10-K 1 form10k2006.htm FORM 10K 2006 Form 10K 2006
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K
 
ý
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
 
 
For the fiscal year ended December 31, 2006
 
 
 
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

(Exact Name of Registrant as Specified in Its Charter)
 
Delaware
 
91-1957010
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
Dwight D. Eisenhower Building
110 S. Ferrall Street
Spokane, WA
 
99202
(Address of Principal Executive Offices)
 
(Zip Code)
 
Registrant’s telephone number, including area code: (509) 534-6200
 
Securities registered pursuant to Section 12(b) of the Act:
   
Common Stock, $.01 Par Value
 
The Nasdaq Stock Market
(Title of Class)
 
(Name of each exchange on which registered)
 
Securities registered pursuant to Section 12(g) of the Act:
 
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o            Yes
ý            No




Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
o            Yes
ý            No

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.
ý            Yes
o            No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
o            Large Accelerated filer
ý            Accelerated filer
o            Non-Accelerated filer
 
 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
 
 
o 
 
Yes
 
 
ý 
 
No

The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sales price of the Common Stock on The Nasdaq Stock Market on June 30, 2006, was $269,091,710. Shares of Common Stock held by each executive officer and director, and by each entity that owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The number of shares of the registrant’s Common Stock outstanding as of March 6, 2007 was 19,374,841.
 
DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement relating to the 2007 Annual Meeting of Stockholders are incorporated by reference into Part III of this Annual Report on Form 10-K to the extent stated herein.
 




TABLE OF CONTENTS
 
 
Page
 
 
 
 
Item 1.
Business
 1
 
 
 
Item 1A.
Risk Factors
 8
 
 
 
Item 1B.
Unresolved Staff Comments
12
 
 
 
Item 2.
Properties
12
 
 
 
Item 3.
Legal Proceedings
12
 
 
 
Item 4.
Submission of Matters to a Vote of Security Holders
12
 
 
 
 
 
 
 
Item 5.
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
13
 
 
 
Item 6.
Selected Financial Data
17
 
 
 
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operation
21
 
 
 
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
29
 
 
 
Item 8.
Financial Statements and Supplementary Data
29
 
 
 
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
30
 
 
 
Item 9A.
Controls and Procedures
31
 
 
 
Item 9B.
Other Information
33
     
 
 
 
 
Item 10.
Directors, Executive Officers and Corporate Governance
33
 
 
 
Item 11.
Executive Compensation
33
 
 
 
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
33
 
 
 
Item 13.
Certain Relationships and Related Transactions, and Director Independence
33
 
 
 
Item 14.
Principal Accountant Fees and Services
33
 
 
 
 
 
 
 
Item 15.
Exhibits, Financial Statement Schedules
34
   
Signatures
II-1
 



Forward-Looking Statements
 
Statements contained in this Annual Report on Form 10-K of Ambassadors Group, Inc., which are not historical in nature, 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 (the “Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements include, without limitation, statements that relate to expectations concerning matters that are not historical facts. Words such as “projects,” “believes,” “anticipates,” “plans,” “expects,” “intends,” and similar words and expressions are intended to identify forward-looking statements. These forward-looking statements reflect our beliefs or current expectations with respect to, among other things, trends in the travel industry, our business and growth strategies, our use of technology, our ability to integrate acquired businesses, and fluctuations in our results of operations.
 
Forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from anticipated results. These risks and uncertainties include factors affecting the travel industry generally, competition, our ability to successfully integrate the operations of existing or acquired companies, and a variety of factors such as conflict in Iraq and the Middle East, periods of international unrest, the outbreak of disease, changes in the direct-mail environment, recession, weather conditions and concerns for passenger safety that could cause a decline in travel demand, as well as the risk factors set forth in Item 1A and other factors as may be identified from time to time in our filings with the Securities and Exchange Commission (the “SEC”) or in our press releases. All forward-looking statements are expressly qualified in their entirety by these factors and all related cautionary statements. We do not undertake any obligation to update any forward-looking statements.
 
 
Item 1.           Business
 
Business Overview
 
Ambassadors Group, Inc. (“Ambassadors”, “we”, “us” or “our”) is a leading educational travel company that organizes and promotes international and domestic programs for students, athletes and professionals. We were founded in 1967, were reincorporated in Delaware in 1995, and operated as Ambassadors Education Group, a wholly owned subsidiary of Ambassadors International, Inc. (“International”) until February 2002. Effective February 28, 2002, we spun off from International by virtue of a special stock dividend to International’s shareholders of all of the outstanding shares of our Company that International owned (the “Distribution”). Beginning March 1, 2002, we began operating as an independent stand-alone company. Trading of our Common Stock on The Nasdaq Stock Market began on March 1, 2002 under the symbol “EPAX.”
 
Our business consists of several specialized private-label educational travel programs, including (i) the “People to People Student Ambassador Programs” (“Student Ambassador Programs”), which provide opportunities for grade school, middle school and high school students to visit domestic and foreign destinations to learn about the history, government, economy and culture of such countries, (ii) the “People to People Sports Ambassador Programs” (“Sports Ambassador Programs”), which provide opportunities for middle school and high school athletes to participate in international sports challenges, (iii) the “People to People Leadership Summit,” “People to People Future Leaders Summit,” and “World Leadership Forum” (“Student Leader Programs”), which provide domestic travel experiences for grade school and high school students emphasizing leadership, community involvement, and government education, and (iv) the “People to People Ambassador Programs” (“Professional Ambassador Programs”), which provide foreign travel experiences for professionals, with emphasis on meetings and seminars between delegates and persons in similar professions abroad.
 
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Since International’s initial public offering in 1995, we expanded our operations primarily through internal growth and two acquisitions of travel related businesses. Since 1983, we have organized programs for more than 344,000 students, adults and athletes. Our educational travel programs feature visits abroad, including, but not limited to, Antarctica, Australia, China, France, Germany, Great Britain, Italy, South Africa, and New Zealand. In 2006, 43,075 delegates traveled on our programs to more than 40 countries on seven continents, including students from 70 different countries.

We have the exclusive right from People to People International (“People to People”) to develop and conduct student programs for kindergarten through high school students using the People to People name. We also have the non-exclusive right to develop, market and operate programs for professionals, college students and athletes using the People to People name. However, at the present time, we are the only entity that has been given this right by People to People. These rights, granted pursuant to agreements with People to People, expire in 2010 and, at our election, may be extended through 2020. People to People is a private, non-profit organization dedicated to the promotion of world peace through cultural exchange.

People to People was founded by President Dwight D. Eisenhower in 1956 and was originally administered by the U.S. State Department. Eight U.S. Presidents since President Eisenhower have served as honorary chairman of People to People, including President George W. Bush, who currently holds that position. Mary Eisenhower, the president and chief executive officer of People to People, also continues her grandfather’s legacy by serving the organization.

We believe that our 40 years of continuous experience, relationships arising from organizing travel programs, and our association with People to People have provided the foundation for our Company. This foundation allows us to develop and maintain strong strategic alliances and a competitive edge in the educational and travel industries at a competitive program cost. This foundation also allows us to provide high quality and unique educational programs and customer service. We intend to continue to grow our business internally through marketing enhancements, new programs and strategic alliances, and may make selective acquisitions of and or joint agreements with travel, education, and direct marketing related businesses.
 
Our principal offices are located in Spokane, Washington USA.
 
Student Ambassador Programs
 
Our Student Ambassador Programs provide an educational opportunity for students in grade school, middle school and high school to travel to one or more foreign countries or domestically, to learn about the history, government, economy and culture of such countries. We market our Student Ambassador Programs through a combination of direct mail and local informational meetings primarily from August through November. Our representatives review candidate applications and conduct selection interviews throughout the country. Accepted applicants participate in orientation meetings to prepare for their educational travel programs.
 
Our Student Ambassador Program delegations depart primarily during the summer months, June through August, and generally travel for approximately 14 to 23 days, during which time each delegation visits one or more countries. Each delegation generally consists of approximately 30 to 40 students and is accompanied by several teachers and local delegation leaders/guides in each country who assist the delegations for the duration of each program. Teachers and students comprising a delegation generally come from the same locale.
 
Programs are designed by our staff of international planners and researchers to provide an educational and entertaining travel experience by exposing students to the history, government, economy and culture of the country or countries visited. We have contracts with program coordinators to provide day-to-day coordination and oversight of the programs. In many instances, we also provide students with the opportunity for a home stay (a brief stay with a host family), which gives students a glimpse of daily life in the visited country.
 
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Students who complete certain written assignments and other projects can receive high school and university credit for their participation in the program. Universities recognizing academic credit include, but are not limited to, Stanford University, Princeton University, Yale University, the University of California, Los Angeles, the University of Washington, MIT (Massachusetts Institute of Technology), Brown University, Johns Hopkins University, Columbia University, Cornell University, Dartmouth College, and Georgetown University. In addition, high school students who successfully complete the program may be eligible to receive service learning credits, which have become a high school graduation requirement in many curricula countrywide.

Sports Ambassador Programs
 
Our Sports Ambassador Programs provide an opportunity for student athletes in middle school and high school to explore the host country’s culture and to participate in international tournaments with teams from across the world in up to eight different sports. We market our Sports Ambassador Programs through a combination of direct mail and local informational meetings during the months of January to March. Interested athletes apply to the program and are interviewed by our representatives, after which the selected athletes are accepted for the program.
 
Delegates in the Sports Ambassador Programs depart during the summer months, June through August, and travel for approximately nine to fourteen days. Teams are formed based on gender and age, and most teams comprise athletes from several different states. During a three to four day training camp, all athletes participate in an individual skill assessment, after which rosters are formed to ensure balanced and competitive teams. After the formation of rosters, the rest of the training camp focuses on team practice and fundamentals in preparation for the ensuing tournament competition. In each tournament, we have contracts with overseas tournament organizers to provide day-to-day coordination and oversight of the programs. Additionally, athletes participate in sports nutrition, psychology, leadership, physical training, and international cultural excursions.
 
Athletes who complete certain written assignments and projects can receive university credit for their participation in the program. Universities recognizing academic credit include, but are not limited to, Stanford University, Princeton University, Yale University, the University of California, Los Angeles, the University of Washington, MIT (Massachusetts Institute of Technology), Brown University, Johns Hopkins University, Columbia University, Cornell University, Dartmouth College, and Georgetown University.

Student Leader Programs

Our Student Leader Programs provide the opportunity for motivated students with academic promise, leadership potential and a desire to serve their communities to travel domestically and internationally to exchange ideas with renowned speakers, field specific experts, professional educators and their peers. This program is specifically designed for students in middle school and high school. In addition to the academic coursework, delegates engage in specially designed team-building and leadership-building exercises.

