SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2000 or [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to ______________ Commission file number: 000-25279 CHEAP TICKETS, INC. (Exact name of registrant as specified in its charter) Delaware 99-0338363 (State or other jurisdiction (I.R.S. Employer of incorporation) Identification No.) 1440 Kapiolani Blvd., Honolulu, Hawaii 96814 (Address of principal executive offices) (Zip Code) (808) 945-7439 (Registrant's telephone number, including area code) (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No As of August 10, 2000, the Registrant had 24,238,278 shares of Common Stock, $.001 par value per share, outstanding. 1 INDEX Page ---- PART I FINANCIAL INFORMATION Item 1. Financial Statements (unaudited)................................... 3 - Balance sheets at December 31, 1999 and June 30, 2000............ 3 - Statements of operations for the three and six months ended June 30, 1999 and 2000........................................... 4 - Statement of stockholders' equity for the three and six months ended June 30, 1999 and 2000..................................... 5 - Condensed statements of cash flows for the six months ended June 30, 1999 and 2000........................................... 6 - Notes to financial statements.................................... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...................... 10 Item 3. Quantitative and Qualitative Disclosure about Market Risk....................................... 14 PART II OTHER INFORMATION.................................................. 15 Item 1. Legal Proceedings.................................................. 15 Item 2. Changes in Securities and Use of Proceeds.......................... 15 Item 3. Defaults Upon Senior Securities.................................... 15 Item 4. Submission of Matters to a Vote of Security Holders................ 15 Item 5. Other Information.................................................. 16 Item 6. Exhibits and Reports on Form 8-K................................... 17 SIGNATURES......................................................... 17 2 PART I FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS CHEAP TICKETS, INC. BALANCE SHEETS (In thousands, except per share data) December 31, June 30, 1999 2000 ----------- ------- (unaudited) ASSETS Current Assets: Cash and cash equivalents $ 40,718 $ 62,762 Marketable securities 98,580 93,858 Trade accounts and other receivables 4,520 6,526 Refundable income taxes 355 - Ticket inventories 348 430 Other current assets 1,370 1,368 -------- -------- Total current assets 145,891 164,944 Property and equipment, net 9,263 8,577 Other assets 456 594 -------- -------- $155,610 $174,115 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable $ 7,131 $ 18,549 Accrued salaries 1,763 1,140 Accrued vacation 540 620 Accrued expenses and other liabilities 377 581 Current installments of long-term debt 133 25 Current installments of capital lease obligations 1,405 1,394 Deferred revenue, current 400 400 Income taxes payable - 1,162 -------- -------- Total current liabilities 11,749 23,871 Long-term debt, excluding current installments 517 504 Capital lease obligations, excluding current installments 3,376 2,675 Deferred revenue, noncurrent 1,200 1,000 Other noncurrent liabilities 156 141 -------- -------- Total liabilities 16,998 28,191 Stockholders' Equity: Preferred stock, $0.01 par value as of December 31, 1999 and June 30, 2000. Authorized 10,000,000 shares; Issued and Outstanding none at December 31, 1999 and June 30, 2000 (Note 4). - - Common stock, $.001 par value. Authorized 70,000 shares; Issued and outstanding 24,025 shares at December 31, 1999 and 24,233 shares at June 30, 2000 (Note 4). 24 24 Additional paid-in capital 146,002 145,907 Unearned compensation (382) (187) Retained earnings 7,708 14,920 Treasury stock, at cost--1,037 common shares at December 31, 1999 and June 30, 2000 (14,740) (14,740) -------- -------- Total stockholders' equity 138,612 145,924 -------- -------- $155,610 $174,115 ======== ======== The accompanying notes are an integral part of the financial statements. 3 CHEAP TICKETS, INC. STATEMENTS OF OPERATIONS (in thousands, except per share data) (Unaudited) Three months ended June 30, Six months ended June 30, --------------------------- --------------------------- 1999 2000 1999 2000 Non-published fares $ 97,416 $ 119,911 $ 153,379 $ 213,727 Published fare commissions and bonuses 5,154 8,763 9,720 15,024 -------------- ------------ -------------- -------------- Net revenues 102,570 128,674 163,099 228,751 Cost of sales 83,028 102,678 130,880 183,581 --------------- ------------- -------------- -------------- Gross Profit 19,542 25,998 32,219 45,170 Selling, general and administrative expenses 14,739 20,069 25,896 37,303 --------------- -------------- -------------- -------------- Net operating income 4,803 5,927 6,323 7,867 Other income (deductions): Interest income 738 2,270 884 4,333 Interest expense (58) (97) (94) (202) Other, net 7 (132) 21 (175) --------------- -------------- -------------- -------------- Earnings before income taxes 5,490 7,968 7,134 11,823 Income taxes 2,251 3,069 2,925 4,611 --------------- -------------- -------------- ------------ Net earnings 3,239 4,899 4,209 7,212 Preferred stock dividends - - (79) - Accretion of mandatorily redeemable cumulative preferred stock discount - - (37) - Redemption of mandatorily redeemable cumulative preferred stock - - (586) - -------------- -------------- -------------- -------------- Income available to common shares $ 3,239 $ 4,899 $ 3,507 $ 7,212 ============= ============= ============== ============== Basic earnings per common share $ 0.15 $ 0.21 $ 0.19 $ 0.31 ============= ============= ============== ============== Average common shares outstanding 21,367 23,171 18,217 23,137 ============= ============= ============== ============== Diluted earnings per common share $ 0.15 $ 0.21 $ 0.17 $ 0.31 ============= ============= ============== ============== Average diluted common shares outstanding 22,141 23,542 20,294 23,561 ============= ============= ============== ============== The