Expedia 10Q 2006 Q2 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the quarterly period ended June 30, 2006

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the transition period from to

Commission File Number: 000-51447

EXPEDIA, INC.

(Exact name of registrant as specified in its charter)


Delaware		20-2705720
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

3150 139th Avenue SE

Bellevue, WA 98005

(Address of principal executive office) (Zip Code)

(425) 679-7200

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Large accelerated filer o Accelerated filer o Non-accelerated filer þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes o No þ

The number of shares outstanding of each of the registrant’s classes of common stock as of July 31, 2006 was:


Common stock, $0.001 par value per share			304,611,704 shares
Class B common stock, $0.001 par value per share			25,599,998 shares

EXPEDIA, INC.

Form 10-Q

For the Quarter Ended June 30, 2006

Contents


Part I	Financial Information

Item 1	Consolidated Financial Statements
	Consolidated Statements of Income for the Three and Six Months Ended June 30, 2006 and 2005 (unaudited)	2
	Consolidated Balance Sheets as of June 30, 2006 (unaudited), and December 31, 2005	3
	Consolidated Statement of Changes in Stockholders’ Equity and Comprehensive Loss for the Six Months Ended June 30, 2006 (unaudited)	4
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2006 and 2005 (unaudited)	5
	Notes to Consolidated Financial Statements	6
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3	Quantitative and Qualitative Disclosures about Market Risk	29
Item 4	Controls and Procedures	31

Part II	Other Information

Item 1	Legal Proceedings	31
Item 1A	Risk Factors	33
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	33
Item 4	Submission of Matters to a Vote of Security Holders	34
Item 5	Other Information	34
Item 6	Exhibits	35
Signature		36
EXHIBIT 10.17
EXHIBIT 10.18
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 31.3
EXHIBIT 32.1
EXHIBIT 32.2
EXHIBIT 32.3

Part I. Item 1. Consolidated Financial Statements

EXPEDIA, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(Unaudited)


			Three Months Ended						Six Months Ended
			June 30,						June 30,

			2006			2005			2006			2005

Revenue			$	598,458		$	555,007		$	1,092,356		$	1,040,053
Cost of revenue(1)				128,449			129,484			247,763			243,587

Gross profit				470,009			425,523			844,593			796,466
Operating expenses:
	Selling and marketing(1)			198,666			192,613			399,692			372,203
	General and administrative(1)			71,053			66,111			144,414			123,050
	Technology and content(1)			33,288			35,152			68,832			71,144
	Amortization of intangible assets			30,120			31,783			60,291			63,448
	Amortization of non-cash distribution and marketing			627			3,485			8,867			3,917

Operating income				136,255			96,379			162,497			162,704
Other income:
	Interest income, net:
		Interest income from IAC/ InterActiveCorp		—			17,105			—			24,773
		Other interest income, net		6,559			2,607			8,262			4,738
	Other, net			10,466			3,476			14,123			4,510

Total other income, net				17,025			23,188			22,385			34,021

Income before income taxes and minority interest				153,280			119,567			184,882			196,725
Provision for income taxes				(56,158	)		(45,484	)		(65,816	)		(74,869	)
Minority interest in earnings of consolidated subsidiaries, net				(1,640	)		(651	)		(249	)		(395	)

Net income			$	95,482		$	73,432		$	118,817		$	121,461

Net earnings per share available to common stockholders:
	Basic		$	0.28		$	0.22		$	0.34		$	0.36
	Diluted			0.27			0.22			0.33			0.36
Shares used in computing earnings per share:
	Basic			346,014			335,540			345,896			335,540
	Diluted			359,090			340,549			362,130			340,549


(1) Includes stock-based compensation as follows:
	Cost of revenue		$	1,586	$	5,265	$	4,811	$	11,185
	Selling and marketing			3,446		7,362		8,697		15,451
	General and administrative			8,753		21,110		18,440		35,736
	Technology and content			3,436		8,871		9,160		18,536

		Total stock-based compensation	$	17,221	$	42,608	$	41,108	$	80,908

See accompanying notes.

EXPEDIA, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)


			June 30,			December 31,
			2006			2005

			(Unaudited)
ASSETS
Current assets:
	Cash and cash equivalents		$	643,341		$	297,416
	Restricted cash and cash equivalents			20,623			23,585
	Accounts and notes receivable, net of allowance of $3,474 and $3,914			202,913			174,019
	Deferred income taxes, net			15,551			—
	Prepaid merchant bookings			68,994			30,655
	Prepaid expenses and other current assets			67,740			64,569

Total current assets				1,019,162			590,244
Property and equipment, net				104,344			90,984
Long-term investments and other assets				49,262			39,431
Intangible assets, net				1,117,046			1,176,503
Goodwill				5,860,166			5,859,730

TOTAL ASSETS			$	8,149,980		$	7,756,892

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Accounts payable, merchant		$	627,041		$	534,882
	Accounts payable, trade			111,628			107,580
	Short-term borrowings			93			230,755
	Deferred merchant bookings			825,729			406,948
	Deferred revenue			12,580			7,068
	Income taxes payable			75,796			43,405
	Deferred income taxes, net			—			3,178
	Other current liabilities			161,179			104,409

Total current liabilities				1,814,046			1,438,225
Deferred income taxes, net				375,671			368,880
Derivative liabilities				34,067			105,827
Other long-term liabilities				39,792			38,423
Minority interest				58,847			71,774
Commitments and contingencies
Stockholders’ equity:
	Preferred stock $.001 par value			—			—
		Authorized shares: 100,000,000
		Series A shares issued and outstanding: 846 and 846
	Common stock $.001 par value			327			323
		Authorized shares: 1,600,000,000
		Shares issued: 326,700,252 and 323,184,577
		Shares outstanding: 314,097,674 and 321,979,486
	Class B common stock $.001 par value			26			26
		Authorized shares: 400,000,000
		Shares issued and outstanding: 25,599,998 and 25,599,998
	Additional paid-in capital			5,829,411			5,695,498
	Treasury stock — Common stock, at cost			(185,779	)		(25,464	)
		Shares: 12,602,578 and 1,205,091
	Retained earnings			183,795			64,978
	Accumulated other comprehensive loss			(223	)		(1,598	)

Total stockholders’ equity				5,827,557			5,733,763

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY			$	8,149,980		$	7,756,892

See accompanying notes.

EXPEDIA, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY AND

COMPREHENSIVE LOSS

(In thousands, except share data)

(Unaudited)


										Class B												Accumulated
		Preferred Stock				Common Stock				Common Stock				Additional								Other
														Paid-In			Treasury			Retained		Comprehensive
		Shares		Amount		Shares		Amount		Shares		Amount		Capital			Stock			Earnings		Loss			Total
								��
Balance as of December 31, 2005			846	$	—		323,184,577	$	323		25,599,998	$	26	$	5,695,498		$	(25,464	)	$	64,978	$	(1,598	)	$	5,733,763
Comprehensive income:
	Net income																				118,817					118,817
	Net loss on derivative contracts																						(4,209	)		(4,209	)
	Currency translation adjustment																						5,584			5,584

Total comprehensive income																										120,192

Release of derivative liability															71,583											71,583
Proceeds from exercise of equity instruments							3,515,675		4						23,753											23,757
Tax deficiencies on equity awards and other, net															(5,004	)										(5,004	)
Treasury stock activity related to exercise of equity instruments																		(6,488	)							(6,488	)
Common stock repurchases																		(153,827	)							(153,827	)
Modification of cash-based equity awards															2,930											2,930
Stock-based compensation expense															40,651											40,651

Balance as of June 30, 2006			846	$	—		326,700,252	$	327		25,599,998	$	26	$	5,829,411		$	(185,779	)	$	183,795	$	(223	)	$	5,827,557

See accompanying notes.

EXPEDIA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)


			Six Months Ended
			June 30,

			2006			2005

Operating activities:
Net income			$	118,817		$	121,461
Adjustments to reconcile net income to net cash provided by operating activities:
	Depreciation			22,673			23,505
	Amortization of intangible assets, non-cash distribution and marketing, and stock-based compensation			110,266			148,273
	Deferred income taxes			(5,595	)		23,086
	Unrealized gain on derivative instruments, net			(12,212	)		—
	Equity in (earnings) losses of unconsolidated affiliates			(586	)		795
	Minority interest in earnings of consolidated subsidiaries, net			249			395
	Other			479			—
	Changes in operating assets and liabilities, net of effects from acquisitions:
		Accounts and notes receivable		(26,514	)		(48,605	)
		Prepaid merchant bookings and prepaid expenses		(51,314	)		(60,230	)
		Accounts payable, trade and other current liabilities		50,854			60,634
		Accounts payable, merchant		91,263			123,142
		Deferred merchant bookings		418,720			388,907
		Deferred revenue		5,503			2,121
		Other, net		—			(34	)

Net cash provided by operating activities				722,603			783,450

Investing activities:
	Acquisitions, net of cash acquired			(4,891	)		13,579
	Capital expenditures			(34,029	)		(26,010	)
	Proceeds from sale of marketable securities			—			1,000
	Increase in long-term investments and deposits			(1,632	)		(2,393	)
	Transfers to IAC/ InterActiveCorp, net			—			(560,768	)
	Other, net			—			161

Net cash used in investing activities				(40,552	)		(574,431	)

Financing activities:
	Repayment of short-term borrowings			(230,668	)		—
	Changes in restricted cash and cash equivalents			(4,479	)		(32,595	)
	Proceeds from exercise of equity awards			23,938			555
	Excess tax benefit on equity awards			781			—
	Treasury stock activity			(127,195	)		—
	Contributions from IAC/ InterActiveCorp, net			—			5,769
	Other, net			—			5,360

Net cash used in financing activities				(337,623	)		(20,911	)

	Effect of exchange rate changes on cash and cash equivalents			1,497			(907	)

Net increase in cash and cash equivalents				345,925			187,201
Cash and cash equivalents at beginning of period				297,416			141,668

Cash and cash equivalents at end of period			$	643,341		$	328,869

Supplemental Cash Flow Information
	Cash paid for interest		$	2,700		$	—
	Income tax payments, net			33,055			3,746

See accompanying notes.

Notes to Consolidated Financial Statements

June 30, 2006

(Unaudited)

Note 1 — Basis of Presentation


	*Description of Business*

Expedia, Inc. and its subsidiaries provide travel products and services to leisure and corporate travelers in the United States (“U.S.”) and abroad. These travel products and services are offered through a diversified portfolio of brands including: Expedia.com and Hotels.com (as well as related international websites), Hotwire.com, our private label programs (Worldwide Travel Exchange and Interactive Affiliate Network), Classic Vacations, Expedia Corporate Travel (“ECT”), eLong and TripAdvisor. We refer to Expedia, Inc. and its subsidiaries collectively as “Expedia,” the “Company,” “us,” “we” and “our” in these unaudited consolidated financial statements.

On December 21, 2004, IAC/ InterActiveCorp (“IAC”) announced its plan to separate into two independent public companies to allow each company to focus on its individual strategic objectives. We refer to this transaction as the “Spin-Off.” A new company, Expedia, Inc., was incorporated under Delaware law in April 2005, to hold substantially all of IAC’s travel and travel-related businesses. On August 9, 2005, the Spin-Off was completed and Expedia, Inc. shares began trading on The Nasdaq Stock Market, Inc. under the symbol “EXPE.”


