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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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Form 10-K
(Mark One)
[X] Annual report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 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 No.: 000-25279
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CHEAP TICKETS, INC.
(Exact name of Registrant as specified in its charter)
Delaware 99-0338363
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
1440 Kapiolani Boulevard
Honolulu, Hawaii 96814
(Address of principal executive offices, including zip code)
(808) 945-7439
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act: None
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(Title of each class) (Name of exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value per share
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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. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the Common Stock held by non-affiliates of
the Registrant as of March 15, 2001 was approximately $66,600,000 based upon
the closing sale price of the Registrant's Common Stock on such date, as
reported on the Nasdaq National Market. Shares of Common Stock held by each
executive officer and director and each person owning more than 5% of the
outstanding Common Stock of the Registrant have been excluded in that such
persons may be deemed to be affiliates of the Registrant. This determination
of affiliate status is not necessarily a conclusive determination for other
purposes.
As of March 15, 2001, the Registrant had 24,270,542 shares of Common Stock,
$.001 par value per share, outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement for its 2001 Annual
Meeting of Stockholders scheduled to be held on May 21, 2001 are incorporated
by reference into Part III of this Form 10-K.
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All historical financial information contained in this Annual Report on
Form 10-K has been restated to comply with recently issued accounting
standards as discussed on page 29 (see Note 1 to the Financial 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," "plan" 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 "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contained in this Annual Report on Form
10-K, and in Cheap Tickets' other filings with the SEC. 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 under "Risk Factors." 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.
PART I
Item 1. Business.
Cheap Tickets is one of the leading retail sellers of discount tickets for
domestic leisure travel. Offering more than 1 million non-published airfares
on more than 40 major airlines, Cheap Tickets sells directly to consumers
through its Internet site, located at "www.cheaptickets.com;" through its
toll-free number, 1-800-OKCHEAP; and at its 10 retail stores. For the year
ended December 31, 2000, Cheap Tickets sold more than 2.1 million airline
tickets, primarily through its call centers and its Internet site. Cheap
Tickets was incorporated in Hawaii in August 1986 and reincorporated in
Delaware in February 1999.
Products and Services
Leisure Airline Tickets. Cheap Tickets has the right to acquire non-
published fares pursuant to contracts from carriers. Cheap Tickets then
resells these tickets at profit margins which exceed the typical commissions
payable for the sale of tickets on an agented basis. The prices Cheap Tickets
offers to customers are generally at a substantial discount to published
fares. Cheap Tickets purchases these fares only when it resells them to
customers, so that it does not have inventory carrying costs. Cheap Tickets'
non-published fares are not available to consumers directly from the airlines
and are not published, except as advertised by Cheap Tickets. Availability of
non-published fares varies from route to route based on availability from the
airline carriers. Cheap Tickets currently offers approximately 1 million non-
published fares at any given time, covering most major domestic and
international routes. Cheap Tickets sells these tickets with limitations and
restrictions that make them unattractive for full fare travelers, who seek the
convenience of tickets that can be exchanged or canceled and do not have
advance purchase or minimum stay requirements. For the years ended December
31, 1999 and 2000, approximately 64% and 57%, respectively, of Cheap Tickets'
airline gross bookings were from non-published fares.
For customers who are unable to find a non-published fare for a particular
itinerary, Cheap Tickets also offers a full menu of regularly published fares.
For published fares, Cheap Tickets receives commissions on gross bookings.
Airlines generally pay commissions of 5% of total ticket price, although these
commissions are frequently capped at $25 for a domestic U.S. one-way ticket
and $50 for a domestic round trip ticket. Cheap Tickets receives commissions
at least as favorable as those received by travel agents, and with many
carriers
2
Cheap Tickets has negotiated more favorable commission rates. In addition,
Cheap Tickets frequently benefits from performance-based override commissions.
In 1994, Cheap Tickets became the first non-airline to file its non-
published fares through the Airline Tariff Publishing Corporation. This allows
Cheap Tickets to integrate its non-published fares with published fares in a
special area of the SABRE reservations system to which only Cheap Tickets has
access. This system automatically sorts through millions of fares, including
Cheap Tickets' own non-published fares, to identify the lowest fares available
for the desired itinerary. These fares are then posted in ascending price
order for use by Cheap Tickets' reservation agents and Internet customers.
Other Travel Products and Services. Cheap Tickets has contractual
relationships to sell cruises on Carnival Cruises and Princess Cruises and
also has contractual relationships with major auto rental companies to provide
reservations. Cheap Tickets has also entered into a number of contracts to
sell hotel room reservations. Such alternative products represented 3% of
Cheap Tickets' gross bookings for the year ended December 31, 2000. Management
views these other travel products and services as potential areas of future
growth.
Call Center Operations. At December 31, 2000, Cheap Tickets had
approximately 602 reservation agents and other call center employees at its
four call centers. Facilities are located in Honolulu, Colorado Springs,
Los Angeles and Lakeport, California. Reservation agents at these call centers
receive all in-bound calls to Cheap Tickets' toll free number "1-800-OK-
CHEAP." On average, the call centers received approximately 22,000 calls per
day in 2000. Reservation agents currently conduct fare searches for requested
itineraries, sell airline tickets, explain rules and restrictions applicable
to fares and ticket delivery details, identify retail ticket locations, and
provide other assistance. The call centers also provide customer service for
both call center customers and Internet users.
Cheap Tickets uses an intelligent call routing and interactive voice
response technology that enables callers to direct inquiries in an automated
phone-based environment. By automating caller activities and compensating
agents on an incentive basis, Cheap Tickets seeks to maximize agent
productivity. Call centers are segmented into teams, which are rewarded for
the highest productivity and operating effectiveness.
Internet Operations. Cheap Tickets accepts online reservations and provides
ticketing service through its website at "www.cheaptickets.com." On the
website, customers can access information on schedules, availability and non-
published and published fares and book their own travel arrangements at their
convenience. The website is designed to provide customers with quick,
efficient and flexible service in a manner that facilitates comparison
shopping. Cheap Tickets' online service automates the processing of customer
orders, interacts with the systems of third-party travel suppliers, and allows
Cheap Tickets to gather, store and use customer and transaction information in
a comprehensive and cost-efficient manner. The website requires users to
complete a profile before searching for fares. The website has permitted Cheap
Tickets to expand its customer base through better service while reducing
transactional costs.
The website contains customized software applications that interface the
website with an electronic booking system and database. Cheap Tickets has
contracted with SABRE for the development and hosting of the site, the
development of the customized software applications, and access to the
electronic booking system and database.
Cheap Tickets maintains a relational database containing information
compiled from customer profiles, shopping patterns and sales data. Cheap
Tickets analyzes information in this database to develop targeted marketing
programs and provide personalized and enhanced customer service. Its database
is scaleable to permit large transaction volumes. Cheap Tickets' systems
support automated e-mail communications with customers to facilitate
confirmations of orders, provide customer support, obtain customer feedback
and engage in targeted marketing programs.
Cheap Tickets uses a combination of proprietary and industry-standard
encryption and authentication measures designed to protect a customer's
information. Cheap Tickets maintains an Internet firewall to protect its
internal systems and all credit card and other customer information.
3
Strategic Relationships
Airline Relationships. Cheap Tickets currently has contracts with more than
40 airlines. For the year ended December 31, 2000, approximately 48% of sales
of non-published fares came from tickets acquired from three airlines. Cheap
Tickets sells non-published fares purchased under these contracts, with
minimum stay and advance purchase requirements, as non-refundable, non-
endorsable and non-changeable tickets and without frequent flyer mileage or
upgrades. Generally, the airline contracts range from one to one and a half
years in length and can be cancelled on short notice. None of these carriers
has any obligation to renew the contracts at their expiration, but Cheap
Tickets has consistently been successful in obtaining renewals. Management
believes that Cheap Tickets' track record of selling excess capacity without
compromising the airlines' fare structures provides a strong incentive for the
airlines to continue to use Cheap Tickets for the sale of domestic non-
published fares. Management believes that Cheap Tickets' success in matching
excess capacity to consumer demand for low ticket prices comes from its
strategy of directing its marketing efforts to leisure travelers and selling
restricted tickets directly to the public in high volumes through call centers
and over the Internet. Although Cheap Tickets has a consistent history of
renewing its contracts, there are no assurances that any one or several of
them will be renewed.
SABRE Relationship. SABRE is a world leader in the electronic distribution
of travel-related products and services and is a leading provider of
information technology solutions for the travel and transportation industry.
SABRE's electronic booking system and database contains flight schedules,
availability, and published fare information for more than 440 airlines, 50
auto rental companies, 47,000 hotel properties, and dozens of railways, tour
companies, passenger ferries, and cruise lines located throughout the world.
Through the SABRE reservations system, Cheap Tickets offers millions of
published airfares, including those of all major domestic and international
commercial airlines. In addition, SABRE's electronic booking system and
database hosts Cheap Tickets' non-published fare information through a unique
arrangement that permits Cheap Tickets to integrate its non-published fares
with published fares on a special area of the SABRE reservations system to
which only Cheap Tickets has access. This system automatically sorts through
millions of fares, including Cheap Tickets' own non-published fares, to
identify the lowest fares available for the desired itinerary. These choices
are then posted in ascending price order for use by Cheap Tickets' reservation
agents and Internet customers.
Marketing and Brand Awareness
Cheap Tickets intends to aggressively build brand awareness. Traditionally
Cheap Tickets has depended primarily on print and, more recently, Internet-
based advertising. During 2000, Cheap Tickets launched a campaign using
television, print, radio promotions and the Internet. As part of its branding
program Cheap Tickets plans to increase its marketing and advertising
expenditures. It will also continue to pursue a highly targeted Internet-based
advertising campaign. Its Internet advertising efforts will be targeted using
keyword search and banner ads on Internet sites frequented by its target
consumer base. Through such targeted efforts, Cheap Tickets seeks to obtain a
high return for its advertising expenditures. It is a featured advertiser on
the Travelocity website. Cheap Tickets also advertises on Yahoo!, Excite,
Lycos, HotBot, Snap.com and OnSale. Through its banner advertisements, Cheap
Tickets has achieved "click-through" rates to its website in 2000 as high as 6
percent.
Competition
Competition for Non-Published Fares
Sellers of Non-Published Fares. Cheap Tickets' existing direct competition
for non-published fares comes largely from online companies that specialize in
the distribution of discounted fares. Online competition has developed rapidly
from a small number of sellers to a large number of sellers. Competition in
the sale of non-published fares also continues to come from a large number of
other sellers, primarily using call centers or the Internet, or a combination
of both. The market for the sale of non-published discounted fares for
international routes is more competitive than that for domestic routes. As the
leisure travel market evolves, other competitors could increase their share of
the market, or new ones could enter the market.
4
Online Travel Companies. Online travel companies traditionally have
established a strong market presence primarily based on the sale of published
fares. Some of these companies also sell non-published fares. Two primary
online competitors have emerged in the sale of non-published fares. The
leading online competitor is Priceline.com, which has induced a number of
major domestic airlines to supply non-published fares by offering warrants and
other forms of equity compensation in the company. Priceline.com sells tickets
in an auction-based process where the customer offers a price and
Priceline.com then seeks to find a ticket to match the customer's offer. The
other online competitor is Hotwire.com, which began operations in September of
2000. Hotwire acquires non-published fares primarily from five domestic
airlines that are Hotwire shareholders. Hotwire sells tickets in an opaque
environment in which the customer identifies a citypair and date for travel
and Hotwire displays a fare. The customer then has 30 minutes to accept the
fare, without knowing the carrier brand, schedule, connections or equipment
type. If the customer chooses not to accept the fare, he or she is restricted
from using Hotwire for the same citypair and date for 72 hours. By contrast,
the Cheap Tickets customer immediately can buy a fare posted on the Cheap
Tickets website or available through a call center, and unlike both Priceline
and Hotwire, a Cheap Tickets customer can choose a specific airline and learn
the schedule, connections, if any, and equipment prior to making the purchase.
Notwithstanding the difference in purchase procedures, Priceline and Hotwire
have emerged as vigorous competitors. Other start-up online companies are also
attempting to enter the market by acquiring non-published fares by offering
airlines equity participations in their companies.
Airlines and Travel Agents. Airlines do not generally offer non-published
fares directly or indirectly through affiliates or travel agents for regularly
scheduled travel, presumably to prevent the erosion of their published fare
structure. Many airlines do offer limited special discounted fares through
their Internet sites that are not generally made available to travel agents.
These fares are typically offered only on a last-minute, "special sale" basis.
In addition, some airlines offer special promotion fares, percentage discount
off of the published fare, bonus frequent flier mileage, or the ability to
combine frequent flier miles with a low base fare when purchased on their
respective Internet sites. Airlines may expand their offering of special
promotional fares, enter the non-published fare market or sell non-published
tickets through travel agents.
Certain Competitive Factors Affecting Non-Published Fares
Published fares also compete with Cheap Tickets' non-published fares. They
effectively establish price ceilings for Cheap Tickets' non-published fares.
From time to time, airlines also offer special fares, which may compete
directly with Cheap Tickets' discounted non-published fares. Direct
competition also comes from the airlines when fare wars break out.
Competition for Published Fares
In the sale of published fares, Cheap Tickets currently competes with
airlines, traditional travel agents, online travel services and travel
industry reservation databases. The online travel services market is new,
rapidly evolving and intensely competitive, and Cheap Tickets expects such
competition to intensify in the future. In the online travel services market,
Cheap Tickets competes for published fares with similar commercial websites of
other companies, such as Expedia, which is operated by Microsoft Corporation,
Travelocity, Cendant Corporation, TravelWeb, which is operated by Pegasus,
Internet Travel Network, Biztravel.com and TheTrip.com, among others. In
addition, a new entrant named Orbitz, jointly owned by five airlines
(American, Continental, Delta, Northwest and United) is expected to begin
operations in June 2001. Several traditional travel agencies, including larger
travel agencies such as American Express Travel Related Services Co. Inc.,
Uniglobe Travel and Carlson Wagonlit Travel, have established, or may
establish in the future, commercial websites offering online travel services.
Several airlines also have established commercial websites to sell their
tickets and offer other online travel services. A number of Cheap Tickets'
competitors possess larger customer bases, greater brand recognition and
significantly greater financial, marketing and other resources than Cheap
Tickets.
5
Employees
As of December 31, 2000, Cheap Tickets had 1,051 employees including 602
reservation agents and other call center employees, 60 retail store employees,
15 cruise employees, 257 operations support employees and 117 corporate and
administrative employees. Cheap Tickets' ability to attract and retain highly
qualified employees will be the principal determinant of its success. Cheap
Tickets has a policy of using performance-based and equity-based compensation
programs to reward and motivate significant contributors among its employees.
Competition for qualified personnel in the industry is intense. There can be
no assurance that Cheap Tickets' current and planned staffing will be adequate
to support its future operations or that management will be able to hire,
train, retain, motivate and manage required personnel. Although none of Cheap
Tickets' employees is represented by a labor union, there can be no assurance
that its employees will not join or form a labor union. However, Cheap Tickets
has not experienced any work stoppages and considers its relations with its
employees to be good.
Operating Segments
See Operating Segments section in Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations and Note 13 to the
financial statements for a detailed discussion on operating segments.
6
Risk Factors
In addition to the other information we provide in this Annual Report on
Form 10-K, you should carefully consider the following risks that may cause
our actual results, levels of activity, performance or achievements to be
materially different from any future results, levels of activity, performance,
or achievements expressed or implied by forward-looking statements contained
herein. These are not the only risks we face. Some risks are not yet known to
us and there are others we do not currently believe are material but could
later turn out to be so. All of these could hurt our business.
For access to non-published fares, we depend on travel suppliers with which we
have no long-term or exclusive contracts.
