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Expedia Inc. (NASDAQ:EXPE)

Q4 2008 Earnings Call

February 19, 2009 11:00 am ET

Executives

Stu Haas - IR

Dara Khosrowshahi - President and CEO

Michael Adler - CFO

Analysts

Imran Khan - JPMorgan

Jennifer Watson - Goldman Sachs

Ron Josey - Barclays Capital

Mark Mahaney - Citi

Kevin Crissey - UBS

Scott Hamann - KeyBanc Capital Markets

Michael Millman - Millman Research Associates

Justin Post - Merrill Lynch

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Expedia Incorporated Fourth Quarter 2008 Conference Call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator Instructions)

This conference is being recorded today February 19, 2009. I would now like to turn the conference over to our host Mr. Stu Haas. Please go ahead, sir.

Stu Haas

Thank you, Operator. Good morning, everyone and thanks for joining us for Expedia, Inc.’s financial results conference call for the fourth quarter and year-ended December 31, 2008.

I am pleased to be joined on the call today by Dara Khosrowshahi, Expedia’s CEO and President, and Michael Adler our CFO.

The following discussion including responses to your questions reflects management's views as of today, February 19, 2009 only. As always some of the statements made on today's call are forward-looking including comments on financial expectations and performance, operational results, margins, planned investments and spending, foreign exchange and growth of business lines.

Actual results may differ materially. We do not undertake any obligation to update or revise this information. Please refer to today's press release and the company’s filings with the SEC including Forms 10-K for the year ended December 31, 2007 and subsequent 10-Qs for additional information about factors that could potentially affect our financial and operational results.

During this call we will discuss certain non-GAAP financial measures including OIBA, operating expenses excluding stock-based compensation, free cash flow, adjusted net income and adjusted EPS. In our press release, which is posted on the company’s IR website at expediainc.com/ir you will find additional disclosures regarding these non-GAAP measures including reconciliations of the measures with the most comparable GAAP measures.

Finally unless otherwise stated, all references to gross margin, selling and marketing expense, general and administrative expense, and technology and content expense, exclude stock-based compensation and all comparisons in the call will be against results for the comparable period of 2007.

And with that, let me turn the call to Dara.

Dara Khosrowshahi

Thanks Stu. Now it will be beyond (inaudible) to start with the call with how difficult the economic environment has been. So, we will spend the majority of today's call talking about how the environment affected Q4 results and what we are doing about it.

Our hotel volumes actually held up pretty well, with 10% worldwide room night growth. In the US significantly above overall US demand which Smith Travel indicates was down around 5% in the September to December time period.

On the downside, we have seen significantly weaker ADR trends relative to the industry. With our average ADRs down 10%, the weakest we have seen since 9/11, revenue per night down 19% on a worldwide basis, steeper than the ADR decline due to the impact of foreign exchange and to a lesser extent service fee reductions.

Now, in this environment as our hotel partners’ look to fill rooms, they are turning to leisure segment, which seems to be displaying signs of short-term price elasticity. As a result, we have seen incredible deals in our marketplace which has brought down our ADRs faster than the industry average, a trend we see continuing into early 2009.

We are encouraged as this pricing does seem to be stimulating demand. Weakening ADRs in the November to January time period have been met with improving room night growth with worldwide growth improving and into the double digits during that same period. January's room night growth was frankly very good.

Now, keep in mind that we do have costs high to transactions versus ADRs or dollars, so running higher volumes at lower unit prices does challenge our margins.

In Q4, we saw some pretty negative volume trends in our air and package businesses. In early '09 however we are seeing airlines respond to lower demand curves with price cuts and we are in general seeing better package savings than ever. Both leading to better air ticket and package volume trends in January and February relative to what we saw in Q4.

Whether these recent improved trends in air, packages and hotel room nights continue is unclear, but we are encouraged by the recent data.

I also want to quickly share some highlights on some of the 2009 focus areas that I mentioned on our last call.