We market the Student Leader Programs through a direct mail marketing effort throughout the year, and they travel throughout the year for approximately seven to ten days. They include group discussions, workshops, educational meetings and other social and recreational activities. Programs originate from our internal marketing and research staff, who identify academic topics, speakers and facilitators. During 2005 we began to organize and operate all activities of most of our Student Leader Programs, including speakers, facilitators, events, accommodations and transportation. Previously, these activities were provided by outside vendors.

Delegates traveling on these programs may receive transferable high school or university credits as part of the academic program. Universities recognizing academic credit include, but are not limited to, Stanford University, Princeton University, Yale University, the University of California, Los Angeles, the University of Washington, MIT (Massachusetts Institute of Technology), Brown University, Johns Hopkins University, Columbia University, Cornell University, Dartmouth College, and Georgetown University. In addition, students who successfully complete the program may be eligible to receive service learning credits, which have become a high school graduation requirement in many curricula countrywide.
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Professional Ambassador Programs
 
Our Professional Ambassador Programs provide professionals with common interests the opportunity to travel abroad to meet and exchange ideas with foreign citizens who have similar backgrounds, interests or professions. Professional Ambassador Programs are developed and travel throughout the year. Direct mail invitations are sent to candidate delegates approximately six to eight months prior to the travel period for the delegation. Each program is designed to meet the interests of the individual delegates, and travel for eight to twelve days, with an optional additional cultural exchange following each program. Programs originate from our internal development and research staff, who identify potential delegation topics and leaders. Professional programs have been conducted in such areas as agriculture, economics, education, law, medicine and science. Many of our professional programs provide continuing educational credit for the delegates as part of the program experience. Continuing education credits are granted through alliances with professional and academic institutions, including the American College of Medical Quality, the University of Pittsburgh, the American Bar Association, many state bar associations and other
professional associations and societies.

We believe that our Professional Ambassador Programs provide delegates with enriching experiences and deeper understandings of foreign cultures and people than visits arranged independently or through travel agencies. Unlike travel programs provided by travel agencies, these professional exchanges are intended largely as working programs, with a significant amount of the participant’s time involved in organized meetings, seminars and round-table discussions with their foreign counterparts, visits to major foreign facilities and institutions, and informal gatherings with foreign counterparts. Each program is led by a delegation leader chosen by us based upon his or her recognition in the field and expertise regarding the special focus of the particular program.
 
Academic Accreditation
 
Since 2004, we have been academically accredited through the Northwest Association of Accredited Schools. We developed the Washington School of World Studies to provide an opportunity for middle school, junior high and high school students to earn academic credit through their participation in the Student Ambassador Programs, Sports Ambassador Programs or Student Leader Programs. The courses offered by the Washington School of World Studies emphasize the total learning experience of the participant while preparing for and participating in the selected program. In addition to elective academic credit, students are eligible to earn service learning credits on select programs after successfully completing the course requirements.

Our delegates are also able to earn academic credit through Eastern Washington University’s Eisenhower Center (“EWU”). Student Ambassadors in grades nine through 12 may enroll in EWU courses and earn up to 12 credits. In addition, Student Ambassadors in grades seven and eight are eligible to earn one credit per course. Between 1980 and 2006, Student Ambassadors transferred more than 41,300 college credits from EWU to the university of their choice.

Strategic Alliances

Alliances with Students on Ice, Inc. and Full On (Europe) Limited provide adventure and quality for our Student and Professional Ambassador Programs. These agreements prescribe the nature, scope and pricing of the travel services provided to our delegates. Alliances with SafeTravel, Inc. exhibit our adherence to safety on all our programs.

We have also entered into alliances with the American College of Medical Quality, the American Bar Association and the University of Pittsburgh to provide continuing education credits on our Professional Ambassador Programs.

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Service Marks
 
We have registered or applied for a variety of service and trademarks, including, but not limited to, the names “People to People Ambassador Programs,” “Ambassador Programs,” “Initiative for Understanding,” “People to People Student Ambassador Programs,” “People to People Sports Ambassador Programs,” and “World Leadership Forum.” In addition, we have the right, subject to certain exceptions, to use People to People’s name, service mark and logo for use in our marketing. We believe that the strength of our service and trademarks is valuable to our business and intend to continue to protect and promote our marks as appropriate. We believe that our business is not overly dependent upon any one trademark or service mark.
 
Insurance
 
We maintain insurance coverage that we believe is adequate for our business, including, but not limited to, professional and general liability insurance. We also maintain insurance coverage on our leased real property and personal property on a replacement cost basis. There is no assurance that the insurance maintained by us will be adequate in the event of a claim, or that such insurance will continue to be available in the future.
 
Employees
 
On December 31, 2006, we employed 273 employees, of which 249 were full-time employees. Of our full-time employees, 240 are located in Spokane, Washington and six are located in Washington, DC. We have 204 full-time employees engaged in selling and marketing and 45 full-time employees in general and administrative positions. We also employ a temporary workforce on a seasonal basis to assist with our direct marketing efforts in recognition of the fact that our travel programs are seasonal in nature. None of our employees are subject to collective bargaining agreements or are represented by a union. We believe that our labor relations are good.

Competition

The travel industry and the educational segment within the travel industry are highly competitive. Our Student Ambassador Programs, Sport Ambassador Programs, and Student Leader Programs compete with similar educational travel programs operated by other individuals and organizations, as well as independent programs organized and sponsored by local teachers with the assistance of local travel agents. Our Sports Ambassador Programs also compete with independent organizations, which coordinate and travel already intact teams for international competition. Professional Ambassador Programs compete with independent professional associations that sponsor and organize their own travel programs through the assistance of local travel agents, and other organizations that design travel programs and continuing professional education for adults.
 
We believe that the principal basis of competition in the educational segment of the market is the quality and uniqueness of the educational program offered, customer service, safety, reputation and program cost. We believe that our 40 years of experience organizing student and professional educational programs and established relationships with public officials, organizations and residents in countries where we provide programs, as well as our agreements with People to People, allow us to provide an educational opportunity that is not easily duplicated by competitors’ programs.
 
We believe the barriers to entry are relatively low for any future competitors. Certain organizations engaged in the travel business could have substantially greater financial, marketing and sales resources than we do. There can be no assurance that our present or future competitors will not exert significant competitive pressures on us in the future.

 
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Available Information

We are subject to the informational requirements of the Exchange Act that require us to file reports, proxy and information statements, and other information with the SEC. The public may read and copy our filings at the SEC’s Public Reference Room 100 F. Street, N.E., Washington, D.C. 20549. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov.  Similarly, we maintain a website at www.AmbassadorsGroup.com. On this website, we make available our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practical after, or on the same day as, such material is electronically filed with or furnished to the SEC. We make these available free of charge.


 



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BUSINESS STRATEGY
 
We believe that high quality programs and exceptional customer service are and will remain key elements of our success. Our strategy is to maintain quality standards while increasing the volume of business. To grow the business, we intend to (i) expand the marketing and travel volume of existing student, sport, student leader and professional educational travel programs, (ii) introduce new student, sport, student leader and professional travel programs independently and through strategic alliances, and (iii) pursue acquisition opportunities.
 
Expand the Marketing and Travel Volume
 
U.S. Census data projects that there will be more than 41.1 million people in the 10 to 19 year-old age range by 2010. We believe that a large number of qualified students in this age group are not aware of our youth travel programs. In light of these factors, we intend to improve our marketing techniques by targeting additional age groups, making greater use of referrals from teachers, parents and past student travelers, and expanding and refining our extensive databases of potential delegates.

According to U.S. Census data, the number of Americans 45 to 74 years old is expected to grow substantially, increasing to more than 102.3 million people in 2010, from 80.8 million people in 2000. This trend is expected to benefit us, since this population segment historically has been the most likely to participate in one of our professional travel programs. In addition, we believe that American adults interested in traveling abroad will increasingly seek convenient and unique experiences. Consequently, we believe that the opportunity exists to expand the professional educational travel programs by continuing to improve the quality and number of specialty professional programs, including professional education credit opportunities and by exploring new country destinations. We continue to look for alliances with partners that have strong brand recognition and access to well defined customer segments.

Introduce New Programs
 
We continually seek to develop and introduce additional innovative and educational travel experiences. We intend to continue to maintain our contacts with foreign governmental agencies and officials and intend to continue to utilize these and other foreign contacts to organize opportunities for our program delegates that other travel programs do not currently offer. In addition, we may develop new youth travel programs organized around common extracurricular activities such as science, nature and music.
 
Pursue Acquisition Opportunities
 
We consider the travel and youth education industries encompassed by our business to be large and fragmented, which present attractive acquisition opportunities. We believe that these industries’ large size and fragmentation provides an opportunity for acquisitions of businesses that are either compatible with our current business or represent a developing specialty segment.
  

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Item 1A.           Risk Factors

The following risk factors could materially and adversely affect our future operating results and could cause actual results to differ materially from those predicated in forward-looking statements we make about our business.

Travel Industry

Our results of operations will depend upon factors affecting the travel industry in general. Our revenues and earnings are especially sensitive to events that affect domestic and international air travel and the level of hotel reservations. A number of factors, including those mentioned above, a rise in fuel prices or other travel costs, excessive inflation, currency fluctuations, foreign taxation changes, extreme weather conditions and concerns about passenger safety could result in a temporary or longer-term overall decline in demand for our programs. Also, demand for our products and services may be significantly affected by the general level of economic activity and employment in the United States and key international markets. Therefore, any significant economic downturn or recession in the United States or these other markets could have a material adverse affect on our business, financial condition, cash flows and results of operations.

International Operations and Natural Occurrences

Our operations are subject to special risks inherent in doing business internationally, as substantially all of our travel programs are conducted outside the United States. In the past, gross revenues from programs to Europe, the South Pacific (Australia and New Zealand) and China have accounted for a majority of our gross revenues. Risks inherent in doing business internationally include potential adverse effects from operations from war, U.S. military deployments, international and domestic terrorism, civil disturbances, political instability, governmental activities and deprivation of contract rights.

The continued U.S. military presence as a result from the war in Iraq has affected and will continue to affect the travel industry, the markets in which we operate, and our operations and profitability. The potential and long-term effects are uncertain for our customers, the market for our Common Stock, the markets for our services, the strength of the U.S. dollar and the U.S. economy. In the past, we have experienced increased cancellations for our travel programs. We have also experienced a weakened U.S.dollar, the negative effect of which will cost us more to travel delegates abroad.

Periods of international and domestic unrest have reduced demand for our travel programs and could have a material adverse effect on our business and results of operations. Examples of such past events include but are not limited to the attacks on September 11, 2001, the Gulf War in 1991, civil unrest in China in 1989 and the Chernobyl disaster in 1986.

Demand for our travel programs also may be adversely affected by natural occurrences such as hurricanes, earthquakes, epidemics or other disease outbreaks, and flooding in geographic regions in which we conduct travel programs. The occurrence of any of the events described above or other unforeseen developments in one or more of these regions would have a material adverse effect on our business, financial condition, cash flows, and results of operations.