For the year ended December 31, 2000, approximately 97% of our gross
bookings came from the sale of airline tickets. Non-published fares
represented about 57% of our airline gross bookings and 57% of total revenue,
and we believe that our continuing ability to obtain non-published fares is
key to our success. Our business could be hurt by:
. refusals by airlines to renew contracts for supply of non-published
fares;
. lack of available excess capacity for an extended time period;
. renewals of the contracts on less favorable terms; or
. cancellation of contracts.
Non-published fares are tickets we acquire from the airlines and resell to
consumers at substantial discounts off published fares. The airlines sell us
tickets at these non-published fares primarily to dispose of excess capacity
without eroding published fare structures. We have contracts with more than 40
airlines that permit us to acquire non-published fares on routes designated in
the contracts at specified prices. These contracts do not require airlines to
provide a specific quantity of tickets or to deal with us exclusively.
Although the terms vary, the typical contract is for a period from one to one
and a half years, and many are cancelable on 30 days' notice or less. We have
a consistent record of renewing these contracts, but airlines may decide not
to do business with us or to dispose of excess capacity themselves or through
others. At times in the past, airlines have renewed contracts with us on less
favorable terms and this may continue to occur in the future. In addition,
there may be times when they have less excess capacity to sell.
A large percentage of our sales of non-published fares currently comes from a
limited number of suppliers.
For the year ended December 31, 2000, approximately 48% of our sales of
non-published fares came from tickets we bought from three airlines. If one or
more of these carriers were to discontinue to supply non-published fares to
us, our business could be hurt.
The percentages of non-published fare sales represented by our leading
carriers are likely to change from year to year depending upon a variety of
factors, including the availability of excess capacity from each carrier and
the breadth of routes on which non-published fares are available. We typically
engage in ongoing discussions with existing carriers about increasing the
routes available for sale of non-published fares. From time to time, we also
discuss potential new relationships for the supply of non-published fares with
carriers with whom we currently do not have contracts.
Our travel suppliers may be acquired and then not continue to deal with us.
We believe that our continued ability to obtain non-published fares is key
to our success. Because many of our contracts are short-term and can be
cancelled on short notice, we depend on our relationships with our suppliers
for a continued supply of non-published fares. We also depend on continuation
of our suppliers' policy
7
of selling excess capacity through non-published fares. The acquisition of one
of our suppliers could hurt our relationship with that supplier and/or could
change that supplier's policy of dealing with excess capacity.
A decline in airline commission rates or the elimination of commissions could
hurt our business.
We earned approximately 30% of our revenue for the year ended December 31,
2000 from airline commissions, including incentive overrides, paid by
airlines. However, the airlines are not required to pay any particular
commission rates or any commissions at all. If air carriers reduce, restrict
or eliminate altogether commissions or impose surcharges for tickets not sold
by them at any time, it could hurt our business. In recent years, airlines
have reduced rates and capped per-ticket commissions. In addition, they have
further reduced rates and capped commissions for online reservations.
Potential fluctuations in our financial results makes financial forecasting
difficult.
Our annual or quarterly results of operations may be below the expectations
of public market analysts and investors. This could result in a decline in the
value of our common stock.
Our business is seasonal due to customers' leisure travel patterns and
changes in the availability of non-published fares. We typically have higher
sales and gross profit in the second and third quarters and lower sales and
gross profit in the fourth quarter, and historically, we have experienced
losses in net income in the fourth quarter. During periods of high-volume air
travel, such as occur in the fourth quarter of each year, we historically have
had access to fewer non-published fares, and such fares on certain major
routes may be 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 which recently occurred in the fourth quarter of 2000. This
could lead to unusual volatility in revenue and earnings.
Gross profit may be impacted by a number of different factors, including:
. the number of fares sold;
. the percentage of gross bookings represented by non-published fare
sales;
. the gross margin percentages on non-published fare sales. These
percentages in turn can be impacted by the sales mix of airlines, whose
net fare prices to us vary, and by competitive factors on various routes
and the possible elimination of profitable routes;
. rates of commissions on published fare sales;
. the amount of volume bonuses; and
. changes in service fees and advertising revenue volumes.
Any change in these factors could materially affect our gross margins and
operating results in future periods. Other events outside our control,
including those set forth in other risk factors, may cause us to experience
significant fluctuations in revenue and earnings. For example, the regulatory
changes affecting the energy industry instituted in 1996 by the California
government has caused power prices to increase. Under the revised regulatory
scheme, utilities were encouraged to sell their plants, which traditionally
had produced most of California's power, to independent energy companies that
were expected to compete aggressively on price. Instead, due in part to a
shortage of supply, wholesale prices have increased dramatically over the past
year. If wholesale prices continue to increase, our operating expenses will
likely increase, as two of our call centers are located in California.
We intend to increase operating expenses in anticipation of future sales.
If these increased sales do not occur or occur only in subsequent periods, we
may experience downward fluctuations in our earnings.
8
A decline in leisure travel or disruptions in travel generally could hurt our
business.
We earn almost all our revenue from the travel industry, particularly from
leisure travel. Leisure travel is highly sensitive to personal discretionary
spending levels and thus tends to decline during general economic downturns.
In addition, other adverse trends or events that tend to reduce leisure travel
are likely to hurt our business. These may include:
. political instability;
. regional hostilities;
. terrorism;
. fuel price escalation;
. travel-related accidents;
. bad weather; or
. airline or other travel related strikes.
A number of airlines are currently in various stages of negotiation with
unions representing their employees. If those negotiations fail and the unions
select to strike or effect a slowdown, our business could be harmed.
We face actual and potential competition from many sources.
We compete in ticket sales against travel wholesalers, consolidators,
online travel companies, airlines and travel agents based on price and the
quality of service to the customer. In the leisure travel market, we also
compete against frequent flyer awards and charter flights. Increased
competition may result in reduced operating margins, loss of market share and
decreased brand recognition. Ultimately, we may not be able to compete
successfully against current and future competitors.
Among other factors, our success depends heavily on our access to non-
published fares, on our brand recognition and on the ability of our systems to
integrate our non-published fares with published fares to offer customers a
broad choice. Some of our competitors, including the air carriers themselves,
have longer histories, larger customer bases, greater brand recognition and
significantly greater financial, marketing and other resources than we do.
These competitors may be able to replicate the factors that make us
successful. They may also enter into strategic or commercial relationships
with larger, established and well-financed companies. Some of our competitors
have agreements to buy non-published fares from our major suppliers. For
example, Priceline.com, Inc. signed an agreement to purchase non-published
tickets from Continental, United and American Airlines and others and has
granted warrants to purchase Priceline.com common stock to certain carriers,
and Hotwire.com acquires non-published fares primarily from five domestic
airlines that are its shareholders. Our competitors may be able to induce one
or more of our suppliers of non-published fares, through pricing, equity or
other incentives, to cease doing business with us, or to do business with us
on less favorable terms. They might also be able to build strong brand
recognition in the leisure travel market, through widespread advertising and
other marketing efforts. Some of our competitors may be able to devote greater
resources to marketing and promotional campaigns on the Internet. Competitors
may also devote substantially more resources to website and systems
development than we do. Any or all of these developments could bring heavy
competitive pressures to bear on us.
We also face the prospect of competition from potential competitors not yet
in the leisure travel market. We believe that potential competitors are likely
to be large, well-financed companies with existing brand name recognition and
proven retail distribution ability. For a more complete description of the
competitive environment in which we operate, please refer to "Business--
Competition."
9
The success of our business will depend on continued growth of online commerce
and Internet infrastructure.
Our future revenue and profits depend, to a certain degree, upon the
widespread acceptance and use of the Internet and online services as a medium
for commerce by customers and sellers. If acceptance and growth of Internet
use does not continue, it will hurt our business.
Rapid growth rate in the use of the Internet and online services is a
recent phenomenon. This growth may not continue. A sufficiently broad base of
customers may not accept, or continue to use, the Internet as a medium of
commerce. Demand for and market acceptance of recently introduced products and
services over the Internet are subject to a high level of uncertainty. There
are few proven products and services. For us to achieve significant growth,
customers who have historically used traditional means of commerce will
instead need to elect to purchase products and services online, and sellers of
products and services will need to accept or expand use of the Internet as a
channel of distribution. Our revenue and profits depend on customers visiting
our website and actually purchasing tickets. Customers could potentially use
the site for route information and choose to purchase tickets directly from
the airlines or elsewhere.
The Internet has experienced, and is expected to continue to experience,
significant growth in the number of users and amount of traffic. Our success
will depend upon the development and maintenance of the Internet's
infrastructure to cope with this increased traffic. This will require a
reliable network backbone with the necessary speed, data capacity and
security, and the timely development of complementary products, such as high-
speed modems, for providing reliable Internet access and services.
Major online service providers and the Internet itself have experienced
outages and other delays as a result of software and hardware failures and
could face such outages and delays in the future. Outages and delays are
likely to affect the level of Internet usage and the processing of
transactions on the Cheap Tickets website. It is unlikely that we could make
up for the level of orders lost in those circumstances by increased phone
orders. In addition, the Internet could lose its viability by reason of delays
in the development or adoption of new standards to handle increased levels of
activity or of increased government regulation. The adoption of new standards
or government regulation may require us to incur substantial compliance costs.
Our brand may not achieve the broad recognition necessary to succeed.
We believe that we must maintain and enhance the Cheap Tickets brand to
continue to attract and expand business. Failure to maintain and enhance our
brand could hurt our business.
The success of the Cheap Tickets brand will depend to a certain extent on
our ability to enhance our advertising programs. The number of Internet sites
that offer competing services increases the importance of establishing and
maintaining our brand name recognition. Many online sites already have well-
established brands in online services or the travel industry generally. We
intend to expand significantly our advertising expense, including national
television and radio promotions, but these expenditures may not result in
increased business activity or the desired enhancement of brand recognition.
This could adversely affect our results of operations.
We may be unable to manage our rapid growth effectively.
We have rapidly and significantly expanded our operations and anticipate
further significant expansion. Our inability to manage growth effectively
could hurt our business.
We have recently added a number of key managerial and technical employees,
and we expect to add additional key personnel in the future. This expansion
has placed, and we expect it will continue to place, a significant strain on
our management, operational and financial resources. To manage the expected
growth of our operations and personnel, we plan to:
. improve and upgrade transaction-processing, operational, customer
service and financial systems, procedures and controls;
10
. maintain and expand our relationships with various travel service
suppliers, Internet portals and other travel-related website companies
and other third parties necessary to our business;
. expand our finance, administrative and operations staff;
. continue to attract, train and manage our employee base; and
. implement a disaster recovery program.
Our current and planned personnel, systems, procedures and controls may be
inadequate to support our planned growth, and our management may not be able
to identify, manage and exploit existing and potential market opportunities
successfully.
We may not be able to keep up with the industry's rapid technological and
other changes.
The industry in which we compete is characterized by:
. rapid technological change;
. changes in user and customer requirements and preferences;
. frequent new product and service introductions embodying new
technologies;
. the emergence of new industry standards and practices; and
. the emerging importance of the Internet and the proliferation of
companies offering Internet-based products and services.
These developments could render our existing online sites and proprietary
technology and systems to become quickly obsolete. Our inability to modify or
adapt our infrastructure in a timely manner or the expenses incurred in making
such adaptations could hurt our business.
As a result, we will be required to continually improve the performance,
features and reliability of our services, particularly in response to
competitive offerings. Our success will depend, in part, on our ability to
enhance our existing services and develop new services in a cost-effective and
timely manner. The development of proprietary technology entails significant
technical and business risks and requires substantial expenditures and lead
time. We may not be able to adapt successfully to customer requirements or
emerging industry standards. In addition, the widespread adoption of Internet,
networking or telecommunications technologies or other technologies could
require us to incur substantial expenditures to modify or adapt our services
or infrastructure.
Our computer and communications systems are vulnerable to business
interruptions.
Our ability to receive and fill orders through our call centers or online
and provide high-quality customer service largely depends on the efficient and
uninterrupted operation of our computer and communications hardware systems.
The occurrence of interruptions, delays, loss of data or the inability to
accept and confirm customer reservations could hurt our business.
Our online servers are located in Tukwila, Washington and Herndon,
Virginia; The SABRE Group's computers are located in Tulsa, Oklahoma; our
communication systems are located at four call centers; and our accounting
systems' computers are located in Hawaii. These systems and operations are
vulnerable to damage or interruption from power loss, telecommunications
failure, break-ins, natural disasters and similar events. The operations of
several major online companies have, in the past, been disrupted by "data
floods" from hackers, and we may be vulnerable to similar acts of sabotage. In
addition, California is in the midst of an energy crisis that could disrupt
our operations and increase our expenses. In the event of an acute power
shortage, which occurs when power reserves for the State of California fall
below 1.5%, California has on some occasions implemented, and may in the
future continue to implement, rolling blackouts throughout California. Our
California call centers currently do not have backup generators or alternate
sources of power in the event of a blackout.
11
We currently do not carry adequate business interruption insurance.
Although we have adopted network security measures, our servers are vulnerable
to computer viruses, physical or electronic break-ins and similar disruptions.
These kinds of events could lead to interruptions, delays, loss of data or the
inability to accept and confirm customer reservations. The occurrence of any
of the foregoing risks could damage our reputation, harm our ability to retain
existing customers and to obtain new customers, and could result in lost
revenue, any of which could substantially harm our business and results of
operations.
Interruptions in service from third parties could hurt our business.
We rely on certain third-party computer systems and third-party service
providers, including the computerized central reservation systems of the
airline and hotel industries to make airline ticket and hotel room
reservations. Any interruption in these third-party services or a
deterioration in their performance could hurt our business. If our arrangement
with any of these third parties is terminated, we may not find an alternative
source of systems support on a timely basis or on commercially reasonable
terms.
We rely on third parties to print our airline tickets and arrange for their
delivery. We rely on third parties to host our online system's infrastructure,
web and database servers.
We currently rely on SABRE for our general reservations system, including
customer profiling, making reservations and credit card verification and
confirmations. Currently, over 90% of our computing transactions are processed
through the SABRE systems. Our technology relationship with SABRE for Internet
operations will further increase our dependency. If we or SABRE ever elect to
terminate the existing relationship, we would be forced to convert to another
provider or develop our own solution. This conversion would require a
substantial commitment of time and resources and potentially hurt our
business.
Our current reservation systems may not be able to handle all calls
adequately.
Our call centers have not been able to answer all calls or service all
inquiries adequately. Our systems' lack of capacity to handle the demands of
our customers can cause unanticipated system disruptions, slower response
times, poor customer service, impaired quality and speed of reservations and
confirmations and delays in reporting accurate financial information. These
problems could hurt our business.
If we experience a substantial increase in our web traffic or in
reservations beyond expected levels, we may need to expand and upgrade our
technology, transaction-processing systems and network infrastructure beyond
planned levels of improvement. If we fail to expand and upgrade in a timely
manner, our business could be hurt. In addition, we may not be able to:
. project accurately the rate or timing of increases in demand;
. upgrade our systems and infrastructure to accommodate future traffic
levels;
. integrate successfully any newly developed or purchased technology with
our existing systems; or
. upgrade and expand our systems in a timely or efficient manner.
Online security breaches could hurt our business.
In our business, secured transmission of confidential information over
public networks is essential to maintain consumer and supplier confidence. If
any compromise of our security were to occur, it could hurt our business.
Concerns over the security of transactions conducted on the Internet and
the potential compromise of customer privacy may inhibit the growth of
commercial online services as a means of conducting commercial transactions.
We have expended significant resources to protect against security breaches
and to alleviate problems caused by such breaches, and we may need to make
further expenditures for this purpose in the future.
12
We rely on encryption and authentication technology licensed from third
parties to provide the security and authentication necessary to transmit
securely confidential information, such as customer credit card numbers. In
addition, we maintain an extensive confidential database of customer profiles
and transaction information. Our current security measures may not be adequate
and advances in computer capabilities, new discoveries in the field of
cryptography, or other events or developments may result in a compromise or
breach of the methods we use to protect customer transaction and personal
data. A party who can circumvent our security might be able to misappropriate
proprietary information or cause interruptions in our operations. Security
breaches could also expose us to a risk of loss or litigation and possible
liability for failing to secure confidential customer information.
