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Travelzoo Inc. (NASDAQ:TZOO)

Q3 2007 Earnings Call

October 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 Lennan - Broadpoint Capital

Lance Ettis - Mortar Capital Management

Operator

Good day, everyone and welcome to the Travelzoo third quarter 2007 financial results conference call. (Operator Instructions) And now it is my pleasure to turn the floor over to your host, Mr. Ralph Bartel, Travelzoo's Chairman and Chief Executive Officer. Please go ahead, sir.

Ralph Bartel

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

Ralph Bartel

Before we begin I would like to walk you through today’s format. First, we will discuss the company’s third 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 results for the third quarter of 2007. Diluted earnings per share for Q3 2007 were $0.14, down from $0.28 in the prior year period, primarily as a result of the aggressive expansion of our international operations. Our revenue increased to $19.9 million in Q3 2007, an increase of 13% over revenue of $17.6 million in the same period last year.

Q3 North America revenue was impacted by technical and execution problems of a third party provider that manages traffic acquisition for our Super Search product.

Quarterly sequential revenue decreased 1% from Q2 2007 to Q3 2007.

The publications and products that contributed to our year-over-year revenue growth are the Travelzoo websites in the U.S. and in the U.K.; the Travelzoo network in the U.S.; the top 20 newsletters in Canada, Germany, the U.K. and the U.S.; the Newsflash alert services in the U.K. and in the U.S.; and Super Search in the U.S. and in the U.K.

The Travelzoo website in France and Hong Kong did not generate any revenue as of the end of Q3.

Our publications and products provide latest and reliable information on the very best travel offers from more than 1,000 travel companies. Super Search is a travel search tool that leverages more than 2.5 million ratings from Travelzoo users and makes it very easy for users to find supplier websites that offer the best prices and connections for specific dates.

The Travelzoo Network is an affiliate network of partners that list test booked travel deals published by Travelzoo.

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

Wayne Lee

Thank you, Ralph. Our North America business segment revenue in Q3 2007 was $18.4 million, an increase of 10% year over year. Our Europe business segment revenue in Q3 2007 was $1.6 million, an increase of 67% year over year. Our new Asia-Pacific business segment did not generate any revenue in Q3 2007.

In terms of revenue concentration, Travelzoo had one group of advertisers under common control that accounted for 15% of revenue and another group of advertisers under common control that accounted for 12% of revenue in Q3 2007. No other group of advertisers accounted for 10% or more of revenue.

Travelzoo's operating income in Q3 2007 was $4.9 million, a decrease of 39% compared to Q3 2006 operating income of $8.1 million. Operating margin in Q3 2007 was 24.8%, down from 46.2% in Q3 2006. Travelzoo's net income in Q3 2007 was $2.2 million, down from Q3 2006 net income of $4.6 million. Reported net income was negatively impacted by an increase in our effective income tax rate.

Travelzoo's effective income tax rate in Q3 2007 was 59.5% compared to 54.2% in Q2 2007 and 45.9% in Q3 2006. The increase in our effective tax rate compared to Q2 2007 and Q3 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 Q3 2007 was $1.3 million.

DSOs, that’s days sales outstanding, as of September 30, 2007 was 45 days compared to 41 days as of June 30, 2007.

Total cash and cash equivalents as of September 30, 2007 decreased to $23.3 million from $41.9 million as of June 30, 2007, due primarily to the repurchase of our common stock. During Q3 2007, Travelzoo completed the repurchase of 1 million shares of common stock under the share repurchase program announced in April 2007.

We believe that Travelzoo continues to be a highly productive company. We had 128 employees as of September 30, 2007, up from 81 employees as of September 30, 2006 and up from 113 employees as of June 30, 2007. Eighty-nine of these employees were in North America, 29 employees were in Europe and 10 were in Asia.

