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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 
 
Washington, D.C. 20549
 
 
FORM 10-Q
 
 
(Mark One)
 
     
þ
 
QUARTERLY report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

     
   
For the quarterly period ended September 30, 2014
 
OR
 
     
o
 
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 0-33347
 
Ambassadors Group, Inc.
 
 (Exact name of registrant as specified in its charter)
 
     
Delaware
(State or Other Jurisdiction of
Incorporation or Organization)
 
91-1957010
(I.R.S. Employer
Identification No.)

     
Dwight D. Eisenhower Building
2001 South Flint Road
Spokane, WA
(Address of Principal Executive Offices)
 
99224
(Zip Code)
 
Registrant’s Telephone Number, Including Area Code: (509) 568-7800
 
 
 

 
 
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.
 
þ
 
Yes
o
 
No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

þ
 
Yes
o
 
No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

o
 
Large accelerated  filer
o
 
Accelerated filer
o
 
Non-accelerated filer (Do not check if a smaller reporting company)
þ
 
Smaller reporting company
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
o
 
Yes
þ
 
No
 
The number of shares outstanding of the registrant’s Common Stock, $0.01 par value, as of November 10, 2014 was 17,043,625.
 
.
 


 
 

 



 
 
AMBASSADORS GROUP, INC.
FORM 10-Q QUARTERLY REPORT
 
 
TABLE OF CONTENTS
 


 
 

 

 
PART I
FINANCIAL INFORMATION
 
 
Item 1. FINANCIAL STATEMENTS
 
AMBASSADORS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of September 30, 2014 and December 31, 2013
(in thousands, except share and per share data)

  
 
UNAUDITED
   
AUDITED
 
 
September 30,
   
December 31,
 
 
2014
   
2013
 
ASSETS
         
Current assets:
         
Cash and cash equivalents
$ 3,550     $ 9,473  
Available-for-sale securities and other
  43,586       36,174  
Prepaid program costs and expenses
  2,597       7,069  
Accounts receivable
  1,071       1,792  
Deferred tax assets
  -       1,295  
Assets held for sale
  8,400       -  
    Total current assets
  59,204       55,803  
Property and equipment, net
  3,821       18,452  
Available-for-sale securities
  724       719  
Deferred tax assets
  125       -  
Intangibles
  -       3,522  
Goodwill
  70       9,781  
Other long-term assets
  483       82  
    Total assets
$ 64,427     $ 88,359  
               
LIABILITIES
             
Current liabilities:
             
Accounts payable and accrued expenses
$ 6,646     $ 3,587  
Participants’ deposits
  9,303       26,362  
Foreign currency exchange contracts
  625       244  
Deferred tax liabilities
  149       -  
Other liabilities
  -       119  
    Total current liabilities
  16,723       30,312  
Participants’ deposits
  190       -  
Foreign currency exchange contracts
  -       52  
Deferred tax liabilities
  -       2,087  
    Total liabilities
  16,913       32,451  
               
Commitments and Contingencies (Note 15)
             
               
STOCKHOLDERS’ EQUITY
             
Preferred stock, $.01 par value; 2,000,000 shares authorized; none issued and outstanding
  -       -  
Common stock, $.01 par value; 50,000,000 shares authorized; 17,044,905 and 17,040,724 shares issued and outstanding, respectively
  170       170  
Additional paid-in capital
  1,478       411  
Retained earnings
  46,478       55,876  
Accumulated other comprehensive gain (loss)
  (612 )     (549 )
    Stockholders’ equity
  47,514       55,908  
    Total liabilities and stockholders’ equity
$ 64,427     $ 88,359  
 
 
The accompanying notes are an integral part of the consolidated financial statements.
 
 
-1-

 
AMBASSADORS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
For the three and nine months ended September 30, 2014 and 2013
(in thousands, except per share amounts)

               
 
Three months ended
   
Nine months ended
 
 
September 30,
   
September 30,
 
 
2014
   
2013
   
2014
   
2013
 
Net revenue, non-directly delivered programs
$ 10,818     $ 15,071     $ 29,027     $ 36,254  
Gross revenue, directly delivered programs
  5,896       6,296       9,734       10,460  
    Total revenue
  16,714       21,367       38,761       46,714  
Cost of sales, directly delivered programs
  3,372       4,128       5,816       7,053  
Cost of sales, program merchandise markdown
  -       -       554       -  
    Gross margin
  13,342       17,239       32,391       39,661  
Operating expenses:
                             
     Selling and marketing
  8,369       9,224       20,868       24,275  
     General and administrative
  2,418       2,676       8,647       11,007  
     Restructuring costs
  217       1,756       1,756       1,756  
     Asset impairments
  350       6,461       2,350       6,461  
Total operating expenses
  11,354       20,117       33,621       43,499  
    Operating income (loss)
  1,988       (2,878 )     (1,230 )     (3,838 )
Other income:
                             
     Interest and dividend income
  84       70       356       357  
     Foreign currency and other income
  (2 )     1       6       22  
Total other income
  82       71       362       379  
    Income (loss)  before income tax benefit (provision) from continuing operations
  2,070       (2,807 )     (868 )     (3,459 )
Income tax benefit (provision)
  (158 )     1,004       (416 )     1,269  
    Net income (loss) from continuing operations
  1,912       (1,803 )     (1,284 )     (2,190 )
                               
Discontinued operations:
                             
    Income (loss) from discontinued segment
  196       250       (9,298 )     959  
   Income tax benefit (provision)
  230       (61 )     1,184       (350 )
Net income (loss) from discontinued operations
  426       189       (8,114 )     609  
                               
    Net Income (Loss)
$ 2,338     $ (1,614 )   $ (9,398 )   $ (1,581 )
                               
Weighted-average common shares outstanding - basic
  17,041       16,984       16.827       16,982  
Weighted-average common shares outstanding - diluted
  17,046       16,984       16,827       16,982  
                               
Net income (loss) from continuing operations per share - basic
$ 0.11     $ (0.11 )   $ (0.08 )   $ (0.13 )
Net income (loss) from continuing operations per share - diluted
$ 0.11     $ (0.11 )   $ (0.08 )   $ (0.13 )
                               
Net income (loss) from discontinued operations per share - basic
$ 0.03     $ 0.01     $ (0.48 )   $ 0.04  
Net income (loss) from discontinued operations per share - diluted
$ 0.03     $ 0.01     $ (0.48 )   $ 0.04  
                               
 
The accompanying notes are an integral part of the consolidated financial statements.
 
 
 
-2-

 
 
AMBASSADORS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
For the three and nine months ended September 30, 2014 and 2013
(in thousands)
 
 
Three months ended September 30,
   
Nine months ended September 30,
 
 
2014
   
2013
   
2014
   
2013
 
Net income (loss)
$ 2,338     $ (1,614 )   $ (9,398 )   $ (1,581 )
Unrealized gain (loss) on foreign currency exchange contracts, net of income tax benefit (provision) of $0, ($112), $0 and $324
  (685 )     209       (329 )     (603 )
Unrealized gain (loss) on available-for-sale securities, net of income tax benefit (provision) of $0, ($12), $0 and $89
  (2 )     21       265       (165 )
Comprehensive income (loss)
$ 1,651     $ (1,384 )   $ (9,462 )   $ (2,349 )
 
 
The accompanying notes are an integral part of the consolidated financial statements.
 
