Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  
TRANSCRIPT SPONSOR

Priceline.com Inc. (NASDAQ:PCLN)
Q1 2007 Earnings Call
May 8, 2007 4:30 pm ET

Executives:

Jeff Boyd - President and CEO
Bob Mylod - CFO

Analysts:

Aaron Kessler - Piper Jaffray
Jennifer Watson - Goldman Sachs
Bridget Wysha - JP Morgan
Chris Gutek - Morgan Stanley
Paul Keung – CIBC World Markets
Mark Mahaney - Citigroup Investment
James Sanford - Merrill Lynch
Michael Millman - Soleil Securities

Operator

Welcome to Priceline’s first quarter 2007 conference call. Priceline would like to remind everyone that this call may contain forward-looking statements which remain 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 fact 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’d like to introduce Priceline’s speaker for this afternoon, Mr. Jeff Boyd. Please go ahead.

TRANSCRIPT SPONSOR

Tech-Stock Prospector seeks out promising small- and large-cap technology stocks offering a combination of growth and value. The research service is made up of Daily Online Updates at TechStockProspector.com, Action Alert e-mails and a 12-page monthly newsletter.

Editor Robert DeFrancesco, formerly senior writer at Louis Rukeyser's Wall Street, has covered the tech market for 15 years. He uses both fundamental and technical analysis to put together two long-term model portfolios. Tech-Stock Prospector also offers Trading Ideas and maintains a Watch List of potential additions to the portfolios.

To sponsor a Seeking Alpha transcript click here.

Jeff Boyd

Thank you very much and welcome everybody to Priceline’s first quarter conference call. I’m here with Priceline’s CFO, Bob Mylod.

Priceline recorded gross bookings for the first quarter of $998 million, up 34% year over year. Pro forma gross profit of $104 million was up 43% and pro forma net income was $17 million, or $0.43 per share.

First quarter results surpassed the high end of our guidance due to better than forecast earnings in both our domestic and European businesses, and exceeded first call consensus estimates of $0.27 per share.

Priceline’s gross bookings growth rate was driven by a 91% growth at Booking.com, which again exceeded our growth expectations in the first quarter. Bottom line, over performance was attributable to European bookings growth, growth in domestic gross profit, and marketing efficiencies.

Priceline’s domestic growth rate was 1% in the first quarter, a decrease from 12% in Q4. Merchant gross bookings were up 8% in the first quarter, a decrease from 18% growth in Q4. The previously announced termination of the Orbitz Opaque and Travelweb relationships and forecasted weakness in retail airline ticket sales were responsible for slowing domestic growth.

Booking.com continues to benefit from positive e-commerce and travel-market trends in Europe. Booking.com is building supply, content, and distribution across Europe, which is contributing to growth of the business. We also continue to see benefits from integration activities, product enhancement, and marketing efficiencies.

Booking.com continues to focus on online brand building, building repeat business, and bringing in more destinations and hotels, with the network now including over 32,000 hotels in 54 countries.

Our European management and employees continue to execute well in building market leadership in key western European markets, and planting seeds for future growth in newer markets.

Our supply and distribution teams are building strong local relationships based on our supplier-friendly model. The team has also done a good job scaling the business and achieving integration benefits and objectives.

As expected, gross bookings for Priceline’s domestic business were negatively impacted by the loss of Opaque and Travelweb business from Orbitz. We decided last year not to renew the Opaque transaction with Orbitz, and have increased the return on investment hurdles in other online channels.

These steps have reduced gross bookings, especially in airlines tickets, which accounted for the majority of Orbitz Opaque business, and in retail tickets, where reduced GDS economics magnified the effect of higher ROI requirements.

Despite the loss of Orbitz business, our domestic hotel and rental car businesses continue to perform well in the quarter, showing solid growth in units and gross bookings. The strength of these businesses is evident in the 8% growth in merchant bookings, and 11% growth in pro forma and domestic growth profit dollars in the quarter.

The performance of our merchant business together with the benefit of greater marketing efficiencies contributed to better than expected domestic earnings. And importantly, our airline ticket business, hardest hit by the aforementioned changes, made a significant contribution to growth and earnings.

We believe that the favorable results we are seeing in the business coming directly to Priceline.com, rather than through branded affiliates like Orbitz, are being driven by our new advertising campaign, The Negotiator, featuring William Shatner, and good execution in other online channels.

We continue to role out new creative initiatives for the Negotiator and are seeding the campaign in other media. We are also pursuing new online partnerships at reasonable rates in an effort to replace some of the lost Orbitz business over time.

