UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

Commission File No.: 000-50171

TRAVELZOO INC.

     Registrant’s telephone number, including area code: (212) 521-4200

     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. Yesx No

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes o Nox

     As of November 11, 2004, the registrant had outstanding 16,233,204 shares of its $0.01 par value common stock.

TRAVELZOO INC.

Table of Contents

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PART I—FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements

See accompanying notes to unaudited condensed consolidated financial statements.

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TRAVELZOO INC.

See accompanying notes to unaudited condensed consolidated financial statements.

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TRAVELZOO INC.

See accompanying notes to unaudited condensed consolidated financial statements.

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TRAVELZOO INC.

(1) The Company and Basis of Presentation

     Travelzoo Inc. (the “Company” or “Travelzoo”) is an Internet media company. The Company’s publications include the Travelzoo Web site, the Travelzoo Top 20 e-mail newsletter, and the Newsflash e-mail product. The Company also operates SuperSearch, a pay-per-click travel search engine.

     Travelzoo is controlled by Ralph Bartel, who held approximately 83% of the outstanding shares as of November 11, 2004.

     The accompanying unaudited condensed consolidated financial statements have been prepared by Travelzoo Inc. in accordance with the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosure 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 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, 2003, included in the Company’s Form 10-K filed with the SEC on March 29, 2004.

     The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

     The results of operations for the nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004 or any other future period, and the Company makes no representations related thereto.

     The Company was formed as a result of a combination and merger of entities founded by the Company’s majority stockholder, Mr. Ralph Bartel. In 1998, Mr. Bartel founded Travelzoo.com Corporation, a Bahamas corporation, which issued 5,155,874 shares via the Internet to approximately 700,000 stockholders for no cash consideration (“Netsurfer shares”). In 1998, Mr. Bartel also founded Silicon Channels Corporation, a California corporation, to operate the Travelzoo Web site. During 2001, Travelzoo Inc. was formed as a subsidiary of Travelzoo.com Corporation, and Mr. Bartel contributed all of the outstanding shares of Silicon Channels to Travelzoo Inc. in exchange for 8,129,273 shares of Travelzoo Inc. and options to acquire an additional 2,158,349 shares at $1.00. The merger was accounted for as a combination of entities under common control using “as-if pooling-of-interests” accounting. Under this method of accounting, the assets and liabilities of Silicon Channels Corporation and Travelzoo Inc. were carried forward to the combined company at their historical costs. In addition, all prior period financial statements of Travelzoo Inc. were restated to include the combined results of operations, financial position and cash flows of Silicon Channels Corporation.

     During January 2001, the Board of Directors of Travelzoo.com Corporation proposed that Travelzoo.com Corporation be merged with Travelzoo Inc. whereby Travelzoo Inc. would be the surviving entity. On March 15, 2002, the stockholders of Travelzoo.com Corporation approved the merger with Travelzoo Inc. On April 25, 2002, the certificate of merger was filed in Delaware upon which the merger became effective and Travelzoo.com Corporation ceased to exist. Each outstanding share of common stock of Travelzoo.com Corporation was converted into the right to receive one share of common stock of Travelzoo Inc. Under and subject to the terms of the merger agreement, stockholders were allowed a period of two years following the effective date of the merger to receive shares of Travelzoo Inc. The records of Travelzoo.com Corporation showed that, assuming all of the shares applied for by the Netsurfer stockholders were validly issued, there were 11,295,874 shares of Travelzoo.com Corporation outstanding. As of April 25, 2004, two years following the effective date of the merger, 7,180,342 shares of Travelzoo.com Corporation had been exchanged for shares of Travelzoo Inc. Prior to that date, the remaining shares which were available for issuance pursuant to the merger agreement were included in the issued and outstanding common stock of Travelzoo Inc. and included in the calculation of basic and diluted earnings per share. After April 25, 2004, the Company ceased issuing shares to the former stockholders of Travelzoo.com Corporation, and no additional shares are reserved for issuance to any former stockholders, because their right to receive shares has now expired. On April 25, 2004, the number of shares reported as outstanding was reduced from 19,425,147 to 15,309,615 to reflect actual shares issued as of the expiration date. As of September 30, 2004, there were 15,448,204 shares of common stock outstanding,

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and earnings per share calculations reflect the reduction of the number of shares reported as outstanding during the period.

