**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

# **Form 10-K**

 
| **ý** |   | **ANNUAL  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                  |
|------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                                                                                                                                                                                                      |
|       |   | **For the fiscal year ended December 31,  2003**                                                                                                                                                                                                                                                                                     |
|       |   |                                                                                                                                                                                                                                                                                                                                      |
| **or**     |
|       |   |                                                                                                                                                                                                                                                                                                                                      |
| **o**      |   | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                              |
|       |   |                                                                                                                                                                                                                                                                                                                                      |
|       |   | **For the transition  period from                         to                          .** |

 

**Commission file number: 0-33347**

##### ** **

**Ambassadors Group, Inc.**

(ExactName of Registrant as Specified in Its Charter)

 

| **Delaware**                                                                      |   | **91-1957010**                         |
|-----------------------------------------------------------------------------------|--------|----------------------------------------|
| (State  or Other Jurisdiction of  Incorporation or Organization)                  |   | (I.R.S.  Employer  Identification No.) |
|                                                                              |
| **Dwight D. Eisenhower  Building  110 S. Ferrall Street  Spokane, WA**            |   | **99202**                              |
| (Address  of Principal Executive Offices)                                         |   | (Zip  Code)                            |
|                                                                              |
| Registrant’s  Telephone Number, Including Area Code: **(509) 534-6200** |
|                                                                              |
| Securities  registered pursuant to Section 12(b) of the Act: **None**        |
|                                                                              |   |
| Securities registered pursuant to Section 12(g) of  the Act:                 |
|                                                                              |
| **Common Stock, $.01 Par Value**                                                  |
| (Title  of Each Class)                                                            |

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant was requiredto file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

ý            Yes

o            No

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K.

ý

 

Indicate by check mark whether the registrant is an accelerated fileras defined in the Securities and Exchange Act Rule 12b-2.

ý            Yes

o            No

 

The aggregate market value of the voting stock of the registrant heldby non-affiliates of the registrant, based upon the closing sales price of theCommon Stock on the Nasdaq Stock Market on June 30, 2003, was $96,665,527.The number of shares of the registrant’s Common Stock outstanding as ofFebruary 11, 2004 was 10,016,790.

 

## **DOCUMENTS INCORPORATED BY REFERENCE**

Portions of the registrant’sdefinitive Proxy Statement relating to the 2004 Annual Meeting of Stockholdersare incorporated by reference into Part III.

 

 

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**TABLE OF CONTENTS**

 
|         | **Page**                                                                                    |
|--------------|---------------------------------------------------------------------------------------------|
| **PART I**   |                                                                                        |
|         |                                                                                        |   |
| Item 1.      | Business                                                                                    | 3 |
|         |                                                                                        |   |
| Item 2.      | Properties                                                                                  | 14 |
|         |                                                                                        |   |
| Item  3.     | Legal  Proceedings                                                                          | 14 |
|         |                                                                                        |   |
| Item  4.     | Submission  of Matters to a Vote of Security Holders                                        | 14 |
|         |                                                                                        |   |
| **PART II**  |                                                                                        |
|         |                                                                                        |   |
| Item  5.     | Market  for the Registrant’s Common Equity and Related Stockholder Matters             | 15 |
|         |                                                                                        |   |
| Item 6.      | Selected Financial  Data                                                                    | 16 |
|         |                                                                                        |   |
| Item  7.     | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 18 |
|         |                                                                                        |   |
| Item  7A.    | Quantitative  and Qualitative Disclosures About Market Risk                                 | 27 |
|         |                                                                                        |   |
| Item  8.     | Financial  Statements and Supplementary Data                                                | 27 |
|         |                                                                                        |   |
| Item  9.     | Changes  in and Disagreements With Accountants on Accounting and Financial Disclosure       | 27 |
|         |                                                                                        |   |
| Item 9A      | Controls and  Procedures                                                                    | 27 |
|         |                                                                                        |   |
| **PART III** |                                                                                        |
|         |                                                                                        |   |
| Item  10.    | Directors  and Executive Officers of the Registrant                                         | 28 |
|         |                                                                                        |   |
| Item  11.    | Executive  Compensation                                                                     | 28 |
|         |                                                                                        |   |
| Item  12.    | Security  Ownership of Certain Beneficial Owners and Management                             | 28 |
|         |                                                                                        |   |
| Item  13.    | Certain  Relationships and Related Transactions                                             | 28 |
|         |                                                                                        |   |
| Item  14.    | Principal  Accountant Fees and Services                                                     | 28 |
|         |                                                                                        |   |
| Item 15.     | Exhibits, Financial Statement Schedules  and Reports on Form 8-K                            | 29 |
|         |                                                                                        |   |
| SIGNATURES   | 52                                                                                          |

 

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**Forward-Looking Statements**

 

*Statements contained in this Annual Report onForm 10-K of Ambassadors Group, Inc. (the “Company”), which are not historicalin nature, are forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995. These forward-looking statementsinclude, without limitation, statements in Item 1., “Business,” and Item 7., “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,”regarding intent, belief or current expectations of the Company or its officerswith respect to, among other things, trends in the travel industry, theCompany’s business and growth strategies, the Company’s use of technology, theCompany’s ability to integrate acquired businesses, and fluctuations in theCompany’s  results of operations.*

 

*Forward-looking statements involve certainrisks and uncertainties that could cause actual results to differ materiallyfrom anticipated results. These risks and uncertainties include factorsaffecting the travel industry generally, competition, the ability of theCompany to successfully integrate the operations of existing or acquired companies,and a variety of factors such as war with Iraq, conflict in the Middle East,periods of international unrest, the outbreak of disease, changes in thedirect-mail environment, recession, weather conditions and concerns forpassenger safety that could cause a decline in travel demand, as well as therisk factors set forth in Item 1. “Business — Risk Factors,” and other factorsas may be identified from time to time in the Company’s filings with theSecurities and Exchange Commission or in the Company’s press releases.*

 

##### **PART I**

 

**Item 1.****          *****Business***

 

**OVERVIEW**

 

The businessof Ambassadors Group, Inc. (the “Company”) has been active since AmbassadorsInternational, Inc. (“International”) was founded in 1967. Prior toFebruary 28, 2002, the Company was a wholly owned subsidiary of International. Effective February 28, 2002,International completed the spin-off of the Company by virtue of a specialstock dividend to International’s stockholders of all of the outstanding sharesof the Company that Internationalowned (the “Distribution”). Beginning March 1, 2002, the Company operatedas an independent stand-alone company. Trading of the common stock of the Company on the Nasdaq National Marketbegan on March 1, 2002 under the symbol “EPAX”.

 

The Company consists of several specialized private-label travelprograms, including (i) the “People to People Student Ambassador Programs”(“Student Ambassador Programs”), which provide opportunities for middle schooland high school students to visit domestic and foreign destinations to learnabout the history, government, economy and culture of such countries,(ii) the “People to People Sports Ambassador Programs” (“Sports AmbassadorPrograms”), which provide opportunities for middle school and high schoolathletes to participate in international sports challenges, and (iii) the“People to People Ambassador Programs” (“Professional Ambassador Programs”),which provide foreign travel experiences for professionals, with emphasis onmeetings and seminars between participants and persons in similar professionsabroad.

 

Since International’s initial public offering in 1995, the Company hasexpanded its operations primarily through internal growth and two acquisitionsof travel businesses. Since 1983, the Company has organized programs for morethan 232,000 students, adults and athletes. The Company’s educational travelprograms feature visits abroad including but not limited to Australia, China,France, Germany, Great Britain, Italy and New Zealand. In 2003, more than23,000 participants traveled on the Company’s programs in more than 35countries on seven continents.

 

The Company believes that its association with People to PeopleInternational (“People to People”) and its 37 years of continuousexperience and relationships arising from organizing travel programs haveprovided the foundation for the Company to develop and maintain strongstrategic alliances, including but not limited to those with Yosemite NationalInstitute, Off the Beaten Path LLP, Full On (Europe) Limited, US TennisAssociation, the Amateur Athletic Union, USA Volleyball and Swimming,US Soccer, American Youth Soccer Association, and Young American BowlingAlliance.

 

The Company intends to growits business internally through marketing enhancements, new programs andstrategic alliances, and may make selective acquisitions of and jointagreements with travel and travel-related businesses.

 

The principal offices of theCompany are located in Spokane, Washington.

 

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**BUSINESS**

 

The Company organizes andpromotes educational travel programs for students, professionals and athletes,principally using the People to People name. People to People International isa private, non-profit organization dedicated to the promotion of world peacethrough cultural exchange. People to People International was founded byPresident Dwight D. Eisenhower in 1956 and was originally administered by theU.S. State Department. Eight U.S. Presidents since PresidentEisenhower have served as honorary chairman of People to People International,including President George W. Bush, who currently holds that position.Mary Eisenhower, the president and chief executive officer of People to PeopleInternational, also continues her grandfather’s legacy by serving theorganization.

 

The Company has theexclusive right to develop and conduct student programs for kindergartenthrough high school students using the People to People name. The Company alsohas the non-exclusive right to develop, market and operate programs forprofessionals, college students, and athletes using the People to People name;however, at the present time, the Company is the only entity that has beengiven this right by People to People International. These rights have beengranted pursuant to agreements with People to People International, whichexpire in 2010 and, at the election of the Company, may be extended through2020.

 

**StudentAmbassador Programs**

 

The Company’s StudentAmbassador Programs provide an educational opportunity for students in middleschool and high school to travel to one or more foreign countries ordomestically to learn about the history, government, economy and culture ofsuch countries. The Company markets its Student Ambassador Programs through acombination of direct mail and local informational meetings fromAugust through February. Representatives of the Company review candidateapplications and conduct selection interviews throughout the country, afterwhich accepted applicants participate in orientation meetings to prepare fortheir educational travel program.

 

Student Ambassador Programdelegations depart during the summer months, June through August, andgenerally travel for approximately 14 to 23 days, during which time eachdelegation visits one or more foreign countries. Each delegation generallyconsists of approximately 30 to 40 students and several teachers, who act asthe delegation’s leaders. Teachers and students comprising a delegationgenerally come from the same locale. Local guides in each country assist thedelegations in their travels.

 

Programs are designed by theCompany’s staff of international planners and researchers to provide aneducational and entertaining travel experience by exposing students to thehistory, government, economy and culture of the country or countries visited.In each country, the Company contracts with program coordinators to provideday-to-day oversight of the programs. Additionally, a local guide trained bythe Company accompanies the group throughout the duration of its program. Inmany instances, the Company also provides students with the opportunity for ahome stay (a brief stay with a host family), which gives students a glimpse ofdaily life in the visited country.

 

Students who completecertain written assignments and other projects can receive high school anduniversity credit for their participation in the program. Universitiesrecognizing academic credit include, but are not limited to, StanfordUniversity, the University of California, Los Angeles, and GeorgetownUniversity. In addition, high school students who successfully complete theprogram may be eligible to receive Service Learning Credits, which havebecome a high school graduation requirement in many curricula countrywide.

 

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**SportsAmbassador Programs**

 

The Company’s SportsAmbassador Programs provide an opportunity for student athletes in middleschool and high school to explore the host country’s culture and to participatein international tournaments with teams from across the world in up toeight different sports. The Company markets its Sports Ambassador Programsthrough a combination of direct mail and local informational meetings.Interested athletes apply to the program and are interviewed by representativesof the Company, after which the selected athletes are accepted for the program.

 

Participants in the SportsAmbassador Programs depart during the summer months, June through August,and travel for nine to 14 days. Teams are formed based on gender and age.Most teams comprise athletes from several different states. During a three tofour day training camp, all athletes participate in an individual skillassessment, after which rosters are formed to ensure balanced and competitiveteams. After the formation of rosters, the rest of the training camp focuses onteam practice and fundamentals in preparation for the ensuing tournamentcompetition. In each tournament, the Company contracts with overseas tournamentorganizers to provide day-to-day oversight of the programs. Additionally,athletes are exposed to international culture through Company-arrangededucational excursions.

 

Athletes who completecertain written assignments and projects can receive high school and universitycredit for their participation in the program. Universities recognizingacademic credit include, but are not limited, to Stanford University, theUniversity of California, Los Angeles, and Georgetown University. All athleteswho successfully complete the program are eligible to receive Service LearningCredits, which have become a high school graduation requirement in manycurriculums countrywide.

 

**ProfessionalAmbassador Programs**

 

The Company’s ProfessionalAmbassador Programs provide professionals with common interests the opportunityto travel abroad to meet and exchange ideas with foreign citizens who havesimilar backgrounds, interests or professions. The Company markets itsProfessional Ambassador Programs through a direct mail marketing effortthroughout the year. Programs originate from the Company’s internal marketingand research staff, who identify potential delegation topics and leaders.Professional programs have been conducted in such areas as agriculture,economics, education, law, medicine and science.

 

The Company believes thatits Professional Ambassador Programs provide participants with enrichingexperiences and deeper understandings of foreign cultures and people thanvisits arranged independently or through travel agencies. ProfessionalAmbassador Programs operate year-round and are generally designed to provide aspecialized adult educational experience. Professional Ambassador Programstravel 10 to 14 days. Unlike travel programs provided by travel agencies,these professional exchanges are intended largely as working programs, with asignificant amount of the participant’s time involved in organized meetings,seminars and round-table discussions with their foreign counterparts, visits tomajor foreign facilities and institutions and informal gatherings with foreigncounterparts. Each program is led by a delegation leader chosen by the Companybased upon his or her recognition in the field and expertise regarding thespecial focus of the particular program. Participants in the professionalprograms may be eligible for continuing education credits as available withintheir profession.

 

**OtherPrograms**

 

The Company offers threeadditional types of programs: Conference Programs, Eisenhower Scholar Programsand Golf Programs. The Conference Programs provide the opportunity formotivated students with academic promise, leadership potential and a desire toserve their communities to travel domestically to exchange ideas with renownedspeakers, field- specific experts, professional educators and their peers. Thisprogram is specifically designed for students in middle school and high school.In addition to the academic coursework, delegates engage in specially designedteam-building and leadership-building exercises.

 

The Eisenhower ScholarPrograms provide university students a unique leadership-building exercisesopportunity to study abroad during their semester or quarter breaks. Thesecurriculum-based programs focus on specific areas of study such asinternational business, medicine, law, diplomacy, humanities, and leadership. Both the Conference and EisenhowerScholar Programs travel for approximately seven to 18 days and include groupdiscussions, workshops, educational meetings and other social and recreationalactivities.

 

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The Company markets theConference and Eisenhower Scholar Programs through a direct mail marketingeffort throughout the year. Programs originate from the Company’s internalmarketing and research staff, who identify delegation topics, speakers andleaders.  Delegates traveling on theseprograms may receive transferable high school or university credits as part ofthe academic program. These programs currently do not generate significantrevenues.

 

People to People Golf Programs build international understandingthrough the game of golf.  Theseprograms provide delegates with opportunities to experience foreign cultures,delve into history, explore beautiful landscapes and play golf at some of thefinest courses in the world.  TheCompany markets the golf programs through a direct mail marketing effortthroughout the year.  These programscurrently do not generate significant revenues.

 

**StrategicAlliances**

 

The Company also operatescertain specialty travel programs to North American destinations. The Companyhas entered into an alliance with Yosemite National Institutes, a non-profitorganization with operations in Yosemite National Park, Olympic National Parkand Golden Gate National Recreation Area. The Company’s agreement with YosemiteNational Institutes prescribes the nature, scope and pricing of the travelservices provided by Yosemite National Institutes to the Company’s delegates.The agreement with Yosemite National Institutes is exclusive, except thatYosemite National Institutes may conduct its own programs. The Company also hasagreements with the Amateur Athletic Union, Young American Bowling Alliance,and American Youth Soccer Organization to offer international travel for itsplayers.  These agreements currently donot generate significant revenues.

 

The Company has entered intostrategic alliances to further introduce innovative, educational travelexperiences both internationally and domestically. Such strategic alliancesinclude, but are not limited to, Off the Beaten Path LLP, Students on Ice, andFull On (Europe) Limited.

 

**ServiceMarks**

 

The Company and itssubsidiaries have registered or applied for a variety of service andtrademarks, including, but not limited to the names “Venture Into the World,”“Initiative for Understanding,” “Student Ambassador Program,” “People to PeopleSports Ambassador,” “Eisenhower Scholar,” and “American Ambassador Program.” Inaddition, the Company has the right, subject to certain exceptions, to usePeople to People’s name, service mark and logo for use in its marketing. TheCompany believes that the strength of its service and trademarks is valuable toits business and intends to continue to protect and promote its marks asappropriate. However, the Company believes that its business is not overly dependentupon any trademark or service mark.

 

**Insurance**

 

The Company maintainsinsurance coverage that it believes is adequate for its business, including butnot limited to, professional and general liability insurance. The Company alsomaintains insurance coverage on its leased real property and personal propertyon a replacement cost basis. There is no assurance that the insurancemaintained by the Company will be adequate in the event of a claim, or thatsuch insurance will continue to be available in the future.

 

**Employees**

 

On December 31, 2003,the Company employed 164 employees, of which 152 were full-time employees. Ofthe Company’s full-time employees, 149 are located in Spokane, Washington and 3are located in California. The Company has 113 full-time employees engaged inselling and tour promotion and 39 full-time employees in general andadministrative positions. The Company also employs temporary labor on aseasonal basis to assist with its direct marketing efforts in recognition ofthe fact that the Company’s travel programs are seasonal in nature. None of theCompany’s employees are subject to collective bargaining agreements or arerepresented by a union. The Company believes that its labor relations are good.

 

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##### ** **

##### **BUSINESS STRATEGY**

 

The Company believes thathigh quality programs and exceptional customer service are and will remain keyelements of its success. The Company’s strategy is to maintain qualitystandards while increasing the volume of business. To grow the business, theCompany intends to (i) expand the marketing and travel volume of existingstudent, sports and conference educational travel programs, (ii) introducenew student, sport and conference travel programs independently and throughstrategic alliances, (iii) broaden professional travel programs, and(iv) pursue acquisition opportunities.

 

**Expand theMarketing and Travel Volume**

 

U.S. Census data projectsthat there will be more than 42.5 million people in the 10 to19 year-old age range by 2006. The Company believes that a large number ofqualified students in this age group are not aware of the Company’s youthtravel programs. In light of these factors, the Company intends to improve itsmarketing techniques by targeting additional age groups, making greater use ofreferrals from teachers, parents and past student travelers, and expanding andrefining its extensive databases of potential participants.

 

**IntroduceNew Programs**

 

The Company continuallyseeks to develop and introduce additional innovative, educational travelexperiences. The Company intends to continue to maintain its contacts withforeign governmental agencies and officials and intends to continue to utilizethese and other foreign contacts to organize opportunities for its programdelegates that other travel programs do not currently offer. In addition, theCompany may develop new youth travel programs organized around commonextracurricular activities such as sports, science, nature, and music.

 

**BroadenProfessional Travel Programs**

 

According to U.S. Censusdata, the number of Americans 45 to 74 years old is expected to growsubstantially, increasing to more than 95.2 million people in 2006 from82.8 million people in 2001. This trend is expected to benefit the Company,since this population segment historically has been the most likely toparticipate in one of the Company’s professional travel programs. In addition,the Company believes that American adults interested in traveling abroad willincreasingly seek convenient and unique experiences. Consequently, the Companybelieves that the opportunity exists to expand its professional educationaltravel programs by continuing to improve the quality and number of itsspecialty professional programs and by exploring new country destinations. TheCompany continues to look for alliances with partners that have strong brandrecognition and access to well defined customer segments.

 

**PursueAcquisition Opportunities**

 

The Company considers theindustries encompassed by its business to be large and fragmented, whichpresent attractive acquisition opportunities. The Company believes that theindustry’s large size and fragmentation provides an opportunity foracquisitions of businesses that are either compatible with the Company’s currentbusiness or represent a developing specialty segment.

 

**COMPETITION**

 

The travel industry and the educational segment within the travelindustry are highly competitive. The Company’s youth programs compete withsimilar educational travel programs operated by other individuals andorganizations, as well as independent programs organized and sponsored by localteachers with the assistance of local travel agents. The Company’s sportsprograms compete with independent organizations, which coordinate and travelalready intact teams for international competition. The Company’s professionalprograms compete with independent professional associations that sponsor andorganize their own travel programs through the assistance of local travelagents, and other organizations that design travel programs for adults.

