10-Q 1 form10q.txt 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------- FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to __________ Commission File Number 0-25581 PRICELINE.COM INCORPORATED -------------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) Delaware 06-152849 --------------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 800 Connecticut Avenue Norwalk, Connecticut 06854 -------------------------------------------------------------------------------- (address of principal executive offices) (203) 299-8000 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) N/A -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed, since last report) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES _X_ NO ___ Number of shares of Common Stock outstanding at August 10, 2001: Common Stock, par value $0.008 per share 220,312,862 -------------------------------------------------- --------------------------- (Class) (Number of Shares) priceline.com Incorporated Form 10-Q For the Quarter Ended June 30, 2001 PART I - UNAUDITED FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS Consolidated Balance Sheets at June 30, 2001 and December 31, 2000 ............. 3 Consolidated Statements of Operations For the Three and Six Months Ended June 30, 2001 and 2000 ............................................ 4 Consolidated Statement of Changes in Stockholders' Equity For the Six Months Ended June 30, 2001 ..................................................... 5 Consolidated Statements of Cash Flows For the Six Months Ended June 30, 2001 and 2000 ............................................................... 6 Notes to Unaudited Consolidated Financial Statements ........................... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ..................................................... 13 Item 3. Quantitative and Qualitative Disclosures About Market Risk ............. 30 PART II - OTHER INFORMATION Item 1. Legal Proceedings ...................................................... 30 Item 4. Submission of Matters to a Vote of Security Holders..................... 30 Item 6. Exhibits and Reports on Form 8-K ....................................... 30 SIGNATURES ..................................................................... 32
2 PART I - UNAUDITED FINANCIAL INFORMATION Item 1. Consolidated Financial Statements priceline.com Incorporated CONSOLIDATED BALANCE SHEETS (In thousands)
JUNE 30, DECEMBER 31, 2001 2000 ---------- ------------ ASSETS (unaudited) Current assets: Cash and cash equivalents ........................................................ $ 124,284 $ 77,024 Restricted cash .................................................................. 11,015 13,568 Short-term investments ........................................................... 30,433 10,952 Accounts receivable, net of allowance for doubtful accounts of $2,108 and $2,372 . 25,839 13,889 Note receivable .................................................................. 8,500 -- Prepaid expenses and other current assets ........................................ 10,908 15,790 ----------- ----------- Total current assets .......................................................... 210,979 131,223 Property and equipment, net ........................................................... 34,870 37,083 Related party receivable .............................................................. 41 3,503 Warrants to purchase common stock of licensee ......................................... 3,250 3,250 Other assets .......................................................................... 19,521 20,019 ----------- ----------- Total assets .................................................................. $ 268,661 $ 195,078 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ................................................................. $ 69,531 $ 40,691 Accrued expenses ................................................................. 32,210 33,172 Other current liabilities ........................................................ 5,161 5,434 ----------- ----------- Total current liabilities ..................................................... 106,902 79,297 ----------- ----------- Accrued expenses ...................................................................... 3,789 5,108 ----------- ----------- Total liabilities ............................................................. 110,691 84,405 ----------- ----------- MANDATORILY REDEEMABLE CONVERTIBLE SERIES A PREFERRED STOCK ........................... -- 359,580 MANDATORILY REDEEMABLE SERIES B PREFERRED STOCK ....................................... 55,032 -- Stockholders' equity (deficiency): Common stock, $0.008 par value, authorized 1,000,000,000 shares; issued 214,946,458 and 181,798,204 shares, respectively ......................................... 1,720 1,454 Treasury stock, 5,450,236 shares .................................................. (326,633) (326,633) Additional paid-in capital ........................................................ 1,971,588 1,618,956 Deferred compensation ............................................................. (4,304) (13,053) Accumulated other comprehensive loss .............................................. -- (1,156) Accumulated deficit ............................................................... (1,539,433) (1,528,475) ----------- ----------- Total stockholders' equity (deficiency).......................................... 102,938 (248,907) ----------- ----------- Total liabilities and stockholders' equity............................................. $ 268,661 $ 195,078 =========== ===========
See notes to consolidated financial statements. 3 priceline.com Incorporated CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, 2001 2000 2001 2000 -------- --------- --------- --------- Travel revenues .............................. $362,492 $ 346,822 $ 629,512 $ 658,429 Other revenues 2,264 5,273 4,948 7,464 -------- --------- --------- --------- Total revenues ........................... 364,756 352,095 634,460 665,893 Cost of travel revenues ...................... 303,979 296,386 529,475 561,056 Cost of other revenues ....................... 671 533 1,764 634 Supplier warrant costs ....................... -- 381 -- 762 -------- --------- --------- --------- Total costs of revenues .............. 304,650 297,300 531,239 562,452 Gross profit ................................. 60,106 54,795 103,221 103,441 -------- --------- --------- --------- Operating expenses: Sales and marketing....................... 32,818 37,617 63,441 78,066 General and administrative ............... 7,477 15,222 16,881 27,926 Payroll tax expense on employee stock options .............................. 367 2,507 390 8,414 Stock based compensation ................. 3,140 -- 8,297 -- Systems and business development ......... 9,892 6,695 21,004 12,563 Restructuring charge ..................... -- -- 1,400 -- Severance charge ......................... 5,412 -- 5,412 -- -------- --------- --------- --------- Total operating expenses ............. 59,106 62,041 116,825 126,969 Operating income (loss) ...................... 1,000 (7,246) (13,604) (23,528) Other income: Loss on sale of equity investment ........ -- -- (946) -- Interest income .......................... 1,816 2,725 3,592 5,440 -------- --------- --------- --------- Total other income 1,816 2,725 2,646 5,440 Net income (loss) ............................ 2,816 (4,521) (10,958) (18,088) Preferred stock dividend ..................... -- (7,191) -- (7,191) -------- --------- --------- --------- Net income (loss) applicable to common stockholders ............................. $ 2,816 $ (11,712) $ (10,958) $ (25,279) ======== ========= ========= ========= Net income (loss) applicable to common stockholders per basic common share ...... $ 0.01 $ (0.07) $ (0.06) $ (0.15) ======== ========= ========= ========= Weighted average number of basic common shares outstanding ........................... 196,581 165,399 188,890 166,051 ======== ========= ========= ========= Net income (loss) applicable to common stockholders per diluted common share .... $ 0.01 $ (0.07) $ (0.06) $ (0.15) ======== ========= ========= ========= Weighted average number of diluted common shares outstanding ........................... 220,021 165,399 188,890 166,051 ======== ========= ========= =========
See notes to consolidated financial statements. 4 priceline.com Incorporated CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY AS OF JUNE 30, 2001 (UNAUDITED) (IN THOUSANDS)
ACCUMULATED COMMON STOCK ADDITIONAL OTHER ------------------ PAID-IN ACCUMULATED COMPREHENSIVE SHARES AMOUNT CAPITAL DEFICIT INCOME ------- ------- ----------- ----------- ------------- Balance, January 1, 2001 ............ 181,798 $ 1,454 $ 1,618,956 $(1,528,475) $(1,156) Net loss applicable to common stockholders ........................ -- -- -- (10,958) -- Sale of equity investments .......... -- -- -- -- 1,156 Exchange of preferred stock ......... -- -- 279,530 -- -- Issuance of common stock under deferred compensation plans ......... 170 1 525 -- -- Cancellation of common stock under deferred compensation plans ............................... (500) (4) (762) -- -- Amortization of deferred compensation -- -- -- -- -- Share withholding ................... (782) (6) (4,431) -- -- Sale of common stock ................ 23,809 191 49,318 -- -- Exercise of stock options and Warrants ............................ 10,451 84 28,452 -- -- Balance, June 30, 2001 .............. 214,946 $ 1,720 $ 1,971,588 $(1,539,433) $ -- ======== ======= =========== =========== ======= TREASURY STOCK ------------------- DEFERRED SHARES AMOUNT COMPENSATION TOTAL ------ --------- ------------ --------- Balance, January 1, 2001 ......... (5,450) $(326,633) $(13,053) $(248,907) Net loss applicable to common stockholders ..................... -- -- -- (10,958) Sale of equity investments ....... -- -- -- 1,156 Exchange of preferred stock ...... -- -- -- 279,530 Issuance of common stock under deferred compensation plans ...... -- -- (526) -- Cancellation of common stock under deferred compensation plans ............................ -- -- 766 -- Amortization of deferred compensation ..................... -- -- 8,509 8,509 Shares reacquired for withholding taxes........................... -- -- -- (4,437) Sale of common stock ............. -- -- -- 49,509 Exercise of stock options and warrants ......................... -- -- -- 28,536 ------ --------- -------- --------- Balance, June 30, 2001 ........... (5,450) $(326,633) $ (4,304) $ 102,938 ====== ========= ======== =========
See notes to consolidated financial statements. 5 priceline.com Incorporated CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
SIX MONTHS ENDED JUNE 30, 2001 2000 --------- --------- OPERATING ACTIVITIES: Net loss ........................................................... $ (10,958) $ (18,088) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization ................................ 8,146 6,249 Provision for uncollectible accounts ......................... 6,542 1,800 Warrant costs ................................................ -- 762 Net loss on sale of equity investments ....................... 946 -- Acceleration of stock options ................................ 61 -- Non-cash severance ........................................... 3,076 -- Amortization of deferred compensation ........................ 8,509 -- Changes in assets and liabilities: Accounts receivable .......................................... (18,126) (29,718) Prepaid expenses and other current assets .................... (368) (9,945) Accounts payable and accrued expenses ........................ 26,286 51,293 Issuance of short-term note receivable ....................... (3,250) -- Other ........................................................ 366 1,652 --------- --------- Net cash provided by operating activities .......................... 21,230 4,005 --------- --------- INVESTING ACTIVITIES: Additions to property and equipment .......................... (5,800) (19,843) Purchase of convertible notes and warrants of licensees ...... -- (24,706) Proceeds from sales of investments ........................... 770 (4,502) Funding of restricted cash and bank certificate of deposits .. 2,553 230 Purchase of marketable securities ............................ (20,042) (5,000) --------- --------- Net cash used in investing activities .............................. (22,519) (53,821) --------- --------- FINANCING ACTIVITIES: Payment of capital lease obligations ......................... -- (14) Shares reacquired for withholding taxes....................... (4,431) -- Proceeds from sale of common stock/purchase of warrants, net . 49,459 -- Proceeds from exercise of stock options ...................... 3,521 12,322 --------- --------- Net cash provided by financing activities .......................... 48,549 12,308 --------- --------- Net increase (decrease) in cash and cash equivalents ............... 47,260 (37,508) Cash and cash equivalents, beginning of period ..................... 77,024 124,383 --------- --------- Cash and cash equivalents, end of period ........................... $ 124,284 $ 86,875 ========= ========= SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid during the period for interest ..................... $ 0 $ 1 ========= =========
