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Priceline.com Inc. (NASDAQ:PCLN)

Q2 2013 Earnings Conference Call

August 8, 2013 4:30 PM ET

Executives

Jeffery H. Boyd – Chairman, President and Chief Executive Officer

Daniel J. Finnegan – Chief Financial Officer and Chief Accounting Officer

Analysts

Ross Sandler – Deutsche Bank Securities, Inc.

Naved A. Khan – Cantor Fitzgerald Securities

Ron Victor Josey – JMP Securities LLC

Mike J. Olson – Piper Jaffray, Inc.

Heath P. Terry – Goldman Sachs & Co.

Douglas T. Anmuth – JPMorgan Securities, LLC

Tom Cauthorn White – Macquarie Capital, Inc.

Mark S. Mahaney – RBC Capital Markets LLC

Brian P. Fitzgerald – Jefferies LLC

Michael Millman – Millman Research Associates

Ken Sena – Evercore Partners

Scott H. Kessler – Standard & Poor’s Investment Advisory Services LLC

Justin Post – Bank of America Merrill Lynch

Brian T. Nowak – Susquehanna Financial Group, LLLP

Eric J. Sheridan – UBS Securities LLC

Aaron Kessler – Raymond James & Associates, Inc.

Operator

Welcome to Priceline Group’s Second Quarter 2013 Conference Call. Priceline would like to remind everyone that this call may contain forward-looking statements, which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. 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 reflecting something other than historical facts are intended to identify forward-looking statements.

For a list of factors that could cause Priceline’s actual results to differ materially from those described in the forward-looking statements, please refer to the Safe Harbor statements at the end of Priceline’s earnings press release as well as Priceline’s most recent filings with the Securities and Exchange Commission. Unless required by law, Priceline undertakes no obligation to update publicly any forward-looking statements whether as a result of new information, future events, or otherwise.

A copy of Priceline’s earnings press release together with an accompanying financial and statistical supplement is available in the Investor Relations section of Priceline’s website located at www.priceline.com.

And now, I like to introduce the Priceline Group speakers for this afternoon, Jeffrey Boyd and Daniel Finnegan. Go ahead, gentlemen.

Jeffery H. Boyd

Thank you and welcome to Priceline’s second quarter conference call. I’m here with Priceline’s CFO, Dan Finnegan. I will make some opening remarks and Dan will give a detailed financial review. After the prepared portion, we will take questions.

The Priceline Group reported consolidated gross bookings for the second quarter of approximately $10.1 billion, up 38% year-over-year. Non-GAAP net income was $508 million or $9.70 per share, up 24% versus prior year. Second quarter results surpassed FactSet consensus estimates of $9.38 per share and our guidance for the quarter. Worldwide hotel room night reservations were $69.4 million for the quarter, up 38% year-over-year.

Our international business recorded 44% gross bookings growth on a local currency basis, roughly consistent with Q1’s growth rate. Growth rates benefitted from good results in Europe and continued high growth rates in Asia-Pacific and the Americas. International gross bookings also benefited generally from growth in hotel supply and strong results at rentalcars.com.

Booking.com’s platform now has over 330,000 hotels and other accommodations, up 40% over last year. Booking.com’s growth in Europe has held up well this year, despite continuing economic and political uncertainty. We believe the steady international room night growth we have posted this year is driving market share gains. Booking.com continued its aggressive development of markets outside Europe. These markets continue to grow faster than the core European markets, contributing to more overall growth as they become a larger percentage of the whole business. We are investing in growing hotel and accommodation supply and in marketing, including Booking.com’s offline marketing experiment in United States, which we believe is contributing to the room night growth Booking.com is seeing in the U.S.

Agoda delivered good room night growth in the quarter and continues to build its business as a leading site for Asia Pacific bookers. With Agoda and Booking.com, whose Asia Pacific business does particularly well within international bookers, we believe the group is strengthening its position in this part of the world with attractive prospects as the region grows.

Priceline’s domestic gross bookings grew 12% in the second quarter showing continued improvement aided by growth in domestic rental car reservations as well as improved hotel room night gross bookings, with Express Deals becoming a larger part of the APAC hotel business. Priceline.com has done a good job building Express Deals for customers who want Priceline savings without the bidding and the response to some new ads we are running featuring William Shatner and Kaley Cuoco seems positive.

Merchant gross bookings growth of 30% continues to reflect growth at Agoda and rentalcars.com. Growth in rental car days increased sequentially from 43% to 46% driven by a strong growth at rentalcars.com and continuing improved results at priceline.com. Rentalcars.com continued to perform well as it builds out its international footprint.

We closed the KAYAK transaction on May 21 and Dan will discuss the impact of including their financial results for the stub period. KAYAK is being run independently and we are encouraged as we start to look at opportunities to promote KAYAK’s growth. The group’s business performance exceeded expectations in the quarter and operating margins, while down, came in within the range of our forecast.

Advertising efficiency continues to be an important variable, which is difficult to forecast with precision. Efficiencies are impacted not only by changing business mix and competitive and seasonal factors, but by substantial ongoing changes to our most important distribution channels, including the growth in mobile and changing interfaces at our largest partners. Based on what we see in the marketplace, I believe our online and offline teams are executing well in a challenging environment. I want to thank our employees around the world for their hard work and dedication.

I will now turn the call over to Dan for the detailed financial review.

Daniel J. Finnegan

Thanks, Jeff. I’ll discuss some of the highlights in operating results and cash flows for the quarter and then provide guidance for the third quarter of 2013. Growth rates mentioned in my remarks are in relation to the prior year comparable period unless otherwise indicated. KAYAK is included in our income statement from the acquisition close date of May 21, through the end of the quarter, as well as in our guidance for all of Q3.

