Earnings Call Transcript - TZOO Q3 2022

Operator, Operator

Hello, everyone. Welcome to the Travelzoo Third Quarter 2022 Financial Results Conference Call. All participants have been placed in a listen-only mode and the floor will be open for questions following the presentation. 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 in 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 on the Travelzoo Investor Relations website. Now it's my pleasure to turn the floor over to Travelzoo's Global CEO, Holger Bartel; its Chief Financial Officer, Wayne Lee; and its Global Director Travelzoo META, Arveena Ahluwalia. Wayne will start with an overview of the third quarter 2022 financial results.

Wayne Lee, CFO

Thank you, Lisa, 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 number 3. Our Q3 revenues were lower than expected. Consolidated Q3 revenue was $15.8 million, up 1% from $15.7 million in the previous year. And in constant currencies, it was $16.7 million, which is an increase of 6% year-over-year. Our net income in Q3 was $790,000, which resulted in earnings per share of $0.06. Operating income, which we as management call operating profit, was $270,000, which is approximately 2% of revenues. As of September 30, we had 30.5 million unduplicated members compared to 30.7 million as of September 30, 2021. On slide 4, we go into more details about the revenues and operating profits of our two more significant business segments: North America and Europe. North America revenue increased 9% year-over-year from $9.7 million to $10.5 million. The operating profit in North America was $812,000 in Q3 compared to an operating loss of $918,000 a year ago. Europe revenue decreased by $725,000 or 14% year-over-year. At constant currencies, Europe revenue increased 2% year-over-year. Europe had an operating loss of $551,000 in Q3 compared to an operating profit of $600,000 in the prior year. On slide 5, 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 $1.1 million in Q3. Slide 6 provides more information about the items that are excluded in the calculation of non-GAAP operating profit. Please turn to slide 7. As of September 30, 2022, consolidated cash, cash equivalents and restricted cash was $20.5 million. The cash balance reached the expected level as the number of vouchers outstanding has become smaller. Slides 8 and 9 detail our revenues by business segment. The North America business segment saw a year-over-year revenue increase of $800,000. Turning to slide 9. The Europe business segment, which we report in U.S. dollars, was and continues to be negatively impacted by the strong dollar. We saw revenue in Q3 decrease by $725,000, but in constant currencies revenue increased by $200,000 year-over-year. Slide 10 shows that the pandemic led to a significant reduction of fixed costs. We believe we can keep our fixed costs relatively low in the foreseeable future, while revenues are expected to grow. For Q4 of 2022, we currently expect substantially higher revenue and profitability. We see the demand curve in the travel industry returning to a more normal situation. We believe this allows us to negotiate and recommend more and better offers resulting in higher revenue. However, there could be unexpected fluctuations in the short term. Now I turn over to Holger.

Holger Bartel, CEO

Thank you, Wayne. In Q3, indeed our revenue was lower than expected due to the unique travel situation in the summer of 2022. Demand jumped after the pandemic, but suppliers were still rebuilding capacity. The demand curve temporarily shifted, while the supply curve remained inelastic in the short term and didn't recover quickly enough from the cutbacks during the pandemic. This pushed up prices to levels where we did not want to recommend certain overpriced travel and leisure offers to Travelzoo members anymore. In the 24 years of Travelzoo's history, I haven't seen a situation like this, and I believe it will not last. So it was frustrating for us. While airlines, other travel suppliers, and online travel agencies benefited from overpriced travel services, our business remained flat. Now we are seeing a rapid change. Demand is returning to normal levels. Suppliers continue to build up capacity. And we have more and better offers for our members again and revenues are accelerating. I would like to provide you a few specific examples that may illustrate what we are seeing. Today, for example, we are presenting to Travelzoo members in the UK an exclusive offer at the Grove of Narberth, one of only 12 hotels in the UK awarded five Red Stars and four Rosettes by the British AA. For roughly £400, Travelzoo members can stay here for two nights in an upgraded room with lavish bed and breakfast and a welcome gift. Just two months ago, a similar package would have cost over £1,000, and the hotel was full. One other example, in Germany last week Travelzoo members took advantage of a vacation package for €279 that included flights and four days at the 4-star Lisbon Plaza. Just a month ago, the hotel's occupancy was so high and flights so expensive that an offer for Travelzoo members would not have looked attractive. Now it very much does. Or in New York, prices at 4-star hotels often exceeded $400 to $500 per night or even more in summer. Now demand has flattened, hotels are further staffing up, and we were able to negotiate exclusive member offers this month for trips in fall and winter. Members have already booked over 2,000 stays just since the beginning of October. As you see on Slide 11, with more than 30 million members, seven million mobile app users, and four million followers on social media, Travelzoo is loved by travel enthusiasts who are both affluent, active, open to new experiences, and they trust us. The latest survey for Travelzoo members shows that 58% took three or more vacations in 2021, which was during the time when we still were in the middle of the pandemic; 94% have valid passports compared to 43% of the US population. To summarize, Slide 13 provides 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. We want to grow Jack's Flight Club's profitable subscription revenue. We want to utilize higher operating margins to significantly increase EPS. And we want to launch Travelzoo META.