In marketing we have been improving our Search Engine Optimization capabilities, so that we can drive more traffic to this channel. We have seen benefits already as SEO traffic is growing in the double digits for both E.com and H.com here in the US and I expect substantial improvement in Europe in 2009.

In conversion, we have had great success at Hotels.com both in Europe and especially in the US. Through a combination of site optimization, reduction of fees and our Welcome Rewards program in the US, we are driving higher transactions at lower spent. And continue to push on this in order to see similar improvement on other points of sales.

Client additions in Q4 was very strong with bookable merchant properties up 15% sequentially and combined with our growing Venere agency hotel base Expedia’s bookable properties now are over 99,000 worldwide.

As I mentioned earlier, promotional inventory is better than ever and we certainly see travelers clicking on and booking our great deals. To facilitate these deals and improve ongoing supplier interactions, we have launched Expedia Partner Central, which allows our hotel partners to better manage their rates, inventory and exposure in a marketplace.

In advertising and media, we saw solid growth of 29% in Q4 '08 and we continue to see opportunity going forward. In 2009 TripAdvisor will expand its efforts in three areas of the travel-media space; meta-search, vacation rentals and China.

We are building a new and innovative air meta-search product, which we expect to launch soon. We recently launched a new Vacation Rental product on TripAdvisor, which is powered by FlipKey, a recent acquisition. And later this year, we will officially launch our user-generated content product in China [dowdow.com]. We have earned terrific returns on capital invested in travel media and we will continue to invest where we think returns will be strong over the long-term.

Now, Mike will cover our progress on cost reductions, but I would like to mention some decisions we have made in terms of compensation. We have decided to freeze salaries at 2008 levels, as have many other companies. We have significantly cut our 2008 annual bonus pool in light of softer results for the year.

We also expect to find additional efficiencies here in 2009 as the recent global restructuring of our brands allows us to fundamentally change how we structure our functions and operate as a company.

This kind of redesign takes a huge amount of effort and more time to effect, but we think it will result not only in cost efficiencies but also in our becoming a more nimble and competitive company.

This unpredictable and unprecedented environment requires us to be especially thoughtful and vigilant in our approach and our teams are working harder than they have ever before. We certainly believe we are up for the challenge.

Mike?

Michael Adler

Thanks, Dara. Let me begin with a couple of key trends in the business. First, we had a huge headwind in Q4 from the extreme volatility in foreign currency. Excluding the negative impact of FX, gross bookings would have been down by 8% and revenue would have grown by 1%.

Not surprisingly, FX had its greatest impact on our business in Europe, where revenue would have grown 6% excluding the impact of foreign exchange. Absent FX for the quarter, OIBA would have been positive. Second, despite the pressure we saw on the top line, we do have businesses, which continue to grow even in this difficult environment albeit at slower rates.

Hotwire continues to grow as its value conscious consumer proposition resonates well. Our advertising businesses continue to grow across the TripAdvisor Network as well as on our transactional sites. In Apex our gross bookings grow more than 20%.

Third, volume in our hotel business is proving somewhat resilient to the economic climate. Room night volume continues to grow in the hotel front across most of our markets. This reinforces the value we bring to our hotel partners and to travelers in this environment.

From a cost perspective, we understand the need to manage costs diligently. Through the process Dara described earlier, in actions already taken, we have achieved approximately $20 million of annualized cost savings from variable cost reductions primarily in cost of revenue and another $20 million from headcount reductions, which will be reflected primarily in operating expenses.

We expect to achieve additional efficiencies from our global realignment and will have more to share with you on our Q1 call. We expect some related restructuring or one-time charges, which will be excluded from OIBA, but of course will be included in our GAAP results.

We are also focused on continually improving management of our FX exposure. Since our gross bookings are reported on a booked basis and revenue on a stayed basis, there are differences in the FX impact between the two. In short, we have FX risk on our revenue based on currency movement between the time of booking and the time of the stay.

The steak decline in the pound in the late part of 2008 created a significant headwind in the fourth quarter. Obviously if FX rates don't fluctuate significantly on a sequential basis in 2009, then we won't see this type of impact going forward.

