TZOO

Business Context and Reporting Period

Company: Travelzoo Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2010
Business Overview: Travelzoo is a global Internet media company that informs subscribers about travel and entertainment deals. Revenue is generated primarily through advertising fees on its websites, email newsletters (Top 20, Newsflash), and search tools (SuperSearch, Fly.com). The company operates in two segments: North America and Europe. The Asia Pacific segment was sold in October 2009 and is reported as discontinued operations.

Key Financial Metrics

Margins: Gross margin was 94.2% in Q1 2010 (down from 94.7% in Q1 2009). Operating margin was 18.1% (down from 19.7%). The effective tax rate was 50%.

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 24% year-over-year. North America revenue grew 12%, while Europe revenue surged 107% (91% in local currency), driven by subscriber growth and the launch of Fly.com in Europe.
• Profitability: Net income increased significantly to $2.5 million from $0.3 million in the prior year. This improvement is partly due to the absence of a $1.7 million loss from discontinued operations (Asia Pacific) recorded in Q1 2009.
• Operating Expenses: Sales and marketing expenses rose 31% to $15.0 million, primarily due to increased subscriber acquisition costs and marketing for Fly.com. General and administrative expenses increased 15% to $6.7 million, driven by higher headcount and professional services.
• Cash Flow: Net cash provided by operating activities increased by $7.7 million to $9.8 million, largely due to a $6.1 million decrease in income tax receivables and higher net income.

Guidance, Outlook, and Risks

Management Commentary:

• Europe Strategy: Management expects European operations to continue incurring losses through the end of 2010 due to significant subscriber acquisition and Fly.com launch expenses. However, revenue growth in Europe outpaced subscriber growth, indicating potential for future margin improvement.
• Rate Increases: The company aims to increase advertising rates annually. Rates were increased on select U.S. listings in January 2010 and on most European listings. Future rate increases are not guaranteed due to competition.
• Capital Resources: With $30.1 million in cash, management believes funds are sufficient for working capital needs for at least the next 12 months.

Risks and Contingencies:

• Former Stockholder Claims: There is a contingent liability regarding unissued shares from a 2002 merger. If claims are successful, the company could be required to issue up to 4.07 million additional shares, causing significant dilution. A cash payment program for these claims incurred $2,000 in Q1 2010; total future costs are not reliably estimable.
• Tax Dispute: The IRS has contested tax deductions related to the former stockholder program for 2005 and 2006. If the company agrees to the proposed adjustment, it would result in an additional payment of approximately $590,000 plus interest.
• Management Transition: Christopher Loughlin is scheduled to replace Holger Bartel as CEO on July 1, 2010.

Investor Verification Checklist

• Europe Profitability Timeline: Verify if the expectation of losses continuing through 2010 holds true in subsequent quarters, given the high marketing spend.
• Former Stockholder Liability: Monitor updates on the 2002 merger share claims and the IRS tax dispute to assess potential dilution or cash outflows.
• Subscriber Acquisition Costs (CPA): Track the trend in CPA, particularly in Europe, as rising costs could pressure margins despite revenue growth.
• Customer Concentration: Note that no single customer accounted for 10% or more of revenue in Q1 2010, a change from Q1 2009 where one customer represented 13%.
• Discontinued Operations: Confirm that no further material economic interests or ongoing involvement exist with the sold Asia Pacific segment.