 

The Company believes that the principal basis of competition in theeducational segment of the market is the quality and uniqueness of theeducational program offered, customer service, reputation and program cost. TheCompany believes that its agreements with People to People, as well as its37 years of experience organizing student and professional educationalprograms and established relationships with public officials, organizations andresidents in countries in which it provides programs, allow the Company toprovide an educational opportunity that is not easily duplicated bycompetitors’ programs.

 

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The Company believes thatthe barriers to entry are relatively low for any future competitors. Certainorganizations engaged in the travel business have substantially greaterfinancial, marketing and sales resources than the Company. There can be noassurance that the Company’s present or future competitors will not exertsignificant competitive pressures on the Company.

 

**RISKFACTORS**

 

**RisksRelating to the Company’s Business**

 

***Warwith Iraq***

 

Thewar with Iraq has affected and will continue to affect the travelindustry, the markets in which the Company operates, and the Company’soperations and profitability. The potential and long-term effects are uncertainfor the Company’s customers, the market for the Company’s common stock, themarkets for the Company’s services, the strength of the U.S. dollar and the U.S.economy. The Company has experienced increased cancellations for its futuretravel programs and a weakened U.S. dollar. The negative effect of a weakenedU.S. dollar will cost the Company more to travel participants abroad. Therepercussions of the war with Iraq are unpredictable and the Company may not beable to foresee events that may have a material adverse affect on the business,financial condition, cash flows and results of operations of the Company.

 

***Terrorism***

 

Terrorist attacks, such asthe attacks that occurred on September 11, 2001; the response by theUnited States; and other acts of violence or war have and will affect thetravel industry generally, the markets in which the Company operates, as wellas the Company’s operations and profitability. Further terrorist attacksagainst the United States or U.S. businesses at home and abroad may occur. TheSeptember 11 attacks have had a very negative impact on domestic andinternational air travel and the travel industry in general. As a result, theCompany experienced a significant decrease in profitability in 2002. Thepotential near-term and long-term effects of these attacks are uncertain forthe Company’s customers, the market for the Company’s common stock, the marketsfor our services and the U.S. economy. The consequences of any terroristattacks, or any armed conflicts including war which may result, areunpredictable, and the Company may not be able to foresee events that couldhave an adverse affect on its business or operations.

 

***InternationalOperations and Natural Occurrences; Travel Industry***

 

The Company’s operations aresubject to special risks inherent in doing business internationally, assubstantially all of the Company’s travel programs are conducted outside theUnited States. Such risks include the adverse effects on operations from war,international and domestic terrorism, civil disturbances, politicalinstability, governmental activities and deprivation of contract rights.Periods of international and domestic unrest have reduced demand for theCompany’s travel programs and could have a material adverse effect on theCompany’s business and results of operations. Examples of such past eventsinclude the attacks on September 11, 2001, the Gulf War in 1991, civilunrest in China in 1989 and the Chernobyl disaster in 1986.

 

In the past, gross receiptsfrom programs to Europe, the South Pacific (Australia and New Zealand) andChina have accounted for a majority of the Company’s gross receipts. Theoccurrence of any of the events described above or other unforeseendevelopments in one or more of these regions would have a material adverseeffect on the Company. Demand for the Company’s travel programs also may beadversely affected by natural occurrences such as hurricanes, earthquakes, epidemicssuch as the SARS virus, and flooding in geographic regions in which the Companyconducts its travel programs.

 

The Company’s results ofoperations will depend upon factors affecting the travel industry in general.The Company’s revenues and earnings are especially sensitive to events thataffect domestic and international air travel and the level of hotelreservations. A number of factors, including those mentioned above, a rise infuel prices or other travel costs, excessive inflation, currency fluctuations,extreme weather conditions and concerns about passenger safety could result ina temporary or longer-term overall decline in demand for the Company’s travelprograms. Demand for the Company’s products and services may be significantlyaffected by the general level of economic activity and employment in the UnitedStates and key international markets. Therefore, any significant economicdownturn or recession in the United States or these other markets could have amaterial adverse affect on the business, financial condition, cash flows andresults of operations of the Company.

 

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***Seasonality; Fluctuations in QuarterlyResults***

 

The Company’s businesses arehighly seasonal. The Company recognizes gross program receipts, revenues andprogram pass-through expenses upon the departure of its program delegates. Themajority of the Company’s travel programs are scheduled in June andJuly of each year, and the Company anticipates that this trend will continuefor the foreseeable future. Substantially all of the Company’s operating incomeis generated in this period, which historically has offset the operating lossesincurred during the rest of the year. The Company’s annual results would beadversely affected if the Company’s revenues were to be substantially belowseasonal norms during the second and third quarters of the year. The Company’soperating results may fluctuate as a result of many factors, including the mixof student, sports, and professional programs and program destinations offeredby the Company and its competitors, the introduction and acceptance of newprograms and program enhancements by the Company and its competitors, timing ofprogram completions, cancellation rates, competitive conditions in theindustry, marketing expenses, extreme weather conditions, international ordomestic conflicts, timing of and costs related to acquisitions, changes inrelationships with certain travel providers, economic factors and otherconsiderations affecting travel. In addition, the Company records on aquarterly basis realized gains and losses on its forward foreign exchangecontracts that do not qualify as cash flow hedges under Statement of FinancialAccounting Standards No. 133. As a result of the foregoing, annual orquarterly operating results may be below the expectations of public marketanalysts and investors. In such event, the price of the common stock could bematerially and adversely affected. See “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.”

 

***Competition***

 

The travel industry ingeneral and the educational segment of the travel industry is highlycompetitive and has relatively low barriers to entry. The Company competes withother companies that provide similar educational travel programs for studentsand athletes as well as independent programs organized and sponsored by localteachers and coaches with the assistance of local travel agents. People toPeople International, under the terms of its agreement with the Company,reserves the right to offer programs to college students for studies abroad andto grant other entities which compete with the Company the right to use thePeople to People name in connection with People to People’s professionaleducation and sports programs. In general, the Company’s professional travelprograms compete with independent professional organizations that sponsor andorganize their own travel programs through the assistance of local travelagents, and other organizations that offer travel programs for adults. Some ofthe Company’s competitors are larger and have greater brand name recognitionand financial resources than the Company. There can be no assurance that theCompany will be able to compete successfully, and the failure to competesuccessfully may have a material adverse affect on the business, financialcondition, cash flows and results of operations of the Company.

 

***Dependence on “People to People”***

 

The Company’s agreementswith People to People International give the Company the exclusive right todevelop and conduct programs for kindergarten through high school studentsusing the People to People name, and the non-exclusive right to develop andconduct programs for professionals, college students, and athletes using the Peopleto People name. The Company’s agreements with People to People International,however, allow People to People International to continue to conduct collegeand professional seminars and internship programs and to develop other sportsand professional programs. The People to People International agreements expirein 2010 and, at the election of the Company, may be further extended through2020. The Company believes that it derives benefit from its ability to marketits programs using the People to People name. If the Company’s agreements with People to People International wereterminated or if the Company was unable to use the People to People name tomarket new programs or destinations, it could have a material adverse affect onthe Company’s business, financial condition, cash flows and results ofoperations.

 

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***Dependence on Travel Suppliers***

 

The Company is dependentupon travel suppliers for access to their products and services. Travelsuppliers include airlines, hotels, bus lines and other participants in thetravel industry. Consistent with industry practices, the Company currently hasno long-term agreements with its travel suppliers that obligate such suppliersto sell services or products through the Company on an ongoing basis.Therefore, the Company’s travel suppliers generally can cancel or modify theiragreements with the Company upon relatively short notice. In addition, anydecline in the quality of travel products and services provided by thesesuppliers, or a perception by travelers of such a decline, could adverselyaffect the Company’s reputation. The loss of contracts, changes in theCompany’s pricing agreements, commission schedules or incentive overridecommission arrangements, more restricted access to travel suppliers’ productsand services or less favorable public opinion of certain travel suppliers andresulting low demand for the products and services of such travel supplierscould have a material adverse affect on the business, financial condition, cashflows and results of operations of the Company.

 

***Dependence on Key Personnel***

 

The Company’s performance is substantially dependent on the continuedservices and performances of its senior management and certain other keypersonnel. The loss of the services of any of its executive officers or otherkey employees could have a material adverse affect on the Company’s business,financial condition and results of operations. The Company does not havelong-term employment agreements with any of its executive officers. TheCompany’s future success also depends on its ability to identify, attract,hire, train, retain and motivate other highly skilled managerial, marketing andcustomer service personnel. The failure to retain and attract necessarymanagerial, marketing and customer service personnel could have a materialadverse affect on the Company’s business, financial condition, cash flows andresults of operations.

 

***Marketing***

 

The Company’s performance is substantially dependent on effectivenessof its direct marketing efforts including but not limited to direct mail andlocal informational meetings.  Failureof its marketing efforts or changes in the direct mail environment could have amaterial adverse affect on the Company’s business, financial condition, cashflows and results of operations. Such changes in the direct mail environmentcould include, but not be limited to, a threat of disease or bioterrorismwithin the mail environment and new or different regulatory schemes or changesin costs or services by the United States Postal Service.

 

***Government Regulation and Taxation***

 

Many travel suppliers,particularly airlines, are subject to extensive regulation by federal, stateand foreign governments. In addition, the travel industry is subject to certainseller of travel laws of certain states and special taxes by federal, state,local and foreign governments, including hotel bed taxes, car rental taxes,airline excise taxes and airport taxes and fees. New or different regulatoryschemes or changes in tax policy could have an adverse impact on the travelindustry in general and could have a material adverse affect on the business,financial condition, cash flows and results of operations of the Company.

 

***Fluctuation of Currency Exchange Rates: Increased Costs***

 

Many of the Company’sarrangements with its foreign-based suppliers require payment to be made inforeign currencies. Any decrease in the value of the U.S. dollar in relation toforeign currencies has the effect of increasing the cost of the services to beprovided. Since late 1993, the Company generally has purchased forwardcontracts with less than two years maturity to help manage program costs andhedge against foreign currency valuation increases. While the ability toutilize forward contracts for the delivery of foreign currencies can mitigatethe effect of increased program costs and foreign currency exchangefluctuations, there can be no assurance that increased program costs relatingto such currency fluctuations will not be substantial in future periods. Therecan also be no assurance the Company’s hedging strategy will mitigate longerterm foreign exchange valuation trends. The Company’s contract with delegates in its travel programs providesthe Company the option of passing along to delegates any increase in programcosts resulting from currency fluctuations. Although the Company has exercisedthis option in the past, there can be no assurance that the Company will beable to increase program prices to offset any such cost increases in the futureand any failure to do so could have a material adverse affect on the Company’sbusiness, financial condition, cash flows and results of operations. See“Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

10

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***Casualty Losses***

 

Due to the nature of itsbusiness, the Company may be subject to liability claims arising out ofaccidents or disasters causing injury to delegates in its programs, includingclaims for serious personal injury or death. The Company believes that it hasadequate liability insurance for risks arising in the normal course of itsbusiness. Although there have been no claims the Company has experienced forwhich it did not have adequate insurance coverage, there can be no assurancethat insurance coverage will be sufficient to cover one or more large claims orthat the applicable insurer will be solvent at the time of any covered loss.Further, there can be no assurance that the Company will be able to obtaininsurance coverage at acceptable levels and cost in the future. Successfulassertion against the Company of one or a series of large uninsured claims, orof one or a series of claims exceeding any insurance coverage, could have a materialadverse affect on the Company’s business, financial condition, cash flows andresults of operations. See “Business — Insurance.”

 

***Growth, Acquisitionsand Alliances***

 

The Company’s performance is dependent on its ability to grow itsbusiness and expand the marketing and travel volume of its youth, sports andprofessional travel programs.  Inaddition, the Company’s ability to grow is dependent on ability to acquire orenter into strategic alliances.  Failureof growth strategies could have a material adverse affect on the Company’sbusiness, financial condition, cash flows and results of operations.

 

***Control of theCompany by Certain Stockholders***

 

As of December 31,2003, John Ueberroth, Joseph Ueberroth and Peter Ueberroth (all family members)beneficially owned in the aggregate approximately 19 percent of the outstandingshares of the Company’s common stock. Accordingly, they have the ability toexercise effective voting control of the Company, and may elect all of theCompany’s directors and be able to determine the outcome of any matter beingvoted upon by the Company’s stockholders, including any merger, sale of assetsor other change in control of the Company. The Ueberroths’ ownership position,together with the antitakeover effects of certain provisions contained in theCompany’s Certificate of Incorporation and Bylaws, may have the effect ofdelaying or preventing a change of control of the Company.

 

**RisksRelating to the Separation of the Company from International**

 

***Indemnification ofInternational for Tax Liabilities Incurred in Connection With the Distribution***

 

In connection with the Distribution, the Company and Internationalentered into a tax sharing agreement pursuant to which the Company agreed toindemnify International for certain taxes and similar obligations that it wouldincur if the Distribution does not qualify for tax-free treatment due to any ofthe following events:

 

•                  the acquisition of a controlling interest inthe Company stock after the Distribution;

 

•                  the Company’s failure to continue itsbusiness after the Distribution;

 

•                  a repurchase of the Company stock; or

 

•                  other acts or omissions by the Company.

 

Internationalagreed to indemnify the Company for any tax liabilities the Company incurs as aresult of its operations and International’s operations prior to the Company’sseparation from International. Nevertheless, the Company may be held jointlyand severally liable for such liabilities, and it cannot make any assurancesthat it will be able to recover from International any losses it may suffer. Ifthe Company takes any action or fails to take any action that would causeInternational’s distribution of the Company’s common stock to be taxable toInternational, the Company’s financial condition could be seriously harmed.

 

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***The Company’s Historical FinancialInformation May Not Be Representative of Its Results as a Separate Company***

 

The Company’s financialstatements, for the year ended December 31, 2001, and for the periodJanuary 1, 2002 through February 28, 2002, have been carved out fromthe consolidated financial statements of International using the historical operating results andhistorical bases of the assets and liabilities of the International’s business that the Company comprised.Accordingly, the historical financial information of the Company does notnecessarily reflect the Company’s financial position, operating results andcash flows as if the Company had been a separate, stand-alone entity duringthose periods. The Company’s costs and expenses for the year endedDecember 31, 2001 and the period from January 1, 2002 throughFebruary 28, 2002, include allocations from International for centralized corporate services andinfrastructure costs, including legal, accounting, insurance, finance andinformation technology. See “Notes to Consolidated Financial Statements,Note 1.”

 

These allocations weredetermined on bases that International and the Company consider to be reasonable reflections of theutilization of services provided to or for the benefit received by the Company.The historical financial information is not necessarily indicative of what theCompany’s operating results, financial position and cash flows will be in thefuture. While the Company has made certain adjustments to its historicalfinancial information, it has not made all of the necessary adjustments to itshistorical financial information to reflect all significant changes that willoccur in its cost structure, funding and operations as a result of itsseparation from International,including increased costs associated with reduced economies of scale, increasedmarketing expenses related to building a company brand identity separate from Internationaland increased costs associated withbeing a publicly-traded, stand-alone company.

 

***Availabilityof Future Financing***

 

The Company believes thatits capital requirements will vary from quarter to quarter, depending on, amongother things, capital expenditures, fluctuations in operating results, financingactivities, acquisitions, investments and receivables management. The Companybelieves that its future cash flow from operations will be sufficient tosatisfy its working capital, capital expenditure and product developmentrequirements for the foreseeable future. However, the Company may require orchoose to obtain additional debt or equity financing in order to financeacquisitions or other investments in its business. Future equity financingswould be dilutive to the existing holders of the Company common stock. Futuredebt financings could involve restrictive covenants. There can be no assurancethat the Company will be able to obtain financing with favorable interest ratesor that the Company will be able to obtain financing at all.

 

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***Company’sOfficers and Directors May Have Conflicts of Interest Due to Their Ownership ofInternational Common Stock***

 

Many of the Company’s directors and executive officers own substantialamounts of International common stock and options to purchase Internationalcommon stock. Ownership of International common stock by the Company’sdirectors and officers may create, or appear to create, potential conflicts ofinterest when directors and officers are faced with decisions that could havedifferent implications for International and the Company.

 

***Company’s Directors May Have Conflicts of Interest Due toTheir Dual Service as Directors of International***

 

All but two of the Company’s directors also serve as directors (and inone instance an executive officer) of International. Whenever a director of theCompany serves as an executive officer or director of another entity such asInternational, there is the potential for a conflict of interest, in that thefiduciary obligations of an individual to International conflict with thefiduciary obligations to the Company and vice versa. Involvement by these sameindividuals in the affairs of International specifically creates demands ontheir time and resources, which may be needed for the Company and its affairs.The Company’s directors resolve all conflicts in accordance with theirfiduciary duties and utilize an audit committee to approve all related partytransactions as required by Nasdaq Marketplace Rules.

 

**RisksRelating to the Securities Markets and Ownership of the Company Common Stock**

 

***Fluctuations in StockPrice***

 

Themarket price of the Company’s common stock could be subject to significantfluctuations. Among the factors that could affect the Company’s stock priceare:

 

•                  quarterly variations in operating results;

 

•                  changes in revenue or earnings estimates orpublication of research reports by analysts;

 

•                  speculation in the press or investmentcommunity;

 

•                  strategic actions by the Company or itscompetitors, such as acquisitions or restructurings;

 

•                  actions by institutional stockholders;

 

•                  general market conditions;

 

•                  domestic and international economic factorsunrelated to the Company’s performance; and

 

•                  limited shares of common stock available fortrading

 

The stock markets have experienced extreme volatilitythat has often been unrelated to the operating performance of particularcompanies. These broad market fluctuations may adversely affect the tradingprice of the Company’s common stock. In particular, the Company cannot makeassurances that its stock will sell at any particular price, or at all.

 

##### **AVAILABLE INFORMATION**

 

The Company is subject to the informational requirements of theSecurities Exchange Act of 1934 that require the Company to file, most oftenelectronically, reports, proxy and information statements, and otherinformation with the Securities and Exchange Commission (SEC).  The public may read and copy the Company’sfilings at the SEC’s Public Reference Room at 450 Fifth Street, N.W.,Washington, D.C. 20549.  The public canobtain information on the operation of the Public Reference Room by calling1-800-SEC-0330.  The SEC maintains anInternet site that contains reports, proxy and information statements and otherinformation regarding issuers that file electronically with the SEC atwww.sec.gov.  Similarly, the Companymaintains a website at http://www.ambassadorsgroup.com/EPAX/default.htm.  The Company makes available free of chargeon this website, its annual report on Form 10-K, quarterly reports on Form10-Q, current reports on Form 8-K and all amendments to those reports as soonas reasonably practical after, and in any event on the same day as, suchmaterial is electronically filed with or furnished to the SEC.

 

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**Item 2.****          *****Properties***

 

The principal executiveoffices of the Company, consisting of approximately 48,000 square feet, arelocated in Spokane, Washington, and are occupied pursuant to a lease thatexpires December 31, 2004. The lease currently provides for monthly rentalpayments of approximately $37,000. The Company anticipates to renew this leasewith terms consistent with the current lease.

 

The Company also occupies additional office space totalingapproximately 11,000 square feet in Spokane, Washington, pursuant to a leasedated October 2, 2000, which expires December 31, 2004. The lease maybe extended an additional five years with 120 days advance notice to thelandlord. The Company anticipates to renew this lease. Current monthly rentapproximates $4,400 per month, with increases specified in the lease.

 

During 2003, the Company occupied additional space totalingapproximately 4,800 square feet in Spokane, Washington, pursuant to a leasedated November 18, 2003. The Company occupies this space primarily forstorage of corporate records. The lease currently provides for only annualproperty tax payments of approximately $3,500. The lease expires concurrentwith the corporate office lease on December 31, 2004. The Companyanticipates to renew this lease  withthe corporate office space lease above.

 

Management believes that itsexisting facilities are sufficient to meet its present needs and anticipatedneeds for the near future. However, additional facilities may be required inconnection with future business acquisitions and company growth.

 

**Item 3.****          *****Legal Proceedings***

 

The Company is not a party to any material pending legal proceedingsother than ordinary routine litigation incidental to its business, the outcomeof which the Company believes will not have a material adverse affect on itsbusiness, financial condition, cash flows or results of operations.