In Q4, we began hedging a small portion of the book to stay exposure, resulting in a net gain of nearly $2 million in the quarter and we are expanding the program here in Q1. I should note that gains or losses from these hedges offsetting the impact on revenue will be below the line in other net. Of course, like other FX gains and losses, they will be included in adjusted net income and adjusted EPS.

The impairment charge we took in Q4 is essentially a result of the macroeconomic pressures on our business and the decline in our stock price, which required us to write-down the value of goodwill and intangibles for acquisitions made several years ago. But importantly there was no cash or operating impact from this charge and it certainly doesn't reflect on the fundamental health and strength of our businesses. We also amended our credit facility and there was no impact on the company's liquidity.

Normally on our Q4 call, we would layout our OIBA expectations for the coming year. But given the uncertainty around FX, the economy and especially ADRs, we are not prepared to give an OIBA range at this time. Instead I will talk about how we see the current trends in the marketplace impacting our business going forward.

We are currently assuming that the economy and the travel market will be challenging for all of 2009. No indications pointing to significant improvement. In hotel, the ADR trends clearly create headwinds for hotel revenue. We also have reduced hotel fees in the past and could make further reductions. We are however seeing solid room night growth early in the year in our economics with suppliers should be stable to improving as we become an increasingly important distribution channel for our hotel supply partners.

In air, our former bookings for the next several months show ticket prices continuing to trend down. We do have a few carrier contracts renewing in 2009 but don't expect the non fee portion of our air economics to change significantly this year. All in we think it is very likely that gross bookings and revenue will decline in full year 2009, and our operating plan assumes that will be the case.

On operating expenses, we are cutting back on marketing spend significantly and are raising the bar on our expected return. We will also see cost reductions from the activity, Dara and I referred to earlier. And lastly, while we expect both OIBA and free cash flow to decline in 2009, we are not providing any ranges for that decline due to the uncertainty and variability in the economy and the travel market.

One quick housekeeping item; Easter falls in Q2 in ‘09 compared with Q1 in ‘08. This will make for relatively tough revenue and OIBA comps in Q1 and easier ones in Q2, all else being equal.

With that we will turn to Q&A. Operator, would you please remind listeners how to ask a question.

Question-and-Answer Session

Operator

Thank you, Sir. We will now begin the question-and-answer session. (Operator Instructions)

Our first question comes from the line of Imran Khan from JPMorgan. Please go ahead.

Imran Khan - JPMorgan

Yes. Thank you very much for taking my questions. Dara, two questions. First, about booking fee. I think you talked about a 12% decline in tickets sold and one of your competitors had a 44% increase in tickets sold. So, trying to understand how much of that is size, versus how much is because they are discounting, they are not taking the booking fee and that's helping them to grow the business in your opinion. And would you consider removing the booking fee?

And my second question is regarding advertising. Could you give us some color as to what kind of trends you're seeing on cost per click and the traffic conversion rate from the advertising? Thank you.

Dara Khosrowshahi

Sure, Imran. As far as booking fee goes, it’s difficult to tell exactly what portion of the share loss that we are seeing is due to booking fee and/or the overall momentum of the business.

You’ll remember that we increased our booking fee, maybe a year ago on Expedia from $5 to $7, it was around mid-year. And since then, we have seen some share loss, not just relative to price line, but relative to the OTA category in general.

January, we saw reversal of that share loss, a pretty sharp reversal, but January is just one month. So, we don't know whether that’s a continuing trend or not, but it’s certainly a good trend.

And when we try to break down the share loss compared to the revenue gain from the increase in the booking fee, we still think it’s a net positive from a revenue contribution standpoint.

Now, all that said, we are not happy with our unit volume growth in the air segment. We are watching it very closely. And you’ve seen us experiment a ton with booking fees last year. We are going to be taking a hard look at all aspects of our air business and booking fee as part of it. So, I don't think that the book is by any means closed as far as booking fees go.

