10-Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________________________________________________
Form 10-Q
______________________________________________________________________________ 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
or 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             .
Commission File No.: 000-50171
_______________________________________________________________________________ 
TRAVELZOO INC.
(Exact name of registrant as specified in its charter)
 ________________________________________________________________________________
DELAWARE
36-4415727
(State or other jurisdiction of
incorporation or organization)
(I.R.S. employer
identification no.)
 
 
590 Madison Avenue, 37th Floor
New York, New York
10022
(Address of principal executive offices)
(Zip code)
Registrant’s telephone number, including area code: (212) 484-4900
_________________________________________________________________________________ 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): 
Large accelerated filer
¨
Accelerated filer
x
 
 
 
 
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
The number of shares of Travelzoo common stock outstanding as of November 9, 2015 was 14,730,454 shares.

1



TRAVELZOO INC.
Table of Contents
 

PART I—FINANCIAL INFORMATION
Page
 
 
 
 
PART II—OTHER INFORMATION
 
 
 
 
 
 
 
 

2




PART I—FINANCIAL INFORMATION

Item 1.        Financial Statements

TRAVELZOO INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except par value) 

 
September 30,
2015
 
December 31,
2014
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
34,570

 
$
55,417

Accounts receivable, less allowance for doubtful accounts of $374 and $444 as of September 30, 2015 and December 31, 2014, respectively
17,822

 
16,124

Income tax receivable
1,745

 
3,756

Deposits
717

 
86

Deferred tax assets
1,214

 
1,311

Prepaid expenses and other
2,639

 
2,802

Total current assets
58,707

 
79,496

Deposits
607

 
1,436

Deferred tax assets
1,935

 
1,432

Restricted cash
1,346

 
1,393

Property and equipment, net
8,361

 
9,498

Intangible assets, net
15

 
178

Total assets
$
70,971

 
$
93,433

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
23,031

 
$
26,984

Accrued expenses and other
11,654

 
11,814

Deferred revenue
1,268

 
1,472

Income tax payable
857

 
574

Reserve for unexchanged promotional shares

 
1,393

Total current liabilities
36,810

 
42,237

Note payable to related party
5,658

 
1,000

Long-term tax liabilities
3,087

 
10,936

Long-term deferred rent and other
3,030

 
3,433

Commitments and contingencies

 

Stockholders’ equity:
 
 
 
Preferred stock, $0.01 par value per share (5,000 shares authorized; none issued)

 

Common stock, $0.01 par value (40,000 shares authorized; 15,801 shares issued, 14,730 shares outstanding as of September 30, 2015 and December 31, 2014)
163

 
163

Treasury stock (at cost, 1,071 shares at September 30, 2015 and December 31, 2014)
(21,517
)
 
(21,517
)
Additional paid-in capital
30,732

 
30,586

Retained earnings
16,892

 
29,197

Accumulated other comprehensive loss
(3,884
)
 
(2,602
)
Total stockholders’ equity
22,386

 
35,827

Total liabilities and stockholders’ equity
$
70,971

 
$
93,433

 
See accompanying notes to unaudited condensed consolidated financial statements.

3



TRAVELZOO INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Revenues
$
33,728

 
$
36,307

 
$
109,665

 
$
118,949

Cost of revenues
4,742

 
4,813

 
14,496

 
14,534

Gross profit
28,986

 
31,494

 
95,169

 
104,415

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
19,089

 
21,570

 
61,881

 
62,782

Product development
2,917

 
3,108

 
9,212

8,370

8,370

General and administrative
6,120

 
7,220

 
17,906

 
21,399

Unexchanged promotional shares

 
(2,250
)
 

 
(5,750
)
Total operating expenses
28,126

 
29,648

 
88,999

 
86,801

Income from operations
860

 
1,846

 
6,170

 
17,614

Other income (loss)
(202
)
 
95

 
(866
)
 
439

Income before income taxes
658

 
1,941

 
5,304

 
18,053

Income taxes
(8,199
)
 
158

 
(5,125
)
 
4,905

Net income
$
8,857

 
$
1,783

 
$
10,429

 
$
13,148

Basic net income per share
$
0.60

 
$
0.12

 
$
0.71

 
$
0.89

Diluted net income per share
$
0.60

 
$
0.12

 
$
0.71

 
$
0.88

Shares used in computing basic net income per share
14,730

 
14,730

 
14,730

 
14,781

Shares used in computing diluted net income per share
14,730

 
14,771

 
14,730

 
14,923


See accompanying notes to unaudited condensed consolidated financial statements.


4



TRAVELZOO INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(In thousands)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Net income
$
8,857

 
$
1,783

 
$
10,429

 
$
13,148

Other comprehensive loss:
 
 
 
 
 
 
 
Foreign currency translation adjustment
(362
)
 
(1,470
)
 
(1,282
)
 
(1,092
)
Total comprehensive income
$
8,495

 
$
313

 
$
9,147

 
$
12,056


See accompanying notes to unaudited condensed consolidated financial statements.


5



TRAVELZOO INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Nine Months Ended
 
September 30,
 
2015
 
2014
Cash flows from operating activities:
 
 
 
Net income
$
10,429

 
$
13,148

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
2,198

 
2,132

Impairment of software

 
249

Provision for losses on accounts receivable
(99
)
 
(5
)
Stock-based compensation
146

 
834

Deferred income tax
(407
)
 
(108
)
Net foreign currency effect
789

 
(316
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(2,052
)
 
(1,656
)
Deposits
118

 
248

Income tax receivable
1,980

 
(951
)
Prepaid expenses and other
123

 
742

Accounts payable
(2,706
)
 
(9,514
)
Reserve for unexchanged promotional shares
(1,393
)
 
(7,184
)
Accrued expenses
(508
)
 
(463
)
Income tax payable
306

 
1,806

Other non-current liabilities
(7,849
)
 
381

Net cash provided by (used in) operating activities
1,075

 
(657
)
Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(885
)
 
(3,185
)
Release of restricted cash
66

 
202

Net cash used in investing activities
(819
)
 
(2,983
)
Cash flows from financing activities:
 
 
 
Payment for the acquisition of the Asia Pacific business
(16,974
)
 

Payment of loan to related party
(3,250
)
 

Proceeds from loan from related party
2,224

 

Decrease in bank overdraft
(341
)
 

Repurchase of common stock

 
(5,855
)
Reverse/forward stock split, including transaction costs
(102
)
 
(479
)
Net cash used in financing activities
(18,443
)
 
(6,334
)
Effect of exchange rate changes on cash and cash equivalents
(2,660
)
 
(934
)
Net decrease in cash and cash equivalents
(20,847
)
 
(10,908
)
Cash and cash equivalents at beginning of period
55,417

 
68,668

Cash and cash equivalents at end of period
$
34,570

 
$
57,760

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for income taxes, net
742

 
3,916

Note payable for the acquisition of the Asia Pacific business
5,658

 

See accompanying notes to unaudited condensed consolidated financial statements.

6



TRAVELZOO INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1: The Company and Basis of Presentation
Travelzoo Inc. (the “Company” or “Travelzoo”) is a global media commerce company. We inform over 28 million members in North America, Europe and Asia Pacific, as well as millions of website users, about the best travel, entertainment and local deals available from thousands of companies. Our deal experts source, research and test-book offers, recommending only those that meet Travelzoo’s rigorous quality standards. We provide travel, entertainment, and local businesses with a fast, flexible, and cost effective way to reach millions of consumers. Our revenues are generated primarily from advertising fees.
Our publications and products include the Travelzoo websites (www.travelzoo.com, www.travelzoo.ca, www.travelzoo.co.uk, www.travelzoo.de, www.travelzoo.es, www.travelzoo.fr, cn.travelzoo.com, www.travelzoo.co.jp, www.travelzoo.com.au, www.travelzoo.com.hk, www.travelzoo.com.tw, among others), the Travelzoo Top 20 e-mail newsletter, the Newsflash e-mail alert service, the SuperSearch pay-per-click travel search tool, and the Travelzoo Network, a network of third-party websites that list travel deals published by Travelzoo. Our Travelzoo websites include Local Deals and Getaways listings that allow our members to purchase vouchers for deals from local businesses such as spas, hotels and restaurants. We receive a percentage of the face value of the voucher from the local businesses. We also operate Fly.com, a travel search engine that allows users to quickly and easily find the best prices on flights from hundreds of airlines and online travel agencies.
Ralph Bartel, who founded Travelzoo and who is a Director of the Company is the sole beneficiary of the Ralph Bartel 2005 Trust, which is the controlling shareholder of Azzurro Capital Inc. ("Azzurro"). As of September 30, 2015, Azzurro is the Company's largest stockholder, holding approximately 50.4% of the Company's outstanding shares.
On August 20, 2015 we acquired the Travelzoo Asia Pacific business (“Asia Pacific”), which includes the Travelzoo businesses in Australia, China, Hong Kong, Japan, Taiwan, and Southeast Asia. This business was independently operated by Azzurro Capital Inc. under a licensing agreement with Travelzoo Inc. Azzurro was the majority stockholder of the Travelzoo Asia Pacific business. Travelzoo Inc. accounted for the acquisition as a common control transaction and change in reporting entity. The financial results for Travelzoo Inc. have been retrospectively adjusted to include the financial results of Asia Pacific in the current and prior periods as though the transaction occurred at the beginning of each period presented. The Asia Pacific assets and liabilities have been combined with Travelzoo Inc. at their carrying values as though the transaction occurred at the beginning of each period presented. The Asia Pacific transaction proceeds were reflected as an equity transaction, included in retained earnings, during the period the transaction occurred, which was in the three months ended September 30, 2015.
See Note 12 to the accompanying unaudited condensed consolidated financial statements for further information on the acquisition of Asia Pacific.
Certain prior period statement of operations amounts have been reclassified to conform to the current period presentation primarily due to the Company's allocation of facilities costs to all of its operating activities and separate disclosure of product development costs as shown below (in thousands):

 
Period Ending September 30, 2014
 
3 months
 
9 months
Cost of revenues
$
100

 
$
261

Sales and marketing
2,188

 
6,546

Product development
3,038

 
8,161

General and administrative
(5,326
)
 
(14,968
)
 
$

 
$



7



The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with the rules and regulations of the U.S. Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted in accordance with such rules and regulations. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position of the Company and its results of operations and cash flows. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and related notes as of and for the year ended December 31, 2014, included in the Company’s Form 10-K filed with the SEC on February 17, 2015.
The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, including the recently acquired Asia Pacific subsidiaries reflected in the current and prior periods. All significant intercompany accounts and transactions have been eliminated in consolidation. All foreign subsidiaries use the local currency of their respective countries as their functional currency. Assets and liabilities are translated into U.S. dollars at exchange rates prevailing at the balance sheet dates. Revenues, costs and expenses are translated into U.S. dollars at average exchange rates for the period.
The results of operations for the three and nine months ended September 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015 or any other future period, and the Company makes no representations related thereto.
Note 2: Net Income Per Share
Basic net income per share is computed using the weighted-average number of common shares outstanding for the period. Diluted net income per share is computed by adjusting the weighted-average number of common shares outstanding for the effect of dilutive potential common shares outstanding during the period. Potential common shares included in the diluted calculation consist of incremental shares issuable upon the exercise of outstanding stock options calculated using the treasury stock method.
The following table sets forth the calculation of basic and diluted net income per share (in thousands, except per share amounts):
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Basic net income per share:
 
 
 
 
 
 
 
Net income
$
8,857

 
$
1,783

 
$
10,429

 
$
13,148

Weighted average common shares
14,730

 
14,730

 
14,730

 
14,781

Basic net income per share
$
0.60

 
$
0.12

 
$
0.71

 
$
0.89

Diluted net income per share:
 
 
 
 
 
 
 
Net income
$
8,857

 
$
1,783

 
$
10,429

 
$
13,148

Weighted average common shares
14,730

 
14,730

 
14,730

 
14,781

Effect of dilutive securities: stock options

 
41

 

 
142

Diluted weighted average common shares
14,730

 
14,771

 
14,730

 
14,923

Diluted net income per share
$
0.60

 
$
0.12

 
$
0.71

 
$
0.88

For the three and nine months ended September 30, 2015 and September 30, 2014, options to purchase 775,000 and 150,000 shares of common stock, respectively, were not included in the computation of diluted net income per share because the effect would have been anti-dilutive.

8



Note 3: Financial Instruments
The following tables summarize our financial assets measured at fair value on a recurring basis at September 30, 2015 and December 31, 2014 (in thousands):
 
Fair Value Measurements at Reporting Date Using
 
 
 
Quoted Prices in
Active Markets
for Identical
Assets
 
Significant
Other
Observable
Inputs
 
Significant
Unobservable
Inputs
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Balance at September 30, 2015
 
 
 
 
 
 
 
Cash
$
34,570

 
$
34,570

 
$

 
$

Total cash
$
34,570

 
$
34,570

 
$

 
$

Certificates of deposit
$
705

 
$

 
$
705

 
$

Merchant bank deposit
744

 
744

 

 

Total restricted cash and cash equivalent
$
1,449

 
$
744

 
$
705

 
$

 
 
 
 
 
 
 
 
Balance at December 31, 2014
 
 
 
 
 
 
 
Cash
$
55,417

 
$
55,417

 
$

 
$

Total cash
$
55,417

 
$
55,417

 
$

 
$

Certificates of deposit
$
762

 
$

 
$
762

 
$

Merchant bank deposit
800

 
800

 

 

Total restricted cash and cash equivalent
$
1,562

 
$
800

 
$
762

 
$

At September 30, 2015, accounts receivable and accounts payable are not measured at fair value; however, the Company believes that the carrying amounts of these assets and liabilities are a reasonable estimate of their fair value because of their relative short maturity. Accounts receivable and accounts payable are categorized as Level 2.
There have been no transfers and no changes in valuation methods for these assets or liabilities for the periods ended September 30, 2015 and December 31, 2014.
Note 4: Intangible Assets
Intangible assets consist of the following (in thousands):
 
 
September 30,
2015
 
December 31,
2014
Internet domain names and technology
$
2,787

 
$
2,787

Accumulated amortization
(2,772
)
 
(2,609
)
Total
$
15

 
$
178

Intangible assets have a useful life of 3 to 5 years. For the three months ended September 30, 2015 and 2014, amortization expense was $55,000 and $69,000, respectively. For the nine months ended September 30, 2015 and 2014, amortization expense was $163,000 and $175,000, respectively.
Future expected amortization expense related to intangible assets at September 30, 2015 is as follows (in thousands):
 
Remainder of 2015
$
15

Total
$
15

The expected amortization expense is an estimate. Actual amounts of amortization expense may differ from estimated amounts due to additional intangible asset acquisitions, impairment of intangible assets, accelerated amortization of intangible assets and other events.