 

**Item 4.****          *****Submissionof Matters to a Vote of Security Holders***

 

None.

 

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**PART II**

 

**Item 5.****          *****Market forthe Registrant’s Common Equity and Related Stockholder Matters***

 

**StockMarket and Other Information**

 

The Company’s common stock has been traded on the Nasdaq NationalMarket under the symbol EPAX since March 1, 2002. Prior to March 1,2002, there was no public trading market for the Company’s equity securities.As of February 11, 2004, the last reported sale price of the Company’scommon stock was $22.66.  As ofFebruary 11, 2004, there were approximately 34 holders of record of theCompany’s Common Stock. This number does not include beneficial owners holdingshares through nominee or street name.

 

The following table sets forth the high and low sale prices of a shareof the Company’s Common Stock as reported on the Nasdaq National Market on a quarterlybasis for the Company’s fiscal years ended December 31, 2003 and 2002.

 
|                                  |   | **High** |   | **Low** |   |
|---------------------------------------|--------|----------|--------|---------|--------|
| Quarter ended March 31, 2003     |   | $        | 13.34  |    | $      | 11.64 |   |
| Quarter ended June 30, 2003      |   | $        | 15.29  |    | $      | 11.70 |   |
| Quarter ended September 30, 2003 |   | $        | 18.81  |    | $      | 13.85 |   |
| Quarter ended December 31, 2003  |   | $        | 24.16  |    | $      | 16.75 |   |
|                                  |   |     |   |    |   |
| Quarter ended March 31, 2002     |   | $        | 15.50  |    | $      | 11.50 |   |
| Quarter ended June 30, 2002      |   | $        | 16.49  |    | $      | 13.02 |   |
| Quarter ended September 30, 2002 |   | $        | 15.00  |    | $      | 10.72 |   |
| Quarter ended December 31, 2002  |   | $        | 15.40  |    | $      | 12.17 |   |

 

**DividendPolicy**

 

The Company declared andpaid cash dividends to International during the first quarters of 2002, 2001, and 1998.

 

At the November 2003meeting, the board of directors initiated a new dividend policy paying commonshareholders $0.44 per share annually, distributable at $0.11 per share on aquarterly basis. The Company’s board of directors also declared an initialquarterly dividend payment of $0.11 per share, which was paid onDecember 8, 2003, to all common shareholders of record onNovember 24, 2003. On February 24, 2004, the Board of Directorsapproved a second quarterly dividend payment of $0.11 per share, payable onMarch 23, 2004, to all common shareholders of record on March 9,2004.

 

The payment of dividends inthe future will be at the discretion of the board of directors and will bedependent upon the Company’s financial condition, results of operations,capital requirements and such other factors as the board of directors, in itsdiscretion, deems relevant.

 

**Transfer Agentand Registrar**

 

Mellon Investor Services LLCserves as transfer agent and registrar of the Company’s common stock.

 

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**Item 6.****          *****Selected Financial Data***

 

This section presentsthe Company’s historical financial data which should be read carefully with thefinancial statements included in this Form 10-K, including the notes tothe consolidated financial statements, and Management’s Discussion and Analysisof Financial Condition and Results of Operations. The statement of operationsdata for each of the years in the three-year period ended December 31,2003, and the balance sheet data as of December 31, 2003 and 2002 havebeen derived from audited financial statements included elsewhere in this Form 10-K.The statement of operations data for the year ending December 31, 2000 and1999 and the balance sheet data as of December 31, 2001, 2000 and 1999 hasbeen derived from the audited financial statements, which are not included inthis Form 10-K. The financial data as of December 31, 2001, 2000 and1999 and for the years then ended and for the period January 1, 2002through February 28, 2002, have been carved out from the consolidatedfinancial statements of International using the historical operating results and historical bases of theassets and liabilities of International’s business, which the Company comprised. Historical results are notnecessarily indicative of future results.

 
|                                                           |   | **December 31,**                     |    |
|----------------------------------------------------------------|--------|-------------------------------------------|---------|
|                                                           |   | **2003**                                  |    | **2002** |   | **2001 (B)** |   | **2000** |   | **1999** |   |
|                                                           |   | **(in thousands, except per share data)** |    |
| Statement of Operations data:                                  |   |                                      |    |   |   |   |   |   |   |   |   |
| Net revenue (A)                                                |   | $                                         | 37,665  |   | $ | 36,090 |   | $ | 43,414 |   | $ | 40,322 |   | $ | 26,533 |   |
| Selling and tour promotion expenses                            |   | $                                         | 18,170  |   | $ | 15,259 |   | $ | 18,392 |   | $ | 19,868 |   | $ | 13,779 |   |
| General and administrative expenses                            |   | $                                         | 4,930   |   | $ | 5,504 |   | $ | 6,531 |   | $ | 5,125 |   | $ | 3,536 |   |
| Write-down of intangible assets                                |   | $                                         | —  |   | $ | — |   | $ | 5,937 |   | $ | — |   | $ | — |   |
| Operating income                                               |   | $                                         | 14,565  |   | $ | 15,327 |   | $ | 12,554 |   | $ | 15,329 |   | $ | 9,218 |   |
| Net income after tax                                           |   | $                                         | 10,154  |   | $ | 10,798 |   | $ | 9,488 |   | $ | 11,056 |   | $ | 6,701 |   |
| Earnings per share – basic                                |   | $                                         | 1.02    |   | $ | 1.10 |   | $ | 0.97 |   | $ | 1.13 |   | $ | 0.68 |   |
| Earnings per share – diluted                              |   | $                                         | 1.00    |   | $ | 1.06 |   | $ | 0.97 |   | $ | 1.13 |   | $ | 0.68 |   |
| Balance sheet data:                                            |   |                                      |    |   |   |   |   |   |   |   |   |
| Cash, cash equivalents, and available-for-sale  securities (C) |   | $                                         | 67,525  |   | $ | 51,399 |   | $ | 39,773 |   | $ | 71,543 |   | $ | 39,897 |   |
| Total assets                                                   |   | $                                         | 79,321  |   | $ | 58,517 |   | $ | 46,123 |   | $ | 81,142 |   | $ | 49,398 |   |
| Total stockholders’ equity                                |   | $                                         | 40,809  |   | $ | 27,860 |   | $ | 24,839 |   | $ | 53,554 |   | $ | 34,634 |   |
| Other key financial measures:                                  |   |                                      |    |   |   |   |   |   |   |   |   |
| Cash flow from operating activities                            |   | $                                         | 17,255  |   | $ | 21,382 |   | $ | 6,994 |   | $ | 25,386 |   | $ | 9,696 |   |
| Cash flow from investing activities                            |   | $                                         | (13,139 | ) | $ | 1,259 |   | $ | 16,683 |   | $ | (35,399 | ) | $ | (9,215 | ) |
| Cash flow from financing activities                            |   | $                                         | 34      |   | $ | (9,668 | ) | $ | (37,462 | ) | $ | 7,231 |   | $ | 9,421 |   |
| Deployable cash (D1)                                           |   | $                                         | 32,903  |   | $ | 22,773 |   | $ | 20,493 |   | $ | 45,967 |   | $ | 26,353 |   |
| Free cash generated (D2)                                       |   | $                                         | 13,879  |   | $ | 11,834 |   | $ | 12,324 |   | $ | 13,649 |   | $ | 8,656 |   |
| Return on adjusted equity (D3)                                 |   | 32                                        | %       | 42 | % | 24 | % | 25 | % | 25 | % |

 

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(A)      Net revenue is a function of gross programreceipts less program pass-through expenses. Program pass-through expensesinclude all direct costs associated with the Company’s programs, including butnot limited to costs related to airfare, hotels, meals, ground transportation,guides, professional exchanges and changes in currency exchange rates. Grossprogram receipts during the years ended December 31, 2003, 2002, 2001,2000, and 1999, were $108.6 million, $97.1 million, $116.3 million, $107.8 million,and $71.6 million, respectively.

 

(B)        Excluding the effects of a write-down ofintangible assets during the year ended December 31, 2001, operatingincome, net income after tax, and basic and diluted earnings per share wouldhave been $18.5 million, $13.2 million, and $1.35, respectively.

 

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(C)        Cashand cash equivalents and available-for-sale securities include restricted cashequivalents of a nominal amount for the periods ended December 31, 2003,2002 and 2001 and the amount of $112,000 for the periods endedDecember 31, 2000 and 1999.

 

(D)       See below for reconciliation and description of non-GAAP financialmeasures.

 

**Non-GAAP Financial Measures:**

 

The Companyanalyzes its performance on a net income, cash flow, and liquidity basis inaccordance with generally accepted accounting principles (GAAP) as well as on anon-GAAP operating, cash flow, and liquidity basis referred to below as“non-GAAP operating results” or “non-GAAP cash flows and liquidity measures”.  These measures and related discussions arepresented as supplementary information in this analysis to enhance the readers’understanding of, and highlight trends in, the Company’s core financialresults.  Any non-GAAP financial measureused by the Company should not be considered in isolation or as a substitutefor measures of performance or liquidity prepared in accordance with GAAP.

 

(D1)                    Deployable cash:  Deployablecash is a non-GAAP liquidity measure. Deployable cash is calculated as the sumof cash and cash equivalents, available for sale securities and prepaid programcosts and expenses less the sum of accounts payable, accrued expenses and othershort-term liabilities (excluding deferred taxes), participant deposits and thecurrent portion of long-term capital lease. Management believes this non-GAAPmeasure is useful to investors in understanding the cash available to deployfor future business opportunities.

 

**Deployable Cash Reconciliation:**

 
|                                                                                  |   | **2003** |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
|---------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
| Cash and cash equivalents and available for  sale securities                          |   | $        | 67,525 |     | $      | 51,399   |   | $        | 39,773 |     | $      | 71,543 |   | $ | 39,897 |   |
| Prepaid program costs and expenses                                                    |   | 1,608    |   | 1,516    |   | 1,501    |   | 1,006    |   | 706      |   |
| Less: accounts payable                                                                |   | (2,599   | )      | (2,181   | )      | (2,521   | )      | (2,076   | )      | (1,649   | )      |
| Less: accrued expenses & other  short-term liabilities (excluding deferred taxes) |   | (5,260   | )      | (2,060   | )      | (1,709   | )      | (1,743   | )      | (594     | )      |
| Less: participant deposits                                                            |   | (28,220  | )      | (25,901  | )      | (16,551  | )      | (22,763  | )      | (12,007  | )      |
| Less: current portion of long-term capital  lease                                     |   | (151     | )      | —   |   | —   |   | —   |   | —   |   |
| Total deployable cash at December 31                                             |   | $        | 32,903 |     | $      | 22,773   |   | $        | 20,493 |     | $      | 45,967 |   | $ | 26,353 |   |
|                                                                                       |        |          |        |          |        |          |        |          |        |          |        |  |  |  |  |  |  |

 

(D2)                    Free cash generated:  Free cashgenerated is a non-GAAP cash flow measure. Free cash generated is calculated as cash flow from operations lesschange in participant deposits less purchase of property and equipment.  Management believes this non-GAAP measure isuseful to investors in understanding the cash generated within a calendar yearfor future use in operations. The change in participant deposits is excluded,as the cash related to such deposits is limited in use until travel hasoccurred.

 

**Free Cash Generated Reconciliation:**

 
|                                  |   | **2003** |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
|---------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
| Cash flow from operations as reported |   | $        | 17,255 |     | $      | 21,382   |   | $        | 6,994  |     | $      | 25,386 |   | $ | 9,696 |   |
| Change in participant deposits        |   | (2,319   | )      | (9,350   | )      | 6,212    |   | (10,756  | )      | (252     | )      |
| Purchase of property and equipment    |   | (1,057   | )      | (198     | )      | (882     | )      | (981     | )      | (788     | )      |
| Total free cash generated             |   | $        | 13,879 |     | $      | 11,834   |   | $        | 12,324 |     | $      | 13,649 |   | $ | 8,656 |   |
|                                       |        |          |        |          |        |          |        |          |        |          |        |  |  |  |  |  |  |

 

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(D3)              Return on adjustedequity:  Return on adjusted equity is anon-GAAP operating result.  Averageadjusted equity is calculated as the average of stockholders equity at January 1less other comprehensive income at January 1 and stockholders equity atDecember 31 less other comprehensive income at December 31.  Other comprehensive income is excluded fromthe calculation as it represents the marking to market of certain foreignexchange contracts designated as cash flow hedges.  As management fully intends to use the foreign exchange contractsfor their stated purpose the amounts related to the marking to market of thesecash flow hedges do not reflect the equity generated from past performance,which has been reinvested in the Company. Management believes this non-GAAP measure is useful to investors inunderstanding the performance of equity maintained in the business from pastearnings net of any dividends distributed to stockholders.

 

**Return on Adjusted Stockholders’Equity Reconciliation:**

 
|                                                                              |   | **2003** |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
|-----------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
| Stockholders’ equity at January 1, as  reported                         |   | $        | 27,860 |     | $      | 24,839   |   | $        | 53,554 |     | $      | 34,634 |   | $ | 17,763 |   |
| Less: other comprehensive income at  January 1                               |   | 1,155    |   | (340     | )      | 401      |   | (232     | )      | (182     | )      |
| Plus: stockholders’ equity at  December 31, as reported                 |   | 40,809   |   | 27,860   |   | 24,839   |   | 53,554   |   | 34,634   |   |
| Less: other comprehensive income at  December 31                             |   | 3,451    |   | 1,155    |   | (340     | )      | 633      |   | (232     | )      |
| Average adjusted stockholders’ equity (the  sum of the above divided by two) |   | $        | 32,032 |     | $      | 25,942   |   | $        | 39,166 |     | $      | 43,894 |   | $ | 26,406 |   |
| Net income                                                                        |   | $        | 10,154 |     | $      | 10,798   |   | $        | 9,488  |     | $      | 11,056 |   | $ | 6,701 |   |
| Return on adjusted equity                                                         |   | 32       | %      | 42       | %      | 24       | %      | 25       | %      | 25       | %      |

 

**Item 7.****          *****Management’sDiscussion and Analysis of Financial Condition and Results of Operations***

 

The following discussion should be read in conjunction with theselected consolidated financial data and the Company’s consolidated financialstatements and the notes thereto included in this Report.

 

**General**

 

The Company is a leadingeducational travel company that organizes and promotes international anddomestic programs for students, athletes, and professionals. Youth programsprovide opportunities for middle and high school students to learn about thehistory, government, economy and culture of the foreign and domesticdestinations they visit as well as for middle and high school athletes toparticipate in international sports challenges. The Company’s professionalprograms emphasize meetings and seminars between delegates and persons in similarprofessions abroad.

 

The Company was founded in1967 and was reincorporated in Delaware in 1995, when it was purchased andconsolidated with International. Prior to February 28, 2002 the Company was a wholly ownedsubsidiary of International.Beginning March 1, 2002, the Company operated as an independentstand-alone company.

 

On January 25, 2002,the board of directors of International approved the distribution of all of the Company’s common stock to International’sstockholders (the spin-off).  The International Board of Directors declared a dividend ofthe Company’s common stock to the International’s stockholders of record on February 4,2002. The dividend was distributed after the close of business onFebruary 28, 2002, in the amount of one share of the Company’s commonstock for each outstanding share of International common stock. The distribution of common stock was intended to betax-free to the Company and to its stockholders, and International received a favorable Internal RevenueService private letter ruling to that effect. The trading of the common stock of the Company on the Nasdaq NationalMarket began on March 1, 2002, under the ticker symbol “EPAX.” Prior toFebruary 28, 2002, the Company composed the operations of the formerEducation Group segment of International.

 

In anticipation of thespin-off transaction, the Company’s common stock was split in April 2001and February 2002 and 9,813,140 shares became issued and outstanding.Shares outstanding for the years ended December 31, 2001 and 2000, and asof December 31, 2001, have been retroactively adjusted for the stocksplit.

 

18

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The consolidated financialstatements include the accounts of Ambassadors Group, Inc., and its whollyowned subsidiaries, Ambassador Programs, Inc., Ambassadors Sports Group, Inc.,Ambassadors Specialty Group, Inc., and Ambassadors Unlimited, LLC. Allsignificant intercompany accounts and transactions have been eliminated inconsolidation.

 

The consolidated financialstatements for the year ended December 31, 2001, and for the periodJanuary 1, 2002 through February 28, 2002, have been carved out fromthe consolidated financial statements of International using the historicaloperating results and historical bases of the assets and liabilities ofInternational’s business, which the Company comprised. Accordingly, thehistorical financial information presented herein does not necessarily reflectwhat the Company’s financial position, operating results and cash flows wouldhave been had the Company been a separate, stand-alone entity during theperiods presented (see Notes to Consolidated Financial Statements, Note 1).

 

The Company has a singleoperating segment consisting of the educational travel and sports programs forstudents, athletes and professionals. These programs have similar economiccharacteristics, offer comparable products to delegates, and utilize similarprocesses for program marketing.

 

Gross program receiptsreflect total payments received by the Company. Gross program receipts lessprogram pass-through expenses constitute the Company’s revenues. Programpass-through expenses include all direct costs associated with the Company’sprograms, including but not limited to, costs related to airfare, hotels, meals,ground transportation, guides, professional exchanges, and changes in currencyexchange rates. The Company recognizes gross program receipts, pass-throughexpenses and revenues upon the departure of the program. Operating expenses,which are expensed by the Company as incurred, are the costs related to thecreation of programs, promotional materials and marketing costs, salaries,rent, other general and administrative expenses and all of the Company’sordinary expenses. The Company’s policy is to obtain payment for substantiallyall travel services prior to entering into commitments for incurring expensesrelating to such travel.

 

The Company’s business isseasonal. The majority of the Company’s travel programs occur in June andJuly of each year. The Company has historically earned more than 90percent of its annual revenues in the second and third quarters, which theCompany anticipates will continue for the foreseeable future. Historically,these seasonal revenues have more than offset operating losses incurred duringthe rest of the year. The Company’s annual results would be adversely affectedif the Company’s revenues were to be substantially below seasonal norms duringthese periods. The Company’s operating results may fluctuate as a result of manyfactors. See “Risk Factors” for further explanation.

 

The majority of theCompany’s programs take place outside the United States and most foreignsuppliers require payment in local currency rather than in U.S. dollars.Accordingly, the Company is exposed to foreign currency risks in certaincountries as foreign currency exchange rates between those currencies and theU.S. dollar fluctuate. The Company has a program to provide a hedge againstcertain of these foreign currency risks. The Company uses forward contractsthat allow the Company to acquire the foreign currency at a fixed price for aspecified period of time. Some of the Company’s forward contracts include asynthetic component if a pre-determined trigger occurs during the term of thecontract.

 

These foreign exchangecontracts are entered into to support normal anticipated recurring purchasesand, accordingly, are not entered into for speculative purposes. See“Management’s Discussion and Analysis of Financial Condition and Results ofOperations — Market Risk.”

 

**CriticalAccounting Policies**

 

The preparation ofconsolidated financial statements requires the Company to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenue andexpenses, and related disclosure of contingent assets and liabilities. On anon-going basis, the Company evaluates its estimates, including cash and cashequivalents, available-for-sale securities, intangible assets, income taxes,derivative financial instruments, and contingencies and litigation.

 

Cash, cash equivalents, andavailable-for-sale securities are exposed to concentrations of credit risk. TheCompany places its cash and temporary cash investments with high credit qualityinstitutions. At times, such balances may be in excess of the federaldepository insurance limit or may be on deposit at institutions, which are notcovered by this insurance. If such institutions were to become insolvent duringwhich time it held the Company’s cash, cash equivalents, or available-for-salesecurities in excess of the insurance limit, it would be necessary for theCompany to obtain credit financing to operate its programs.

 

19

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The asset and liabilityapproach is used to account for income taxes by recognizing deferred tax assetsand liabilities for the expected future tax consequences of temporarydifferences between the carrying amounts and the tax bases of assets andliabilities. While the Company has considered future taxable income and ongoingprudent and feasible tax planning strategies in assessing the need for avaluation allowance, in the event the Company were to determine that it wouldnot be able to realize all or part of its net deferred tax assets in thefuture, an adjustment to the deferred tax assets would be charged to income inthe period such determination was made.