See notes to consolidated financial statements. 6 priceline.com Incorporated Notes to Unaudited Consolidated Financial Statements 1. BASIS OF PRESENTATION The Company is responsible for the unaudited financial statements included in this document. The financial statements have been prepared in accordance with generally accepted accounting principles ("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 condensed 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. As these are condensed financials, one should also read the financial statements in the Company's December 31, 2000, Form 10-K. 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. Certain amounts in prior years' financial statements have been reclassified to conform to the current year presentation. 2. NET LOSS PER SHARE The Company computes basic and diluted earnings per share in accordance with Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per Share". SFAS 128 requires the Company to report both basic earnings per share, which is based on the weighted average number of common shares outstanding, and diluted earnings per share, which is based on the weighted average number of common shares outstanding and all dilutive potential common shares outstanding. 3. RECENT ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations." SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. The Company does not believe that the adoption of SFAS 141 will have a significant impact on its financial statements. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets," which is effective January 1, 2002. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS 142 also requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. The Company is currently assessing but has not yet determined the impact of SFAS 142 on its financial position and results of operations. 4. RESTRUCTURING, SPECIAL AND SEVERANCE CHARGES In the first quarter of 2001, the Company recorded a restructuring charge of approximately $1.4 million. This restructuring charge related primarily to the Company's reduction of its workforce in February 2001. The charge relates primarily to severance payments and the Company believes that the entire amount of the charge will be disbursed during 2001. During the year ended December 31, 2000, the Company recorded restructuring charges of approximately $32.0 million and a special charge of approximately $34.8 million. The following are the changes in the related liability (included in accounts payable and long-term accrued expenses) during the first half of 2001 (in thousands): 7
RESTRUCTURING SPECIAL SEVERANCE TOTAL ------------- -------- --------- ------- Accrued at December 31, 2000 ..... $ 13,470 $ 11,093 -- $24,563 2001 restructuring charge ........ 1,400 -- -- 1,400 2001 severance charge ............ -- -- 5,412 5,412 Disbursed during 2001 ............ (6,315) (6,762) -- (13,077) Acceleration of vesting and loan forgiveness (non-cash) .. -- -- (4,325) (4,325) Accrued at June 30, 2001 ......... $ 8,555 $ 4,331 $ 1,087 $13,973 -------- -------- -------- ------- At June 30, 2001: Current Portion ............... $ 4,766 $ 4,331 $ 1,087 $10,184 Long-term portion ............. 3,789 -- -- 3,789
On May 7, 2001, the Company's Board of Directors announced that Richard S. Braddock had been reappointed as Chief Executive Officer. Mr. Braddock replaced Daniel H. Schulman, the Company's prior President and Chief Executive Officer. In connection with Mr. Schulman's separation from the Company, the Company recorded a severance charge of $5.4 million in the second quarter 2001, primarily as the result of the forgiveness of outstanding loans to Mr. Schulman and the payment of severance, all of which was required by the terms of Mr. Schulman's employment agreement. The Company also accelerated, pursuant to the terms of Mr. Schulman's employment agreement, the vesting of 2,000,000 shares of restricted common stock and 1,000,000 shares underlying stock options granted to Mr. Schulman. 5. OTHER ASSETS AND WARRANTS TO PURCHASE COMMON STOCK OF LICENSEE Other assets consists of the following as of June 30, 2001 (in thousands): Convertible loans and other advances - priceline Asia $11,110 Convertible loans and other advances - Alliance Partner Capital/My Price 6,456 Other 1,955 ------- Total $19,521 =======
"Convertible loans and other advances-priceline Asia" represents a convertible note and receivables for reimbursable expenses from a licensee. "Convertible loans and other advances-Alliance Partner Capital/MyPrice" represents convertible notes, receivables for reimburseable expenses incurred by the Company and billed to Alliance and the estimated net realizable value of the amounts due to the Company from its Australian licensee. At June 30, 2001, the warrants to purchase shares of priceline.com Europe Ltd. are carried at cost, $3.2 million, which the Company believes approximates the fair value. The Company purchased these warrants for cash in 2000. The underlying shares are not publicly traded. On June 28, 2001 and August 10, 2001, priceline.com europe Ltd issued to the Company an $8.5 million promissory note and a $1.5 million promissory note, respectively, in exchange for an aggregate of $10.0 million. 6. STOCKHOLDERS' EQUITY During the first quarter 2001, the Company sold approximately 23.8 million shares of its Common Stock to Hutchison Whampoa Limited and Cheung Kong (Holdings) Limited in a private placement. The net proceeds were 8 approximately $49.5 million. Hutchison Whampoa Limited also received a seat on the Company's Board of Directors. At the same time, Hutchison purchased $9.5 million worth of Hutchison-Priceline Limited convertible notes. In connection with the sale, Hutchison received the right, for a period of six months, to negotiate with the Company for the establishment of a potential business in Japan. In June 2000, the Company entered into definitive agreements with subsidiaries of Hutchison Whampoa Limited to introduce the Company's services to several Asian markets. Under the terms of the agreements, the Company licenses its business model and provides expertise in technology, marketing and operations. During the first quarter 2001, the Company issued 120,000 shares of restricted stock to employees. The accrual for the shares issued was recorded at the market value on the date of grant ($2.2187) and the related compensation expense will be amortized over the vesting period. During the second quarter 2001, the Company issued 50,000 shares of restricted stock to employees. The accrual for the shares issued was recorded at the market value on the date of grant ($5.19) and the related compensation expense will be amortized over the vesting period. During the second quarter 2001, the Company repurchased shares of common stock, at fair market value upon employee option exercise or share vesting, to meet such employees' minimum tax statutory withholding. 7. DELTA AIR LINES During the first quarter 2001, Delta Air Lines, Inc. ("Delta") and the Company agreed to restructure Delta's investment in the Company. Delta exchanged 6,000,000 shares of Series A Convertible Redeemable PIK Preferred Stock for 80,000 shares of a newly created Series B Redeemable Preferred Stock ("Series B Preferred Stock") and a warrant to purchase approximately 27 million shares of the Company's common stock at an exercise price of $2.96875 per share. Pursuant to the terms of the certificate of designations relating to the Series B Preferred Stock, the Series B Preferred Stock bears a dividend that is payable through the issuance of approximately 3.0 million shares of the Company's common stock each year, subject to adjustment, as defined. The Series B Preferred Stock has a liquidation preference of $1,000 per share, is subject to mandatory redemption on February 6, 2007 or is subject to redemption at the option of Delta or the Company prior to February 6, 2007 in the event the Company consummates any of certain business combination transactions. In the event that any of the business combination transactions occurs before November 16, 2002, Delta would be entitled to a premium payment of $625 per share. The warrant provides that at any time the closing sales price of the Company's common stock has exceeded $8.90625 (subject to adjustment) for 20 consecutive trading days, the warrant will automatically be exercised. During the second quarter 2001, as the result of the exercise of approximately 8.4 million warrants, the liquidation preference of the Series B preferred stock was reduced from $80 million to approximately $55 million. On July 27, 2001, Delta exercised warrants to purchase 10 million shares of the Company's common stock. As a result, the liquidation preference of the Company's outstanding Series B Redeemable Preferred Stock has been reduced to approximately $25 million. In accordance with the terms of the Series B Preferred Stock, the Company delivered 986,491 shares of the Company's common stock to Delta on August 6, 2001 as a dividend payment and, as a result, the Company will record a non-cash dividend of $8.6 million in the third quarter of 2001. As a result of Delta's warrant exercises, the Company's future semi-annual dividend has been reduced to 454,323 shares of common stock. 8. COMMITMENTS AND CONTINGENCIES On January 6, 1999, the Company received notice that a third party patent applicant and patent attorney, Thomas G. Woolston, purportedly had filed in December 1998 with the United States Patent and Trademark Office a 9 request to declare an interference between a patent application filed by Woolston and our U.S. Patent 5,794,207. The Company is currently awaiting information from the Patent Office regarding whether it will initiate an interference proceeding. On January 19, 1999, Marketel International Inc. ("Marketel"), a California corporation, filed a lawsuit against priceline.com, among others. On February 22, 1999, Marketel filed an amended and supplemental complaint. On March 15, 1999, Marketel filed a second amended complaint. On May 9, 2000, Marketel filed a third amended complaint against priceline.com and Priceline Travel, Inc. The third amended complaint alleged causes of action for misappropriation of trade secrets, conversion, false advertising and for correction of inventorship of U.S. Patent 5,794,207. In its third amended complaint, Marketel alleged, among other things, that the defendants conspired to misappropriate Marketel's business model, which allegedly was provided in confidence approximately ten years ago. The third amended complaint also alleged that four former Marketel employees are the actual sole inventors or co-inventors of U.S. Patent 5,794,207, which was issued on August 11, 1998 and had been assigned to priceline.com. Marketel asked that the patent's inventorship be corrected accordingly. On February 5, February 10 and March 31, 1999, the Company filed answers respectively, to the complaint, amended complaint and second amended complaint, in which priceline.com denied the material allegations of liability. On May 19, 2000, the Company filed a motion to dismiss the third amended complaint for failure to state a complaint upon which relief can be granted. The Company strongly disputed the material legal and factual allegations contained in Marketel's third amended complaint and believe that the amended complaint is without merit. In addition, on July 13, 2000, the Company filed a motion for summary judgment alleging that Marketel had not identified legally protectable trade secrets and is not entitled to correction of inventorship of U.S. Patent 5,794,207. On December 5, 2000, the United States District Court for the Northern District of California granted priceline.com's motion for summary judgment with respect to Marketel's theft of trade secret and patent inventorship claims, and ruled that there were triable issues of fact as to Marketel's false advertising claims, although Judge Legge volunteered that it was unlikely that Marketel could establish damages and suggested that these claims should be voluntarily dismissed. The false advertising claims were subsequently dismissed by stipulation, and on February 1, 2001, Judge Legge clarified his inventorship ruling in favor of priceline.com and entered final judgment in favor of priceline.com. On March 13, 2001, Marketel filed a Notice of Appeal to the United States Court of Appeals for the Federal Circuit. The Company intends to continue defending vigorously against the action. Pursuant to the indemnification obligations contained in the Purchase and Intercompany Services Agreement with Walker Digital, Walker Digital has agreed to indemnify, defend and hold priceline.com harmless for damages, liabilities and legal expenses incurred in connection with the Marketel litigation. However, Walker Digital currently is experiencing financial difficulties and is not honoring its indemnification obligation. We are paying for the defense of this action and recognizing the expense, subject to a reservation of all rights to recover these amounts from Walker Digital. Subsequent to the Company's announcement on September 27, 2000 that revenues for the third quarter 2000 would not meet expectations, the Company was served with the following putative class action complaints: o Weingarten v. priceline.com Incorporated and Jay S. Walker 300 CV 1901 (District of Connecticut). o Twardy v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 1884 (District of Connecticut). o Berdakina v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 1902 (District of Connecticut). o Mazzo v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 1924 (District of Connecticut). 