9



Note 5: Commitments and Contingencies
On September 28, 2012, Metasearch Systems, LLC filed a lawsuit in the U.S. District Court for the District of Delaware against Travelzoo Inc. d/b/a Fly.com alleging infringement of several U.S. patents. Metasearch Systems alleges that the trip-planning metasearch service available on Fly.com infringes one or more claims of the asserted patents. During September 2012, Metasearch Systems filed similar lawsuits against several of Travelzoo's competitors including Expedia, Inc., Orbitz Worldwide, Inc., Travelocity.com, LP, Priceline.com, Inc., Yahoo! Inc., American Express Company, Kayak Software Corp., and BookIt.com. The parties agreed to submit certain Metasearch Systems patents for a post-grant review with the U.S. Patent and Trademark Office, which were determined to be unpatentable upon review. During three months ended September 30, 2015, based upon the U.S. Patent and Trademark Office findings, the court granted the parties' motion to dismiss this action.
The Company was formed as a result of a combination and merger of entities founded by the Company’s principal stockholder, Ralph Bartel. In 2002, Travelzoo.com Corporation was merged into Travelzoo Inc. Under and subject to the terms of the merger agreement, holders of promotional shares of Travelzoo.com Corporation (“Netsurfers”) who established that they had satisfied certain prerequisite qualifications were allowed a period of 2 years following the effective date of the merger to receive one share of Travelzoo Inc. in exchange for each share of common stock of Travelzoo.com Corporation. In 2004, two years following the effective date of the merger, certain promotional shares remained unexchanged. As the right to exchange these promotional shares expired, no additional shares were reserved for issuance. Thereafter, the Company began to offer a voluntary cash program for those who established that they had satisfied certain prerequisite qualifications for Netsurfer promotional shares as further described below.
Beginning in 2010, the Company became subject to unclaimed property audits of various states in the United States related to the above unexchanged promotional shares. The Company recorded charges for the estimated settlements with these states of $20.0 million, $3.0 million and $22.0 million in 2011, 2012 and 2013, respectively. In 2014, the Company released $7.6 million of the reserve related to the completion of settlements with the states.
Although the Company has settled the unclaimed property claims with all states, the Company may still receive inquiries from certain potential Netsurfer promotional stockholders that had not provided their state of residence to the Company by April 25, 2004. Therefore, the Company is continuing its voluntary program under which it makes cash payments to individuals related to the promotional shares for individuals whose residence was unknown by the Company and who establish that they satisfy the original conditions required for them to receive shares of Travelzoo.com Corporation, and who failed to submit requests to convert their shares into shares of Travelzoo Inc. within the required time period. This voluntary program is not available for individuals whose promotional shares have been escheated to a state by the Company, except those individuals for which their residence was unknown to the Company. The accompanying condensed consolidated financial statements include a charge in general and administrative expenses of $1,000 and $2,000 for these cash payments for the three and nine months ended September 30, 2015.
The total cost of this program cannot be reliably estimated because it is based on the ultimate number of valid requests received and future levels of the Company’s common stock price. The Company’s common stock price affects the liability because the amount of cash payments under the program is based in part on the recent level of the stock price at the date valid requests are received. The Company does not know how many of the requests for shares originally received by Travelzoo.com Corporation in 1998 were valid, but the Company believes that only a portion of such requests were valid. In order to receive payment under this voluntary program, a person is required to establish that such person validly held shares in Travelzoo.com Corporation.
The Company leases office space in Australia, Canada, China, France, Germany, Hong Kong, Japan, Singapore, Spain, Taiwan, the U.K., and the U.S. under operating leases which expire between December 31, 2015 and November 30, 2024. The Company has purchase commitments which represent the minimum obligations the Company has under agreements with certain vendors. These minimum obligations are less than our projected use for those periods. Payments may be more than the minimum obligations based on actual use.

10



The following table summarizes principal contractual commitments as of September 30, 2015 (in thousands): 
 
2015
 
2016
 
2017
 
2018
 
2019
 
Thereafter
 
Total
Operating leases
$
1,388

 
$
4,576

 
$
3,790

 
$
3,205

 
$
2,857

 
$
10,254

 
$
26,070

Purchase obligations
371

 
1,046

 
438

 
365

 

 

 
2,220

Note payable for the acquisition of the Asia Pacific business
99

 
396

 
396

 
5,911

 

 

 
6,802

Total commitments
1,858

 
6,018

 
4,624

 
9,481

 
2,857

 
10,254

 
35,092

Local Deals and Getaways merchant payables included in accounts payable were $16.6 million and $21.5 million, as of September 30, 2015 and December 31, 2014, respectively.

11



Note 6: Income Taxes
In determining the quarterly provisions for income taxes, the Company uses an estimated annual effective tax rate, which is generally based on our expected annual income and statutory tax rates in the U.S., Canada, Japan, Hong Kong and U.K. For the three months ended September 30, 2015 and 2014, the Company's effective tax rate was (1,246)% and 8.1%, respectively. For the nine months ended September 30, 2015, and September 30, 2014, the Company’s effective tax rate was (96.6)% and 27.2%, respectively. Our effective tax rate decreased for the three and nine months ended September 30, 2015 from the corresponding three and nine months ended September 30, 2014, due primarily to the recognition of an $8.4 million tax benefit related to the unexchanged promotional shares after a lapse of certain statute of limitations.
U.S. income and foreign withholding taxes have not been provided on undistributed earnings for certain non-U.S. subsidiaries. The undistributed earnings on a book basis for the non-U.S. subsidiaries as of September 30, 2015 are approximately $5.9 million. The Company intends to reinvest these earnings indefinitely in its operations outside the U.S. If the undistributed earnings are remitted to the U.S., these amounts would be taxable in the U.S. at the current federal and state tax rates net of foreign tax credits. Also, depending on the jurisdiction any distribution may be subject to withholding taxes at rates applicable for that jurisdiction. The estimated amount of the unrecognized deferred tax liability attributed to future dividend distributions of undistributed earnings is approximately $354,000 at September 30, 2015.
The Company maintains liabilities for uncertain tax positions. At September 30, 2015, the Company had approximately $2.2 million in total unrecognized tax benefits, if recognized, would favorably affect the Company’s effective income tax rate.
The Company’s policy is to include interest and penalties related to unrecognized tax positions in income tax expense. To the extent accrued interest and penalties do not ultimately become payable, amounts accrued will be reduced and reflected as a reduction in the overall income tax provision in the period that such determination is made. As of September 30, 2015 and December 31, 2014, the Company had approximately $857,000 and $1.5 million, respectively, in accrued interest and penalties related to uncertain tax positions. The Company is in various stages of multiple year examinations by federal taxing authorities. Although the timing of initiation, resolution and/or closure of audits is highly uncertain, it is reasonably possible that the balance of the gross unrecognized tax benefits related to the method of computing income taxes in certain jurisdictions and losses reported on certain income tax returns could significantly change in the next 12 months. These changes may occur through settlement with the taxing authorities or the expiration of the statute of limitations on the returns filed. The Company is unable to estimate the range of possible adjustments to the balance of the gross unrecognized tax benefits.
The Company files income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. The Company is subject to U.S. federal and certain state tax examinations for years after 2009 and is subject to California tax examinations for years after 2005. The Company's 2009 and 2010 federal income returns are currently under examination, including a review of the impact of the sale of Asia Pacific business segment in 2009. These examinations may lead to ordinary course adjustments or proposed adjustments to our taxes or our net operating income. The Company has received a Revenue Agent’s Report (RAR) generally issued at the conclusion of an IRS examination, which was consistent with the Notice of Proposed Adjustment we received earlier from the IRS for the 2009 calendar year related to the sale of our Asia Pacific business segment with additional penalties. The RAR proposes an increase to the Company's U.S. taxable income which would result in additional federal tax, federal penalty and state tax expense totaling approximately $31 million, excluding interest and state penalties, if any. The proposed adjustment is primarily driven by IRS’s view that the Asia Pacific business segment assets sold by the Company had a significantly higher valuation than the sales proceeds the Company received upon the sale. The Company disagrees with the proposed adjustments and intends to vigorously contest them. The Company did not make any adjustments to its liabilities for uncertain tax positions related to the RAR during the three months ended September 30, 2015 because the Company does not believe the IRS’s valuation of Asia Pacific business segment assets is appropriate. If we are not able to resolve these proposed adjustments at the IRS examination level, we plan to pursue all available administrative and, if necessary, judicial remedies.

12



Note 7: Accumulated Other Comprehensive Loss
The following table summarizes the changes in accumulated balances of other comprehensive loss (in thousands):
 
 
Three Months Ended
 
 
September 30,
 

2015
 
2014
Beginning balance

$
(3,522
)
 
$
4

Other comprehensive loss due to foreign currency translation, net of tax
 
(362
)
 
(1,470
)
Ending balance

$
(3,884
)
 
$
(1,466
)
 
 
 
 
 
 
 
Nine Months Ended
 
 
September 30,
 
 
2015
 
2014
Beginning balance
 
$
(2,602
)
 
$
(374
)
Other comprehensive loss due to foreign currency translation, net of tax
 
(1,282
)
 
(1,092
)
Ending balance
 
$
(3,884
)
 
$
(1,466
)
There were no amounts reclassified from accumulated other comprehensive loss for the three and nine months ended September 30, 2015 and 2014. Accumulated other comprehensive loss consists of foreign currency translation gains or losses.
Note 8: Stock-Based Compensation and Stock Options
In November 2009, the Company granted an executive stock options to purchase 300,000 shares of common stock with an exercise price of $14.97, of which 75,000 options vest and become exercisable annually starting July 1, 2011. The options expire in November 2019. As of September 30, 2015, 300,000 of these options were outstanding and vested. As of September 30, 2015 and 2014, there was no unrecognized stock-based compensation expense relating to these options. Total stock-based compensation for the three and nine months ended September 30, 2014 related to this option grant were nil and $375,000.
In January 2012, the Company granted certain executives stock options to purchase 100,000 shares of common stock with an exercise price of $28.98, of which 25,000 options become exercisable annually starting January 23, 2013. The options expire in January 2022. As of September 30, 2015, 50,000 options were outstanding and 37,500 of these options were vested. During 2014, 25,000 options were canceled and 25,000 options were forfeited upon the departure of an executive. Total stock-based compensation for the three months ended September 30, 2015 and 2014 related to the outstanding stock option grant were $60,000 for each period. Total stock-based compensation for the nine months ended September 30, 2015 and 2014 related to the outstanding stock option grant were $179,000 and $194,000, respectively. As of September 30, 2015, there was approximately $70,000 of unrecognized stock-based compensation expense relating to these options. This amount is expected to be recognized over 0.3 years.
In July 2013, the Company granted an executive stock options to purchase 75,000 shares of common stock with an exercise price of $29.58, of which 25,000 options become exercisable annually starting July 1, 2015. The options expire in July 2023. As of September 30, 2015, 25,000 options were outstanding and vested. Total stock-based compensation for the three months ended September 30, 2015 and 2014 related to the outstanding stock option grant was a reversal of expense of $217,000 and an expense of $89,000, respectively. Total stock-based compensation for the nine months ended September 30, 2015 and 2014 related to the outstanding stock option grant was a reversal of expense of $39,000 and an expense of $267,000, respectively. The reversal of expense during the three and nine months ended September 30, 2015, is related to previously recognized expense on the portion of options that are no longer expected to vest due to the planned departure of this executive. As of September 30, 2015, there was there was no unrecognized stock-based compensation expense relating to these options.
In September 2015, the Company granted an executive stock options to purchase 400,000 shares of common stock with an exercise price of $8.07, of which 50,000 options become exercisable quarterly starting March 31, 2016. The options expire in September 2025. As of September 30, 2015, 400,000 options were outstanding and none of these options were vested. Total stock-based compensation for the three and nine months ended September 30, 2015, related to this option grant was $7,000. As of September 30, 2015, there was approximately $1.8 million of unrecognized stock-based compensation expense relating to these options. This amount is expected to be recognized over 2.3 years. See Note 12 to the accompanying unaudited condensed consolidated financial statements for further information.

13



Note 9: Stock Repurchase Program
The Company's stock repurchase programs assist in offsetting the impact of dilution from employee equity compensation and for capital allocation purposes. Management is allowed discretion in the execution of the repurchase program based upon market conditions and consideration of capital allocation.
In July 2012, the Company announced a stock repurchase program authorizing the repurchase of up to 1,000,000 shares of the Company’s outstanding common stock. There were 29,000 shares remaining to be repurchased under this program as of December 31, 2013.
In January 2014, the Company announced a stock repurchase program authorizing the repurchase of up to 500,000 shares of the Company’s outstanding common stock. During the year ended December 31, 2014, the Company repurchased 261,000 shares of common stock for an aggregate purchase price of $5.9 million, which were recorded as part of treasury stock as of December 31, 2014. The Company did not repurchase any of its outstanding common stock during the three and nine months ended September 30, 2015. There were 268,000 shares remaining to be repurchased under this program as of September 30, 2015.

