Expedia Group Inc (EXPE) 2005 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Expedia Incorporated fourth quarter 2005 conference 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. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to Mr. Stu Haas, Vice President of Investor Relations.

Please go ahead, sir.

Good afternoon, and welcome to Expedia Inc.'s financial results conference call for the fourth quarter and year ended December 31st, 2005.

Joining me on today's call are Barry Diller, Expedia's Chairman and Senior Executive, Dara Khosrowshahi, our CEO, and Mark Gunning, our CFO.

The following discussion and responses to your questions reflect managements' views as of today, February 15th, 2006 only.

As always, some of the statements made on today's call are forward-looking, including our comments on guidance, our operational performance and margins, planned investments and spending, platform improvements, systems upgrades, growth of business lines, financial performance and dilution.

Actual results may differ materially.

We do not undertake any obligation to update or revise this information to reflect future events or circumstances.

Please refer to today's press release and the Company's filings with the SEC, including our Form 10-Q for the quarter ended September 30th, 2005, 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, free cash flow, adjusted net income and adjusted EPS.

In our press release, which is posted on the IR website at expediainc.com/IR, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with the most comparable GAAP measures.

We encourage to you review the section entitled "basis of presentation" in today's earnings release for more details on how we are presenting results for the periods presented.

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 Dara.

Thanks, Stu, and thank you to everyone for making the call, and the time to join us today.

Expedia ended a solid year with over 15.5 billion in annual gross bookings, and generated nearly 800 million in free cash flow for our stockholders.

We launched our Australian site, the eighth Expedia-branded website in the world, and our hotels.com brand recorded 4 straight quarters of accelerating growth in 2005.

And we signed an innovative 3-year agreement with Marriott that for the first time, rewards us for filling rooms when our chain partners most need them.

And we successfully completed our spin-off from IAC with a minimum of disruption to our core operations.

On the flip side, 2005 was not without its challenges, including our results for Q4.

Now Mark will cover this in greater detail during his remarks, but I wanted to briefly speak to it.

On the top line, we saw the impact of foreign exchange and reduced growth in Europe.

From a product standpoint, worldwide air revenue was down 4% year-on-year, as we saw a reduction in our revenue per air ticket, especially in our merchant air business.

On the cost side in Q4, we saw the year-on-year selling and marketing increase that we mentioned throughout 2005, as well as significant increases in our fixed G&A costs as a stand-alone public company.

Let me talk a little bit about Europe.

After adjusting for foreign exchange and acquisitions, our organic international gross bookings did decrease from 44% in the first half of '05, to 28% in the second half of '05.

While we don't think this 28% is significantly different from what other healthy online travel players are seeing in Europe, in the back half of the year we do think that there are several challenges in the region.

Specifically, we are seeing the effects of increased agency and supplier direct competition which we mentioned on the last call, as well as an aggressive push by the traditional European tour operators to grow their online share as their off-line business slows.

We also realize that we need to do a better job of complementing our core City Break business, with more inventory and air lift, along with better merchandising into the European summer sun markets, something that will be focused on in 2006 and beyond.

Unfortunately the challenges in Europe have been most pronounced in the U.K., which has had generally weak consumer sentiment, and as many of you know, is our largest European point-of-sale.

Stepping back from Q4 now, I think its safe to say that from a challenges perspective, worldwide competition from suppliers and travel agencies only intensified in 2005, and differentiation amongst travelers online experiences narrowed.

To address this challenge, Expedia has set out to transform the way travelers plan, purchase and enjoy trips again.

As we approach our tenth anniversary this October, we are in the early stages of transitioning the Company from an efficient and first-class transaction processor, to the world's leading retailer and merchandiser of travel experiences.

Let me be clear that we fully recognized that this is much easier said than done, and we also acknowledge that there are many able companies pursuing these travel dollars.

We expect this to be a multi-year, evolutionary process.

Of course, we don't begin this journey from a standing start.

We have a significant foundation of traffic, loyal travelers with strong brand recognition. 75% of U.S. travel shoppers online visit one of our sites prior to making a purchase, 75%.

Yet at the end of the day, just 5% of total U.S. travel expenditures occur at Expedia.com.

We have to do better.

We saw many seeds of progress planted in 2005, including Expedia.com's first home page redesign in several years, hotels.com rebranding from low prices to hotel experts, including side by side comparison features, compelling e-mail campaigns tied to shopper behavior and segmentation, TripAdvisor reaching over 3 million reviews and opinions, and early in 2006 we introduced Expedia Promise and Expedia Best Price Guarantee, offering the industry's broadest and richest price guarantee across nearly all products purchased at Expedia, with not only a price match but a $50 travel coupon on top of it.

On the supplier or Partner Services front, we have strong relationships with nearly every major hotel chain.

In addition to Marriott, we've also signed deals with Kimpton Hotels and at [Core] North America.

And we've also made strides in the car rental business, with strong preferred relationships with Budget and Hertz, and Enterprise, with whom we recently signed an agreement.

We hope to have much more good news in this area going forward.

We focus on investment in 3 significant areas as we take our Company to the next level: Our people, our international businesses, and our technology and operations.

First, people.

We've made great strides in 2005, and have put in place what I think is the most talented, driven, and focused team in the travel industry.

This excellence extends across our organization from our worldwide points of sale, to staff function such as finance, HR, Partner Services, technology and operations and traveller care.

This investment doesn't just stop at senior management.

It goes deep into our organization, from attracting and retaining great talent at all levels, to putting training programs in place to improve our employee skills across the board.

We are continuing to invest in our international markets, organically building a global business, where our competitors have had to establish their presence through acquisitions.