10 o Fialkov v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 1954 (District of Connecticut). o Licht v. priceline.com Incorporated and Jay S. Walker 300 CV 2049 (District of Connecticut). o Ayach v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 2062 (District of Connecticut). o Zia v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 1968 (District of Connecticut). o Mazzo v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 1980 (District of Connecticut). o Bazag v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 2122 (District of Connecticut). o Breier v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 2146 (District of Connecticut). o Farzam et al. v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 2176 (District of Connecticut). o Caswell v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 2169 (District of Connecticut). o Howard Gunty Profit Sharing Plan v. priceline.com Inc. Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 1917 (District of Connecticut). o Cerelli v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 1918 (District of Connecticut) o Mayer v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 1923 (District of Connecticut) o Anish v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 1948 (District of Connecticut) o Atkin v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 1994 (District of Connecticut). o Lyon v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 2066 (District of Connecticut). o Kwan v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 2069 (District of Connecticut). o Krim v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 2083 (District of Connecticut). o Karas v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 2232 (District of Connecticut). 11 o Michols v. priceline.com Inc., Richard S. Braddock, Daniel H. Schulman and Jay S. Walker 300 CV 2280 (District of Connecticut). All of these cases have been transferred to Judge Dominick J. Squatrito, and two groups have filed motions requesting to be appointed as lead plaintiffs and lead counsel. By agreement of counsel, once the lead plaintiffs and lead counsel have been appointed, such lead plaintiffs and counsel shall have forty-five days to file an amended and consolidated complaint, and the Company will thereafter have forty-five days to respond to the amended and consolidated complaint. The Company intends to defend vigorously against these actions. In addition, the Company has been served with a complaint that purports to be a shareholder derivative action against the Company's Board of Directors and certain of its current executive officers, as well as priceline.com (as a nominal defendant). The complaint alleges breach of fiduciary duty. The action is captioned Mark Zimmerman v. Richard Braddock, J. Walker, D. Schulman, P. Allaire, R. Bahna, P. Blackney, W. Ford, M. Loeb, N. Nicholas, N. Peretsman, and priceline.com Incorporated 18473-NC (Court of Chancery of Delaware, County of New Castle, State of Delaware). On February 6, 2001, all defendants moved to dismiss the complaint for failure to make a demand upon the Board of Directors and failure to state a cause of action upon which relief can be granted. Pursuant to a stipulation by the parties, an amended complaint was filed on June 21, 2001. Defendants may renew their motion to dismiss or answer the complaint by August 20, 2001. The Company intends to defend vigorously against this action. On March 16, March 26, April 27, and June 5, 2001, respectively, four putative class action complaints were filed in the U.S. District Court for the Southern District of New York naming priceline.com, Inc., Richard S. Braddock, Jay Walker, Paul Francis, Morgan Stanley Dean Witter & Co., Merrill Lynch, Pierce, Fenner & Smith, Inc., BancBoston Robertson Stephens, Inc. and Salomon Smith Barney, Inc. as defendants (01 Civ. 2262, 01 Civ. 2576, 01 Civ. 3590 and 01 Civ. 4956). SHIVES ET AL. V. BANK OF AMERICA SECURITIES LLC ET AL., 01 Civ. 4956, also names other defendants and states claims unrelated to the Company. The complaints allege, among other things, that priceline.com and the individual defendants named in the complaints violated the federal securities laws by issuing and selling priceline.com common stock in priceline.com's March 1999 initial public offering without disclosing to investors that some of the underwriters in the offering, including the lead underwriters, had allegedly solicited and received excessive and undisclosed commissions from certain investors. The Company intends to defend vigorously against these actions. The Company has been informed that a sub-committee of the board of directors of Myprice pty. Ltd. has been formed to evaluate whether a lawsuit should be instituted against priceline.com in connection with its investment in Myprice. If necessary, the Company will defend against any such suit vigorously. From time to time, the Company has been and expects to continue to be subject to legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of third party intellectual property rights by it. Such claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources and could adversely effect priceline.com's results of operations and business. 9. SUBSEQUENT EVENTS On June 5, 2001, Cheung Kong (Holdings) Limited and Hutchison Whampoa Limited announced that they had entered into an agreement to increase their stake in the Company by purchasing an aggregate of 25,028,023 shares of the Company's common stock from the Company's founder Jay S. Walker and his trust. The purchase closed on July 6, 2001. As a result of their purchase, Cheung Kong and Hutchison owned approximately 28% of the Company's outstanding common stock as of August 10, 2001. In connection with the transaction, Cheung Kong and Hutchison received a total of two additional seats on the Company's Board of Directors, bringing their total representation on the Company's Board of Directors to three members. On August 11, 2001, pursuant to the terms of a registration rights agreement and stockholders agreement between certain affiliates of Cheung Kong and Hutchison (the "Hutchison Entities") and the Company, the Hutchison Entities requested that the Company file and maintain the effectiveness of a shelf registration statement with respect to all of the shares of the Company's Common stock held by the Hutchison Entities. In connection with the notice to the Company, Cheung Kong and Hutchison noted that the request to file the shelf registration was consistent with their standard corporate policy and required of all their investments in order to maintain maximum flexibility. In addition, Cheung Kong and Hutchison noted that they had no present intention to sell their interest in the Company and fully supported the Company and its long-term plan. 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR FINANCIAL STATEMENTS, INCLUDING THE NOTES TO THOSE STATEMENTS, INCLUDED ELSEWHERE IN THIS FORM 10-Q, AND THE SECTION ENTITLED "SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS" IN THIS FORM 10-Q. AS DISCUSSED IN MORE DETAIL IN THE SECTION ENTITLED "SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS," THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS WHICH INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE THOSE DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN "FACTORS THAT MAY AFFECT FUTURE RESULTS." OVERVIEW We have pioneered a unique e-commerce pricing system known as a "demand collection system" that enables consumers to use the Internet to save money on a wide range of products and services while enabling sellers to generate incremental revenue. Using a simple and compelling consumer proposition - Name Your Own PriceSM - we collect consumer demand, in the form of individual customer offers, for a particular product or service at a price set by the customer. We then communicate that demand directly to participating sellers or access a proprietary database of inventory available to us for purchase and, based upon the customer's offer price, elect whether or not to accept that customer's offer. Consumers agree to hold their offers open for a specified period of time and, once fulfilled, offers generally cannot be canceled. We benefit consumers by enabling them to save money, while at the same time benefiting sellers by providing them with an effective revenue management tool capable of identifying and capturing incremental revenues. By requiring consumers to be flexible with respect to brands, sellers and product features, we enable sellers to generate incremental revenue without disrupting their existing distribution channels or retail pricing structures. Our business model and brand are currently, through us or independent licensees, supporting several products and service offerings, including the following: o leisure airline tickets, provided by 10 domestic and 24 international airline participants, and travel insurance; o hotel rooms, in substantially all major United States markets with more than 50 national hotel chains as participants; o rental cars, in substantially all major United States airport markets with five leading rental car chains as participants; o new automobiles, in substantially all major United States markets; o home financing services, in substantially all major United States markets, which includes home mortgage services, home equity loans and refinancing services; and o long distance telephone calling, provided by two carriers, in substantially all United States markets. In certain instances, we have licensed the priceline.com name and demand collection system to third parties to offer a particular product or service (HOME FINANCING) or to offer a number of products or services in a distinct international region (EUROPE AND ASIA). Pursuant to these licensee transactions, we generally receive a royalty under the license and may also receive fees for services and reimbursement of certain expenses. We also hold convertible securities or warrants entitling us to acquire a significant percentage of such licensee's equity securities upon the occurrence of certain events. 13 On May 7, 2001, our Board of Directors announced that Richard S. Braddock had been reappointed as Chief Executive Officer. Mr. Braddock replaced Daniel H. Schulman, our prior President and Chief Executive Officer. At that time, we also announced that Chief Operating Officer Jeffery H. Boyd was named President of priceline.com and that Mr. Schulman had resigned from our Board of Directors. In connection with Mr. Schulman's separation from the company, we recorded a severance charge of $5.4 million in the second quarter 2001, primarily as the result of the forgiveness of outstanding loans to Mr. Schulman and the payment of severance, all of which was required by the terms of Mr. Schulman's employment agreement. We also accelerated, pursuant to the terms of Mr. Schulman's employment agreement, the vesting of 2,000,000 shares of restricted common stock and 1,000,000 shares underlying stock options granted to Mr. Schulman. For the three-months ended June 30, 2001, we had net income of $2.8 million, marking our first profitable quarter. We believe that our success will depend in large part on our ability to sustain profitability, primarily from our travel business, and to continue to promote the priceline.com brand. We intend to continue to invest in marketing and promotion, technology and personnel within parameters consistent with attempts to improve operating results. Our goal is to sustain profitability. Our limited operating history makes the prediction of future results of operations difficult, and accordingly, we cannot assure you that we will sustain revenue growth or profitability. RECENT DEVELOPMENTS On June 5, 2001, Cheung Kong (Holdings) Limited and Hutchison Whampoa Limited announced that they had entered into an agreement to increase their stake in priceline.com by purchasing an aggregate of 25,028,023 shares of priceline.com common stock from priceline.com's founder Jay S. Walker and his trust. The purchase closed on July 6, 2001. As a result of their purchase, Cheung Kong and Hutchison own approximately 28% of priceline.com's outstanding common stock as of August 10, 2001. In connection with the transaction, Cheung Kong and Hutchison received a total of two additional seats on our Board of Directors, bringing