Earnings Call Transcript - TZOO Q2 2022

Operator, Operator

Hello, everyone. Welcome to the Travelzoo Second Quarter 2022 Financial Results Conference Call. Today's call is being recorded. The company would like to remind you that all statements made during this conference call and presented in the slides that are not statements of historical facts constitute forward-looking statements and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results could vary materially from those contained in the forward-looking statements. Factors that could cause actual results to differ materially from those in the forward-looking statements are described in the company's Form 10-K and 10-Q and other periodic filings with the SEC, unless required by law. The company undertakes no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. Please refer to the company's website for important information, including the company's earnings press release issued earlier this morning. An archived recording of this conference call will be made available in the Travelzoo Investor Relations website. Now it's my pleasure to turn the floor over to Travelzoo's global CEO, Holger Bartel; its Chief Accounting Officer, Lisa Su; and its Global Director of Travelzoo META, Arveena Ahluwalia. Lisa will start with an overview of the second quarter 2022 financial results.

Lisa Su, Chief Accounting Officer

Thank you, operator, and welcome to those of you joining us today. Please open the management presentation to follow along with our prepared remarks. The presentation in PDF format is available on our Investor Relations website. Let's begin with Slide #3. Our Q2 revenues were lower than expected. However, profitability was good. Operating income, which we as management call operating profit, was $1.8 million, which is approximately 10% of revenues. Our Q2 revenue was $17.7 million, down 7% from $19.1 million year-over-year. Our operating profit in Q2 was $1.8 million, which resulted in earnings per share of $0.08. Compared to the previous quarter, the number of members remained the same. On Slide 4, we go into more details about the revenues and operating profit of our two more significant business segments: North America and Europe. North America continues to outperform Europe in the recovery from the pandemic. North America revenue decreased 11% year-over-year but increased 6% quarter-over-quarter. The operating profit in North America was $3.1 million in Q2 compared to $1.7 million in Q1. Europe had revenue growth year-over-year of 5%. Europe had an operating loss of $1.5 million due to increased member acquisition spend in Q2. As shown on Slide 5, even though revenue was still lower than pre-pandemic revenue levels, the changes that we have made to the business are generating higher operating margins compared to pre-pandemic. On slide 6, North America's business segment reached a 25% operating margin, which is the highest it has been in 6 years, and we think that it can still go higher. On Slide 7, we provide information on non-GAAP operating profit as we believe it better explains how Travelzoo evaluates performance. This slide shows the non-GAAP operating profit, which was $2.6 million in Q2. Slide 8 provides details on the items that are excluded in the calculation of non-GAAP operating profit. Please turn to Slide 9. As of June 30, 2022, consolidated cash, cash equivalents, and restricted cash were $26.7 million. The cash balance reached the expected level as the number of vouchers outstanding has become smaller. Merchant payables decreased proportionately. Slides 10 and 11 detail our revenues by business segment. When neutralizing FX changes, the North America business segment saw a year-over-year decrease of $1.6 million. The Europe business segment, which we report in U.S. dollars, is negatively impacted by the strong dollar. Yet we saw in Q2 an increase of $700,000 year-over-year, which represents 17% growth. The local business, which consists of advertising from restaurants, bars, and entertainment shows and events, remains far behind what it was pre-pandemic. Slide 12 shows that this pandemic led to a significant reduction of fixed costs, which can be kept relatively low in the foreseeable future, while revenues are expected to grow. For Q3 2022, we currently expect higher revenue year-over-year and also profitability. We continue to see a trend of recovery of our revenue. However, there could be unexpected fluctuations in the short term. During the pandemic, we have been able to lower our fixed costs. We believe we can keep our fixed costs relatively low in the foreseeable future, while revenue is still expected to grow. Now I turn over to Holger.