Arveena Ahluwalia, Global Director Travelzoo META

Thank you, Holger. I am happy to speak about Travelzoo META, Travelzoo's 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 16. We launched phase one in Q2 in a controlled test environment to a limited set of users and have had significant learnings. We are continuing to extensively gather data and analytics and deploy these into our strategy. We plan to launch the next phase in Q4 and will provide updates as appropriate. The next slide on page 17 outlines what Travelzoo META experiences will be. Travelzoo META experiences will be browser-enabled entertaining travel experiences that allow members to interact with the Metaverse. These experiences will, in many cases, overcome limitations of access, geography, economic and physical ability, as well as provide opportunities for social connection and interaction regardless of location. Please turn to slide 18, which confirms consumer interest. Travelzoo META is targeting a completely new demographic: Gen Z. While Travelzoo META targets Gen Z, we interviewed existing Travelzoo members who represent a wide range of travel enthusiasts and real-world travelers and found they are interested in traveling in the Metaverse. 57% of those who have heard of the Metaverse want to travel in the Metaverse. In comparison, interest in shopping NFTs in the Metaverse was only 2%. This aligns with the consumer survey commissioned by McKinsey & Company. Their survey confirmed that after making social connections, exploring digital worlds is the most important driver of interest in the Metaverse. With that, I am handing over to the operator for questions for Holger, Wayne, and me.

Operator, Operator

Thank you. The floor is now open for questions. We'll take our first question from Mike Kupinski with NOBLE Capital Markets.

Mike Kupinski, Analyst

Thank you for taking my questions. I have a couple. You mentioned that you're seeing a significant acceleration heading into this fiscal quarter. Can you share how October performed and clarify whether you were referring to October or the months of November and December regarding the acceleration in travel? It would be helpful to have some context around your comments.

Holger Bartel, CEO

Hi, Mike. I was referring to October. The examples I provided and the response we're observing are occurring right now in October. Yes, there was a noticeable slowdown from mid-July to late September when we weren't able to promote as many offers to our members as usual. However, we're back to normal now, and so far for next month, things are looking positive. While I can't quantify it at this moment, you heard from Wayne that we anticipate significantly higher revenues in Q4 compared to the same quarter last year, based on what we currently know.

Mike Kupinski, Analyst

Okay. In terms of gross profit margins, obviously, were a little lower because of the revenues being a little soft. Do you have any sense of where do you think that the gross profit margins move back towards where we were maybe in Q2 where they were maybe 87% or so? Do you have any sense about how gross profit margins look?

Holger Bartel, CEO

Yes. As revenues continue to grow or accelerate again, we will be getting back to the same profit margins.

Mike Kupinski, Analyst

Can you describe the acceleration in travel with a comparison between Europe and North America? Are we seeing similar increases in both regions, or is one performing better than the other?

Holger Bartel, CEO

We are observing similar trends across all markets. The changes we experienced during the summer were consistent everywhere, and currently, we are seeing the same acceleration in both Europe and North America.

Mike Kupinski, Analyst

It was anticipated that the cash position would decrease due to merchant payables and other factors. However, when examining the cash ratio relative to merchant payables, it appears that this percentage has declined. It was around 63% in the last quarter, and now it has dropped to 51%. Could you explain the cash management opportunities available? How do you view the redemptions of merchant payables, and what is your perspective on your cash position and the ability to meet those merchant payables given the current cash situation?

Holger Bartel, CEO

Sure. Wayne can comment on that, because we do of course every quarter quite sophisticated cash forecast. And for Q4 we expect that cash will decrease again, a little bit by a few million, but merchant payables will decrease much more than that because we have a vast number of vouchers that are expiring this quarter. But Wayne, do you have any further comments on this?

Wayne Lee, CFO

Yeah. So the cash movement in Q3, as Holger said, was expected. Well, it's as we had expected. It's again due to a decrease in merchant payables. And we're expecting the cash balances to then improve as revenues increase.

Mike Kupinski, Analyst

Do you have an idea of how many of those merchant payables will expire compared to those that will be redeemed?

Wayne Lee, CFO

Regarding redemptions and expiration, even if the voucher expires, we may still pay the breakage amount to the merchants in certain cases. Therefore, there would still be a payment.