     It is possible that claims may be asserted against the Company in the future by former stockholders of Travelzoo.com Corporation seeking to receive shares in the Company, whether based on a claim that the two-year deadline for exchanging their shares was unenforceable or otherwise. In addition, one or more jurisdictions, including the Bahamas or the State of Delaware, may assert rights to unclaimed shares of the Company under escheat statutes. If such escheat claims are asserted, the Company intends to challenge the applicability of escheat rights, in that, among other reasons, the identity, residency and eligibility of the holders in question cannot be determined. There were certain conditions applicable to the issuance of shares to the Netsurfer stockholders, including requirements that (i) they be at least 18 years of age, (ii) they be residents of the U.S. or Canada and (iii) they not apply for shares more than once. The Netsurfer stockholders were required to confirm their compliance with these conditions, and were advised that failure to comply could result in cancellation of their shares in Travelzoo.com Corporation. Travelzoo.com Corporation was not able to verify that the applicants met the requirements referred to above at the time of their applications for issuance of shares. If claims are asserted by persons claiming to be former stockholders of Travelzoo.com Corporation, the Company intends to assert that their rights to receive their shares expired two years following the effective date of the merger, as provided in the merger agreement. The Company also expects to take the position, if escheat or similar claims are asserted in respect of the unissued shares in the future, that it is not required to issue such shares. Further, even if it were established that unissued shares were subject to escheat claims, the Company would assert that the claimant must establish that the original Netsurfer stockholders complied with the conditions to issuance of their shares. The Company is not able to predict the outcome of any future claims which might be asserted relating to the unissued shares. If such claims were asserted, and were fully successful, that could result in the Company’s being required to issue up to an additional 4,115,532 shares of common stock for no additional payment.

     On October 15, 2004, the Company announced a program under which it will make cash payments to persons who establish that they were former stockholders of Travelzoo.com Corporation, and who failed to submit requests for shares in Travelzoo Inc. within the required time period. The accompanying unaudited financial statements include a liability of $220,135 charged to other expenses during the three months ended September 30, 2004. The liability amount is based on management’s best estimate as of the reporting date of the minimum loss that is probable to be paid in the future as a result of this program. The total liability incurred under this program is not reliably estimable 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 merger of Travelzoo.com Corporation into Travelzoo Inc. was accounted for as a combination of entities under common control using “as-if pooling-of-interests’’ accounting. Under this method of accounting, the assets and liabilities of Travelzoo.com Corporation and Travelzoo Inc. were carried forward at their historical costs. In addition, all prior period financial statements of Travelzoo Inc. were restated to include the combined results of operations, financial position and cash flows of Travelzoo.com Corporation. The restated results of operations and cash flows of Travelzoo Inc. are identical to the combined results of Travelzoo.com Corporation and Travelzoo Inc.

(2) Revenue Recognition

     Substantially all revenue consists of advertising sales. Advertising revenues are derived from the sale of advertising in the Company’s publications and in SuperSearch, a pay-per-click travel search engine.

     Advertising revenues are recognized in the period in which the advertisement is displayed, provided that evidence of an arrangement exists, the fees are fixed or determinable, no significant obligations remain at the end of the period, and collection of the resulting receivable is reasonably assured. Where collectibility is not reasonably assured, the revenue will be recognized upon cash collection, provided that the other criteria for revenue recognition have been met. If fixed-fee advertising is displayed over a term extending beyond a reporting period, revenues are recognized ratably over the period. To the extent that any minimum guaranteed impressions are not met during the contract period, the Company defers recognition of the corresponding revenues until the guaranteed impressions are achieved. Fees for banner advertising and other variable-fee advertising arrangements are recognized based on the number of impressions displayed or clicks delivered 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 a non-cancelable insertion order signed by the client or its agency to be evidence of an arrangement.

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•		Delivery. Delivery is considered to occur when the advertising has been displayed and, if applicable, the click-throughs have been delivered.
•		Fixed or determinable fee. We consider the fee to be fixed or determinable if the fee is not subject to refund or adjustment.
•		Collection is deemed reasonably assured. We conduct a credit review for all significant transactions at the time of the arrangement to determine the creditworthiness of the client. Collection is deemed reasonably assured if we expect that the client will be able to pay amounts under the arrangement as payments become 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 not reasonably assured when a client 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.

     During the three months ended September 30, 2004, the Company recognized no revenue on a cash-received basis. As of September 30, 2004, the Company deferred recognition of $57,000 of advertising delivered during the three months ended September 30, 2004 for which collectibility was not reasonably assured. Such revenue will be recognized in future periods when and if collected.

     Our standard payment terms are 30 days net. We invoice our clients monthly. Insertion orders that include fixed-fee advertising are invoiced on the first day of the month. Insertion orders that include variable-fee advertising are invoiced on the first business day following the end of the month. Our standard terms state that in the event that Travelzoo fails to publish advertisements as specified in the insertion order, the liability of Travelzoo to the advertiser shall be limited to, at Travelzoo’s sole discretion, a pro rata refund of the advertising fee, the placement of the advertisements at a later time in a comparable position, or the extension of the term of the insertion order until the advertising is fully delivered. The company believes that no significant obligations exist after the full delivery of advertising.

