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Travelzoo Inc. (NASDAQ:TZOO)

Q3 2006 Earnings Call

October 24, 2006 11:00 am ET

Executives

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

Wayne Lee - Chief Financial Officer

Holger Bartel - Executive Vice President, Director

Analysts

Marianne Wolk - Susquehanna Capital

Scott Devitt - Stifel Nicolaus

Michael Millman - Soleil Securities

Presentation

Operator

Good day, everyone, and welcome to the Travelzoo third quarter 2006 financial results conference call. At this time, all participants have been placed in 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 third quarter 2006 financial results conference call. I am Ralph Bartel, Chairman and Chief Executive Officer. With me today is Wayne Lee, the company’s Chief Financial Officer, and Holger Bartel, Executive Vice President.

Wayne Lee

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 third 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 33rd consecutive quarter of growth in online advertising sales.

Diluted earnings per share for Q3 2006 were $0.28, up from $0.13 in the prior year period. Our revenue increased to $17.6 million for Q3 2006, an increase of 31% over revenue of $13.4 million in the same period last year.

The quarterly sequential revenue increase from Q2 2006 to Q3, was $228,000, or 1.3%.

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

Our North America business segment revenue in Q3 2006 was $16.7 million, an increase of $3.6 million year over year.

Our Europe business segment revenue in Q3 2006 was $963,000, a $595,000 increase year over year.

In terms of revenue concentration, Travelzoo had one group of advertisers under common control that accounted for 18% of revenues and another group of advertisers under common control that accounted for 15% of revenues in Q3 2006. No other group of advertisers accounted for 10% or more of revenues.

Travelzoo's operating income in Q3 2006 was $8.1 million, an increase of 95% compared to Q3 2005 operating income of $4.2 million.

Operating margin in Q3 2006 was 46.2%, up from 31.2% in Q3 2005.

Travelzoo's net income in Q3 2006 was $4.6 million, an increase of 98% compared to Q3 2005 net income of $2.3 million.

Travelzoo's effective income tax rate in Q3 2006 was 45.9%, compared to 47.3% in Q2 2006 and 48.4% in Q3 2005.

The decrease in our effective tax rate compared to Q2 2006 was due primarily to the decrease in the loss from our Europe business segment. For financial reporting purposes, the losses from our Europe business segment and operations in Canada, and the cash flow from expenses were treated as having no recognizable tax benefit.

Cash flow from operations in Q3 2006 was $2.8 million. Cash flow from operations was impacted by income tax payments of approximately $4.5 million during the quarter.

DSOs, that is days sales outstanding, as of September 30, 2006, was 48 days, unchanged from June 30, 2006.

Total cash, cash equivalents, and short-term investments, as of September 30, 2006, increased to $28 million, from $25.1 million as of June 30, 2006, due primarily to the cash generated from operations.

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

Wayne Lee

Thank you. We believe that Travelzoo continues to be a highly productive company. We have 81 employees as of September 30, 2006. 66 of these employees were in North America, and 15 employees were in Europe. Average annualized revenue per employee in Q3 2006 was $868,000, up from $824,000 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 expenses were $6.2 million, down 7% from $6.7 million in Q3 2005, and down from $7.1 million in Q2 2006.

Sales and marketing expenses, as a percentage of revenue, decreased to 37.4% in Q3 2006, from 51.5% in Q3 2005. The decrease from Q3 2005 was primarily due to decreased spending on subscriber acquisition campaigns, offset by increased spending on marketing for SuperSearch, and increased salary expenses associated with sales and marketing staff.

The decrease from Q2 2006 was primarily due to decreased spending on subscriber acquisition campaigns, as well as decreases in expenses related to specific promotional and brand marketing campaigns, offset by an increase in spending on marketing for SuperSearch.

The North America general and administrative expenses were $1.8 million in Q3 2006, compared to $1.6 million in Q3 2005, and flat compared to Q2 2006. The $242,000 increase in general and administrative expenses versus last year was due primarily to a $230,000 increase in legal and professional services expense.

North America operating income for Q3 2006 was $8.4 million, up from $4.6 million for the same period last year.

Operating margin for Q3 2006 was 50.4%, compared to 34.8% 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 Q3 2006 were $739,000, compared to $814,000 in Q2 2006. The $75,000 decrease from the last quarter was due primarily to a $193,000 decrease in subscriber acquisition expense, and was partially offset by an increase in salary expense.

In Europe, total general and administrative expenses in Q3 2006 were $481,000, compared to $396,000 in Q2 2006. The increase from last quarter was mostly attributable to increased salary expense.

Our Europe business segment incurred an operating loss of $276,000 in Q3 2006, compared to an operating loss of $494,000 in Q2 2006, as we were able to keep total operating expenses flat, while growing our revenues by 30%.

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

This concludes our discussion of Travelzoo's Q3 2006 financial results. We will now turn back to Ralph, who will provide more information on the growth of our reach and our growth strategy.

