Expedia Inc.’s (EXPE) first quarter earnings beat the Zacks Consensus by 4 cents, or 17.4%. Revenue was in line with expectations. Shares opened slightly higher this morning, but have been down roughly 3% since then. This could be because of the continued decline in sequential earnings despite the solid revenue growth that is an indication of shrinking margins at Expedia.
Revenue
Revenue for the quarter was $717.9 million, up 2.9% sequentially and 12.9% year over year. The sequential increase was in line with seasonal trends. The increase from the year-ago period was helped by higher volumes, partially offset by lower fees charged to customers.
Revenue by Segment
Leisure customers remained the largest revenue contributors, generating 81% of revenue. Corporate customers (Egencia) generated a little over 4%, while TripAdvisor brought in the remaning 15%. The three categories grew -0.6%, 17.2% and 42.5%, respectively, from the Dec 09 quarter. They were up 9.7%, 36.0% and 119.2%, respectively, from the year-ago quarter.
The strong performance from the year-ago quarter was helped by weak comps, as the recession impacted corporate spending on travel and the company made use of promotional and discounted inventories to boost sales. TripAdvisor, in particular, did exceptionally well, as traffic grew very strongly, as evidenced by the strong pickup in click rates.
Additionally, more than 12,000 subscribers were signed up for the new business listings product. Acquisitions had a 0.4% positive impact on year-over-year comps in the last quarter.
Revenue by Channel
Around 63% of total revenue was generated through the merchant business (direct sales), another 23% came through the agency model (where Expedia operates as an agent of the supplier) and roughly 14% from Advertising and Media.
The 15.9% and 9.1% sequential and year-over-year increases in the agency business were attributable to better product selection, which helped growth in traffic.
The merchant business was down 5.1% seqentially and up 10.3% from the year-ago quarter. The sequential decline was on account of seasonality. The year-over-year increase was attributable to the company’s marketing iniatives and investment in an experienced marketing team, as well as the addition of properties. Management stated that the number of hotels doing business through Expedia increased 24% from the year-ago quarter.
Advertising and Media saw robust growth in the last quarter, with revenue increasing 34.2% sequentially and 13.7% year over year. The company is making strategic investments in this area, which along with a recovering travel market should continue to generate strong growth.
Revenue by Product Line
Although both Hotel and Air — the two main product lines — grew from the year-ago period, the growth in hotel revenue was more robust at 12.0%. While hotel room nights continued to grow at a double-digit clip (up 17.8%), the most encouraging factor was the flat average daily rate (ADR). The ADR has been sliding in four straight quarters prior to the March quarter, three of which were double-digit declines.
With the number of hotels increasing rapidly, the revenue per night growth declined 5% from the year-ago period. Ticket volume growth of 22.0% was also strong, although it was lower than in the preceding two quarters. Airfares were up 9.0%, with revenue per ticket declining 13.0% from the year-ago quarter.
Last year, the company decided to reduce and/or waive booking fees, which impacted both revenue and margins. With improving market conditions, we may expect booking fees to return.
Revenue by Geography
Around 65% of first quarter revenue was generated from the domestic market, while 35% came from international sources. Although the domestic market grew 12.8% sequentially, the international market down 11.7%. However, International was up 31.6% from the year-ago quarter, fueled by solid growth in hotel room nights.
Bookings and Revenue Margin
Gross bookings were $6.6 billion in the last quarter, up 31.4% sequentially and 26.9% year over year. Acquisitions had a 2.0% positive impact on gross bookings in the last quarter.
The percentage of bookings converted to revenue (revenue margin) was 11.5%, a decline of 290 bps sequentially and 70 bps from the year-ago quarter. The international revenue margin was better than the domestic. All segments and channels contributed to both the sequential and year-over-year declines, although the merchant business and leisure segments suffered more.
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. However, comps will get easier from next year, as most of the fee reductions were implemented in the first quarter of 2009.
Margins
The pro forma gross margin for the quarter was 78.0%, down 115 bps sequentially and up 56 bps year over year. Despite volume increases, fee waivers and other promotions impacted the gross margin negatively. Credit card processing costs and customer operation costs were significantly higher in the last quarter, although the increase in data center costs moderated.
The operating expenses of $438.7 million were up 9.0% sequentially. The operating margin was 16.9%, down 456 bps sequentially and up 54 bps from the year-ago period. The sequential increase in selling and marketing expenses in the last quarter was necessitated by higher business volumes. Overall, COGS and selling & marketing expenses were up 115 bps and 545 bps, respectively, while technology & content and general and administrative expenses declined 17 bps and 186 bps, respectively.
Net Income
On a pro forma basis, EXPE generated a net income of $66.7 million, or a 9.3% net income margin compared to a $99.3 million, or 14.2% in the previous quarter and $51.7 million or 8.1% net income margin in the same quarter last year. The fully diluted pro forma earnings per share (EPS) were $0.23, compared to $0.34 in the Dec 2009 quarter and $0.18 in the prior-year quarter.
Our pro forma estimate excludes intangibles amortization charges 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 $59.4 million ($0.20 a share) compared to $102.2 million ($0.35 a share) in the previous quarter and a $39.4 million ($0.14 a share) in the year-ago quarter.
Balance Sheet
Cash and short-term investments totaled $1.04 billion at quarter-end, up $355.6 million during the quarter, resulting in a net cash position of $148.7 million. Including long-term liabilities, the debt-to-total-capital ratio was 35.0%. Days sales outstanding (DSOs) went up slightly from 40 to around 48 days.
The company generated $619.5 million of cash from operations, compared to a cash usage of $144.3 million in the previous quarter. Expedia spent $29.7 million on capex, $20.2 million on dividends and $197.6 million on share repurchases.
We have a Neutral rating on EXPE shares.
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