 

The Company uses foreigncurrency exchange contracts as part of an overall risk-management strategy.These instruments are used as a means of mitigating exposure to foreigncurrency risk connected to anticipated travel programs. In entering into thesecontracts, the Company has assumed the risk, which might arise from thepossible inability of counterparties to meet the terms of their contracts. TheCompany does not expect any losses as a result of counterparty defaults.However, if such defaults occurred, the necessity would arise to locatealternative counterparties, or the Company would then consider alternate meansof settling its foreign exchange contractual obligations.

 

The Company bases itsestimates on historical experience and on various other assumptions that arebelieved to be reasonable under the circumstances, the results of which formthe basis for making judgments about the carrying values of assets and liabilitiesthat are not readily apparent from other sources. Actual results may differfrom these estimates under different assumptions or conditions.

 

**Results ofOperations**

 

The following table setsforth, for the periods indicated, the relative percentages that certain incomeand expense items bear to consolidated revenues.

 
|                                |   | **Year Ended  December 31,** |   |
|-------------------------------------|--------|-----------------------------------|--------|
|                                |   | **2003**                          |   | **2002** |   | **2001 (A)** |   | **2000** |   | **1999** |   |
|                                |   | **(% of  revenues)**              |   |
| Net revenue                         |   | 100                               | %      | 100 | % | 100 | % | 100 | % | 100 | % |
| Selling and tour promotion expenses |   | 48                                |   | 42 |   | 42 |   | 49 |   | 52 |   |
| General and administrative expenses |   | 13                                |   | 15 |   | 15 |   | 13 |   | 13 |   |
| Write-down of intangible assets     |   | —                            |   | — |   | 14 |   | — |   | — |   |
| Operating income                    |   | 39                                |   | 43 |   | 29 |   | 38 |   | 35 |   |
| Other income                        |   | 2                                 |   | 3 |   | 5 |   | 4 |   | 3 |   |
| Income before tax                   |   | 41                                |   | 45 |   | 34 |   | 42 |   | 38 |   |
| Income tax provision                |   | 14                                |   | 15 |   | 12 |   | 14 |   | 13 |   |
| Net income                          |   | 27                                | %      | 30 | % | 22 | % | 27 | % | 25 | % |

 

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(A)       Excluding the effects of a write-down of intangible assets during theyear ended December 31, 2001, the relative percentages of operatingincome, income before tax, and net income to consolidated revenues would havebeen 43%, 48%, and 31%, respectively.

 

20

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***Comparison of Year Ended December 31, 2003 to YearEnded December 31, 2002***

 

Gross programreceipts increased to $108.6 million for the year ended December 31,2003 from $97.1 million for the year ended December 31, 2002. The$11.5 million or 12 percent increase is primarily the result of travelingapproximately 1,700 additional delegates, which represents an increase of 8.4 percentand approximately a 3.2 percent increase in program tuition. The Companytraveled more than 23,000 delegates during 2003 as compared to more than 21,000delegates during 2002.

 

Net revenue increased to $37.7 million for the year endedDecember 31, 2003 from $36.1 million for the year endedDecember 31, 2002. The $1.6 million or four percent increase is primarilythe result of traveling additional delegates. Gross margin (revenue as apercentage of gross program receipts) decreased to 35 percent for the yearended December 31, 2003, as compared to 37 percent for the year endedDecember 31, 2002. The decrease in gross margin of two percent primarilyresulted from two events. First, a decline in the gross margin resulted from aweaker U.S. dollar relative to the currencies in which the Company pays foreignsuppliers, including the Euro dollar, Australian dollar, and British pound.Second, the average travel group size was smaller during 2003 compared to 2002due to higher cancellations because of the war with Iraq and the outbreak ofthe SARS virus.

 

The Company’s policy is to expense all selling and tour promotion costsas incurred. Selling and tour promotion expenses increased to $18.2 millionfrom $15.3 million comparing the years ended December 31, 2003 and2002, respectively. The increase of $2.9 million or 19 percent is primarily theresult of $1.3 million of increased marketing efforts  and $0.9 million of personnel costs. The increase in marketingefforts resulted from increased mailings for 2004 travel, shifting the timingof certain mail campaigns, and retention efforts of delegates during the warwith Iraq.

 

General and administrativeexpenses decreased to $4.9 million for the year ended December 31,2003 from $5.5 million  for theyear ended December 31, 2002.The decrease of $0.6 million or 11 percent is primarily the result of areduction in estimated liability related to certain general and administrativeexpenses.

 

For the year ended December 31, 2003, the Company earned operatingincome of $14.6 million in comparison to the operating income of$15.3 million  for the year endedDecember 31, 2002. Changes in operating income from 2002 to 2003 are theresult of changes as described above.

 

Other income consisted primarily of interest income generated by cash,cash equivalents, and available-for-sale securities.   The Company realized interest and dividend income of $0.8million in the year ended December 31, 2003, compared to $1.1 million inthe year ended December 31, 2002. The decrease of realized interest anddividend income is related to lower rates of return. In 2003 and 2002, theaverage rate of return was 1.3 percent and 2.2 percent, respectively.

 

For the year ended December 31, 2003, income before income taxeswas $15.4 million in comparison to income before income taxes of $16.4 millionfor the year ended December 31, 2002. Changes in income before incometaxes are the result of changes as described above.

 

The Company incurred an income tax provision of approximately $5.2million for the year ended December 31, 2003, in comparison to$5.6 million for the year ended December 31, 2002. The income taxprovision incurred was based upon the estimated annual effective income taxrate applied to the pre-tax income. The Company’s effective tax rate of 34.0percent for 2003 was comparable to 34.1 percent for 2002.

 

Net income decreased to $10.2 million for the year endedDecember 31, 2003 from $10.8 million for the year endedDecember 31, 2002. Changes in net income from 2003 to 2002 are the resultof changes as described above.

 

21

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***Comparison of Year Ended December 31,2002 to Year Ended December 31, 2001***

 

Gross programreceipts decreased to $97.1 million for the year ended December 31,2002, from $116.3 million for the year ended December 31, 2001. The$19.2 million or 16 percent decrease is primarily the result of a decreasein traveled delegates. The Company traveled more than 21,000 delegates during2002 as compared to more than 25,000 delegates during 2001.

 

Net revenue decreased to$36.1 million for the year ended December 31, 2002 from$43.4 million for the year ended December 31, 2001. This decrease is primarily the result of adecrease in traveled delegates. Gross margins (revenue as a percentage of grossprogram receipts) remained comparable during the years ended December 31,2002 and 2001, at 37 percent.

 

The Company’s policy is to expense all selling and tour promotion costsas incurred. Selling and tour promotion expenses decreased to $15.3 millionfrom $18.4 million comparing the years ended December 31, 2002 and2001, respectively. The decrease of $3.1 million or 17 percent is primarily theresult of personnel cost management controls implemented subsequent toSeptember 11, 2001, including decreased staffing, a wage freeze, salarycuts for members of management and limited hiring throughout 2002, whichdecreased personnel costs $1.5 million. Cost management controls were alsoimplemented to limit marketing efforts for certain programs during 2002, whichresulted in a  $1.0 million costsavings.

 

General and administrativeexpenses decreased to $5.5 million for the year ended December 31,2002, from $6.5 million for the year ended December 31, 2001. The decrease of $1.0 million or 16percent is also primarily the result of a series of personnel cost managementcontrols of $0.7 million implemented subsequent to September 11, 2001, asdiscussed in the paragraph above. In addition, other cost controls includedlimiting professional fees incurred of $0.6 million by the Company.

 

During thefourth quarter of 2001, the Company incurred a $5.9 million impairmentcharge for intangible assets, incurred primarily as a result of the impact tooperations of the terrorist acts that occurred on September 11, 2001, theresponse by the United States since October 7, 2001, and the resultingnegative impact these events have had on domestic and international air travel,and the travel industry in general.

 

For the yearended December 31, 2002, the Company earned operating income of$15.3 million in comparison to the operating income of $12.6 millionfor the year ended December 31, 2001. Excluding an impairment charge of$5.9 million during 2001, operating income would have been $18.5 million.Changes in operating income from 2001 to 2002 are the result of changes asdescribed above.

 

Other income consisted primarily of interest income generated by cash,cash equivalents, and available-for-sale securities.   The Company realized interest and dividend income of $1.1million for the year ended December 31, 2002, compared to $2.1 million forthe year ended December 31, 2001. The decrease of realized interest anddividend income is related to lower rates of return. In 2002 and 2001, theaverage rate of return was 2.2 percent and 4.7 percent, respectively.

 

For the year ended December 31, 2002, income before income taxeswas $16.4 million in comparison to income before income taxes of $14.7 millionfor the year ended December 31, 2001. Excluding an impairment charge of $5.9million during 2001, income before income taxes would have been $20.6million.  Changes in income beforeincome taxes are the result of changes as described above.

 

The Company incurred an income tax provision of approximately $5.6million for the year ended December 31, 2002, in comparison to$5.2 million for the year ended December 31, 2001. The income taxprovision incurred was based upon the estimated annual effective income taxrate applied to the pre-tax income. The Company’s effective tax rate of 34.1percent for 2002 decreased from 35.5 percent for 2001 primarily as a result ofa reduction in state income taxes.

 

Net income increased to $10.8 million for the year endedDecember 31, 2002 from $9.5 million for the year endedDecember 31, 2001. Excluding the impairment charge of $5.9 million during2001, net income would have been $13.2 million during the year endedDecember 31, 2001. Changes in net income from 2002 to 2001 are the resultof changes as described above.

 

22

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**Liquidityand Capital Resources**

 

The Company’s business isnot capital intensive. However, the Company does retain funds for operatingpurposes in order to conduct sales and marketing efforts for future programs.

 

Net cash provided byoperations for years ended December 31, 2003 and 2002 was approximately$17.3 million and $21.4 million, respectively. The decrease of $4.1million in operating cash flows from the year ending December 31, 2002, tothe year ending December 31, 2003, primarily results from two events.First, a decrease of $7.0 million is due to a decrease in cash flows fromparticipant deposits as a result of comparable enrollments at December 31,2003 and December 31, 2002 versus low enrollments at December 31,2001 as a result of the terrorist attacks on September 11, 2001.  Second, an increase of $3.4 million is dueto a refund of moneys previously paid to a foreign tax authority.

 

Net cash provided by (used in) investing activities for the years endedDecember 31, 2003 and 2002 was $(13.1) million and $1.3 million,respectively. The decrease of $14.4 million from the year endedDecember 31, 2002, to the year ended December 31, 2003 is primarilydue to net activities with the sale or maturity and purchase of available-for-salesecurities of $13.5 million and the purchase of property and equipment of $0.9million.

 

Net cash provided by (used in) financing activities for the years endedDecember 31, 2003 and 2002, was $34,000 and $(9.7) million,respectively. The increase of $9.7 million in cash from financing activities inthe year ended December 31, 2003, is primarily due to activities betweenthe Company and International.  During2002, concurrent with the spin-off in February 2002 and in accordance withthe terms of the Master Separation and Distribution Agreement, there was acalculation made which resulted in additional dividends approximating $20.5million being paid to International and a capital contribution to the Companyapproximating $10.4 million from International.  During 2003, there was no activity between the Company andInternational. In addition, the Company paid a $1.1 million dividend toshareholders in 2003 and proceeds from the exercise of stock options increased$0.7 million for the year ended December 31, 2003.

 

At December 31, 2003, the Company had approximately$67.5 million of cash, cash equivalents including restricted cash, andavailable-for-sale securities, which included program participant funds ofapproximately $28.2 million. At December 31, 2002, the Company hadapproximately $51.4 million of cash and cash equivalents includingrestricted cash, and available-for-sale securities, which included programparticipant funds of $25.9 million. Under the Company’s cancellationpolicy, a program delegate may be entitled to a refund of a portion of his orher deposit, less certain fees, depending on the time of cancellation. Should agreater number of delegates cancel their travel in comparison to that which ispart of the Company’s ongoing operations, due to circumstances such asinternational or domestic unrest, terrorism, or general economic downturn, theCompany’s cash balances could be significantly reduced. Cash balances couldalso be reduced significantly if the financial institutions, which held balancesbeyond that federally insured, were to become insolvent.

 

The results of operations and financial position of the Company’sbusiness may be affected by a number of trends or uncertainties that have, orthe Company reasonably expects could have, a material impact on income fromcontinuing operations and cash flows, as well as the balance sheet. Such trendsand uncertainties include: the repercussions of the war with Iraq, possiblefuture terrorist acts, and the residual impact of the SARS epidemic. Furthermore,the war with Iraq has affected and will continue to affect the travel industry,as well as the markets in which the Company operates. The potential andlong-term effects of the war with Iraq, conflict in the Middle East, and theSARS epidemic result in uncertainties for the Company’s customers, the marketfor the Company’s common stock, the markets for the Company’s services, thestrength of the U.S. dollar and the U.S. economy. The consequences of suchtrends or events are unpredictable and the Company is not currently able todetermine whether the impact will be material or highly material on theCompany’s business, financial condition, cash flows and results of operations.

 

The Company is continuing topursue further acquisitions of related travel businesses that may require theuse of cash and cash equivalents. No such acquisitions are currently pendingand no assurance can be given that definitive agreements for any suchacquisitions will be entered into, or, if they are entered into, that they willbe on terms favorable to the Company.

 

The Company used a significant amount of cash in 2002 toward itsdividend payment to International prior to its spin-off. The Company alsoreceived a capital contribution from International concurrent with its spin-off.The Company does not have any material capital expenditure commitments for2004. Management believes that existing cash and cash equivalents and cashflows from operations will be sufficient to fund the Company’s anticipatedoperating needs, capital expenditures, dividend payments and acquisitionsthrough the next 12 months of operation.

 

23

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The following table presents the maturities of the Company’scontractual cash obligations as of December 31, 2003 (in thousands):

 
|                        |   | **Payments  due by period** |   |
|-----------------------------|--------|-----------------------------|--------|
| **Contractual Obligations** |   | **Total**                   |   | **Less   than  1 year** |   | **1 – 3  years** |   | **3 – 5  years** |   |
| Operating leases            |   | $                           | 1,674  |   | $ | 816 |   | $ | 671 |   | $ | 187 |   |
| Capital lease               |   | 807                         |   | 164 |   | 492 |   | 151 |   |
| Total                       |   | $                           | 2,481  |   | $ | 980 |   | $ | 1,163 |   | $ | 338 |   |

 

**Market Risk**

 

The following table summarizes the financial instruments other thanderivative financial instruments held by the Company at December 31, 2003and 2002, which are sensitive to changes in interest rates. This table presentsprincipal cash flows for available-for-sale securities by contractual maturitydate and the related average interest rate and fair value (in thousands):

 
|                              |   | **December 31,  2003** |   | **December 31,  2002** |   |
|-----------------------------------|--------|-----------------------------|--------|-----------------------------|--------|
|                              |   | **2004**                    |   | **2005**                    |   | **Total** |   | **Fair  Value** |   | **Total** |   | **Fair  Value** |   |
| U.S. govt. and agency obligations |   | $                           | 28,114 |                        | $      | 5,758 |   | $ | 33,872 |   | $ | 33,872 |   | $ | 21,896 |   | $ | 21,896 |   |
| Interest rate                     |   | 1.39                        | %      | 1.40                        | %      | 1.39 | % | — |   | 2.59 | % | — |   |
|                                   |        |                             |        |                             |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The majority of the Company’s travel programs take place outside theUnited States and most foreign suppliers require payment in currency other thanthe U.S. dollar. Accordingly, the Company is exposed to foreign currency riskrelative to changes in foreign currency exchange rates between those currenciesand the U.S. dollar. The Company has a program to provide a hedge againstcertain of these foreign currency risks with less than two years maturity. TheCompany uses forward contracts, which allow the Company to acquire the foreigncurrency at a fixed price for a specified period of time. Some of the Company’sforward contracts include a synthetic component if a pre-determined triggeroccurs during the term of the contract.

 

The Company is exposed tocredit risk under the foreign currency contracts and options to the extent thatthe counterparty is unable to perform under the agreement. The fair value offoreign currency exchange contracts is based on quoted market prices and thespot rate of the foreign currencies subject to contracts at year-end.

 

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The tablebelow provides information about the Company’s derivative financial instrumentsthat are sensitive to foreign currency exchange rates. For foreign currencyforward exchange agreements, the table presents the notional amounts andweighted average exchange rates. All contracts held as of December 31,2003, mature in 2004 and 2005. These notional amounts generally are used tocalculate the contractual payments to be exchanged under the contract. None ofthese contracts is entered into for trading purposes.

 

At December 31, 2003and 2002, the Company had outstanding forward contracts as follows (inthousands):

 
|                                                                           |   | **Notional  Amount** |   | **U.S.  Dollar  Average  Contractual  Exchange Rate** |   |
|--------------------------------------------------------------------------------|--------|----------------------|--------|-------------------------------------------------------|--------|
|                                                                           |   |                 |   |                                                  |   |
| **December 31, 2003**                                                     |   |                 |   |                                                  |   |
| Forward contracts (pay $U.S./receive foreign  currency):                       |   |                 |   |                                                  |   |
| Australian dollar                                                              |   | 12,400               |   | $                                                     | 0.64   |   |
| British pound                                                                  |   | 5,650                |   | $                                                     | 1.58   |   |
| Euro dollar                                                                    |   | 16,500               |   | $                                                     | 1.12   |   |
| New Zealand dollar                                                             |   | 6,240                |   | $                                                     | 0.55   |   |
|                                                                           |   | 40,790               |   |                                                  |   |
|                                                                           |   |                 |   |                                                  |   |
| **December 31, 2002**                                                     |   |                 |   |                                                  |   |
| Forward contracts (pay $U.S./receive foreign  currency):                       |   |                 |   |                                                  |   |
| Australian dollar                                                              |   | 5,500                |   | $                                                     | 0.53   |   |
| Euro  dollar                                                                   |   | 7,600                |   | $                                                     | 0.98   |   |
| New Zealand dollar                                                             |   | 2,500                |   | $                                                     | 0.47   |   |
|                                                                           |   | 15,600               |   |                                                  |   |
| Forward contracts with synthetic option (pay  $U.S./receive foreign currency): |   |                 |   |                                                  |   |
| Australian dollar                                                              |   | 8,750                |   | $                                                     | 0.57   |   |
| British  pound                                                                 |   | 4,300                |   | $                                                     | 1.48   |   |
| Euro  dollar                                                                   |   | 2,500                |   | $                                                     | 0.97   |   |
| New  Zealand dollar                                                            |   | 2,600                |   | $                                                     | 0.46   |   |
|                                                                           |   | 18,150               |   |                                                  |   |

 

At December 31, 2003 and 2002, the Company had unrealized foreigncurrency gains associated with these financial instruments of approximately$5.2 million and $1.6 million, respectively.

 

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**NewAccounting Pronouncements**

 

In August 2001, theFASB approved SFAS 143, Accounting for Asset Retirement Obligations(SFAS 143), which will be effective for the fiscal year beginningJanuary 1, 2003. SFAS 143 addresses the financial accounting andreporting for obligations associated with the retirement of tangible long-livedassets and the associated asset retirement costs. The Company adopted thisstatement during the first quarter of fiscal 2003. The adoption ofSFAS 143 did not have a material impact on our financial condition,results of operations or cash flows.

 

In December2002, the FASB issued SFAS No. 148 “Accounting for Stock- Based Compensation -Transition and Disclosure - an amendment of FASB Statement No. 123” (FAS148).  This statement amends SFAS No.123 “Accounting for Stock Based Compensation” (FAS 123) to provide alternativemethods of voluntarily transitioning to the fair-value based method ofaccounting for stock-based employee compensation.  FAS 148 also amends the disclosure requirements of FAS 123 torequire disclosure of the method used to account for stock-based employeecompensation and the effect of the method on reported results in both annualand interim financial statements.  Theinterim disclosure provisions are effective for financial reports containingfinancial statements for interim periods beginning after December 15, 2002. TheCompany currently discloses the effects of stock-based employee compensationand does not anticipate adoption of the fair-value based method of accountingfor stock-based compensation under the current accounting rules.

 

In April 2003,the FASB issued SFAS No. 149, “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities” (SFAS No. 149). SFAS No. 149 amends andclarifies accounting for derivative instruments, including certain derivativeinstruments embedded in other contracts, and for hedging activities under SFASNo. 133. In particular, SFAS No. 149 clarifies under what circumstances acontract with an initial net investment meets the characteristics of aderivative and when a derivative contains a financing component that warrantsspecial reporting in the statement of cash flows. SFAS No. 149 is generallyeffective for contracts entered into or modified after June 30, 2003 TheCompany adopted this statement during the second quarter of fiscal 2003. Theadoption of SFAS 149 did not have a material impact on our financial condition,results of operations or cash flows.

