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Travelzoo Inc. (NASDAQ:TZOO)

Q1 2007 Earnings Call

July 25, 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

Bill Lemmon - First Albany

Michael Millman - Soleil Securities

Presentation

Operator

Good afternoon, everyone and welcome to the Travelzoo second quarter 2007 financial results conference call. (Operator Instructions) 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 afternoon and thank you all for joining us today for Travelzoo's second quarter 2007 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

Hello, everyone. Welcome to our conference call.

Holger Bartel

Good afternoon, 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 2007 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 36th consecutive of revenue growth. Diluted earnings per share for Q2 2007 were $0.17, down from $0.23 in the prior year period. Our revenue increased to $20.1 million in Q2 2007, an increase of 16% over revenue of $17.4 million in the same period last year. The quarterly sequential revenue increase from Q1 2007 to Q2 2007 was 2%.

All of our publications and products, which provide latest and reliable information on the very best travel offers from more than 600 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. and Germany; Newsflash, Super Search, a travel search engine; and the Travelzoo Network, an affiliate network of partners that list travel deals published by Travelzoo.

Our North America business segment revenue in Q2 2007 was $18.7 million, an increase of 12%. Our Europe business segment revenue in Q2 2007 was $1.5 million, an increase of 102% year over year. Our new Asia-Pacific business segment did not generate any revenue in Q2 2007.

In terms of revenue concentration, Travelzoo had one group of advertisers under common control that accounted for 16% of revenue and another group of advertisers under common control that accounted for 10% of revenue in Q2 2007. No other group of advertisers accounted for 10% or more of revenue.

I will turn now to Wayne to discuss additional information for the group and our three business segments, North America, Europe, and Asia-Pacific, including headcount, expenses, and operating income.

Wayne Lee

Thank you, Ralph. Travelzoo's operating income in Q2 2007 was $5.8 million, a decrease of 18% compared to Q2 2006 operating income of $7 million. Operating margin in Q2 2007 was 28.6%, down from 40.3% in Q2 2006. Travelzoo's net income in Q2 2007 was $2.8 million, down from Q2 2006 net income of $3.9 million.

Reported net income was negatively impacted by an increase in our effective income tax rate. Travelzoo's effective income tax rate in Q2 2007 was 54.2% compared to 48.2% in Q1 2007 and 47.3% in Q2 2006. The increase in our effective tax rate compared to Q1 2007 and Q2 2006 was due primarily to the increase in the losses from our Europe and Asia-Pacific business segments. For financial reporting purposes, the losses from our Europe and Asia-Pacific business segments, the losses from our operations in Canada, and the cash program expenses were treated as having no recognizable tax benefit.

Cash flow from operations in Q2 2007 was $2.2 million.

DSO, that’s days sales outstanding, as of June 30, 2007 was 42 days compared to 45 days as of March 31, 2007.

Total cash and cash equivalents as of June 30, 2007 increased to $41.9 million from $39.0 million as of March 31, 2007, due primarily to the cash generated from operations.

We believe that Travelzoo continues to be a highly productive company. We had 113 employees as of June 30, 2007, up from 75 employees as of June 30, 2006 and up from 94 employees as of March 31, 2007. 82 of these employees were in North America, 25 employees were in Europe and 6 were in Asia.

Average annualized revenue per employee in Q2 2007 was $712,000, down from $926,000 in the same period last year.

Let’s now look at the expense line items of our three 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 $8.7 million, up from $7.1 million in Q2 2006 and $7.9 million in Q1 2007. Sales and marketing expenses as a percentage of revenue increased to 46.7% in Q2 2007 from 42.8% in Q2 2006. The increase from Q2 2006 was primarily due to increased salary expenses associated with sales and marketing staff and increased spending on marketing for Super Search. The increase from Q1 2007 was primarily due to increased spending on marketing for Super Search and increased spending on brand marketing campaigns, offset by decreased spending on subscriber acquisition campaigns.

In North America, general and administrative expenses were $2.3 million in Q2 2007, up from $1.8 million in Q2 2006 and up from $2.1 million in Q1 2007. The increase in general and administrative expenses versus last year was due primarily to increases in legal and professional service expenses and expenses for corporate functions.

North America operating income for Q2 2007 was $7.3 million, down from $7.5 million for the same period last year.

Operating margin for Q2 2007 was 39.1%, compared to 44.9% for the same period last year.

In Europe, our largest expense item also 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 in Q2 2007 were $2 million, up from $814,000 in Q2 2006 and up from $1.5 million in Q1 2007. The $1.2 million increase from Q2 2006 was due primarily to a $565,000 increase in spending on subscriber acquisition campaigns, as well as increased spending on search advertising and increased salary expenses associated with sales and marketing staff. The $528,000 increase from Q1 2007 was due primarily to a $293,000 increase in spending on subscriber acquisition campaigns, and increased spending on search advertising.

