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Travelzoo, Inc. (TZOO)

Q1 2006 Earnings Conference Call

April 18, 2006, 11:00 a.m. EST

Executives:

Ralph Bartel, Ph.D., President, CEO, CFO, and Chairman of Board of Directors

Holger Bartel, Ph.D., Executive Vice President and Director

Lisa Su, Controller and Chief Accounting Officer

Analysts:

Robert Peck, Bear Stearns

George Mihalos, Gilford Security

William Lennan, Wedbush Morgan

Scott Devitt, Stifel Nicolaus

Operator

Please stand by, we’re about to begin. Good day everyone and welcome to the Travelzoo First Quarter 2006 Financial Results Conference Call. At this time, all participants have been placed on a listen-only mode and the floor will be opened 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, Ph.D., President, CEO, CFO, Chairman, Board of Directors

Thank you operator. Good morning and thank you all for joining us today for Travelzoo’s First Quarter 2006 Financial Results Conference Call. I’m Ralph Bartel, Chairman and Chief Executive Officer. With me today are Lisa Su, the company’s Controller and Chief Accounting Officer, and Holger Bartel, Executive Vice President.

Lisa Su, Controller and Chief Accounting Officer

Good morning. Welcome to our conference call.

Holger Bartel, Executive Vice President

Good morning everyone.

Ralph Bartel, Ph.D., Chairman and Chief Executive Officer

Before we begin, I would like to walk you through today’s format. First, we will discuss the company’s first quarter 2006 financial results. Then, we will provide additional information on the company’s growth in subscribers and reach. 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 31st consecutive quarter of growth in online advertising sales. Diluted earnings per share for the first quarter 2006 were $0.24, up from $0.10 in the prior year period. Our revenue increased to $16.9 million for the first quarter 2006, an increase of 51% over revenue of $11.2 million in the same period last year. The quarterly sequential revenue increased from the fourth quarter 2005 to the first quarter 2006, was 22%. Our North America business segment revenue increased $2.8 million, which represented 94% of the quarterly sequential revenue increase from the fourth quarter 2005 to the first quarter 2006. Our Europe business segment revenue increased $186,000, which represents 6% of the quarterly sequential revenue increase.

In terms of revenue concentration, Travelzoo had two customers in the first quarter 2006 that accounted for 14% and 12% of revenue respectively. No other customer accounted for more than 10%. Travelzoo views entities under common control as one customer. Travelzoo’s net income in first quarter 2006 was approximately $4.1 million, an increase of 125% compared to the first quarter 2005 net income of $1.8 million. Quarter over quarter net income increased 149% from $1.7 million in the fourth quarter 2005.

Travelzoo’s EPS for the first quarter 2006 was impacted by a lower than anticipated loss from our Europe business segment and a decrease in our effective tax rate. Travelzoo’s effective income tax rate in the first quarter 2006 was 43.6% compared to 56.7% in the fourth quarter 2005 and 48.7% in the first quarter 2005. The decrease in our effective tax rate compared to the fourth quarter 2005 was due primarily to the decrease in the loss from our Europe business segment, the expenses related to the cash program, and the true up of the estimated effective tax rate used throughout fiscal year 2005.

For financial reporting purposes, the losses from our Europe business segment and the cash program expenses were treated as having no recognizable tax benefit. Cash flow from operations in the first quarter 2006 was $5.8 million. DSO, Days Sales Outstanding, as of March 31, 2006, was 51 days, down from 61 days as of December 31, 2005. Total cash equivalents and short-term investments as of March 31, 2006 decreased to $41.7 million from $44.4 million as of December 31, 2005, due in part to the company’s repurchase of common stock.

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

Lisa Su, Controller and Chief Accounting Officer

Thank you. We believe that Travelzoo continues to be a highly productive company. We had 68 employees as of March 31, 2006. Fifty seven of these employees were in our North American offices and eleven employees were in our European offices. Average annualized revenue per employee in the first quarter 2006 was $996,000, up from $862,000 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 $6.5 million, up 28% from $5 million in the first quarter 2005 and down from $6.8 million in the fourth quarter 2005. The increase from the first quarter 2005 was primarily due to increased spending on marketing for SuperSearch, salary expenses associated with sales and marketing staff, and spending on subscriber acquisition campaign. The decrease from fourth quarter 2005 was primarily due to a $318,000 decrease in spending our marketing for SuperSearch.

