Source: https://www.sec.gov/Archives/edgar/data/1075531/000107553113000045/pcln6301310q.htm
Timestamp: 2019-04-18 20:21:03+00:00

Document:
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES ý NO o.
(1) Net of tax benefit of $12,613 and tax of $14,284 for the three and six months ended June 30, 2013, respectively, and net of tax of $23,697 and $10,735 for the three and six months ended June 30, 2012, respectively, associated with hedges of foreign denominated net assets. See Note 12.
(2) Net of tax benefit of $258 and $251 for the three and six months ended June 30, 2013, respectively, and net of tax of $7 and tax benefit of $345 for the three and six months ended June 30, 2012, respectively.
Priceline.com Incorporated (the "Priceline Group" or the "Company") is responsible for the Unaudited Consolidated Financial Statements included in this document. The Unaudited Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and include all normal and recurring adjustments that management of the Company considers necessary for a fair presentation of its financial position and operating results. The Company prepared the Unaudited Consolidated Financial Statements following the requirements of the Securities and Exchange Commission for interim reporting. As permitted under those rules, the Company condensed or omitted certain footnotes or other financial information that are normally required by GAAP for annual financial statements. These statements should be read in combination with the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2012.
The Unaudited Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries, including priceline.com International Ltd. ("PIL"), Booking.com B.V. ("Booking.com"), Booking.com Limited, priceline.com Europe Ltd, priceline.com Mauritius Company Limited ("Agoda.com"), KAYAK Software Corporation ("KAYAK") since its acquisition on May 21, 2013 (see Note 14), and TravelJigsaw Holdings Limited ("rentalcars.com"). All inter-company accounts and transactions have been eliminated in consolidation. The functional currency of the Company's foreign subsidiaries is generally the respective local currency. Assets and liabilities are translated into U.S. Dollars at the rate of exchange existing at the balance sheet date. Income statement amounts are translated at the average exchange rates for the period. Translation gains and losses are included as a component of "Accumulated other comprehensive loss" 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.
In February 2013, the Financial Accounting Standards Board ("FASB") issued accounting guidance which requires entities to provide additional information about items reclassified out of accumulated other comprehensive income ("AOCI"). Changes in AOCI balances by component, both before tax and after tax, must be disclosed and significant items reclassified out of AOCI by component must be reported either on the face of the income statement or in a separate footnote to the financial statements. The accounting guidance is effective for public companies for fiscal years, and interim periods within those years, beginning after December 15, 2012. See Note 12 for information on AOCI balances. There were no reclassifications out of AOCI for the six months ended June 30, 2013 and 2012.
In July 2013, the 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. Early adoption of the update is permitted and an entity may choose to apply this amendment retrospectively to each reporting period presented.
Stock-based compensation expense included in personnel expenses in the Unaudited Consolidated Statements of Operations was approximately $34.7 million and $17.6 million for the three months ended June 30, 2013 and 2012, respectively, and $56.4 million and $34.1 million for the six months ended June 30, 2013 and 2012, respectively.
share units reflects the estimated probable outcome at the end of the performance period. The fair value of the unvested employee stock options assumed in the acquisition of KAYAK, which relates to post-combination service, was determined using the Black-Scholes model and the market value of the Company's common stock at the merger date. The fair value of the vested employee stock options assumed in the acquisition of KAYAK, which relates to pre-combination service, was determined based on the fair value of the option calculated as the difference between the exercise price of the underlying award and the market value of the Company's common stock at the merger date. Fair value is recognized as expense on a straight line basis, net of estimated forfeitures, over the employee requisite service period.
As of June 30, 2013, there was $153.6 million of total future compensation cost related to unvested share-based awards to be recognized over a weighted-average period of 1.8 years.
During the three months ended March 31, 2013, the Company made broad-based grants of 43,431 restricted stock units that generally vest after three years. These share-based awards had a total grant date fair value of $30.2 million based on a weighted average grant date fair value per share of $695.62. During the three months ended June 30, 2013, the Company made broad-based grants of 4,334 restricted stock units that generally vest after three years. These share-based awards had a total grant date fair value of $3.5 million based on a weighted average grant date fair value per share of $801.43.
In addition, during the three months ended March 31, 2013, the Company granted 92,615 performance share units to certain executives. The performance share units had a total grant date fair value of $64.4 million based upon a weighted average grant date fair value per share of $695.62. During the three months ended June 30, 2013, the Company granted 12,250 performance share units to certain executives which had a total grant date fair value of $10.0 million based upon a weighted average grant date fair value per share of $816.45. The performance share units are payable in shares of the Company's common stock upon vesting. Subject to certain exceptions for terminations related to a change in control and terminations other than for "cause," for "good reason" or on account of death or disability, 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, 2015, assuming there is no accelerated vesting for, among other things, a termination of employment under certain circumstances, or a change in control. As of June 30, 2013, the estimated number of probable shares to be issued is a total of 104,301 shares. If the maximum performance thresholds are met at the end of the performance period, a maximum number of 229,097 total shares could be issued. If the minimum performance thresholds are not met, 40,689 shares would be issued at the end of the performance period.
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.
a maximum of 116,240 total shares could be issued pursuant to these performance share units. If the minimum performance thresholds are not met, 36,366 shares would be issued at the end of the performance period.
During the year ended December 31, 2011, the Company granted 77,144 performance share units with a grant date fair value of $35.9 million, based on a weighted average grant date fair value per share of $464.79. The actual number of shares to be issued will be determined upon completion of the performance period which ends December 31, 2013.
At June 30, 2013, there were 73,045 unvested 2011 performance share units outstanding, net of actual forfeitures and vesting. As of June 30, 2013, 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 149,112 shares. If the maximum performance thresholds are met at the end of the performance period, a maximum of 156,310 total shares could be issued pursuant to these performance share units. If the minimum performance thresholds are not met, 18,697 shares would be issued at the end of the performance period.