accompanying notes are an integral part of the financial statements. CHEAP TICKETS, INC. STATEMENT OF STOCKHOLDERS' EQUITY (In thousands) (Unaudited) Additional Total Common Paid-In Unearned Retained Treasury Stockholders' Stock Capital Compensation Earnings Stock Equity --------------- ---------- ------------ -------- -------- ------------- Shares Amount ------ ------ Balance, December 31, 1999 24,023 $ 24 $146,002 $ (382) $ 7,708 $ (14,740) $ 138,612 Net earnings - - - - 7,212 - 7,212 Exercise of stock options 204 - 32 - - - 32 Other issuance of common stock 4 - 47 - - - 47 Amortization and forfeiture of stock option compensation - - (174) 195 - - 21 ----------------- ---------- -------- -------- --------- ------------ Balance, June 30, 2000 24,233 $ 24 $145,907 $ (187) $ 14,920 $ (14,740) $ 145,924 ================= ========== ======== ======== ========= ============ The accompanying notes are an integral part of the financial statements. 5 CHEAP TICKETS, INC. CONDENSED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) Six months ended June 30, ---------------- 1999 2000 ---- ---- Cash flows from operating activities: Net earnings $ 4,209 $ 7,212 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 585 1,226 Stock option compensation 44 21 Amortization of discount/premium on marketable securities (58) (151) Loss on sale or disposal of property and equipment - 134 Loss on sale of marketable securities 5 68 Changes in operating assets and liabilities 10,997 10,157 ------ ------ - - Net cash provided by operating activities 15,782 18,667 Cash flows from investing activities: Capital expenditures (2,167) (779) Proceeds from sale of property and equipment - 105 Purchase of marketable securities (28,666) (75,449) Proceeds from sale of marketable securities 10,255 80,254 ------ ------ - - Net cash provided by (used in) investing activities (20,578) 4,131 Cash flows from financing activities: Redemption of mandatorily redeemable cumulative preferred stock (4,839) - Proceeds from issuance of common stock, net of expenses paid 54,953 79 Proceeds from issuance of long-term debt 236 - Principal payments on long-term debt (194) (121) Principal payments on capital lease obligations (298) (712) ------ ------ - - Net cash provided by (used in) financing activities 49,858 (754) Net increase in cash 45,062 22,044 Cash and cash equivalents at beginning of period 2,974 40,718 ------ ------ - - Cash and cash equivalents at end of period $ 48,036 $ 62,762 ======== ======== Supplemental cash flow information: Cash paid for: Interest $ 96 $ 202 Income taxes 1,365 3,093 Noncash investing and financing activities: Acquisitions of new equipment through capital leases 2,033 - The accompanying notes are an integral part of the financial statements. 6 CHEAP TICKETS, INC. NOTES TO FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation The accompanying unaudited financial statements of Cheap Tickets, Inc. ("Cheap Tickets") have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and reflect all normal recurring adjustments which are, in the opinion of management, necessary for a fair presentation for the periods reported. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules or regulations, although management believes that the disclosures made are adequate to make the information presented not misleading. These financial statements should be read in conjunction with the financial statements for the year ended December 31, 1999 and the notes thereto included in Cheap Tickets' Annual Report on Form 10-K for the year ended December 31, 1999 filed with the Securities and Exchange Commission. The results of operations for the three and six months ended June 30, 2000 are not necessarily indicative of results expected for the full fiscal year or for any future period. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the useful lives of property and equipment, the valuation allowance for deferred tax assets and the allowance for doubtful receivables. Management believes that such allowances have been appropriately determined in accordance with generally accepted accounting principles. Revenue Recognition Revenues consist of non-published fares, commissions and overrides on published fares, and volume bonuses from a travel service network. Non-published fares are fares that are bought by Cheap Tickets under negotiated net fare contracts from various airline carriers and other travel service providers and resold to consumers at fares determined by Cheap Tickets generally sold at a significant discount off published fares. In such transactions, Cheap Tickets is the credit card merchant of record. Cheap Tickets also sells travel services at regular published fares and earns a commission on such sales. In published fare sales, the fares are set by the airlines and Cheap Tickets is not the credit card merchant of record. Cheap Tickets recognizes revenues and commissions when earned, which is at the time the reservation is ticketed and payment is received. Such revenues are reported net of an allowance for cancellations and refunds. Due to the restrictive nature of Cheap Tickets' sales, which are generally noncancelable and nonrefundable, cancellations and refunds are not significant. Volume bonus and incentive payments are recognized at the end of each monthly or quarterly measurement period if the specified target has been achieved. Bonuses received in connection with contract acceptances or extensions are deferred and recognized as income over the life of the contract. New Pronouncements In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB No. 101"), "Revenue Recognition in Financial Statements." SAB No. 101 provides guidance on applying generally accepted accounting principles to revenue recognition issues in financial statements. In June 2000, the Securities and Exchange Commission issued SAB No. 101B to defer the effective date of implementation of SAB No. 101 until the fourth quarter of fiscal 2000. Cheap Tickets will adopt this accounting pronouncement as required in the fourth quarter of fiscal 2000. In July 2000, the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board reached a consensus on EITF Issue 99-19, "Recording Revenue Gross As a Principal versus Net As an Agent." This issue is intended to develop an accounting model that is consistent with the requirements of SAB No. 101 and provides guidance on reporting revenue based on the gross amount billed to a customer or on the net amount retained (amount billed to the customer less the amount paid to a supplier). 