This year we expect to invest over $30 million in incremental marketing dollars in some of our newer markets, France, Italy, as well as our Asia Pacific region, where we already have a presence in China, have launched Australia, and are aiming to open up shop in Japan, hopefully by year end.

Turning to technology and operations.

As we mentioned last quarter, you should expect to see the pace and significance of product innovation increase going forward.

And fueling that acceleration will be some significant platform improvements that we're targeting to complete over the next 2 years.

First and most importantly, we are investing in and building a scalable, extensible, service-oriented technology platform that will extend cross our transactional brands; resulting in long-term cost savings, improved flexibility, faster go forward innovation.

This transition will allow us to improve our site merchandising, browse and search functionality and add significant personalization features and ultimately improve our ability to drive higher return on investment in our online and off-line advertising.

We expect this transition to occur in a phased approach with worldwide points of sale migrating to the new platform over the next 2 years or so.

We are also adding a significant upgrade to our data aggregation and mining capabilities across Expedia Inc., with an installation of a robust enterprise data warehouse.

This is a 20 to a $25 million undertaking with about 10% of that investment already incurred, and the remaining split between '06 and '07.

We are also making investments in systems and operations to integrate and significantly improve the customer experience of our travelers going forward.

And last, but certainly not least, by this time next year we anticipate that we will have launched a significant loyalty effort for our travelers.

I don't want to say anything more on this program just yet, but we will update you on our progress as we move later into the year.

Before I move to some thoughts on 2006, I want up to date you on 3 specific items, our GDS integration, the hotels.com rebranding, and our progress at Expedia Corporate Travel.

As we have mentioned in prior calls, having multiple distribution options in a deregulated air environment is just good business.

And we remain committed to the GDS model for air connectivity.

As such, we are proceeding on technical integration of 2 new GDS partners.

The first is Amadeus, with whom we expect to complete our initial integration by the beginning of Q2.

The second is Sabre, with whom we expect to complete our initial integration by the beginning of Q3.

These integrations afford us the option, but not the obligation, of flowing segments to multiple GDS vendors.

The estimated timing and distribution of actual segments among the vendors is not something we are going to comment on at this time.

That said, I do want to stress that we continue to value our relationship with Worldspan, and anticipate that they will remain a meaningful part of our GDS mix going forward.

Regarding GDS economics, which I know is of great interest to our investors, Sabre's recent announcement of 5-year deals with several carriers reinforces our belief that the fundamental GDS airline model will remain intact, albeit at -- likely at reduced compensation levels.

As a result, we continue to believe that Expedia will experience reduced revenue per air ticket in '06 as we did in '05.

In Q3, we mentioned that early results from the hotels.com brand transition were promising.

This trend continued in Q4 as gross bookings grew 16 percent, its highest quarterly rate of growth since Q1 of '04.

Hotels.com is a significant online travel brand with traction.

Its $1.9 billion in annual bookings will make it the fifth largest online travel brand in the world.

As importantly from a brand portfolio standpoint, its traveler base is complementary to the core Expedia traveller;

More value conscious, more likely to draw to their destination, more likely to book by phone, and partial to a shorter booking window.

Turning to Expedia Corporate Travel.

ECT grew its 2005 gross bookings more than 90% year-over-year to over $700 million.

We also recently expanded the geographic footprint of ECT to Canada, and we continued to build our client roster during the quarter, including adding CVS, America's largest retail pharmacy.

While ECT has become a leading travel management company in 3 short years, we certainly aren't anywhere near satisfied with our progress.

We continue to believe, and thousands of our clients reinforce, that there is market demand for the industry-leading technical solutions that we offer.

That said, we need to improve our worldwide supply and point-of-sale reach.

These are areas on which we will be focused in 2006 and beyond, and we hope to report on our progress in these dimensions in quarterly calls to come.

It's our expectation that ECT will grow from less than 5% of our worldwide gross bookings in 2005, to 10% over the next few years.

Now let me talk a bit about our expectations for 2006.

Our management team proactively decided that it was emphatically worth to it increase our investment in people, technology and systems.

Yes, Expedia is a leading online player in the vast industry that is travel, products, and services.

But despite our lead, we still account for a small percentage of total travel transactions, which we regard as our marketplace.

Along with the ongoing investments we outlined, we also had a cost of being an independent public company in 2005, which we believe will be very much in our long-term benefit.

But these factors will combine for difficult year-on-year cost comparables in 2006, especially early in the year, which we will not offset with direct marketing cuts.

We believe that the investments I've outlined will begin to separate us from the pack in 2007, but we don't expect that they will have much effect in the current year.

Taken together, we believe that these factors will result in high single-digit negative OIBA growth in the first half of 2006.

But we expect positive OIBA growth in the second half of the year.

We are positioning ourselves for what we hope will be a great 2007 and beyond, and we certainly believe that we are making the right bets for our Company going forward.

With that, over to you, Mark.

Thanks, Dara.

Rather than reiterate our release figures in detail, I'd prefer to spend some time analyzing a few key pieces of our business model.

And then talk to some longer term shareholder issues around working capital, taxes, uses of cash and dilution.

As Dara indicated in his open, gross bookings growth was down from 21% in Q3 to 17% in Q4, based on the domestic and international factors he mentioned.

Further, revenue margin decreased 59 basis points year-over-year, yielding revenue growth of 13%.

In addition to the pressure on air revenues per ticket and higher airfares, we witnessed 125 basis points of decline in our merchant hotel raw margins from 2004 to 2005.

