UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004

OR

[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                    

Commission file number: 0-26420

AMBASSADORS INTERNATIONAL, INC.

Registrant’s Telephone Number, Including Area Code: (949) 759-5900

     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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [   ]

     The number of shares of the registrant’s Common Stock outstanding as of October 25, 2004 was 9,866,325.

AMBASSADORS INTERNATIONAL, INC.
FORM 10-Q QUARTERLY REPORT

TABLE OF CONTENTS

PART 1 — FINANCIAL INFORMATION

Item 1. Financial Statements

Ambassadors International, Inc.

(in thousands, except share data)

See Notes to Consolidated Financial Statements.

1

Ambassadors International, Inc.

(in thousands, except per share data)

See Notes to Consolidated Financial Statements.

2

Ambassadors International, Inc.

(in thousands)

See Notes to Consolidated Financial Statements.

3

Ambassadors International, Inc.

1.

Description of the Company and Basis of Presentation

The Company

		Ambassadors International, Inc. (the “Company”) was founded in 1967 as a travel services company and reincorporated in Delaware in 1995. Ambassadors Group, Inc. (“AGI”) represented the entire operations of the Company until 1996 when Ambassadors Performance Group, LLC (“APG” or the “Performance Group”) commenced operations. Ambassadors Services Group, Inc. (“ASG” or the “Services Group”) commenced operations in 1998 and Ambassadors Technology Corporation (“ATC” or the “Technology Group”) commenced operations in 2002. On February 28, 2002, the Company completed a spin-off of its wholly owned subsidiary, AGI, into a separate publicly traded company. In December 2003, the Company formed Cypress Reinsurance, Ltd (“Cypress Re”).
		In January 2004, the Company realigned its business operations and consolidated the Performance Group, the Services Group and the Technology Group into one segment, called Ambassadors.
		The following further describes the operations of the Company’s current business segments:

•		Ambassadors — Develops, markets and manages meetings and incentive programs for a nationwide roster of corporate clients utilizing incentive travel, merchandise award programs and corporate meeting management services. Provides comprehensive hotel reservation, registration and travel services for meetings, conventions, expositions and trade shows. Develops, markets and distributes event portfolio management technology solutions for corporations and large associations.
•		Cypress Re — Participates in selective specialty property and casualty reinsurance programs.

Basis of Presentation

		The accompanying unaudited consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly they do not include all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements. In the opinion of management all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2004 are not necessarily indicative of the results that may be expected for future periods or the year ending December 31, 2004.
		The consolidated balance sheet at December 31, 2003 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements. For further information refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2003.
		Accounting for Stock Options
		As permitted by Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” the Company accounts for its stock-based employee compensation plans under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related interpretations. Because all options granted under the Company’s plans had an exercise price equal to the market value of the underlying common stock on the date of grant, no stock-based compensation cost is reflected in net income under the Company’s application of APB Opinion No. 25.

4

Ambassadors International, Inc.
Notes to Consolidated Financial Statements, Continued

The following table presents the effects on net income and earnings per share if the Company had recognized compensation expense under the fair value recognition provisions of SFAS No. 123 (in thousands, except per share data):

		Dividends Declared
		On September 2, 2003, the Board of Directors authorized a new dividend policy paying stockholders $0.40 per share annually, distributable at $0.10 per share on a quarterly basis. During the quarter ended March 31, 2004, a dividend of approximately $1,000,000 was paid on March 23, 2004 to stockholders of record on March 9, 2004. During the quarter ended June 30, 2004, a dividend of approximately $974,000 was paid on June 16, 2004 to stockholders of record on June 1, 2004. During the quarter ended September 30, 2004, a dividend of approximately $987,000 was paid on September 14, 2004 to stockholders of record on August 30, 2004.
		The Company and its Board of Directors intend to continually review the dividend policy to ensure compliance with capital requirements, regulatory limitations, the Company’s financial position and other conditions which may affect the Company’s desire or ability to pay dividends in the future.
2.		Business Acquisitions and Investments
		In November 2002, APG acquired a 51% ownership interest in Innovations in Marketing, LLC (“IIM”). IIM was a start-up performance incentive and meeting management company. IIM’s initial capital consisted of $1,000 of which 51% was contributed by APG and 49% was contributed by the minority owner. The Operating Agreement specified that APG shall loan IIM up to $400,000, which eliminates in consolidation, for the working capital needs of IIM. On October 15, 2003, APG sold its 51% ownership interest to the minority owner and the outstanding balance of the loan was resolved prior to sale.
		In December 2002, ATC acquired certain of the assets and business of Bluedot Virtual Event Organization, Inc. (“Bluedot Software”) out of Chapter 11 bankruptcy. Bluedot Software, located in San Francisco, California, develops, markets and distributes event portfolio management solutions for corporations and large associations. The purchase price consisted of debtor-in possession financing and other costs of $308,000, the assumption of liabilities and future contingent payments to the sellers covering the twenty-four months following the closing date. The Company allocated the excess purchase price to an intangible asset, purchased software, of $607,000. The amortization period for this intangible asset was five years. During 2003, the Company provided an additional investment of approximately $21,000 which was allocated to purchased software. As more fully