7 Cheap Tickets is still evaluating EITF Issue 99-19 and the effect that its adoption may have on its financial statements. Should Cheap Tickets be required to report non-published fare revenue on a net basis, such reporting would be similar to commission income and accordingly may have a material effect on reported net revenues. The implementation of this new accounting pronouncement will not affect Cheap Tickets' net income. In July 2000, the EITF reached a consensus on EITF Issue 00-10, "Accounting for Shipping and Handling Fees and Costs." This consensus requires that all amounts billed to a customer in a sale transaction related to shipping and handling, if any, represent revenue and should be classified as revenue. The EITF did not reach a consensus with respect to the classification of costs related to shipping and handling incurred by the seller and withdrew its previous tentative conclusion that costs incurred by the seller for shipping and handling be classified as costs of goods sold. However, the Securities and Exchange Commission is expected to issue a staff announcement that would require shipping and handling costs to be included in costs of goods sold. The implementation of this new pronouncement will change the way Cheap Tickets presently presents these income and expense items in its financial statements. Presently, Cheap Tickets offsets amounts collected from customers for shipping and handling costs against the related expenses. Cheap Tickets does not expect the adoption of this consensus and any change to the classification of shipping and handling costs to have a material effect on its financial statements. 2. Net Income Per Share In accordance with the requirements of Statement of Financial Accounting Standards No. 128, "Earnings Per Share," a reconciliation of the numerator and denominator of basic and diluted EPS is provided as follows (in thousands, except per share data). Three months ended Six months ended ------------------ ---------------- June 30, June 30, ------- ------- 1999 2000 1999 2000 ---- ---- ---- ---- Numerator: Income available to common shares .......... $ 3,239 $ 4,899 $ 3,507 $ 7,212 ------- ------- ------- ------- Denominator: Shares - basic............................... 21,367 23,171 18,217 23,137 Effect of Dilutive Securities: Common stock warrants ................... -- -- 1,322 -- Stock options ........................... 774 371 755 424 Shares - diluted........................... 22,141 23,542 20,294 23,561 Basic earnings per share: .................... $ 0.15 $ 0.21 $ 0.19 $ 0.31 ======= ======= ======= ======= Diluted earnings per share: .................. $ 0.15 $ 0.21 $ 0.17 $ 0.31 ======= ======= ======= ======= Net income per share is computed using the weighted average number of common and common equivalent shares outstanding during the period. Options to purchase 975,650 shares of common stock at a range of $15.00 to $37.50 were outstanding during the three months ended June 30, 2000 but were not included in the computation of the diluted EPS because the options' exercise price was greater than the average market price of the common stock. 3. Mandatorily Redeemable Cumulative Preferred Stock In July 1997, Cheap Tickets issued and sold 425,000 shares of mandatorily redeemable cumulative preferred stock with detachable warrants to purchase an aggregate of 2,969,456 shares of common stock of Cheap Tickets at an aggregate exercise price of $2,121, in exchange for cash consideration of $4,250,000. 8 The net proceeds of $3,875,482, after reflecting transaction costs of $374,518, were allocated between the warrants and preferred stock based on their relative fair values, resulting in an allocation of $510,652 and $3,364,830 to the warrants and preferred stock, respectively. The value attributable to the warrants was recorded as additional paid-in capital. The excess of the redemption value of the preferred stock of $4,250,000 over the initial carrying value of $3,364,830 was being accreted by periodic charges to retained earnings. The accretion amounted to $36,657 for the six months ended June 30, 1999 and none for six months ended June 30, 2000. The preferred stock had a par value of $1 per share, was nonvoting and accrued cumulative annual dividends of $.80 per share. Accrued dividends amounted to $78,712 for the year ended December 31, 1999 and the three months ended March 31, 1999, which were subsequently paid at the preferred stock redemption on March 24, 1999. By its terms, the preferred stock was required to be redeemed at the time of an initial public offering of Cheap Tickets' common stock. The initial public offering of Cheap Tickets' common stock occurred on March 19, 1999. The redemption price was equal to its price of issuance, $4,250,000, plus accrued dividends of $589,000 at March 24, 1999, the date of redemption. Unamortized accretion of approximately $587,000 on March 24, 1999 was charged against retained earnings. Coincident with the redemption of the preferred stock, the warrants were exercised and 2,969,375 shares were issued in a cashless exercise. 