Here’s the entire text of the prepared remarks from Expedia’s (ticker: EXPE) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.
Stu Haas, Vice President, Investor Relations
Barry Diller, Chairman
Dara Khosrowshahi, CEO
Mark Gunning, CFO
Mark Mahaney, Citigroup
Heath Terry, Credit Suisse First Boston
Justin Post, Merrill Lynch
Aaron Kessler, Piper Jaffray
Douglas Anmuth, Lehman Brothers
Scott Devitt, Legg Mason
Michael Millman, Soleil
Robert Peck, Bear Stearns
Good afternoon, ladies and gentlemen, and welcome to Expedia Inc Third Quarter 2005 Earnings Call. At this time all participants are in a listen-only mode. Following today’s presentation, instructions will be given for the question and answer session. If anyone should require operator assistance during the conference, please press the “*” key followed by the “0”. I would now like to turn the conference over to Stu Haas, Vice President of Investor Relations. Please go ahead, sir.
Stu Haas, Vice President, Investor Relations
Good afternoon and welcome to Expedia Inc.’s financial results conference call for the third quarter ended September 30, 2005. Joining us on today’s call, are Barry Diller, Expedia Inc Chairman; Dara Khosrowshahi, our CEO, and Mark Gunning, our CFO. The following discussion and responses to your questions reflects management’s views as of today, November 3, 2005 only.
As always, some of the statements made on today’s call are forward-looking, including our comments on guidance. Actual results may differ materially. We do not intend to update or revise these forward-looking statements until our next quarterly call. Additional information about factors that could potentially impact our financial results is included in today’s press release and the Company’s filings with the SEC including IAC Interactive Corp.’s 2004 annual report on Form 10-K, as well as Form S-4 and amendments thereto filed in relation the spin-off transaction of Expedia Inc. During this call, we will discuss certain non-GAAP financial measures. In our press release and our 8-K furnished to the SEC today, each of which is posted on the IR web site, at www.expedia.com/ir, you will find additional disclosures regarding these non-GAAP measures including reconciliation of these measures with the most comparable GAAP measures. We strongly encourage you to review the section entitled “Basis of Presentation” in today’s earnings release for more details on how we are presenting results for the period ended September 30, 2005. Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2004.
And with that, let me turn the call over to Barry for some introductory remarks.
Barry Diller, Chairman
Well, I add my welcome to this, the first Expedia Inc conference call. We all know about the dislocating nature of a spin-off. But for both IAC and Expedia, it’s been mostly a frictionless process, both entities hitting the ground truly running. And Expedia’s operations are off to a fine start as a stand-alone company.
Under the hood, Expedia has begun to significantly transform itself over the last 18 months. And I’d say in every respect it’s the better for it. Maintaining stability during change is always difficult as is undertaking lots of new initiatives. It’s a testament to Dara and his leadership; together with the truly talented executives he’s recruited to the cause, as well as to the great Expedia team in place that we are able to report solid operating results amid all this combustion. The earnings season thus far has certainly been fascinating for Internet companies, something for every species of bull and bear with plenty of volatility to go around. But apparently lost in the cacophony of who beat or missed consensus by a penny and who raised or raised yet lowered guidance, is the fact that they are continued to be some amazingly durable companies being built in this space. Companies who share sizable markets, operating leverage, expansive global reach, the inexorable push of online penetration, most importantly, technology and innovation at their core, which certainly defines Expedia.
We did not make Expedia a stand-alone company out of weakness, weakness about the travel sector or our own operations. We did it because we believed it was worthy of being judged solely in its space, both big enough and with enough runway ahead to make it compelling to any constituency. We have the size, the substance, momentum, to claim leadership and strength in online travel services. While micro conditions always contain volatility, I and my colleagues are convinced we have a truly great and enduring business model, to report on that, Mr. Khosrowshahi.
Dara Khosrowshahi, Chief Executive Officer
Thanks, Barry. And thank you to everyone for making the time to join us on the call. I’m going to spend a portion of my call talking more specifically about Expedia’s continued innovation during the quarter. And then turn things over to Mark to review some financial highlights.
Innovation has long been a compelling differentiator for Expedia. And our third quarter was no exception, as we continued to improve our service for our customers and for our supply partners. Let me start with Hotels.com.
As we mentioned in our release today, Hotels continued its efforts to transition from a brand based exclusively on price, to one anchored by expertise. Most notably, the brand’s web site was re-launched in September with a meaningful upgrade in content and functionality. If you haven’t visited Hotels.com lately, I really urge each of you to check it our and book, of course. There are many great innovations on the new site, but one feature that stands out is the compare feature.
If, for example, you’re considering a trip to Las Vegas, you can quickly line up the Palms, the Wynn Las Vegas, which is a great new hotel, and the Bellagio and compare those properties on a single web page across several different dimensions. Amenities, prices for your state, prices for your stay-by-room class, customer and star ratings, strip location, and so on. This is on top of several other great features like enhanced pictures, virtual tours of the hotel rooms, mapping capabilities, and much, much more. And, I should point out that Hotels.com operates 28 international sites. And during Q3, our European team improved their sites as well including integrating photo-browsing and cleaner tab display options.