14



Note 10: Reverse/Forward Stock Split
On June 11, 2013, a Special Committee of the Company’s Board of Directors, consisting of three independent directors, unanimously approved a reverse/forward stock split transaction (collectively referred to as the “reverse/forward split”), subject to shareholder approval. The reverse/forward split was intended to reduce the Company’s shareholder account administration costs by reducing the number of its shareholders.
On September 12, 2013, at the Company’s annual shareholders meeting, Travelzoo shareholders voted in favor of the reverse/forward split, with the transaction receiving the votes of both (A) a majority of the issued and outstanding shares of common stock and (B) a majority of the issued and outstanding shares of common stock that are not held or controlled, directly or indirectly, by directors or officers of the Company, including, without limitation, the shares held by Azzurro, our principal stockholder.
On November 6, 2013, the Special Committee approved the execution of the transaction after receiving an opinion from a financial advisor regarding the fairness of the transaction from a financial point of view to the Company's shareholders whose positions, individually considered, consisted of fewer than 25 shares, of the per-share consideration to be received by such shareholders in the reverse/forward split. The Special Committee received legal counsel from Young Conaway Stargatt & Taylor, LLP in connection with its review of the transaction. In addition, the Company received legal counsel from Skadden, Arps, Slate, Meagher & Flom LLP and Bryan Cave LLP in connection with the transaction.
On November 6, 2013, based upon the Special Committee’s approval of the transaction and the receipt of a fairness opinion from the financial advisor, the Company executed the shareholder approved reverse/forward split.
The reverse/forward split transaction consisted of a 1-for-25 reverse stock split of the Company's outstanding common stock, followed immediately by a 25-for-1 forward stock split. Shareholders who held less than 25 shares immediately prior to the reverse stock split received a right to cash payment based on and equal to their resulting fractional interest times the price of a share equal to the higher of (a) the trailing ten day average trading price of the Company’s common stock immediately preceding the consummation date of the reverse/forward split or (b) the average aggregate sales price received in the sale on the open market of the shares resulting from aggregation of the fractionalized interests. Shareholders that held 25 or more shares of common stock immediately before the reverse/forward split did not receive a right to cash payment; instead these shareholders continued to hold the same number of shares after completion of the reverse/forward split as they held immediately prior. A description of the terms and conditions of the reverse/forward split was set forth in the Company’s definitive Proxy Statement for the 2013 annual shareholders meeting filed with the SEC on July 25, 2013.
The reverse/forward split resulted in approximately 643,218 of the Company’s outstanding shares being fractionalized. Shareholders holding less than 25 shares of common stock immediately prior to the reverse split did not receive fractional shares in the reverse stock split; instead these shareholders had their shares converted into the right to receive a cash payment in exchange for and in proportion to the fractional share interests resulting from the reverse stock split. To fund the cash payment due to shareholders that held a right to receive cash from the transaction, the fractional share interests were aggregated by the Company’s transfer agent, who sold the aggregated shares in the open market following the execution of the transaction.
As of December 31, 2013, the Company completed the sales of the aggregated fractional shares from the reverse/forward split in the open market and the sales proceeds of $13.6 million were held by the Company’s transfer agent in anticipation of the payment to be made to the fractionalized shareholders and were included in Funds Held for Reverse/Forward Stock Split on the Company’s balance sheet. As of December 31, 2013, the total amount payable of $13.7 million to fractionalized shareholders as a result of the execution of the reverse/forward split was reflected as a Payable to Shareholders for Reverse/Forward Stock Split on the Company’s balance sheet.
For the year ended December 31, 2014, the Company’s retained earnings includes a total adjustment of $346,000 related to the reverse/forward split, which includes transaction costs. For the nine months ended September 30, 2015, the Company’s retained earnings includes a total adjustment of $102,000 related to the reverse/forward split, which includes transaction costs. During the year ended December 31, 2014, the Company’s transfer agent issued checks amounting to $13.4 million to pay shareholders that held a right to cash in exchange for the fractional shares that were a result of the reverse/forward split. The Company's transfer agent intends to pay $190,000 due to the remaining shareholders that hold a right to cash after receiving the required documentation regarding their physical stock certificates. As of September 30, 2015, the sale proceeds of $190,000 are held by the Company’s transfer agent in anticipation of the payment to be made to the fractionalized shareholders and are included in Prepaid Expense and Other on the Company’s balance sheet. As of September 30, 2015, the total amount payable of $190,000 to fractionalized shareholders as a result of the execution of the reverse/forward split is included in Accrued Expenses and Other on the Company’s balance sheet.

15



Note 11: Segment Reporting and Significant Customer Information
The Company manages its business geographically and has three reportable operating segments: North America, Europe and Asia Pacific. North America consists of the Company’s operations in Canada and the U.S. Europe consists of the Company’s operations in France, Germany, Spain, and the U.K. On August 20, 2015, the Company acquired the Travelzoo Asia Pacific business (“Asia Pacific”), which includes the Travelzoo businesses in Australia, China, Hong Kong, Japan, Taiwan, and Southeast Asia.
Management relies on an internal management reporting process that provides revenue and segment operating income (loss) for making financial decisions and allocating resources. Management believes that segment revenues and operating income (loss) are appropriate measures of evaluating the operational performance of the Company’s segments.
The following is a summary of operating results and assets (in thousands) by business segment:
 
Three Months Ended September 30, 2015
North
America
 
Europe
 
Asia Pacific
 
Elimination and Other
 
Consolidated
Revenues from unaffiliated customers
$
20,538

 
$
10,444

 
$
2,746

 
$

 
$
33,728

Intersegment revenues
155

 
(127
)
 
(28
)
 

 

Total net revenues
20,693

 
10,317

 
2,718

 

 
33,728

Operating income (loss)
$
687

 
$
587

 
$
(414
)
 
$

 
$
860

 
Three Months Ended September 30, 2014
North
America
 
Europe
 
Asia Pacific
 
Elimination and Other
 
Consolidated
Revenues from unaffiliated customers
$
22,601

 
$
10,899

 
$
2,807

 
$

 
$
36,307

Intersegment revenues
321

 
(304
)
 
(17
)
 

 

Total net revenues
22,922

 
10,595

 
2,790

 

 
36,307

Operating income (loss)
$
265

 
$
195

 
$
(864
)
 
$
2,250

 
$
1,846

 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2015
North
America
 
Europe
 
Asia Pacific
 
Elimination and Other
 
Consolidated
Revenues from unaffiliated customers
$
68,978

 
$
32,560

 
$
8,127

 
$

 
$
109,665

Intersegment revenues
470

 
(422
)
 
(48
)
 

 

Total net revenues
69,448

 
32,138

 
8,079

 

 
109,665

Operating income (loss)
$
5,322

 
$
2,363

 
$
(1,515
)
 

 
$
6,170

 
Nine Months Ended September 30, 2014
North
America
 
Europe
 
Asia Pacific
 
Elimination and Other
 
Consolidated
Revenues from unaffiliated customers
$
74,130

 
$
36,451

 
$
8,368

 
$

 
$
118,949

Intersegment revenues
777

 
(706
)
 
(71
)
 

 

Total net revenues
74,907

 
35,745

 
8,297

 

 
118,949

Operating income (loss)
$
8,718

 
$
5,470

 
$
(2,324
)
 
$
5,750

 
$
17,614

 
As of September 30, 2015
North
America
 
Europe
 
Asia Pacific
 
Elimination
 
Consolidated
Long-lived assets
$
7,014

 
$
1,011

 
$
351

 
$

 
$
8,376

Total assets
$
75,679

 
$
52,023

 
$
5,824

 
$
(62,555
)
 
$
70,971

 
As of December 31, 2014
North
America
 
Europe
 
Asia Pacific
 
Elimination
 
Consolidated
Long-lived assets
$
7,678

 
$
1,507

 
$
491

 
$

 
$
9,676

Total assets
$
73,508

 
$
40,818

 
$
3,636

 
$
(24,529
)
 
$
93,433

Revenue for each segment is recognized based on the customer location within a designated geographic region. Property and equipment are attributed to the geographic region in which the assets are located.

16



For the three months ended September 30, 2015 and 2014, the Company did not have any customers that accounted for 10% or more of revenue. As of September 30, 2015 and December 31, 2014, the Company had one customer that accounted for 13% and 12%, respectively, of accounts receivable.
The following table sets forth the breakdown of revenues (in thousands) by category and segment. Travel revenue includes travel publications (Top 20, Website, Newsflash, Travelzoo Network), Getaways vouchers and hotel booking. Search revenue includes SuperSearch and Fly.com. Local revenue includes Local Deals vouchers and entertainment offers (vouchers and direct bookings). 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
North America
 
 
 
 
 
 
 
Travel
$
12,986

 
$
13,943

 
$
43,716

 
$
46,357

Search
3,816

 
4,216

 
12,453

 
12,441

Local
3,891

 
4,763

 
13,279

 
16,109

Total North America revenues
$
20,693

 
$
22,922

 
$
69,448

 
$
74,907

Europe
 
 
 
 
 
 
 
Travel
$
8,190

 
$
8,472

 
$
25,793

 
$
27,913

Search
725

 
455

 
2,064

 
2,604

Local
1,402

 
1,668

 
4,281

 
5,228

Total Europe revenues
$
10,317

 
$
10,595

 
$
32,138

 
$
35,745

Asia Pacific
 
 
 
 
 
 
 
Travel
2,426

 
2,322

 
7,029

 
6,916

Search
3

 
25

 
30

 
88

Local
289

 
443

 
1,020

 
1,293

Total Asia Pacific revenues
2,718

 
2,790

 
8,079

 
8,297

Consolidated
 
 
 
 
 
 
 
Travel
$
23,602

 
$
24,737

 
$
76,538

 
$
81,186

Search
4,544

 
4,696

 
14,547

 
15,133

Local
5,582

 
6,874

 
18,580

 
22,630

Total revenues
$
33,728

 
$
36,307

 
$
109,665

 
$
118,949

Revenue by geography is based on the billing address of the advertiser. Long-lived assets attributed to the U.S. and international geographies are based upon the country in which the asset is located or owned. The following table sets forth revenue for individual countries that exceed 10% of total revenue (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Revenue
 
 
 
 
 
 
 
United States of America
$
19,465

 
$
16,711

 
$
65,391

 
$
65,141

United Kingdom
6,686

 
7,023

 
21,413

 
23,763

Rest of the world
7,577

 
12,573

 
22,861

 
30,045

Total revenues
$
33,728

 
$
36,307

 
$
109,665

 
$
118,949

 

17



The following table sets forth long lived asset by geographic area (in thousands):  
 
As of September 30, 2015
 
As of December 31, 2014
United States of America
$
6,503

 
$
7,646

Rest of the world
1,873

 
2,030

Total long lived assets
$
8,376

 
$
9,676


Note 12: Related Party Transactions
On August 20, 2015, Travelzoo acquired the Travelzoo Asia Pacific business (“Asia Pacific”), which includes the Travelzoo businesses in Australia, China, Hong Kong, Japan, Taiwan, and Southeast Asia. This business was independently operated by Azzurro Capital Inc. ("Azzurro") under a licensing agreement with Travelzoo Inc. The Company held an option right to acquire Asia Pacific at fair market value as determined by a third party valuation expert. Under the terms of the definitive acquisition agreement, Travelzoo (Europe) Limited, a United Kingdom subsidiary of the Company, was authorized by the Company to exercise the option right to acquire Asia Pacific for a fair market transaction value of $22.6 million, subject to a working capital adjustment, using available cash of $17.0 million and a promissory note of $5.7 million with a maturity date of three years.
The Company’s board of directors established a special committee (the “Special Committee”), consisting of independent and disinterested directors and provided it with the exclusive power and authority to determine whether any potential transaction to acquire Asia Pacific was advisable, fair to and in the best interests of the Company's stockholders other than Azzurro Capital Inc., the principal stockholder of Travelzoo Inc. The Special Committee engaged independent legal counsel and an independent financial advisor, Stout Risius Ross, Inc. (“SRR”). The Special Committee obtained the right to select its own independent financial advisor, SRR, to independently determine the fair market value of Asia Pacific to be used as the option exercise price and received an opinion from SRR regarding the fairness of the Asia Pacific transaction from a financial point of view. SRR determined that $22.6 million represented the fair market value of Asia Pacific to be used as the option exercise price based upon the use of established valuation methodologies. The Special Committee, which was composed solely of independent and disinterested directors, unanimously approved the acquisition of Asia Pacific at the fair market value option exercise price with the assistance of its independent legal and financial advisors.
Ralph Bartel, who founded Travelzoo and who is a Director of the Company is the sole beneficiary of the Ralph Bartel 2005 Trust, which is the controlling shareholder of Azzurro Capital Inc. As of June 30, 2015, Azzurro held a proxy given to it by Holger Bartel that provides it with a total of 50.4% of the voting power. On July 2, 2015, Azzurro purchased 200,000 shares of the Company’s stock held by Holger Bartel; thereafter, and as of September 30, 2015, Azzurro directly held approximately 50.4% of the Company’s outstanding shares. In addition, Azzurro was the majority stockholder of the Travelzoo Asia Pacific business that was acquired by the Company.