 
 
-3-

 
 
AMBASSADORS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the nine months ended September 30, 2014 and 2013
(in thousands)
 
 
Nine months ended September 30,
 
 
2014
   
2013
 
Cash flows from operating activities:
         
Net loss
$ (9,398 )   $ (1,581 )
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
             
Depreciation and amortization
  4,497       4,088  
Stock-based compensation
  1,305       2,161  
Deferred income tax benefit
  (877 )     (2,373 )
Impairment and loss on sale of discontinued operations
  9,676       -  
Loss on disposition and impairment of property and equipment
  2,364       6,461  
Program merchandise writedown
  554       -  
Excess tax shortfall from stock-based compensation
  109       2,103  
Change in assets and liabilities:
             
Accounts receivable and other assets
  663       (169 )
Prepaid program costs and expenses
  3,890       9,652  
Accounts payable, accrued expenses, and other current liabilities
  2,374       4,802  
Participants’ deposits
  (16,869 )     (15,888 )
Net cash provided by (used in) operating activities
  (1,712 )     9,256  
               
Cash flows from investing activities:
             
Purchase of available-for-sale securities
  (29,733 )     (27,297 )
Proceeds from sale of available-for-sale securities
  22,582       22,931  
Purchase of property and equipment
  (1,202 )     (2,413 )
Proceeds from sale of property and equipment
  28       -  
Purchase of intangibles
  (189 )     (251 )
Proceeds from sale of BookRags, Inc.
  4,600       -  
Net cash used in investing activities
  (3,914 )     (7,030 )
               
Cash flows from financing activities:
             
Repurchase of common stock
  (188 )     (486 )
Dividend payment to shareholders
  -       (1,017 )
Proceeds from exercise of stock options
  -       5  
Excess tax shortfall from stock-based compensation
  (109 )     (2,103 )
Net cash used in financing activities
  (297 )     (3,601 )
               
Net decrease in cash and cash equivalents
  (5,923 )     (1,375 )
Cash and cash equivalents, beginning of period
  9,473       6,150  
Cash and cash equivalents, end of period
$ 3,550     $ 4,775  

 

The accompanying notes are an integral part of the consolidated financial statements.
 
 
 
-4-

 
 
AMBASSADORS GROUP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
1. The Company
 
Ambassadors Group, Inc. (the “Company”, “we”, “us” or “our”) is an educational company primarily engaged in organizing and promoting differentiated worldwide travel programs for students and professionals. These consolidated financial statements include the accounts of Ambassadors Group, Inc., and our wholly owned subsidiaries, Ambassador Programs, Inc., World Adventures Unlimited, Inc., Ambassadors Unlimited, LLC, AGI Hong Kong Limited, Beijing People to People Education Consultation Co., Ltd, Marketing Production Systems LLC, and BookRags, Inc. (“BookRags”). All significant intercompany accounts and transactions, which are of a normal recurring nature, are eliminated in consolidation.

During part of the third quarter we also operated an education oriented research website, BookRags.com, which provided study guides, lesson plans and other educational resources to students and teachers. On September 5, 2014, we consummated the sale of BookRags. All activities related to BookRags have been reflected as discontinued operations for all periods presented.  For additional information, see Note 5 of Notes to Consolidated Financial Statements.
 
2. Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”), have been condensed or omitted in accordance with such rules and regulations, although management believes the disclosures are adequate to prevent the information presented from being materially misleading. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included. Operating results for the nine months ended September 30, 2014 are not indicative of the results that may be expected for the year ending December 31, 2014.
 
These financial statements should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2013.
 
3. Recent Accounting Pronouncements
 
In April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (ASU 2014-08). This ASU relates to discontinued operations reporting for disposals of components of an entity that represent strategic shifts that have, or will have, a major effect on the entity’s operations and financial results. The standard expands disclosures for discontinued operations and requires new disclosures related to individually material disposals that do not meet the definition of a discontinued operation. The provisions of this ASU are effective for interim and annual periods beginning after December 15, 2014 and will be reflected in periods following the fourth quarter of 2014.
 
In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing GAAP.
 
The standard is effective for annual periods beginning after December 15, 2016, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). We are currently evaluating the impact of our pending adoption of ASU 2014-09 on our consolidated financial statements and have not yet determined the method by which we will adopt the standard in 2017.
 
 
-5-

 
AMBASSADORS GROUP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
In June, 2014, the FASB issued Accounting Standards Update No. 2014-12, Compensation-Stock Compensation: Accounting for Share-Based Payments when the terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition on performance stock unit awards. In some cases, the terms of an award may provide that the performance target could be achieved after an employee completes the requisite service period. That is, the employee would be entitled to benefit from the award regardless of whether the employee is rendering service on the date the performance target is achieved. Current performance stock unit awards are contingent upon employment status as well as internal metrics. As such, this ASU is not expected to have an impact on our financial statements or disclosures.
 
4. Restructuring Costs
 
During the third quarter of 2013, we initiated a corporate restructuring plan aimed at streamlining our cost structure and focusing our business on our core Student Ambassador programs in order to promote the long-term health of the organization. This plan included the restructuring of operations and programs associated with Discovery Student Adventures and terminating the operations associated with our Beijing office.
 
During the second quarter of 2014, we took additional measures to continue to streamline the organization and to further our businesses focus on our core Student Ambassador programs. We completed a workforce reduction during the second quarter of 2014 that resulted in restructuring expense of $1.6 million. Under the terms of executive separation agreements, we will continue to pay each terminated executive bi-weekly during the executive’s severance period, with the future payments having been accrued and reflected in the below table as outstanding liabilities at September 30, 2014.
 
Other costs recorded as restructuring during the first nine months of 2014 included accelerated depreciation of assets scheduled for replacement within the next year as well as continued transition costs from the termination of operations of our Beijing office.
 
We anticipate all restructuring expenses to be recognized within twelve months of the initial implementation of the restructuring plan.
 
The following table summarizes costs incurred to date from continuing operations as part of the restructuring plan, which began during the third quarter of 2013, and the balance of the restructuring cost liability as of September 30, 2014 (in thousands).
 
 
                                    Restructuring Costs  
 
Ambassador Programs and Other
Contract termination fees
$ 1,550
Separation payments
  949
Equity compensation expenses
  377
Other transition costs
  1,166
Accumulated expense at September 30, 2014
  4,042
less: cash payments
  3,302
less: non-cash expenses
  377
Total restructuring liabilities at September 30, 2014
$ 363

 
 
 

 

 
 
 
-6-

 

AMBASSADORS GROUP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
5. Discontinued Operations

In furtherance to the Company’s focus on its core Student Ambassadors programs, in September 2014, the Company announced it had consummated a sale of BookRags for $5.0 million, subject to a $0.4 million escrow arrangement.  All interests and future cash flows from BookRags were released upon sale.  All activities related to BookRags have been reflected as discontinued operations on our consolidated financial statements for all periods presented.

Included in the consolidated balance sheet at December 31, 2013, were $15.5 million of assets and $1.5 million of liabilities associated with the discontinued operations of BookRags.  The following table summarizes the assets and liabilities of discontinued operations included in the consolidated balance sheet as of December 31, 2013.  There were no assets and liabilities of discontinued operations as of September 30, 2014.
 