4. Stockholders' Equity Common Stock In February 1999, Cheap Tickets increased its authorized common stock from 5,000,000 shares at $.01 par value to 70,000,000 shares at $.001 par value. Cheap Tickets also effected a 14-for-one stock split. In these statements, all per share accounts have been restated to reflect the stock splits. Public Offerings On March 19, 1999 Cheap Tickets completed an initial public offering of its common stock in which 3,500,000 shares were issued at an offering price of $15 per share. The offering raised $47.7 million after underwriting discounts and other related costs of issuance. Concurrently with the issuance of 3,500,000 shares in the offering, warrants for 2,969,375 shares were exercised. In connection with the initial public offering, the underwriters had the option to purchase an additional 525,000 shares of common stock. They exercised this option on April 19, 1999. Net proceeds to Cheap Tickets were $7.3 million after underwriting discounts and other costs of issuance. On August 20, 1999 Cheap Tickets completed a secondary public offering of its common stock, whereby 5,750,000 shares were sold at an offering price of $38.00 per share. Of the total shares sold, 2,500,000 were offered by Cheap Tickets and 3,250,000 were offered by certain existing stockholders. Net proceeds to Cheap Tickets were $89.6 million after underwriting discounts and other related costs of issuance. The total number of shares of common stock outstanding at June 30, 2000 was 24,232,958. Preferred Stock In February 1999, the authorized preferred stock of Cheap Tickets, Inc. was increased from 5,000,000 shares at $1 par value to 10,000,000 shares at $.01 par value. The board of directors has the authority to issue shares of preferred stock in one or more series and to fix the rights, preferences, privileges, and restrictions thereof, including dividend rights, preferences, privileges and restrictions thereof, including dividend rights, conversion rights, voting rights, terms of redemption, and liquidation preferences. 9 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the financial statements and notes thereto included elsewhere herein. Overview Cheap Tickets is principally engaged in the sale of discount tickets for domestic leisure air travel. A majority of its gross bookings have historically come from the sale of non-published fares, which Cheap Tickets acquires from airlines and resells to the public at a profit. Cheap Tickets purchases non- published fares only when it resells them to customers, so that it has no inventory carrying costs. On these fares, Cheap Tickets sets its resale prices to meet the demands of leisure travelers who are looking for the lowest price. Cheap Tickets also sells published fares for which it receives commissions from the airlines. Sales of non-published fares generally carry higher margins as a percentage of gross bookings than commissions on published fare bookings. Cheap Tickets' revenues historically had been generated by ticket sales through Cheap Tickets' four call centers and, to a lesser extent, through 12 walk-in retail stores. In October 1997, Cheap Tickets broadened its ticket distribution by offering online booking at "www.cheaptickets.com." Internet bookings accounted for approximately 29% of total gross bookings in 1999 and approximately 39% during the three months ended June 30, 2000. In the second quarter of 2000 Cheap Tickets added approximately 1.7 million registered online users. At June 30, 2000, total registered online users were approximately 5.9 million. Cheap Tickets expects online gross bookings and online net revenues to represent an increasing portion of gross bookings and net revenues in future periods. Gross bookings represent the aggregate retail value of tickets sold under non-published fares and published fares. The difference between gross bookings and revenues as reported in Cheap Tickets' statement of operations derives solely from the difference in revenue treatment accorded to sales of published fares. With respect to published fares, Cheap Tickets records as revenue in its statement of operations only the commissions earned by Cheap Tickets on the sale of such fares. Gross bookings represent the retail value of the sales of published fares. With respect to non-published fares, revenues as reported in Cheap Tickets' statement of operations are equivalent to gross bookings, which is the retail value of such fares. Gross bookings are not required by generally accepted accounting principles and should not be considered in isolation or as a substitute for other information prepared in accordance with GAAP. Management uses gross bookings as a key indicator of general business activity, success of promotional efforts, capacity to handle customer demand and efficiency of reservation agents. In addition, management believes that gross bookings provide a useful comparison between historical periods, and year-to-year changes in such information provide a useful measure of market acceptance of Cheap Tickets' products. Net revenues consist of sales of non-published fares and commissions. Net revenues from sales of non-published fares represent revenues from the sale of tickets purchased from the airlines. Cheap Tickets' cost of sales consists of the net fare cost paid to carriers to purchase non-published fares. Commissions, including incentive payments, are earned primarily on published air fares sold and include certain other payments based on the volume of transactions. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB No. 101"), "Revenue Recognition in Financial Statements." SAB No. 101 provides guidance on applying generally accepted accounting principles to revenue recognition issues in financial statements. In June 2000, the Securities and Exchange Commission issued SAB No. 101B to defer the effective date of implementation of SAB No. 101 until the fourth quarter of fiscal 2000. Cheap Tickets will adopt this accounting pronouncement as required in the fourth quarter of fiscal 2000. In July 2000, the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board reached a consensus on EITF Issue 99-19, "Recording Revenue Gross As a Principal versus Net As an Agent." This issue is intended to develop an accounting model that is consistent with the requirements of SAB No. 101 and provides guidance on reporting revenue based on the gross amount billed to a customer or on the net amount retained (amount billed to the customer less the amount paid to a supplier). Cheap Tickets is still evaluating EITF Issue 99-19 and the effect that its adoption may have on its financial statements. Should Cheap Tickets be required to report non-published fare revenue on a net basis, such reporting would be similar to commission income and accordingly may have a material effect on reported net revenues. The implementation of this new accounting