their total representation on our Board of Directors to three members. On August 11, 2001, pursuant to the terms of a registration rights agreement and stockholders agreement between certain affiliates of Cheung Kong and Hutchison (the "Hutchison Entities") and us, the Hutchison Entities requested that we file and maintain the effectiveness of a shelf registration statement with respect to all of the shares of our Common Stock held by the Hutchison Entities. In connection with the notice, Cheung Kong and Hutchison noted that the request to file the shelf registration was consistent with their standard corporate policy and required of all their investments in order to maintain maximum flexibility. In addition, Cheung Kong and Hutchison noted that they had no present intention to sell their interest in us and fully supported priceline.com and its long-term plan. On July 27, 2001, Delta Air Lines, Inc. exercised warrants to purchase 10 million shares of the Company's common stock. As a result, the liquidation preference of the Company's outstanding Series B Redeemable Preferred Stock has been reduced to approximately $25 million. In accordance with the terms of the Series B Preferred Stock, the Company delivered 986,491 shares of the Company's common stock to Delta on August 6, 2001 as a dividend payment and, as a result, the Company will record a non-cash dividend of $8.6 million in the third quarter of 2001. As a result of Delta's warrant exercises, the Company's future semi-annual dividend has been reduced to 454,323 shares of common stock. On June 28, 2001 and August 10, 2001, priceline.com europe Ltd. issued and sold to us an $8.5 million promissory note and a $1.5 million promissory note, respectively, in exchange for an aggregate of $10.0 million. In addition, we have entered into a non-binding agreement in principle with General Atlantic Partners (Bermuda), L.P. pursuant to which we would, subject to the satisfaction of certain conditions, including negotiation and execution of definitive agreements, lend an additional $20.0 million to priceline.com europe (the "Loan"), $10.0 million of which would be used by priceline.com europe to repay the outstanding promissory notes. The Loan would accrue interest at a rate of 13.5% per annum, would mature on November 30, 2001 and would be subordinated to priceline.com europe's other liabilities. Priceline.com europe would use the proceeds from the Loan for general corporate purposes and to fund operations while it seeks permanent financing. The agreement in principle also contemplates that upon the occurrence of certain events, we would have, among other things, the right to receive, in exchange for the promissory note evidencing the Loan, a substantial equity stake in priceline Europe Holdings, N.V., which would effectively give us control of priceline.com europe. Please see "Factors that May Affect Future Results -- There are Risks Associated with our Investment in Priceline.com europe Ltd." RESULTS OF OPERATIONS Three and six months ended June 30, 2001 compared to three and six months ended June 30, 2000 REVENUES
THREE MONTHS ENDED % SIX MONTH ENDED % JUNE 30, CHANGE JUNE 30, CHANGE ------------------------- ------ ------------------------- ------ ($000) ($000) 2001 2000 2001 2000 -------- -------- -------- -------- TRAVEL REVENUES .................. $362,492 $346,822 4.5% $629,512 $658,429 (4.4)% OTHER REVENUES ................... 2,264 5,273 (57.1)% 4,948 7,464 (33.7)% -------- -------- -------- -------- TOTAL REVENUES ................... $364,756 $352,095 3.6% $634,460 $665,893 (4.7)%
14 TRAVEL REVENUES Travel revenues for the three and six months ended June 30, 2001 consisted primarily of: (1) transaction revenues representing the selling price of airline tickets, hotel rooms and rental cars; and (2) ancillary fees we earned in connection with the sale of our travel products, including Worldspan reservation booking fees and customer processing fees. In addition to the above, travel revenues for the three and six months ended June 30, 2000 include fee income from marketing programs offered in connection with the sale of airline tickets, hotel rooms and rental cars. During the three and six months ended June 30, 2001, we sold approximately 1.4 million, 680,600 and 922,500 and 2.5 million, 1.1 million and 1.5 million airline tickets, hotel room nights and rental car days, respectively. During the three and six months ended June 30, 2000, we sold approximately 1.3 million, 432,500 and 430,000 and 2.5 million, 842,000 and 660,000 airline tickets, hotel room nights and rental car days, respectively. We believe that the approximately 11.4% increase in the number of airline tickets sold in the second quarter of 2001 over the second quarter 2000 came despite stiff competition from aggressive discounting by airlines of retail prices and from travel companies offering specially-discounted Internet fares and opaque fares. We expect this discounting to continue to occur throughout the third quarter of 2001 and we can give no assurance that any such discounting will not adversely effect the number of airline tickets we sell in the third quarter of 2001. Our "bind rate" is the percentage of unique offers that we ultimately fulfill. Since April 1999, each initial offer and any resubmitted offers are treated as a single offer - a unique offer - for purposes of measuring our total offer volume and our offer fulfillment rates. Previously, each had been counted as a separate offer. Therefore, comparisons with prior periods may not be meaningful. Our "bind rate" for all unique airline ticket, hotel room and rental car offers were as follows:
UNIQUE OFFERS FOR ------------------------------------ AIRLINE HOTEL RENTAL TICKETS ROOMS CARS ------- ----- ------ THREE MONTHS ENDED JUNE 30, 2001 57.2% 60.2% 49.8% THREE MONTHS ENDED JUNE 30, 2000 49.6% 45.3% 40.0% SIX MONTHS ENDED JUNE 30, 2001 54.4% 57.5% 48.3% SIX MONTHS ENDED JUNE 30, 2000 46.7% 46.1% 40.5%
We believe that our overall bind rate for the three and six months ended June 30, 2001 increased compared to the same period a year ago primarily due to our access to better airline inventory as a result of a deterioration in the retail environment for the sale of airline tickets during 2001. Travel revenues for the three months ended June 30, 2001 increased approximately 4.5% to $362.5 million from approximately $346.8 million for the three months ended June 30, 2000. Travel revenues for the six months ended June 30, 2001 decreased approximately 4.4% to $629.5 million from $658.4 million for the six months ended June 30, 2000. We added approximately 1,025,000 and 1.9 million new unique customers (a unique customer is defined as someone who has made a guaranteed offer for at least one of our products) during the three and six months ended June 30, 2001 compared to approximately 1.5 million and 3.0 million new unique customers during the three and six months ended June 30, 2000. In addition, we generated approximately 1.6 million and 2.8 million repeat customer offers during the three and six months ended June 30, 2001 compared to approximately 964,000 and 1.8 million repeat customer offers during the three and six months ended June 30, 2000. We believe that the declines in travel revenues for the six month period ended June 30, 2001 compared to the same period in the previous year and the decline in the number of new unique customer offers in the three and six month periods ended June 30, 2001 compared to the same periods a year ago were primarily the result of the lingering effect of a decrease in the momentum of our business in the second half of 2000. The average revenue per total booked travel offer decreased approximately 5.2% to $252 in the second quarter 2001 from $266 in the first quarter 2001 primarily as a result of a change in our product mix. Specifically, revenues from our hotel and rental car businesses grew as a percentage of total travel revenue in the second quarter 2001 compared to the first quarter 2001. However, the average price of an airline ticket booked on priceline.com 15 remained essentially flat compared to the first quarter 2001 and decreased approximately 12% from the second quarter 2000 primarily as a result of a deterioration in the retail environment for the sale of airline tickets in the second quarter 2001. Seasonal variations in our travel business, where the third and fourth quarters are typically weaker than the first two quarters, have historically and are expected to continue to impact our travel revenues. Travel products, particularly airline tickets, continue to account for the majority of our revenue. OTHER REVENUES Other revenues during the three and six months ended June 30, 2001 consisted primarily of: (1) transaction revenues and fees from our long distance phone service and (2) commissions and fees from our home financing and automobile services, and license fees from our international licensees. Other revenues during the three and six months ended June 30, 2000 consisted primarily of commissions and fees from our home financing and automobile services and WebHouse Club licensee. Other revenues for the three and six months ended June 30, 2001 decreased approximately 57.1% and 33.7%, respectively, from the same periods a year ago, primarily as a result of the decrease in fees from our licensees and long distance phone service. COST OF REVENUES AND GROSS PROFIT
THREE MONTHS ENDED % SIX MONTHS ENDED % JUNE 30, CHANGE JUNE 30, CHANGE --------------------------- ------ ------------------------- -------- ($000) ($000) 2001 2000 2001 2000 ---------- ---------- ---------- -------- TOTAL COST OF TRAVEL REVENUES ............. $ 303,979 $ 296,767 2.4% $ 529,475 $561,818 (5.8)% % OF TRAVEL REVENUES ................. 83.9% 85.6% 84.1% 85.3% COST OF OTHER REVENUES .................... $ 671 $ 533 25.9% $ 1,764 $ 634 178.2% % OF OTHER REVENUES .................. 29.6% 10.1% 35.7% 8.5% ---------- ---------- ---------- -------- TOTAL COST OF REVENUES .................... $ 304,650 $ 297,300 2.5% $ 531,239 $562,452 (5.5)% % OF REVENUES ........................ 83.5% 84.4% 83.7% 84.5%
COST OF REVENUES COST OF TRAVEL REVENUES. Cost of travel revenues consist of product costs and, in 2000, supplier warrant costs. For the three and six months ended June 30, 2001 and 2000, product costs consisted of: (1) the cost of airline tickets from our suppliers, net of the federal air transportation tax, segment fees and passenger facility charges imposed in connection with the sale of airline tickets; (2) the cost of hotel rooms from our suppliers, net of hotel tax; and (3) the cost of rental cars from our suppliers, net of applicable taxes. COST OF OTHER REVENUES. For the three and six months ended June 30, 2001 and the three and six months ended June 30, 2000, cost of other revenues consisted primarily of the cost of long distance telephone service. 16 GROSS PROFIT
THREE MONTHS ENDED % SIX MONTHS ENDED % JUNE 30, CHANGE JUNE 30, CHANGE -------------------------- ------ -------------------------- ------ ($000) ($000) 2001 2000 2001 2000 --------- --------- ---------- -------- TRAVEL GROSS PROFIT ................... $ 58,513 $ 50,055 16.9% $ 100,037 $ 96,611 3.5% TRAVEL GROSS MARGIN .............. 16.1% 14.4% 15.9% 14.7% OTHER GROSS PROFIT .................... $ 1,593 $ 4,740 (66.4)% $ 3,184 $ 6,830 (53.4)% OTHER GROSS MARGIN ............... 70.4% 90.0% 64.3% 91.5% TOTAL GROSS PROFIT .................... $ 60,106 $ 54,795 9.7% $ 103,221 $103,441 (0.2)% TOTAL GROSS MARGIN ............... 16.5% 15.6% 16.3% 15.5%
TRAVEL GROSS PROFIT. Travel gross profit consists of travel revenues less the cost of travel revenues. For the three and six months ended June 30, 2001, travel gross profit and related travel gross margin increased over the same periods in 2000 primarily as a result of increased transactional sales volume and an increase in the average margins on air tickets, hotel rooms and rental cars. The fee portion of the travel transactions are an integral component in pricing acceptance decisions we make. We intend to continue to improve travel gross margin slightly in 2001, which may adversely affect our ability to promote top-line revenue growth. OPERATING EXPENSES SALES AND MARKETING
THREE MONTHS ENDED % SIX MONTHS ENDED % JUNE 30, CHANGE JUNE 30, CHANGE ----------------------- ------ ---------------------- -------- ($000) ($000) 2001 2000 2001 2000 ------- ------- ------- ------- ADVERTISING ............................. $13,701 $13,826 (0.9)% $29,890 $34,165 (13.5)% OTHER SALES & MARKETING ................. 19,117 23,791 (19.6)% 33,551 43,901 (23.6)% ------- ------- ------- ------- TOTAL ................................... $32,818 $37,617 (12.8)% $63,441 $78,066 (18.7)% % OF REVENUES ........................... 9.0% 10.7% 10.0% 11.7%
