The principal executive offices of the Company, consisting of approximately 48,000 square feet, are located in Spokane, Washington and are occupied pursuant to a lease that expires December 31, 2004. The lease currently provides for monthly rental payments of approximately $37,000. The Company may cancel the lease without penalty (upon one year’s prior notice) and also may extend the term of the lease for an additional five year period upon providing written notice to the Lessor of its intention to exercise such option at least six months prior to the end of the initial term in 2004. If the Company elects to exercise the extension option, the monthly rental during the renewal period will be the fair market rental value of the leased premises as of the date the option is exercised (as determined based on market rentals of similar properties in the Spokane, Washington area).
The Company also occupies additional office space totaling approximately 11,000 square feet in Spokane, Washington, pursuant to a lease dated October 2, 2000, which expires on December 31, 2004. The lease may be extended an additional five years with 120 days advance notice to the landlord. Current monthly rent approximates $4,300 per month, with increases specified in the lease. If the lease option to extend is chosen, the lease payments will increase pursuant to the lease terms.
The following discussion should be read in conjunction with the Company’s consolidated financial statements and the notes thereto in this Report.
The Company is a leading educational travel company that organizes and promotes international and domestic programs for students, athletes, and professionals. Youth programs provide the opportunities for grade school, junior, and senior high school students to learn about the history, government, economy and culture of the foreign and domestic destinations they visit as well as for junior and senior high school athletes to participate in domestic and international sports challenges. The Company’s professional programs emphasize meetings and seminars between participants and persons in similar professions abroad.
The Company was founded in 1967 and was reincorporated in Delaware in 1995, when it was purchased and consolidated with Ambassadors. Since Ambassador’s initial public offering in August 1995, the Company has expanded its operations primarily through internal growth and acquisitions of businesses within the travel industry. These acquisitions included a February 1996 acquisition of certain assets of Marc L. Bright and Associates and a June 1999 acquisition of certain assets of Travel Dynamics, Inc. Both of these acquisitions were accounted for under the purchase method of accounting. Therefore, the results of operations of the acquired businesses are included in the Company’s results of operations since their respective dates of acquisition. On February 28, 2002, the Company was spun-off to the stockholders of Ambassadors (see Notes to Consolidated Financial Statements, Note 1).
The Company has a single operating segment consisting of the educational travel and sports programs for students, athletes and professionals. These programs have similar economic characteristics, offer comparable products to participants, and utilize similar processes for program marketing.
The Company’s businesses are seasonal. The majority of the Company’s travel programs occur in June and July of each year. The Company has historically earned more than ninety percent of its annual revenues in the second and third quarters, which the Company anticipates will continue for the foreseeable future. Historically, these seasonal revenues have more than offset operating losses incurred during the rest of the year. The Company’s annual results would be adversely affected if the Company’s revenues were to be substantially below seasonal norms during these periods. The Company’s operating results may fluctuate as a result of many factors, including the mix of student, sport, and professional programs, the mix of programs and program destinations offered by the Company and its competitors, the introduction and acceptance of new programs and program enhancements by the Company and its competitors, timing of program completions, cancellation rates, competitive conditions in the industry, marketing expenses, extreme weather conditions, international conflicts,
timing of and costs relating to acquisitions, changes in relationships with certain travel providers, economic factors, fluctuations of foreign currency exchange rates and other considerations affecting travel.
The preparation of consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including cash and cash equivalents, available-for-sale securities, intangible assets, income taxes, derivative financial instruments, and contingencies and litigation.
Cash, cash equivalents, and available-for-sale securities are exposed to concentrations of credit risk. The Company places its cash and temporary cash investments with high credit quality institutions. At times, such balances may be in excess of the federal depository insurance limit or may be on deposit at institutions which are not covered by this insurance. If such institutions were to become insolvent during which time it held the Company’s cash, cash equivalents, or available-for-sale securities in excess of the insurance limit, it would be necessary for the Company to obtain credit financing to operate its programs.
The Company values its goodwill and intangible assets using fair value on the date of an acquisition. The Company periodically assesses the recoverability of the recorded goodwill. As experienced during the fourth quarter of 2001, impacts of international unrest, terrorism, and the resulting economic downturn can influence the recoverability of the goodwill and intangible assets carrying value. During the fourth quarter of 2001, the Company recorded a charge related to management’s conclusion that the goodwill was impaired (see Note 2 in the Notes to the Consolidated Financial Statements). The impact of external influences such as terrorism combined with the effects to the Company’s operations could result in future inability to recover the carrying value of goodwill and certain intangible assets.
The asset and liability approach is used to account for income taxes by recognizing deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, in the event the Company were to determine that it would not be able to realize all or part of its net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income in the period such determination was made.