Average annualized revenue per employee in Q3 2007 was $623,000, down from $868,000 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 in Q3 2007 were $8.7 million, up from $6.2 million in Q3 2006 and flat compared to Q2 2007. Sales and marketing expenses as a percentage of revenue increased to 47.2% in Q3 2007 from 37.4% in Q3 2006. The increase from Q3 2006 was primarily due to increased spending on subscriber acquisition and brand marketing campaigns, increased spending on marketing for Super Search, and increased salary expenses associated with an increase in headcount.

In North America, general and administrative expenses were $2.1 million in Q3 2007, up from $1.8 million in Q3 2006 and down from $2.3 million in Q2 2007. The increase in general and administrative expenses versus last year was due primarily to increases in rent and office expenses.

North America operating income for Q3 2007 was $7.1 million, down from $8.4 million for the same period last year.

Operating margin for Q3 2007 was 38.5%, compared to 50.5% 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 Q3 2007 were $2.1 million, up from $739,000 in Q3 2006 and up from $2 million in Q2 2007. The $1.4 million increase from Q3 2006 was due primarily to a $826,000 increase in spending on subscriber acquisition campaigns in the U.K., Germany, and for our new operations in France, as well as increased spending on search advertising and increased salary expenses associated with sales and marketing staff.

In Europe, total general and administrative expenses in Q3 2007 was $893,000, up from $481,000 in Q3 2006 and up from $602,000 in Q2 2007. The increases in general and administrative expenses versus last year and last quarter were due primarily to increases in rent and office expenses, and increased salary expenses.

Travelzoo began operations in France in March, 2007. Our Europe business segment incurred an operating loss of $1.4 million in Q3 2007, compared to an operating loss of $277,000 in Q3 2006. Though revenues increased by $648,000, 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 and Japan, incurred operating expenses and an operating loss of $706,000 in Q3 2007, compared to an operating loss of $400,000 in Q2 2007. Our Asia-Pacific business segment did not generate any revenues in Q3 2007. In Q3 2007, general and administrative expenses were $513,000, related primarily to salary expenses and office expenses. Travelzoo began operations in Hong Kong in April, 2007 and began operations in Japan in September, 2007.

This concludes our discussion of Travelzoo's Q3 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 Q3 2007, Travelzoo added a total of 759,000 new subscribers to its e-mail publications. In North America, we acquired 385,000 subscribers at an average cost of $3.92 per subscriber, compared to 552,000 subscribers at an average cost of $3.03 in Q2 2007.

In North America, Travelzoo's Top 20 Newsletter and Newsflash e-mail alert service had a net unduplicated total of 11 million subscribers as of September 30, 2007. This represents an increase of 8% versus the same time last year, while revenues increased 10% 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 332,000 subscribers at an average cost of $2.96 per subscriber, compared to 332,000 subscribers at an average cost of $4.43 in Q2 2007.

In Europe, Travelzoo's Top 20 Newsletter and Newsflash e-mail alert service had a net unduplicated total of 1.2 million subscribers as of September 30, 2007, an increase of 102% versus the same time last year.

In Asia, we acquired 42,000 subscribers at an average cost of $2.17 per subscriber in Q3 2007.

The cost of subscriber acquisition in North America, Europe, and Asia are expensed as incurred.

In 2005, Travelzoo began its growth strategy of expanding into selected international markets. 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 local expertise. Over the last two years, we have built a unique global network of producers and sales staff in eight countries -- Canada, Germany, Hong Kong, France, Japan, Spain, U.K., and the U.S. We are in the process of launching operations in Australia, China, and Taiwan. Our plan is to aggressively leverage this global network to provide Travelzoo users with the very best information available.

In Q3 2007, we continued to develop a new section of our U.S. website that lists deals for shows and events, and we continued to develop 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.

In Q4, we will continue to aggressive execute our global strategy and focus on better execution in North America.

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 will come from Bill Lennan with Broadpoint. Please go ahead.

Bill Lennan - Broadpoint Capital

Thanks. The customer acquisition cost in Asia seems encouraging, maybe not by U.S. standards five years ago but compared to Europe, so I wonder if you could tell us if pound for pound, acquiring customers in Asia, you expect it to stay less expensive than Europe, part one.

