.1 million and $16.7 million , respectively, related to convertible notes.  Interest expense related to convertible notes for the three months ended March 31, 2014 and 2013 was comprised of $3.5 million and $4.3 million , respectively, for the contractual coupon interest, $12.4 million and $11.1 million , respectively, related to the amortization of debt discount and $1.2 million and $1.3 million , respectively, related to the amortization of debt issuance costs.  For the three months ended March 31, 2014 , included in the amortization of debt discount mentioned above was $0.7 million of original issuance discount related to the 2020 Notes. In addition, the Company incurred interest expense of $0.3 million related to debt conversions in 2014. The remaining period

17



for amortization of debt discount and debt issuance costs is the stated maturity dates for the respective debt. The effective interest rate for the three months ended March 31, 2014 and 2013 was 3.6% and 4.7% , respectively.

In addition, if the Company's convertible debt is redeemed or converted prior to maturity, a gain or loss on extinguishment is recognized.  The gain or loss is the difference between the fair value of the debt component immediately prior to extinguishment and its carrying value.  To estimate the fair value of the debt at the conversion date, the Company estimated its straight rate borrowing rate, considering its credit rating and straight debt of comparable corporate issuers.  For the three months ended March 31, 2014 , the Company recognized a non-cash loss of $3.4 million ( $2.1 million after tax) in "Foreign currency transactions and other" in the Unaudited Consolidated Statements of Operations in connection with the conversion of the 2015 Notes.


9.                                TREASURY STOCK
 
The Board of Directors has 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 72,277 shares and 110,679 shares at aggregate costs of $96.7 million and $76.4 million in the three months ended March 31, 2014 and 2013 , respectively, to satisfy employee withholding taxes related to stock-based compensation.
 
As of March 31, 2014 , there were approximately 9.3 million shares of the Company's common stock held in treasury.

As of March 31, 2014 , the Company has a remaining authorization of $654.5 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.


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 provided when it is more likely than not that some portion or all of a 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, 2014 and 2013 , a substantial majority of the Company's foreign-sourced income was generated in the Netherlands.  Income tax expense for the three months ended March 31, 2014 and 2013 differs from the expected tax expense at the U.S. statutory rate of 35% , primarily due to lower foreign tax rates, including the Innovation Box Tax benefit discussed below, partially offset by state income taxes and certain non-deductible expenses. 
 
According to Dutch corporate income tax law, income generated from qualifying "innovative" activities is taxed at a rate of 5% ("Innovation Box Tax") 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 is eligible for Innovation Box Tax treatment. The ruling from the Dutch tax authorities is valid through December 31, 2017.

The Company has significant deferred tax assets, resulting principally from U.S. net operating loss carryforwards ("NOLs"). The amount of NOLs available for the Company's use is limited by Section 382 of the U.S. Internal Revenue Code ("IRC Section 382 "). At December 31, 2013 , after considering the impact of IRC Section 382 , the Company had approximately $1.4 billion of available NOLs for U.S. federal income tax purposes, comprised of $0.3 billion of NOLs generated from operating losses and approximately $1.1 billion of NOLs generated from 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 dependent upon the Company's ability to generate sufficient future taxable income in the United States. 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. 


18



11.                                REDEEMABLE NONCONTROLLING INTERESTS
 
On May 18, 2010 , the Company, through its wholly-owned subsidiary, priceline.com International Ltd. ("PIL"), purchased a controlling interest of the outstanding equity of TravelJigsaw Holdings Limited and its operating subsidiary, TravelJigsaw Limited (now known as the rentalcars.com business), a Manchester, U.K.-based international rental car reservation service.
 
Certain key members of rentalcars.com's management team retained a noncontrolling ownership interest in rentalcars.com.  In addition, certain key members of the management team of Booking.com purchased a 3% ownership interest in rentalcars.com from PIL in June 2010 (together with rentalcars.com management's investment, the "Redeemable Shares"). Subject to certain exceptions, one-third of the Redeemable Shares were subject to the put and call options in each of 2011, 2012 and 2013.  In April 2013, in connection with the exercise of the March 2013 call and put options, PIL purchased the remaining outstanding shares underlying redeemable noncontrolling interests for an aggregate purchase price of approximately $192.5 million .

A reconciliation of redeemable noncontrolling interests for the three months ended March 31, 2013 is as follows (in thousands):

 
 
Three Months Ended
March 31, 2013
Balance, beginning of period
 
$
160,287

Net income attributable to noncontrolling interests
 
21

Fair value adjustments (1)  
 
42,768

Currency translation adjustments
 
(12,183
)
Balance, end of period
 
$
190,893


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


12.                                ACCUMULATED OTHER COMPREHENSIVE INCOME
 
The table below provides the balances for each classification of accumulated other comprehensive income as of March 31, 2014 and December 31, 2013 (in thousands): 
 
 
March 31,
2014
 
December 31,
2013
Foreign currency translation adjustments, net of tax (1)
 
$
92,512

 
$
84,598

Net unrealized gain on marketable securities, net of tax (2)
 
239

 
131

Accumulated other comprehensive income
 
$
92,751

 
$
84,729

 
(1)           Foreign currency translation adjustments, net of tax, includes net losses from fair value adjustments at March 31, 2014 of $57.4 million after tax ( $96.4 million before tax) and net losses from fair value adjustments at December 31, 2013 of $58.7 million after tax ( $98.8 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 gain before tax at March 31, 2014 and December 31, 2013 was $0.4 million and $0.2 million , respectively.


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13.                                COMMITMENTS AND CONTINGENCIES
 
Litigation Related to Travel Transaction Taxes
 
The Company and certain third-party online travel companies ("OTCs") 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 travel transaction taxes (e.g., hotel occupancy taxes, excise taxes, sales taxes, etc.).  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 OTCs violated each jurisdiction's respective relevant travel transaction 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.  In addition, approximately seventy-nine municipalities or counties, and at least eleven states, have initiated audit proceedings (including proceedings initiated by more than forty municipalities in California, which have been inactive for several years), issued proposed tax assessments or started inquiries relating to the payment of travel transaction taxes.  Additional state and local jurisdictions are likely to assert that the Company is subject to travel transaction taxes 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 laws at issue do not apply to the services it provides, namely the facilitation of travel reservations, and, therefore, that it does not owe the taxes that are claimed to be owed.  Rather, the Company believes that the laws at issue generally impose travel transaction taxes on entities that own, operate or control hotels (or similar businesses) or furnish or provide hotel rooms or similar accommodations or other travel services.  In addition, in many of these matters, the taxing jurisdictions 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 taxing jurisdictions 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 laws in judicial proceedings.  This requirement is commonly referred to as "pay to play" or "pay first."  For example, the City and County 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, and issued a second assessment totaling approximately $2.7 million , which the Company paid in January 2013.  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 that it should not be subject to such taxes.  In the San Francisco action, for example, the court ruled in February 2013 that the Company and OTCs do not owe transient accommodations tax to the city and ordered the city to refund the amount paid in July 2009; the Company also is seeking a refund of the amount paid in January 2013.