Terrorism

Terrorist attacks, such as the attacks that occurred in London on July 7 and 21, 2005 and in the United States on September 11, 2001, the continued U.S. military response, and other acts of violence or war have and will affect the travel industry generally, the markets in which we operate, as well as our operations and profitability. Further terrorist attacks against the United States or U.S. businesses and citizens at home and abroad may occur. The September 11 attacks have had a very negative impact on domestic and international air travel and the travel industry in general. As a result, we experienced a significant decrease in profitability in 2002. The potential near-term and long-term effects of these attacks are uncertain for our customers, the market for our Common Stock, the markets for our services and the U.S. economy. The consequences of any terrorist attacks, or any armed conflicts including war which may result, are unpredictable, and we may not be able to foresee events that could have an adverse affect on our business or operations.

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Seasonality; Fluctuations in Quarterly Results

Our business is highly seasonal. The majority of our travel programs are scheduled in June and July of each year, and we anticipate that this trend will continue for the foreseeable future. We recognize gross program receipts, revenues and program pass-through expenses upon the departure of our program delegates for the majority of our programs. Substantially all of our operating income is generated in the second and third quarters, which historically has offset the operating losses incurred during the rest of the year. Annual results would be adversely affected if our revenues were to be substantially below seasonal norms during the second and third quarters of the year. Furthermore, our operating results may fluctuate as a result of many factors, including the mix of student, sports, student leader and professional programs and program destinations offered by us and our competitors, the introduction and acceptance of new programs and program enhancements by us and our competitors, timing of program completions, cancellation rates, competitive conditions in the industry, marketing expenses, extreme weather conditions, international or domestic conflicts, timing of and costs related to acquisitions, changes in relationships with certain travel providers, economic factors and other considerations affecting travel. As a result of the foregoing, annual or quarterly operating results may be below the expectations of public market analysts and investors. In such event, the price of our Common Stock could be materially and adversely affected.

Competition

The travel industry in general and the educational segment of the travel industry is highly competitive and has relatively low barriers to entry. We compete with other companies that provide similar educational travel programs for students and athletes, as well as independent programs organized and sponsored by local teachers and coaches with the assistance of local travel agents. People to People, under the terms of its agreement with us, reserves the right to offer programs to college students for studies abroad and to grant other entities which we compete with, the right to use the People to People name in connection with People to People’s professional education and sports programs. In general, our Professional Ambassador Programs compete with independent professional organizations that sponsor and organize their own travel programs through the assistance of local travel agents, and other organizations that offer travel programs and continuing education credits for adults. Some of our competitors are larger and have greater brand name recognition and financial resources than we do. There can be no assurance that we will be able to compete successfully, and the failure to compete successfully may have a material adverse affect on our business, financial condition, cash flows and results of operations.

Dependence on “People to People”

Our agreements with People to People give us the exclusive right to develop and conduct programs for kindergarten through high school students using the People to People name, and the non-exclusive right to develop and conduct programs for professionals, college students and athletes using the People to People name. Our agreements with People to People, however, allow People to People to continue to conduct college and professional seminars and internship programs and to develop other sports and professional programs. Our agreements with People to People expire in 2010 and, at our election, may be further extended through 2020. We believe that we derive benefit from our ability to market our programs using the People to People name. If our agreements with People to People were terminated or if we were unable to use the People to People name to market new programs or destinations, we could have a material adverse affect on our business, financial condition, cash flows and results of operations. Similarly, if our relationship with People to People is disrupted or is adversely impacted because People to People experiences interruption, delay or ceases operations in the future for any reason, our business could be harmed and our stock price may decline.


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Dependence on Travel Suppliers

We are dependent upon travel suppliers for access to their products and services. Travel suppliers include airlines, hotels, bus lines, overseas coordinators and other participants in the travel industry. Consistent with industry practices, we currently have no long-term agreements with travel suppliers that obligate such suppliers to sell services or products through us on an ongoing basis. Therefore, the travel suppliers generally can cancel or modify their agreements with us upon relatively short notice. In addition, any decline in the quality of travel products and services provided by these suppliers, or a perception by our delegates of such a decline, could adversely affect our reputation. The loss of contracts, changes in our pricing agreements, commission schedules or incentive override commission arrangements, more restricted access to travel suppliers’ products and services or less favorable public opinion of certain travel suppliers and resulting low demand for the products and services of such travel suppliers could have a material adverse affect on our business, financial condition, cash flows and results of operations.

Dependence on Key Personnel

Our performance is substantially dependent on the continued services and performances of our senior management and certain other key personnel. The loss of the services of any of our executive officers or other key employees could have a material adverse affect on our business, financial condition and results of operations. Our future success also depends on our ability to identify, attract, hire, train, retain and motivate other highly skilled managerial, marketing and customer service personnel. The failure to retain and attract necessary managerial, marketing and customer service personnel could have a material adverse affect on our business, financial condition, cash flows and results of operations.

Marketing

Our performance is substantially dependent on the effectiveness of our direct marketing efforts, including but not limited to, direct mail and local informational meetings. Failure of our marketing efforts or changes in the direct mail environment could have a material adverse affect on our business, financial condition, cash flows and results of operations. Such changes in the direct mail environment could include, but not be limited to, a threat of disease or bioterrorism within the mail environment and new or different regulatory schemes or changes in costs or services by the United States Postal Service.

Government Regulation and Taxation

Many travel suppliers, particularly airlines, are subject to extensive regulation by federal, state and foreign governments. In addition, the travel industry is subject to certain seller of travel laws of certain states and special taxes by federal, state, local and foreign governments, including hotel bed taxes, car rental taxes, airline excise taxes and airport taxes and fees. New or different regulatory schemes or changes in tax policy could have an adverse impact on the travel industry in general and could have a material adverse affect on our business, financial condition, cash flows and results of operations.

Fluctuation of Currency Exchange Rate; Increased Costs

Many of our arrangements with our foreign-based suppliers require payment to be made in foreign currencies. Any decrease in the value of the U.S. dollar in relation to foreign currencies has the effect of increasing the cost of the services to be provided. Since late 1993, we generally have purchased forward contracts and options with less than two years maturity to help manage program costs and hedge against foreign currency valuation increases. While the ability to utilize forward contracts for the delivery of foreign currencies can mitigate the effect of increased program costs and foreign currency exchange fluctuations, there can be no assurance that increased program costs relating to such currency fluctuations will not be substantial in future periods. There can also be no assurance our hedging strategy will mitigate longer term foreign exchange valuation trends. Our contract with delegates in our travel programs provides us the option of passing along to delegates any increase in program costs resulting from currency fluctuations. Although we have exercised this option in the past, there can be no assurance that we will be able to increase program prices to offset any such cost increases in the future and any failure to do so could have a material adverse affect on our business, financial condition, cash flows and results of operations.

-10-

Casualty Losses

Due to the nature of our business, we may be subject to liability claims arising out of accidents or disasters causing injury to delegates in our programs, including claims for serious personal injury or death. We believe that we have adequate liability insurance for risks arising in the normal course of business. Although we have experienced no claims for which we did not have adequate insurance coverage, there can be no assurance that insurance coverage will be sufficient to cover one or more large claims or that the applicable insurer will be solvent at the time of any covered loss. Further, there can be no assurance that we will be able to obtain insurance coverage at acceptable levels and cost in the future. Successful assertion against us of one or a series of large uninsured claims, or of one or a series of claims exceeding any insurance coverage could have a material adverse affect on our business, financial condition, cash flows and results of operations.

Growth, Acquisitions and Alliances

Our performance is dependent on our ability to grow our business and expand the marketing and travel volume of our youth, sports, student leader and professional travel programs. In addition, our ability to grow is dependent on our ability to acquire or enter into strategic alliances. Failure of growth strategies could have a material adverse affect on our business, financial condition, cash flows and results of operations.

Concentration of Credit Risk

Cash, cash equivalents and available-for-sale securities are exposed to concentrations of credit risk. We place our cash and temporary cash investments with high credit quality institutions. At times, such balances may be in excess of the federal depository insurance limit or may be on deposit at institutions which are not covered by this insurance. If such institutions were to become insolvent during which time it held our cash, cash equivalents or available-for-sale securities in excess of the insurance limit, it could be necessary to obtain credit financing to operate our travel programs.

Risks Relating to the Securities Markets and Ownership of our Common Stock

Fluctuations in Stock Price

The market price of our Common Stock could be subject to significant fluctuations. Among the factors that
could affect our stock price are:

• Quarterly variations in operating results;
• Changes in revenue or earnings estimates or publication of research reports by analysts;
• Speculation in the press or investment community;
• Strategic actions by us or our competitors, such as acquisitions or restructurings;
• Actions by institutional shareholders;
• General market conditions;
• Change in key employees;
• Domestic and international, social and economic factors unrelated to our performance;
• Terrorist activities, and
• Limited shares of Common Stock available for trading

The stock markets have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our Common Stock. In particular, we cannot make assurances that our stock will sell at any particular price, or at all.

-11-

Item 1B.           Unresolved Staff Comments

None.

Item 2.           Properties

Our principal offices, consisting of approximately 48,000 square feet, are located in Spokane, Washington, and are occupied pursuant to a lease that expires December 31, 2009. The lease currently provides for monthly rental payments of approximately $37,000. We expect to vacate the property in 2007 and will consider alternatives for subletting to a third party for the duration of the lease. We occupy additional space totaling approximately 4,800 square feet in Spokane, Washington, primarily for storage of corporate records. The lease term expires December 31, 2009. Current monthly rent is approximately $1,000 per month. During 2007, we expect to vacate the property.
 
We occupy additional office space totaling approximately 11,000 square feet in Spokane, Washington, pursuant to a lease which expired December 31, 2006 but will continue month to month during 2007. Current monthly rent is approximately $4,700 per month. During 2007, we expect to vacate the property.
 
We also occupy office space totaling approximately 2,400 square feet in Arlington, Virginia pursuant to a lease which expires April 30, 2011. Current monthly rent is approximately $5,575 per month, with increases specified in the lease.

We are in the process of building a corporate office in Spokane, Washington, increasing the size of our corporate offices and mailhouse facilities. We expect to fully occupy the office in late 2007. We believe that we will be able to meet our future facility needs.
 
 
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 affect on our business, financial condition, cash flows or results of operations.
 
 
No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 2006.
 


-12-


 
Purchases of Equity Securities
 
Market Information
 
Our Common Stock has been traded on The Nasdaq Stock Market under the symbol “EPAX” since March 1, 2002. Prior to March 1, 2002, there was no public trading market for our equity securities. On September 15, 2005, our stock split two-for-one, doubling our shares of Common Stock outstanding. The stock split was implemented in the form of a 100 percent stock dividend, payable on September 15, 2005 to shareholders of record on August 31, 2005.
 
As of March 6, 2007, the last reported sale price of our Common Stock was $31.54. The following table sets forth the high and low sale prices of a share of our Common Stock as reported on The Nasdaq Stock Market on a quarterly basis for our fiscal years ended December 31, 2006 and 2005. The high and low sale prices for 2005 have been adjusted to reflect the affect of the September 15, 2005 two-for-one stock split.
 