	*Basis of Presentation*

These accompanying financial statements present our results of operations, financial position, stockholders’ equity and comprehensive loss, and cash flows on a combined basis through the Spin-Off on August 9, 2005, and on a consolidated basis thereafter. We have prepared the combined financial statements from the historical results of operations and historical bases of the assets and liabilities of Expedia with the exception of income taxes. We have computed income taxes using our stand-alone tax rate. The unaudited consolidated financial statements include Expedia, Inc., our wholly-owned subsidiaries, and entities we control. We have eliminated significant intercompany transactions and accounts.

We believe that the assumptions underlying our unaudited consolidated financial statements are reasonable. However, these unaudited consolidated financial statements do not present our future financial position, the results of our future operations and cash flows, nor do they present what our historical financial position, results of operations and cash flows would have been prior to Spin-Off had we been a stand-alone company.

We have prepared the accompanying unaudited consolidated financial statements in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial reporting. In our opinion, we have included all adjustments necessary for a fair presentation of the results of the interim period. These adjustments consist of normal recurring items. Our interim unaudited consolidated financial statements are not necessarily indicative of results that may be expected for any other interim period or for the full year. These interim unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2005, previously filed with the Securities and Exchange Commission (“SEC”).


	*Accounting Estimates*

We use estimates and assumptions in the preparation of our interim unaudited consolidated financial statements in accordance with GAAP. Our estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of our interim unaudited consolidated financial statements. These estimates and assumptions also affect the reported amount of net income during any period. Our actual financial results could differ significantly from these estimates. The significant estimates underlying our interim unaudited consolidated financial statements include revenue

Notes to Consolidated Financial Statements — (Continued)

recognition, accounting for merchant payables, recoverability of long-lived and intangible assets and goodwill, income taxes, occupancy tax, stock-based compensation and accounting for derivative instruments.


	*Reclassifications*

We have reclassified prior period financial statements to conform to the current period presentation.

In our consolidated statements of income for the three and six months ended June 30, 2005, we reclassified stock-based compensation expense to the same operating expense line items as cash compensation paid to employees in accordance with the SEC Staff Accounting Bulletin No. 107 (“SAB 107”). Our adoption of SAB 107 did not have a material impact on our financial position, results of operations or cash flows.

In our consolidated statements of cash flows for the six months ended June 30, 2005, we reclassified $560.8 million of transfers to IAC from financing activities to investing activities, and we reclassified $13.3 million of changes in restricted cash and cash equivalents to financing activities.

In our consolidated balance sheet as of December 31, 2005, we reclassified $19.7 million from accounts payable, trade, to accounts payable, merchant ($19.3 million) and other current liabilities ($0.4 million).


	*Seasonality*

We generally experience seasonal fluctuations in the demand for our travel products and services. For example, traditional leisure travel bookings are generally the highest in the first three quarters of the year as travelers plan and book their spring, summer and holiday travel. The number of bookings decreases in the fourth quarter. Because revenue in the merchant business is generally recognized when the travel takes place rather than when it is booked, revenue typically lags bookings by a month or longer. As a result, revenue is typically the lowest in the first quarter and highest in the third quarter.

Note 2 — Summary of Significant Accounting Policies


	*Stock-Based Compensation*

Beginning on January 1, 2006, we account for stock-based compensation under the modified prospective method provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R),Share-Based Payment(“SFAS 123(R)”), and related guidance. Under SFAS 123(R), we continue to measure and amortize the fair value for all share-based payments consistent with our past practice under SFAS 123,Accounting for Stock-Based Compensationand SFAS No. 148,Accounting for Stock-Based Compensation — Transition and Disclosure. As a result, the adoption of SFAS 123(R) did not have a material impact on our financial position.

We measure and amortize the fair value of restricted stock units, stock options and warrants as follows:

Restricted Stock Units (“RSU”). RSUs are stock awards that are granted to employees entitling the holder to shares of common stock as the award vests, typically over a five-year period. We measure the value of RSUs at fair value based on the number of shares granted and the quoted price of our common stock at the date of grant. We amortize the fair value, net of estimated forfeitures, as stock-based compensation expense over the vesting term on a straight-line basis. RSUs that may be settled by the holder in cash, rather than shares, are recorded as a liability and we remeasure these instruments at fair value at the end of each reporting period. Upon settlement of these awards, our total compensation expense recorded over the vesting period of the awards will equal the settlement amount, which is based on our stock price on the settlement date.

Performance-based RSUs vest upon achievement of certain company-based performance conditions. On the date of grant, we assess whether it is probable that the performance targets will be achieved, and if assessed as probable, we determine the fair value of the performance-based award based on the fair value of

Notes to Consolidated Financial Statements — (Continued)

our common stock at that time. We record compensation expense for these awards over the estimated performance period using the accelerated method under Financial Accounting Standards Board (“FASB”) Interpretation No. 28,Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans — an interpretation of Accounting Principles Board Opinion No. 15 and 25.At each reporting period, we reassess the probability of achieving the performance targets and the performance period required to meet those targets. The estimation of whether the performance targets will be achieved and of the performance period required to achieve the targets requires judgment, and to the extent actual results or updated estimates differ from our current estimates, the cumulative effect on current and prior periods of those changes will be recorded in the period estimates are revised. The ultimate number of shares issued and the related compensation expense recognized will be based on a comparison of the final performance metrics to the specified targets.

Stock Options and Warrants. We measure the value of stock options and warrants issued or modified, including unvested options assumed in acquisitions, on the grant date (or modification or acquisition dates, if applicable) at fair value, using the Black-Scholes option valuation model. We amortize the fair value, net of estimated forfeitures, over the remaining vesting term on a straight-line basis.

Estimates of fair value are not intended to predict actual future events or the value ultimately realized by employees who receive these awards, and subsequent events are not indicative of the reasonableness of our original estimates of fair value. In determining the estimated forfeiture rates for stock-based awards, we periodically conduct an assessment of the actual number of equity awards that have been forfeited to date as well as those expected to be forfeited in the future. We consider many factors when estimating expected forfeitures, including the type of award, the employee class and historical experience. The estimate of stock awards that will ultimately be forfeited requires significant judgment and to the extent that actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period such estimates are revised.

We have calculated an additional paid-in capital (“APIC”) pool pursuant to the provisions of SFAS 123(R). The APIC pool represents the excess tax benefits related to stock-based compensation that are available to absorb future tax deficiencies. We include only those excess tax benefits that have been realized in accordance with SFAS No. 109,Accounting for Income Taxes.If the amount of future tax deficiencies is greater than the available APIC pool, we will record the excess as income tax expense in our consolidated statements of income. For the three and six months ended June 30, 2006, we recorded tax deficiencies of $2.3 million and $7.1 million against the APIC pool; as a result, such deficiencies did not affect our results of operations. Excess tax benefits or tax deficiencies are a factor in the calculation of diluted shares used in computing dilutive earnings per share. The adoption of SFAS 123(R) did not have a material impact on our dilutive shares.

Prior to our adoption of SFAS 123(R), we recorded cash retained as a result of tax benefit deductions relating to stock-based compensation in operating activities in our consolidated statements of cash flows, along with other tax cash flows, in accordance with the provisions of the Emerging Issues Task Force (“EITF”) No. 00-15,Classification in the Statement of Cash Flows of the Income Tax Benefit Received by a Company upon Exercise of a Nonqualified Employee Stock Option(“EITF 00-15”). SFAS 123(R) supersedes EITF 00-15, amends SFAS No. 95,Statement of Cash Flows, and requires that, upon adoption, we present the tax benefit deductions relating to excess stock-based compensation deductions as a financing activity in our consolidated statements of cash flows. For the six months ended June 30, 2006, we reported $0.8 million of tax benefit deductions as a financing activity that previously would have been reported as an operating activity.


	*Marketing Promotions*

We periodically provide incentive offers to our customers to encourage booking of travel products and services. We record these incentive offers in accordance with EITF No. 01-9,Accounting for Consideration

Notes to Consolidated Financial Statements — (Continued)

Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products)and EITF No. 00-22,Accounting for “Points” and Certain Other Time-Based or Volume-Based Sales Incentive Offers, and Offers for Free Products or Services to Be Delivered in the Future. Generally, our incentive offers are as follows:

Current Discount Offers. These promotions include dollar off discounts to be applied against current purchases. We record the discounts as reduction in revenue at the date we record the corresponding revenue transaction.

Inducement Offers. These promotions include discounts granted at the time of a current purchase to be applied against a future qualifying purchase. We treat inducement offers as a reduction to revenue based on estimated future redemption rates. We allocate the discount amount between the current purchase and the potential future purchase based on our expected relative value of the transactions. We estimate our redemption rates using our historical experience for similar inducement offers.

Concession Offers. These promotions include discounts to be applied against a future purchase to maintain customer satisfaction. Upon issuance, we record these concession offers as a reduction to revenue based on estimated future redemption rates. We estimate our redemption rates using our historical experience for concession offers.


	*New Accounting Pronouncement*

In July 2006, the FASB issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109(“FIN 48”), which clarifies the accounting for uncertainty in tax positions. FIN 48 prescribes guidance related to the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 requires that we recognize in our financial statements the impact of a tax position, if that position is more likely than not to be sustained upon an examination, based on the technical merits of the position. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. We have not yet determined the impact, if any, of this interpretation on our results from operations, financial position or cash flows.

Note 3 — Short-Term Borrowings

In July 2005, we entered into a $1.0 billion five-year unsecured revolving credit facility with a group of lenders, which was effective as of the Spin-Off, and is unconditionally guaranteed by certain Expedia subsidiaries. The facility bears interest based on our financial leverage, which as of June 30, 2006, was equal to LIBOR plus 0.50%. The facility also contains financial covenants consisting of a leverage ratio and a minimum net worth requirement. As of June 30, 2006, and December 31, 2005, we were in compliance with all financial covenants.

The amount of stand-by letters of credit issued under the facility reduces the amount available to us. As of June 30, 2006, and December 31, 2005, there was $49.2 million and $53.2 million of outstanding stand-by letters of credit issued under the facility. As of December 31, 2005, we had $230.0 million outstanding under the facility, which we fully repaid during the quarter ended March 31, 2006. As of June 30, 2006, there was no amount outstanding under the facility.

Notes to Consolidated Financial Statements — (Continued)

Note 4 — Derivative Instruments

The fair values of the derivative financial instruments generally represent the estimated amounts we would expect to receive or pay upon termination of the contracts as of the reporting date. Components of our derivative liabilities balance are as follows:


	June 30, 2006		December 31, 2005

	(In thousands)
Ask Jeeves Convertible Subordinated Notes	$	21,100	$	104,800
Cross-currency swaps and other		12,967		1,027

	$	34,067	$	105,827

As a result of the Spin-Off, we assumed certain obligations to IAC related to IAC’s Ask Jeeves Convertible Subordinated Notes (“Ask Jeeves Notes”). In 2006, certain of these notes were converted and we released approximately 3.0 million shares of our common stock from escrow with a fair value of $71.6 million to satisfy the conversion requirements. For the three and six months ended June 30, 2006, we recorded in other income a net unrealized gain of $8.0 million and $12.1 million related to the derivative liability on the outstanding Ask Jeeves Notes. As of June 30, 2006, we estimate that we could be required to release from escrow up to 1.3 million shares of our common stock (or pay cash in equal value, in lieu of issuing such shares). The Ask Jeeves Notes are due June 1, 2008; upon maturity of these notes, our obligation ceases.