18



Since Azzurro Capital Inc. had a controlling interest in both Travelzoo Inc. and the Travelzoo Asia Pacific business at the time of the transaction and in prior periods, this transaction is accounted for as a common control transaction and a change in reporting entity for the Company. The financial results for Travelzoo Inc. have been retrospectively adjusted to include the financial results of Asia Pacific in the current and prior periods as though the transaction occurred at the beginning of each period presented, including the following adjustments:
 
Three Months Ended
Nine Months Ended
 
September 30,
September 30,
 
2015
 
2014
 
2015
 
2014
Revenue
$
2,718

 
$
2,790

 
$
8,079

 
$
8,297

Operating loss
(414
)
 
(864
)
 
(1,515
)
 
(2,324
)
Net Loss
(480
)
 
(754
)
 
(2,148
)
 
(1,949
)
Other Comprehensive income
115

 
181

 
303

 
112

Basic and diluted earnings per share
$
(0.03
)
 
$
(0.05
)
 
$
(0.15
)
 
$
(0.13
)
The Asia Pacific assets and liabilities have been combined with Travelzoo Inc. at their carrying values as though the transaction occurred at the beginning of each period presented. At September 30, 2015, December 31, 2014 and September 30, 2014, Asia Pacific net liabilities, total assets minus total liabilities, were $6.0 million, $4.0 million and $2.8 million, respectively.
The Asia Pacific transaction proceeds of $22.6 million were reflected as an equity transaction, included in retained earnings, during the period the transaction occurred, which was in the three months ended September 30, 2015.
Travelzoo (Europe) Limited, a United Kingdom subsidiary of the Company, acquired the Asia Pacific business, which include certain customary seller indemnifications, through the acquisition of Travelzoo (Asia) Limited, including its wholly owned subsidiaries, and Travelzoo Japan KK. All significant intercompany accounts and transactions between Travelzoo Inc. and the acquired Asia Pacific entities have been eliminated for all periods presented.
In November 2014, Azzurro provided a loan to Asia Pacific of $1.0 million with a stated interest rate of 8%. During nine months ended September 30, 2015, Azzurro provide loans to the Asia Pacific amounting to $2.2 million with a stated interest rate of 10%. During the three months ended September 30, 2015, the Company repaid these loans amounting to a principal loan amount of $3.3 million and accrued interest of $128,000. On August 20, 2015, as part of the transaction proceeds Travelzoo (Europe) Limited issued a promissory note to Azzurro with a principal amount of $5.7 million, which is due in three years on August 20, 2018 and has a stated interest rate of 7%, which is due and payable on a quarterly basis. Accrued interest for the loans and promissory note outstanding was $84,000 and $166,000 for the three and nine months ended September 30, 2015. There were no loans outstanding and no accrued interest due to Azzurro during the three and nine months ended September 30, 2014.
On September 28, 2015, Holger Bartel, Executive Chairman and Chairman of the Board of Directors, was granted 400,000 stock options that vest through December 31, 2017 in connection with his appointment to the role of Global Chief Executive Officer. See Note 8 to the accompanying unaudited condensed consolidated financial statements for further information.



19



Item 2.        Management’s Discussion and Analysis of Financial Condition and Results of Operations
The information in this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are based upon current expectations, assumptions, estimates and projections about Travelzoo and our industry. These forward-looking statements are subject to the many risks and uncertainties that exist in our operations and business environment that may cause actual results, performance or achievements of Travelzoo to be different from those expected or anticipated in the forward-looking statements. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. For example, words such as “may”, “will”, “should”, “estimates”, “predicts”, “potential”, “continue”, “strategy”, “believes”, “anticipates”, “plans”, “expects”, “intends”, and similar expressions are intended to identify forward-looking statements. Travelzoo’s actual results and the timing of certain events could differ significantly from those anticipated in such forward-looking statements. Factors that might cause or contribute to such a discrepancy include, but are not limited to, those discussed elsewhere in this report in the section entitled “Risk Factors” and the risks discussed in our other SEC filings. The forward-looking statements included in this report reflect the beliefs of our management on the date of this report. Travelzoo undertakes no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other circumstances occur in the future.
Overview
Travelzoo Inc. (the “Company”or “Travelzoo”) is a global media commerce company. We inform over 28 million members in North America, Europe and Asia Pacific, as well as millions of website users, about the best travel and entertainment deals available from thousands of companies. Our deal experts source, research and test-book offers, recommending only those that meet Travelzoo’s rigorous quality standards. We provide travel, entertainment and local businesses with a fast, flexible, and cost-effective way to reach millions of consumers. Our revenues are generated primarily from advertising fees.
Our publications and products include the Travelzoo websites (www.travelzoo.com, www.travelzoo.ca, www.travelzoo.co.uk, www.travelzoo.de, www.travelzoo.es, www.travelzoo.fr, cn.travelzoo.com, www.travelzoo.co.jp, www.travelzoo.com.au, www.travelzoo.com.hk, www.travelzoo.com.tw, among others), the Travelzoo Top 20 e-mail newsletter, and the Newsflash e-mail alert service. We operate SuperSearch, a pay-per-click travel search tool, and the Travelzoo Network, a network of third-party websites that list deals published by Travelzoo. Our Travelzoo websites include Local Deals and Getaways listings that allow our members to purchase vouchers for deals from local businesses such as spas, hotels and restaurants. We receive a percentage of the face value of the voucher from the local businesses. We also operate Fly.com, a travel search engine that allows users to quickly and easily find the best prices on flights from hundreds of airlines and online travel agencies.
On August 20, 2015 we acquired the Travelzoo Asia Pacific business (“Asia Pacific”), which includes the Travelzoo businesses in Australia, China, Hong Kong, Japan, Taiwan, and Southeast Asia. This business was independently operated by Azzurro Capital Inc., under a licensing agreement with Travelzoo Inc. Azzurro was the majority stockholder of the Travelzoo Asia Pacific business. Travelzoo Inc. accounted for this transaction is accounted for as a common control transaction and change in reporting entity. The financial results for Travelzoo Inc. have been retrospectively adjusted to include the financial results of Asia Pacific in the current and prior periods as though the transaction occurred at the beginning of the each period presented. The Asia Pacific assets and liabilities have been combined with Travelzoo Inc. at their carrying values as though the transaction occurred at the beginning of each period presented. The Asia Pacific transaction proceeds were reflected as an equity transaction, included in retained earnings, during the period the transaction occurred, which was in the three months ended September 30, 2015.
See Note 12 to the accompanying unaudited condensed consolidated financial statements for further information on the acquisition of Asia Pacific.
Certain prior period statement of operations amounts have been reclassified to conform to the current period presentation primarily due to the Company's allocation of facilities costs to all of its operating activities and separate disclosure of product development costs. See Note 1 to the accompanying unaudited condensed consolidated financial statements for further information.
More than 2,000 companies use our services, including Air New Zealand, Apple Vacations, British Airways, Expedia, Fairmont Hotels and Resorts, Hawaiian Airlines, Iceland Air, InterContinental Hotels Group, Interstate Hotels & Resorts, Key Tours International, Liberty Travel, Princess Cruises, Starwood Hotels & Resorts Worldwide, TripAdvisor, United Airlines, and Virgin America.


20



We have three operating segments based on geographic regions: North America, Europe and Asia Pacific. North America consists of our operations in Canada and the U.S. Europe consists of our operations in France, Germany, Spain, and the U.K. Asia Pacific consists of our operations in Australia, China, Hong Kong, Japan, Taiwan, and Southeast Asia.
When evaluating the financial condition and operating performance of the Company, management focuses on financial and non-financial indicators such as growth in the number of members to the Company’s newsletters, operating margin, growth in revenues in the absolute and relative to the growth in reach of the Company’s publications measured as revenue per member and revenue per employee as a measure of productivity.
How We Generate Revenues
Our revenues are advertising revenues, consisting primarily of listing fees paid by travel companies, entertainment companies and local businesses to advertise their offers on Travelzoo’s media properties. Listing fees are based on audience reach, placement, number of listings, number of impressions, number of clicks, number of referrals, or percentage of the face value of vouchers sold. Insertion orders are typically for periods between one month and twelve months and are not automatically renewed. Merchant agreements for Local Deals and Getaways advertisers are typically for twelve months and are not automatically renewed. We have three separate groups of our advertising products: Travel, Search and Local.
Our Travel category of revenue includes the publishing revenue for negotiated high-quality deals from travel companies, such as hotels, airlines, cruises or car rentals and includes products such as Top 20, Website, Newsflash, Travelzoo Network, as well as Getaways vouchers and commission revenues from hotel booking reservations. The revenues generated from these products are based upon a fee for number of e-mails sent to our audience, a fee for clicks delivered to the advertisers, a fee for placement of the advertising on our website or a fee based on a percentage of the face value of vouchers sold or other items sold. We recognize revenue upon delivery of the e-mails, delivery of the clicks, over the period of placement of the advertising and upon the sale of the vouchers or other items sold. Commission revenues generated through provision of hotel booking reservations to hotels are recognized upon the estimated date the stay occurs at the hotel, which includes estimates of cancellations of the hotel bookings based upon historical patterns. If the hotel booking cannot be canceled then revenue is recognized upon booking.
Our Search category of revenue includes comparison shopping tools for consumers to quickly and easily compare airfares, hotel and car rental prices and includes SuperSearch and Fly.com products. The revenues generated from these products are based upon a fee for clicks delivered to the advertisers or a fee for clicks delivered to advertisers that resulted in revenue for advertisers (i.e., successful clicks). We recognize revenue upon delivery of the clicks or successful clicks.
Our Local category of revenue includes the publishing revenue for negotiated high-quality deals from local businesses, such as restaurants, spas, shows, and other activities and includes Local Deals vouchers and entertainment offers (vouchers and direct bookings). The revenues generated from these products are based upon a percentage of the face value of vouchers or items sold or a fee for clicks delivered to the advertisers. We recognize revenue upon the sale of the vouchers, when we receive notification of the direct bookings or upon delivery of the clicks. The Company earns a fee for acting as an agent in these transactions, which is recorded on a net basis and is included in revenue upon completion of the voucher sale. Certain merchant contracts in foreign locations allow us to retain fees related to vouchers sold that are not redeemed by purchasers upon expiration, which we recognize as revenue after the expiration of the redemption period and after there are no further obligations to provide funds to merchants, members or others.

21



Trends in Our Business
Our ability to generate revenues in the future depends on numerous factors such as our ability to sell more advertising to existing and new advertisers, our ability to increase our audience reach and advertising rates and our ability to develop and launch new products.
Our current revenue model primarily depends on advertising fees paid primarily by travel, entertainment and local businesses. A number of factors can influence whether current and new advertisers decide to advertise their offers with us. We have been impacted and expect to continue to be impacted by external factors such as the shift from offline to online advertising, the relative condition of the economy, competition and the introduction of new methods of advertising. The introduction of competing services and changing search algorithms by search engines such as Google, Yahoo! and Microsoft which may reduce the level or quality of Internet traffic to our services, in particular our Search products, SuperSearch and Fly.com, the competitive market pricing of voucher-based offerings may lead to us reducing our take rate (i.e., our commission) in order to maintain or grow the number of quality deals and merchants we are seeking. For example, the consolidation of the airline industry reduced our revenues generated from this sector, the reduction of capacity in the airline industry reduced demand to advertise for excess capacity, the introduction of new voucher-based products offered by competitors impacted our ability to sell our existing advertising products. A number of factors will have impact on our revenue, such as the reduction in spending by travel intermediaries due to their focus on improving profitability, the trend towards mobile usage by consumers, the willingness of consumers to purchase the deals we advertise, and the willingness of certain competitors to grow their business unprofitably. In addition, we have been impacted and expect to continue to be impacted by internal factors such as introduction of new advertising products, hiring and relying on key employees for the continued maintenance and growth of our business and ensuring our advertising products continue to attract the audience that advertisers desire. In response to declining Search product revenue, which includes SuperSearch and Fly.com products, the Company is reviewing the performance of these products, which may result in merging the products, discontinuing or replacing one or both of them. Challenges in traffic acquisition from search engines and poor monetization on mobile devices have led to declines in Search revenue. As we review these products and work on their improvement, revenue from our Search products may continue to decline.

Existing advertisers may shift from one advertising service (e.g. Top 20) to another (e.g. Local Deals and Getaways). These shifts between advertising services by advertisers could result in no incremental revenue or less revenue than in previous periods depending on the amount purchased by the advertisers, and in particular with Local Deals and Getaways, depending on how many vouchers are purchased by members. In addition, we are anticipating a shift from our existing hotel revenue to commission-based revenue as we expand the use of our hotel booking platform, which may result in lower revenue depending on volume of hotel bookings.

Local revenues have been and may continue to decline over time due to market conditions driven by competition and declines in consumer demand. Since the introduction of Local Deals in 2010 and Getaways in 2011, we have seen a decline in the number of vouchers sold and a decrease in the average take rate earned by us from the merchants for the voucher sold.
Our ability to continue to generate advertising revenue depends heavily upon our ability to maintain and grow an attractive audience for our publications. We monitor our members and page views of our websites to assess our efforts to maintain and grow our audience reach. We obtain additional members and activity on our websites by acquiring traffic from Internet search companies. The costs to grow our audience have had, and we expect to continue to have, a significant impact on our financial results and can vary from period to period. We may have to increase our expenditures on acquiring traffic to continue to grow or maintain our reach of our publications due to competition. We continue to see a shift in the audience accessing our services through mobile devices and social media. We are starting to address this growing channel of our audience through development of our mobile applications and through marketing on social media channels. However, we will have to keep pace with technological change and trend to further address this shift in the audience behavior in order to offset any related declines in revenue.
We believe that we can increase our advertising rates only if the reach of our publications increases. We do not know if we will be able to increase the reach of our publications. If we are able to increase the reach of our publications, we still may not be able to or want to increase rates given market conditions such as intense competition in our industry. We have not had any significant rate increase in recent years due to intense competition in our industry. Even if we increase our rates, the increased price may reduce the amount of advertisers willing to advertise with us and, therefore, decrease our revenue. We may need to decrease our rates based on competitive market conditions and the performance of our audience in order to maintain or grow our revenue.