KAYAK revenue included in Q2 results net of inter-company activity amounted to $31.1 million. We will report KAYAK’s revenue for the first year to help investors understand the impact of the acquisition on our top line growth. We expect that the impact of the KAYAK acquisition on our non-GAAP EPS for 2013 will de minimis.

Q2 was a strong quarter from a top line perspective. Hotel room nights booked grew by 38% in the second quarter consistent with the unit growth rates achieved in both Q1 and Q4. Our international business performed well in all of our key markets. Our priceline.com U.S. business achieved accelerating room night growth in Q2 compared to Q1. Average daily rates or ADRs for Q2 2013 were up on a local currency basis by about 1% for the consolidated group.

Rental car days booked were up by 46%, reflecting strong results for both rentalcars.com and priceline.com. For the second quarter compared to the prior year, the FX rate for the euro to the U.S. dollar was favorable by about 2%. The FX rate for the British pound to U.S. dollar was unfavorable by about 3%. As a result, currency exchange rates had a little impact on our year-over-year growth rates expressed in U.S. dollars for gross bookings, revenue, gross profit, adjusted EBITDA and net income.

The FX rate for the Euro to the U.S. dollar was about 1% on favorable to our guidance forecast assumption. In summary, strong unit growth rate drove solid results compared to our guidance on all key operating metrics.

Q2 gross bookings grew by 38% compared to prior year. Our Q2 international gross bookings grew by 44% on both the U.S. dollar and local currency basis. Gross bookings grew by 12% for our priceline.com brand business in the U.S. Growth in both retail and opaque reservation services contributed to year-over-year growth.

Gross profit for the quarter was $1.4 billion and grew 38% as compared to prior year. Year-over-year gross profit growth for Q2 was hindered slightly by Easter falling on March 31, this year, which resulted in some revenue related to holiday shifting into Q1.

The inclusion of KAYAK in our results contributed about 3 percentage points of inorganic growth for the quarter. Our international operations generated gross profit of $1.2 billion, which constituted an increase of 40% as compared to the prior year and an increase of 39% on a local currency basis.

Gross profit for our U.S. business including KAYAK amounted to $183 million, which represented 26% growth versus prior year. Non-GAAP operating income as a percentage of non-GAAP gross profit amounted to 44.1% for Q2, compared to 48.2% for the prior year Q2.

The operating margin declined by 410 bps compared to prior year that was near the better end of the range of 400 to 500 bps of our operating deleverage assumed in our guidance forecast.

As we’ve discussed over the last several quarters, operating margins were impacted by lower year-over-year advertising ROIs, business mix, as well as offline advertising spend for KAYAK and Booking.com. Also as we discussed last year, Q2 margins are negatively impacted by an earlier Easter this year, which caused the shift of some gross profit into Q1, as well as the tough prior year margin comp.

Other OpEx besides advertising delevered by 50 bps as we invested in personnel and other expenses to keep up with current and future business growth. We excluded $6.4 million of deal costs incurred in Q2 related to the KAYAK acquisition from non-GAAP net income, because the expenses are not driven by core operating results and were under comparisons with prior periods less meaningful.

Adjusted EBITDA for Q2 amounted to $621 million, which exceeded our guidance range of $560 million to $595 million, and represents 26% growth versus prior year. Non-GAAP net income also grew by 26% and non-GAAP EPS grew by 24%, reflecting the impact of higher fully diluted share count.

In terms of cash flow, it was a busy quarter. we generated approximately $593 million of cash from operations during second quarter 2013, which is about 37% higher than last year. Operating cash flow for the quarter benefits from our decision to prepay in the first quarter $224 million of income taxes for Booking.com, in return for an early payment cash discount. These taxes would otherwise have been paid monthly over the year, and so second quarter and subsequent quarters of 2013 have a lower payment burden as a result.

We spent about $21 million on CapEx in the quarter and $193 million to acquire the remaining non-controlling interest in rentalcars.com. We also paid cash of $328 million, net of cash acquired, and $1.55 billion in shares of our common stock and assumed KAYAK stock options to close the KAYAK acquisition.

As we announced in May, we completed a $1 billion convertible debt offering during the second quarter. We believe this represents attractive financing for the company with the coupon interest rate of 0.35% and a conversion price of $1,315 per share. The debt has a seven-year term and generally cannot be converted prior to maturity unless our stock trades above $1,973 per share. Concurrent with the offering, we announced an authorization from our Board of Directors to purchase up to $1 billion of our common stock. We repurchased $347 million of our common stock in Q2. The remaining proceeds as well as the other cash investments totaling about $6 billion at quarter close, are available for general corporate purposes, including additional share repurchases, acquisitions and debt repayment.

Now for third quarter 2013 guidance. We are forecasting total gross booking to grow by 27% to 34% and to grow on a local currency basis by approximately 25% to 32%. With U.S. gross bookings growing by 5% to 10%, we accept international gross bookings expressed in U.S. dollars to grow by 32% to 39% and to grow on a local currency basis by approximately 30% to 37%. Our Q3 forecast assumes that local currency ADRs for the consolidated group will be up by about 1% compared to prior year. Our Q3 forecast assumes that foreign exchange rates remain at the same $1.33 per euro and $1.55 per British pound as yesterday’s closing rates, which would result in average exchange rate to be stronger by about 5.5% for the euro and weaker by about 2% for the British pound as compared to the prior year.