 
High
 
Low
Quarter ended March 31, 2006
$
27.11
 
$
23.25
Quarter ended June 30, 2006
$
30.36
 
$
24.99
Quarter ended September 30, 2006
$
29.46
 
$
24.83
Quarter ended December 31, 2006
$
30.87
 
$
25.71
 
 
 
 
Quarter ended March 31, 2005
$
18.11
 
$
16.48
Quarter ended June 30, 2005
$
19.63
 
$
15.99
Quarter ended September 30, 2005
$
23.31
 
$
18.47
Quarter ended December 31, 2005
$
26.89
 
$
19.14


-13-


Performance Graph

The following graph compares our cumulative total shareholder return with The Nasdaq Stock Market Index and The Russell 2000 Index. The graph assumes that $100 was invested on March 1, 2002 (the first trading day for our Common Stock) in our Common Stock and in each of the indexes mentioned above and that all dividends were reinvested.

 
 
The performance graph is being furnished by us and shall not be deemed “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities of that section, nor shall it be deemed to be incorporated by reference in any filing under the Act, or the Exchange Act.

Holders of Record

As of March 6, 2007, there were approximately 63 holders of record of our Common Stock. This number does not include beneficial owners holding shares through nominee or street name.

Dividends
  
In November 2003, the Board of Directors initiated a dividend policy, payable on a quarterly basis. Each quarter, our Board of Directors reviews the dividend payment assessing the amount, timing and
alignment with its strategic direction.

On August 12, 2005, our Board of Directors declared a two-for-one stock split of our Common Stock in the form of a 100 percent common stock dividend, payable on September 15, 2005 to shareholders of record on August 31, 2005.

-14-


From February 2005 through February 2007, our Board of Directors declared the following dividend payments:

Declaration Date
Record Date
Payment Date
Dividend Per Share
February 11, 2005
February 28, 2005
March 15, 2005
$0.065
May 13, 2005
May 30, 2005
June 14, 2005
$0.065
August 12, 2005
August 26, 2005
September 9, 2005
$0.065
November 11, 2005
November 28, 2005
December 13, 2005
$0.085
February 17, 2006
March 3, 2006
March 17, 2006
$0.085
May 4, 2006
May 22, 2006
June 6, 2006
$0.085
August 11, 2006
August 25, 2006
September 8, 2006
$0.085
November 9, 2006
November 24, 2006
December 8, 2006
$0.115
February 15, 2007
March 1, 2007
March 15, 2007
$0.115

Transfer Agent and Registrar
 
Mellon Investor Services LLC serves as transfer agent and registrar of our Common Stock.
 
Equity Compensation Plan Information

The following tables provide information as of December 31, 2006 about our Common Stock that may be issued upon the exercise of options, warrants and rights under all of our existing equity compensation plans.
 
 
(a)
 
(b)
 
(c)
Plan category
 
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
 
Weighted-average
exercise price of
outstanding options,
warrants and rights
 
Number of securities remaining available
for future issuance under equity
compensation plans (excluding securities
reflected in column (a))
Equity compensation plans approved by security holders
 
1,753,363
 
$ 9.79
 
781,255
Equity compensation plans not approved by security holders
 
N/A
 
N/A
 
N/A
Total
 
1,753,363
 
$ 9.79
 
781,255
 
Issuer Purchases of Equity Securities
 
On May 18, 2004, our Board of Directors authorized the repurchase of up to $5.0 million of our Common Stock in the open market or through private transactions. On August 12, 2005 and November 9, 2006, our Board of Directors increased the authorized Common Stock repurchase plan amounts to $14.0 million and to $25.0 million, respectively. During the quarter ended December 31, 2006, we repurchased 279,400 shares of our Common Stock for $7.7 million. Since inception, we have repurchased approximately 788,400 shares of our Common Stock, adjusted to reflect the effect of our two-for-one stock split of our Common Stock, for an approximate total of $16.9 million. As of December 31, 2006, approximately $8.1 million remained available for repurchase under the plan.
 
Independent of this share repurchase plan, during the first quarter 2007, our board of directors approved a single repurchase of 1.2 million shares of common stock for approximately $33.0 million.
 
-15-


The following is a summary of issuer purchases of equity securities during the quarter ended December 31, 2006:
                             
Maximum Number
                     
Total Number of
     
(or Approximate
                     
Shares
     
Dollar Value) of
                     
Purchased as
     
Shares that May Yet
     
Total Number
     
Average
     
Part of Publicly
     
Be
     
Of
     
Price
     
Announced
     
Purchased Under
     
Shares
     
Paid per
     
Plans or
     
the Plans or
Period
   
Purchased
     
Share
     
Programs
     
Programs
Amount available for repurchase at September 30, 2006
   
$
4,814,732
October 1 - October 31, 2006
 
 
55,700
 
 
$
27.61
 
 
 
55,700
 
 
 
3,276,977
November 1 - November 30, 2006
 
 
180,600
     
27.51
     
180,600
 
 
 
9,309,017
December 1 - December 31, 2006
 
 
43,400
     
27.78
     
43,400
     
8,103,240
 
 
 
279,700
 
 
$
27.57
 
 
 
279,700
 
 
$
8,103,240
 
Recent Sales of Unregistered Securities
 
During the fiscal year ended December 31, 2006, no equity securities were sold by us that were not registered under the Act.

-16-


 
This section presents our historical financial data which should be read carefully with the financial statements included in this Form 10-K, including the notes to the consolidated financial statements, and Management’s Discussion and Analysis of Financial Condition and Results of Operations. The statement of operations data for each of the years in the three-year period ended December 31, 2006, and the balance sheet data as of December 31, 2006 and 2005 have been derived from audited financial statements included elsewhere in this Form 10-K. The statement of operations data for the years ended December 31, 2003 and 2002 and the balance sheet data as of December 31, 2003 and 2002 have been derived from the audited financial statements, which are not included in this Form 10-K. The financial data for the period January 1, 2002 through February 28, 2002, have been carved out from the consolidated financial statements of International using the historical operating results and historical bases of the assets and liabilities of International’s business, which we comprised. Historical results are not necessarily indicative of future results.

 
December 31,
 
2006(C)
 
2005
 
2004
 
2003
 
2002(D)
 
(in thousands, except per share data)
Statement of Operations data:
 
 
 
 
 
 
 
 
 
 
Net revenue, non-directly delivered programs (A)
$
69,554
 
$
64,321
 
$
51,824
 
$
37,665
 
$
 
36,090
 
Gross revenue, directly delivered programs
$
19,401
 
$
4,969
 
$
 
$
 
$
 
 
Total revenue
$
88,955
 
$
69,290
 
$
51,824
 
$
37,665
 
$
 
36,090
 
Cost of sales, directly delivered programs
$
11,473
 
$
2,841
 
$
 
$
 
$
 
 
Gross margin
$
77,482
 
$
66,449
 
$
51,824
 
$
37,665
 
$
 
36,090
 
Selling and marketing expenses
$
31,638
 
$
27,574
 
$
22,616
 
$
18,534
 
$
 
15,632
 
General and administrative expenses
$
11,721
 
$
8,185
 
$
6,537
 
$
4,566
 
$
 
5,131
 
Operating income
$
34,123
 
$
30,690
 
$
22,671
 
$
14,565
 
$
 
15,327
 
Operating margin
 
44
%
 
46
%
 
44
%
 
39
%
   
42
%
Net income
$
26,692
 
$
22,410
 
$
15,647
 
$
10,154
 
$
 
10,798
 
Earnings per share - basic (B)
$
1.30
 
$
1.10
 
$
0.78
 
$
0.51
 
$
 
0.55
 
Earnings per share - diluted (B)
$
1.25
 
$
1.05
 
$
0.75
 
$
0.50
 
$
 
0.53
 


 
 

 

-17-

 

     
December 31,
 
 
2006(C)
 
2005
 
2004
 
2003
 
2002(D)
 
(in thousands, except per share data)
Balance sheet data:
 
 
 
 
 
 
 
 
   
Cash, cash equivalents and available-for-sale securities
$
133,134
 
$
116,604
 
$
87,557
 
$
67,525
 
$
51,399
Total assets
$
153,953
 
$
125,046
 
$
97,516
 
$
79,321
 
$
58,517
Total stockholders’ equity
$
84,047
 
$
66,502
 
$
49,501
 
$
40,809
 
$
 27,860
Other key financial measures:
 
 
 
 
 
 
      
Cash flow from operating activities
$
37,207
 
$
37,792
 
$
27,906
 
$
17,255
 
$
  21,382
Cash flow used in investing activities
$
(12,923
)
$
(15,592
) 
$
(22,830
$
(10,749
)
$
 (13,354)
Cash dividends declared and paid
$
(7,655
)
$
(5,729
)
$
(4,630
)
$
(1,100
)
$
 
Cash dividends declared and paid, per common share
$
0.37
 
$
0.28
 
$
0.23
 
$
0.06
 
$
 
Cash flow (used in) from financing activities
$
(14,416
$
(6,320
)
$
(5,825)
 
$
34
 
$
  (9,668)
Deployable cash (E1)
$
67,947
 
$
61,939
 
$
43,180
 
$
32,903
 
$
 22,773
Free cash flow (E2)
$
30,752
 
$
35,532
 
$
25,999
 
$
42,197
 
$
 21,184
Return on adjusted equity (E3)
36
%
39
%
37
%
32
%
   42%

 
(A)
Net revenues are a function of gross program receipts from non-directly delivered programs, less program pass-through expenses from non-directly delivered programs. Program pass-through expenses include all direct costs associated with our programs, including, but not limited to, costs related to airfare, hotels, meals, ground transportation, guides, professional exchanges and changes in currency exchange rates. Gross revenues, directly delivered programs are a function of the gross program receipts for those programs we directly organize and operate, including all activities such as speakers, facilitators, events, accommodations and transportation. Gross program receipts for both directly delivered and non-directly delivered programs during the years ended December 31, 2006, 2005, 2004, 2003 and 2002 were $219.5 million, $180.0 million, $147.1 million, $108.6 million, and $97.1 million, respectively. Gross margin as a percent of gross program receipts during the years ended December 31, 2006, 2005, 2004, 2003, and 2002 were 35%, 37%, 35%, 35%, and 37%, respectively.
 
(B)
Earnings per share - basic and diluted are calculated using our Common Stock, which was split in April 2001 and February 2002 in anticipation of our spin-off from International. This Common Stock split resulted in 9,813,140 shares issued and outstanding. Earnings per share - diluted are calculated using stock options, which were originally granted under International and converted to our options on February 28, 2002 in connection with our spin-off from International.

During September 2005, we implemented a two-for-one stock split in the form of a 100 percent stock dividend. The earnings per share calculations for all periods presented
reflect the increase in the number of shares of Common Stock outstanding as a result of the stock split.
 
