TZOO

Business Context and Reporting Period

Company: Travelzoo Inc.
Filing Type: Form 10-Q (Unaudited)
Period Ended: June 30, 2006
Business Overview: Travelzoo is an Internet media company publishing travel offers via websites, email newsletters (Top 20, Newsflash), and a pay-per-click search engine (SuperSearch). The company operates in two segments: North America (U.S. and Canada) and Europe (U.K., Germany, Spain).

Key Financial Metrics

Margins (Six Months 2006): Gross Margin was 98.4%; Operating Margin was 40.7%; Net Margin was 23.2%.

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 42% year-over-year for the quarter and 46% for the six-month period. Growth was driven by a 13% increase in advertising rates and an increase in client volume. North America contributed 88% of growth; Europe contributed 12%.
• Profitability: Operating income increased 86% for the quarter and 95% for the six-month period. Operating margin improved from 30.5% to 40.7% (six months), primarily due to a decrease in general and administrative expenses related to the former stockholder payment program.
• Cash Flow: Net cash provided by operating activities increased to $9.0 million (six months 2006) from $5.1 million (six months 2005). However, cash and cash equivalents decreased significantly from $24.5 million to $10.2 million due to a $28.6 million share repurchase program.
• Segment Performance: North America operating income grew 103% year-over-year. Europe, which began operations in May 2005, reported an operating loss of $954,000 for the six months ended June 30, 2006, compared to $175,000 in the prior year, due to subscriber acquisition costs.

Guidance, Outlook, Risks, and Unusual Items

• Share Repurchases: The company completed a $28.6 million repurchase of 1.0 million shares in the first half of 2006. No shares remain to be purchased under this specific plan.
• Former Stockholder Liability: The company continues a program to pay cash to former stockholders of Travelzoo.com Corporation who missed the merger exchange deadline. Expenses for this program were $89,000 for the six months ended June 30, 2006. The total cost is not reliably estimable as it depends on future stock prices and the number of valid claims. Up to 4,076,000 shares remain unclaimed.
• SOX Compliance: The company expects to incur significant expenses in 2006 for Section 404 of the Sarbanes-Oxley Act compliance. Approximately $674,000 was expensed in the first six months of 2006.
• Customer Concentration: Two clients (Cendant Corporation and Expedia, Inc.) accounted for 19% and 15% of revenues, respectively, in the second quarter of 2006.
• Outlook: Management expects sales and marketing expenses to increase to support subscriber acquisition and brand awareness. They anticipate continued upward pressure on subscriber acquisition costs due to competition and rising online advertising rates.

Investor Verification Checklist

• Stockholder Claims: Verify the status of the cash payment program for former stockholders and the potential dilution risk if the 4,076,000 unclaimed shares are successfully asserted.
• Customer Concentration: Monitor the stability of contracts with Cendant and Expedia, which collectively represent over 30% of quarterly revenue.
• European Expansion: Assess the timeline for profitability in the Europe segment, which currently operates at a loss due to high marketing spend.
• Subscriber Acquisition Costs: Track the trend in cost per new subscriber, which has historically increased and could impact future margins.
• Liquidity: Confirm that the remaining cash and short-term investments ($25.1 million) are sufficient to fund operations and expansion without further equity dilution or debt.