pronouncement will not affect Cheap Tickets' net income. Gross profits include (1) the gross profit on non-published sales where Cheap Tickets establishes the markup and retail price, and (2) commissions earned on the sale of published fares sold. There is no cost of sale component for published fare sales, whereas there is a cost of sale component for non- published fare sales. Cheap Tickets earns higher profits on the sale of non- published fares than on the sale of published fares. Substantially all of Cheap Tickets' gross bookings represent sales of airline tickets. For the three months ended June 30, 1999 and 2000, approximately 98% of gross bookings arose from airline ticket sales. The remaining gross bookings arose from 10 sales of cruise tickets, auto rentals, hotel reservations and other travel related products. Cheap Tickets expects gross bookings from sources other than airline ticket sales to increase in future periods. Cheap Tickets' selling, general and administrative expenses include all operating and corporate overhead. Major expense categories include compensation, advertising, communications, credit card bank fees, occupancy and delivery costs. In July 2000, the EITF reached a consensus on EITF Issue 00-10, "Accounting for Shipping and Handling Fees and Costs." This consensus requires that all amounts billed to a customer in a sale transaction related to shipping and handling, if any, represent revenue and should be classified as revenue. The EITF did not reach a consensus with respect to the classification of costs related to shipping and handling incurred by the seller and withdrew its previous tentative conclusion that costs incurred by the seller for shipping and handling be classified as costs of goods sold. However, the Securities and Exchange Commission is expected to issue a staff announcement that would require shipping and handling costs to be included in costs of goods sold. The implementation of this new pronouncement will change the way Cheap Tickets presently presents these income and expense items in its financial statements. Presently, Cheap Tickets offsets amounts collected from customers for shipping and handling costs against the related expenses. Cheap Tickets does not expect the adoption of this consensus and any change to the classification of shipping and handling costs to have a material effect on its financial statements. Results of Operations Three months ended June 30, 2000 and June 30, 1999 Net revenues. Net revenues for the second quarter of 2000 increased $26.1 million, or 25.4%, to $128.7 million. Non-published fare sales increased $22.5 million, or 23.1%, to $119.9 million, reflecting a significant increase in the number of non-published fare tickets sold. Commissions increased $3.6 million, or 70.0%, to $8.8 million. The $3.6 million increase in commissions primarily reflected two factors: first, a $1 million increase in commissions on increased sales of published fares; and second, an improvement in incentive payments earned, offset by decreased rates. Non-published fare sales as a percentage of net revenues decreased from 95.0% to 93.2%. The increase in net revenues benefitted from accelerating usage of Internet commerce in the leisure travel market and improving recognition of the Cheap Tickets brand name, particularly through Internet and overall advertising to targeted markets. Net revenues through call centers and retail operations increased $6.9 million, or 9.2%, to $81.2 million. The increase of $6.9 million mainly reflected a higher percentage of calls answered due to increased staffing and an increase in the average ticket price. Net revenues from Internet sales increased $19.2 million, to $47.0 million. Net revenues through the Internet increased to 36.5% of total net revenues in the second quarter of 2000, compared with 27.1% in the second quarter of 1999. Gross Profit. Gross profit for the second quarter of 2000 increased $6.5 million, or 33.0%, to $26.0 million. As a percentage of net revenues, gross profit increased from 19.0% to 20.2% of net revenues. This increase can be attributed to a higher percentage of published fares sold and a $2.6 million increase in incentive payments earned. Selling, General and Administrative Expenses. For the three months ended June 30, 2000, selling, general and administrative expenses increased $5.3 million, or 36.2%, to $20.1 million, and increased as a percentage of net revenues from 14.4% to 15.6%. The increase in selling, general and administrative expenses as a percentage of net revenues was primarily due to an increase in advertising to $6.4 million. As a percentage of net revenues, advertising increased from 2.3% to 5.0%. Advertising expenses targeted to increase Internet sales were $2.0 million higher for the three months ended June 30, 2000 than in the same period in 1999. Net Earnings. Net earnings for the three months ended June 30, 2000 increased $1.7 million, or 51.2% to $4.9 million. The increase reflected higher net revenues and interest income from marketable securities. Six months ended June 30, 2000 and June 30, 1999 Net revenues. Net revenues for the first six months ended June 30, 2000 increased $65.6 million, or 40.2%, to $228.7 million. Non-published fare sales increased $60.3 million, or 39.3%, to $213.7 million, reflecting a significant increase in the number of non-published fare tickets sold. Commissions increased $5.3 million, or 54.6%, to $15.0 million. The $5.3 million increase in commissions primarily reflected two factors: first, an increase in commissions on increased sales of published fares; and second, a $3.3 million increase in incentive payments. Published fare sales as a percentage of net revenues increased from 6.0% to 6.6%. 