Now, I’ve heard some investors express skepticism that customers care only about price when it comes to making travel decisions or choosing a travel service provider. While we’ve always felt strongly that content is a key factor in the choice of the hotel, the Hotels.com team validated this belief with extensive research ahead of the re-launch. And their findings indicated that content was a very significant factor in customers’ rating of a travel site and their propensity to return to the site. Of course, the proof of progress is ultimately in results and while it’s still early days in Hotels.com evolution, their early returns are quite encouraging. Q3 ‘05 gross bookings for Hotels.com were up 9% year-on-year, its highest year-on-year growth since mid 2004 and early results in Q4 show a similar, positive trend.
Transitioning to the Expedia.com brand, we re-launched our homepage and category landing pages last month. While our booking wizard remains prominent, we’ve moved toward more prominent merchandising of the real estate around the wizard, stressing our most popular destinations, and highlighting compelling offers, such as our $150 discount on the trip you really want to take in ‘06 by booking travel on Expedia this holiday season.
The discount is intended to drive incremental behavior from customers since the discount is only valid on package travel, hotel and air for example. We want customers to think of Expedia as their travel agent of choice for all their travel, not just an occasional rental care or airline purchase. The site redesign builds on the success that we’ve had in adding rich hotel content this year, including over 75,000 qualified traveler reviews of actual hotel stays, which is unique to Expedia, a 50% increase from the figure we discussed on last quarter’s call. And we found that user reviews are the most visited content feature immediately prior to checkout indicating their importance in driving purchases. As the base of reviews grows, this becomes a unique asset for Expedia to leverage more prominently in our customers’ experience.
In an effort to improve our email targeting, we also debuted our air shopper email campaign in Q3. The first iteration targeted customers who shopped for a flight with Expedia but did not purchase. We sent those customers outstanding hotel and car offers for those travel dates for that destination as well as updated flight purchases for their date of travel. We think this is a great product.
As Barry mentioned in his open, there’s a lot more innovation ahead for Expedia. And I consider these developments at Hotels.com and Expedia.com to just be the very initial steps, in driving greater personalization, more effective merchandising and a broader definition of value for our customers, and as a result for our suppliers. While we’ve certainly built a strong base of business as Expedia, we also recognize that we have a lot of upside. 75% of all people who buy travel online according to our statistics visit our site at least once while shopping for their trip. Most of our customers, however, still spend a fairly modest portion of their annual travel spend at Expedia. And we’re setting out to change that.
We also continued to innovate this quarter on behalf of our suppliers with a significant increase in the number of properties we’ve direct connected. We announced today that over 5,000 properties, approximately 20% of our merchant hotel base, are now fully direct connected.
With full Direct Connect, we relieve the hotel properties from having to load availability and pricing into an Extranet. We also provide real-time purchasing data to the hotels, eliminating the delay of accompanying faxed reservations. In turn, we save our suppliers a great deal of time that would otherwise arise in processing the nearly 300,000 rate and inventory changes per day, we now receive from Direct Connect hoteliers.
While we’re on Direct Connect and Hotels, investors often ask me what a Company like Expedia gains for its size and scale advantages versus its competition. When it comes to hotels, this manifests itself in several ways. But one is the network effect of a content feature like traveler reviews. The greater a traffic advantage, the more high quality, and more recent reviews we post on the site, the more high quality reviews, the higher our conversion, which means a greater pool of reviews and so on in the virtual cycle. Our size and global reach means that we can invest more and provide better content to our customers as we amortize that cost over a larger sales base than our competitors. And we plan to expand our content’s advantage going forward.
Our size also allows us to approach hotels with valuable assets, including the ability to fill significant room volume at their properties with our targeted merchandising, as well as offering significant free advertising and the marketing intelligence for their properties. This scale hopefully affords us better room allocation at better terms against our competitors.
While Expedia drills considerable innovation during the quarter, we expect the pace in significance of innovation and the level of technology and content spend across our sites to pick up in 2006 and 2007 as we expand our software and engineering teams. We believe that we are still in the early days of our evolution as a consumer service. And we have considerable growth, both local and global ahead of us.
Now you’ll hear from our CFO, Mark Gunning. Mark joined us in July and brings over 20 years of significant expertise to bear, in the areas of financial controls, operations, analytics, and forecasting from senior financial leadership experience with AT&T Wireless, Nextlink, and AirTouch. Mark is one of several top shelf executives Expedia has brought on board over the past 12 months to help transition the Company from a leadership position in online travel transactions, to becoming a world class retailer of travel experiences. We’re very pleased to have Mark on board. And now I’ll turn the call over to him to touch on our financial performance. Mark?