Based on the recent deals we've signed with many of the top chains, and our existing arrangements with independent and smaller chain hoteliers, we think more of the margin erosion is behind us than ahead.

As such, we are expecting half as much as much raw margin decline in our worldwide merchant hotel business in 2006 than in 2005.

I want to reemphasize that internally we are much more focused on driving absolute profit dollars than maximizing profit margins.

We are certainly mindful of margin, but more important are the absolute level of transactions through the various Expedia points of sale.

Part and parcel to this effort is increasing our packages mix, where we make significantly more profit dollars per transaction.

And many of the initiatives Dara laid out earlier are designed to improve our packaging volumes.

Despite 13% revenue growth in Q4, we saw our Company's primary operating metric for measuring success, operating income before amortization, or OIBA, decline by 7%.

Reasonable questions for investors to ask are, 1, why did we see this degree of deleveraging in Q4?

And, 2, what can we expect going forward?

Beginning with gross margin.

Gross margin was down just 33 basis points year-over-year, accounting for 1% of the difference between revenue and OIBA growth.

As for gross margin going forward, some of our Apollo efforts are focused on reducing fulfillment costs on air ticketing, as well as our transaction and fraud costs on credit cards.

But we are also capture data center, and traveller service costs in COGS.

And not only will the efforts outlined earlier in the call put upward pressure on these costs, but these costs tend to move with gross bookings versus revenue.

Moving to operating expenses, in total OpEx increased from 45% percent of revenue in Q4 '04, to 51% in Q4 '05, with each of our operating expense line items growing 20% or more.

Selling and marketing for the quarter was up over 20%, which is consistent with our emphasis on prior calls that we would see a significant increase as we lapped Q4 '04 spend, a level at which we felt we underspent in marketing.

But digging in a little deeper, our direct ad spend, affiliates, paid search, portal spend and off-line media was up 15%, fairly in line with revenues, but certainly an acceleration from the 3% decrease in direct spend we saw in the first 3 quarters of '05.

The personnel spend in selling and marketing was up 40%.

This is primary fixed costs we added by ramping our market management staff and our Partner Services group in '04 and '05, expanding the team to over 350 across the globe by year end.

Now, market managers are critical touch points in building successful supplier relationships, and this was an explicit decision we made to ramp this team aggressively.

These relationships combined with our scale can make Expedia the most important online partner for our air, hotel and other supplier partners.

We are already seeing benefits from our Partner Services group, as witnessed by our recent hotel deals and our expectation of lower margin erosion in 2006.

But this hiring and other hiring in marketing was costly and did significantly impact our leverage in 2005.

For the full year, over 90% of the year-over-year increase in sales and marketing dollar expense was due to people costs.

Had we not made these and other personnel investments, selling and marketing as a percent of revenue, would have decreased from 35.4% to 30.8%, generating 460 basis points of leverage, or over 200 basis points more efficiently than the improvement we actually showed for the year.

Going forward, we not only have the increased fixed costs of market management I mentioned, but we also anticipate lower efficiency gains in our direct spend versus 2005.

We also expect to see some inflation in both our online and off-line media buys.

This includes a full year of increased rates from our renewed MSN deal.

Given all these factors, we anticipate selling and marketing expense increasing as a percent of revenue in 2006.

G&A expense is the next biggest bucket of OpEx, and was up 39% year-over-year, increasing to 13.2 percent of revenue from 10.7%.

Much of the increase had been building in Q2 and in Q3 as we ramped up our staff functions and leveraged external staffing providers to support becoming an independent public Company, particularly in the areas of legal, finance and accounting.

In Q4, our people cost was relatively flat from Q3.

But we will see some additional hiring and increased G&A in 2006, particularly in the first half on a year-over-year basis.

Lastly, is technology and content expense, which grew from 5.3% of revenue to 6.3% -- to 6.3 in Q4.

As with G&A, the bulk of this year-over-year increase is due to hiring on our technical teams, adding software engineers, product managers, program managers, Q&A, and other technical staff.

Given the technology initiatives outlined at the outset of this call, investors should expect our absolute level of spend in technology and content to increase in 2006 and beyond.

I do want to address 4 areas of interest to our long-term shareholders.

First, is the role of working capital in our free cash model.

Our business is unique in that we have a negative operating cycle as it relates to merchant transactions.

We collect cash from our travelers significantly ahead of the time that we pay our suppliers.

Our entire book to pay window for merchant hotels in 2005 was over 60 days, up slightly from the cycle time in 2004.

Roughly one-third of this time window is from the time travelers book their travel, to when they stay.

And two-thirds is related to the time from when travelers stay, to when we pay our hotel suppliers.

As long as this cycle is not compressed due to shorter booking windows from travelers or tighter terms from our supplier partners, we would expect working capital to be a meaningful component of our free cash flow growth going forward.

On taxes, we anticipate fully utilizing our net operating losses, or NOLs, in 2006.

We are not forecasting our effective tax rate at this time, but we would expect it to be in excess of the standard Federal rate of 35%.

Turning to uses of cash.

Our senior leadership is very mindful of our investors returns on equity.

We would therefore intend to return excess cash to our shareholders in the form of stock repurchases, while maintaining a prudent level of flexibility in the event of changes in the competitive and macroeconomic environments.

And as always, our decision depends on the specific opportunity, i.e., our stock price, our relative valuations of potential acquisitions, or other uses of cash which we feel will enhance long-term stockholder value.

And lastly, is the matter of dilution.

We think dilution is an often overlooked but key piece of information in helping long-term investors forecast their expected returns.

Expedia is committed to efficiently managing dilution to our owners.

