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EPAX > SEC Filings for EPAX > Form 10-K on 11-Mar-2013All Recent SEC Filings

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Form 10-K for AMBASSADORS GROUP INC


11-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is designed to provide a reader of our consolidated financial statements with a narrative perspective from our management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A should be read in conjunction with the other sections of this annual report on Form 10-K, including Part I, "Item 1A: Risk Factors"; Part II, "Item 6: Selected Financial Data"; and

Part II, "Item 8: Financial Statements and Supplementary Data."

Certain statements in this report, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Act and
Section 21E of the Securities Exchange Act. Forward-looking statements may appear throughout this report, including without limitation, statements in Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations. These forward-looking statements generally are identified by the words "believe," "project," "expect," "anticipate," "estimate," "intend," "strategy," "future," "opportunity," "plan," "may," "should," "will," "would," "will be," "will continue," "will likely result," and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements.

Introduction

Ambassadors Group, Inc. is a leading provider of educational travel experiences and online education research materials primarily engaged in organizing and promoting worldwide educational travel programs for students through a direct to consumer revenue model. We operate student travel programs primarily using the People to People brand under a long-term exclusive license agreement. We have been traveling students on People to People programs for over 50 years and have over 500,000 alumni. We believe that our association with that brand and experience in the educational travel industry give us both a strong awareness in the market and a high level of credibility.

Our core program offering is an international destination trip for U.S. students in the 11 to 17 year old age group ("Student Ambassadors Program"). We also offer domestic destination travel programs for U.S. students and international students from over 50 countries focused on leadership and education ("Student Leadership Program"). During 2011, we began to expand our in-bound travel programs by establishing a Beijing office traveling Chinese students on U.S. destination trips ("People to People - China").

In addition to our People to People student programs, we operate professional travel programs for adults under the People to People brand ("Citizen Ambassadors Program") and a student travel operation under the Discovery Student Adventures brand ("DSA"). Our DSA program is associated with Discovery Student Education and operates through a teacher recruited revenue model. Lastly, we operate BookRags (www.bookrags.com), an education oriented research website which provides study guides, lesson plans and other educational resources to students and teachers. The site attracts students and teachers each month to its millions of pages of content, which includes internally developed material, licensed material, and user-generated content.

As further discussed below, our operating results depend on the number of travelers that attend our programs ("travelers" or "delegates"), the fees we are able to charge for each traveler net of pass-through expenses associated with non-directly delivered programs such as airfare and third-party tour operator fees ("total revenue"), and the direct costs associated with the traveler's itinerary on directly delivered programs including airfare, hotel charges, meal costs, event and location fees, chaperone costs, tour manager fees, and the cost of in-country travel ("cost of sales"). Our business is highly seasonal and the second quarter is typically our highest period for gross revenue and cost of sales activity. The majority of sales and marketing expenses are incurred in the third and fourth quarters of the current year to attract delegates for the following year, while the associated revenue is generally recognized in the second and third quarter of the following fiscal year.

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Table of Contents

Executive Summary

Our strategy is to maintain our high quality and unique out-of-classroom educational experiences while increasing our volume of business through multi-channel marketing. In order to grow the business, our operating plans include the following: further integrating digital and social marketing into our approach; introducing new conversion channels while refining existing ones; building and preserving high quality customer relationships; and introducing new educational travel programs and experiences independently and through strategic alliances.

During 2012, we traveled 21,252 delegates compared to 23,928 delegates during 2011. This represents an 11 percent decline year-over-year, primarily driven by fewer delegates traveled from our core product, Student Ambassadors Programs. Anticipating that delegate counts were likely to decline in 2012, we actively implemented cost savings initiatives that reduced our total operating expenses by $5.9 million, or 10 percent, compared to the year ended December 31, 2011. Net income decreased $1.2 million, or 41 percent, to $1.7 million during the year ended December 31, 2012 compared to $3.0 million during 2011.

As we have concluded our fall and winter marketing campaigns, we anticipate a reduced level of travelers for 2013 compared to 2012 driven by a continued decline in Student Ambassador
Programs enrollments due to a faster than expected decline in the performance of the stand-alone mail component of our integrated marketing strategy. In addition, while our in-person information meetings remain our strongest conversion channel and deliverer of student travelers, attendance, and the number of enrollments through this channel are down year-over-year.

We have taken and continue to take steps to address this downward trend through the development of our multi-channel strategy and are implementing additional marketing initiatives to confront the gap created against our 2013 enrollment expectations. We have implemented market-specific coordination of direct mail and digital advertising and continue to test higher touch conversion channels such as webinars and telesales. Additionally, we are testing a shift in our selling cycle this coming spring to accelerate the timing of our early enrollment efforts and move us toward a year-round marketing strategy. We believe this strategy aligns better with consumer behavior while also mitigating some of the risks involved with the emphasis on the fall marketing campaign.