If we lose our key personnel or cannot recruit additional personnel, our
business may suffer.
We depend substantially on the continued services and performance of our
senior management, particularly Michael J. Hartley, Executive Chairman of the
Board, Sam Galeotos, President and Chief Executive Officer, and certain other
key personnel. The loss of the services of any of these executive officers or
other key employees could hurt our business.
We have employment agreements with only certain of our key personnel. In
addition, most members of our senior management group have been recruited and
hired over the past 24 months. These individuals may not be able to fulfill
their responsibilities adequately and may not remain with us.
Our future success also depends on our ability to identify, attract, hire,
train, retain and motivate other highly skilled technical, managerial,
marketing and customer service personnel. Competition for such personnel is
intense. The location of our headquarters in Hawaii may also make it more
difficult to attract qualified personnel from the mainland. We may not be able
to attract, assimilate or retain sufficiently qualified personnel. In
particular, we may encounter difficulties in attracting a sufficient number of
qualified software developers for our online services and transaction-
processing systems. The failure to retain and attract necessary technical,
managerial, marketing and customer service personnel could hurt our business
and impair our growth strategy.
Although none of our employees is represented by a labor union, our
employees may join or form a labor union.
Our business could be hurt if we do not offer new services successfully.
We plan to introduce new and expanded services. Our inability to generate
revenue from such expanded services or products sufficient to offset their
development or offering cost could hurt our business. Our alternative
products, including cruises, auto rentals and hotel room reservations,
represented less than 3% of our gross bookings for the year ended December 31,
2000. Our business strategy is to increase the percentage of such alternate
travel offerings as a percentage of our revenue. We may not be able to offer
such services in a cost-effective or timely manner and our efforts may not be
successful. Further, any new service that is not favorably received by
customers could damage our reputation or brand name. Expansion of our services
could also require significant additional expenses and may strain our
management, financial and operational resources. If we cannot obtain alternate
travel offerings in the future, we may not be able to benefit fully from our
growth strategy.
Our business could be hurt if we make acquisitions that are not successful.
We may in the future broaden the scope and content of our business through
the acquisition of existing complementary businesses. We may not be successful
in overcoming problems encountered in connection with such acquisitions, and
our inability to do so could hurt our business.
13
We may consider the acquisition of companies providing similar services in
international markets or in other sectors of the travel industry in the
future. Future acquisitions would expose us to increased risks. These include
risks associated with:
. the assimilation of new operations, sites and personnel;
. the diversion of resources from our existing businesses, sites and
technologies;
. the inability to generate revenue from new sites or content sufficient
to offset associated acquisition costs;
. the maintenance of uniform standards, controls, procedures and policies;
and
. the impairment of relationships with employees and customers as a result
of integration of new businesses.
Acquisitions may also result in additional expenses associated with
amortization of acquired intangible assets or potential businesses.
Our business could be hurt if our international expansion is not successful.
One component of our growth strategy is to expand internationally.
International expansions will present us with special problems of adapting to
foreign business customs and regulations and of managing staff effectively
from a distance. If we do not address these problems adequately, our
international expansion may not produce desired results. This could hurt our
business. We may expend significant financial and management resources to
establish local offices overseas, create localized user interfaces and comply
with local customs and regulations. If the revenue generated by these
international operations are insufficient to offset the expense of
establishing and maintaining them, our business could be hurt. To date, we
have no experience in developing localized versions of our online sites or
offshore call centers and only limited experience in marketing and
distributing our travel services internationally. We may not be able to expand
our operations successfully in such markets. Conducting business on an
international level also involves certain inherent risks, such as unexpected
changes in regulatory requirements, tariffs and other trade barriers,
difficulties in staffing and managing foreign operations, political
instability, currency rate fluctuations, seasonality in leisure travel in
certain countries and potentially adverse tax consequences.
We may be unable to meet our future capital requirements.
We may not be able to fund our expansion, develop or enhance our products
or services or respond to competitive pressures if we lack adequate funds.
This could hurt our business. Alternatively, if we raise additional funds by
issuing equity or convertible debt securities, the percentage ownership of our
stockholders will be diluted. Further, any new securities could have rights,
preferences and privileges senior to those of the common stock.
We currently do not have any commitments for additional financing. We
cannot be certain that additional financing will be available in the future to
the extent required or that, if available, it will be on acceptable terms. For
more information on management's view of liquidity and capital resources,
please refer to "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources."
Our success depends on our ability to protect our intellectual property.
Trademarks, copyrights and trade secrets
We regard our copyrights, service marks, trademarks, trade secrets and
similar intellectual property as critical to our success. Claims, infringement
or misappropriation by third parties may hurt our business. We rely on a
combination of laws and contractual restrictions, including trademark and
copyright law, trade secret protection and confidentiality and/or license
agreements with our employees, customers, partners and others to
14
establish and protect our proprietary rights. However, laws and contractual
restrictions may not be sufficient to prevent misappropriation of our
technology or deter others from developing similar technologies. We pursue the
registration of certain of our key trademarks and service marks in the United
States. Effective trademark, service mark, copyright and trade secret
protection may not be available in every country in which our products and
services are made available. The steps we have taken to protect our
proprietary rights may not be adequate, third parties may infringe or
misappropriate our copyrights, trademarks, trade dress and similar proprietary
rights, and we may be required to incur significant expenses preserving our
rights. In addition, other parties may assert infringement claims against us.
We may be subject to legal proceedings and claims from time to time in the
ordinary course of our business, including claims of alleged infringement of
the trademarks and other intellectual property rights of third parties by us.
Such claims, even if not meritorious, could result in the expenditure of
significant financial and managerial resources.
Domain names
We currently hold the Internet domain name "www.cheaptickets.com," as well
as various other related names. Third parties may acquire domain names that
infringe or otherwise decrease the value of our trademarks and other
proprietary rights which may hurt our business. Domain names generally are
regulated by Internet regulatory bodies. The regulation of domain names in the
United States and in foreign countries is subject to change. Regulatory bodies
could establish additional top-level domains, appoint additional domain name
registrars or modify the requirements for holding domain names. The
relationship between regulations governing domain names and laws protecting
trademarks and similar proprietary rights is unclear. As a result, we may not
acquire or maintain the "www.cheaptickets.com" domain name in all of the
countries in which we conduct business.
Regulatory and legal uncertainties could harm our business.
Certain segments of the travel industry are heavily regulated by the United
States and other governments. Accordingly, certain services offered by us are
affected by such regulations. New legislation or regulation, the application
of laws and regulations from jurisdictions whose laws do not currently apply
to our business, or the application of existing laws and regulations to the
Internet and commercial online services could hurt our business.
We are subject to federal regulations prohibiting unfair and deceptive
practices. In addition, federal regulations concerning the display and
presentation of information currently applicable to airline booking services
could be extended to us in the future, as well as other laws and regulations
aimed at protecting customers accessing travel services through an online or
Internet service. In California, Hawaii and certain other states, we are
required to register as a seller of travel, comply with certain disclosure
requirements and participate in the state's restitution fund.
We are also subject to regulations applicable to businesses generally and
laws or regulations applicable to online and Internet commerce. Although
currently, there are not many laws and regulations that directly apply to the
Internet and commercial online services, it is possible that laws and
regulations may be adopted with respect to the Internet or commercial online
services covering issues such as user privacy, advertising, pricing, content,
copyrights, distribution, antitrust and characteristics and quality of
products and services. Further, the growth and development of the market for
online and Internet commerce may prompt calls for more stringent consumer
protection laws. Such laws would likely impose additional burdens on companies
conducting business online. The adoption of any additional laws or regulations
may decrease the growth of the Internet or commercial online services. In
turn, this could decrease the demand for our products and services and
increase our cost of doing business, or otherwise hurt our business.
Moreover, in many states, there is currently great uncertainty whether or
how existing laws governing property ownership, sales and other taxes, libel,
personal jurisdiction, choice of law and privacy apply to the Internet and
commercial online services. These issues may take years to resolve. For
example, tax authorities in
15
a number of states, as well as a Congressional advisory commission, are
currently reviewing the appropriate tax treatment of companies engaged in
online and Internet commerce, and new state tax regulations may subject us to
additional state sales and income taxes.
Federal legislation imposing certain limitations on the ability of states
to impose taxes on Internet-based sales was enacted in 1998. The Internet Tax
Freedom Act, as this legislation is known, imposes on electronic commerce a
three-year moratorium on state and local taxes imposed after October 1, 1998
but only where such taxes are discriminatory on Internet access. It is
possible that the legislation could not be renewed when it terminates in
October 2001. Failure to renew the legislation could allow state and local
government to impose taxes on Internet-based sales, and such taxes could hurt
our business.
Our stock price is likely to be volatile.
The market price of our common stock is likely to be volatile and could be
subject to significant fluctuations in response to factors such as the
following, some of which are beyond our control:
. quarterly variations in our operating results;
. operating results that vary from the expectations of securities analysts
and investors;
. changes in expectations as to our future financial performance,
including financial estimates by securities analysts and investors;
. changes in market valuations of other travel, Internet or online service
companies;
. announcements of technological innovations or new services by us or our
competitors;
. announcements by us or our competitors of significant contracts,
acquisitions, strategic partnerships, joint ventures or capital
commitments;
. loss of one or more major travel suppliers;
. additions or departures of key personnel;
. future sales of our common stock; and
. stock market price and volume fluctuations.
Domestic and international stock markets often experience extreme price and
volume fluctuations. These fluctuations, as well as general political and
economic conditions, such as a recession or interest rate or currency rate
fluctuations, may adversely affect the market price of our common stock. The
market prices for stocks of Internet-related and technology companies
frequently reach levels that bear no relationship to the operating performance
of these companies. These market prices often are not sustainable and are
subject to wide variations. Recently, the Nasdaq National Market, in general,
and our stock and the stock of our competitors, in particular, has experienced
substantial price and volume fluctuations, in many cases without any direct
relationship to the affected companies' operating performance. An outgrowth of
this market volatility is the significant vulnerability of our stock price and
the stock prices of our competitors to any actual or perceived fluctuation in
the strength of the markets we serve, no matter how minor in actual or
perceived consequence. These broad market and industry factors have and may in
the future cause the market price of our stock to decline, regardless of our
actual operating performance. In the past, securities class action litigation
has often been brought against a company following periods of volatility in
the market price of its securities. We may in the future be the target of
similar litigation. Securities litigation could result in substantial costs
and divert management's attention and resources.
The market price of our stock could be adversely affected because a
significant portion of our stock is closely controlled.
At December 31, 2000, Michael J. Hartley, Executive Chairman of the Board
of Cheap Tickets, together with his affiliates, beneficially owned
approximately 48% of our outstanding common stock, subject to certain
16
adjustments. Such ownership could discourage others from initiating potential
merger, takeover or other change of control transactions. As a result, the
market price of our common stock could be adversely affected. If they act
together, they will effectively have the ability to control the outcome on all
matters requiring stockholder approval, including the election and removal of
directors and any merger, consolidation or sale of all or substantially all of
our assets, and to control our management and affairs.
Anti-takeover provisions affecting us could prevent or delay a change of
control.
Our Board of Directors has the authority to issue up to 10,000,000 shares
of preferred stock and to determine the price, rights, preferences, privileges
and restrictions, including voting rights, of those shares without any further
vote or action by the stockholders. This could have an adverse impact on the
market price of our common stock. The rights of the holders of common stock
may be subject to, and adversely affected by, the rights of the holders of any
preferred stock that may be issued in the future. Moreover, the issuance of
preferred stock may have the effect of delaying, deferring or preventing a
change of control of Cheap Tickets without further action by the stockholders
and may adversely affect the voting and other rights of the holders of common
stock. Further, certain provisions of our charter documents, including
provisions permitting stockholders to take action by written consent with a
two-thirds vote and limiting the ability of stockholders to raise matters at a
meeting of stockholders without giving advance notice, may have the effect of
delaying or preventing changes in control or management of Cheap Tickets.
These governance provisions also could hurt the market price of our common
stock.
Forward-Looking Statements
Statements contained in this Annual Report on Form 10-K which are not
historical facts are forward-looking statements within the meaning of Section
21E of the Securities Exchange Act of 1934, as amended. A forward-looking
statement may contain words such as "anticipate," "believe," "expect,"
"estimate," "project," "plan" and similar expressions. These forward-looking
statements include statements relating to our expectations as to:
. future growth in travel products and services other than leisure airline
tickets;
. our ability to enhance consumer awareness and add new customers through
our brand name;
. increasing our marketing and advertising expenditures to support our
brand name and to obtain a high return for our advertising expenditures;
. pursuing a highly targeted Internet-based advertising campaign;
. an increasing portion of gross bookings and revenue in future periods
will be represented from sources other than airline ticket sales and by
online gross bookings and online revenue;
. our continuing ability to obtain non-published fares;
. increasing operating expenses in anticipation of future sales;
. significant growth in the number of users and amount of traffic on the
Internet;
. the addition of key personnel in the future and our ability to
effectively manage the growth of our operations and personnel;
. broadening the scope and content of our business through the acquisition
of existing and complimentary businesses;
. the non-materiality of our interest rate exposure; and
. sufficiency of our current cash and cash equivalents, short term
marketable securities and anticipated cash flow from operations to meet
our anticipated cash needs for working capital, debt service and capital
expenditures, at least for the foreseeable future.
17
Management cautions that these forward-looking statements are not
guarantees of future performance and are subject to risks and uncertainties
that could cause our actual results to differ materially from those projected
in such forward-looking statements. Some of the factors that may cause actual
results to differ materially from those contemplated by such forward-looking
statements include, but are not limited to, the following possibilities:
. uncertainty regarding demand for our products in general;
. actual and potential competition for leisure travel customers and for
discount tickets;
. the strength and breadth of the market for leisure travel;
. the continued growth of online commerce and Internet infrastructure;
. the success of our advertising programs and the strength of our brand
recognition;
. our ability to enter into new supply agreements and to expand, enhance
and renew existing supply agreements;
. our ability to retain and attract key personnel and to manage growth
effectively;
. our ability to maintain and renew our technological infrastructure and
to maintain the security of our communications network;
. our ability to obtain needed services from reliable third parties; and
. the availability of sufficient liquidity and capital resources for the
future.
Some of these factors and additional risks and uncertainties are further
discussed under the other factors identified in the "Risk Factors" section
beginning on page 7. Further, our future business, financial condition and
results of operations could differ materially from those anticipated by such
forward-looking statements and are subject to risks and uncertainties
including the risks set forth above. Moreover, neither we nor any other person
assumes responsibility for the accuracy and completeness of the forward-
looking statements. We are under no duty to update any of the forward-looking
statements after the date of this Annual Report on Form 10-K to conform such
statements to actual results or to changes in our expectations.
Item 2. Properties.
Cheap Tickets is headquartered in Honolulu, Hawaii, where it leases an
aggregate of approximately 38,704 square feet of space housing its corporate
offices and a call center. The leases for this space expire in December 2003,
with an option to renew. Cheap Tickets also leases an aggregate of
approximately 7,300 square feet of retail or storage space in five other
locations in Hawaii. In July 1994, Cheap Tickets entered into a lease expiring
in September 2004 for approximately 9,600 square feet in Los Angeles,
California, to serve as one call center. In June 1999, Cheap Tickets entered
into a lease expiring in June 2009 for approximately 25,000 square feet to
house its Colorado Springs, Colorado call center. Cheap Tickets also leases an
aggregate of approximately 8,800 square feet of retail and administrative
space in five other locations in California and approximately 975 square feet
of retail space in Seattle in one location. Cheap Tickets owns a 20,000
square-foot facility in Lakeport, California, which serves as a fourth call
center.