In Europe, total general and administrative expenses in Q2 2007 were $602,000, up from $396,000 in Q2 2006 and up from $469,000 in Q1 2007. The increases in general and administrative expenses versus last year and last quarter were due primarily to increases in office expenses and salary expenses.

Our Europe business segment incurred an operating loss of $1.2 million in Q2 2007, compared to an operating loss of $494,000 in Q2 2006. Though revenues increased by $755,000, the operating loss increased as both sales and marketing and general and administrative expenses increased.

Our Asia-Pacific business segment, which consists of our operations in Hong Kong, incurred operating expenses and an operating loss of $400,000 in Q2 2007. The $400,000 was primarily general and administrative expenses related to salary expense and office expense. Travelzoo began operations in Hong Kong in April, 2007.

This concludes our discussion of Travelzoo's Q2 2007 financial results. 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, Wayne. During Q2 2007, Travelzoo added a total of 758,000 new subscribers to its e-mail publications. In North America, we acquired 552,000 subscribers at an average cost of $3.03 per subscriber in Q2 2007, compared to 730,000 subscribers at an average cost of $2.61 in Q1 2007.

In North America, Travelzoo's Top 20 Newsletter and Newsflash e-mail alert service had a net unduplicated total of 10.8 million subscribers as of June 30, 2007. This represents an increase of 9% versus the same time last year, while revenue increased 12% year over year. Management believes that this shows that Travelzoo is able to successfully generate higher revenue as our reach continues to increase.

In Europe, we acquired 206,000 subscribers at an average cost of $4.43 per subscriber in Q2 2007 compared to 159,000 subscribers at an average cost of $3.89 in Q1 2007.

In Europe, Travelzoo's Top 20 Newsletter and Newsflash e-mail alert service had a net unduplicated total of 950,000 subscribers as of June 30, 2007, an increase of 83% versus the same time last year.

In 2005, Travelzoo began its growth strategy of expanding into selected international markets. So far, we are pleased with this strategy. We see a competitive advantage from being able to cross-sell advertising globally. 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 offices in six countries and 12 cities.

In Q2, we further developed a new section of our U.S. website that lists deals for shows and events. We further developed the Travelzoo Network, an affiliate network that increases the reach of our content beyond Travelzoo's own media properties.

This concludes the discussion of the 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 turn the call back to the operator now for the question-and-answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Bill Lemmon with First Albany. Please go ahead.

Ralph Bartel

Hello, Bill.

Bill Lemmon - First Albany

Hi, how are you, Ralph? Thank you, and hi Holger, Wayne as well. Looking at the significant customer percentages you gave, if my math is correct, assuming the two significant customers are the same as a year ago, the spending on the two significant customers was down $600,000 or $700,000 year over year. That’s part one.

And then part two, if you back those customers out, also back out other significant customers you had last year, it looks like the revenue from non-significant, non-10% customers was up maybe 5% or 6%. I don’t know if those numbers are actually precise but my question is, is expenditure down in total from your two significant customers? If is, why?

Also, for everybody else, the non-10% customers, growth seems to have slightly decelerated. Is that in fact true and if so, what is going on there?

Ralph Bartel

Wayne will take this question.

Wayne Lee

Hi, Bill. With our 10% and our 16% customers, they haven’t changed so you are correct in that regard. With regard to their specific spending and why it would have decreased, I can’t comment on that. I am not really sure as to what their plans were.

Ralph Bartel

It is our policy, Bill, not to comment on individual clients.

Holger Bartel

Maybe I can make a comment from the product side because first of all, of course it is our interest to diversify revenues as much as we can, particularly on the Super Search product, as this has grown over the last three years. We are adding continuously new advertisers. The model there is a little bit like Google -- the more advertisers you have, the less clicks you deliver to a certain customer. So the actual spend of a customer is not necessarily related to their desire of how many clicks they want to purchase. It rather could also indicate that we just have a larger number of advertisers in that product and the more advertisers we have participating in the Super Search product, the better it is for us.

Bill Lemmon - First Albany

Okay, and then on the customer acquisition side, the costs per sub acquired both in the U.S. and Europe. I know it jumps around but I think this is the first time we have seen it with a four in North America. Can you tell us what is going on there? Is it getting more difficult to acquire customers? Do you have any comments on the outlook for those customer acquisition costs in the next two quarters or so?

Ralph Bartel

As you said, the subscriber acquisition cost historically fluctuated a lot at Travelzoo. Of course, long-term you saw a trend with it going up because the more subscribers Travelzoo has, the more difficult it is to sign up additional subscribers.

