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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended March 31, 2003

Commission File Number 0-27429

EXPEDIA, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (425) 564-7200

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  x    No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).    Yes  x    No  ¨

The number of shares outstanding of the registrant’s stock as of April 30, 2003 was 119,826,000 consisting of 50,824,000 of common stock and 69,002,000 of Class B common stock.

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EXPEDIA, INC.

FORM 10-Q

For the Quarter Ended March 31, 2003

INDEX

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PART I.  FINANCIAL INFORMATION

ITEM 1.    UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

EXPEDIA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

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EXPEDIA, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)

(unaudited)

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EXPEDIA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

(in thousands)

(unaudited)

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EXPEDIA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

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EXPEDIA, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.    Description of Business

Expedia, Inc. (the Company or Expedia) sells travel services to leisure and corporate customers around the world. This encompasses providing schedule, pricing and availability information for booking reservations for airlines, hotels, rental cars, cruises and other travel products such as sightseeing tours, show and event tickets and theme park passes. The Company sells these travel services both individually and as components of dynamically-assembled packaged travel vacations and trips. In addition, the Company provides content that presents travelers with information about travel destinations, maps and other travel details.

The Company sells these travel services through five different distribution channels. The primary distribution channel is through its own websites. These websites are located at Expedia.com, Expedia.co.uk, Expedia.de, Expedia.ca, Expedia.it and Expedia.nl. The Expedia-branded websites also serve as the travel channel on MSN.com, Microsoft’s online services network. Visitors can also connect to the Expedia-branded websites via links from other websites.

The second distribution channel the Company sells through is directly on other travel companies’ websites. The Company does this through Worldwide Travel Exchange (WWTE), the private label travel business of one of its subsidiaries. A third distribution channel is selling travel services to customers through a toll-free telephone number designed to assist customers with complex or high-priced offerings. The fourth distribution channel the Company sells through is a network of third-party travel agents and travel agencies. The fifth distribution channel is through the Company’s own travel agents for its corporate travel business. The Company’s travel agents work both in the Company’s offices and onsite at various corporate customer locations.

The Company classifies revenues into three categories: merchant, agency, and advertising and other. Merchant revenues are derived from travel related sales transactions where the Company both purchases from the supplier and sells to the customer the requested travel service. Merchant revenues are presented in the statement of operations at the net amount, which reflects the gross amount charged to the customer less the cost paid to the supplier. Agency revenues are derived from travel-related sales transactions where the Company receives commissions and fees from travel suppliers and customers. Agency revenues also include paper ticket mailing fee revenues, which are generated by processing and delivering a paper ticket via express mail if the customer chooses not to have an electronic ticket or an electronic ticket is not available, and service fees which are charged to customers for most airline tickets booked on the Company’s U.S. and Canadian websites. Advertising and other revenues consist primarily of advertising revenues. The Company derives advertising revenues from advertisements on its websites. The Company has also licensed components of its technology to other companies.

The Company was incorporated in the state of Washington on August 23, 1999. Prior to that, it operated as a separate business within Microsoft Corporation (Microsoft). It began selling travel services on its first website, Expedia.com, in October 1996. On October 1, 1999, Microsoft separated the Company’s assets and contributed them in exchange for 66,000,000 shares of Expedia common stock or 100% of the outstanding common stock at that date. On November 10, 1999, the Company completed an initial public offering in which it sold 11,960,000 shares of common stock at a price of $7.00 per share, raising $76.6 million in net proceeds. On February 4, 2002, USA Interactive (formerly known as USA Networks, Inc.) (USA) completed its acquisition of a controlling interest in Expedia, including all of Microsoft’s shares, through a subsidiary merger (the USA acquisition of control). On March 19, 2003, the Company announced that it entered into a merger agreement with USA whereby USA would acquire all of the Company’s publicly held shares it did not currently own in a stock-for-stock merger. Upon completion of the merger, Expedia will be a wholly-owned subsidiary of USA. See Note 3.

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2.    Summary of Significant Accounting Policies

Basis of Presentation

The accompanying condensed consolidated balance sheets and related interim condensed consolidated statements of operations, cash flows and changes in stockholder’s equity and comprehensive income, are unaudited and in the opinion of management, include all adjustments (consisting only of normal recurring items) necessary for their fair presentation in conformity with accounting principles generally accepted in the U.S. Preparing financial statements requires the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. Actual results may differ from those estimates. Interim results are not necessarily indicative of results for a full year. Readers of the condensed consolidated financial statements should read the information included in this Form 10-Q in conjunction with Management’s Discussion and Analysis and consolidated financial statements and notes included in the Company’s report on Form 10-K/A for the year ended December 31, 2002 filed with the Securities and Exchange Commission on April 30, 2003.

