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Travelzoo Inc. (NASDAQ:TZOO)

Q2 2006 Earnings Conference Call

July 19, 2006, 5:00 p.m. ET

Executives

Ralph Bartel - Chairman of the Board, President, Chief Executive Officer, Chief Financial Officer

Holger Bartel - Executive Vice President

Lisa Su - Controller for North America

Analysts

George Mihalos - Gilford Securities

Bill Lennan - Wedbush Morgan Securities, Inc.

Operator

Good day, everyone, and welcome to the Travelzoo second quarter 2006 financial results conference call. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions following the presentation. Today's call is being recorded.

It is now my pleasure to turn the floor over to your host, Ralph Bartel, Travelzoo’s Chairman and Chief Executive Officer. Sir, you may begin

Ralph Bartel

Thank you, Operator. Good morning, and thank you all for joining us today for Travelzoo’s second quarter 2006 financial results conference call. I am Ralph Bartel, Chairman and Chief Executive Officer. With me today is Lisa Su, the Company’s Controller for North America, and Holger Bartel, Executive Vice President.

Lisa Su

Good morning, welcome to our conference call.

Holger Bartel

Good morning, everyone.

Ralph Bartel

Before we begin, I would like to walk you through today’s format. First, we will discuss the company’s second quarter 2006 financial results. Then, we will provide additional information on the company’s growth in subscribers and growth strategy. We will then conclude with a question-and-answer session.

Before we discuss the company's financial results released earlier today, I would like to remind you that all statements made during this conference call that are not statements of historical fact constitute forward-looking statements and are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Actual results could vary materially from those contained in the forward-looking statements. Factors that could cause actual results to differ materially from those in the forward-looking statements are described in our Forms 10-K and 10-Q, and other periodic filings with the SEC.

An archived recording of this conference call will be available on the Travelzoo Investor Relations website at www.travelzoo.com/ir, beginning approximately 90 minutes after the conclusion of this call.

Today, Travelzoo announced its 32nd consecutive quarter of growth in online advertising sales. For eight years now, since inception, Travelzoo has reported quarter-over-quarter increases in revenues and has been continuously profitable.

Diluted earnings per share for Q2 2006 were $0.23, up from $0.12 in the prior year period.

Our revenue increased to $17.4 million for Q2 2006, an increase of 42% over revenue of $12.3 million in the same period last year. The quarterly sequential revenue increase from Q1 2006 to Q2 2006 was 3%.

All of our publications and products, which provide latest and reliable information on the very best server offers for more than 500 travel companies, contributed to the growth. Our publications and products include the Travelzoo websites and Travelzoo Top 20 newsletters in the U.S, Canada and the UK, Newsflash and SuperSearch, a travel search engine.

Our North America business segment revenue in Q2 2006 was $16.7 million -- an increase of $4.4 million compared to Q2 2005.

Our Europe business segment revenue in Q2 2006 was $743,000 -- a $734,000 increase year-over-year.

In terms of revenue concentration, Travelzoo had one group of advertisers under common control that accounted for 19% of revenue, and another group of advertiser under common control that accounted for 15% of revenues in Q2 2006. No other group of advertisers accounted for more then 10% of revenues.

Travelzoo’s operating income in Q2 2006 was $7 million, an increase of 86% compared to Q2 2005 operating income of $3.8 million.

Operating margin in Q2 2006 was 43%, up from 36% in Q2 2005.

Travelzoo’s net income in Q2 2006 was approximately $3.9 million, an increase of 77% compared to Q2 2005 net income of $2.2 million. Net income in Q2 2006 was impacted by a higher income tax rate. Travelzoo's effective income tax rate in Q2 2006 was 47.3% compared to 43.6% in Q1 2006 and 45.1% in Q2 2005. The increase in our effective tax rate compared to Q1 2006 was due primarily to the increase in the loss from our Europe business segment and our new operations in Canada.

For financial reporting purposes, the losses from our Europe business segment and operations in Canada and the cash program expenses appeared as having no recognizable tax benefit.

Cash flow from operations in Q2 2006 was $3.3 million. Cash flow from operations was impacted by income tax payments of approximately $5.2 million during the quarter. DSOs -- that is days sales outstanding -- as of June 30, 2006 was 48 days, compared to 51 days as of March 31, 2006.

Total cash, cash equivalents and short-term investments as of June 30, 2006 decreased from $25.1 million from $41.7 million as of March 31, 2006, due primarily to the company's repurchase of common stock.

I will now turn to Lisa to discuss additional information for our two business segments, North America and Europe, including headcount expenses and operating income.

Lisa Su

Thank you. We believe that Travelzoo continues to be a highly productive company. We had 75 employees as of June 30, 2006. Sixty-three of these employees where in North America and 12 employees were in Europe. Average annualized revenue per employee in Q2 2006 was $926,000, up from $817,000 in the same period last year.

