<PAGE>
As filed with the Securities and Exchange Commission on March 18, 1999
Registration No. 333-70841
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------
Amendment No. 3
to
FORM S-1
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933
--------------
CHEAP TICKETS, INC.
(Exact Name of Registrant as Specified in Its Charter)
--------------
<TABLE>
<S> <C> <C>
Delaware 561599 99-0338363
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
</TABLE>
1440 Kapiolani Boulevard, Honolulu, Hawaii 96814
(808) 945-7439
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
--------------
Michael J. Hartley
Chairman of the Board, Chief Executive Officer and President
Cheap Tickets, Inc.
1440 Kapiolani Boulevard, Honolulu, Hawaii 96814
(808) 945-7439
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
Copies of all communications to be sent to:
<TABLE>
<S> <C>
Henry M. Fields, Esq. Arthur J. Simon, Esq.
Victor H. Sim, Esq. Diane Bono, Esq.
Mavis L. Yee, Esq. SONNENSCHEIN NATH & ROSENTHAL
MORRISON & FOERSTER LLP 8000 Sears Tower, Chicago, Illinois 60606
555 West Fifth Street, Los Angeles, California
90013-1024 (312) 876-8000
(213) 892-5200
</TABLE>
--------------
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this registration statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------
Proposed Proposed
Amount maximum maximum Amount of
Title of each class of to be offering price aggregate registration
securities to be registered registered(1) per unit(1) offering price(2) fee(2)
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, par value $.001........ 4,025,000 shares $13.00 $52,325,000 $14,546.35(3)
- ------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes 525,000 shares which the underwriters have options to purchase to
cover, if any, over-allotments.
(2) Estimated solely for purpose of calculating the amount of the registration
fee. This estimate is made in accordance with Rule 457 under the Securities
Act of 1933, as amended.
(3) A fee of $15,841 was previously paid with the initial filing on January 20,
1999.
--------------
The registrant hereby amends this registration statement on such date or
dates as may be necessary to delay its effective date until the registrant
shall file a further amendment that specifically states that this registration
statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until this registration statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+Information in this prospectus is not complete and may be changed. We may not +
+sell these securities until the time the registration statement filed with +
+the Securities and Exchange Commission becomes effective. This prospectus is +
+not an offer to sell the securities and we are not soliciting an offer to buy +
+these securities in any state where the offer or sale is not permitted or +
+would be unlawful prior to registration or qualification under the securities +
+laws of any such state. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION
PROSPECTUS
3,500,000 Shares
[LOGO OF CHEAP TICKETS INC. APPEARS HERE]
www.cheaptickets.com
Common Stock
Cheap Tickets, Inc. is offering 3,500,000 shares of its common stock.
This is our initial public offering, and no market currently exists for our
shares. We anticipate that the initial public offering price will be between
$11.00 and $13.00 per share. The offering price may not reflect the market
price of our shares after the offering. We will list the common stock on the
Nasdaq National Market under the trading symbol "CTIX."
This investment involves a high degree of risk. You should purchase shares
only if you can afford a complete loss. See "Risk Factors" commencing on Page
7.
-------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
The Offering Per Share Total
- -----------------------------------------------------------------------------------
<S> <C> <C>
Public Offering Price........................................ $ $
Underwriting Discounts....................................... $ $
Proceeds to Cheap Tickets, Inc. ............................. $ $
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
We have granted the underwriters the right to purchase an additional 525,000
shares at the public offering price, less the underwriting discount within 30
days from the date of this prospectus to cover over-allotments.
William Blair & Company Dain Rauscher Wessels
a division of Dain Rauscher Incorporated
The date of this prospectus is , 1999
<PAGE>
[PICTURE OF CHEAP TICKETS' INTERNET HOME PAGE]
Cheap Tickets' Home Page serves the discount travel needs of consumers for
airfare, hotels and car rentals. The fully-functional Internet site sold
nearly 100,000 tickets in 1998.
[PICTURE OF CHEAP TICKETS' INTERNET REQUEST PAGE]
In addition to calling any of the Company's over 300 sales agents at its four
call centers, the customer can easily schedule domestic and international
travel on the web site.
[PICTURE OF CHEAP TICKETS' INTERNET FARES PAGE]
The customer is presented with a broad array of fare possibilities, including
proprietary "non-published" fares representing excess airline capacity. Cheap
Tickets buys these fares from over 25 domestic and international airlines.
Also, a full menu of regularly published fares through the SABRE reservations
system is available.
Certain persons participating in this offering may engage in transactions
which stabilize, maintain or otherwise affect the price of common stock of the
Company including stabilizing bids, syndicate covering transactions or the
imposition of penalty bids. For a discussion of these activities, see
"Underwriting." These transactions may be made on the Nasdaq National Market or
otherwise. Stabilizing, if commenced, may be discontinued at any time.
2
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements appearing elsewhere in this prospectus.
This prospectus contains forward-looking statements that involve risks and
uncertainties. Cheap Tickets' actual results may differ significantly from the
results discussed in the forward-looking statements. Factors that might cause
such a difference include, but are not limited to, those discussed in "Risk
Factors."
CHEAP TICKETS, INC.
We are a leading retail seller of discount tickets for domestic leisure air
travel. In 1998, we sold approximately 960,000 airline tickets through call
centers, retail stores and our Internet site at "www.cheaptickets.com." We
believe we are the leading seller of non-published fares for regularly
scheduled domestic routes. Non-published fares are tickets that we buy from
airlines and resell to consumers at significant discounts off published fares.
Sales of non-published fares accounted for approximately 59% of our airline
gross bookings in 1998. We have rights to buy these fares under contracts from
over 30 airline carriers, including America West, American, Continental,
Northwest TWA and US Airways. Our airline contracts, which typically run for a
term of 1 1/2 years or less and can be cancelled on short notice, do not
require the airlines to deal with us exclusively or to provide a specific
quantity of tickets. Under the contracts, we purchase tickets only when we
resell to customers, so that we do not have inventory carrying costs. We also
offer a full complement of regularly published fares, affording customers a
breadth of choice in leisure travel tickets at attractive prices that we
believe is unmatched in the industry. In addition, we sell cruise tickets, auto
rentals and hotel reservations.
We began selling tickets over the Internet in October 1997. In 1998, we sold
96,000 tickets through our website, generating $25 million in gross bookings.
Internet sales represented approximately 9% of our gross bookings in 1998 and
15% in the fourth quarter of 1998, reflecting the rapid increase in Internet
sales as a percentage of gross bookings. At February 22, 1999, we had over
575,000 registered online users, with 155,000 registering since December 1998.
Since 1986, we have provided an efficient distribution channel for airlines
to sell excess capacity without eroding their published fare structures.
Domestic airlines had average excess system capacity of 32.5% from 1995 to
1997, and excess capacity is estimated to be 29.3% in 1998. We seek to match
excess capacity with consumer demand for the lowest price available. Currently,
we offer approximately 375,000 non-published fares at any given time, covering
most major domestic and international routes. We set prices on these fares
lower than those available on published fares to meet the demands of leisure
travelers. These fares contain restrictions typically making them unattractive
for full fare passengers, who seek the convenience of tickets that can be
exchanged or cancelled and that do not have advance purchase or minimum stay
requirements. We believe our track record of selling excess capacity without
compromising the airlines' fare structures provides a strong incentive for the
airlines to continue to use us for the sale of domestic non-published fares.
We also offer to customers a full menu of regularly published fares in
addition to non-published fares. In 1994, we became the first non-airline to
file our non-published fares through the Airline Tariff Publishing Corporation.
This allows us to integrate our non-published fares with published fares in a
special area of the SABRE reservations system to which only we have access.
This system
3
<PAGE>
automatically sorts through millions of fares, including our non-published
fares, to identify the lowest fares available for the desired itinerary. These
fares are then posted in ascending price order for use by our reservation
agents and Internet customers.
The travel industry is large and growing. Consumers in the United States
spent $126 billion on travel through travel agencies in 1997, up from $101
billion in 1995. Airline travel continues to be the largest segment of the
industry with $70.5 billion, or 56%, of total travel booked through travel
agencies in 1997. Increasingly, the Internet has become an attractive method to
sell travel tickets directly to the public. Currently, travel represents the
second largest online retail category sold over the Internet. Online airline
travel bookings were $1.6 billion in 1998 and are expected to grow at a
compounded annual growth rate of 46%, reaching $10.6 billion in 2003.
