Expedia Gets Volumes, Gives Profits

Expedia Inc.’s (EXPE: 21.35 +0.08 +0.38%) third quarter earnings beat the Zacks consensus by a penny. Revenue was basically in line, beating by 0.7%.
 
Revenue
 
Revenue for the quarter was $697.5 million, down 18.2% sequentially but up 12.4% year over year. Acquisitions had a 0.3 percentage point positive impact on revenue in the last quarter. The revenue decline from the previous quarter was due to seasonality, while the increase from the year-ago quarter was driven by higher volumes, partially offset by lower fees charged to customers.
 
Revenue by Segment
 
Leisure customers remained the largest revenue contributors, generating 85% of revenue. Corporate customers (Egencia) generated 4%, while TripAdvisor brought in the remaining 11%. The three categories grew -19.8%, -17.5% and 7.4%, respectively from the Sep quarter of 2009. They were up 11.4%, 90.5% and 16.0%, respectively from the year-ago quarter.
 
Leisure should continue to perform better than corporate, as occupancy rates remain higher for this segment, especially during the weekend. Besides, corporate spending on travel (which is considered discretionary in many cases) will recover slower than leisure.
 
Revenue by Channel
 
Around 68% of total revenue was generated through the merchant business (direct sales), another 21% came through the agency model (where Expedia operates as an agent of the supplier) and roughly 11% from Advertising and Media.
 
The 20.2% sequential decline in the merchant business was due to seasonality, while the 16.4% year-over-year increase was attributable to better product selection, which helped growth in traffic.
 
The 17.1% decline in the agency business was slightly more than normal seasonality and attributable to the gradual takeoff of management’s new strategy.
 
Advertising and Media revenue was down 7.2% sequentially and up 18.5% year over year. The continued strength from a year-ago perspective is due to the success of TripAdvisor, where the click rate far exceeded the revenue growth rate. The company is making solid investments in this business, which are expected to generate revenue over the next few years.
 
Revenue by Product Line
 
Hotel and Air, the two main product lines, experienced mixed results. Compared to the year-ago quarter, hotel room nights grew 22.6%, while air tickets sold grew 32.0%. The higher volumes were helped by management’s decision to waive hotel and ticket booking and cancellation fees. However, the higher volumes in hotels were partially offset by a 9% decline in the average daily rate and a 6% decline in revenue per night, which ultimately resulted in a 16% year-over-year increase in hotel revenue.
 
The increase in ticket volumes were more than offset by a 4% decline in airfares and 26% decline in revenue per ticket, resulting in a 2% year-over-year decline in ticket revenue. Although ticket revenue continued to decline in the last quarter, the rate of decline has slowed down considerably.
 
Revenue by Geography
 
Around 60% of fourth quarter revenue was generated from the domestic market, while 40% came from international sources. The sequential declines from the domestic and international markets were 20.5% and 14.5%, respectively. Negative seasonality and extension of fee reduction plan to several international markets were responsible for the declines.
 
Bookings and Revenue Margin
 
Gross bookings were $5.0 billion in the last quarter, a sequential decline of 14.6% and a year-over-year increase of 25.6%. Acquisitions had a 1.7% positive impact on gross bookings in the last quarter.
 
The percentage of bookings converted to revenue (revenue margin) was 14.4%, a decline of 72 bps sequentially and 107 bps from the year-ago quarter. The international revenue margin was better than the domestic. All segments and channels contributed to the year-over-year decline, although the merchant business improved with respect to the previous quarter.
 
The decline in revenue margin is largely attributable to service and booking fee reductions at hotels and helped by revenue offsets from the welcome rewards loyalty program and a shift to lower-margin agency bookings from cruise ship centers.
 
Margins
 
The pro forma gross margin for the quarter was 79.2%, down 97 bps sequentially and up 119 bps year over year. Despite volume increases, fee waivers and other promotions impacted the gross margin negatively compared to both sequential and year-over-year periods.

However, a 13% decline in data center costs and a 1% decline in credit card processing fees compared to the year-ago quarter were enough to offset the 19% increase in customer operation costs.
 
The operating expenses of $387.9 million were down 8.2% sequentially. The operating margin was 23.6%, down 701 bps sequentially and up 151 bps from the year-ago period. The largest contributor to the sequential decline was the 294 bps increase in general and administrative expenses as a percentage of sales.

Higher technology and content expenses (up 288 bps), COGS (up 97 bps) and selling and marketing expenses (up 21 bps) also contributed.
 
Stock-based compensation has been excluded from the above margins.
 
Net Income
 
On a pro forma basis, EXPE generated a net income of $91.5 million, or a 13.1% net income margin compared to $146.1 million, or 17.1% in the previous quarter and net income of $67.5 million or 10.9% net income margin in the same quarter last year. The fully diluted pro forma earnings per share (EPS) were $0.26, compared to $0.45 in the Sep quarter and $0.19 in the prior-year quarter.
 
Our pro forma estimate excludes restructuring expenses, intangibles amortization charges, an adjustment to an earlier provision made for occupancy tax matters that was determined in the last quarter on a tax-adjusted basis, but includes deferred stock compensation. Our pro forma calculations may differ from management’s presentation due to the inclusion/exclusion of some items that were not considered by management.
 
Including the special items, the GAAP net income was $102.2 million ($0.35 a share) compared to $117.0 million ($0.40 a share) in the previous quarter and a net loss of $2.7 billion (-$9.60 a share) in the year-ago quarter. The company took a $2.7 billion goodwill impairment charge and $233.9 million asset impairment charge in the year-ago quarter, which was responsible for the GAAP loss.
 
Balance Sheet
 
Cash and short term investments totaled $688.4 million at quarter-end, down $199.0 million during the quarter, resulting in a net debt position of $206 million. Including long term liabilities, the debt to total capital ratio was 33.5%. Both long term and short term investments also declined during the quarter. Days sales outstanding (DSOs) went up slightly from 39 to around 40 days.
 
The company used $144.3 million of cash in operation, up significantly from the $24.2 million used in the Sep quarter. The company also spent $29.1 million on capex, $36.6 million on acquisitions and also bought back a small amount of shares.
 
The increase in cash burn, coupled with liquidated investments and a very significant amount of goodwill on the balance sheet are a concern.
 
Management did not provide guidance for the first quarter or for fiscal 2010.