We have hedged contracts in place to substantially shield our third quarter EBITDA and net earnings from any fluctuation in the euro or the pound versus the dollar between now and the end of the quarter. But these hedges do not offset the impact of translation on our gross bookings, revenue, gross profit and operating income, and do not hedge our earnings beyond the third quarter.

We expect Q3 revenue to grow year-over-year by approximately 23% to 30%, and gross profit dollars to grow by approximately 32% to 39%. We expect about 250 bps of deleverage in non-GAAP operating income as a percentage of gross profit compared to prior year. We assume that margins in Q3 will again be impacted by deleverage in online advertising expense due to lower year-over-year ROIs, business mix continuing to shift to our international brands and to pay channels for certain of our brands.

We will continue our investment in TV advertising in the U.S. market for our Booking.com brand and the inclusion of KAYAK will also increase offline advertising compared to prior year. Other OpEx is stable as a percentage of gross profit, reflecting continued investment in people and related expenses to support business growth, offset by a favorable comp because Q3 2012 included a $13 million one-time payroll tax charge in the Netherlands.

Adjusted EBITDA is expected to range between $990 million and $1.055 billion, which at the midpoint, represents 31% growth versus prior year. Our non-GAAP EPS forecast includes an estimated cash income tax rate of approximately 16%, comprised of international income taxes and alternative minimum tax and state income taxes in the U.S.

We are targeting non-GAAP fully diluted EPS of approximately $15.30 to $16.30 per share, which at the midpoint represents 27% growth over prior year. Our non-GAAP EPS guidance assumes a fully diluted share count of 53.3 million shares based upon yesterday’s closing stock price of $927.58 and reflects the impact of shares issued and options assumed as part of the KAYAK acquisition, net of shares repurchased during Q2.

We forecast GAAP EPS between $13.75 and $14.75 per share for Q3. The difference between our GAAP and non-GAAP results is driven by non-GAAP adjustments that are detailed in our earnings release.

We are pleased by the strong and steady unit growth the group has delivered over the last several quarters and that is inherent in our forecast. Over the trailing 12 months, the company has facilitated travel bookings accounting for about 234 million hotel room nights and total gross bookings of $33.7 billion. I highlight that our guidance reflects deceleration and growth experience to-date in the quarter and our expectation that such a large business comparing against high transaction growth rates will experience sequentially decelerating growth rates.

Our forecast does not assume any material change in macroeconomic conditions in general and conditions in the consumer travel market in particular.

We’ll now take your questions.

Question-and-Answer Session

Operator

Thank you, gentlemen. (Operator Instructions) Our first question comes from Ross Sandler of Deutsche Bank. Your line is open.

Ross Sandler – Deutsche Bank Securities, Inc.

Thanks, guys. Just two quick questions, so we’ve seen Dan, as you’ve mentioned, we’ve seen a lot of change in some of your core customer acquisition channel. So Google Hotel Finder going better, TripAdvisor going better. Do you guys view these kinds of changing dynamics as an opportunity for Priceline to take market share versus OTAs and supplier direct? And then with the concept of changing dynamics in mind, how do you view your opportunity to gain market share in mobile versus maybe some of the smaller OTAs and supplier direct? Thanks.

Jeffery H. Boyd

So with respect to the first channel, whenever you have changing interfaces in important advertising channels, represents both the risk gained and opportunity. We have done particularly well in the legacy environment. And so I think we have risk when the interfaces change, but I think our teams have done a good job in executing against those changes and trying to build the processes and the understanding to do well in those marketplaces as they change.

But the fundamental asset that we have is a great website that converts customers very well and that is an asset that has high value in all of these interfaces, whether it’s meta-search or pop-ups, we tend to do well once we get a visit into the website and that continues to be very important part of how we try to improve our product and help build share in these markets. So we look at it both as a risk and as an opportunity. And I think it’s a given in our space that these markets will continue to change. The media model businesses will continue to try to optimize for their customer flows and for revenue and all of us just have to be prepared to deal with those changes.

With respect to mobile, I think, the teams have also done a very good job of building terrific mobile websites. Building functionality in our regular websites did work well in a tablet environment and building mobile apps. If you look at the number of downloads that we as a group, it’s in the tens of millions, and I think we’re doing good job in building apps that consumer want to download. And our focus is really to try to build downloads that consumers will actually use those apps to buy products because they tend to be quiet loyal, and I think we are doing well there based on the disclosures that have come out from competitors in the space. We are comfortable that we are tracking nicely in terms of mobile share.

Operator

Thank you. Our next question comes from Naved Khan of Cantor Fitzgerald. Your question please.

Naved A. Khan – Cantor Fitzgerald Securities

Jeff, can you talk a little bit about the efficacy of your TV ad campaign in the U.S. and how much did it contributed to your performance versus your own expectations in the quarter? And how do you see it tracking going into the second half? And then I have a follow-up.

Jeffery H. Boyd

So I assume you are asking about the Booking.com campaign here in the United States, because keep in mind, now we have three brands that are advertising…

Naved A. Khan – Cantor Fitzgerald Securities

Correct.

Jeffery H. Boyd

…Priceline booking in KAYAK. As I mentioned in my prepared remarks, we’re happy with the results we’ve seen to-date and we think that the ad campaign is contributing to the growth that Booking.com is seeing here in the United State. So it’s an ongoing experiment and we continue to monitor the results, but we’re pleased with what we see so far. And you got a follow-up?