Our growth strategy is to expand our customer base, significantly increase
our brand awareness, expand our strategic relationships and increase call
center productivity. First, we plan to capitalize on our position in selling
non-published fares to rapidly grow our Internet ticket sales. We intend to
broaden our online visibility with Internet content, commerce and service
providers. Second, we plan to aggressively expand brand recognition nationally
and internationally. To accomplish this goal, we intend to augment our
successful print media marketing and increase advertising on leading websites
and in other media. Third, we plan to expand existing and establish new
strategic relationships with airlines to increase sales of their excess
capacity. We also intend to seek new relationships with other travel suppliers,
certain Internet portals and travel-related websites. Finally, we plan to
expand our call center capacity through improved productivity. We intend to
invest substantial resources in developing, acquiring and implementing
technological enhancements to our call centers.
Our executive offices are located at 1440 Kapiolani Boulevard, Honolulu,
Hawaii 96814; our telephone number is (808) 945-7439 and our facsimile number
is (808) 946-3844. We were incorporated in Hawaii in 1986 and reincorporated in
Delaware on February 1, 1999.
THE OFFERING
<TABLE>
<S> <C>
Common stock offered by the Company.................... 3,500,000 shares
Common stock to be outstanding after the offering...... 20,943,132 shares(1)
Use of proceeds........................................ For advertising and brand
development; for development of
technological infrastructure; to
redeem outstanding mandatorily
redeemable preferred stock; and
for general corporate purposes.
For a more detailed discussion of
the use of proceeds, please refer
to "Use of Proceeds" on page 21.
</TABLE>
- --------
(1) Based on the number of shares outstanding as of December 31, 1998.
Excludes 1,979,642 shares reserved for issuance under the 1997 Stock
Option Plan as of December 31, 1998. Includes 2,969,456 shares of common
stock issuable upon the exercise of warrants outstanding as of December
31, 1998. It is anticipated that all the warrants will be exercised
immediately prior to the closing of the offering. Excludes 1,260,000
shares reserved for issuance under the 1999 Stock Incentive Plan. For a
more detailed discussion of our capital stock and stock option plans
please refer to notes 6 and 12 to the financial statements on pages F-15
and F-20, "Management--Employee Stock Plans" on page 53, and "Description
of Capital Stock" on page 59.
----------------
4
<PAGE>
SUMMARY FINANCIAL DATA
(in thousands, except per share and operating data)
Set forth below are summary financial data of Cheap Tickets for the periods
indicated, which have been derived from Cheap Tickets' audited financial
statements. The operating data were not audited. The summary financial data set
forth below should be read in conjunction with Cheap Tickets' financial
statements and "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1996 1997 1998
------- -------- --------
<S> <C> <C> <C>
Results of Operations:
Non-published fares................................ $58,982 $ 96,379 $159,846
Commissions........................................ 5,614 6,470 11,268
------- -------- --------
Net revenues(1).................................. 64,596 102,849 171,114
Gross profit....................................... 15,428 21,479 35,047
Selling, general and administrative expenses(2).... 14,352 23,091 33,411
------- -------- --------
Net operating income (loss)...................... 1,076 (1,612) 1,636
Net earnings (loss)................................ $ 674 $ (1,009) $ 1,065
Basic earnings (loss) per share(3)................. $ 0.05 $ (0.09) $ 0.04
Shares used in computing basic earnings (loss) per
share(3).......................................... 14,249 14,847 14,567
Diluted earnings (loss) per share(3)............... $ 0.05 $ (0.09) $ 0.03
Shares used in computing diluted earnings (loss)
per share(3)...................................... 14,249 14,847 17,921
</TABLE>
<TABLE>
<CAPTION>
December 31, 1998
----------------------
Actual As Adjusted(4)
------- --------------
<S> <C> <C>
Balance Sheet Data:
Net working capital ..................................... $ 3,473 $36,975
Total assets............................................. 13,226 46,728
Long-term debt........................................... 1,238 1,238
Mandatorily redeemable preferred stock(5)................ 4,136 --
Stockholders' equity(5).................................. 1,385 39,023
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Operating Data (unaudited):
Gross bookings (in thousands)(6)
Non-published fares............................... $ 58,982 $ 96,379 $159,846
Published fares................................... 46,962 57,295 110,287
-------- -------- --------
Total gross bookings............................. $105,944 $153,674 $270,133
======== ======== ========
Airline tickets sold:............................... 357,551 554,403 960,879
Call centers...................................... 357,551 551,973 865,015
Internet.......................................... -- 2,430 95,864
Registered Internet users........................... -- 18,891 420,023
</TABLE>
- --------
(1) Net revenues consist of sales of non-published fares and commissions. Net
revenues from sales of non-published fares represent revenues from the sale
of tickets purchased from the airlines. Cost of sales consists of the net
fare cost paid to carriers to purchase non-published fares. Commissions,
including incentive overrides, are earned primarily on published fares sold
and include certain other payments based on the volume of transactions.
(2) In 1998, Cheap Tickets issued stock options to employees to acquire an
aggregate of 728,000 shares of Cheap Tickets' common stock of which 660,800
have an exercise price of $0.18 per share and 67,200 have an exercise price
of $1.57 per share. Total compensation associated with these options
amounted to $722,600 of which $26,325 has been charged to operations in
1998. The remainder will be charged over
5
<PAGE>
the remaining five-year vesting period of the options, with the exception
of $1,062, which will be charged at the closing of the offering at which
time 140,000 options vest by their terms.
(3) Please refer to notes 1 and 6 to the financial statements for the
calculation of earnings per share, including an explanation of the number
of shares used in computing the amount of basic and diluted earnings per
share.
(4) As adjusted to reflect (1) the receipt of net proceeds of the offering;
(2) the redemption of the mandatorily redeemable preferred stock
(including a charge for the unaccreted discount); (3) the exercise of
warrants to purchase up to 2,969,456 shares of common stock at an
aggregate exercise price of $2,121 and (4) the immediate recognition of
unearned compensation related to certain stock options that fully vest
upon the completion of this offering.
(5) The mandatorily redeemable preferred stock is required to be redeemed upon
the closing of this offering. The redemption price upon the closing of
this offering will be approximately $4.8 million. The preferred stock was
issued at a discount of $885,170. Cheap Tickets is accreting the discount
over a five year period. Upon redemption, the unaccreted discount will be
charged directly to stockholders' equity and have a dilutive effect on the
calculation of earnings per share.
(6) Gross bookings represent the aggregate retail value of tickets sold under
non-published fares and published fares. The difference between gross
bookings and revenues as reported in Cheap Tickets' statement of
operations derives solely from the difference in revenue treatment
accorded to sales of published fares. With respect to published fares,
Cheap Tickets records as revenue in its statement of operations only the
commissions earned by Cheap Tickets on the sale of such fares. Gross
bookings represents the retail value of the sales of published fares. With
respect to non-published fares, revenues as reported in Cheap Tickets
statement of operations is equivalent to gross bookings, which is the
retail value of such fares. Management uses gross bookings as a key
indicator of general business activity, success of promotional efforts,
capacity to handle customer demand and efficiency of reservation agents.
In addition, management believes that gross bookings provide a useful
comparison between historical periods, and year-to-year changes in such
information provide a useful measure of market acceptance of Cheap Tickets
products.
6
<PAGE>
RISK FACTORS
In addition to the other information we provide in this prospectus, you
should carefully consider the following risks before deciding whether to invest
in our common stock. These are not the only risks we face. Some risks are not
yet known to us and there are others we do not currently believe are material
but could later turn out to be so. All of these could hurt our business. The
trading price of our common stock could decline because of general market
conditions or if any or all of these risks came to pass, and you could lose all
or part of your investment. In evaluating the risks of investing in us, you
should also evaluate the other information set forth in this prospectus,
including our financial statements.
For access to non-published fares, we depend on travel suppliers with which we
have no long-term contracts.
In 1998, approximately 98% of our gross bookings came from the sale of
airline tickets. Non-published fares represented about 59% of our airline gross
bookings and 93% of our net revenues, and we believe that our continuing
ability to obtain non-published fares is key to our success. Our business could
be hurt by:
. Refusals by airlines to renew contracts for supply of non-published
fares;
. Lack of available excess capacity for an extended time period;
. Renewals of the contracts on less favorable terms; or
. Cancellation of contracts.
Non-published fares are tickets we acquire from the airlines and resell to
consumers at substantial discounts off published fares. The airlines sell us
tickets at these non-published fares primarily to dispose of excess capacity
without eroding published fare structures. We have contracts with more than
30 airlines that permit us to acquire non-published fares on routes designated
in the contracts at specified prices. These contracts do not require airlines
to provide a specific quantity of tickets or to deal with us exclusively.