Excluding stock options assumed in the acquisition of KAYAK (refer to disclosure below on assumed options), during the six months ended June 30, 2013, stock options were exercised for 53,975 shares of common stock with a weighted average exercise price per share of $18.84. As of June 30, 2013, the aggregate number of stock options outstanding and exercisable (excluding stock options assumed in the acquisition of KAYAK) was 17,026 shares, with a weighted average exercise price per share of $22.57 and a weighted average remaining term of 1.4 years.
The total intrinsic value of KAYAK assumed employee stock options exercised for the period May 22 through June 30, 2013 was $197.5 million.
At May 21, 2013, there were 408,716 shares of KAYAK vested assumed employee stock options with a fair value of $260.9 million. The fair value of these KAYAK vested assumed employee stock options was included in the purchase price allocation, with a corresponding offset to additional paid in capital.
At May 21, 2013, there were 131,463 shares of KAYAK unvested assumed employee stock options. The fair value of these KAYAK unvested assumed employee stock options was $57.4 million, with a weighted average fair value per share of $443.92. The fair value of the KAYAK assumed employee stock options that vested during the three months ended June 30, 2013 was $7.6 million.
For the three months ended June 30, 2013, the Company recorded stock-based compensation expense of $11.0 million for the KAYAK unvested assumed employee stock options. As of June 30, 2013, there was $44.0 million of total future compensation cost related to these KAYAK unvested assumed employee stock options to be recognized over a weighted-average period of 2.1 years.
The Company computes basic net income per share by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per share is based upon the weighted average number of common and common equivalent shares outstanding during the period.
Common equivalent shares related to stock options, restricted stock 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.
Anti-dilutive potential common shares for the three and six months ended June 30, 2013 includes approximately 2.6 million shares for each period 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.
price of $40.38 per share (subject to adjustment in certain circumstances) in 2013, and the counterparties are entitled to purchase from the Company a total of approximately 4.3 million shares of the Company's common stock at a strike price of $50.47 per share (subject to adjustment in certain circumstances) in 2013.
The 2013 Notes were converted prior to maturity. Therefore, upon early conversion of the 2013 Notes, the Company delivered any related conversion premium in shares of stock or a combination of shares or cash. The Conversion Spread Hedges are separate transactions entered into by the Company and are not part of the terms of the 2013 Notes. The Conversion Spread Hedges did not immediately hedge against the associated dilution from early conversions of the 2013 Notes. Because of this timing difference, the number of shares, if any, that the Company receives from the Conversion Spread Hedges can differ materially from the number of shares that it delivered to the holders of the 2013 Notes upon their early conversion. The actual number of shares to be received will depend upon the Company's stock price on the dates the Conversion Spread Hedges are exercisable, which is the 20 trading days beginning September 23, 2013. The settlement of the Conversion Spread Hedges will be accounted for as an equity transaction and is not expected to have a significant impact on the number of common shares outstanding.
The Conversion Spread Hedges are outstanding at June 30, 2013. However, since the beneficial impact of the Conversion Spread Hedges was anti-dilutive, it was excluded from the calculation of net income per share.
As of June 30, 2013, foreign government securities included investments in debt securities issued by the governments of Germany, the Netherlands, and the United Kingdom.
There were no realized gains or losses related to investments for the three and six months ended June 30, 2013 and 2012.
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 considered its redeemable noncontrolling interests to represent a "Level 3" fair value measurement that requires a high degree of judgment to determine fair value. The fair value of the redeemable noncontrolling interests was determined by industry peer comparable analysis and a discounted cash flow valuation model. In April 2013, the Company purchased the remaining shares underlying redeemable controlling interests. See Note 11 for information on the estimated fair value of redeemable noncontrolling interests.
As of June 30, 2013 and December 31, 2012, the carrying value of the Company's cash and cash equivalents approximated their fair value and consisted primarily of foreign and U.S. government securities and bank deposits. Other financial assets and liabilities, including restricted cash, accounts receivable, accrued expenses and deferred merchant bookings are carried at cost which approximates their fair value because of the short-term nature of these items. See Note 4 for information on the carrying value of investments and Note 8 for the estimated fair value of the Company's convertible senior notes.
In the normal course of business, the Company is exposed to the impact of foreign currency fluctuations. The Company limits these risks by following established risk management policies and procedures, including the use of derivatives. The Company does not use derivatives for trading or speculative purposes. All derivative instruments are recognized in the Unaudited Consolidated Balance Sheets at fair value. Gains and losses resulting from changes in the fair value of derivative instruments which are not designated as hedging instruments for accounting purposes are recognized in the Unaudited Consolidated Statements of Operations in the period that the changes occur. Changes in the fair value of derivatives designated as net investment hedges are recorded as currency translation adjustments to offset a portion of the translation adjustment of the international subsidiary's net assets and are recognized in the Unaudited Consolidated Balance Sheets in "Accumulated other comprehensive loss."
Derivatives Not Designated as Hedging Instruments — The Company is exposed to adverse movements in currency exchange rates as the 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 June 30, 2013 and December 31, 2012, there were no outstanding derivative contracts associated with foreign currency translation risk. Foreign exchange gains of $1.8 million and $2.2 million for the three and six months ended June 30, 2013, respectively, and foreign exchange gains of $5.2 million and $5.8 million for the three and six months ended June 30, 2012, respectively, were recorded in "Foreign currency transactions and other" on 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 June 30, 2013 associated with hedging these risks resulted in a net asset of $0.9 million, with $1.3 million recorded in "Prepaid expenses and other current assets" and $0.4 million recorded in "Accrued expenses and other current liabilities" on the Unaudited Consolidated Balance Sheet. Foreign exchange derivatives outstanding as of December 31, 2012 associated with hedging these risks resulted in a net asset of $0.3 million, with $0.8 million recorded in "Prepaid expenses and other current assets" and $0.5 million recorded in "Accrued expenses and other current liabilities" on the Unaudited Consolidated Balance Sheet. Foreign exchange gains of $3.5 million and $0.3 million for the three and six months ended June 30, 2013 compared to foreign exchange losses of $5.0 million and $2.6 million for the three and six months ended June 30, 2012 were recorded related to these derivatives in "Foreign currency transactions and other" on the Unaudited Consolidated Statements of Operations.
