SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 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 November 7, 2000, the Registrant had 24,247,996 shares of Common Stock, $.001 par value per share, outstanding. 1 INDEX Page ---- PART I FINANCIAL INFORMATION Item 1. Consolidated Financial Statements (unaudited).................... 3 - Consolidated balance sheets at December 31, 1999 and September 30, 2000............................................. 3 - Consolidated statements of operations for the three and nine months ended September 30, 1999 and 2000....................... 4 - Consolidated statement of stockholders' equity for the three and nine months ended September 30, 1999 and 2000.............. 5 - Condensed consolidated statements of cash flows for the nine months ended September 30, 1999 and 2000....................... 6 - Notes to consolidated financial statements..................... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................... 9 Item 3. Quantitative and Qualitative Disclosure about Market Risk..................................... 13 PART II OTHER INFORMATION................................................ 14 Item 1. Legal Proceedings................................................ 14 Item 2. Changes in Securities and Use of Proceeds........................ 14 Item 3. Defaults Upon Senior Securities.................................. 14 Item 4. Submission of Matters to a Vote of Security Holders.............. 14 Item 5. Other Information................................................ 14 Item 6. Exhibits and Reports on Form 8-K................................. 15 SIGNATURES....................................................... 15 2 PART I FINANCIAL INFORMATION Item 1. CONSOLIDATED FINANCIAL STATEMENTS CHEAP TICKETS, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except per share data) December 31, September 30, 1999 2000 -------- -------- (unaudited) ASSETS Current Assets: Cash and cash equivalents $ 40,718 $ 57,856 Marketable securities 98,580 96,600 Trade accounts and other receivables 4,520 6,424 Refundable income taxes 355 106 Ticket inventories 348 354 Other current assets 1,370 1,437 -------- -------- Total current assets 145,891 162,777 Property and equipment, net 9,263 9,786 Other assets 456 721 -------- -------- $155,610 $173,284 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable $ 7,131 $ 14,310 Accrued salaries 1,763 1,751 Accrued vacation 540 650 Accrued expenses and other liabilities 377 685 Current installments of long-term debt 133 25 Current installments of capital lease obligations 1,405 1,410 Deferred revenue, current 400 400 -------- -------- Total current liabilities 11,749 19,231 Long-term debt, excluding current installments 517 498 Capital lease obligations, excluding current installments 3,376 2,316 Deferred revenue, noncurrent 1,200 900 Other noncurrent liabilities 156 131 -------- -------- Total liabilities 16,998 23,076 Stockholders' Equity: Preferred stock, $0.01 par value as of December 31, 1999 and September 30, 2000. Authorized 10,000,000 shares; Issued And Outstanding none at December 31, 1999 and September 30, 2000 (Note 4). - - Common stock, $.001 par value. Authorized 70,000 shares; Issued and outstanding 24,025 shares at December 31, 1999 and 24,243 shares at September 30, 2000 (Note 4). 24 24 Additional paid-in capital 146,002 145,911 Unearned compensation (382) (172) Retained earnings 7,708 19,185 Treasury stock, at cost--1,037 common shares at December 31, 1999 and September 30, 2000 (14,740) (14,740) -------- -------- Total stockholders' equity 138,612 150,208 -------- -------- $155,610 $173,284 ======== ======== The accompanying notes are an integral part of the consolidated financial statements. 3 CHEAP TICKETS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except for per share data) (unaudited) Three months ended September 30, Nine months ended September 30, -------------------------------- ------------------------------- 1999 2000 1999 2000 Non-published fares $103,764 $114,161 $257,143 $327,888 Published fare commissions and bonuses 6,391 7,238 16,112 22,263 -------- -------- -------- -------- Net revenues 110,155 121,399 273,255 350,151 Cost of sales 88,628 96,111 219,508 279,693 -------- -------- -------- -------- Gross Profit 21,527 25,288 53,747 70,458 Selling, general and administrative expenses 18,393 20,640 44,289 57,943 -------- -------- -------- -------- Net operating income 3,134 4,648 9,458 12,515 Other income (deductions): Interest income 1,297 2,432 2,181 6,765 Interest expense (67) (90) (161) (292) Other, net (8) 3 13 (173) -------- -------- -------- -------- Earnings before income taxes 4,356 6,993 11,491 18,815 Income taxes 1,786 2,727 4,711 7,338 -------- -------- -------- -------- Net earnings 2,570 4,266 6,780 11,477 Preferred stock dividends --- --- (79) --- Accretion of mandatorily redeemable cumulative preferred stock discount --- --- (37) --- Redemption of mandatorily redeemable cumulative preferred stock --- --- (587) --- -------- -------- -------- -------- Income available to common shares $ 2,570 $ 4,266 $ 6,077 $ 11,477 -------- -------- -------- -------- Basic earnings per common share $ 0.11 $ 0.18 $ 0.31 $ 0.50 ======== ======== ======== ======== Average common shares outstanding 22,607 23,201 19,711 23,159 ======== ======== ======== ======== Diluted earnings per common share $ 0.11 $ 0.18 $ 0.29 $ 0.49 ======== ======== ======== ======== Average diluted common shares outstanding 23,256 23,534 21,310 23,554 ======== ======== ======== ======== The accompanying notes are an integral part of the consolidated financial statements. 