Balance Sheet (Audited)
As of December 31, 2013
Assets
 
Current assets:
 
Cash and cash equivalents
$ 765
Accounts receivable
  731
Other current assets
  62
   Total current assets
  1,558
Property and equipment, net
  710
Intangibles
  3,522
Goodwill
  9,711
    Total assets
$ 15,501
     
Liabilities
   
Current liabilities:
   
Accounts payable and accrued expenses
$ 283
Other current liabilties
  118
   Total current liabilites
  401
Other long-term liabilties
  1,056
    Total liabilties
$ 1,457
 

 


 
 
-7-

 
 
AMBASSADORS GROUP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 
The following table summarizes the results of discontinued operations for the periods indicated (in thousands):

 
Three months ended September 30, 2014
   
Three months ended September 30, 2013
   
Nine months ended September 30, 2014
   
Nine months ended September 30, 2013
 
Total revenue
$ 545     $ 910     $ 2,608     $ 2,938  
Gross margin
$ 472     $ 785     $ 2,285     $ 2,558  
Selling & marketing expenses
$ (53 )   $ (364 )   $ (706 )   $ (1,155 )
General & administrative expenses
$ (258 )   $ (171 )   $ (679 )   $ (444 )
Restructuring costs $     $     $ (522  )   $  
Impairment and gain (loss) on sale of discontinued operations
$ 35     $ -     $ (9,676 )   $ -  
Operating income (loss) from discontinued operations
$ 196     $ 250     $ (9,298 )   $ 959  
Income tax benefit (provision) on discontinued operations
$ 230     $ (61 )   $ 1,184     $ (350 )
Net income (loss) from discontinued operations
$ 426     $ 189     $ (8,114 )   $ 609  

 
During the second quarter of 2014  due to business changes as well as the narrow margin results of its most recent annual impairment test in December 2013, the Company re-evaluated the carrying value of BookRags and recorded a goodwill impairment charge of $9.7 million, as the implied fair value of the goodwill was determined to be lower than its carrying value.  Using the income and market approaches, the significant assumptions used to determine fair value included projected operating revenues and expenses, growth rates, terminal value, discount rates, future cash flows and capital expenditures.  This impairment charge was recorded within discontinued operations and is reflected in the table above for the nine months ended, September 30, 2014.

6. Assets Held For Sale
 
In April 2012, the Company listed for sale its corporate headquarters building located in Spokane, Washington. During the third quarter of 2014, a purchase and sale agreement was executed for a sale of the building for $8.8 million.  During the second quarter of 2014, the Company recorded an asset impairment charge of $2.0 million to lower the building’s carrying value to the anticipated sales price.  During the third quarter of 2014, the Company recorded approximately $0.4 million in additional expense related to expected closing costs and broker fees. These charges are classified as asset impairment costs on the consolidated statements of operations.
 
During the third quarter of 2014, the corporate headquarters building was recorded within current assets as an asset held for sale for $8.8 million less anticipated transaction closing costs of approximately $0.4 million. The Company anticipates this purchase and sale agreement to be finalized during the fourth quarter of 2014.

Simultaneous with the final purchase and sales agreement, the Company expects to enter into a leasing agreement to remain in our current location until April 30, 2015 (with optional extensions until June 30, 2015), to provide us time to find a new leased location in the Spokane area.
 
7. Investments and Fair Value Measurements

Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining fair value, we consider the principal or most advantageous market, and we consider assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of non-performance.

Our financial instruments are measured and recorded at fair value. Our non-financial assets, including property and equipment, intangible assets and goodwill, are measured at fair value upon acquisition, reviewed at least annually for impairment, and are fully assessed if there is an indicator of impairment. An adjustment would be made to the fair value of non-financial assets if an impairment charge is recognized.

Fair value is determined for assets and liabilities using a three-tiered hierarchy, based upon significant levels of inputs as follows:

 
-8-

 
AMBASSADORS GROUP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 
-  
Level 1 – Quoted prices in active markets for identical assets or liabilities.
 
-  
Level 2 – Observable inputs, other than Level 1 prices, such as quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

-  
Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

The following tables summarize the composition of our investments at September 30, 2014 and December 31, 2013 (in thousands):
 
                 
Classification on Balance Sheet
September 30, 2014
 
Amortized Cost
 
Unrealized Gains (Losses)
   
Aggregate Fair Value
 
Cash and cash equivalents
 
Short-term
available-for-sale securities
 
Long-term available for-sale securities
Auction rate securities (“ARS”), greater than one year
  $ 1,000   $ (276 )   $ 724   $ -   $ -   $ 724
Money market funds, ninety days or less
    17     -       17     17     -     -
Municipal securities1
                                     
Short term municipal securities funds2
    42,803     17       42,820     -     42,820     -
One year or less
    -     -       -     -     -     -
After one year through three years
    -     -       -     -     -     -
Greater than three years
    782     (16 )     766     -     766     -
Total
  $ 44,602   $ (275 )   $ 44,327   $ 17   $ 43,586   $ 724
 
                           
                 
Classification on Balance Sheet
December 31, 2013
 
Amortized Cost
 
Unrealized Gains (Losses)
   
Aggregate Fair Value
 
Cash and cash equivalents
 
Short-term available-for-sale securities
 
Long-term available-for-sale securities
ARS, greater than one year
  $ 1,002   $ (283 )   $ 719   $ -   $ -   $ 719
Money market funds, ninety days or less
    488     -       488     488     -     -
Municipal securities1
                                     
Short term municipal securities funds2
    27,493     (143 )     27,350     -     27,350     -
One year or less
    952     3       955     -     955     -
After one year through three years
    3,132     20       3,152     -     3,152     -
Greater than three years
    4,854     (137 )     4,717     -     4,717     -
Total
  $ 37,921   $ (540 )   $ 37,381   $ 488   $ 36,174   $ 719
 
 
1Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

2Amounts include short-term municipal security funds that do not have a set maturity date.





 
-9-

 


AMBASSADORS GROUP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 
The following tables detail the fair value measurements of assets and liabilities within the three levels of the fair value hierarchy at September 30, 2014 and December 31, 2013 (in thousands):
 

     
Fair Value Measurements at Reporting Date Using
September 30, 2014
Fair Market Value
 
Level 1
 
Level 2
 
Level 3
Financial assets:
 
 
 
 
 
 
 
ARS
$ 724   $ -   $ -   $ 724
Money market funds
  17     17     -     -
Municipal securities1
  43,585     42,819     766     -
Foreign currency exchange contracts
  -     -     -     -
Total financial assets
$ 44,326   $ 42,836   $ 766   $ 724
Financial liabilities:
                     
Foreign currency exchange contracts
  625     -     625     -
Total financial liabilities
$ 625   $ -   $ 625   $ -
 
               
     
Fair Value Measurements at Reporting Date Using
December 31, 2013
Fair Market Value
 
Level 1
 
Level 2
 
Level 3
Financial assets:
 
 
 
 
 
 
 
ARS
$ 719   $ -   $ -   $ 719
Money market funds
  488     488     -     -
Municipal securities1
  36,174     27,350     8,824     -
Foreign currency exchange contracts
  253     -     253     -
Total financial assets
$ 37,634   $ 27,838   $ 9,077   $ 719
Financial liabilities:
                     
Foreign currency exchange contracts
  549     -     549     -
Total financial liabilities
$ 549   $ -   $ 549   $ -

 
1 At September 30, 2014, municipal securities were split 98/1/1 percent between holdings in short-term municipal security funds, municipal revenue bonds, and municipal general obligation bonds, respectively. At December 31, 2013, municipal securities were split 76/13/11 percent split between holdings in short-term municipal security funds, municipal revenue bonds and municipal general obligation bonds, respectively. The underlying credit rating of the municipal securities at September 30, 2014 and December 31, 2013 were A+, A1 or better as defined by S&P 500 and Moody’s, respectively.