Sales and marketing consists of advertising expenses and other sales and marketing expenses. Advertising expenses consist primarily of: (1) television and radio advertising; (2) agency fees and production costs for television and radio commercials; and (3) on-line and print advertisements. For the three and six months ended June 30, 2001, advertising expenses decreased over the same periods in 2000 primarily due to an overall decline in the cost of advertising and an effort to reduce our advertising spending. We intend to continue to pursue an advertising and 17 branding campaign at lower spending levels than we achieved in 2000. We intend to decrease significantly our advertising expense in the remainder of 2001 from levels in corresponding periods of 2000 and place greater reliance on tactical radio and direct marketing programs and campaigns targeting our large customer base. There can be no assurance that we will be successful in achieving revenue growth targets as advertising spending is reduced. Other sales and marketing expenses consist primarily of: (1) credit card processing fees; (2) fees paid to third-party service providers that operate our call centers; (3) provisions for customer credit card charge-backs; and (4) compensation for our sales and marketing personnel. For the three and six months ended June 30, 2001, other sales and marketing expenses decreased over the same period in 2000 due to reductions in the average credit card and customer service transaction costs. GENERAL AND ADMINISTRATIVE
THREE MONTHS ENDED % SIX MONTHS ENDED % JUNE 30, CHANGE JUNE 30, CHANGE ----------------------- ------- ---------------------- -------- ($000) ($000) 2001 2000 2001 2000 ------- ------- ------- ------- GENERAL AND ADMINISTRATIVE .............. $ 7,477 $15,222 (50.9)% $16,881 $27,926 (39.6)% PAYROLL TAX EXPENSE ON EMPLOYEE STOCK OPTIONS ............... 367 2,507 (85.4)% 390 8,414 (95.4)% STOCK BASED COMPENSATION ................ 3,140 -- -- 8,297 -- -- ------- ------- ----- ------- ------- ----- TOTAL ................................... $10,984 $17,729 (38.0)% $25,568 $36,340 (29.6)% % OF REVENUES ........................... 3.0% 5.0% 4.0% 5.5%
General and administrative expenses consist primarily of: (1) compensation for personnel; (2) fees for outside professionals; (3) telecommunications costs; and (4) occupancy expenses. General and administrative expenses decreased during the three and six months ended June 30, 2001 over the same periods in 2000 as a result of decreased headcount and resulting payroll and overhead costs associated with the shift in focus to our core travel products and the indefinite postponement of other product initiatives, all of which was part of our turn-around plan implemented in the fourth quarter of 2000. SYSTEMS AND BUSINESS DEVELOPMENT
THREE MONTHS ENDED % SIX MONTHS ENDED % JUNE 30, CHANGE JUNE 30, CHANGE ----------------------- ------ ------------------------ ------- ($000) ($000) 2001 2000 2001 2000 -------- -------- --------- ------- SYSTEMS & BUSINESS DEVELOPMENT .............. $ 9,892 $ 6,695 47.8% $ 21,004 $12,563 67.2% % OF REVENUES ............................... 2.7% 1.9% 3.3% 1.9%
18 Systems and business development expenses consist primarily of: (1) depreciation and amortization on computer hardware and software, (2) payments to outside contractors, (3) compensation to our information technology and product development staff, and (4) data communications and other expenses associated with operating our Internet site. For the three and six months ended June 30, 2001, systems and business development expenses increased over the same periods in 2000 due primarily to increases in costs associated with a decrease in the amounts reimbursed by licensees and expanding the redundancy capabilities of our data centers. INTEREST INCOME, NET
THREE MONTHS ENDED % SIX MONTHS ENDED % JUNE 30, CHANGE JUNE 30, CHANGE --------------------- -------- --------------------- ------- ($000) ($000) 2001 2000 2001 2000 ------ ------ ------ ------ INTEREST INCOME, NET ..................... $1,816 $2,725 (33.4)% $3,592 $5,440 (34.0)%
For the three and six months ending June 30, 2001, interest income on cash and marketable securities decreased over the same periods in 2000 primarily due to lower interest rates. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2001, we had approximately $165.7 million in cash, cash equivalents, restricted cash and short-term investments. Approximately $11.0 million is restricted cash collateralizing certain letters of credit issued in favor of certain suppliers and landlords. We generally invest excess cash, cash equivalents and short-term investments predominantly in debt instruments that are highly liquid, of high-quality investment grade, and predominantly have maturities of less than one year with the intent to make such funds readily available for operating purposes. Net cash provided by operating activities was $21.2 million for the six months ended June 30, 2001. Net cash provided by operating activities during 2001 was primarily attributable to changes in working capital and operations. Net cash provided by operating activities was $4.0 million for the six months ended June 30, 2000. Net cash provided by operating activities during 2000 was primarily attributable to expanding gross margin on increasing revenues, which was partially offset by increasing operating expenses. Net cash used in investing activities was $22.5 million and $53.8 million for the six months ended June 30, 2001 and 2000, respectively. Net cash used in investing activities for 2001 was primarily related to the purchase of short-term marketable securities and additions to property and equipment. Net cash used in investing activities for the six months ended June 30, 2000, was primarily related to purchases of property and equipment, to purchase convertible notes and warrants in certain licensees and to purchase certain equity investments. We have certain commitments for capital expenditures as part of our ongoing business cycle. None of these commitments are material to our financial position either individually or in the aggregate. Capital expenditures for the third and fourth quarters of 2001 are expected to be approximately $3.0 million to $5.0 million per quarter and will be primarily focused on computer equipment, software and internally developed software. Net cash provided by financing activities was $48.5 million for the six months ended June 30, 2001, primarily as a result of the sale of 23.8 million shares of common stock at a price of $2.10 per share to Hutchison-Whampoa Limited and Cheung Kong (Holdings) Limited in February 2001. Net cash provided by financing activities was $12.3 million for the six months ended June 30, 2000, primarily as a result of the exercise of stock options by employees. We believe that our existing cash balances and liquid resources will be sufficient to fund our operating activities, capital expenditures and other obligations through at least the next twelve months. However, if during that 19 period or thereafter, we are not successful in generating sufficient cash flow from operations or in raising additional capital when required in sufficient amounts and on terms acceptable to us, we may be required to reduce our planned capital expenditures and scale back the scope of our business plan, either of which could have a material adverse effect on our projected financial condition or results of operation. We cannot assure you that we will generate sufficient cash flow from operations in the future, that anticipated revenue growth will be realized or that future borrowings or equity contributions will be available in amounts sufficient to make anticipated capital expenditures or finance our business plan. FACTORS THAT MAY AFFECT FUTURE RESULTS The following risk factors and other information included in this Form 10-Q should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of the following risks occur, our business, financial condition, operating results and cash flows could be materially adversely affected. OUR LIMITED OPERATING HISTORY MAKES EVALUATING OUR BUSINESS DIFFICULT Priceline.com was formed in July 1997 and began operations on April 6, 1998. As a result, we have only a limited operating history on which you can base an evaluation of our business and prospects. Our prospects must be considered in the light of the risks, uncertainties, expenses and difficulties frequently encountered by companies in their early stages of development, particularly companies in new and rapidly evolving markets, such as online commerce, using new and unproven business models. To address these risks and uncertainties, we must, among other things: o continue to attract leading sellers and consumers to the priceline.com service; o maintain and enhance our brand; o attract, integrate, retain and motivate qualified personnel; and o adapt to meet changes in our markets and competitive developments. We may not be successful in accomplishing these objectives. WE MAY CONTINUE TO INCUR LOSSES As of June 30, 2001, we had an accumulated deficit of $1.5 billion. While we had $2.8 million of net income in the three month period ending June 30, 2001, we may incur losses and may not be profitable in future quarters. A substantial portion of our revenues to date have been derived from travel products. Over time, we may introduce new products and services. With respect to current product and service offerings, we may not have decreased our operating expenses in connection with our recent restructuring on an on-going basis sufficiently to sustain profitability. With respect to possible future product and service offerings, we may have to increase our operating expenses. For us to make a profit in future quarters, our revenues and gross profit margins will need to increase sufficiently to cover these and other possible future costs. Otherwise, we may not be able to sustain profitability. POTENTIAL FLUCTUATIONS IN OUR FINANCIAL RESULTS MAKE FINANCIAL FORECASTING DIFFICULT Our revenues and operating results have varied significantly from quarter to quarter and our revenues and operating results may continue to vary significantly from quarter to quarter. As a result, quarter to quarter comparisons of our revenues and operating results may not be meaningful. In addition, due to our limited operating history and a business model that is, especially when compared to "brick and mortar" companies, still relatively new and unproven, it may be difficult to predict our future revenues or results of operations accurately. Our operating results have recently fallen below the expectations of securities analysts and investors and may, in one or more future 20 quarters, fall below such expectations again. If this happens, the trading price of our common stock would almost certainly be materially and adversely affected. Our business has almost no backlog and almost all of our revenues for a particular quarter are derived from transactions that are both initiated and completed during that quarter. Our current and future expense levels are based largely on our investment plans and estimates of future revenues and are, to a large extent, fixed. Despite our recent restructurings, we may be unable to further adjust spending in a timely manner to compensate for any unexpected revenue shortfall, including any shortfall resulting from unexpected fare sales by the airlines and any significant shortfall in revenues relative to our planned expenditures could have an immediate adverse effect on our business and results of operations. Our limited operating history makes it difficult for us to assess the impact of seasonal factors on our business. Nevertheless, we believe that our business is subject to seasonal fluctuations, reflecting a combination of seasonality trends for the products and services offered by us and seasonality patterns affecting Internet use. For example, with regard to our travel products, demand for leisure travel may increase over summer vacations and holiday periods, while Internet usage may decline during the summer months. We believe that our results are affected by seasonal fluctuations in the inventory made available to the priceline.com service by participating sellers, especially airlines. Airlines, for example, typically enjoy high demand for tickets through traditional distribution channels for travel during Thanksgiving and the year-end holiday period. As a result, during those periods, less excess airline ticket inventory would be available to us. Our business also may be subject to cyclical variations for the products and services offered; for example, leisure travel and home mortgage financing tend to decrease in economic downturns. These factors could have an adverse effect on our business and results of operations. WE ARE DEPENDENT ON THE AIRLINE INDUSTRY AND CERTAIN AIRLINES Our financial prospects are significantly dependent upon our sale of leisure airline tickets. Sales of leisure airline tickets represented a substantial majority of total revenue for the three and six months ended June 30, 2001. Leisure travel, including the sale of leisure airline tickets, is dependent on personal discretionary spending levels. As a result, sales of leisure airline tickets and other leisure travel products tend to decline during general economic downturns and recessions. In addition, unforeseen events, such as political instability, regional hostilities, increases in fuel prices, imposition of taxes or surcharges by regulatory authorities, travel-related accidents and unusual weather patterns also may adversely affect the leisure travel industry. As a result, our business also is likely to be affected by those events. Further, work stoppages or labor unrest at any of the major airlines could materially and adversely affect the airline industry and, as a consequence, our business. Sales of airline tickets from our seven largest airline suppliers accounted for approximately 91.9% and 90.5%, respectively, of airline ticket revenue for the six months ended June 30, 2001 and 2000, respectively. As a result, currently we are substantially dependent upon the continued participation of these airlines in the priceline.com service in order to maintain and continue to grow our total airline ticket revenues and, as a consequence, our overall revenues. We currently have 34 participating airlines. However, our airline participation agreements: o do not require the airlines to make tickets available for any particular routes; o do not require the airlines to provide any specific quantity of airline tickets; o do not require the airlines to provide particular prices or levels of discount; o do not require the airlines to deal exclusively with us in the public sale of discounted airline tickets; and o generally, can be terminated upon relatively short notice. 