4 CHEAP TICKETS, INC. CONSOLIDATED 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 24,025 $24 $146,002 $(382) $ 7,708 $(14,740) $138,612 Net earnings - - - - 11,477 - 11,477 Exercise of stock options 214 - 37 - - - 37 Other issuance of common stock 4 - 47 - - - 47 Amortization and forfeiture of stock option compensation - - (175) 210 - - 35 --------------- --------- ------ ------- --------- -------- Balance, September 30, 2000 24,243 $24 $145,911 $(172) $19,185 $(14,740) $150,208 =============== ========= ====== ======= ========= ======== The accompanying notes are an integral part of the consolidated financial statements. 5 CHEAP TICKETS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) Nine months ended September 30, ----------------------- 1999 2000 --------- --------- Cash flows from operating activities: Net earnings $ 6,780 $ 11,477 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 1,037 2,097 Stock option compensation 69 35 Amortization of discount on marketable securities (35) (381) Loss on sale or disposal of property and equipment 20 124 Loss on sale of marketable securities 9 86 Changes in operating assets and liabilities 10,415 5,267 ---------- ---------- Net cash provided by operating activities 18,295 18,705 Cash flows from investing activities: Capital expenditures (2,913) (2,877) Proceeds from sale of property and equipment 11 133 Purchase of marketable securities (103,806) (111,109) Proceeds from sale of marketable securities 18,506 113,384 ---------- ---------- Net cash used in investing activities (88,202) (469) Cash flows from financing activities: Redemption of mandatorily redeemable cumulative preferred stock (4,839) - Proceeds from issuance of common stock, net of expenses paid 144,640 84 Proceeds from issuance of long-term debt 236 - Principal payments on long-term debt (299) (127) Principal payments on capital lease obligations (567) (1,055) ---------- ---------- Net cash provided by (used in) financing activities 139,171 (1,098) Net increase in cash 69,264 17,138 Cash and cash equivalents at beginning of period 2,974 40,718 ---------- ---------- Cash and cash equivalents at end of period $ 72,238 $ 57,856 ========== ========== Supplemental cash flow information: Cash paid for: Interest $ 164 $ 292 Income taxes 4,172 7,088 Noncash investing and financing activities: Acquisitions of new equipment through capital leases 4,446 - The accompanying notes are an integral part of the consolidated financial statements. 6 CHEAP TICKETS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation The accompanying unaudited consolidated 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 consolidated 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 consolidated 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 nine months ended September 30, 2000 are not necessarily indicative of results expected for the full fiscal year or for any future period. Principles of Consolidation The consolidated financial statements include the accounts of Cheap Tickets and its wholly-owned subsidiary. All significant intercompany transactions have been eliminated in consolidation. Use of Estimates The preparation of consolidated 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 consolidated 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 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 7 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 consolidated 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 consolidated 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 consolidated 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 Nine months ended ------------------ ----------------- September 30, September 30, ------------- ------------- 1999 2000 1999 2000 Numerator: Income available to common shares........ $ 2,570 $ 4,266 $ 6,077 $11,477 ------- ------- ------- ------- Denominator: Shares - basic........................... 22,607 23,201 19,711 23,159 Effect of Dilutive Securities: Common stock warrants................. -- -- 881 -- Stock options......................... 649 333 718 395 ------- ------- ------- ------- Shares - diluted......................... 23,256 23,534 21,310 23,554 ------- ------- ------- ------- Basic earnings per share:.................. $ 0.11 $ 0.18 $ 0.31 $ 0.50 ======= ======= ======= ======= Diluted earnings per share:................ $ 0.11 $ 0.18 $ 0.29 $ 0.49 ======= ======= ======= ======= Net income per share is computed using the weighted average number of common and common equivalent shares outstanding during the period. Options to purchase 1,317,950 shares of common stock at a range of $11.44 to $37.50 were outstanding during the three months ended September 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. 8 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the consolidated 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 30% of total gross bookings in 1999 and approximately 40% during the three months ended September 30, 2000. In the third quarter of 2000, Cheap Tickets added approximately 1.6 million registered online users. At September 30, 2000, total registered online users were approximately 7.5 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' consolidated 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' consolidated 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 generally accepted accounting principles. 