Money market funds and municipal securities are classified as Level 1 assets because market prices are readily available for these investments. Level 2 financial assets and liabilities represent the fair value of our municipal bonds and foreign currency exchange contracts that were valued using pricing models that take into account the contract terms, as well as multiple inputs where applicable, such as equity prices, interest rates, volatility and currency rates. Level 3 financial assets represent the fair value of our one auction-rate security (“ARS”), which was valued using a pricing model that takes into account the average life of the underlying collateral, the rate of return, and the spread used for similar issuances.


 
-10-

 
 
AMBASSADORS GROUP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 
The following table details the fair value measurements of assets measured on a non-recurring basis within the three levels of the fair value hierarchy at September 30, 2014 (in thousands):
 
     
Fair Value Measurements at Reporting Date Using
 
Total Loss
September 30, 2014
Fair Market Value
 
Qouted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Other Unobservable Inputs (Level 3)
 
Three months ended September 30, 2014
Non-financal assets:
                 
Property and equipment, net
$ 8,750   $ -   $ -   $ 8,750   $ 2,000
 
Our corporate headquarters building is recorded as an asset held for sale on the balance sheet at $8.4 million, which is the expected sales price less expected costs to sell of $0.4 million.
 
The following table details the fair value measurements of assets measured on a non-recurring basis within the three levels of the fair value hierarchy at December 31, 2013 (in thousands):
 
     
Fair Value Measurements at Reporting Date Using
 
Total Loss
December 31, 2013
Fair Market Value
 
Qouted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Other Unobservable Inputs (Level 3)
 
Year ended December 31, 2013
Non-financal assets:
                 
Property and equipment, net
$ 11,000   $ -   $ -   $ 11,000   $ 4,544

Fair value measurements on a recurring basis using Level 3 inputs consist of one available-for-sale ARS. The following table presents a reconciliation for the three and nine months ended September 30, 2014 and 2013, of available-for-sale ARS measured at fair value on a recurring basis using Level 3 inputs (in thousands):

 
Three months ended
 
Nine months ended
 
 
September 30,
 
September 30,
 
 
2014
   
2013
 
2014
 
2013
 
Beginning balance
$ 729     $ 716   $ 719   $ 723  
Total realized / unrealized gains (losses):
                         
Included in OCI
  (5 )     1     5     (6 )
Ending balance
$ 724     $ 717   $ 724   $ 717  

 
During the nine months ended September 30, 2014, we experienced one failed ARS auction, representing principal of $1.0 million. This ARS continues to be classified as a long-term asset due to the high probability that the ARS may fail in future auctions. The next scheduled auction for this ARS is March 6, 2015. We have determined that there is no other-than-temporary impairment on this security, since we do not intend and are not required to sell this security before we have recovered the amortized cost basis, there has been no further deterioration of the credit rating of this investment, interest payments at coupon rate continue to be received, and we expect to recover the amortized cost basis of this security. We will continue to reassess liquidity in future reporting periods based on several factors, including the success or failure of future auctions, possible failure of the investment to be redeemed, deterioration of the credit rating of the investment, market risk, and other factors.

In determining the fair value of bond and ARS investments we consider the individual ratings of each holding. With regard to bonds, we consider the following: the underlying rating of the issuer irrespective of the insurance; the performance of the issuer; the term of the bond; and the quality of bond insurance provided by the rating of the bond insurer. With regard to valuation of our ARS, which is comprised of student loans, we consider the underlying credit quality of comparable student loan portfolios and the average life of the underlying student loan assets and apply a discount related to the illiquidity of our ARS due to past failed auctions. Based on these inputs, we have applied a discount of 321.0-basis points to the London interbank offered rate resulting in a valuation of $0.7 million from a cost basis of $1.0 million as of September 30, 2014. At the reporting dates and in the future, we recognize that this investment is subject to general credit, liquidity, market and interest rate risks. The fair value of this investment accordingly will continue to change and we will continue to evaluate its carrying value.


 
-11-

 

AMBASSADORS GROUP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
8. Derivative Financial Instruments
 
The majority of our travel programs take place outside of the United States, and most foreign suppliers require payment in currency other than the U.S. dollar. Accordingly, we are exposed to foreign currency risk relative to changes in foreign currency exchange rates between those currencies and the U.S. dollar for our non-directly delivered programs. We use forward contracts that allow us to acquire foreign currency at a fixed price for a specified point in time to provide a hedge against foreign currency risk. All of our derivatives are cash flow hedges and at September 30, 2014, all contracts qualified for cash flow hedge accounting.

For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income or loss and reclassified into earnings in the same period during which the hedged transaction is recognized in earnings; this is primarily during the second and third quarters of the year when our student travel programs occur. Gains or losses representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

At September 30, 2014, the following forward contracts were outstanding (in thousands):
 
 
Notional Amount
 
Matures
Forward contracts: 
     
     Australian dollar
                       3,250
 
January 2015 - July 2015
     Euro
                       9,500
 
January 2015 - July 2015
     British pound
                       1,900
 
January 2015 - July 2015
     Canadian dollar
                          400
 
March 2015 - May 2015
     New Zealand dollar
                          400
 
March 2015 - July 2015
     Japenese Yen  25,000    May 2015

 
The fair values of our forward contracts were as follows (in thousands):

 
September 30, 2014
 
Derivatives designated as hedging instruments
 
Total Net
 
Assets
 
Liabilities
 
Liabilities
Forward contracts
  $ -   $ 625     $ 625
                     
 
December 31, 2013
 
Derivatives designated as hedging instruments
 
Total Net
   
Assets
 
Liabilities
 
Liabilities
Forward contracts
  $ 253   $ 549     $ 296
 
The net asset and liability derivatives at September 30, 2014 and December 31, 2013 are reported in the consolidated balance sheet as current and long-term foreign currency exchange contracts.






 
-12-

 
 
AMBASSADORS GROUP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
9. Accumulated Other Comprehensive Income (Loss)

Unrealized gains or losses related to derivative securities are recorded in accumulated other comprehensive income (“AOCI”). The change in unrealized gains or losses related to derivative securities are recorded in other comprehensive income net of income taxes in the period the change occurred. When derivative securities designated as cash flow hedges are used to pay vendors, the effective portion of the hedge is reclassified into the income statement and recorded in net revenue, non-directly delivered programs.

Unrealized gains or losses related to available-for-sale securities are recorded in AOCI. The change in unrealized gains or losses related to available-for-sale securities are recorded in other comprehensive income net of income taxes in the period the change occurred. When securities are sold and a realized gain or loss is recognized, the amount is reclassified from AOCI to the income statement and recorded in interest and dividend income. During the nine months ended September 30, 2014 and 2013, the Company recognized net realized losses of $19 thousand and $120 thousand, respectively, due to the sale of investments.
 