Although the terms vary, the typical contract is for a period from one to one
and a half years, and many are cancelable on 30 days' notice or less. We have a
consistent record of renewing these contracts, but airlines may decide not to
do business with us or to dispose of excess capacity themselves or through
others. At times in the past, airlines have renewed contracts with us on less
favorable terms and this may continue to occur in the future. In addition,
there may be times when they have less excess capacity to sell.
A large percentage of our sales of non-published fares currently comes from
three suppliers.
In 1998, approximately 49% of our sales of non-published fares came from
tickets we bought from three airlines: Continental represented approximately
25%, and America West and TWA represented approximately 12% each. If one or
more of these carriers were to discontinue to supply non-published fares to us,
our business could be hurt.
The percentages of non-published fare sales represented by our leading
carriers are likely to change from year to year depending upon a variety of
factors, including the availability of excess capacity from each carrier and
the breadth of routes on which non-published fares are available. We typically
engage in ongoing discussions with existing carriers about increasing the
routes available for sale of non-published fares. From time to time, we also
discuss potential new relationships for the supply of non-published fares with
carriers with whom we currently do not have contracts. Although these
discussions are at times successful, we do not anticipate that the percentages
for non-published fare sales among the leading carriers will change
significantly in the foreseeable future.
7
<PAGE>
Our travel suppliers may be acquired and then not continue to deal with us.
We believe that our continued ability to obtain non-published fares is key
to our success. The acquisition of a key supplier could, however, adversely
change that supplier's relationship with us and hurt our business.
Because many of our contracts are short-term and can be cancelled on short
notice, we depend on our relationships with our suppliers for a continued
supply of non-published fares. We also depend on continuation of our suppliers'
policy of selling excess capacity through non-published fares. The acquisition
of one of our suppliers could hurt our relationship with that supplier and/or
could change that supplier's policy of dealing with excess capacity.
A decline in airline commission rates or the elimination of commissions could
hurt our business.
We earned approximately 24% of our gross profit in 1998 from commissions
paid by airlines. However, they are not required to pay any particular
commission rates or any commissions at all. If air carriers reduce, restrict or
eliminate altogether commissions or impose surcharges for tickets not sold by
them at any time, it could hurt our business. In recent years, airlines have
reduced rates and capped per-ticket commissions. In addition, they have further
reduced rates and capped commissions for online reservations.
Potential fluctuations in our financial results makes financial forecasting
difficult.
Our annual or quarterly results of operations may be below the expectations
of public market analysts and investors. This could result in a decline in the
value of our common stock.
Our business is seasonal due to customers' leisure travel patterns and
changes in the availability of non-published fares. We typically have higher
sales and gross profit in the second and third quarters and lower sales and
gross profit in the fourth quarter, and historically we have experienced losses
in net income in the fourth quarter. During periods of high-volume air travel,
such as occur in the fourth quarter of each year, we historically have had
access to fewer non-published fares, and such fares on certain major routes may
be unavailable. Online gross bookings may also tend to be seasonal and may
decline or grow less rapidly in the summer months. The seasonal sales cycle is
fairly predictable, but the cycle may shift year-to-year, corresponding to
changes in the economy or other factors affecting the market such as price
wars. This could lead to unusual volatility in revenues and earnings.
Gross profit may be impacted by a number of different factors, including:
. the amount of fares sold;
. the percentage of gross bookings represented by non-published fare
sales;
. the gross margin percentages on non-published fare sales. These
percentages in turn can be impacted by the sales mix of airlines,
whose net fare prices to us vary, and by competitive factors on
various routes and the possible elimination of profitable routes;
.rates of commissions on published fare sales; and
.the amount of volume bonuses.
8
<PAGE>
Any change in these factors could materially affect our gross margins and
operating results in future periods. Other events outside our control,
including those set forth in other risk factors, may cause us to experience
significant fluctuations in revenues and earnings.
We intend to increase operating expenses in anticipation of future sales. If
these increased sales do not occur or occur only in subsequent periods, we may
experience downward fluctuations in our earnings.
A decline in leisure travel or disruptions in travel generally could hurt our
business.
We earn almost all our revenues from the travel industry, particularly from
leisure travel. Leisure travel is highly sensitive to personal discretionary
spending levels and thus tends to decline during general economic downturns. In
addition, other adverse trends or events that tend to reduce leisure travel are
likely to hurt our business. These may include:
.Political instability;
.Regional hostilities;
.Terrorism;
.Fuel price escalation;
.Travel-related accidents;
.Bad weather; or
.Airline or other travel related strikes.
A number of airlines are currently in various stages of negotiation with
unions representing their employees. If those negotiations fail and the unions
elect to strike or effect a slowdown, our business could be harmed.
We face actual and potential competition from many sources.
We compete in ticket sales against travel wholesalers, consolidators, online
travel companies, airlines and travel agents based on price and the quality of
service to the customer. In the leisure travel market, we also compete against
frequent flyer awards and charter flights. Increased competition may result in
reduced operating margins, loss of market share and decreased brand
recognition. Ultimately, we may not be able to compete successfully against
current and future competitors.
Among other factors, our success depends heavily on our access to non-
published fares, on our brand recognition and on the ability of our systems to
integrate our non-published fares with published fares to offer customers a
broad choice. Some of our competitors, including the air carriers themselves,
have longer histories, larger customer bases, greater brand recognition and
significantly greater financial, marketing and other resources than we do.
These competitors may be able to replicate the factors that make us successful.
They may also enter into strategic or commercial relationships with larger,
established and well-financed companies. They may be able to induce one or more
of our suppliers of non-published fares to cease doing business with us, or to
do business with us on less favorable terms. They might also be able to build
strong brand recognition in the leisure travel market, through widespread
advertising and other marketing efforts. Certain of our competitors may be able
to devote greater resources to marketing and promotional campaigns on the
9
<PAGE>
Internet. Competitors may also devote substantially more resources to website
and systems development than we do. Any or all of these developments could
bring heavy competitive pressures to bear on us.
We also face the prospect of competition from potential competitors not yet
in the leisure travel market. We believe that potential competitors are likely
to be large, well-financed companies with existing brand name recognition and
proven retail distribution ability. Potential competitors are also likely to
need well developed Internet capabilities to compete effectively with us.
Without these characteristics, or without significant amounts of capital to
create them, we believe it would be relatively difficult, although not
impossible, for potential competitors to enter our market. Potential
competitors would have to convince air carriers to use them to distribute
excess capacity effectively without eroding existing fare structures. We
believe our suppliers have confidence in us in this regard based on our
historical results, but these suppliers could be induced to change their method
of distribution, if offered higher returns, broad distribution capability and
protection against fare erosion by potential competitors.
For a more complete description of the competitive environment in which we
operate, please refer to "Business--Competition" on pages 45 and 46.
The success of our business will depend on continued growth of online commerce
and internet infrastructure.
Our future revenues and profits depend, to a certain degree, upon the
widespread acceptance and use of the Internet and online services as a medium
for commerce by customers and sellers. If acceptance and growth of Internet use
does not continue, it will hurt our business.
Rapid growth in the use of the Internet and online services is a recent
phenomenon. This growth may not continue. A sufficiently broad base of
customers may not accept, or continue to use, the Internet as a medium of
commerce. Demand for and market acceptance of recently introduced products and
services over the Internet are subject to a high level of uncertainty. There
are few proven products and services. For us to achieve significant growth,
customers who have historically used traditional means of commerce will instead
need to elect to purchase products and services online, and sellers of products
and services will need to accept or expand use of the Internet as a channel of
distribution. Our revenues and profits depend on customers visiting our website
and actually purchasing tickets. Customers could potentially use the site for
route information and choose to purchase tickets directly from the airlines or
elsewhere.
The Internet has experienced, and is expected to continue to experience,
significant growth in the number of users and amount of traffic. Our success
will depend upon the development and maintenance of the Internet's
infrastructure to cope with this increased traffic. This will require a
reliable network backbone with the necessary speed, data capacity and security,
and the timely development of complementary products, such as high-speed
modems, for providing reliable Internet access and services.
Major online service providers and the Internet itself have experienced
outages and other delays as a result of software and hardware failures and
could face such outages and delays in the future. Outages and delays are likely
to affect the level of Internet usage and the processing of transactions on the
Cheap Tickets website. It is unlikely that we could make up for the level of
orders lost in those circumstances by increased phone orders. In addition, the
Internet could lose its viability by
10
<PAGE>
reason of delays in the development or adoption of new standards to handle
increased levels of activity or of increased government regulation. The
adoption of new standards or government regulation may require us to incur
substantial compliance costs.