Holger Bartel, CEO

Thanks, Lisa. From the perspective of management, Q2 was a good quarter. The company is profitable again and, even better, profitability is higher than before the pandemic. We now see that the changes and improvements in efficiencies that we've made over the last two years are resulting in higher operating margins. In Q2, when the revenue was a little lower than expected, the company's operating margin was actually the highest that we have seen in 6 years. And in North America, the operating margin was already 25%. We believe that revenue will continue to recover and grow. As you can see on Slide 13, with more than 30 million members, 7 million mobile app users, and 4 million social media followers, Travelzoo is loved by travel enthusiasts who are affluent, active, and open to new experiences. The latest survey results for Travelzoo members in the U.S. show that 58% took three or more vacations in 2021. 94% have a valid passport, which compares to 43% of the U.S. population. Next on Slide 15, I provide an overview of what management and our global team are focused on. We want to increase the number of members and accelerate revenue growth to reach and then exceed pre-pandemic levels. Grow Jack's Flight Club's profitable subscription revenue, utilize higher operating margins to significantly increase EPS, and launch Travelzoo META. So at this point, I'd actually like to turn over to Arveena Ahluwalia, who is Travelzoo's Global Director of Travelzoo META.

Arveena Ahluwalia, Global Director of Travelzoo META

Thank you, Holger. I am happy to speak about Travelzoo META, Travelzoo's new initiative towards a paid subscription-based service in the Metaverse. In today's update, we would like to address the status and timing of Travelzoo META. Please turn to Slide 18. Given the newness of this industry, we launched Phase 1 in May in a controlled test environment to a limited set of users. We are deploying learnings from the test into our next phase, which is scheduled to launch in September. We are continuing with our phased approach and test and learn strategy. We will provide updates as appropriate. The next slide on Page 19 is top categories of value creation in the Metaverse. According to a large consumer survey by McKinsey & Company published in June 2022, virtual immersive travel is the second most sought-after experience in the Metaverse. Please see the next slide on Page 20. The McKinsey & Company report validates Travelzoo META strategy. McKinsey & Company found that consumers in the Metaverse are looking to explore and travel the digital world. Travelzoo META will allow its members to do so and therefore, give them the experiences they value the most. Travelzoo META experiences will be browser-enabled entertaining travel experiences that allow members to interact with and in the Metaverse. Travelzoo META is expected to attract a completely new generation of members, in addition to complementing real-world lifestyle and travel experiences curated by Travelzoo for its existing 30 million members. Being a first-mover is important. With that, I'm handing over to the operator for questions for Holger, Lisa, and me. Thank you.

Operator, Operator

Our first question coming from the line of Michael Kupinski with Noble Capital Markets.

Michael Kupinski, Analyst

As you mentioned, the revenues were a little lighter, but Holger, I was wondering if you can just give us your thoughts on what caused the softer revenues. Were there still travel restrictions out there? Were most of those lifted? Do you think it's just consumer behavior, reaction to geopolitical events? Just your general thoughts.

Holger Bartel, CEO

Michael, yes, revenues were a bit lower than we expected, but not that much. I have to say we had a very strong quarter in Q2 2021. As you know, the comparison this quarter was tough year-over-year. For the first six months, revenues are still up, and we expect Q3 and Q4 revenues to be up again quite a bit over the last year. So it wasn't anything particular. I would say the biggest challenge in Q2 was that, as we all know, airlines and hotels have reduced capacity. They are quite busy. They have reduced capacity because they're struggling to bring their staff back and training them. So flights are full. Hotels are full. So towards the end of the quarter, it became a bit more difficult to source deals, particularly from hotels. We saw this continuing in July, but now we clearly see that this is changing. If you look into September, October beyond, it's very clear. Airlines are slashing their fares already. Hotels are reducing their rates. We certainly expect, like many others, that some economic challenges will be coming our way, and we believe that will actually be good for us because it makes it easier for us to source deals for our members. But that was a bit of a challenge in Q2. I have to add that the slight decrease in revenue was mostly driven by voucher purchases. You can also imagine if a lot of our members purchased vouchers in Q2 last year. We saw a great deal of redemptions now this year. And while they are redeeming their vouchers, they are not immediately buying new ones. So that's what's causing the change. However, our advertising business, completely different, is up very strongly versus the previous year.