Litigation is subject to uncertainty and there could be adverse developments in these pending or future cases and proceedings.  For example, in January 2013, the Tax Appeal Court for the State of Hawaii held that the Company and other OTCs are not liable for the State's transient accommodations tax, but held that the OTCs, including the Company, are liable for the State's general excise tax on the full amount the OTC collects from the customer for a hotel room reservation, without any offset for amounts passed through to the hotel. The Company recorded an accrual for travel transaction taxes (including estimated interest and penalties), with a corresponding charge to cost of revenues, of approximately $16.5 million in December 2012 and approximately $18.7 million in the three months ended March 31, 2013, primarily related to this ruling. During the three months ended March 31, 2014 , the Company paid approximately $0.6 million under protest to the State of Hawaii related to this ruling. The Company has filed an appeal now pending before the Hawaii Supreme Court. Other adverse rulings include a decision in September 2012, in which the Superior Court in the District of Columbia granted summary judgment in favor of the District and against the OTCs ruling that tax is due on the OTCs' margin and service fees, which the Company is appealing. As a result, the Company increased its accrual for travel transaction taxes (including estimated interest), with a corresponding charge to cost of revenues, by approximately $4.8 million in September 2012 and by approximately $5.6 million in the three months ended March 31, 2013. Also, in July 2013, the Circuit Court of Cook County, Illinois, ruled that the Company and the other OTCs are liable for tax and other obligations under the Chicago Hotel Accommodations Tax. A summary judgment to determine the extent of the liability is now pending. In addition, in October 2009, a jury in a San Antonio class action found that the Company and the other OTCs 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 Company intends to vigorously appeal the trial court's judgment when it becomes final.
 

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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 could be material to the Company's results of operations or cash flow in any given operating period. However, the Company believes that even if it were to suffer adverse determinations in the near term in more of the pending proceedings than currently anticipated, given results to date it would not have a material impact on the Company's liquidity because of the Company's available cash.
 
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 travel reservations to its customers and, consequently, could make the Company's travel reservation services less competitive (as compared to the services of other OTCs or travel service providers) and reduce the Company's travel reservation transactions; alternatively, the Company could choose to reduce the compensation for its services.  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, the taxing jurisdictions 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 these taxes are due and payable on the Company's U.S. merchant hotel business.  With respect to taxing jurisdictions that have not initiated proceedings to date, it is possible that they will do so in the future or that they will seek to amend their tax statutes and seek to collect taxes from the Company only on a prospective basis.
 
Accrual for Travel Transaction Taxes
 
As a result of this litigation and other attempts by jurisdictions to levy similar taxes, the Company has established an accrual (including estimated interest and penalties) for the potential resolution of issues related to travel transaction taxes in the amount of approximately $54 million at March 31, 2014 compared to approximately $55 million at December 31, 2013 (which includes, among other things, amounts related to the litigation in the State of Hawaii, District of Columbia, San Antonio and Chicago). The accrual is based on the Company's estimate of the probable cost of resolving these issues. The Company's legal expenses for these matters are expensed as incurred and are not reflected in the amount accrued. 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.
 
OFT Inquiry

In July 2012, the Office of Fair Trading (the "OFT"), the competition authority in the United Kingdom, issued a "Statement of Objections" ("SO") to Booking.com, which set out the OFT's preliminary views on why it believed Booking.com and others in the hotel online booking sector were allegedly in breach of E.U. and U.K. competition law.  The SO alleged, among other things, that there were agreements or concerted practices between hotels and Booking.com and between hotels and at least one other OTC that restricted Booking.com's (and the other OTC's) ability to discount hotel room reservations, which the OFT alleged was a form of resale price maintenance.  The Company disputes the allegations in the SO. 

On January 31, 2014, the OFT announced that it had accepted commitments offered by Booking.com, as well as Expedia and Intercontinental Hotel Group, (the "Commitments") to close the investigation on the basis that they address the OFT's competition concerns.  The OFT has now closed its investigation with no finding of infringement or admission of wrongdoing and no imposition of a fine.
 
The Commitments provide, among other things, that hotels will continue to be able to set retail prices for hotel room reservations on all OTC websites, such as Booking.com.  OTCs, such as Booking.com, now have the flexibility to discount a hotel's retail price, but only to members of closed groups, a concept that is defined in the Commitments, who have previously made a booking with the OTC.  The discount may be up to Booking.com's commission.  In addition, Booking.com will not require rate parity from hotels in relation to discounted rates that are provided by other OTCs or hotels to members of their

21



closed groups, provided the discounted rate is not made public.  The Commitments apply to bookings by EEA residents at UK hotels.

On March 31, 2014, Skyscanner, a meta-search site based in the United Kingdom, filed an appeal in the Competition Appeal Tribunal (CAT) against the OFT's (now CMA) decision to accept commitments. Booking.com has been granted permission to intervene in support of the CMA in the CAT. The appeal is expected to be heard in July 2014.

Investigations have also been opened by the national competition authorities in France, Germany, Austria, Hungary, Sweden and Switzerland that focus on Booking.com's rate parity clause in its contracts with accommodation providers in those jurisdictions.  All of these investigations are at a preliminary stage.  The Company is currently unable to predict the outcome of these investigations or how the Company's business may be affected.  Possible outcomes include requiring Booking.com to remove its rate parity clause from its contracts with accommodation providers in those jurisdictions and/or the imposition of fines.

Lawsuits Alleging Antitrust Violations

On August 20, 2012, one complaint was filed on behalf of a putative class of persons who purchased hotel room reservations from certain hotels (the "Hotel Defendants") through certain OTC defendants, including the Company.  The initial complaint, Turik v. Expedia, Inc. , Case No. 12-cv-4365, filed in the U.S. District Court for the Northern District of California, alleges that the Hotel Defendants and the OTC defendants violated federal and state laws by entering into a conspiracy to enforce a minimum resale price maintenance scheme pursuant to which putative class members paid inflated prices for hotel room reservations that they purchased through the OTC defendants.  Thirty-one other complaints containing similar allegations have been filed in a number of federal jurisdictions across the country. Plaintiffs in these actions seek treble damages and injunctive relief. 

The Judicial Panel on Multidistrict Litigation ("JPML") heard arguments on a motion for consolidation and transfer of pretrial proceedings under 28 U.S.C. § 1407 on November 29, 2012.  Pursuant to JPML orders, all of the pending cases were consolidated before Judge Boyle in the U.S. District Court for the Northern District of Texas. On May 1, 2013, an amended consolidated complaint was filed.