For the three months ended September 30, 2014 and 2013, a summary of AOCI balances and gains (losses) recognized in OCI are as follows (in thousands):

 
Accumulated Other Comprehensive Income (Loss)
 
 
Derivative Securities
   
Available-for-sale securities
 
 
Three months ended
   
Three months ended
 
 
September 30,
   
September 30,
 
 
2014
   
2013
   
2014
   
2013
 
Balance, beginning of period
$ 164     $ (267 )   $ (90 )   $ (366 )
Change before reclassification
  (690 )     253       12       (24 )
Reclassification into net revenue, non-directly delivered programs
  5       (67 )     -       -  
Reclassification into interest and dividend income
  -       -       (14 )     70  
Effect of incomes taxes
  (0 )     23       0       (25 )
Other comprehensive income (loss), net of income taxes
  (685 )     209       (2 )     21  
Balance, end of period
$ (521 )   $ (58 )   $ (91 )   $ (345 )
 
 
For the nine months ended September 30, 2014 and 2013, a summary of AOCI balances and gains (losses) recognized in OCI are as follows (in thousands):

 
Accumulated Other Comprehensive Income (Loss)
 
 
Derivative Securities
   
Available-for-sale securities
 
 
Nine months ended
   
Nine months ended
 
 
September 30,
   
September 30,
 
 
2014
   
2013
   
2014
   
2013
 
Balance, beginning of period
$ (192 )   $ 544     $ (357 )   $ (180 )
Change before reclassification
  (310 )     (482 )     272       (216 )
Reclassification into net revenue, non-directly delivered programs
  (19 )     (185 )     -       -  
Reclassification into interest and dividend income
  -       -       (6 )     79  
Effect of incomes taxes
  (0 )     65       0       (28 )
Other comprehensive income (loss), net of income taxes
  (329 )     (602 )     266       (165 )
Balance, end of period
$ (521 )   $ (58 )   $ (91 )   $ (345 )

 



 
 
-13-

 
 
AMBASSADORS GROUP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
10. Income Taxes

We regularly assess the need for a valuation allowance against our deferred tax assets. In making that assessment, we consider both positive and negative evidence related to the likelihood of realization of the deferred tax assets to determine, based on the weight of available evidence, whether it is more-likely-than-not that some or all of the deferred tax assets will not be realized. A significant piece of objective negative evidence we evaluated was our cumulative loss incurred during the three-year period ended June 30, 2014. Such objective evidence limits the ability to consider other subjective evidence such as our projections for future growth. As a result, we determined that the negative evidence outweighed the positive evidence as of June 30, 2014 and recorded a one-time, non-cash charge to income tax expense of approximately $0.7 million to establish a valuation allowance against our total U.S. deferred tax assets, net of U.S. deferred tax liabilities, almost all of which relates to the beginning of the year balance. This accounting treatment has no effect on our ability to utilize deferred tax assets such as loss carryforwards and tax credits to reduce future cash tax payments. We will continue to assess the likelihood that the deferred tax assets will be realizable at each reporting period and the valuation allowance will be adjusted accordingly

11. Stock-Based Compensation

Under our Equity Participation Plan (the “Plan”), we may grant stock-based incentive compensation awards to eligible employees (including officers), non-employee directors and consultants in the form of distribution equivalent rights, incentive stock options, non-qualified stock options, performance share awards, performance unit awards, restricted stock awards, restricted stock units awards, stock appreciation rights, tandem stock appreciation rights, unrestricted stock awards or any combination of the foregoing. As of September 30, 2014, we had 2,125,512 shares authorized under the Plan available for future stock-based compensation.

Stock Options

Under the terms of the Plan, options to purchase shares of our common stock are granted at a price set by the Compensation Committee of the Board of Directors (the “Compensation Committee”). The price is not to be less than the fair market value of the stock on the date of grant. The Compensation Committee establishes the vesting period of the awards, which is generally set at 25 percent per year for four years. Options may be exercised any time after they vest for a period up to 10 years from the grant date.

The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of options. Option valuation models require the input of highly subjective assumptions, particularly for the expected term and stock price volatility. The assumptions used to calculate the fair value of options granted are evaluated and revised, as necessary, to reflect market conditions and our experience. Our employee stock options do not trade on a secondary exchange; therefore, employees do not derive a benefit from holding stock options unless there is an appreciation in the market price of our stock above the grant price. Such an increase in stock price would benefit all shareholders commensurately.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in the three and nine months ended September 30, 2014 and 2013.
 
 
Three months ended 
September 30, 2014
 
Three months ended 
September 30, 2013
   
Nine months ended 
September 30, 2014
 
Nine months ended 
September 30, 2013
 
Expected dividend yield
  -      %   -   %       -    %     1.37    %
Expected stock price volatility
  41.94      %   -   %       47.98    %     54.66  
 
%
Risk-free interest rate
  2.47      %   -   %       2.31    %     2.08   %
Expected life of options
  4.15    
Years
  -   Years
 
    4.28  
Years
    4.56  
Years
Estimated fair value per option granted
$ 1.58        $           $ 1.61       $ 1.63    

 
 
 


 
-14-

 
 
AMBASSADORS GROUP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
The dividend yield is based on expected quarterly cash dividends paid to our shareholders. Expected stock price volatility is based on historical volatility of our stock. The risk-free interest rate is based on the implied yield available on U.S. Treasury zero-coupon issues with an equivalent remaining term. The expected term of the options represents the estimated period of time until exercise and is based on historical experience of similar awards, giving consideration to the contractual terms, vesting schedules and expectations of future employee behavior. Additionally, an annualized forfeiture rate of 14.08 percent is used as a best estimate of future forfeitures based on our historical forfeiture experience. Stock-based compensation expense will be adjusted in later periods if the actual forfeiture rate is different from the estimate.

A summary of option activity under the Plan as of September 30, 2014, and the changes during the nine months then ended is presented below:

 
Stock Options
 
Weighted-Average Exercise Price
 
Weighted-Average
Remaining Contractual
Life (years)
Outstanding at December 31, 2013
                   907,945
 
$
                         6.54
   
Granted
                   186,072
   
                         4.13
   
Forfeited / Expired
                  (510,450)
   
                         6.07
   
Exercised
                             -
   
                             -
   
Outstanding at September 30, 2014
                   583,567
 
$
                         6.17
 
                           7.45
Exercisable at September 30, 2014
                   214,348
 
$
                         9.21
 
                           4.86

 
During the nine months ended September 30, 2014, the total intrinsic value of stock options exercised was zero and the total fair value of options which vested was $0.8 million. During the nine months ended September 30, 2013, the total intrinsic value of stock options exercised was zero and the total fair value of options which vested was $1.0 million. Compensation expense recognized in the consolidated statement of operations for stock options was $0.1 million for the three months ended September 30, 2014 and 2013, respectively, before the effect of income taxes. Compensation expense recognized in the consolidated statement of operations for stock options was $0.5 million and $1.0 million for the nine months ended September 30, 2014 and 2013, respectively, before the effect of income taxes. As of September 30, 2014, total unrecognized stock-based compensation expense related to non-vested stock options was approximately $0.4 million, which is expected to be recognized over approximately 3.83 years.

 
 
-15-

 
 
AMBASSADORS GROUP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
Restricted Stock Grants

Restricted stock awards and restricted stock units may be granted under the Plan by the Compensation Committee. The Compensation Committee also establishes the vesting period of the awards, which is generally set at 100 percent at the conclusion of one to four years for restricted stock awards. Restricted stock units generally vest pro rata at 25 percent each year over a four year vesting period. Our key employees who have been granted awards are typically subject to a four year vesting period, while members of our Board of Directors who have been granted awards are subject to a one year vesting period. The fair value of restricted stock awards and restricted stock units is based on the market price of our shares on the grant date.