Finally, we continue to build content and functionality aimed at enhancing customer loyalty, and expect to deploy some of these programs later this year. With these initiatives, the momentum of our domestic merchant business, and improved customer acquisition costs, we expect domestic earnings growth to continue for the balance of 2007.

Priceline’s objective is to be the leading domestic online destination for value-conscious leisure travelers, and the leading online hotel reservation service in Europe. We continue to show superior growth and profitability in Europe, and the domestic business is contributing nicely to growth and earnings.

We continue to be pleased with Priceline’s combined financial performance.

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

Bob Mylod

Thanks Jeff.

First quarter of 2007 was another strong quarter, during which we were able to continue the strong earnings momentum on both sides of the Atlantic that we had established during the fourth quarter of 2006.

Internationally, Booking.com once again turned in gross bookings growth that significantly exceeded our expectations, and that further added to our already formidable position as the largest online hotel reservations booking service in Europe.

That top-line growth combined with great operational execution and expense management was the single biggest contributor to the upside and consolidated pro forma earnings for the quarter.

In the US, Priceline’s earnings results also grew significantly on a year-over-year basis, coming in higher than our expectations. And because incremental operating income generated within the US is essentially free of tax because of our significant NOL tax assets, our US operations also played a big part in our earnings upside.

Let me quickly go through some of the details of the quarter, and then I’ll get to guidance. I’ll start with total gross bookings of $998 million, which grew by 34% year-over-year.

In our last earnings call we projected that our European businesses would generate $477-491 million of gross bookings in Q1. That guidance was based upon an assumption that we would experience fairly material monthly sequential declines in our annualized gross bookings growth rates in Europe. And in fact, while we did indeed experience monthly sequential declines, the rate of decline was not as steep as anticipated, and accordingly, our European annualized gross bookings growth rate came in at 91%, substantially above our forecast of between 75-80%, which drove European gross bookings of $520 million.

As for our domestic business, to recap what Jeff just mentioned, our gross bookings came in pretty much where we expected, although we did a little bit better with respect to our hotel and rental car services, and we came in below expectations with respect to the sale of airline tickets, which is evidenced by the 12.2% year-over-year decline in the unit sales of airline tickets.

And while we were generally disappointed with this result, keep in mind that the airline ticket service represents a small fraction of our domestic profitability, and an even smaller fraction of our consolidated profitability.

Moreover, the shortfall in airline ticket sales relative to our forecast came more from the very low margin retail airline ticket service than it did the high margin opaque airline ticket service.

Consequently, the lower than expected airline ticket sales had a negligible impact on overall results. As for revenues, the strong gross bookings performance led to an 18% revenue growth, which was in excess of our 15% guidance.

As for gross profit dollars, again, gross bookings over performance coupled with a favorable shift (inaudible) towards the higher margin merchant products, including retail merchant hotels, allowed us to deliver pro forma and gross profit dollars in growth that also came in substantially ahead of the high end of our guidance.

As for our pro forma operating expenses, our Q1 advertising expense of $43.3 million came in below our prior guidance. Which, given that it is the largest of our expense-line items, was a big driver to our profit upside.

This was gratifying for several reasons. First, as we have mentioned for several quarters now, our goal domestically is to focus with even greater intensity on achieving operating leverage and high return on investment. We clearly achieved this in Q1. Jeff detailed this point with his discussion of the Orbits online ad deal, but I want to also stress that the improvements in domestic online ROI generally came across the board.

Second, while the European market is certainly becoming more and more competitive with respect to online spend, we remain disciplined in sticking to our ROI targets, and in fact did a little bit better than planned.

And finally, as you can see from overall gross bookings growth, none of these online marketing efficiencies came at the expense of our overall growth targets.

Moving on to the remainder of our pro-forma expenses, the sum of personnel costs, G&A, depreciation and amortization, and sales and marketing expense came in roughly in line with our prior guidance.

Our pro forma income tax expense actually came in higher than our prior guidance due to the strong pre-tax income performance in Europe, where our NOLs do not apply and where we are a taxpayer.

We also incurred approximately $300,000 of losses associated with foreign exchange hedging activities due to the increase in the value of the Euro and the Pound, the two principal foreign currencies with which we transact in Europe, relative to the Dollar. These losses were generally offset by favorable FX earnings translations for our European operations which flowed through each line item of our income statement.

As I mentioned on our prior earnings call, our general goal with respects to FX is to hedge a substantial portion of our expected year term earnings, mainly through the use of fairly plain manila forward contracts. Therefore while there were FX gains achieved by the Euro and the Pound against the Dollar during the first quarter, the impact to our Q1 EPS was not material due to the offsetting impact of our hedging activities.

Our European gross bookings metric was positively impacted by FX in the first quarter and our statistical supplement shows our European gross bookings growth rates on a local currency basis.