21 These agreements also outline the terms and conditions under which ticket inventory provided by the airlines may be sold. Our agreement with Delta contains certain restrictions relating to the terms of participation in our service by other carriers and the circumstances under which we may transfer or license our intellectual property to other travel providers. It is possible that, as the priceline.com service grows and as other carriers seek participation in the priceline.com service, these competitively restrictive provisions of the Delta agreement could raise issues under federal and state antitrust laws. If that happened, either a federal or state government agency or private party could initiate litigation seeking to enjoin us and Delta from enforcing these provisions or seeking to collect treble damages. The outcome of any such litigation would be uncertain. If, however, such a lawsuit resulted in an injunction or subjected us to damages, our business and financial condition could suffer. Due to our dependence on the airline industry, we could be severely affected by changes in that industry, and, in many cases, we will have no control over such changes or their timing. For example, we believe that the decline in our revenues in the third quarter 2000 when compared to the immediately preceding quarter was attributable, in part, to specific events in the airline industry, including a $20 fuel surcharge imposed by airlines due to increased fuel prices, a high level of flight cancellations that negatively affected supply and the introduction by certain airlines of their own special sale fares which contributed to lower average offer prices for tickets in that quarter. In addition, given the concentration of the airline industry, particularly in the domestic market, major airlines that are not participating in the priceline.com service, or our competitors, could exert pressure on other airlines not to supply us with tickets. Moreover, the airlines may attempt to establish their own buyer-driven commerce service or participate or invest in other similar services, like Hotwire, a Web site that offers discounted fares on opaque inventory, that compete directly with us. We also could be materially adversely affected by the bankruptcy, consolidation, insolvency or other material adverse change in the business or financial condition of one or more of our airline participants. THERE ARE RISKS ASSOCIATED WITH OUR INVESTMENT IN PRICELINE.COM EUROPE LTD. There can be no assurances that the conditions to the loan contemplated by the non-binding agreement in principle we entered into with General Atlantic Partners (Bermuda), L.P. pursuant to which we would lend $20.0 million to priceline.com Europe Ltd. (the "Loan") will be satisfied or that the transactions contemplated by the agreement in principle will be consummated or consummated on the terms described in the Form 10-Q. If priceline.com europe is unable to secure additional financing in the near future to repay principal and interest on outstanding promissory notes to us in the aggregate amount of $10.0 million or, if the Loan is made and priceline.com europe is unable to obtain additional financing during the term of the Loan, it will not be able to repay the principal and interest on the outstanding promissory notes or the Loan, respectively. In such an event, we may not be able to recover or be reimbursed for our ongoing costs associated with priceline.com europe's development and may choose to exercise our right to obtain a substantial equity interest in priceline.com Holdings, which would effectively give us control of priceline.com europe. Priceline.com europe currently has operating losses. To the extent that we exercised our rights to obtain a substantial equity stake in priceline.com Europe Holdings, it is likely that we would have to consolidate priceline.com europe's financial results with ours and recognize its operating losses. In such an event, it is likely that we would have to restructure priceline.com europe's operations. While we currently believe that our investment in priceline.com europe would not be impaired if we restructured priceline.com europe's operations, we can give no assurance that over the long term our investment would not be impaired and that any such consolidation and restructuring would not have a material adverse effect on our business, results of operations and financial conditions. Please see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Recent Developments." OUR BUSINESS MODEL IS RELATIVELY NOVEL AND UNPROVEN The priceline.com service is based on a relatively novel and unproven business model. We will be successful only if consumers and sellers continue to actively use the priceline.com service. Prior to the launch of the priceline.com service, consumers and sellers had never bought and sold products and services through a demand collection system over the Internet. Therefore, it is impossible to predict the degree to which consumers and sellers will continue to use the priceline.com service over time. Many of the factors influencing consumers' and sellers' willingness to use the priceline.com service are outside our control. For example, a labor dispute that disrupts airline service or an airline accident could make consumers unwilling to use a service like priceline.com that does not permit the customer to designate the airline on which the customer purchases a ticket. In addition, a breach of security on the Internet, even if we were not involved, could make consumers unwilling to place orders online with a credit card. Also, recent adverse publicity surrounding our recent public announcements and the slowdown in our business momentum in the second half of 2000 may affect consumers' willingness to use our service and have a lingering effect on our business. Consequently, it is possible that consumers and sellers will never utilize the priceline.com service to the degree necessary for us to sustain profitability. WE MAY NOT BE ABLE TO INTRODUCE NEW PRODUCTS AND SERVICES Should we decide to introduce additional products, we may incur substantial expenses and use significant resources. However, we may not be able to attract sellers, other participants and licensees to provide such products and services or consumers to purchase such products and services through the priceline.com service. In addition, if we or our licensees launch new products or services that are not favorably received by consumers, our reputation and the value of the priceline.com brand could be damaged. 22 The great majority of our experience to date is in the travel industry. The travel industry is characterized by "expiring" inventories. For example, if not used by a specific date, an airline ticket, hotel room reservation or rental car reservation has no value. The expiring nature of the inventory creates incentives for airlines, hotels and rental car companies to sell seats, hotel room reservations or rental car reservations at reduced rates. Because we have only limited experience in selling "non-expiring" inventories on the priceline.com service, such as new cars or financial services, we cannot predict whether the priceline.com business model can be successfully applied to such products and services. IF WE LOSE OUR KEY PERSONNEL OR CANNOT RECRUIT ADDITIONAL PERSONNEL, OUR BUSINESS MAY SUFFER Competition for personnel with experience in Internet commerce is intense. We depend on the continued services and performance of our executive officers and other key personnel. We do not have "key person" life insurance policies. If we do not succeed in attracting new employees or retaining and motivating current and future employees or executive officers, our business could suffer significantly. Our ability to retain key employees could be materially adversely affected by recent developments concerning priceline.com and the decline in the market price of our common stock and by limitations on our ability to pay cash compensation that is equivalent to cash paid by traditional businesses and limitations imposed by our employee benefit plans to issue additional equity incentives. TWO LARGE STOCKHOLDERS BENEFICIALLY OWN APPROXIMATELY 28% OF OUR STOCK. Hutchison Whampoa Limited and its 49.94% shareholder, Cheung Kong (Holdings) Limited, beneficially owned approximately 28% of our outstanding common stock as of August 10, 2001. Together, Cheung Kong (Holdings) Limited and Hutchison Whampoa Limited have the right to appoint three of the eleven members of our Board of Directors. As a result of its ownership and positions, Cheung Kong (Holdings) Limited and Hutchison Whampoa Limited collectively are able to significantly influence all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. Such concentration of ownership may also have the effect of delaying or preventing a change in control of our company. In addition, both Cheung Kong (Holdings) Limited and Hutchison Whampoa Limited have registration rights with respect to their shares held in priceline.com. On August 11, 2001, Cheung Kong (Holdings) Limited and Hutchinson Whampoa Limited requested that the Company file and maintain the effectiveness of a shelf registration statement with respect to all of the shares of the Company's common stock held by them. There can be no assurance that Cheung Kong (Holdings) Limited, Hutchison Whampoa Limited, or both, will not dispose of all or substantially all of the Company's common stock held by them at any time after the effectiveness of the shelf registration statement. Sales of significant amounts of shares held by Cheung Kong (Holdings) Limited or Hutchison Whampoa Limited, or the prospect of these sales, could adversely affect the market price of our common stock. WE RELY ON THIRD-PARTY SYSTEMS We rely on certain third-party computer systems and third-party service providers, including the computerized central reservation systems of the airline and hotel industries to satisfy demand for airline tickets and hotel room reservations. In particular, our travel business is substantially dependent upon the computerized reservation system of Worldspan, an operator of a database for the travel industry. Any interruption in these third-party services systems, including Worldspan's, or deterioration in their performance could prevent us from booking airline, hotel and rental car reservations and have a material adverse effect on our business. Our agreements with third-party service providers are terminable upon short notice and often do not provide recourse for service interruptions. In the event our arrangement with any of such third parties is terminated, we may not be able to find an alternative source of systems support on a timely basis or on commercially reasonable terms and, as a result, our business and results of operations could be materially and adversely affected. INTENSE COMPETITION COULD REDUCE OUR MARKET SHARE AND HARM OUR FINANCIAL PERFORMANCE We compete with both online and traditional sellers of the products and services offered on priceline.com. Current and new competitors can launch new sites at a relatively low cost. In addition, the traditional retail industry for the products and services we offer is intensely competitive. We currently or potentially compete with a variety of companies with respect to each product or service we offer. With respect to travel products, these competitors include: 23 o Internet travel services such as Expedia, Travelocity.com, Orbitz and Hotwire, a Web site that offers discounted fares on opaque inventory; o traditional travel agencies; o consolidators and wholesalers of airline tickets and other travel products, including consolidators such as Cheaptickets.com and Hotel Reservation Network; o