Mike Kupinski, Analyst

Got you.

Holger Bartel, CEO

Our forecast indicates that the cash position will decline slightly in Q4, reaching its lowest point. After that, we anticipate a significant increase in Q1 and Q2 next year, based on our current models. Merchant payables will decrease more than cash, resulting in an improvement in net working capital over the next few quarters, which is important to us.

Mike Kupinski, Analyst

Got you. Okay. That's all I have for now. Thank you.

Holger Bartel, CEO

Sure. You're welcome, Mike.

Operator, Operator

We'll take our next question from Jim Goss with Barrington Research.

Jim Goss, Analyst

Thanks. I assume this situation is quite different from anything you've experienced in the past due to the severity of the pandemic. Could you elaborate on how you're working with suppliers to rebuild capacity and create travel options that better serve your clients? Also, could you discuss the volume of offers compared to the uptake on those offers? If hotels are fully booked and flight prices are high, there might be less incentive for them to use external agents to drive traffic. As you navigate what you described as a challenging process, could you share what you're currently experiencing and how you're communicating that to your clients?

Holger Bartel, CEO

Yeah. It's actually quite simple, Jim. So first, the world has never seen a period where for two years people could simply not travel. So what happens when they can travel again, they want to travel, and they didn't care what it costs. So they were willing to pay prices that were just absurd. Some hotels became quite greedy. I mean I saw in cases where three-star hotels charged over $1,000 a night, but people were desperate to go. If this is your first time in two years to visit your grandmother that your grandchildren have never seen, you don't care. You just go, okay? But it's very unusual as you said. Second, hotels, airlines, cruise lines, everybody cut their staff during the pandemic. It takes time to rehire. Some of the hotels in July, they had the demand. July, August, September, they had the demand. However, they just did not have the people. So hotels actually made only maybe 50% of their rooms available. Some of them were happy because they said, oh, if we sell 50% of our rooms at twice the price, we make the same amount of money with fewer employees, so that's good for us. So that's really what happened. It just takes time to rehire pilots and train them. It takes time to hire people to work in hotels again. It takes time to rehire people at restaurants, and anyone who has been at a hotel over the last few months sees that the level of staff and service levels are just not what they used to be. But that's changing. They all want to hire back to the levels where they were before, and that's what we mean by inelastic supply. The supply in the travel industry is not coming back quickly. It just takes time. And third, how do the members respond to that? Well, first of all, as I said, and gave with these examples, it's changing. People are not paying these high prices any longer. They are looking for better offers. Hotels are not full anymore. Many flights are not running at full capacity any longer. So now we have fantastic offers for our members at a time when they have been used to very high prices. So for us, it's actually a very good situation right now after these four or five months of summer, which have been frustrating for us. Now, members love to receive these offers. They take advantage of them. They take up on them at even higher levels than what we saw before the pandemic. So in general, we are doing fine. But I just explained this today very diligently in the call because as earnings from other travel companies will be coming out in the next few weeks, people will wonder why are the OTAs doing so well? Why are the airlines reporting record revenues? And why is Travelzoo not yet back to where we were before the pandemic? And I hope we were able to explain today why this was a very unique situation this year that we just haven't seen before.

Jim Goss, Analyst

Okay. Thanks. Just a couple of other things. The fixed costs that you were able to contain during the pandemic, I wonder if you could talk about how much of those costs and expense levels you think could return and whether you're still able to get a benefit of the resetting of some of their cost structure during the pandemic over the next year or two?

Holger Bartel, CEO

First, a lot of these expenses came from our Asia Pacific division, which we decided to close down in 2020. And second, we are not expecting these to increase significantly. We are currently operating with the resources that we believe we need to operate this business. Increases will probably come in 2023 from two factors. First, of course like other companies, we will have to increase salaries, so there will be a few percentage points that the expenses will go up because of just the inflation that we're seeing all over the world. Second, we are planning to invest more in member acquisition. We have spent the last six, nine months to really improve and our efficiencies are now better than before. Q4 is generally not a quarter where it makes a lot of sense to invest in member acquisition. But Q1, Q2, Q3 when that comes back we will increase our investments. So related to that, then expenses will go up maybe by $1 million or $1.5 million. But in general, it's not that we are expecting, Jim, that our fixed costs will go back to the levels we had before the pandemic.

Jim Goss, Analyst

Okay. Thanks. And then the last one, with regard to META. The notion that Gen Z might be a good target market, since that's probably something ingrained in them as they've grown up, is this something you think is transitory or something that they will then take the lead on and sort of expand into other areas, as they move into other stages of their life?

Arveena Ahluwalia, Global Director Travelzoo META

I can take that.

