Expedia's Disappointing Quarter: Scott Devitt's Take (EXPE)

From Stifel Nicolaus analyst Scott Devitt on Expedia's (NASDAQ: EXPE) Q1 earnings:

Expedia's results were below our expectations and below management's expectations. Much of the shortfall from expectations was concentrated in domestic operations, specifically occurring at the Expedia.com brand due to lower traffic and lower conversion rates. Management noted that traffic was the largest contributor to shortfall in the quarter. Shortfall was particularly acute in the packaging product, where the company generates the greatest gross bookings and revenue dollars per transaction. Adding to this were weaker-than-expected results from third party distribution channels, including MSN, which generated less traffic than the company had seen in years and quarters past. Management expects the remedy to the MSN issue to be a slow process.

In addition, conversion rates were negatively impacted by a number of factors, including reduced site availability, increased competition, higher supplier pricing, and tight inventory in select markets and lower airlift into certain markets. Revenue margins were down 125 basis points year-over-year, principally due to lower domestic margins, higher domestic airfares, which increase gross bookings, but have little impact on gross revenue. Management had planned for reduction in revenue margin in the quarter, but experienced a greater increase in airfares than expected for Expedia.com.

Expedia reported 1Q revenue of $493.9 million, an increase of 2% year/year, and EBITA of $88.5 million. Adjusted EPS for the quarter were $0.15 with GAAP EPS of $0.06. We had estimated revenue of $543 million and adjusted EPS of $0.23. Top-line growth was primarily driven by increased worldwide merchant hotel revenue and advertising revenue, and partially offset by a decline in worldwide agency revenues. First quarter domestic revenue declined 4% and international revenue grew 24%, or 35% excluding FX impact. Revenue as a percentage of gross bookings was 10.6% for the first quarter.

EBITA, or "OIBA" decreased 35% year/year, driven by higher operating expenses, particularly SG&A and marketing expenses. OIBA as a percentage of revenue was down over ten percentage points to 17.9%, due to higher growth in operating expenses compared to revenue growth during the quarter. Operating income declined 60% during the quarter to $26 million. Gross profit for 1Q06 was $375 million, up about $4 million, or 1% from the year-ago quarter.

Worldwide merchant hotel revenue increased 3% for the first quarter, driven by 11% growth in room nights stayed, but partially offset by a 7% decrease in revenue per room night due to a contraction in hotel raw margins. Worldwide air revenues decreased 7% for the quarter, due to a 9% decrease in revenue per air ticket due to pressure on commission payments to agencies from airlines. Air tickets sold increased 3%. Lower availability of merchant air inventory also impacted packages revenue, which was flat year/year at $114 million.

Gross travel bookings for the quarter were $4.648 billion, up 14% over the comparable year-ago period, and 10% domestically. International bookings of $1,140 million represents a 26% increase year/year, or 34% excluding the effects of foreign exchange. We had expected gross bookings of $4.74 billion for the quarter. Bookings through the Expedia brand grew 13% year/year to $3.7 billion and $582 million, or a 21% increase at Hotels.com. Expedia® Corporate Travel grew gross bookings in the quarter were $250 million.

Expedia, Inc.'s international points of sale accounted for 25% of gross bookings and revenue in the first quarter, up from 22% of gross bookings and 20% of revenue in the prior-year period.

For the quarter ended March 31, 2006, net cash provided by operating activities was $454 million. Free cash flow for the quarter was $441 million. Management also announced a 20 million share buyback program.

Conclusion
Due to the shortfall and continued top-line softness management expects in 2Q, the company is not expected to meet the expectation of the first half decline in the high-negative-single-digits for EBITA. That said, management does continue to believe the growth in the back half of the year will be positive, and for the year as a whole, now expects EBITA to decline between 15% and 5%.

Management expects margin comps to improve and the company executes on new initiatives, and particularly into the back half of the year when the company will have easier comps on chain deals that were renewed at less advantageous economics in the second half of 2005. Further, management expects to see some softness in 2Q bookings (due to the World Cup event) but believes there will be a stronger second half in Europe. Also, Expedia will look to expand in even more countries, including Japan in 4Q.

We forecast that Expedia will generate $534 million in EBITA in 2006 and $605 million in EBITA in 2007. For 2006, we estimate revenue of $2.3 billion and $0.96 in EPS. We forecast $17.88 billion in gross bookings for full year 2006, or growth of 15% year/year. We rate shares of EXPE Hold.