Naved A. Khan – Cantor Fitzgerald Securities

Yes, I do. Actually, so just I think going back to your comments on your earnings call for the last quarter, I think you talked about seeing some easier comps in the second half for advertising just because you start to anniversary some of the spending that you had in the last year. So are you still comfortable with that or would you want to revisit that and give us an update on how you look at that?

Jeffery H. Boyd

I think the best update we have is the guidance that Dan gave you for overall pressure on operating margins, which is going from 410 basis points in the second quarter to our guidance for approximately 250 basis points in the third quarter. The components of that pressure, while lower than in the second quarter, continue to be pressure on ROIs. And as I’ve said in previous calls, we first and foremost want to make sure that we are adequately investing in distribution and building the franchise, and while we haven’t changed the fundamental way that we do that or the disciplines that we apply to that process, we want to make sure that we are adequately supporting the business and so whether it’s offline or online, if we think there is an attractive opportunity to spend money to build the business, we’ll do so.

Naved A. Khan – Cantor Fitzgerald Securities

Thank you.

Operator

Thank you. Our next question comes from Ron Josey of JMP Securities. Your line is open.

Ron Victor Josey – JMP Securities LLC

Thanks for taking my questions. So two really, they are sort of combined. The first is just on macro, and I think, Jeff, you said that summer travels off to a strong start and seeing sustained improvement in Europe, but I think you said good results over there. Wondering if that just if you are seeing maybe a change in macro in the travel vertical over in Europe, such that things are getting better, or you just don’t want to operate better in a challenging environment?

And then the second part of the question is any update on say 3Q trend, I think some of your competitors have been out there saying July might be a little bit slow, thank you.

Jeffery H. Boyd

Sure. So with respect to the macro, I think what I said in my prepared remarks really is a good summary of how we look at it. We still view it as a challenging environment from an economic standpoint, because there is continuing economic and political uncertainty.

Having said that, the market has been relatively stable, when I say relatively, relative to six months ago into parts of last year where we are having civil unrest in Greece and a lot more headline activity around the economy and the potential for sovereign defaults that those headlines have abated in recent months. And so as both I mentioned we were relatively pleased with sort of the growth rates that we saw in Europe and we are not calling out any particular market or region as being particularly problematic compared to others.

With respect to the third quarter basically what we’ve said in the guidance is that we guided to what we think are attractive growth rates, they represented deceleration from what we reported in 2Q and we said that that deceleration is something that we would witness so far in the quarter. And I don’t think we go beyond that in terms of characterizing the sort of month-to-month kind of results.

Ron Victor Josey – JMP Securities LLC

Great, makes sense. Thank you.

Operator

Thank you. Our next question comes from Mike Olson of Piper Jaffray. Your question please.

Mike J. Olson – Piper Jaffray, Inc.

All right, thanks. Good afternoon. Maybe the question on domestic and you come in at high end or above the high end of your domestic bookings growth over the last couple of quarter. And I think the midpoint of your domestic guidance 5% to 10% would suggest kind of 400 to 500 basis point declaration, is there anything that you expect to change during the quarter or is that you are already seeing that, they have changed in the quarter that leads you expect the sell or is it just more conservatism? Thanks.

Jeffery H. Boyd

It’s just declaration in the business. We think it was a great quarter in Q2 and we think the guidance for Q3 is strong, top end of that range would be very similar to the growth that was delivered in Q2. So really nothing in particular there Mike, they were crawling out, but just the expectation for some declaration.

Mike J. Olson – Piper Jaffray, Inc.

All right. Thank you.

Operator

Thank you. Our next question comes from Heath Terry of Goldman Sachs. Your line is open.

Heath P. Terry – Goldman Sachs & Co.

Great. Jeff, I know you get a lot of questions around mobile. I’m curious if you take a step back and look at the broader impact that you see mobile having particularly in the cost of customer acquisition, as well as adding incremental users, especially now that KAYAK is sort of in-house. Are you noticing that mobile in general is driving to you a newer or different customer base and you’ve typically seen online, and is it doing it either a different cost to customer acquisition or do those customers have kind of a different economic profile?

Jeffery H. Boyd

Heath, I think it really, it’s still too early to say with certainty how mobile advertising and mobile customer flows are going to change acquisition cost.

There's a couple of things that are still in play that we and others haven’t figured out. First of all, I think, most major brands are investing heavily in mobile to make sure that they understand how the channel works and that they are holding share and that they are not missing something, and those levels of spend and the efficiency of those spends, may not be steady state. They maybe more aggressively spending in the early days of the development of the marketplace to build the capacity and the confidence to win in that marketplace over the long-term, but you really don’t know what the steady state spend is going to be, because we’re still early days.

Second thing we don’t know is how sticky ultimately the customer is and I think that you could hypothesize that ad customers, for example, would be sticker. If you get them to download and use the app, you don’t have to pay for them again therefore. They would have high lifetime value relative to advertising costs. And those theories are being acted out not just in the travel space, but all over the Internet trying to figure out what the real value of an app download is and how to drive one that’s effective in terms of the usage. And again, I just think it’s too early to map that out.

And finally, a lot of this activity doesn’t happen exclusively on the mobile device, and people are still trying to figure out how to attribute marketing spend that results in a search on a mobile phone and a booking on the desktop or vice versa, and that’s stuff that we’re looking at and we’ll get a lot better at. So I think this is a field that is new, exciting. It’s going to change and we’re very hopeful that we’ll be able to execute effectively and build a nice loyal customer following in mobile, but I really couldn’t tell you right now, whether it’s over the long haul going to make our customer acquisition costs go up or go down.

Heath P. Terry – Goldman Sachs & Co.