We reported pro forma net income of $0.43 per share, which as Jeff mentioned, represented a 126% year-over-year growth and handily invested both our guidance and first call estimates of $0.27 per share.

We reported a GAAP net loss of $0.44 per share for the quarter driven principally by our previous (inaudible) settlement of the securities class action lawsuit that dates back to the year 2000. The cost of the settlement and associated legal expenses, net of offsetting insurance proceeds, was approximately $55 million.

None of the cash associated with the legal settlement has yet been paid, so the settlement appears on our balance sheet as an accrued expense. It is our expectation that the cash payments, net of the offsetting insurance contribution, will be paid in the second quarter.

The securities litigation settlement expenses were partially offset by income that was recognized with respect to an excised tax refund that was confirmed by the Internal Revenue Service several weeks ago. As I discussed on our prior earnings call, we received a favorable ruling from the IRS last year on whether or not Federal Transportation Excise taxes are due and payable on the gross profit that we earn on the sale of merchant airline tickets.

Prior to that ruling we had been remitting such a tax to the IRS and recognizing the expenses associated with the tax as a deduction to our merchant revenues. Upon receipt of the ruling, we immediately stopped remitting the taxes and then pressed for a refund of the amount that we had paid previously. Approximately $15.9 million of the refund appears as revenue in our GAAP P&L and another $2.8 million appears on our interest income line item as the IRS paid us for foregone interest on our refund.

The cash from the excise tax refund had not been paid as of the end of Q1, so it appears on our balance sheet as another current asset. The cash refund was actually received in April. Finally, our income tax expense was positively impacted by the net cost of the legal settlement, net of the excised tax refund, by approximately $14.4 million.

So the negative after tax impact of the legal settlement, net of the excised tax refund, was approximately $22 million and all of these items have been excluded from our pro forma results because of their one time nature and their lack of comparability to prior periods' results.

GAAP results were also negatively impacted by approximately $5.9 million of acquisition related amortization and $3.2 million of stock based compensation expense which reflects the impact of the adoption of FAS 123R last year. All these expenses were non-cash in nature.

GAAP results exclude approximately 3.9 million shares of common stock equivalence associated with our convertible bonds, employee stock options, and un-invested restricted stock due to the anti dilutive impact that the inclusion of the stock would have had on our GAAP loss.

As for cash and cash flow we generated approximately $18.8 million in operating cash flow during the quarter which consistent with our historical operating cash flow was slightly in excess of our pro forma net income. The problem was we noticed that our OCF was roughly flat versus last year, but keep in mind that in last year's first quarter there was no cash outflow associated with the payment of income taxes versus a $6.6 million outflow this year.

Also the comparability of this year's first quarter OCF versus last year's was distorted by the payment of approximately $5.5 million in performance based employee bonuses in Europe that were accrued last year and paid in the first quarter of this year. In last year's first quarter there were no such payments made in Europe.

As for our cash balances we began the quarter with $434 million of cash in marketable securities and we closed the quarter with $457.6 million of cash in marketable securities representing an increase in cash of $23.6 million in the quarter.

We generated approximately $7.6 million from the exercise of employee stock options and we repurchased approximately $1.4 million of our stock during the quarter. Total capital expenditures in the first quarter were approximately $2.2 million.

And now for a few comments on guidance. We're looking for second quarter gross bookings to grow by approximately 23-28% on a year-over-year basis with gross bookings from Priceline Europe growing approximately 72-76% on a year-over basis. You will note that this guidance implies a decline in our domestic gross bookings, although it is our expectation that our higher margin merchant gross bookings will be roughly flat with last year, despite the loss of the Orbitz business which was a significant contributor to domestic merchant gross bookings last year.

We expect pro forma revenue, which excludes the benefit of additional excised tax refunds that are expected in Q2, to grow by approximately 10-15% on a year-over-year basis. We expect pro forma gross profit dollars to grow by approximately 34-38% on a year-over-year basis. As for Q2 operating expenses, we're targeting consolidated advertising expenses of approximately $52-55 million with approximately 75-80% of that amount being spent on online advertising.

We expect sales and marketing expense of between $13-14 million and we expect personnel cost excluding stock based compensation to come in between $19.5-20.5 million. We expect G&A expenses of approximately $8-8.5 million and information and technology costs of approximately $3-3.2 million. And depreciation and amortization expense excluding acquisition amortization of approximately $3.2 million.

We expect total below the line positive impact of approximately $1.3 million, which comprises net interest income, foreign exchange expense, equity and income of Priceline Mortgage and minority interest expense. We're targeting pro forma EPS of approximately $0.80-0.90 per share and our pro forma EPS forecast includes an estimated cash income tax of approximately $7 million comprised of alternative minimum tax in the United States and income taxes in Europe.