In North America, General and Administrative expenses were $2.3 million in the first quarter 2006, compared to $2.6 million in the first quarter 2005 and $2.4 million in the fourth quarter 2005. The $100,000 decrease in G&A versus last quarter was due primarily to a $72,000 decrease in stocks compliance cost. The $300,000 decrease in G&A versus last year was due primarily to $949,000 decrease in expenses related to our program under which the company makes cash payments to people who establish they were former stockholders of Travelzoo.com Corporation, who failed to submit request to convert their shares into Travelzoo Inc. within the required time period. This was offset by a $287,000 increase in stocks compliance cost and a $247,000 increase in bad debt expense.

North America operating income for the first quarter 2006 was $7.4 million, up from $3.4 million for the same period last year. Operating margin for the first quarter 2006 was 45.2% compared to 30.4% 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 the first quarter 2006 was $638,000.

In Europe, total General and Administrative expenses in the first quarter 2006 were $337,000. Our Europe business segment incurred an operating loss of $460,000 in the first quarter 2006, down from an operating loss of $579,000 in the fourth quarter 2005.

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

Ralph Bartel, Ph.D., Chairman and Chief Executive Officer

Thank you Lisa. During the first quarter 2006, Travelzoo added a total of 858,000 new subscribers to its e-mail publications surpassing the 10 million subscriber mark. In North America, we acquired 714,000 subscribers at an average cost of $2.54 per subscriber in the first quarter 2006 compared to $2.41 in the fourth quarter 2005. In North America, Travelzoo’s top 20 newsletters and news/e-mail alert service had a net unduplicated total of 9.8 million subscribers as of March 31, 2006. This represents an increase of 17% versus the same time last year while revenue increased 46% 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 144,000 subscribers at an average cost of $2.12 per subscriber in the first quarter 2006 compared to $2.02 in the fourth quarter 2005. Europe had a net unduplicated total of 425,000 subscribers as of March 31, 2006.

This concludes the discussion of financial results and the growth in subscribers. Travelzoo’s consistent practice is not to provide guidance for future periods because of the dynamics of industry. Therefore, this will conclude our prepared discussion, and I’ll turn the call back to the operator for the question and answer session.

Question-and-Answer Session

Operator

Thank you. Ladies and gentleman, the floor is now open for questions. If you would like to ask a question at this time, simply press “*” and “1” on your touchtone telephone. Again, that’s “*” and “1” for your questions or comments at this time. We’ll pause for just a moment to assemble the question queue. We’ll go first to Bob of Peck of Bear Stearns.

Robert Peck, Bear Stearns

Hi, a quick question on the marketing side. How do you see or how have you seen the keyword pricing trend over the past quarter or so?

Ralph Bartel, Ph.D., President, CEO, CFO, Chairman, Board of Directors

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

Holger Bartel, Executive Vice President

We advertised SuperSearch quite a bit on search engines and as you heard, the marketing expense for promoting SuperSearch on the search engines has gone up versus the first quarter 2005. We have definitely noted that versus the first quarter 2005 prices for keywords on travel have increased dramatically. However, from the fourth quarter 2005 to the first quarter 2006, our marketing expense for SuperSearch actually decreased and part of that was that we were able to acquire actually more traffic at a lower cost per click. So, I don’t know what the experience of other travel advertisers on search is, so price is going down while we were able to acquire slightly more clicks.

Robert Peck, Bear Stearns

And was that also because the keywords that you were using were probably more towards the tail?

Holger Bartel, Executive Vice President

No, I mean this is a question really that you would need to ask the search engines, whether the keywords at the tail change less or more I really don’t know.

Robert Peck, Bear Stearns

Okay, thank you so much.

Operator

We’ll go next to George Mihalos at Gilford Security.

George Mihalos, Gilford Security

Hi guys, a couple of questions. Can you tell us how many shares have been bought back as part of your plan thus far?

Ralph Bartel, Ph.D., President, CEO, CFO, Chairman, Board of Directors

Good morning, we will disclose this in the 10-Q that the company will file.

George Mihalos, Gilford Security

Okay, and in the past you’ve provided query volumes from SuperSearch, can you do so now as in the first quarter?

Ralph Bartel, Ph.D., President, CEO, CFO, Chairman, Board of Directors

Holger Bartel will go ahead and answer this question.