We entered into cross-currency swaps to hedge against the change in value of certain intercompany loans denominated in currencies other than the lending subsidiaries’ functional currencies. These swaps have been designated as cash flow hedges and are re-measured at fair value each reporting period.

Note 5 — Stock-Based Awards and Other Equity Instruments

Our 2005 Stock and Annual Incentive Plan provides for grants of restricted stock, restricted stock awards (“RSA”), RSUs, stock options, and other stock-based awards to directors, officers, employees and consultants. As of June 30, 2006, we had approximately 7.8 million shares of common stock reserved for new stock-based awards under the 2005 Stock and Annual Incentive Plan. We issue new shares to satisfy the exercise or release of stock-based awards.

RSUs, which are awards in the form of phantom shares or units that are denominated in a hypothetical equivalent number of shares of our common stock, are our primary form of stock-based award. While we do not generally compensate our employees with stock options, when we do make such grants, they are granted at an exercise price not less than the fair market value of the stock on the grant date. The terms and conditions upon which the stock options become exercisable vary.

We have fully vested stock warrants with expiration dates through February 2012 outstanding, certain of which trade on the NASDAQ under the symbols “EXPEW” and “EXPEZ.” Each stock warrant is exercisable for a certain number of shares of our common stock or a fraction thereof. As of June 30, 2006, and December 31, 2005, we had approximately 58.5 million warrants outstanding with a weighted average exercise price of $22.33, which if exercised in full would entitle holders to acquire 34.6 million of our common shares.

Notes to Consolidated Financial Statements — (Continued)

As of June 30, 2006, we had approximately 7.6 million RSUs and approximately 0.1 million RSAs outstanding. The following table presents a summary of these awards from December 31, 2005, through June 30, 2006:


				Weighted Average
				Grant-Date Fair
	RSU and RSA			Value

	(In thousands)
Beginning balance as of December 31, 2005		5,765		$	24.08
Granted		3,956			18.21
Vested and released		(1,081	)		24.69
Cancelled		(986	)		23.88

Ending balance as of June 30, 2006		7,654			21.21

During the three months ended March 31, 2006, we granted approximately one millionperformance-based RSUs for the first time to certain senior executives. In order for these awards to vest, certain performance targets must be achieved. The fair value of these awards at the grant date was $18.9 million with a weighted average fair value of $19.39 per share and we amortize the fair value on an accelerated basis over the estimated probable period of time to achieve the target.

The following table presents a summary of stock option activity from December 31, 2005, through June 30, 2006:


				Weighted Average		Remaining		Aggregate Intrinsic
	Options			Exercise Price		Contractual Life		Value

	(In thousands)					(In years)		(In thousands)
Beginning balance as of December 31, 2005		27,706		$	15.71
Exercised		(2,466	)		9.69
Cancelled		(391	)		18.73

Ending balance as of June 30, 2006		24,849		$	16.25		3.8	$	88,996

Exercisable as of June 30, 2006		20,455		$	13.33		2.8	$	87,876

The aggregate intrinsic value of outstanding options shown in the table above represents the total pretax intrinsic value at June 30, 2006, based on our closing stock price of $14.99 on that date. The total intrinsic value of stock options exercised was $25.7 million for the six months ended June 30, 2006.

For the three months ended June 30, 2006 and 2005, we recognized stock-based compensation expense of $17.2 million and $42.6 million. The total income tax benefit recognized in income related to this compensation expense was $6.0 million and $14.9 million for those periods. For the six months ended June 30, 2006 and 2005, we recognized stock-based compensation expense of $41.1 million and $80.9 million. The total income tax benefit recognized in income related to this compensation expense was $14.3 million and $28.3 million for those periods. Cash received from stock-based award exercises for the six months ended June 30, 2006, was $23.9 million.

Our employees that held vested stock options prior to the Spin-Off received vested stock options in both Expedia and IAC. As these stock options are exercised, we receive a tax deduction. Total income tax benefits realized during the six months ended June 30, 2006 associated with the exercise of IAC and Expediastock-based awards held by our employees were $23.9 million, of which we recorded approximately $10 million as a reduction of goodwill.

Notes to Consolidated Financial Statements — (Continued)

As of June 30, 2006, there was approximately $166 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to unvested stock-based awards, which is expected to be recognized in expense over a weighted-average period of 1.8 years.

Note 6 — Income Taxes

We determine our provision for income taxes for interim periods using an estimate of our annual effective rate. We record any changes to the estimated annual rate in the interim period in which the change occurs, including discrete tax items.

Our effective tax rate was 36.6% and 35.6% for the three and six months ended June 30, 2006. Our effective tax rate is higher than the 35% statutory rate primarily due to state income taxes and the valuation allowance on foreign losses, partially offset by the disallowance for tax purposes of themark-to-market net gain related to our derivative instruments.

Our effective tax rate was 38.0% and 38.1% for the three and six months ended June 30, 2005, which was higher than the 35% statutory rate primarily due to state taxes, non-deductible stock compensation andnon-deductible transaction expenses related to the Spin-Off from IAC.

Note 7 — Earnings Per Share

The following table presents our basic and diluted earnings per share:


		Three Months Ended				Six Months Ended
		June 30,				June 30,

		2006		2005		2006		2005

		(In thousands, except per share data)
Net income		$	95,482	$	73,432	$	118,817	$	121,461
Net earnings per share available to common stockholders:
Basic		$	0.28	$	0.22	$	0.34	$	0.36
Diluted			0.27		0.22		0.33		0.36
Weighted average number of shares outstanding:
Basic			346,014		335,540		345,896		335,540
Dilutive effect of:
	Options to purchase common stock		7,330		—		8,643		—
	Warrants to purchase common stock		3,189		5,009		4,178		5,009
	Other potentially dilutive securities		2,557		—		3,413		—

Diluted			359,090		340,549		362,130		340,549

For the three and six months ended June 30, 2005, we included the dilutive effect of certain warrants since the terms of the stock warrant agreements obligated us, as of the Spin-Off, to issue underlying common stock. We did not have such obligations for options and other potentially dilutive securities.

Note 8 — Stockholders’ Equity


	*Share Repurchases*

In May 2006, our Board of Directors authorized a share repurchase program for up to 20 million outstanding shares of our common stock. During the three months ended June 30, 2006, we repurchased 10.5 million shares for a total cost of $153.8 million, at an average price of $14.66 per share including transaction costs. As of June 30, 2006, we had $33.1 million of unsettled transactions related thereto, which is included in other current liabilities. In July 2006, we completed the repurchase of all 20 million shares for a

Notes to Consolidated Financial Statements — (Continued)

total cost of $288.3 million, at an average price of $14.42 per share including transaction costs. All shares were repurchased in the open market at prevailing market prices.

In August 2006, our Board of Directors authorized a share repurchase program. Under this program, we are authorized to purchase up to 20 million outstanding shares of our common stock. There is no fixed termination date for the repurchase program and purchases may be made in the open market, in block purchases, in accelerated purchase programs, through forward contracts, in privately negotiated transactions, or in a combination of the foregoing, or otherwise.

Note 9 — Acquisitions


	*Put and Call Option Agreements*

In connection with our acquisitions of ECT — Europe and TripAdvisor, we had call and put option agreements in place to acquire the remaining shares held by the minority shareholders of each company. In April 2006, we acquired the remaining 8.6% minority ownership interest in ECT — Europe for $3.3 million in cash and recorded a $3.1 million liability that will be paid in cash over the next two years. In June 2006, we incurred an obligation to acquire 3.5% of the remaining 4.9% minority ownership in TripAdvisor for $13.0 million, which we have included in other current liabilities. We paid this amount in cash in the third quarter of 2006. We acquired the remaining 1.4% minority ownership in TripAdvisor during the third quarter 2006 for $5.3 million in cash.

Note 10 — Commitments and Contingencies


	*Purchase Obligations*

At June 30, 2006, we have agreements with national telecommunications companies relating to data transmission lines and telephones services for which we have future obligations as follows: $8.7 million within the year, $12.8 million in one to three years and $2.2 million in three to five years.


	*Legal Proceedings*

In the ordinary course of business, we are a party to various lawsuits. In the opinion of management, we do not expect these lawsuits to have a material impact on the liquidity, results of operations, or financial condition of Expedia. We also evaluate other potential contingent matters, including value-added tax, federal excise tax, transient occupancy or accommodation tax and similar matters. We do not believe that the amount of liability that could be reasonably possible with respect to these matters would have a material adverse affect on our financial results.

Note 11 — Related Party Transactions


	*Expenses Allocated from IAC*

Prior to Spin-Off, our operating expenses included allocations from IAC for accounting, treasury, legal, tax, corporate support, human resource functions and internal audit. For the three and six months ended June 30, 2005, expenses allocated from IAC were $2.5 million and $4.1 million. We recorded the expense allocation from IAC in general and administrative expense in our consolidated statements of income.

Additional allocations from IAC prior to the Spin-Off related to stock-based compensation expense attributable to our employees. Stock-based compensation expense allocated from IAC was $42.6 million and $80.9 million for the three and six months ended June 30, 2005.

Notes to Consolidated Financial Statements — (Continued)


	*Interest Income from IAC*

The majority of the interest income recorded in our consolidated statements of income for the three and six months ended June 30, 2005, arose from intercompany receivable balances from IAC. The interest income from IAC ceased upon Spin-Off on August 9, 2005.


	*Relationship Between IAC and Expedia, Inc. after the Spin-Off*

In connection with the Spin-Off, we entered into various agreements with IAC, a related party due to common ownership, to provide for an orderly transition and to govern our ongoing relationships with IAC. These agreements include the following:


	•	a Separation Agreement that sets forth the arrangements between IAC and Expedia with respect to the principal corporate transactions necessary to complete the Spin-Off, and a number of other principles governing the relationship between IAC and Expedia following the Spin-Off;

	•	a Tax Sharing Agreement that governs the respective rights, responsibilities and obligations of IAC and Expedia after the Spin-Off with respect to tax liabilities and benefits, tax attributes, tax contests and other matters regarding income taxes, other taxes and related tax returns;

	•	an Employee Matters Agreement that governs a wide range of compensation and benefit issues, including the allocation between IAC and Expedia of responsibility for the employment and benefit obligations and liabilities of each company’s current and former employees (and their dependents and beneficiaries); and

	•	a Transition Services Agreement that governs the provision of transition services from IAC to Expedia.

In May 2006, the airplane, which we own indirectly with IAC, was placed into service and is being depreciated over 10 years.