Our pro forma EPS guidance is based upon pro forma diluted share count of approximately 42.9 million shares. The mid point of our pro forma EPS range represents a 55% increase versus last year's second quarter.

As for expected GAAP results, we expect to report a GAAP EPS of between $0.52-0.62 per share. The difference between our GAAP and pro forma results will be driven primarily by the inclusion of acquisition related amortization, stock based compensation, and certain income tax expenses, all of which are non-cash in nature.

GAAP results will be positively impacted by additional receipts of excise tax refunds in the amount of approximately $3 million, while the refund is cash in nature it is excluded from the pro forma results due to its one time nature and its lack of comparability to prior period results.

Finally, GAAP results will be negatively impacted by the inclusion of approximately 1.4 million shares of additional unissued common stock associated with our 2006 convertible note offerings that we are required to use in the calculation of GAAP EPS. As I've mentioned on our prior earnings calls, because of the convertible note hedges that we have in place, the 2006 convertible notes do not begin to become dilutive unless and until our stock reaches a level of $50.47 per share.

Therefore the share count used in computed pro forma EPS includes the treasury stock method dilutive impact of our two most recently completed debt transactions, only to the extent that our stock exceeds $50.47 per share.

While we're not going to give detailed line item guidance for the full year 2007, we are comfortable giving the following bookings and pro forma EPS guidance as outlined in our press release last week.

To summarize where we were before our earnings announcement, we had been forecasting full year 2007 pro forma EPS of between $2.60-2.90 per share. We're now targeting pro forma EPS of approximately $2.90-3.10 per share.

This is based on a pro forma income tax rate of approximately 15.5%.

GAAP EPS is expected to be approximately $1.25-1.45 per share primarily as a result as the same non-cash items that will impact Q1 as well as the shareholder litigation settlement and the income tax refund. We expect to achieve full year gross bookings of approximately $4.1-4.2 billion.

The pro forma EPS guidance for the full year of 2007 is based upon a diluted share count of approximately 42.6 million shares, which includes a calculation of the economic dilutive impact of all of our outstanding convertible notes and stock options net of the favorable economic impact of our convertible note hedges based on actual year to date trading prices of our stock, and an assumption that the future trading price of our stock for the remainder of 2007 would be equal to yesterday’s closing stock price of $62.54 per share.

This calculation produces an average trading price for the year of $58.59 per share. The share count in today’s guidance is a slightly higher share count than the one we shared in last week’s pre-announcement due to additional treasury stock method shares that have been added to our share count due to the increase in our stock price due to last week’s pre-announcement. Despite the slight increase in share count, we remain comfortable with our $2.90-3.10 range.

And that leads me to a couple of final points that I would like to make about our forward-looking earnings for 2007 and beyond. The first point is essentially a repeat of a point I made on last quarter’s earnings call with respect towards diluted share count. On that call, I spend quite a bit of time talking about the potential dilutive impact that our outstanding convertible notes could have on our pro forma diluted shares outstanding, and therefore our pro forma EPS.

Given the current trading levels of our stock, the diluted share count used to compute both GAAP and pro forma EPS will be more affected by movements up or down in the future trading price of our stock. As I also mentioned, we do not want to get into the business of projecting our stock price, so instead, we wanted to give you some numerical guideposts to use, to allow investors to better understand the potential dilutive impact to EPS that our convertible notes could have on our diluted share count.

Specifically, at an average stock price of $50 per share for the full year 2007, the share counts that I just quoted for our full year 2007 pro forma EPS guidance would be reduced by approximately 1.8 million shares, and therefore our diluted share count would be approximately 40.8 million shares. At an annual stock price of $60 per share, the share counts would be increased by 300,000 shares, and therefore our diluted share count would be approximately 42.9 million shares.

At an average annual stock price of $70 per share, the share counts would be increased by 1.8 million in shares, and therefore our diluted share count would be approximately 44.4 million shares. Finally, at an average annual stock price of $80 per share, the share counts would be increased by 3 million shares, and therefore our diluted share count would be approximately 45.6 million shares.

As you can see, the higher our stock price goes, the more shares get included in our pro forma diluted EPS calculation, although as you can also see, the relationship is not linear, and the number of additional marginal shares decreases at ever higher stock price levels.

The second point has to do with our income tax rate. As most of you know, because of our significant NOL tax assets in the US, we are not much of a cash tax payer in the US other than on a small alternative minimum tax basis. On the other hand, our NOL’s do not apply in Europe, and we are therefore a significant payer of cash income taxes there. In recent years, our effective cash tax rate has increased significantly because of the increasing share of consolidated pre-tax profits that are generated in Europe.