Nice. I appreciate that. That’s really helpful. One other question, you’ve been able to – a lot of focus obviously on advertising deleverage, but you’ve been able to get for that additional advertising accelerating growth particularly from a bookings perspective. Can you gauge for us your willingness to push that growth accelerator forward particularly as at least some of your competitors seem to be maybe pulling back a little bit?

Jeffery H. Boyd

I think that we will try to be consistent and sustainable. Those are the two things that we would try to focus on. We’re an opportunistic company. So if there’s an opportunity to build business with these inefficiencies, we’ll take it. But we want to make sure that we have a disciplined approach that we apply across channels and that we can stick with as the channels change and we want it to be sustainable. It’s just like offline advertising. You’re not going to accomplish anything if you spend a tremendous amount of money in a given year, but then you can’t spend that money in a future year. And by the way, there has been some variability in the television spend of our competition, as they are trying to work their way through that. That variability doesn’t seem to serve a brand well. You want to have an advertising program that is sustainable overtime. So that whatever benefits you get from building your brand in the consumers’ mind, you can continue to reinforce and maintain.

Heath P. Terry – Goldman Sachs & Co.

Great. Thanks, Jeff. I really appreciate it.

Operator

Thank you. Our next question comes from Douglas Anmuth of JPMorgan. Please go ahead.

Douglas T. Anmuth – JPMorgan Securities, LLC

My question, Jeff, I was hoping if you could help us understand the reasons for the KAYAK slowdown that we’ve seen over the last few quarters and then also how are you thinking about the booking path for KAYAK strategically going forward? Thanks.

Jeffery H. Boyd

So with respect to KAYAK’s revenue, I probably not going to say much more than what’s been reported publicly in the separate financials and the disclosures that Dan gave you because inter-company advertising with KAYAK is eliminated. You really can’t get a good impression of the revenue trajectory just by looking at the stub revenue we reported and because we are continuing to evaluate how our brands work with KAYAK, and I think it’s fair to say, traditionally that Priceline Group brands were under represented in KAYAK’s products, that we didn’t sort of fight through our weight in their various marketplaces and now that we’re one company, of course, we want to make sure that we have a reasonable share of KAYAK’s business given the size of our brands and that will benefit both our brands and KAYAK. I think that’s sort of how as far as we really want to go on that.

Douglas T. Anmuth – JPMorgan Securities, LLC

Okay. Thank you.

Operator

And your next question comes from Tom White of Macquarie. Your question please.

Tom Cauthorn White – Macquarie Capital, Inc.

Thanks for taking my question. Firstly on EBITDA margins, I was wondering if maybe you guys could talk about whether your margin expectations for the business, say over the next couple of years, have changed in anyway, given the fact that your overall unit growth rates haven’t really decelerated to extend. You guys have sort of talked about it in the past. I understand you guys are making the investments in new geographies, but how should we think about, I guess, overall leverage in the model over the next couple of years? And then just quickly on China, it’s been about a year since you announced the Ctrip partnership. Any updated learnings you can share about the market there or how’s your view on how you want to participate in that market longer term change in anyway? Thanks.

Jeffery H. Boyd

I think with respect to long-term margins, I don’t have any particular guidance for you. I can give you an historical perspective, which might be helpful for you coming to your own conclusions about where you think it’s going to go. For many years, we were very fortunate to be able to hold or even improve margins as the business grew at very high rates and we felt that at that point in time, we are investing adequately in the business and we were building very substantial share gains in the course of those years and at that time, we said it was our goal to deliver growing business and to essentially maintain our margins.

We haven’t been saying that for the last couple of years and I think that reflects the statement that I’ve been making now for many quarters that to the degree that we think it’s necessary to invest in people or in marketing or technology, to basically capitalize on the global growth opportunity that we have, we are willing to do so. And we will tip the balance between trying to improve operating margins versus growing the franchises where the opportunities are so attractive and important.

We’re going to tip the balance in favor of growing and I think that’s particularly the right strategy for our Group, given the fact that our absolute margins are so much higher than our nearest competitor. We’ve got the resources to do it, and shame on us, if we didn’t capitalize on that asset and use it to our greatest advantage.

I’ve also said that we don’t foresee a situation where we’re forced to completely capitulate on margins, and not be able to deliver earnings growth as we invest in the business. I think the model is still robust enough to do that, and in fact, we are doing it. So I don’t foresee the time when we’re in a position of an Amazon, where the things that they are working on are so big and costly and obviously, have such massive potential, that they are prepared for a period of time to, in effect, reinvest all of their earnings growth in those new opportunities. I don’t see us sustaining in that position, at least not in the foreseeable future.

Tom Cauthorn White – Macquarie Capital, Inc.

Thank you.

Jeffery H. Boyd

And I guess there was question about China there, a second question. Dan, why don’t you …

Daniel J. Finnegan

So we’ve had the partnership with Ctrip for the past year, and we’re happy with the results to-date. Our approach in China remains pretty consistent, which is continuing to add hotels in China to our extranet for Booking.com and for Agoda.com. We’ve had good success with inbound travel into China and we’ve also had good success with Chinese travelers traveling within APAC and outside of the region. And so we hope that overtime, we can continue to build our supply there, and build our brand recognition with Chinese travelers and participate to a greater extent in the domestic market as well.

Tom Cauthorn White – Macquarie Capital, Inc.

Great. Thanks for the color, guys.

Operator

Thank you. Our next question comes from Mark Mahaney of RBC Capital Markets. Your question, please.