	*Commercial Agreements*

Since the Spin-Off, we have continued to work with some of IAC’s businesses pursuant to a variety of commercial relationships. These commercial agreements generally include (i) distribution agreements, pursuant to which certain subsidiaries of IAC distribute their respective products and services via arrangements with Expedia, and vice versa, (ii) services agreements, pursuant to which certain subsidiaries of IAC provide Expedia with various services and vice versa and (iii) office space lease agreements. The distribution agreements typically involve the payment of fees, usually on a fixed amount-per-transaction, revenue share or commission basis, from the party seeking distribution of the product or service to the party that is providing the distribution. During the three months ended June 30, 2006, we recorded income of $0.6 million from IAC, and recorded expense of $8.6 million to IAC. During the six months ended June 30, 2006, we recorded income of $1.3 million from IAC, and recorded expense of $17.0 million to IAC. Amounts receivable from IAC, which are included in accounts and notes receivable, totaled $0.1 million at June 30, 2006, and $0.6 million at December 31, 2005. Amounts payable to IAC, which are included in accounts payable, trade, totaled $6.6 million at June 30, 2006, and $3.6 million at December 31, 2005.


	*Agreements with Microsoft Corporation*

We have various agreements with Microsoft Corporation (“Microsoft”), which is the beneficial owner of more than 5% of our outstanding common stock, including an agreement that maintains our presence as the provider of travel shopping services on MSN.com and several international MSN websites. Total expense incurred with respect to these agreements was $5.1 million and $11.8 million for the three and six months ended June 30, 2006 and $2.9 million and $6.8 million for the three and six months ended June 30, 2005. Amounts payable related to these agreements was $4.6 million and $6.2 million as of June 30, 2006, and December 31, 2005.

Notes to Consolidated Financial Statements — (Continued)

In November 1999, we were spun-off from Microsoft. In conjunction with that transaction, we entered into a tax allocation agreement under which we must pay Microsoft for a portion of the tax savings resulting from the exercise of certain stock options. We have recorded $36.3 million in other long-term liabilities on our consolidated balance sheets as of June 30, 2006, and December 31, 2005, related to this agreement. We will pay Microsoft this amount when we realize the tax savings on our tax return.

Note 12 — Segment Information

Beginning with the first quarter of 2006, we have two reportable segments: North America and Europe. The change from a single reportable segment is a result of the reorganization of our business. We determined our segments based on how our chief operating decision makers manage our business, make operating decisions and evaluate operating performance. Our primary operating metric for evaluating segment performance is “Operating Income Before Amortization” (defined below), which requires allocations of certain expenses to the segments. We base the allocations primarily on transaction volumes and other usage metrics; we are currently evaluating our allocation methodology. For certain expenses that we do not allocate to reportable segments such as partner services, worldwide product development, accounting, human resources and legal, we include them in Corporate and Other.

Our North America segment provides a full range of travel services to customers in the U.S., Canada and Mexico. This segment operates through a variety of brands including Expedia.com, Hotels.com, Hotwire.com TripAdvisor and Classic Vacations. Our Europe segment provides travel services primarily through localized Expedia websites in the United Kingdom, France, Germany, Italy and the Netherlands, as well as localized versions of Hotels.com in various European countries.

Corporate and Other includes ECT, Expedia Asia Pacific and unallocated corporate functions and expenses. ECT provides travel products and services to corporate customers in North America and Europe. Expedia Asia Pacific provides online travel information and reservation services in Australia and the People’s Republic of China. In addition, we record amortization of intangible assets and stock-based compensation expense in Corporate and Other.

The following table presents our segment information for the three and six months ended June 30, 2006. We have not reported segment information for the three and six months ended June 30, 2005, as it is not practicable to do so. In addition, we do not currently allocate assets to our operating segments, nor do we report such information to our chief operating decision makers.


	Three Months Ended June 30,

	2006											2005

	North					Corporate and
	America			Europe		Other			Total			Total

	(In thousands)
Revenue	$	455,925		$	113,374	$	29,159		$	598,458		$	555,007

Operating Income Before Amortization	$	217,178		$	36,305	$	(69,260	)	$	184,223		$	174,255
Amortization of intangible assets		—			—		(30,120	)		(30,120	)		(31,783	)
Stock-based compensation		—			—		(17,221	)		(17,221	)		(42,608	)
Amortization of non-cash distribution and marketing		(627	)		—		—			(627	)		(3,485	)

Operating income (loss)	$	216,551		$	36,305	$	(116,601	)	$	136,255		$	96,379

Notes to Consolidated Financial Statements — (Continued)


	Six Months Ended June 30,

	2006											2005

	North					Corporate and
	America			Europe		Other			Total			Total

	(In thousands)
Revenue	$	837,850		$	199,541	$	54,965		$	1,092,356		$	1,040,053

Operating Income Before Amortization	$	368,547		$	48,963	$	(144,747	)	$	272,763		$	310,977
Amortization of intangible assets		—			—		(60,291	)		(60,291	)		(63,448	)
Stock-based compensation		—			—		(41,108	)		(41,108	)		(80,908	)
Amortization of non-cash distribution and marketing		(8,867	)		—		—			(8,867	)		(3,917	)

Operating income (loss)	$	359,680		$	48,963	$	(246,146	)	$	162,497		$	162,704

In the above table, Operating Income Before Amortization and operating income for the North America and Europe segments do not include the allocation of corporate expenses, which include functions such as partner services, worldwide product development, accounting, human resources and legal. We include these expenses in Corporate and Other.


	*Definition of Operating Income Before Amortization (“OIBA”)*

We provide OIBA as a supplemental measure to GAAP. We define OIBA as operating income plus: (1) amortization of non-cash distribution and marketing expense, (2) stock-based compensation expense, (3) amortization of intangible assets and goodwill impairment, if applicable and (4) certain one-time items, if applicable.

OIBA is our primary operating metric used by which management evaluates the performance of the business, on which internal budgets are based, and by which management is compensated. Management believes that investors should have access to the same set of tools that management uses to analyze our results. This non-GAAP measure should be considered in addition to results prepared in accordance with GAAP, but should not be considered a substitute for or superior to GAAP. We endeavor to compensate for the limitation of the non-GAAP measure presented by also providing the comparable GAAP measures, GAAP financial statements, and descriptions of the reconciling items and adjustments, to derive the non-GAAP measure. We present a reconciliation of this non-GAAP financial to GAAP below.

OIBA represents the combined operating results of Expedia, Inc.’s businesses, taking into account depreciation, which we believe is an ongoing cost of doing business, but excluding the effects of other non-cash expenses that may not be indicative of our core business operations. We believe this measure is useful to investors for the following reasons:


	•	It corresponds more closely to the cash operating income generated from our core operations by excluding significant non-cash operating expenses.

	•	It aids in forecasting and analyzing future operating income as stock-based compensation and non-cash distribution and marketing expenses are likely to decline significantly going forward.

	•	It provides greater insight into management decision making at Expedia, as OIBA is our primary internal metric for evaluating the performance of our business.

OIBA has certain limitations in that it does not take into account the impact of certain expenses to our consolidated statements of income, including stock-based compensation, non-cash payments to partners, acquisition-related accounting and certain one-time items. Due to the high variability and difficulty in predicting certain items that affect net income, such as tax rates, stock price and interest rates, we are unable to provide reconciliation to net income on a forward-looking basis without unreasonable efforts.

Notes to Consolidated Financial Statements — (Continued)


	*Reconciliation of OIBA to Operating Income and Net Income*

The following table presents a reconciliation of OIBA to operating income and net income for the three and six months ended June 30, 2006 and 2005:


	Three Months Ended						Six Months Ended
	June 30,						June 30,

	2006			2005			2006			2005

	(In thousands)
OIBA	$	184,223		$	174,255		$	272,763		$	310,977
Amortization of intangible assets		(30,120	)		(31,783	)		(60,291	)		(63,448	)
Stock-based compensation		(17,221	)		(42,608	)		(41,108	)		(80,908	)
Amortization of non-cash distribution and marketing		(627	)		(3,485	)		(8,867	)		(3,917	)

Operating income		136,255			96,379			162,497			162,704
Interest income, net		6,559			19,712			8,262			29,511
Other, net		10,466			3,476			14,123			4,510
Provision for income taxes		(56,158	)		(45,484	)		(65,816	)		(74,869	)
Minority interest in earnings of consolidated subsidiaries, net		(1,640	)		(651	)		(249	)		(395	)

Net income	$	95,482		$	73,432		$	118,817		$	121,461

Note 13 — Subsequent Event

On August 10, 2006, we announced a plan to privately offer senior unsecured notes guaranteed by certain of our subsidiaries (the “Notes”). The timing of the closing of the offering will be subject to market conditions. We plan to use the net proceeds of the offering for general corporate purposes, which may include repurchase of common stock, repayment of debt, acquisitions, investments, additions to working capital, capital expenditures and advances to or investments in our subsidiaries.

The offering will be made only (i) in the United States to qualified institutional buyers in accordance with Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”), and (ii) outside the United States to certainnon-U.S. persons in accordance with Regulation S under the Securities Act. The Notes will not be registered under the Securities Act and may not be offered or sold without registration unless an exemption from such registration is available.


Part 1. Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the views of our management regarding current expectations and projections about future events and are based on currently available information. Actual results could differ materially from those contained in these forward-looking statements for a variety of reasons, including, but not limited to, those discussed in our Annual Report on Form 10-K for the year ended December 31, 2005, Part I, Item 1A, “Risk Factors,” as well as those discussed elsewhere in this report. Other unknown or unpredictable factors also could have a material adverse effect on our business, financial condition and results of operations. Accordingly, readers should not place undue reliance on these forward-looking statements. The use of words such as “anticipates,” “estimates,” “expects,” “intends,” “plans” and “believes,” among others, generally identify forward-looking statements; however, these words are not the exclusive means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. These forward-looking statements are inherently subject to uncertainties, risks and changes in circumstances that are difficult to predict. We are not under any obligation and do not intend to publicly update or review any of these forward-looking statements, whether as a result of new information, future events or otherwise, even if experience or future events make it clear that any expected results expressed or implied by those forward-looking statements will not be realized. Please carefully review and consider the various disclosures made in this report and in our other reports filed with the Securities and Exchange Commission (“SEC”) that attempt to advise interested parties of the risks and factors that may affect our business, prospects and results of operations.

The information included in this management’s discussion and analysis of financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes included in this Quarterly Report and the audited consolidated financial statements and notes, and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2005.

Overview

Expedia, Inc. is an online travel company, empowering business and leisure travelers with the tools and information they need to efficiently research, plan, book and experience travel. We have created a global travel marketplace used by a broad range of leisure and corporate travelers and offline retail travel agents. We make available, on a stand-alone and package basis, travel products and services provided by numerous airlines, lodging properties, car rental companies, destination service providers, cruise lines and other travel products and services.

Our portfolio of brands includes: Expedia.com and Hotels.com (as well as related international websites), Hotwire.com, our private label programs (Worldwide Travel Exchange and Interactive Affiliate Network), Classic Vacations, Expedia Corporate Travel (“ECT”), eLong and TripAdvisor. For additional information about our portfolio of brands, see the disclosure set forth in our Annual Report on Form 10-K for the year ended December 31, 2005.