(C)  
We adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, as of January 1, 2006.
During 2006, stock option expense was $1.3 million, and $2.3 million excess tax benefit from stock based compensation is included in net cash provided by operating activities and net cash used in financing activities.

(D)
The consolidated financial statements for the period January 1, 2002 through February 28, 2002, have been carved out from the consolidated financial statements of International using the historical operating results and historical bases of the assets and liabilities of International’s business, which we comprised. We composed the operations of the former Education Group segment of International. Accordingly, the historical financial information presented herein does not necessarily reflect what our financial position, operating results and cash flows would have been had we been a separate, stand-alone entity during the periods presented.

-18-

(E)
Non-GAAP Financial Measures
 
See below for reconciliation and description of non-GAAP financial measures.

We analyze our performance on a net income, cash flow and liquidity basis in accordance with generally accepted accounting principles (“GAAP”) as well as on a non-GAAP operating, cash flow and liquidity basis referred to below as “non-GAAP operating results” or “non-GAAP cash flows and liquidity measures.”  These measures and related discussions are presented as supplementary information in this analysis to enhance the readers’ understanding of, and highlight trends in, our core financial results. Any non-GAAP financial measure used by us should not be considered in isolation or as a substitute for measures of performance or liquidity prepared in accordance with GAAP.
 
(E1) Deployable Cash Reconciliation (in thousands)

 
December 31,
   
2006
 
2005
 
2004
 
2003
 
2002
 
Cash and cash equivalents and available-for-sale securities
$
133,134
 
$
116,604
 
$
87,557
 
$
67,525
 
$
51,399
 
Prepaid program costs and expenses
 
3,786
 
1,596
 
2,461
 
1,608
 
1,516
 
Less: accounts payable
 
(2,941
)
(2,540
)
(1,390
)
(2,599
)
(2,181
)
Less: accrued expenses and other short-term liabilities (excluding deferred taxes)
 
(5,190
)
(6,078
)
(6,693
)
(5,260
)
(2,060
)
Less: participant deposits
 
(60,651
)
(47,463
)
(38,608
)
(28,220
)
(25,901
)
Less: current portion of long-term capital lease
 
(191
)
(180
(147
(151
 
Total deployable cash
 $
67,947
 
$
61,939
 
$
43,180
 
$
32,903
 
$
22,773
 
                                   
 
Deployable cash is a non-GAAP liquidity measure. Deployable cash is calculated as the sum of cash and cash equivalents, 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), participant deposits and the current portion of long-term capital lease. Management believes this non-GAAP measure is useful to investors in understanding the cash available to deploy for future business opportunities.

(E2) Free Cash Flow Reconciliation (in thousands)
 


 
December 31,
 
2006
 
2005
 
2004
 
2003
 
2002
 
Cash flow from operations as reported
$
37,207
 
$
37,792
 
$
27,906
 
$
17,255
 
$
21,382
 
Purchase of property and equipment
 
(6,455
)
(2,260
)
(1,907
)
(1,057
)
(198
)
Free cash flow
$
30,752
 
$
35,532
 
$
25,999
 
$
16,198
 
$
21,184
 
                                   
 
 
 
Free cash flow is a non-GAAP cash flow measure. Free cash flow is calculated as cash flow from operations less purchase of property and equipment.  Management believes this non-GAAP measure is useful to investors in understanding the cash generated within a calendar year for future use in operations.

-19-


(E3) Return on Adjusted Stockholders’ Equity Reconciliation (in thousands except return percentages)

 
December 31,
 
2006
 
2005
 
2004
 
2003
 
2002
 
Stockholders’ equity at January 1, as reported
$
66,502
 
$
49,501
 
$
40,809
 
$
27,860
 
$
24,839
 
Less: other comprehensive income (loss) at January 1
(1,396
1,645
 
3,451
 
1,155
 
(340
)
Plus: stockholders’ equity at December 31, as reported
84,047
 
66,502
 
49,501
 
40,809
 
27,860
 
Less: other comprehensive income (loss) at December 31
1,636
 
(1,396
1,645
 
3,451
 
1,155
 
Average adjusted stockholders’ equity (the sum of the above divided by two)
$
75,155
 
$
57,877
 
$
42,607
 
$
32,032
 
$
25,942
 
Net income
$
26,692
 
$
22,410
 
$
15,647
 
$
10,154
 
$
10,798
 
Return on adjusted equity
36
%
39
%
37
%
32
%
42
%
 
Return on adjusted equity is a non-GAAP operating result. Average adjusted equity is calculated as the average of stockholders’ equity at January 1 less other comprehensive income at January 1 and stockholders’ equity at December 31 less other comprehensive income at December 31.  Other comprehensive income is excluded from the calculation as it represents the fair value of foreign exchange contracts designated as cash flow hedges.  As management fully intends to use the foreign exchange contracts for their stated purpose, the amounts related to the market valuation of these cash flow hedges do not reflect the equity generated from past performance, which has been reinvested in our Company.  We believe this non-GAAP measure is useful to investors in understanding the performance of equity maintained in the business from past earnings net of any dividends distributed to stockholders and share repurchases.


-20-


 
The following discussion should be read in conjunction with the selected consolidated financial data and our consolidated financial statements and the notes thereto included in this Annual Report.
 
Executive Overview
 
We are a leading educational travel company that organizes and promotes international and domestic programs for students, athletes and professionals. Youth programs provide opportunities for grade school, middle school and high school students to learn about the history, government, economy and culture of the foreign and domestic destinations they visit as well as for middle and high school athletes to participate in international sports challenges. Our student leader programs provide educational opportunities for middle school and high school students to learn leadership, government, college admissions and community involvement skills at domestic destinations. Our professional programs emphasize meetings and seminars between delegates and persons in similar professions abroad.
 
We were founded in 1967, were reincorporated in Delaware in 1995, and operated as Ambassadors Education Group, a wholly owned subsidiary of International until February 2002, at which time we spun off to operate as an independent stand-alone company beginning in March, 2002. Since then, our Common Stock has traded on The Nasdaq Stock Market under the ticker symbol “EPAX.” The consolidated financial statements include the accounts of Ambassadors Group, Inc., and our wholly owned subsidiaries, Ambassador Programs, Inc., Ambassadors Specialty Group, Inc., and Ambassadors Unlimited, LLC. All significant inter-company accounts and transactions have been eliminated in consolidation.
 
We have a single operating segment consisting of the educational travel and sports programs for students, athletes and professionals. These programs have similar economic characteristics, offer comparable products to delegates, and utilize similar processes for program marketing.

Our Seasonality 

Our business is seasonal. The majority of our travel programs occur in June and July of each year. We have historically earned more than 90 percent of our annual revenues in the second and third quarters, which we anticipate will continue for the foreseeable future. Historically, these seasonal revenues have more than offset operating losses incurred during the rest of the year. Our annual results would be adversely affected if our revenues were to be substantially below seasonal norms during these periods. Our operating results may fluctuate as a result of many factors. See Item 1A, “Risk Factors” for further explanation.

Our Foreign Exposure 

The majority of our programs take place outside the United States and most foreign suppliers require payment in local currency rather than in U.S. dollars. Accordingly, we are exposed to foreign currency risks in certain countries as foreign currency exchange rates between those currencies and the U.S. dollar fluctuate. We have a program to provide a hedge against certain of these foreign currency risks. We use forward contracts and options that allow us to acquire the foreign currency at a fixed price for a specified period of time. Some of our forward contracts and options include a variable component if a pre-determined trigger occurs during the term of the contract.
 
These foreign exchange contracts and options are entered into to support normal anticipated recurring purchases and, accordingly, are not entered into for speculative purposes. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Market Risk.”

-21-


 
Program Revenue and Accounting Structure
 
Revenue from non-directly delivered programs is presented as net revenue and recognized as the program convenes. For these programs, we do not actively deliver the operations of each program, and our remaining performance obligation for these programs after they convene is perfunctory. For certain programs, however, we organize and operate all activities including speakers, facilitators, events, accommodations and transportation. As such, we recognize the gross revenue and cost of sales of these directly delivered programs over the period the programs are being delivered.

Our policy is to obtain payment for substantially all travel services prior to entering into commitments for incurring expenses relating to such travel. Program pass-through and direct delivery expenses include all direct costs associated with our programs, including, but not limited to, costs related to airfare, hotels, meals, ground transportation, guides, presenters, facilitators, professional exchanges and changes in currency exchange rates. 

Operating expenses, which are expensed as incurred, are the costs related to the creation of programs, promotional materials and marketing costs, salaries, rent, other general and administrative expenses and all ordinary expenses.

Results of Operations
 
The following table sets forth, for the periods indicated, the relative percentages that certain income and expense items bear to consolidated gross margin.
 
 
Year Ended December 31,
 
 
2006
 
2005
 
2004
 
2003
 
2002
 
 
(% of net revenue)
 
Gross margin
100
%
100
%
100
%
100
%
100
%
Selling and marketing
41
 
41
 
44
 
49
 
43
 
General and administrative expenses
15
 
12
 
13
 
12
 
14
 
Operating income
44
 
46
 
44
 
39
 
43
 
Other income
6
 
4
 
2
 
2
 
3
 
Income before tax
50
 
50
 
46
 
41
 
45
 
Income tax provision
16
 
16
 
16
 
14
 
15
 
Net income
34
%
34
%
30
%
27
%
30
%
 


-22-


Comparison of Year Ended December 31, 2006 to Year Ended December 31, 2005

During 2006, we traveled 43,075 delegates compared to approximately 37,800 delegates in 2005. Gross margin increased 17 percent, to $77.5 million from $66.4 million in 2005. The $11.0 million increase is primarily due to the 14 percent increase in delegates traveled during the year.
 
Our policy is to expense all selling and marketing costs as incurred. Selling and marketing expenses were $31.6 million and $27.6 million for the years ended December 31, 2006 and 2005, respectively. The $4.1 million increase is primarily the result of $1.0 million additional personnel costs and $1.8 million in selling support functions to support larger volume of delegates, $1.3 million increased marketing efforts towards 2007 travel programs. As a percent of gross margin, selling and marketing expenses were consistently 41 percent during 2006 and 2005.
 
General and administrative expenses increased to $11.7 million for the year ended December 31, 2006 from $8.2 million for the year ended December 31, 2005. The $3.5 million increase is primarily the result of $1.6 million of additional personnel costs supporting our additional delegate base combined with $1.3 million of stock option compensation expense recorded during 2006 with the implementation of SFAS 123(R). As a percent of gross margin, general and administrative expenses increased to 15 percent in 2006 from 12 percent in 2005.
 
For the year ended December 31, 2006, we increased our operating income to $34.1 million from $30.7 million for the year ended December 31, 2005. Operating income as a percent of gross margin decreased to 44 percent for 2006 from 46 percent in 2005.
 