Mark Gunning, Chief Financial Officer
Thank you very much, Dara. And, thank you to those listening in today. This was a solid quarter for Expedia Inc. Gross bookings a quarter grew 21% to over 3.9 billion, the domestic growth of over 16% and international growth of 39% versus the prior year quarter. Our domestic gross bookings growth has been fairly stable throughout 2005 in the mid-teens; our international gross bookings did see a drop off in the third quarter from 66% growth in the first half of the year down to 39% in Q3. Certainly, terrorist activity in London and foreign exchange affected growth rates, but also saw an impact from economic conditions in Germany and UK as well as strong competition from supplier direct sites. These impacts were more pronounced on our air business than on our merchant hotel business in Europe.
Revenue rose 16% during the quarter or 14% excluding the impact of foreign exchange movements and acquisitions. This organic topline growth rate is the Company’s highest in 4 quarters and represents acceleration over the 11% we witnessed in the first half of the year. And our international growth, excluding the impact of FX, was 47% in the third quarter, versus 62% in the first half of the year. Revenue margins, basically, our take rate on bookings was 14.8% this quarter, down 58 basis points versus last year. We continue to see airline pressuring distribution costs and hotels enjoying above historical average occupancy levels. But this decline in revenue margin is a lower year-over-year decline than we saw in the second quarter.
I do want to spend a little time talking about our overall hotel business. As I know there is quite a bit of focus externally on the concept of raw margins and continued pressure on those margins. But occupancy levels continue to be tight with attendant pressure on hotel deals. We also encourage investors to look beyond just raw margins in assessing the fortunes of this business for Expedia.
Specifically, revenue growth for merchant hotels was 15% in the third quarter, our highest rate of growth since Q3 ‘04 and the third straight quarter of accelerating growth. This is due to the healthy pace of nights stayed through our various points of sale. It’s also due to the flip side of high occupancy. Increased room rates in the form of ADRs have translated into a higher level of revenue per room night despite the raw margin pressure. Going forward, our over-arching goal at Expedia is to deliver outstanding hotel performance to our shareholders, regardless of where we might be in the macroeconomic and occupancy cycles.
Our gross bookings of revenue are critical metrics in evaluating our business. As most of you know, our Company’s primary metric for measuring success is operating income before amortization or OIBA. OIBA strips out large, non-cash items such as amortization of intangibles and stock-based compensation, which aren’t particularly useful in assessing our future cash earnings prospects.
During the third quarter, OIBA grew 15%, the same rate of year-on-year growth we saw in Q2. OIBA grew; OIBA growth exceeded 20%, excluding the impact of acquired companies, the negative impact from foreign exchange, and a $4.4 million net adjustment primarily for the reversal of an excise tax reserve. Year-to-date, we’ve expanded OIBA margin 121 basis points despite an 85 basis point drop in revenue margins and despite a necessary increase in G&A costs as Expedia moved toward becoming an independent public company.
Turning to cash, net cash provided by operating activities for the 9 months ending on September 30 was over $940 million while free cash flow, operating cash flow less capital expenditures was over $900 million. We expect free cash flow in the fourth quarter to be negative as we process increased hotel payables, meaning trailing 12-month free cash flow at yearend will be lower than the $940 million through the first 3 quarters of 2005.
We have begun implementing some recommendations from Project Apollo, which as you’ll recall, was focused on better leveraging and integrating our brand portfolio and removing redundant costs. We’re undertaking several initiatives, including call center integration, improving customer service and fulfillment processes, and moving our financial and operating systems to common platforms.
As part of this movement to common infrastructure as well as a spin-off from IAC, we are examining accounting policies among our various brands and businesses. As such, we recently reclassified certain operating expenses to be more in line with how we want to report our results, now that Expedia is an independent public company. I want to emphasize, this re-class had no impact on overall expenses or OIBA.
We also had one-time items during the quarter, which impacted GAAP results, specifically, a $30 million pre-tax net credit primarily due to a change in our forfeiture rate assumption for equity awards and a $23 million pre-tax write-off of an investment. In addition, we reported a derivative liability for obligations related to Ask Jeeves convertible debt assumed by IAC, which gave rise to an unrealized pre-tax gain of $12 million for Q3. These 3 items combined increased GAAP net income by $8 million and GAAP EPS by $0.02 but had no impact on our OIBA or adjusted net income measures.
Looking ahead to expectations for Q4 and full-year 2005, we have seen the growth rate declines in Europe I mentioned earlier in the call continue into the early part of Q4. The hurricane activity in Q4 is having an impact on our domestic results. Lastly, we have indicated in prior calls, compared to last year we are pushing more marketing spend into Q4 of this year, which will pressure Q4 OIBA growth. As such, we are maintaining our prior expectation of low to mid-teens growth in full-year OIBA for 2005.
Okay, Stu. Let’s take some questions.
Stu Haas, Vice President, Investor Relations
Great, thanks Mark. Let’s move on to the Q&A portion of the call with Barry, Dara, and Mark. As a reminder, please limit yourselves to 1 or 2 questions. Operator, will you please remind our listeners how to ask a question?
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