11 The increase in net revenues benefitted from accelerating usage of Internet commerce in the leisure travel market and improving recognition of the Cheap Tickets brand name, particularly through Internet and overall advertising to targeted markets. Net revenues through call centers and retail operations increased $23.5 million, or 19.1%, to $146.7 million. Of this $23.5 million increase, $15.8 million reflected the improving call center sales from improved productivity, higher staffing levels and increased average ticket price. Net revenues from Internet sales increased $42.1 million, to $82.1 million. Net revenues through the Internet represented 35.9% of net revenues in the first six months ended June 30, 2000, compared with 24.5% in the first six months ended June 30, 1999. Gross Profit. Gross profit for the first six months ended June 30, 2000 increased $12.9 million, or 40.2%, to $45.2 million, reflecting a comparable percentage increase in net revenues. As a percentage of net revenues, gross profit remained the same at 19.7% of net revenues. This can be attributed to modestly lower non-published gross margins from a shift in sales mix to lower margin carriers and lower average published fare commissions from an industry wide reduction in the fourth quarter of 1999, offset by an increase in volume incentive payments earned. Selling, General and Administrative Expenses. For the six months ended June 30, 2000, selling, general and administrative expenses increased $11.4 million, or 44.0%, to $37.3 million, and increased as a percentage of net revenues from 15.9% to 16.3%. The increase as a percentage of net revenues was primarily the result of increases in advertising expenses of $5.5 million, which was 4.2% of net revenues this year compared with 2.5% in 1999. Advertising expenses targeted to increase internet sales were $3.2 million higher for the six months ended June 30, 2000, including a campaign encompassing print, radio, television, e-mail and special airfare promotions. Other expenses such as compensation, credit card fees and telephone expenses were higher than the same period in 1999 as a result of higher sales volumes. In the aggregate, all other selling, general and administrative expenses, other than advertising, were 13.3% and 12.1% of net revenues for the six months ended June 30, 1999 and 2000, respectively. Net Earnings. Net earnings for the six months ended June 30, 2000 increased $3.0 million, or 71.3% to $7.2 million. The increase reflected higher net revenues and interest income from marketable securities of $4.3 million. Operating Segments Net Revenues By Segment - ----------------------- Three Months Ended June 30, Six Months Ended June 30, ---------------------------------------------- ---------------------------------------------- 1999 2000 1999 2000 ---------------------------------------------- ---------------------------------------------- Percent Percent Percent Percent In Thousands of Total In Thousands of Total In Thousands of Total In Thousands of Total Segments - -------- Internet $ 27,760 27% $ 46,998 37% $ 39,944 24% $ 82,081 36% Call Center 74,810 73% 81,676 63% 123,155 76% 146,670 64% --------- ----- --------- ----- --------- ----- --------- ----- Net Revenues $ 102,570 100% $ 128,674 100% $ 163,099 100% $ 228,751 100% ========= ===== ========= ===== ========= ===== ========= ===== Gross Profit By Segment - ----------------------- Three Months Ended June 30, Six Months Ended June 30, ---------------------------------------------- ---------------------------------------------- 1999 2000 1999 2000 ---------------------------------------------- ---------------------------------------------- Percent Percent Percent Percent In Thousands of Total In Thousands of Total In Thousands of Total In Thousands of Total Segments - -------- Internet $ 5,578 29% $ 9,956 38% $ 8,473 26% $ 17,036 38% Call Center 13,964 71% 16,040 62% 23,746 74% 28,134 62% --------- ----- --------- ----- --------- ----- --------- ----- Gross Profit $ 19,542 100% $ 25,996 100% $ 32,219 100% $ 45,170 100% ========= ===== ========= ===== ========= ===== ========= ===== Three Months Ended June 30, 2000 and June 30, 1999 by Segment Net Revenues. Net revenues through the Internet increased $19.2 million, or 69.3% to $47.0 million. The retail value of non-published fares is the largest component of net revenues. Sales volumes increased as a result of a targeted advertising campaign, growing acceptance of Internet commerce, and a significant increase in registered users to our website. The non-published fare component in the Internet sales mix was 68% and 58%, respectively, of total Internet bookings for the three months ended June 30, 1999 and 2000. 12 Net revenues through call centers increased $6.9 million, or 9.2% to $81.2 million. This increase reflected higher staffing levels and the benefits of increased advertising. Gross Profit. Gross profit from Internet sales increased $4.4 million, or 78.5% to $10.0 million. As a percentage of net revenues, Internet gross profit increased from 20.1% to 21.2%. The increase in published fare commissions combined with a decrease in non-published fare margins from changes in carrier sales mix resulted in the increase in gross profit as a percentage of net revenues. A higher component of commissions paid on published fare sales combined with lower non-published fare margins primarily from changes in carrier sales mix resulted in a higher gross profit as a percentage of net revenues. As published fare commissions have no accompanying cost of sales, an increase in the published fare component of sales will result in an increase in gross profit as a percentage of net revenues. Call center gross profit increased $2.1 million, or 14.9% to $16.0 million. As a percentage of net revenues, gross profit from call centers increased from 18.7% to 19.6% for the three months ended June 30, 1999 and 2000, respectively. Six Months Ended June 30, 2000 and June 30, 1999 by Segment Net Revenues. Net revenues through the Internet increased $42.1 million, or 105.5% to $82.1 million. The non-published fare component in the Internet sales mix was 64% and 56% of total Internet bookings for the six months ended June 30, 1999 and 2000, respectively. Sales volumes increased as a result of a targeted advertising campaign, growing acceptance of Internet commerce, and a significant increase in registered users to our website. Net revenues through call centers increased $23.5 million, or 19.1% to $146.7 million. The increase reflected the overall industry demand, the results of the Cheap Tickets' branding campaign, increased