Other income consisted primarily of interest income generated by our cash, cash equivalents and available-for-sale securities. We realized interest and dividend income of $4.7 million in the year ended December 31, 2006, compared to $2.6 million in the year ended December 31, 2005. The increase in interest and dividend income is related to higher cash balances held and increased interest rates during 2006. In 2006 and 2005, the average rate of return was 3.3 percent and 2.4 percent, respectively.
 
For the year ended December 31, 2006, income before income taxes was $38.9 million in comparison to income before income taxes of $33.3 million for the year ended December 31, 2005.
 
We recorded an income tax provision of approximately $12.2 million for the year ended December 31, 2006, in comparison to $10.9 million for the year ended December 31, 2005. Our effective tax rate was 31.3 percent and 32.8 percent for the years ended December 31, 2006 and 2005, respectively. The decrease in the effective rate from 2005 was primarily the result of higher interest earned from tax exempt securities.
 
Net income increased to $26.7 million for the year ended December 31, 2006 from $22.4 million for the year ended December 31, 2005.




-23-


Comparison of Year Ended December 31, 2005 to Year Ended December 31, 2004

During 2005, we traveled more than 37,800 delegates compared to approximately 31,000 delegates in 2004, an increase of 22 percent. Gross profit increased 28 percent, to $66.4 million from $51.8 million in 2004. The $14.6 million increase is primarily the result of traveling additional delegates mentioned above, combined with the affect of traveling efficient group sizes, negotiating savings within program pass through expenses, and the benefits associated with receiving a reprieve of certain goods and services tax.
 
Our policy is to expense all selling and marketing costs as incurred. Selling and marketing expenses were $27.6 million and $22.6 million for the years ended December 31, 2005 and 2004, respectively. The $5.0 million increase is primarily the result of $1.3 million additional personnel costs to support the larger volume of delegates and $2.7 million of increased marketing efforts toward 2006 and 2007 travel programs. As a percent of net revenue, selling and marketing costs decreased from 44 percent in 2004 to 41 percent in 2005.
 
General and administrative expenses increased to $8.2 million for the year ended December 31, 2005 from $6.5 million for the year ended December 31, 2004. The $1.7 million, 26 percent, increase is primarily the result of $1.2 million of additional personnel costs supporting our additional delegate base. As a percent of net revenues, general and administrative expenses decreased from 13 percent in 2004 to 12 percent in 2005.
 
For the year ended December 31, 2005, we increased our operating income to $30.7 million from $22.7 million for the year ended December 31, 2004. Operating income as a percent of net revenues increased to 46 percent for 2005 from 44 percent in 2004.
 
Other income consisted primarily of interest income generated by our cash, cash equivalents and available-for-sale securities. We realized interest and dividend income of $2.6 million in the year ended December 31, 2005, compared to $1.1 million in the year ended December 31, 2004. The increase in interest and dividend income is related to higher cash balances held and increased interest rates during 2005. In 2005 and 2004, the average rate of return was 2.4 percent and 1.4 percent, respectively.
 
For the year ended December 31, 2005, income before income taxes was $33.3 million in comparison to income before income taxes of $23.7 million for the year ended December 31, 2004.
 
We recorded an income tax provision of approximately $10.9 million for the year ended December 31, 2005, in comparison to $8.1 million for the year ended December 31, 2004. Our effective tax rate was 32.8 percent and 34.0 percent for the years ended December 31, 2005 and 2004, respectively. The decrease in the effective rate from 2004 was primarily the result of higher interest earned from tax exempt securities.
 
Net income increased to $22.4 million for the year ended December 31, 2005 from $15.6 million for the year ended December 31, 2004.

 

-24-


Liquidity and Capital Resources
 
At December 31, 2006, we had approximately $133.1 million of cash, cash equivalents, and available-for-sale securities, which included program participant funds of approximately $60.7 million. At December 31, 2005, we had approximately $116.6 million of cash and cash equivalents, restricted cash, and available-for-sale securities, which included program participant funds of $47.5 million.

Net cash provided by operations for the years ended December 31, 2006 and 2005 was approximately $37.2 million and $37.8 million, respectively. The $0.6 million decrease in operating cash flows between the years ending December 31, 2006 and 2005, primarily results from a $4.3 million increase in earnings, the effect of stock based compensation expense and excess tax benefit during 2006, $4.3 million in increased participant fund balances year over year, and the net effect of certain payment timing for programs traveled or to be traveled.
 
Net cash used in investing activities for the years ended December 31, 2006 and 2005 was $12.9 million and $15.6 million, respectively. The $2.7 million decrease year over year resulted from a $6.8 million decrease in net purchases of available-for-sale investments and a $4.2 million increase in purchases of property, plant and equipment during 2006. The increase in property, plant and equipment was primarily due to the construction of our new headquarters to be occupied in 2007.
 
Net cash used in financing activities was $14.4 million in the year ending December 31, 2006 and $6.3 million during the year ending December 31, 2005. The net change in financing activities was a result of three factors: an increase of $1.9 million used for cash dividends to our shareholders, a $7.0 million increase in cash used for the repurchase of our Common Stock, offset by a decrease of $1.6 million received from the proceeds of stock option exercises and the effects of excess tax benefit from stock based compensation in 2006. During 2006, we paid $7.7 million in cash dividends and used $10.7 million for stock repurchases. As of March 6, 2007, we deployed $35.6 million for the repurchase of Common Stock since December 31, 2006.
 
The results of operations and financial position of our business may be affected by a number of trends or uncertainties that have, or we reasonably expect could have, a material impact on income from continuing operations and cash flows, as well as the balance sheet. Such trends and uncertainties include: the repercussions of the continued deployment of U.S. military as a result of the war with Iraq, possible future terrorist acts, and possible natural occurrences such as flooding or epidemics. Furthermore, these international occurrences and others may continue to affect the travel industry, as well as the markets in which we operate. The potential and long-term effects of these circumstances result in uncertainties for our customers, the market for our Common Stock, the markets for our services, the strength of the U.S. dollar and the U.S. economy. The consequences of such trends or events are unpredictable, and we are not currently able to determine whether the impact will be material or highly material on our business, financial condition, cash flows and results of operations.
 
Under our cancellation policy, a program delegate may be entitled to a refund of a portion of his or her deposit, less certain fees, depending on the time of cancellation. Should a greater number of delegates cancel their travel in comparison to that which is part of our ongoing operations, due to circumstances such as international or domestic unrest, terrorism or general economic downturn, our cash balances could be significantly reduced. Cash balances could also be reduced significantly if the financial institutions, which held balances beyond that federally insured, were to become insolvent.
 
Our business is not capital intensive. However, we do retain funds for operating purposes in order to conduct sales and marketing efforts for future programs, and progress on our new headquarters continues as planned. As of December 31, 2006, we capitalized $7.5 million of the less than $20 million total project costs. We plan on funding the remaining project costs with currently available cash, cash equivalents, and available-for-sale securities during 2007.
 
-25-

 We continue to consider acquisitions of educational, travel and youth businesses that may require the use of cash and cash equivalents. No such acquisitions are currently pending and no assurance can be given that definitive agreements for any such acquisitions will be entered into, or, if they are entered into, that they will be on terms favorable to us.
We do not have any material capital expenditure commitments for 2006, not already presented within our financial statements or discussed in our current report on Form 8-K filed on September 29, 2006. We believe that existing cash and cash equivalents and cash flows from operations will be sufficient to fund our anticipated operating needs and capital expenditures through 2007.

Other than capital leases, we have no long-term debt or purchase obligations as of December 31, 2006. The following table presents the maturities of our contractual cash obligations as of December 31, 2006 (in thousands), excluding normal accounts payable and accrued expenses:
 
 
 
Payments due by period
Contractual Obligations
 
Total
 
Less
than
1 year
 
1 - 3
years
 
4 - 5
years
Operating leases
 
$
1,971
 
$
742
 
$
1,229
 
$
Capital lease
   
407
   
211
   
196
   
Total
 
$
2,378
 
$
953
 
$
1,425
 
$
 
Market Risk
 
The following table summarizes the financial instruments other than derivative financial instruments held by us at December 31, 2006 and 2005, which are sensitive to changes in interest rates. This table presents principal cash flows for available-for-sale securities by contractual maturity date and the related average interest rate and fair value (in thousands):

 
December 31, 2006
 
December 31, 2005
 
2007
 
2008
 
Total
 
Fair
Value
 
Total
 
Fair
Value
U.S. govt. and agency obligations
$
54,155
 
$
40,142
 
$
94,297
 
$
94,297
 
$
89,688
 
$
89,688
Corporate obligations
$
2,053
 
$
 
$
2,053
 
$
2,053
 
 
   
Interest rate
3.70
%
3.53
%
3.65
%
 
2.41
%
 
The majority of our travel programs take place outside 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. We generally hedge against certain of these foreign currency risks with less than two years maturity, and we use forward contracts and options, which allow us to acquire the foreign currency at a fixed price for a specified period of time. Some of our forward contracts and options include a variable component if a pre-determined trigger occurs during the term of the contract.
 
We are exposed to credit risk under the foreign currency contracts and options to the extent that the counterparty is unable to perform under the agreement. The fair value of foreign currency exchange contracts is based on quoted market prices and the spot rate of the foreign currencies subject to contracts at year-end.
 
The table below provides information about our derivative financial instruments that are sensitive to foreign currency exchange rates. For foreign currency forward exchange agreements, the table presents the notional amounts and weighted average exchange rates. All contracts held as of December 31, 2006 mature in 2007. These notional amounts generally are used to calculate the contractual payments to be exchanged under the contract. None of these contracts is entered into for trading purposes.
-26-

At December 31, 2006 and 2005, we had outstanding forward contracts as follows (in thousands):
 

 
Notional
Amount
 
U.S. Dollar
Average
Contractual
Exchange Rate
 
 
 
 
December 31, 2006
 
 
 
Forward contracts (pay $U.S./receive foreign currency):
   
 
Australian dollar
 
14,000
     
$
0.73
British pound
 
3,510
     
$
1.75
Canadian dollar
 
1,080
     
$
0.90
Euro
 
16,550
     
$
1.26
Japanese yen
 
225,000
     
$
0.01
New Zealand dollar
 
4,500
     
$
0.66
       
 
Forward contracts with variable option (pay $U.S./receive foreign currency):
 
Australian dollar
 
15,640
     
$
0.72
British pound
 
3,780
     
$
1.85
Canadian dollar
 
440
     
$
0.91
Euro
 
8,950
     
$
1.29
Japanese yen
 
170,500
     
$
0.01
         
December 31, 2005
   
 
Forward contracts (pay $U.S./receive foreign currency):
   
 
Australian dollar
 
15,500
     
$
0.75
British pound
 
5,100
     
$
1.81
Canadian dollar
 
800
     
$
0.83
Euro
 
18,850
     
$
1.26
Japanese yen
 
304,000
     
$
0.01
South African rand
 
2,100
     
$
0.16
New Zealand dollar
 
5,450
     
$
0.68
 
   
 
Forward contracts with variable option (pay $U.S./receive foreign currency):
 
Australian dollar
 
12,710
     
$
0.77
British pound
 
4,640
     
$
1.85
Canadian dollar
 
374
     
$
0.83
Euro
 
12,510
     
$
1.25
Japanese yen
 
56,100
     
$
0.01
South African rand
 
642
     
$
0.14
New Zealand dollar
 
2,210
     
$
0.69

At December 31, 2006 and 2005, we had unrealized foreign currency gains and (losses) associated with these financial instruments of approximately $2.6 million and $(1.9) million, respectively.