	*Trends*

The travel industry, which includes travel agencies and travel suppliers, has been characterized by rapid and significant change. The United States (“U.S.”) airline industry has experienced significant turmoil in recent years, with several of the largest airlines seeking the protection of Chapter 11 bankruptcy proceedings. The need to rationalize high fixed cost structures to better compete with low cost carriers offering no frills flights at discounted prices, as well as the pressure of high-priced jet fuel has caused the airlines to aggressively pursue cost reductions in every aspect of their operations. These cost reduction efforts include distribution costs, which the airlines have pursued by seeking to reduce travel agent commissions and overrides. The airlines have and are pursuing reduced fees with the Global Distribution System (“GDS”)

intermediaries as their contracts with the GDSs come up for renewal mid to late 2006. In addition, the U.S. airline industry has experienced increased load factors and ticket prices. These trends have affected our ability to obtain inventory in our agency and merchant air businesses and led to reduced discounts for merchant air tickets. These competitive forces have caused our air revenue per ticket to decline significantly since the fourth quarter of 2004. Lastly, the airline carriers, which participate in the Expedia marketplace, have been reducing their flight capacity; lower cost carriers, most of which do not currently participate in the Expedia marketplace, are replacing this capacity.

The hotel sector has recently been characterized by robust demand and constrained supply, resulting in increasing occupancy rates and average daily rates (“ADR”). Industry experts expect supply growth to continue to outstrip demand through at least 2007. Increasing ADRs generally have a positive effect on our merchant hotel operations as our remuneration is variable with the room price. However, higher occupancies can restrict our ability to obtain merchant hotel inventory, particularly in very high occupancy destinations such as Las Vegas, Nevada and New York, New York. In addition, higher occupancies tend to drive lower raw margins as hotel room suppliers have less need for third party intermediaries to meet demand.

Increased usage and familiarity with the internet has driven rapid growth in online penetration of travel expenditures. According to PhoCusWright, an independent travel, tourism and hospitality research firm, 29% of U.S. leisure and unmanaged travel expenditures occurred online in 2005, more than double the 14% rate in 2002. An estimated 14% of European travel was booked online in 2005, up from just 4% in 2002. In addition to the growth of online travel agencies, airlines and lodging companies have aggressively pursued direct online distribution of their products and services over the last several years, with supplier growth outpacing online growth since 2002. Differentiation among the various website offerings have narrowed in the past several years, and the travel landscape has grown extremely competitive, with the need for competitors to generally differentiate their offerings on features other than price.


	*Business Strategy*

We are in the early stages of leveraging our historic strength as an efficient transaction processor to become a retailer and merchandiser of travel experiences. Our business strategy to accomplish this is as follows:

Leverage our portfolio of travel brands. We seek to appeal to the broadest possible range of travelers and suppliers through our collection of industry-leading travel brands. We target several different demographics, from the value-conscious traveler to luxury travelers seeking a high-touch, customized vacation package.

Innovate on behalf of travelers and supplier partners. We have a long tradition of innovation, from Expedia.com’s inception as a division of Microsoft, to our introduction of more recent innovations such as Expedia^® Fare Alerts, Travel Ticker^tm by Hotwire.com^tm and ECT’s business intelligence toolset. We will continue to aggressively innovate on behalf of our travelers and suppliers, including our current efforts in building a scaleable, extensible, service-oriented technology platform, which will extend across our portfolio of brands. We expect our worldwide points of sale to migrate to the new platform beginning in 2007.

Expand our international and corporate travel businesses. We currently operate Expedia-branded websites in the U.S., Australia, Canada, France, Germany, Italy, the Netherlands and the United Kingdom. We intend to continue investing in and growing our existing international points of sale. We anticipate launching additional sites in new countries in the future where we find large travel markets and rapid growth of online commerce, such as Japan where we plan to launch a hotels-only site in late 2006. We also operate Hotels.com-branded websites in over 30 international locations. ECT currently conducts operations in the U.S., Belgium, Canada, France and the United Kingdom. We believe the corporate travel sector represents a large opportunity for Expedia, and we believe expanding our corporate travel business also increases our appeal to travel product and service suppliers, as the average corporate traveler has a higher incidence of first class and international travel than the average leisure traveler.

Expand our product and service offerings worldwide. In general, through our websites, we offer the most comprehensive array of innovation and selection of travel products and services to travelers. We plan to continue improving and growing these offerings, as well as expanding them to our worldwide points of sale over time.

Leverage our scale in technology and operations. We have invested over $3 billion in technology, operations, brand building, supplier integration and relationships, and other areas since the launch of Expedia.com in 1996. We intend to continue leveraging our substantial investment when launching operations in new countries, introducing site features, adding supplier products and services or adding value-added content for travelers.


	*Seasonality*

Critical Accounting Policies and Estimates

Critical accounting policies and estimates are those that we believe are important in the preparation of our consolidated financial statements because it requires that we use judgment and estimates in applying those policies. We prepared our consolidated financial statements and accompanying notes in accordance with generally accepted accounting principles in the United States (“GAAP”). Preparation of the consolidated financial statements and accompanying notes requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and revenue and expenses during the periods reported. We base our estimates on historical experience, where applicable, and other assumptions that we believe are reasonable under the circumstances. Actual results may differ from our estimates under different assumptions or conditions.

There are certain critical estimates that we believe require significant judgment in the preparation of our consolidated financial statements. We consider an accounting estimate to be critical if:


	•	It requires us to make assumptions because information was not available at the time or it included matters that were highly uncertain at the time we were making the estimate, and

	•	Changes in the estimate or different estimates that we could have selected may have had a material impact on our financial condition or results of operations.

For additional information about our critical accounting policies and estimates, see the disclosure set forth in our Annual Report on Form 10-K for the year ended December 31, 2005.


	*Stock-Based Compensation*

On January 1, 2006, we adopted the modified prospective method provisions of SFAS No. 123(R),Share-Based Payment(“SFAS 123(R)”), and related guidance. Under SFAS 123(R), we continue to measure and amortize the fair value for all share-based payments consistent with our past practice under SFAS 123 and 148. As a result, the adoption of SFAS 123(R) did not have a material impact on our financial position.

in accordance with SFAS No. 109,Accounting for Income Taxes. If the amount of future tax deficiencies is greater than the available APIC pool, we will record the excess as income tax expense in our consolidated statements of income. For the three and six months ended June 30, 2006, we recorded tax deficiencies of $2.3 million and $7.1 million against the APIC pool; as a result, such deficiencies did not affect our results of operations. Excess tax benefits or tax deficiencies are a factor in the calculation of diluted shares used in computing dilutive earnings per share. The adoption of SFAS 123(R) did not have a material impact on our dilutive shares.

In accordance with SFAS 123(R), we measure stock-based compensation expense for equity awards at fair value and recognize compensation, net of estimated forfeitures, over the service period for awards expected to vest. In determining the estimated forfeiture rates, we periodically conduct an assessment of the actual number of equity awards that have been forfeited to date as well as those expected to be forfeited in the future. We consider many factors when estimating expected forfeitures, including the type of award, the employee class and historical experience. The estimate of stock awards that will ultimately be forfeited requires significant judgment and to the extent that actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period such estimates are revised.

Performance-based restricted stock units (“RSUs”) vest upon achievement of certain company-based performance conditions. On the date of grant, we assess whether it is probable that the performance targets will be achieved, and if assessed as probable, we determine the fair value of the performance-based award based on the fair value of our common stock at that time. We record compensation expense for these awards over the estimated performance period using the accelerated method under Financial Accounting Standards Board Interpretation No. 28,Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans — an interpretation of Accounting Principles Board Opinion No. 15 and 25. At each reporting period, we reassess the probability of achieving the performance targets and the performance period required to meet those targets. The estimation of whether the performance targets will be achieved and of the performance period required to achieve the targets requires judgment, and to the extent actual results or updated estimates differ from our current estimates, the cumulative effect on current and prior periods of those changes will be recognized in the period estimates are revised. The ultimate number of shares issued and the related compensation expense recognized will be based on a comparison of the final performance metrics to the specified targets.

New Accounting Pronouncement

For a discussion of the new accounting pronouncement, see Note 2, Summary of Significant Accounting Policies, in the notes to the consolidated financial statements.

Operating Metrics

Our operating results are affected by certain metrics that represent the selling activities generated by our travel products and services. As travelers have increased their use of the internet to book their travel arrangements, we have seen our gross bookings increase, reflecting the growth in the online travel industry and our business acquisitions. Gross bookings represent the total retail value of transactions that we processed

and recorded for both agency and merchant transactions at the time of booking. For example, gross bookings include the total price paid by travelers, including amounts paid to airlines, hotels, taxes, fees and other charges, and are generally not reduced for cancellations or traveler refunds.


	Three Months Ended									Six Months Ended
	June 30,									June 30,

	2006			2005			% Change			2006			2005			% Change

	($ in thousands)									($ in thousands)
Gross bookings	$	4,564,764		$	4,132,742			10	%	$	9,212,971		$	8,218,820			12	%
Revenue margin		13.1	%		13.4	%					11.9	%		12.7	%

Gross bookings increased $432.0 million and $994.2 million, or 10% and 12%, for the three and six months ended June 30, 2006, compared to the same periods in 2005. Domestic gross bookings increased 7% and 9% for the three and six months ended June 30, 2006, compared to the same periods in 2005. International gross bookings increased 22% and 24% for the three and six months ended June 30, 2006, compared to the same periods in 2005.

Revenue margin, which is defined as revenue as a percentage of gross bookings, decreased 32 basis points and 80 basis points for the three and six months ended June 30, 2006, compared to the same periods in 2005. Revenue margin for our domestic operations decreased 82 basis points and 120 basis points for the three and six months ended June 30, 2006, compared to the same periods in 2005. Revenue margin for our international operations increased 134 basis points and 53 basis points for the three and six months ended June 30, 2006, compared to the same periods in 2005, as our international business continues to benefit from an increasing mix of merchant hotel bookings. The decline in worldwide revenue margin was primarily due to declines in domestic air revenue per ticket coupled with an average increase in average worldwide airfares of 13% and 10% for the three and six months ended June 30, 2006, compared to the same periods in 2005. Airfare inflation has the effect of increasing gross bookings without a corresponding increase in per ticket air revenues, as our remuneration generally does not vary with the price of the ticket.

Results of Operations for the Three and Six Months Ended June 30, 2006 and 2005


	*Reclassifications*

For the three and six months ended June 30, 2005, we reclassified stock-based compensation expense to the same operating expense line items as cash compensation paid to employees in accordance with the SEC Staff Accounting Bulletin No. 107.


	*Revenue*


	Three Months Ended							Six Months Ended
	June 30,							June 30,

	2006		2005		% Change			2006		2005		% Change

	($ in thousands)							($ in thousands)
Revenue	$	598,458	$	555,007		8	%	$	1,092,356	$	1,040,053		5	%

Revenue increased for the three and six months ended June 30, 2006, compared to the same periods in 2005, primarily due to increases in worldwide merchant hotel business and advertising and other revenue, partially offset by decreases in our worldwide merchant air business. For the three and six months ended June 30, 2006, domestic revenue increased by 1% and decreased by 1% compared to the same periods in 2005. For the three and six months ended June 30, 2006, international revenue increased by 35% and 30% compared to the same periods in 2005.