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 consolidated 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, 9 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 September 30, 1999 and 2000, approximately 99% of gross bookings arose from airline ticket sales. The remaining gross bookings arose from 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 consolidated 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 consolidated financial statements. Results of Operations Three months ended September 30, 2000 and September 30, 1999 Net revenues. Net revenues for the third quarter of 2000 increased $11.2 million, or 10.2%, to $121.4 million. Non-published fare sales increased $10.4 million, or 10.0%, to $114.2 million, reflecting a significant increase in the number of non-published fare tickets sold. Commissions increased $847,000, or 13.3%, to $7.2 million. The increase in net revenues reflected increased sales volumes and higher commissions on published fares from more favorable supplier agreements. Non-published fare sales as a percentage of net revenues remained the same at 94%. 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 decreased $4.4 million, or 5.5%, to $76.0 million. The decrease can be attributed to some pricing competition resulting from United Airlines' pricing actions and Cheap Tickets' focus on optimizing margins. Net revenues from Internet sales increased $15.7 million, to $45.4 million. Net revenues through the Internet increased to 37.4% of total net revenues in the third quarter of 2000, compared with 27.1% in the third quarter of 1999. Gross Profit. Gross profit for the third quarter of 2000 increased $3.8 million, or 17.5%, to $25.3 million. As a percentage of net revenues, gross profit increased from 19.5% to 20.8% of net revenues. This increase reflects a higher percentage of published fares sold and higher margins from more effective yield management of non-published fares. Selling, General and Administrative Expenses. For the three months ended September 30, 2000, selling, general and administrative expenses increased $2.2 million, or 12.2%, to $20.6 million, and increased as a percentage of net revenues from 16.7% to 17.0%. The increase in selling, general and administrative expenses as a percentage of net revenues was primarily due to increases in compensation, telephone and credit card charges. Net Earnings. Net earnings for the three months ended September 30, 2000 increased $1.7 million, or 66.0% to $4.3 million. The increase reflected higher net revenues, operating margins, and interest income. Nine months ended September 30, 2000 and September 30, 1999 Net revenues. Net revenues for the nine months ended September 30, 2000 increased $76.9 million, or 28.1%, to $350.1 million. Non-published fare sales increased $70.7 million, or 27.5%, to $327.9 million, reflecting a significant increase in the number of non-published fare tickets sold. Commissions increased $6.2 million, or 38.2%, to $22.3 million. The $6.2 million increase in commissions primarily reflected two factors: first, an increase in commissions on increased sales of published fares; 10 and second, a $4.2 million increase in incentive payments. Published fare commissions as a percentage of net revenues increased from 5.9% to 6.4%. 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 $19.6 million, or 9.7%, to $222.7 million. The increase reflected higher staffing levels and increased average ticket price. Net revenues from Internet sales increased $57.2 million, to $127.4 million. Net revenues through the Internet represented 36.4% of net revenues in the first nine months ended September 30, 2000, compared with 25.7% in the first nine months ended June 30, 1999. Gross Profit. Gross profit for the nine months ended September 30, 2000 increased $16.7 million, or 31.1%, to $70.5 million, driven by a 28.1% increase in net revenues. As a percentage of net revenues, gross profit increased from 19.7% to 20.1%. This can be attributed to slightly higher non-published gross margins from more effective non-published fare yield management and increased volume incentive payments earned. Selling, General and Administrative Expenses. For the nine months ended September 30, 2000, selling, general and administrative expenses increased $13.7 million, or 30.8%, to $57.9 million, and increased slightly as a percentage of net revenues from 16.2% to 16.5%. The increase as a percentage of net revenues was primarily the result of increases in advertising expenses of $5.8 million, which was 4.1% of net revenues this year compared with 3.1% in 1999. Advertising expenses targeted to increase Internet sales were $3.2 million higher for the nine months ended September 30, 2000, including campaigns 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 but lower as a percentage of net revenues. In the aggregate, all other selling, general and administrative expenses, other than advertising, were 13.1% and 12.4% of net revenues for the nine months ended September 30, 1999 and 2000, respectively. Net Earnings. Net earnings for the nine months ended September 30, 2000 increased $4.7 million, or 69.3% to $11.5 million. The increase reflected higher net revenues, higher operating margins, and interest income from cash and marketable securities of $6.7 million. Operating Segments Net Revenues By Segment - ----------------------- Three Months Ended September 30, Nine Months Ended September 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 $ 29,707 27% $ 45,358 37% $ 70,189 26% $ 127,439 36% Call Center 80,448 73% 76,041 63% 203,066 74% 222,712 64% ---------------------- ------------------------ ---------------------- ---------------------- Net Revenues $ 110,155 100% $ 121,399 100% $ 273,255 100% $ 350,151 100% ====================== ======================== ====================== ====================== Gross Profit By Segment - ----------------------- Three