On July 1, 2013, the Company, together with the other OTC defendants and Hotel Defendants, filed a joint motion to dismiss the amended consolidated complaint. On February 18, 2014, Judge Boyle dismissed the amended consolidated complaint without prejudice, and ordered that plaintiffs must move for leave to amend within thirty days if they wish to file a second consolidated amended complaint, and further ordered that any such motion for leave to amend be accompanied by a synopsis explaining why a second amended complaint would overcome the deficiencies stated in the court's February 18, 2014 Memorandum Opinion and Order. On March 20, 2014, plaintiffs moved for leave to file a proposed Second Consolidated Amended Complaint (the "proposed SCAC"). The proposed SCAC names only the OTC defendants as defendants and alleges that the OTC defendants violated federal and state laws by entering into minimum resale price maintenance agreements with the Hotel defendants and by conspiring to enforce the terms of those resale price maintenance agreements. On April 3, 2014, the OTC defendants filed an opposition to plaintiffs' motion for leave to file the proposed SCAC.

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 a reasonably possible 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 adversely affect the Company's business, results of operations, financial condition and cash flows.



22



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 those discussed in " Risk Factors " and elsewhere in this Form 10-Q.
 
Overview

     We are a leading online travel company that connects consumers wishing to make travel reservations with providers of travel services around the world. We offer consumers accommodation reservations (including hotels, bed and breakfasts, hostels, apartments, vacation rentals (including “aparthotels,” which are apartments with a front desk and cleaning service)
and other properties) through our Booking.com, priceline.com, and agoda.com brands. In the United States, we also offer consumers reservations for rental cars, airline tickets, vacation packages and cruises through our priceline.com brand. We offer rental car reservations worldwide through rentalcars.com. We also allow consumers to easily compare airline ticket, hotel reservation and rental car reservation information from hundreds of travel websites at once through KAYAK's websites and mobile applications (or "apps"). We refer to our company and all of our subsidiaries and brands, including Booking.com, priceline.com, agoda.com, KAYAK and rentalcars.com, collectively as "The Priceline Group," the "Company," "we," "our" or "us."

We launched our business in the United States in 1998 under the priceline.com brand and have since expanded our operations to include Booking.com, agoda.com, KAYAK, and rentalcars.com, which are independently managed and operated brands.  Our principal goal is to serve consumers with worldwide leadership in online travel services.  Our business is driven primarily by international results, which consist of the results of Booking.com, agoda.com and rentalcars.com, as well as the results of KAYAK's international based websites, in each case regardless of where the consumer is resident, from where the consumer makes a reservation or where the travel service is provided. During the year ended December 31, 2013 , our international business (the substantial majority of which is generated by Booking.com) represented approximately 85% 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 94% of our consolidated operating income. A significant majority of our gross profit is earned in connection with facilitating accommodation reservations.

We derive substantially all of our gross profit from the following sources:

Commissions earned from facilitating reservations of accommodations, rental cars, cruises and other travel services;
Transaction gross profit and customer processing fees from our accommodation, rental car, and vacation package reservation services;
Advertising revenues primarily earned by KAYAK from sending referrals to OTAs and travel service providers, as well as from advertising placements on KAYAK's websites and mobile apps; and
Global distribution system ("GDS") reservation booking fees related to our Name Your Own Price ® hotel, rental car and airline ticket reservation services, and price-disclosed airline ticket and rental car reservation services.

Our priceline.com U.S. brand offers merchant Name Your Own Price ® opaque travel services, which are recorded in revenue on a "gross" basis and have associated cost of revenue. All of our other services 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 ® travel services and other travel services. Gross profit reflects the commission or net margin earned for our retail, Name Your Own Price ® and semi-opaque travel services and our advertising services. Consequently, gross profit has become an increasingly important measure of evaluating growth in our business because, in contrast to our revenues, it is not affected by the mix between our Name Your Own Price ® travel services and our other travel services.

Over the last several years we have experienced strong growth in our accommodation reservation services. We believe this growth is the result of, among other things, the broader shift of travel purchases from offline to online, the widespread adoption of mobile devices, 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 accommodation supply, content and distribution and to improve the customer experience on our websites and mobile apps. We experienced strong year-over-year growth in recent years, though that growth has generally decelerated. For example, for the three months ended March 31, 2014 , our accommodation room night reservation growth was 32% , a deceleration from 38% in the same period in 2013 and 47% in the

23



same period in 2012 . Given the size of our hotel reservation business, we believe it is highly likely that our year-over-year growth rates will continue to decelerate, though the rate of deceleration may fluctuate.

Many governments around the world, including the U.S. government and certain European governments, are operating at large financial deficits, resulting in high levels of sovereign debt in such countries. Failure to reach political consensus regarding workable solutions to these issues has resulted in a high level of uncertainty regarding the future economic outlook. This uncertainty, as well as concern over governmental austerity measures including higher taxes and reduced government spending, could impair consumer spending and adversely affect travel demand. At times, we have experienced volatility in transaction growth rates and weaker trends in hotel average daily rates ("ADRs") across many regions of the world, particularly in those European countries that appear to be most affected by economic uncertainties. We believe that these business trends are likely impacted by weak economic conditions and sovereign debt concerns. Disruptions in the economies of such countries could cause, contribute to or be indicative of deteriorating macro-economic conditions. In addition, during periods of elevated uncertainty, the value of the U.S. Dollar compared to other currencies, including the Euro, has often increased, which adversely affects our gross bookings, gross profit, operating income and net income as expressed in U.S. Dollars. The uncertainty of macro-economic factors and their impact on consumer behavior across regions, which may differ, makes it more difficult to forecast industry and consumer trends and the timing and degree of their impact on our markets and business, which in turn could adversely affect our ability to effectively manage our business and adversely affect our results of operations.

We compete with both online and traditional travel reservation services. The market for the travel reservation services we offer is intensely competitive, and current and new competitors can launch new services at a relatively low cost. Some of our current and potential competitors, such as Google, Apple and Facebook, have access to significantly greater and more diversified resources than we do, and they may be able to leverage other aspects of their businesses (e.g., search or mobile device businesses) to enable them to compete more effectively with us. For example, Google has entered various aspects of the online travel market through its acquisition of ITA Software, Inc., a major flight information software company, in 2011, its hotel meta-search service known as "Hotel Finder" (discussed below) and its recent license of hotel-booking software from Room 77.
We currently, or potentially may, compete with a variety of companies, including:
online travel reservation services such as those owned by Expedia, Orbitz, Travelocity, Ctrip, Rakuten, ODIGEO, Jalan and Wotif;

search, social networking and group buying companies, such as Google, Facebook and Groupon;

traditional travel agencies, wholesalers and tour operators, such as Carlson Wagonlit, American Express, Thomas Cook and Tui Travel, as well as thousands of individual travel agencies around the world;

travel service providers such as accommodation providers, rental car companies and airlines; and

online travel search and price comparison services (generally referred to as "meta-search" services), such as trivago (in which Expedia has acquired a majority ownership interest), TripAdvisor, Qunar and HotelsCombined.