More specifically, we are targeting net dilution from employee equity awards, those are grants net of cancellations, to an average of 1% or less, assuming present capitalization.

There may be years where we will be above or below this level, but on average we are targeting 1% or less.

I will now turn the call over to Barry for some closing thoughts ahead of Q&A.

Look, I really do hope that no one mistakes our message today.

Expedia had a good year in 2005.

It certainly wasn't without a lot of challenges, both within and without, and that's because we decided to take on every issue and deal with them straightaway.

We knew it would cause some rough waves here and there, but hard-cementing our leadership is an opportunity we really shouldn't pass up.

It is simply the nature of the ecosystem that we inhabit.

No Internet company is beyond the clutch of increasing competition.

Transparency, relentless expansion, and continuous innovation is what we have to do every day.

What I think is really important for our long-term investors to take with them, is that we are by conscious choice, and from a position of strength, choosing the path that Dara and Mark have articulated.

We are laying the technical foundations for significant improvements throughout our worldwide points of sale, both for our travelers and our suppliers.

My colleagues and I strongly believe that these investments will afford us an opportunity to transform today's largest online travel engine, by far, into tomorrow's leading purveyor of travel experiences.

And from that, I would expect would come meaningful value for our shareholders.

So I think we now ought to move on to questions.

I'm sure you all have a lot of questions.

We will take as much time as you need within anybody's level of rationality.

So, Stu, why don't we proceed.

Great.

Thanks, Barry.

Let's move on to the Q&A portion of the call with Barry, Dara and Mark.

As a reminder, please limit yourself to 1 or 2 questions.

Operator, would you please remind our listeners how to ask a question?

Thank you, sir. [OPERATOR INSTRUCTIONS] Brian Egger, Harris Nesbitt.

Can you talk about specifically in your merchant business, both the airline business and hotels, was there any specific change in the tone of business in the fourth?

I know you talked a lot about lower hotel raw margins.

And I'm wondering if that was anything that was just sort of an ongoing trend or something that maybe changed in the back half of the year?

And maybe fill us in a little bit more on maybe the mark-up trend -- or, the margin trend as relates to airline merchant business?

Sure.

Talking about the airline business in general, I think the trends that we are seeing in Q4 are not that different from the trends that we have seen at least for the past couple of quarters.

Which is the airlines are flying at very, very high load factors.

The load factors continue into this year, and as a result, the per ticket air pricing is up significantly.

I think in Q4 we saw increases in kind of our agency ticket prices on average of 8 to 9%, at least in the U.S. businesses.

What that does for us, the increase in gross bookings value per ticket so to speak, is great for the airlines, doesn't benefit us, because we get paid on a per ticket basis.

So certainly, while the pricing is healthy, it's not something that translates to our bottom line, and again we are seeing the same trends going forward.

In addition to that, it doesn't look like the domestic carriers are adding a significant amount of volume to at least their domestic routes.

They are adding volume to the international routes, and we are seeing benefit from that.

But the domestic routes, they are not adding much load to the domestic routes.

On the hotel side of the equation, I think the hotel business is very solid.

You've seen reports from different hotel company's out there.

And I don't think that we have seen any significant trends that are different this year than last year.

We are pretty confident on the progress that our team has been making as far as our chain relationships go, in the Partners Services group.

And what we have essentially seen are long-term deals that we are signing up with the large chains that go on for multiple years.

Marriott is just an example, where we are locking in kind of what I would call the merchant rate of record.

So as Mark did say on the call, we do think that the rate of decline in our merchant hotel margin is going to decrease as the year goes on in '06.

Probably you will see a decrease in the first half, and again the rate will, as the year goes on, I think things will get better there.

And that is a very, very important metric for us, and something that we are pretty pleased with the progress that we are seeing.

So I guess I could take away from this that the raw merchant mark-ups at which these preferred, or the supplier relationships are being negotiated are probably well within previous years, but we seem to be maybe approaching some type of trough here, where things stabilize a bit?

I think we are certainly seeing stability, as far as the kind of conversation that we are having with the big chains.

They recognize the value that we bring to the table.

And more and more, we are talking to them about, I would say more value-added relationships.

One transaction doesn't fit all sizes, and we are actually sitting down with them.

We really understand their business a lot better now than we used to.

And we are setting up deals with them, where if we help them during periods in which they have high needs, so to speak, they may give us higher margins.

And to the extent that we need them during certain periods, we may get lower margins.

That allows us to optimize kind of the demand and the supply coming into our funnel a lot better going forward than we have in the past.

Okay.

Thank you.

Marianne Wolk, Susquehanna.

Thank you.

I just wanted to get back to your comment about cash flow and working capital benefits.

You implied that the cycle was actually improving for you in '05.

Are you also indicating that based on performance recently, that we should see that improve again in the first half of '06?

Yes, this is Mark.

No, I don't think you should be assuming that it's going to -- I don't want to give guidance as far as what happens in '06 on cash flows.

So much of our cash flow is due to timing of working capital.

And so, at any one point in time, at the end of the year, when you have prepays, when you are paying off your merchant payables, there's a lot of fluctuations there.

It's very difficult to give guidance in one period of time.

I think that the business cycle itself, nothing else should -- if nothing else changes, as far as from the standpoint of we don't see any changes, then when we pay our merchants, that this is strictly a timing issue at the end of the year.

So just to confirm, based on the long-term contracts you are signing with your merchant hotels, there should be no change in the terms that would hurt your ability to capture cash flow?

Well, with all contracts there are slight changes.

Any time you renegotiate a contract.

But nothing of significance changes at all at this point in time going forward.