Item 3. 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 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of stockholders during the fourth
quarter of 2000.
18
PART II
Item 5. Market for Company's Common Equity and Related Stockholder Matters.
Nasdaq National Market Listing
Our common stock trades on the Nasdaq National Market under the symbol
"CTIX." The following table sets forth the range of high and low closing sales
prices of our common stock, as reported by the Nasdaq National Market, for the
periods indicated. As of March 15, 2001, there were approximately 5,178
holders of record of our common stock.
High Low
------ ------
Quarter ended March 31, 1999 (from March 19, 1999).......... $33.63 $25.88
Quarter ended June 30, 1999................................. $45.00 $27.31
Quarter ended September 30, 1999............................ $66.63 $31.06
Quarter ended December 31, 1999............................. $32.63 $12.25
Quarter ended March 31, 2000................................ $18.50 $12.13
Quarter ended June 30, 2000................................. $15.31 $ 9.69
Quarter ended September 30, 2000............................ $13.88 $ 9.50
Quarter ended December 31, 2000............................. $11.13 $ 7.16
Dividends
We have never declared or paid dividends on our common stock and anticipate
for the foreseeable future that all earnings will be retained for use in our
business. The payment of any future dividends will be at the discretion of our
board of directors. The Delaware General Corporation Law also restricts our
ability to pay dividends. The Delaware General Corporation Law provides that a
Delaware Corporation may pay dividends either (1) out of the corporation's
surplus (as defined by Delaware law), or (2) if there is no surplus, out of
the corporation's net profit for the fiscal year in which the dividend is
declared or the preceding fiscal year. Any determination in the future to pay
dividends will depend on our financial condition, capital requirements,
results of operations, contractual limitations, legal restrictions and any
other factors our board of directors deems relevant.
19
Item 6. Selected Financial Data.
The historical financial information below and elsewhere in this Annual
Report on Form 10-K has been restated to comply with recently issued
accounting standards as discussed on page 29 (see Note 1 to the Financial
Statements).
Years Ended December 31,
-----------------------------------------------
1996 1997 1998 1999 2000
-------- -------- -------- --------- ---------
(in thousands, except per share data, tickets
sold and
registered internet users)
Results of Operations:
Revenue:
Non-published fares......... $ 9,814 $ 15,009 $ 23,779 $ 45,698 $ 56,179
Commissions and bonuses..... 5,614 6,470 11,268 22,349 29,781
Service fees and other...... 1,228 1,787 3,169 5,960 12,482
-------- -------- -------- --------- ---------
Total revenue(1).......... 16,656 23,266 38,216 74,007 98,442
Cost of sales(1).............. 1,880 3,036 4,244 6,790 7,541
-------- -------- -------- --------- ---------
Gross profit.................. 14,776 20,230 33,972 67,217 90,901
Selling, general and
administrative expenses...... 13,700 21,842 32,336 58,446 80,289
-------- -------- -------- --------- ---------
Net operating income (loss)... 1,076 (1,612) 1,636 8,771 10,612
Other income (deductions)..... 37 (3) 169 4,088 8,588
-------- -------- -------- --------- ---------
Earnings (loss) before income
taxes........................ 1,113 (1,615) 1,805 12,859 19,200
Income taxes.................. 439 (606) 740 5,272 7,188
-------- -------- -------- --------- ---------
Net earnings (loss)....... $ 674 $ (1,009) $ 1,065 $ 7,587 $ 12,012
======== ======== ======== ========= =========
Basic earnings (loss) per
share........................ $ 0.05 $ (0.09) $ 0.04 $ 0.33 $ 0.52
Shares used in computing basic
earnings (loss) per share.... 14,249 14,847 14,567 20,731 23,171
Diluted earnings (loss) per
share........................ $ 0.05 $ (0.09) $ 0.03 $ 0.31 $ 0.51
Shares used in computing
diluted earnings (loss)
per share.................... 14,249 14,847 17,921 22,060 23,545
Balance Sheet Data
Net working capital........... $ 466 $ 2,356 $ 3,473 $ 134,142 $ 138,735
Total Assets.................. 5,999 11,204 13,226 155,610 166,485
Long-term debt................ 1,715 948 1,238 3,893 2,452
Mandatorily redeemable
preferred stock(2)........... -- 3,622 4,136 -- --
Stockholders' equity.......... 1,544 812 1,385 138,613 150,795
Other Operating Data
(unaudited)
Gross bookings(3)
Non-published fares......... $ 58,982 $ 96,379 $159,846 $ 317,260 $ 380,272
Published fares............. 46,962 57,295 110,287 178,065 285,254
-------- -------- -------- --------- ---------
Total gross bookings...... $105,944 $153,674 $270,133 $ 495,325 $ 665,526
======== ======== ======== ========= =========
Airline tickets sold.......... 357,551 554,403 960,879 1,828,186 2,134,260
Call centers................ 357,551 551,973 865,015 1,276,007 1,293,673
Internet.................... -- 2,430 95,864 552,179 840,587
Registered Internet users, as
of........................... -- 18,891 420,023 2,593,574 8,682,630
- --------
(1) Revenue consists of gross margin on the sale of non-published fares,
published fare commissions, net advertising revenue and service fees. Cost
of sales consists of distribution costs related to the sale of tickets.
Commissions, including incentive overrides, are earned primarily on
published fares sold and include certain other payments based on the
volume of transactions.
(2) The mandatorily redeemable preferred stock was redeemed on March 24, 1999.
The redemption price was approximately $4.8 million, including accrued
dividends.
(3) Gross bookings represents the aggregate retail value of tickets sold under
non-published fares and published fares. Revenue as reported in Cheap
Tickets' statement of operations represents the gross margin on the sales
of non-published fares and commissions earned on the sale of published
fares. 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 that year-to-year changes in such
information provide a useful measure of market acceptance of Cheap Tickets
products.
20
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The following discussion should be read in conjunction with the financial
statements of Cheap Tickets. Some of the statements under this caption
constitute forward-looking statements. These statements involve known and
unknown risks, uncertainties and other factors that may cause our actual
results, levels of activity, performance or achievements to be materially
different from any future results, levels of activity, performance, or
achievements expressed or implied by such forward-looking statements. Such
factors include, among other things, those listed under "Risk Factors" and
elsewhere in this Annual Report. In some cases, you can identify forward-
looking statements by terminology such as "may," "will," "should," "could,"
"expects," "plans," "intends," "anticipates," "believes," "estimates,"
"predicts," "potential" or "continue" or the negative of such terms and other
comparable terminology. Although we believe that the expectations reflected in
the forward-looking statements are reasonable, we cannot guarantee future
results, levels of activity, performance or achievements. Moreover, neither we
nor anyone else assumes responsibility for the accuracy and completeness of
such statements. We are under no duty to update any of the forward-looking
statements after the date of this Annual Report.
Overview
Cheap Tickets is principally engaged in the sale of discount tickets for
domestic leisure 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' revenue historically had been generated by ticket sales
through Cheap Tickets' four call centers and, to a lesser extent, through 10
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 38% during the year ended December 31, 2000. At December 31,
2000, Cheap Tickets had approximately 8.7 million registered online users.
Cheap Tickets expects online gross bookings and online revenue to represent an
increasing portion of gross bookings and revenue in future periods.
Gross bookings represent the aggregate retail value of tickets sold under
non-published fares and published fares. Cheap Tickets records as revenue in
its statement of operations only the commissions earned by Cheap Tickets on
the sale of published fares and gross margin on the sale of non-published
fares. Gross bookings are not required by generally accepted accounting
principles ("GAAP") 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 that year-to-year
changes in such information provide a useful measure of market acceptance of
Cheap Tickets' products.
Revenue consists of gross margin on non-published fare sales, published
fare commissions, net advertising revenue and service fees. Cheap Tickets'
cost of sales consists of distribution costs related to the sale of tickets.
Commissions, including incentive overrides, are earned primarily on published
air fares sold and include certain other payments based on the volume of
transactions.
Gross profits include (1) the gross profit on non-published sales where
Cheap Tickets establishes the markup and retail price, (2) commissions earned
on the sale of published fares sold, (3) net advertising revenue and
(4) service fees less distribution costs. Cheap Tickets earns higher profits
on the sale of non-published fares than on the sale of published fares.
21
Substantially all of Cheap Tickets' gross bookings represent sales of
airline tickets. For the years ended December 31, 1999 and 2000, approximately
99% and 97% respectively, 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 and
occupancy.
Results of Operations
The following table sets forth, for the years ended December 31, 1998, 1999
and 2000, information derived from the statement of operations of Cheap
Tickets expressed as a percentage of revenue, and the percentage change in
such items and in gross bookings for the years ended December 31, 1998, 1999
and 2000, compared with the prior period. Any trends illustrated in the
following table are not necessarily indicative of future results.
Percentage Increase
As a Percentage (Decrease)
of Total Revenue Over Prior Periods
------------------- -------------------------
Year Ended
December 31, Year Ended December 31,
------------------- -------------------------
1998 1999 2000 1998 to 1999 1999 to 2000
----- ----- ----- ------------ ------------
Results of Operations:
Revenue:
Non-published fares.......... 62.2% 61.7% 57.1% 92.2% 22.9%
Commissions and bonuses...... 29.5 30.2 30.3 98.3 33.3
Service fees and other....... 8.3 8.1 12.6 88.1 109.4
----- ----- -----
Total revenue.............. 100.0 100.0 100.0 93.7 33.0
Gross profit................... 88.9 90.8 92.3 97.9 35.2
Selling, general and
administrative expenses....... 84.6 79.0 81.6 80.7 37.4
----- ----- -----
Net operating income....... 4.3 11.9 10.8 436.1 21.0
Net earnings................... 2.8 10.3 12.2 612.4 58.3
Operating Data (unaudited):
Gross bookings................. n/a n/a n/a 83.4% 34.4%
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Total Revenue. Total revenue for the year ended December 31, 2000 increased
$24.4 million, or 33.0%, to $98.4 million. Non-published fare revenue
increased $10.5 million or 22.9% and represented 57.1% of total revenue. The
increase in non-published fare revenue was the result of an increase in the
number of non-published tickets sold and higher margins on non-published fares
from more effective yield management. Gross bookings of non-published fares
increased $63.0 million, or 19.9%, to $380.3 million. Non-published fares
decreased from 64.1% of gross bookings last year to 57.1% this year.
Commissions and bonuses increased $7.4 million, or 33.2%, to $29.8 million.
The $7.4 million increase reflected an increase in the amount of published
fares sold and an increase in volume incentives received from our global
distribution system or GDS supplier. Gross bookings of published fares
increased from 35.9% to 42.9% of total gross bookings year over year.
Service fees and other revenue includes gross service fees and a small
amount of banner advertising. The increase from $6.0 million in 1999 to $12.5
million in 2000 was primarily the result of increases in service fees. Cheap
Tickets began banner advertising on its website in the fourth quarter of 2000.
22
Accelerated usage of Internet commerce in the leisure travel market,
broader recognition of the Cheap Tickets brand name, particularly through the
Internet and advertising to targeted markets contributed to the growth in
total revenue.
Total revenue through call centers and retail operations increased $8.2
million, or 15.6% to $61.0 million. Of this $8.2 million increase, $5.6
million reflected an increase in sales and $2.6 million represented an
increase in service fee revenue. Higher gross bookings in the call centers and
higher non-published margins, volume bonuses, and service fees largely
accounted for this increase in revenue.
Total revenue through the Internet, increased $16.2 million, to $37.4
million. Internet revenue equaled 38.0% of total revenue for the year ended
December 31, 2000 compared with 28.7% for the year ended December 31, 1999.
Fourth quarter banner advertising resulted in revenue of $133,152. In 2000,
the Internet published sales mix increased from 43% to 48% of total Internet
bookings.
Gross Profit. Gross profit increased $23.7 million, or 35.2% to $90.9
million. As a percentage of total revenue, gross profit increased from 90.8%
to 92.3%. Of the increase of $23.7 million, $10.5 million was the result of
increased non-published revenue, $7.4 million was from higher published
commissions and GDS fees, and $5.8 million was substantially from the margin
on service fees.
Cost of sales consists of the distribution costs of tickets. Both non-
published revenue and commissions in total revenue have no associated costs of
sale and are included 100% in gross profit.
Selling, General and Administrative Expenses. For the year ended December
31, 2000, selling, general and administrative expenses increased $21.8
million, or 37.4%, to $80.3 million, and increased as a percentage of total
revenue from 79.0% to 81.6%. Advertising expenses increased by $7.5 million,
representing an increase from 15.0% to 18.9% of total revenue. Compensation
and volume related costs increased, but these and all other costs in the
aggregate were less than 1999 as a percentage of total revenue.
Net Earnings. For the year ended December 31, 2000, Cheap Tickets' net
earnings increased $4.4 million, or 58.3% to $12.0 million. This increase
reflected: 1) higher total revenue; 2) increased gross profit from higher
volumes and margins; 3) increased interest from investments; and 4) a fourth
quarter adjustment due to a lower effective tax rate resulting from actions
taken to reduce state income taxes.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Total Revenue. Total revenue for the year ended December 31, 1999 increased
$35.8 million, or 93.7%, to $74.0 million. Non-published fare revenue
increased $21.9 million, or 92.2%, to $45.7 million. The increase in non-
published fare revenue reflected a significant increase in the amount of non-
published tickets sold. Commissions and bonuses increased $11.1 million, or
98.3%, to $22.3 million. The $11.1 million increase in commissions and bonuses
reflected an increase in the amount of published fares sold and an improvement
in bonus overrides as a percentage of total revenue. Gross bookings of
published fares decreased from 40.8% to 35.9% of total gross bookings.
Strong growth in the leisure travel market and particularly in air travel,
improving recognition of the Cheap Tickets brand from both increased exposure
coincident with becoming a public company and significantly higher advertising
expenditures in 1999 compared with 1998, and increasing acceptance of Internet
commerce in 1999 all contributed to this growth in total revenue.
Total revenue through call centers and retail operations increased $18.1
million, or 52.0% to $52.8 million. The $18.1 million increase reflected the
effect of operations in 1999 of a new call center that opened in late May 1998
and increased productivity and staffing in the remainder of the call centers.
Total revenue through the Internet increased $17.7 million, to $21.2
million. Total revenue through the Internet represented 28.7% of total revenue
for the year ended December 31, 1999 compared with 9.1% for the
23
year ended December 31, 1998. In 1999, the non-published fare component in the
Internet sales mix increased from 44% to 57% of total Internet bookings.
Gross Profit. Gross profit increased $33.2 million, or 97.9% to $67.2
million. As a percentage of total revenue, gross profit increased from 88.9%
to 90.8%. In 1999, a lower percentage of published fares and lower margins on
non-published fares reduced the gross profit percent of total revenue, but was
offset somewhat by higher performance-based commission income earned. An
industry-wide reduction in published fare commissions from 8% to 5% in the
fourth quarter of 1999 had a minor impact on the year's results.
Selling, General and Administrative Expenses. For the year ended December
31, 1999, selling, general and administrative expenses increased $26.1
million, or 80.1%, to $58.4 million, and decreased as a percentage of total
revenue from 84.6% to 79.0%. The decrease in selling, general, and
administrative expenses as a percentage of total revenue was primarily
attributable to decreases in compensation, telephone and rent expense and most
other expenses as a percentage of total revenue. These decreases were
partially offset by increases, as a percentage of total revenue, in credit
card charges and advertising expenses. Advertising expenses targeted to
increase Internet sales were $4.9 million higher for the year ended December
31, 1999, and overall brand advertising, primarily through print media,
increased by $2.4 million.
Net Earnings. For the year ended December 31, 1999, Cheap Tickets' net
earnings increased $6.5 million, or 612.4% to $7.6 million. This increase
reflected higher total revenue, increased gross profit from these higher
volumes, and lower selling, general, and administrative expenses as a
percentage of total revenue as a result of proportionately lower operating
leverage.