Holger Bartel, CEO

We were very surprised by the strong interest in the META offering from our existing Travelzoo members, who tend to be a bit older. That's where my surprise lies. However, Generation Z, which currently makes up a small portion of our membership, represents a completely new market we are targeting. I apologize for interrupting, Arveena; please continue.

Arveena Ahluwalia, Global Director Travelzoo META

I agree with Holger. It's usually the Gen Z audience that are early adopters of new technologies, but our survey shows that other generations are also very interested in the Metaverse. We believe this demographic will be broader than we initially thought.

Jim Goss, Analyst

All right. Well, thank you very much.

Operator, Operator

We'll take our next question from Steve Silver with Argus Research.

Steve Silver, Analyst

Thanks everybody. Thanks for taking the questions. Most of my questions have now been answered. That was a very great level of detail, you guys provided, so thanks for that. I guess, the last question that I had related to the mention of significant learnings on Travelzoo META. Just trying to get a sense, as to whether there's something more specific in terms of the learnings that you guys have acquired whether that relates more to just the potential demographics for the offering or whether there's just something embedded in the offering itself, that you guys have learned along the way as you develop.

Arveena Ahluwalia, Global Director Travelzoo META

Sure. I can take that. So as you know, we are proceeding with a test-and-learn strategy, and the test launch, which was conducted in Q2, was to really determine the feasibility of our strategy. The test was conducted, as mentioned previously, in a controlled manner both internally and externally to a limited set of users. And we did acquire significant data from this test, and we have tweaked our strategy accordingly. Now, also given our attempt to be the first mover in providing travel experiences in the Metaverse, please understand at this time, we can only provide limited information, but we have been following up with the data and analytics provided from that study and implemented them in our current strategy.

Steve Silver, Analyst

Great. Your slide noted that 57% of the members you surveyed expressed interest in META. I'm curious to know if, as the product launches and you learn from the experience to make further improvements, you believe there will be an opportunity to engage those members who initially did not show interest over time.

Arveena Ahluwalia, Global Director Travelzoo META

Absolutely, that is the intention because like any early technology, the adoption rate is limited. Initially, there are the early adopters, but that grows. But absolutely, we do plan to at some point go after even people and pursue people who have not yet heard of the Metaverse or haven't expressed interest in the Metaverse yet.

Steve Silver, Analyst

Great. Thank you so much for taking the question.

Arveena Ahluwalia, Global Director Travelzoo META

Thank you.

Operator, Operator

We'll take our next question from Ed Woo with Ascendiant Capital. Please go ahead.

Ed Woo, Analyst

First, I want to say, welcome back Wayne. It's good to hear your voice. And then, the question I have is, we know how demand you mentioned is beginning to return back to normal. How much of it do you think is because of seasonality, or how much do you think it is because of the economy, or how much do you think it's just people already getting the initial travel out of the way and may not have that kind of high demand that they had previously?

Holger Bartel, CEO

Ed, I think we just see this across all industries. In any country in the world, we had this pandemic, and that changed consumer behavior and they used more tech. They were at home. They went out less. They traveled less. And now everything is going back to normal and almost see anywhere on any front. Seasonality was different. Seasonality is going back to normal. So, I think we're seeing exactly the same in the travel industry. I would say, also that the pandemic has probably made people in general more interested in traveling because once you're actually at home for two years and you're not going anywhere, you really realize what you have been missing. So, that's not only coming from me, but from other companies as well. We are hearing that generally consumers will probably after this pandemic have more interest in experiences in travel, and we still see in the past I sometimes talked about sort of bucket list experiences that people are looking for. And we still see at Travelzoo that, in general, members are interested in trips, vacations, and experiences that include things that go beyond what is normal, higher price points, better hotels, better trips, more activities. They want to do something special. Today we have an offer in the US for our members for travel hunting in Italy. We already heard from several members, back, great, I always dreamed about doing that. And that's the kind of behavioral change that we see among consumers. But otherwise, I think in the next year and probably more quickly than expected, things will shift back to the normal patterns we had before the pandemic.

Ed Woo, Analyst

Great. And my last question is just on the macro environment, you mentioned that a lot of these travel suppliers, hotels are ramping up. But have we seen them slow down or actually cut back again, because they're concerned that we have various macro issues in the US and globally?

Holger Bartel, CEO

No, I haven't heard about it.

Ed Woo, Analyst

Great. Well, thanks for answering my question, and I wish you guys good luck. Thank you.

Holger Bartel, CEO

Sure.

Operator, Operator

And I would now like to turn the call back to Mr. Holger Bartel. Please go ahead.

Holger Bartel, CEO

Yes. So, thank you for your interest in today's call, and we look forward to speaking with you again next year or next time and have a great day.

Operator, Operator

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