Mark S. Mahaney – RBC Capital Markets LLC

Please first, if you could talk a little bit about the rentalcars.com strategy extended their cross-selling opportunity, the unit economics how attractive that segment is versus your core business. And then secondly, Jeff, you described the U.S. advertising, the brand support TV ad support for Booking.com is experimental. But it sounds like you’re also making the comment that sustained branding helps businesses. So when does the experimental stage end and when do you go to full-fledged advertising support for Booking.com in the U.S.? Thank you.

Jeffery H. Boyd

Okay. Thank you, Mark. So with respect to rentalcars.com, their business model is to build out a global platform for rental cars, much the way that Booking.com has done for hotels and it’s a very similar approach, one product simple website focused on conversation, and with significant investment in online marketing to support building the customer base. The unit economics for the rental car business flow, probably not as attractive to a degree as hotels might be, are certainly attractive, especially in the international markets to support that strategy, and you’ve seen the unit growth of that we’ve been reporting for rental cars groupline rentalcars.com is a big part of it, and doing very, very well.

Cross-sell has been a piece of that. rentalcars.com is an option post-transaction for Booking.com customers. It also provides some support for the U.S. customers at priceline.com. And over time, it will advertise and be available on KAYAK. and so we’ll promote cross-sell where we can, Agoda as well.

Keep in mind that because our biggest business is hotel, the cross-sell opportunity, while a valuable and good opportunity, is not huge, because the cross-sell from hotel to rental car is not as material as it is, for example, the cross-sell from an airline ticket here in the United States to rental car, but an opportunity that we value and that we’re pursuing.

With respect to Booking.com, when does it not become an experiment, I think, that the cultural of Booking.com is that everything is an experiment permanently and that you’re always evaluating what the return on investment is, and all of the quantitative aspects of the spend and the impact on traffic and conversion on the website.

Having said that, Booking.com is going to have a decision to make as early as the end of this year, as to whether they continue the campaign next year and that decision hasn’t been made yet, but as I said, previously in my prepared remarks, we think the ads are contributing to the growth that Booking.com is seeing here in the United States and we’re happy with the results so far.

Mark S. Mahaney – RBC Capital Markets LLC

Thanks a lot, Jeff.

Operator

Thank you. Our next question comes from Brian Fitzgerald of Jefferies. Your question please.

Brian P. Fitzgerald – Jefferies LLC

As the industry is pushing on the various marketing channels; offline, online, display, search et cetera, are you seeing a different dynamics in terms of conversion rates? And then maybe a little more specifically on mobile, are those conversion rates inflecting up or is it still more browsing in that channel? Thanks.

Jeffery H. Boyd

Dan, you want to handle on?

Daniel J. Finnegan

Yeah, we don’t disclose our conversion rates by channel, Brian. It’s one of the areas that I think is a key area of competency for us. We’ve got very well converting websites, and it’s one of our key efforts everyday is to continuously improve the experience for our customers on our website and continue to add contents to continue to push that conversion upward.

In mobile, it’s more challenging, because you got a smaller screen, and it’s still earlier days. so as Jeff pointed to earlier when we’re still learning there, what’s the best way to acquire traffic, and then continuously improving from a much earlier, from a much more recent starting point, the experience for our customers as they land on those smaller screens. So it’s ongoing, and we hope that given the expertise we’ve developed over the years in desktop that we can transfer that to the smaller screen, and also give our customers a great experience there.

Brian P. Fitzgerald – Jefferies LLC

Great, guys. thanks for the color.

Operator

Thank you. Our next question comes from Michael Millman of Millman Research. Your line is open, sir.

Michael Millman – Millman Research Associates

Okay. I was wondering a couple of things, one, on Expedia’s transaction, preference, promotion or maybe more than promotion, practice. If you’re seeing any effect on volume or margins, secondly, on rental cars, as maybe you can separate the U.S. and Europe in terms of availability and year-over-year price and even look at that in terms of retail and express and maybe, if there’s any, mainly on price, and just maybe, you can help with why the cost of revenues in the quarter was down? Thank you.

Jeffery H. Boyd

So Michael, maybe, I’ll try the first couple, and then Dan can address the cost of revenue question. So I think that the first question you are referring to Expedia’s Traveler Preference program, which is the program where they offer consumers the ability to book agency or merchant with the same hotel, depending on what the traveler, whether they prefer to pay upfront or pay at the hotel. Expedia has been rolling that out. I think it’s benefited their results.

and so that’s something that seems to be the case according to the disclosures that they have made. It’s hard to tell whether that has had an impact on our businesses, as you’ve seen the results that we’ve reported they’ve been fairly consistent. and I think we’re still in a position where we’re gaining share, despite the launch of that program, Expedia’s got a lot of more hotels to put in it.

We have a similar program here at Priceline.com in the United States where you can book both merchant and agency for the same hotel, depending on Traveler Preference and we’ve been doing that for a couple of years now. and we think it’s a good feature. But I don’t think that feature by itself has really changed Priceline’s position in the U.S. marketplace.

Per se, with respect to the rental car marketplace, I think the high-level commentary, I can give you is that pricing has been a little bit stronger this year than, in last the couple of years, the pricing environment has been challenging for the rental car businesses, but I think the pricing is firmer this year, both in the United States and in Europe. But availability has not been a material issue for us at least not so far this summer as you can see by the unit growth rates that we’ve reported in the last two quarters. I just don’t think you can get to that kind of a growth unless you had some decent availability supporting it. So I think those numbers give you the best indication of at least our experience with availability. And Dan…

Daniel J. Finnegan

Michael, the cost of revenue decrease is driven by Name Your Own Price hotel business. That business is continuing to decline and we recorded in our income statement on a growth basis. So the total value of the transaction is in revenue and then the cost that we pass on to the supplier is in cost of revenue and the decline there is what’s driving the decrease in that line item.