Michael Kupinski, Analyst

Okay, I understand. You mentioned plans to grow your member base globally, and it seems you've had some success in Europe. What are your strategies for increasing members in North America? Could you also discuss your customer acquisition efforts there? Additionally, I noticed that Jack's Flight Club membership grew, primarily in the U.K. What are your plans for introducing Jack's Flight Club to the U.S. market? One more question, please. How much did you spend on customer acquisition during the quarter?

Holger Bartel, CEO

So member acquisition, as you said, was up in Europe in Q2 because we saw a good opportunity. In North America, member acquisition costs now in Q3 have come down quite a bit, probably because more people are looking for deals and are turning to a service like ours. So we are growing. We are adding more new members in the U.S. this quarter. And Jack's Flight Club is growing again as well, yes, both in the U.K. and the U.S.

Michael Kupinski, Analyst

Got you. And if you can also talk a little bit about the CapEx for this year remaining for the second half and maybe for next year. And then a little bit about the Metaverse strategy. Can you talk a little bit about what your CapEx plans are there? I would assume that while this looks like a great opportunity, there's always the bleeding edge of being in new technologies and new services like this. I was just wondering what your thoughts are in terms of how you plan to manage the investment spend for this over the next, let's say, year?

Holger Bartel, CEO

Yes, sure. Lisa and Arveena, maybe you can jump in here. But let me just explain that the way we are approaching the Metaverse opportunity is quite light on the investment side. It's not an investment in technology that we need to do. We are simply providing a service to the subscribers of that service, and that is something in which we don't have to invest heavily into technology. But Arveena, feel free to add on here or Lisa.

Arveena Ahluwalia, Global Director of Travelzoo META

Thank you, Holger. I am happy to add here. So we are building Travelzoo META strategically using a phased approach in a cost-efficient manner with no significant upfront investment. It is the phased cost control strategy that allows us to judiciously navigate the rapidly changing Metaverse environment. Also, we are measuring and assessing the performance of each phase and pursuing the next steps accordingly. And by using this process of continuous improvement and deploying a robust system of checks and procedures, we are monitoring progress and keeping investment in check.

Operator, Operator

The next question coming from the line of Edward Woo with Ascendiant Capital.

Edward Woo, Analyst

In terms of what you're seeing with some of the price cuts in the fall, have you seen it greater than what it is normally seasonally on a basis? And what are you hearing in terms of, obviously, by inflation impacting the consumer? Are you seeing some of your travel providers noticing a significant slowdown in consumer demand?

Holger Bartel, CEO

To answer the first question. Well, the decrease is quite significant, yes, because hotel prices and airfares were up so much in summer. So yes, it's a more significant decrease than you have seen in the past. And then with regards to how is inflation affecting the consumer and our members, it's the same. They are looking for value. Interestingly, our members have not said that they want to cut back travel; maybe they take slightly shorter trips. They are looking for better offers. And as I said, they are looking for value. Travelzoo is ultimately about value because we are delivering our members really incredible experiences at a great deal, and that's what consumers are looking for. And that's why we feel it will also become easier for us in the second half of the year to acquire new members, and we will probably see our existing members also more active than in the past few months.

Edward Woo, Analyst

Great. And then just on a segment your European business versus your North America. Have you noticed any change in consumers in either region? Or are they all kind of acting the same in terms of the reaction to how the inflation is going globally?

Holger Bartel, CEO

They behave the same way. I would say we are maybe seeing in the U.K. consumers be a little bit more sensitive to prices than in other markets. But in general, they behave the same.

Operator, Operator

And our next question coming from the line of Steve Silver of Argus Research.

Steve Silver, Analyst

I guess my question relates to the company's capital position given that it sounds like you guys saw an uptick in the levels of voucher redemptions this past quarter. Just trying to get a sense of your current thinking of the capital position, just given the fact that the merchant payables are coming down significantly, the cash balance is coming down with that. Just trying to get your thoughts about how the capital position might affect other capital allocation strategies, including the recently announced share repurchase program.