 

In May 2003,the FASB issued SFAS No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity.” SFAS No. 150 establishesstandards for how an issuer classifies and measures certain financialinstruments with characteristics of both liabilities and equity. It requiresthat an issuer classify a financial instrument that is within its scope as aliability (or an asset in some circumstances). Many of those instruments werepreviously classified as equity. SFAS No. 150 is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective at the beginning of the first interim period beginning afterSeptember 15, 2003. It is to be implemented by reporting the cumulative effectof a change in an accounting principle for financial instruments created beforethe issuance date of SFAS No. 150 and still existing at the beginning of theinterim period of adoption. Restatement is not permitted. On November 7, 2003,FASB issued FASB Staff Position No. FAS 150-3 (FSP 150-3), “Effective Date,Disclosures, and Transition for Mandatorily Redeemable Financial Instruments ofCertain Nonpublic Entities and Certain Mandatorily Redeemable NoncontrollingInterests under FASB Statement No. 150, Accounting for Certain FinancialInstruments with Characteristics of Both Liabilities and Equity.” FSP 150-3deferred certain aspects of FAS 150. The Company adopted this statement duringthe second quarter of fiscal 2003. The adoption of SFAS 150 and FAS 150-3 didnot have a material impact on our financial condition, results of operations orcash flows.

 

On December17, 2003, the Staff of the SEC issued Staff Accounting Bulletin No. 104 (SAB104), Revenue Recognition, which supercedes SAB 101, Revenue Recognition inFinancial Statements. SAB 104’s primary purpose is to rescind accountingguidance contained in SAB 101 related to multiple element revenue arrangements,superceded as a result of the issuance of EITF 00-21, “Accounting for RevenueArrangements with Multiple Deliverables.” Additionally, SAB 104 rescinds theSEC’s Revenue Recognition in Financial Statements Frequently Asked Questionsand Answers (the FAQ) issued with SAB 101 that had been codified in SEC Topic13, Revenue Recognition. Selected portions of the FAQ have been incorporatedinto SAB 104. While the wording of SAB 104 has changed to reflect the issuanceof EITF 00-21, the revenue recognition principles of SAB 101 remain largelyunchanged by the issuance of SAB 104. The Company adopted this statement duringthe fourth quarter of fiscal 2003. The adoption of SAB 104 did not have amaterial impact on our financial condition, results of operations or cashflows.

 

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**Item 7A.**** *****Quantitativeand Qualitative Disclosures About Market Risk***

 

The information required bythis item is incorporated herein by reference to the section entitled“Market Risk” in Management’s Discussion and Analysis of Results of Operationsand Financial Condition (Part II, Item 7).

 

**Item 8.****          *****FinancialStatements and Supplementary Data***

 

Consolidated FinancialStatements: See Part III, Item 15 of this Form 10-K.

 

**Item 9.****          *****Changes inand Disagreements With Accountants on Accounting and Financial Disclosure***

 

None.

 

**Item 9A.**** *****Controls and Procedures***

 

(a)   Evaluation of disclosurecontrols and procedures: As of December 31, 2003, the end of the periodcovered by this report, the Company’s chief executive officer and its chieffinancial officer reviewed and evaluated the effectiveness of the Company’sdisclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)and 15d-15(e)), which are designed to ensure that material information theCompany must disclose in its report filed or submitted under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed,summarized, and reported on a timely basis, and have concluded, based on thatevaluation, that as of such date, the Company’s disclosure controls andprocedures were effective to ensure that information required to be disclosedby the Company in reports that it files or submits under the Exchange Act isaccumulated and communicated to the Company’s chief executive officer and chieffinancial officer as appropriate to allow timely decisions regarding requireddisclosure.

 

(b)   Changes in internalcontrol over financial reporting: For the fiscal year ended December 31,2003, there has been no change in the Company’s internal control over financialreporting that has materially affected, or is reasonably likely to materiallyaffect, its internal control over financial reporting.

 

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**PART III**

 

**Item 10.      *Directors and Executive Officers of the Registrant***

 

The information called forby this item is hereby incorporated by reference from the registrant’sdefinitive Proxy Statement for the fiscal year ended December 31, 2003,for which the Proxy Statement is expected to be filed with the Securities andExchange Commission on or about April 14, 2004.

 

**Item 11.      *Executive Compensation***

 

The information called forby this item is hereby incorporated by reference from the registrant’s definitiveProxy Statement for the fiscal year ended December 31, 2003, for which theProxy Statement is expected to be filed with the Securities and ExchangeCommission on or about April 14, 2004.

 

**Item 12.      *Security Ownership of Certain Beneficial Owners andManagement***

 

The information called forby this item is hereby incorporated by reference from the registrant’sdefinitive Proxy Statement for the fiscal year ended December 31, 2003,for which the Proxy Statement is expected to be filed with the Securities andExchange Commission on or about April 14, 2004.

 

**Equity Compensation Plan Information**

 
|                                                        |   | **(a)**                                                                                             |   | **(b)**                                                                            |   | **(c)**                                                                                                                                             |
|-------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------|
| **Plan category**                                           |   | **Number of  securities to  be issued upon exercise  of outstanding options,  warrants and rights** |   | **Weighted-average  exercise price of  outstanding options,  warrants and rights** |   | **Number of  securities remaining available  for future issuance under equity  compensation plans (excluding securities  reflected in column (a))** |
| Equity compensation plans approved by  security holders     |   | 1,139,000                                                                                           |   | $                                                                                  | 11.21  |                                                                                                                                                | 470,000 |
| Equity compensation plans not approved by  security holders |   | N/A                                                                                                 |   | N/A                                                                                |   | N/A                                                                                                                                                 |
| Total                                                       |   | 1,139,000                                                                                           |   | $                                                                                  | 11.21  |                                                                                                                                                | 470,000 |

 

**Item 13.      *Certain Relationships and Related Transactions***

 

The information called for by this item is hereby incorporated by referencefrom the registrant’s definitive Proxy Statement for the fiscal year endedDecember 31, 2003, for which the Proxy Statement is expected to be filedwith the Securities and Exchange Commission on or about April 14, 2004.

 

**Item 14.      *Principal Accountant Fees and Services***

 

The information called for by this item is hereby incorporated byreference from the registrant’s definitive Proxy Statement for the fiscal yearended December 31, 2003, for which the Proxy Statement is expected to befiled with the Securities and Exchange Commission on or about April 14,2004

 

28

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**Item 15****.     *Exhibits, Financial Statement Schedules andReports on Form 8-K***

 

(a)* The following documents are filed as part ofthis Report:*

 

(1)* Consolidated Financial Statements:*

 
| Report of Independent  Auditors                                                                                             | 30     |
|-----------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                        |   |
| Consolidated Balance Sheets  at December 31, 2003 and 2002                                                             | 31     |
|                                                                                                                        |   |
| Consolidated Statements of Operations for  the years ended December 31, 2003, 2002 and 2001                       | 32     |
|                                                                                                                        |   |
| Consolidated  Statements of Comprehensive Income for the years ended December 31,  2003, 2002 and 2001                 | 33     |
|                                                                                                                        |   |
| Consolidated Statements of Changes in  Stockholders’ Equity for the years ended December 31, 2003, 2002 and  2001 | 34     |
|                                                                                                                        |   |
| Consolidated  Statements of Cash Flows for the years ended  December 31, 2003, 2002 and 2001                           | 35     |
|                                                                                                                        |   |
| Notes to  Consolidated Financial Statements                                                                                 | 36     |

 

(2) *Financial Statement Schedules:*

 

Nofinancial statement schedules are presented, as the required information iseither not applicable or is included in the Consolidated Financial Statementsor notes thereto.

 

(3) *Exhibits*

 

The exhibits listed on theaccompanying Exhibit Index are filed as part of this Form 10-K.

 

(b) *Reports on Form 8-K*

 

*(1)**      *Thecompany filed a report on Form 8-K on October 23, 2003, under Item 12, inconnection with the dissemination of an earnings release*.

*(2)**      *Thecompany filed a report on Form 8-K on November 12, 2003, under Item 5, inconnection with the appointment of a new chief financial officer.

*(3)**      *Thecompany filed a report on Form 8-K on February 10, 2004, under Item 12, inconnection with the dissemination of an earnings release*.

 

----

*     Reportcontaining information that is required to be furnished under Item 12 is notdeemed to be “filed” for the purpose of Section 18 of the SecuritiesExchange Act of 1934 and the Company is not subject to the liabilities of thatsection. The Company is not incorporating, and will not incorporate by thereference this report into a filing under the Securities Act or the ExchangeAct.

 

29

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**Reportof Independent Auditors**

 

To Board of Directors and Stockholders

of Ambassadors Group, Inc.

 

In our opinion,the consolidated financial statements listed in the index appearing under Item15(a)(1) present fairly, in all material respects, the financial position ofAmbassadors Group, Inc. and its subsidiaries (the Company) at December 31,2003 and December 31, 2002, and the results of its operations and its cashflows for each of the three years in the period ended December 31, 2003 inconformity with accounting principles generally accepted in the United Statesof America.  These financial statementsare the responsibility of the Company’s management; our responsibility is toexpress an opinion on these financial statements based on our audits.  We conducted our audits of these statementsin accordance with auditing standards generally accepted in the United Statesof America, which require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

As discussed inNote 2 to the Consolidated Financial Statements, the Company adopted theprovisions of Statement of Financial Accounting Standards No. 142, Goodwill andOther Intangible Assets, during the year ended December 31, 2002.

 

 
| /s/ PRICEWATERHOUSECOOPERS  LLP |   |
|---------------------------------|--------|
|                            |   |
| Portland, Oregon                |   |
| January 30,  2004          |   |

 

30

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**AMBASSADORS GROUP, INC.**

 

**CONSOLIDATEDBALANCE SHEETS**

 
|                                                                                                                                                                                     |   | **December 31,**                                     |       |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------|------------|
|                                                                                                                                                                                     |   | **2003**                                                  |       | **2002** |   |
|                                                                                                                                                                                     |   | **(in  thousands,  except share and****per share  data)** | ** ** |
| **Assets**                                                                                                                                                                               |   |                                                      |       |   |   |
| Current Assets:                                                                                                                                                                          |   |                                                      |       |   |   |
| Cash and cash equivalents (includes $12 of  restricted cash)                                                                                                                             |   | $                                                         | 33,653     |   | $ | 29,503 |   |
| Available-for-sale securities                                                                                                                                                            |   | 33,872                                                    |       | 21,896 |   |
| Foreign currency exchange contracts                                                                                                                                                      |   | 5,209                                                     |       | 1,642 |   |
| Accounts receivable                                                                                                                                                                      |   | 233                                                       |       | 91 |   |
| Prepaid program costs and expenses                                                                                                                                                       |   | 1,608                                                     |       | 1,516 |   |
| Total current assets                                                                                                                                                                     |   | 74,575                                                    |       | 54,648 |   |
| Property and equipment, net                                                                                                                                                              |   | 2,966                                                     |       | 1,914 |   |
| Deferred tax asset                                                                                                                                                                       |   | 1,664                                                     |       | 1,711 |   |
| Other long-term assets                                                                                                                                                                   |   | 116                                                       |       | 244 |   |
| Total assets                                                                                                                                                                             |   | $                                                         | 79,321     |   | $ | 58,517 |   |
|                                                                                                                                                                                     |   |                                                      |       |   |   |
| **Liabilities**                                                                                                                                                                          |   |                                                      |       |   |   |
| Current Liabilities:                                                                                                                                                                     |   |                                                      |       |   |   |
| Accounts payable                                                                                                                                                                         |   | $                                                         | 2,599      |   | $ | 2,181 |   |
| Accrued expenses                                                                                                                                                                         |   | 1,836                                                     |       | 2,060 |   |
| Other liabilities                                                                                                                                                                        |   | 3,424                                                     |       | — |   |
| Participants’ deposits                                                                                                                                                              |   | 28,220                                                    |       | 25,901 |   |
| Deferred tax liability                                                                                                                                                                   |   | 1,690                                                     |       | 515 |   |
| Current portion of long-term capital lease                                                                                                                                               |   | 151                                                       |       | — |   |
| Total current  liabilities                                                                                                                                                               |   | 37,920                                                    |       | 30,657 |   |
| Long-term capital lease                                                                                                                                                                  |   | 592                                                       |       | — |   |
| Total liabilities                                                                                                                                                                        |   | 38,512                                                    |       | 30,657 |   |
| Commitments and contingencies (Notes 3 and 9)                                                                                                                                            |   |                                                      |       |   |   |
| **Stockholders’ Equity**                                                                                                                                                            |   |                                                      |       |   |   |
| Preferred stock, $.01 par value; 2,000,000 shares  authorized; none  issued and outstanding                                                                                              |   | —                                                    |       | — |   |
| Common stock, $.01 par value; authorized,  20,000,000 shares; issued and outstanding, 10,013,967 and 9,877,702 shares  for the years ended December 31, 2003 and 2002, respectively |   | 100                                                       |       | 99 |   |
| Additional paid-in capital                                                                                                                                                               |   | 17,406                                                    |       | 15,808 |   |
| Retained earnings                                                                                                                                                                        |   | 19,852                                                    |       | 10,798 |   |
| Accumulated other comprehensive income                                                                                                                                                   |   | 3,451                                                     |       | 1,155 |   |
| Total stockholders’  equity                                                                                                                                                         |   | 40,809                                                    |       | 27,860 |   |
| Total liabilities and  stockholders’ equity                                                                                                                                         |   | $                                                         | 79,321     |   | $ | 58,517 |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

31

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**AMBASSADORS GROUP, INC.**

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

 
|                                                                                |   | **Years  Ended December 31,**          |   |
|-------------------------------------------------------------------------------------|--------|---------------------------------------------|--------|
|                                                                                |   | **2003**                                    |   | **2002** |   | **2001** |   |
|                                                                                |   | **(in  thousands, except  per share data)** |   |
|                                                                                |   |                                        |   |   |   |   |   |
| Revenue                                                                             |   | $                                           | 37,665 |   | $ | 36,090 |   | $ | 43,414 |   |
| Operating expenses:                                                                 |   |                                        |   |   |   |   |   |
| Selling and tour promotion                                                          |   | 18,170                                      |   | 15,259 |   | 18,392 |   |
| General and administrative                                                          |   | 4,930                                       |   | 5,504 |   | 6,531 |   |
| Write-down of intangible assets                                                     |   | —                                      |   | — |   | 5,937 |   |
|                                                                                |   | 23,100                                      |   | 20,763 |   | 30,860 |   |
| Operating income                                                                    |   | 14,565                                      |   | 15,327 |   | 12,554 |   |
| Other income (expense):                                                             |   |                                        |   |   |   |   |   |
| Interest and dividend income                                                        |   | 820                                         |   | 1,062 |   | 2,099 |   |
| Realized and unrealized gain on foreign currency  exchange contracts and other, net |   | —                                      |   | — |   | 55 |   |
|                                                                                |   | 820                                         |   | 1,062 |   | 2,154 |   |
| Income before income taxes                                                          |   | 15,385                                      |   | 16,389 |   | 14,708 |   |
| Income tax provision                                                                |   | 5,231                                       |   | 5,591 |   | 5,220 |   |
| Net income                                                                          |   | $                                           | 10,154 |   | $ | 10,798 |   | $ | 9,488 |   |
| Earnings per share - basic and diluted:                                             |   |                                        |   |   |   |   |   |
|                                                                                |   |                                        |   |   |   |   |   |
| Net income per share - basic                                                        |   | $                                           | 1.02   |   | $ | 1.10 |   | $ | 0.97 |   |
| Weighted-average common shares outstanding - basic                                  |   | 9,923                                       |   | 9,837 |   | 9,813 |   |
| Net income per share - diluted                                                      |   | $                                           | 1.00   |   | $ | 1.06 |   | $ | 0.97 |   |
| Weighted-average common shares outstanding -  diluted                               |   | 10,170                                      |   | 10,207 |   | 9,813 |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

32

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**AMBASSADORS GROUP, INC.**

 

**CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME**

 
|                                                                                                                                 |   | **Years  Ended December 31,** |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                                                                                 |   | **2003**                           |   | **2002** |   | **2001** |   |
|                                                                                                                                 |   | **(in  thousands)**                |   |
| Net income                                                                                                                           |   | $                                  | 10,154 |   | $ | 10,798 |   | $ | 9,488 |   |
| Unrealized gain (loss) on foreign currency exchange  contracts, net of income tax (provision) benefit of $(1,213), $(784), and  $435 |   | 2,354                              |   | 1,424 |   | (741 | ) |
| Unrealized gain (loss) on available-for-sale  securities, net of income tax (provision) benefit of $35 and $(41)                     |   | (58                                | )      | 71 |   | — |   |
| Comprehensive income                                                                                                                 |   | $                                  | 12,450 |   | $ | 12,293 |   | $ | 8,747 |   |

 

The accompanying notes are an integral part of the consolidated financialstatements.

 

33

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**AMBASSADORS GROUP, INC.**

 

**CONSOLIDATEDSTATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY**

 
|                                                   |   | **Common  Stock**   |   | **Additional  Paid-In** |   | **Retained** |   | **Accumulated  Other  Comprehensive** |   |               |   |
|--------------------------------------------------------|--------|---------------------|--------|-------------------------|--------|--------------|--------|---------------------------------------|--------|--------------------|--------|
|                                                   |   | **Shares**          |   | **Amount**              |   | **Capital**  |   | **Earnings**                          |   | **Income  (Loss)** |   | **Total** |   |
|                                                   |   | **(in  thousands)** |   |
| **Balances, December 31, 2000**                   |   | 9,813               |   | $                       | 98     |         | $      | 26,099                                |   | $                  | 26,956 |   | $ | 401 |   | $ | 53,554 |   |
| Net  income                                            |   | —              |   | —                  |   | —       |   | 9,488                                 |   | —             |   | 9,488 |   |
| Distribution from parent company                       |   | —              |   | —                  |   | (10,469      | )      | —                                |   | —             |   | (10,469 | ) |
| Dividend to parent company                             |   | —              |   | —                  |   | —       |   | (26,993                               | )      | —             |   | (26,993 | ) |
| Other comprehensive income, net of income taxes        |   | —              |   | —                  |   | —       |   | —                                |   | (741               | )      | (741 | ) |
| **Balances, December 31, 2001**                   |   | 9,813               |   | 98                      |   | 15,630       |   | 9,451                                 |   | (340               | )      | 24,839 |   |
| Net  income                                            |   | —              |   | —                  |   | —       |   | 10,798                                |   | —             |   | 10,798 |   |
| Stock issued                                           |   | 10                  |   | —                  |   | 77           |   | —                                |   | —             |   | 77 |   |
| Stock options exercised                                |   | 55                  |   | 1                       |   | 424          |   | —                                |   | —             |   | 425 |   |
| Tax benefit associated with exercise of stock  options |   | —              |   | —                  |   | 128          |   | —                                |   | —             |   | 128 |   |
| Dividend to parent company                             |   | —              |   | —                  |   | (10,851      | )      | (9,451                                | )      | —             |   | (20,302 | ) |
| Contribution from parent company                       |   | —              |   | —                  |   | 10,400       |   | —                                |   | —             |   | 10,400 |   |
| Other comprehensive loss, net of income taxes          |   | —              |   | —                  |   | —       |   | —                                |   | 1,495              |   | 1,495 |   |
| **Balances, December 31, 2002**                   |   | 9,878               |   | 99                      |   | 15,808       |   | 10,798                                |   | 1,155              |   | 27,860 |   |
| Net income                                             |   | —              |   | —                  |   | —       |   | 10,154                                |   | —             |   | 10,154 |   |
| Stock options exercised                                |   | 136                 |   | 1                       |   | 1,146        |   | —                                |   | —             |   | 1,147 |   |
| Tax benefit associated with exercise of stock options  |   | —              |   | —                  |   | 452          |   | —                                |   | —             |   | 452 |   |
| Dividend to shareholders                               |   | —              |   | —                  |   | —       |   | (1,100                                | )      | —             |   | (1,100 | ) |
| Other comprehensive income, net of income taxes        |   | —              |   | —                  |   | —       |   | —                                |   | 2,296              |   | 2,296 |   |
| **Balances, December 31, 2003**                   |   | 10,014              |   | $                       | 100    |         | $      | 17,406                                |   | $                  | 19,852 |   | $ | 3,451 |   | $ | 40,809 |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