22



We do not know what our cost of revenues as a percentage of revenues will be in future periods. Our cost of revenues will increase if the number of searches performed on Fly.com increases because we pay a fee based on the number of searches performed on Fly.com. Our cost of revenues will increase if the face value of vouchers that we sell for Local Deals and Getaways increases or the total number of vouchers sold increases because we have credit card fees based upon face value of vouchers sold, due to customer service costs related to vouchers sold and due to member refunds on vouchers sold. Our cost of revenues are expected to increase due to our effort to develop our hotel booking platform as well. We expect fluctuations in cost of revenues as a percentage of revenues from quarter to quarter. Some of the fluctuations may be significant and have a material impact on our results of operations.
We do not know what our sales and marketing expenses as a percentage of revenue will be in future periods. Increased competition in our industry may require us to increase advertising for our brand and for our products. In order to increase the reach of our publications, we have to acquire a significant number of new members in every quarter and continue to promote our brand. One significant factor that impacts our advertising expenses is the average cost per acquisition of a new member. Increases in the average cost of acquiring new members may result in an increase of sales and marketing expenses as a percentage of revenue. We believe that the average cost per acquisition depends mainly on the advertising rates which we pay for media buys, our ability to manage our member acquisition efforts successfully, and the degree of competition in our industry. We may decide to accelerate our member acquisition for various strategic and tactical reasons and, as a result, increase our marketing expenses. We expect the average cost per acquisition to increase with our increased expectations for the quality of the members we acquire. We may see an unique opportunity for a brand marketing campaign that will result in an increase of marketing expenses. In addition, there may be a significant number of members that cancel or we may cancel their subscription for various reasons, which may drive us to spend more on member acquisition in order to replace the lost members. Further, we expect to continue our strategy over time to replicate our business model in selected foreign markets to result in a significant increase in our sales and marketing expenses and have a material adverse impact on our results of operations. Due to the continued desire to grow our business in North America, Europe and Asia Pacific, we expect relatively high level of sales and marketing expenses in the foreseeable future. We expect fluctuations in sales and marketing expenses as a percentage of revenue from year to year and from quarter to quarter. Some of the fluctuations may be significant and have a material impact on our results of operations. We expect increased marketing expense to spur continued growth in members and revenue in future periods; however, we cannot be assured of this due to the many factors that impact our growth in members and revenue. We expect to adjust the level of such incremental spending during any given quarter based upon market conditions, as well as our performance in each quarter. We have increased and may continue to increase our spending on sales and marketing to increase the number of our members and address the growing audience from mobile and social media channels, as well as to increase our analytic capabilities to continuously improve the presentation of our offerings to our audience.
We do not know what our product development expenses as a percentage of revenue will be in future periods. There may be fluctuations that have a material impact on our results of operations. We expect our efforts on developing our product and services will continue to be focus in the future, which may lead to increased product development expenses. This increase in expense may be the result of an increase in headcount, the compensation related to existing headcount and the increased use of professional services. We expect our continued expansion into foreign markets and development of new advertising formats to result in a significant additional increase in our product development expenses. We expect to incur additional costs related to the development of our hotel platform capabilities, which we are developing, in part, to address the shift to mobile devices. In addition, we expect to incur additional costs related to the development of our search capabilities of our website and mobile applications.
We do not know what our general and administrative expenses as a percentage of revenue will be in future periods. There may be fluctuations that have a material impact on our results of operations. We expect our headcount to continue to increase in the future. The Company’s headcount is one of the main drivers of general and administrative expenses. Therefore, we expect our absolute general and administrative expenses to continue to increase. We expect our continued expansion into foreign markets to result in an increase in our general and administrative expenses. Our general and administrative expenses as a percentage of revenue may also fluctuate depending on the number of requests received related to a program under which the Company intends to make cash payments to people who establish that they were former stockholders of Travelzoo.com Corporation, whose claims were not escheated to states and who failed to submit requests to convert shares into Travelzoo Inc. within the required time period. We expect an increase in professional fees for various initiatives.
We do not know what our income taxes will be in future periods. There may be fluctuations that have a material impact on our results of operations. Our income taxes are dependent on numerous factors such as the geographic mix of our taxable income, federal and state and foreign country tax law and regulations and changes thereto, the determination of whether valuation allowances for certain tax assets are required or not, audits of prior years’ tax returns resulting in adjustments, resolution of uncertain tax positions and different treatment for certain items for tax versus books, such as the disposition of our Asia Pacific business segment in 2009. We expect fluctuations in our income taxes from year to year and from quarter to quarter. Some of the fluctuations may be significant and have a material impact on our results of operations.

23



The key elements of our growth strategy include building a travel and lifestyle brand with a large, high-quality user base and offering our users products that keep pace with consumer preference and technology, such as the trend toward mobile usage by consumers. We expect to continue our efforts to grow; however, we may not grow or we may experience slower growth. Some examples of our efforts to expand our business internationally since our inception in the U.S. have been expansion to the U.K. in 2005, Canada in 2006, Germany in 2006, France in 2007, Spain in 2008 and Asia Pacific in 2015. We also have launched new products to grow our revenue, such as the introduction of Fly.com in 2009, Local Deals in 2010, Getaways in 2011, as well as our mobile application launches in 2011 and 2012. In late 2012, we bought an online hotel booking platform to assist in our development of a product to better serve hotels and to facilitate the development of our hotel booking platform. We have also increased our spending on addressing the shift of our audience to mobile devices and social media.
We believe that we can sell more advertising if the market for online advertising continues to grow and if we can maintain or increase our market share. We believe that the market for advertising continues to shift from offline to online. We do not know if we will be able to maintain or increase our market share. We do not know if we will be able to increase the number of our advertisers in the future. We do not know if we will have market acceptance of our new products or whether the market will continue to accept our existing products.
Results of Operations
The following table sets forth, as a percentage of total revenues, the results from our operations for the periods indicated.
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Revenues
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
Cost of revenues
14.1

 
13.3

 
13.2

 
12.2

Gross profit
85.9

 
86.7

 
86.8

 
87.8

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
56.6

 
59.3

 
56.5

 
52.8

Product development
8.6

 
8.6

 
8.4

 
7.0

General and administrative
18.1

 
19.9

 
16.3

 
18.0

Unexchanged promotional shares

 
(6.2
)
 

 
(4.8
)
Total operating expenses
83.3

 
81.6

 
81.2

 
73.0

Income from operations
2.6

 
5.1

 
5.6

 
14.8

Other income
(0.6
)
 
0.2

 
(0.8
)
 
0.4

Income before income taxes
2.0

 
5.3

 
4.8

 
15.2

Income taxes
(24.3
)
 
0.4

 
(4.7
)
 
4.1

Net income
26.3
%
 
4.9
%
 
9.5
%
 
11.1
%

24



Operating Metrics
The following table sets forth selected operating metrics in North America, Europe and Asia Pacific:
 
 
Three Months Ended
 
September 30,
 
2015
 
2014
North America
 
 
 
Total members (1)
17,231,000

 
16,954,000

Average cost per acquisition of a new member
$
2.31

 
$
2.99

Revenue per member (2)
$
5.47

 
$
6.02

Revenue per employee (3)
$
358,000

 
$
314,000

Mobile application downloads
2,685,000

 
2,235,000

Social media followers
2,219,000

 
1,711,000

Europe
 
 
 
Total members (1)
7,795,000

 
7,299,000

Average cost per acquisition of a new member
$
3.20

 
$
4.47

Revenue per member (2)
$
5.83

 
$
7.04

Revenue per employee (3)
$
273,000

 
$
276,000

Mobile application downloads
1,391,000

 
1,131,000

Social media followers
585,000

 
472,000

Asia Pacific
 
 
 
Total members (1)
3,420,000

 
3,566,000

Average cost per acquisition of a new member
$
2.25

 
$
2.15

Revenue per member (2)
$
2.99

 
$
3.00

Revenue per employee (3)
$
112,000

 
$
93,000

Mobile application downloads
548,000

 
355,000

Social media followers
382,000

 
363,000

Consolidated
 
 
 
Total members (1)
28,307,000

 
27,671,000

Average cost per acquisition of a new member
$
2.30

 
$
3.51

Revenue per member (2)
$
5.29

 
$
5.90

Revenue per employee (3)
$
282,000

 
$
257,000

Mobile application downloads
4,076,000

 
3,366,000

Social media followers
2,804,000

 
2,184,000


(1)
Members represent individuals who are signed up to receive one or more of our free email publications that present our travel, entertainment and local deals.
(2)
Annualized revenue divided by number of members at the beginning of the year.
(3)
Annualized revenue divided by number of employees at the end of the quarter.


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Revenues
The following table sets forth the breakdown of revenues (in thousands) by category and segment. Travel revenue includes travel publications (Top 20, Website, Newsflash, Travelzoo Network), Getaways vouchers and hotel booking. Search revenue includes SuperSearch and Fly.com. Local revenue includes Local Deals vouchers and entertainment offers (vouchers and direct bookings). 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
North America
 
 
 
 
 
 
 
Travel
$
12,986

 
$
13,943

 
$
43,716

 
$
46,357

Search
3,816

 
4,216

 
12,453

 
12,441

Local
3,891

 
4,763

 
13,279

 
16,109

Total North America revenues
$
20,693

 
$
22,922

 
$
69,448

 
$
74,907

Europe
 
 
 
 
 
 
 
Travel
$
8,190

 
$
8,472

 
$
25,793

 
$
27,913

Search
725

 
455

 
2,064

 
2,604

Local
1,402

 
1,668

 
4,281

 
5,228

Total Europe revenues
$
10,317

 
$
10,595

 
$
32,138

 
$
35,745

Asia Pacific
 
 
 
 
 
 
 
Travel
2,426

 
2,322

 
7,029

 
6,916

Search
3

 
25

 
30

 
88

Local
289

 
443

 
1,020

 
1,293

Total Asia Pacific revenues
2,718

 
2,790

 
8,079

 
8,297

Travel
$
23,602

 
$
24,737

 
$
76,538

 
$
81,186

Search
4,544

 
4,696

 
14,547

 
15,133

Local
5,582

 
6,874

 
18,580

 
22,630

Total revenues
$
33,728

 
$
36,307

 
$
109,665

 
$
118,949


North America
North America revenues decreased $2.2 million for the three months ended September 30, 2015 from the three months ended September 30, 2014. This decrease was primarily due to the decrease in Travel and Local revenues. The decrease in Travel revenue of $957,000 was primarily due to the decreased number of Getaways vouchers sold and paid clicks. The decrease in Local revenues of $872,000 was primarily due to the decreased number of Local Deals vouchers sold.
North America revenues decreased $5.5 million for the nine months ended September 30, 2015 from the nine months ended September 30, 2014. This decrease was due to the decrease in Local and Travel. The decrease in Local revenues of $2.8 million was primarily due to the decreased number of Local Deals vouchers sold. The decrease in Travel revenue of $2.6 million was primarily due to the decreased number of Getaways vouchers sold and paid clicks.
Europe
Europe revenues decreased $278,000 for the three months ended September 30, 2015 from the three months ended September 30, 2014. This decrease was primarily due to a $1.2 million negative impact from foreign currency movements relative to the U.S. dollar, offset by increase in Travel and Search revenues. The increase in Travel revenue of $728,000 was primarily due to increased number of emails sent and paid clicks. The increase in Search revenue of $301,000 was primarily due to the increased revenue per click.
Europe revenues decreased $3.6 million for the nine months ended September 30, 2015 from the nine months ended September 30, 2014. This decrease was primarily due to the $4.3 million negative impact from foreign currency movements relative to the U.S. dollar, the decrease in Local revenues, offset by the increase in Travel revenue. The decrease in Local revenues of $312,000 was primarily due to the decreased number of Local Deals vouchers sold. The increase in Travel revenue of $1.3 million was primarily due to the increased number of emails sent and paid clicks.

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Foreign currency movements relative to the U.S. dollar positively impacted our revenues from our operations in Europe by approximately $526,000 and $2.1 million for the three months and nine months ended September 30, 2014.
Asia Pacific
Asia Pacific revenues decreased $72,000 for the three months ended September 30, 2015 from the three months ended September 30, 2014. The decrease was primarily due to a $270,000 negative impact from foreign currency movements relative to the U.S. dollar and the decrease in Local revenues, offset by the increase in Travel revenues. The decrease in Local revenues of $110,000 was primarily due to the decreased number of Local Deals vouchers sold. The increase in Travel revenue of $327,000 was primarily due to the increased number of increased number of emails sent and paid clicks.
Asia Pacific revenues decreased $218,000 for the nine months ended September 30, 2015 from the nine months ended September 30, 2014. This decrease was primarily due to a $684,000 negative impact from foreign currency movements relative to the U.S. dollar, and the decrease in Local revenues, offset by the increase in Travel revenues. The decrease in Local revenues of $167,000 was primarily due to the decreased number of Local Deals vouchers sold. The increase in Travel revenue of $683,000 was primarily due to the increased number of increased number of emails sent and paid clicks.
For the three and nine months ended September 30, 2015 and 2014, none of our customers accounted for 10% or more of our revenue.
Cost of Revenues
Cost of revenues consists primarily of network expenses, including fees we pay for co-location services and depreciation and maintenance of network equipment, payments made to third-party partners of the Travelzoo Network, fees we pay related to user searches on Fly.com, amortization of capitalized website development costs, credit card fees, certain estimated member refunds and customer service costs associated with vouchers we sell, and salary expenses associated with network operations and customer service staff and facilities costs. Cost of revenues was $4.7 million and $4.8 million for the three months ended September 30, 2015 and September 30, 2014, respectively. Cost of revenues was $14.5 million for the nine months ended September 30, 2015 and September 30, 2014, respectively.
Operating Expenses
Sales and Marketing
Sales and marketing expenses consist primarily of advertising and promotional expenses, salary expenses associated with sales, marketing and production staff, expenses related to our participation in industry conferences, public relations expenses and facilities costs. Sales and marketing expenses were $19.1 million and $21.6 million for the three months ended September 30, 2015 and 2014, respectively. For the three months ended September 30, 2015 and 2014, advertising expenses accounted for 38% and 32%, respectively, of total sales and marketing expenses and consisted primarily of online advertising referred to as traffic acquisition cost and member acquisition costs. The goal of our advertising was to acquire new members to our e-mail products, increase the traffic to our websites, increase brand awareness and increase our audience through mobile and social media channels.

Sales and marketing expenses were $61.9 million and $62.8 million for the nine months ended September 30, 2015 and 2014, respectively. For the nine months ended September 30, 2015 and 2014 , advertising expenses accounted for 34% and 27%, respectively, of total sales and marketing expenses.
Sales and marketing expenses decreased $2.5 million for the three months ended September 30, 2015 from the three months ended September 30, 2014. The decrease was primarily due to a $1.7 million decrease in salary and employee related expenses due in part to a decrease in headcount.
Sales and marketing expenses decreased $901,000 for the nine months ended September 30, 2015 from the nine months ended September 30, 2014. The decrease was primarily due to a $2.1 million decrease in salary and employee related expenses due in part to a decrease in headcount, a $1.1 million planned decrease in Search traffic acquisition costs, offset by $2.0 million increase in member acquisition costs.

