Priceline.com (PCLN - Analyst Report) reported strong results in the third quarter with earnings exceeding the Zacks Consensus Estimate on revenues that were in line. Share prices plunged 8.4% yesterday with minimal movement after-hours as the guidance disappointed.

Revenue

Priceline reported revenue of $2.84 billion in the quarter, up 33.6% sequentially and 25.0% from the year-ago quarter. This was better than management’s guidance of $2.72 billion (at the mid-point).

Revenue by Channel

Priceline’s operating model has been changing over the last two years or so, with the merchant business gradually becoming a smaller part. This is mainly because the agency business has been growing much faster.

Both channels grew sequentially, with agency up 42.4% and merchant 8.2%. Merchant revenues declined 1.2% from the year-ago quarter due to the opaque business, which remained impacted by the non-availability of discounts in a strengthening travel market and a share shift to express deals.

Agency revenue growth decelerated but still jumped 33.2%, more than making up for the decline. The merchant/agency mix went from 27%/69% in the March quarter to 22%/74% in the last quarter.

Other revenue was up 50.5% sequentially and 70.0% from last year.

Room nights, rental car days and airline tickets grew a respective 5.8%, -0.7% and -4.8% sequentially and 26.7%, 18.3% and 11.1% from last year. Priceline also saw an increase in ADRs (up 3% on a local currency basis), but not as good as Expedia’s (EXPE - Analyst Report) 5%.

Bookings

Priceline’s overall bookings were up 2.1% sequentially and 28.4% year over year, over the guided range. Foreign currency had a slightly negative impact on gross bookings in the last quarter.

While international bookings continued to grow strong double-digits from the year-ago quarter, domestic bookings growth dropped off sharply. Agoda.com recovered following the civil unrest in Thailand and along with Booking.com helped share gains in Asia (management estimates). The company recently expanded its relationship with Ctrip International to further strengthen its position in China.

Sequential growth of 2.1% in agency bookings was marginally lower than merchant bookings growth of 2.3%. But its 31.0% growth from last year trumped the 14.9% increase recorded for the merchant business. 

Operating Performance

Priceline reported a pro forma gross margin of 92.4%, up 370 basis points (bps) sequentially and 474 bps year over year. In the last quarter, gross profit benefited from the addition of OpenTable, which did not add any cost of sales. Because of the nature of the business and the mix of agency versus merchant revenue, management usually uses gross profit dollars rather than margin to gauge performance during any quarter.

Priceline’s gross profit dollars were up 39.1% sequentially and 31.7% from last year. Both international and domestic (including OpenTable) gross profits were up strong double-digits, although international growth was higher than domestic. The rapid growth in Asia and Latin America where ADRs are low and margins respond strongly to higher volumes is the main reason for the expansion of the international gross profit.

Priceline’s operating income jumped 79.7% sequentially to $1.36 billion but the more important thing is, this was also 27.0% above year-ago levels. The operating margin of 47.9% expanded 1,230 bps sequentially and 77 bps from the year-ago quarter. All expenses declined sequentially as a percentage of sales but the 545 bp decline in offline advertising was the most significant factor. All except COGS increased from last year, with online advertising being the most significant driver.

Priceline reported adjusted EBITDA of $1.43 billion, up 28.4% from the year-ago quarter, better than management’s expectations of adjusted EBITDA in the $1.265-1.365 billion range.

Net Income

The pro forma net income was $1.10 billion, or 38.8% of revenue, compared to $603.8 million, or 28.4% in the previous quarter and $865.1 million, or 38.1% in the year-ago quarter. Our pro forma estimate excludes charges related to amortization of intangibles, other charges and tax adjustments, and includes stock based compensation in the last quarter.

Including these items, Priceline’s GAAP net income was $1.06 billion or $20.03 a share, compared to $576.4 million, or $10.89 a share in the Jun 2014 quarter and $833.0 million, or $15.72 a share in the year-ago quarter.

Balance Sheet

Priceline ended with a cash and short term investments balance of $6.24 billion, down $927.6 million during the quarter. Priceline generated $1.29 billion of cash from operations. It spent around $28.7 million on capex, $2.40 billion on the OpenTable acquisition and $245.5 million on share repurchases. It also raised $2.28 billion from debt issued.

At quarter-end, Priceline had $3.89 billion in long-term debt and $37.8 million in short term debt, totaling $3.93 billion. The net cash position at quarter-end was $2.31 billion, down from $5.36 billion at the beginning of the quarter. Days sales outstanding (DSOs) were around 27, down from 36 at the beginning of the quarter.

Guidance

For the fourth quarter, Priceline expects total gross bookings to grow 8-15% year over year (13-20% on a local currency basis), with international growing 10-17% (16-23% on a local currency basis) and domestic growing 0-5%. This is expected to yield a year-over-year revenue increase of 11-18% ($1.76 billion at the mid-point, slightly lower than the Zacks Consensus of $1.89 billion).

Priceline expects gross profit dollars to increase 17-24%, with the adjusted EBITDA at $625 million to $665 million.

The pro forma EPS is expected to come in at $9.40-$10.10, based on a 15% tax rate and 53.2 million shares. The GAAP EPS is expected to be $7.55 to $8.25. Analysts were expecting pro forma earnings of $10.20 a share when the company reported earnings, better than guided.

Conclusion

Priceline reported a very strong quarter, with both revenue and earnings topping our expectations. Priceline’s decision to significantly increase inventory, especially in the lower-priced segment in Europe is also likely to have helped.

Priceline has also been steadily building position in emerging international markets. It is not only increasing its hotel inventories, but also entering into strategic alliances and making acquisitions that could help growth in the future.

The company’s international business continues to do very well, but there appear to be some issues in the domestic market. The OpenTable acquisition could help on this front. Online travel companies in general have been collaborating to generate additional revenue all over the world and Priceline is no different.

Priceline will continue investing in the business to push growth and especially, to continue its international expansion strategy.

The company has started providing conservative guidance, which has been well below expectations, but has come back to beat those expectations very strongly.

Priceline shares currently carry a Zacks Rank #4 (Sell) similar to companies like Expedia and Makemytrip (MMYT - Snapshot Report). Orbitz Worldwide (OWW -Snapshot Report) is better-ranked at #2 (Buy).