34

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**AMBASSADORS GROUP, INC.**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
|                                                                               |   | **Years  Ended December 31,** |   |
|------------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                               |   | **2003**                           |   | **2002** |   | **2001** |   |
|                                                                               |   | **(in  thousands)**                |   |
| **Cash flows from operating  activities:**                                         |   |                               |   |   |   |   |   |
| Net income                                                                         |   | $                                  | 10,154 |   | $ | 10,798 |   | $ | 9,488 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |   |                               |   |   |   |   |   |
| Depreciation and amortization                                                      |   | 935                                |   | 775 |   | 926 |   |
| Deferred income tax provision (benefit)                                            |   | 44                                 |   | 157 |   | (1,465 | ) |
| Write-down of intangible assets                                                    |   | —                             |   | — |   | 5,607 |   |
| Write-down of investments                                                          |   | —                             |   | — |   | 330 |   |
| Loss (gain) on foreign currency exchange contracts                                 |   | —                             |   | — |   | (36 | ) |
| Unrealized gain on foreign currency exchange  contracts                            |   | —                             |   | — |   | (1,565 | ) |
| Equity in earnings on investment                                                   |   | (33                                | )      | — |   | — |   |
| Change in assets and liabilities, net of effects of  purchase of subsidiary:       |   |                               |   |   |   |   |   |
| Restricted cash equivalents                                                        |   | —                             |   | — |   | 100 |   |
| Accounts receivable                                                                |   | (142                               | )      | 52 |   | (95 | ) |
| Prepaid program costs and expenses                                                 |   | (92                                | )      | (15 | ) | (495 | ) |
| Accounts payable and accrued expenses                                              |   | 4,070                              |   | 265 |   | 411 |   |
| Participants’ deposits                                                        |   | 2,319                              |   | 9,350 |   | (6,212 | ) |
| Net cash provided by operating activities                                          |   | 17,255                             |   | 21,382 |   | 6,994 |   |
| **Cash flows from investing  activities:**                                         |   |                               |   |   |   |   |   |
| Proceeds from sale of available-for-sale securities                                |   | 24,012                             |   | 32,516 |   | 37,885 |   |
| Purchase of available-for-sale securities                                          |   | (36,081                            | )      | (31,057 | ) | (20,000 | ) |
| Purchase of property and equipment                                                 |   | (1,057                             | )      | (198 | ) | (882 | ) |
| Purchase of other investments                                                      |   | (13                                | )      | (2 | ) | (320 | ) |
| Net cash provided by (used in) investing activities                                |   | (13,139                            | )      | 1,259 |   | 16,683 |   |
| **Cash flows from financing  activities:**                                         |   |                               |   |   |   |   |   |
| Contribution from parent company                                                   |   | —                             |   | 10,400 |   | — |   |
| Dividend to parent company                                                         |   | —                             |   | (20,493 | ) | (37,462 | ) |
| Proceeds from exercise of stock options                                            |   | 1,147                              |   | 425 |   | — |   |
| Dividend payment to shareholders                                                   |   | (1,100                             | )      | — |   | — |   |
| Payments on capital lease                                                          |   | (13                                | )      | — |   | — |   |
| Net cash provided by (used in) financing activities                                |   | 34                                 |   | (9,668 | ) | (37,462 | ) |
| Net increase (decrease) in cash and cash  equivalents                              |   | 4,150                              |   | 12,973 |   | (13,785 | ) |
| Cash and cash equivalents, beginning of period                                     |   | 29,503                             |   | 16,530 |   | 30,315 |   |
| Cash and cash equivalents, end of period                                           |   | $                                  | 33,653 |   | $ | 29,503 |   | $ | 16,530 |   |

 

SeeNote 14 for Supplemental Disclosures of Consolidated Statements of Cash Flows.

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

35

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**AMBASSADORS GROUP, INC.**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**1.     The Company**

 

Ambassadors Group, Inc. (theCompany) is a leading educational travel company that organizes and promotesinternational and domestic educational travel and sports programs for youth,athletes and professionals.

 

Beginning March 1,2002, the Company operated as an independent stand-alone company.  Prior to February 28, 2002, the Companywas a wholly owned subsidiary of Ambassadors International, Inc.(International).

 

On January 25, 2002,the board of directors of International approved the distribution of all of theCompany’s common stock to International’s stockholders (the spin-off).  The International Board of Directorsdeclared a dividend of the Company’s common stock to the International’sstockholders of record on February 4, 2002. The dividend was distributedafter the close of business on February 28, 2002, in the amount of oneshare of the Company’s common stock for each outstanding share of Internationalcommon stock. The distribution of common stock was intended to be tax-free tothe Company and to its stockholders, and International received a favorableInternal Revenue Service private letter ruling to that effect.  The trading of the common stock of theCompany on the Nasdaq National Market began on March 1, 2002, under theticker symbol “EPAX.” Prior to February 28, 2002 the Company comprised theoperations of the former Education Group segment of its parent, International.

 

In anticipation of thespin-off transaction, the Company’s common stock was split in April 2001and February 2002 and 9,813,140 shares became issued and outstanding.Shares outstanding for the years ended December 31, 2001 and 2000, and asof December 31, 2001, have been retroactively adjusted for the stocksplit.

 

Prior to the spin-off fromInternational, the Company transferred approximately $20.5 million in cash toInternational as a dividend. The dividends per share were $2.78 in 2001.Additionally, prior to the spin-off, International funded business acquisitionsand certain working capital requirements of the Company and has not charged anyinterest on these advances. These transactions have been recorded ascontributions from the parent company. In connection with the spin-off,the Company entered into agreements with International that separated the Company’s business operationsfrom International.  Theseagreements also govern ongoing relationships. During 2002, prior to itsspin-off from International and pursuant to the Master Separation andDistribution Agreement, the Company paid to International a cash dividendapproximating $2.08 per outstanding share. International also contributed tothe Company a capital contribution approximating $10.4 million.

 

The consolidated financialstatements include the accounts of Ambassadors Group, Inc. and its wholly ownedsubsidiaries, Ambassador Programs, Inc., Ambassadors Sports Group, Inc. (SportsGroup), Ambassadors Specialty Group, Inc., and Ambassadors Unlimited, LLC. Allsignificant inter-company accounts and transactions are eliminated inconsolidation.  For the periods prior tothe spin-off, the consolidated financial statements have been carved out fromthe consolidated financial statements of its parent, International, using thehistorical operating results and historical bases of the assets and liabilitiesof its parent’s business that the Company comprised. Accordingly, thehistorical financial information presented herein does not necessarily reflectwhat the Company’s financial position, operating results and cash flows wouldhave been had the Company been a separate, stand-alone entity during theperiods presented.

 

For the periods prior to thespin-off, the consolidated financial statements include certain costs incurredby International, which were allocated to the Company. These costs areprimarily corporate personnel, finance, travel, marketing and other general andadministrative costs. The costs were allocated to the Company primarily basedon headcount or revenues of the Company relative to the total consolidatedheadcount or revenues of International. Management believes the cost allocations are reasonable within theconsolidated parent company. If the Company operated as a separate entitywithout International, however, management believes that these expenses wouldhave increased due to increased costs associated with being a stand-alonepublic company and the additional personnel costs, marketing costs, and othergeneral administrative costs associated therewith. Management believes thatthese expenses would have increased by the following proforma amounts(unaudited):

 

| **Year Ended December 31,** |   |   |      |
|----------------------------------|--------|--------|-----------|
| 2002 *                           |   | $      | 171,000   |   |
| 2001                             |   | $      | 1,242,000 |   |

 

----

*This represents only thetwo months ended February 28, 2002.

 

36

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**AMBASSADORS GROUP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —(Continued)**

 

The Companyhas a single operating segment consisting of the educational travel and sportsprograms for students, athletes and professionals. These programs have similareconomic characteristics, offer comparable products to participants and utilizesimilar processes for program marketing. All of the Company’s assets arelocated in the United States. The Company’s revenues as a percentage of totalrevenues were derived from travel programs conducted in the followinggeographic areas:

 
|                                                 |   | **Years  Ended****December 31,** |   |
|------------------------------------------------------|--------|---------------------------------------|--------|
|                                                 |   | **2003**                              |   | **2002** |   | **2001** |   |
| South Pacific (primarily Australia and New  Zealand) |   | 36                                    | %      | 55 | % | 34 | % |
| Europe                                               |   | 50                                    | %      | 31 | % | 46 | % |
| Asia (primarily China)                               |   | 2                                     | %      | 5 | % | 7 | % |
| United States                                        |   | 7                                     | %      | 5 | % | 7 | % |
| Other                                                |   | 5                                     | %      | 4 | % | 6 | % |

 

**2*.    *Summaryof Significant Accounting Policies**

 

***Credit Risk***

 

The Company’s financialinstruments that are exposed to concentrations of credit risk consist primarilyof cash and cash equivalents, certain investments and trade accountsreceivable. The Company places its cash and temporary cash investments withhigh credit quality institutions. At times, such balances may be in excess ofthe federal depository insurance limit or may be on deposit at institutions,which are not covered by this insurance. The Company believes that its primarytrade accounts receivable credit risk exposure is limited as delegates arerequired to pay for their entire program tuition prior to the programdeparture.

 

The Companyuses foreign currency exchange contracts as part of an overall risk-managementstrategy. These instruments are used as a means of mitigating exposure toforeign currency risk connected to anticipated travel programs. In enteringinto these contracts, the Company has assumed the risk, which might arise fromthe possible inability of counterparties to meet the terms of their contracts.The Company does not expect any losses as a result of counterparty defaults.

 

***Cash and Cash Equivalents***

 

The Companyinvests cash in excess of operating requirements in short-term time deposits,money market instruments, government mutual bond funds and other investments.The Company considers investments with remaining maturities at date of purchaseof three months or less to be cash equivalents.

 

The Company’srestricted cash equivalents represent certificates of deposit issued in theCompany’s name and held by one airline company as collateral for airfarepurchase agreements. Additionally, the Company has a $2.0 millionrevolving credit facility for the purpose of issuing letters of credit toseveral airlines. The facility allows for letters of credit to be issuedthrough September 2004 and must expire no later than September 2005.At December 31, 2003 and 2002, the Company had letters of creditoutstanding of approximately $1.3 million under this facility.  Management anticipates renewal of thefacilities.

 

37

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**AMBASSADORS GROUP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —(Continued)**

 

***Derivative Financial Instruments***

 

InJune 1998, Statement of Financial Accounting Standards No. 133 (SFAS133), “Accounting for Derivative Instruments and Hedging Activities” wasissued. The Company implemented the Statement on July 1, 1998. TheStatement requires that all derivative instruments be recorded on the balancesheet at fair value. Changes in the fair value of derivatives are recorded eachperiod in current earnings or other comprehensive income, depending on whethera derivative is designated as part of a hedge transaction and, if it is,depending on the type of hedge transaction. For qualifying cash flow hedgetransactions in which the Company is hedging the variability of cash flowsrelated to a forecasted transaction, changes in the fair value of thederivative instrument are reported in other comprehensive income. The gains andlosses on the derivative instruments that are reported in other comprehensiveincome are reclassified as earnings in the periods in which earnings areimpacted by the variability of the cash flows of the hedged item. Theineffective portion of all hedges is recognized in the statements of operationsas other income (expense). Unrealized gains and losses on foreign currencyexchange contracts that are not qualifying cash flow hedges as defined by SFAS133 are recognized in the statements of operations as other income(expense).  All of the Company’soutstanding foreign currency exchange contracts at December 31, 2003 and2002 are qualifying cash flow hedges.

 

***Investments***

 

The Company classifies itsmarketable debt investments as available-for-sale securities, which are carriedat fair value. Unrealized gains and losses on available-for-sale securities areexcluded from operations and reported as accumulated other comprehensiveincome, net of deferred income taxes. Realized gains and losses on the sale ofavailable-for-sale securities are recognized on a specific identification basisin the statement of operations in the period the investments are sold.

 

During August 2003, theCompany purchased a minority interest in a certain company. This companyprovides a one full day development activity for delegates traveling in Europe.This investment is reported using the equity method.

 

During January 2001,the Company purchased a minority interest in a certain company. This companyprovides unique adventure travel experiences to a sophisticated clientelethroughout the Rocky Mountains, American Southwest, Alaska and Patagonia. Thisinvestment is reported at the lower of cost or estimated net realizable value.During the year ended December 31, 2001, the Company recorded a loss of$0.3 million representing what the Company’s management believes to be otherthan temporary decline in the fair value of this investment.

 

***Property and Equipment***

 

Property and equipment arestated at cost. Cost of maintenance and repairs that do not improve or extendthe lives of the respective assets are expensed currently. Major additions andbetterments are capitalized. Depreciation and amortization are provided overthe lesser of the estimated useful lives of the respective assets or the leaseterm (including extensions), using the straight-line method, generally five toseven years.

 

The Company performs reviewsfor the impairment of property and equipment whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. When property and equipment are sold or retired, the related costand accumulated depreciation are removed from the accounts and any gain or lossis recognized in the statement of income.

 

38

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**AMBASSADORS GROUP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —(Continued)**

 

***Goodwill and Intangible Assets***

 

Prior to January 1,2002, goodwill was being amortized using the straight-line method over30 years. The cost of the covenant-not-to-compete is amortized using thestraight-line method over five years, the term of the agreement. Bothgoodwill and the covenant-not-to-compete are classified as other long-termassets on the balance sheet. Principally as a result of the impact of the terrorist acts thatoccurred on September 11, 2001, the response by the United States sinceOctober 7, 2001, and the resulting negative impact these events have hadon domestic and international air travel, and the travel industry in general,the Company reviewed the carrying value of long-lived assets associated withcertain of its acquisitions and recorded a non-cash charge of $5.9 millionin the fourth quarter of 2001, which represented the impairment of goodwill andother related intangible assets. This charge is based on the amount by whichthe book value exceeded the current estimated fair market value of thegoodwill. The current estimated fair market value was determined primarilyusing the anticipated cash flows of the operations of the related acquiredcompanies. The impairment charge fully eliminated the remaining carrying valueof the goodwill associated with the acquisition of a company primarily engagedin providing youth sports travel programs.

 

InMarch 2002, the Company issued 2,000 shares of its common stock to theowners of a golf travel company in exchange for certain assets of the golftravel company. The cost of the assets is amortized using the straight-linemethod over five years and is classified as other long-term assets on thebalance sheet. In June 2003, the Company reviewed the carrying value ofthis asset and determined that there is no future value of the asset and theCompany will not be able to generate future profits. The Company thereforewrote off the remaining unamortized balance of approximately $154,000.

 

InJune 2001, the FASB issued SFAS 142, “Goodwill and Other IntangibleAssets,” which supersedes APB Opinion No. 17, “Intangible Assets.” SFAS 142,among other things, establishes new standards for intangible assets acquired ina business combination, eliminates amortization of goodwill and sets forthrequirements to periodically evaluate goodwill for impairment. The Companyadopted this statement during the first quarter of 2002 and goodwill andcertain intangibles with indefinite lives are no longer being amortized.Accordingly, approximately $64,000 of previous annual amortization is no longerbeing recorded.

 

The followingtable presents the impact of SFAS 142 on our net income and our net income pershare had the new standard been in effect for the year ended December 31,2001 (in thousands, except per share amounts):

 
|                                                  |   | **2001*** |   |
|-------------------------------------------------------|--------|-----------|--------|
| Net income - as reported                              |   | $         | 9,488  |   |
| Adjustments:                                          |   |      |   |
| Amortization of goodwill                              |   | 64        |   |
| Income  tax effect                                    |   | (24       | )      |
| Net  adjustments                                      |   | 40        |   |
| Net income - as adjusted                              |   | $         | 9,528  |   |
| Basic and diluted net income per share - as  reported |   | $         | 0.97   |   |
| Basic and diluted net income per share  adjusted      |   | $         | 0.97   |   |

 

----

*The Companyincurred an impairment charge of intangibles of approximately $5.9 millionduring the year ended December 31, 2001.

 

***Revenue Recognition***

 

The Company bills traveldelegates in advance, which are recorded as participants’ deposits. The Companypays for certain direct program costs including but not limited to airfare,hotel, rail passes and other program costs in advance of travel, which arerecorded as prepaid program costs and expenses. The Company recognizes travelrevenue and related costs when travel convenes.

 

39

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**AMBASSADORS GROUP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —(Continued)**

 

***Selling and Tour Promotion Expenses***

 

The Company expenses allselling and tour promotion expenses as incurred.

 

***Income Taxes***

 

The asset and liabilityapproach is used to account for income taxes by recognizing deferred tax assetsand liabilities for the expected future tax consequences of temporarydifferences between the carrying amounts and the tax bases of assets andliabilities.  For the period fromJanuary 1, 2002 through February 28, 2002, and for the year endedDecember 31, 2001, the Company was included in the consolidated income taxreturn of International.  Therefore, theincome tax provision recorded in these financial statements was computed on aseparate return basis.

 

***Earnings Per Share***

 

Earnings per share —basic is computed by dividing net income by the weighted-average number ofcommon shares outstanding during the period. Earnings per share — dilutedis computed by increasing the weighted-average number of common sharesoutstanding by the additional common shares that would have been outstanding ifthe potentially dilutive common shares had been issued.

 

In connection with thespin-off transaction, approximately 839,000 options originally granted underInternational were converted to options of the Company on February 28,2002. The dilutive effect of these converted stock options are excluded fromthe Company’s earnings per share calculation for the year endedDecember 31, 2001, as they were not options of the Company. The dilutiveeffect to International of these options was less than eight percent for 2001.However, this is not necessarily indicative of the impact on diluted earningsper share to the Company.

 

***Comprehensive Income***

 

Othercomprehensive income refers to revenues, expenses, gains and losses that underaccounting principles generally accepted in the United States are included incomprehensive income but are excluded from net income as these amounts arerecorded directly as an adjustment to stockholders’ equity, net of tax. TheCompany’s other comprehensive income is composed of unrealized gains and losseson foreign currency exchange contracts and available-for-sale securities.

 

***Accounting for Stock Options***

 

As permittedby Statement of Financial Accounting Standards No. 123 (SFAS 123),“Accounting for Stock-Based Compensation,” the Company has chosen to measurecompensation cost for stock-based employee compensation plans using theintrinsic value method of accounting prescribed by Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees,” and to providethe disclosure only requirements of SFAS 123.

 

No stock options of theCompany were outstanding as of December 31, 2001. However, in conjunctionwith the spin-off and during 2002, the Company granted stock options to itsemployees (see Note 10).

 

The fair value of eachoption grant is estimated on the date of grant using the Black-Scholesoption-pricing model with the following weighted-average assumptions used forgrants in 2003 and 2002:

 
|                            |   | **2003**   |   | **2002**   |   |
|---------------------------------|--------|------------|--------|------------|--------|
| Expected dividend yield         |   | 1.81       | %      | 0.00       | %      |
| Expected stock price volatility |   | 38.87      | %      | 41.94      | %      |
| Risk-free interest rate         |   | 5.27       | %      | 3.14       | %      |
| Expected life of options        |   | 7.12 years |   | 5.03 years |   |

 

The weighted average fairvalue of options granted during 2003 and 2002 was $8.54 and $5.01,respectively.