Worldwide merchant hotel revenue increased 17% and 11% for the three and six months ended June 30, 2006, compared to the same periods in 2005. These increases were primarily due to a 15% and 13% increase in room nights stayed, including rooms delivered as a component of vacation packages. For the same periods year-over-year, revenue per room night increased 2% and decreased 2%. The increase in revenue per room night for the three months ended June 30, 2006, compared to the same period in 2005, was primarily due to a 6% increase in ADRs, partially offset by a decrease in hotel raw margin (defined as hotel net revenue as a

percentage of hotel gross revenue). For the six months ended June 30, 2006, compared to the same period in 2005, the decrease in hotel raw margin more than offset the 3% increase in ADRs resulting in a decrease in revenue per room night. Our merchant hotel raw margins have decreased in 2005 and 2006 as hotel room suppliers have taken advantage of higher occupancies and the efficacy of their own online distribution to negotiate more favorable terms with on-line travel agencies.

Worldwide air revenue decreased 13% and 10% for the three and six months ended June 30, 2006, compared to the same periods in 2005, primarily due to continued challenges in obtaining air inventory in both our agency and merchant air businesses due to record industry load factors and the continued reduction in relative capacity of carriers participating in our worldwide marketplace. For the same periods year-over-year, air tickets sold decreased 4% and remained flat and the revenue per ticket decreased by 10% for both periods as airlines continued to reduce compensation to agencies. The lower availability of merchant air inventory also affected our packages revenue, which grew 5% and 3% for the three and six months ended June 30, 2006, compared to the same periods in 2005.

Advertising and other revenue increased by 3% and 6% for the three and six months ended June 30, 2006, compared to the same periods in 2005, primarily due to higher revenues from click-through fees charged to our travel partners for traveler leads sent to the travel partners’ websites.


	*Cost of Revenue and Gross Profit*


	Three Months Ended									Six Months Ended
	June 30,									June 30,

	2006			2005			% Change			2006			2005			% Change

	($ in thousands)									($ in thousands)
Cost of revenue	$	128,449		$	129,484			(1	)%	$	247,763		$	243,587			2	%
% of revenue		21	%		23	%					23	%		23	%
Gross profit	$	470,009		$	425,523			10	%	$	844,593		$	796,466			6	%
% of revenue		79	%		77	%					77	%		77	%

Cost of revenue decreased for the three months ended June 30, 2006, compared to the same period in 2005, primarily due to lower stock-based compensation, partially offset by higher costs associated with an increase in transaction volumes. Stock-based compensation expense decreased in 2006 compared to the same periods in 2005 due to stock options that are completing their vesting cycles and higher forfeiture rates. For the six months ended June 30, 2006, the higher costs associated with the increase in transaction volumes more than offset the lower stock-based compensation resulting in an increase in cost of revenue.

Gross profit increased for the three and six months ended June 30, 2006, compared to the same periods in 2005, primarily due to an increase in revenue and a 187 basis point and 74 basis point improvement in gross margin primarily due to lower stock-based compensation and a lower mix of destination service revenue.


	*Selling and Marketing*


	Three Months Ended									Six Months Ended
	June 30,									June 30,

	2006			2005			% Change			2006			2005			% Change

	($ in thousands)									($ in thousands)
Selling and marketing	$	198,666		$	192,613			3	%	$	399,692		$	372,203			7	%
% of revenue		33	%		35	%					37	%		36	%

Selling and marketing increased for the three and six months ended June 30, 2006, compared to the same periods in 2005, primarily due to growth in personnel-related expenses related to our partner services group and an increase in traffic generation expense from internet portals, search engines, private label and affiliate programs. In addition, we continue to increase our selling and marketing spending in our international businesses, which contributed to higher expenses. These increases were partially offset by lower stock-based compensation expense, reduced broad-based television advertising spend at our North American points of

sale and a shift of marketing spend from second quarter of 2006 to the third quarter of 2006 at our European points of sale in part due to the timing of the World Cup soccer tournament.

While we remain focused on optimizing the efficiency of our various selling and marketing channels, we expect the absolute amounts spent in selling and marketing to increase over time due to continued expansion of our international businesses, inflation in search-related and other traffic acquisition vehicles, lower marketing efficiencies, costs associated with our tenth-year anniversary promotions in 2006 and increased fixed costs associated with the increase in staffing in our market management area. We expect selling and marketing expense to continue to increase as a percentage of revenue for the full year 2006 compared to 2005 as we continue to support and invest in our portfolio of brands.


	*General and Administrative*


	Three Months Ended									Six Months Ended
	June 30,									June 30,

	2006			2005			% Change			2006			2005			% Change

	($ in thousands)									($ in thousands)
General and administrative	$	71,053		$	66,111			7	%	$	144,414		$	123,050			17	%
% of revenue		12	%		12	%					13	%		12	%

General and administrative expense increased for the three and six months ended June 30, 2006, compared to the same periods in 2005, primarily due to an increase in our use of professional services and costs to build our executive teams and supporting staff levels, largely in connection with being a stand-alone public company as well as increased legal costs. These increases are partially offset by a decrease in stock-based compensation expense. We expect year-over-year general and administrative expense growth to slow down in the second half of 2006, but increase as a percentage of revenue versus prior full year in part due to our incremental costs as a stand-alone public company and increased legal costs.


	*Technology and Content*


	Three Months Ended									Six Months Ended
	June 30,									June 30,

	2006			2005			% Change			2006			2005			% Change

	($ in thousands)									($ in thousands)
Technology and content	$	33,288		$	35,152			(5	)%	$	68,832		$	71,144			(3	%)
% of revenue		6	%		6	%					6	%		7	%

Technology and content decreased for the three and six months ended June 30, 2006, compared to the same periods in 2005 due to lower stock-based compensation expense, partially offset by growth in personnel-related expenses in our software development and engineering teams as we increase our level of website innovation.

Given the increasing complexity of our business, geographic expansion, initiatives in corporate travel, increased supplier integration, service-oriented architecture improvements and other initiatives, we expect absolute amounts spent on technology and content expenses to increase over time. In addition, we expect the percentage of technology and content expense to revenue to increase for full year 2006 to support our technology platform, data warehouse and other initiatives.


	*Amortization of Intangible Assets*


	Three Months Ended									Six Months Ended
	June 30,									June 30,

	2006			2005			% Change			2006			2005			% Change

	($ in thousands)									($ in thousands)
Amortization of intangible assets	$	30,120		$	31,783			(5	)%	$	60,291		$	63,448			(5	%)
% of revenue		5	%		6	%					6	%		6	%

Amortization of intangible assets decreased for the three and six months ended June 30, 2006, compared to the same periods in 2005, as some of our intangible assets fully amortized.


	*Amortization of Non-Cash Distribution and Marketing*


	Three Months Ended									Six Months Ended
	June 30,									June 30,

	2006			2005			% Change			2006			2005			% Change

	($ in thousands)									($ in thousands)
Amortization of non-cash distribution and marketing	$	627		$	3,485			(82	)%	$	8,867		$	3,917			126	%
% of revenue		0	%		1	%					1	%		0	%

Amortization of non-cash distribution and marketing increased for the six months ended June 30, 2006, compared to the same period in 2005, due to an increase in advertising. The amortization of non-cash distribution and marketing relates to the media time we received from IAC in conjunction with the Spin-Off, with a value of $17.1 million. As of June 30, 2006, we have $0.8 million of media time remaining that we anticipate will be utilized in 2006.


	*Operating Income*


	Three Months Ended									Six Months Ended
	June 30,									June 30,

	2006			2005			% Change			2006			2005			% Change

	($ in thousands)									($ in thousands)
Operating income	$	136,255		$	96,379			41	%	$	162,497		$	162,704			(0	%)
% of revenue		23	%		17	%					15	%		16	%

Operating income increased for the three months ended June 30, 2006, compared to the same period in 2005, primarily due to an increase in revenue and lower stock-based compensation expense, partially offset by higher selling and marketing and general and administrative expenses. For the six months ended June 30, 2006, compared to the same period in 2005, our operating expense increases more than offset the increase in revenue and lower stock-based compensation expense resulting in a decrease in operating income.


	*Operating Income Before Amortization (“OIBA”)*


	Three Months Ended									Six Months Ended
	June 30,									June 30,

	2006			2005			% Change			2006			2005			% Change

	($ in thousands)									($ in thousands)
OIBA	$	184,223		$	174,255			6	%	$	272,763		$	310,977			(12	%)
% of revenue		31	%		31	%					25	%		30	%

OIBA increased for the three months ended June 30, 2006, compared to the same period in 2005, primarily due to increased revenue, partially offset by increased selling and marketing expense and general and administrative expense. For the six months ended June 30, 2006, compared to the same period in 2005, the increase in operating expenses more than offset the increase in revenue resulting in a decrease in OIBA. We expect OIBA for the year to decrease relative to 2005.


	*Definition of OIBA*

We provide OIBA as a supplemental measure to GAAP. We define OIBA as operating income plus: (1) amortization of non-cash distribution and marketing expense (2) stock-based compensation expense, (3) amortization of intangible assets and goodwill impairment, if applicable and (4) certain one-time items, if applicable.

of the non-GAAP measure presented by also providing the comparable GAAP measures, GAAP financial statements, and descriptions of the reconciling items and adjustments, to derive the non-GAAP measure. We present a reconciliation of this non-GAAP financial measure to GAAP below.


	•	It corresponds more closely to the cash operating income generated from our core operations by excluding significant non-cash operating expenses.

	•	It aids in forecasting and analyzing future operating income as stock-based compensation and non-cash distribution and marketing expenses are likely to decline significantly going forward.

	•	It provides greater insight into management decision making at Expedia, as OIBA is our primary internal metric for evaluating the performance of our business.


	*Reconciliation of OIBA to Operating Income and Net Income*

The following table presents a reconciliation of OIBA to operating income and net income for the three and six months ended June 30, 2006 and 2005:


	Three Months Ended						Six Months Ended
	June 30,						June 30,

	2006			2005			2006			2005

	(In thousands)
OIBA	$	184,223		$	174,255		$	272,763		$	310,977
Amortization of intangible assets		(30,120	)		(31,783	)		(60,291	)		(63,448	)
Stock-based compensation		(17,221	)		(42,608	)		(41,108	)		(80,908	)
Amortization of non-cash distribution and marketing		(627	)		(3,485	)		(8,867	)		(3,917	)

Operating income		136,255			96,379			162,497			162,704
Interest income, net		6,559			19,712			8,262			29,511
Other, net		10,466			3,476			14,123			4,510
Provision for income taxes		(56,158	)		(45,484	)		(65,816	)		(74,869	)
Minority interest in earnings of consolidated subsidiaries, net		(1,640	)		(651	)		(249	)		(395	)

Net income	$	95,482		$	73,432		$	118,817		$	121,461


	*Interest Income, Net*


		Three Months Ended									Six Months Ended
		June 30,									June 30,

		2006			2005			% Change			2006			2005			% Change

		($ in thousands)									($ in thousands)
Interest income, net:
	Interest income from IAC/ InterActiveCorp	$	—		$	17,105			(100	)%	$	—		$	24,773			(100	)%
	Other interest income, net		6,559			2,607			152	%		8,262			4,738			74	%

Interest income, net		$	6,559		$	19,712			(67	)%	$	8,262		$	29,511			(72	)%
% of revenue			1	%		4	%					1	%		3	%

Interest income, net decreased for the three and six months ended June 30, 2006, compared to the same periods in 2005, primarily due to the decrease in our intercompany receivable balances with IAC. Prior to the Spin-Off, the intercompany receivable balances were subject to a cash management arrangement with IAC. Because we extinguished our intercompany receivable balances with IAC at Spin-Off with a non-cash distribution to IAC, we no longer receive interest income from IAC.