On the advertising areas, the trends in general, the traffic trends have been quite good, especially in Europe. CPCs, we have certainly seen pressure come on the CPC area, and advertising and media segment along with ADRs coming down. So, average daily rates for online travel agencies, in general, have come down. They have self-corrected as far as what they are willing to bid and Google and other direct channels including TripAdvisor.

So, we are seeing a bit of pressure on the CPC side on TripAdvisor. We are looking at the advertising and media area from a bigger picture, while we are seeing CPC pressure. What we are trying to do is increase the addressable market for advertising and media segment, which is why you are seeing us going to metasearch.

That's an area to which we didn't have any exposure. It's a new area to which we will have exposure that is going to go overtime. That's why you have seen us going to vacation rentals and the listings market, in general, which we think is a huge market. There are some big players there, like HomeAway.com and we certainly want to give them some competition, and then China is a new market that we are going into with TripAdvisor as well.

And then on the transactional side, there are a number of new products that we are coming out with, for example, the travel ad product continues to get momentum and is growing very, very nicely, actually on a week-on-week basis. So, that's a new exposure area for us. Also, we are looking Google AdWords etcetera.

So, we are seeing some great pressure on advertising and media, but we think the increase in exposure, the increase in new product, etc., is going to drive it to be a growth area in 2009.

Imran Khan - JPMorgan

Great, thank you.

Dara Khosrowshahi

You bet.

Operator

Thank you. Our next question comes from the line of Jennifer Watson with Goldman Sachs. Please go ahead.

Jennifer Watson - Goldman Sachs

Great, thank you. When we look at '08 results, we saw margins in the travel products business decline about 220 basis points year-over-year, if we exclude the advertising business. It seems like this trend has been prevalent prior to 2008 as well. Can you talk a little bit about what's driving this trend in your view, particularly as you have raised airline booking fees? How you can stabilize margins at current rates?

Michael Adler

Sure. As far as the margins go, when we look at the margins and the negotiated margins, so to speak, with our travel partners, we're seeing stability there in general. When we go out and renegotiate with our strategic partners, whereas two, three years ago you saw decreases in margins, those renegotiations are stable margins and, in some cases, already increased margins.

And we are seeing on a local level with our local hotels, etc., they are coming in and asking for higher exposure and exchange for higher margin. In those cases, to the extent that we have a hotel partner who is looking for more exposure, we will try to help them out as best as we can.

I'd say the decline in margins that you're seeing is more focused on our activity as it relates to the consumer and reducing the reasons, let's say, for a consumer to not book on Expedia. So, for example, on Expedia or Hotels.com, we have taken booking fees down on the hotel segment pretty consistently throughout the year. We have removed, eliminated change in cancellation fees, which hurts on a revenue basis, but we think increases the return type of business.

And so those activities, which are more consumer-centric activities, have contributed to the reduction to the decline in margins. So, as far as our activity with our supply base, we see margins being stable to actually going up, especially on the hotel side of the coin.

Michael Adler

And to clarify, our revenue margin, excluding advertising and media, actually improved by 23 bps in Q4, so relatively flat, as you said.

Jennifer Watson - Goldman Sachs

All right. Thank you.

Dara Khosrowshahi

Sure.

Operator

Thank you. Our next question comes from the line of Doug Anmuth from Barclays Capital. Please go ahead.

Ron Josey - Barclays Capital

Hi, this is actually Ron Josey calling in for Doug. Two quick questions. The first is, it was refreshing to hear hotel air and packages rebounded somewhat in January. I’m wondering if that's more due to typical seasonality or response to improved offers available to users. And is any insight in the summer travel going forward? Thank you.

Dara Khosrowshahi

Sure, Ron. The trends that we are talking about are year-over-year trends, so they would typically take into account any seasonality that we see from January to January. I would say that last year's January for us was a little bit slow, so the comps are a bit easy.

So we don't want to get our hopes up too much. But I think that part of what you're seeing, in prior calls there’ve been a lot of discussions on whether our business was counter-cyclical or not.