     Revenues for advertising sold to clients through agencies are reported at the net amount billed to the agency.

(3) Stock-based Compensation

     The Company did not provide any stock-based compensation in fiscal year 2003 or in the nine months ended September 30, 2004. In addition, all previously issued options vested prior to January 1, 2002 and therefore there are no applicable disclosures under Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, as amended.

(4) Net Income Per Share

     Net income per share has been calculated under SFAS No. 128, Earnings per Share. Basic net income per share is computed by dividing the net income by the weighted-average number of reported common shares outstanding for the period. Diluted net income per share is computed by dividing net income by the weighted-average number of reported common shares and potential common shares outstanding during the period. Potential common shares included in the diluted calculation consists 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:

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(5) Commitments and Contingencies

     The Company leases office space in Chicago, Miami, Mountain View (California), and New York, under operating leases which expire on July 31, 2005, December 31, 2005, December 31, 2005 and December 31, 2005, respectively. The future minimum rental payments under these operating leases as of September 30, 2004, and December 31, 2003 total $1,242,606 and $827,638, respectively. The future lease payments consist of $255,123 of payments due in 2004 and $987,483 of payments due in 2005.

     As described in note 1, the Company has recorded a liability of $220,135 as of September 30, 2004 as its best estimate of the minimum loss that is probable to be paid as a result of the announced program to make cash payments to former stockholders of Travelzoo.com Corporation. The total liability incurred under this program is not reliably estimable 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.

(6) Significant Customer Information and Segment Reporting

     SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information, establishes standards for the reporting by business enterprises of information about operating segments, products and services, geographic areas, and major customers. The method for determining what information to report is based on the way that management organizes the operating segments within a company for making operational decisions and assessing performance. As of September 30, 2004, the Company has one operating segment.

     Significant customer information is as follows:

All of the above customers are located in the United States of America.

* Less than 10%

(7) Subsequent Events

     In October 2004, the Company completed a private placement offering of 750,000 newly-issued shares of common stock for gross proceeds of $30.0 million to a group of investors. The proceeds from the offering are intended to be used for general corporate purposes, including new product development and marketing expenditures, and potential acquisitions or strategic investments.

     In October 2004, the Company announced a program to make cash payments to former stockholders of Travelzoo.com Corporation. As a result, the Company recorded a liability of $220,135 as of September 30, 2004. See note 1 for further details.

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     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 Securities and Exchange Commission (“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.

Overview

     Travelzoo Inc. is an Internet media company. As the Internet is becoming consumers’ preferred medium to search for travel offers, we provide airlines, hotels, cruise lines, vacation packagers, and other travel companies with a fast, flexible, and cost-effective way to reach millions of users. While our products provide advertising opportunities for travel companies, they also provide Internet users with a free source of information on current offers from hundreds of travel companies. Our publications include the Travelzoo Web site, the Travelzoo Top 20 e-mail newsletter, and the Newsflash e-mail product. We also operate SuperSearch, a pay-per-click travel search engine. More than 300 travel companies purchase our advertising services.

     Our revenues are advertising revenues, consisting of listing fees paid by travel companies to advertise their offers on the Travelzoo Web site, in the Travelzoo Top 20 e-mail newsletter, through the Newsflash e-mail alert service and through the SuperSearch pay-per-click search engine, and banner advertising sales. Revenues are principally generated from the sale of advertising on our Travelzoo Web site and in our Travelzoo Top 20 newsletter. Listing fees are based on placement, number of listings, number of impressions, or number of click-throughs. Banner advertising rates are based on CPM rates (cost per thousand impressions). Smaller advertising agreements — typically $2,000 or less per month — typically renew automatically each month if they are not terminated by the client. Larger agreements are typically related to advertising campaigns and are not automatically renewed.

     When evaluating the financial condition and operating performance of the Company, management focuses on the following financial and non-financial indicators:

•		Growth of number of subscribers of the Company’s e-mail products and page views of selected sections of the Travelzoo Web site;
•		Growth in revenues in the absolute and relative to the growth in reach of the Company’s products;
•		Pre-tax profitability; and
•		Revenue per employee as a measure of productivity.

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 and the allowance for doubtful accounts. These policies, and our procedures related to these policies, are described below.