The settlement of derivative contracts not designated as hedging instruments resulted in a net cash inflow of $1.5 million for the six months ended June 30, 2013 compared to a net cash outflow of $0.1 million for the six months ended June 30, 2012, and are reported within "Net cash provided by operating activities" on the Unaudited Consolidated Statements of Cash Flows.
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 June 30, 2013 was a net asset of $13.3 million, with $21.2 million recorded in "Prepaid expenses and other current assets" and $7.9 million recorded in "Accrued expenses and other current liabilities" on the Unaudited Consolidated Balance Sheet. The fair value of these derivatives at December 31, 2012 was a net liability of $62.4 million, with $62.6 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. A net cash outflow of $44.2 million for the six months ended June 30, 2013 compared to a net cash inflow of $61.7 million for the six months ended June 30, 2012 were reported within "Net cash used in investing activities" on the Unaudited Consolidated Statements of Cash Flows.
Intangible assets with determinable lives are amortized on a straight-line basis. Intangible asset amortization expense was approximately $14.8 million and $8.2 million for the three months ended June 30, 2013 and 2012, respectively. Intangible asset amortization expense was approximately $24.0 million and $16.4 million for the six months ended June 30, 2013 and 2012, respectively.
A substantial portion of the intangible assets and goodwill relate to the acquisition of the KAYAK business in May 2013. See Note 14 for further information on the acquisition.
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.
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%.
December 31, 2012, there were no borrowings under the facility and there were approximately $1.9 million of letters of credit issued under the facility for both periods.
Based upon the closing price of the Company's common stock for the prescribed measurement period during the three months ended June 30, 2013 and December 31, 2012, 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 June 30, 2013 and December 31, 2012. 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 $42.8 million and $54.7 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 June 30, 2013 and December 31, 2012, respectively. The determination of whether or not the 2015 Notes are convertible must continue to be performed on a quarterly basis. Consequently, the 2015 Notes may not be convertible in future quarters, and therefore may again be classified as long-term debt, if the contingent conversion threshold is not met in such quarters. The contingent conversion thresholds on the 2018 Notes (as defined below) and the 2020 Notes (as defined below) were not exceeded at June 30, 2013 and the contingent conversion threshold for the 2018 Notes was not exceeded at December 31, 2012, and therefore these Notes are reported as a non-current liability on the Unaudited Consolidated Balance Sheets.
As of June 30, 2013 and December 31, 2012, the estimated market value of the outstanding convertible senior notes was approximately $3.7 billion and $2.3 billion, respectively, and was considered a "Level 2" fair value measurement (see Note 5). Fair value was estimated based upon actual trades at the end of the reporting period or the most recent trade available as well as the Company's stock price at the end of the reporting period. A substantial portion of the market value of the Company's debt in excess of the outstanding principal amount relates to the conversion premium on the bonds.
value ranging from $0 to approximately $397 million depending upon the date of the transaction and the then current stock 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 $20.4 million in debt issuance costs during the six months ended June 30, 2012, related to this offering. The 2018 Notes are convertible, subject to certain conditions, into the Company's common stock at a conversion price of approximately $944.61 per share. The 2018 Notes are convertible, at the option of the holder, prior to March 15, 2018, upon the occurrence of specific events, including but not limited to a change in control, or if the closing sales price of the Company's common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is more than 150% of the applicable conversion price in effect for the notes on the last trading day of the immediately preceding quarter. In the event that all or substantially all of the Company's common stock is acquired on or prior to the maturity of the 2018 Notes in a transaction in which the consideration paid to holders of the Company's common stock consists of all or substantially all cash, the Company would be required to make additional payments in the form of additional shares of common stock to the holders of the 2018 Notes in aggregate value ranging from $0 to approximately $344.0 million depending upon the date of the transaction and the then current stock price of the Company. As of December 15, 2017, holders will have the right to convert all or any portion of the 2018 Notes. The 2018 Notes may not be redeemed by the Company prior to maturity. The holders may require the Company to repurchase the 2018 Notes for cash in certain circumstances. Interest on the 2018 Notes is payable on March 15 and September 15 of each year.
In March 2010, the Company issued in a private placement $575.0 million aggregate principal amount of Convertible Senior Notes due March 15, 2015, with an interest rate of 1.25% (the "2015 Notes"). The Company paid $13.3 million in debt issuance costs 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. In the event that all or substantially all of the Company's common stock is acquired on or prior to the maturity of the 2015 Notes in a transaction in which the consideration paid to holders of the Company's common stock consists of all or substantially all cash, the Company would be required to make additional payments in the form of additional shares of common stock to the holders of the 2015 Notes in aggregate value ranging from $0 to approximately $132.7 million depending upon the date of the transaction and the then current stock price of the Company. As of December 15, 2014, holders will have the right to convert all or any portion of the 2015 Notes. The 2015 Notes may not be redeemed by the Company prior to maturity. The holders may require the Company to repurchase the 2015 Notes for cash in certain circumstances. Interest on the 2015 Notes is payable on March 15 and September 15 of each year.
Accounting guidance requires that cash-settled convertible debt, such as the Company's convertible senior notes, be separated into debt and equity components at issuance and 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 $42.8 million before tax and $54.7 million before tax out of additional paid-in capital to the mezzanine section in the Company's Unaudited Consolidated Balance Sheets at June 30, 2013 and December 31, 2012, respectively, related to the 2015 Notes.