Intangible Assets and Goodwill

Statements of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, prescribes a two-phase process for impairment testing of goodwill, which is performed once annually, absent indicators of impairment. The first phase screens for impairment, while the second phase (if necessary) measures the impairment. The Company has elected to perform the annual impairment test during the fourth calendar quarter of each year. No indicators of impairment were identified during the first quarter of 2003.

Amortization expense for acquired intangible assets for the three months ended March 31, 2003 and 2002, was $4.5 million and $8.8 million, respectively. The estimated amortization for the remaining nine months ended December 31, 2003, is $8.5 million.

The annual estimated amortization expense for the acquired intangible assets for the next five years ending December 31 is as follows (in thousands):

Stock Split in the Form of a Stock Dividend

On February 5, 2003, the Company announced that its Board of Directors had approved a two-for-one stock split in the form of a stock dividend, payable to shareholders of record as of February 24, 2003. References to the number of shares, options and warrants, income per share and other per share amounts in these condensed consolidated financial statements have been adjusted to reflect the split. The stock split was effective on March 10, 2003.

Stock-Based Compensation

Effective January 1, 2003, the Company adopted SFAS No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148 Accounting for Stock-Based Compensation—Transition and Disclosure. Under SFAS No. 148, the Company has elected to apply the fair value recognition approach of SFAS No. 123 on a prospective basis. As a result, the Company has expensed all employee awards granted, modified or settled after January 1, 2003. For employee stock-based compensation awards granted prior to January 1, 2003, the Company accounted for the awards under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations.

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The Company’s stock-based compensation awards include both non-qualified stock options and restricted stock units. Under SFAS No. 123, these awards are valued at the grant date using the Black-Scholes valuation model and compensation cost is recognized ratably over the vesting period. To the extent awards are forfeited prior to vesting, the corresponding previously-recognized expense is reversed in the period of forfeiture.

The following assumptions are used in the valuation of stock-based compensation:

The following table illustrates the results of operations that would have been reported if the fair value based method had been applied to all stock awards granted since the Company’s inception (in thousands, except per share amounts):

Recent Accounting Pronouncements

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities. The Interpretation is to be adopted for financial statements for the fiscal year or interim period beginning after June 15, 2003. This Interpretation clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, and requires consolidation of the results of variable interest entities in which an entity has a majority variable interest. The Company does not expect the adoption of the Interpretation to have a material effect on its financial position or results of operations.

3.    USA Merger

On March 19, 2003, the Company announced that it entered into a merger agreement with USA whereby USA would acquire all the Company’s publicly held shares it did not currently own in a stock-for-stock merger. The Expedia Board of Directors approved the agreement following the unanimous recommendation and approval

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of a disinterested Special Committee of the Expedia Board. Under the agreement, Expedia shareholders will receive 1.93875 shares of USA common stock for each share of Expedia stock that they own. In connection with the merger, Expedia warrants and options will be converted into warrants and options to acquire USA common stock. The parties expect that the transaction will generally be tax-free to Expedia shareholders. The merger is subject to certain conditions to closing contained in the merger agreement, which was filed with the SEC on March 19, 2003.

4.    Classic Custom Vacations Acquisition

On March 9, 2002, the Company acquired substantially all of the assets of CCV, a wholly-owned subsidiary of Classic Vacation Group, Inc. (CVG), a publicly traded corporation, for an aggregate purchase price of approximately $48.6 million, plus the assumption of approximately $30 million in net liabilities. The Company has accounted for this transaction under the purchase method of accounting in accordance with SFAS No. 141, Business Combinations.

The following table summarizes the purchase accounting for the acquisition (in thousands):

The following table presents the results of operations of the Company for the three months ended March 31, 2002 on a pro forma basis. These results are based on the individual historic results of the Company and CCV and reflect adjustments to give effect to the acquisition as if they had occurred at the beginning of the period presented (in thousands):

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5.    Income Tax

Effective October 1, 1999, the Company entered into a tax allocation agreement with Microsoft. On March 18, 2000, Microsoft’s investment in the Company fell below 80 percent ownership and as a result, the Company began filing separate tax returns. Based on the tax allocation agreement, the Company may be reimbursed by Microsoft for tax losses incurred during the period from October 1, 1999, to March 17, 2000, that are utilized on the Microsoft consolidated U.S. federal tax return. Reimbursements of approximately $2.5 million are expected to be received from Microsoft under this agreement when Microsoft utilizes the Company’s tax losses. As of March 31, 2003, the Company has received $0.1 million of reimbursement from Microsoft, which was recorded as a capital contribution.