Operating Segments
Cheap Tickets' reported segments are comprised of Internet and Call
Center/Other operations.
24
The accounting policies of the segments are the same as those used in the
preparation of Cheap Tickets' consolidated financial statements. Cheap Tickets
evaluates the performance of its operating segments based on segment operating
income, which includes sales and marketing expenses and other overhead charges
directly attributable to the operating segment. Certain expenses managed
outside of the operating segments are excluded, such as corporate expenses,
including other income and expense items, unallocated shared expenses, and
income taxes. Asset information by operating segment is not reported since
Cheap Tickets does not identify assets by segment.
Total revenue by segment
Year Ended Year Ended Year Ended
December 31, 1998 December 31, 1999 December 31, 2000
----------------- ----------------- -----------------
Percent Percent Percent
In of In of In of
Segments Thousands Total Thousands Total Thousands Total
- -------- --------- ------- --------- ------- --------- -------
Internet.................. $ 3,481 9% $21,212 29% $37,399 38%
Call Center/Other......... 34,735 91% 52,795 71% 61,043 62%
------- --- ------- --- ------- ---
Total revenue........... $38,216 100% $74,007 100% $98,442 100%
======= === ======= === ======= ===
Gross profit by segment
Year Ended Year Ended Year Ended
December 31, 1998 December 31, 1999 December 31, 2000
----------------- ----------------- -----------------
Percent Percent Percent
In of In of In of
Segments Thousands Total Thousands Total Thousands Total
- -------- --------- ------- --------- ------- --------- -------
Internet.................. $ 3,087 9% $18,960 28% $34,155 38%
Call Center/Other......... 30,885 91% 48,257 72% 56,746 62%
------- --- ------- --- ------- ---
Gross profit............ $33,972 100% $67,217 100% $90,901 100%
======= === ======= === ======= ===
Operating income by segment
Year Ended Year Ended Year Ended
December 31, 1998 December 31, 1999 December 31, 2000
----------------- ----------------- -----------------
Percent Percent Percent
In of In of In of
Segments Thousands Total Thousands Total Thousands Total
- -------- --------- ------- --------- ------- --------- -------
Internet.................. $ 1,257 14% $ 7,929 42% $16,325 64%
Call Center/Other......... 7,420 86% 11,014 58% 8,999 36%
------- --- ------- --- ------- ---
Operating income........ $ 8,677 100% $18,943 100% $25,324 100%
======= === ======= === ======= ===
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999 by
Segment
Total Revenue. Total revenue through the Internet increased $16.2 million,
or 76.31% to $37.4 million. Total revenue through the Internet represented 38%
of total revenue for the year ended December 31, 2000 compared with 29% for
the year ended December 31, 1999. In 2000, revenue increased due to additional
advertising spent, growing acceptance of Internet commerce and a significant
increase in new registered users to our website. In 2000, published fare gross
bookings increased from 43% to 48% of total Internet bookings.
Total revenue through call centers increased $8.2 million, or 15.6% to
$61.0 million. Of this $8.2 million increase, $5.6 million was produced from
increased sales volume and $2.6 million represented an increase in service fee
revenue. The increase in revenue was due to increased bookings from
advertising and additional staffing, as well as higher non-published margins
and volume bonuses.
25
Gross Profit. Gross profit from Internet sales increased $15.2 million, or
80.1% to $34.1 million. As a percentage of total revenue, Internet gross
profit increased from 89.4% for the year ended December 31, 1999 to 91.3% for
the year ended December 31, 2000. Increased margin was largely due to higher
volumes and higher margins on non-published fare revenue combined with
increased incentive bonuses and net service fee income.
Call center gross profit increased $8.5 million, or 17.6% to $56.7 million.
As a percentage of total revenue, gross profit from call centers increased
from 91.4% in 1999 to 93.0% in 2000. Increased non-published fare margins,
higher incentive bonuses and net service fee income contributed to the
increase in gross profit as a percentage of total revenue.
Operating Income. Operating income from Internet sales increased $8.4
million, or 105.9% to $16.3 million. As a percentage of total revenue,
Internet operating income increased from 37.4% for the year ended December 31,
1999 to 43.7% for the year ended December 31, 2000. Operating expenses as a
percentage of total revenue decreased from 52.0% to 47.7%.
Call center operating income decreased $2.0 million, or 18.3% to $9.0
million. As a percentage of total revenue, operating income from call centers
decreased from 20.9% in 1999 to 14.7% in 2000. Increased compensation costs
for reservation agents and customer care staffing, allocated advertising, and
other general and administrative costs as a percentage of total revenue
reduced operating income.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998 by
Segment
Total Revenue. Total revenue through the Internet increased $17.8 million,
or 509.4% to $21.2 million. Sales volumes increased as a result of additional
advertising, 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 increased from 44% in 1998 to 57% of total Internet
bookings in 1999, contributing to the total revenue growth.
Total revenue through call centers increased $18.1 million, or 52.0% to
$52.8 million. The increase resulted from good consumer demand, increased
productivity and staffing in the call centers, and full year versus partial
year sales from a fourth call center opened in late May of 1998.
Gross Profit. Gross profit from Internet sales increased $15.9 million, or
514.2% to $19.0 million. As a percentage of total revenue, Internet gross
profit increased from 88.7% for the year ended December 31, 1998 to 89.4% for
the year ended December 31, 1999. A higher percentage of non-published fare
revenue via the Internet increased gross profit as a percentage of total
revenue along with higher performance-based commission income earned.
Call center gross profit increased $17.4 million, or 56.2% to $48.3
million. As a percentage of total revenue, gross profit from call centers
increased from 88.9% in 1998 to 91.4% in 1999. An increase in the non-
published fare revenue contributed to the increase in gross profit as a
percentage of total revenue.
Operating Income. Operating income from Internet sales increased $6.7
million, or 530.8% to $7.9 million. As a percentage of total revenue, Internet
operating income increased from 36.1% for the year ended December 31, 1998 to
37.4% for the year ended December 31, 1999. Lower operating expenses as a
percentage of total revenue contributed to the increased operating income as a
percentage of total revenue.
Call center operating income increased $3.6 million to $11.0 million. As a
percentage of total revenue, operating income from call centers decreased from
21.4% in 1998 to 20.9% in 1999. Operating expenses as a percentage of total
revenue increased from 67.5% to 70.5%.
26
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 also tend to follow the same
seasonal pattern. 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 revenue and earnings.
The following table sets forth selected unaudited quarterly financial
information for each of the eight quarters in the period ended December 31,
2000, as well as such data expressed as a percentage of Cheap Tickets' revenue
for the periods presented. This information has been derived from unaudited
statements of operations data that, in the opinion of management, are stated
on a basis consistent with the audited financial statements and include all
adjustments (consisting only of normal recurring adjustments) necessary for a
fair presentation of such information in accordance with GAAP. Cheap Tickets'
results of operations for any quarter are not necessarily indicative of the
results to be expected in any future period.
Quarter Ended
-----------------------------------------------------------------------
1999 2000
---------------------------------- -----------------------------------
Mar. 31 June 30 Sept. 30 Dec. 31 Mar. 31 June 30 Sept. 30 Dec. 31
------- -------- -------- -------- -------- -------- -------- --------
(unaudited)
Results of Operations:
Revenue:
Non-published fares... $ 8,111 $ 14,387 $ 15,136 $ 8,063 $ 12,912 $ 17,233 $ 18,049 $ 7,985
Commissions and
bonuses.............. 4,566 5,155 6,391 6,238 6,262 8,763 7,239 7,517
Service fees and
other................ 1,127 1,477 1,841 1,515 2,057 3,583 3,966 2,876
------- -------- -------- -------- -------- -------- -------- --------
Total revenue........ 13,804 21,019 23,368 15,816 21,231 29,579 29,254 18,378
Cost of sales........... 1,472 1,875 1,999 1,445 1,807 2,247 2,082 1,405
------- -------- -------- -------- -------- -------- -------- --------
Gross profit............ 12,332 19,144 21,369 14,371 19,424 27,332 27,172 16,973
Selling, general and
administrative
expenses............... 10,812 14,341 18,235 15,057 17,484 21,405 22,524 18,876
------- -------- -------- -------- -------- -------- -------- --------
Net operating income
(loss)................. 1,520 4,803 3,134 (686) 1,940 5,927 4,648 (1,903)
Other income............ 124 687 1,222 2,054 1,915 2,041 2,345 2,287
------- -------- -------- -------- -------- -------- -------- --------
Earnings before income
taxes.................. 1,644 5,490 4,356 1,368 3,855 7,968 6,993 384
Income taxes............ 674 2,251 1,786 561 1,542 3,069 2,727 (150)
------- -------- -------- -------- -------- -------- -------- --------
Net earnings......... $ 970 $ 3,239 $ 2,570 $ 807 $ 2,313 $ 4,899 $ 4,266 $ 534
======= ======== ======== ======== ======== ======== ======== ========
Basic earnings per
share.................. $ 0.02 $ 0.15 $ 0.11 $ 0.03 $ 0.10 $ 0.21 $ 0.18 $ 0.02
Diluted earnings per
share.................. $ 0.01 $ 0.15 $ 0.11 $ 0.03 $ 0.10 $ 0.21 $ 0.18 $ 0.02
Operating Data:
Gross bookings.......... $89,740 $135,296 $149,646 $120,643 $158,617 $193,096 $180,295 $133,517
======= ======== ======== ======== ======== ======== ======== ========
27
As a Percentage of Total Revenue
Quarter Ended
-----------------------------------------------------------------
1999 2000
-------------------------------- --------------------------------
Mar. 31 June 30 Sept. 30 Dec. 31 Mar. 31 June 30 Sept. 30 Dec. 31
------- ------- -------- ------- ------- ------- -------- -------
(unaudited)
Revenue:
Non-published fares... 58.8% 68.4% 64.8% 51.0% 60.8% 58.3% 61.7% 43.4%
Commissions and
bonuses.............. 33.1 24.5 27.3 39.4 29.5 29.6 24.7 40.9
Service fees and
other................ 8.2 7.0 7.9 9.6 9.7 12.1 13.6 15.6
----- ----- ----- ----- ----- ----- ----- -----
Total revenue....... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Cost of sales........... 10.7 8.9 8.6 9.1 8.5 7.6 7.1 7.6
----- ----- ----- ----- ----- ----- ----- -----
Gross profit............ 89.3 91.1 91.4 90.9 91.5 92.4 92.9 92.4
Selling, general and
administrative
expenses............... 78.3 68.2 78.0 95.2 82.4 72.4 77.0 102.7
----- ----- ----- ----- ----- ----- ----- -----
Net operating income
(loss)................. 11.0 22.9 13.4 -4.3 9.1 20.0 15.9 -10.4
Other income............ 0.9 3.3 5.2 13.0 9.0 6.9 8.0 12.4
----- ----- ----- ----- ----- ----- ----- -----
Earnings before income
taxes.................. 11.9 26.1 18.6 8.6 18.2 26.9 23.9 2.1
Income taxes............ 4.9 10.7 7.6 3.5 7.3 10.4 9.3 -0.8
----- ----- ----- ----- ----- ----- ----- -----
Net earnings......... 7.0% 15.4% 11.0% 5.1% 10.9% 16.6% 14.6% 2.9%
===== ===== ===== ===== ===== ===== ===== =====
- --------
Note: Percentages may not add due to rounding.
Liquidity and Capital Resources
For the year ended December 31, 2000, Cheap Tickets generated cash from
operating activities of $9.7 million, compared with $10.5 million for the year
ended December 31, 1999. For the year ended December 31, 2000, cash generated
from operating activities was comprised principally of net earnings of
$12.0 million plus depreciation of $2.9 million less an increase in trade
accounts receivable of $2.5 million and net changes in working capital and
other accounts. For the year ended December 31, 1999, cash generated from
operating activities was comprised principally of net earnings of $7.6 million
plus depreciation of $1.6 million and net changes in working capital and other
accounts. The primary trade account receivable is the volume-based commission
earned on the sale of airline tickets. The timing of the current receipts
relative to month-end or changes in sales volume can cause fluctuations in
month-end balances.
For the year ended December 31, 2000, Cheap Tickets used cash in investing
activities of $8.7 million, while in the prior period we used cash in
investing activities of $96.8 million. Cash used in investing activities for
the year ended December 31, 2000 included net purchases of short term
marketable securities of $1.4 million and capital expenditures of $7.4
million. For the year ended December 31, 1999, net purchases of short-term
marketable securities were $93.6 million and capital expenditures were $3.2
million. In 1999, Cheap Tickets received net proceeds from an initial public
offering and a follow-on offering 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 December 31, 2000, Cheap Tickets maintained on hand cash and cash
equivalents of $40.3 million and short term marketable securities of $100.5
million. Cheap Tickets' net working capital was $138.7 million. Cheap Tickets
had outstanding long-term debt and capital lease obligations, net of current
installments, of $491,000 and $1,961,000, respectively.
In January 2000, Cheap Tickets completed a 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.
28
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. Cheap
Tickets spent approximately $7.4 million and $3.2 million for capital
expenditures in 2000 and 1999, respectively, nearly all of which was used for
technological improvements and upgrades. If cash generated from internal
operations is not sufficient to satisfy Cheap Tickets' liquidity requirements,
Cheap Tickets may seek to acquire bank 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.
Recently Issued Accounting Standards
Cheap Tickets implemented several new accounting pronouncements in the
fourth quarter of 2000 that affected its revenue recognition policies. These
new pronouncements included EITF 99-19 "Reporting Revenue Gross as a Principal
versus Net as an Agent" SAB 101 "Revenue Recognition in Financial Statements,"
and EITF 00-10 "Accounting for Shipping and Handling Fees and Costs." To
promote the comparability of our financial statements, all periods presented
have been restated to conform with these new pronouncements.
EITF 99-19 "Reporting Revenue Gross as a Principal versus Net as an Agent"
required that we report our revenue from sales of non-published fares on a net
basis. Accordingly, only the net margin on the sale of non-published fares is
reported as revenue. Previously we reported the sales of these fares on a
gross basis, whereby the gross booking or retail amount was reported as
revenue, and the amount we paid to the airline carrier was reported as cost of
sales. The implementation of EITF 99-19 did not affect the reporting of
commissions on published fares, which was and continues to be reported on a
net basis.
SAB 101 "Revenue Recognition in Financial Statements" required us to delay
recognition of revenue until tickets had been delivered to our customers.
Previously, we reported revenue once the reservation was ticketed and payment
was received. This change in our policy did not have a material impact on our
financial statements.
Under EITF 00-10 "Accounting for Shipping and Handling Fees and Costs," we
now report distribution, handling and service fees as revenue. The related
cost of distribution is reported as cost of sales. Previously we reported
distribution costs as part of selling, general and administrative expenses
with the fees charged to our customers as an offset to that expense.
There are a number of other recently issued accounting pronouncements that
affect companies like Cheap Tickets, including EITF 99-17 "Accounting for
Barter Transactions," EITF 00-14 "Accounting for Certain Sales Incentives,"
EITF 00-21 "Accounting for Multiple-Element Revenue Arrangements," FIN 44
"Accounting for Certain Transactions involving Stock Compensation," EITF 00-23
"Issues Related to the Accounting for Stock Compensation under APB 25 and FIN
44," EITF 00-02 "Accounting for Website Development Costs," and SFAS 133
"Accounting for Derivative Instruments and Hedging Activities." These
accounting pronouncements did not or will not have a material effect on our
financial statements as we either do not enter into such transactions, or we
have previously been in compliance with the guidance of these pronouncements.
29
Item 7A. Quantitative and Qualitative Disclosures 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.
Item 8. Financial Statements and Supplementary Data.