For the three months ended June 30, 2013 and 2012, the Company recognized interest expense of $18.9 million and $16.3 million, respectively, related to convertible notes. Interest expense related to convertible notes for the three months ended June 30, 2013 and 2012 was comprised of $4.6 million and $4.3 million, respectively, for the contractual coupon interest, $13.1 million, which includes $0.2 million of original issuance discount for the 2020 Notes, and $10.8 million, respectively, related to the amortization of debt discount and $1.2 million for each period related to the amortization of debt issuance costs. The effective interest rate for the three months ended June 30, 2013 and 2012 was 4.6% and 4.7%, respectively.
For the six months ended June 30, 2013 and 2012, the Company recognized interest expense of $35.6 million and $26.9 million, respectively, related to convertible notes. Interest expense related to convertible notes for the six months ended June 30, 2013 and 2012 was comprised of $8.9 million and $6.9 million, respectively, for the contractual coupon interest, $24.2 million, which includes $0.2 million of original issuance discount for the 2020 Notes, and $18.0 million, respectively, related to the amortization of debt discount and $2.5 million and $2.0 million, respectively, related to the amortization of debt issuance costs. The effective interest rate for the six months ended June 30, 2013 and 2012 was 4.6% and 5.1%, respectively.
In the second quarter of 2013, the Company's Board of Directors authorized a program to purchase $1.0 billion of the Company's common stock. The Company repurchased 431,910 shares in the second quarter of 2013 for an aggregate cost of $345.5 million in privately negotiated, off-market transactions.
In the first quarter of 2012, the Company's Board of Directors authorized a one-time purchase of the Company's common stock up to $200 million concurrent with the issuance of the 2018 Notes. The Company repurchased 263,913 shares in the first quarter of 2012 for an aggregate cost of $166.2 million.
As of June 30, 2013, the Company has a remaining aggregate amount from all authorizations granted by the Board of Directors of $1.1 billion 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.
The Board of Directors has also given the Company the general authorization to repurchase shares of its common stock to satisfy employee withholding tax obligations related to stock-based compensation. The Company repurchased 112,544 shares and 138,171 shares at aggregate costs of $77.8 million and $89.0 million in the six months ended June 30, 2013 and 2012, respectively, to satisfy employee withholding taxes related to stock-based compensation.
As of June 30, 2013, there were approximately 8.7 million shares of the Company's common stock held in treasury.
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 and six months ended June 30, 2013 and 2012, a substantial majority of the Company's foreign-sourced income was generated in the Netherlands. Income tax expense for the three and six months ended June 30, 2013 and 2012 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, and includes a three year extension granted by the Dutch tax authorities in July 2013.
generated from operating losses and approximately $0.9 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.
On May 18, 2010, the Company, through its wholly-owned subsidiary, PIL, paid $108.5 million, net of cash acquired, to purchase a controlling interest of the outstanding equity of TravelJigsaw Holdings Limited and its operating subsidiary, TravelJigsaw Limited (now known as the rentalcars.com business), a Manchester, U.K.-based international rental car reservation service.
Certain key members of TravelJigsaw's management team retained a noncontrolling ownership interest in TravelJigsaw Holdings Limited. In addition, certain key members of the management team of Booking.com purchased a 3% ownership interest in TravelJigsaw from PIL in June 2010 (together with TravelJigsaw management's investment, the "Redeemable Shares"). The holders of the Redeemable Shares had the right to put their shares to PIL and PIL had the right to call the shares in each case at a purchase price reflecting the fair value of the Redeemable Shares at the time of exercise. Subject to certain exceptions, one-third of the Redeemable Shares were subject to the put and call options in each of 2011, 2012 and 2013, respectively, during specified option exercise periods. In April 2012 and April 2011, in connection with the exercise of call and put options, PIL purchased a portion of the shares underlying redeemable noncontrolling interests for an aggregate purchase price of approximately $61.1 million and $13.0 million, respectively. As a result of the April 2012 purchase, the redeemable noncontrolling interests in TravelJigsaw Holdings Limited were reduced from 19.0% to 12.7%. 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.
Redeemable noncontrolling interests are measured at fair value, both at the date of acquisition and subsequently at each reporting period. The redeemable noncontrolling interests are reported on the Unaudited Consolidated Balance Sheets in mezzanine equity in "Redeemable noncontrolling interests."
(1) The fair value of the redeemable noncontrolling interests was determined by industry peer comparable analysis and a discounted cash flow valuation model.
(1) Foreign currency translation adjustments, net of tax, includes net gains from fair value adjustments at June 30, 2013 of $41.1 million after tax ($70.3 million before tax) and net gains from fair value adjustments at December 31, 2012 of $23.8 million after tax ($38.7 million before tax) associated with net investment hedges (see Note 5). The remaining balance in currency translation adjustments excludes income taxes due to the Company's practice and intention to reinvest the earnings of its foreign subsidiaries in those operations.
(2) The unrealized loss before tax at June 30, 2013 and the unrealized gain before tax at December 31, 2012 were $0.5 million and $0.2 million, respectively.
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-five municipalities or counties, and at least twelve 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 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 pay first amounts paid in July 2009; the Company is also seeking a refund of the amounts paid first in January 2013. It is possible the city may take the position that it need not refund the pay first amounts until after it has exhausted all appeals.
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. The Company was required to pay approximately $10.4 million of this amount prior to filing its notice of appeal of the Tax Appeal Court's decision on April 30, 2013, and in advance of filing an appeal of the forthcoming ruling by the Tax Appeal Court, the Company paid under protest approximately $5.0 million in June 2013. The Company will vigorously appeal this ruling. In September 2012, the Superior Court in the District of Columbia granted summary judgment in favor of the city and against OTCs ruling that tax is due on the OTCs' margin and service fees. 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. 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 and the other defendants are appealing.
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.
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 service 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, but also, among other things, interest, penalties, punitive damages and/or attorney fees and costs. Therefore, any liability associated with travel transaction tax matters is not constrained to the Company's liability for tax owed, 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 travel reservations have not asserted that taxes are due and payable on the Company's travel services. 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.