Under the tax allocation agreement, the Company must pay Microsoft for a portion of the tax savings resulting from the exercise of certain stock options. In November 2001, the Company entered into an agreement with Microsoft setting forth the manner in which the Company will compensate Microsoft for these tax savings. Under the November 2001 agreement, the Company generally will be required to indemnify Microsoft for the actual federal and state tax savings, up to approximately $36 million that the Company may realize as a result of the use of certain compensation deductions, if and when the Company utilizes such tax savings. As of March 31, 2003, the Company has not utilized the tax savings. Any compensation to Microsoft as a result of utilized tax savings will be recorded as a capital distribution.

At March 31, 2003, the Company has net operating loss carryforwards of approximately $293 million for federal income tax purposes. The net operating loss carryforwards begin to expire in 2017. Approximately $31 million of the loss carryforwards are from acquired companies, the utilization of which, in each carryforward year, may be limited by the Internal Revenue Code.

At March 31, 2003, the Company has utilized the benefit of all of its net operating loss carryforwards other than those generated by stock compensation tax deductions. The remaining net operating loss carryforwards will be utilized to reduce income taxes payable. The benefit of the remaining net operating losses will be recorded as an increase to additional paid-in capital, when realized.

Based upon the Company’s limited operating history, the difficulty in accurately forecasting long-term future results, the large amount of net operating loss carryforwards for income tax purposes and the expected continuation of tax deductions attributable to stock option deductions, the Company has applied a valuation allowance equivalent to the expected tax benefit from its net operating loss carryforward and other deferred tax assets. As a result, the Company has not recorded a benefit for current federal and state income taxes or a related deferred tax asset.

6.    Net Income Per Share

Net income per share has been computed in accordance with SFAS No. 128, Earnings Per Share. Net income per share is computed by dividing the net income for the period by the weighted average number of common shares outstanding.

7.    Related Party Transactions

Microsoft

Subsequent to October 1, 1999, the Company had entered into a number of agreements with Microsoft to facilitate the operations of the Company. Through February 4, 2002, when Microsoft ceased being a related party, the Company recorded revenues and incurred costs representing charges from these agreements as follows (in thousands):

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USA

In connection with the USA acquisition of control consummated on February 4, 2002, the Company received the right to advertising, marketing and promotion time, valued at $15 million for each of the five years after the consummation date, on the various media outlets related to USA. The total amount due under this arrangement was recorded as “contribution receivable from parent” within the consolidated statement of changes in stockholders’ equity and comprehensive income. During the three months ended March 31, 2003 and 2002, the Company recorded $3.0 million and $1.5 million, respectively, under this arrangement as sales and marketing expense.

On March 19, 2003, Expedia and USA announced that they entered into a merger agreement by which USA would acquire the Expedia shares it does not currently own in a stock-for-stock merger. Our Board of Directors approved the agreement following the unanimous recommendation and approval of a disinterested Special Committee of our Board. Under the agreement, Expedia shareholders will receive 1.93875 shares of USA common stock for each share of Expedia stock that they own. In connection with the merger, Expedia warrants and options will be converted into warrants and options to acquire USA common stock. The parties expect that the transaction will generally be tax-free to Expedia shareholders. The merger is subject to certain conditions to closing contained in the merger agreement, which was filed with the SEC on March 19, 2003.

Ticketmaster

The Company entered into an agreement with Ticketmaster, Inc. (Ticketmaster), a subsidiary of USA, on March 19, 2002, to create a new gateway channel on Citysearch.com’s website. This is a content area that provides site visitors with Citysearch’s local content and enables them to plan and book trips using an Expedia.com booking tool with the availability of some Ticketmaster event tickets within Expedia’s customer-built trips. Revenues generated through the gateway channel are shared based on an agreed-upon transaction fee paid by the Company to Ticketmaster. The transaction fees paid in connection with this agreement during the three months ended March 31, 2003 and 2002 were $0.1 million and $0, respectively.

Hotels.com

As the Company and Hotels.com have a common controlling shareholder, the Company previously has said that it would explore areas where it might work together with Hotels.com in a way that would benefit all Expedia customers and stockholders. Although there continues to be many areas of its business where the Company has decided that it can best achieve its goals through separate strategies and practices, there have been instances where, fully consistent with its existing contractual agreements, it has worked cooperatively with Hotels.com, and it anticipates that it will continue to explore such possibilities in the future. On April 10, 2003, USA announced that that they had entered into an agreement with Hotels.com by which USA, already the majority owner of Hotels.com, would acquire the Hotels.com shares it does not currently own in a tax-free, stock-for-stock transaction.