At this point, we don't see any changes to the model, to the fundamental model, if that's what you're asking.

Exactly.

Thank you very much.

You're welcome.

And Marianne, I would just remind you as was said earlier, we did see an expansion of the negative operating cycle days in '05 versus '04.

Operator, if we could take the next question, please.

Michael Savner, Banc of America Securities.

Thanks very much. 2 questions. 1, just a continuation on working cap.

Just to make sure I'm understanding correctly.

Maybe I'm not.

But when you talk about free cash flow from working cap being part of the growth of overall free cash flow going forward, we should assume though that that's a diminishing contribution unless we were to assume that your gross bookings continued to accelerate its growth rate.

Because if you are growing your bookings at a slower rate, then that should decline over time.

So I just want to make sure I am thinking about it correctly.

And number 2, maybe just touch on the balance sheet for a minute.

Kind of what the optimal balance sheet is.

Obviously, you have basically no debt.

And so what are your uses of free cash flow?

You've outlined some investments in '06 and going forward, but certainly not a meaningful percentage of free cash flow that you are going to be generating.

So just how you think about the optimal balance sheet.

Thanks very much.

Well, I think, and Mark, and correct me if I'm wrong.

On the working capital question, I think what we are saying is that working capital will be a positive contributor.

How positive a contributor will it be, depends on not only the growth rate, but the incremental growth dollars, gross booking dollars, growth that we are seeing year-over-year.

And we certainly don't think that the portion of the free cash flow that you are seeing from working capital is going to grow as fast as the portion of free cash flow kind of growing as a result of operations.

Yes, thanks.

That makes sense, because I think the way it was worded was it will be a meaningful component of free cash flow growth.

Yes, I think it's free cash flow.

Thank you.

Okay And then the second question I think was on balance sheet.

And I think our attitude on balance sheet is that we want to retain a significant amount of flexibility, first and most importantly.

And we do have a revolver to that effect, but we certainly do want to have some cash on the books, to the extent that an unforeseen circumstances happens.

We do have a fair amount of -- a significant amount of deferred merchant bookings on our balance sheet.

And we always want to have the flexibility and the liquidity, just in case something happens to either credit our customers back, or for payables, et cetera.

I think we are happy with the amount of liquidity that we have now.

And to the extent that we have excess liquidity, we will look to alternative uses of that cash.

Those could be acquisitions, it could be stock buybacks, or other uses of capital.

Certainly, we do throw a bunch of cash from operations.

So later in the year, I think we will be addressing this.

Thank you very much.

Go ahead, Mark.

We also -- I think you mentioned that we did not have any debt, but we do have $230 million of debt at the end of the year.

It's not net debt, I guess it's gross debt.

Okay, operator, if we could take the next question.

Aaron Kessler, Piper Jaffray.

It's actually Safa Rashtchy from Piper Jaffray.

A couple of questions.

First, Dara and Barry, you mentioned that you are embarking on investments -- fairly sizeable investments in '06, which you feel is the correct strategy and will help you differentiate from the competition.

From what we've seen, and your initial comments as well, the difficulties that you face in '05, Q4 were more because of the broader market conditions.

Do you that feel differentiating from competition will help alleviate that?

And if so, can you give us some more color, and in what way these investments will help you offset, for instance, declining airline revenues, or more inclination by the hotel suppliers to go direct?

I think on the software, we are not saying that the environment isn't difficult.

I think it is difficult.

It is competitive, but you have got to look at the overall size of the travel market.

It's $800 billion.

It's huge.

Right?

So it is natural that you are going to have a ton of competitors going after this large a market, and we are less than 5 percent of the total market, even the U.S.

So we think the size of the market is very large.

While we do think it is going to be competitive, I think the course that we are taking going forward, is really moving from trying to gather, call it new users, to try to convert the users that are coming to our front-end more effectively.

And in the little bit of work that we've done, and kind of the website redesign, and some of the direct marketing work that we've done, so that the e-mails that we are sending out to our consumers are specifically segmented.

They are targeted, rather than 1 e-mail for all consumers, we are seeing really nice conversion benefits.

Unfortunately, we are just getting started on this, and the systems that we have in place can't really scale the way we want them to, in order to get these conversions on a broader scale and on a global scale.

So we've got to make the systems investments which are kind of up front investments.

We already know that the stuff works.

We just have to execute on it.

Okay.

And to follow up if I may, could you give us some color on how the package business was in Q4, and overall also in '05?

You mentioned that you are pretty positive and hopeful on it.

Given that the air component, and I think you mentioned that the merchant air was also under pressure, how should we look at the package margins going forward, overall?

What do you see in terms of demand dynamics for packages?

The demand dynamics in packages are good, although I don't think -- what we are not doing as effectively as we can, is to move the shoppers who are coming into the Expedia or hotels.com or hotwire sites, to move them from booking individually, and booking individual components, to have them shop on a package path.

So that's really what we are focused on, is merchandising better and pushing our consumers to packages much more aggressively.

In mid-year, for example, we have a bit of a site redesign that's focused on that more.

So, I'd say our package performance in '05 was okay.

I think we have a long way to go, and clearly our -- the profitability for a package customer is significantly, significantly more.

And the revenue per package customer, significantly more, than the customer that tends to shop on a stand alone basis.

Safa, this is Barry Diller.

I think that in packages and in every other area, the area that Dara just spoke to, the areas that you've raised in terms of differentiation, these investments were late.

They should have been made before, but for a whole host of reasons, they weren't.

So the operating management, led by Dara and by the great group that he's brought in in this last year, have really put these investments now towards differentiation.