The Company uses foreign currency exchange contracts as part of an overall risk-management strategy. These instruments are used as a means of mitigating exposure to foreign currency risk connected to anticipated travel programs. In entering into these contracts, the Company has assumed the risk which might arise from the possible inability of counterparties to meet the terms of their contracts. The Company does not expect any losses as a result of counterparty defaults. However, if such defaults occurred, the necessity would arise to locate alternative counterparties, or the Company would then consider alternate means of settling its foreign exchange contractual obligations.
General and administrative expenses decreased to $5.5 million in the year ended December 31, 2002 from $6.5 million during the comparable period in 2001. The decrease of $1.0 million or 16 percent is also primarily the result of a series of personnel cost management controls implemented subsequent to September 11, 2001 as discussed in the paragraph above. In addition, other cost controls included limiting professional fees incurred by the Company.
In the year ended December 31, 2002, the Company earned operating income of $15.3 million in comparison to the operating income of $12.6 million for the comparable period of 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 as described above.
In the year ended December 31, 2002, income before income taxes was $16.4 million in comparison to income before income taxes of $14.7 million in the comparable period of 2001. Excluding an impairment charge of $5.9 million during 2001, income before income taxes would have been $20.6 million. Changes in income before income taxes are the result of changes as described above.
The Company incurred an income tax provision of approximately $5.6 million for the year ended December 31, 2002 in comparison to $5.2 million for the comparable period in 2001. The income tax provision incurred was based upon the estimated annual effective income tax rate applied to the pre-tax income. The Company’s effective tax rate of 34.1% for 2002 decreased from 35.5% for 2001 primarily as a result of a reduction in state income taxes.
Gross program receipts increased to $116.3 million in the year ended December 31, 2001 from $107.8 million in the same period of 2000. The $8.5 million or 8 percent increase was primarily the result of an increase in traveled participants. The Company traveled more than 25,800 participants during 2001 as compared to more than 25,300 participants during 2000.
Net revenue increased to $43.4 million in the year ended December 31, 2001 from $40.3 million in the same period of 2000. This increase was primarily the result of reductions in program pass through expenses, combined with the effects of increased participants. Gross margins (revenue as a percentage of gross program receipts) remained comparable during the years ended December 31, 2001 and 2000 at 37 percent.
General and administrative expenses increased to $6.5 million in the year ended December 31, 2001 from $5.1 million during the comparable period in 2000. The $1.4 million increase is due to a number of factors, including but not limited to professional fees and personnel costs.
In the year ended December 31, 2001, income before income taxes was $14.7 million in comparison to income before income taxes of $16.9 million in the comparable period of 2000. Excluding an impairment charge of $5.9 million during 2001, income before income taxes would have been $20.6 million. Changes in income before income taxes are the result of changes as described above.
Net income decreased to $9.5 million in the year ended December 31, 2001 from $11.1 million in the comparable period of 2000. Excluding the impairment charge of $5.9 million during 2001, net income would have been $13.2 million during the year ended December 31, 2001 in comparison to $11.1 million during the year ended December 31, 2000. Changes in net income from 2001 to 2000 are the result of changes as described above.
Net cash provided by investing activities for the years ended December 31, 2002 and 2001 was $1.3 million and $16.7 million, respectively. The decrease of $15.4 million from the year ending December 31, 2001 to the year ending December 31, 2002 is primarily due to net activities with the sale or maturity and purchase of available-for-sale securities.
The Company has a credit facility available with a large financial institution, with a current limit of up to $50.0 million for foreign currency purchases and foreign exchange forward contracts. This facility would be drawn upon in the event the Company is unable to provide payment for such foreign currency purchases and foreign exchange forward contracts upon their maturity, and it cannot be used for operational or working capital purposes. This credit facility is renewable annually and expires in March 2003. In connection with the Distribution, Ambassadors agreed to provide a credit facility to the Company up to $20 million for on-going operations and potential acquisition needs through August 2003. Ambassadors’ ability to fund the credit facility could be impaired due to a variety of factors including sudden capital expenditures, fluctuations in operating results, financing activities and receivables management. To the extent any one of these factors causes Ambassadors to be unable to fund all or part of the $20 million, the Company could be forced to seek and obtain alternative financing in the form of debt or equity. There can be no assurance that the Company would be successful in obtaining alternative financing on favorable terms, or at all. The Company’s failure to obtain such financing or to obtain such financing on favorable terms could have a material adverse effect on the Company’s business, financial condition and results of operations.
At December 31, 2002, the Company had approximately $51.4 million of cash, cash equivalents including restricted cash, and available-for-sale securities, which included program participant funds of approximately $25.9 million. At December 31, 2001, the Company had approximately $39.8 million of cash and cash equivalents including restricted cash, and available-for-sale securities, which included program participant funds of $16.6 million. Under the Company’s cancellation policy, a program participant may be entitled to a refund of a portion of his or her deposit, less certain fees, depending on the time of cancellation. Should a greater number of participants cancel their travel in comparison to that which is part of the Company’s ongoing operations, due to circumstances such as international or domestic unrest, terrorism, or general economic downturn, the Company’s cash balances could be significantly reduced. Cash balances could also be reduced significantly if the financial institutions, which held balances beyond that federally insured, were to become insolvent.