TripAdvisor, a leading travel research and review website, Google, the world's largest search engine, and other large, established companies with substantial resources and expertise in developing online commerce and facilitating Internet traffic have launched meta-search services and may create additional inroads into online travel, both in the United States and internationally. Meta-search services leverage their search technology to aggregate travel search results for the consumer's specific itinerary across travel service provider (e.g. hotels, rental car companies or airlines), OTA and other travel websites and, in many instances, compete directly with us for customers. Meta-search services intend to appeal to consumers by showing broader travel search results than may be available through OTAs or other travel websites, which could lead to travel service providers or others gaining a larger share of search traffic. TripAdvisor has begun supporting its meta-search service with offline advertising, and trivago, a leading meta-search service in Europe, recently expanded its offline advertising campaign into the United States. Google offers "Hotel Finder", a meta-search service that Google has at times placed at or near the top of its hotel-related search results. As a result of our recent acquisition of KAYAK, a meta-search service, we now compete more directly with other meta-search services. As a meta-search service, KAYAK depends on access to information related to travel service pricing, schedules, availability and other related information from OTAs and travel service providers.

As consumers attempt to be more efficient in their shopping behavior, they may favor travel services offered by meta-search websites or search companies over OTAs, which could reduce traffic to our travel reservation websites, increase consumer awareness of our competitors' brands and websites and increase our advertising and other customer acquisition costs.

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To the extent any such consumer behavior leads to growth in our KAYAK meta-search business, such growth may not result in sufficient increases in profits from our KAYAK meta-search business to offset any related decrease in profits experienced by our OTA brands. Further, meta-search services may evolve into more traditional OTAs by offering consumers the ability to make travel reservations directly through their websites. For example, TripAdvisor facilitates hotel reservations on its transactional websites Tingo and Jetsetter and intends to allow consumers to make a reservation while staying on TripAdvisor. Meta-search providers may also offer direct booking services with travel service providers, which may lead to more consumers booking directly with a travel service provider rather than an OTA. To the extent consumers book travel services through a meta-search website or directly with a travel service provider after visiting a meta-search website or meta-search utility on a traditional search engine without using an OTA like us, we may need to increase our advertising or other customer acquisition costs to maintain or grow our reservation bookings.  If meta-search services limit our participation within their search results, there could be an adverse effect on our business, gross bookings and results of operations.

Travel service providers, including multi-national hotel chains, rental car companies and airlines with which we conduct business, compete with us in online channels to drive consumers to their own websites in lieu of third-party distributors such as us. Travel service providers who sell on their own websites may charge lower prices and, in some instances, offer advantages such as loyalty points or special discounts to members of closed user groups (such as loyalty program participants or customers with registered accounts). We may need to offer similar advantages to maintain or grow our reservation bookings, which could adversely impact our profitability.

Widespread adoption of mobile devices, such as the iPhone, Android-enabled smart phones, and tablets such as the iPad, coupled with the improved web browsing functionality and development of thousands of useful "apps" available on these devices, is driving substantial traffic and commerce activity to mobile platforms.  We have experienced a significant shift of business to mobile platforms and our advertising partners are also seeing a rapid shift of traffic to mobile platforms. Our major competitors and certain new market entrants are offering mobile applications for travel products and other functionality, including proprietary last-minute discounts for accommodation reservations.  Advertising and distribution opportunities may be more limited on mobile devices given their smaller screen sizes.  The gross profit earned on a mobile transaction may be less than a typical desktop transaction due to different consumer purchasing patterns. For example, accommodation reservations made on a mobile device typically are for shorter lengths of stay and are not made as far in advance. Further, given the device sizes and technical limitations of tablets and smartphones, mobile consumers may not be willing to download multiple apps from multiple travel service providers and instead prefer to use one or a limited number of apps for their mobile travel activity. As a result, the consumer experience with mobile apps as well as brand recognition and loyalty are likely to become increasingly important. We have made significant progress creating mobile offerings, which have received strong reviews and solid download trends, and which are driving a material and increasing share of our business. We believe that mobile bookings present an opportunity for growth and are necessary to maintain and grow our business as consumers increasingly turn to mobile devices instead of a personal computer and to mobile applications instead of a web browser. If we are unable to continue to rapidly innovate and create new, user-friendly and differentiated mobile offerings and efficiently and effectively advertise and distribute on these platforms, or if our mobile apps are not downloaded and used by consumers, we could lose market share to existing competitors or new entrants and our future growth and results of operations could be adversely affected.

Apple, Inc., one of the most innovative and successful companies in the world and producer of, among other things, the iPhone and iPad, obtained a patent for "iTravel," a mobile app that would allow a traveler to check in for a travel reservation. In addition, Apple's iPhone operating system includes "Passbook," a virtual wallet app that holds tickets, boarding passes, coupons and gift cards, and along with iTravel, may be indicative of Apple's intent to enter the travel reservations business in some capacity. Apple has substantial market share in the smart phone category and controls integration of offerings, including travel services, into its mobile operating system. Apple also has more experience producing and developing mobile apps and has access to greater resources than we have. Apple may use or expand iTravel, Passbook, Siri (Apple's voice recognition "concierge" service) or another mobile app as a means of entering the travel reservations marketplace. Similarly, Google's Android operating system is the leading smart phone operating system in the world. As a result, Google could leverage its Android operating system to give its travel services a competitive advantage, either technically or with prominence on its Google Play app store or within its mobile search results. To the extent Apple or Google use their mobile operating systems or app distribution channels to favor their own travel service offerings, our business could be harmed.

There has been a proliferation of new channels through which accommodation providers can offer reservations.  For example, some accommodations offer 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 facilitate accommodation reservations to Groupon customers under the "Groupon Getaways" brand name. New entrants, such as HotelTonight, BackBid, GuestMob, Tingo and Hipmunk, have developed new and differentiated offerings that endeavor to provide savings on accommodation reservations to consumers and that compete directly with us. Further, meta-

25



search services may lower the cost for new companies to enter the market by providing a distribution channel without the cost of promoting the new entrant's brand to drive consumers directly to its website.  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.

In August 2013, Expedia and Travelocity announced that they had entered into an exclusive, long-term strategic marketing agreement, whereby Expedia will power the technology platforms for Travelocity's existing websites in the United States and Canada, while providing Travelocity access to Expedia's supply and customer services. To the extent this arrangement enhances Expedia's and/or Travelocity's ability to compete with us in the affected markets, our market share and results of operations could be adversely affected.