Let’s now look at the expense line items of our two business segments.

In North America, our largest expense item continues to be sales and marketing, consisting primarily of advertising and promotional expenses and salary expenses associated with sales and marketing staff.

Total sales and marketing expense were $7.1 million, up 16% from $6.2 million in Q2 2005, and up from $6.5 million in Q1 2006. Sales and marketing expenses as a percentage of revenue decreased from 50% in Q2 2005 to 42.8% in Q2 2006.

The increase from Q2 2005 was primarily due to increased spending on marketing for SuperSearch, salary expenses associated with sales and marketing staff, and spending on subscriber acquisition campaigns.

The increase from Q1 2006 was primarily due to expenses related to specific promotional and brand marketing, including the promotion of our 10-millionth subscriber and an increase of salary expenses associated with sales and marketing staff.

In North America, general and administrative expenses were $1.8 million in Q2 2006, compared to $2 million in Q2 2005 and $2.3 million in Q1 2006. The $500,000 decrease in G&A versus last quarter was due primarily to a $366,000 decrease in legal and professional services expense, which included SOX compliance costs and a $269,000 decrease in bad debt expense, offset by increases in office expenses. The $200,000 decrease in G&A versus last year was due primarily to a $142,000 decrease in legal and professional services expense.

North America operating income for Q2 2006 was $7.5 million, up from $3.9 million for the same period last year. Operating margin for Q2 2006 was 44.9%, compared to 32% for the same period last year.

In Europe, our largest expense item is also sales and marketing, consisting primarily of advertising and promotional expenses and salary expenses associated with sales and marketing staff.

Total sales and marketing expenses in Q2 2006 was $814,000, compared to $638,000 in Q1 2006. The increase over last quarter was due primarily to expenses related to subscriber acquisition, which were necessary to achieve the critical number of 500,000 subscribers in the U.K.

In Europe, total general and administrative expenses in Q2 2006 were $396,000, compared to $337,000 in Q1 2006. Our Europe business segment incurred an operating loss of $494,000 in Q2 2006 compared to an operating loss of $460,000 in Q1 2006. Excluding subscriber acquisition cost, the operating loss would have been $146,000 in Q2 2006.

It is our goal to achieve profitability in the UK as soon as possible.

This concludes our discussion of Travelzoo’s Q2 2006 financial result. We will turn back now to Ralph, who will provide more information on the growth of our reach and our growth strategy.

Ralph Bartel

Thank you, Lisa. Travelzoo added a total of 895,000 new subscribers to its e-mail publications during Q2 2006. In North America, we acquired 738,000 new subscribers at an average cost of $2.11 per subscriber in Q2 2006, compared to $2.54 in Q1 2006.

In North America, Travelzoo’s Top 20 newsletter and Newsflash e-mail alert service had a net unduplicated total of 10 million subscribers as of June 30, 2006. This represents an increase of 16% versus the same time last year, while revenue increased 42%. Management believes this shows that Travelzoo is able to successfully generate higher revenue as our reach continues to increase.

In Europe, we acquired 129,000 subscribers at an average cost of $2.69 per subscriber in Q2 2006, compared to $2.12 in Q1 2006. Europe had a net unduplicated total of 520,000 subscribers as of June 30, 2006.

In 2005, Travelzoo began its growth strategy of expanding into selected foreign markets. So far, we are very pleased with this strategy.

We see a competitive advantage from being able to cross-sell advertising internationally. For example, our sales force in the U.S. now sells inclusions for our U.K. publications, while our sales forces in the U.K. and Germany also sell inclusion for our U.S. publications.

Another competitive advantage is our improved ability to solve the very best travel deals and perform a very high quality review by leveraging the specific knowledge of our producers in our offices in four countries and 8 cities: New York; Mountain View, California; Les Vegas; Chicago; Miami; Toronto; London; and Munich.

This concludes the discussion of financial results, the growth in subscribers and our growth strategy. Travelzoo's consistent practice is not to provide guidance for future periods because of the dynamics of the industry. Therefore, this will conclude our prepared discussion.

I will turn the call back to the operator now for the question-and answer-session.

Question-and-Answer Session

Operator

Thank you. The floor is now open for questions.

(Operator Instructions)

We take our first question from George Mihalos with Gilford Securities.

George Mihalos - Gilford Securities

Good morning. Ralph, I was hoping you could provide some more clarity in terms of revenues during the quarter. Specifically, could you talk a little bit about the newsletter business versus SuperSearch? If you can not get all that specific, can you maybe talk about search query growth in SuperSearch on a sequential basis?

Ralph Bartel

Yes, we will talk. As you know, we do not break-out revenues by product, but certainly we will provide more information. Holger Bartel, our Executive Vice President, will take your question.

