Travelzoo Q3 2007 Earnings Call Transcript

| About: Travelzoo Inc (TZOO)
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Travelzoo Inc. (NASDAQ:TZOO) Q3 2007 Earnings Call October 25, 2007 5:00 PM ET


Ralph Bartel - Chairman of the Board, President, ChiefExecutive Officer

Wayne Lee - Chief Financial Officer

Holger Bartel - Executive Vice President, Director


Bill Lennan - Broadpoint Capital

Lance Ettis - Mortar Capital Management


Good day, everyone and welcome to the Travelzoo thirdquarter 2007 financial results conference call. (Operator Instructions) And nowit 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 forjoining us today for Travelzoo's third quarter 2007 financial resultsconference call. I am Ralph Bartel, Chairman and Chief Executive Officer. Withme today is Wayne Lee, the company’s Chief Financial Officer, and HolgerBartel, 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’sformat. First, we will discuss the company’s third quarter 2007 financialresults. Then we will provide additional information on the company’s growth insubscribers and growth strategy. We will then conclude with aquestion-and-answer session.

Before we discuss the company’s financial results releasedearlier today, I would like to remind you that all statements made during thisconference call that are not statements of historical fact constituteforward-looking statements and are made pursuant to the Safe Harbor provisionsof the Private Securities Litigation Reform Act of 1995. Actual results couldvary materially from those contained in the forward-looking statements. Factorsthat could cause actual results to differ materially from those in theforward-looking statements are described in our forms 10-K and 10-Q and otherperiodic filings with the SEC.

An archived recording of this conference call will beavailable on the Travelzoo investor relations website at,beginning approximately 90 minutes after the conclusion of this call.

Today Travelzoo announced its results for the third quarterof 2007. Diluted earnings per share for Q3 2007 were $0.14, down from $0.28 inthe prior year period, primarily as a result of the aggressive expansion of ourinternational operations. Our revenue increased to $19.9 million in Q3 2007, anincrease of 13% over revenue of $17.6 million in the same period last year.

Q3 North America revenue was impacted by technical andexecution problems of a third party provider that manages traffic acquisitionfor our Super Search product.

Quarterly sequential revenue decreased 1% from Q2 2007 to Q32007.

The publications and products that contributed to ouryear-over-year revenue growth are the Travelzoo websites in the U.S. and in theU.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 theU.S.; and Super Search in the U.S. and in the U.K.

The Travelzoo website in France and Hong Kong did notgenerate any revenue as of the end of Q3.

Our publications and products provide latest and reliableinformation on the very best travel offers from more than 1,000 travelcompanies. Super Search is a travel search tool that leverages more than 2.5million ratings from Travelzoo users and makes it very easy for users to findsupplier websites that offer the best prices and connections for specificdates.

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

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

Wayne Lee

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

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

Travelzoo's operating income in Q3 2007 was $4.9 million, adecrease of 39% compared to Q3 2006 operating income of $8.1 million. Operatingmargin in Q3 2007 was 24.8%, down from 46.2% in Q3 2006. Travelzoo's net incomein 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 effectiveincome 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 oureffective tax rate compared to Q2 2007 and Q3 2006 was due primarily to theincrease in the losses from our Europe and Asia-Pacific business segments. Forfinancial reporting purposes, the losses from our Europe and Asia-Pacific businesssegments, the losses from our operations in Canada, and the cash programexpenses 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, 2007was 45 days compared to 41 days as of June 30, 2007.

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

We believe that Travelzoo continues to be a highlyproductive company. We had 128 employees as of September 30, 2007, up from 81employees 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 werein 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 threebusiness segments. In North America, our largest expense item continues to besales and marketing, consisting primarily of advertising and promotional expensesand salary expenses associated with sales and marketing staff.

Total sales and marketing expenses in Q3 2007 were $8.7million, up from $6.2 million in Q3 2006 and flat compared to Q2 2007. Salesand marketing expenses as a percentage of revenue increased to 47.2% in Q3 2007from 37.4% in Q3 2006. The increase from Q3 2006 was primarily due to increasedspending on subscriber acquisition and brand marketing campaigns, increased spendingon marketing for Super Search, and increased salary expenses associated with anincrease 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 $2.3million in Q2 2007. The increase in general and administrative expenses versuslast 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 besales and marketing, consisting primarily of advertising and promotionalexpenses and salary expenses associated with sales and marketing staff.

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

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

Travelzoo began operations in France in March, 2007. OurEurope 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 increasedby $648,000, the operating loss increased as both sales and marketing andgeneral and administrative expenses increased.

Our Asia-Pacific business segment, which consists of ouroperations in Hong Kong and Japan, incurred operating expenses and an operatingloss of $706,000 in Q3 2007, compared to an operating loss of $400,000 in Q22007. Our Asia-Pacific business segment did not generate any revenues in Q3 2007. In Q3 2007, general andadministrative expenses were $513,000, related primarily to salary expenses andoffice expenses. Travelzoo began operations in Hong Kong in April, 2007 andbegan operations in Japan in September, 2007.

This concludes our discussion of Travelzoo's Q3 2007financial results. We will turn back now to Ralph who will provide moreinformation on the growth of our reach and our growth strategy.