We use third party websites, including online search engines (primarily Google) and meta-search and travel research services, and affiliate marketing as primary means of generating traffic to our websites. Our online advertising expense has increased significantly in recent years, a trend we expect to continue. Various factors can impact whether our online advertising will grow faster or slower than gross profit. Our international brands are generally growing faster than our U.S. brands, and typically spend a higher percentage of gross profit on online advertising, causing our online advertising to grow more quickly than our gross profit. Our online advertising returns on investment ("ROIs") have been down year-over-year for the last several quarterly periods, but to a lesser extent in the fourth quarter or 2013 and the first quarter or 2014, and these declines also cause online advertising expense to grow more quickly than our gross profit. Thus far in the second quarter of 2014, we have experienced more significant year-over-year declines in our online marketing ROIs. These negative factors have recently been slightly offset by an increasing share of traffic coming directly to us, a trend that may or may not continue. We also intend to continue to invest in offline advertising, in particular for our Booking.com, priceline.com and KAYAK brands, and expect to increase our overall offline advertising spend in 2014. For example, building on its first offline advertising campaign, which it launched in the United States in 2013, Booking.com recently began offline advertising campaigns in Australia, Canada and the United Kingdom and may expand its offline advertising into other markets during 2014.

The inclusion of KAYAK since its acquisition on May 21, 2013 had a significant favorable impact on online advertising as a percentage of gross profit for the three months ended March 31, 2014 because KAYAK spends a lower percentage of gross profit on online advertising than our other brands, and our consolidated results exclude intercompany advertising by our brands on KAYAK since the acquisition date. This favorable impact will benefit year-over-year comparisons until the anniversary of the acquisition on May 21, 2014.

Advertising efficiency is impacted by a number of factors that are subject to variability and that are, in some cases, outside of our control, including ADRs, costs per click, cancellation rates, foreign exchange rates and our ability to convert paid traffic to booking customers and then having customers return directly to our websites or mobile apps for future bookings. If Google changes how it presents travel search results or the manner in which it conducts the auction for placement among search results in a manner that is competitively disadvantageous to us, whether to support its own travel related services or otherwise, our ability to efficiently generate traffic to our websites could be harmed. See Part II Item 1A Risk Factors - " We rely on online advertising channels to enhance our brand awareness and to generate a significant amount of traffic to our websites " and " Our business could be negatively affected by changes in Internet search engine algorithms and dynamics or traffic-generating arrangements. " Further, we have observed increased offline advertising by OTAs, meta-search services and travel service providers, particularly in North America and Europe, which may make such advertising more expensive and less effective.

The competition authorities of many governments have begun investigations into competitive practices within the online travel industry, and we may be involved or affected by such investigations and their results. For example, Booking.com and others recently agreed to certain commitments to resolve an investigation by the U.K. Office of Fair Trading, which commitments provide that OTAs will have the flexibility to discount a hotel's retail price, notwithstanding "rate parity" requirements in contracts with hotels (requirements that generally require a hotel to offer the same room rates to all OTAs), but only to members of closed user groups. Other national competition authorities, including, without limitation, those in France, Germany, Austria, Hungary, Sweden and Switzerland, have opened investigations that focus on Booking.com's rate parity clause in its contracts with accommodation providers in those jurisdictions. All of these investigations are at a preliminary stage.  We are currently unable to predict the outcome of these investigations or how our business may be affected.  Possible outcomes include requiring Booking.com to remove its rate parity clause from its contracts with accommodation providers in those jurisdictions. We note that the German competition authority has required Hotel Reservation Service, a leading OTA in Germany, to remove its rate parity clause from its contracts with hotels, though this decision is currently subject to appeal. To the extent that regulatory authorities require changes to our business practices or to those currently common to the industry, our business, competitive position and results of operations could be materially and adversely affected. Negative publicity regarding any such investigations could adversely affect our brand and therefore our market share and results of operations.


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In addition, we have observed an increase in promotional pricing to closed user groups, including through mobile apps. If we are not as effective as our competition in offering discounted prices to closed user groups, our ability to grow and compete could be harmed. If we need to fund such discounts out of our gross profit in order to effectively compete, our profitability could be adversely affected.

International Trends . The size of the travel market outside of the United States is substantially greater than that within the United States. Historically, Internet adoption rates and e-commerce adoption rates of international consumers have trailed those of the United States. However, international consumers are rapidly moving to online means for purchasing travel. Accordingly, recent international online travel growth rates have substantially exceeded, and are expected to continue to exceed, the growth rates within the United States. 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 properties 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 accommodation reservation service brands, Booking.com and agoda.com. Booking.com, our most significant brand, included over 455,000 properties on its website as of May 7, 2014 , which included over 140,000 vacation rental properties (updated property counts are available on the Booking.com website). Booking.com has added properties 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 leading online accommodation reservation service provider in the world as measured by room nights booked.

As our international business represents the substantial majority of our financial results, we expect to continue to see our operating results and other financial metrics largely driven by international performance. For example, 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 accommodations available for reservation on our websites, including hotels, bed and breakfasts, hostels and vacation rentals. Vacation rentals generally consist of, among others, properties categorized as single-unit and multi-unit villas, holiday homes, apartments, “aparthotels” (which are apartments with a front desk and cleaning service) and chalets and are generally self-catered (i.e., include a kitchen), directly bookable properties. Many of the newer accommodations we add to our travel reservation services, especially in highly penetrated markets, may have fewer rooms, lower ADRs or higher credit risk and may appeal to a smaller subset of consumers (e.g., hostels and bed and breakfasts), and therefore may also negatively impact our margins. For example, because a vacation rental is either a single unit or a small collection of independent units, vacation rental properties represent more limited booking opportunities than non-vacation rental properties, which generally have more units to rent per property. Our non-hotel accommodations in general may be subject to increased seasonality due to local tourism seasons, weather or other factors. If we increase our non-hotel accommodation business, these different market characteristics could negatively impact our profit margins; and, if these properties represent an increasing percentage of the properties added to our websites, our gross bookings growth rate and property growth rate will likely diverge over time (since each such property has fewer booking opportunities). As a result of the foregoing, as the percentage of non-hotel accommodations increases, the number of reservations per property will likely decrease.

Another impact of the size of our international business is our exposure to foreign currency exchange risk. Because we conduct a substantial majority of our business outside the United States and report our results in U.S. Dollars, we face exposure to adverse movements in currency exchange rates as the financial results of our international business are translated from local currency (principally the Euro and the British Pound Sterling) into U.S. Dollars upon consolidation. For example, 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. Certain 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 fluctuations that could impact our 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 year-over-year on a local currency basis by approximately 37% for the three months ended March 31, 2014 , compared to the same

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period in 2013, as a result of the negative impact of currency exchange rates, revenue from our international operations as reported in U.S. Dollars grew 34.6% for the three months ended March 31, 2014 .