A summary of the activity of non-vested restricted stock awards and restricted stock units under the Plan as of September 30, 2014, and the changes during the nine months then ended is presented below:
 
 
 
Restricted Stock Awards
 
Restricted Stock Units
 
Restricted Stock
Awards
 
Weighted-
Average Grant
Date Fair Value
 
Weighted-
Average
Remaining Contractual
Life (years)
 
Restricted Stock
Units
 
Weighted-
Average Grant
 Date Fair Value
 
Weighted-
Average
Remaining Contractual
 Life (years)
Balance at December 31, 2013
                   285,435
 
$
                         5.24
     
                      28,123
 
$
                 3.88
   
Granted
                     51,704
   
                         3.72
     
                      81,060
   
                 4.34
   
Forfeited
                    (13,364)
   
                         5.76
     
                    (12,689)
   
                 4.13
   
Vested
                  (190,335)
   
                         4.97
     
                      (9,555)
   
                 4.15
   
Balance at September 30, 2014
                   133,440
 
$
                         5.00
 
                           1.61
 
                      86,939
 
$
                 4.24
 
                              2.06
 
At September 30, 2014, the aggregate value of non-vested restricted stock awards and restricted stock units was $0.5 million and $0.3 million, respectively, before applicable income taxes, based on a $3.70 closing stock price at September 30, 2014. During the three months ended September 30, 2014 and 2013, the weighted-average grant date fair value of restricted stock awards, which vested was $0.1 million and $0, respectively. During the nine months ended September 30, 2014 and 2013, the weighted-average grant date fair value of restricted stock awards, which vested was $1.0 million and $2.0 million, respectively. Compensation expense recognized in the consolidated statement of operations for restricted stock awards and units was $0.1 million for the three months ended September 30, 2014 and 2013, before the effect of income taxes. Compensation expense recognized in the consolidated statement of operations for restricted stock awards and units was $0.8 million and $1.1 million for the nine months ended September 30, 2014 and 2013, respectively, before the effect of income taxes. As of September 30, 2014, total unrecognized stock-based compensation expense related to restricted stock awards and units was approximately $0.3 million and $0.3 million, respectively, which is expected to be recognized over approximately 3.83 years.
 
Performance Stock Awards

Under the terms of the Plan, performance stock awards may be granted by the Compensation Committee to key executive employees. Performance stock awards are based on achieving key internal metrics measured at the end of each fiscal year over a three year performance period. If performance objectives are achieved as determined by the Compensation Committee, common stock is granted. The fair value of these awards is determined on the date of grant based on our share price. Compensation expense related to performance stock units is evaluated quarterly to determine the likelihood that performance metrics will be achieved during the performance period.

 
 
-16-

 

AMBASSADORS GROUP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
 
A summary of the activity of performance stock units under the Plan as of September 30, 2014, and the changes during the nine months then ended is presented below:
 
 
Performance Stock
Units
 
Weighted-Average Grant Date Fair Value
 
Weighted-Average
Remaining Contractual
Life (years)
Balance at December 31, 2013
114,560
 
$
4.41
   
Granted
-
   
-
   
Forfeited
(78,514)
   
4.41
   
Vested
-
   
-
   
Balance at September 30, 2014
36,046
 
$
4.41
 
2.25

During the three and nine months ended September 30, 2014, no performance stock units were granted. Performance stock units outstanding on September 30, 2014 are payable upon the achievement of certain internal metrics over a performance period of January 1, 2014 through December 31, 2016. As of September 30, 2014, no compensation expense related to performance share unit awards was recognized.
 
12. Net Income (Loss) per Share

The following table presents a reconciliation of basic and diluted income (loss) from continuing operations per share computations (in thousands, except per share data and anti-dilutive stock option counts):
 
 
Three months ended 
September 30,
   
Nine months ended
 September 30,
 
 
2014
 
2013
   
2014
   
2013
 
Numerator:
                   
Net income (loss) from continuing operations
$ 1,912   $ (1,803 )   $ (1,284 )   $ (2,190 )
                             
Denominator:
                           
   Weighted-average shares outstanding
  16,903     16,984       16,827       16,982  
     Effect of unvested restricted stock awards
     considered participating securities
  138     -       -       -  
   Weighted-average shares outstanding – basic
  17,041     16,984       16,827       16,982  
     Effect of dilutive common stock options
  -     -       -       -  
     Effect of dilutive restricted stock units
  5     -       -       -  
   Weighted-average shares outstanding – diluted
  17,046     16,984       16,827       16,982  
                             
Net income (loss) per share - basic
$ 0.11   $ (0.11 )   $ (0.08 )   $ (0.13 )
                             
Net income (loss) per share - diluted
$ 0.11   $ (0.11 )   $ (0.08 )   $ (0.13 )
                             
Cash dividends declared per share1
$ -   $ -     $ -     $ 0.06  
                             
Stock options and restricted stock units excluded from the calculation of diluted earnings per share because their effect would have been anti-dilutive
  658,000     782,000       751,000       1,319,000  

 
1The Company suspended quarterly dividend payments during the second quarter of 2013.

13. Supplemental Disclosures of Consolidated Statements of Cash Flows

Our non-cash investing and financing activities during the three and nine months ended September 30, 2014 and 2013 were as follows (in thousands):
 
 
September 30, 2014
   
September 30, 2013
 
Unrealized loss on foreign currency exchange contracts
$ (329 )   $ (927 )
Unrealized income (loss) on available-for-sale securities
$ 265     $ (254 )

 


 
 
-17-

 
 
AMBASSADORS GROUP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
14. Line of Credit

The Company’s credit agreement with Wells Fargo expired on June 1, 2014 and was not renewed.

15.  Commitments and Contingencies

On May 7, 2014, Anthony F. Dombrowik, our former interim Chief Executive Officer and Chief Financial Officer, was terminated by the Board of Directors.  In connection with Mr. Dombrowik’s departure, we entered into a separation agreement effective May 7, 2014. The separation agreement required cash payouts of approximately $0.4 million to be made to Mr. Dombrowik, all of which was fully expensed during the second quarter of 2014 although approximately $0.4 million remained to be paid during the 8 months following June 30, 2014.  Additionally, the separation agreement called for the immediate vesting of stock options and stock grants for Mr. Dombrowik in the amount of $0.2 million.
 
We are not a party to any material pending legal proceedings other than ordinary routine litigation incidental to our business, the outcome of which we believe will not have a material adverse effect on our business, financial condition, cash flows or results of operations.

We are subject to the possibility of various loss contingencies, including claims, suits and complaints, arising in the ordinary course of business. We consider the likelihood of loss or impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in determining loss contingencies. An estimated loss contingency is accrued when it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. We regularly evaluate current information available to us to determine whether such accruals should be adjusted and whether new accruals are required.

Under our Bylaws, our directors and officers have rights to indemnification by us against certain liabilities that may arise by reason of their status or service as directors or officers. We maintain director and officer insurance, which covers certain liabilities arising from our obligation to indemnify our directors and officers and former directors in certain circumstances. No material indemnification liabilities were accrued at September 30, 2014.
 
 
 
 
-18-

 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto included in this Quarterly Report on Form 10-Q.
 
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 Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “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. For a detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements, please refer to Item 1A Risk Factors disclosure in our Annual Report on Form 10-K filed on March 27, 2014. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.

Introduction

Ambassadors Group, Inc. is a leading provider of educational travel experiences primarily engaged in organizing and promoting worldwide educational travel programs for students through a direct to consumer revenue model. We operate student and adult 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 under the People to People brand is international destination trips for U.S. students in the 11 to 17 year old age group (“Student Ambassador Program”). Student Ambassador Programs make up the majority of our program offerings and are the center of our strategic focus. However, under the People to People brand, we also offer domestic destination travel programs for U.S. students and international students focused on leadership and education (“Leadership Ambassador Program”), as well as professional travel programs for adults (“Citizen Ambassador Program”).