Ralph Bartel

Thank you, Wayne. During Q3 2007, Travelzoo added a total of759,000 new subscribers to its e-mail publications. In North America, weacquired 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 andNewsflash e-mail alert service had a net unduplicated total of 11 millionsubscribers as of September 30, 2007. This represents an increase of 8% versusthe same time last year, while revenues increased 10% year over year.Management believes that this shows that Travelzoo is able to successfullygenerate higher revenues as our reach continues to increase.

In Europe, we acquired 332,000 subscribers at an averagecost of $2.96 per subscriber, compared to 332,000 subscribers at an averagecost of $4.43 in Q2 2007.

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

In Asia, we acquired 42,000 subscribers at an average costof $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 expandinginto selected international markets. We see a competitive advantage from beingable to cross-sell advertising globally. For example, our sales force in theU.S. now sells inclusions for our U.K. and Canadian publications, while oursales force in Europe also sells inclusions for our U.S. and Canadianpublications.

Another competitive advantage is our improved ability tosource the best travel deals and perform a very high quality review byleveraging the local expertise. Over the last two years, we have built a uniqueglobal 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 Travelzoousers with the very best information available.

In Q3 2007, we continued to develop a new section of ourU.S. website that lists deals for shows and events, and we continued to developthe Travelzoo Network, an affiliate network that increases the reach of ourcontent beyond Travelzoo's own media properties.

This concludes the discussion of the financial results, thegrowth in subscribers, and our growth strategy.

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

Travelzoo's consistent practice is not to provide guidancefor future periods because of the dynamics of the industry. Therefore, thiswill conclude our prepared discussion and I will turn the call back to theoperator now for the question-and-answer session.



(Operator Instructions) Our first question will come from Bill Lennanwith Broadpoint. Please go ahead.

Bill Lennan -Broadpoint Capital

Thanks. The customer acquisition cost in Asia seemsencouraging, 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 inAsia, 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 NorthAmerican ex those factors seems to be decelerating. Could you tell us what is goingon there? Is there something macro going on or is the competition?

Ralph Bartel

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

When a user types in their e-mail address on the website andthey press the submit button, they are not registered immediately to thenewsletter anymore. They receive an e-mail where there is a link in the e-mailthat they have to click to confirm their subscription. The advantage of doingthat is that the company verifies that the person who typed in the e-mailaddress is in fact the person that they claim to be. Another advantage is thatyou avoid as a company signing up e-mail address that are misspelled or thatare otherwise bad e-mail addresses from the beginning. That explains theincrease in the subscriber acquisition cost that we saw in North America in Q3per the average cost per subscriber.

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

Now in Europe, we actually had good news in Q3. As you cansee, the average CTA decreased from $4.43 to $2.96, and this was because of avery successful launch of subscriber marketing in France, where we saw a goodvolume of subscribers that we acquired at a very attractive cost, which againshows you that there will be fluctuations from market to market and in Asia, wewill 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 willanswer this question.

Holger Bartel

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

And in Super Search, part of the traffic into the tool comesfrom search marketing campaigns. As most other companies out there, we areworking with a third party to help us optimize these campaigns and starting inlate July, early August, it looked like their strategy of how they optimize ourcampaigns, particularly with Google, didn’t work anymore. They tried somefixes. 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 dateswhere our traffic from Google was down by 30% to 40% year over year.

But I cannot comment on how that impacted revenues exactlybut just to give you some number for August and September, the traffic weacquired from Google was down by approximately 25%, which compared to 10% to15% increase that we saw prior to this problem.

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

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

In the end, it is something that really depends on whatresponse companies are getting from Travelzoo's products. I think youcontinuously interview our advertisers, some of our advertisers, and you willhear that -- at least I’m hearing that a lot of these competitive products arenot working very well.

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

Bill Lennan -Broadpoint Capital

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

Holger Bartel

We pride ourselves in the quality of our products. What weare 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 tocompare it to a competitor who might only have one, of course we’ll get lessresponse.

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

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

Bill Lennan -Broadpoint Capital

Thank you very much.


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

Lance Ettis - MortarCapital Management

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

Ralph Bartel

Hello, Lance. Wayne Lee will answer your question.

Wayne Lee

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

Lance Ettis - MortarCapital Management

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

Wayne Lee

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

Lance Ettis - MortarCapital Management

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

Wayne Lee

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

Lance Ettis - MortarCapital Management

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

Wayne Lee


Lance Ettis - MortarCapital Management

You’re still not profitable there. Okay.

Ralph Bartel

Let me provide additional information. When you look atprofitability, you have to keep in mind that the largest expense item for us innew markets is the acquisition of new subscribers, and we expense the relatedcosts as they incur, so none of these expenses actually in a new market, we donot capitalize any expenses.

Now, in reality, once you have signed up let’s say a millionsubscribers in the U.K. and you have spent that money, you have recognized allthese expenses in financial reporting, but then you have these subscribers andthey enable you to generate revenue from these subscribers in the futurewithout incurring the same expenses again. But that’s definitely something thatyou want to look at, so when we often analyze the performance of our foreignoperations, we internally sometimes exclude the subscriber acquisitionexpenses, which gives us a different view on the progress that we have made.

Lance Ettis - MortarCapital Management

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

Ralph Bartel

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

Lance Ettis - MortarCapital Management

Okay. Thank you.


Any further questions, Mr. Ettis?

Lance Ettis - MortarCapital Management

No, that’s it. Thank you.


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

Ralph Bartel

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


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

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