And I think what you saw in Q4, and certainly what we are hoping that you saw in Q4, is, as the environment got worse, there was a bit of the suppliers and the hoteliers, etc., really not knowing what to do. And not taking what I'll call aggressive action to try to build demand in a difficult market.

And we think that in the December-January timeframe, a lot of our suppliers have leapt into action. We have a market management force that's out there on the streets talking with them, coaching them on what's going on, how demand patterns are looking. And I think that we are seeing our hoteliers being a lot more active in responding to the environment.

The second note that you have to take here is that, another difference between our take Q4 and what we were seeing in January is that the business demand has gotten significantly worse.

We see that both in our agency business, on a same account basis, business demand has come down pretty significantly. The government certainly has not helped in the meetings and incentive business, it has, I think, done quite poorly in terms of the travel industry and what they’ve said in the meeting, it’s an incentive meeting business.

So, a lot of these larger hotels need help. They have taken action in January by working with us to stimulate demand and we are seeing the results of that action. So we saw it in January, we are seeing it continue in February. But it’s just a month and a half, and while we are happy with it, we don't want to get our hopes up too much.

And then, of course, as far as summer goes, our booking windows are, we have some long booking windows, but it’s really too soon to call summer. What I will say is that March stays because of April, because of Easter, are going to look relatively poor and April stays are looking better because of Easter. So that's about the widest window that we have.

Ron Josey - Barclays Capital

Great, thank you very much.

Dara Khosrowshahi

Sure.

Operator

Thank you. Our next question comes from the line of Mark Mahaney with Citi. Please go ahead.

Mark Mahaney - Citi

Thank you, two questions. Dara, I think on the last call, when I asked about the timing for the full integration of Venere, I think you said mid-2009. Could you give us an update on how that integration process is going?

And then separately, in your breakout, it looks like this by brand, gross bookings other showed nice acceleration on a tough comp. I think in there is Hotwire, I think there is maybe a little bit of corporate and maybe a little (Inaudible). Could you break that down a little bit? What's performing best in that gross bookings other brand category? Thank you.

Dara Khosrowshahi

Sure. The Venere integration remains on track. The teams are working very hard. The Venere teams along with Expedia and Hotel teams, and it’s on track for mid-year. Now, there is a limited amount of what I'll call limited integration on Hotels.com in Europe already, where some of the Venere hotels are showing up in the back of the sort.

So, to the extent that there aren't merchant properties available, when call it a secondary or tertiary city, Venere properties are showing up. What you’ll see in mid-year is Venere properties showing up in the Expedia’s sort, and Venere property is showing up, intermingled with the merchant product for both Expedia and Hotels.com.

So, it will be a much more proper integration, so to speak. So, that's on track and we are quite excited about it. We think the addition of that inventory can really help us in some secondary and tertiary markets, where Booking.com has a relative advantage.

As far as the other drivers, I'd say the strongest two segments are Hotwire and our Asia Pacific segments. I think we were certainly listening to the results, pipeline strong results yesterday and, if you look at our Hotwire business in the US, you will see very similar strong results that they had through the year. Hotwires’ revenue for Q4 was up 25%. Hotwires’ profits were up over 50%.

So, that team is executing really well, but I think that they are also benefiting from the fact that they are in the opaque segment, they have no booking fees, their inventory is more attractive than it ever has been. So, it’s a combination of, I think, good execution and also a friendly environment for the Hotwire brands, and certainly we have seen it with price line as well.

Asia Pacific segment, for us growth is still growing pretty healthily over a small base. We think we can do even better in 2009, and we are investing pretty aggressively in ‘09. And Egencia, on a relative basis, performed better than the leisure businesses. Although based on business travel demand in ’09, what you'll see with Egencia is same-store sales, so to speak, are going to be down, but new sales, our ability to go out and get new clients are stronger than they ever have been.

Mark Mahaney - Citigroup

Thank you, Dara.

Dara Khosrowshahi

Sure.

Operator

Thank you. Our next question comes from the line of Kevin Crissey with UBS. Please go ahead.