Domestic Trends . Competition in U.S. online travel remains intense and online travel companies are creating new promotions and consumer value features in an effort to gain competitive advantages. In particular, the competition to provide "opaque" hotel reservation services to consumers, an area in which our priceline.com U.S. business has been a leader, has become more intense. For example, Expedia makes opaque hotel reservations available through its Hotwire brand and on its principal website under the name "Expedia Unpublished Rates" and has, we believe, supported this initiative with steeper discounts through lower margins. As with our opaque Name Your Own Price ® and Express Deals ® hotel reservation services, the name of the hotel is not disclosed until after booking the reservation. We believe these offerings, in particular "Expedia Unpublished Rates," have adversely impacted the market share and year-over-year room night reservations growth rate for our Name Your Own Price ® opaque hotel reservation service, which began to experience a decline in the third quarter of 2011. In addition, some hotels offer discounted room reservations through "daily deal" websites such as Groupon and Living Social. If Expedia or others are successful in growing their opaque hotel reservation services, 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 reservation services over time, and we would face more competition for access to the limited supply of discounted hotel room rates. In an effort to compete more effectively against these new offerings, in 2012 we launched Express Deals ® , a semi-opaque price-disclosed hotel reservation service. While Express Deals ® has been a significant contributor to the improved performance of our opaque hotel reservation service, the offering may not ultimately be successful at recovering or growing U.S. hotel reservation service market share. As a result of this increased competition, our share of the discount hotel reservation market in the United States could further decrease.

While demand for online travel services in the United States continues to experience growth, we believe that the U.S. market share of third-party distributors is impacted in part by a concerted initiative by travel service providers to direct customers to their own websites in an effort to reduce distribution expenses and establish more direct control over their pricing.

U.S. airlines have, at times, reduced capacity and increased fares. Decreases in capacity reduce the amount of airline tickets available, while increases in average airfares can adversely impact leisure travel demand. Generally, reduced airline capacity and demand negatively impact our priceline.com air ticket reservation service, which in turn can have negative repercussions on our priceline.com hotel and rental car services. 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 gross bookings are generated early in the year, as customers plan and reserve their spring and summer vacations in Europe and North America. 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 reservations are booked. However, we generally do not recognize associated revenue until future quarters when the travel occurs. 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 accommodation checkouts for the year for our North American and European businesses.

In addition, the date on which certain holidays fall can have an impact on our quarterly results. For example, in 2013 our first quarter year-over-year growth rates in revenue, gross profit, operating income and operating margins were favorably affected by Easter falling in the first quarter instead of the second quarter, as it did in 2012. Conversely, our first quarter 2014 year-over-year growth rates in revenue, gross profit, operating income and operating margins were negatively impacted by Easter falling in the second quarter instead of the first quarter, as it did in 2013.

The impact of seasonality can be exaggerated in the short-term by the gross bookings growth rate of the business. For example, in periods where our growth rate substantially decelerates, our operating margins typically benefit from relatively less variable advertising expense. In addition, gross profit growth is typically less impacted in the near term due to the benefit of revenue related to reservations booked in previous quarters.

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.

Other Factors . We believe that our success will depend in large part on our ability to continue to profitably grow our brands worldwide, 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 weather patterns, natural disasters

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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 or travel related accidents, 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 late 2012 Hurricane Sandy disrupted travel in the northeastern United States. In early 2011, Japan was struck by a major earthquake, tsunami and nuclear emergency. 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, Thailand has recently experienced disruptive civil unrest, which has negatively impacted booking volumes and cancellation rates in this market. In early 2010, Thailand also experienced 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, even if those expenditures create pressure on operating margins. We have experienced pressure on operating margins as we prioritize initiatives that drive growth. 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 grow gross profit and achieve healthy operating margins in an effort to maintain profitability. The uncertain environment described above makes the prediction of future results of operations difficult, and accordingly, we may not be able to sustain gross profit growth and profitability.

On May 21, 2013, we acquired KAYAK Software Corporation, a leading travel meta-search service. The purchase price was $2.1 billion ($1.9 billion net of cash acquired). A substantial portion of the total consideration related to identifiable acquired intangibles and goodwill (see Note 6 to the Unaudited Consolidated Financial Statements). Since our annual goodwill impairment test in September 2013, there have been no events or changes in circumstances to indicate a potential impairment to the goodwill associated with this acquisition. If KAYAK is unsuccessful in profitably growing its global online travel brand or it experiences a significant reduction in advertising revenues due to factors such as a loss of continued access to travel services information provided by other OTAs or travel service providers or a reduction in advertising on its websites or mobile apps, we may incur an impairment charge related to this goodwill.


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Results of Operations
 
Three Months Ended March 31, 2014 compared to the Three Months Ended March 31, 2013

Operating and Statistical Metrics
 
Our financial results are driven by certain operating metrics that encompass the booking activity generated by our travel services.  Specifically, reservations of accommodation 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 our Booking.com, agoda.com and rentalcars.com businesses and domestic gross bookings reflect gross bookings generated principally by our priceline.com business, in each case without regard to the travel destination or the location of the customer purchasing the travel.

Gross bookings resulting from accommodation room nights, rental car days and airline tickets reserved through our international and U.S. operations for the three months ended March 31, 2014 and 2013 were as follows (numbers may not total due to rounding): 
 
 
Three Months Ended
March 31,
(in millions)
 
 
 
 
2014
 
2013
 
Change
International
 
$
10,643

 
$
7,783

 
36.8
%
Domestic
 
1,637

 
1,370

 
19.5
%
Total
 
$
12,280

 
$
9,153

 
34.2
%
 
Gross bookings increased by 34.2% for the three months ended March 31, 2014 compared to the same period in 2013 (growth on a local currency basis was approximately 35% ), principally due to growth of 32.0% in accommodation room night reservations, 3% growth on a local currency basis in Group wide ADRs, 22.6% growth in airline ticket reservations and growth of 24.6% in rental car day reservations.  The 36.8% increase in international gross bookings for the three months ended March 31, 2014 compared to the same period in 2013 (growth on a local currency basis was approximately 38% ) was primarily attributable to growth in accommodation room night reservations for our Booking.com and agoda.com businesses, as well as growth in rental car day reservations for our rentalcars.com business.  Domestic gross bookings increased by 19.5% for the three months ended March 31, 2014 compared to the same period in 2013 , primarily due to an increase in priceline.com's retail airline ticket service, Express Deals ® hotel reservation service, and retail rental car service, partially offset by a decline in our Name Your Own Price ® hotel and air reservation services.
 