And over time, they are going to allow Expedia to be a value-add.

The ideal is to be a value-add service.

You come to Expedia not just for information, because compellingly, you are going to have a better experience all the way through.

And that, with rewards and other things that are going to be part of that, is I think the thing that is going to take this leadership that we have, and really, truly, hard-cement it for the future.

That's the motivation for doing this.

And it's, it is being done in, of course, what is a very tough environment.

But it's a tough environment where we've maintained our leadership, and this is what I think is going to allow to us extend it.

That's helpful.

Thanks, Barry.

Thanks, Dara.

Anthony Noto, Goldman Sachs.

Thank you very much.

Dara, you laid out a lot of different areas of investment and challenges.

And I was wondering on this differentiation question, we ask consumers every year what drives their purchases at one site versus the next, and it's prioritized, price, selection, information.

And I was wondering, against those 3 dimensions, which do you think you can really dominate?

And if you could give us the prioritization of the things you are trying to accomplish in 2006 with the spending to accomplish that.

And the last question is, the returns on invested capital for Expedia using a strict definition, is about 7% in 2005. 2006 clearly won't go up, given the growth that you've laid out for net operating profit after tax, and the level of investment you will make in invested capital.

Where do you see that going over time, after you get a benefit from these investments?

Thanks.

Anthony, actually when we looked at, we've looked at our customer segmentation as well.

And I think the price, price is kind of the common denominator out there.

We have to be able to get competitor pricing with everyone else, and I don't think that price is necessarily something that you can differentiate.

You can make claims about price, but we think our base job is to get the best prices out there.

I don't think that that's going to be able to vault us ahead of anyone else.

I think that's kind of the ticket to play, so to speak.

So we do take price as a base.

Now that said, when we look at our customer segmentation, around 20 to 25% of our customers are almost totally price -- will, without almost any other consideration, go to the lowest price.

They will spend hours and hours and hours on the Web to save $10, and tell their neighbor about how they saved $10.

We are very focused on that segment with Hotwire.

That has kind of stayed true to its opaque roots, and is trying to move from just being opaque to being a real price leader for that specific segment.

While Expedia will certainly serve that segment, there's 75% of the population that's looking for what you talked about, selection, information, convenience, et cetera.

And honestly, we want to be best of breed across all of those factors.

You see in the investments that we've made, in the content that we have on the website, the kind of hotel content that we have.

I think internationally, it's best of breed.

I think the selections that we bring to bear is the best selection out there.

The customer service that we provide to our travelers, we've done a lot of studies there, is leading, although we don't think that it's nearly where it can be be.

So we certainly want to improve on our customer experience, as well.

And I think more than anything, we want to change the way that we merchandise to our customers.

We want our travelers, when they come to Expedia, to feel and experience where Expedia is talking to them, and is talking to that particular customer in a different way from other customers.

So a lot of the advances that you will see are actually on how we talk to customers and how we reach out to customers.

I think there was, what was the second question?

I'm sorry, it was about returns.

Oh, okay.

I think on return on invested capital, the numbers that you see, the 7%, it's certainly not something that we are satisfied with from a long-term.

It's the result of Expedia coming together, as a result of a number of acquisitions.

So there is a significant amount of goodwill on the books.

And that goodwill is defined as invested capital.

As we go forward, and we certainly do expect to grow kind of net after tax profits, which is the numerator of that formula, I think that our return on invested capital will increase fairly significantly.

And, Anthony, if you take a look at what I will call incremental return on invested capital, remember that on an organic basis, we actually have a negative working capital cycle.

So I think if you look at the business on the increment, there aren't that many businesses that get you better returns on invested capital than this one.

Thank you.

Scott Devitt, Stifel Nicolaus.

I had a question about Europe.

I was wondering if you can just go into a little more detail in terms what is going on there?

And I'm particularly interested in, you noted economic environment, as well as more aggressive actions by airlines directly, as well as tour operators.

And I was wondering if you can give us some color as to the distinction between the 2, and whether or not you think Europe is becoming similar to what the U.S. was 2 years ago, where suppliers began to aggressively pursue direct opportunities?

Thanks.

Well, I certainly wouldn't expect it to be any different from a supplier perspective.

Now, the first thing that I would point out to you, is that a significant amount of the difference in the growth, second half versus first half for Europe, was because of FX.

So, you really should take those numbers out.

It's certainly a reality of our business, but it's not, that's not something that we can do about it.

But we do see in Europe the same supplier dynamics that we have in the U.S. slightly different.

The airlines are as aggressive as the airlines in the U.S. were kind of now, and were a year or 2 years ago.

The chains on the hotel side are much less of a factor.

They are a factor in Europe, but not nearly as large a factor.

And as you know, the penetration of independent hotels in Europe is much larger, which is good for us from an economic perspective.

But the players, however, that you see in Europe, which are the tour operators, the TUIs of the world, the Thomsons of the world, they are very, very large leisure players.

They are significantly larger in Europe than we are.

They are getting much more aggressive on the online side of the business, as kind of the off-line side of their business slows down.

So we do expect to see similar dynamics in Europe now, as we saw in the U.S. 2 years ago.

I think we are up for it.

We've learned some lessons.

But I would also mention that Europe is a bigger market than the U.S., and we are pretty positive on where we can take it.

One other question.

Could you update us on Direct Connect, the percentage of merchant partners that are actually on Direct Connect.

And also if you could give a percentage of merchant bookings that are from Direct Connected hotels?

Thanks.

It's approximately 30% is Direct Connect right now.

30% of bookings?

30% of the total merchant hotels are fully Direct Connected, Scott.