Our brand may not achieve the broad recognition necessary to succeed.
We believe that we must maintain and enhance the Cheap Tickets brand to
continue to attract and expand business. Failure to maintain and enhance our
brand could hurt our business.
The success of the Cheap Tickets brand will depend to a certain extent on
our ability to enhance our advertising programs. The number of Internet sites
that offer competing services increases the importance of establishing and
maintaining our brand name recognition. Many online sites already have well-
established brands in online services or the travel industry generally. We may
find it necessary to increase substantially our financial commitment to
advertising and publicity. This could adversely affect our results of
operations.
We may be unable to manage our rapid growth effectively.
We have rapidly and significantly expanded our operations and anticipate
further significant expansion. Our inability to manage growth effectively could
hurt our business.
We have recently added a number of key managerial and technical employees,
and we expect to add additional key personnel in the future. This expansion has
placed, and we expect it will continue to place, a significant strain on our
management, operational and financial resources. To manage the expected growth
of our operations and personnel, we plan to:
. improve and upgrade transaction-processing, operational, customer
service and financial systems, procedures and controls;
. maintain and expand our relationships with various travel service
suppliers, Internet portals and other travel-related website
companies and other third parties necessary to our business;
. expand our finance, administrative and operations staff;
. continue to attract, train and manage our employee base; and
. implement a disaster recovery program.
Our current and planned personnel, systems, procedures and controls may be
inadequate to support our planned growth, and our management may not be able to
identify, manage and exploit existing and potential market opportunities
successfully.
We may not be able to keep up with the industry's rapid technological and other
changes.
The industry in which we compete is characterized by:
. rapid technological change;
. changes in user and customer requirements and preferences;
. frequent new product and service introductions embodying new
technologies;
. the emergence of new industry standards and practices; and
. the emerging importance of the Internet and the proliferation of
companies offering Internet-based products and services.
11
<PAGE>
These developments could render our existing online sites and proprietary
technology and systems quickly obsolete. Our inability to modify or adapt our
infrastructure in a timely manner or the expenses incurred in making such
adaptions could hurt our business.
As a result, we will be required to continually improve the performance,
features and reliability of our services, particularly in response to
competitive offerings. Our success will depend, in part, on our ability to
enhance our existing services and develop new services in a cost-effective and
timely manner. The development of proprietary technology entails significant
technical and business risks and requires substantial expenditures and lead
time. We may not be able to adapt successfully to customer requirements or
emerging industry standards. In addition, the widespread adoption of Internet,
networking or telecommunications technologies or other technologies could
require us to incur substantial expenditures to modify or adapt our services or
infrastructure.
Our computer and communications systems are vulnerable to business
interruptions.
Our ability to receive and fill orders through our call centers or online
and provide high-quality customer service largely depends on the efficient and
uninterrupted operation of our computer and communications hardware systems.
The occurence of interruptions, delays, loss of data or the inability to accept
and confirm customer reservations could hurt our business.
Our online servers are located in San Jose, California, The SABRE Group's
computers are located in Tulsa, Oklahoma, our communication systems are located
at four call centers, and our accounting systems' computers are located in
Hawaii. These systems and operations are vulnerable to damage or interruption
from power loss, telecommunications failure, break-ins, natural disasters and
similar events.
We currently do not have back-up systems and do not carry adequate business
interruption insurance. In addition, although we back up data on a regular
basis, we do not have a formal disaster recovery plan. Although we have adopted
network security measures, our servers are vulnerable to computer viruses,
physical or electronic break-ins and similar disruptions. These kinds of events
could lead to interruptions, delays, loss of data or the inability to accept
and confirm customer reservations. The occurrence of any of the foregoing risks
could hurt our business.
Interruptions in service from third parties could hurt our business.
We rely on certain third-party computer systems and third-party service
providers, including the computerized central reservation systems of the
airline and hotel industries to make airline ticket and hotel room
reservations. Any interruption in these third-party services or a deterioration
in their performance could hurt our business. If our arrangement with any of
these third parties is terminated, we may not find an alternative source of
systems support on a timely basis or on commercially reasonable terms.
We rely on third parties to print our airline tickets and arrange for their
delivery. We rely on iXL Holdings to host our online system's infrastructure,
web and database servers.
We use an internally developed system for our website and substantially all
aspects of transaction processing. We currently rely on SABRE for our general
reservations system, including customer profiling, making reservations and
credit card verification and confirmations. Currently, over 90% of our
computing transactions are processed through the SABRE systems. Our technology
relationship with SABRE for Internet operations will further increase our
dependency. If
12
<PAGE>
we or SABRE ever elect to terminate the existing relationship, we would be
forced to convert to another provider. This conversion could require a
substantial commitment of time and resources and hurt our business.
Our current reservation systems may not be able to handle all calls adequately.
During traffic peaks, our call centers have not been able to answer all
calls or service all inquiries adequately. Our systems' lack of capacity to
handle the demands of our customers can cause unanticipated system disruptions,
slower response times, poor customer service, impaired quality and speed of
reservations and confirmations and delays in reporting accurate financial
information. These problems could hurt our business.
We intend to use part of the proceeds of this offering to upgrade our
systems and increase our processing capability, both online and through our
call centers, to accommodate anticipated increases in customer ticket sales.
However, if we experience a substantial increase in our web traffic or in
reservations beyond expected levels, we may need to expand and upgrade our
technology, transaction-processing systems and network infrastructure. If we
fail to expand and upgrade in a timely manner, our business could be hurt. We
believe that our contemplated systems enhancements will be sufficient to handle
increases in expected demand, but we may not be able to:
. project accurately the rate or timing of such increases;
. upgrade our systems and infrastructure to accommodate future traffic
levels;
. integrate successfully any newly developed or purchased technology
with our existing systems; or
. upgrade and expand our systems in a timely or efficient manner.
Online security breaches could hurt our business.
In our business, secured transmission of confidential information over
public networks is essential to maintain consumer and supplier confidence. If
any compromise of our security were to occur, it could hurt our business.
Concerns over the security of transactions conducted on the Internet and the
potential compromise of customer privacy may inhibit the growth of commercial
online services as a means of conducting commercial transactions. We have
expended significant resources to protect against security breaches and to
alleviate problems caused by such breaches, and we may need to make further
expenditures for this purpose in the future. We rely on encryption and
authentication technology licensed from third parties to provide the security
and authentication necessary to transmit securely confidential information,
such as customer credit card numbers. In addition, we maintain an extensive
confidential database of customer profiles and transaction information. Our
current security measures may not be adequate and advances in computer
capabilities, new discoveries in the field of cryptography, or other events or
developments may result in a compromise or breach of the methods we use to
protect customer transaction and personal data. A party who can circumvent our
security might be able to misappropriate proprietary information or cause
interruptions in our operations. Security breaches could also expose us to a
risk of loss or litigation and possible liability for failing to secure
confidential customer information.
13
<PAGE>
If we lose our key personnel or cannot recruit additional personnel, our
business may suffer.
We depend substantially on the continued services and performance of our
senior management, particularly Michael J. Hartley, the Chairman of the Board,
Chief Executive Officer and President, and certain other key personnel. The
loss of the services of any of these executive officers or other key employees
could hurt our business.
We do not have employment agreements with any of our key personnel. In
addition, most members of our senior management group have been recruited and
hired over the past 18 months. These individuals may not be able to fulfill
their responsibilities adequately and may not remain with us.
Our future success also depends on our ability to identify, attract, hire,
train, retain and motivate other highly skilled technical, managerial,
marketing and customer service personnel. Competition for such personnel is
intense. The location of our headquarters in Hawaii may also make it more
difficult to attract qualified personnel from the mainland. We may not able to
attract, assimilate or retain sufficiently qualified personnel. In particular,
we may encounter difficulties in attracting a sufficient number of qualified
software developers for our online services and transaction-processing systems.
The failure to retain and attract necessary technical, managerial, marketing
and customer service personnel could hurt our business and impair our growth
strategy.
Although none of our employees is represented by a labor union, our
employees may join or form a labor union. For a more detailed description of
our management and key employees, please refer to "Management" on page 47.
Our business could be hurt if we do not offer new services successfully.