Michael Millman – Millman Research Associates

Okay. Thank you.

Daniel J. Finnegan

You’re welcome.

Operator

Thank you. Our next question comes from Ken Sena of Evercore Partners. Your question please.

Ken Sena – Evercore Partners

I was hoping that maybe on some of the unit growth figures, you could maybe talk a little bit about the impact of KAYAK and what it had in the quarter, and maybe if you could just provide it sort of on a pro forma basis? Thanks.

Jeffery H. Boyd

We’re not going to disclose the specific inter-company unit transaction trends between our group brands and KAYAK.

Daniel J. Finnegan

And just to be clear, there is no room night bookings for KAYAK itself, it would just be through referrals to other group brands, but nothing in our unit growth is specific to the KAYAK acquisition.

Ken Sena – Evercore Partners

Thank you.

Operator

Thank you. Our next question comes from the Scott Kessler of S&P Capital. Your question, please.

Scott H. Kessler – Standard & Poor’s Investment Advisory Services LLC

Hi, thanks a lot. There has been some discussion about Asia, and I’m wondering if you could provide some additional, I guess details about how you think Agoda is doing, you obviously spoke to the alliance with Ctrip, but any additional details as to opportunities that you see, the nature of the competitive environment, the pace of growth that the market and you are experiencing there. Any additional information would be appreciated, thanks.

Jeffery H. Boyd

As we mentioned previously, Asia is a very attractive market for Booking.com and Agoda. I think we are fortunate to have two very strong brands that have emphasis in different parts of the market with Agoda serving; a vast majority of its customers are APAC travelers traveling in the APAC region, whereas Booking.com has a lot more international travelers coming in to the region from outside.

We are very pleased with the trajectory for both of those businesses. We haven’t given color on unit growth rates for Agoda for a long, long time. What we have said with respect to those markets though as that they generally are growing faster for the group than our core markets and that continues to be the case. So we are comfortable and encouraged by what we are seeing there for both Agoda and for Booking.com.

Scott H. Kessler – Standard & Poor’s Investment Advisory Services LLC

Thanks a lot.

Operator

Thank you. Our next question comes from Justin Post of Merrill Lynch. Your line is open, sir.

Justin Post – Bank of America Merrill Lynch

Thank you. Jeff, as you look out across your pipeline of hotels, or just look at your share versus offline in Europe and Asia, do you feel like you still have plenty of growth ahead as you look out a couple of years, maybe give us a big picture of where you are today versus a couple of years ago on that front? And what would you do if the day ever came that you kind of fully penetrated on the hotel market? And then on the KAYAK side, I know you can’t give us specifics, but it is the KAYAK acquisition material for gross profit guidance or for your booking guidance in 3Q. Thank you.

Jeffery H. Boyd

Okay. Well, I’ll handle the first one Justin, and Dan, you can handle the question on KAYAK. If you look at the growth that Booking.com has been able to maintain for several quarters now, improving its inventory of hotel and accommodation supplies by 40% year-over-year in the second quarter. It shows that we are still able to add significant properties to the platform. I’ve said before and I’ll repeat that there is a diminishing return that those properties tend to be smaller, have less rooms, and potentially not as wide appeal is some of the properties that are already on the program, but there is still a lot of room to add supply. And by definition the supply we are adding is our accommodations and hotels where we have zero penetration, and so there is real opportunity to build our penetration in those properties.

There have been things published and we published a year or two ago a number from Eurostat trying to get arms around what the market opportunity is and suffice it to say that we are not going to be in the business of doing that just because it’s so hard to get data on how many hotels there are and how many nights you have stayed in those hotels on a global basis. But we certainly believe that there is a substantial opportunity for all of our brands to continue to grow their business.

Booking.com, as everybody knows is now advertising in the United States and trying to build a stronger position here, it’s a market that Booking.com is a relevant newcomer too. And I think that represents a significant opportunity and what is one of the largest worldwide markets for accommodation and we are still in early days, notwithstanding our success in Asia, given the size of that market, our penetration there is relatively low, and South America as well.

So it’s just a lot of, at least in our opinion a lot of opportunity out there for us to continue to build the business. And the new market strategy where we continue to invest in these new markets and try to build them aggressively, so they get to deal a larger size and they haven’t made more of a difference on total gross bookings, as continued to serve us well and we’ll be focused there also.

Daniel J. Finnegan

And KAYAK doesn’t impact our gross bookings Justin; we don’t look at KAYAK as a platform upon which a booking is made. It may send a referral to other group brands and they make get a gross booking and then that would chop in our numbers the way it always has in the past. In terms of gross profit, we’re not giving guidance on that level of detail. And we report KAYAK’s revenue though when we report the quarter. But KAYAK will be included in our gross profit, net of revenue that it earns from other group brands which will be eliminated as inter-company. So KAYAK’s numbers for last year, are a public record, you can look at that and come up with your own forecast, which you think might be included.

Justin Post – Bank of America Merrill Lynch

Great. I appreciate that. May be one quick follow-up. Could Kayak help the other Priceline brands as you utilize it more or will that be kind of a small impact do you think?

Jeffery H. Boyd

I just definitely can help to a degree that our brands are more effective in advertising on KAYAK that will generate bookings and gross profit for those brands and market share for those brands, so it absolutely can help. And KAYAK is a big player here in the United States, and so for the U.S. business, the referrals from KAYAK definitely matter. And hopefully, there will be a very big business in Europe and globally over time and that will matter too. And in the future right now, it’s relatively smaller in the international markets.