27



Product Development
Product development expenses consist primarily of compensation for software development staff, fees for professional services, software maintenance and amortization, and facilities costs. Product development expenses were $2.9 million and $3.1 million for the three months ended September 30, 2015 and 2014, respectively. Product development expenses were $9.2 million and $8.4 million for the nine months ended September 30, 2015 and 2014, respectively.
Product development expenses decreased $191,000 for three months ended September 30, 2015 from the three months ended September 30, 2014. The decrease was primarily due to a $179,000 decrease in salary and employee related expenses due in part to a decrease in headcount.
Product development expenses increased $842,000 for the nine months ended September 30, 2015 from the nine months ended September 30, 2014. The increase was primarily due to an increase in professional service expenses due in part to the development of our hotel platform capabilities.
General and Administrative
General and administrative expenses consist primarily of compensation for administrative, executive, bad debt expense, amortization of intangible assets, general office expense and facilities costs. General and administrative expenses were $6.1 million and $7.2 million for the three months ended September 30, 2015 and 2014, respectively. General and administrative expenses were $17.9 million and $21.4 million for the nine months ended September 30, 2015 and 2014, respectively.
General and administrative expenses decreased $1.1 million for the three months ended September 30, 2015 from the three months ended September 30, 2014. The decrease was primarily due to a $1.8 million decrease in salary and employee related expenses due in part to a decrease in headcount, offset by $600,000 of accrued compensation related to planned departure of an executive.
General and administrative expenses decreased $3.5 million for the nine months ended September 30, 2015 from the nine months ended September 30, 2014. The decrease was primarily due to a $3.8 million decrease in salary and employee related expenses due in part to a decrease in headcount, offset by $600,000 of accrued compensation related to planned departure of an executive.
Unexchanged Promotional Shares
During the three and nine month periods ending September 30, 2014, the Company released $2.3 million and $5.8 million, respectively, of reserves related to completion of settlements with certain states for unclaimed property disputes in connection with unexchanged promotional shares. See Note 5 to the accompanying unaudited condensed consolidated financial statements for further information on the unexchanged promotional shares contingency.
Income Taxes
Our income is generally taxed in the U.S., Canada, and U.K. Our income tax provisions reflect federal, state and country statutory rates applicable to our levels of worldwide income, adjusted to take into account expenses that are treated as having no recognizable tax benefit. Income tax benefit and expense was $8.2 million and $2.3 million for the three months ended September 30, 2015 and 2014, respectively. Our effective tax rate was (1,246)% and 8% for the three months ended September 30, 2015 and 2014, respectively. Income tax benefit and expense was $5.1 million and $4.9 million for the nine months ended September 30, 2015 and 2014, respectively. Our effective tax rate was (97)% and 27% for the nine months ended September 30, 2015 and 2014, respectively.
Our effective tax rate decreased for the three and nine months ended September 30, 2015 from the three and nine months ended September 30, 2014, due primarily to the recognition of an $8.4 million tax benefit related to the unexchanged promotional shares after a lapse of certain statute of limitations. We expect our effective tax rate to fluctuate in future periods depending on the geographic mix of our worldwide taxable income, losses or gains incurred by our operations in Asia Pacific, Canada and Europe, statutory tax rate changes that may occur, existing or new uncertain tax matters that may arise and require changes in tax reserves, and the need for valuation allowances on certain tax assets, if any.
U.S. income and foreign withholding taxes have not been provided on undistributed earnings for certain non-U.S. subsidiaries. The undistributed earnings on a book basis for those non-U.S. subsidiaries are approximately $5.9 million. The Company intends to reinvest these earnings indefinitely in its operations outside the U.S. If the undistributed earnings are remitted to the U.S., these amounts would be taxable in the U.S. at the current federal and state tax rates net of foreign tax

28



credits. Also, depending on the jurisdiction any distribution may be subject to withholding taxes at rates applicable for that jurisdiction.
We file income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. We are subject to U.S. federal and certain state tax examinations for years after 2009 and are subject to California tax examinations for years after 2005. Our 2009 and 2010 federal income tax returns are currently under examination, including a review of the impact of the sale of Asia Pacific business segment in 2009. During the year ended December 31, 2014, the Company received a Revenue Agent's Report (RAR) from the IRS, generally issued at the conclusion of an IRS examination. The RAR proposes an increase to our U.S. taxable income, which would result in additional federal tax, federal penalty and state tax expense totaling approximately $31.0 million, excluding interest and state penalties, if any. The Company did not make any adjustments to its liabilities for uncertain tax positions related to the RAR during the three months ended September 30, 2015 because the Company does not believe the IRS’s valuation of Asia Pacific business segment assets is appropriate. If we are not able to resolve these proposed adjustments at the IRS examination level, we plan to pursue all available administrative and, if necessary, judicial remedies.
North America
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
(In thousands)
Revenues
20,693

 
22,922

 
69,448

 
74,907

Income from operations
$
687

 
$
265

 
$
5,322

 
$
8,718

Income from operations as a % of revenues
3.3
%
 
1.2
%
 
7.7
%
 
11.6
%
North America net revenues decreased $2.2 million for the three months ended September 30, 2015 from the three months ended September 30, 2014 (see “Revenues” above). North America expenses decreased $2.5 million for the three months ended September 30, 2015 from the three months ended September 30, 2014. This decrease was primarily due to a $2.0 million decrease in salary and employee related expense due in part to a decrease in headcount.
North America net revenues decreased $5.5 million for the nine months ended September 30, 2015 from the nine months ended September 30, 2014 (see “Revenues” above). North America expenses decreased $2.1 million for the nine months ended September 30, 2015 from the nine months ended September 30, 2014. This decrease was primarily due to a $3.5 million decrease in salary and employee related expense due in part to a decrease in headcount, offset by a $1.2 million increase in member acquisition costs.
Europe
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
(In thousands)
Revenues
10,317

 
10,595

 
32,138

 
35,745

Income from operations
$
587

 
$
195

 
$
2,363

 
$
5,470

Income from operations as a % of revenues
5.7
%
 
1.8
%
 
7.4
%
 
15.3
%
Europe net revenues decreased $278,000 for the three months ended September 30, 2015 from the three months ended September 30, 2014 (see “Revenues” above). Europe expenses decreased $729,000 for the three months ended September 30, 2015 from the three months ended September 30, 2014. This decrease was primarily due to a $555,000 decrease in salary and employee related expense due in part to a decrease in headcount.
Europe net revenues decreased $3.6 million for the nine months ended September 30, 2015 from the nine months ended September 30, 2014 (see “Revenues” above). Europe expenses decreased $593,000 for the nine months ended September 30, 2015 from the nine months ended September 30, 2014. This decrease was primarily due to a $1.7 million decrease in salary and employee related expense due in part to a decrease in headcount, a $1.1 million decrease in search traffic acquisition costs, offset by a $2.4 million increase in member acquisition and marketing costs.

29



Foreign currency movements relative to the U.S. dollar positively impacted our local currency income from our operations in Europe by approximately $60,000 for the three months ended September 30, 2015. Foreign currency movements relative to the U.S. dollar positively impacted our income from our operations in Europe by approximately $69,000 for the three months ended September 30, 2014.
Foreign currency movements relative to the U.S. dollar positively impacted our local currency income from our operations in Europe by approximately $15,000 for the nine months ended September 30, 2015. Foreign currency movements relative to the U.S. dollar positively impacted our income from our operations in Europe by approximately $318,000 for the nine months ended September 30, 2014.

Asia Pacific  
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
(In thousands)
Revenues
2,718

 
2,790

 
8,079

 
8,297

Income from operations
$
(414
)
 
$
(864
)
 
$
(1,515
)
 
$
(2,324
)
Income from operations as a % of revenues
(15.2
)%
 
(31.0
)%
 
(18.8
)%
 
(28.0
)%
Asia Pacific net revenues decreased $72,000 for the three months ended September 30, 2015 from the three months ended September 30, 2014 (see “Revenues” above). Asia Pacific expenses decreased $522,000 for the three months ended September 30, 2015 from the three months ended September 30, 2014. This decrease was primarily due to a $360,000 decrease in salary and employee related expense due in part to a decrease in headcount.
Asia Pacific net revenues decreased $218,000 for the nine months ended September 30, 2015 from the nine months ended September 30, 2014 (see “Revenues” above). Asia Pacific expenses decreased $1.0 million for the nine months ended September 30, 2015 from the nine months ended September 30, 2014. This decrease was primarily due to a $506,000 decrease in salary and employee related expense due in part to a decrease in headcount and a $289,000 decrease in other marketing costs.
Foreign currency movements relative to the U.S. dollar negatively impacted our local currency loss from our operations in Asia Pacific by approximately $38,000 for the three months ended September 30, 2015. Foreign currency movements relative to the U.S. dollar negatively impacted our loss from our operations in Asia Pacific by approximately $9,000 for the three months ended September 30, 2014.
Foreign currency movements relative to the U.S. dollar negatively impacted our local currency loss from our operations in Asia Pacific by approximately $78,000 for the nine months ended September 30, 2015. Foreign currency movements relative to the U.S. dollar negatively impacted our loss from our operations in Asia Pacific by approximately $2,000 for the nine months ended September 30, 2014.
Liquidity and Capital Resources
As of September 30, 2015, we had $34.6 million in cash and cash equivalents, of which $19.2 million was held outside the U.S. in certain of our foreign operations. If these assets are distributed to the U.S., we may be subject to additional U.S. taxes in certain circumstances. Cash and cash equivalents decreased from $55.4 million as of December 31, 2014 primarily as a result of cash used in acquiring the Travelzoo Asia Pacific business, effect of exchange rate changes on cash and cash equivalents, offset by cash provided by operating activities as explained below. We expect that cash on hand will be sufficient to provide for working capital needs for at least the next twelve months.
 

30



 
Nine Months Ended September 30,
 
2015
 
2014
 
(In thousands)
Net cash provided by (used in) operating activities
$
1,075

 
$
(657
)
Net cash used in investing activities
(819
)
 
(2,983
)
Net cash used in financing activities
(18,443
)
 
(6,334
)
Effect of exchange rate changes on cash and cash equivalents
(2,660
)
 
(934
)
Net decrease in cash and cash equivalents
$
(20,847
)
 
$
(10,908
)

Net cash provided by operating activities is net income adjusted for certain non-cash items and changes in assets and liabilities. Net cash provided by operating activities for the nine months ended September 30, 2015 was $1.1 million which consisted of a net income of $10.4 million, adjustments for non-cash items of $2.6 million and a $11.9 million decrease in cash from changes in operating assets and liabilities. Adjustments for non-cash items primarily consisted of $2.2 million of depreciation and amortization expense on property and equipment. In addition, the decrease in cash from changes in operating assets and liabilities primarily consisted of $7.8 million in other non-current liabilities, $2.0 million in accounts receivable, $1.4 million in accrued expenses for unexchanged promotional shares, $3.2 million in accounts payable and accrued expenses, offset by $2.1 million in income tax receivable.
Cash paid for income tax net of refunds received during the nine months ended September 30, 2015 and September 30, 2014 was $742,000 and $3.9 million, respectively.
Net cash used in investing activities for the nine months ended September 30, 2015 and 2014, was $819,000 and $2.9 million, respectively. The cash used in investing activities for the nine months ended September 30, 2015 was primarily due to $885,000 in purchases of property and equipment. The cash used in investing activities for the nine months ended September 30, 2014 was due to $3.2 million purchases of property and equipment, offset by $202,000 release of restricted cash.
Net cash used in financing activities for the nine months ended September 30, 2015 and September 30, 2014, was $18.4 million and $6.3 million, respectively. Net cash used in financing activities for the nine months ended September 30, 2015 was primarily due to cash used in acquiring the Travelzoo Asia Pacific business. Net cash used in financing activities for the nine months ended September 30, 2014 was primarily due to repurchases of our common stock.

See Note 5 to the accompanying unaudited condensed consolidated financial statements for information on the unexchanged promotional share settlements and related cash program.
Although the Company has settled the states unclaimed property claims with all states, the Company may still receive inquiries from certain potential Netsurfer promotional stockholders that had not provided their state of residence to the Company by April 25, 2004. Therefore, the Company is continuing its voluntary program under which it makes cash payments to individuals related to the promotional shares for individuals whose residence was unknown by the Company and who establish that they satisfied the conditions to receive shares of Travelzoo.com Corporation, and who failed to submit requests to convert their shares into shares of Travelzoo Inc. within the required time period. This voluntary program is not available for individuals whose promotional shares have been escheated to a state by the Company.
Our capital requirements depend on a number of factors, including market acceptance of our products and services, the amount of our resources we devote to the development of new products, cash payments to former stockholders of Travelzoo.com Corporation or to their original domicile state as unclaimed property, expansion of our operations, and the amount of resources we devote to promoting awareness of the Travelzoo and Fly.com brands. Since the inception of the program under which we make cash payments to people who establish that they were former stockholders of Travelzoo.com Corporation, and who failed to submit requests to convert their shares into shares of Travelzoo Inc. within the required time period, we have incurred expenses of $2.9 million. While future payments for this program are expected to decrease, the total cost of this program is still undeterminable because it is dependent on our stock price and on the number of valid requests ultimately received.
Consistent with our growth, we have experienced fluctuations in our cost of revenues, sales and marketing expenses and our general and administrative expenses, including increases in product development costs, and we anticipate that these increases will continue for the foreseeable future. We believe cash on hand will be sufficient to pay such costs for at least the next twelve months. In addition, we will continue to evaluate possible investments in businesses, products and technologies, the consummation of any of which would increase our capital requirements.