And then just a quick follow up on Dara's point.

I would also point out in Q4, that international rev margin was above domestic revenue margin, something that, to think about as you think about those dynamics, internationally.

Operator, could we take the next question, please?

Justin Post, Merrill Lynch.

I'm really interested in the international outlook, and how things have changed there.

Was there any events in the U.K. that really made a difference in the second half versus the first half, X currency?

And then secondly, are there any other countries that are building scale that could be meaningfully helpful as we look forward in 2006 and 2007?

It's difficult to point to a specific event in the U.K., Justin, that caused the slow down, but we definitely saw the slow down.

We have, we think that it is something that has affected our competitors.

You've seen kind of the Cendant announcements, and their write-down of ebookers.

I think Sabre has said that they have challenges in the last minute business, but they are good operators, so I am sure they will work their way through it.

And as we kind of ask some other folks about what they see in Europe, and what they see specifically in the U.K., they are seeing some slow down as well.

Now I do think that some of the slow down is probably a little greater as it relates to us because of the supply direct kind of dynamics that I talked about, but just the U.K. just seems kind of slow right now.

As far as other markets that are getting to scale, there aren't any markets in Europe that are nearly the size of the U.K., but certainly taken together, Germany, France, Italy are starting to get to pretty good sizes.

Germany for example, this year was profitable for the first time.

And while we are plowing significant amounts of incremental marketing dollars into Italy and France, we think those are kind of investments that will pay off.

We certainly saw them pay off in the U.K.

We saw them pay off in Germany.

And we expect to see similar pay-offs in those markets as well.

Okay.

And 2 quick housekeeping things.

Did you get any benefit from deferred income taxes?

I didn't see it in the cash flow statement for cash flows in '05.

Will that change next year?

And then, you didn't mention Project Apollo.

Is that still going on?

Mark, you want to take those?

Yes.

I'll start with Apollo first.

First of all, yes, there is a lot going on with Apollo.

We are focused, as we mentioned before, on the integration.

Dara mentioned, and I mentioned about the investments we are making.

A lot of that is also tied to Apollo.

We should -- this is an ongoing -- whenever you integrate, it's an ongoing process.

It's not something that happens within 3 or 6 months.

We are starting to see savings -- we should start to see savings in '06 related to Apollo.

When you start talking about integrating your businesses, which is a big part of it, this is a 12-month-type, 18-month process you go through.

Particularly when you start talking about integrating systems, back offices, so what the teams have developed is detailed work plans, we are executing against those plans, and as we said, we will start seeing those benefits in 2006.

So there is a laser focus on this right now, and a big push for the business on Apollo.

And just the up front costs for this stuff were pretty significant.

So even though we will see the savings come on to some extent in '06, they are going to be offset by costs of doing this kind of integration work, right Mark?

That's right.

And then on taxes, did you get any benefit in '05, as far as the NOLs on cash flow?

Yes.

The answer is yes.

Okay.

Can you quantify that at all?

No.

Do you have a number for that?

Not right now I don't.

We can get back to you with the detail off-line, Justin.

Robert Peck, Bear Stearns.

Hi, Barry or Dara.I was wondering if you can comment a little bit about the metasearch engines, and what Kayak and SideStep have meant to your -- the implications it has had on the business so far.

As well as, can you talk a little bit about the Google relationship, when you tied Philadelphia to New York into the search engine, and get those bunch of choices back.

How is that implicated in your financials, as well?

Just quickly, Barry, I will start, and I don't know if you want to continue.

But the metasearch engines really, certainly are less of a deal in a reality for us than they have been made in the press.

I can't -- I think Kayak and some of the others have a nice product out there.

But fundamentally, I think if we do our job, which is to get great and broad pricing across our air product, across our hotel product, across our car product, I don't see what they are offering other than kind of an economic model that doesn't match our economic model.

And I don't see how they can gain any kind of real brand awareness or broad brand awareness.

Are they going to go away?

No.

Are they going to compete with us?

Absolutely.

I think it keeps us on our toes, and I expect them to get better and better as time goes on.

But I don't see them as any kind of a fundamental threat to our business.

I think that our business model is better, and I think there's much, much more that we can do as far as improving our customer experience and getting broader selection, better information from our customers with our model.

As far as Google goes, Google is a great partners of ours.

They are a significant kind of a source of transactions for us across our brands.

They do an excellent job with us.

Our -- the amount of business that we do with them grows year-over-year fairly significantly.

So we are obviously interested in what they do, from a product standpoint going forward.

And, for example, what you mentioned, the New York to Philadelphia, we are a partner that works with them on those kinds of products, and hopefully we will be partnering with them going forward.

We are certainly a very big client.

We have seen search terms in travel increase, mostly due to supplier direct bidders being out there.

The increase is around 5% a year or so, is what we've seen so far.

Frankly, it's something that we expected, and it's a cost of doing business.

And can you maybe give us a quick follow-up on your look-to-book ratio, as well as some people have talked about one of the benefits of Expedia is that it could potentially be a counter cyclical player as well.

Do you sort of see that as a potential positive for Expedia?

I think on the look-to-book ratio is the conversion rates actually on Expedia are slightly up year-on-year.

So we are pretty happy with what we've seen.

And again, it's a result of the merchandising team that we put together, and a lot of the efforts going on there, the e-mail marketing efforts that are going on.

So we think that we turned the corner on conversion, and hopefully, with the platform and investments, we will continue to see that trend improve.

What was your second question?

It was on the counter cyclicality, right?

Correct.

Yes, I think we absolutely have counter cyclical elements in our business.