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 $65 million at June 30, 2013 and approximately $56 million at December 31, 2012 (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.
entered an order denying the OTCs' motion for partial summary judgment relating to the general excise tax, holding that the Company and the other OTCs are liable for that 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 court denied the OTCs' motion for reconsideration on April 1, 2013. The Court has orally ruled that the Company will owe 50% penalties with respect to the alleged general excise tax liability, but has not yet issued an order specifying the amount of penalties to be imposed on the Company. On April 22, 2013, the Hawaii Supreme Court denied the OTCs' petition that sought relief from the Tax Court's orders and also from the "pay first" requirement to appeal the Tax Court's judgment. On June 28, 2013, the Intermediate Court of Appeals of the State of Hawaii dismissed without prejudice the OTCs' appeal of the Tax Court's orders, holding that the notice of appeal was prematurely filed. The Company intends to vigorously pursue an appeal of the Tax Court's orders and any order imposing penalties with respect to the alleged general excise tax liability. In addition, on June 17, 2013, the Company and other OTCs each filed in the Hawaii Tax Appeal Court appeals of a second set of hotel tax and general excise tax assessments issued by the state; these assessments relate to the tax year of 2012. Those actions are captioned In the Matter of the Tax Appeal of priceline.com Inc. and In the Matter of Tax Appeal of Travelweb LLC (Tax Appeal Court of the State of Hawaii).
On February 28, 2013, in Leon County, et al. v. Expedia, Inc., et al. (filed November 2009); (Florida First District Court of Appeal; filed in May 2012), the First District Court of Appeal affirmed summary judgment in favor of defendants. The appellate court denied the plaintiffs' motion for a rehearing en banc on April 16, 2013 and granted plaintiffs' request for certification to the Florida Supreme Court. The parties have completed jurisdictional briefing before the Florida Supreme Court.
On March 12, 2013, in Expedia, Inc., et al. v. City and County of Denver, et al. (filed in March 2012), the court entered an order upholding the administrative hearing officer's opinion that OTCs are subject to accommodations tax, but also finding that the statute of limitations limits any recovery by the City of Denver to the period April 30, 2007 forward. The Company filed a notice of appeal of that decision on April 26, 2013.
On April 4, 2013, in City of San Antonio, Texas v. Hotels.com, L.P., et al. (U.S. District Court for the Western District of Texas; filed in May 2006), the court entered its judgment against the Company and other OTC defendants. The Company is appealing the judgment.
On April 11, 2013, in County of Nassau v. Expedia, Inc., et al. (filed September 2011), the trial court certified the action as a class action. On April 26, 2013, the Company and other OTC defendants filed a notice of appeal of that decision and the trial court's prior denial of the OTCs' motion to dismiss. On August 1, 2013, the court authorized plaintiff to notify members of the class of the pending class action.
On April 18, 2013, in City of Los Angeles v. Hotels.com, et al., (CA Superior Ct., Los Angeles County, filed in December 2004), the Los Angeles Superior Court granted the OTC defendants' motion for judgment granting a writ of mandamus, and denied the city's cross-motion for denial of a writ of mandamus, holding the OTCs are not subject to the city's transient occupancy tax. The Company anticipates the city will appeal the decision.
On April 30, 2013, in Elizabeth McAllister, et al. v. Hotels.com L.P., et al., (Circuit Court of Saline County, Arkansas; filed in February 2011), the trial court granted the OTC defendants' motion to dismiss, holding plaintiffs lack standing. On June 19, 2013, plaintiffs appealed to the Arkansas Supreme Court.
On July 8, 2013, in City of Chicago, Illinois v. Hotels.com, L.P., et al. (Circuit Court of Cook County Illinois; filed in November 2005), the Cook County Circuit Court entered an order denying the OTCs' motion for summary judgment and granting, in part, the City's motion for summary judgment relating to the Chicago Hotel Accommodations Tax ("CHAT") and related common law claims, holding that the Company and the other OTCs are liable for that tax and other obligations under CHAT. The Court's order applied only to liability and did not address or resolve any issues as to damages.
On July 8, 2013, in Warrenville, et al. v. Priceline.com Incorporated, et al. (U.S. District Court for the Northern District of Illinois; filed in April 2013), the plaintiffs voluntarily dismissed the putative class action pending in federal court, and filed a new class action complaint in Illinois state court. That action is captioned Village of Bedford Park, et al. v. Expedia, Inc., et al. (Circuit Court of Cook County, Illinois; filed in July 2013). The complaint alleges violation of the municipalities' respective accommodations ordinances, conversion, civil conspiracy, unjust enrichment, breach of fiduciary duty, and seeks a declaratory judgment, imposition of a constructive trust, and an accounting.
the state's accommodations tax law, breach of fiduciary duty, conversion and money had and received, and seeks imposition of a constructive trust and injunctive relief.
Two matters were resolved. In The Village of Rosemont, Illinois v. Priceline.com, Inc., et al. (U.S. District Court for the Northern District of Illinois; filed in July 2009) (U.S. Court of Appeals for the Seventh Circuit, appeal filed in November 2012), the Company and other OTC defendants resolved the litigation through mediation. A final agreement has been executed by all parties and a dismissal of the litigation with prejudice is expected shortly. The Company and other OTC defendants also resolved in principle the remaining issues in City of Gallup, New Mexico v. Hotels.com, L.P., et al. (U.S. District Court for the District of New Mexico; filed in July 2007) ); (U.S. Court of Appeals for the Tenth Circuit; appeal filed in April 2013).