Part two, could you tell us what -- back out the 10% customers and the price increase this year, the organic growth in North American ex those factors seems to be decelerating. Could you tell us what is going on there? Is there something macro going on or is the competition?

Ralph Bartel

Let’s answer your question about subscriber acquisition first. In Asia, the average costs for a new subscriber was $2.17. We believe in Asia it is too early to tell what the trend will be. If you look at the North America numbers, please keep in mind that in Q3, the company began applying a new method, confirmed opt-ins. We did that as of July 1, 2007.

When a user types in their e-mail address on the website and they press the submit button, they are not registered immediately to the newsletter anymore. They receive an e-mail where there is a link in the e-mail that they have to click to confirm their subscription. The advantage of doing that is that the company verifies that the person who typed in the e-mail address is in fact the person that they claim to be. Another advantage is that you avoid as a company signing up e-mail address that are misspelled or that are otherwise bad e-mail addresses from the beginning. That explains the increase in the subscriber acquisition cost that we saw in North America in Q3 per the average cost per subscriber.

It is too early to tell if we will continue the confirmed opt-in. We are still in a testing mode.

Now in Europe, we actually had good news in Q3. As you can see, the average CTA decreased from $4.43 to $2.96, and this was because of a very successful launch of subscriber marketing in France, where we saw a good volume of subscribers that we acquired at a very attractive cost, which again shows you that there will be fluctuations from market to market and in Asia, we will watch and see how it continues, and I think in the next conference call, we will be able to provide more information regarding this.

Your other question about revenue growth, Holger Bartel will answer this question.

Holger Bartel

We obviously are not happy with the quarter in North America. It has been an unusual quarter to some extent, as we have heard before, as Ralph highlighted and as we highlighted in the press release, we had some issues with Super Search traffic acquisition at the beginning of the quarter. In July, we actually were looking at a very good quarter in North America. We were quite pleased with how things were going, how most of the products are developing.

And in Super Search, part of the traffic into the tool comes from search marketing campaigns. As most other companies out there, we are working with a third party to help us optimize these campaigns and starting in late July, early August, it looked like their strategy of how they optimize our campaigns, particularly with Google, didn’t work anymore. They tried some fixes. Google gave us some recommendations on what to change with our campaign, but as opposed to seeing improvement, numbers went down and we saw some dates where our traffic from Google was down by 30% to 40% year over year.

But I cannot comment on how that impacted revenues exactly but just to give you some number for August and September, the traffic we acquired from Google was down by approximately 25%, which compared to 10% to 15% increase that we saw prior to this problem.

We frankly don’t understand to some extent what the reason is. We are looking into things. We have made some fixes. We are evaluating and testing to work with a different company, but we are not very pleased with the situation in that area.

The other question was regarding competition. Of course competition always impacts your business. If another travel company starts a newsletter or starts a new website and sells advertising, then a lot of the advertisers we have might say let’s give this new competitor a try and see how it works, or some of the funds they allocated before to us will go to the competitor.

In the end, it is something that really depends on what response companies are getting from Travelzoo's products. I think you continuously interview our advertisers, some of our advertisers, and you will hear that -- at least I’m hearing that a lot of these competitive products are not working very well.

So short-term, yes, competition definitely impacts the situation in North America. Long-term, we have to watch and see what is happening but we had a lot of advertisers coming back to us and say let’s spend the money again with Travelzoo.

Bill Lennan - Broadpoint Capital

That’s a very detailed and helpful answer. Thank you for that. Just one follow-up on the -- when your suppliers say they are less satisfied, speaking honestly, do you think they are giving inferior product to these new people? Ralph talked about your competitive advantage of sourcing the best deals, so part one of this follow-up is, are they giving inferior product to your competitors or is it the fact that your competitors have a fraction of your sub base and it is therefore harder to liquidate competitors’ product?