Kevin Crissey - UBS

Hi, everyone. Thank you. In terms of your air contracts, which air contracts do you have coming up and why do you expect to achieve some more terms to prior contracts?

Dara Khosrowshahi

Kevin, we don't disclose the specific contracts that are coming up or the negotiations that are coming up. I think that we are in contact with our airline partners on a continuing basis. And there are contracts that are renegotiated all the time and I'd say, the economics with our supply partners, in general, these are both our hotel and air partners, are more stable than call at the last round of negotiations.

Kevin Crissey - UBS

Right, more stable doesn't necessarily imply stable, if you know what I'm saying, because the last round wasn't exactly very good for you, I guess.

Dara Khosrowshahi

No, I think the last round was, I don't want to characterize it as good or bad. But they are with some partners, they will be positives, with some partners, they will be negatives. We just don't think they are going to be, at least based on what we know now, we don't anticipate big step changes in economics similar to what we saw in the past. It doesn't mean every single deal is either going to be better or worse.

Kevin Crissey - UBS

Okay, terrific. And can you guys give details as to what percentage of international, what percentage of your air, your international itineraries?

Dara Khosrowshahi

I don't think that we disclose that in general. A third of our business is international and two-thirds is domestic. And I think for the airlines segment, it’s similar. It could be a little bit lower, because Hotwire is a domestic only player. But I think that the numbers are going to be roundabout similar

Kevin Crissey - UBS

Thank you.

Dara Khosrowshahi

You're welcome.

Operator

Thank you. Our next question comes from the line of Scott Hamann with KeyBanc Capital Markets. Please go ahead.

Scott Hamann - KeyBanc Capital Markets

One of the competitors yesterday indicated that bad debt expense looked like it was picking up a bit internationally. Is that something that you're seeing as well, and just maybe a little color on that?

Michael Adler

Yeah. I mean it is something that we are seeing. Our international partners, historically, have paid slower than our partners in the US, and we have seen some pressure on stretching that out.

It's not something that we really anticipate, it’s going to be a problem for us going forward. And it's really related mostly to our advertising business and our corporate travel business. So we watch it closely and think that it's in pretty good shape.

Dara Khosrowshahi

I think, Scott, one of the advantages that we have actually in the merchant model is that we don't have any kind of a collections issue on the merchant hotel business. So the consumer pays us directly. So we collect a 100%. Our collection rate is a 100%.

And we are, in general, trying to remit on time or faster than on time to our hotel partners, especially the ones who are in need. But it is a real advantage of the merchant business in this kind of an environment, which is, our collection rate is perfect.

Scott Hamann - KeyBanc Capital Markets

Okay. And then just on cash flow for 2009. I mean, can you just talk around some of the major drivers there, and what the use of free cash flow would be as we move through the year. I notice, it looks like there is going to be some debt pay down. But are you thinking about acquisitions and what can we expect?

Michael Adler

Okay. So, in terms of free cash flow, the biggest driver is OIBA. And while we did say that we expect decline in OIBA, we will be generating significant amounts of OIBA in 2009.

We also will be having significantly less CapEx in 2009, 2008, including a number of large real estate projects that will not be recurring.

A fairly important part of our cash flow, as well, is from working capital, in particular from our merchant hotel business. And depending upon whether we see growth or not in that business, working capital will also be impacting our free cash flow next year.

In terms of debt pay-down or acquisitions, that’s actually not included in our free cash flow. Obviously, it’s included in our overall cash figures. We did indicate in our release that we would be paying down almost all of our revolver debt in the next day or two. So that is occurring.

On the acquisition front, we did use about $500 million in cash in '08. In '09, I would say we don't expect the same level of activity or near the same level of activity. The market prices for deals, we don't yet think really reflects the value of businesses, but we will continue to be opportunistic and look at things as they come up.