The Company is continuing to pursue further acquisitions of related travel businesses that may require the use of cash and cash equivalents. No such acquisitions are currently pending and no assurance can be given that definitive agreements for any such acquisitions will be entered into, or, if they are entered into, that they will be on terms favorable to the Company.
The Company used a significant amount of cash in 2002 toward its dividend payment to Ambassadors prior to its spin-off. The Company also received a capital contribution from Ambassadors concurrent with its spin-off. The Company does not have any material capital expenditure commitments for 2003. Management believes existing cash and cash equivalents and cash flows from operations, combined with the Company’s $20 million credit facility with Ambassadors, will be sufficient to fund the Company’s anticipated operating needs, capital expenditures, and acquisitions through 2003.
The substantial majority of the Company’s travel programs take place outside the United States and most foreign suppliers require payment in currency other than the U.S. dollar. Accordingly, the Company is exposed to foreign currency risk relative to changes in foreign currency exchange rates between those currencies and the U.S. dollar. The Company has a program to provide a hedge against certain of these foreign currency risks with less than two years maturity. The Company uses forward contracts, which allow the Company to acquire the foreign currency at a fixed price for a specified period of time. Some of the Company’s forward contracts include a synthetic component if a pre-determined trigger occurs during the term of the contract.
The table below provides information about the Company’s derivative financial instruments that are sensitive to foreign currency exchange rates. For foreign currency forward exchange agreements, the table presents the notional amounts and weighted average exchange rates. All contracts held as of December 31, 2002 mature in 2003. These notional amounts generally are used to calculate the contractual payments to be exchanged under the contract. None of these contracts is entered into for trading purposes.
After the unexpected events of September 11, 2001 and the resulting down turn in the travel industry, the Company took early exit of forward foreign exchange contracts aggregating $5.7 million as it was anticipated that such contracts would not be needed for the related travel season and the related forecasted transactions were no longer probable of occurring. The Company recorded a nominal gain as a result of the early termination of these contracts.
In June 2001, the FASB issued SFAS 142, “Goodwill and Other Intangible Assets,” which supersedes APB Opinion No. 17, “Intangible Assets.” SFAS 142, among other things, establishes new standards for intangible assets acquired in a business combination, eliminates amortization of goodwill and sets forth requirements to periodically evaluate goodwill for impairment. The Company adopted this statement during the first quarter of 2002 and thus goodwill and certain intangibles with indefinite lives are no longer being amortized. Accordingly, approximately $64,000 of previous annual amortization is no longer being recorded.
The following table presents the impact of SFAS 142 on our net income and our net income per share had the new standard been in effect for the years ended December 31, 2001 and 2000 (in thousands, except per share amounts):
In August 2001, the FASB approved SFAS 143, Accounting for Asset Retirement Obligations (SFAS 143), which will be effective for the fiscal year beginning January 1, 2003. SFAS 143 addresses the financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Company does not anticipate that the adoption of SFAS 143 will have a material impact on its financial condition or results of operations.
In October 2001, the FASB approved SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), which supercedes SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of (SFAS 121) and the accounting and reporting provisions of APB 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions for the disposal of a segment of a business. SFAS 144 retains many of the fundamental provisions of SFAS 121, but resolves certain implementation issues associated with that Statement. The Company adopted this statement during the first quarter of fiscal 2002. The adoption of SFAS 144 did not have a material impact on its financial condition or results of operations.
In April 2002, the FASB adopted SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Considerations. This Statement eliminates the requirement that gains and losses from the extinguishments of debt be aggregated and classified as an extraordinary item, net of tax. SFAS 145 also provides clarification for the accounting of sale-leaseback transactions and certain lease modifications that have economic effects that are similar to sale-leaseback transactions. The Company adopted this Statement during the second quarter of fiscal 2002. The adoption of SFAS No. 145 did not have a material impact on the Company’s consolidated financial statements.
The FASB adopted SFAS No.146, Accounting for Costs Associated with Exit or Disposal Activities, issued in June 2002, and is effective for activities initiated after December 31, 2002. This Statement nullifies EITF 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit or Disposal Activity (Including Certain Costs Incurred in a Restructuring) and EITF 88-0, Costs Associated with a Lease Modification or Termination. SFAS 146 establishes that the initial liability for costs associated with exit and disposal activities be measured at fair value and recognized when the liability is incurred. SFAS 146 prohibits the recognition of a liability based solely on an entity’s commitment to a plan for disposal. SFAS 146 also provides an accounting model for one-time termination benefits and guidance on accounting for costs to terminate operating leases. The Company adopted SFAS 146 in the fourth quarter of 2002. The adoption of SFAS 146 did not have a material impact on the Company’s consolidated financial statements.