We plan to introduce new and expanded services. Our inability to generate
revenues from such expanded services or products sufficient to offset their
development or offering cost could hurt our business. In 1998, approximately 2%
of our gross bookings came from the sale of cruise tickets, auto rentals and
hotel reservations. Our business strategy is to increase the percentage of such
alternate travel offerings as a percentage of our revenues. We may not be able
to offer such services in a cost-effective or timely manner and our efforts may
not be successful. Further, any new service that is not favorably received by
customers could damage our reputation or brand name. Expansion of our services
could also require significant additional expenses and may strain our
management, financial and operational resources. If we cannot obtain alternate
travel offerings in the future, we may not be able to benefit fully from our
growth strategy.
Our business could be hurt if we make acquisitions that are not successful.
We may in the future broaden the scope and content of our business through
the acquisition of existing complementary businesses. We may not be successful
in overcoming problems encountered in connection with such acquisitions, and
our inability to do so could hurt our business.
Although we are not currently contemplating any acquisitions, we may
consider the acquisition of companies providing similar services in
international markets or in other sectors of the travel industry in the future.
Future acquisitions would expose us to increased risks. These include risks
associated with:
. the assimilation of new operations, sites and personnel;
. the diversion of resources from our existing businesses, sites and
technologies;
14
<PAGE>
. the inability to generate revenues from new sites or content
sufficient to offset associated acquisition costs;
. the maintenance of uniform standards, controls, procedures and
policies; and
. the impairment of relationships with employees and customers as a
result of integration of new businesses.
Acquisitions may also result in additional expenses associated with
amortization of acquired intangible assets or potential businesses.
Our business could be hurt if our international expansion is not successful.
One component of our growth strategy is to expand internationally.
International expansions will present us with special problems of adapting to
foreign business customs and regulations and of managing staff effectively from
a distance. If we do not address these problems adequately, our international
expansion may not produce desired results. This could hurt our business. We may
expend significant financial and management resources to establish local
offices overseas, create localized user interfaces and comply with local
customs and regulations. If the revenues generated by these international
operations are insufficient to offset the expense of establishing and
maintaining them, our business could be hurt. To date, we have no experience in
developing localized versions of our online sites or offshore call centers and
only limited experience in marketing and distributing our travel services
internationally. We may not be able to expand our operations successfully in
such markets. Conducting business on an international level also involves
certain inherent risks, such as unexpected changes in regulatory requirements,
tariffs and other trade barriers, difficulties in staffing and managing foreign
operations, political instability, currency rate fluctuations, seasonality in
leisure travel in certain countries and potentially adverse tax consequences.
We may be unable to meet our future capital requirements.
We may not be able to fund our expansion, develop or enhance our products or
services or respond to competitive pressures if we lack adequate funds. This
could hurt our business. Based on our current operating plan, we anticipate
that the net proceeds of this offering, together with our available funds and
bank lines, will be sufficient to satisfy our anticipated needs for working
capital, capital expenditures and business expansion for the foreseeable
future. After that time, we may need additional capital. Alternatively, we may
need to raise additional funds sooner in order to fund more rapid expansion, to
develop new or enhanced services, or to respond to competitive pressures. If we
raise additional funds by issuing equity or convertible debt securities, the
percentage ownership of our stockholders will be diluted. Further, any new
securities could have rights, preferences and privileges senior to those of the
common stock.
We currently do not have any commitments for additional financing. We cannot
be certain that additional financing will be available in the future to the
extent required or that, if available, it will be on acceptable terms. For more
information on how the proceeds from this offering are intended to be used,
please refer to "Use of Proceeds" on page 21 and for more information on
management's view of liquidity and capital resources, please refer to
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" on page 32.
15
<PAGE>
Year 2000 risks may harm our business.
The risks posed by Year 2000 issues could hurt our business in a number of
significant ways. Our information technology system could be substantially
impaired or cease to operate due to Year 2000 problems. Additionally, we rely
on information technology supplied by third parties, and our participating
sellers are also heavily dependent on information technology systems and on
their own third party vendors' systems. The main supplier of our reservations
system is SABRE. Currently, over 90% of our transactions are processed through
SABRE. Year 2000 problems experienced by us or any such third parties could
hurt our business. Additionally, the Internet could face serious disruptions
arising from the Year 2000 problem.
We are evaluating our internal information technology systems and contacting
our information technology suppliers and participating sellers to ascertain
their Year 2000 status. However, our own systems may not be Year 2000 compliant
in a timely manner, any of our participating sellers or other website vendors
may not be Year 2000 compliant in a timely manner, and there may be significant
interoperability problems among information technology systems. Consumers may
not be able to visit our website without serious disruptions arising from the
Year 2000 problem. Given the pervasive nature of the Year 2000 problem,
disruptions in other industries and market segments may hurt our business.
Moreover, the costs related to Year 2000 compliance could be significant.
Finally, Year 2000 issues may impact other entities with which we do
business, including, for example, those responsible for maintaining telephone
and Internet communications. Accordingly, we cannot predict the effect of the
Year 2000 problem on such entities. If these other entities fail to take
preventive or corrective actions in a timely manner, the Year 2000 issue could
hurt our business. For more information on management's view of the Year 2000
risks, please refer to "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Year 2000 Compliance" on page 33.
Our success depends on our ability to protect our intellectual property.
Trademarks, copyrights and trade secrets
We regard our copyrights, service marks, trademarks, trade secrets and
similar intellectual property as critical to our success. Claims, infringement
or misappropriation by third parties may hurt our business. We rely on a
combination of laws and contractual restrictions, including trademark and
copyright law, trade secret protection and confidentiality and/or license
agreements with our employees, customers, partners and others to establish and
protect our proprietary rights. However, laws and contractual restrictions may
not be sufficient to prevent misappropriation of our technology or deter others
from developing similar technologies. We pursue the registration of certain of
our key trademarks and service marks in the United States. Effective trademark,
service mark, copyright and trade secret protection may not be available in
every country in which our products and services are made available. The steps
we have taken to protect our proprietary rights may not be adequate, third
parties may infringe or misappropriate our copyrights, trademarks, trade dress
and similar proprietary rights, and we may be required to incur significant
expenses preserving our rights. In addition, other parties may assert
infringement claims against us. We may be subject to legal proceedings and
claims from time to time in the ordinary course of our business, including
claims of alleged infringement of the trademarks and other intellectual
property rights of third parties by us. Such claims, even if not meritorious,
could result in the expenditure of significant financial and managerial
resources.
16
<PAGE>
Domain names
We currently hold the Internet domain name "www.cheaptickets.com," as well
as various other related names. Third parties may acquire domain names that
infringe or otherwise decrease the value of our trademarks and other
proprietary rights which may hurt our business. Domain names generally are
regulated by Internet regulatory bodies. The regulation of domain names in the
United States and in foreign countries is subject to change. Regulatory bodies
could establish additional top-level domains, appoint additional domain name
registrars or modify the requirements for holding domain names. The
relationship between regulations governing domain names and laws protecting
trademarks and similar proprietary rights is unclear. As a result, we may not
acquire or maintain the "www.cheaptickets.com" domain name in all of the
countries in which we conduct business.
Regulatory and legal uncertainties could harm our business.
Certain segments of the travel industry are heavily regulated by the United
States and other governments. Accordingly, certain services offered by us are
affected by such regulations. New legislation or regulation, the application of
laws and regulations from jurisdictions whose laws do not currently apply to
our business, or the application of existing laws and regulations to the
Internet and commercial online services could hurt our business.
We are subject to federal regulations prohibiting unfair and deceptive
practices. In addition, federal regulations concerning the display and
presentation of information currently applicable to airline booking services
could be extended to us in the future, as well as other laws and regulations
aimed at protecting customers accessing online or other travel services. In
California, Hawaii and certain other states, we are required to register as a
seller of travel, comply with certain disclosure requirements and participate
in the state's restitution fund.
We are also subject to regulations applicable to businesses generally and
laws or regulations applicable to online commerce. Currently, few laws and
regulations directly apply to the Internet and commercial online services.
However, it is possible that laws and regulations may be adopted with respect
to the Internet or commercial online services covering issues such as user
privacy, pricing, content, copyrights, distribution, antitrust and
characteristics and quality of products and services. Further, the growth and
development of the market for online commerce may prompt calls for more
stringent consumer protection laws. Such laws would likely impose additional
burdens on companies conducting business online. The adoption of any additional
laws or regulations may decrease the growth of the Internet or commercial
online services. In turn, this could decrease the demand for our products and
services and increase our cost of doing business, or otherwise hurt our
business.