Prior to September 2014, we operated BookRags (www.bookrags.com), an education oriented research website, which provided study guides, lesson plans and other educational resources to students and teachers. This wholly-owned subsidiary was sold in September 2014, and results of operations have been reflected as discontinued operations for all periods presented.

Our operating results depend primarily on the number of travelers who 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 our gross revenue and cost of sales are typically at their highest levels in the second and third quarters. Our marketing and sales efforts are conducted year-round and expenses are recognized when incurred.  Revenue associated with these marketing and sales expenses are generally recognized in the second and third quarter of the following fiscal year upon delegate travel.



 
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Executive Summary

Our year-to-date results reflect several initiatives intended to streamline the organization and continue our business focus toward our core Student Ambassadors programs.  We executed and finalized the sale of BookRags for $5.0 million in September 2014, and believe we will close a purchase and sale agreement related to our corporate headquarters building during the fourth quarter of 2014 for $8.8 million less costs associated with closing.  Upon sale, we will enter into a short-term lease contract to remain in our current location.

The number of enrollments for the Company’s 2015 travel season resulting from our fall 2014 marketing campaign indicates a decline in net travelers and revenue in 2015 compared to 2014.  The Company’s marketing programs and sales initiatives are heavily concentrated in the fall of the year before the summer travel season. Based on the results to date of the 2014 fall marketing campaign, we anticipate that 2015 revenue will be lower than 2014.

 
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Results of Operations

Comparison of the Three and Nine Months Ended September 30, 2014 with the Three and Nine Months Ended September 30, 2013

Financial results from continuing operations for the three and nine months ended September 30, 2014 and 2013 were as follows (in thousands):
 
 
Three Months Ended September 30,
 
 
2014
   
2013
   
$ Change
   
% Change
 
Total revenue
$ 16,714     $ 21,367     $ (4,653 )   -22 %
Cost of goods sold
  3,372       4,128       (756 )   -18 %
Gross margin
  13,342       17,239       (3,897 )   -23 %
   Selling and marketing expenses
  8,369       9,224       (855 )   -9 %
General and administrative expenses
  2,418       2,676       (258 )   -10 %
Restructuring costs
  217       1,756       (1,539 )   -88 %
Asset impairments
  350       6,461       (6,111 )   -95 %
Operating income (loss)
  1,988       (2,878 )     4,866     169 %
Other income
  82       71       11     15 %
Income (loss) before income tax benefit (provision)
  2,070       (2,807 )     4,877     174 %
Income tax benefit (provision)
  (158 )     1,004       (1,162 )   -116 %
Net income (loss) from continuing operations
$ 1,912     $ (1,803 )   $ 3,715     206 %
 
 
 
Nine Months Ended September 30,
 
 
2014
   
2013
   
$ Change
   
% Change
 
Total revenue
$ 38,761     $ 46,714     $ (7,953 )   -17 %
Cost of goods sold
  6,370       7,053       (683 )   -10 %
Gross margin
  32,391       39,661       (7,270 )   -18 %
   Selling and marketing expenses
  20,868       24,275       (3,407 )   -14 %
General and administrative expenses
  8,647       11,007       (2,360 )   -21 %
Restructuring costs
  1,756       1,756       -     0 %
Asset impairments
  2,350       6,461       (4,111 )   -64 %
Operating loss
  (1,230 )     (3,838 )     2,608     68 %
Other income
  362       379       (17 )   -4 %
Loss before income tax benefit (provision)
  (868 )     (3,459 )     2,591     75 %
Income tax benefit (provision)
  (416 )     1,269       (1,685 )   -133 %
Net income (loss) from continuing operations
$ (1,284 )   $ (2,190 )   $ 906     41 %
 
 
During the third quarter of 2014, we traveled 6,808 delegates compared to 8,140 delegates during the prior year period primarily due to lower delegates traveled on our core Student Ambassadors programs.  The prior year period includes 536 Discovery Student Adventures (“DSA”) and People to People China (“China”) traveled students affecting year-over-year comparability given our decision during the third quarter of 2013 to no longer operate these programs in 2014. Total revenue from continuing operations of $16.7 million declined 21.8 percent from $21.4 million in the prior year quarter driven by lower travel-related revenue. Gross margin from continuing operations for the quarter was $13.3 million compared to $17.2 million in the third quarter of 2013, and gross margin percentage was 33.7 percent compared to 36.8 percent in the prior year period.  The lower current period gross margin percentage is reflective of higher foreign exchange rates, a higher ratio of teacher leaders to traveling students, and lower overall traveling group sizes negatively impacting land vendor program costs year-over-year.
 
During the nine months ended September 30, 2014, we traveled 15,711 delegates compared to 17,940 delegates during the same period in the prior year. The prior period includes 816 DSA and China traveled students affecting year-over-year comparability given the Company’s decision to not operate these programs in 2014.  Total revenue from continuing operations of $38.8 million declined 17.0 percent from $46.7 million in the same period last year driven by the decline in travelers.  Gross margin from continuing operations for the nine months ended September 30, 2014 was $32.4 million, down from $39.7 million in the same period last year, with gross margin percentage at 33.4 percent compared to the prior year at 36.0 percent.  The lower current period gross margin percentage is reflective of higher land vendor costs as discussed in the preceding paragraph, as well as an inventory write-down during the year 2014.
 
 
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Selling and marketing expenses decreased approximately $0.9 million, or 9 percent, during the three months ended September 30, 2014 to $8.4 million compared to the same period in 2013, mainly due to an overall reduction in personnel and marketing spend.  General and administrative expenses decreased approximately $0.3 million, or 10 percent, during the three months ended September 30, 2014 to $2.4 million compared to the same period in 2013, primarily due to reductions in executive overhead and salaries as a result of reductions in personnel. Additionally, we incurred approximately $0.2 million in additional restructuring charges and recorded $0.4 million to asset impairments related to the sale of our corporate headquarters during the three months ended September 30, 2014, compared to $1.8 million recorded to restructuring costs as well as $6.5 million in asset impairments primarily related to our corporate headquarters during the third quarter of 2013.
 
Selling and marketing expenses decreased approximately $3.4 million, or 14 percent, to $20.9 million during the nine months ended September 30, 2014 compared to the same period in 2013, due to a purposeful reduction in marketing spend reflecting primarily a smaller winter and spring marketing campaign compared to one year ago, as well as lower personnel expenditures. General and administrative expenses decreased approximately $2.4 million, or 21 percent, to $8.6 million during the nine months ended September 30, 2014 compared to the same period in 2013, primarily due to lower separation and other related benefit expenses year over year.  Additionally, we incurred approximately $1.8 million in restructuring charges and $2.4 million in asset impairments during the nine months ended September 30, 2014, compared to $1.8 million and $6.5 million during the nine months ended September 30, 2013, respectively.

During the third quarter of 2014, we completed the sale of BookRags and have reflected those results as discontinued operations for all periods presented.  During the third quarter of 2014, we recorded income from discontinued operations of $0.4 million compared to $0.2 million during the comparable prior year period.  During the first nine months of 2014, we recorded a loss from discontinued operations of $8.1 million compared to income of $0.6 million recorded during the first nine months of 2013.  The current year period includes the $9.7 million goodwill impairment charge recorded during the second quarter of 2014.