8.    Commitments and Contingencies

The Company has multi-year agreements with certain travel service providers that make available the services accessed through the Company’s website. Under these agreements, the Company pays monthly service fees to the service providers based on the volume of activity. The Company expenses these amounts as the services are provided. None of the transactions involves any payment or discount to the customer.

The Company will incur an additional $5.0 million of expense related to financial advisory fees in conjunction with USA’s proposal in March 2003 a merger whereby USA would seek to acquire all of the Company’s publicly held shares. The expenditure is contingent upon consummation of the merger and will be recorded upon consummation.

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Between June 5 and July 26, 2001, four class action complaints, alleging violations of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20 of the Securities Exchange Act of 1934, were filed in the United States District Court for the Southern District of New York against the Company, certain of its officers and directors and certain underwriters of the Company’s initial public offering (IPO). On August 9, 2001, these actions were consolidated before a single judge along with cases brought against numerous other issuers and their underwriters that make similar allegations involving the IPOs of those issuers. The consolidation was for purposes of pretrial motions and discovery only. Plaintiffs filed an amended complaint on April 20, 2002. The amended complaint alleges that the Company’s prospectus was false or misleading in that it failed to disclose (i) that the underwriters allegedly were paid excessive commissions by certain customers in return for receiving shares in the IPO and (ii) that certain of the underwriters’ customers allegedly agreed to purchase additional shares of the Company in the aftermarket in return for an allocation of shares in the IPO. The complaint further alleges an agreement by the underwriters with the Company to provide positive market analyst coverage for the Company after the IPO that had the effect of manipulating the market for Expedia’s stock. Plaintiffs contend that, as a result of the alleged omissions from the prospectus and alleged market manipulation through the use of analysts, the price of the Company’s stock was artificially inflated between November 9, 1999 and December 6, 2000, and that the defendants are liable for unspecified damages to those persons who purchased stock during that period. On July 15, 2002, the Company and the individual defendants, along with the other issuers and their related officer and director defendants, filed a joint motion to dismiss based on common issues. Arguments for and against the motion to dismiss were presented to the court on November 1, 2002. The court denied the Company’s motion on February 19, 2003. Discovery is currently ongoing. The Company intends to vigorously defend against this action.

On September 6, 2002, a complaint was filed with the Superior Court of the State of Washington for King County by Amazon.com Commerce Services, Inc. alleging that the Company breached a May 25, 2001 Linking Agreement between Expedia and Amazon. Amazon alleges that the Company breached the Linking Agreement by failing to make payments due. Amazon also alleges that the Company refused to pay the amounts owed unless Amazon renegotiated the Linking Agreement and despite Amazon’s willingness and ability to continue performing its obligations, and that as a result, the Company is in breach of the duty of good faith and fair dealing implied in every contract. Amazon’s complaint seeks a judgment of approximately $3.7 million, plus prejudgment interest, an award of attorneys’ fees and other unspecified damages. On March 3, 2003, the Company answered Amazon’s complaint, denied its claims and asserted affirmative defenses. The Company also alleged that Amazon failed to perform under the Linking Agreement and asserted counterclaims for (1) breach of contract, (2) breach of the duty of good faith and fair dealing, (3) violation of the Washington Consumer Protection Act, and (4) declaratory relief. The Company is claiming damages in an amount to be determined at trial, and additionally is seeking attorneys’ fees and costs and a declaration from the court that Amazon is in material breach of the Linking Agreement and that the Company has the right to terminate the term of the Linking Agreement and/or to rescind the Linking Agreement. The court’s case schedule, issued upon filing of the complaint, sets a trial date of February 2, 2004. Discovery is currently ongoing. The Company intends to vigorously defend against Amazon’s claims and prosecute the Company’s counterclaims.

Following USA’s announcement on June 3, 2002 that it intended to commence an exchange offer to acquire up to 100% of the outstanding shares of Expedia that it did not already own, putative class action complaints against USA, Expedia, and members of the Expedia board of directors were filed by individual shareholders of Expedia in King County Superior Court in the State of Washington. The complaints generally alleged that consummation of the exchange offer would be a breach of fiduciary duty and that the indicated exchange ratio was unfair to the minority shareholders of Expedia. Each of the complaints sought, among other things, injunctive relief against consummation of the exchange offer, damages in an unspecified amount and rescission in the event the exchange offer occurred.