See pages F-1 through F-21 of this Annual Report on Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
The SEC allows us to "incorporate by reference" the information we file
with them, which means that we can disclose important information to you by
referring you to those documents. The information incorporated by reference is
considered to be part of this Annual Report. We incorporate by reference in
Items 10 to 13 below certain sections of our definitive proxy statement, to be
filed pursuant to Regulation 14A with the SEC within 120 days after December
31, 2000.
Item 10. Directors and Executive Officers.
Information required by this Item 10 is incorporated by reference in this
Annual Report from our definitive proxy statement to be filed pursuant to
Regulation 14A with the SEC within 120 days after December 31, 2000.
Item 11. Executive Compensation.
Information required by this Item 11 is incorporated by reference in this
Annual Report from our definitive proxy statement to be filed pursuant to
Regulation 14A with the SEC within 120 days after December 31, 2000.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Information required by this Item 12 is incorporated by reference in this
Annual Report from our definitive proxy statement to be filed pursuant to
Regulation 14A with the SEC within 120 days after December 31, 2000.
Item 13. Certain Relationships and Related Transactions.
Information required by this Item 13 is incorporated by reference in this
Annual Report from our definitive proxy statement to be filed pursuant to
Regulation 14A with the SEC within 120 days after December 31, 2000.
30
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a)(1) Financial Statements
Our financial statements, the management statement, and the report of
independent accountants are set forth on pages F-1 through F-21 (See index on
page F-1).
(a)(2) Financial Statement Schedules
All schedules to our financial statements are omitted because of the absence
of the conditions under which they are required.
(a)(3) List of Exhibits
See Exhibit Index.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of 2000.
(c) Exhibits
Reference is made to the Exhibits index and exhibits filed as a part of this
Annual Report.
(d) Additional Financial Statements
Not applicable.
Exhibits
Exhibit No. Description Note No.
----------- ----------- --------
3.1(1) Certificate of Incorporation.
3.2(1) Form of First Amended and Restated Certificate of
Incorporation.
3.3(1) Bylaws.
3.4(1) Form of First Amended and Restated Bylaws.
10.1(1)# 1997 Stock Option Plan.
10.2(2)# Amended and Restated 1999 Stock Incentive Plan.
10.3(1)# Form of Severance Agreement for Michael J. Hartley and
Sandra T. Hartley.
10.4(1)# Form of Indemnification Agreement.
10.5(3) The Commerce Tower Office Lease dated July 2, 1995
between Tosei Shoji Co. and Cheap Tickets, Inc., as
amended by the 1st Amendment to the Commerce Tower
Office Lease dated June 14, 1996, the 2nd Amendment
to the Commerce Tower Office Lease dated October 9,
1997, the 3rd Amendment of Commerce Tower Office
Lease dated December 2, 1998, the Amendment of
Commerce Tower Office Lease for Additional Premises,
Suite 901 dated July 14, 1999, and the Amendment of
Commerce Tower Office Lease for Additional Premises,
Suite 915 dated July 14, 1999.
10.6(1) Sublease dated June 1, 1998 between Levi Straus & Co.
and Cheap Tickets, Inc.
10.7(1) Lease Agreement dated January 19, 1994 between Airport
Center Associates LP and Cheap Tickets, Inc., as
amended by the 1st Amendment to Lease dated July 20,
1994 and the 2nd Amendment to Lease dated April 25,
1997.
31
Exhibit No. Description Note No.
----------- ----------- --------
10.8(3) Commercial Lease Agreement dated December 22, 1998
between Connell Development Co. and Cheap Tickets,
Inc., as amended by the 1st Amendment to the
Commercial Lease Agreement dated May 17, 1999.
10.9(1)+ 1994 Net Fare/Commission Agreement dated October 18,
1993 between Continental Airlines, Inc. and Cheap
Tickets, Inc., as amended by Addendum dated November
12, 1998.
10.10(1)+ 1999 Net Consolidator Agreement dated November 1, 1998
between Trans World Airlines, Inc. and Cheap Tickets,
Inc.
10.11(1)+ Consolidator Agreement dated December 14, 1998 between
America West Airlines, Inc. and Cheap Tickets, Inc.
10.12(1) Credit Agreement dated November 26, 1997 between Bank
of Hawaii and Cheap Tickets, Inc., as amended by First
Loan Modification Agreement dated as of June 15, 1998;
and Security Agreement dated November 26, 1997 between
Bank of Hawaii and Cheap Tickets, Inc.
10.13(1)+ Subscriber Agreement dated December 31, 1998 between
The SABRE Group, Inc. and Cheap Tickets, Inc., as
amended by Amendment No. 1 to SABRE Subscriber
Agreement dated December 31, 1998.
10.14(1)+ Agreement for Negotiated Fares Maintenance dated July
15, 1994 between SABRE Travel Information Network and
CTI Corporation.
10.15(1) Sabre TravelBase System Lease Agreement between SABRE
Travel Information Network and Cheap Tickets, Inc.
10.16(4)+ 2000 Net Consolidator Program Agreement dated June
23,1999 between Trans World Airlines, Inc. and Cheap
Tickets, Inc.
10.17(5)# Employment Agreement dated as of October 25, 1999
between Sam E. Galeotos and Cheap Tickets, Inc.
10.17.1# Amendment No. 1 to Employment Agreement dated as of
October 18, 2000 by and between Cheap Tickets, Inc.
and Sam E. Galeotos.
10.18(5)# Promissory Note dated October 31, 1999 by Sam E.
Galeotos to Cheap Tickets, Inc.
10.19(5)+ Consolidator Agreement dated February 4, 2000 between
America West Airlines, Inc. and Cheap Tickets, Inc.
10.20(6)# Employment Agreement dated as of January 24, 2000
between Paul B. Halstead and Cheap Tickets, Inc.
10.20.1# Amendment No. 1 to Employment Agreement dated as of
September 29, 2000 by and between Cheap Tickets, Inc.
and Paul B. Halstead.
10.21(6)# Employment Agreement dated as of January 24, 2000
between Jason D. Horstman and Cheap Tickets, Inc.
23.1 Consent of PricewaterhouseCoopers LLP.
- --------
(1) Incorporated by reference from Registration Statement No. 333-70841, as
amended, originally filed with Securities and Exchange Commission on
January 20, 1999.
(2) Incorporated by reference from definitive Proxy Statement on Schedule 14A
filed with the Securities and Exchange Commission on April 7, 2000.
(3) Incorporated by reference from Registration Statement No. 333-84323, as
amended, originally filed with Securities and Exchange Commission on
August 3, 1999.
32
(4) Incorporated by reference from Quarterly Report on Form 10-Q filed with the
Securities and Exchange Commission on November 15, 1999.
(5) Incorporated by reference from Annual Report on Form 10-K filed with the
Securities and Exchange Commission on March 30, 2000.
(6) Incorporated by reference from Quarterly Report on Form 10-Q filed with the
Securities and Exchange Commission on May 15, 2000.
# Management contract or compensatory plan or arrangement.
+ Portions have been omitted pursuant to a confidential treatment request.
33
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized on March 30, 2001.
CHEAP TICKETS, INC.
/s/ Michael J. Hartley
By: _________________________________
Name: Michael J. Hartley
Title: Executive Chairman of the
Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ Michael J. Hartley March 30, 2001
___________________________________________
Michael J. Hartley
Executive Chairman of the Board
/s/ Sam E. Galeotos March 30, 2001
___________________________________________
Sam E. Galeotos
President and Chief Executive Officer and
Director
/s/ Samuel D. Horgan March 30, 2001
___________________________________________
Samuel E. Horgan
Vice President of Finance and Chief
Financial Officer
/s/ Cece Smith March 30, 2001
___________________________________________
Cece Smith
Director
/s/ George R. Mrkonic March 30, 2001
___________________________________________
George R. Mrkonic
Director
/s/ Giles H. Bateman March 30, 2001
___________________________________________
Giles H. Bateman
Director
/s/ A. Maurice Myers March 30, 2001
___________________________________________
A. Maurice Myers
Director
/s/ Jeffrey Watanabe March 30, 2001
___________________________________________
Jeffrey Watanabe
Director
34
CHEAP TICKETS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Accountants.......................................... F-2
Consolidated Balance Sheets................................................ F-3
Consolidated Statements of Operations...................................... F-4
Consolidated Statements of Stockholders' Equity............................ F-5
Consolidated Statements of Cash Flows...................................... F-6
Notes to the Consolidated Financial Statements............................. F-8
F-1
Report of Independent Accountants
The Stockholders and Board of Directors
Cheap Tickets, Inc.
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, stockholders' equity and cash
flows present fairly, in all material respects, the financial position of
Cheap Tickets, Inc. and subsidiary at December 31, 1999 and 2000, and the
results of their operations and their cash flows for each of the three years
in the period ended December 31, 2000, in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America which
require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
Honolulu, Hawaii
February 6, 2001
F-2
CHEAP TICKETS, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 1999 and 2000
1999 2000
------------ ------------
ASSETS
------
Current Assets:
Cash and cash equivalents........................ $ 40,717,517 $ 40,324,823
Marketable securities (Note 2)................... 98,579,668 100,485,312
Trade accounts and other receivables............. 4,519,775 6,994,705
Refundable income taxes ......................... 355,568 659,115
Ticket inventories............................... 348,263 464,313
Other current assets ............................ 1,370,158 2,119,395
------------ ------------
Total current assets........................... 145,890,949 151,047,663
Property and equipment, net (Notes 3 and 4)........ 9,263,101 13,570,529
Other assets....................................... 456,665 1,867,229
------------ ------------
$155,610,715 $166,485,421
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable................................. $ 7,131,497 $ 7,357,882
Accrued salaries................................. 1,763,380 1,596,056
Accrued vacation................................. 540,000 680,000
Accrued expenses and other liabilities........... 376,592 837,172
Current installments of long-term debt (Note 4).. 132,806 25,774
Current installments of capital lease obligations
(Note 9)........................................ 1,405,080 1,415,210
Deferred revenue, current........................ 400,000 400,000
------------ ------------
Total current liabilities...................... 11,749,355 12,312,094
Long-term debt, excluding current installments
(Note 4).......................................... 516,503 491,330
Capital lease obligations, excluding current
installments (Note 9)............................. 3,376,119 1,960,477
Deferred revenue, non-current ..................... 1,200,000 800,000
Other noncurrent liabilities....................... 155,879 126,485
------------ ------------
Total liabilities.............................. 16,997,856 15,690,386
------------ ------------
Commitments and contingencies (Notes 8, 9, and 12)
Stockholders' Equity (Notes 5, 6, 10 and 11):
Preferred stock, $0.01 par value
Authorized--10,000,000 shares
Issued--none in 1999 and 2000................... -- --
Common stock, $0.001 par value
Authorized--70,000,000 shares
Issued--24,025,413 shares in 1999 and 24,250,362
shares in 2000................................. 24,025 24,250
Additional paid-in capital....................... 146,002,475 145,873,281
Unearned compensation............................ (382,094) (82,906)
Retained earnings................................ 7,708,455 19,720,412
Treasury stock, at cost--1,037,288 common shares
in 1999 and 2000................................ (14,740,002) (14,740,002)
------------ ------------
Total stockholders' equity..................... 138,612,859 150,795,035
------------ ------------
$155,610,715 $166,485,421
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
CHEAP TICKETS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 1998, 1999 and 2000
1998 1999 2000
----------- ----------- -----------
Revenue:
Non-published fares.................. $23,778,674 $45,698,235 $56,179,308
Commissions and bonuses.............. 11,268,472 22,349,477 29,780,600
Service fees and other............... 3,169,185 5,960,082 12,482,253
----------- ----------- -----------
Total revenue...................... 38,216,331 74,007,794 98,442,161
Cost of sales.......................... 4,244,673 6,790,759 7,541,402
----------- ----------- -----------
Gross profit........................... 33,971,658 67,217,035 90,900,759
Selling, general and administrative
expenses.............................. 32,335,625 58,445,947 80,289,421
----------- ----------- -----------
Net operating income................... 1,636,033 8,771,088 10,611,338
Other income (deductions):
Interest income...................... 374,269 4,310,746 9,113,987
Interest expense..................... (148,253) (261,256) (374,932)
Loss on sale or disposal of property
and equipment....................... (48,786) (19,839) (124,109)
Loss on sale of marketable
securities.......................... -- (18,512) (77,703)
Other, net........................... (7,731) 76,994 51,349
----------- ----------- -----------
169,499 4,088,133 8,588,592
----------- ----------- -----------
Earnings before income taxes........... 1,805,532 12,859,221 19,199,930
Income taxes (Note 7).................. 740,268 5,272,281 7,187,973
----------- ----------- -----------
Net earnings........................... 1,065,264 7,586,940 12,011,957
Preferred dividends.................... (340,000) (78,712) --
Accretion of mandatorily redeemable
cumulative preferred stock discount... (174,132) (36,657) --
Redemption of mandatorily redeemable
cumulative preferred stock............ -- (587,315) --
----------- ----------- -----------
Income available to common shares...... $ 551,132 $ 6,884,256 $12,011,957
=========== =========== ===========
Basic earnings per common share........ $ 0.04 $ 0.33 $ 0.52
=========== =========== ===========
Average common shares outstanding...... 14,567,084 20,731,375 23,171,498
=========== =========== ===========
Diluted earnings per common share...... $ 0.03 $ 0.31 $ 0.51
=========== =========== ===========
Average diluted common shares
outstanding........................... 17,920,868 22,060,051 23,544,887
=========== =========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
CHEAP TICKETS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1998, 1999 and 2000
Common Stock Additional
------------------- Paid-in Unearned Retained Treasury Total
Shares Amount Capital Compensation Earnings Stock Stockholders'
---------- ------- ------------ ------------ ----------- ------------ -------------
Balance at December 31,
1997................... 1,060,523 $10,605 $ 547,017 $ (19,127) $ 273,067 $ -- $ 811,562
Net earnings............ -- -- -- 1,065,264 -- 1,065,264
Accretion to mandatorily
redeemable cumulative
preferred stock
redemption price (Note
5)..................... -- -- -- (174,132) -- (174,132)
Accrual of dividends on
mandatorily redeemable
cumulative preferred
stock (Note 5)......... -- -- -- (340,000) -- (340,000)
Reversal of amortization
of unearned
compensation (Note
10).................... -- -- (3,820) -- -- (3,820)
Forfeiture of common
stock (Note 10)........ (26,689) (267) (22,680) 22,947 -- -- --
Stock option
compensation (Note
11).................... -- 722,600 (722,600) -- -- --
Amortization of unearned
stock option
compensation........... -- -- 26,325 -- -- 26,325
---------- ------- ------------ --------- ----------- ------------ ------------
Balance at December 31,
1998................... 1,033,834 10,338 1,246,937 (696,275) 824,199 -- 1,385,199
Net earnings............ -- -- -- 7,586,940 -- 7,586,940
14-for-1 common stock
split.................. 13,439,842 4,136 (4,136) -- -- -- --
Accretion to mandatorily
redeemable cumulative
preferred stock
redemption price (Note
5)..................... -- -- -- (36,657) -- (36,657)
Accrual of dividends on
mandatorily redeemable
cumulative preferred
stock (Note 5)......... -- -- -- (78,712) -- (78,712)
Redemption of
mandatorily redeemable
cumulative preferred
stock (Note 5)......... -- -- -- (587,315) -- (587,315)
Exercise of common stock
warrants (Note 5)...... 2,969,375 2,969 (848) -- -- -- 2,121
Sale of common stock
under public offerings,
net of expenses (Note
6)..................... 6,525,000 6,525 144,603,522 -- -- -- 144,610,047
Exercise of stock
options................ 56,560 56 13,565 -- -- -- 13,621
Other issuance of common
stock.................. 802 1 12,982 -- -- -- 12,983
Purchase of 1,037,288
treasury shares........ -- -- -- -- (14,740,002) (14,740,002)
Income tax benefit for
stock option
compensation........... -- 350,674 -- -- -- 350,674
Amortization and
forfeiture of unearned
stock option
compensation........... -- (220,221) 314,181 -- -- 93,960
---------- ------- ------------ --------- ----------- ------------ ------------
Balance at December 31,
1999................... 24,025,413 24,025 146,002,475 (382,094) 7,708,455 (14,740,002) 138,612,859
Net earnings............ -- -- -- 12,011,957 -- 12,011,957
Expense related to 1999
public offerings....... -- (10,682) -- -- -- (10,682)
Exercise of stock
options................ 218,100 218 55,335 -- -- -- 55,553
Other issuance of common
stock.................. 6,849 7 80,493 -- -- -- 80,500
Amortization and
forfeiture of unearned
stock option
compensation........... -- (254,340) 299,188 -- -- 44,848
---------- ------- ------------ --------- ----------- ------------ ------------
Balance at December 31,
2000................... 24,250,362 $24,250 $145,873,281 $ (82,906) $19,720,412 $(14,740,002) $150,795,035
========== ======= ============ ========= =========== ============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
CHEAP TICKETS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1998, 1999 and 2000
1998 1999 2000
----------- ------------- -------------
Cash flows from operating
activities:
Net earnings...................... $ 1,065,264 $ 7,586,940 $ 12,011,957
Adjustments to reconcile net
earnings to net cash provided by
operating activities--
Deferred income taxes............ (102,049) (151,875) (157,786)
Depreciation and amortization.... 563,514 1,630,599 2,861,288
Stock option compensation........ 26,325 93,960 44,848
Stock compensation expense
(benefit)....................... (3,820) -- --
Amortization of discount on
marketable securities........... (51,029) (38,703) (614,076)
Loss on sale or disposal of
property and equipment.......... 48,786 19,839 124,109
Loss on sale of marketable
securities...................... -- 18,512 77,703
Changes in:
Trade accounts and other
receivables................... (269,202) (3,595,427) (2,474,930)
Refundable income taxes........ 663,209 (4,894) (303,547)
Ticket inventories............. (166,560) (61,932) (116,050)
Other current assets........... (289,087) (422,787) (591,451)
Other noncurrent assets........ (242,743) (79,900) (1,411,656)
Accounts payable............... 295,276 2,450,443 226,385
Accrued salaries............... 61,712 1,364,213 (167,324)
Accrued vacation............... 342,120 118,712 140,000
Income taxes payable........... 139,640 (139,640) --
Accrued expenses and other
liabilities................... 81,416 154,271 460,580
Deferred revenue............... -- 1,600,000 (400,000)
Other noncurrent liabilities... (155,284) (7,886) (29,394)
----------- ------------- -------------
Net cash provided by
operating activities........ 2,007,488 10,534,445 9,680,656
----------- ------------- -------------
Cash flows from investing
activities:
Capital expenditures.............. (484,817) (3,159,988) (7,424,733)
Proceeds from sale of property and
equipment........................ 551,214 10,900 133,000
Purchases of marketable
securities....................... (4,884,200) (119,209,534) (133,491,545)
Proceeds from sale of marketable
securities....................... -- 25,585,286 132,122,274
----------- ------------- -------------
Net cash used in investing
activities.................. (4,817,803) (96,773,336) (8,661,004)
----------- ------------- -------------
Cash flows from financing
activities:
Proceeds from issuance of common
stock, net of expenses paid...... -- 144,638,771 125,371
Redemption of mandatorily
redeemable cumulative preferred
stock............................ -- (4,838,712) --
Purchases of treasury stock....... -- (14,740,002) --
Proceeds from issuance of long-
term debt........................ 307,200 235,875 --
Principal payments on long-term
debt............................. (627,138) (393,591) (132,205)
Principal payments on capital
lease obligations................ (150,165) (919,921) (1,405,512)
----------- ------------- -------------
Net cash provided by (used
in) financing activities.... (470,103) 123,982,420 (1,412,346)
----------- ------------- -------------
Net increase (decrease) in
cash and cash equivalents... (3,280,418) 37,743,529 (392,694)
Cash and cash equivalents at
beginning of period................ 6,254,406 2,973,988 40,717,517
----------- ------------- -------------
Cash and cash equivalents at end of
period............................. $ 2,973,988 $ 40,717,517 $ 40,324,823
=========== ============= =============
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
CHEAP TICKETS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years Ended December 31, 1998, 1999 and 2000
1998 1999 2000
-------- ---------- ----------
Supplemental cash flow information:
Cash paid during the year for:
Interest.................................... $145,447 $ 264,062 $ 374,932
Income taxes, net of refunds received....... 39,467 5,538,910 7,223,419
Noncash investing and financing activities:
Unearned compensation for stock options
granted.................................... 722,600 -- --
Acquisitions of new equipment through
capital leases............................. 608,069 4,760,952 --
Accrued and unpaid dividends on mandatorily
redeemable preferred stock................. 340,000 -- --
The accompanying notes are an integral part of the consolidated financial
statements.