Moreover, in many states, there is currently great uncertainty whether or
how existing laws governing issues such as property ownership, sales and other
taxes, libel and personal privacy apply to the Internet and commercial online
services. These issues may take years to resolve. For example, tax authorities
in a number of states, as well as a Congressional advisory commission, are
currently reviewing the appropriate tax treatment of companies engaged in
online commerce, and new state tax regulations may subject us to additional
state sales and income taxes.
Federal legislation imposing certain limitations on the ability of states to
impose taxes on Internet-based sales was enacted in 1998. The Internet Tax
Freedom Act, as this legislation is known, imposes on electronic commerce a
three-year moratorium on state and local taxes imposed after October 1, 1998
but only where such taxes are discriminatory on Internet access. It is possible
that the legislation could not be renewed when it terminates in October 2001.
Failure to renew the
17
<PAGE>
legislation could allow state and local government to impose taxes on Internet-
based sales, and such taxes could hurt our business.
Our business could be hurt if management uses the proceeds of this offering
inappropriately.
The net proceeds of this offering are estimated to be approximately $38.3
million at an assumed initial public offering price of $12.00 per share and
after deducting the estimated underwriting discount and estimated offering
expenses. If the underwriters' over-allotment option is exercised in full, the
net proceeds are estimated to be approximately $44.1 million. Our management
will retain broad discretion as to the allocation of approximately $15.5
million of the proceeds of this offering. For more information on our use of
proceeds from this offering, please refer to "Use of Proceeds" on page 21.
Our stock price is likely to be very volatile.
Prior to this offering, you could not buy or sell our common stock publicly.
An active market for our common stock may not develop or be sustained after
this offering because stockholders may elect not to trade their shares. With
the underwriters, we will determine the offering price for our common stock.
That price may bear no relationship to the price at which the common stock will
trade after completion of this offering. The market price of the common stock
is likely to be volatile and could be subject to significant fluctuations in
response to factors such as the following, some of which are beyond our
control:
. quarterly variations in our operating results;
. operating results that vary from the expectations of securities
analysts and investors;
. changes in expectations as to our future financial performance,
including financial estimates by securities analysts and investors;
. changes in market valuations of other travel, Internet or online
service companies;
. announcements of technological innovations or new services by us or
our competitors;
. announcements by us or our competitors of significant contracts,
acquisitions, strategic partnerships, joint ventures or capital
commitments;
. loss of one or more major travel suppliers;
. additions or departures of key personnel;
. future sales of our common stock; and
. stock market price and volume fluctuations.
Domestic and international stock markets often experience extreme price and
volume fluctuations. These fluctuations, as well as general political and
economic conditions, such as a recession or interest rate or currency rate
fluctuations, may adversely affect the market price of our common stock.
The market prices for stocks of Internet-related and technology companies,
particularly following an initial public offering, frequently reach levels that
bear no relationship to the operating performance of these companies. These
market prices generally are not sustainable and are subject to wide variations.
If our common stock trades to such levels following this offering, it likely
will thereafter experience a material decline.
18
<PAGE>
In the past, securities class action litigation has often been brought
against a company following periods of volatility in the market price of its
securities. We may in the future be the target of similar litigation.
Securities litigation could result in substantial costs and divert management's
attention and resources.
The market price of our stock could be adversely affected because a significant
portion of our stock is closely controlled.
Upon consummation of this offering, Michael J. Hartley, Chairman of the
Board, Chief Executive Officer and President of Cheap Tickets, and Sandra T.
Hartley, Vice President, Employee Relations and Director and wife of Michael J.
Hartley, together with their respective affiliates, will beneficially own
approximately 64.0 percent of our outstanding common stock, subject to certain
adjustments. If the underwriters' over-allotment option is exercised in full,
Michael J. Hartley and Sandra T. Hartley will beneficially own approximately
62.4 percent of our outstanding common stock. Such ownership could discourage
others from initiating potential merger, takeover or other change of control
transactions. As a result, the market price of our common stock could be
adversely affected. If they act together, they will have the ability to control
the outcome on all matters requiring stockholder approval, including the
election and removal of directors and any merger, consolidation or sale of all
or substantially all of our assets, and to control our management and affairs.
For more information on beneficial ownership of stock, please refer to
"Principal Stockholders" on page 57.
Anti-takeover provisions affecting us could prevent or delay a change of
control.
Upon the closing of this offering our Board of Directors will have the
authority to issue up to 10,000,000 shares of preferred stock and to determine
the price, rights, preferences, privileges and restrictions, including voting
rights, of those shares without any further vote or action by the stockholders.
This could have an adverse impact on the market price of our common stock. We
have outstanding 425,000 shares of mandatorily redeemable preferred stock, all
of which are required to be redeemed by us upon the closing of the offering. We
have no present plans to issue any additional shares of preferred stock, but we
may do so. The rights of the holders of common stock may be subject to, and
adversely affected by, the rights of the holders of any preferred stock that
may be issued in the future. Moreover, the issuance of preferred stock may have
the effect of delaying, deferring or preventing a change of control of Cheap
Tickets without further action by the stockholders and may adversely affect the
voting and other rights of the holders of common stock. Further, certain
provisions of our charter documents, including provisions permitting
stockholders to take action by written consent with a two-thirds vote and
limiting the ability of stockholders to raise matters at a meeting of
stockholders without giving advance notice, may have the effect of delaying or
preventing changes in control or management of Cheap Tickets. These governance
provisions also could hurt the market price of our common stock. For more
information on our capital stock, please refer to "Description of Capital
Stock" on page 59.
Substantial sales of our common stock could adversely affect our stock price.
Sales of substantial amounts of our common stock in the public market after
this offering could adversely affect the prevailing market price of the common
stock. Immediately upon the effectiveness of this offering, 3,500,000 shares
will be freely tradable. Commencing 180 days following the date of this
offering, an additional 17,443,132 shares will become freely tradable upon the
expiration of agreements not to sell such shares, subject to compliance with
Rule 144
19
<PAGE>
promulgated under the Securities Act of 1933, as amended, assuming the exercise
of warrants to purchase 2,969,456 shares of common stock. William Blair &
Company, L.L.C. may, in its sole discretion and at any time without notice,
release all or any portion of the securities subject to these agreements.
Immediately after this offering, we intend to register approximately 3,239,642
shares of our common stock reserved for issuance under our stock option plans.
Sales of common stock by stockholders upon expiration of the lock-up agreements
may adversely affect the market price of the common stock. For more information
regarding the terms upon which our common stock will be underwritten, please
refer to "Underwriting" on pages 63 and 64.
As of the effective date of the registration statement, holders of 2,969,456
shares of common stock will be entitled to registration rights with respect to
their shares. Holders of such shares can require us to register the shares at
any time following 180 days after the effective date, subject to certain
conditions.
You will experience immediate and substantial dilution.
The initial public offering price is expected to be substantially higher
than book value per share of the outstanding common stock. Investors purchasing
shares of common stock will incur immediate substantial dilution in the amount
of $10.14 per share. In addition, investors purchasing shares in the offering
will incur additional dilution to the extent outstanding options are exercised.
For more information on the dilution of our common stock, please refer to
"Dilution" on page 23.
FORWARD-LOOKING STATEMENTS
Some of the statements under "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business" and elsewhere in this prospectus constitute forward-
looking statements. These statements involve known and unknown risks,
uncertainties and other factors that may cause our actual results, levels of
activity, performance or achievements to be materially different from any
future results, levels of activity, performance, or achievements expressed or
implied by such forward-looking statements. Such factors include, among other
things, those listed under "Risk Factors" and elsewhere in this prospectus.
In some cases, you can identify forward-looking statements by terminology
such as "may," "will," "should," "could," "expects," "plans," "intends," "
anticipates," "believes," "estimates," "predicts," "potential" or "continue" or
the negative of such terms and other comparable terminology.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor anyone else
assumes responsibility for the accuracy and completeness of such statements. We
are under no duty to update any of the forward-looking statements after the
date of this prospectus.