Months Ended September 30, Nine Months Ended September 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 $ 6,509 30% $ 9,561 38% $ 14,984 28% $ 26,598 38% Call Center 15,018 70% 15,727 62% 38,763 72% 43,860 62% ---------------------- ------------------------ ---------------------- ---------------------- Gross Profit $ 21,527 100% $ 25,288 100% $ 53,747 100% $ 70,458 100% ====================== ======================== ====================== ====================== Three Months Ended September 30, 2000 and September30, 1999 by Segment Net Revenues. Net revenues through the Internet increased $15.7 million, or 52.7% to $45.4 million. The retail value of non-published fares is the largest component of net revenues. Sales volumes increased as a result of targeted advertising and email campaigns, growing acceptance of Internet commerce, and a significant increase in registered users to our website. 11 The non-published fare component in the Internet sales mix was 62% and 60%, respectively, of total Internet bookings for the three months ended September 30, 1999 and 2000. Net revenues through the call centers decreased $4.4 million, or 5.5% to $76.0 million. This decrease can be attributed to some pricing competition resulting from United Airlines' pricing actions and Cheap Tickets' focus on optimizing margins. Gross Profit. Gross profit from Internet sales increased $3.1 million, or 46.9% to $9.6 million. As a percentage of net revenues, Internet gross profit decreased from 21.9% to 21.1%. The reduction was primarily due to a decrease in margins on Internet non-published fare sales. Call center gross profit increased $709,000, or 4.7% to $15.7 million. As a percentage of net revenues, gross profit from call centers decreased from 20.7% to 18.7% for the three months ended September 30, 1999 and 2000, respectively. Nine Months Ended September 30, 2000 and September 30, 1999 by Segment Net Revenues. Net revenues through the Internet increased $57.2 million, or 81.6% to $127.4 million. The non-published fare component in the Internet sales mix was 63% and 57% of total Internet bookings for the nine months ended September 30, 1999 and 2000, respectively. Sales volumes increased as a result of targeted advertising and email campaigns, growing acceptance of Internet commerce, and a significant increase in registered users to our website. Net revenues through call centers increased $19.6 million, or 9.7% to $222.7 million. The increase reflected the overall industry demand, the results of the Cheap Tickets' branding campaign and higher staffing levels in the call centers. Gross Profit. Gross profit from Internet sales increased $11.6 million, or 77.5% to $26.6 million. As a percentage of net revenues, Internet gross profit decreased from 21.3% to 20.9%. The reduction was primarily due to the impact of a decrease in non-published fare margins from changes in the carrier sales mix. Call center gross profit increased $5.1 million, or 13.1% to $43.9 million. As a percentage of net revenues, gross profit from call centers increased slightly from 19.1% to 19.7% for the nine months ended September 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 nine months ended September 30, 2000, Cheap Tickets generated cash from operating activities of $18.7 million, compared with $18.3 million for the nine months ended September 30, 1999. For the nine months ended September 30, 2000, cash generated from operating activities was comprised principally of net earnings of $11.4 million plus depreciation of $2.1 million and an increase in accounts payable of $7.1 million. For the nine months ended September 30, 1999, cash generated from operating activities was comprised principally of net earnings of $6.8 million plus depreciation of $1.0 million and an increase in accounts payable of $10.6 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. 12 For the nine months ended September 30, 2000, Cheap Tickets received cash from investing activities of $468,000, while in the prior period it used cash in investing activities of $88.2 million. Cash used in investing activities for the nine months ended September 30, 2000 included net proceeds from the sale of short term marketable securities of $2.3 million and capital expenditures of $2.8 million. For the nine months ended September 30, 1999 net purchases of short term marketable securities were $85.3 million and capital expenditures were $2.9 million. For the nine months ended September 30, 1999, Cheap Tickets received net proceeds from initial and secondary public offerings of $144.6 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 September 30, 2000, Cheap Tickets maintained on hand cash and cash equivalents of $57.8 million and short term marketable securities of $96.6 million. Cheap Tickets' net working capital was $143.5 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 $498,000 and capital lease obligations of $2,316,000. 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. 13 PART II--OTHER INFORMATION Item 1. LEGAL PROCEEDINGS 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 Consolidated 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 Not applicable. Item 5. OTHER INFORMATION Not applicable. 14 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) /s/ Michael J. Hartley Date: November 13, 2000 Michael J. Hartley Chairman of the Board, Chief Executive Officer /s/ Sam E. Galeotos Date: November 13, 2000 Sam E. Galeotos President and Chief Operating Officer /s/ Dale K. Jorgenson Date: November 13, 2000 Dale K. Jorgenson Chief Financial Officer and Vice President (Principal Financial Officer and Principal Accounting Officer) 15