Our goal is to adjust to the realities of our marketplace and we plan to continue to evolve our multi-channel sales and marketing strategies to adapt to the needs and behaviors of our target audience. We plan to continue to refine our integrated multi-channel strategy with a heavier emphasis on digital reinforcement of the direct mail component. We believe we need to make multiple touch points available while our consumers are researching their decision to travel, moving them toward the point of sale, which we anticipate will ultimately translate to stronger conversion for our programs.

As we continue to transition our business to a multi-channel approach, we believe it is important to right-size our balance sheet and return capital to shareholders while we continue to focus on our core business to position the Company for long-term success. With the financial flexibility we believe our balance sheet affords, during the fourth quarter of 2012 the Board of Directors approved additional share repurchases to augment the existing approximately $13.5 million authorization. During the fourth quarter of 2012, we returned over $3.0 million to our shareholders in the form of repurchases. In addition, a $0.50 per share special dividend was approved and paid out to shareholders during the fourth quarter of 2012 returning an additional $8.8 million to shareholders.

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Results of Operations

Comparison of Year Ended December 31, 2012 to Year Ended December 31, 2011

The following table sets forth the consolidated financial results and change in
dollars and percentages for the periods indicated:

                                                      Year Ended December 31,
                                          2012          2011        $ Change       % Change
Total revenue                           $  58,052     $  66,438     $  (8,386 )          -13 %
Cost of goods sold                          6,661         7,397          (736 )          -10 %
Gross margin                               51,391        59,041        (7,650 )          -13 %
  Selling and marketing expenses           34,845        40,367        (5,522 )          -14 %
  General and administrative expenses     16,224        16,564          (340   )         -2   %
Operating income                              322         2,110        (1,788 )          -85 %
Other income                                1,717         1,495           222             15 %
Income before income tax provision          2,039         3,605        (1,566 )          -43 %
Income tax provision                         (295 )        (649 )         354            -55 %
Net income                              $   1,744     $   2,956     $  (1,212 )          -41 %

During the year ended December 31, 2012, we traveled 21,252 delegates compared to 23,928 delegates in 2011. We experienced a decline in the number of delegates that traveled on our core Student Ambassador Programs offerings as well as in two of our non-core programs, Leadership Programs and Citizen Ambassador Programs as the market demand for these programs shifted. The decline in total revenue is mainly due to the decrease in delegates traveled, but based on the fact that we report our international travel programs on a net revenue basis, increased costs associated with airfare, in particular increased fuel surcharges, and higher foreign currency exchange rates also contributed to this decline. Gross margin as a percentage of gross revenues declined to 36.7 percent during 2012 compared to 38.1 in 2011. The decrease in revenues from the travel business is partially offset by an increase in BookRag's internet content revenue.

Due to several cost saving initiatives implemented throughout 2012, selling and marketing expenses declined $5.5 million while general and administrative expenses declined $0.3 million for the year ended December 31, 2012 compared to 2011. In line with our strategy to reduce overall operating expenses to maximize profitability, these reductions consisted of approximately $3.5 million in lower marketing expenses related to selected travel campaigns as well as reduced personnel costs associated with a reduction in staffing offset by increased depreciation and technology expenses associated with investment in technology improvements. In addition, we experienced lower legal expenses related to an SEC investigation that has now been closed, offset by costs incurred related to a previously disclosed proxy contest.

Other income increased $0.2 million during the year ended December 31, 2012 compared to 2011 due primarily to realized gains on the sale of investments diverted to municipal bond funds offset by lower interest income associated with lower investment balances year over year.

For the years ended December 31, 2012 and 2011, the income tax provision recorded resulted in a 14 percent and 18 percent annual effective income tax rate applied to pre-tax income, respectively, in relation to our current federal statutory tax rate of 34 percent. The difference from our effective tax rate on a year over year basis is primarily due to the increased weight of our tax exempt interest earned during the period as a percent of our lower pre-tax net income. During the fourth quarter of 2012 and subsequent to our third quarter reporting period, we increased our estimated income tax provision as a result in a change in estimate related to non-taxable interest income earned throughout 2012. This change had no impact on our consolidated statement of operations for the year ended December 31, 2012.