Revenue Recognition

     We recognize advertising revenues in the period in which the advertisement is displayed, provided that evidence of an arrangement

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exists, the fees are fixed or determinable, no significant obligations remain at the end of the period, and collection of the resulting receivable is deemed reasonably assured. If fixed-fee advertising is displayed over a term greater than one month, revenues are recognized ratably over the period. To the extent that any minimum guaranteed impressions are not met during the contract period, the Company defers recognition of the corresponding revenues until the guaranteed impressions are achieved. Fees for banner advertising and other variable-fee advertising arrangements are recognized based on the number of impressions displayed or clicks delivered 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 a non-cancelable insertion order signed by the client or its agency to be evidence of an arrangement.
•		Delivery. Delivery is considered to occur when the advertising has been displayed and, if applicable, the click-throughs have been delivered.
•		Fixed or determinable fee. We consider the fee to be fixed or determinable if the fee is not subject to refund or adjustment.
•		Collection is deemed reasonably assured. We conduct a credit review for all significant transactions at the time of the arrangement to determine the creditworthiness of the client. Collection is deemed reasonably assured if we expect that the client will be able to pay amounts under the arrangement as payments become due. If we determine that collection is not reasonably assured, then we defer the revenue and recognize the revenue upon cash collection.

     During the three months ended September 30, 2004, the Company recognized no revenue on a cash-received basis. As of September 30, 2004, the Company deferred recognition of $57,000 of advertising delivered during the three months ended September 30, 2004 for which collectibility was not reasonably assured. Such revenue will be recognized in future periods when and if collected.

     Our standard payment terms are 30 days net. We invoice our clients monthly. Insertion orders that include fixed-fee advertising are invoiced on the first day of the month. Insertion orders that include variable-fee advertising are invoiced on the first business day following the end of the month. Our standard terms state that in the event that Travelzoo fails to publish advertisements as specified in the insertion order, the liability of Travelzoo to the advertiser shall be limited to, at Travelzoo’s sole discretion, a pro rata refund of the advertising fee, the placement of the advertisements at a later time in a comparable position, or the extension of the term of the insertion order until the advertising is fully delivered. The company believes that no significant obligations exist after the full delivery of advertising.

     Revenues for advertising sold to clients through agencies is reported at the net amount billed to the agency.

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 client, the economic conditions of the client’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 clients were to deteriorate, affecting their ability to make payments, additional provision for doubtful accounts may be required.

Results of Operations

     The following table sets forth, as a percentage of total revenues, the results of our operations for the periods indicated.

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     For the nine months ended September 30, 2004, we reported pre-tax income of approximately $7.3 million. As of September 30, 2004, we had retained earnings of approximately $8.0 million. Pre-tax profitability increased to 31.6% of sales for the nine months ended September 30, 2004 from 21.3% for the same period last year. Pre-tax profitability increased because revenues grew faster than operating expenses.

Reach

     The following table sets forth the number of subscribers of each of our e-mail publications as of September 30, 2004 and 2003 and the total number of page views for selected sections of the Travelzoo Web site for the nine months ended September 30, 2004 and 2003. Management considers the Travelzoo homepage and the front pages of destination categories as indicators for the growth of site traffic. Management reviews these non-financial metrics for two reasons: first, to monitor the progress that the Company makes in increasing the reach of its publications, and second, to evaluate if the Company is able to convert higher reach into higher revenues.

     Management believes that the increase in reach of its publications in the nine months ended September 30, 2004 was in line with its strategy and goals.

     The Company’s revenues for the nine months ended September 30, 2004 increased by 81% from the same period last year. The number of subscribers of the Travelzoo Top 20 e-mail newsletter increased by 41%. Page views of selected sections of the Travelzoo Web site increased by 43% and 42% as shown in the table above. In the nine months ended September 30, 2003, 100% of revenues were generated from the Travelzoo Web site and the Travelzoo Top 20 newsletter. In the nine months ended September 30, 2004, 85% of revenues were generated from the Travelzoo Web site and the Travelzoo Top 20 newsletter. Management believes that the data for the nine months ended September 30, 2004 and 2003 indicate that the Company was able to generate higher revenues as reach increased.

Revenues

     Our total revenues increased to $9.5 million for the three months ended September 30, 2004 from $4.8 million for the three months ended September 30, 2003. Our total revenues increased to $23.0 million for the nine months ended September 30, 2004 from $12.8 million for the nine months ended September 30, 2003. This represents an increase of 81%. The increase was primarily due to an increase in the number of advertisers. Also contributing to the increase was an increase in our advertising rates on January 1, 2004.

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     Management believes that our ability to increase revenues in the future depends mainly on three factors:

•		Our ability to increase our advertising rates;
•		Our ability to sell more advertising to existing advertisers; and
•		Our ability to increase the number of advertisers.

     We believe that we can increase our advertising rates only if the reach of our publications increases. We do not know if we are able to increase the reach of our publications. We believe that we can sell more advertising only 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 online advertising continues to grow. We do not know if we will be able to m