individual or groups of airlines, hotels, rental car companies, cruise operators and other travel service providers; and o operators of travel industry reservation databases such as Worldspan and Sabre. A number of airlines have invested in and offer discount airfares and travel services through the Orbitz internet travel service, and a number of airlines, including a number that participate in our system, participate in and have received an equity stake from Hotwire. Similar steps may be under consideration by certain hotel companies and travel service providers. Competition from these and other sources could have a material adverse effect on our business, results of operations and financial condition. Our current or potential competitors with respect to the arrangement and sale of new automobiles in the online marketplace include, among others, Auto-by-Tel, Carsdirect.com, Autoweb.com and Microsoft's CarPoint. To some extent, we compete for new car shoppers' attention with retail new car dealers, many of which offer online shopping capabilities. With respect to financial service products, our competitors include: o banks and other financial institutions; o online and traditional banks and brokers, including Quicken Mortgage and E-Loan; and o insurance companies. With respect to long distance services, our current or potential competitors include long distance providers, local exchange providers that may be entering the long distance market and Internet Protocol telephone services. We potentially face competition from a number of large Internet companies and services that have expertise in developing online commerce and in facilitating Internet traffic, including Amazon.com, America Online and Yahoo!, who could choose to compete with us either directly or indirectly through affiliations with other e-commerce or off-line companies. Other large companies with strong brand recognition, technical expertise and experience in Internet commerce could also seek to compete with us. Competition from these and other sources could have a material adverse effect on our business, results of operations and financial condition. Many of our current and potential competitors, including Internet directories and search engines and large traditional retailers, have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing, technical and other resources than we have. Some of these competitors may be able to secure products and services on more favorable terms than we can. In addition, many of these competitors may be able to devote significantly greater resources to: (1) marketing and promotional campaigns, (2) attracting traffic to their Web sites, (3) attracting and retaining key employees, (4) securing vendors and inventory and (5) Web site and systems development. Increased competition could result in reduced operating margins and loss of market share and could damage our brand. There can be no assurance that we will be able to compete successfully against current and future 24 competitors or that competition will not have a material adverse effect on our business, results of operations and financial condition. OUR SUCCESS DEPENDS ON OUR ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY We regard our intellectual property as critical to our success, and we rely on trademark, copyright and patent law, trade secret protection and confidentiality and/or license agreements with our employees, customers, partners and others to protect our proprietary rights. If we are not successful in protecting our intellectual property, there could be a material adverse effect on our business. While we believe that our issued patents and pending patent applications help to protect our business, there can be no assurance that: o any patent can be successfully defended against challenges by third parties; o pending patent applications will result in the issuance of patents; o competitors or potential competitors of priceline.com will not devise new methods of competing with us that are not covered by our patents or patent applications; o because of variations in the application of our business model to each of our products and services, our patents will be effective in preventing one or more third parties from utilizing a copycat business model to offer the same product or service in one or more categories; o new prior art will not be discovered which may diminish the value of or invalidate an issued patent; or o a third party will not have or obtain one or more patents that prevent us from practicing features of our business or will require us to pay for a license to use those features. There has been recent discussion in the press regarding the examination and issuance of so called "business-method" patents. As a result, the United States Patent and Trademark Office has indicated that it intends to intensify the review process applicable to such patent applications. The new procedures are not expected to have a direct effect on patents already granted. We cannot anticipate what effect, if any, the new process will have on our pending patent applications. We pursue the registration of our trademarks and service marks in the U.S. and internationally. However, effective trademark, service mark, copyright and trade secret protection may not be available in every country in which our services are made available online. We have licensed in the past, and expect to license in the future, certain of our proprietary rights, such as trademarks or copyrighted material, to third parties. These licensees may take actions that might diminish the value of our proprietary rights or harm our reputation. LEGAL PROCEEDINGS We are a party to the legal proceedings described in Item 1 of Part II of this Form 10-Q - "Commitments and Contingencies." The defense of the actions described in Item 1 may increase our expenses and an adverse outcome in any of such actions could have a material adverse effect on our business and results of operations. THE SUCCESS OF OUR BUSINESS WILL DEPEND ON CONTINUED GROWTH OF INTERNET COMMERCE The market for the purchase of products and services over the Internet is a relatively new and emerging market. As an Internet commerce business, our future revenues and profits are substantially dependent upon the 25 widespread acceptance and use of the Internet and other online services as a medium for commerce by consumers and sellers. If widespread acceptance and growth of Internet use does not occur, our business and financial performance will suffer. Rapid growth in the use of and interest in the Internet and other online services is a recent phenomenon. This growth may not continue. A sufficiently broad base of consumers may not adopt, or continue to use, the Internet as a medium of commerce. Demand for and market acceptance of recently introduced products and services over the Internet are subject to a high level of uncertainty, and there are few proven products and services. For us to grow, consumers who historically have purchased through traditional means of commerce, such as a travel agent for airline tickets or a branch of a bank for home financings, will need to elect to purchase online products and services. Sellers of products and services will need to adopt or expand use of the Internet as a channel of distribution. The Internet has experienced significant growth in the number of users and amount of traffic over the recent past. Our success will depend upon the development and maintenance of the Internet's infrastructure to cope with this increased traffic. This will require a reliable network backbone with the necessary speed, data capacity and security, and the timely development of complementary products, such as high-speed modems, for providing reliable Internet access and services. The Internet has experienced a variety of outages and other delays as a result of damage to portions of its infrastructure and could face such outages and delays in the future. Outages and delays are likely to affect the level of Internet usage generally, as well as the processing of transactions on the priceline.com Web site. It is unlikely that the level of orders lost in those circumstances could be made up by increased phone orders. In addition, the Internet could lose its viability due to delays in the development or adoption of new standards to handle increased levels of activity or due to increased government regulation. The adoption of new standards or government regulation may, however, require us to incur substantial compliance costs and could have a material adverse effect upon our business and results of operations. CAPACITY CONSTRAINTS AND SYSTEM FAILURES COULD HARM OUR BUSINESS If our systems cannot be expanded to cope with increased demand or fails to perform, we could experience: o unanticipated disruptions in service; o slower response times; o decreased customer service and customer satisfaction; or o delays in the introduction of new products and services; any of which could impair our reputation, damage the priceline.com brand and materially and adversely affect our revenues. Publicity about a service disruption also could cause a material decline in our stock price. Like many online businesses, we have experienced system failures from time to time. For example, in May 2001, our primary website was interrupted for a period of 12 hours. In addition to placing increased burdens on our engineering staff, these outages create a flood of user questions and complaints that need to be addressed by our customer support personnel. Any unscheduled interruption in our service could result in an immediate loss of revenues that can be substantial and may cause some users to switch to our competitors. If we experience frequent or persistent system failures, our reputation and brand could be permanently harmed. We have been taking steps to increase the reliability and redundancy of our system. These steps are expensive, may reduce our margins and may not be successful in reducing the frequency or duration of unscheduled downtime. Substantially all of our computer hardware for operating our services currently is located at the facilities of Exodus Communications, Inc. in New Jersey. These systems and operations are vulnerable to damage or interruption from human error, floods, fires, power loss, telecommunication failures and similar events. They are also subject to break-ins, sabotage, intentional acts of vandalism and similar misconduct. We do not maintain fully redundant systems or hosting services, and we do not carry business interruption insurance sufficient to compensate us for losses that may occur. Despite any precautions we may take, the occurrence of a natural disaster 26 or other unanticipated problems at the Exodus facility could result in lengthy interruptions in our services. In addition, the failure by Exodus to provide our required data communications capacity could result in interruptions in our service. Any system failure that causes an interruption in service or decreases the responsiveness of the priceline.com service could impair our reputation, damage our brand name and materially adversely affect our business and results of operations. We use internally developed systems to operate the priceline.com service, including transaction processing and order management systems that were designed to be scaleable. However, if the number of users of the priceline.com service increases substantially, we will need to significantly expand and upgrade our technology, transaction processing systems and network infrastructure. We do not know whether we will be able to accurately project the rate or timing of any such increases, or expand and upgrade our systems and infrastructure to accommodate such increases in a timely manner. WE MAY NOT BE ABLE TO KEEP UP WITH RAPID TECHNOLOGICAL AND OTHER CHANGES The markets in which we compete are characterized by rapidly changing technology, evolving industry standards, frequent new service and product announcements, introductions and enhancements and changing consumer demands. We may not be able to keep up with these rapid changes. In addition, these market characteristics are heightened by the emerging nature of the Internet and the apparent need of companies from many industries to offer Internet-based products and services. As a result, our future success will depend on our ability to adapt to rapidly changing technologies, to adapt our services to evolving industry standards and to continually improve the performance, features and reliability of our service in response to competitive service and product offerings and the evolving demands of the marketplace. In addition, the widespread adoption of new Internet, networking or telecommunications technologies or other technological changes could require us to incur substantial expenditures to modify or adapt our services or infrastructure. ONLINE SECURITY BREACHES COULD HARM OUR BUSINESS The secure transmission of confidential information over the Internet is essential in maintaining consumer and supplier confidence in the priceline.com service. Substantial or ongoing security breaches -- whether