In Europe, the number was impacted by higher subscriber acquisition costs in Germany and there it is too early to say for us if this is a trend or not, so we cannot say how this will develop in the future quarters.

Bill Lemmon - First Albany

Okay, and there is one number I think you normally wait to give until the filing, I wonder if you have it handy and you could share it with us on the call, if possible. That’s advertising, the percentage that advertising represented of total sales and marketing? I think it was 67% last quarter.

Wayne Lee

We’ll provide that number when we file our 10-Q.

Bill Lemmon - First Albany

Okay, final question then; where I’m really going with this, I’m trying to break out what you spend on advertising versus the fixed cost of headcount. Was there any material move on the marketing side, the percentage of costs that are fixed? You’ve got some new hires, you’ve got new offices. Is it safe to say that that fixed cost on the marketing side stepped up materially from Q1 to Q2?

Wayne Lee

The increase from Q107 to Q207 was not material on the headcount side.

Bill Lemmon - First Albany

Okay, thanks.

Ralph Bartel

Thank you, Bill.

Operator

(Operator Instructions) We will take our next question from Michael Millman with Soleil Securities. Please go ahead.

Ralph Bartel

Hello, Michael, how are you?

Michael Millman - Soleil Securities

Hello. Thank you for taking my call. Along the same lines as the first question about industry dynamics, the travel companies, Expedia and Orbitz, have substantially accelerated their pursuit of advertising, and in fact Expedia has actually made a number of small acquisitions. Can you talk about how you see that competition affecting the market and your business specifically?

Ralph Bartel

Michael, once again we don’t comment as it is our policy not to comment on individual clients.

Michael Millman - Soleil Securities

I’m asking more about not them as clients but them as competitors.

Ralph Bartel

We don’t view them as competitors. They are clients that provide unique and very attractive content that is relevant to our millions of subscribers.

Michael Millman - Soleil Securities

So you don’t see any reduction from the fact that they are also trying to attract advertisers to their sites?

Ralph Bartel

No. Our objective is to have, to provide these millions of subscribers and users the highest quality information. On one hand, that is variety. The more travel companies we have that provide deals on our websites and newsletters, the better, and the more we review these deals and make sure that the very best deals get published and they are accurate and they are easy to book, the better we do our job and the better the quality is that is provided to the subscribers and users.

Michael Millman - Soleil Securities

Thank you very much.

Ralph Bartel

Thank you, Michael.

Holger Bartel

Maybe I can add one interesting data point here. From the outside, a lot of the e-mails that are sent out by various companies about travel deals look very similar. But as Ralph point out, where we will differentiate ourselves is the high quality standards we have. We have a test booking center. We have the largest amount of producers. We source deals globally. This is what makes our content very interesting for the affiliates we are now signing up for our network.

But an interesting number, just to see how loyal our audience is, if you look for example at the month of June 2007, compare it to the previous year the number of subscribers in North America increased by 12% year over year, yet the number of clicks that we are generating from sending the Top 20 e-mail to these subscribers increased on average by 21%, so it increased even more than the number of subscribers.

If you keep in mind that this is an audience that to some extent is also maturing, it just indicates how active our subscriber base is, how loyal they are. They like the product we send them because the quality of the deals we send them is higher than the quality that they receive from other newsletters.

So in the short-term, yes, you might see other companies launching similar products but we have to see and wait whether these are successful in the long run. The business is not so easy as it might look like from an outside perspective.

Michael Millman - Soleil Securities

Just following up on that, and that was very useful, what kind of typical clicks do you get from new subscribers versus from existing?

Holger Bartel

That is a specific number we don’t want to release for competitive reasons but as you see from the numbers I indicated, subscribers that we have signed up years ago are still very active in responding to the newsletter.

Michael Millman - Soleil Securities

Are new subscribers more or less active than existing?

Holger Bartel

Again, to what extent they click more or less is something that we don’t want to disclose.

Michael Millman - Soleil Securities

Okay. Thank you.

Operator

(Operator Instructions) We do have a follow-up question from Bill Lemmon with First Albany. Please go ahead. Mr. Lemmon, your line is open. Please come forward with your question.

Bill Lemmon - First Albany

Sorry, I was on mute. This is probably for Wayne. Wayne, could you remind us again on the losses in Europe and Asia. Are those treated separately? In other words, if Europe goes profitable before Asia, that will have -- you’ll be able to use those against your U.S. taxes, or is all international treated as one lump sum for tax purposes?

Wayne Lee

They are treated separately but they would -- if they would turn profitable, for example, in Europe, they would go to -- the loss carry-forward would go to offset any profits that they would make in the future and not against the U.S.

Bill Lemmon - First Albany

Thanks.

Operator

There are no further questions. I will turn back now 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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