31



Although we currently believe that we have sufficient capital resources to meet our anticipated working capital and capital expenditure requirements for at least the next twelve months, unanticipated events and opportunities or a less favorable than expected development of our business with one or more of advertising formats may require us to sell additional equity or debt securities or establish new credit facilities to raise capital in order to meet our capital requirements.
If we sell additional equity or convertible debt securities, the sale could dilute the ownership of our existing stockholders. If we issue debt securities or establish a new credit facility, our fixed obligations could increase, and we may be required to agree to operating covenants that would restrict our operations. We cannot be sure that any such financing will be available in amounts or on terms acceptable to us.
If the development of our business is less favorable than expected, we may decide to significantly reduce the size of our operations and marketing expenses in certain markets with the objective of reducing cash outflow.
The information set forth under “Note 5 — Commitments and Contingencies” to the accompanying unaudited condensed consolidated financial statements included in Part I, Item 1 of this report is incorporated herein by reference. Litigation and claims against the Company may result in legal defense costs, settlements or judgments that could have a material impact on our financial condition.
The following summarizes our principal contractual commitments as of September 30, 2015 (in thousands):
 
 
2015
 
2016
 
2017
 
2018
 
2019
 
Thereafter
 
Total
Operating leases
$
1,388

 
$
4,576

 
$
3,790

 
$
3,205

 
$
2,857

 
$
10,254

 
$
26,070

Purchase obligations
371

 
1,046

 
438

 
365

 

 

 
2,220

Note payable for the acquisition of the Asia Pacific business
$
99

 
$
396

 
$
396

 
$
5,911

 
$

 
$

 
$
6,802

Total commitments
$
1,858

 
$
6,018

 
$
4,624

 
$
9,481

 
$
2,857

 
$
10,254

 
$
35,092


We also have contingencies related to net unrecognized tax benefits, including interest, of approximately $3.0 million as of September 30, 2015. In addition, the Company received a Revenue Agents' Report from the IRS for the 2009 calendar year related to the sale of our Asia Pacific business segment, which would result in additional federal and state tax expense totaling approximately $31.0 million, excluding interest and penalties, if any. We are unable to make reasonably reliable estimates on the timing of the cash settlements with the respective taxing authorities, if any. See Note 6 to the accompanying unaudited condensed consolidated financial statements for further information.
Critical Accounting Policies
We believe that there are a number of accounting policies that are critical to understanding our historical and future performance, as these policies affect the reported amounts of revenue and the more significant areas involving management’s judgments and estimates. These significant accounting policies relate to revenue recognition, reserve for member refunds, allowance for doubtful accounts, income tax and loss contingencies. These policies, and our procedures related to these policies, are described in detail below.
Revenue Recognition
We recognize advertising revenues in the period in which the advertisement is displayed or the voucher sale has been completed, provided that evidence of an arrangement exists, the fees are fixed or determinable and collection of the resulting receivable is reasonably assured. If fixed-fee advertising is displayed over a term greater than one month, revenues are recognized ratably over the period as described below. The majority of insertion orders have terms that begin and end in a quarterly reporting period. In the cases where at the end of a quarterly reporting period the term of an insertion order is not complete, the Company allocates the total arrangement fee to each element based on the relative estimated selling price of each element. The Company uses prices stated on its internal rate card, which represents stand-alone sales prices, to establish estimated selling prices. The stand-alone price is the price that would be charged if the advertiser purchased only the individual insertion. Fees for variable-fee advertising arrangements are recognized based on the number of impressions displayed, number of clicks delivered, or number of referrals generated during the period. Under these policies, no revenue is recognized unless persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collection is deemed reasonably assured. The Company evaluates each of these criteria as follows:
Evidence of an arrangement. We consider an insertion order signed by the advertiser or its agency to be evidence of an arrangement.

32



Delivery. Delivery is considered to occur when the advertising has been displayed and, if applicable, the click-throughs have been delivered or the voucher sale has been completed, as applicable.
Fixed or determinable fee. We consider the fee to be fixed or determinable if the fee is not subject to refund or adjustment and payment terms are standard.
Collection is deemed reasonably assured. We conduct a credit review for all advertising transactions at the time of the arrangement to determine the creditworthiness of the advertiser. Collection is deemed reasonably assured if we expect that the advertiser will be able to pay amounts under the arrangement as payments become due. Collection is deemed not reasonably assured when an advertiser is perceived to be in financial distress, which may be evidenced by weak industry conditions, a bankruptcy filing, or previously billed amounts that are past due. If we determine that collection is not reasonably assured, then we defer the revenue and recognize the revenue upon cash collection. Collection is deemed reasonably assured for our voucher sales to consumers as these transactions require the use of credit cards subject to authorization.
Revenues from advertising sold to advertisers through agencies are reported at the amount billed to the agency.
For Local Deals and Getaways products, the Company earns a fee for acting as an agent in these transactions which is recorded on a net basis and is included in revenue upon completion of the voucher sale. Certain merchant contracts in foreign locations allow us to retain fees related to vouchers sold that are not redeemed by purchasers upon expiration, which we recognize as revenue after the expiration of the redemption period and after there are no further obligations to provide funds to merchants, members or others.
Commission revenues generated through provision of hotel booking reservations to hotels are recognized upon the estimated date the stay occurs at the hotel, which includes estimates of cancellations of the hotel bookings based upon historical patterns. If the hotel booking cannot be canceled then revenue is recognized upon booking.
Reserve for Member Refunds
We record an estimated reserve for member refunds based on our historical experience at the time revenue is recorded for Local Deals and Getaways voucher sales. We accrue costs associated with refunds in accrued expenses on the consolidated balance sheets. We consider many key factors such as the historical refunds based upon the time lag since the sale, historical reasons for refunds, time period that remains until the deal expiration date, any changes in refund procedures and estimates of redemptions and breakage. Should any of these factors change, the estimates made by management will also change, which could impact the level of our future reserves for member refunds. Specifically, if the financial condition of our advertisers, the businesses that are providing the vouchered services, were to deteriorate, affecting their ability to provide the services to our members, additional reserves for member refunds may be required.
Estimated member refunds that are determined to be recoverable from the merchant and the portion of which represents our fee from the merchant are recorded in the consolidated statements of operations as a reduction to revenue. Estimated member refunds that are determined not to be recoverable from the merchant are presented as a cost of revenue. If our judgments regarding estimated member refunds are inaccurate, reported results of operations could differ from the amount we previously accrued.
Allowance for Doubtful Accounts
We record a provision for doubtful accounts based on our historical experience of write-offs and a detailed assessment of our accounts receivable and allowance for doubtful accounts. In estimating the provision for doubtful accounts, management considers the age of the accounts receivable, our historical write-offs, the creditworthiness of the advertiser, the economic conditions of the advertiser’s industry, and general economic conditions, among other factors. Should any of these factors change, the estimates made by management will also change, which could impact the level of our future provision for doubtful accounts. Specifically, if the financial condition of our advertisers were to deteriorate, affecting their ability to make payments, additional provision for doubtful accounts may be required.

33



Income Taxes
We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate, as well as the related net interest.
Our effective tax rates have differed from the statutory rate primarily due to the tax impact of foreign operations, state taxes, certain benefits realized related to stock option activities, credits, the extent that our earnings are indefinitely reinvested outside the U.S. and tax asset valuation allowance determinations including on certain loss carryforwards. For the nine months ended September 30, 2015 and 2014, our effective tax rates were (97)% and 27%, respectively. Our future effective tax rates could be materially impacted by earnings being lower than anticipated in countries where we have lower statutory rates and higher than anticipated in countries where we have higher statutory rates, changes in the deferred tax assets or liabilities, existing or new uncertain tax matters that may arise and require changes in tax reserves, changes in tax asset valuation allowance determinations, changes in our judgment about whether certain foreign earnings are indefinitely reinvested outside the U.S., or changes in tax laws, regulations, and accounting principles. In addition, we are subject to the continuous examination of our income tax returns by the IRS and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. See Note 6 to the accompanying unaudited condensed consolidated financial statements for further information.
Loss Contingencies
We are involved in claims, suits, and proceedings arising from the ordinary course of our business. We record a provision for a liability when we believe that it is both probable that a liability has been incurred, and the amount can be reasonably estimated. Significant judgment is required to determine both probability and the estimated amount. Such claim proceedings are inherently unpredictable and subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to have been incorrect, it could have a material impact on our results of operations, financial position and cash flows. We have several known loss contingencies such as our liability to former stockholders of Travelzoo.com Corporation that may be realized as a result of our cash program for these claimants, state unclaimed property claims and a patent infringement lawsuit. Please refer to Note 5 to the accompanying unaudited condensed consolidated financial statements for further information regarding our loss contingencies.

Recent Accounting Pronouncements
In April 2014, the FASB issued an accounting standard update that changes the threshold and amends the requirements for reporting discontinued operations. Under the amended guidance, a disposal of a component of an entity or a group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results when the component or group of components meets the criteria to be classified as held for sale or when the component or group of components is disposed of by sale or other than by sale. For disposals of individually significant components that do not qualify as discontinued operations, an entity must disclose pre-tax earnings of the disposed component. For public business entities, this guidance is effective prospectively for all disposals (or classifications as held for sale) of components of an entity that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. Early adoption is permitted, but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issuance. This accounting standard update became effective for the Company in the first quarter of fiscal year 2015. The adoption of this accounting standard update did not have a material impact on the Company’s consolidated results of operations, financial position or cash flows.
In May, 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most of the existing revenue recognition guidance in U.S. GAAP when it becomes effective. This new accounting standard is effective for the Company on January 1, 2017. Early application is not permitted, however, in April 2015, the FASB agreed to propose a one-year deferral of the effective date. In July 2015, FASB has agreed to the one year deferral. The new standard will become effective for us in the first quarter of fiscal 2018. This new accounting standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU

34



2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.
In August 2014, the FASB issued an accounting standard update that requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued and provides guidance on determining when and how to disclose going concern uncertainties in the financial statements. Certain disclosures will be required if conditions give rise to substantial doubt about an entity’s ability to continue as a going concern. This accounting standard update applies to all entities and is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter, with early adoption permitted. This accounting standard update will be effective for the Company beginning in the first quarter of fiscal year 2017. The adoption of this accounting standard update is not expected to have a material impact on the Company’s consolidated results of operations, financial position or cash flows.





35



RISK FACTORS
Investing in our common stock involves a high degree of risk. Any or all of the risks listed below as well as other variables affecting our operating results could have a material adverse effect on our business, our quarterly and annual operating results or financial condition, which could cause the market price of our stock to decline or cause substantial volatility in our stock price, in which event the value of your common stock could decline. You should also keep these risk factors in mind when you read forward-looking statements.

Risks Related to Our Financial Condition and Business Model
We cannot assure you that we will be profitable.
For the nine months ended September 30, 2015 and September 30, 2014, we generated a profit of $10.4 million and $13.1 million, respectively. In the year ended December 31, 2014, we generated a net income of $13.1 million. In the year ended December 31, 2013, we incurred a net loss of $6.6 million. Although we were profitable in 2014 and the nine months ended September 30, 2015, there is no assurance that we will be profitable in the future. We forecast our future expense levels based on our operating plans and our estimates of future revenues. We may find it necessary to significantly accelerate expenditures relating to our sales and marketing efforts or otherwise increase our financial commitment to creating and maintaining brand awareness among Internet users and advertisers. We may also make investments in our products as well as develop new products that may impact our profitability. If our revenues grow at a slower rate than we anticipate or decline, or if our spending levels exceed our expectations or cannot be adjusted to reflect slower revenue growth, we may not generate sufficient revenues to be profitable. Any of these developments could result in a significant decrease in the trading price of our common stock.
Fluctuations in our operating results may negatively impact our stock price.
Our quarterly and annual operating results may fluctuate significantly in the future due to a variety of factors that could affect our revenues or our expenses in any particular period. You should not rely on quarter-to-quarter comparisons of our results of operations as an indication of future performance. Factors that may affect our quarterly results include:
mismatches between resource allocation and client demand due to difficulties in predicting client demand in a new market;
changes in general economic conditions that could affect marketing efforts generally and online marketing efforts in particular;
the magnitude and timing of marketing initiatives, including our acquisition of new members and our expansion efforts in other regions;
the introduction, development, timing, competitive pricing and market acceptance of our products and services and those of our competitors;
our ability to attract and retain key personnel;
our ability to manage our planned growth;
our ability to attract users to our websites, which may be adversely affected by the audience shift to mobile devices;
technical difficulties or system downtime affecting the Internet generally or the operation of our products and services specifically; and
volatility of our operating results in new markets.
We may significantly increase our operating expenses related to advertising campaigns for the Travelzoo and Fly.com brands, as well as our hotel booking platform, for a certain period if we see a unique opportunity for a brand marketing campaign, if we find it necessary to respond to increased brand marketing by a competitor, or if we decide to accelerate our acquisition of new members.
If revenues fall below our expectations in any quarter and we are unable to quickly reduce our operating expenses in response, our operating results would be lower than expected and our stock price may fall.