Which is if you think about it, any distributor is going to have less power in an up-market, so to speak, when suppliers can get access to demand and access to customers easily.

And in down markets, when suppliers need us more, kind of our market power increases, so to speak.

So I think you've seen it, in our raw merchant margins, that as the travel industry has improved, our raw merchant margins have gone down.

That has been largely offset by ADR growth.

So we would expect the opposite to happen in a down travel market.

ADR growth will go down, which will hurt us.

But we would expect to see some raw margin expansion.

Obviously, the industry is really young.

We haven't gone through a bunch of cycles, so a lot of this is theory.

And we will believe it when we see it, so to speak, but theoretically that should be the case.

Thanks, Dara.

Hey Justin, this is Mark.

I do want to add a comment around taxes.

I know that it's -- they've been trying to figure out when are we going to be a full taxpayer when you try to do your modeling.

As I pointed out on my call, it's important to understand that in 2006 we will no longer have any NOLs.

If people were thinking through how to model when will we be a full taxpayer?

It will be some time in 2006.

Okay, operator, if we could take 2 more questions, please.

Mark Mahaney, Citigroup Investment Research.

On the Expedia corporate travel, of the different investment priorities for 2006, how high does that rank?

And what kind of impact should that have on the revenue margin, as it grows from 5% of total bookings to 10% over time?

Thank you.

Honestly, it's hard to rank the various initiatives that we're undertaking.

We are a very big company.

We are throwing off significant cash flows, and one of the great spots that we are in, is that we can invest across multiple fronts.

And we can invest aggressively across multiple fronts.

We think long-term, it is absolutely the right thing to do.

It's hard for me to rank it, but the corporate business in the U.S. is half -- is close to half the total travel market in the U.S.

It is a very, very large market.

It is a large market in Europe, as well.

And we have a great technology solution.

We put together a great management team there.

And we are competing against competitors who, I believe, have to fundamentally revolutionize their business processes and their business model to compete against us.

I am much more bullish on ECT than most people around here.

I think that we have got a great team and I think we can drive that business.

The great kind of side benefit to that, is that ECT brings very high yielding traffic to our supply partners.

So if there's 1 potential kind of, I'd say, misconception of Expedia that some of our supplier partners have had, is that we only bring price sensitive customers to the table.

That's no longer true, as the Internet becomes mainstream.

And also as we add in an element of corporate travel, very high yielding kind of customers, and as that percentage of our business increases as a percentage of the whole, we think that our value to suppliers increases as well.

As it relates to supply margin, I'm sorry, revenue margin, revenue margin will go down.

Revenue margin at ECT on average, is lower than the revenue margin for the whole business.

That's because we have a lower percentage of merchants/hotel mix so to speak.

But again we think the dollars are incremental.

We think it's great for our relationships with our suppliers, and we think it's a huge opportunity.

Thank you.

Michael Millman, Soleil Securities.

It looks like there's a disconnect between Internet traffic, which looks like for the fourth quarter was up about 40% for you, and that seemed to translate into the gross bookings and the revenue numbers that you've given out.

And that compares with Travelocity, who was in single-digits in Internet traffic, but had a substantially higher growth from a lower base, but substantially higher growth in bookings, and in revenue as well.

And they also seemed to suggest that they had some very high efficiency in their marketing.

Could you talk about what seems to disconnect here, and whether their relationship program has really taken hold, and has allowed them to get this seemingly much higher marketing efficiency?

Mike, it's very difficult to -- it's very difficult to tell kind of what the internal data is with Travelocity, versus the internal data with ours.

I can tell you that while the long-term trends in these numbers tend to hold true, at times there are very, very large diversions between what these external services say about traffic, and what our internal traffic metrics tell us, either on a monthly or a quarterly basis.

So there may be a disconnect there, and I wish I could explain it.

If we got together with you and Travelocity, I think the Justice Department might say, comparing notes, it might be a bad idea.

But again, I just don't know.

That said, we are seeing similar efficiencies as Travelocity.

And for the year, if you don't include kind of the direct investments that Mark talked about in the PSG group, the marketing managers, we actually saw around 460 basis points in overall marketing efficiency for the year.

So we are seeing good efficiency there.

Certainly, from what we see, Travelocity is getting good results, and they are doing a good job, and as is our intention going forward.

I guess, a quick follow-up.

They also continue to say that they see adequate inventory, and that they see that their raw margins are stable and sustainable.

Can you comment on what the disconnect is there?

I think that I would guess that our raw margins in general, as far as the level that we are starting off with, my guess is that our raw margins are actually significantly higher than theirs.

So at least I believe that the raw margins that they get from suppliers, maybe not every single supplier, is actually lower than ours.

And that's simply because of the market power that we bring to bear, and the number of customers that we bring to bear, and the diversity of brands that we bring to bear.

So they may be starting from a lower level than where we are.

Remember that we've been in the market, in the merchant hotel business a much longer time than they have been.

And also again the trends that we see in the raw margin area, especially in the hotel -- in the hotel raw margins, are actually pretty encouraging.

The decrease in raw margins is declining, and I think we are seeing really, really good work there from the Partner Services group.

They say they are seeing low 20s sustainable margins.

That's what they said, and again, we don't comment on the specific margins.

But we do believe ours are higher.

Thank you.

Thank you for joining us on the call today, and for your questions.

A replay will be available on our Investor Relations website following completion of this call.

We appreciate your interest in Expedia, and look forward to talking with you again next quarter.

Thanks very much.

Thank you.

Ladies and gentlemen, this concludes the Expedia Incorporated fourth quarter 2005 conference call.

At this time, you may now disconnect.