During the first nine months of 2014, we recorded a valuation allowance against our deferred tax asset due to the loss recorded in the current period.  This allowance resulted in a reduced net income tax benefit of approximately $0.8 million recorded for the first nine months of 2014. The result is an effective income tax rate of 7.6 percent. The difference from the statutory rate of 34 percent during 2014 was a result of the valuation allowance. For additional information, see Note 10 to Consolidated Financial Statements. For the first nine months of 2013, we recorded an income tax benefit using an effective income tax rate of 36.9 percent applied to pre-tax income. The difference from the statutory rate of 34 percent during 2013 was primarily due to the impact of tax exempt interest income on projected net loss for the year ending December 31, 2013.
 
Key Performance Non-GAAP Financial Indicators

We analyze our performance on a net income, cash flow and liquidity basis in accordance with 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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Net Enrollments
 
Net enrollments on a forward looking basis consist of all active participants, which we define as those who have enrolled in our programs, including travel that has already been completed, less those who have already withdrawn for the travel year referenced. This is a point in time measurement that we use as an indication of expected future gross revenues for our travel programs
 
     
As of November 2, 2014 and 2013
     
Delegates
Enrollment detail for travel year
   
2015
 
2014
Change
% Change
Student Ambassadors
   
                     10,246
 
                     15,853
                       (5,607)
-35.4%
Total, all programs
   
                     12,115
 
                     17,955
                       (5,840)
-32.5%
 
 
 Deployable Cash

We use deployable cash as a liquidity measure, which 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 capital deployment. 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 our business.
     
    Deployable Cash Reconciliation (in thousands)
 
 
September 30,
   
December 31,
 
 
2014
   
2013
   
2013
 
Cash, cash equivalents and short-term available-for-sale securities
$ 47,136     $ 41,015     $ 45,647  
Prepaid program cost and expenses
  2,597       7,090       7,069  
Less: Participants’ deposits
  (9,493 )     (9,847 )     (26,362 )
Less: Accounts payable / accruals / other liabilities
  (6,646 )     (9,129 )     (3,706 )
Deployable cash
$ 33,594     $ 29,129     $ 22,648  
 
Free Cash Flow

Free cash flow is calculated as cash flow from operations less the 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.

Free Cash Flow Reconciliation (in thousands)
 
Nine months ended September 30,
 
 
2014
   
2013
   
$ Change
 
Net cash provided by (used in) operating activities
$ (1,712 )   $ 9,256     (10,968 )
Purchase of property, equipment and intangibles
  (1,391 )     (2,664 )   1,273  
Free cash flow
$ (3,103 )   $ 6,592     (9,695 )
 
 
Liquidity and Capital Resources
 
Total assets at September 30, 2014 were $64.4 million, of which 73 percent, or $47.1 million, were cash, cash equivalents and short-term available-for-sale securities, and $8.4 million was classified as an asset held for sale related to our corporate headquarters anticipated to be finalized during the fourth quarter of 2014. At September 30, 2014, long-lived assets totaled $4.5 million primarily related to technology hardware and systems.  During the third quarter of 2014, we recorded $0.4 million in other long-term assets related to funds held in escrow under the terms of the BookRags purchase and sale agreement.  Total liabilities at September 30, 2014 were $16.9 million, including $9.5 million in participant deposits for future travel.
 
 
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Net cash used in operations was $1.7 million during the nine months ended September 30, 2014 compared to net cash provided by operations of $9.3 million during the nine months ended September 30, 2013.  This $10.7 million decrease was primarily due to higher net loss.
 
Net cash used in investing activities was $3.9 million during the first nine months of 2014 compared to $7.0 million during the first nine months of 2013. The current year period reflects cash proceeds of $4.6 million from the sale of BookRags.
 
Net cash used in financing activities was $0.3 million and $3.6 million during the nine months ended September 30, 2014 and 2013, respectively.  The prior year period included excess tax benefits associated with the cancellation of expired stock compensation benefits and the repurchase of our common stock through buybacks and share surrenders of $2.6 million compared to $0.3 million in the current year period. In addition, the prior year period included $1.0 million paid in stockholder dividends that did not recur in 2014.
 
Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported disclosures of assets, liabilities, revenue and expenses. Our estimates are based on our experience and our interpretation of economic, political, regulatory, and other factors that affect our business.  We consider that our most critical accounting estimates are related to the valuation of available-for-sale securities, valuation of goodwill, intangible assets, and long-lived assets, foreign currency exchange contracts, revenue recognition, and contingencies and litigation as they require us to make assumptions that may be highly uncertain at the time the accounting estimates were made and changes in them are reasonably likely to occur from period to period.  There are other items within our consolidated financial statements that require estimation but are not deemed to be critical.  Changes in estimates used in these and other items could have a material impact on our consolidated financial statements. For a more complete discussion, please refer to our consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K filed on March 27, 2014.
 
 
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Item 4. Controls and Procedures
 
(a) Evaluation of disclosure controls and procedures
 
As of September 30, 2014, the end of the period covered by this report, our interim chief executive officer and principal financial officer reviewed, evaluated and concluded that our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e) and 15d-15(e)) were effective. These controls and procedures are designed to ensure information required to be disclosed in our Form 10-Q filed or submitted under the Exchange Act is recorded, processed, summarized, and reported on a timely basis, and has been accumulated and communicated to our management including our interim chief executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
 
(b) Changes in internal control over financial reporting
 
In the nine months ended September 30, 2014, there was no change in our internal control over financial reporting that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
 
 
 
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OTHER INFORMATION

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On various dates between May 2004 and May 2011, our Board of Directors authorized the repurchase of shares of our Common Stock in the open market or through private transactions (the “Repurchase Plan”). During the quarter ended September 30, 2014, there were no shares repurchased under the Repurchase Plan. As of September 30, 2014, approximately $13.1 million was available to repurchase shares of our Common Stock under the Repurchase Plan.

Item 6. Exhibits
 

 
10.1
Stock Purchase Agreement dated as of September 6, 2014 by and between GradeSaver, LLC and Ambassadors Group, Inc., incorporated by reference to the Company’s Current Report on Form 8-K filed September 9, 2014.
   
         
 
31.1  
Certification under Section 302 of the Sarbanes-Oxley Act of 2002. (1)
   
         
 
31.2
Certification under Section 302 of the Sarbanes-Oxley Act of 2002. (1)
   
         
 
32.1  
Certification under Section 906 of the Sarbanes-Oxley Act of 2002. (2)
   
 
 
(1) Filed herewith.

(2) This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that Section.  Such exhibit shall not be deemed incorporated into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.

 
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SIGNATURES
 
Pursuant to the requirements 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.
 
 
.
 
   
AMBASSADORS GROUP, INC
 
Date: November 13, 2014
By:
/s/ PHILIP B. LIVINGSTON
   
Philip B. Livingston,
   
Interim Chief Executive Officer
(Principal Executive Officer)
   
 


 
 
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EXHIBIT INDEX
 
 
         
 
10.1
Stock Purchase Agreement dated as of September 6, 2014 by and between GradeSaver, LLC and Ambassadors Group, Inc., incorporated by reference to the Company’s Current Report on Form 8-K filed September 9, 2014.
   
         
 
31.1  
Certification under Section 302 of the Sarbanes-Oxley Act of 2002. (1)
   
 
 
31.2
Certification under Section 302 of the Sarbanes-Oxley Act of 2002. (1)
   
         
 
32.1  
Certification under Section 906 of the Sarbanes-Oxley Act of 2002. (2)
   
 
(1) Filed herewith.
 
(2) This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that Section.  Such exhibit shall not be deemed incorporated into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.