In July 2002, the actions were consolidated, and orders were entered providing that the defendants need not respond to the complaint until after the announcement of a transaction contemplating the purchase by USA of the shares of Expedia that it did not already own. The consolidated action was dismissed without prejudice on November 22, 2002.

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On March 20, 2003, one day after the public announcement that USA and Expedia had entered into a definitive merger agreement, the plaintiffs in the consolidated action filed a purported notice of reinstatement of their claims. On March 20, 2003, three additional purported class actions on behalf of Expedia shareholders were filed in King County Superior Court against Expedia, USA, and members of the board of directors of Expedia. Additional purported class action complaints were filed on March 24, 2003 and April 2, 2003. These recent complaints allege, in essence, that the defendants breached their fiduciary duties to Expedia’s public shareholders by entering into and/or approving the merger agreement, which allegedly does not reflect the true value of Expedia. The complaints seek to enjoin consummation of the transaction or, in the alternative, to rescind the transaction, as well as damages in an unspecified amount. On April 22, 2003, the Washington court entered an Order formally reinstating the consolidated action. On May 5, 2003, upon the stipulation of all parties, the court consolidated the five recently filed class actions into the consolidated action.

The Company is currently conducting an on-going review and interpretation of the tax laws in various state and local jurisdictions surrounding state and local sales and hotel occupancy taxes. The current business practice is that the hotels collect and remit these taxes to the various tax authorities based on the amounts collected by the hotels. Consistent with this practice, the Company recovers the taxes from customers and remits the taxes to the hotel operators for payment to the appropriate tax authorities. Several jurisdictions have stated that they may take the position that the tax is also applicable to the Company’s gross profit on merchant hotel transactions and one of them has contacted the Company regarding whether hotel occupancy taxes should be remitted on the Company’s revenues from its merchant hotel transactions. The Company has not paid nor agreed to pay such taxes but has a reserve for potential payment. An unfavorable outcome of some of all of these matters could have a substantial impact on the Company’s financial position, liquidity, and results of operations.

In addition to the matters discussed above, the Company is subject to various legal proceedings and claims that arise in the ordinary course of business. Management believes that the resolution of all such matters will not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

9.    Stock repurchase

On February 5, 2003, the Company publicly announced that its Board of Directors had approved the repurchase of up to $200 million of the Company’s stock. As of March 31, 2003, the Company repurchased approximately 816,000 shares in the amount of $25.0 million of common stock pursuant to this program at prices ranging from $29.68 to $31.47 per share. The Company recorded the repurchase of the common stock as a charge to retained deficit.

10.    Segment Information

As of April 1, 2002, the Company changed its reportable segments to two, North America and International, to reflect a restructuring of its organization. The segment information relating to the three-month period ended March 31, 2002 has been restated to reflect the change in reportable segments. The North America segment generates its revenues from its points-of-sale in the U.S. and Canada. The International segment generates its revenues from its points-of-sale in the U.K., Germany, Belgium, Italy, the Netherlands and France.

Segment information is presented in accordance with SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. SFAS No. 131 is based on a management approach, which requires segmentation based upon the Company’s internal organization and disclosures of revenue and operating loss based upon internal accounting methods.

Management evaluates each segment’s performance based upon income or loss from operations. This involves significant allocations of various corporate and overhead expenses across the segments. These allocations are primarily based on transaction volumes and other metrics.

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The segment information is as follows (in thousands):

Assets of the segments are not relevant for management of the business. Depreciation expense has been allocated to the two segments based on a usage metric. Amortization of goodwill and intangibles exclusively relates to the North America segment. There are no reconciling items between the segment information indicated above to the consolidated statements of operations, nor are there any inter-segment revenues.

The Company has allocated revenues from external customers to geographic areas by selling location. The North America segment derives revenues from the Company’s U.S. and Canadian websites and other operations and the International segment derives revenues from the Company’s international websites.

11.    Restatement

In April 2003, the Company became aware of an error in the computation of amortization of stock-based compensation expense for the year ended June 30, 2000, related to stock options granted on the completion of its initial public offering in place of the cancelled unvested Microsoft options. Subsequent periods (year ended June 30, 2001, six-month period ended December 31, 2001, and the year ended December 31, 2002) were also affected by the impact of the error. As a result of the error, the Company revised the consolidated financial statements, including the notes to consolidated financial statements in the Form 10-K/A which was filed April 30, 2003.

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The effect of the restatement for the three months ended March 31, 2002, is as follows (in thousands, except per share amounts):