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Operator
Good day, ladies and gentlemen, and welcome to the priceline.com third-quarter conference call.
At this time, all participants are in a listen-only mode.
Later, we will conduct a question and answer session and instructions will follow at that time.
As a reminder, this conference call is being recorded.
Priceline.com 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.
The following factors, among others, could cause priceline.com's actual results to differ materially from those described in the forward-looking statements.
Adverse changes in general market conditions for leisure and other travel products as the result of, among other things, terrorist attacks or hostilities; adverse changes in priceline.com's relationships with airlines and other product and service providers, including, without limitation, the withdrawal of providers from the priceline.com system; the bankruptcy or insolvency of a major domestic airline; the effects of increased competition; systems-related failures and/or security breaches; priceline.com's ability to protect its intellectual property rights, losses by priceline.com and its licensees; final adjustments made in closing the quarter; legal and regulatory risks; and the ability to attract and retain qualified personnel.
For a detailed discussion of these and other factors that could cause priceline.com's actual results to differ materially from those described in the forward-looking statements, please refer to priceline.com's most recent filings with the Securities and Exchange Commission.
Unless required by law, priceline.com undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.
And now, let me turn the call over to priceline's Chairman and Co-Chief Executive Officer, Mr. Richard Braddock.
Please go ahead, sir.
Rick Braddock - Chairman and Co-Chief Executive Officer
Thanks, and welcome to our third-quarter earnings call.
As usual, I'm joined by Bob Mylod Jr., our CFO, and Jeff Boyd, our President and Co-CEO, both of whom will speak a little later on in the call.
In a word, our results for the quarter were disappointing, although the reasons were mixed.
Financially, we lost 11 cents a share on a GAAP basis on total revenue of $240 million, with the results significantly impacted by a $24 million charge we took primarily to reflect asset impairment in our European and Asian ventures.
On pro forma or net operating bases, however, we basically broke even for the quarter.
Our results were obviously dominated by the continued soft results in our airline business.
With the airlines continuing to price extremely low in the market -- and I might add, below the level they would need to attain to survive financially -- the savings we can offer our customers remain substandard.
This reflected itself in a substantial year-to-year decline in airline tickets written, down 46%.
At the same time, our hotel business continues to grow extremely well.
We have booked offers for the quarter up 37% and a modest increase also registered sequentially.
Viewed from the perspective of our customer base, our results were also mixed.
While our total offers were basically flat -- actually up 2% on a year-to-year basis -- our new customer flow decreased about 11%, more than entirely due to air.
On the other hand, our repeat customer traffic increased by 9% year to year, and our repeat rate as reported strengthened to 67.4%, up from 62.7% a year ago, reflecting not only the somewhat slower new customer flows, but also the continued strengthening and loyalty of our repeat franchise.
I might add that almost one-third of our repeat offers were due to multiple repeaters within the quarter, another sign of our core customer loyalty.
While we report these metrics only on a business-wide basis, our numbers I've just described are all substantially stronger for hotel than air, as reflected in the fact that our non-air booked offers increased from 41% to 61% of the company total year to year, up 20 percentage points.
These results reflected our view that we need to take some specific actions going forward.
First of all, we're not forecasting an improvement in our air business because we have no visibility as to how and when the airlines are going to go about restoring their pricing to a sustainable level.
We'll continue not only to offer our current name your own price airline product, but we'll also supplement it with a retail offering available both as a choice for unbound price line customers and through our lowest fare site.
More importantly, we will turn our marketing emphasis to our growing businesses, including, of course, hotel and our new vacation product.
Furthermore, we're announcing a restructuring of the business, reducing our head count complement by approximately 15%, down to about 300 people.
Bob will summarize the details, but we expect our non-discretionary expenses to be down by at least $13 million next year.
Now let me turn the call over to Bob, who will review the financials, and then Jeff, who will talk about the business, and then wrap up before questions.
Robert Mylod Jr. - Chief Financial Officer
Thanks, Rick.
Rick covered the main financial numbers for our third quarter, and Jeff will expound further on some of our metrics momentarily, so I'm going to focus my remarks on discussing a few specific topics that are worthy of greater amplification.
And I'd like to start with revenues.
I mentioned on our previous earnings call that the challenging supply dynamics that we were experiencing in our airline product, coupled with the uncertainty around demand for travel during the first anniversary of the terrorist attacks made it extremely difficult to predict our top line for the third quarter.
We therefore chose to not give specific revenue guidance for the third quarter.
Instead, we stated that our actual July revenues, representing the first month of our third quarter, were between 92 and $93 million, and that we expected to experience a monthly sequential decline in our August revenues.