Dara Khosrowshahi

I think Scott, just to give you a bit more color on the use of cash. Certainly, I think our paying down the revolver and I think it was $550 million. Is that the number, should reflect the fact that we feel good about our cash flows early in the year and the balance sheet of the company. As far as use of cash in 2009, one significant factor is going to be the extension, if any, of our revolver in 2010.

We do want to have significant liquidity of the company. We value flexibility. The revolver has given us that flexibility. To the extent that we know that we can extend the revolver beyond 2010, you will see us be more aggressive in general on cash use, but, until we know that we can extend in 2010, we will tend to use our cash early on at least in 2009 to build a cushion, so that we are not dependent on a refinancing. There have been a lot of companies, which have debt on refinancing happening, which have been trapped, and we don't want to fall into that same trap.

Scott Hamann - KeyBanc Capital Markets

Sounds fair, thanks a lot.

Dara Khosrowshahi

You're welcome.

Operator

Thank you. Our next question comes from the line of Michael Millman with Millman Research Associates. Please go ahead.

Michael Millman - Millman Research Associates

Thank you. Obviously, there has been a lot of discussion of the numbers that price line reported yesterday and so, in that connection, can you talk about Venere, if that model is doing, what the price line model has been doing in Europe. And, maybe generally, are we in a market, we will continue to be in a market where price becomes the most important factor for consumers and the merchant model, at least, just is not modeled for this economic environment?

And then regarding the merchant, another question regarding the deferred merchant revenue. Is there some point that drops, where you have to make some significant decisions regarding cash flow and maybe covenants affected? Thank you.

Dara Khosrowshahi

Sure, Mike. As far as Venere in Europe and the overall merchant hotel business, the Venere production in Europe is not that different from, let's say, the production of our other businesses in Europe. If you look at Venere, it was owned by private equity holders and, I think, to some extent, it suffered from a lack of investment and IT functions and technology, which we are doing our best to make up for.

So, when you look at Booking.com production in Europe, and you compare that to Venere production, I’d say Booking.com is comfortably ahead of Venere for now. I don't think that the difference in the relative performance in Europe of the companies has really to do fundamentally with the merchant model versus agency model.

It has to do with technology, search engine, marketing expertise, scale and a lot of other factors. And for example, you see our Hotels.com production in Europe not as good as Booking.com, but better than Venere and better than Expedia in Europe, because I think that group has jelled for a longer period. The technology is relatively newer and is executing very well, and we are quite confident that we can get Expedia to similar levels as well.

So, we don't think that it’s a fundamental issue between merchant and agency. Now, the reason why we were attracted to the agency model is that we do think that the agency model has an advantage in secondary and tertiary markets with smaller hotels, where having an agency model is easier for those hotels. So, what we are trying to create is the right product for the right hotel sets.

And as far as pricing, more important in this marketplace, I would say price is more important in this marketplace. And again, we think that the merchant model has actually responded quite well to price. To some extent, you see our average daily rates being lower than the industry's average daily rates. And while we haven't reported it, we are seeing it in the improving trends that we are seeing in unit sales in January, going into February as well.

The second factor, and the advantage of the merchant model, is the ability for the package business to become a new opaque channel. And for example, in January, our package business is performing much, much better, certainly relative to Q4, because we are getting great discounts. Consumers are finding those discounts in our booking.

So, I do take exception to any kind of statement saying that the merchant model isn't the model for this kind of a marketplace, because the merchant model, I think, in '09, is going to increase share gain versus, for example, in '08. I'm quite confident of that.

Mike, do you want to talk about the working capital impact?

Michael Adler

Yes. The question on working capital and the impact or potential impact on covenants is that there is no impact from the deferred merchant booking size on covenants. We have no minimum cash covenants.

Michael Millman - Millman Research Associates

Okay. Thank you very much.

Operator

Thank you. Our next question comes from the line of Justin Post with Merrill Lynch. Please go ahead.

Justin Post - Merrill Lynch

Thank you. Dara, can we revisit the 1Q improvement? What do you think turned on in January, if anything? And was it fair to say that the booking metrics are actually better so far in 1Q than they were in 4Q in total dollars in addition to units?

