Expedia Inc.’s (EXPE) fourth quarter earnings missed the Zacks consensus by 2 cents, or 6.1% on revenue that beat by 0.7%. Expedia beat the Zacks Consensus by an average 9.23% in the preceding four quarters. Therefore, this miss was a big disappointment, reflected in the 12.65% plunge in share prices in after-market trading yesterday.
Revenue
Revenue for the quarter was $808.4 million, down 18.2% sequentially and up 15.9% year over year. Expedia stated that fourth quarter results were hurt by bad weather, and market trends remained strong. Currency had a 1 percentage point impact on year-over-year comparisons.
Revenue by Segment
Leisure customers remained the largest revenue contributors, generating nearly 83% of revenue. Corporate customers (Egencia) were under 5%, while TripAdvisor brought in the remaining 13%.
Sequential comparisons were mixed at -19.0%, 11.4% and -23.0%, respectively for the three categories. The segments were up 13.3%, 33.8% and 34.5%, respectively from the year-ago quarter.
While the leisure segment is the largest and most important for Expedia, it is clear that the company is gaining ground in the Egencia (corporate) segment. Earlier, management stated that both large companies and small and medium-sized ones had started to increase their traval expenditure.
Expedia appears well positioned to gain from this increase in spend. Egencia has increased at a double-digit year-over-year clip in each of the last five quarters and recent growth trends indicate that the segment is gaining momentum.
The increase from the year-ago quarter in both Leisure and TripAdvisor are also encouraging. However, while Expedia stated that it was gaining share in lodging, we think this is possible, mainly because online bookings are growing strongly at the expense of offline bookings and something that Expedia would gain from.
With a stronger outlook for both leisure and corporate travel, advertisers are also coming. TripAdvisor, in particular, did exceptionally well, recording third-party revenue growth of 48% (100% in the international business). This business is growing at a $500 million annual runrate, with the international portion posting triple-digit year-over-year growth in each of the last 5 quarters.
Revenue by Channel
Around 68% of total revenue was generated through the merchant business (direct sales), another 20% came through the agency model (where Expedia operates as an agent of the supplier) and roughly 12% came from Advertising and Media.
The three channels witnessed 17.3%, 19.1% and 14.5% sequential declines, respectively in the last quarter. Growth rates from the year-ago quarter were 11.7%, 14.9% and 29.9%, respectively.
Revenue by Product Line
Hotel and Air, the two main product lines grew 15% each from the year-ago quarter. The increase in Hotel revenue came from a 15.3% increase in room nights, helped by a 2% increase in the average daily rate (“ADR”). This was the biggest ADR increase since December 2008.
Revenue per night was again flattish, possibly due to the large number of hotel additions in the recent past. The increase in ticket revenue was attributable to a 6% increase in ticket volumes and 9% increase in the revenue per ticket. Airfares were up 5%, indicative of the fact that demand continues to increase.
Revenue by Geography
Around 59% of Expedia’s quarterly revenue was generated from the domestic market, with the remaining 41% coming from international sources. The domestic market declined 19.2% sequentially, but grew 14.9% from a year ago. The international market was down 16.8% sequentially and up 17.0% from last year.
Bookings and Revenue Margin
Gross bookings were $5.8 billion in the last quarter, down 16.5% sequentially and up 14.0% year over year. The percentage of bookings converted to revenue (revenue margin) was 14.7%, down 36 bps sequentially and up 30 bps from a year ago.
International conversion was better than domestic. Egencia and the merchant channel were the more important contributors to the revenue margin in the last quarter.
Margins
The pro forma gross margin for the quarter was 78.2%, down 256 bps sequentially and 93 bps year over year. Credit card processing costs continued to increase, although the number of transactions dropped from 15.8 million in the year-ago quarter to 14.8 million in the last quarter. However, volume increases continued, partially offsetting the negative impact.
The operating expenses of $465.8 million were down 9.2% sequentially and up 6.2% from last year. Technology and content expenses were up 230 bps sequentially as a percentage of sales, while G&A was up 328 bps. They were both down from last year. The operating margin of 20.6% dropped 826 bps sequentially and 86 bps from last year.
Operating Income before Amortization (OIBA) increased from $162.9 million in December 2009 to $175.1 million in the last quarter.
Net Income
On a pro forma basis, Expedia generated a net income of $85.3 million, or a 10.6% net income margin compared to a $184.7 million, or 18.7% in the previous quarter and $99.3 million or 14.2% net income margin in the same quarter last year. The fully diluted pro forma earnings per share (EPS) were 30 cents, compared to 64 cents in the September 2010 quarter and 34 cents in the prior-year quarter.
Our pro forma estimate excludes intangibles amortization charges and occupancy tax assessments and legal reserves 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 $71.3 million ($0.30 a share) compared to $176.6 million ($0.62 a share) in the previous quarter and $102.2 million ($0.35 a share) in the year-ago quarter.
Balance Sheet
Cash and short term investments totaled $1.23 billion at quarter-end, down $324.4 million during the quarter. The net debt position of $414.9 million was higher than the net debt of $90.4 million going into the quarter. Including long term liabilities, the debt to total capital ratio was 43.1%, still at very manageable levels.
Days sales outstanding (DSOs) went down slightly from 38 to around 37 days. We note that more than half the assets are goodwill (not real assets).
Expedia used $160.2 million in operations in the last quarter, compared to $4.4 million of cash generated from operations in the previous quarter. It spent $41.9 million on capex, $14.1 million on acquisitions, $19.3 million on dividends and $107.6 million on share repurchases.
Our Take
Expedia witnessed a temporary setback in the last quarter, as bad weather hurt its business. However, the secular drivers of the company’s business remain on track.
Aside from growth prospects in the domestic market, which are improving as a result on the economic turnaround, Expedia has tremendous growth opportunities internationally, particularly in the Asia/Pacific market, where online penetration is still low.
The company has responded by steadily increasing its hotel inventory. Additionally, ADRs are also on an upward trend, so profitability may be expected to improve.
That said, the company will continue to face challenges from players like Priceline.com (PCLN), Orbitz Worldwide (OWW) and Travelocity, as well as a growing number of local Chinese players that could make expansion in the fast-growing Chinese market difficult.
Additionally, Google Inc’s (GOOG) venture into the travel market is expected to increase costs for Expedia. Competition aside, Expedia and other online travel agents are fighting the incidence of occupancy taxes, which remains a hotly debated and contested issue today.
We have a Zacks #4 Rank on Expedia shares, which translates to a short-term Sell rating.
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