 

40

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**AMBASSADORS GROUP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —(Continued)**

 

The Company has adopted thedisclosure-only provisions of SFAS No. 123 and as amended by SFAS No. 148,“Accounting for Stock-Based Compensation-Transition and Disclosure.”  Accordingly, no compensation expense hasbeen recognized in 2003 and 2002 for unexercised options related to the stockoption plan.  Had compensation cost forthe Company’s stock option plan been determined based on fair value at thegrant dates under the plan consistent with the method of SFAS No. 123, theCompany’s net income and net income per share amounts for the years endedDecember 31, 2003 and 2002, would have been changed to the pro-formaamounts indicated below (in thousands except per share data):

 
|                                                                                                                                  |   | **2003** |   | **2002** |   |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| Net income as reported                                                                                                                |   | $        | 10,154 |     | $      | 10,798 |   |
| Total stock-based employee compensation expense  determined under fair-value based method for all awards, net of related tax  effects |   | 474      |   | 724      |   |
| Pro forma net income                                                                                                                  |   | $        | 9,680  |     | $      | 10,074 |   |
| Pro forma net income per share - basic                                                                                                |   | $        | 0.98   |     | $      | 1.02 |   |
| Pro forma net income per share - diluted                                                                                              |   | $        | 0.95   |     | $      | 0.99 |   |

 

***Estimates***

 

The preparation ofconsolidated financial statements requires the Company to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenue andexpenses, and related disclosure of contingent assets and liabilities. On anon-going basis, the Company evaluates its estimates, including investments,intangible assets, income taxes, derivative financial instruments, andcontingencies and litigation. The Company bases its estimates on historicalexperience and on various other assumptions that are believed to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions.

 

***Reclassifications***

 

Certain prior-yearamounts have been reclassified to conform with current year financial statementpresentation.  Such reclassificationshad no impact on previously reported net income, cash flows or stockholders’equity.

 

***New Accounting Pronouncements***

 

In August 2001, theFASB approved SFAS 143, Accounting for Asset Retirement Obligations(SFAS 143), which will be effective for the fiscal year beginningJanuary 1, 2003. SFAS 143 addresses the financial accounting andreporting for obligations associated with the retirement of tangible long-livedassets and the associated asset retirement costs. The Company adopted thisstatement during the first quarter of fiscal 2003. The adoption ofSFAS 143 did not have a material impact on our financial condition,results of operations or cash flows.

 

InDecember 2002, the FASB issued SFAS No. 148 “Accounting for Stock- BasedCompensation - Transition and Disclosure - an amendment of FASB Statement No.123” (FAS 148).  This statement amendsSFAS No. 123 “Accounting for Stock Based Compensation” (FAS 123) to providealternative methods of voluntarily transitioning to the fair value based methodof accounting for stock-based employee compensation.  FAS 148 also amends the disclosure requirements of FAS 123 torequire disclosure of the method used to account for stock-based employeecompensation and the effect of the method on reported results in both annualand interim financial statements.  Theinterim disclosure provisions are effective for financial reports containingfinancial statements for interim periods beginning after December 15,2002. The Company currently discloses the effects of stock-based employeecompensation and does not anticipate adoption of the fair value based method ofaccounting for stock-based compensation under the current accounting rules.

 

41

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**AMBASSADORS GROUP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —(Continued)**

 

InApril 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 onDerivative Instruments and Hedging Activities” (SFAS No. 149). SFAS No. 149amends and clarifies accounting for derivative instruments, including certainderivative instruments embedded in other contracts, and for hedging activitiesunder SFAS No. 133. In particular, SFAS No. 149 clarifies under whatcircumstances a contract with an initial net investment meets thecharacteristics of a derivative and when a derivative contains a financingcomponent that warrants special reporting in the statement of cash flows. SFASNo. 149 is generally effective for contracts entered into or modified afterJune 30, 2003 The Company adopted this statement during the second quarterof fiscal 2003. The adoption of SFAS 149 did not have a material impact onour financial condition, results of operations or cash flows.

 

In May 2003,the FASB issued SFAS No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity.” SFAS No. 150 establishesstandards for how an issuer classifies and measures certain financialinstruments with characteristics of both liabilities and equity. It requiresthat an issuer classify a financial instrument that is within its scope as aliability (or an asset in some circumstances). Many of those instruments werepreviously classified as equity. SFAS No. 150 is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective at the beginning of the first interim period beginning afterSeptember 15, 2003. It is to be implemented by reporting the cumulativeeffect of a change in an accounting principle for financial instruments createdbefore the issuance date of SFAS No. 150 and still existing at the beginning ofthe interim period of adoption. Restatement is not permitted. On November 7,2003, FASB issued FASB Staff Position No. FAS 150-3 (FSP 150-3), “EffectiveDate, Disclosures, and Transition for Mandatorily Redeemable FinancialInstruments of Certain Nonpublic Entities and Certain Mandatorily RedeemableNoncontrolling Interests under FASB Statement No. 150, Accounting for CertainFinancial Instruments with Characteristics of Both Liabilities and Equity.” FSP150-3 deferred certain aspects of FAS 150. The Company adopted this statementduring the second quarter of fiscal 2003. The adoption of SFAS 150 and FAS150-3 did not have a material impact on our financial condition, results ofoperations or cash flows.

 

OnDecember 17, 2003, the Staff of the SEC issued Staff Accounting BulletinNo. 104 (SAB 104), Revenue Recognition, which supercedes SAB 101, RevenueRecognition in Financial Statements. SAB 104’s primary purpose is to rescindaccounting guidance contained in SAB 101 related to multiple element revenuearrangements, superceded as a result of the issuance of EITF 00-21, “Accountingfor Revenue Arrangements with Multiple Deliverables.” Additionally, SAB 104rescinds the SEC’s Revenue Recognition in Financial Statements Frequently AskedQuestions and Answers (the FAQ) issued with SAB 101 that had been codified inSEC Topic 13, Revenue Recognition. Selected portions of the FAQ have beenincorporated into SAB 104. While the wording of SAB 104 has changed to reflectthe issuance of EITF 00-21, the revenue recognition principles of SAB 101remain largely unchanged by the issuance of SAB 104. The Company adopted thisstatement during the fourth quarter of fiscal 2003. The adoption of SAB 104 didnot have a material impact on our financial condition, results of operations orcash flows.

 

42

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**AMBASSADORS GROUP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —(Continued)**

 

**3.  DerivativeFinancial Instruments**

 

The majority of theCompany’s travel programs take place outside of the United States and mostforeign suppliers require payment in currency other than the U.S. dollar.Accordingly, the Company is exposed to foreign currency risk relative tochanges in foreign currency exchange rates between those currencies and theU.S. dollar. The Company has a program to provide a hedge against certain ofthese foreign currency risks. The Company uses forward contracts that allow theCompany to acquire the foreign currency at a fixed price for a specified periodof time. Some of the Company’s forward contracts include a synthetic componentif a pre-determined trigger occurs during the term of the contract. All of theCompany’s derivatives are cash flow hedges of forecasted transactions.

 

At December 31, 2003,the Company had outstanding forward contracts as follows (in thousands):

 
|               |   | **Notional  Amount** |   | **Matures**                     |   |
|--------------------|--------|----------------------|--------|---------------------------------|--------|
| Forward contracts: |   |                 |   |                            |   |
| Australian dollar  |   | 12,400               |   | January -  July 2004  |   |
| British pound      |   | 5,650                |   | January -  July 2004  |   |
| Euro dollar        |   | 16,500               |   | February -  June 2005 |   |
| New Zealand dollar |   | 6,240                |   | March -  July 2004    |   |
|               |   | 40,790               |   |                            |   |

 

At December 31, 2002,the Company had outstanding forward contracts as follows (in thousands):

 
|                                     |   | **Notional  Amount** |   | **Matures**                     |   |
|------------------------------------------|--------|----------------------|--------|---------------------------------|--------|
| Forward contracts:                       |   |                 |   |                            |   |
| Australian dollar                        |   | 5,500                |   | May  - June 2003           |   |
| Euro dollar                              |   | 7,600                |   | April -  June 2003    |   |
| New Zealand dollar                       |   | 2,500                |   | May  - July 2003           |   |
|                                     |   | 15,600               |   |                            |   |
|                                     |   |                 |   |                            |   |
| Forward contracts with synthetic option: |   |                 |   |                            |   |
| Australian dollar                        |   | 8,750                |   | January -  July 2003  |   |
| British  pound                           |   | 4,300                |   | February -  July 2003 |   |
| Euro  dollar                             |   | 2,500                |   | February -  July 2003 |   |
| New Zealand dollar                       |   | 2,600                |   | May  - July 2003           |   |
|                                     |   | 18,150               |   |                            |   |

 

AtDecember 31, 2003 and 2002, associated with these financial instruments,the Company had a net unrealized gain of approximately $5.2 million and $1.6million, respectively. Unrealized gains on forward contracts recorded in othercomprehensive income and expected to be reclassified to revenue during the yearending December 31, 2004 are approximately $3.1 million.

 

Unrealizedgains or losses associated with these transactions that qualify as cash flowhedges under SFAS 133 are reported in other comprehensive income. Any realizedgains or losses associated with these transactions are recognized in theCompany’s operations in the period the contracts are closed. The net unrealizedgain (loss) reclassified to revenue (expense) from other accumulatedcomprehensive income for the years ended December 31, 2003 and 2002, wasapproximately $(1.1) million and $(0.3) million, respectively. Income tax(benefit) on the unrealized gain (loss) reclassified in 2003 and 2002was approximately $(0.6) million and $(0.2) million, respectively. The Companyassesses hedge ineffectiveness on a quarterly basis and records the gain orloss related to the ineffective portion in the statements of income. During theyears ended December 31, 2003 and 2002, there were no significant amountsrecognized in income due to hedge ineffectiveness.

 

43

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**AMBASSADORS GROUP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —(Continued)**

 

**4.     Investments**

 

At December 31, 2003,and December 31, 2002, the cost and estimated fair values of the Company’sinvestments in U.S. government and agency obligations were as follows (inthousands): 

 
|                   |   | **Cost** |   | **Gross  Unrealized  Gain** |   | **Gross  Unrealized  Losses** |   | **Fair  Value/  Carrying  Value** |   |
|------------------------|--------|----------|--------|-----------------------------|--------|-------------------------------|--------|-----------------------------------|--------|
| December 31, 2003 |   | $        | 33,853 |                        | $      | 19                            |   | $                                 | — |   | $ | 33,872 |   |
| December 31, 2002 |   | $        | 21,784 |                        | $      | 112                           |   | $                                 | — |   | $ | 21,896 |   |

 

AtDecember 31, 2003, the amortized cost and fair value of theavailable-for-sale securities, by contractual maturity were as follows (in thousands):

 
|                             |   | **Amortized  Cost** |   | **Fair  Value** |   |
|----------------------------------|--------|---------------------|--------|-----------------|--------|
| One year or less                 |   | $                   | 28,090 |            | $      | 28,114 |   |
| After one year through two years |   | 5,763               |   | 5,758           |   |
|                             |   | $                   | 33,853 |            | $      | 33,872 |   |

 

Expectedmaturities may differ from contractual maturities because issuers may have theright to call or prepay obligations with or without call or prepaymentpenalties.

 

**5.     Property and Equipment**

 

Property and equipmentconsists of the following (in thousands): 

 
|                                           |   | **December 31,** |   |
|------------------------------------------------|--------|-----------------------|--------|
|                                           |   | **2003**              |   | **2002** |   |
| Office furniture, fixtures and equipment       |   | $                     | 3,504  |   | $ | 2,639 |   |
| Computer equipment and software                |   | 4,682                 |   | 3,800 |   |
| Leasehold improvements                         |   | 972                   |   | 905 |   |
|                                           |   | 9,158                 |   | 7,344 |   |
| Less accumulated depreciation and amortization |   | (6,192                | )      | (5,430 | ) |
|                                           |   | $                     | 2,966  |   | $ | 1,914 |   |

 

Depreciation andamortization expense on property and equipment of approximately $760,000,$740,000, and $668,000, for the years ended December 31, 2003, 2002, and2001, respectively, was included in the determination of net income.

 

**6.     Other Liabilities**

 

During October 2003,the Company received a $3.1 million refund of moneys previously paid to aforeign tax authority. It is currently unclear as to whether the refund ispermanent and accordingly, the Company has recorded this refund as a liabilityon the balance sheet. On a quarterly basis, the Company adjusts the liabilityfor interest and any gain or loss on the currency exchange. AtDecember 31, 2003, the refund of moneys was $3.4 million included in otherliabilities.

 

44

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**AMBASSADORS GROUP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —(Continued)**

 

**7.     Income Taxes**

 

The provisionfor income taxes consisted of the following (in thousands):

 
|     |   | **Years  Ended December 31,** |   |
|----------|--------|------------------------------------|--------|
|     |   | **2003**                           |   | **2002** |   | **2001** |   |
| Current: |   |                               |   |   |   |   |   |
| Federal  |   | $                                  | 5,176  |   | $ | 5,429 |   | $ | 6,135 |   |
| State    |   | 11                                 |   | 5 |   | 550 |   |
| Deferred |   | 44                                 |   | 157 |   | (1,465 | ) |
|     |   | $                                  | 5,231  |   | $ | 5,591 |   | $ | 5,220 |   |

 

Components of the netdeferred tax assets and liabilities are as follows (in thousands):

 
|                                                    |   | **December 31,  2003** |   |
|---------------------------------------------------------|--------|-----------------------------|--------|
|                                                    |   | **Assets**                  |   | **Liabilities** |   | **Total** |   |
| Amortization of goodwill and non-compete  agreement     |   | $                           | 1,675  |   | $ | — |   | $ | 1,675 |   |
| Accrued vacation and compensation                       |   | 87                          |   | — |   | 87 |   |
| Unrealized gain on foreign currency  exchange contracts |   | —                      |   | (1,771 | ) | (1,771 | ) |
| Unrealized gain on available-for-sale  securities       |   | —                      |   | (6 | ) | (6 | ) |
| Depreciation                                            |   | —                      |   | (11 | ) | (11 | ) |
| Total temporary differences                             |   | $                           | 1,762  |   | $ | (1,788 | ) | $ | (26 | ) |

 
|                                                    |   | **December 31,  2002** |   |
|---------------------------------------------------------|--------|-----------------------------|--------|
|                                                    |   | **Assets**                  |   | **Liabilities** |   | **Total** |   |
| Amortization of goodwill and non-compete  agreement     |   | $                           | 1,771  |   | $ | — |   | $ | 1,771 |   |
| Accrued vacation and compensation                       |   | 85                          |   | — |   | 85 |   |
| Unrealized gain on foreign currency exchange  contracts |   | —                      |   | (559 | ) | (559 | ) |
| Unrealized loss on available-for-sale securities        |   | —                      |   | (41 | ) | (41 | ) |
| Depreciation                                            |   | —                      |   | (60 | ) | (60 | ) |
| Total temporary differences                             |   | $                           | 1,856  |   | $ | (660 | ) | $ | 1,196 |   |

 

The income taxprovision differs from that computed using the federal statutory rate appliedto income before income taxes as follows (in thousands):

 
|                                     |   | **Years  Ended December 31,** |   |
|------------------------------------------|--------|------------------------------------|--------|
|                                     |   | **2003  Amount**                   |   | **%** |   | **2002  Amount** |   | **%** |   | **2001  Amount** |   | **%** |   |
| Provision at the federal statutory rate  |   | $                                  | 5,385  |   | 35.0 | % | $ | 5,736 |   | 35.0 | % | $ | 5,146 |   | 35.0 | % |
| Tax exempt interest                      |   | (235                               | )      | (1.5 | ) | (221 | ) | (1.3 | ) | (54 | ) | (0.4 | ) |
| State income tax, net of federal benefit |   | 7                                  |   | — |   | 3 |   | — |   | 358 |   | 2.4 |   |
| Other                                    |   | 74                                 |   | 0.5 |   | 73 |   | 0.4 |   | (230 | ) | (1.5 | ) |
|                                     |   | $                                  | 5,231  |   | 34.0 | % | $ | 5,591 |   | 34.1 | % | $ | 5,220 |   | 35.5 | % |

 

45

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**AMBASSADORS GROUP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —(Continued)**

 

**8.     Capital Lease**

 

The Companyleases certain office equipment under a capital lease arrangement. The totalcost and accumulated depreciation of equipment under capital lease isapproximately $756,000 and $13,000, respectively, at December 31,2003.  The following is aschedule of minimum lease payments required under the capital lease as ofDecember 31, 2003 (in thousands):

 

| **Year Ended December 31,**  |   |   |   |
|-----------------------------------|--------|--------|--------|
|                              |   |   |   |
| 2004                              |   | $      | 164    |   |
| 2005                              |   | 164    |   |
| 2006                              |   | 164    |   |
| 2007                              |   | 164    |   |
| 2008                              |   | 151    |   |
|                              |   | 807    |   |
| Less amount representing interest |   | 64     |   |
|                              |   | 743    |   |
| Less current portion              |   | 151    |   |
|                              |   | $      | 592    |   |

 

At the end ofthe lease term, the Company has the option to purchase the equipment at fairmarket value.

 

**9.     Commitments and Contingencies**

 

The Company leases officefacilities and office equipment under non-cancelable operating leases. AtDecember 31, 2003, future minimum lease commitments were as follows (inthousands):

 

| **Year Ended December 31,** |   |   |   |
|----------------------------------|--------|--------|--------|
|                             |   |   |   |
| 2004                             |   | $      | 816    |   |
| 2005                             |   | 224    |   |
| 2006                             |   | 224    |   |
| 2007                             |   | 223    |   |
| 2008                             |   | 187    |   |
|                             |   | $      | 1,674  |   |

 

Total rent expense for the years ended December 31, 2003, 2002,and 2001, was approximately $719,000, $699,000, and $600,000, respectively.

 

TheCompany is subject to claims, suits and complaints, which have arisen in theordinary course of business. In the opinion of management and its legalcounsel, all matters are adequately covered by insurance or, if not covered,are without merit or are of such a nature, or involve such amounts as would nothave a material effect on the financial position, cash flows or results ofoperations of the Company.

 

46

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**AMBASSADORS GROUP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —(Continued)**

 

**10.  Stock Plans**

 

EffectiveNovember 2001 the Company adopted the 2001 Equity Participation Plan (thePlan). The Plan provides for the grant of stock options, awards of restrictedstock, performance or other awards or stock appreciation rights to directors,key employees and consultants of the Company. The maximum number of shares,which may be awarded under the Plan, is 1.8 million shares.

 

Under the terms of the Plan, options to purchase shares of theCompany’s common stock are granted at a price set by the Compensation Committeeof the Board of Directors, not to be less than the par value of a share ofcommon stock and if granted as performance-based compensation or as incentivestock options, no less than the fair market value of the stock on the date ofgrant. The Compensation Committee establishes the vesting period of the awards,which is generally set at 25 percent per year for four years. The options maybe exercised any time after they are fully vested for a period up to10 years from the grant date.

 

Uponthe Company’s spin-off effective February 28, 2002, the Company grantedapproximately 1.2 million stock options to Company employees and directorspursuant to this Plan.  The total grantof approximately 1.2 million stock options resulted from approximately 0.8million converted options originally granted under International andapproximately 0.4 million additional options granted by the Company inconjunction with the spin-off.  Thestock options and other awards, as converted or adjusted, have the same vestingprovisions, option periods, and other terms and conditions as Internationaloptions. The number of shares and exercise price of each stock option wereadjusted so that each option has the same ratio of the exercise price per shareto the market value per share, and the same economic value.  In order for the economic value to remainconstant, the aggregate difference between market value and exercise priceprior to and immediately after the spin-off had to be the same.  No new measurement date occurred uponconversion of the stock options.