Holger Bartel, Executive Vice President

As you saw, we don’t want to provide the detailed information about the specific growth of specific products anymore. We feel part of the reason is that this is information that we don’t want to share with our competitors. Another reason for that is that we are not necessarily looking at the business segments that separately…for example a large percentage of traffic into SuperSearch comes from our website, so do you want to see if this as website revenue or SuperSearch revenue. We don’t want to split that out anymore. Overall, if I’m looking at traffic, compare the fourth quarter 2005 with the first quarter 2006. Homepage views have gone up around 25%. We had some increases of around 30% in specific sections of our website. SuperSearch grew at approximately the same rate, without giving you a specific number. But the growth of our products in the US was relatively even across all of them. If you see the product in the UK, of course, it grows much more quickly than the ones in the US. The US products grew by 22%, the UK grew by 49%.

George Mihalos, Gilford Security

Okay, that’s sequential data you’re giving there, right?

Holger Bartel, Executive Vice President

This was all sequential fourth quarter versus first quarter.

George Mihalos, Gilford Security

Okay and just last question, can you talk a little bit about the pricing trends you were seeing with some of your products?

Holger Bartel, Executive Vice President

In general, as I said on the last call in February, we did make some rate adjustments in the first quarter; it’s not unusual. Typically at the beginning of the year, we review the rate card, we issue a new 2006 rate card, but we also do adjustments throughout the year. I looked at the rates for placements and there were actually many placements where we didn’t change the rates at all, but there are other placements where we changed the rates up to 20%, some even less and some even more. So, typically rate increases on the rate card ranged from 0-20%. What determines these rate increases is of course the change in reach product where we can also advertise a broader a reach, we increase the prize. Also, as I said in February, it’s the demand for specific placements that are in very high demand, we feel that we can increase the prices. Typically, we don’t pursue a strategy of maximizing the rates. As you know, all the advertising we are running is subject to editorial review, so we don’t want to necessarily go to a maximum level with the prices. But overall the rate increases contributed to our revenue increased partially, but it wasn’t the only sector.

George Mihalos, Gilford Security

Okay, can you break out…actually that’s okay, thank you.

Ralph Bartel, Ph.D., President, CEO, CFO, Chairman, Board of Directors

Thank you George.

Operator

We’ll go now to Bill Lennan with Wedbush Morgan.

William Lennan, Wedbush Morgan

Hi, good morning everyone, thanks for taking my call. Looks like your revenue was up exactly $5.7 million year over year? Question one is, I wonder if you can give us a sense, a rough split of how much that $5.7 million came from new customers and how much came from penetrating existing accounts, that’s question one. Number two, we’ve got two macroeconomic trends going on right now, gas prices are still going up and mortgage prices are going up, and if you do the math, what happens to a payment when it goes from 5% to 8%, it’s kind of frightening. So, have you explicitly or at least generally factored in any impact if any of these two negative consumer trends on your business this year? Thanks.

Ralph Bartel, Ph.D., President, CEO, CFO, Chairman, Board of Directors

Holger will take this question again.

Holger Bartel, Ph.D., Executive Vice President and Director

Yes. So on the breakout of the $5.7 million in revenue increase, we don’t even internally analyze it necessarily that we are not able to provide you the breakout. It’s certainly a good mix between an increase in customers as well as deeper penetration, although there were some advertisers that slightly decreased their spend in the first quarter 2006 versus the first quarter 2005; there are others that go with the lot. In general, we are focused on a long-term perspective of not having certain advertising clients become very large customers, so we are constantly looking to diversify our revenue. So, a revenue increase of $5.7 million is only possible if we added a substantial number of new customers. And I’m sorry, what was the second question again?

William Lennan, Wedbush Morgan

Either explicitly or generally, have you factored in two…I’m not even sure these will have an impact on your business…we’ve got two negative macroeconomic trends going on right now, gasoline prices are going up and we’ve got mortgage rates going up, and people who have their fixed rates turned to variable this year and next year maybe in for a fake negative shock. So do you see any impact on these macroeconomic trends on consumer spending and therefore on the travel business and your business?

Holger Bartel, Ph.D., Executive Vice President and Director

Yeah, this actually is an excellent question which you might ask, though the companies that sell travel like EDL or Cendant or Saber, it’s actually still very common that…even I saw this morning the media still sometimes thinks of us as a travel site, but we are really a pure media site. Now, as a media company, what I have observed over the last eight years is that these trends don’t affect us that much. If travel is strong, then that means a lot of people will come to our site and we build increased traffic, we can sell more advertising. If travel is weak, like a period after September 11th, for example, then the travel suppliers need to encourage consumers to travel more, which mean they turn to us to promote more specials. So, we really haven’t seen over the last seven or eight years that it impacts our business a lot.