A new action commenced. City of Columbia, South Carolina, et al. v. Hotelguides.com, Inc. et al. (Court of Common Pleas, Ninth Judicial Circuit, County of Charleston; filed in July 2013) is a putative class action brought on behalf of South Carolina local governments and taxing authorities against the Company and other OTCs (and other defendants) alleging that the defendants have failed to collect and/or remit transient accommodations taxes as required by the putative class members' respective ordinances. The complaint asserts violations of these ordinances, conversion, civil conspiracy, "voluntary undertaking" and "contractual undertaking" by defendants, and other equitable claims, including constructive trust, unjust enrichment and an accounting. The Company has not yet been served in this action.
The Company intends to vigorously defend against the claims in all of the proceedings described below.
City of Columbia, South Carolina, et al. v. Hotelguides.com, Inc. et al. (Court of Common Pleas, Ninth Judicial Circuit, County of Charleston; filed in July 2013).
At various times, the Company has also received inquiries or proposed tax assessments from municipalities and other taxing jurisdictions relating to the Company's charges and remittance of amounts to cover state and local travel transaction taxes. Among others, the City of Phoenix, Arizona (on behalf of itself and twelve other Arizona cities); the City of Paradise Valley, Arizona; fifteen cities (and one county) in Colorado (Greenwood Village, Littleton, Golden, city and county of Broomfield, Colorado Springs, Breckenridge, Durango, Grand Junction, Greeley, Lafayette, Silverthorne, Loveland, Glendale, Glenwood Springs, Lakewood); Arlington, Texas; Lake County, Indiana; Saratoga County, New York; and state tax officials from Arkansas, Colorado, Hawaii, Louisiana, Maryland, Michigan, Ohio, Pennsylvania, South Dakota, Texas, West Virginia, and Wisconsin have begun formal or informal administrative procedures or stated that they may assert claims against the Company relating to allegedly unpaid state or local travel transaction taxes. Priceline.com and Travelweb LLC received notices of assessment from the City of Phoenix, Arizona (on its behalf and on behalf of twelve other Arizona cities) arising from the multijurisdictional transaction privilege tax audit conducted by Phoenix. Priceline.com and Travelweb LLC are protesting such assessments and filed a petition for hearing. Between 2008 and 2010, the Company received audit notices from more than forty cities in the state of California. The audit proceedings in those cities have not been active but are not yet concluded. The Company has also been contacted for audit by five counties in the state of Utah and by the City of St. Louis, Missouri.
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 sets out its preliminary views on why it believes Booking.com and others in the hotel online booking sector have allegedly breached E.U. and U.K. competition law. The SO alleges, among other things, that there are agreements or concerted practices between hotels and Booking.com and at least one other OTC that restrict Booking.com's (and the other travel company's) ability to discount hotel room reservations, which the OFT alleges is a form of resale price maintenance.
The Company disputes the allegations in the SO and intends to contest them vigorously. Booking.com runs an agency model hotel reservation platform in which hotels have complete discretion and control over setting the prices that appear on the Booking.com website. Booking.com is a facilitator of hotel room reservations; it does not take possession of or title to hotel rooms and is not a reseller of hotel rooms. Because Booking.com plays no role in price setting, does not control hotel pricing and does not resell hotel rooms, it does not believe that it engages in the conduct alleged in the SO. The Company will have the right to respond to the allegations in the SO in writing and orally (which it expects to do in the second half of 2013). If the OFT chooses to maintain its objections after hearing Booking.com's responses, the OFT will issue a "Decision" which will state its case against Booking.com and others under investigation. The Company expects that a final infringement Decision, if any, will be issued at the earliest in the first half of 2014. The Company will have the opportunity to challenge an adverse Decision by the OFT in the U.K. courts.
In connection with a Decision, the OFT may impose a fine against Booking.com. The Company estimates that a fine could range from $0 to approximately $50 million. A fine in this amount could adversely impact the Company's cash flow and results of operations. In addition, the OFT may require changes to Booking.com's business practices, including changes to its approach to pricing and the use of "Most Favored Nation" clauses in contracts with hotels. The Company is unable at this time to predict the outcome of the proceedings before the OFT and, if necessary, before the U.K. courts, and the impact of changes to its business practices that may be required, if any, on its business, financial condition and results of operations. In addition, the Company is also unable to predict at this time the extent to which other regulatory authorities may pursue similar claims against it.
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 and one of them in Minnesota state court (which was then removed to federal court, the "Mooney Action"). Plaintiffs in these actions seek treble damages and injunctive relief.
Mooney action 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 January 29, 2013, plaintiff in the Mooney Action filed a voluntary notice of dismissal with prejudice. The case was dismissed with prejudice on January 31, 2013.
On July 1, 2013, the Company, together with the OTC and hotel defendants, filed an omnibus motion to dismiss the amended consolidated complaint. Plaintiffs' opposition is due on August 15, 2013 and defendants' reply is due on September 16, 2013.
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.
On May 21, 2013, the Company acquired 100% of KAYAK Software Corporation in a stock and cash transaction. The purchase value was approximately $2.1 billion ($1.9 billion net of cash acquired). The Company paid $0.5 billion in cash, from cash on hand in the United States, and $1.6 billion in shares of its common stock (based upon the market value of the Company's common stock at the merger date) and the fair value of the assumed vested KAYAK stock options. These assumed KAYAK stock options are related to pre-combination service.
KAYAK is a leading travel research site that allows people to easily compare hundreds of travel sites at once when searching for flights, hotels, and rental cars, and gives travelers choices on where to book. KAYAK has built a strong brand in online travel research and its track record of profitable growth is demonstrative of its popularity with consumers and value to advertisers. KAYAK also has world class technology and a tradition of innovation in building great user interfaces across multiple platforms and devices. The Company believes that it can be helpful with KAYAK's plans to build a global online travel brand.
Also in conjunction with the acquisition, the Company assumed unvested KAYAK employee stock options, which relate to post-combination service, with an acquisition date fair value of $57.4 million. See Note 2 for further information on the assumed KAYAK unvested employee stock options.