Dara Khosrowshahi

The booking metrics, you mean our gross bookings levels?

Justin Post - Merrill Lynch

Yes.

Dara Khosrowshahi

Yeah. I don’t want to, again, the specific gross bookings, etc., but I'd say, in general, unit metrics are better, ADRs are a little bit weaker. And I think that what you're seeing is a little bit of what I talked about previously, which is, our hotel partners moving from relative inaction in response to demand trends to action in response to demand trends.

If you look at a typical hotel, typically there will be three large demand buckets for a hotel lobby, the meetings and incentives business, there will be the corporate business and there will be the transient leisure business.

It's very hard on a short-term basis to stimulate the other two buckets. Meetings and incentives have long sales cycles. Business travel typically has longer sales cycles. By cutting prices on business travel, you're not going to necessarily stimulate business travel.

So the one channel, the transient leisure traveler does seem to respond to stimulus and great prices and great deals. So we've seen a lot of activities from our supply partners December, January going to February on creating promotions, loading in better package inventory, etc., which has resulted in better unit growth.

Again, that is somewhat offset by rate. But there is no question that we're seeing unit growth in the first quarter going to February that's better than what we saw in Q4. Again, it’s only a month and a half.

Justin Post - Merrill Lynch

Okay. And then a second bigger picture. As you look out to 2009 and 2010, obviously, you have three very large travel brands, and then you're getting into some other businesses, like advertising and other things you’ve talked about. What do you think is Expedia’s competitive advantage? Is it really knowing the traveler across platforms, and really having a good look at different customers, or do you think it’s just a scale that you bring that you can leverage expenses? What do you see as your long-term advantage as a company?

Dara Khosrowshahi

I think that there are three areas. One is just scale of the business. As far as being able to talk to a partner and being able to deliver to them, not only demand across multiple channels, but demand across multiple geographies. There are very few companies that have built, there are very few, there is no real true worldwide travel brand out there and we are building three of them, Expedia, Hotels and TripAdvisor.

So, the ability to go to a partner, discuss their needs and be able to help them across different brands, but also on a worldwide basis, we think, is a real advantage that translates into better economics, closer relationships, etc. If the hotel needs, is in need after a weekend, where a meeting is canceled, they will come to us first, because we can do more for them.

The second, we think, is business intelligence, which is our ability to see what's going on in the marketplace, compare trends for Expedia, Hotels.com, Hotwire, etc. We think this is quite valuable and will be valuable on a go-forward basis, and there is a lot of best practice sharing that can happen among the various brands.

The third area, we think, is the advertising and media space. And there are two reasons there. One is, if you look at our model in general, marketing is the highest expense of any OTA out there. So it provides us with a great hedge against marketing in general becoming more expensive. We are significant recipients of that.

And, I think, on a go-forward basis, to the extent that you're seeing models hybridize much more. You see advertising on Amazon. Amazon getting into the listings business, etc.

So, to the extent that 10 years from now this business, this online travel agency business turns into what I’ll call an online travel business, where we will be delivering either transactions to our partners or [eyeballs] to our partners, our having a big stake in both the transactional side and advertising and media side of the equation. And being front and center on the technology delivery there, we think will be a great long-term advantage.

Justin Post - Merrill Lynch

Okay. Thank you.

Dara Khosrowshahi

You're welcome.

Operator

Thank you. At this time, there are no further questions in the queue. I would like to turn the call back over to Stu Haas for closing remarks.

Stu Haas

Thank you for joining us on the call today and your questions. A replay will be available on the IR website shortly after the completion of the call. We certainly appreciate your interest in Expedia and look forward to convening with you again next quarter.

Dara, did you want to make any final comments?

Dara Khosrowshahi

No, just thank you very much for joining the call and we hope to tell you much more after our first quarter call. Thank you.

Operator

Ladies and gentlemen, that does conclude the Expedia Incorporated Fourth Quarter 2008 Conference Call. We thank you for your participation and for using AT&T. You may now disconnect.

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