Holger Bartel, CEO

Yes, Steve, I'll let Lisa provide more details. In summary, everything is progressing as anticipated. The ratio of cash to merchant payables is improving quarter-over-quarter. More vouchers are being redeemed, and the majority of purchased vouchers have either been redeemed or refunded. Consequently, the number of outstanding vouchers for which we need to pay the merchants is decreasing every quarter. Additionally, we have deposits with credit card processors that will be released in the future. However, not all of them are paying us immediately; we receive cash with a slight delay after transactions are processed. Lisa can elaborate further.

Lisa Su, Chief Accounting Officer

Yes. We would expect that we get some of our long-term deposits along with our accounts receivable in the next 6 to 12 months. So we expect that our cash position will actually improve. We also expect that our working capital deficit will improve because of that release.

Holger Bartel, CEO

So we have quite a positive development of the balance sheet.

Lisa Su, Chief Accounting Officer

Yes, our balance sheet will get much more robust.

Operator, Operator

And our next question coming from the line of James Goss of Barrington Research.

James Goss, Analyst

Okay. A couple of things. One, you have been good at controlling G&A and product development costs. Sales and marketing expenses have been higher, which is to be expected as you're trying to grow the business. But I wonder if you could talk about your thought process and how you're allocating those expenses as you try to scale it up and make sure they are productive expenses.

Holger Bartel, CEO

Expenses for member acquisition fall into sales and marketing. So that's what's driving that increase, and for us acquiring a member is an expense, so we have to record the full expense for acquiring a new member right away. Even though we obviously benefit from this new member for a long period after that. So that's what's driving the increase in sales and marketing expenses, Jim.

James Goss, Analyst

Now is there any certain pace you're trying to adhere to as you're developing that? I understand it is in terms of growing the subscriber base domestically and internationally.

Holger Bartel, CEO

We want to do it efficiently and with a good ROI. So as I mentioned, in North America, we are seeing a much better ROI this quarter than last. So this means we will be spending more or investing more.

James Goss, Analyst

A couple of things on the META project. Will the pricing of the service be some flat subscription rate or based on usage? Is there any plan at this point?

Lisa Su, Chief Accounting Officer

I can take that. So we are building Travelzoo META in phases. And yes, there will be a pre-registration followed by an annual subscription fee.

Steven Silver, Analyst

Okay. Okay. So you can use it as much as you want or as little as you want, but it will be the fixed rate that would be able to count on modeling.

Arveena Ahluwalia, Global Director of Travelzoo META

Correct. Yes, annual subscription fee. Yes.

Steven Silver, Analyst

Okay. Do you think subscribers to the service will see it as a substitute for traveling or as a way to travel more virtually? Who do you think you will be competing with and will this encourage them to use your other services more? Is that the main objective or is it intended to stand alone?

Arveena Ahluwalia, Global Director of Travelzoo META

Travelzoo META will be complementing real-world travel and attracting a completely new generation of members. So we will not be competing with real-world travel but making places that are inaccessible more accessible via virtual travel experiences. In addition, we'll be providing other forms of travel experiences which you cannot experience in the real world.

Steven Silver, Analyst

Okay. And maybe one final thing. In terms of the overall experience you've had with your higher demographics. Do you think that has proven to be an advantage that's kept your business better than it would be otherwise? I presume that's how the target is working, but are there any thoughts you might add in terms of the rebound in your particular demographics?

Holger Bartel, CEO

Our members last year, even while we were still in the midst of the pandemic, demonstrated impressive engagement with most taking more than three trips. We take great pride in the high-quality member base we've established, which is why numerous travel companies are eager to partner with us. Travelzoo focuses on value, not just affordability; we emphasize exceptional trips and experiences that resonate with our valued members, and we're proud of that. Great. Thanks, Jim. And ladies and gentlemen, thank you so much for your time and support, and we look forward to speaking with you again next quarter. Have a great day.

Operator, Operator

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may now disconnect your lines at this time. Have a nice day.