Ralph Bartel

Thank you, Wayne. During Q3 2006, Travelzoo added a total of 619,000 new subscribers to its e-mail publications. In North America, we acquired 492,000 subscribers, at an average cost of $1.86 per subscriber in Q3 2006, compared to 738,000 subscribers at an average cost of $2.11 in Q2 2006.

Our average cost per subscriber in Q3 2006 was positively impacted by a credit we received from a vendor. Excluding this credit, our average cost per subscriber in Q3 2006 would have been $2.21.

In North America, Travelzoo's Top 20 Newsletter and Newsflash e-mail alert service had a net unduplicated total of 10.1 million subscribers as of September 30, 2006. This represents an increase of 14% versus the same time last year, while revenues increased 27% year over year. Management believes that this shows that Travelzoo is able to successfully generate higher revenues, as our reach continues to increase.

In Europe, we acquired 127,000 subscribers at an average cost of $1.23 per subscriber in Q3 2006, compared to 129,000 subscribers at an average cost of $2.69 in Q2 2006.

In Europe, Travelzoo’s Top 20 Newsletter and Newsflash e-mail alert service had a net unduplicated total of 617,000 subscribers as of September 30, 2006.

In 2005, Travelzoo began its growth strategy of expanding into selected international 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. and Canadian publications, while our sales force in Europe also sells inclusions for our U.S. and Canadian publications.

Another competitive advantage is our improved ability to source the 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 eight cities -- Chicago; Las Vegas; London; Miami; Mountain View, California; Munich, Germany; New York; and Toronto, Canada.

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

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question comes from Marianne Wolk of Susquehanna Capital.

Marianne Wolk - Susquehanna Capital

Thank you. I was wondering if you could give us some more details on the decline in sales and marketing expenses on a Q-over-Q basis? First of all, you mentioned a credit in the U.S. Could you talk about what drove that credit and whether that is repeatable? Also, I noticed that the cost per sub was down substantially in Europe. Could you explain what happened there? Why didn’t you spend more then to acquire even more subs? Thank you.

Ralph Bartel

Good morning, Marianne. Let me first give you an overview, and then Wayne Lee can provide more information.

In the U.S., we met the target for our operating margin that we set in our internal budget. The strategy for our Europe segment is to invest aggressively in subscribers, while the strategy in North America is to continue solid growth. Now, after being in business for 8 years in North America, optimize the management of the business.

I think in the past, there was often a concern that marketing and sales expenses are too high in the North America segment, and it is our goal to bring these marketing expenses down. What we did in Q3, on one hand, we focused more on finding ways to acquire subscribers organically. We believe there are a lot of opportunities on our website where we could sign up more subscribers at virtually no cost. We are also working on more referral programs where we can leverage the existing subscriber base to sign up more subscribers.

In Europe, we are very pleased with the average cost per subscriber decreasing. I think it is the result of more experience in this market, and yes, it is our goal to leverage this competitive CPA and sign up more subscribers in the coming quarters. As I said, our goal is to invest heavily in subscriber acquisition in European markets, including the U.K. and Germany at this time.

Wayne, would you be able to provide more information on the credit received, please?

Wayne Lee

Sure. The credit that we received was an amount that we were disputing with one of our vendors, so this is a one-time credit of $170,000 that we saw in the quarter.

Marianne Wolk - Susquehanna Capital

I guess I am just surprised that you do not think there is more growth opportunity in the U.S. and Europe that you wouldn’t try to optimize growth now, rather than margin improvement, particularly since we note significant momentum for players like Sidestep and Kayak out there. Are you saying you do not think there is a substantial growth opportunity left in the U.S. subscriber base?

Ralph Bartel

Yes, there is, so please do not misunderstand me. We think that managing the company in a professional way in the United States requires also that we sign subscribers up at a speed where we can monetize the additional subscribers. In the past, often because of a relatively high tax rate, I believe we signed up more subscribers than we actually needed. I think on past conference calls over the years, we talked about that often more subscribers were signed up than the growth of the business needs.

Our goal is not to slow down subscriber acquisition. Please do not misunderstand. Our goal is now that things in North America are not as crazy anymore, to spend more time on figuring out how can we sign up subscribers organically. We know from surveys that the existing Travelzoo subscribers are very loyal and are very happy with the service, so one thing that we are trying to do is to leverage that subscriber base to refer others to the website and to the e-mail publications.

Marianne Wolk - Susquehanna Capital

Thank you.

Ralph Bartel

Thank you, Marianne.

Operator

(Operator Instructions)

Our next question will come from Scott Devitt of Stifel Nicolaus.

Scott Devitt - Stifel Nicolaus

Thank you. The question relates to the growth in the business in North America. I believe you initiated a price increase in the first quarter, which really reaccelerated the growth rate. Since that time, in North America, the growth has been relatively flat. I was wondering if you could talk to the business in terms of the organic growth, ex-price increases, and just remind us of the level of price increase this year. Then I have one follow-up.

Ralph Bartel

Good morning, Scott, thanks for joining. Holger Bartel, our Executive Vice President, will take your question.

