TZOO

Business Context and Reporting Period

Company: Travelzoo Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2005
Business Overview: Travelzoo is an Internet media company publishing travel offers from over 500 travel companies via websites, email newsletters (Top 20, Newsflash), and a pay-per-click search engine (SuperSearch). The company operates in two segments: North America (99% of revenue) and Europe (1% of revenue, operations began May 2005). The company is controlled by Ralph Bartel, who beneficially owns approximately 78% of outstanding shares.

Key Financial Metrics

Margins: Gross margin remained stable at 98%. Operating margin decreased to 29.3% in 2005 from 32.8% in 2004. Net income margin was 16% in 2005 compared to 18% in 2004.

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 51% year-over-year to $50.8 million. Approximately 68% of this growth was attributed to the new SuperSearch product, 4% to U.K. operations, and 28% to existing products (driven by a 15% average price increase and higher client volume).
• Operating Expenses: Sales and marketing expenses rose 65% to $25.9 million, primarily due to increased advertising campaigns to acquire subscribers and promote SuperSearch. General and administrative expenses increased 46% to $9.1 million, driven by $1.0 million in Sarbanes-Oxley (SOX) compliance costs and $536,000 in additional office space expenses.
• European Operations: The company incurred a loss of approximately $1.1 million from its U.K. subsidiary (inception May 2005 to Dec 31, 2005), contributing to the decline in operating margin.
• Client Concentration: One client accounted for 15% of total revenues in 2005, up from 12% in 2004. This concentration is primarily due to the SuperSearch product.

Guidance, Outlook, Risks, and Unusual Items

• Outlook: Management expects to continue expanding operations, including further expansion into European countries in 2006. They anticipate continued upward pressure on subscriber acquisition costs and increased sales and marketing expenses.
• Unusual Items: The company recorded $1.2 million in expenses in 2005 related to a program making cash payments to former stockholders of Travelzoo.com Corporation who failed to claim shares in a 2002 merger. A liability of $11,000 remained as of year-end.
• Risks:
  • Customer Concentration: Reliance on a single client for 15% of revenue poses a risk if that client terminates the agreement.
  • International Expansion: Losses from U.K. operations and potential future losses from other European expansions could materially impact results.
  • Stockholder Claims: Potential claims from former "Netsurfer" stockholders could result in the issuance of up to 4.1 million additional shares, causing significant dilution.
  • Competition: Intense competition from portals (AOL, MSN, Yahoo!) and search engines (Google) could reduce margins and market share.
• Capital Resources: The company has no outstanding debt. Cash and short-term investments totaled $44.4 million as of December 31, 2005. Management believes this is sufficient for operations for at least the next 12 months.

Key Facts for Investor Verification

• Revenue Concentration: Verify the stability of the single client representing 15% of revenue and the terms of their contract (cost-per-click, 90-day cancellation notice).
• European Losses: Monitor the profitability timeline of the U.K. subsidiary and the financial impact of planned 2006 European expansion.
• Merger Liability: Assess the potential dilution risk from the 4.1 million unclaimed shares from the 2002 merger and the ongoing cash payment program for former stockholders.
• Subscriber Acquisition Costs: Review trends in the cost per new subscriber, which has generally increased over the last few years, potentially impacting future margins.
• Stock Ownership: Note that Ralph Bartel controls approximately 78% of the company, giving him significant influence over corporate decisions.