5

Ambassadors International, Inc.
Notes to Consolidated Financial Statements, Continued

		described in Note 4, in the fourth quarter of 2003 the Company wrote off the unamortized balance of the intangible asset.
		During the first twelve months following the closing, the Technology Group shall pay the greater of (i) 5% of the gross revenues actually received in each quarter allocable to the assets purchased, or (ii) $25,000 per quarter as the First Year Minimum Payments. During the second year following the closing, ATC shall pay the greater of (i) 5% of the gross revenues actually received in each quarter allocable to the assets purchased, or (ii) $15,000 per quarter as the Second Year Minimum Payments. As of September 30, 2004, Ambassadors had paid $130,000 for the first and second year minimum contingent payments and recorded these payments as an adjustment to the purchase price.
		In March 2002, APG acquired a 49% ownership interest in Incentive Travel, LLC (“ITI”). ITI develops, markets and manages meetings and incentive programs for a select roster of corporate clients utilizing incentive travel and corporate meeting management services. The terms of the purchase agreement call for contingent payments through 2005 based upon actual income before income taxes multiplied by APG’s 49% ownership interest calculated based on a predefined multiplier. Total payments related to ITI’s fiscal 2002 results were $2.5 million of which approximately $1.9 million was paid during 2003 and was allocated to intangible assets (license). Total payments related to ITI’s fiscal 2003 results were $0.6 million and was allocated to intangible assets (license). The remaining purchase price of $542,000 was paid during 2002 and was allocated to goodwill. As of September 30, 2004, the Company’s obligation related to ITI’s fiscal 2004 results is estimated to be $302,000 which has been accrued and allocated to intangible assets (license).
		License fees earned from ITI are included in the operations of Ambassadors and represent approximately $37,000 and $119,000 for the three months ended September 30, 2004 and 2003, respectively, and $170,000 and $405,000 for the nine months ended September 30, 2004 and 2003, respectively. The Company also recorded its proportional share of the earnings (loss) and management fees from ITI of approximately $93,000 and $150,000 for the three months ended September 30, 2004 and 2003, respectively, and $139,000 and $623,000 for the nine months ended September 30, 2004 and 2003, respectively, which are included in other income. At September 30, 2004 and 2003, the Company had approximately $37,000 and $160,000, respectively, in receivables related to license and management fees and approximately $72,000 and $466,000, respectively, in undistributed earnings from ITI.
3.		Reinsurance
		In 2004, the Company transferred its investment interest in two insurance programs to its wholly-owned subsidiary, Cypress Re. On March 29, 2004, Cypress Re entered into a reinsurance agreement which incorporated the terms and conditions of the above interest of these programs. The quota share reinsurance agreement covered a retroactive period from July 1, 2002 through March 29, 2004, as well as a prospective period from March 29, 2004 to June 30, 2004. The reinsurance agreement meets the requirements of SFAS No. 113 “Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts” and has both prospective and retroactive elements.
		During the quarter ended September 30, 2004, Cypress Re entered into additional quota share reinsurance agreements. These reinsurance agreements represent participation in selective property and casualty programs. The reinsurance agreements meet the requirements of SFAS No. 113 “Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts.” One of the quota share reinsurance agreements covered a retroactive period from January 1, 2003 through May 31, 2004 and a prospective period from June 1, 2004 through December 31, 2004. The other agreements only contained a prospective component.

6

Ambassadors International, Inc.
Notes to Consolidated Financial Statements, Continued

Accounting for prospective reinsurance transactions results in premiums and related acquisition costs being recognized over the remaining period of the insurance contracts reinsured. As a result, unearned premium reserves, deferred policy acquisition costs and ceded prepaid reinsurance premiums of $4.7 million, $1.3 million and $0.9 million, respectively, were recorded on the balance sheet as of September 30, 2004.

