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Travelzoo Inc. (TZOO)

Q4 2006 Earnings Call

February 6, 2007 5:00 pm ET

Executives

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

Wayne Lee - Chief Financial Officer

Holger Bartel - Executive Vice President, Director

Analysts

William Lennan - First Albany Corporation

Scott Devitt - Stifel Nicolaus

Presentation

Operator

Good afternoon, everyone, and welcome to the Travelzoo fourth quarter 2006 financial results conference. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions following the presentation. As a reminder, today’s conference is being recorded.

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

Ralph Bartel

Thank you, Operator. Good afternoon, and thank you all for joining us today for Travelzoo's fourth 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.

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Wayne Lee

Hello, everyone. Welcome to our conference call.

Holger Bartel

Good afternoon, everybody.

Ralph Bartel

Before we begin, I would like to walk you through today’s format. First, we will discuss the company’s fourth 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 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.travelzoocom/ir beginning approximately 90 minutes after the conclusion of this call.

Today, Travelzoo announced its 34th consecutive quarter of growth in online advertising sales. Diluted earnings per share for Q4 2006 were $0.26, up from $0.10 in the prior year period.

Our revenue increased to $17.7 million for Q4 2006, an increase of 27% over revenue of $13.9 million in the same period last year. The quarterly sequential revenue increase from Q3 2006 to Q4 2006 was 0.4%.

All of our publications and products which provide the 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, U.K., Germany, Newsflash and Super Search, our travel search engine.

Our North America business segment revenue in Q4 2006 was $16.8 million, an increase of $3.2 million year over year. Our Europe business segment revenue in Q4 2006 was $961,000, a $581,000 increase year over year.

In terms of revenue concentration, Travelzoo had one group of advertisers under common control that accounted for 15% of revenues and another group of advertisers under common control that accounted for 13% of revenues in Q4 2006. No other group of advertisers accounted for 10% or more of revenues.

Travelzoo's operating income in Q4 2006 was $7.7 million, an increase of 118% compared to Q4 2005 operating income of $3.5 million. Operating margin in Q4 2006 was 43.5%, up from 25.4% in Q4 2005.

Travelzoo's net income in Q4 2006 was $4.3 million, an increase of 159% compared to Q4 2005 net income of $1.7 million.

Travelzoo's effective income tax rate in Q4 2006 was 46.3% compared to 45.9% in Q3 2006 and 56.7% in Q4 2005. The increase in our effective tax rate compared to Q3 2006 was due primarily to the increase 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 program expenses were treated as having no recognizable tax benefit.

Cash flow from operations in Q4 2006 was $5.5 million.

DSOs, that is days sales outstanding, as of December 31, 2006, was 41 days, down from 48 days as of September 30, 2006.

Total cash, cash equivalents, and short-term investments as of December 31, 2006, increased to $33.4 million from $28 million as of September 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, Ralph. We believe that Travelzoo continues to be a highly productive company. We had 82 employees as of December 31, 2006. Sixty-five of these employees were in North America and 17 employees were in Europe. Average annualized revenue per employee in Q4 2006 was $861,000, up from $794,000 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 $6.5 million, down from $6.8 million in Q4 2005, and up from $6.2 million in Q3 2006. Sales and marketing expenses as a percentage of revenue decreased to 39% in Q4 2006 from 50.3% in Q4 2005. The decrease from Q4 2005 was primarily due to decreased spending on subscriber acquisition campaigns, offset by increased spending on marketing for Super Search, and increased salary expenses associated with sales and marketing staff.

The increase from Q3 2006 was primarily due to increased spending on marketing for Super Search and increased spending related to the introduction of video content on our website, and increased spending on brand marketing campaigns, offset by decreased spending on subscriber acquisition campaigns.

In North America, general and administrative expenses were $1.9 million in Q4 2006, down from $2.4 million in Q4 2005 and up slightly from $1.8 million in Q3 2006. The $500,000 decrease in general and administrative expenses versus last year was due primarily to a $335,000 decrease in legal and professional services expense, and a $145,000 decrease in bad debt expense.

The decrease in legal and professional services expense was primarily due to decreased product and stocks compliance expenses.

North America operating income for Q4 2006 was $8 million, up from $4.1 million for the same period last year. Operating margin for Q4 2006 was 47.9%, compared to 30.2% 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 Q4 2006 were $800,000 compared to $739,000 in Q3 2006. The $61,000 increase from the last quarter was due primarily to increased spending for subscriber acquisition and an increase in the average exchange rate in Q4 compared to Q3.

In Europe, total general and administrative expenses in Q4 2006 were $496,000 compared to $481,000 in Q3 2006. The $15,000 increase in general and administrative expense in Q4 compared to Q3 is primarily as a result of the change in the exchange rate between Q4 and Q3.

Our Europe business segment incurred an operating loss of $356,000 in Q4 2006 compared to an operating loss of $276,000 in Q3 2006. As revenues remain flat quarter over quarter, while both sales and marketing and general and administrative expenses increased, as discussed earlier.