Finally, we said that while September should typically be an up month from a seasonal perspective, it was certainly possible that September could be down sequentially, due to the current operating environment.
As the quarter played out, August, as predicted, was down sequentially.
And September was not only not up sequentially, it came in significantly below August levels.
All other financial measures -- most notably gross margin, variable operating expenses and fixed operating expenses -- came in at or better than expected levels, which is why we were able to manage our business to a break-even quarter, consistent with the low end of our EPS guidance on a pro forma basis, despite our disappointing revenue performance.
The second topic that I want to cover centers around the nonrecurring charges that we recognized in the third quarter related to the impairment of the carrying value of our investments in our European and Asian licensees.
You will recall that during the course of the past several years, we have pursued a licensing strategy for our business model in both Europe and Asia.
Priceline Europe was originally launched in the year 2000 and funded primarily by outside investors up until 2001, when priceline acquired a majority interest in priceline Europe and began consolidating its results of operations.
Hutchison priceline is our Asian licensee.
We own a convertible note that is convertible into roughly a 30% equity interest in Hutchison priceline.
Due to a whole host of factors, including the recent operating performance of both priceline Europe and Hutchison priceline as well as the overall decline in the fourth third quarter in the market value of priceline.com's common stock, which is the single most relevant comparable for determining the carrying value of our investments in our offshore licensees, it was appropriate to recognize an impairment charge for these investments.
The charge totaled $24.2 million.
The charge was non-cash in nature, and represents the single largest component of the difference between our break-even pro forma results and our GAAP loss of 11 cents per share.
This charge in no way diminishes our hope that both offshore licensees will ultimately become successful.
Both priceline Europe and Hutchison priceline continue to operate their businesses and we and our financial and operating partners are working harder than ever on putting both businesses in the best position to succeed.
I want to reiterate that these charges were non-cash and did not affect our cash flows during the quarter, which leads me to our next topic, which is cash flow.
Because while the impairment charges did not affect our cash flow, we did witness a $28 million decrease in our cash balances during the quarter, and I want to walk you through the causes of this decline.
In previous conference calls, we have often remarked that we benefit from a favorable working capital cycle due to the fact that we collect cash up front from our customers and then pay our vendors generally over a 10 to 15-day period.
From a balance sheet perspective, this means that our customer receivables are deminimus, regardless of our revenue levels, while our payables do move up or down significantly upon material changes in our revenue and cost of revenue.
Historically, we have experienced quarters where this dynamic has driven abnormally large increases in cash as well as abnormally large decreases in cash.
For example, in the second quarter of 2001, our cash balances increased to higher levels than our EBITDA would have indicated.
Namely because of the upward trajectory of our business in that quarter drove a large increase in supplier payables as compared to the previous quarter's levels, thus creating increased cash balances.
Conversely, in the third quarter of last year, our payables dropped to very low levels due to the dramatic decrease in customer activity in the wake of the terrorist attacks.
Consequently, our cash balances decreased quite dramatically in that quarter, despite our positive pro forma EBITDA.
I make mention of these two historical quarters to provide some context and to assure investors who are new to priceline that we have experienced such swings, both positive and negative, in cash before.
As for the specific detail for this quarter, we began the quarter with $180.2 million of cash and we closed the quarter with $152.5 million of cash, representing a $27.7 million decline.
To help you bridge the gap between our reported pro forma positive EBITDA of $4.5 million and our cash decline, let me draw your attention to our accounts payable account, which declined by almost $15 million during the quarter, driven primarily as a result of the aforementioned decline in revenues during the quarter.
In addition, we invested $11.7 million of cash in our stock buyback during the quarter, and finally, we invested $3.1 million on capital expenditures.
The sum of these three items totaled just south of $30 million during the quarter, and were the principal causes of our cash decline.
Finally, my last topic to cover is guidance and I'm going to mirror the format used on our last earnings call.
Our October revenues, representing the first month of the fourth quarter, came in at roughly $72.5 million.
This monthly performance actually represented a slight recovery from our September levels, which is contrary to the typical seasonal pattern we would expect to see.
However, we do expect to experience monthly sequential declines in revenue for the remainder of the quarter, which is typical of our seasonal pattern, and which will drive our fourth-quarter revenues to below the $218 million that that our October monthly run rate might suggest.
As for earnings, we expect to report EPS before restructuring charges of between a loss of 2 cents per share and break-even.
In addition, we do expect to record a restructuring charge in the fourth quarter of approximately 4 to $5 million, primarily related to the downsizing in our workforce and the restructuring of our non-travel verticals which was implemented today.
Approximately one-third of this charge will be non-cash in nature.