Yet in 2007, our guidance for our cash tax rate assumes that this trend will stop and that there will be little change in the rate in 2007 versus 2006. This is due to our ongoing efforts to grow our domestic pre-tax income at significant higher rates in 2007 then in 2006. And while pre tax income is likely to grow at a faster rate in European than in the US in 2007, the respective growth rates are expected to be much more similar than in past years, and therefore we do not expect to see much of a change in our consolidated cash tax rate in 2007.

However, it is our current expectation that in 2008 and beyond, Europe will grow its pre-tax income at significantly higher rates than the US. And therefore, it is our expectation that our cash tax rate will increase in 2008 and beyond, as our European business generates an ever-increasing share of our pre-tax income.

So, while we are not going to get into a discussion of EPS for 2008 and beyond, I hope that this discussion of share counts and tax breaks are helpful to investors that are engaging in such a discussion.

And finally, I’ll point out as I’ve done on previous calls, that all of our forecasts are based on an assumption that we’ll continue operating in a consumer travel market that’s roughly similar to the current one, and any terrorist event, particularly within the United States or Europe in all likelihood would have a negative impact on the travel market in general, and our operating results in particular.

And with that, we’d be happy to answer your questions.

Question-and-Answer Session

Operator

Ladies and Gentleman, to ask a question please press the one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the question queue, please press the pound key. Again, to ask a question, press the one key. At this time we are holding for questions.

First question comes from Aaron Kessler of Piper Jaffray. Your line is open.

Aaron Kessler - Piper Jaffray

Great thank you. Good quarter guys. A couple questions, first, can you give us a sense for what the housekeeping is on what the international revenue number was? And then on, in terms of brand awareness, can you give us a sense they would have aided or unaided brand awareness bookings has in Europe at this point? I have one follow up question.

Bob Mylod

Sure, and I’ll take the first one. Europe revenues for Q1 were $48 million and the growth profit dollars were $47.1 million.

Aaron Kessler - Piper Jaffray

Good.

Jeff Boyd

And Aaron, as to the brand awareness, we don’t have the same kind of research for Europe that we have for the United States. We use that principally here, to track the impact of our offline marketing and we don’t do any offline marketing in Europe but I think you can get an indication of that from looking at some of the published traffic data that’s out there for the booking.com sites compared to some of the other online sites.

Aaron Kessler - Piper Jaffray

And you would imagine at some point, you would have to maybe increase the Europe brand aware system to kind of protect your brand anddo some search marketing and gain share, would you at some point consider doing more with the brand advertising in Europe?

Jeff Boyd

The way we look at that at this point in time is there are a lot of things that we are doing and can do to build the brand and build awareness without getting into television and magazine advertising, which the complexities of the European market make that very expensive and sometimes not that effective. So, we’re principally engaged in efforts to build repeat business and customer loyalty based on online advertising and based on their experience on the website.

Aaron Kessler - Piper Jaffray

Great thank you and good quarter.

Jeff Boyd

Thanks.

Operator

Thank you. Our next question comes from Anthony Noto with Goldman Sachs. Your line is open.

Jennifer Watson - Goldman Sachs

Hi, this is actually Jen Watson in for Anthony. Quick question on the higher net revenue rates on both the merchant and agency bookings quarter. Can you discuss the factors that drove that and if they are sustainable throughout the year?

Bob Mylod

Sure, Jen. With respect to merchant, our merchant products, I would say that we generally have experienced a slight increase in our core raw margins. With respect to the net revenue rate on agency, that’s more driven by seasonal factors as well as sort of the relative growth rates on a quarter by quarter basis. So because we did experience a sequential decrease in our gross bookings, remember because we recognized revenue on a stayed basis, there will always be a little bit of a lag effect. So, you should always see the revenue, if gross bookings are declining sequentially the revenues would not decline quite as fast in the same quarter.

Jennifer Watson- Goldman Sachs

Right, on a year over year basis, though with agency bookings, I see it never having a rate extended about 140%, does that year over year expansion likely to continue?

Bob Mylod

I think there’s more of an impact with respect to Q1 and you shouldn’t necessarily start extrapolating with that trend.

Jennifer Watson- Goldman Sachs

OK, thank you.

Operator

Thank you. Imran Kahn of JP Morgan, your line is open, sir.

Bridget Wysha - JP Morgan

Hi, this is Bridget Wysha calling in for Imran. We have a quick question about the international performance. It's consistently stronger than we all expect. Could you give any indication of what you think it will be going forward in the 15 different countries?