36



Our expansion of our product offering to include Local Deals and Getaways formats and the addition of a hotel booking platform may result in additional costs that exceed revenue and may trigger additional stock volatility.
During the third quarter of 2010, we launched our Local Deals format of advertising and during the second quarter of 2011, we launched our Getaways format of advertising, under which we sell vouchers directly to consumers to advertise promotional deals provided by merchants. For example, a consumer could buy a voucher for $99 for a dinner for two at a merchant’s restaurant that would normally be valued at $199, representing a promotional value of $100 to the consumer. This format may require investments to maintain and grow the business including additional sales force hiring, building a customer service organization, marketing, technology tracking systems and payment processing. This format, introduced to the market in recent years, has resulted in many competitors entering the marketplace, thereby creating a very competitive marketplace. This competitive landscape along with the required investments to start, maintain and grow this format creates a risk that our costs may exceed our revenues in the short and long term, which may materially impact our results of operations and financial condition. Operating this format may introduce additional volatility to our stock price due to the performance of this format by the Company and/or the overall market valuations that are being determined by the market for companies operating this format of advertising. Moreover, the rate at which our existing customers purchase vouchers has declined, and may continue to decline, given, among other things, increased competition in the marketplace and the decrease in demand of consumers for voucher deals. Historically, our customers often purchased a voucher when they received our emails, even though they may not have intended to use the voucher in the near term. The growth in recent periods of competition and the marketplaces of deals has enabled customers to wait until they are ready to use the related vouchers before making purchases. This shift in purchasing behavior may adversely impact revenues. While we are continuing to evolve our strategy to address the changing market dynamics, we may not always be successful in doing so.
In addition, we have been in the process of expanding our hotel booking platform which may result in an increase in costs to further develop the platform in the near-term and an increase in cost structure in the long-term, which may be in excess of incremental revenue. If our hotel booking platform is not embraced by our users or our advertising partners, our business and financial results could be adversely affected. To the extent that our room rates on our hotel booking platform are not competitive (i.e., versus the websites of other online travel companies or hotel company websites), we may not be able to attract members. If we cannot attract members to the hotel booking platform to make bookings, our financial results could be adversely affected. In addition, the hotel booking platform will be sensitive to fluctuations in hotel supply, occupancy and average daily rates and a fluctuation in any of these factors could negatively impact our hotel booking revenue. We can give no assurances that the hotel booking platform will yield the benefits we expect and will not result in additional costs or have adverse impacts on our business.

Our business could be negatively affected by changes in search engine algorithms and dynamics or other traffic-generating arrangements.
We utilize Internet search engines such as Google, principally through the purchase of travel-related keywords, to generate additional traffic to our websites. Search engines, including Google, frequently update and change the logic that determines the placement and display of results of a user’s search, such that the purchased or algorithmic placement of links to our websites can be negatively affected. In addition, a significant amount of traffic is directed to our websites through our participation in pay-per-click and display advertising campaigns on search engines, including Google, travel metasearch engines, including Kayak, and Internet media properties, including TripAdvisor. Pricing and operating dynamics for these traffic sources can experience rapid change, both technically and competitively. Moreover, a search or metasearch engine could, for competitive or other purposes, alter its search algorithms or results causing a website to place lower in search query results. If a major search engine changes its algorithms or results in a manner that negatively affects the search engine ranking, paid or unpaid, of our websites or that of our third-party distribution partners, or if competitive dynamics impact the costs or effectiveness of search engine optimization, search engine marketing or other traffic-generating arrangements in a negative manner, our business and financial performance would be adversely affected, potentially to a material extent.


37



Recent trends in consumer adoption and use of mobile devices create new challenges.
Widespread adoption of mobile devices, such as the iPhone, Android-enabled smart phones, and tablets such as the iPad, coupled with the improved web browsing functionality and development of thousands of useful “apps” available on these devices, is driving substantial traffic and commerce activity to mobile platforms. We have experienced a significant shift of business to mobile platforms and our advertising partners are also seeing a rapid shift of traffic to mobile platforms. Our major competitors and certain new market entrants are offering mobile applications for travel products and other functionality, including proprietary last-minute discounts for hotel bookings. Advertising and distribution opportunities may be more limited on mobile devices given their smaller screen sizes. The gross profit earned on a mobile transaction may be less than that earned from a typical desktop transaction due to different consumer purchasing patterns. For example, hotel reservations made on a mobile device typically are for shorter lengths of stay and are not made as far in advance as hotel reservations made on a desktop. Further, given the device sizes and technical limitations of tablets and smartphones, mobile consumers may not be willing to download multiple applications from multiple travel service providers and instead prefer to use one or a limited number of applications for their mobile travel activity. As a result, the consumer experience with mobile applications, as well as brand recognition and loyalty, are likely to become increasingly important. We have made progress creating mobile offerings which have received strong reviews and have shown solid download trends. We believe that mobile bookings present an opportunity for growth. Further development of our mobile offerings is necessary to maintain and grow our business as consumers increasingly turn to mobile devices instead of a personal computer and to mobile applications instead of a web browser. Further, many consumers use a mobile device based web browser instead of an application. As a result, it is increasingly important for us to develop and maintain effective mobile websites optimized for mobile devices to provide customers with appealing easy-to-use mobile website functionality. We do not have a mobile offering for our SuperSearch product and believe this has negatively impacted our Search revenue and will continue to negatively impact our Search revenue as long as SuperSearch is not offered on mobile. If we are unable to continue to rapidly innovate and create new, user-friendly and differentiated mobile offerings and efficiently and effectively advertise and distribute on these platforms, or if our mobile applications are not downloaded and used by travel consumers, we could lose market share to existing competitors or new entrants and our future growth and results of operations could be adversely affected.

Recent trends showing that consumers are becoming more interested in a “pull” marketplace than a “push” marketplace have created new challenges .
We have been successful with a “push” marketplace by inspiring people to take trips or purchase travel deals that they had not planned. We have noticed that consumers, however, have been seeking a “pull” marketplace to allow consumers the ability to search and browse for specific needs on specific dates. As we continue to invest in products, such as the hotel booking platform, to make it easier to search for our travel deals and move towards a “pull” marketplace, our results of operations could be adversely affected. Our required investment to make our website, mobile site and apps easier to search and more simple to buy or book deals create a risk that our costs and product development expenditures may exceed our revenues in the short and long term, which may materially impact our financial condition. We anticipate that our financial results will be impacted as we continue to invest in our growth through increased spending in improving our products to accommodate a “pull” marketplace.

We may have exposure to additional tax liabilities.    
As a global company, we are subject to income taxes as well as non-income based tax, in both the U.S. and various foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes and other tax liabilities. Although we believe that our tax estimates are reasonable, there is no assurance that the final determination of tax audits or tax disputes will not be different from what is reflected in our historical income tax provisions and accruals. Changes in tax laws or tax rulings may have a significantly adverse impact on our effective tax rate.
We are also subject to non-income based taxes, such as value-added, payroll, sales, use, net worth, property and goods and services taxes, in both the U.S. and various foreign jurisdictions. From time to time, we are under audit by tax authorities with respect to these non-income based taxes and may have exposure to additional non-income based tax liabilities. The Company's 2009 and 2010 federal income returns are currently under examination, including a review of the impact of the sale of Asia Pacific business segment in 2009. These examinations may lead to ordinary course adjustments or proposed adjustments to our taxes or our net operating income. In 2014, we received a Revenue Agent’s Report (RAR) generally issued at the conclusion of an IRS examination, which was consistent with the Notice of Proposed Adjustment we received earlier from the IRS for the 2009 calendar year related to the sale of our Asia Pacific business segment with the addition of penalties. The RAR proposes an increase to our U.S. taxable income which would result in additional federal tax expense, federal penalty and state tax expense totaling approximately $31 million, excluding interest and state penalties, if any. The proposed adjustment is primarily driven by IRS’s view that the Asia Pacific business segment assets sold by the Company had a significantly higher valuation than the sales proceeds the Company received upon the sale. The Company disagrees with the proposed adjustments and intends to vigorously contest them. The Company did not make any adjustments to its liabilities for uncertain tax positions related to the RAR as of September 30, 2015 because the Company does not believe the IRS’s valuation

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of Asia Pacific business segment assets is appropriate. If we are not able to resolve these proposed adjustments at the IRS examination level, we plan to pursue all available administrative and, if necessary, judicial remedies. The Company is not able to predict the ultimate amount or outcome of this tax audit and we may incur additional costs in defending any claims that may arise, even if we ultimately are not liable for any additional taxes.

Adverse application of state and local tax laws could have an adverse effect on our business and results of operation.
Our expansion of our product offering to include a hotel booking platform may subject us to state and local tax laws and result in additional tax liabilities. A number of jurisdictions in the U.S. have initiated lawsuits against other online travel companies, related to, among other things, the payment of hotel occupancy and other taxes (i.e., state and local sales tax). In addition, a number of municipalities have initiated audit proceedings, issued proposed tax assessments or started inquiries relating to the payment of hotel occupancy and other taxes.
Given that we intend for our hotel booking platform to consist of an agency model whereby we will facilitate reservations on behalf of a hotel, the payment of hotel occupancy taxes and other taxes should be the responsibility of the merchant. The intended business practice for our hotel booking platform will primarily be for the merchant to be responsible for remitting applicable taxes to the various tax authorities. Nevertheless, to the extent that any tax authority succeeds in asserting that we have a tax collection responsibility, or we determine that we have one, with respect to future transactions, we may collect any such additional tax obligation from our customers, which would have the effect of increasing the cost of hotel room reservations to our customers and, consequently, could make our hotel service less competitive (i.e., versus the websites of other online travel companies or hotel company websites) and reduce hotel reservation transactions. Either step could have a material adverse effect on our business and results of operations. We will continue to assess the risks of the potential financial impact of additional tax exposure.

Our business model may not be adaptable to a changing market.
Our current revenue model depends primarily on advertising fees paid by travel and entertainment companies. If current clients decide not to continue advertising their offers with us and we are unable to replace them with new clients, our business may be adversely affected. To be successful, we must provide online marketing solutions that achieve broad market acceptance by travel and entertainment companies. In addition, we must attract sufficient Internet users with attractive demographic characteristics to our products. It is possible that we will be required to further adapt our business model and products in response to changes in the online advertising market or if our current business model is not successful. For example, the trend toward mobile online traffic will require us to adapt our product offering to facilitate consumers use of our products. If we do not adapt to this trend fully or quickly enough, we may lose advertising revenue as consumer usage may decline from our non-mobile traffic. If we are not able to anticipate changes in the online advertising market or if our business model is not successful, our business could be materially adversely affected.

If we fail to retain existing advertisers or add new advertisers, our revenue and business will be harmed.
We depend on our ability to attract and retain advertisers (hotels, spas, restaurants, vacation packagers, airlines, etc.) that are prepared to offer products or services on compelling terms to our members. We do not have long-term arrangements to guarantee the availability of deals that offer attractive quality, value and variety to consumers or favorable payment terms to us. We must continue to attract and retain advertisers in order to increase revenue and maintain profitability. If new advertisers do not find our marketing and promotional services effective, or if existing advertisers do not believe that utilizing our products provides them with a long-term increase in customers, revenue or profit, they may stop making offers through our marketplace. In addition, we may experience attrition in our advertisers in the ordinary course of business resulting from several factors, including losses to competitors and advertiser closures or bankruptcies. If we are unable to attract new advertisers in numbers sufficient to grow our business, or if too many advertisers are unwilling to offer products or services with compelling terms to our members or offer favorable payment terms to us, we may sell less advertising, and our operating results will be adversely affected. For example, we may lose advertisers due to market conditions or performance, such as our recent loss of revenue from certain online booking engines, airlines and vacation packagers. We may not add enough additional revenue, such as hotel revenue from Getaways or the hotel booking platform, in order to replace the lost revenue. Furthermore, the new revenue may cost more to generate compared to the costs that the lost revenue required to generate, thereby adversely impacting our operating results.

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Our existing advertisers may shift from one advertising service to another, which may adversely affect our revenue.
Existing advertisers may shift from one advertising service (e.g. Top 20) to another (e.g. Local Deals, Getaways or the hotel booking platform). These shifts between advertising services by advertisers could result in no incremental revenue or less revenue than in previous periods depending on the amount purchased by the advertisers, and in particular with Local Deals, Getaways, and hotel booking platform, depending on how many vouchers are purchased by members and how many hotel bookings are made. In addition, we are anticipating a shift from our existing hotel revenue to commission-based revenue in connection with the launch of our hotel booking platform, which may result in lower revenue depending on volume of hotel bookings.
An increase in our refund rates related to our Local Deals and Getaways could reduce our liquidity and profitability.
We provide refunds related to our Local Deals and Getaways voucher sales. As we increase our revenue, our refund rates may exceed our historical levels. A downturn in general economic conditions may also increase our refund rates. An increase in our refund rates could significantly reduce our liquidity and profitability.
As we do not have control over our merchants and the quality of products or services they deliver, we rely on a combination of our historical experience with our merchants over time and the type of refunds provided for development of our estimate for refund claims. Our actual level of refund claims could prove to be greater than the level of refund claims we estimate. If our refund reserves are not adequate to cover future refund claims, this inadequacy could have a material adverse effect on our liquidity and profitability.
Our standard agreements with our merchants generally limit the time period during which we may seek reimbursement for member refunds or claims. Our members may make claims for refunds with respect to which we are unable to seek reimbursement from our merchants. Our members could also make false or fraudulent refund claims. Our inability to seek reimbursement from our merchants for refund claims could have an adverse effect on our liquidity and profitability.
If our advertisers do not meet the needs and expectations of our members, our business could suffer.
Our business depends on our reputation for providing high-quality deals, and our brand and reputation may be harmed by actions taken by advertisers that are outside our control. In particular, this is the case with our Local Deals and Getaways merchants, since we are selling vouchers on behalf of the merchants, directly to our members as opposed to our travel business when we are only collecting the advertising fee from the advertiser and the members are booking the deal directly with the advertiser. Any shortcomings of one or more of our merchants, particularly with respect to an issue affecting the quality of the deal offered or the products or services sold, may be attributed by our members to us, thus damaging our reputation and brand value and potentially affecting our results of operations. In addition, negative publicity and member sentiment generated as a result of fraudulent or deceptive conduct by our merchants could damage our reputation, reduce our ability to attract new members or retain our current members, and diminish the value of our brand.

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Our business relies heavily on e-mail and other messaging services, and any restrictions on the sending of e-mails or messages or a decrease in member willingness to receive messages could adversely affect our revenue and business.
Our business is highly dependent upon e-mail and other messaging services. Deals offered through e-mails and other messages sent by us, or on our behalf by our affiliates, generate a substantial portion of our revenue. Because of the importance of e-mail and other messaging services to our businesses, if we are unable to successfully deliver e-mails or messages to our members or potential members, or if members decline to open our e-mails or messages, our revenue and profitability would be adversely affected. New laws and regulations regulating the sending of commercial e-mails, including those enacted in foreign jurisdictions (such as Canada), may affect our ability to deliver e-mails or messages to our members or potential members and may also result in increased compliance costs. Further, actions by third parties to block, impose restrictions on, or charge for