For the three and six months ended June 30, 2006, other interest income, net includes interest income of $7.0 million and $10.6 million, partially offset by expenses of $0.4 million and $2.3 million related toshort-term borrowings on our revolving credit facility and related fees. Our other interest income increased in 2006 compared to the same periods in 2005 due to higher cash balances, which was partially offset by the cash used to repurchase stock.


	*Other, Net*


	Three Months Ended									Six Months Ended
	June 30,									June 30,

	2006			2005			% Change			2006			2005			% Change

	($ in thousands)									($ in thousands)
Other, net	$	10,466		$	3,476			201	%	$	14,123		$	4,510			213	%
% of revenue		2	%		1	%					1	%		0	%

Other, net increased for the three and six months ended June 30, 2006, compared to the same periods in 2005. These increases were primarily due to net unrealized gains of $7.9 million and $12.2 million in the fair value of derivative instruments related to the Ask Jeeves Notes and certain stock warrants for the respective periods in 2006, partially offset by lower gains in 2006 from the fluctuation of foreign exchange rates.


	*Provision for Income Taxes*


	Three Months Ended									Six Months Ended
	June 30,									June 30,

	2006			2005			% Change			2006			2005			% Change

	($ in thousands)									($ in thousands)
Provision for income taxes	$	56,158		$	45,484			23	%	$	65,816		$	74,869			(12	)%
% of revenue		9	%		8	%					6	%		7	%

Our effective tax rate was 36.6% and 35.6% for the three and six months ended June 30, 2006, which is higher than the 35% statutory rate primarily due to state income taxes and the valuation allowance on foreign losses, partially offset by the disallowance for tax purposes of themark-to-market net gain related to our derivative instruments.

Our effective tax rate of 38.0% and 38.1% for the three and six months ended June 30, 2005, which was higher than the 35% statutory rate, was primarily due to state taxes, non-deductible stock compensation and non-deductible transaction expenses related to the Spin-Off from IAC.


	*Segment Operating Results*

Beginning with the first quarter of 2006, we have two reportable segments; North America and Europe. The change from a single reportable segment is a result of the reorganization of our business. We determined our segments based on how our chief operating decision makers manage our business, make operating decisions and evaluate operating performance. Our primary operating metric for evaluating segment performance is OIBA (defined above). For additional information about our segment results, see Note 12, Segment Information.

Financial Position, Liquidity and Capital Resources


	*Sources and Uses of Cash*

In July 2005, we entered into a $1.0 billion revolving credit facility. As of December 31, 2005, we had $230.0 million outstanding under the revolving credit facility, which we fully repaid during the quarter ended March 31, 2006. As of June 30, 2006, we had outstanding stand-by letters of credit of $49.2 million, which leaves us with $950.8 million available to use under the revolving credit facility. As of June 30, 2006, and December 31, 2005, we were in compliance with all related financial covenants.

In the merchant business, we receive cash from travelers at the time of booking and we record these amounts on our consolidated balance sheets as deferred merchant bookings. We pay our suppliers related to these bookings approximately one week after completing the booking for air travel and, for all other merchant bookings, after the travelers’ use and the subsequent billing from the supplier. Therefore, especially for the hotel business, which represents the majority of our merchant bookings, there is generally some time from the receipt of the cash from the traveler to the payment to the suppliers.

As long as the merchant hotel business continues to grow and our business model does not change, we expect that the change in working capital will continue to be positive. If this business declines or if the model changes, our working capital could be negatively affected. As of June 30, 2006, and December 31, 2005, we had a working capital deficit of $794.9 million and $848.0 million. These deficits resulted from $2.5 billion of net intercompany receivable balances we extinguished through a non-cash distribution to IAC upon our Spin-Off on August 9, 2005.

Seasonal fluctuations in our merchant bookings affect our cash flows. During the first half of the year, hotel bookings have traditionally exceeded payment for stays, resulting in much higher cash flow related to working capital. During the second half of the year, this pattern typically reverses. While we expect the impact of seasonal fluctuations to continue, changes in the rate of growth of merchant bookings may affect working capital, which might counteract or intensify the anticipated seasonal fluctuations.

We anticipate continued investment in the development and expansion of our operations. These investments include but are not limited to improvements to infrastructure, which include our enterprise data warehouse investment and continued efforts in building a scaleable, extensible, service-oriented technology platform that will extend across our portfolio of brands. We expect our worldwide points of sale to migrate to the new platform beginning in 2007. Our future capital requirements may include capital needs for acquisitions, legal risks and to support our business strategy. In the event we have acquisitions, this may reduce our cash balance and increase our debt. Legal risks and challenges to our business strategy may also negatively affect our cash balance.

In our opinion, available cash, funds from operations and available borrowings will provide sufficient capital resources to meet our foreseeable liquidity needs.


	*Cash Flows*

For the six months ended June 30, 2006, compared to the same period in 2005, net cash provided by operating activities decreased by $60.8 million, to $722.6 million. This decrease was primarily due to a decrease in cash flows from operating income. In addition, we made tax payments of $33.1 million, an increase of $29.3 million over the same period in 2005, reducing cash provided by operations due primarily to IAC’s payment of taxes related to Expedia during the pre-spin period. Cash used in investing activities decreased by $533.9 million primarily due to the absence of transfers to IAC of $560.8 million during the six months ended June 30, 2006, changes in the amount of cash acquired in acquisitions and an $8.0 million increase in capital expenditures in the current period primarily due to capitalized software costs incurred for the development of our enterprise data warehouse and other improvements to our technology infrastructure. Cash used in financing activities increased during the six months ended June 30, 2006 due to the $230.0 million repayment of our revolving credit facility and $127.2 million of treasury stock activity primarily related to our share repurchase program.


	*Contractual Obligations and Commercial Commitments*

For a discussion of our purchase obligations, see Note 10, Commitments and Contingencies, in the notes to the consolidated financial statements. There have been no other material changes to our contractual obligations and commercial commitments since December 31, 2005. Other than our contractual obligations and commercial commitments, including derivatives, we did not have any off-balance sheet arrangements as of June 30, 2006, or December 31, 2005.

Part I. Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market Risk Management

Market risk is the potential loss from adverse changes in interest rates, foreign exchange rates and market prices. Our exposure to market risk includes our revolving credit facility, derivative instruments, and merchant accounts payable and deferred merchant bookings denominated in foreign currencies. We manage

our exposure to these risks through established policies and procedures. Our objective is to mitigate potential income statement, cash flow and market exposures from changes in interest and foreign exchange rates.


	*Interest Rate Risk*

In July 2005, we entered into a $1.0 billion revolving credit facility. The revolving credit facility bears interest based on our financial leverage and as of June 30, 2006, was equal to LIBOR plus 0.50%. As a result, we may be susceptible to fluctuations in interest rates if we do not hedge the interest rate exposure arising from any borrowings under our revolving credit facility.

We did not experience any significant impact from changes in interest rates for the three and six months ended June 30, 2006 or 2005.


	*Foreign Exchange Risk*

We conduct business in certain international markets, primarily in Australia, Canada, the People’s Republic of China and the European Union. Because we operate in international markets, we have exposure to different economic climates, political arenas, tax systems and regulations that could affect foreign exchange rates. Our primary exposure to foreign currency risk relates to transacting in foreign currency and recording the activity in U.S. dollars. We mitigate this exposure by maintaining natural hedges between our current assets and current liabilities denominated in foreign currency. Changes in exchange rates between the U.S. dollar and these other currencies result in transaction gains or losses, which we recognize in our consolidated statements of income.

As we increase our operations in international markets, our exposure to fluctuations in foreign currency exchange rates increases. The economic impact to us of foreign currency exchange rate movements is linked to variability in real growth, inflation, interest rates, governmental actions and other factors. These changes, if material, could cause us to adjust our financing and operating strategies.

As foreign currency exchange rates fluctuate, translation of the income statements of our international businesses into U.S. dollars affects year-over-year comparability of operating results. Historically, we have not hedged foreign exchange risks because we generally reinvested cash flows from international operations locally. We periodically review our strategy for hedging foreign exchange risks. Our goal in managing our foreign exchange risk is to minimize our potential exposure to the changes that exchange rates might have on our earnings, cash flows and financial position.

We use cross-currency swaps to hedge against the change in value of a receivable denominated in a currency other than the subsidiary’s functional currency.


	*Equity Price Risk*

We do not maintain any investments in equity securities as part of our marketable securities investment strategy. Our equity price risk relates to fluctuation in our stock price, which affects our derivative liabilities primarily related to the Ask Jeeves Notes. We base the fair value of these derivative instruments on the changes in the market price of our common stock.

During the six months ended June 30, 2006, certain of these notes were converted at fair value for $71.6 million of common stock, or 3.0 million shares. As additional notes are converted, the value of the derivative liability will be reduced and our equity price risk will decrease accordingly. The conversion of the Ask Jeeves Notes during the six months ended June 30, 2006, reduced our obligation to issue our common stock from 4.3 million shares as of December 31, 2005, to 1.3 million shares as of June 30, 2006.

As of June 30, 2006, each $1.00 fluctuation in our common stock will result in approximately $1.3 million change in the aggregate fair value of our Ask Jeeves Notes derivative liability. An increase in our common stock price will result in a charge to our consolidated statements of income and vice versa for a decrease in our common stock price. The Ask Jeeves Notes are due June 1, 2008; upon maturity of these notes, our obligation ceases.

For additional information about the Ask Jeeves Notes, see Note 4, Derivative Instruments, in the notes to the consolidated financial statements.

Part I. Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures.

The Company’s management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

As required by Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), our management, including our Chairman and Senior Executive, Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined by Rule 13a-15(e) and15d-15(e) under the Exchange Act).

Based upon that evaluation, our Chairman and Senior Executive, Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report, our disclosure controls and procedures were effective in providing reasonable assurance that information we are required to disclose in our filings with the SEC under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including our principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

Changes in internal control over financial reporting.

We have been evaluating, designing and enhancing controls related to processes that previously were handled by IAC, including equity transactions, income taxes, derivatives, treasury functions and periodic reporting in accordance with SEC rules and regulations. We also have been evaluating our internal controls over financial reporting and discussing these matters with our independent accountants and our audit committee.

Based on these evaluations and discussions, we consider what revisions, improvements or corrections are necessary in order for us to conclude that our internal controls are effective. As part of this process, we have identified a number of areas where there is a need for improvement in our internal controls over financial reporting. We are in the process of designing and implementing controls and processes to address the issues identified through this review.

There were no changes to our internal controls over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. We expect to continue monitoring and evaluating our disclosure controls and internal control over financial reporting on an ongoing basis in an effort to improve their overall effectiveness. In the course of this evaluation, we anticipate we will continue to modify and refine our internal processes over several reporting periods.