Jeff Boyd

I think we've given guidance to a range of growth rates for the second quarter, and so that represents our best estimate today. In terms of specific countries, I think our experience has been consistent over the last few quarters that the growth rates in continental Europe tend to be higher than the UK, which is a more mature market. And as I mentioned in the prepared remarks, we try to build business, albeit from a small base, in some of the newer markets as you travel east, and some of those markets do have a higher growth rate. But again, it's from a small base.

Bridget Wysha - JP Morgan

OK. And the operating leverage, could you discuss in more detail where you got that from, and how we should look at that going forward throughout the year?

Bob Mylod

Sure, well with respect to the US, I think we've been trying to alert investors, at least for two to three quarters, that our goal, and it really started in the fourth quarter of last year, but certainly into 2007, is that domestically we are very trying to manage our business for above-market growth and earnings, domestically, even if that comes at the expense of a little bit of top-line growth. And so that's why, if you look at our domestic gross bookings while they were flat, our earnings grew at substantial rates.

And that's very consistent with how we've been trying to manage the business, and that's as a result of, as we mentioned in our prepared remarks, more stringent ROI requirements with respect to on-line spend, and of course very careful expense management overall, which is something really that has been a part of Priceline going all the way back to the year 2000.

In Europe, I would say the leverage, again, was driven by very good ROIs with respect to on line spend better than we had planned, but with respect to fixed costs, if anything, that was really driven by, we said we probably did not hire as many people as quickly as we expected. We have very big growth plans in Europe to sort-of support the on line growth that we have, and our goal is to hire people, basically at this point, almost as fast as we can. And maybe we did not hire at the rate we expected in Q1. Our goal is to catch up to that because, again, we think the opportunity is large in Europe.

So while we had very good leverage in Q1, I would not say that in Europe we have reached the point that we are at in the US, where we are really trying to go for leverage. Our goal is to go for growth in Europe. It just so happened that expenses did not catch up to our growth in Europe in Q1. But our goal is build up those markets across Europe, and there will be some expenses associated with it.

Bridget Wysha - JP Morgan

Alright, thank you.

Operator

Thank you. Our next question comes from Chris Gutek of Morgan Stanley. Your line is open.

Chris Gutek - Morgan Stanley

Thanks. Hi guys, nice quarter. A couple of follow-ups on a previous line of thinking. First, focusing back on the US for a minute, could you elaborate a little more about how you're thinking about the optimal trade-off between growth and margins in the US, specifically, do you think that you could further cut back on the marketing and further boost margins meaningfully, or conversely, are you a little bit unhappy with the kind of growth you're seeing, and you'd like to spend a little more and get the growth rates back up? How much more opportunity is there to further tweak that optimal mix of growth versus profitability?

Jeff Boyd

You know, I think there are a couple of points I would make in response Chris. The first is, we do look at the different lines of business a little bit differently. Going back several years ago for Priceline, we experienced substantial year-over-year declines in our Opaque airline ticket business. And yet we were able to generate significant growth in Opaque hotels and Opaque rental car. And so I think that, while we're a little bit disappointed to see the year-over-year decline in airline tickets, it's much more important for us to have better trends in hotels and rental cars. And I think I said in the prepared remarks that we saw unit growth in hotels and rental cars, and that was in respectable levels, given what we understand about growth otherwise in the marketplace.

So I think, while we're disappointed to see the airline ticket growth disappear and shrink here in the first quarter, as we mentioned, most of that is tied to Orbit's, and to really declining margins in retail tickets. We are absolutely not going to chase that business at a loss. We don't think that's the right way to run the business, and our experience tells us it's not necessary for us to that, in order to maintain relevance and continued growth in the hotel and rental car businesses, which are really much more important to driving our overall profitability, and I think maintaining high relevance and brand loyalty with our customers.

Chris Gutek - Morgan Stanley

OK. Maybe it's a similar conversation in the European business, and maybe to the extent that you're several years behind in Europe than what you are in the US, but could you elaborate on the opportunities to increase penetration in larger markets and to get into some newer markets, in terms of, how many years does it take before your European business looks like your US business? And maybe how many multiples of the current size in Europe can it be as that plays out over the next few years?

Jeff Boyd

We think there are just so many differences in the marketplace, that we don't really look at Europe and say, “OK, how much is this like the United States, and how can we map a path to the same levels of maturity that we see here in the United States?” Because of the relative youth of the market, because of basic travel trends, because of the complexity that different languages, different countries and cultures inject into the process, we just think it's a fundamentally different opportunity.