We have reduced our employee and consultant head count by approximately 65 as a result of today's initiatives and we expect to enter 2003 with an approximately 300 employees, and an even leaner fixed cost structure.
Rick mentioned earlier that our non-discretionary costs will be reduced by approximately $13 million next year.
Half of this improvement comes as a result of today's restructuring initiatives, and the other half comes from reduced depreciation expense resulting from our capex savings in the past two years.
As for 2003, we are not going to provide specific guidance, but I did want to leave you with two thoughts.
First, the projected operating losses that we expect to incur in the fourth quarter of this year are likely to continue into the first quarter of next year, as we are planning for one of the largest quarterly advertising expenditures in almost two years aimed at re-vitalizing and reenergizing our brand and our business momentum.
Second, despite those first-quarter operating losses, it is our goal to deliver full-year Pro Forma EPS results that on a percentage basis are materially better than the pro forma EPS that we deliver this year.
As for our cash balance, despite our projected operating loss and our decrease in revenues during the fourth quarter, we expect our cash balance to come in at roughly the same $150 million level that we start the quarter with, as our Q4 changes in working capital will not be nearly as severe as those experienced in Q3.
And now I'm going to turn the call over to Jeff.
Jeffery Boyd - President and Co-Chief Executive Officer
Thanks, Bob.
Priceline's results continue to suffer from the crisis in the domestic airline industry, which is now entering its second year.
These protracted conditions affect priceline more than other prominent on-line travel companies for several reasons.
First, a significant majority of our revenue and gross profit is still derived from the sale of airline tickets.
Second, widespread discounting of published fares by major carriers and low-cost carriers has reduced the amount of savings available to priceline customers.
Finally, given capacity reductions, airlines have limited seat availability to opaque channels, particularly during peak travel periods.
These trends have caused lower buying rates and suppressed customer demand and there is no evidence of an intention or ability on the part of the major carriers to significantly change these circumstances.
Indeed, there is mounting evidence that the strategy of major airlines to drive distribution cost savings through published discounts in owned on-line channels such as Orbitz and hotwire is a substantial factor, together with lower sales of business travel fares in the continued yield deterioration that has resulted in multi-billion dollars industry losses.
Widespread publication of deeply discounted fares is clearly shaping leisure and business customer expectation, as to what they should pay to fly today.
While distribution costs are an important expense for major carriers, they pale in comparison to the revenue decreases associated with falling yields.
Similarly, if airlines continue to drop distribution channels in an effort to eliminate costs, they will have no distribution costs in that channel, but they will also have no revenue, a risky strategy for an industry that is expected to lose over $15 billion over the last two years.
In summary, we continue to believe our name your own price model provides the best non-dilutive model for airlines to move unsold inventory, and increase load factors and revenues, but we also expect difficult industry conditions will continue to put pressure on our airline ticket business.
Given these environmental factors, we continue our strategic emphasis on our hotel and packaged products and on supplementing our name your own price offerings, particularly air tickets, with discounted retail product offered by lowestfare.com.
In hotels, we sold over a million room nights in the third quarter and launched an improved website with a best price guarantee.
With great inventory and pricing, and more marketing support slated for next year, we look forward to continued strong growth from this product.
Our vacation product is now available in 45 destinations, and it continued its growth in the third quarter.
The transaction with go-go we announced today will allow us to offer a full range of package options on both lowest fare.com and priceline.
We will also continue to build priceline destinations, last-minute travel deals, and other product.
Finally, we will use our dynamic packaging technology to offer bundled product for non-resort destinations so that a customer visiting family or friends for three or four days in Chicago can save more by combining his air and hotel purchase.
We intend to launch the first phase of our retail airline ticket offering on lowestfare.com shortly, and we will begin integration and measurement of customer response.
Later this quarter, we will integrate lowest fare retail options for unbound air customers on priceline.
We believe we can retain unbound customers and ultimately benefit by attaching hotel and rental car sales to bound retail air customers.
Our marketing efforts will continue to focus on building the franchise through new customer acquisition, with a particular emphasis on our hotel product.
We will also target existing customers and encourage them to offer multiple products through billion dollar egg and more focused cross-sales.
These initiatives are under way today and early results are promising.
Priceline will continue to aggressively market through on-line and affiliate channels, as well as through traditional off-line channels.
Our investment in building priceline's brand and customer base through marketing will be unabated going forward.
The initiatives I outlined have benefited our non-air results this year, and we expect they will contribute going forward.
However, as I previously mentioned, given the size of priceline's airline ticket business, we expect continued pressure on our total revenues in the fourth quarter and 2003 from airline industry challenges.