Gross bookings resulting from reservations of accommodation room nights, rental car days and airline tickets made through our agency and merchant models for the three months ended March 31, 2014 and 2013 were as follows (numbers may not total due to rounding): 
 
 
Three Months Ended
March 31,
(in millions)
 
 
 
 
2014
 
2013
 
Change
Agency
 
$
10,516

 
$
7,648

 
37.5
%
Merchant
 
1,764

 
1,505

 
17.2
%
Total
 
$
12,280

 
$
9,153

 
34.2
%
 
Agency gross bookings increased 37.5% for the three months ended March 31, 2014 compared to the same period in 2013 , primarily due to growth in Booking.com accommodation room night reservations, as well as growth in priceline.com's retail airline ticket, rental car and hotel services. Merchant gross bookings increased 17.2% for the three months ended March 31, 2014 compared to the same period in 2013 , primarily due to an increase in the sale of agoda.com hotel room night reservations, rentalcars.com rental car day reservations, priceline.com Express Deals ® hotel room night reservations and

30



priceline.com retail hotel room night reservations, partially offset by a decline in our Name Your Own Price ® hotel room night and airline ticket reservation services.

Units sold for accommodation room nights, rental car days and airline tickets for the three months ended March 31, 2014 and 2013 were as follows:
 
 
Three Months Ended
March 31,
(in millions)
 
 
 
 
2014
 
2013
 
Change
Room Nights
 
83.4
 
63.2
 
32.0
%
Rental Car Days
 
12.3
 
9.9
 
24.6
%
Airline Tickets
 
2.0
 
1.7
 
22.6
%
 
Accommodation room night reservations increased by 32.0% for the three months ended March 31, 2014 compared to the same period in 2013 , principally due to an increase in Booking.com, agoda.com and priceline.com accommodation room night reservations. Booking.com, our most significant brand, included over 455,000 properties on its website as of May 7, 2014 (updated property counts are available on the Booking.com website).  Booking.com has added properties 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 and our core European market.  Our priceline.com agency hotel reservations benefited from the integration of the growing number of properties on the Booking.com extranet.
 
Rental car day reservations increased by 24.6% for the three months ended March 31, 2014 compared to the same period in 2013 , due to an increase in retail rental car day reservations for rentalcars.com and priceline.com, partially offset by a decline in our Name Your Own Price ® service.
 
Airline ticket reservations increased by 22.6% for the three months ended March 31, 2014 compared to the same period in 2013 , due to an increase in price-disclosed airline ticket reservations for priceline.com driven in part by increased paid advertising placements on KAYAK.
 
Revenues

We classify our revenue into three categories:
 
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 travel services and customer processing fees and are reported at the net amounts received, without any associated cost of revenue. Substantially all of the revenue for Booking.com is agency revenue comprised of travel commissions.
 
Merchant revenues are derived from services 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 night, rental car and airline ticket reservations and vacation packages; (2) transaction revenues representing the amount charged to a customer, less the amount charged by travel service providers in connection with (a) the accommodation reservations provided through our merchant price-disclosed hotel services at agoda.com and priceline.com and (b) the reservations provided through our merchant rental car service at rentalcars.com and merchant Express Deals ® hotel service at priceline.com, which allows customers to see the price of the hotel reservation prior to purchase but not the identity of the travel service provider; (3) customer processing fees charged in connection with the sale of Name Your Own Price ® hotel, rental car and airline ticket reservations and merchant price-disclosed hotel reservations; and (4) ancillary fees, including GDS reservation booking fees related to certain of the services listed above.
 
Advertising and other revenues are derived primarily from KAYAK for sending referrals to OTAs and travel service providers, as well as from advertising placements on KAYAK's websites and mobile applications.

 

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Three Months Ended March 31,
(in thousands)
 
 
 
 
2014
 
2013
 
Change
Agency Revenues
 
$
1,041,144

 
$
769,928

 
35.2
 %
Merchant Revenues
 
526,998

 
528,564

 
(0.3
)%
Advertising and Other Revenues
 
73,660

 
3,520

 
1,992.6
 %
Total Revenues
 
$
1,641,802

 
$
1,302,012

 
26.1
 %
 
  Agency Revenues
 
Agency revenues for the three months ended March 31, 2014 increased 35.2% compared to the same period in 2013 , primarily as a result of growth in the business of Booking.com.  Our priceline.com agency revenues benefited from growth in our retail rental car and airline ticket businesses as well as the integration on the priceline.com website of the growing number of properties on the Booking.com extranet.

Merchant Revenues
 
Merchant revenues for the three months ended March 31, 2014 decreased 0.3% compared to the same period in 2013 , primarily due to decreases in Name Your Own Price ® hotel and air reservation services, mostly offset by increases in our agoda.com business, rentalcars.com business and priceline.com Express Deals ® hotel reservation service and vacation package reservation service for the three months ended March 31, 2014 , compared to the same period in 2013 . Merchant revenue growth over the prior year period was substantially lower than merchant gross bookings growth because our merchant revenues are disproportionately affected by our Name Your Own Price ® service. Name Your Own Price ® revenues are recorded "gross" with a corresponding supplier cost recorded in cost of revenues, and represented a smaller percentage, year-over-year, of total revenues compared to our faster-growing agoda.com, rentalcars.com and priceline.com Express Deals ® services, which are recorded in revenue "net" of supplier cost. As a result, we believe that gross profit is an important measure of evaluating growth in our business.

Advertising and Other Revenues
 
Advertising and other revenues during the three months ended March 31, 2014 consisted primarily of advertising revenues.  Advertising revenues for the three months ended March 31, 2014 includes $69.2 million as a result of the inclusion of KAYAK since its acquisition on May 21, 2013, and excludes intercompany revenues earned by KAYAK from other Priceline Group brands.
 
Cost of Revenues
 
 
Three Months Ended March 31,
(in thousands)
 
 
 
 
2014
 
2013
 
Change
Cost of Revenues
 
$
235,331

 
$
292,347

 
(19.5
)%
 
For the three months ended March 31, 2014 , cost of revenues consisted primarily of: (1) the cost paid to travel service providers for our Name Your Own Price ® services, net of applicable taxes and charges; (2) fees paid to third parties by KAYAK and priceline.com to return travel itinerary information in response to search queries; and (3) the cost related to accruals for travel transaction taxes (e.g., hotel occupancy taxes, excise taxes, sales taxes, etc.). Cost of revenues for the three months ended March 31, 2014 decreased by 19.5% compared to the same period in 2013 , primarily due to a decrease in our Name Your Own Price ® hotel, rental car and airline ticket reservation services, partially offset by the inclusion of KAYAK since its acquisition on May 21, 2013 and increases in our priceline.com vacation package service. Cost of revenues for the three months ended March 31, 2013 includes an accrual recorded in the first quarter of 2013 of approximately $20.5 million (including estimated interest and penalties) for travel transaction taxes, principally related to unfavorable rulings in the State of Hawaii and the District of Columbia.