 

47

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**AMBASSADORS GROUP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —(Continued)**

 

Thefollowing table presents information about the options as of December 31,2003:

 
|                  |   |                |   |                       |   | **Weighted-Average** |   |
|-----------------------|--------|---------------------|--------|----------------------------|--------|----------------------|--------|
|                  |   | **Numberof Shares** |   | **Range ofExercise Price** |   | **ExercisePrice**    |   | **RemainingLife (years)** |   |
| Exercisable options   |   | 39,894              |   | $                          | 3.90   | -                    | 5.85   |   | $ | 4.95 |   | 1.8 |   |
| Exercisable options   |   | 111,041             |   | 5.85                       | -      | 7.80                 |   | 6.48 |   | 4.5 |   |
| Exercisable options   |   | 188,845             |   | 7.80                       | -      | 9.75                 |   | 8.46 |   | 5.1 |   |
| Exercisable options   |   | 13,081              |   | 9.75                       | -      | 11.70                |   | 9.92 |   | 6.8 |   |
| Exercisable options   |   | 187,520             |   | 11.70                      | -      | 13.65                |   | 12.32 |   | 8.0 |   |
| Exercisable options   |   | 18,258              |   | 13.65                      | -      | 15.60                |   | 15.19 |   | 6.9 |   |
| Exercisable options   |   | 12,647              |   | 15.60                      | -      | 17.55                |   | 17.12 |   | 4.4 |   |
| Total exercisable     |   | 571,286             |   | 3.90                       | -      | 17.55                |   | 9.54 |   |   |   |
|                  |   |                |   |                       |   |                 |   |   |   |   |   |
| Unexercisable options |   | 10,697              |   | 5.85                       | -      | 7.80                 |   | 6.52 |   | 4.5 |   |
| Unexercisable options |   | 32,627              |   | 7.80                       | -      | 9.75                 |   | 8.41 |   | 5.1 |   |
| Unexercisable options |   | 7,054               |   | 9.75                       | -      | 11.70                |   | 9.92 |   | 6.8 |   |
| Unexercisable options |   | 426,126             |   | 11.70                      | -      | 13.65                |   | 12.24 |   | 8.0 |   |
| Unexercisable options |   | 13,929              |   | 13.65                      | -      | 15.60                |   | 14.98 |   | 6.9 |   |
| Unexercisable options |   | 77,573              |   | 17.55                      | -      | 19.50                |   | 19.43 |   | 9.8 |   |
| Total unexercisable   |   | 568,006             |   | 3.90                       | -      | 19.50                |   | 11.21 |   |   |   |
|                  |   |                |   |                       |   |                 |   |   |   |   |   |
| Total all options     |   | 1,139,292           |   | $                          | 3.90   | -                    | 19.50  |   | $ | 11.21 |   | 6.9 |   |

 

At December 31, 2002, there were 493,372exercisable stock options at the weighted average exercise price of $8.64 pershare.

 

Stockoption transactions during 2003 were as follows:

 
|                                  |   | **Number of****Shares** |   | **Weighted  Average****Exercise Price** |   |
|---------------------------------------|--------|-------------------------|--------|-----------------------------------------|--------|
| Converted upon spin-off (see Note 1)  |   | 839,084                 |   | $                                       | 9.14   |   |
| Granted                               |   | 430,150                 |   | 12.12                                   |   |
| Forfeited                             |   | (31,308                 | )      | 9.87                                    |   |
| Exercised                             |   | (54,799                 | )      | 7.52                                    |   |
| **Balance at December 31, 2002** |   | 1,183,127               |   | 10.28                                   |   |
| Granted                               |   | 127,223                 |   | 16.74                                   |   |
| Forfeited                             |   | (34,793                 | )      | 11.31                                   |   |
| Exercised                             |   | (136,265                | )      | 8.32                                    |   |
| **Balance December 31, 2003**    |   | 1,139,292               |   | $                                       | 11.21  |   |

 

48

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**AMBASSADORS GROUP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —(Continued)**

 

**11.  Employee Benefit Plan**

 

EffectiveMarch 2002, the Company established a 401(k) Profit Sharing Plan for theemployees of the Company. All Plan assets associated with the employees of theCompany were transferred from International’s Plan to the new Plan establishedby the Company during April 2002. Prior to March 2002, the Company’semployees participated in International’s 401(k) Profit Sharing Plan.

 

The Company’s employees participate in Ambassadors Group, Inc. 401(k)Profit Sharing Plan (the Plan). Employees are eligible to participate in thePlan upon six months of service and 18 years of age. Employees maycontribute up to 92 percent of their salary, subject to the maximumcontribution allowed by the Internal Revenue Service. The Company’s matchingcontribution is discretionary based upon approval by management. Employees are100 percent vested in their contributions and vest in Company matchingcontributions equally over four years. During the years ended December 31,2003, 2002, and 2001, the Company contributed approximately $31,000, $34,000,and $45,000, to the Plan, respectively.

 

**12.  Fair Value of Financial Instruments**

 

Thefollowing disclosure of the estimated fair value of financial instruments ismade in accordance with the requirements of Statement of Financial AccountingStandards No. 107, “Disclosures about Fair Value of FinancialInstruments.” The estimated fair value amounts have been determined usingavailable market information and appropriate valuation methodologies.

 

However,considerable judgment is necessarily required to interpret market data and todevelop the estimates of fair value. Accordingly, the estimates presentedherein are not necessarily indicative of the amounts the Company could realizein a current market exchange. The use of different market assumptions and/orestimation methodologies may have a material effect on the estimated fair valueamounts.

 

Thefollowing methods and assumptions were used to estimate the fair value of eachclass of financial instrument for which it is practicable to estimate thatvalue. Potential income tax ramifications related to the realization ofunrealized gains and losses that would be incurred in an actual sale and/orsettlement have not been taken into consideration.

 

*Cash and Cash Equivalents*— The carrying value of cash and cashequivalents approximates fair value due to the nature of the cash investments.

 

*Derivatives*— The fair value of the Company’s investments in foreign currencyforward contracts is based on quoted market prices and the spot rate of theforeign currencies subject to contracts at period end.

 

*Available-for-Sale Securities*— The fair value of the Company’s investmentin debt securities is based on quoted market prices.

 

49

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**AMBASSADORS GROUP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —(Continued)**

 

Theestimated fair values of the financial instruments as of the dates indicatedare as follows (in thousands):

 
|                          |   | **December 31,  2003** |   | **December 31,  2002** |   |
|-------------------------------|--------|-----------------------------|--------|-----------------------------|--------|
|                          |   | **Carrying  Amount**        |   | **Fair  Value**             |   | **Carrying  Amount** |   | **Fair  Value** |   |
| Financial Assets:             |   |                        |   |                        |   |   |   |   |   |
| Cash and cash equivalents     |   | $                           | 33,653 |                        | $      | 33,653 |   | $ | 29,503 |   | $ | 29,503 |   |
| Derivatives                   |   | 5,209                       |   | 5,209                       |   | 1,642 |   | 1,642 |   |
| Available-for-sale securities |   | 33,872                      |   | 33,872                      |   | 21,896 |   | 21,896 |   |
|                               |        |                             |        |                             |        |  |  |  |  |  |  |  |  |

 

*Limitations*— The fair value estimates are made at a discrete point in time basedon relevant market information and information about the financial instruments.Fair value estimates are based on judgments regarding current economicconditions, risk characteristics of various financial instruments and otherfactors. These estimates are subjective in nature and involve uncertainties andmatters of significant judgment and, therefore, cannot be determined withprecision. Changes in assumptions could significantly affect the estimates.Accordingly, the estimates presented herein are not necessarily indicative ofwhat the Company could realize in a current market exchange.

 

**13.  Earnings Per Share**

 

Thefollowing table presents a reconciliation of basic and diluted earnings pershare (EPS) computations (in thousands, except per share data):

 
|                                                |   | **Years  Ended December 31,** |   |
|-----------------------------------------------------|--------|------------------------------------|--------|
|                                                |   | **2003**                           |   | **2002** |   | **2001** |   |
| Numerator:                                          |   |                               |   |   |   |   |   |
| Net income for basic and diluted earnings per share |   | $                                  | 10,154 |   | $ | 10,798 |   | $ | 9,488 |   |
|                                                |   |                               |   |   |   |   |   |
| Denominator:                                        |   |                               |   |   |   |   |   |
| Weighted-average shares outstanding - basic         |   | 9,923                              |   | 9,837 |   | 9,813 |   |
| Effect of dilutive common stock options             |   | 247                                |   | 370 |   | — |   |
| Weighted-average shares outstanding - diluted       |   | 10,170                             |   | 10,207 |   | 9,813 |   |
|                                                |   |                               |   |   |   |   |   |
| Earnings per share – basic:                    |   |                               |   |   |   |   |   |
| Net income per share – basic                   |   | $                                  | 1.02   |   | $ | 1.10 |   | $ | 0.97 |   |
|                                                |   |                               |   |   |   |   |   |
| Earnings per share – diluted:                  |   |                               |   |   |   |   |   |
| Net income per share – diluted                 |   | $                                  | 1.00   |   | $ | 1.06 |   | $ | 0.97 |   |

 

**14.  Supplemental Disclosures of ConsolidatedStatements of Cash Flows**

 

Cash paid by the Company for taxes during 2003 was approximately $4.5million.  Prior to the Company’sspin-off from International, all taxes were paid by International.

 

Non-cash investing and financing activities of the Company during theyears ended December 31, 2003, 2002 and 2001, are as follows (inthousands):

 
|                                                                                             |   | **2003** |   | **2002** |   | **2001** |   |
|--------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Unrealized gain (loss) on foreign currency  exchange contracts                                   |   | $        | 3,567  |     | $      | 2,145    |   | $ | (1,176 | ) |
| Unrealized gain (loss) on  available-for-sale securities                                         |   | (93      | )      | 112      |   | —   |   |
| Tax benefit from stock options exercised                                                         |   | 452      |   | 128      |   | —   |   |
| A capital lease obligation was incurred  when the Company entered into a lease for new equipment |   | 756      |   | —   |   | —   |   |
|                                                                                                  |        |          |        |          |        |          |        |  |  |  |

 

50

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**AMBASSADORS GROUP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS —(Continued)**

 

**15.  Quarterly Financial Data**

 

Summarizedquarterly financial data for 2003, 2002, and 2001 is as follows (unaudited, andin thousands except per share data):

 
|                              |   | **Quarters  Ended** |   |
|-----------------------------------|--------|---------------------|--------|
|                              |   | **March 31**   |   | **June 30** |   | **September 30** |   | **December 31** |   |
| **2003**                          |   |                |   |   |   |   |   |   |   |
| Net  Revenues                     |   | $                   | 1,037  |   | $ | 18,184 |   | $ | 16,231 |   | $ | 2,213 |   |
| Income (loss) before taxes        |   | (2,600              | )      | 13,665 |   | 9,304 |   | (4,985 | ) |
| Net income (loss)                 |   | (1,716              | )      | 9,019 |   | 6,141 |   | (3,290 | ) |
| Earnings (loss) per share-basic   |   | (0.17               | )      | 0.91 |   | 0.62 |   | (0.33 | ) |
| Earnings (loss) per share-diluted |   | (0.17               | )      | 0.90 |   | 0.60 |   | (0.33 | ) |
|                                   |        |                     |        |  |  |  |  |  |  |  |  |  |  |

 

Gross program receipts totaled $2.6 million, $53.7 million, $46.8million and $5.5 million for the quarters ended March 21, June 30,September 30, and December 31, 2003, respectively.

 
|                              |   | **Quarters  Ended** |   |
|-----------------------------------|--------|---------------------|--------|
|                              |   | **March 31**   |   | **June 30** |   | **September 30** |   | **December 31** |   |
| **2002**                          |   |                |   |   |   |   |   |   |   |
| Net Revenues                      |   | $                   | 667    |   | $ | 17,367 |   | $ | 16,284 |   | $ | 1,772 |   |
| Income (loss) before taxes        |   | (2,633              | )      | 13,278 |   | 10,279 |   | (4,535 | ) |
| Net income (loss)                 |   | (1,765              | )      | 8,843 |   | 6,731 |   | (3,011 | ) |
| Earnings (loss) per share-basic   |   | (0.18               | )      | 0.90 |   | 0.68 |   | (0.31 | ) |
| Earnings (loss) per share-diluted |   | (0.18               | )      | 0.88 |   | 0.67 |   | (0.31 | ) |
|                                   |        |                     |        |  |  |  |  |  |  |  |  |  |  |

 

Gross program receipts totaled $2.4 million, $49.5 million, $41 millionand $4.3 million for the quarters ended March 31, June 30,September 30, and December 31, 2002, respectively.

 
|                              |   | **Quarters  Ended** |   |
|-----------------------------------|--------|---------------------|--------|
|                              |   | **March 31**   |   | **June 30** |   | **September 30** |   | **December 31** |   |
| **2001**                          |   |                |   |   |   |   |   |   |   |
| Net Revenues                      |   | $                   | 1,939  |   | $ | 20,500 |   | $ | 19,338 |   | $ | 1,637 |   |
| Income (loss) before taxes        |   | (2,542              | )      | 15,886 |   | 12,444 |   | (11,080 | ) |
| Net income (loss)                 |   | (1,677              | )      | 10,485 |   | 8,212 |   | (7,532 | ) |
| Earnings (loss) per share-basic   |   | (0.17               | )      | 1.07 |   | 0.84 |   | (0.77 | ) |
| Earnings (loss) per share-diluted |   | (0.17               | )      | 1.07 |   | 0.84 |   | (0.77 | ) |
|                                   |        |                     |        |  |  |  |  |  |  |  |  |  |  |

 

Gross program receipts totaled $5.0 million, $58.7 million,$48.5 million, and $4.1 million for the quarters ended March 31,June 30, September 30, and December 31, 2001, respectively.Excluding the effect of a write-down of intangible assets, loss before taxes,net loss, and loss per basic and diluted shares were $5.1 million,$3.7 million, and $0.38, respectively, for the quarter endedDecember 31, 2001.

 

51

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**SIGNATURES**

 

    Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the registrant has caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 

 
|   | AMBASSADORS GROUP, INC. |                      |
|--------|-------------------------|---------------------------|
|   | (Registrant)            |
|   |
|   | By:                     | /s/  JEFFREY D. THOMAS    |   |
|   |                    | Jeffrey  D. Thomas,       |   |
|   |                    | *Chief Executive Officer* |   |
|        |                         |                           |  |  |  |

 

Date: March 12, 2004

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.

 

 
| **Signature**                 |   | **Title** |                                                                             | **Date** |
|-------------------------------|--------|-----------|----------------------------------------------------------------------------------|----------|
|                          |   |      |                                                                             |     |
| /s/  JEFFREY D. THOMAS        |   |      | President,  Chief Executive  Officer and Director  (Principal Executive Officer) |     | March 12, 2004 |
| Jeffrey  D. Thomas            |
|                          |   |      |                                                                             |     |   |
| /s/  JOHN A. UEBERROTH        |   |      | Chairman  of the Board of Directors                                              |     | March 12, 2004 |
| John  A. Ueberroth            |   |      |                                                                             |     |   |
|                          |   |      |                                                                             |     |   |
| /s/  MARGARET M. SESTERO      |   |      | Executive  Vice-President                                                        |     | March 12, 2004 |
| Margaret  M. Sestero          |   |      |                                                                             |     |   |
|                          |   |      |                                                                             |     |   |
| /s/  COLLEEN K. MCCANN-LILLIE |   |      | Chief  Financial Officer and Secretary                                           |     | March 12, 2004 |
| Colleen K. McCann-Lillie      |   |      |                                                                             |     |   |
|                          |   |      |                                                                             |     |   |
| /s/  BRIGITTE M. BREN         |   |      | Director                                                                         |     | March 12, 2004 |
| Brigitte M. Bren              |   |      |                                                                             |     |   |
|                          |   |      |                                                                             |     |   |
| /s/  JAMES L. EASTON          |   |      | Director                                                                         |     | March 12, 2004 |
| James  L. Easton              |   |      |                                                                             |     |   |
|                          |   |      |                                                                             |     |   |
| /s/  DALE F. FREY             |   |      | Director                                                                         |     | March 12, 2004 |
| Dale F. Frey                  |   |      |                                                                             |     |   |
|                          |   |      |                                                                             |     |   |
| /s/  RAFER L. JOHNSON         |   |      | Director                                                                         |     | March 12, 2004 |
| Rafer  L. Johnson             |   |      |                                                                             |     |   |
|                          |   |      |                                                                             |     |   |
| /s/  JOHN C. SPENCE           |   |      | Director                                                                         |     | March 12, 2004 |
| John  C. Spence               |   |      |                                                                             |     |   |
|                          |   |      |                                                                             |     |   |
| /s/  JOSEPH J. UEBERROTH      |   |      | Director                                                                         |     | March 12, 2004 |
| Joseph  J. Ueberroth          |   |      |                                                                             |     |   |
|                          |   |      |                                                                             |     |   |
| /s/  RICHARD D. C. WHILDEN    |   |      | Director                                                                         |     | March 12, 2004 |
| Richard  D. C. Whilden        |   |      |                                                                             |     |   |

 

52

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##### **INDEX TO EXHIBITS**

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                    |
|---------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                                               |
| 2.1                 |   | Master Separation and  Distribution Agreement between Ambassadors International, Inc. and the  registrant incorporated by reference to the registrant’s Registration  Statement on Form 10 initially filed on November 15, 2001.    |
|                |   |                                                                                                                                                                                                                                               |
| 2.2                 |   | Indemnification and Insurance  Matters Agreement between Ambassadors International, Inc. and the registrant  incorporated by reference to the registrant’s Registration Statement on  Form 10 initially filed on November 15, 2001. |
|                |   |                                                                                                                                                                                                                                               |
| 2.3                 |   | Master Transitional  Services Agreement between Ambassadors International, Inc. and the registrant  incorporated by reference to the registrant’s Registration Statement on  Form 10 initially filed on November 15, 2001.          |
|                |   |                                                                                                                                                                                                                                               |
| 2.4                 |   | Employee Matters Agreement  between Ambassadors International, Inc. and the registrant incorporated by  reference to the registrant’s Registration Statement on Form 10  initially filed on November 15, 2001.                      |
|                |   |                                                                                                                                                                                                                                               |
| 2.5                 |   | Tax Sharing Agreement  between Ambassadors International, Inc. and the registrant incorporated by  reference to the registrant’s Registration Statement on Form 10  initially filed on November 15, 2001.                           |
|                |   |                                                                                                                                                                                                                                               |
| 2.6                 |   | Master Confidential  Disclosure Agreement between Ambassadors International, Inc. and the  registrant incorporated by reference to the registrant’s Registration Statement  on Form 10 initially filed on November 15, 2001.        |
|                |   |                                                                                                                                                                                                                                               |
| 2.7                 |   | Credit Facility Agreement  between Ambassadors International, Inc. and the registrant incorporated by  reference to the registrant’s Registration Statement on Form 10  initially filed on November 15, 2001.                       |
|                |   |                                                                                                                                                                                                                                               |
| 3.1                 |   | Amended and Restated  Certificate of Incorporation of the registrant incorporated by reference to  the registrant’s Registration Statement on Form 10 initially filed on  November 15, 2001.                                        |
|                |   |                                                                                                                                                                                                                                               |
| 3.2                 |   | Bylaws of the registrant  incorporated by reference to the registrant’s Registration Statement on  Form 10 initially filed on November 15, 2001.                                                                                    |
|                |   |                                                                                                                                                                                                                                               |
| 4.1                 |   | Form of Common Stock  certificate of the registrant incorporated by reference to the registrant’s  Registration Statement on Form 10 initially filed on November 15,  2001.                                                         |
|                |   |                                                                                                                                                                                                                                               |
| 10.1                |   | 2001 Equity Participation  Plan incorporated by reference to the registrant’s Registration Statement on  Form 10 initially filed on November 15, 2001.                                                                              |
|                |   |                                                                                                                                                                                                                                               |
| 10.2                |   | Form of 2001 Equity  participation Plan Agreements incorporated by reference to the registrant’s  Registration Statement on Form 10 initially filed on November 15,  2001.                                                          |
|                |   |                                                                                                                                                                                                                                               |
| 10.3                |   | Form of Indemnification  Agreement between the registrant and each of its executive officers and  directors incorporated by reference to the registrant’s Registration  Statement on Form 10 initially filed on November 15, 2001.  |
|                |   |                                                                                                                                                                                                                                               |
| 10.4                |   | Commercial Lease  Agreement, as amended (Ferrall Street) incorporated by reference to the  registrant’s Registration Statement on Form 10 initially filed on November 15,  2001.                                                    |
|                |   |                                                                                                                                                                                                                                               |
| 21.1                |   | Subsidiaries of the  registrant incorporated by reference to the registrant’s Registration  Statement on Form 10 initially filed on November 15, 2001.                                                                              |
|                |   |                                                                                                                                                                                                                                               |
| 23.1                |   | Consent of  PricewaterhouseCoopers LLP.                                                                                                                                                                                                            |
|                |   |                                                                                                                                                                                                                                               |
| 31.1                |   | Certification required by  Rule 13a-14(a) or Rule 15(d)-14(a).                                                                                                                                                                                     |
|                |   |                                                                                                                                                                                                                                               |
| 31.2                |   | Certification required by  Rule 13a-14(a) or Rule 15(d)-14(a).                                                                                                                                                                                     |
|                |   |                                                                                                                                                                                                                                               |
| 32.1                |   | Certification by the CEO  and CFO as required by Rule 13a-14(b) or 15(d)-14-(b) and Section 1350  of Chapter 63 of Title 13 of the United Status Code (18.U.S.C. §1350).                                                                 |

 

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