instigated internally or externally -- on our system or other Internet-based systems could significantly harm our business. We currently require buyers to guarantee their offers with their credit card, either online or through our toll-free telephone service. We rely on licensed encryption and authentication technology to effect secure transmission of confidential information, including credit card numbers. It is possible that advances in computer capabilities, new discoveries or other developments could result in a compromise or breach of the technology used by us to protect customer transaction data. We incur substantial expense to protect against and remedy security breaches and their consequences. However, we cannot guarantee that our security measures will prevent security breaches. A party that is able to circumvent our security systems could steal proprietary information or cause significant interruptions in our operations. For instance, several major Web sites have experienced significant interruptions as a result of improper direction of excess traffic to those sites, and computer viruses have substantially disrupted e-mail and other functionality in a number of countries, including the United States. Security breaches also could damage our 27 reputation and expose us to a risk of loss or litigation and possible liability. Our insurance policies carry low coverage limits, which may not be adequate to reimburse us for losses caused by security breaches. We also face risks associated with security breaches affecting third parties conducting business over the Internet. Consumers generally are concerned with security and privacy on the Internet and any publicized security problems could inhibit the growth of the Internet and, therefore, the priceline.com service as a means of conducting commercial transactions. NEW BUSINESSES WE MAY ENTER OR OUR EXISTING LICENSEES MAY NOT BE SUCCESSFUL We have entered into, and may enter into in the future, licensing or other arrangements with third parties in connection with expansion of the priceline.com service. For example, we licensed our name and business model to Alliance Capital Partners in connection with our home financing services and to other third parties in connection with the development of our business model abroad, including priceline.com europe Ltd. These new businesses typically incur start-up costs and operating losses and may not be successful. If these new businesses are not favorably received by consumers or are unsuccessful, the association of our brand name and business model with these new entities may adversely affect our business and reputation and may dilute the value of our brand name. Further, to the extent that these new businesses are not successful, we may not be able to recover or be reimbursed for our ongoing costs associated with their development, which could have a material adverse effect on our business and results of operations. OUR STOCK PRICE IS HIGHLY VOLATILE The market price of our common stock is highly volatile and is likely to continue to be subject to wide fluctuations in response to factors such as the following, some of which are beyond our control: o quarterly variations in our operating results; o operating results that vary from the expectations of securities analysts and investors; o changes in expectations as to our future financial performance, including financial estimates by securities analysts and investors; o changes in our capital structure; o changes in market valuations of other Internet or online service companies; o announcements of technological innovations or new services by us or our competitors; o announcements by us or our competitors of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments; o loss of a major seller participant, such as an airline or hotel chain; o changes in the status of our intellectual property rights; o lack of success in the expansion of our business model horizontally or geographically; o adverse publicity surrounding recent announcements concerning priceline.com; o announcements by third parties of significant claims or proceedings against us or adverse developments in pending proceedings; 28 o additions or departures of key personnel; and o stock market price and volume fluctuations. Sales of a substantial number of shares of our common stock could adversely affect the market price of our common stock by introducing a large number of sellers to the market. Given the volatility that exists for our shares, such sales could cause the market price of our common stock to decline. In addition, the trading prices of Internet stocks in general, including ours, have experienced extreme price and volume fluctuations. To the extent that the public's perception of the prospects of Internet or e-commerce companies is negative, our stock price could decline further regardless of our results. Other broad market and industry factors may decrease the market price of our common stock, regardless of our operating performance. Market fluctuations, as well as general political and economic conditions, such as a recession or interest rate or currency rate fluctuations, also may decrease the market price of our common stock. The market value of e-commerce stocks has declined dramatically over recent months based on profitability and other concerns. The recent declines in the value of our common stock and market conditions could adversely affect our ability to raise additional capital. We are currently the subject of a number of securities class action litigations. In the past, securities class action litigation often has been brought against a company following periods of volatility in the market price of their securities. To the extent our stock price declines or is volatile, we may in the future be the target of additional litigation. Securities and other litigation could result in substantial costs and divert management's attention and resources. UNCERTAINTY REGARDING STATE TAXES We file tax returns in such states as required by law based on principles applicable to traditional businesses. In addition, we do not collect sales or other similar taxes in respect of transactions conducted through the priceline.com service (other than the federal air transportation tax). However, one or more states could seek to impose additional income tax obligations or sales tax collection obligations on out-of-state companies, such as ours, which engage in or facilitate online commerce. A number of proposals have been made at state and local levels that could impose such taxes on the sale of products and services through the Internet or the income derived from such sales. Such proposals, if adopted, could substantially impair the growth of e-commerce and adversely affect our opportunity to become profitable. Legislation limiting the ability of the states to impose taxes on Internet-based transactions has been enacted by the United States Congress. However, this legislation, known as the Internet Tax Freedom Act, imposes only a three-year moratorium, which commenced October 1, 1998 and ends on October 21, 2001, on state and local taxes on (1) electronic commerce where such taxes are discriminatory and (2) Internet access unless such taxes were generally imposed and actually enforced prior to October 1, 1998. It is possible that the tax moratorium could fail to be renewed prior to October 21, 2001. Failure to renew this legislation would allow various states to impose taxes on Internet-based commerce. The imposition of such taxes could adversely affect our ability to sustain profitability. REGULATORY AND LEGAL UNCERTAINTIES COULD HARM OUR BUSINESS The products and services we offer through the priceline.com service are regulated by federal and state governments. Our ability to provide such products and services is and will continue to be affected by such regulations. The implementation of unfavorable regulations or unfavorable interpretations of existing regulations by courts or regulatory bodies could require us to incur significant compliance costs, cause the development of the affected markets to become impractical and otherwise adversely affect our financial performance. 29 SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS Sections of this Form 10-Q contain forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict; therefore, actual results may differ materially from those expressed, implied or forecasted in any such forward-looking statements. Expressions of future goals and similar expressions including, without limitation, "may," "will," "should," "could," "expects," "does not currently expect," "plans," "anticipates," "believes," "estimates," "predicts," "potential," "targets, " or "continue," reflecting something other than historical fact are intended to identify forward-looking statements. The following factors, among others, could cause our actual results to differ materially from those described in the forward-looking statements: adverse changes in our relationships with airlines and other product and service providers; adverse changes in general market conditions for leisure and other travel products; systems-related failures and/or security breaches; the effects of increased competition; our ability to protect our intellectual property rights; losses by us and our licensees; any adverse impact from negative publicity and negative customer reaction relating to recent announcements concerning us; legal and regulatory risks; and the ability to attract and retain qualified personnel. These factors and others are described in more detail above in the section entitled "Factors That May Affect Future Results." Unless required by law, we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. However, readers should carefully review the reports and documents we file from time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Priceline.com currently has no floating rate indebtedness, holds no derivative instruments other than through investments in licensees and does not earn significant foreign-sourced income. Accordingly, changes in interest rates or currency exchange rates do not generally have a direct effect on priceline.com's financial position. However, changes in currency exchange rates may affect the cost of international airline tickets and international hotel reservations offered through the priceline.com service, and so indirectly affect consumer demand for such products and priceline.com's revenue. In addition, to the extent that changes in interest rates and currency exchange rates affect general economic conditions, priceline.com would also be affected by such changes. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Please see Note 8 to the Notes to Unaudited Consolidated Financial Statements included in this Form 10-Q and Part I, Item 3 of priceline.com's Annual Report on Form 10-K for the year ended December 31, 2000. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS We held our Annual Meeting of Stockholders on May 21, 2001. Following are descriptions of the matters voted on and the results of such meeting: Number of Stockholders
Matter Voted On For Withheld --------------- --- -------- 1. Election of Directors Richard S. Braddock 172,355,008 1,242,621 Paul A. Allaire 173,116,374 481,256 Ralph M. Bahna 173,140,243 457,386 Paul J. Blackney 173,144,830 452,799 William B. Ford 173,117,419 480,210 Marshall Loeb 173,099,629 498,000 N.J. Nicholas, Jr 173,140,555 457,074 Nancy B. Perctsman 173,136,321 461,308 Ian F. Wade 173,135,362 462,267
In addition, the terms of office as directors of Dominic Kai Ming Lai and Edmond Tak Cheun Ip continued after the Annual Meeting of Stockholders.
Broker For Against Abstaining Non-votes --- ------- ---------- --------- 2. Approval of Ammendments to priceline.com 1999 Omnibus Plan 167,461,280 4,881,208 241,673 3,468 3. Ratification of appointment of Deloitte & Touche LLP as independent auditors for fiscal year ending December 31, 2001 173,327,670 170,892 99,067 --
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits EXHIBIT NUMBER DESCRIPTION -------------- ----------- 10.66 Amendment to Employment Agreement, dated June 15, 2001, by and between priceline.com and Robert Mylod. 30 (b) REPORTS ON FORM 8-K On April 2, 2001, we furnished a report on Form 8-K in connection with the reaffirmation of first and second quarter 2001 guidance at the Goldman Sachs Internet Conference. On May 2, 2001, we furnished a report on Form 8-K in connection with our first quarter earnings release. On May 8, 2001, we filed a report on Form 8-K in connection with Richard Braddock's reappointment as Chief Executive Officer replacing Daniel Schulman and Jeffery Boyd being named President of the Company. On June 6, 2001, we filed a report on Form 8-K in connection with the purchase of shares of priceline.com common stock from Jay Walker by Cheung Kong (Holdings) Limited and Hutchison Whampoa Limited. 31 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PRICELINE.COM INCORPORATED (Registrant) Date: August 14, 2001 By: /s/ Robert Mylod ------------------------- Name: Robert Mylod Title: Chief Financial Officer 32