productivity and higher staffing levels in the call centers. Gross Profit. Gross profit from Internet sales increased $8.6 million, or 101.1% to $17.0 million. As a percentage of net revenues, Internet gross profit decreased from 21.2% to 20.7%. The reduction was primarily due to the impact of a decrease in non-published fare margins from changes in the carrier sales mix and the impact of fuel surcharges. Call center gross profit increased $4.4 million, or 18.5% to $28.1 million. As a percentage of net revenues, gross profit from call centers decreased slightly from 19.3% to 19.2% for the six months ended June 30, 1999 and 2000, respectively, also primarily due to the same reasons as stated above. Seasonality and Quarterly Financial Information Cheap Tickets' business is seasonal due primarily to customers' leisure travel patterns and changes in the availability of non-published fares. As a result, Cheap Tickets typically has higher sales and gross profit in the second and third quarters and lower sales and gross profit in the fourth quarter. During periods of high-volume air travel, such as occur in the fourth quarter of each year, Cheap Tickets historically has had access to fewer non-published fares, and such fares on certain major routes may be blacked out or otherwise unavailable. Online gross bookings may also tend to be seasonal and may decline or grow less rapidly in the summer months. The seasonal sales cycle is fairly predictable, but the cycle may shift year-to-year, corresponding to changes in the economy or other factors affecting the market such as price wars. This could lead to unusual volatility in revenues and earnings. Liquidity and Capital Resources For the six months ended June 30, 2000, Cheap Tickets generated cash from operating activities of $18.7 million, compared with $15.8 million for the six months ended June 30, 1999. For the six months ended June 30, 2000, cash generated from operating activities was comprised principally of net earnings of $7.2 million plus depreciation of $1.2 million and an increase in accounts payable of $11.4 million. For the six months ended June 30, 1999, cash generated from operating activities was comprised principally of net earnings of $4.2 million plus depreciation of $585,000 and an increase in accounts payable of $8.9 million. The primary account payable is the weekly settlement to the Airline Reporting Corporation for airline tickets purchased less commissions earned. This is generally a significant balance, and the timing of the current payment relative to month-end can cause fluctuations in month-end balances. 13 For the six months ended June 30, 2000, Cheap Tickets received cash from investing activities of $4.1 million, while in the prior period it used cash in investing activities of $20.6 million. Cash provided by investing activities for the six months ended June 30, 2000 included net proceeds from the sale of short term marketable securities of $4.8 million and capital expenditures of $779,000. For the six months ended June 30, 1999 net purchases of short term marketable securities were $18.4 million and capital expenditures were $2.2 million. For the six months ended June 30, 1999, Cheap Tickets received net proceeds from an initial public offering of $55.0 million, after deduction of underwriters' fees and other costs of issuance less $4.8 million to redeem mandatorily redeemable preferred stock and accumulated dividends. At June 30, 2000, Cheap Tickets maintained on hand cash and cash equivalents of $62.8 million and short term marketable securities of $93.8 million. Cheap Tickets' net working capital was $141.1 million. Last year, Cheap Tickets had available a $3 million credit facility with a bank which expired on December 5, 1999. Cheap Tickets had outstanding long-term debt net of current installments of $504,000 and capital lease obligations of $2,675,000. In January 2000, Cheap Tickets completed its stock repurchase program. Cheap Tickets repurchased 1,037,288 shares of its outstanding common stock for an aggregate price of $14.7 million through periodic open market transactions. All funds required for the repurchase of common stock were obtained from available cash resources and marketable securities. Cheap Tickets believes that its current cash and cash equivalents, short term marketable securities and anticipated cash flow from operations will be sufficient to meet its anticipated cash needs for working capital, debt service and capital expenditures, at least for the foreseeable future. If cash generated from internal operations is not sufficient to satisfy Cheap Tickets' liquidity requirements, Cheap Tickets may seek to acquire bank credit lines or sell additional equity or debt securities. The sale of convertible debt or equity securities could result in additional dilution to Cheap Tickets' stockholders. There is no assurance that financing will be available in amounts or on terms acceptable to Cheap Tickets, if at all. Risks Associated with Forward-Looking Statements From time to time, Cheap Tickets may make certain statements that contain "forward-looking" information or statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Words such as "anticipate", "believe", "expect", "estimate", "project", and similar expressions are intended to identify such forward-looking statements. Forward-looking statements may be made by management orally or in writing, including, but not limited to, in press releases, as part of this "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in this Report, and in Cheap Tickets' other filings with the Securities Exchange Commission. Although Cheap Tickets believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Such forward-looking statements are subject to certain risks, uncertainties and assumptions, including, without limitation those identified below. Should one or more of these risks or uncertainties materialize, or should any of the underlying assumptions prove incorrect, actual results of current or future operations may vary materially from those anticipated, estimated, or projected. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. General There are several risks and uncertainties that may affect the future operating results, business and financial condition of Cheap Tickets, including, without limitation: (1) the risk of reduction in consumer demand for Cheap Tickets' products; (2) the risk of loss of one or more of the major airline carriers with whom Cheap Tickets does business; (3) the risk that Cheap Tickets may not be able to continue to provide its products at prices which are competitive or that it can continue to market its products in a manner that appeals to consumers even if price-competitive; (4) the risk that Cheap Tickets may not be able to obtain its products on substantially similar terms, including cost, in order to sustain its operating margins; (5) the risks associated with the exercise of management's discretion in the use of proceeds from the initial and secondary public offerings; and (6) the risks inherent in legal proceedings. Readers are encouraged to refer to Cheap Tickets' Annual Report on Form 10-K for the year ended December 31, 1999 for a further discussion of Cheap Tickets' business and the risks and opportunities attendant thereto. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Cheap Tickets does not use derivative financial instruments. We generally place our marketable security investments in high credit quality instruments, primarily U.S. Government obligations and corporate obligations with contractual maturities of less than one year. We do not expect any material loss from our marketable security investments and therefore believe that our potential interest rate exposure is not material. 14 PART II--OTHER INFORMATION Item 1. LEGAL PROCEEDINGS On June 29, 1999, a former employee filed an action against Cheap Tickets and two of its corporate officers in the Superior Court in Los Angeles, California alleging, among other causes of action, that he was fraudulently induced to become and stay as an employee, that he was improperly excluded from participating in management incentive plans, that he was improperly cut back on the allocation of shares in Cheap Tickets' initial public offering, and that Cheap Tickets was unjustly enriched by his management of its cruise division. After amending the initial complaint twice, the amended complaint sought damages of $1,000,000 for the difference the employee received for the sale of a separate business and what this separate business would have been worth had he continued it; $250,000 for the difference between the compensation the employee received from Cheap Tickets and what he would have received if he accepted a competing position with another company; $2,000,000 for improperly excluding the employee from participating in management incentive plans; $20,000,000 for the amount the employee enhanced the value of the Cheap Tickets' public offering; $1,000,000 for the estimated profit from the Cruise Division during the employee's tenure; and unspecified punitive damages. The defense and indemnification on the complaint was tendered to Cheap Tickets' insurance carrier. Defense counsel was provided by the insurance carrier. The defense was vigorous as it was felt the lawsuit had no merit. Defense counsel filed a motion to strike certain claims except the claim for excluding the employee from participating in the management incentive plans. Mediation was held on May 6,2000. During mediation, the insurance carrier decided to settle the claims of the former employee for $75,000, which represents the costs of the defense. This settlement will be paid by the insurance carrier for Cheap Tickets. In addition, Cheap Tickets may from time to time become a party to various legal proceedings arising in the ordinary course of its business. Any such proceeding against Cheap Tickets, even if not meritorious, could result in the expenditure of significant financial and managerial resources. Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Please refer to the discussion in notes 3 and 4 of the Financial Statements set forth in Part I, Item 1 and in the Section entitled "Liquidity and Capital Resources" in Part I, Item 2. Item 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS The Annual Meeting of Stockholders (the "Annual Meeting") of Cheap Tickets was held on May 9, 2000. At the Annual Meeting, three items were put to a vote of the stockholders: The election of the following seven directors of the Company to serve until the 2001 Annual Meeting of Stockholders, and until their successors are elected and qualified: Giles H. Bateman, George R. Mrkonic, A. Maurice Myers, Cece Smith, Sam E. Galeotos, Michael J. Hartley and Sandra T. Hartley. The approval and ratification of the Amended and Restated 1999 Stock Incentive Plan. The appointment of PricewaterhouseCoopers LLP as the independent auditors for the Company for the fiscal year ending December 31, 2000. 15 The voting results were: Item For Against Abstained ---- ---------- --------- ---------- 1. Directors Giles H. Bateman 18,648,519 0 14,717 George R. Mrkonic 18,648,519 0 14,717 A. Maurice Myers 18,648,519 0 14,717 Cece Smith 18,648,519 0 14,717 Sam E. Galeotos 18,648,519 0 14,717 Michael J. Hartley 18,648,519 0 14,717 Sandra T. Hartley 18,648,519 0 14,717 2. Approval and ratification of 18,509,672 125,437 28,127 Amended and Restated 1999 Stock Incentive Plan 3. Appointment of auditors 18,654,188 7,922 1,126 Item 5. OTHER INFORMATION Not applicable. 16 Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27.1 Financial Data Schedule. (b) Reports on Form 8-K The Registrant did not file any reports on Form 8-K during the three months covered by this report. SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CHEAP TICKETS, INC. (Registrant) Date: August 14, 2000 /s/ Michael J. Hartley --------------------------------------- Michael J. Hartley Chairman of the Board, Chief Executive Officer Date: August 14, 2000 /s/ Sam E. Galeotos --------------------------------------- Sam E. Galeotos President and Chief Operating Officer Date: August 14, 2000 /s/ Dale K. Jorgenson --------------------------------------- Dale K. Jorgenson Chief Financial Officer and Vice President (Principal Financial Officer and Principal Accounting Officer) 17