20
<PAGE>
USE OF PROCEEDS
The net proceeds to Cheap Tickets from the offering, after deducting
underwriting discounts and commissions and estimated offering expenses payable
by Cheap Tickets, are estimated to be $38.3 million at an assumed initial
public offering price of $12.00 per share. If the underwriters exercise their
over-allotment option in full, the net proceeds are estimated to be $44.1
million. During 1999, Cheap Tickets intends to use approximately $9 million of
such proceeds for advertising and brand development expenditures and
approximately $9 million for development of Cheap Tickets' technological
infrastructure in order to support growth. An additional use of proceeds will
be the redemption of the existing mandatorily redeemable preferred stock for
approximately $4.8 million, the substantial majority of which is held by
Phillips-Smith Specialty Retail Group III, L.P. Two of Cheap Tickets' directors
are principals of that group. The balance of the proceeds will be used for
general corporate purposes, including working capital, and to fund additional
advertising and brand development expenditures and technological
infrastructure. Cheap Tickets may apply an undetermined amount of the proceeds
toward the acquisition of complementary businesses. Cheap Tickets has no
agreements or understandings with respect to any such acquisition. Pending
application, the net proceeds will be invested in short-term, investment grade,
interest-bearing obligations.
DIVIDEND POLICY
Cheap Tickets has never declared or paid dividends on its common stock and
anticipates for the foreseeable future that all earnings will be retained for
use in its business. The payment of any future dividends will be at the
discretion of the Board of Directors.
21
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of Cheap Tickets as of
December 31, 1998, and as adjusted to give effect to the sale of 3,500,000
shares of common stock offered by Cheap Tickets and the application of net
proceeds therefrom, and the exercise of warrants for 2,969,456 shares of common
stock. This assumes that the underwriters will not exercise their over-
allotment option. The number of shares outstanding used throughout the
prospectus reflect a 14-for-one stock split. For more information on our
anticipated use of proceeds of this offering, please refer to "Use of Proceeds"
on page 21. The table should be read in conjunction with the financial
statements included elsewhere in this prospectus.
<TABLE>
<CAPTION>
December 31, 1998
----------------------
Actual As Adjusted(1)
------ --------------
(in thousands)
<S> <C> <C>
Long-term debt, excluding current installments...... $ 586 $ 586
Capital lease obligations, excluding current
installments....................................... 652 652
------ -------
Total debt (2).................................... 1,238 1,238
------ -------
Mandatorily redeemable preferred stock, $1 par value
(aggregate involuntary liquidation preference of
$4,250,000 plus unpaid cumulative dividends),
425,000 shares issued and outstanding (actual);
none issued or outstanding (as adjusted)(3)........ 4,136 --
------ -------
Stockholders' equity:
Preferred stock, $.01 par value--authorized
5,000,000 shares (actual), 10,000,000 shares (as
adjusted); none issued or outstanding (as
adjusted)(4)..................................... -- --
Common stock, $.001 par value; 70,000,000 shares
authorized, 14,473,676 shares issued and
outstanding (actual); 20,943,132 shares issued
and outstanding (as adjusted)(5)................. 10 75
Additional paid-in capital........................ 1,247 39,444
Unearned compensation............................. (696) (695)
Retained earnings................................. 824 199
------ -------
Total stockholders' equity........................ 1,385 39,023
------ -------
Total capitalization............................ $6,759 $40,261
====== =======
</TABLE>
- --------
(1) As adjusted to reflect the receipt of the net proceeds of the offering of
$38,260,000, the redemption of the preferred stock (which includes a charge
to retained earnings of $623,972 unaccreted issuance costs and discount),
the exercise of 2,969,456 warrants at an aggregate exercise price of $2,121
and the immediate recognition of unearned compensation of $1,062 related to
certain stock options that fully vest upon the completion of this offering.
(2) Total debt excludes Cheap Tickets' current installments of long-term debt
of $221,469 and current installments of capital lease obligations of
$287,809.
(3) The mandatorily redeemable preferred stock amount is presented net of
unaccreted issuance costs and discount aggregating $623,972, and includes
unpaid cumulative dividends, which are required to be paid at redemption of
$510,000. Total redemption value, including dividends of $595,000 upon the
closing of this offering is expected to be $4,845,000. After redemption,
Cheap Tickets will have 10,000,000 authorized shares of preferred stock,
which may be issued with or without mandatory redemption features.
(4) This reflects an increase in the authorized preferred stock and reduction
in par value anticipated to occur before the offering.
(5) This reflects a reduction in par value anticipated to occur before the
offering in conjunction with the stock split. As of December 31, 1998,
there were stock options outstanding to purchase an aggregate of
728,000 shares of common stock of which 660,800 have an exercise price of
$0.18 per share and 67,200 have an exercise price of $1.57 per share and
1,251,642 shares were reserved for future issuance under Cheap Tickets'
employee stock plan. In addition, there were warrants outstanding to
purchase an aggregate of 2,969,456 shares of common stock at an aggregate
exercise price of $2,121.
22
<PAGE>
DILUTION
As of December 31, 1998, Cheap Tickets had a historical and pro forma net
tangible book value of approximately $1,385,000 or $0.10 per share of common
stock, and approximately $763,000 or $0.04 per share of common stock,
respectively. Pro forma net tangible book value represents total tangible
assets less total liabilities, including the effect of the redemption of
mandatorily redeemable preferred stock and the exercise of certain warrants,
divided by the number of shares of common stock outstanding at that date
including shares of common stock to be issued upon the exercise of warrants.
Without taking into account any other changes in the pro forma net tangible
book value after December 31, 1998, other than to give effect to the receipt by
Cheap Tickets of the net proceeds from the sale of the 3,500,000 shares of
common stock offered by Cheap Tickets hereby at the initial public offering
price of $12 per share, the pro forma net tangible book value at December 31,
1998 would have been approximately $39,023,000 or $1.86 per share. This
represents an immediate increase in net tangible book value of $1.82 per share
to existing stockholders and an immediate dilution of $10.14 per share to new
investors purchasing shares of common stock in this offering.
The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share...................... $12.00
Net tangible book value per common share as of December 31,
1998........................................................ .10
Effect of pro forma adjustments:.............................
Redemption of mandatorily redeemable preferred stock....... (.04)
Exercise of warrants....................................... (.02)
-----
Pro forma net tangible book value per share.................. .04
Increase per share attributable to new investors............. 1.82
-----
Pro forma net tangible book value per share after the
offering.................................................... 1.86
------
Dilution per share to new investors.......................... $10.14
======
</TABLE>
The following table summarizes, on a pro forma basis, as of December 31,
1998, the differences between the number of shares of common stock purchased
from Cheap Tickets, the aggregate consideration paid and the average price per
share paid by existing stockholders and new investors purchasing shares of
common stock in this offering:
<TABLE>
<CAPTION>
Shares Purchased Total Considerations
---------------------- ---------------------- Average
Number Amount Price
(in thousands) Percent (in thousands) Percent Per Share
-------------- ------- -------------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing
stockholders(1)...... 17,443 83.3% $ 1,259 2.9% $ 0.07
New investors(1)...... 3,500 16.7 42,000 97.1 12.00
------ ----- ------- -----
Total................ 20,943 100.0% $43,259 100.0%
====== ===== ======= =====
</TABLE>
- --------
(1) The foregoing tables include an aggregate of 2,969,456 shares issuable upon
exercise of warrants outstanding as of December 31, 1998 at an aggregate
exercise price of $2,121, all of which are expected to be exercised
immediately prior to the closing of this offering. Also includes the
redemption of 425,000 shares of preferred stock outstanding as of December
31, 1998. Excludes (a) 728,000 shares issuable upon exercise of outstanding
options at a weighted average exercise price of $0.31 per share as of
December 31, 1998, and (b) an aggregate of 1,251,642 shares available for
future issuance under the 1997 Stock Option Plan.
23
<PAGE>
SELECTED FINANCIAL DATA
(in thousands, except per share and operating data)
The following selected financial data for the years ended December 31, 1996,
1997 and 1998 and as of December 31, 1997 and 1998 have been derived from Cheap
Tickets' financial statements included elsewhere in this prospectus which have
been audited by PricewaterhouseCoopers LLP, independent public accountants. The
following selected financial data for the years ended December 31, 1994 and
1995 and as of December 31, 1994, 1995 and 1996 have been derived from the
audited financial statements of Cheap Tickets not included in this prospectus.