The size of the opportunity is bigger, the population is at least as big, and there's more leisure travel because there is more holidays. The value of the service that we provide is higher for customers because they need the information we provide, and it's higher for suppliers, because they really don't have the ability in general to reach complex European demand on their own. So we really believe it's just fundamentally different.

And if you look at the relative penetration of on-line travel in some of the less mature markets in Eastern and Southern Europe, that's essentially an untapped opportunity, in our opinion. So we just think there's a lot of runway, and we also think that the general travel market is basically developing a little bit differently there because of the very significant penetration of low-cost carriers.

It's really made travel more affordable, and it's changed the way that people book travel. They've gotten used to the idea of being able to book a low-cost airline ticket virtually at will, and the principle shopping ends up being around the hotel. And we've got a great product to meet that demand.

Chris Gutek - Morgan Stanley

OK, great. And a quick one for Bob. Do you have the legal costs on an after-tax basis for the settlement?

Bob Mylod

Well, I gave the components. I didn't break out the tax-effect legal for just the legal settlement. I did it for that including excise taxes. Maybe I could follow-up for you, Chris. It will certainly be in the queue that we file tomorrow.

Chris Gutek - Morgan Stanley

OK, great. Thanks.

Operator

Our next question comes from Paul Keung of CIBC. Your line is open.

Paul Keung – CIBC World Markets

Hey Jeff and Bob. Expedia mentioned today that their investment in Europe's second-tier markets is a long road ahead, and today they're really only making initial steps in the UK. So what do you think are the values to entry for a new entrance, for your strong leash on the secondary and tertiary markets in Europe?

Bob Mylod

I think it represents to an advantage to us in some markets to be a first mover in terms of supply and inventory, but my belief is that those markets are available if somebody wants to go out and try to get supply. I'm sure Expedia will be reasonably successful in doing so. I don't think there's a huger barrier to entry in doing so. But I think we've got an inventory position there that's defensible and attractive for us.

Jeff Boyd

I would also add to that, that I think there's a general view out in the market that Priceline Europe is all about tertiary markets. And obviously that is an aspect of our business. But we've obviously given our gross bookings in Q1. We're at a $2+ billion run rate of gross bookings. And you don't get that big being in tertiary markets. So the major markets are very significant, big contributors to us. I think investors are somewhat a little bit misled into thinking that our gross bookings are driven by a bunch of cities that no one’s ever heard of. The biggest cities, London, Paris, those are our most important cities in terms of gross bookings.

Paul Keung – CIBC World Markets

Thank you.

Operator

Thank you. Our next question comes from Mark Mahaney of Citigroup Investment. Your line is open.

Mark Mahaney - Citigroup Investment

Thank you very much. Just one question on Europe. Can you give us an update on your thinking about different products outside of hotels, you’re clearly at a scale now and a size where you probably could advance aggressively into some other travel products like you already do a little bit of that... how do you think about the trade-offs in terms of doing that and the competitive advantages that you would bring to some of those other segments? Thank you.

Jeff Boyd

I think, going back to the comment I made, Mark, about the differences between Europe and the United States, we really don’t have a view that the airline ticket business there is sufficiently attractive that we would try to start up a green field operation in airline tickets. Given the growth rate that we have in hotels, and we think that the great promise with that market continues to hold at this point in time, and we’re probably going to stay focused on hotels. I wouldn’t say never with respect to any other products, but we think hotels are the most attractive market for us right now.

Mark Mahaney - Citigroup Investment

Thank you Jeff.

Operator

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

James Sanford - Merrill Lynch

Hi, this is James Sanford for Justin Post. A couple really quick questions. One, on the Orbitz falling off this quarter, can you provide us in details, and I apologize if I missed it, on what that US growth might have been excluding the Orbitz on an organic basis? And secondly, it sounds like the US hotel industry is starting to reach a more stable sort of environment from the supplier perspective even with RevPAR potentially coming down. How does that impact Priceline going forward if conditions from suppliers start to improve?

Jeff Boyd

I’ll answer the second question first, and then maybe Bob can hit the first one. I think the conditions in the hotel market are attractive for online travel agents and attractive for hotels, quite frankly. We are starting to see new supply come on with RevPAR growth moderating a little bit here. I think the value of the distribution we bring to the hotels is probably enhanced a little bit. People start to focus a little bit more on getting share versus absolutely maximizing their yield so, I think it’s a good market both for hotels and a good market for us to demonstrate the value of our distribution to hotels.

Bob Mylod

And with respect to Orbitz, we’re not quantifying it, only because it’s impossible to quantify how much of the Orbitz traffic was essentially cannibalistic as you probably remember, that deal was branded. So, certainly some of the folks that came to us through Orbitz would have come to us anyway by just coming directly to our website. All of the Orbitz business appeared as merchant gross bookings, and as you can see, we have the Orbitz business in Q1 of last year.