As a result of the acquisition of KAYAK, the Company expensed approximately $6.4 million and $8.5 million of professional fees for the three and six months ended June 30, 2013, respectively. These acquisition-related expenses were included in "General and administrative" expenses on the Unaudited Consolidated Statements of Operations. In addition, the Company paid approximately $1.2 million of stock issuance costs in the six months ended June 30, 2013, with an offsetting charge to additional paid-in capital.
(1) Includes cash acquired of $194 million.
(2) Acquired definite-lived intangibles, with a weighted average life of 18.7 years, consisted of trade names of $496 million with an estimated useful life of 20 years, supply and distribution agreements of $302 million with an estimated useful life of 20 years, and technology of $73 million with estimated useful life of 5 years.
(3) Goodwill is not tax deductible.
(4) Includes deferred tax liabilities of $326 million.
KAYAK's revenues and earnings since the acquisition date and pro forma results of operations have not been presented as such financial information is not material to the Company's 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.
We are a leading online travel company that offers our customers hotel and accommodation reservations through the Booking.com, priceline.com and Agoda.com brands. In the United States, we offer our customers reservations for car rentals, airline tickets, vacation packages, destination services and cruises through the priceline.com U.S. brand. We offer car rental reservations worldwide through rentalcars.com. We also allow customers to search for rates and availability for airline tickets, hotels rooms and rental cars across hundreds of websites and provide choices on where to book through KAYAK, which we acquired in May 2013. 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 our customers with worldwide leadership in online hotel, accommodation and rental car reservations. Our business is driven primarily by international results. During the year ended December 31, 2012, our international business (the substantial majority of which is generated by Booking.com) represented approximately 82% 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 92% of our consolidated operating income. Given that our international business is primarily comprised of hotel reservation services, and that hotel reservations also represent a significant majority of our domestic business, gross profit earned in connection with the reservation of hotel room nights represents a substantial majority of our gross profit.
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 services.
Over the last several years we have experienced strong growth in the number of hotel room night reservations booked through our hotel reservation services. We believe this growth is the result of, among other things, the broader shift of travel purchases from offline to online, the high growth of travel overall in emerging markets such as Asia-Pacific and South America, and the continued innovation and execution by our teams around the world to build hotel supply, content and distribution and to improve the customer experience on our websites. We experienced strong year-over-year growth in recent years, though that growth has generally decelerated. For example, in the second quarter of 2013, our hotel room night reservation growth was 38%, a deceleration from 39% in the second quarter of 2012 and 56% in the second quarter of 2011. Given the sheer 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. 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. Over the past year, 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. 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.
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, the world's leading travel research and review website and the world's largest online travel service with over 230 million unique monthly visitors across its sites, 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 (like those offered by KAYAK, which we acquired in May 2013) leverage their search technology to aggregate travel search results for the consumer's specific itinerary across travel service provider (e.g., hotels and other accommodations, 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 more detailed 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 recently transitioned some of its offerings to meta-search functionality. TripAdvisor has begun supporting its new meta-search service with offline advertising, while trivago, a leading meta-search service in Europe, recently expanded its offline advertising campaign into the United States. Google launched "Hotel Finder", a meta-search service that Google has at times placed at or near the top of hotel-related search results.
As consumers attempt to be more efficient in their shopping behavior, they may favor travel services offered by meta-search sites 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. 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 sells room night reservations on its transactional sites Tingo and Jetsetter. To the extent consumers book travel services through a meta-search site or directly with a travel service provider after visiting a meta-search site or meta-search utility on a traditional search engine without using an OTA like us, or if meta-search services limit our participation within their search results, we may need to increase our advertising or other customer acquisition costs to maintain or grow our bookings, any of which could have an adverse effect on our business and results of operations.
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. KAYAK accesses some of its information from ITA Software, Inc., a major flight information software company that was acquired by Google. To the extent ITA, other OTAs or travel service providers no longer provide such information to KAYAK, whether due to its affiliation with us or otherwise, KAYAK's business and results of operations could be harmed and the value of our investment in KAYAK could be adversely affected.
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 hotel bookings. 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, hotel reservations made on a mobile device typically are for shorter lengths of stay and are not made as far in advance. We have made significant progress creating mobile offerings, which have received strong reviews, solid download trends, and 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 and differentiated mobile offerings, and efficiently and effectively advertise and distribute on these platforms, we could lose market share to existing competitors or new entrants.
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 most recent 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 hotels can offer hotel room reservations. For example, some hotels offer room reservations through “daily deal” websites such as Groupon and Living Social, which sell coupons to customers at a substantial discount. In 2011, Expedia, one of our largest competitors, entered into a partnership with Groupon to sell hotel room reservations to Groupon customers under the “Groupon Getaways” brand name. New entrants, such as BackBid, GuestMob, Tingo, Hipmunk and Room 77, have developed new and differentiated offerings that endeavor to provide savings on hotel rooms to consumers and that compete directly with us. If any of these new services are successful, we may experience less demand for our services and are likely to face more competition for access to the limited supply of discounted hotel room rates.
We use third party websites, including online search engines and meta-search services, and affiliate marketing as primary means of generating traffic to our websites. As a result, our online advertising expense has increased significantly in recent years, a trend we expect to continue. In addition, our online advertising has grown faster than our gross profit due to (1) lower returns on investment ("ROIs") from our online advertising, (2) brand mix within The Priceline Group and (3) channel mix within certain of our brands. Our online advertising ROIs have recently been down year-over-year. Furthermore, our international brands are growing faster than our priceline.com U.S. brand, and spend a higher percentage of gross profit on online advertising. Finally, certain of our brands are obtaining an increasing share of traffic through paid online advertising channels.
Advertising efficiency is impacted by a number of factors that are subject to variability and that are 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.
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 hotel reservation service brands, Booking.com and Agoda.com. Booking.com, our most significant brand, includes over 330,000 hotels and accommodations on its website as of August 2, 2013 (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 hotel and accommodation reservation service provider in the world as measured by room nights booked.
