Expedia Inc. (EXPE - Analyst Report) reported third-quarter earnings of $1.26 that grew 124.1% sequentially and 0.3% year over year to meet the Zacks Consensus Estimate. Excluding stock based compensation and unrealized gains on revenue hedges (as reported), pro forma earnings would have been 17 cents higher. Investors responded to the reported numbers, sending shares up 18.8% in after-hours trading.
Revenue for the quarter was $1.40 billion, up 16.3% sequentially and 16.9% year over year. While growth rates across most brands were healthy, Expedia, Trivago and Hotels.com were strongest. The Hotwire brand was again impacted by the domestic car business (fleet constraints and attempts to drive up pricing).
Revenue by Segment
Leisure customers remained the significantly larger contributors in the last quarter, generating around 94% of revenue. Corporate customers (Egencia) accounted for the balance. The two segments grew 18.6% and -10.5%, respectively from the previous quarter and were up 17.4% and 9.0%, respectively from the year-ago quarter.
With TripAdvisor gone, Expedia is almost totally dependent on the Leisure segment (although it has been beefing up the Egencia segment with acquisitions). Expedia continued to benefit from the acquisitions of VIA Travel that closed in the second quarter of 2012 and trivago, which closed in the beginning of March 2013. VIA’s operations are mostly in Northern Europe, which has done much better than the South in recent times.
Revenue by Channel
Around 69% of total revenue was generated through the merchant business (direct sales), another 24% came through the agency model (where Expedia operates as an agent of the supplier) and roughly 8% came from Advertising and Media. The three channels were up 22.2%, 12.6% and 36.3%, respectively from the Jun quarter of 2013. Growth from the year-ago quarter was 40.4%, 3.5% and 211.4%, respectively.
Revenue by Geography
Around 51% of Expedia’s quarterly revenue was generated domestically, with the remaining 49% coming from international sources. The domestic business grew 10.3% sequentially and 9.6% from a year ago. The international business was up 23.4% sequentially and 25.7% from last year. Trivago and eLong helped the international business grow in the last quarter.
Revenue by Product Line
Hotel and Air, the two main product lines grew 11% and 16% respectively from the year-ago quarter. The increase in Hotel revenue came from a 20% increase in room nights supported by a flat average daily rate (“ADR”). Revenue per night dropped 7%, which management attributed to lower-cost inventories in places like China. In the last quarter, international room night growth of 28% was more than double the domestic room night growth of 12%.
Mix was clearly negative, as the growth in Asia (much lower ADRs and revenue per room night) remains much stronger than other regions and this will likely remain a negative impact on hotel margins, while driving up volumes. The added scale of the lower-margin business is expected to more than make up for the negative mix impact going forward.
The increase in ticket revenue was attributable to a 7% increase in ticket volumes and a 3% increase in airfares. Revenue per ticket increased 9%.
Bookings and Revenue Margin
Gross bookings were $10.44 billion in the last quarter, up 3.1% sequentially and 15.2% year over year. The revenue margin was 13.4%, up 152 bps sequentially and 18 bps from a year ago due to a stronger leisure business. Merchant conversions appear to be trending down. Domestic conversion for the quarter declined from last year.
The pro forma gross margin for the quarter was 80.3%, up 208 bps sequentially and 61 bps year over year. Higher costs for credit card processing (due to merchant bookings growth) and higher headcount were offset by higher volumes. As a result, there was a 19.4% sequential and 17.8% year-over-year increase in gross profit dollars.
The operating expenses of $823.0 million were up 4.7% sequentially and 20.2% from last year. As a result, the operating margin expanded 893 bps sequentially while dropping 108 bps year over year to 18.8%. As a percentage of sales, selling and technology costs declined sequentially, although general and administrative expenses increased. All except selling and marketing expenses declined from the year-ago quarter.
Adjusted EBITDA as reported by the company was $339.9 million, up 77% sequentially and 16% from the year-ago quarter.
On a pro forma basis, Expedia generated a net profit of $177.2 million, or 12.6% net profit margin compared to $79.4 million, or 6.6% in the previous quarter and $177.9 million or 14.8% net income margin in the same quarter last year.
Our pro forma estimate excludes intangibles amortization charges 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 above special items, as well as non controlling interests, the GAAP earnings attributable to Expedia shareholders was $170.9 million ($1.22 a share) compared to $71.5 million ($0.51 a share) in the previous quarter and $171.5 million ($1.21 a share) in the year-ago quarter.
Cash and short-term investments totaled $1.81 billion at quarter-end, down $457.8 million during the quarter. As a result, the net cash position of $563.0 million was down significantly from $1.02 billion in net cash going into the quarter. Including long term liabilities, the debt to total capital ratio was 49.8%, still at manageable levels. Days sales outstanding (DSOs) went from 52 to 45. We note that nearly 45% of assets is goodwill (not a real asset).
In the last quarter, Expedia used $224.2 million of cash in operations. It spent $77.6 million on capex, $20.5 million on dividends and $221.5 million on share repurchases.
Expedia reported a strong third quarter, driven by the growth in the online travel booking industry. Additionally, TripAdvisor’s transition to the metasearch model appears successful, which had a positive impact in the last quarter. As a result, selling and marketing costs are coming down. However, Expedia is expected to continue investment in international markets because of the higher growth potential in these markets.
However, growth in these markets comes at a cost. The Asia/Pacific region for instance is likely to remain one of the strongest drivers of the company’s business over the next few quarters, particularly since online penetration in many Asia/Pacific markets remains relatively low. The company has responded by steadily increasing its hotel inventory and entering into strategic relationships, such as the one with Air Asia. However, profitability here depends on very high volumes, since the region typically yields lower ADRs.
Of course, in every region, the company will continue to face challenges from players like Priceline.com (PCLN - Analyst Report), Orbitz Worldwide , Travelocity and Ctrip.com International (CTRP - Snapshot Report), as well as a growing number of other local players that could make expansion more difficult.
Expedia shares carry a Zacks Rank #3 (Hold).