Holger Bartel

We pride ourselves in the quality of our products. What we are hearing back from our users is that we have the highest quality products. Of course, if we have an e-mail subscriber base of over 9 million and to compare it to a competitor who might only have one, of course we’ll get less response.

But I was talking about ROI, so really adjusting for the size of the subscriber base that these companies are using.

It is mainly what we believe is that our continuous focus on quality of deals, test booking offers, only sending out best offers that we can get is paying off in the long run because our users continue to use our products.

Bill Lennan - Broadpoint Capital

Thank you very much.

Operator

(Operator Instructions) We move now to Lance [Ettis], [Mortar] Capital Management. Your line is open, sir.

Lance Ettis - Mortar Capital Management

Thank you. I just have a couple of quick questions on -- as far as you know -- I know that you guys bought a lot of stock back this quarter and I think that’s a very good thing. It seems like you bought it at a pretty good price. But your stock I think has come back in again and it looks like it is down in the post mark. I was just wondering, you know, I mean you slapped $23 million in cash on the balance sheet and you are still to this day, even with these growth initiatives, generating some free cash. So will you be in fact initiating another stock buy-back and continuing to buy stock back at these levels?

Ralph Bartel

Hello, Lance. Wayne Lee will answer your question.

Wayne Lee

Hi, Lance. We can’t comment on any future plans for any buy-backs, but it is always a possibility that our board of directors could approve another share repurchase.

Lance Ettis - Mortar Capital Management

I just had a follow-up question now; I know that you guys aren’t -- your losses aren’t tax deductible in other areas of the world, but I would imagine you should generate an NOL or a tax deferred -- deferred tax asset, but I see your deferred tax assets haven’t moved since the start of the year. Why is that?

Wayne Lee

The reason that we haven’t booked a deferred tax asset yet for our losses abroad is to this point, we have yet to show that we’ve been able to generate a profit overseas, so therefore even if we were to book the NOL, it would be fully reserved.

Lance Ettis - Mortar Capital Management

Okay. And as far as areas of the -- I mean, are you -- how much of the world are you, the areas you are in, obviously you are profitable in the U.S. What other areas that you are in now or what other geographies you are in there are you profitable in?

Wayne Lee

To date, aside from the U.S., all our other operations overseas are still not profitable yet.

Lance Ettis - Mortar Capital Management

I thought you were profitable in the U.K., weren’t you?

Wayne Lee

No.

Lance Ettis - Mortar Capital Management

You’re still not profitable there. Okay.

Ralph Bartel

Let me provide additional information. When you look at profitability, you have to keep in mind that the largest expense item for us in new markets is the acquisition of new subscribers, and we expense the related costs as they incur, so none of these expenses actually in a new market, we do not capitalize any expenses.

Now, in reality, once you have signed up let’s say a million subscribers in the U.K. and you have spent that money, you have recognized all these expenses in financial reporting, but then you have these subscribers and they enable you to generate revenue from these subscribers in the future without incurring the same expenses again. But that’s definitely something that you want to look at, so when we often analyze the performance of our foreign operations, we internally sometimes exclude the subscriber acquisition expenses, which gives us a different view on the progress that we have made.

Lance Ettis - Mortar Capital Management

Are you profitable in any of those areas? By excluding the subscriber acquisition costs, are you profitable in other geographies besides the U.S.?

Ralph Bartel

Because this is not our official accounting policy, I don’t want to comment on that, but we said already on last quarter’s call in the U.K., we are very close to profitability. We are very pleased with Canada. In general, it takes us, depending on the market, it takes us between one and three years to turn profitability in a market. Once we turn profitable, then as you said, of course we will benefit from carry-forward losses that we can apply to the tax liability in these new markets.

Lance Ettis - Mortar Capital Management

Okay. Thank you.

Operator

Any further questions, Mr. Ettis?

Lance Ettis - Mortar Capital Management

No, that’s it. Thank you.

Operator

And that would conclude our question-and-answer session. At this time, I would like to turn the program back to Mr. Bartel for any closing remarks.

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, everyone, for your participation on today’s conference and you may disconnect at this time.

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