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Table of Contents

Comparison of Year Ended December 31, 2011 to Year Ended December 31, 2010

                                                     Year Ended December 31,
                                          2011          2010        $ Change      % Change
Total revenue                           $  66,438     $  76,146     $  (9,708 )        -13 %
Cost of goods sold                          7,397        10,045        (2,648 )        -26 %
Gross margin                               59,041        66,101        (7,060 )        -11 %
  Selling and marketing expenses           40,367        41,880        (1,513 )         -4 %
  General and administrative expenses     16,564        14,125         2,439           17   %
Operating income                            2,110        10,096        (7,986 )        -79 %
Other income                                1,495         1,501            (6 )          0 %
Income before income tax provision          3,605        11,597        (7,992 )        -69 %
Income tax provision                         (649 )      (3,481 )       2,832          -81 %
Net income                              $   2,956     $   8,116     $  (5,160 )        -64 %

During the year ended December 31, 2011, we traveled 23,928 delegates compared to 26,657 delegates in 2010. We experienced modest growth in the number of delegates traveled on our core Student Ambassador Programs offerings, but we suffered significant declines in two of our non-core programs, Leadership Programs and Citizen Ambassador Programs as the market demand for these programs decreased. The decline in total revenue is mainly due to the decrease in delegates traveled, as well as increased costs associated with base airfare, fuel surcharges, departure taxes, and foreign currency exchange rates. The decrease in revenues from the travel business is partially offset by an increase in BookRag's internet content and advertising revenue.

Selling and marketing costs were in line with 2010 on a comparable year over year basis. The decline noted above was caused by asset impairments or loss on sale of equipment associated with outsourcing our print and production facilities during 2010. In the year ended December 31, 2011 as compared to the same period in 2010, general and administrative expenses increased mainly due to legal and professional expenses. In fiscal year 2010, a benefit was recorded for favorable insurance recoveries for legal expenses incurred in 2009. In 2011, we continued to sustain significant legal and professional expenses that were outside the normal course of business associated with a securities class action lawsuit and an SEC investigation.

For the years ended December 31, 2011 and 2010, the income tax provision recorded resulted in an 18 percent and 30 percent annual effective income tax rate applied to pre-tax income, respectively, in relation to our current federal statutory tax rate of 34 percent. The difference from our effective tax rate on a year over year basis is primarily due to increased weight of our tax exempt interest earned during the period as a percent of our lower pre-tax net income.

Results of Operations by Segment

Our operations are organized in two reporting segments, 1) "Ambassador Programs and Other," which provides educational travel services to students, and professionals through multiple itineraries within four travel program types and corporate overhead, and 2) "BookRags," which provides online research capabilities through book summaries, critical essays, online study guides, lesson plans, biographies, and references to encyclopedia articles.

Ambassador Programs and Others' gross margin is comprised of gross receipts less direct program costs, including air, accommodation, transportation, speakers, facilitators, and event costs. BookRags' gross margin is comprised of content, subscription, and advertising revenues via www.bookrags.com, less commissions and amortization of intangible assets directly associated with sales.

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Table of Contents

Segment results of operations for the year ended December 31, 2012 and 2011 are as follows (in thousands):

                                        Year ended December 31, 2012                              Year ended December 31, 2011
                               Ambassador                                                Ambassador
                              Programs and                                              Programs and
                               Other (1)            BookRags        Consolidated          Other (1)           BookRags        Consolidated
Total revenue               $         53,845       $     4,207     $       58,052     $         62,392       $     4,046     $       66,438
Cost of goods sold                     6,107               554              6,661                6,822               575              7,397
Gross margin                          47,738             3,653             51,391               55,570             3,471             59,041
Selling and marketing
expenses                              33,384             1,461             34,845               38,912             1,455             40,367
General and
administrative expenses               15,359               865             16,224               15,724               840             16,564
Operating income (loss)               (1,005 )           1,327                322                  934             1,176              2,110
Other income                           1,657                60              1,717                1,452                43              1,495
Income before income tax
provision                                652             1,387              2,039                2,386             1,219              3,605
Income tax provision                     192              (487 )             (295 )               (232 )            (417 )             (649 )
Net income                  $            844       $       900     $        1,744     $          2,154       $       802     $        2,956

(1) Ambassador Programs and Other include all travel programs offered by Ambassador Programs and World Adventures Unlimited as well as corporate overhead.

See 'Results of Operations' above for a discussion of year over year variances for Ambassador Programs and Other, as it represents the largest portion of our operating results. BookRags total revenue and gross margin increased during the fiscal year 2012 as compared to the same period in 2011. The improvement achieved year over year can be attributed to growth from internet content sales.