Off Balance Sheet Arrangements
 
As of December 31, 2006, we had no off balance sheet arrangements, as defined in Item 303(a)(4) of Regulation S-K promulgated by the SEC.
 
-27-

Critical Accounting Policies and Estimates

The preparation of consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates and judgments, including those associated with cash and cash equivalents, available-for-sale securities, income taxes, derivative financial instruments, and contingencies and litigation.

Cash and Investments  

Cash, cash equivalents, and available-for-sale securities are initially recorded at cost, which includes any premiums and discounts.  We determine the appropriate classification of investment securities at the time of purchase.  Held-to-maturity securities are those securities that we have the positive intent and ability to hold to maturity and are recorded at amortized cost.  Available-for-sale securities are those securities that would be available to be sold in the future in response to our liquidity needs.  Available-for-sale securities are reported at fair value, with unrealized holding gains and losses reported in shareholders’ equity as a separate component of other comprehensive income, net of applicable deferred income taxes.
 
Management evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis.  If the fair value of investment securities falls below their amortized cost and the decline is deemed to be other-than-temporary, the securities will be written down to current market value, resulting in a loss recorded in the income statement.  There were no investment securities that management identified to be other-than-temporarily impaired during the year ended December 31, 2006, because the decline in fair value was attributable to changes in interest rates and not credit quality, and because we have the ability and intent to hold these investments until a recovery in market price occurs, or until maturity.  Realized losses could occur in future periods due to a change in management’s intent to hold the investments to maturity, a change in management’s assessment of credit risk, or a change in regulatory or accounting requirements.

Income Taxes 

The asset and liability approach is used to account for income taxes by recognizing deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, in the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income in the period such determination was made.

Foreign Currency 
 
We use foreign currency exchange contracts and options as part of an overall risk-management strategy. These instruments are used as a means of mitigating exposure to foreign currency risk connected to anticipated travel programs. In entering into these contracts, we have assumed the risk, which might arise from the possible inability of counterparties to meet the terms of their contracts. We do not expect any losses as a result of counterparty defaults. However, if such defaults occurred, the necessity would arise to locate alternative counterparties, or we would then consider alternate means of settling our foreign exchange contractual obligations.

Other Liabilities 

We received a refund of monies previously paid for certain foreign goods and services taxes. It is unclear whether the refund is permanent and accordingly, we have recorded this refund as a liability on the balance sheet and adjust the value accordingly for interest and gain or loss on the currency exchange. Also quarterly, we recognize into income any amounts for which the uncertainty has been eliminated.
 
-28-

Revenue Recognition

For non-directly delivered programs, we do not actively manage the operations of each program, and our remaining performance obligation for these programs after they convene is perfunctory. Therefore, revenue from these programs is presented as net revenues and recognized as the program convenes.   For certain directly delivered programs, however, we organize and operate all activities including speakers, facilitators, events, accommodations and transportation. As such, we recognize the gross revenue and cost of sales of these directly delivered programs over the period the programs are operated.
 
We bill delegates in advance of travel, payments of which are recorded as participants’ deposits. We also pay for certain program costs in advance of travel, including, but not limited to, airfare, hotel, rail passes and other program costs, which are recorded as prepaid program costs and expenses. Under our cancellation policy, a program delegate may be entitled to a refund of a portion of his or her deposit, less certain fees, depending on the time of cancellation. We recognize cancellation fees concurrent with the revenue recognition from the related programs.

We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Recent Accounting Pronouncements
 
In July 2006, the Financial Accounting Standards Board (“FASB”) released FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement 109, Accounting for Income Taxes (“FIN 48”). FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that a company has taken or expects to take on a tax return. FIN 48 is effective as of January 1, 2007. We do not expect its implementation to be material to our financial statements.
 
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. This statement does not require any new fair value measurements; rather, it applies under other accounting pronouncements that require or permit fair value measurements. The provisions of this statement are to be applied prospectively as of the beginning of the fiscal year in which this statement is initially applied, with any transition adjustment recognized as a cumulative-effect adjustment to the opening balance of retained earnings. The provisions of SFAS 157 are effective for the fiscal years beginning after November 15, 2007. Therefore, we anticipate adopting this standard as of January 1, 2008. We have not determined the effect, if any, the adoption of this statement will have on our financial condition or results of operations.
 
 
The information contained in Item 7. “Management’s Discussion and Analysis of Results of Operations and Financial Condition - Market Risk” is incorporated by reference into Item 7A.
 
Item 8. Financial Statements and Supplementary Data
 
Reference is made to the Index to Consolidated Financial Statements that appear on page F-1 to this Annual Report. The Reports of Independent Registered Public Accounting Firms, the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements listed in the Index to Consolidated Financial Statements, which appear beginning on page F-2 of this Annual Report, are incorporated by reference into this Item 8.
 
-29-

 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
 
None.
 

-30-


Item 9A.   Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures
 
As of December 31, 2006, the end of the period covered by this Annual Report, our chief executive officer and chief financial officer reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e) and 15d-15(e)), which are designed to ensure information required to be disclosed in our Annual Report filed or submitted under the Exchange Act is recorded, processed, summarized and reported on a timely basis, and have concluded, based on that evaluation, that as of such date, our disclosure controls and procedures were effective to ensure that information required to be disclosed in our reports that we file or submit under the Exchange Act is accumulated and communicated to our chief executive officer and chief financial officer as appropriate to allow timely decisions regarding required disclosure.
 
Management’s Report on Financial Statements and Practices

Our management is responsible for the preparation and fair presentation of the financial statements included in this Annual Report. The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and reflect our management’s judgments and estimates concerning effects of events and transactions that are accounted for or disclosed.
 
Management’s Report on Internal Control over Financial Reporting
 
We are responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting includes the policies and procedures that pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the registrant; to recording transactions as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, to making receipts and expenditures only in accordance with authorizations of management and directors of our company; and for prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. We recognize that because of its inherent limitation, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.  Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation.
 
We conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2006. This evaluation was based on the framework in Internal Control - Integrated Framework” published by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management concluded that we maintained effective internal control over financial reporting as of December 31, 2006.
 
Our management’s assessment of the effectiveness of our Company’s internal control over financial reporting as of December 31, 2006 has been audited by BDO Seidman, LLP, an Independent Registered Public Accounting Firm, as stated in their report which appears herein. 
 
Changes in Internal Control over Financial Reporting
 
For the fiscal year ended December 31, 2006, there has been no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 

-31-


 
Report of Independent Registered Public Accounting Firm
 
Board of Directors and Stockholders
Ambassadors Group, Inc.
Spokane, Washington
 
We have audited management's assessment, included in the accompanying Item 9A, Management’s Report on Internal Control over Financial Reporting, that Ambassadors Group, Inc. maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Ambassadors Group, Inc. management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management's assessment that Ambassadors Group, Inc. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also in our opinion, Ambassadors Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Ambassadors Group, Inc. as of December 31, 2006 and 2005, and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for the years then ended  and our report dated March 8, 2007, expressed an unqualified opinion.


BDO Seidman, LLP

Spokane, Washington
March 8, 2007

-32-


 
Item 9B.  Other Information
 
None.
 

 
  Directors , Executive Officers and Corporate Governance
 
The information called for by this item is hereby incorporated by reference from our definitive Proxy Statement for the fiscal year ended December 31, 2006, to be filed with the SEC on or about April 2, 2007.
 
 Executive Compensation
 
The information called for by this item is hereby incorporated by reference from our definitive Proxy Statement for the fiscal year ended December 31, 2006, to be filed with the SEC on or about April 2, 2007.
 
 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
 
 
The information called for by this item is hereby incorporated by reference from our definitive Proxy Statement for the fiscal year ended December 31, 2006, to be filed with the SEC on or about April 2, 2007.
  
 Certain Relationships and Related Transactions, and Director Independence
 
The information called for by this item is hereby incorporated by reference from our definitive Proxy Statement for the fiscal year ended December 31, 2006, to be filed with the SEC on or about April 2, 2007.
 
 Principal Accountant Fees and Services
 
The information called for by this item is hereby incorporated by reference from our definitive Proxy Statement for the fiscal year ended December 31, 2006, to be filed with the SEC on or about April 2, 2007.

-33-



 Exhibits, Financial Statement Schedules 
 
(a) The following documents are filed as part of this Annual Report:
 
(1) Financial Statements. Please see the accompanying Index to Consolidated Financial Statements, which appears on page F-1 of the Annual Report. The Reports of Independent Registered Public Accounting Firms, the Consolidated Financial Statements and the Notes to Consolidated Financial Statements listed in the Index to Consolidated Financial Statements, which appear beginning on page F-2 of this report, are incorporated by reference into Item 8 above.
  
(2) Financial Statement Schedules. Financial Statement Schedules have been omitted because the information required to be set forth therein is either not applicable or is included in the Consolidated Financial Statements or the notes thereto.
 
(3) Exhibits. See Item 15(b) below.
 
(b) Exhibits.  The exhibits listed on the accompanying Exhibit Index immediately following the signature page are filed as part of, or are incorporated by reference into, this Annual Report on Form 10-K.
 
(c) Financial Statement Schedules.    Reference is made to Item 15(a)(2) above.



-34-





 
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
     
 
  
Page
 
Reports of Independent Registered Public Accounting Firms
  
F-2
   
Consolidated Balance Sheets
  
F-4
   
Consolidated Statements of Operations
  
F-5
     
Consolidated Statements of Comprehensive Income
 
F-6
   
Consolidated Statements of Changes in Stockholders’ Equity
  
F-7
   
Consolidated Statements of Cash Flows
  
F-8
   
Notes to Consolidated Financial Statements
  
F-9

F-1


 
Board of Directors and Stockholders
Ambassadors Group, Inc.
Spokane, Washington
 
We have audited the accompanying consolidated balance sheets of Ambassadors Group, Inc. (the Company) as of December 31, 2006 and 2005 and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Ambassadors Group, Inc. at December 31, 2006 and 2005, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
 
As discussed in Note 2 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, as of January 1, 2006.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 8, 2007 expressed an unqualified opinion thereon.
 

 
BDO Seidman, LLP
Spokane, Washington
March 8, 2007

F-2


 
Report of Independent Registered Public Accounting Firm
 
To the Board of Directors and Stockholders of
Ambassadors Group, Inc.

