TZOO

Business Context and Reporting Period

Company: Travelzoo Inc.
Filing Type: Form 10-Q (Unaudited)
Period Ended: June 30, 2005
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 is controlled by Ralph Bartel, who held approximately 78% of outstanding shares as of August 1, 2005.

Key Financial Metrics

Liquidity and Balance Sheet Highlights

• Cash and Cash Equivalents: $21,684,711 (June 30, 2005) vs. $26,434,989 (Dec 31, 2004).
• Short-term Investments: $19,840,000 (June 30, 2005) vs. $10,031,738 (Dec 31, 2004).
• Total Current Assets: $49,515,945.
• Total Liabilities: $5,241,456 (All current; no long-term debt).
• Stockholders' Equity: $44,579,320.
• Operating Cash Flow (6 months): $5,120,003 provided by operations.

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 70% for the three months and 72% for the six months ended June 30, 2005, compared to the same periods in 2004.
• Revenue Drivers: 71% of the six-month revenue growth was attributed to the new "SuperSearch" product. The remaining 29% came from existing products due to a 15% average price increase and higher client volume.
• Customer Concentration: Revenue concentration increased. For the six months ended June 30, 2005, Click Here, Inc. (representing Travelocity) accounted for 17% of revenues, and Orbitz, LLC accounted for 11%. No single client exceeded 10% in the prior year.
• Operating Expenses: Sales and marketing expenses rose significantly (57% increase for six months) to acquire subscribers. General and administrative expenses increased 114% for the six months, driven by a $1.137 million charge for cash payments to former stockholders and Sarbanes-Oxley compliance costs.
• Operating Margin: Operating margin for the six months improved to 30.5% from 29.1% in the prior year, despite higher expenses, due to faster revenue growth.

Guidance, Outlook, Risks, and Unusual Items

Management Commentary and Outlook

• UK Expansion: Operations began in the UK in May 2005. The subsidiary incurred a loss of approximately $175,000 for the three and six months ended June 30, 2005. Management expects significant additional increases in sales, marketing, and administrative expenses related to this expansion.
• Subscriber Acquisition: The average cost per new subscriber increased to $2.62 in Q2 2005 from $2.58 in Q2 2004. Management anticipates continued upward pressure on acquisition costs due to rising online advertising rates and competition.
• Capital Resources: Management believes cash on hand ($41.5 million in cash and short-term investments) and operating cash flows are sufficient for working capital needs for at least the next 12 months.

Risks and Contingencies

• Former Stockholder Claims: The company faces potential claims from former stockholders of Travelzoo.com Corporation regarding unissued shares from a 2002 merger. A cash payment program was initiated in October 2004. A charge of $1.137 million was recorded in 2005, with a remaining liability of $10,000. The total cost is not reliably estimable as it depends on future stock prices and the number of valid claims. If all potential claims were successful, the company could be required to issue up to 4,082,000 additional shares.
• Customer Dependence: The loss of Click Here, Inc. or Orbitz, LLC could materially adversely affect revenues.
• Internal Controls: The company is in the process of evaluating internal controls under Section 404 of the Sarbanes-Oxley Act. While no material weaknesses have been identified yet, the evaluation is ongoing, and future deficiencies may be found.
• Competition: Intense competition from large portals (Yahoo!, MSN) and search engines (Google) could reduce margins or market share.

Investor Verification Checklist

• Customer Concentration: Verify the stability of contracts with Click Here, Inc. (17% of revenue) and Orbitz (11% of revenue), noting that the Click Here agreement is cancelable with 90 days' notice.
• Former Stockholder Liability: Monitor the number of valid claims received under the cash payment program and the company's stock price, as these directly impact future liabilities and potential dilution.
• UK Subsidiary Performance: Track the profitability timeline of Travelzoo UK Ltd, which is currently operating at a loss and expected to increase overall operating expenses.
• Subscriber Acquisition Costs: Watch for trends in the cost per new subscriber, which has been rising and could compress margins if revenue growth does not keep pace.
• Internal Controls Certification: Review future filings for the final assessment of internal controls under Section 404 of the Sarbanes-Oxley Act.