Holger Bartel

It is not so much that we increase prices at a certain percentage rate from one year to another. Every year at the beginning of the year, we develop a new rate card. We are actually currently developing the new rate card for 2007 and we will have some substantial price changes there. It is not necessarily price increases. It is adjusting the prices more towards the demand that we see in the market, the more our advertisers also pricing our product differently in the areas where we feel we can reap a higher rate from the advertisers.

That continues typically throughout the year, but the biggest changes are usually at the beginning of the year. You are correct. We did that at the beginning of this year and we will do some rate changes at the beginning of next year.

In terms of revenues, the one area we were not that happy with this quarter was SuperSearch. Traffic there, we still saw a very robust increase versus last year. We had a 42% increase in outbound searches versus last year, so Q3 2006 versus Q3 2005. But we actually saw a decrease in searches of around 3% from Q2 2006 to Q3 2006. What we noticed was that July and the first-half of August were periods that were not as strong as we had seen last year. Maybe it had to do with the high oil price that some of the -- you know, the ticket price is very high for airline tickets, so maybe less consumers searched for it. Also, some of the advertisers were hesitating, so there was definitely a bit of a weak spot in our quarter.

The one thing I should also mention is we are really working on a better experience on the website. We are working on a redesign of the site. We know that there is a lot of functionality on our website that can be improved, so we hope that we can put live this quarter a redesigned website that also offers better functionality for the users, particularly with regard to search functions.

One of the other avenues we are also investigating and working on is a better integration of SuperSearch with the search for deals because we are hearing from our users what they would like to see is a better search experience when it comes to finding both sites for a specific route but also seeing what deals are existent at a specific route.

Scott Devitt - Stifel Nicolaus

Specifically around the rate card question, I am trying to get a gauge for the pricing power, if you will, if that is my own definition of it, long-term in the business. What would -- if you utilized the fourth quarter ’05 rate card, what would the growth in the business have been, volume versus rate card changes?

Holger Bartel

That is really a very complicated analysis we would need to do, so I cannot provide you this answer right here.

In terms of your question of what is our pricing power, we look at our sell-out rates, and there are various areas in the top 20 where we are consistently sold out. For example, right now we are looking at -- we have much more hotel demand for advertising in the top 20 than we can actually offer. We are consistently seeing very good demand from the cruise industry, where we often have, in many weeks, we go well beyond our sell-out rates. These are areas where we feel we can change pricing.

As I said, it really depends on the kind of demand we are seeing. Those are the areas where we are just revisiting on the rates to come up with a better rate structure, and maybe offering also a lower degree of discounts.

Scott Devitt - Stifel Nicolaus

Just one final question, relative to us looking forward into 2007, you said you had begun to look at rate card changes for 2007. How should we think of those relative to the changes in 2006?

Holger Bartel

It is more adjustments than strong rate increases, but we actually really did not have that strong rate increases at the beginning of this year either. You are saying the growth that we saw, particularly at the beginning of this year, came only from rate increases. That is not correct. It really came to a large degree from higher sell-out rates across all products.

Scott Devitt - Stifel Nicolaus

Thank you.

Operator

(Operator Instructions)

Our next question will come from Michael Millman of Soleil Securities.

Michael Millman - Soleil Securities

Thank you. A couple of questions. Could you talk about what you see as the maybe just the long-term impact from much more personalization and CRM kind of web 2.0 work that we are seeing from travel companies? Also, you mentioned that you had two advertising groups, one of 15%, one of 18%. Are those typically the same advertising groups that are your highest, or does that kind of switch quarter to quarter? Thank you.

Ralph Bartel

Good morning, Michael. Holger will take your question.

Holger Bartel

I can take the first two questions, the personalization as well as more relevant information.

Two things I would say, Michael, first of all, we have, with our 10.1 million subscribers in North America and over 600,000 subscribers in Europe, we have an extremely loyal audience. We have these subscribers that are very committed to the product. They like to share information and experiences, so obviously we are thinking about ideas of how we can leverage that subscriber base.

Due to the competitive nature of our business, I do not want to discuss what things specifically we are planning, but of course, I do not think there are many companies out there that do not currently think about user-generated content and things like that.

In terms of better and more relevant information and more personalization for the users of our site, I mentioned we are redesigning the website. We want users to more easily find the information that is relevant to them. I think this is something very important that we want to improve, and we are very keen on improving that this quarter, and throughout 2007.

With regard to the advertiser concentration, maybe Wayne should take that question.

Wayne Lee

Yes, that information will be disclosed when we file our 10-Q.

Michael Millman - Soleil Securities

The question was not so much who it was but if you typically have variation in who your top advertisers are, or is it generally the same one or two or three who are your plus-10% advertisers?

Wayne Lee

If you look historically at our filings, you will see that we have had the same advertisers as our top customers. One thing to keep in mind, that these are groups of companies that are under common control, so we consider that as one advertiser, so it is not necessarily, you might be thinking one company that is doing all the advertising.

Michael Millman - Soleil Securities

Okay, thank you, Wayne.

Operator

I will turn the call back 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, and have a nice day.

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