		Accounting for retroactive reinsurance transactions results in the reinsurer reimbursing the ceding company for liabilities incurred as a result of past insurable events covered by the underlying policies reinsured. Loss and loss adjustment expenses are initially recorded at the estimated ultimate payout amount and any gain from any such transaction is deferred and amortized to income. Loss and loss adjustment expense reserves are adjusted for changes in the estimated ultimate payout and the original deferred gain is recalculated and amortized based on and in the period that the changes in estimated ultimate payout are made. As of September 30, 2004, premiums receivable, reinsurance recoverable, loss and loss adjustment expense reserves and a deferred gain on retroactive reinsurance of $2.9 million, $1.3 million, $3.3 million and $0.7 million, respectively, were recorded on the Company’s balance sheet. Loss and loss adjustment expense reserves include $0.4 million for incurred but not reported claims as of September 30, 2004 and the Company has recognized $0.4 million of the deferred gain associated with its retroactive reinsurance activity.
		Cypress Re retrocedes risk to the ceding company under specific excess and aggregate loss treaties. Cypress Re remains obligated for amounts ceded in the event that the reinsurer does not meet its obligations.
		Premiums receivable at September 30, 2004 is comprised of funds held in trust, by the ceding company, of approximately $4.0 million and deferred and not yet due premiums, from the ceding company of approximately $4.0 million. The funds held in trust primarily consist of high grade government bonds and money market funds.
		As of September 30, 2004, reinsurance recoverable and prepaid reinsurance premiums of $1.4 million and $0.9 million, respectively, relate to a single reinsurer. Cypress Re’s exposure to credit loss in the event of non-payment or nonperformance is limited to these amounts.
		Written premiums are a non- GAAP financial measure which represent the amount of premiums charged for policies issued, net of reinsurance, during a fiscal period. Earned premiums are a GAAP measure. Premiums are considered earned and are included in the financial results on a pro rata basis over the policy period. The effect of reinsurance on premiums written and earned for the three and nine months ended September 30, 2004 was as follows (in thousands):

		As of September 30, 2004, the Company has issued approximately $9,898,000 in letters of credit related to property and casualty insurance programs which expire at various dates through 2005.
4.		Impairment Loss and Lease Exit Costs
		In December 2003, the Company consolidated the operations of the Technology Group into its corporate headquarters in Newport Beach, California in order to improve operating efficiencies and reduce future costs. At December 31, 2003, the Company performed its annual impairment test on the Technology Group’s intangible asset, purchased software, and concluded that due to the consolidation of operations, the asset was impaired. Accordingly, the Company recorded a charge related to the unamortized balance of the purchased software related to the acquisition of Bluedot Software in 2002 of approximately $502,000. The Company also recorded

7

Ambassadors International, Inc.
Notes to Consolidated Financial Statements, Continued

		approximately $389,000 related to the write-down of assets, lease exit costs and employee relocation expenses due to the closure of the San Francisco office. The Company recorded approximately $317,000 in accounts payable and other liabilities at December 31, 2003 for the remaining unpaid balance of these expenses. The Company paid and charged against the liability, net of sublease income received, approximately $3,500 and $77,000 in the three and nine months ended September 30, 2004, respectively. In addition, the Company recorded an adjustment to the lease exit costs in general and administrative expenses of approximately $89,000 in the quarter ended June 30, 2004 due to executing a sublease agreement which was more favorable than originally estimated. At September 30, 2004, approximately $151,000 remained unpaid and is included in accounts payable and other liabilities in the accompanying balance sheet.
5.		Comprehensive Income
		The components of comprehensive income (loss) are as follows (in thousands):

6.		Earnings Per Share
		The following table presents a reconciliation of basic and diluted earnings per share (“EPS”) computations and the number of dilutive securities (stock options) that were included in the dilutive EPS computation (in thousands).

For the three months ended September 30, 2004 and 2003 there were approximately 112,000 and 79,000 stock options outstanding, respectively, for which the exercise price exceeded the average common stock market value. For the nine months ended September 30, 2004 and 2003 there were approximately 101,000 and 116,000 stock options outstanding, for which the exercise price exceeded the average common stock market value. The effects of the shares which would be issued upon the exercise of these options have been excluded from the calculation of diluted EPS because they are anti-dilutive.

8

Ambassadors International, Inc.
Notes to Consolidated Financial Statements, Continued

7.		Common Stock Repurchase Program
		In November 1998, the Board of Directors of the Company authorized the repurchase of the Company’s common stock (up to $20.0 million) in the open market or through private transactions. This repurchase program is ongoing and as of September 30, 2004, the Company has repurchased 1,051,500 shares for approximately $12.4 million. During the quarter ended June 30, 2004, the Company repurchased 300,000 shares for $3,675,000. The Company made no additional repurchases during fiscal 2004.
8.		Business Segments
		In January 2004, the Company realigned its business operations and consolidated the Performance Group, the Services Group and the Technology Group into one segment, called Ambassadors. Also, during the first quarter of 2004 the Company launched its reinsurance business segment, Cypress Re. Corporate and Other consists of general corporate assets (primarily cash and cash equivalents, investments and goodwill). Selected financial information related to these segments is as follows (in thousands):