Holger Bartel

Yes, we were actually not that unhappy overall with revenues in the quarter. Our goal is, long-term, to achieve continuous long-term revenue growth, and there is a certain range within which we want to stay.

In Q1, we had a very good quarter. We were on the upper end of this range. This quarter, in Q2, we were a little bit on the lower end of this range. We were actually happy with the growth among all products. The product that did not do so well in Q2 specifically, just to address your question, was the Newsflash alert service, where revenues were a little bit lower than where we wanted to see it. However, what we have noticed is that in the first three weeks of July now, we are seeing a very heavy activity in Newsflash.

I think that this has been primarily a seasonal issue this quarter, because airlines and some other travel providers where very busy this summer, so some of them delayed there sales, and so maybe we were affected by that. Some of these Newsflash e-mails are now being sent out in Q3 rather than in Q2.

In terms of SuperSearch usage, usage overall there has increased 49% versus last year, so we still see very robust growth there.

George Mihalos - Gilford Securities

Thank you. Can you update us on the share buy-back plan? Is that complete as of now?

Ralph Bartel

Yes, George, that has been completed.

George Mihalos - Gilford Securities

Okay, thank you.

Operator

(Operator Instructions)

We will take our next question from Bill Lennan with Wedbush Morgan.

Bill Lennan - Wedbush Morgan Securities, Inc.

Good morning Ralph, Holger, Lisa, everyone. I have three questions. First, I will do the easy one. Can you help us figure out how to think about a tax rate for the rest of the year?

Second question is the acquisition cost of subscribers in the U.S. varied very favorably, at least with our estimate. I wonder if you could tell us how you got that $2.11. That is a great number. Could you tell us what is going on there? I do not think advertising rates are coming down. Are you just getting smarter about buying?

Third question, I will probably ask every quarter from now until the end of time, is with gasoline and consumer financing costs going in the wrong direction, are you hearing any of your customers getting concerned about consumer expenditure over the next 6 to 12 months? Thank you.

Ralph Bartel

Thank you, Bill. Lisa will answer your question regarding the tax rate and Holger will answer your question regarding the subscriber acquisition in the U.S., and will also try to answer your question regarding the gas. Lisa, please.

Lisa Su

Our tax rate is really determined by how much loss we have in our foreign operations. At this time, we really cannot predict what our tax rate is going to be because our losses from foreign operations could fluctuate depending on how fast we grow into those markets.

Right now, there is no taxable benefit for those losses. I would hope that our tax rate does not increase significantly from what it is now but at this time, I cannot really give an accurate forecast.

Holger Bartel

On the subscriber acquisition costs, we were indeed very happy -- $2.11 is a great number. Last year in Q2 we were $2.59, so we actually saw quite a decrease there.

It really has three reasons.

The first reason, yes, we want to become smarter in our media buys. We did some good media buys in Q2 that we hope that we will be able to continue.

Second, you should note that the subscriber acquisition cost is for North America, which means that it includes Canada as well. We started the Top 20 Newsletter in Canada two months ago. What we typically see is when we enter a new market, at the beginning we are able to sign up subscribers at a relatively low cost per acquisition, so we benefited from that. We saw the same in the U.K., as you probably will recall.

Third, overall it is of course our strategy to also leverage our existing subscriber base. We now have 10 million subscribers in North America alone, who love our product. We are developing more and more programs to get them to refer our other users to the newsletter. This is of course the best acquisition strategy for us, because acquisition cost of these subscribers is zero, and we want to leverage that even more in the future.

Finally, with regard to your question on gasoline consumer trends, I really cannot give you a different answer than last quarter. I have not seen it impact our business. I have not heard from the travel companies that it impacted their business. The airline business has been very, very strong this summer, so I do not see anything that has changed over the last three months.

Bill Lennan - Wedbush Morgan Securities, Inc.

Great. Then just a follow-up maybe for Lisa on the tax question. The situation where you see you cannot use any of those -- you get no benefit from any of those losses, does that ever change? Is there any sort of trigger or are those foreign losses of no tax value?

Lisa Su

The trigger will be when we actually make a profit in any of those locations. So at that point, we might actually get a huge tax benefit. In the future, who knows when it will be, but once we start accumulating a profit, we will be able to recognize a tax effect for all of our previous losses.

Bill Lennan - Wedbush Morgan Securities, Inc.

Okay. Thanks a lot.

Operator

(Operator Instructions)

There appear to be no further questions at this time. I will turn the call back over to Mr. Bartel.

Ralph Bartel

Ladies and gentlemen, we thank you for your support. We look forward to speaking with you again next quarter. Have a nice day.

Operator

Thank you, ladies and gentlemen. This concludes today's teleconference. You may disconnect your lines at this time. Have a nice day.

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Source: Travelzoo Inc. Q2 2006 Earnings Conference Call Transcript (TZOO)

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