Justin Post – Bank of America Merrill Lynch

Thank you. I appreciate it.

Operator

Thank you. Our next question comes from Brian Nowak of Susquehanna. Your question please.

Brian T. Nowak – Susquehanna Financial Group, LLLP

Just going back to KAYAK and how you think about growing it from here. Do you think the KAYAK current offering is strong enough to compete and win that traffic, or do you think you need to add more content to it like the reviews or other content from Booking.com? They really improved a visitor value proposition. And then secondly, you talked a bit about non-European trends and the strength in the global conversion machine, I was wondering, we talked roughly about where you are in terms of conversion in the U.S. and the emerging markets, compared to your conversion rates, your more mature markets. And then, is there anything you are seeing so far that makes you think that Booking.com conversion in these new regions, couldn’t reach the same levels that they are in Europe? Thanks.

Jeffery H. Boyd

So with respect to KAYAK, I think their content today is excellent and their business continues to perform well in the United States and outside the United States. You can expect them to continue to optimize experiment, add content over time, but that will be based on their view of the business as they develop it, and it’s certainly a benefit to KAYAK to have potentially accessed to the substantial content that our other brands have to offer, but remains to be seen, how or if that would be applied.

With respect to conversion, I don’t think, I wouldn’t want to speculate as to what would happen to website conversion overtime in markets. We have experienced improving brand recognition and business results as Booking.com and Agoda have expanded their businesses organically, same thing with rentalcars.com.

So it would not be unusual to enter into a new market with a relatively unknown brand and have to invest significantly in marketing to build up the brand recognition to get you to a point of where your efficiency starts to get where you need them to be for a sustainable steady state business development. But I wouldn’t go beyond that in terms of trying to predict what’s going to happen in the marketplace from here on in.

Brian T. Nowak – Susquehanna Financial Group, LLLP

Okay, thank you.

Operator

Thank you. Our next question comes from Eric Sheridan of UBS. Your line is open, sir.

Eric J. Sheridan – UBS Securities LLC

I guess, following on some of the questions on marketing as well. Jeff, how you guys grow valuable time you’re thinking about lifetime value of customers? I think that’s the biggest question we get from investors is, some of these platforms continue to evolve and move down the advertising funnel, how it will impact your decisions and your analytics around what they’re delivering to you as opposed to what they’re delivering today? Thanks.

Jeffery H. Boyd

I think the only color I could give you there is that we spend money in online channels to build our brand and to bring in customers that we have a chance of making loyal customers that will come back to us directly, and not all – not all platforms work alike as you look at those, but as you look at that ultimate objective that we have in bringing customers into website.

So as a, for instance, a white label relationship where nobody sees your brand as relatively less value than an integrated relationship where people are seeing your brand on another website and then actually coming to your website and experiencing your selection, your user interface, and ultimately your customer service.

So those factors or things that we absolutely look at, I wouldn’t say there has been a sea change in how we look at those factors. We evaluate each advertising channel on its own merits and that's been part of our discipline for a long time.

Eric J. Sheridan – UBS Securities LLC

Great. Thank you.

Operator

Thank you. Our final question for the hour comes from Aaron Kessler of Raymond James. Your line is open.

Aaron Kessler – Raymond James & Associates, Inc.

Great, thanks, guys. Couple questions, I may have missed it, but did you give an ADR forecast? And secondly, I think you can talk a little bit about in terms of Booking.com and a Priceline integrating inventory on the back end in the U.S. as well. Thank you.

Jeffery H. Boyd

The ADR forecast Aaron was globally the hours of about 1% for Q3. And Aaron if you could clarify that second question?

Aaron Kessler – Raymond James & Associates, Inc.

I guess, maybe in terms of how many Booking.com and Priceline work together in terms of integrating supply in the U.S. for a hotel supply?

Jeffery H. Boyd

Today, Booking.com and Priceline have separate and distinct inventory, separate and distinct contracting staffs, different people that approach the hotel. The Priceline.com for years has offered Booking.com inventory as an option. That was done originally to accommodate travelers who were traveling from the United States to Europe, and has grown to be a broader relationship where global inventory is available to Priceline’s U.S. customers and Booking.com’s inventory in the United States is available for Priceline customers as well who may want to book an agency property. And we’re pleased with the way that integration is going over the years and we think it’s been hopeful to both businesses and we expect it to continue.

Aaron Kessler – Raymond James & Associates, Inc.

Okay. And then finally, can you just make a comment on the opportunity for KAYAK to expand greater in Europe, it seems like they are mainly a U.S. centric site, but what’s the opportunity to make it much bigger internationally?

Jeffery H. Boyd

I think as we said when we made the acquisition there is an opportunity to try to help KAYAK build its business around the world more quickly, more aggressively than it was able to do as a separate company. We have resources and assets in terms of operating businesses in a lot of these markets where we can be helpful in getting KAYAK up and running. And there is a lot of information that we can share on things that worked in markets for our brands, and obviously we can provide content for KAYAK’s customers. So that’s somethings where we think we can be helpful and we intend to work to hopefully create a successful global expansion for KAYAK.

Aaron Kessler – Raymond James & Associates, Inc.

Great. Thank you.

Operator

And at this time, I would like to turn the call back over to our speakers for any closing remarks.

Jeffery H. Boyd

Thank you all very much for participating in the call.

Operator

And ladies and gentlemen that does conclude your program. Thank you for your participation and have a wonderful day. You may disconnect your lines at this time.

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