We continue to make progress towards our goal to achieve profitability in the U.K. as soon as practical, as the loss in Q4 was approximately $62,000, down from approximately $111,000 in Q3 2006. However, in markets like Germany, we expect operating losses in the near future as we invest in subscriber marketing.

This concludes our discussion of Travelzoo's Q4 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 Q4 2006, Travelzoo added a total of 443,000 new subscribers to its e-mail publications. In North America, we acquired 374,000 subscribers at an average cost of $1.56 per subscriber in Q4 2006, compared to 492,000 subscribers at an average cost of $1.86 in Q3 2006.

In North America, Travelzoo's Top 20 newsletter and News Flash e-mail alert service had a net unduplicated total of 10.2 million subscribers as of December 31, 2006. This represents an increase of 9% versus the same time last year, while revenues increased 23% 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 69,000 subscribers at an average cost of $2.94 per subscriber in Q4 2006, compared to 127,000 subscribers at an average cost of $1.23 in Q3 2006.

In Europe, Travelzoo's Top 20 newsletter and News Flash e-mail alert service had a net unduplicated total of 655,000 subscribers as of December 31, 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 U.S. and Canadian publications.

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

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

Question-and-Answer Session

Operator

(Operator Instructions)

From First Albany, Bill Lennan.

William Lennan - First Albany Corporation

Good afternoon. I have a series of questions here, so maybe I will ask them one at a time. Ralph, for starters, could you give us an update on the competitive landscape? Looking at comScore data, it looks like Sherman’s -- if you believe comScore, which I take with a grain of salt, Sherman’s Travel looks to be getting a bit more successful in unique visitors and page views. Could you give us an idea of how Sherman’s is doing? Then, on a larger scale, what you are seeing with Yahoo! and Google and some of your larger competitors?

Ralph Bartel

Good afternoon, Bill. Holger Bartel, our Executive Vice President, will take your question.

Holger Bartel

Hi, Bill. First of all, yes, comScore and other third party metrics that we are looking at do not necessarily show the same data that we see internally. We see some months they are over -- they are widely ranging too far from one month to another month in terms of what we are seeing in terms of fluctuations.

We also know that advertising plays a big role in terms of driving traffic. Overall, we were very happy with the traffic that we generated in Q4. In Q4, we generated 8,540,937 page views in Q4, which is up by several percentage points over last year.

In terms of why our data in Q4 might not show such a big increase, I think it has to do with our subscriber acquisition efforts, which we decreased in Q4 due to the situation that Q4 is necessarily not a good quarter for subscriber acquisition. As you know, subscriber acquisition drives a lot of traffic to your website, so that is something that you have been seeing.

But product usage, in particular Super Search, actually, I gave you the number for the website. For Super Search now, we are looking at 15 million searches per quarter, which is up substantially versus last year. It is up by 26%, so we continue to see good growth. We do not really see much growth in the areas of Yahoo! and AOL, what they are doing in the travel space.

William Lennan - First Albany Corporation

And then, on Europe, could you help us understand, it looks like North America is stronger than we had modeled, or about in line, but Europe was a little bit weak, actually down sequentially by $1,000. Could you tell us what is going on in Europe A, with growth, what you kind of think ’07 will look like? And B, with the customer acquisition cost, that was a bit expensive compared to your previous history.

Ralph Bartel

Bill, we are very excited about Europe and we are actually very optimistic about the growth in Europe in 2007, and that is why we included this in today’s press release.

You saw a quarter in the U.K. that was not so strong in Q4. I think it has mainly to do with we are spending a significant amount of time on developing the business in Germany, which we think has great prospects. Now, the business developments in Germany did not really result in a lot of revenue in Q4 but we expect this to change in 2007.

Also, in terms of subscriber acquisition, we had some challenges in Germany at the beginning of Q4. We saw very, very high CPAs, which ultimately affected the average CPA for Europe in Q4.

The very good news is that towards the end of Q4, actually in December, we found a way to bring down the CPA very significantly by making a slight change to the sign-up page that we are promoting in Germany. So overall, we are not concerned with the subscriber acquisition in Q4 and actually are on a good way, I think, to develop the European business very well in 2007.

William Lennan - First Albany Corporation

Okay, a couple more here. Could you tell us, you said you had a 15% customer and a 13% customer in Q4. Knowing what you know now about ’07, do you expect the usual suspects who have been your 10% customers to contribute a similar percentage to ’07, or has there been any material change in their behaviors?

Ralph Bartel

I will suggest that Wayne Lee take this question.

Wayne Lee

Yes, hi, Bill. At this time, we do not have any information that will allow us to predict their patterns for 2007. Historically, we have always had a handful of customers that have accounted for 10%-plus of revenue and that will probably continue in 2007. I just do not know to what extent.

William Lennan - First Albany Corporation

Okay, and last one for now, I will hope back on the queue here. Could you give us some color on the extent and nature of this year’s price increase versus past years, just the magnitude of the price increase and how it is taking effect? I have been hearing some talk about more bundling and more creative packaging by you guys from your customers.