Segment results of operations for the year ended December 31, 2011 and 2010 are as follows (in thousands):

                                        Year ended December 31, 2011                              Year ended December 31, 2010
                               Ambassador                                                Ambassador
                              Programs and                                              Programs and
                               Other (1)            BookRags        Consolidated         Other (1)            BookRags        Consolidated
Total revenue               $         62,392       $     4,046     $       66,438     $         73,041       $     3,105     $       76,146
Cost of goods sold                     6,822               575              7,397                9,591               454             10,045
Gross margin                          55,570             3,471             59,041               63,450             2,651             66,101
Selling and marketing
expenses                              38,912             1,455             40,367               40,912               968             41,880
General and
administrative expenses               15,724               840             16,564               13,364               761             14,125
Operating income                         934             1,176              2,110                9,174               922             10,096
Other income                           1,452                43              1,495                1,499                 2              1,501
Income before income tax
provision                              2,386             1,219              3,605               10,673               924             11,597
Income tax provision                    (232 )            (417 )             (649 )             (3,156 )            (325 )           (3,481 )
Net income                  $          2,154       $       802     $        2,956     $          7,517       $       599     $        8,116

(1) Ambassador Programs and Other include all travel programs offered by Ambassador Programs and World Adventures Unlimited as well as corporate overhead.

See 'Results of Operations' above for a discussion of year over year variances for Ambassador Programs and Other, as it represents the largest portion of our operating results. BookRags total revenue and gross margin increased during the fiscal year 2011 as compared to the same period in 2010. The improvement achieved year over year can be attributed to growth from internet content and advertising sales.

Key Performance Non-GAAP Financial Indicators

We analyze our performance on a net income, cash flow and liquidity basis in accordance with generally accepted accounting principles ("GAAP") as well as on a non-GAAP operating, cash flow and liquidity basis referred to below as "non-GAAP operating results" or "non-GAAP cash flows and liquidity measures." These measures and related discussions are presented as supplementary information in this analysis to enhance the readers' understanding of, and highlight trends in, our core financial results. Any non-GAAP financial measure used by us should not be considered in isolation or as a substitute for measures of performance or liquidity prepared in accordance with GAAP.

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Table of Contents

2013 Net Enrollments

Net enrollments on a forward looking basis consist of all active participants, which we define as those who are enrolled or have already traveled in our programs less those who have already withdrawn for the travel year referenced. This is a point in time measurement that we use to estimate future revenues. Enrolled revenue consists of estimated gross receipts to be recognized, in the future, upon travel of an enrolled participant and may not result in the actual gross receipts eventually recognized due both to withdrawals from our programs and expected future enrollments. We believe the decline in enrolled revenue will translate to lower gross revenue in 2013 for our travel programs compared to 2012 travel. We will continue to work to improve retention of our delegates and reduce this gap, but there can be no guarantee that we will be successful. This non-GAAP measure relates to our travel programs only and does not include anticipated revenue for BookRags.

                                                As of February 3,
                                                    Delegates
Enrollment detail for travel year     2013         2012      Change   % Change
Student Ambassadors                    16,886       21,476    (4,590)   -21.4%
Total, all programs                    20,846       24,881    (4,035)   -16.2%

Deployable Cash

We use deployable cash as a liquidity measure and it is calculated as the sum of cash, cash equivalents, short-term available-for-sale securities and prepaid program costs and expenses less the sum of accounts payable, accrued expenses and other short-term liabilities (excluding deferred taxes) and participant deposits. We believe the deployable cash measurement is useful in understanding cash available to deploy for current and future business opportunities, as it represents an estimate of excess cash available for strategic actions. This non-GAAP measure is based on conservative assumptions, such as all participants' deposits being forfeited and should not be construed as the maximum amount of cash sources available to run the business. See the 'Liquidity' section below for explanations of cash sources and uses.

Deployable Cash Reconciliation (in thousands)


                                                   December 31,

                                    2012              2011             2010
Cash, cash equivalents and
short-term available-for-sale
securities                        $  38,272     $         58,647     $  79,378
Prepaid program cost and expenses    17,217               13,299         3,230
Less: Participants' deposits        (25,735 )            (27,396 )     (34,436 )
Less: Accounts payable / accruals
/ other liabilities                  (4,349 )             (5,970 )      (6,061 )
Deployable cash                   $  25,405     $         38,580     $  42,111

Free Cash Flow

Free cash flow is calculated as cash flow from operations less purchase of property, equipment and intangible assets. Management believes this non-GAAP measure is useful to investors in understanding the cash generated or distributed within the current period for future use in operations. See the 'Liquidity' section below for explanations of cash sources and uses.

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Table of Contents

Free Cash Flow Reconciliation (in thousands)

                                                              December 31,

                                                  2012            2011            2010
Cash flow provided by (used in) operations      $  2,219     $       (6,655 )   $ 21,639
Purchase of property, equipment and intangibles   (5,672 )           (3,594 )     (5,402 )
Free cash flow                                  $ (3,453 )   $      (10,249 )   $ 16,237

Liquidity and Capital Resources

Total assets at December 31, 2012 were $97.9 million, of which 39 percent, or $38.3 million, were cash, cash equivalents and short-term available-for-sale securities. At that date, we also had long-lived assets totaling $39.8 million, primarily related to our office building, technology hardware and systems used . . .

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