We did not have it in Q1 of this year, nevertheless, our merchant gross bookings were up as Jeff mentioned. They went from $266 million to $287 million despite the loss of Orbitz. So I think that tells you, obviously, that there was some diluted impact of the Orbitz deal, not to mention, obviously, how much we had to pay for it. Now the Orbitz business did get off to a slow start last year, so the impact of losing Orbitz for Q’s 2,3, and 4, well, will have more of an impact for our merchant gross bookings than they did in Q1. But again, it’s very difficult to quantify it on a dollar by dollar basis given sort of the cannibalism point I made.

James Sanford - Merrill Lynch

That’s great. Thank you.

Operator

Thank you. Our final question comes from Michael Millman of Soleil Securities. Your line is open sir.

Michael Millman - Soleil Securities

I have a couple questions as well. Could you tell us what the ADR increase in Europe and sort of related to that, how much growth comes from adding new hotels versus getting more concentration in the bulk of the hotels you do business with?

Jeff Boyd

We don’t break out the ADR’s for our markets. I mention that we continue to sign up hotels, and we’re over 30,000 now. And we certainly believe that’s helpful to our conversion, and making both the active hotels inventory and bookings hotel inventory together, available together, to all of our customers, has helped our conversion in the latter half of last year and certainly continues to help us now.

Michael Millman - Soleil Securities

Well, in that connection, can you give us some idea, or quantify the conversion rates and/or the repeat rates?

Jeff Boyd

Again, we think that information is sensitive competitively and don’t break it out.

Michael Millman - Soleil Securities

OK, and in regards to talking about the comment on Expedia, do you see, and your comment on Orion Air, do you see their deal with Orion Air helping them get into some of those markets at which you presently are playing?

Jeff Boyd

I think Expedia and Hotels.com have a big enough footprint and enough demand to basically contract for inventory and availability without doing the deal with Orion Air. I think where Orion Air will probably help them is in their most dense destinations, and I’m not sure whether that foots with secondary or tertiary markets or not. I suspect they’re really flying to the primary leisure destinations in Europe.

Michael Millman - Soleil Securities

And I think you said that in ’08 you expect against the European earnings, to significantly outpace the domestic, I guess similar to ’06, but not like ’07. Is there something in particular that you should emphasize is happening in ’07 and domestic to make it, presumably its profit move ahead kind of on a one year basis?

Jeff Boyd

I wouldn’t characterize what’s going on in the United States as something that’s on a one year basis. I think Bob’s comment on the tax rate is more driven by the very significant disparity in gross booking growth rates that you’re seeing between Europe and the Unites States.

Michael Millman - Soleil Securities

But more so in ’08 than in ’07? But when do you expect the bookings growth rate to be slowing in Europe?

Jeff Boyd

Again, the bookings growth rate is also slowed in the United States and you can see that in the first quarter results.

Michael Millman - Soleil Securities

And finally, can you give us an idea or at least ranking of the revenue profitability in the US between the merchant hotels and the merchant cars?

Bob Mylod

We don’t break out profitability by segment, but I think we’ve certainly said on several previous earnings calls that the various significant majority of our gross profit dollars and profit in the US is driven by products not related to our airline ticket service.

Michael Millman - Soleil Securities

Can you break out between hotel and cars? The percentage?

Bob Mylod

Well, obviously we break out unit sales. When you look at rental car days, that’s basically 100% of those rental car days are generated within the US. That’s the most we can give you Mike.

Michael Millman - Soleil Securities

OK. Thank you.

Jeff Boyd

I think the operator said that was the last question. Thank you all very much for participating in our call.

Operator

Ladies and gentlemen, that concludes our program. Thank you for your participation and have a wonderful day. You may all disconnect at this time.

TRANSCRIPT SPONSOR

Tech-Stock Prospector seeks out promising small- and large-cap technology stocks offering a combination of growth and value. The research service is made up of Daily Online Updates at TechStockProspector.com, Action Alert e-mails and a 12-page monthly newsletter.

Editor Robert DeFrancesco, formerly senior writer at Louis Rukeyser's Wall Street, has covered the tech market for 15 years. He uses both fundamental and technical analysis to put together two long-term model portfolios. Tech-Stock Prospector also offers Trading Ideas and maintains a Watch List of potential additions to the portfolios.

To sponsor a Seeking Alpha transcript click here.

Copyright policy: All transcripts on this site are copyright Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY’S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY’S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY’S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

Source: Priceline.com Q1 2007 Earnings Call Transcript
This Transcript
All Transcripts