As our international business represents the substantial majority of our 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 properties to our websites. Many of the newer properties we add, especially in highly penetrated markets, may have fewer rooms, lower ADRs or higher credit risk, and may appeal to a smaller subset of customers (for example, hostels and bed and breakfasts), and therefore may also negatively impact our margins over time.
Another impact of the size of our international business is our exposure to foreign currency exchange risk. Because we are conducting a substantial majority of our business outside the United States and are reporting our results in U.S. Dollars, we face exposure to adverse movements in currency exchange rates as the financial results of our international 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. Greece, Ireland, Portugal and certain other European Union countries with high levels of sovereign debt have had difficulty refinancing their debt. Concern around devaluation or abandonment of the Euro common currency, or that sovereign default risk may be more widespread and could include the United States, has led to significant volatility in the exchange rate between the Euro, the U.S. Dollar and other currencies. We generally enter into derivative instruments to minimize the impact of short-term currency fluctuations on our consolidated operating results. However, such derivative instruments are short term in nature and not designed to hedge against currency fluctuation that could impact our foreign currency denominated gross bookings, revenue or gross profit (see Note 5 to the Unaudited Consolidated Financial Statements for additional information on our derivative contracts). For example, while revenue from our international operations grew year-over-year on a local currency basis by approximately 39% and 42% for the three and six months ended June 30, 2013, respectively, compared to the same periods in 2012, as a result of the positive impact of currency exchange rates, revenue from our international operations as reported in U.S. Dollars grew 40% and 42% for the three and six months ended June 30, 2013, respectively.
price-disclosed hotel reservation service. While Express Deals has been a significant contributor to the recently 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 annualized 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. In addition, certain airlines have attempted to charge additional fees to customers who book airline reservations through an online channel other than their own website. Travel service providers who sell on their own websites typically do not charge a processing fee, and, in some instances, offer advantages such as web-only fares, bonus miles or loyalty points, which could make their offerings more attractive to consumers than models like ours.
U.S. airlines have reduced capacity and increased fares since the latter part of 2009, a trend which may continue. Decreases in capacity reduce the amount of airline tickets available, while significant increases in average airfares have adversely impacted leisure travel demand. Reduced airline capacity and demand negatively impact our priceline.com air ticket reservation business, which in turn has negative repercussions on our priceline.com hotel and rental car businesses. Our Name Your Own Price® rental car business was negatively impacted in 2012 by an increase in the utilization of rental car fleets, resulting in less opaque rental car availability. Although availability improved for us in the first half of 2013, we expect continued variability in the breadth and depth of discounted airline tickets and rental car rates made available to us in the future, depending on market conditions from time to time.
Seasonality. A meaningful amount of retail gross bookings are generated early in the year, as customers plan and reserve their spring and summer vacations in Europe and North America. We expense the substantial majority of our advertising activities as they are incurred, which is typically in the quarter in which bookings are generated. 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 booking and travel consumption for the year for our North American and European businesses. However, we experience the highest levels of booking and travel consumption for our Asia-Pacific and South American businesses in the first and fourth quarters. Therefore, if these businesses continue to grow faster than our North American and European businesses, our operating results for the first and fourth quarters of the year may become more significant over time as a percentage of full year operating results. In addition, our Name Your Own Price® services are generally non-refundable in nature, and accordingly, we recognize travel revenue at the time a booking is generated. However, we recognize revenue generated from our retail hotel services at the time that the customer checks out of the hotel. Therefore, if our retail hotel business continues to grow faster than our Name Our Own Price® services, we expect our quarterly results to become increasingly impacted by these seasonal factors. In addition, the date on which Easter falls can have an impact on our first and second quarters. For example, in 2013 our first quarter growth rates in revenue, gross profit, operating income, and operating margins were favorably affected by Easter falling in the first quarter as compared to the same period in 2012. Conversely, those growth rates were negatively impacted in our second quarter 2013 as compared to the same period in 2012. 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 booked in previous quarters.
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 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, in early 2010, Thailand experienced disruptive civil unrest, which caused the temporary relocation of Agoda.com's Thailand-based operations. Future natural disasters or civil or political unrest could further disrupt our business and operations.
We intend to continue to invest in marketing and promotion, technology and personnel within parameters consistent with attempts to improve long-term operating results, 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, in a stock and cash transaction. The purchase value was approximately $2.1 billion ($1.9 billion net of cash acquired). We paid $0.5 billion in cash, from cash on hand in the United States, and $1.6 billion in shares of our common stock and assumed stock options. See Note 2 and Note 14 to the Unaudited Financial Statements for further information on the acquisition.
Our financial results are driven by certain operating metrics that encompass the booking activity generated by our travel services. Specifically, reservations of hotel room nights, rental car days and airline tickets capture the volume of units purchased by our customers. Gross bookings is an operating and statistical metric that captures the total dollar value, generally inclusive of taxes and fees, of all travel services booked by our customers and is widely used in the travel business. International gross bookings reflect gross bookings generated principally by 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 increased by 38.0% and 37.2% for the three and six months ended June 30, 2013, respectively, compared to the same periods in 2012 (growth on a local currency basis was approximately 38% and 37% for the three and six month periods, respectively), principally due to a 38.2% and 37.9% growth in hotel room night reservations and a 46.3% and 45.0% growth in rental car day reservations, respectively. The 44.1% and 43.5% increase in international gross bookings for the three and six months ended June 30, 2013, respectively, compared to the same periods in 2012 (growth on a local currency basis was approximately 44% for the three and six month periods) was primarily attributable to growth in hotel 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 11.7% and 10.2% for the three and six months ended June 30, 2013, respectively, compared to the same periods in 2012, primarily due to an increase in room-night reservations for priceline.com's retail price-disclosed and semi-opaque Express Deals services as well as higher average prices for airline tickets, hotel room nights, and rental car days, partially offset by a decline in our Name Your Own Price® opaque hotel business.

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