William Lennan, Wedbush Morgan

Okay, thank you very much.

Operator

We’ll go next to Scott Devitt with Stifel Nicolaus.

Scott Devitt, Stifel Nicolaus

Thanks first question is related to the sales and marketing spend. I think in your 10-K you noted that you would anticipate sales and marketing in the US to be consistent with historical levels or increase as a percentage of revenue, and that number was 51% in ’05 and it dipped to 42% in the first quarter. So my question is, should we in terms of building models, should we expect sales and marketing as a percent of revenue to more reflect going forward the first quarter number or historicals? That would be the first question.

Ralph Bartel, Ph.D., President, CEO, CFO, Chairman, Board of Directors

Good morning Scott. Yes, we continue to believe that as a trend marketing expenses as a percentage of revenue should remain at approximately this level. Of course, there will also be fluctuations from quarter to quarter. One reason why marketing expenses are expected to remain at this level is related to the international expansion that we pursue when we enter international markets. You will see in the beginning a higher percentage of marketing expenses, and overall this should lead to marketing expenses as a percentage of revenues remaining at the same level. But as I said, you will always see fluctuations from quarter to quarter, so I wouldn’t rely on the percentage in the first quarter as an indicator for future periods.

Scott Devitt, Stifel Nicolaus

And then secondly, in terms of the revenue growth rate, if you just look at it sequentially, you grew revenue at about the rate of annualized travel industry growth online in the US at 22%. So, the question is, how sustainable is the rate of growth and what is the underlying driver in terms of any granularity you can give us, because your revenue growth rate has been decelerating on a year-over-year basis until this quarter, it was about a 20 percentage point increase in the year-over-year rate?

Ralph Bartel, Ph.D., President, CEO, CFO, Chairman, Board of Directors

Scott, as Holger pointed out before, the company announced in the past…remember we did this on the last earnings call, that it’s the company’s practice to increase advertising rates once a year. We had an increase as of January 1st. This is one sector that drove the revenues in the first quarter. I also wanted to ask Holger if he has additional comments on what we expect would drive revenue growth throughout the year.

Holger Bartel, Ph.D., Executive Vice President and Director

I think we just have to start living a little bit with larger fluctuations and of course you’re in the business to model our financials going forward. The only comment I can make here is that looking back in the past, as you see sometimes revenues come in lower than we maybe expected or you expected, sometimes they come in higher, just ever quarter there seemed to be always some unusual things. For example, this quarter Europe was extremely strong because a lot of consumers tried to book travel to Europe for spring and summer already in the first quarter. Cruise has advertised a lot, I mean every quarter you have a lot of special effects that determine where revenues are going and I feel that you should rather look at the long-term growth. I mean our focus is very long term on growing revenues year over year over year and we are not so concerned specifically about specific quarters, as you saw last year in the fourth quarter 2005; we explained why revenues came in a bit lower, but overall we are much more focused on the long-term yearly growth.

Scott Devitt, Stifel Nicolaus

Okay and then finally on operating expenses. I may have misunderstood what was quoted, but I thought I heard a number for the first quarter 2006 that was mentioned at $6.5 million and the press release showed $7.1 million in sales and marketing, and on G&A the release showed $2.6 million and I think you noted a $2.3 or $2.3 million number. I’m guessing that that number may exclude the stock cost to shareholders, so what I’m asking is if that is accurate. And then secondly, what that $500,000-600,000 difference is in the sales and marketing line?

Holger Bartel, Ph.D., Executive Vice President and Director

Scott, Lisa Su, our Controller and Chief Accounting Officer, will respond.

Lisa Su, Controller and Chief Accounting Officer

Hi Scott, I think you’re confused because you quoted the US expenses. So, the total sales and marketing for US expenses was $6.5 million, and in the remaining portion was for the UK; the same thing with the General and Administrative expenses, for North America it was $2.3 million.

Scott Devitt, Stifel Nicolaus

Okay, thank you.

Holger Bartel, Ph.D., Executive Vice President and Director

Thank you Scott.

Operator

Ladies and gentlemen that does conclude today’s question and answer session. At this time I’ll turn the call back over to Mr. Bartel for any additional or closing comments.

Ralph Bartel, Ph.D., President, CEO, CFO, Chairman, Board of Directors

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

Operator

Once again ladies and gentleman, again that does conclude today’s call. Thank you for your participation. You may disconnect at this time.

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