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Priceline.com’s (PCLN - Analyst Report) second quarter was quite good, with earnings beating the Zacks Consensus by 51 cents (7.2%). However, investors were disappointed with revenue growth, which was impacted by both currency and continued slowdown in Europe.

Revenue

Priceline reported revenue of $1.33 billion in the quarter, representing a sequential increase of 27.9% and a year-over-year increase of 20.3%. This was in line with management’s guidance of $1.33 billion (at the mid-point) and just short of consensus expectations.

Volumes were up sequentially across the business, with hotel room nights, rental car days and airline tickets growing 9.4%, 24.6% and 6.3%, respectively. Room nights and rental car days were up strong double-digits (39.1% and 30.3%, respectively) from last year, although airline tickets were flat.

Revenue by Channel

Priceline’s business model has been changing over the last two years or so, with the merchant business gradually becoming a smaller percentage of revenue. This is mainly because the agency business has been growing at more than three times the rate of growth of the merchant business.

The merchant/agency revenue share in the last quarter was 42%/58%, with other revenues bringing in less than 1%. Merchant revenue was up 11.0% sequentially and 3.9% year over year.

The agency business, on the other hand, was up 43.6% sequentially and 35.6% from the year-ago quarter. Other revenue was up 16.4% sequentially and 24.4% from last year.

Bookings

Priceline’s overall bookings were up 9.2% sequentially and 26.8% year over year, at the low end of the guided range. Excluding the impact of foreign currency, total bookings were up 36% from the year-ago quarter.  

Both international and domestic bookings contributed to the increase, but both were at the low end of guidance, indicating softer-than-expected growth trends. International grew 9.2% sequentially and 33.1% (44% excluding currency impact) year over year. Domestic was up 9.3% sequentially and 5.3% over the prior year.

Booking.com did reasonably well in the last quarter given recent inventory additions across North and South America. The significant exposure to Europe affected results in the last quarter as conditions in Europe, particularly the U.K. and Southern Europe, continued to weaken (hurt by currency, macro). International ADRs also suffered due to the growing business in the Asia/Pacific, as well as weakness in Europe.

The Asia business is likely to grow further given recent initiatives, such as the tie-up with Ctrip.com International (CTRP - Snapshot Report), China’s leading online travel booking service. Domestic ADRs increased in the last quarter. Priceline continued to push its opaque business model, which did not do as well as in the past because of a growing number of competitors offering heavy discounts.

Rental car bookings were very strong in the last quarter, driven by strength in both the domestic and international businesses.

Capacity cuts and price hikes continued to impact the airline ticket business. The opaque side of the business was hit by supply shortage.

Operating Performance

Priceline reported a gross margin of 75.7%, up 402 basis points (bps) sequentially and 774 bps year over year due to higher volumes in the international business, helped by better pricing in the U.S. Because of the nature of the business and the mix of agency versus merchant revenue, management usually uses gross profit dollars rather than margin to gauge performance during any quarter.

Priceline’s gross profit dollars grew 35.1% sequentially and 34.0% from last year. While both the domestic and international businesses contributed to the year-over-year growth, international growth was much stronger at 40% (53% on a local currency basis), with domestic growing 6%.

Priceline’s operating income jumped 86.9% sequentially to $249.7 million helped by higher volumes. The operating margin of 35.2%, grew 1,109 bps sequentially and 495 bps from the year-ago quarter.

While all expenses declined sequentially as a percentage of sales, the most significant were cost of sales (down 402 bps), online advertising (down 302 bps) and personnel (down 156 bps). Cost of sales also declined significantly from last year, with online advertising increasing significantly. Increases/decreases in other segments were less significant.

Priceline reported adjusted EBITDA of $494.8 million, up 41.8% from the year-ago quarter, better than management’s expectations of pro forma EBITDA in the $450-470 million range.

Net Income

The pro forma net income was $387.3 million, or 29.2% of revenue, compared to $204.2 million, or 19.7% in the previous quarter and $269.4 million, or 24.4% in the year-ago quarter. Our pro forma estimate excludes amortization of intangibles and other items as well as tax adjustments and includes stock based compensation of 34 cents a share in the last quarter. Our pro forma calculation may differ from Priceline’s presentation due to the inclusion/exclusion of some items that were not considered by management.

Including these items and after deducting amounts attributable to non-controlling interests, Priceline’s GAAP net income was $352.3 million or $6.88 a share, compared to $181.7 million, or $3.54 a share in the March 2012 quarter and $256.4 million, or $5.02 a share in the year-ago quarter.

Balance Sheet

Priceline ended with a cash and short term investments balance of $3.94 billion, up $323.6 million during the quarter. Priceline generated $431.6 million of cash from operations, significantly higher than the March quarter. It spent around $14.7 million on capex and a very small amount on share repurchases.

At quarter-end, Priceline had $937.8 million in long-term debt and $508.8 million in short term debt, totaling $1.45 billion. The net cash position at quarter-end was $2.50 billion, up slightly during the quarter. Days sales outstanding (DSOs) were around 29, consistent with the prior quarter.

Guidance

For the third quarter, Priceline expects total gross bookings to grow 10-18% year over year, with international growing 12-20% (up 23-31% on local currency basis) and domestic growing around 5%. This is expected to yield a year-over-year revenue increase of 9-15% ($1.63 billion at the mid-point).

Priceline expects gross profit dollars to increase 15-25% on a non-GAAP basis. The adjusted EBITDA is expected to be $690-765 million.

The pro forma EPS is expected to come in at $11.10-$12.10, based on a 16.4% tax rate and 51.5 million shares. The GAAP EPS is expected to be $10.21 to $11.21. Analysts were expecting pro forma earnings of $12.28 when the company reported earnings, well above the guided range.

Conclusion

Priceline’s second quarter results were not bad considering the condition of the global economy, particularly Europe and the fact that it derives a significant chunk of revenue from leisure travel, which is discretionary spending. The guidance was below the consensus, but this was only to be expected, since markets have been deteriorating for some time and competitors, such as Expedia (EXPE - Analyst Report) have also reported weakening trends.

Priceline is likely to be worse affected because of its significant exposure to Europe. Therefore, its focus on Asia and recent success in the region are encouraging. We think this could help the company get through these trying times.

Yes, the hotel business will benefit from recent additions to inventory, but we need to bear in mind that this will be at lower margins (significant ADR pressure internationally, offset by improving ADR in the domestic business which we think is because of a higher mix of corporate versus personal bookings). Add to this the possibility of increasing cancellations, which naturally occur in times of uncertain demand.

Nevertheless, Priceline will continue investing in the business to push growth and especially to continue its international expansion strategy. This is likely to exert some downward pressure on earnings.

We therefore think that some caution regarding the shares is warranted at this point. The Zacks Rank on Priceline shares is currently #3 (Hold in the next 1-3 months). We are also Neutral on a long-term basis.

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