F-7
CHEAP TICKETS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Business
Cheap Tickets, Inc. ("Cheap Tickets" or "the Company" or "we/our") was
incorporated under the laws of the state of Hawaii on August 20, 1986, for the
primary purpose of providing travel services, including airline tickets,
cruise tickets, auto rentals, hotel reservations and other travel products. In
February 1999, Cheap Tickets reincorporated in the state of Delaware. The
Company sells directly to consumers through its Internet site, its 4 call
centers and at its 10 retail stores. We deal with over 100 airline carriers.
Revenues from non-published fares through three of these airline carriers
accounted for approximately 49%, 49% and 48% of total non-published fares for
1998, 1999 and 2000, respectively. In April 2000, the Company formed a
subsidiary, Cheap Tickets Europe, Ltd., which was incorporated under the laws
of the United Kingdom.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiary. All significant intercompany balances and
transactions have been eliminated.
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 estimates have been
appropriately determined in accordance with generally accepted accounting
principles.
Cash Equivalents
We consider all highly liquid debt securities with original maturities of
three months or less to be cash equivalents.
Marketable Securities
Our marketable securities are categorized as available-for-sale securities
as defined by Statement of Financial Accounting Standards (SFAS) No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." Available-
for-sale securities are reported at amortized cost, which approximates fair
value due to their relatively short maturities.
Ticket Inventories
Ticket inventories, consisting of prepaid Hawaii inter-island airline
coupons, are stated at the lower of cost or market. We do not carry any other
airline ticket inventories. Inventory cost is the acquisition price of the
coupons or tickets. The specific identification method is used to determine
the basis of inventory and cost of coupons or tickets removed from inventory.
F-8
CHEAP TICKETS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Trade Accounts and Other Receivables
Trade accounts and other receivables primarily consist of commissions and
volume bonuses from travel service providers. The Company does not extend
credit to customers. There were no allowances for doubtful accounts receivable
at December 31, 1999 and 2000.
Concentrations of Credit Risk
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of cash, cash equivalents and
investments. The Company's policy is to place its cash, cash equivalents and
investments with high quality financial institutions, governmental agencies
and corporate entities and to limit the amount of credit exposure. Cash
balances are generally in excess of available insured depository limits.
Property and Equipment
Property and equipment are carried at cost. Equipment held under capital
leases is stated at the lower of the present value of minimum lease payments
or estimated fair value of the equipment at the inception of the lease.
Depreciation on property and equipment is calculated on the straight-line
method over the estimated useful lives of the respective assets. Leasehold
improvements and equipment held under capital leases are amortized on the
straight-line method over the estimated useful life of the asset or the lease
term, whichever is shorter. When fixed assets are sold or retired, cost and
accumulated depreciation are eliminated from the accounts, and gains or losses
are recorded in income. Website maintenance costs are expensed as incurred.
The estimated depreciable lives of major classes of property and equipment
are as follows:
Building and improvements.................................... 40 years
Leasehold improvements....................................... 5 to 40 years
Furniture, fixtures and office equipment..................... 5 to 7 years
Computer equipment........................................... 3 to 5 years
Vehicles..................................................... 5 years
Revenue Recognition
The Company implemented several new accounting pronouncements in the fourth
quarter of 2000 that affected its revenue recognition policies. These new
pronouncements included EITF 99-19 "Reporting Revenue Gross as a Principal
versus Net as an Agent", SAB 101 "Revenue Recognition in Financial
Statements", and EITF 00-10 "Accounting for Shipping and Handling Fees and
Costs". To promote the comparability of our financial statements, all periods
presented have been restated to conform with these new pronouncements.
EITF 99-19 "Reporting Revenue Gross as a Principal versus Net as an Agent"
required that we report our revenue from sales of non-published fares on a net
basis. Accordingly, only the net margin on the sale of non-published fares is
reported as revenue. Previously we reported the sales of these fares on a
gross basis, whereby the gross booking or retail amount was reported as
revenue, and the amount we paid to the airline carrier was reported as cost of
sales. The implementation of EITF 99-19 did not affect the reporting of
commissions on published fares, which was and continues to be reported on a
net basis.
SAB 101 "Revenue Recognition in Financial Statements" required us to delay
recognition of revenue until tickets had been delivered to our customers.
Previously, we reported revenue once the reservation was ticketed and payment
was received. This change in our policy did not have a material impact on our
financial statements.
F-9
CHEAP TICKETS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Under EITF 00-10 "Accounting for Shipping and Handling Fees and Costs" we
now report distribution, handling and service fees as revenue. The related
cost of distribution is reported as cost of sales. Previously we reported
distribution costs as part of selling, general and administrative expenses
with the fees charged to our customers as an offset to that expense.
Revenue is reported net of an allowance for cancellations and refunds. Due
to the restrictive nature of our sales, which are generally noncancelable and
nonrefundable, cancellations and refunds are not significant.
Volume bonus and override revenue 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.
Advertising revenue from internet banner advertising is reported on a net
basis, which is the net amount remitted to the Company by its advertising
service provider. Such revenue has been immaterial to date.
Advertising
Advertising costs are expensed as incurred. Advertising expenses amounted
to $3,823,150, $11,132,308 and $18,616,812 for 1998, 1999 and 2000,
respectively.
Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, and for operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date.
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
Cheap Tickets adheres to the provisions of SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of." SFAS No. 121 requires that long-lived assets and certain identifiable
intangibles be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows
(undiscounted and without interest) expected to be generated by the asset. If
such assets are considered to be impaired, the impairment to be recognized is
measured as the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower
of the carrying amount or fair value less costs to sell.
Fair Value of Financial Instruments
The fair values of Cheap Tickets' long-term debt approximate carrying
values based on current financing for similar loans available to the Company.
The fair values of marketable securities are based on quoted prices.
Accounting for Stock Based Compensation
The Company accounts for employee stock based compensation in accordance
with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued
to Employees" and related interpretations, as permitted by SFAS No. 123,
"Accounting for Stock Based Compensation."
F-10
CHEAP TICKETS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Foreign Currency Translation
The functional currency of the Company's U.K. subsidiary is the local
currency. Assets and liabilities of the foreign subsidiary are translated into
US dollars at year-end exchange rates, and revenue and expenses are translated
at average rates prevailing during the year. Translation adjustments have been
immaterial to date.
Per Share Data
The following is a reconciliation of the numerator and denominators of
basic and diluted earnings per common share:
Income Shares Per Share
Years ended December 31, (Numerator) (Denominator) Amount
------------------------ ----------- ------------- ---------
1998:
Basic
Income available to common shares..... $ 551,132 14,567,084 $0.04
=====
Effect of dilutive securities
Common stock warrants................. -- 2,969,456
Stock options......................... -- 384,328
----------- ----------
Diluted
Net income and assumed conversions.... $ 551,132 17,920,868 $0.03
=========== ========== =====
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
1999:
Basic
Income available to common shares..... $ 6,884,256 20,731,375 $0.33
=====
Effect of dilutive securities
Common stock warrants................. -- 658,975
Stock options......................... -- 625,112
Option--IPO overallotment............. -- 44,589
----------- ----------
Diluted
Net income and assumed conversions.... $ 6,884,256 22,060,051 $0.31
=========== ========== =====
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
2000:
Basic
Income available to common shares..... $12,011,957 23,171,498 $0.52
=====
Effect of dilutive securities
Stock options......................... -- 373,389
----------- ----------
Diluted
Net income and assumed conversions.... $12,011,957 23,544,887 $0.51
=========== ========== =====
Net earnings per share is computed using the weighted average number of
common and common equivalent shares outstanding during the period.
F-11
CHEAP TICKETS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
New Pronouncements
There are a number of recently issued accounting pronouncements that affect
companies like Cheap Tickets, including EITF 99-17 "Accounting for Barter
Transactions", EITF 00-14 "Accounting for Certain Sales Incentives", EITF 00-
21 "Accounting for Multiple-Element Revenue Arrangements", FIN 44 "Accounting
for Certain Transactions involving Stock Compensation", EITF 00-23 "Issues
Related to the Accounting for Stock Compensation under APB 25 and FIN 44",
EITF 00-02 "Accounting for Website Development Costs", and SFAS 133
"Accounting for Derivative Instruments and Hedging Activities". These
accounting pronouncements did not or will not have a material effect on our
financial statements as we either do not enter into such transactions, or we
have previously been in compliance with the guidance of these pronouncements.
Reclassifications
Certain amounts in the 1998 and 1999 financial statements have been
reclassified to conform with the 2000 presentation. These reclassifications
had no effect on net earnings as previously reported.
2. Marketable Securities
A summary of marketable securities at December 31 follows:
1999 2000
----------- ------------
Fixed income securities:
Corporate notes and obligations.................. $70,161,197 $ 82,637,290
U.S. government obligations...................... 8,752,838 3,293,552
State and municipal obligations ................. 7,200,000 --
Commercial paper................................. 7,065,633 14,554,470
----------- ------------
93,179,668 100,485,312
Equity securities:
Preferred stocks................................. 5,400,000 --
----------- ------------
$98,579,668 $100,485,312
=========== ============
All fixed income securities at December 31, 2000 have contractual
maturities of less than one year.
The cost of securities sold is based on the specific identification method.
There were no sales of securities in 1998. Sales of securities for 1999 and
2000 are summarized below:
1999 2000
----------- ------------
Fixed income securities:
Cash proceeds..................................... $14,585,286 $126,722,274
Gross realized gains.............................. -- 19,859
Gross realized losses............................. 18,214 97,562
Equity securities:
Cash proceeds..................................... $11,000,000 $ 5,400,000
Gross realized gains.............................. -- --
Gross realized losses............................. 298 --
F-12
CHEAP TICKETS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Property and Equipment
A summary of property and equipment at December 31, 1999 and 2000 is as
follows:
1999 2000
----------- -----------
Land ............................................... $ 158,239 $ 158,239
Building improvements............................... 767,601 782,407
Leasehold improvements.............................. 723,630 913,919
Furniture, fixtures and equipment (Note 9).......... 10,493,752 17,404,796
Vehicles............................................ 197,620 197,620
----------- -----------
12,340,842 19,456,981
Less accumulated depreciation and amortization...... 3,077,741 5,886,452
----------- -----------
$ 9,263,101 $13,570,529
=========== ===========
Depreciation and amortization expense amounted to $563,514, $1,630,599 and
$2,861,288 for 1998, 1999 and 2000, respectively.
4. Debt
Long-term debt at December 31, 1999 and 2000 consists of the following:
1999 2000
-------- --------
Bank Debt:
3.125% above an indexed rate (total rate of 9.875% at
December 31, 2000) note payable in monthly installments
of $6,308, including interest, due May 1, 2012,
collateralized by a first mortgage on land and
building................................................ $540,904 $517,104
6.80% note payable in monthly installments of $16,448
including interest, due May 28, 2000.................... 80,859 --
Other:
8.25% note payable in monthly installments of $13,930
including interest, due February 28, 2000............... 27,546 --
-------- --------
Total long-term debt..................................... 649,309 517,104
Less current installments of long-term debt.............. 132,806 25,774
-------- --------
Long-term debt, excluding current installments........... $516,503 $491,330
======== ========
The aggregate maturities of long-term debt subsequent to December 31, 2000
are as follows:
Year ending December 31
-----------------------
2001.............................................................. $ 25,774
2002.............................................................. 28,438
2003.............................................................. 31,376
2004.............................................................. 34,619
2005.............................................................. 38,197
Later years....................................................... 358,700
--------
$517,104
========
F-13
CHEAP TICKETS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. 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 (the
"Equity Transaction").