In our opinion, the consolidated statements of operations, comprehensive income, stockholders' equity and cash flows for the year ended December 31, 2004 present fairly, in all material respects, the results of operations and cash flows of Ambassadors Group, Inc. for the year ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.



PricewaterhouseCoopers LLP
Portland, Oregon
March 11, 2005

 

 




F-3


AMBASSADORS GROUP, INC.





 
December 31,
 
 
2006
 
2005
 
 
(in thousands, except share
and per share data)
 
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
$
36,784
 
$
26,916
 
Available-for-sale securities
96,350
 
89,688
 
Foreign currency exchange contracts
2,571
 
 
Deferred tax asset and other
675
 
955
 
Prepaid program costs and expenses
3,786
 
1,596
 
Total current assets
140,166
 
119,155
 
Property, plant and equipment, net
12,267
 
5,140
 
Deferred tax asset
1,328
 
584
 
Other long-term assets
192
 
167
 
Total assets
$
153,953
 
$
125,046
 
 
 
 
 
 
Liabilities
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
$
2,941
 
$
2,540
 
Accrued expenses
3,922
 
3,482
 
Foreign currency exchange contracts
 
1,896
Participants’ deposits
60,651
 
47,463
 
Deferred tax liability
737
 
 
Other liabilities
1,268
 
2,596
 
Current portion of long-term capital lease
191
 
180
 
Total current liabilities
69,710
 
58,157
 
Long-term capital lease
196
 
387
 
Total liabilities
69,906
 
58,544
 
Commitments and contingencies (notes 3, 5 and 9)
 
 
 
 
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; 20,599,170 and 20,656,957 shares issued and outstanding at December 31, 2006 and 2005, respectively
205
 
206
 
Additional paid-in capital
15,619
 
20,142
 
Retained earnings
66,587
 
47,550
 
Accumulated other comprehensive income (loss)
1,636
 
(1,396
Total stockholders’ equity
84,047
 
66,502
 
Total liabilities and stockholders’ equity
$
153,953
 
$
125,046
 
 The accompanying notes are an integral part of the consolidated financial statements.

F-4


AMBASSADORS GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
 
 
Years Ended December 31,
 
 
2006
 
2005
 
2004
 
 
(in thousands, except per share data)
 
 
 
 
 
 
 
 
Net revenue, non-directly delivered programs
$
69,554
 
$
64,321
 
$
51,824
 
Gross revenue, directly delivered programs
 19,401
 
4,969 
 
— 
 
Total revenue
 
88,955
   
69,290
   
51,824
 
Cost of sales, directly delivered programs
 
11,473
   
2,841
   
 
Gross margin
$
77,482
 
$
66,449
 
$
51,824
 
Operating expenses:
 
 
 
 
 
 
Selling and marketing
31,638
 
27,574
 
22,616
 
General and administrative
11,721
 
8,185
 
6,537
 
 
43,359
 
35,759
 
29,153
 
Operating income
34,123
 
30,690
 
22,671
 
Other income (expense):
 
 
 
 
 
 
Interest and dividend income
4,674
 
2,627
 
1,067
 
Other, net
81
 
21
 
(32
 
4,755
 
2,648
 
1,035
 
Income before income taxes
38,878
 
33,338
 
23,706
 
Income tax provision
12,186
 
10,928
 
8,059
 
Net income
$
26,692
 
$
22,410
 
$
15,647
 
 
 
 
 
 
 
 
Earnings per share — basic and diluted:
 
 
 
 
 
 
Net income per share - basic
$
1.30
 
$
1.10
 
$
0.78
 
Weighted-average common shares outstanding — basic
20,554
 
20,311
 
20,090
 
Net income per share - diluted
$
1.25
 
$
1.05
 
$
0.75
 
Weighted-average common shares outstanding — diluted
21,393
 
21,312
 
20,898
 
 
The accompanying notes are an integral part of the consolidated financial statements.



F-5


AMBASSADORS GROUP, INC. 

 
 
 
Years Ended December 31,
 
 
 
2006
 
2005
 
2004
 
 
 
(in thousands)
 
Net income
 
$
26,692
 
$
22,410
 
$
15,647
 
Unrealized gain (loss) on foreign currency exchange contracts, net of income tax (provision) benefit of ($1,563), $1,550, and $884
 
2,904
 
(2,957
(1,716
)
Unrealized gain (loss) on available-for-sale securities, net of income tax benefit (provision) of ($66), $40, and $48
 
128
 
(84
(90
)
Comprehensive income
 
$
29,724
 
$
19,369
 
$
13,841
 
 
The accompanying notes are an integral part of the consolidated financial statements.
 


F-6


AMBASSADORS GROUP, INC.


               
Accumulated
   
       
Additional
   
Other
   
 
Common Stock
Paid-In
Retained
Comprehensive
   
 
Shares
 
Amount
Capital
Earnings
Income (Loss)
Total
                       
Balances, December 31, 2003
20,028
$
200
$
17,306
$
19,852
$
3,451
$
40,809
Net income
 
 
 
15,647
 
 
15,647
Stock options exercised
330
 
4
 
1,511
 
 
 
1,515
Excess tax benefit from stock-based compensation
 
 
489
 
 
 
489
Stock redemptions
(196)
 
(2)
 
(2,566)
 
 
 
(2,568)
Restricted stock grant
90
 
 
 
 
 
Amortization of unearned restricted stock compensation
 
 
45
 
 
 
45
Dividend to shareholders ($0.23 per share)
 
 
 
(4,630)
 
 
(4,630)
Other comprehensive income, net of income taxes
 
 
 
 
(1,806)
 
(1,806)
Balances, December 31, 2004
20,252
$
202
$
16,785
$
30,869
$
1,645
$
49,501
Net income
 
 
 
22,410
 
 
22,410
Stock options exercised
548
 
5
 
3,323
 
 
 
3,328
Excess tax benefit from stock-based compensation
 
 
3,319
 
 
 
3,319
Stock redemptions
(193)
 
(1)
 
(3,740)
 
 
 
(3,741)
Restricted stock grant
50
 
 
 
 
 
Amortization of unearned restricted stock compensation
 
 
455
 
 
 
455
Dividend to shareholders ($0.28 per share)
 
 
 
(5,729)
 
 
(5,729)
Other comprehensive income, net of income taxes
 
 
 
 
(3,041)
 
(3,041)
Balances, December 31, 2005
20,657
$
206
$
20,142
$
47,550
$
(1,396)
$
66,502
Net income
 
 
 
26,692
 
 
26,692
Stock options exercised
307
 
3
 
1,750
 
 
 
1,753
Stock -based compensation expense
 
 
2,057
 
 
 
2,057 
Excess tax benefit from stock-based compensation
 
 
2,376
 
 
 
2,376
Stock redemptions
(400)
 
(4)
 
(10,706)
 
 
 
(10,710)
Restricted stock grant
35
 
 
 
 
 
Dividend to shareholders ($0.37 per share)
 
 
 
(7,655)
 
 
(7,655)
Other comprehensive income, net of income taxes
 
 
 
 
3,032
 
3,032
Balances, December 31, 2006
20,599
$
205
$
15,619
$
66,587
$
1,636
$
84,047

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

F-7


AMBASSADORS GROUP, INC. 

 
 
 
Years Ended December 31,
 
 
 
2006
 
2005
 
2004
 
 
 
(in thousands)
 
Cash flows from operating activities:
 
 
 
 
 
 
 
Net income
 
$
26,692
 
$
22,410
 
$
15,647
 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
 
Depreciation and amortization
 
1,447
 
1,175
 
962
 
Deferred income tax provision (benefit)
 
(748
130
 
894
 
Stock-based compensation expense
 
2,057
 
455
 
45
 
Excess tax benefit from stock based compensation
 
(2,376
)
 
 
Equity in earnings on investment
 
(25
)
(11
)
 
Change in assets and liabilities:
 
 
 
 
 
 
 
Other current assets
 
(608
)
57
 
110
 
Prepaid program costs and expenses
 
(2,190
)
865
 
(853
)
Accounts payable, accrued expenses, and other liabilities
 
(230
3,856
 
713
 
Participants’ deposits
 
13,188
 
8,855
 
10,388
 
Net cash provided by operating activities
 
37,207
 
37,792
 
27,906
 
Cash flows from investing activities:
 
 
 
 
 
 
 
Net purchase of available-for-sale securities
 
(6,468
(13,296
(20,919
Purchase of property and equipment
 
(6,455
)
(2,260
)
(1,907
)
Purchase of other investments
 
 
(36
)
(4
)
Net cash used in investing activities
 
(12,923
)
(15,592
(22,830
Cash flows from financing activities:
 
 
 
 
 
 
 
Dividend payment to shareholders
 
(7,655
)
(5,729
(4,630
)
Repurchase of common stock
Q
(10,710
)
(3,741
)
(2,568
)
Proceeds from exercise of stock options
 
1,753
 
3,328
 
1,515
 
Excess tax benefit from stock based compensation
 
2,376
 
 
 
Capital lease payments
 
(180
)
(178
(142
Net cash used in financing activities
 
(14,416
(6,320
)
(5,825
)
Net increase (decrease) in cash and cash equivalents
 
9,868
 
15,880
 
(749
)
Cash and cash equivalents, beginning of year
 
26,916
 
11,036
 
11,785
 
Cash and cash equivalents, end of year
 
$
36,784
 
$
26,916
 
$
11,036
 
 
See Note 14 for Supplemental Disclosures of Consolidated Statements of Cash Flows.
 
The accompanying notes are an integral part of the consolidated financial statements.
 


F-8


AMBASSADORS GROUP, INC.
 
 
1.
The Company
 
Ambassadors Group, Inc. is a leading educational travel company that organizes and promotes international and domestic educational travel and sports programs for youth, athletes and professionals. These consolidated financial statements include the accounts of Ambassadors Group, Inc. and our wholly owned subsidiaries, Ambassador Programs, Inc., Ambassadors Specialty Group, Inc., and Ambassadors Unlimited, LLC. All significant intercompany accounts and transactions are eliminated in consolidation.

We have a single operating segment consisting of the educational travel and sports programs for students, athletes and professionals. These programs have similar economic characteristics, offer comparable products to delegates and utilize similar processes for program marketing.

On August 12, 2005, our Board of Directors declared a two-for-one stock split of our Common Stock in the form of a 100 percent common stock dividend, payable on September 15, 2005 to shareholders of record on August 31, 2005. This stock split has been recorded retroactively through all periods presented.

All of our assets are located in the United States. Our revenues as a percentage of total revenues were derived from travel programs conducted in the following geographic areas:
 
 
Years Ended
December 31,
 
 
2006
 
2005
 
2004
 
South Pacific (primarily Australia and New Zealand)
 
26
%
 
30
%
 
34
%
Europe
 
43
%
 
46
%
 
48
%
Asia (primarily China)
 
13
%