Part II. Item 1. Legal Proceedings

In the ordinary course of business, Expedia and its subsidiaries are parties to legal proceedings and claims involving property, personal injury, contract, alleged infringement of third party intellectual property rights and other claims. A discussion of certain legal proceedings can be found in the section titled “Legal

Proceedings,” of our Annual Report on Form 10-K for the year ended December 31, 2005 and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2006. The following development to such legal proceedings occurred during the quarter ended June 30, 2006:

City of Philadelphia, Pennsylvania Litigation. On May 25, 2006, the court dismissed the City of Philadelphia’s lawsuit, effective May 31, 2006, for lack of subject matter jurisdiction. The deadline for appealing the court’s decision has since passed without further action by the City of Philadelphia.

The following additional cases were filed during the quarter ended June 30, 2006:

City of Charleston Litigation. On April 26, 2006, previously reported as March 26, 2006, the City of Charleston, South Carolina filed a state court lawsuit against a number of internet travel companies, including Hotels.com, L.P. (“Hotels.com”), Hotwire, Inc. (“Hotwire”) and Expedia, Inc. (“Expedia”).See City of Charleston, South Carolina v. Hotels.com, et al., No. 2006-CP-10-1680 (Court of Common Pleas, Ninth Judicial Circuit). The complaints allege that the defendants have failed to pay to the city hotel occupancy taxes as required by municipal ordinance. The complaint purports to assert claims for violation of that ordinance, conversion, constructive trust and legal accounting. The defendants removed this action to federal court.See City of Charleston, South Carolina v. Hotel.com, et al., No. 2:06-cv-1646-PMD (United States District Court for the District of South Carolina).

City of San Antonio Litigation. On May 8, 2006, the City of San Antonio filed a purported state-wide class action in federal court against a number of internet travel companies, including Hotels.com, Hotwire, and Expedia.See City of San Antonio, on behalf of itself and all other similarly situated Texas municipalities v. Hotels.com, L.P., et al., No. SA06CA0381 OG (United States District Court, Western District of Texas). The complaint alleges that the defendants have failed to pay to the city hotel occupancy taxes as required by municipal ordinance. The complaint purports to assert claims for violation of that ordinance, common-law conversion, and declaratory judgment. The complaint seeks damages in an unspecified amount, restitution and disgorgement.

City of Gallup, New Mexico Litigation. On May 17, 2006, the City of Gallup, New Mexico filed a purported state-wide class action in state court against a number of internet travel companies, including Hotels.com, Hotwire, and Expedia.See City of Gallup, New Mexico, on behalf of itself and all other similarly situated New Mexico municipalities v. Hotels.com, L.P.,No. CV 2006 272-2 (Eleventh Judicial Court, County of McKinley). The complaints allege that the defendants have failed to pay to the city hotel occupancy taxes as required by municipal ordinance. The complaint purports to assert claims for violation of that ordinance, conversion, and declaratory judgment. The complaint seeks damages in an unspecified amount, restitution and disgorgement.

Town of Mt. Pleasant, South Carolina Litigation. On May 23, 2006, the Town of Mt. Pleasant, South Carolina filed a state court lawsuit against a number of internet travel companies, including Hotels.com, Hotwire, and Expedia.See Town of Mt. Pleasant, South Carolina v. Hotels.com, et al., No. 2006-CP-10-2005 (Court of Common Pleas, Ninth Judicial Circuit). The complaints allege that the defendants have failed to pay to the city hotel occupancy taxes as required by municipal ordinance. The complaint purports to assert claims for violation of that ordinance, conversion, constructive trust and legal accounting.

City of Columbus, Georgia Litigation. On May 30, 2006, the City of Columbus, Georgia filed separate state court lawsuits against a number of internet travel companies, including Hotels.com, Inc. and Expedia.See Columbus, Georgia v. Hotels.com, Inc.,No. S406-CV-1893-8 (Superior Court of Muscogee County, Georgia);Columbus, Georgia v. Expedia, Inc., No. S406-CV-1794-7 (Superior Court of Muscogee County, Georgia). The complaints allege that the defendants have failed to pay to the city hotel occupancy taxes as required by municipal ordinance. The complaint purports to assert claims for violation of that ordinance, unjust enrichment, imposition of a constructive trust, equitable accounting, and declaratory judgment. The complaint seeks damages in an unspecified amount, restitution and disgorgement. On July 12, 2006, the defendants removed the actions to federal court.See City of Columbus, Georgia v. Expedia, Inc., No. 4:06-CV-80 (United States District Court, Middle District Virginia);City of Columbus, Georgia v. Hotels.com, Inc., No. 4:06-CV-80 (United States District Court, Middle District Virginia).

Lake County Convention and Visitors Bureau and Marshall County Litigation. On June 12, 2006, the Lake County Convention and Visitors Bureau, Inc. and Marshall County, Indiana filed a purportedstate-wide class action in federal court against a number of internet travel companies, including Hotels.com, Hotwire, and Expedia.See Lake County Convention and Visitors Bureau, Inc.; Marshall County, and all others similarly situated v. Hotels.com, L.P., et al., No. 2:06CV207JM (United States District Court for the Northern District of Indiana). The complaints allege that the defendants have failed to pay to the city hotel occupancy taxes as required by municipal ordinance. The complaint purports to assert claims for violation of that ordinance, conversion, unjust enrichment, constructive trust and breaches of fiduciary and agency duties. The complaint seeks damages in an unspecified amount, restitution and disgorgement.

The Company believes that the claims discussed above lack merit and will continue to defend vigorously against them.

In addition, on July 26, 2006, Expedia, Inc. and IAC Global LLC filed a lawsuit in Washington State court against Worldspan, L.P. seeking a declaratory judgment, and other relief, regarding the rights and obligations of Expedia and Worldspan under the parties’ June 2001 Amended and Restated Development Agreement (“Development Agreement”) and the parties’ CRS Marketing, Services and Development Agreement and all amendments thereto (“CRS Agreement”).See Expedia, Inc. and IAC Global LLC v. Worldspan, L.P., Cause No. 06-2-24052-9 SEA (King County Superior Court). Specifically, Expedia is seeking, among other things, confirmation from the Court that its use of the services of other global distribution services to provide greater selection of flight schedules, fares and availability to its customers is consistent with its contractual and legal rights, and to ensure that Worldspan does not improperly interfere with Expedia’s relationships with airlines and other global distribution services.

Part II. Item 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A, “Risk Factors,” in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

Part II. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Share Repurchase Program


					Total Number of		Maximum Number
					Shares Purchased		of Shares that May
					as Part of Publicly		Yet Be Purchased
	Total Number of		Average Price		Announced Plans or		Under the Plans or
Period	Shares Purchased		Paid per Share		Programs		Programs

			(In thousands, except per share data)
April 1-30, 2006		—	$	—		—		—
May 1-31, 2006		2,215		14.00		2,215		17,785
June 1-30, 2006		8,276		14.84		8,276		9,509

Total		10,491		14.66		10,491

In July 2006, we repurchased the remaining 9.5 million shares for $134.5 million, representing an average repurchase price of $14.14 per share including transaction costs.

Part II. Item 4. Submission of Matters to a Vote of Security Holders

On May 24, 2006, the Company’s annual meeting of stockholders (the “Annual Meeting”) was held. Stockholders present in person or by proxy, representing 266,909,136 shares of Expedia Common Stock (entitled to one vote per share), 25,599,998 shares of Expedia Class B Common Stock (entitled to ten votes per share) and 466 shares of Expedia Preferred Stock (entitled to two votes per share), voted on the following matters:

Item 1.Election of Directors — The stockholders elected nine directors of the Company, three of whom were elected by holders of Expedia Common Stock only, and six of whom were elected by holders of Expedia Common Stock, Expedia Class B Common Stock and Expedia Series A Preferred Stock, voting together as a single class, each to hold office until the next annual meeting of stockholders or until their successors have been duly elected and qualified. In each case, the affirmative vote of a plurality of the total number of votes cast was required to elect each director. Stockholders eligible to vote voted as follows:

Holders of Expedia Common Stock, voting as a separate class:


	Number of Votes		Number of Votes
	in Favor		Withheld

A. George “Skip” Battle		507,575,738		15,334,310
David Goldhill		507,467,507		15,442,541
Peter Kern		507,475,706		15,434,342

Holders of Expedia Common Stock, Expedia Class B Common Stock and Expedia Series A Preferred Stock, voting together as a single class:


	Number of Votes		Number of Votes
	in Favor		Withheld

Barry Diller		478,828,972		44,081,076
Dara Khosrowshahi		478,970,192		43,939,856
Victor A. Kaufman		478,009,797		44,900,251
Jonathan Dolgen		507,542,482		15,367,566
William R. Fitzgerald		482,668,186		40,241,862
John C. Malone		483,663,164		39,246,884

Item 2. The Independent Accountants Ratification Proposal — The holders of Expedia Common Stock, Expedia Class B Common Stock and Expedia Series A Preferred Stock, voting as a single class, also ratified the appointment of Ernst & Young LLP as the Company’s independent registered accounting firm for the year ending December 31, 2006. The affirmative vote of a majority of the total voting power of those shares of Expedia Common Stock, Class B Common Stock and Series A Preferred Stock present in person or represented by proxy at the Annual Meeting, voting together as a single class, was required to approve the Independent Accountants Ratification Proposal. Those stockholders eligible to vote voted as follows:


Number of Votes in Favor	Number of Votes Against		Number of Votes Abstaining

522,751,625		104,207		54,216

Part II. Item 5. Other Information

On August 8, 2006, the Company entered into a Separation Agreement with William R. Ruckelshaus, its former Senior Vice President, Strategy and Planning. The terms of the Separation Agreement provide that

Mr. Ruckelshaus will refrain from engaging in certain competitive activity for a period of two years following his employment with the Company (the “Restricted Period”). In addition, Mr. Ruckelshaus has agreed during the Restricted Period to refrain from certain hiring, recruiting or soliciting activities related to the Company and its employees and officers. In consideration of these and other commitments from Mr. Ruckelshaus, the Company will pay Mr. Ruckelshaus $10,000, continue to pay his former annual base salary of $270,000, and pay for his COBRA health insurance coverage, for a period of twelve months; provided, that such payments will be offset by any amount earned by Mr. Ruckelshaus from another employer. In addition, Mr. Ruckelshaus was granted accelerated vesting of 10,138 restricted stock units, which represent the restricted stock units that would have vested in the one-year period following his date of termination of employment.

Part II. Item 6. Exhibits

The exhibits listed below are filed as part of this Quarterly Report on Form 10-Q.


Exhibit
Number			Description

	10	.17	Separation Agreement between Keenan M. Conder and Expedia, Inc., dated July 31, 2006

	10	.18	Separation Agreement between William R. Ruckelshaus and Expedia, Inc., dated August 8, 2006

	31	.1	Certification of the Chairman and Senior Executive pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act

	31	.2	Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act

	31	.3	Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act

	32	.1	Certification of the Chairman and Senior Executive pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act

	32	.2	Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act

	32	.3	Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act.

Signature

Pursuant to the requirements of the Section 13 or 15(d) Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.


	Expedia, Inc.


	By:	/s/ MICHAEL B. ADLER



	Michael B. Adler
	Chief Financial Officer

August 10, 2006

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Expedia (EXPE) 10-Q2006 Q2 Quarterly report

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