Accordingly, we took the steps Bob mentioned to refocus our non-travel businesses and reduce expenses.
The result will be more resources devoted to our growth initiatives and better operating leverage.
With that, we'll now take your questions.
Operator
Thank you.
If you do have a question at this time, please press the 1 key on your touch-tone telephone.
If your question has been answered or you wish to remove yourself from the queue, please press the pound key.
One moment, please, if for our first question.
Our first question is from Anthony Noto of Goldman Sachs.
Please go ahead..
Anthony Noto - Analyst
Record low of 37% -- I think it's a record low.
You know, historically, if we go back in time, buying rates were over 50% --
Rick Braddock - Chairman and Co-Chief Executive Officer
Anthony?
Anthony Noto - Analyst
Yeah.
Rick Braddock - Chairman and Co-Chief Executive Officer
Sorry to interrupt you.
This is Rick.
Could you start your question again because we didn't hear the whole question on the other end?
Anthony Noto - Analyst
I apologize.
Buying rates in air have, prior to this quarter, and if we go back in time before September 11th, had been historically above 50%, and now they're trending below 40%.
Is there a way for you to quantify how much higher the average offer would need to be on percentage terms, to get back to that 50% level?
Just to help us delineate between supply and demand, and focusing specifically on the consumer's demand levels.
On a pricing basis.
Rick Braddock - Chairman and Co-Chief Executive Officer
It's not possible, Anthony, to do that calculation because there -- there is a distribution involved in, obviously, the offers.
But I think the problem is that fundamentally, the consumer is making offers with a very low savings range available, and even the tools that we have which you know about, such as best efforts and the like, to, in effect, trade that customer into a range where we can do business with them oftentimes puts them back close to, or in, the retail market.
And at which point, obviously, the -- the priceline trade-offs on air become relevant.
Anthony Noto - Analyst
Right.
As-we -- you know, as we communicate with our airline analysts and the airlines themselves and other people within the industry, what we're starting to hear is that obviously there's continued capacity reductions from the airlines, there's about another 8 to 10% being taken out.
There is some uptick, although its modest, on the corporate side, which should put more seats to business travelers, which should drive higher yields, which ultimately should drive higher prices for leisure fare.
Are you starting to see those signs?
It sounds like you're not seeing those signs at all, but is that sort of the sequence of events that needs to take place before the consumer will see a higher price from the airlines and before they'll make a higher offer to priceline?
Rick Braddock - Chairman and Co-Chief Executive Officer
I think probably there would be a lot of different views on the path that the airlines will travel on the way to getting higher prices.
I think the end game still is that they will have to basically create higher prices to survive.
But having said that, I think there is still a hope that they'll claw back probably more business travel at prior terms than will turn out to be the case.
Anthony Noto - Analyst
Okay.
And then quickly moving to the lodging business, which obviously you're going to focus more on, could you give us a little bit more detail on the marketing programs that you plan to put specifically behind lodging, and then how you'll allocate that spending not on a percentage basis but in terms of key communication behind priceline vis-a-vis lowest fare?
Jeffery Boyd - President and Co-Chief Executive Officer
Anthony, it's Jeff.
I think a couple of things that we can say, although it's really too early to get into a lot of detail about our marketing for next year, is that you will see us shift a higher percentage of our off-line spend towards hotel than you have seen in the past.
I think you will probably see a messaging from us that is more direct than what you've seen in the past.
We'll have programs, promotions, and the like that will be driven by our on-line channels, our affiliate programs, that will be in content related to what we do off-line.
So it will be an integrated approach.
Anthony Noto - Analyst
Right.
Rick Braddock - Chairman and Co-Chief Executive Officer
Anthony, just to supplement that, or add to it, I think the priceline promise -- name your own price -- in order to obtain substantial savings via the internet is totally operative for our hotel product, despite the problems with air.
Our bind rate is high, and we deliver the same consumer benefit that we started out to deliver for priceline total in the early days.
Anthony Noto - Analyst
Right.
There's also a lot of debate on the street in terms of how complicated or difficult it is to gain access to sort of merchant lodging inventory.
You have 8,500 properties now, which is ahead of another major competitor that's much larger and probably has more resources on the ground.
Could you talk about the trend that you see there?
Because you've made strong progress.
Do you see that as a key driver as well, or is it the driver sort of going forward going to be your price differential, or a combination of both supply and lower prices?
Thanks.
Jeffery Boyd - President and Co-Chief Executive Officer
I think the key difference between priceline and some of the other hotel -- merchant hotel sellers you might be talking about is that our model as a tool for managing revenue and inventory in the hotel business is liked very much by the major hotel companies.