Agency revenues have no cost of revenue. Agency revenues principally consist of travel commissions on accommodation reservations.

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Gross Profit  
 
 
Three Months Ended March 31,
(in thousands)
 
 
 
 
2014
 
2013
 
Change
Gross Profit
 
$
1,406,471

 
$
1,009,665

 
39.3
%
Gross Margin
 
85.7
%
 
77.5
%
 
 
 
Total gross profit for the three months ended March 31, 2014 increased by 39.3% compared to the same period in 2013 , primarily as a result of the increased revenue discussed above.  Total gross margin (gross profit as a percentage of total revenue) increased during the three months ended March 31, 2014 , compared to the same period in 2013 , because our revenues are disproportionately affected by our Name Your Own Price ® service. Name Your Own Price ® revenues are recorded "gross" with a corresponding travel service provider cost recorded in cost of revenues, and in the three months ended March 31, 2014 these revenues represented a smaller percentage of total revenues than in the same period in 2013 . Our retail and semi-opaque services, which are recorded in revenue "net" of supplier cost have been growing faster than our Name Your Own Price ® services. As a result, we believe that gross profit is an important measure of evaluating growth in our business. Our international operations accounted for approximately $1.21 billion of our gross profit for the three months ended March 31, 2014 , which compares to $894.4 million for the same period in 2013. Gross profit attributable to our international operations increased, on a local currency basis, by approximately 37% for the three months ended March 31, 2014 compared to the same period in 2013 . Gross profit attributable to our U.S. businesses increased by 74% for the three months ended March 31, 2014 , compared to the same period in 2013 . Gross profit for the three months ended March 31, 2014 was positively impacted by the inclusion of KAYAK since its acquisition on May 21, 2013. Gross profit for the three months ended March 31, 2013 was negatively impacted by an accrual recorded in the first quarter of 2013 of approximately $20.5 million (including estimated interest and penalties) for travel transaction taxes, principally related to unfavorable rulings in the State of Hawaii and the District of Columbia.
 
Operating Expenses
 
Advertising  
 
 
Three Months Ended March 31,
(in thousands)
 
 
 
 
2014
 
2013
 
Change
Online Advertising
 
$
520,848

 
$
403,153

 
29.2
%
% of Total Gross Profit
 
37.0
%
 
39.9
%
 
 
Offline Advertising
 
$
53,474

 
$
27,729

 
92.8
%
% of Total Gross Profit
 
3.8
%
 
2.7
%
 
 
 
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, pop-up and other Internet advertisements; and (5) e-mail campaigns. For the three months ended March 31, 2014 , online advertising expenses increased over the same period in 2013 , primarily to generate increased gross bookings. Online advertising as a percentage of gross profit decreased for the three months ended March 31, 2014 due to the impact of the inclusion of KAYAK in our consolidated results. KAYAK spends a lower percentage of gross profit on online advertising than our other brands, and our consolidated results exclude intercompany advertising by our brands on KAYAK since the acquisition date. This favorable impact will benefit year-over-year comparisons until the anniversary of the acquisition on May 21, 2014. For the three months ended March 31, 2014 , this favorable impact was partially offset by (1) brand mix within The Priceline Group as our international brands grew faster than our U.S. brands and typically spend a higher percentage of gross profit on online advertising and (2) a year-over-year decline in advertising ROIs. In addition, gross profit for the three months ended March 31, 2013 was negatively impacted by an accrual in the amount of approximately $20.5 million (including estimated interest and penalties) for travel transaction taxes, principally related to unfavorable rulings in the State of Hawaii and the District of Columbia.

Offline advertising expenses are related to our Booking.com, KAYAK and priceline.com businesses. For the three months ended March 31, 2014 , offline advertising increased 92.8% , compared to the same period in 2013 , due mainly to the impact of the inclusion of KAYAK in our consolidated results since its acquisition on May 21, 2013, as well as the launch of

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offline advertising campaigns by Booking.com in the United States in 2013 and in Australia, Canada and the United Kingdom in 2014.

Sales and Marketing
 
 
Three Months Ended March 31,
(in thousands)
 
 
 
 
2014
 
2013
 
Change
Sales and Marketing
 
$
64,311

 
$
52,263

 
23.1
%
% of Total Gross Profit
 
4.6
%
 
5.2
%
 
 
 
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 bad debt, primarily related to agency accommodation commission receivables; and (4) provisions for credit card chargebacks. For the three months ended March 31, 2014 , sales and marketing expenses, which are substantially variable in nature, increased over the same period in 2013 , primarily due to increased gross booking volumes as well as expenses related to increased content translations. Sales and marketing expenses as a percentage of gross profit are typically higher for our merchant business, which 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, 2014 , declined compared to the same period in 2013 .

Personnel  
 
 
Three Months Ended March 31,
(in thousands)
 
 
 
 
2014
 
2013
 
Change
Personnel
 
$
194,531

 
$
134,218

 
44.9
%
% of Total Gross Profit
 
13.8
%
 
13.3
%
 
 
 
Personnel expenses consist of compensation to our personnel, including salaries, stock-based compensation, payroll taxes, bonuses and employee health benefits. For the three months ended March 31, 2014 , personnel expenses increased over the same period in 2013 , due primarily to increased headcount to support the growth of our businesses and the impact of the inclusion of KAYAK in our consolidated results since its acquisition on May 21, 2013. Stock-based compensation expense was approximately $38.8 million for the three months ended March 31, 2014 compared to $21.7 million for the three months ended March 31, 2013 . Stock-based compensation expense included $4.1 million for KAYAK unvested assumed employee stock options and payroll taxes of $0.5 million for KAYAK stock option exercises recorded during the three months ended March 31, 2014 .

General and Administrative  

 
 
Three Months Ended March 31,
(in thousands)
 
 
 
 
2014
 
2013
 
Change
General and Administrative
 
$
72,981

 
$
50,161

 
45.5
%
% of Total Gross Profit
 
5.2
%
 
5.0
%
 
 

 
General and administrative expenses consist primarily of: (1) occupancy and office expenses; (2) personnel related expenses such as recruiting, training and travel expenses; and (3) fees for outside professionals, including litigation expenses. General and administrative expenses increased during the three months ended March 31, 2014 over the same period in 2013 , primarily due to higher travel, training and recruiting expenses related to increased headcount in all our businesses, higher occupancy and office expenses related to the expansion of our international businesses, and the impact of the inclusion of KAYAK in our consolidated results since its acquisition on May 21, 2013. General and administrative expenses for three months ended March 31, 2013 included approximately $2 million of professional fees related to the acquisition of KAYAK.

34





Information Technology  
 
 
Three Months Ended March 31,
(in thousands)
 
 
 
 
2014
 
2013
 
Change
Information Technology
 
$
23,224

 
$
13,222

 
75.6
%