Expedia Inc.’s (EXPE) second quarter earnings beat the Zacks Consensus Estimate by 8 cents, or 14.8%. Solid revenue that beat consensus expectations offset higher costs and taxes to generate the results.
Revenue
Revenue for the quarter was $1.02 billion, up 24.5% sequentially and 22.7% year over year. Strength across segments, a notably stronger merchant business, international growth, higher room night volumes and continued increase in the average daily rate were the highlights of Expedia’s revenue performance. However, weakness in air ticket sales continued.
Revenue by Segment
Specifically, leisure customers remained the largest revenue contributors, generating around 80% of revenue. Corporate customers (Egencia) were a little over 4%, while TripAdvisor brought in the remaining 16%. The three segments grew 26.2%, 11.9% and 14.2%, respectively from the previous quarter. The segments were up 20.9%, 30.6% and 35.2%, 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 as well. Corporate spending on travel continues to pick up, helping air ticket sales, despite the rising airfares that were negative to the leisure business.
While the company’s improving technology platform is partially responsible for the increase in new signings, it is also apparent that companies that had curtailed business spending during the downturn were raising their travel budgets in order to drive sales. These two factors are helping Expedia take market share in the corporate segment.
Additionally, the cost of travel continues to escalate, converting into higher revenues for Expedia. Egencia has increased at a double-digit year-over-year clip in each of the last seven quarters and growth rates appear sustainable.
The increase from the year-ago quarter in both Leisure and TripAdvisor are also encouraging. Despite the increase in ADR, room nights continued to increase, which is a big positive, signifying much higher demand.
Management at Expedia also stated that the growing Chinese middle class was making for very good business, both within the country and cross-border to other Asian countries. Expedia’s eLong acquisition is paying dividends according to management and the recent partnership with Tencent is also expected to do well.
With a stronger outlook for both leisure and corporate travel, advertisers are also coming. TripAdvisor, did exceptionally well in the last quarter, recording 35% growth , with growth coming from both the domestic and international markets. TripAdvisor has grown very rapidly in recent times, which was one of the reasons management decided to spin off the business.
Revenue by Channel
Around 67% of total revenue was generated through the merchant business (direct sales), another 19% came through the agency model (where Expedia operates as an agent of the supplier) and roughly 14% came from Advertising and Media.
The three channels grew 10.5%, 31.9% and 14.0%, respectively in the last quarter. Growth rates from the year-ago quarter were 12.4%, 25.4% and 27.8%, respectively.
Revenue by Product Line
Hotel and Air, the two main product lines grew 27% and -1%, respectively from the year-ago quarter. The increase in Hotel revenue came from a 21.2% increase in room nights, helped by a 6% increase in the average daily rate (“ADR”).
Revenue per night increased 5%. This was the biggest ADR increase since December 2008. The decline in ticket revenue was attributable to an 11% increase in airfare growth, which resulted in a 3% decline in ticket volumes. The revenue per ticket increased just 1%.
Revenue by Geography
Around 57% of Expedia’s quarterly revenue was generated domestically, with the remaining 43% coming from international sources. The domestic business grew 18.6% sequentially and 10.1% from a year ago. The international business was up 33.6% sequentially and 45.2% from last year.
Expedia continued to see strength in Europe and opportunities in the Asia/Pacific continued to open up. During the quarter, Expedia signed an agreement with Air Asia that should extend its presence in the region and prove lucrative longer-term. It also made an acquisition in Australia.
Bookings and Revenue Margin
Gross bookings were $7.95 billion in the last quarter, up 9.0% sequentially and 19.0% year over year. The percentage of bookings converted to revenue (revenue margin) was 13.6%, up 160 bps sequentially and 48 bps from a year ago.
Domestic conversion was better than international, the first time in five quarters. Leisure and the merchant channels were the more important contributors to the revenue margin in the last quarter.
Margins
The pro forma gross margin for the quarter was 80.6%, up 223 bps sequentially and 82 bps year over year. Credit card processing costs continued to increase, with the number of transactions increasing from 16.9 million in the year-ago quarter to 19.4 million in the last quarter. Data center costs also went up, although more efficient customer handling mitigated this impact.
However, higher volumes saved the day. As a result, gross profit dollars were up from $665.4 million in the year-ago quarter to $825.1 million in the last quarter.
The operating expenses of $589.0 million were up 11.7% sequentially and 27.1% from last year. The operating margin was 23.1%, up 880 bps sequentially and down 116 bps from last year. The increase in sales and marketing expenses as a percentage of sales was the main reason for the higher opex (up 238 bps sequentially and 289 bps from a year ago).
The cost of sales dropped slightly from both the previous and year-ago quarters. All other expenses (as a percentage of sales) went up both sequentially and year over year, with the exception of G&A, which was down 949 bps from last year. Expedia stated that it continues to focus on technology and sales, so these line items will increase in the next few quarters.
Operating Income before Amortization (OIBA) increased from $219.5 million in June 2010 to $243.3 million in the last quarter, due to strong sales and operating leverage.
Net Income
On a pro forma basis, Expedia generated a net income of $150.0 million, or a 14.7% net income margin compared to a $61.3 million, or 7.5% in the previous quarter and $120.9 million or 14.5% net income margin in the same quarter last year. The fully diluted pro forma earnings per share (EPS) were 54 cents, compared to 22 cents in the March 2011 quarter and 42 cents in the prior-year quarter.
Our pro forma estimate excludes intangibles amortization charges and costs related to the TripAdvisor spin-off, 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 $140.4 million ($0.50 a share) compared to $52.0 million ($0.19 a share) in the previous quarter and $114.3 million ($0.40 a share) in the year-ago quarter.
Balance Sheet
Cash and short term investments totaled $2.29 billion at quarter-end, up $468.8 million during the quarter. The net cash position of $645.4 million was a big improvement from the $176.8 million going into the quarter. Including longterm liabilities, the debt to total capital ratio was 41.4%, still at very manageable levels. Days sales outstanding (DSOs) went from 48 to around 42. We note that nearly half the assets is goodwill (not a real asset).
Expedia generated $490.7 million of cash from operations in the last quarter, down from $729.1 million in the previous quarter. It spent $58.0 million on capex, $8.1 million on acquisitions, $19.2 million on dividends and $1.3 million on share repurchases.
Our Take
Expedia is seeing renewed strength in both domestic and international markets and the secular drivers of the company’s business remain strong. The travel market all over the world is in a growth phase, especially the online segment, which is also gaining from the shift in booking preferences from offline to online.
Aside from a stronger domestic market, Expedia is taking share in Europe and has tremendous growth opportunities in the Asia/Pacific market, where online penetration is still low. The company has responded by steadily increasing its hotel inventory and is in the process of revamping its technology platform, which should improve conversion rates going forward.
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. The TripAdvisor spin-off is a positive in this respect, although Expedia stands to lose the advertising hedge it has enjoyed thus far. Competition aside, Expedia and other online travel agents continue to fight the incidence and collection 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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