Ralph Bartel

Holger Bartel, our Executive Vice President, will take this question.

Holger Bartel

Yes, in the past, we always did a rate increase at the beginning of the year. We did exactly the same this year. We increased the rates on January 1, 2007. In some areas, we increased them as much as 40%, those particular areas where we continue to see strong demand from advertisers and where we had sell-out rates of 100% or more during the course of the year.

We also bundled some products together, which is more, the objective of that is more to provide better solutions to our advertiser in terms of what they need. Also, we decreased frequency discounts in some areas where we saw very robust demand and a higher renewal rate.

Also, one more comment on the competitive product, because you asked about them earlier, particularly newsletter publications. One of you did a lot of interviews with our customers, our advertising customers and I think one big feedback we are hearing from our customers and that you also seem to hear back from them is that in terms of response to advertising newsletter products, they do not see anything close to what we are providing.

So yes, some of these newsletter products that competitors are offering might publish large circulations or increasing circulations, but what we are hearing from our advertisers is that they are not really working very well. Maybe you should ask some of our advertisers and get some additional information there with regard to 2007 and the amount of demand and money they will spend with these publications, because obviously we do not know.

William Lennan - First Albany Corporation

Thanks for your patience for my many questions. I will get back in the queue.

Operator

(Operator Instructions)

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

Scott Devitt - Stifel Nicolaus

Good afternoon, thank you. I wanted to just follow up on the question regarding the rate card change, because if you look at your business in 2006, in the first quarter sequentially the business grew 21%, which is the effect of the adjustment in the advertising costs sequentially, at least a component of it is. Then, after the first quarter, in North America, the business really has not grown. It grew 2% in the second quarter, it didn’t grow in 3Q and in 4Q, it grew 1%.

I was wondering if you could give a little better clarity as to what the blended rate card adjustment is in 2007 and how you think about the growth in North America on an ex-pricing adjustment basis. Thanks.

Ralph Bartel

Good afternoon, Scott. Holger will take this question.

Holger Bartel

Scott, we are very optimistic regarding 2007 and 2006, I think what you saw as you pointed out, we had a significant increase in revenues from Q4 to Q1. Indeed, it was 25%.

I think what we are just seeing more and more is seasonality effects and as they affect not only our business of publishing travel deals but also the Super Search product, particularly the Super Search product follows a very similar traffic pattern as travel sites in general, which means that in Q1 and in Q4, you see less traffic and less usage and the highest usage for Q2 and Q3. Particularly Q4 is also a very weak quarter for travel sites in general in terms of tickets they sell, and that is also regarding Super Search, so we typically see less traffic in Q4.

We partially try to offset that with increased marketing spend in Q4, which we have done now for the last few years, so you see how that also impacts typically our profitability in Q4.

In terms of the rate increases, they happened on January 1, 2007, so yes, it is no surprise that you see, particularly a big jump always in the first quarter. That is just the nature of our business, and we saw that very pronounced this year. I cannot forecast how pronounced that will be next year, but it is a trend that we have been seeing over the last couple of years.

Scott Devitt - Stifel Nicolaus

If I could follow-up, so your business is seasonal in 2Q and 3Q like the rest of the leisure travel industry.

Holger Bartel

The Super Search part. The travel deal publishing part obviously follows more demand of when the advertisers have a need to promote travel deals, and that is very difficult to predict. This year in May and June, there was a lot of demand on the airline side, so they had less of a need to publish here. So it is very difficult to predict, so it is a combination of the rate increase, which typically happen in Q4. You add over that the seasonality, partially the seasonality of the Super Search business, but then on the other hand, the travel deals publishing business, and if you add that all together, you typically see that Q4 is a relatively weak quarter and Q1 is a quarter where we typically see strong growth for us as the previous quarter on a sequential basis.

Scott Devitt - Stifel Nicolaus

Okay, and then just finally, what is the rationale for not giving any information on a forward basis on the company? Is it because it is difficult to forecast the business or something else? And not even on a quarterly basis, but just in terms of underlying trends so investors have some understanding of what it is they own on a forward basis.

Ralph Bartel

Scott, the company made that decision in the past and we use it on a regular basis, and has come to the conclusion, the Board and the management, that in our industry, which is very dynamic, it is not appropriate to give guidance, and we follow that policy consistently.

Scott Devitt - Stifel Nicolaus

Okay. Thank you.

Ralph Bartel

Maybe if I add one more thing here, Scott. We are adding a new product that we are hopeful will already add to our revenue growth and bottom line growth as soon as March of this year. Still, it is a new product, it is very difficult to forecast what the demand will be and how it will impact our financial performance, just to give you an example.

Scott Devitt - Stifel Nicolaus

Thanks.

Operator

That does conclude today’s question-and-answer session. Dr. Bartel, I am turning the conference back over to you.

Ralph Bartel

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

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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