They value their participation in priceline, and they provide us with inventory, and this -- this is a business where major hotel companies -- several of them -- participate exclusively with priceline.
So that's -- that's a differentiator between priceline and others.
Going forward, we could supplement the relationships we have with the major corporate chains by investing in relationships with more independent hotels and franchisees and over time, we intend to do that, but right now we're able to drive the business substantially with our relationships with the major national chains.
Anthony Noto - Analyst
Great.
Thank you very much.
Operator
Our next question is from Mark Mahaney of Morgan Stanley.
Please go ahead.
Mark Mahaney - Analyst
Great.
Thank you.
Two questions.
One, on the competitive landscape, on the opaque -- in the opaque travel space, can you provide any comments on what you're seeing there and to what extent that was an issue behind the quarter's performance?
And secondly, could you provide a little bit more color on how priceline Europe is doing?
Looks like revenues there were down about 8% or 10% quarter to quarter.
Some of the other e-commerce players have experienced pretty interesting inflection points in the third quarter in terms of e-commerce.
Are you seeing any signs of that in Europe, or all the same trends, the negative trends that you're seeing in the U.S. market, particularly in air, relevant to Europe as well?
Thank you.
Rick Braddock - Chairman and Co-Chief Executive Officer
Well, dealing with -- with Europe first, we're -- as you know, Mark -- really primarily doing business out of the U.K. today.
So our trends are not Europe-wide, even though we obviously offer flights and inventory into Europe.
And our business there is modest in size, and is, the trends are as you reflect.
So we don't see any particular buoyancy over there.
In actuality, in the air part of the business, some of the tendencies that are operative in the states here where the discounters are making some major inroads at the expense of the name-brand carriers is at least as pronounced over there as you probably know.
Jeffery Boyd - President and Co-Chief Executive Officer
Mark, as to your question about the competitive landscape here domestically, I think consistent with what both Rick and I said earlier, the principal issue affecting our business is the low level of retail fares, which means that customers often won't make the priceline trade-off and will just buy a retail ticket.
I'm sure there's been some impact on our business by other opaque ticket sellers as well, but I think it pales in comparison to the impact of retail pricing.
Rick Braddock - Chairman and Co-Chief Executive Officer
The opaque category is down substantially year to year.
Mark Mahaney - Analyst
Great.
Thank you very much.
Operator
And our final question is from Tom Underwood of Legg Mason.
Please go ahead.
Tom Underwood - Analyst
Yes.
Actually, I have a couple of questions.
One, I was wondering if you could tell us what portion of hotel buyers were air customers during the quarter, and how that's been trending year over year.
Jeffery Boyd - President and Co-Chief Executive Officer
I don't have that specific percentage for you, Tom.
We could get it for you, but it's -- it's -- the percentage of air customers that we actually cross-sell a hotel room to is pretty small.
Tom Underwood - Analyst
Right.
And I was just wondering -- I'm trying to see if -- just in terms of your growth being 30% in hotels year over year, which is down slightly, could it in part be due to weakness on the air side which could be a source of hotel customers.
Robert Mylod Jr. - Chief Financial Officer
I mean, Tom, it certainly is a factor, but as Jeff mentioned -- and this is one of our big opportunities is to expound on the question about our marketing programs going forward.
One of our biggest opportunities is we still have a huge number of customers, both formerly bound or not bound, in our air product that have still never used our hotel product, and that's going to be one of the key things we go after going forward.
So it's not the major contributor to -- to our year-over-year growth rates in hotel.
Tom Underwood - Analyst
Okay.
And then finally, you said you saw a little bit of a pickup in revenue in October versus September, which was unusual.
Robert Mylod Jr. - Chief Financial Officer
Yeah.
Tom Underwood - Analyst
Was that a -- more on the air side or the hotel side?
Robert Mylod Jr. - Chief Financial Officer
A combination of both, but more -- more related to air.
It's really more a reflection of September was just far worse than we expected.
As a result, primarily, of the terrorist attacks.
Tom Underwood - Analyst
Great.
Thanks.
Jeffery Boyd - President and Co-Chief Executive Officer
The anniversary of the terrorist attacks.
Tom Underwood - Analyst
I understood what you meant.
Jeffery Boyd - President and Co-Chief Executive Officer
I'm not trying to jinx anyone on the call.
Robert Mylod Jr. - Chief Financial Officer
Yeah.
I apologize.
Operator
And there are no further questions at this time.
Please continue.
Ladies and gentlemen, this concludes your conference for today.
Thank you for your participation.
You may disconnect at this time.
Have a good day.--- 0