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 $174,132, $36,657 and none for
1998, 1999 and 2000, respectively.
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 $340,000, $78,712 and none for 1998, 1999 and 2000, respectively.
Undeclared cumulative dividends amounted to $510,000 at December 31, 1998 and
were accrued as an addition to preferred stock in the accompanying balance
sheets.
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 $587,315 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.
6. Stockholders' Equity
Common Stock
In February 1999, the authorized common stock of Cheap Tickets was
increased from 5,000,000 shares at $0.01 par value to 70,000,000 shares at
$0.001 par value. The Company also effected a 14-for-one stock split. In these
financial statements, all per share amounts and number of shares have been
restated to reflect the stock split.
As described in Note 10, 373,646 shares were forfeited by an officer upon
his resignation in March 1998.
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.
F-14
CHEAP TICKETS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Preferred Stock
In February 1999, the authorized preferred stock of Cheap Tickets was
increased from 5,000,000 shares at $1 par value to 10,000,000 shares at $0.01
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,
priviledges and restrictions, thereof, including dividend rights, conversion
rights, voting rights, terms of redemption, and liquidation preferences.
7. Income Taxes
Income tax expense (benefit) for the years ended December 31, 1998, 1999
and 2000 was as follows:
Years ended December 31 Federal State Foreign Total
----------------------- ---------- ---------- --------- ----------
1998:
Current...................... $ 741,237 $ 101,080 $ -- $ 842,317
Deferred..................... (54,232) (47,817) -- (102,049)
---------- ---------- --------- ----------
$ 687,005 $ 53,263 $ -- $ 740,268
========== ========== ========= ==========
1999:
Current...................... $4,431,488 $ 992,668 $ -- $5,424,156
Deferred..................... (186,816) 34,941 -- (151,875)
---------- ---------- --------- ----------
$4,244,672 $1,027,609 $ -- $5,272,281
========== ========== ========= ==========
2000:
Current...................... $6,069,672 $1,276,086 $ -- $7,345,758
Deferred..................... (40,707) 41,864 (158,942) (157,785)
---------- ---------- --------- ----------
$6,028,965 $1,317,950 $(158,942) $7,187,973
========== ========== ========= ==========
A tax benefit of $350,674 was credited directly to additional paid-in
capital for stock option compensation in 1999.
The actual income tax expense for 1998, 1999 and 2000 differed from the
expected income tax expense computed by applying the U.S. federal income tax
rate of 34% to earnings before income taxes due to the following:
1998 1999 2000
-------- ---------- ----------
Federal "expected" income tax expense...... $613,881 $4,372,135 $6,527,976
Additional federal income tax expense at
35%....................................... -- 28,592 91,999
State franchise and income taxes, net of
federal income tax effect................. 93,888 844,021 871,320
Tax exempt interest income................. -- -- (321,236)
Other, net................................. 32,499 27,533 17,914
-------- ---------- ----------
$740,268 $5,272,281 $7,187,973
======== ========== ==========
F-15
CHEAP TICKETS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The tax effects of temporary differences that give rise to deferred tax
assets and deferred tax liabilities at December 31, 1999 and 2000 are
presented below:
1999 2000
--------- ---------
Deferred tax assets:
Accrued rent not deductible for tax purposes........ $ 15,323 $ 8,266
Accrued vacation not deductible for tax purposes.... 147,600 181,333
State tax credit carryforward....................... -- 99,937
Unearned compensation not deductible for tax
purposes........................................... 49,317 66,053
Capital loss carryforward........................... -- 38,577
State franchise tax................................. 243,573 305,864
U.K. net operating loss carryforward................ -- 158,942
--------- ---------
Total gross deferred tax assets................... 455,813 858,972
--------- ---------
Deferred tax liabilities:
Property and equipment, principally due to
differences between accounting and tax depreciation
and amortization................................... (166,090) (358,883)
Other............................................... -- (3,478)
--------- ---------
Total gross deferred tax liabilities.............. (166,090) (362,361)
--------- ---------
Net deferred tax asset............................ $ 289,723 $ 496,611
========= =========
There was no valuation allowance provided for deferred tax assets as of
December 31, 1999 and 2000. In assessing the realizability of deferred tax
assets, management considers whether it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income, and tax planning strategies in
making this assessment. Based upon the level of historical taxable income and
projections for future taxable income over the periods which the deferred tax
assets are deductible, management believes it is more likely than not Cheap
Tickets will realize the benefits of these deductible differences. The amount
of the deferred tax asset considered realizable, however, could be reduced in
the near term if estimates of future taxable income are reduced.
8. Profit Sharing and 401(k) Plan
Cheap Tickets sponsors a defined contribution plan for its employees which
is designed to be qualified under section 401(k) of the Internal Revenue Code.
Eligible employees are permitted to contribute to the 401(k) plan through
payroll deductions within statutory and plan limits. Cheap Tickets did not
contribute to the plan in 1998. Cheap Tickets contributed $415,000 in 1999 and
2000.
F-16
CHEAP TICKETS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Lease Commitments
Cheap Tickets is obligated under capital leases for equipment that expire
at various dates through 2004. At December 31, 1999 and 2000, the gross
amounts of equipment and related accumulated amortization recorded under
capital leases are as follows:
1999 2000
---------- ----------
Equipment............................................. $6,021,188 $5,982,006
Less accumulated amortization (amortization expense
charged to depreciation and amortization expense).... 1,274,484 2,756,025
---------- ----------
$4,746,704 $3,225,981
========== ==========
Cheap Tickets has noncancelable operating leases, primarily for office
space, that expire at various dates through 2009. These leases generally
contain renewal options for periods ranging from one to five years. Rent
expense incurred for all operating leases amounted to $1,175,289, $1,430,902
and $1,926,705 for 1998, 1999 and 2000, respectively.
Future minimum lease payments under noncancelable operating and capital
leases as of December 31, 2000 are as follows:
Capital Operating
Leases Leases
---------- ----------
Year ending December 31
-----------------------
2001................................................ $1,660,686 $1,241,335
2002................................................ 998,674 1,158,830
2003................................................ 670,616 1,161,380
2004................................................ 440,610 630,596
2005................................................ -- 401,119
Later years......................................... -- 1,175,623
---------- ----------
Total minimum lease payments..................... 3,770,586 $5,768,883
==========
Less amounts representing interest (at rates ranging
from 7.75% to 14.05%).............................. 394,899
----------
Present value of minimum capital lease payments.... 3,375,687
Less current installments of capital lease
obligations........................................ 1,415,210
----------
Capital lease obligations, excluding current
installments...................................... $1,960,477
==========
10. Stock Compensation Arrangement
In November 1996, Cheap Tickets entered into a Restricted Stock Grant and
Shareholder Agreement (Agreement) whereby 747,292 shares of common stock were
granted to an officer of Cheap Tickets as compensation for his employment.
There was a two year vesting period whereby the shares vested 50 percent after
each year of service with Cheap Tickets. The estimated fair value of the
common stock shares on the date of grant of $45,895 was being amortized as
compensation expense over the two year vesting period.
In March 1998, the officer resigned from Cheap Tickets. In connection with
the resignation, the officer forfeited his nonvested shares of common stock
issued under the Agreement. Such forfeited common stock amounted to 373,646
shares. The officer's forfeiture of the common shares resulted in a benefit of
$3,820 in 1998 for the recovery of compensation expense previously taken and
decreases in common stock and additional paid-in capital of $267 and $22,680,
respectively.
F-17
CHEAP TICKETS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
11. Stock Option Plans
Cheap Tickets' 1997 Stock Option plan provided for the issuance of up to
1,979,642 shares of common stock.
In 1998, Cheap Tickets granted options for 728,000 shares of common stock
with exercise prices less than the estimated market prices on the grant dates.
The weighted-average grant-date fair value of options granted in 1998 was
$1.30. The estimated compensation cost for these options amounted to $722,600
at the grant dates. Stock option compensation expense, included in selling,
general and administrative expenses, was $26,325, $93,960 and $44,848 for
1998, 1999 and 2000, respectively. The remaining unamortized compensation cost
of $696,275, $382,094 and $82,906 (net of forfeitures) at December 31, 1998,
1999 and 2000, respectively will be amortized over the future vesting periods
of the options. The granted options have a five-year vesting period and a ten-
year exercise period from the date of the grant. However, options to purchase
up to 140,000 shares fully vested upon Cheap Tickets' initial public offering
of its stock.
Cheap Tickets' 1999 Stock Incentive Plan was adopted by the Board of
Directors in February 1999 and approved by the stockholders prior to the
initial public offering. All grants subsequent to the initial public offering
were and will be made under the 1999 Stock Incentive Plan. Under the 1999
Stock Incentive Plan, 1,260,000 shares plus an annual increase to be added on
the first day of Cheap Tickets' fiscal year beginning 2000 equal to two
percent of the number of shares outstanding as of such date or a lesser number
of shares determined by the plan administrator of the 1999 Stock Incentive
Plan were reserved for issuance. The Plan requires that the exercise price be
at least equal to the fair market value of the common stock on the date of the
grant, and the term of the option not exceed ten years. For all optionees
holding less than 10% of the voting power of all classes of Cheap Tickets'
oustanding capital stock, an exercise price equal to market value at date of
grant will not create any requirement for excess compensation charges.
Pursuant to the 1999 Stock Incentive Plan, the Board of Directors adopted the
1999 non-employee Director Option Program. Under this program, each non-
employee director appointed to the Board received an option to acquire 1,500
shares of common stock at an exercise price equal to the then fair market
value of the common stock at the date of grant.
In 2000, stockholders approved and ratified the Amended and Restated 1999
Stock Incentive Plan. Under the plan, the number of shares reserved for
issuance was increased by 240,000 shares and the annual increase to be added
on the first day of Cheap Tickets' fiscal year beginning 2001 was increased
from 2 percent to 3 percent of the number of shares outstanding as of such
date.
F-18
CHEAP TICKETS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table summarizes activity under the stock option plans:
Weighted Weighted
Average Average
Exercise Grant-Date
Shares Price Fair Value
--------- -------- ----------
Balance at December 31, 1997................. -- $ --
Granted...................................... 728,000 0.31 $ 1.30
---------
Balance at December 31, 1998................. 728,000 0.31
Granted--exercise price equals fair value.... 764,500 16.58 16.58
Exercised.................................... (56,560) 0.24
Forfeited.................................... (82,500) 2.35
---------
Balance at December 31, 1999................. 1,353,440 9.37
Granted--exercise price equals fair value.... 1,239,158 10.56 10.56
Exercised.................................... (218,100) 0.25
Forfeited.................................... (96,960) 5.03
---------
Balance at December 31, 2000................. 2,277,538 11.08
=========
Options exercisable at:
December 31, 1999.......................... 190,120 $ 0.23
December 31, 2000.......................... 345,830 $10.32
Options outstanding and exercisable at December 31, 2000 were as follows:
Options Outstanding Options Exercisable
at December 31, 2000 at December 31, 2000
-------------------------------- ----------------------
Average
Average Remaining Average
Range of Exercise Contractual Exercise
Exercise Prices Shares Price Life in Years Shares Price
--------------- --------- -------- ------------- ---------- -----------
$ 0.18-$ 1.57........ 309,980 $ 0.21 7.43 66,380 $ 0.18
7.19- 16.19........ 1,930,658 12.46 5.28 271,550 12.21
27.31- 37.50........ 36,900 29.87 8.19 7,900 30.33
--------- ----------
2,277,538 $11.08 5.62 345,830 $ 10.32
========= ==========
Under SFAS No. 123, the fair value of each grant was estimated on the grant
date using the minimum value method in 1998 and the Black-Scholes valuation
model in 1999 and 2000 based on the following weighted-average assumptions:
1998 1999 2000
----- ----- ------
Expected dividend yield................................ 0.00% 0.00% 0.00%
Average risk-free interest rate........................ 5.73% 6.01% 5.96%
Expected volatility.................................... 0.00% 67.00% 102.87%
Expected life of the options, in years................. 10.00 6.18 5.98
F-19
CHEAP TICKETS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Compensation cost has been charged against income for the stock option plan
under APB No. 25. The pro forma net income and pro forma earnings per share
for the years ended December 31, 1998, 1999 and 2000 had Cheap Tickets elected
to adopt the fair-value based method of accounting prescribed by SFAS No. 123
is presented below:
1998 1999 2000
---------- ---------- -----------
Net income:
As reported............................. $1,065,264 $7,586,940 $12,011,957
Pro forma............................... $1,061,513 $6,528,713 $ 5,335,563
Basic earnings per share:
As reported............................. $ 0.04 $ 0.33 $ 0.52
Pro forma............................... $ 0.04 $ 0.28 $ 0.23
Diluted earnings per share:
As reported............................. $ 0.03 $ 0.31 $ 0.51
Pro forma............................... $ 0.03 $ 0.26 $ 0.23
12. Contingencies
Litigation
Various legal proceedings are pending against Cheap Tickets. The ultimate
liability of Cheap Tickets, if any, cannot be determined at this time. Based
upon consultation with counsel, management does not expect that the aggregate
liability, if any, resulting from these proceedings would have a material
effect on Cheap Tickets' financial position, results of operations or
liquidity.
13. Segment Information
In the fourth quarter of 1999, management began managing its business as
two reportable operating segments based on revenue distribution channels which
include the Internet and Call Centers (including retail stores). Revenue,
including non-published fares, published fare commissions and bonuses and cost
of sales and operating expenses, are disaggregated by operating segment.
Certain expenses managed outside of the operating segments are excluded, such
as general corporate expenses. The exclusion of such expenses from the
operating segments represents a change from prior years. Prior year
information has been restated to conform with our current measurement. The
Company does not allocate assets by operating segment nor are the segments
evaluated by this criteria. The difference between segment operating income
reported below and net operating income reflected in the Consolidated
Statements of Operations represents unallocated general corporate expenses.
The reporting segments follow the same accounting policies used for the
Company's financial statements as described in the summary of significant
accounting policies. Management evaluates a segment's performance based upon
operating income. There were no intersegment sales or transfers.
F-20
CHEAP TICKETS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Information on the reporting segments for 1998, 1999 and 2000 follows:
1998 1999 2000
---------------------------------- ----------------------------------- -----------------------------------
Call Call Call
Internet Centers Total Internet Centers Total Internet Centers Total
---------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Revenue......... $3,481,000 $34,735,000 $38,216,000 $21,212,000 $52,795,000 $74,007,000 $37,399,000 $61,043,000 $98,442,000
Cost of sales... 394,000 3,850,000 4,244,000 2,252,000 4,538,000 6,790,000 3,244,000 4,297,000 7,541,000
---------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Gross profit.... 3,087,000 30,885,000 33,972,000 18,960,000 48,257,000 67,217,000 34,155,000 56,746,000 90,901,000
Operating
expenses....... 1,830,000 23,465,000 25,295,000 11,031,000 37,243,000 48,274,000 17,830,000 47,747,000 65,577,000
---------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating
income......... $1,257,000 $ 7,420,000 $ 8,677,000 $ 7,929,000 $11,014,000 $18,943,000 $16,325,000 $ 8,999,000 $25,324,000
========== =========== =========== =========== =========== =========== =========== =========== ===========
Other:
Depreciation expense
(included in
operating expenses) $ 95,000 $ 469,000 $ 564,000 $ 309,000 $ 1,321,000 $ 1,630,000 $ 280,000 $ 1,587,000 $ 1,867,000
Substantially all of the Company's revenue is derived from sales in the
United States.
F-21