The operating data are derived from information compiled by Cheap Tickets and
are unaudited. The following information is qualified by reference to, and
should be read in conjunction with, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the financial statements
included elsewhere in the prospectus.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------
1994 1995 1996 1997 1998
------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Results of Operations:
Non-published fares........... $ -- (2) $66,340 $ 58,982 $ 96,379 $159,846
Commissions................... -- (2) 2,738 5,614 6,470 11,268
------- ------- -------- -------- --------
Net revenues(1)............. -- (2) 69,078 64,596 102,849 171,114
Cost of sales(1).............. -- (2) 56,424 49,168 81,370 136,067
------- ------- -------- -------- --------
Gross profit.................. 8,128 12,654 15,428 21,479 35,047
Selling, general and
administrative expenses(3)... 7,947 11,921 14,352 23,091 33,411
------- ------- -------- -------- --------
Net operating income (loss)... 181 733 1,076 (1,612) 1,636
Other income (deductions)..... 31 (709) 37 (3) 169
------- ------- -------- -------- --------
Earnings (loss) before income
taxes........................ 212 24 1,113 (1,615) 1,805
Income taxes.................. 60 7 439 (606) 740
------- ------- -------- -------- --------
Net earnings (loss)........... $ 152 $ 17 $ 674 $ (1,009) $ 1,065
======= ======= ======== ======== ========
Basic earnings (loss) per
share(4)..................... $ 0.01 $ 0.00 $ 0.05 $ (0.09) $ 0.04
Shares used in computing basic
earnings (loss) per
share(4)..................... 14,100 14,100 14,249 14,847 14,567
Diluted earnings (loss) per
share(4)..................... $ 0.01 $ 0.00 $ 0.05 $ (0.09) $ 0.03
Shares used in computing
diluted earnings (loss) per
share(4)..................... 14,100 14,100 14,249 14,847 17,921
Balance Sheet Data:
Net working capital........... $ 451 $ 182 $ 466 $ 2,356 $ 3,473
Total assets.................. 2,954 3,740 5,999 11,204 13,226
Long-term debt................ 653 537 1,715 948 1,238
Mandatorily redeemable
preferred stock(5)........... -- -- -- 3,622 4,136
Stockholders' equity(5)....... 849 866 1,544 812 1,385
Operating Data (unaudited):
Gross bookings (in
thousands)(6)
Non-published fares......... $ -- (2) $66,340 $ 58,982 $ 96,379 $159,846
Published fares............. -- (2) 25,654 46,962 57,295 110,287
------- ------- -------- -------- --------
Total gross bookings...... $52,951(2) $91,994 $105,944 $153,674 $270,133
======= ======= ======== ======== ========
Airline tickets sold:......... 180,656 313,863 357,551 554,403 960,879
Call centers................ 180,656 313,863 357,551 551,973 865,015
Internet.................... -- -- -- 2,430 95,864
Registered Internet users..... -- -- -- 18,891 420,023
</TABLE>
24
<PAGE>
- --------
(1) Net revenues consist of sales of non-published fares and commissions. Net
revenues from sales of non-published fares represent revenues from the sale
of tickets purchased from the airlines. Cost of sales consists of the net
fare cost paid to carriers to purchase non-published fares. Commissions,
including incentive overrides, are earned primarily on published fares sold
and include certain other payments based on the volume of transactions.
(2) Net revenues for 1994 were not separately identified from gross bookings
and are not available. In addition, cost of sales for 1994 was previously
accounted for on a gross bookings basis and is not available on a GAAP
basis.
(3) In 1998, Cheap Tickets issued stock options to employees to acquire an
aggregate of 728,000 shares of Cheap Tickets' common stock of which 660,800
have an exercise price of $0.18 per share and 67,200 have an exercise price
of $1.57 per share. Total compensation associated with these options
amounted to $722,600 of which $26,325 has been charged to operations. The
remainder will be charged over the remaining five-year vesting period of
the options, with the exception of $1,062, which will be charged at the
closing of the offering at which time 140,000 options vest by their terms.
(4) Please refer to notes 1 and 6 to the financial statements for the
calculation of earnings per share, including an explanation of the number
of shares used in computing the amount of basic and diluted earnings per
share.
(5) The mandatorily redeemable preferred stock is required to be redeemed upon
the closing of this offering. The redemption price upon the closing of this
offering will be approximately $4.8 million. The preferred stock was issued
at a discount of $885,170. Cheap Tickets is accreting the discount over a
five-year period. At redemption, it is anticipated that the unaccreted
discount will be $580,439. Upon redemption, the unaccreted discount will be
charged directly to stockholders' equity, and have a dilutive effect on the
calculation of earnings per share.
(6) Gross bookings represent the aggregate retail value of tickets sold under
non-published fares and published fares. The difference between gross
bookings and revenues as reported in Cheap Tickets' statement of operations
derives solely from the difference in revenue treatment accorded to sales
of published fares. With respect to published fares, Cheap Tickets records
as revenue in its statement of operations only the commissions earned by
Cheap Tickets on the sale of such fares. Gross bookings represents the
retail value of the sales of published fares. With respect to non-published
fares, revenues as reported in Cheap Tickets statement of operations is
equivalent to gross bookings, which is the retail value of such fares.
Management uses gross bookings as a key indicator of general business
activity, success of promotional efforts, capacity to handle customer
demand and efficiency of reservation agents. In addition, management
believes that gross bookings provide a useful comparison between historical
periods, and year-to-year changes in such information provide a useful
measure of market acceptance of Cheap Tickets products.
25
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion should be read in conjunction with the financial
statements of Cheap Tickets. In evaluating the risks of investing in Cheap
Tickets, prospective investors should also evaluate the other information set
forth in this prospectus, including the Risk Factors.
Overview
Cheap Tickets is principally engaged in the sale of discount tickets for
domestic leisure air travel. A majority of its gross bookings have historically
come from the sale of non-published fares, which Cheap Tickets acquires from
airlines and resells to the public at a profit. Cheap Tickets purchases non-
published fares only when it resells them to customers, so that it has no
inventory carrying costs. On these fares, Cheap Tickets sets its resale prices
to meet the demands of leisure travelers who are looking for the lowest price.
Cheap Tickets also sells published fares for which it receives commissions from
the airlines. Sales of non-published fares generally carry higher margins as a
percentage of gross bookings than commissions on published fare bookings.
Cheap Tickets' revenues have been generated by ticket sales through Cheap
Tickets' four call centers and, to a lesser extent, through 12 walk-in retail
stores. In October 1997, Cheap Tickets broadened its ticket distribution by
offering online booking at "www.cheaptickets.com." Internet bookings have
experienced significant month-to-month growth in 1998 and accounted for
approximately 9% of total gross bookings in 1998 and approximately 15% in the
last quarter of 1998. At December 31, 1998, Cheap Tickets had over 420,000
registered online users, with 180,000 registering in the fourth quarter of
1998. Cheap Tickets expects online gross bookings and net revenue to represent
an increasing portion of gross bookings and net revenues in future periods.
Gross bookings represent the aggregate retail value of tickets sold under
non-published fares and published fares. The difference between gross bookings
and revenues as reported in Cheap Tickets' statement of operations derives
solely from the difference in revenue treatment accorded to sales of published
fares. With respect to published fares, Cheap Tickets records as revenue in its
statement of operations only the commissions earned by Cheap Tickets on the
sale of such fares. Gross bookings represents the retail value of the sales of
published fares. With respect to non-published fares, revenues as reported in
Cheap Tickets statement of operations is equivalent to gross bookings, which is
the retail value of such fares. Gross bookings are not required by generally
accepted accounting principles and should not be considered in isolation or as
a substitute for other information prepared in accordance with GAAP. Management
uses gross bookings as a key indicator of general business activity, success of
promotional efforts, capacity to handle customer demand and efficiency of
reservation agents. In addition, management believes that gross bookings
provide a useful comparison between historical periods, and year-to-year
changes in such information provide a useful measure of market acceptance of
Cheap Tickets products.
Net revenues consist of sales of non-published fares and commissions. Net
revenues from sales of non-published fares represent revenues from the sale of
tickets purchased from the airlines. Cheap Tickets' cost of sales consists of
the net fare cost paid to carriers to purchase non-published fares.
Commissions, including incentive overrides, are earned primarily on published
air fares sold and include certain other payments based on the volume of
transactions.
Substantially all of Cheap Tickets' gross bookings represent sales of
airline tickets. For the year ended December 31, 1998, approximately 98% of
gross bookings arose from airline ticket sales. The
26
<PAGE>
remaining gross bookings arose from sales of cruise tickets, auto rentals,
hotel reservations and other travel related products. Cheap Tickets expects
gross bookings from sources other than airline ticket sales to increase in
future periods.
Cheap Tickets' selling, general and administrative expenses include all
operating and corporate overhead. Major expense categories include
compensation, advertising, communications, credit card bank fees, occupancy and
delivery costs. Selling, general and administrative expenses also include
compensation charges related to the issuance of stock options.
Results of Operations
The following table sets forth, for the years ended December 31, 1995, 1996,
1997 and 1998, information derived from the statement of operations of Cheap
Tickets expressed as a percentage of net revenues, and the percentage change in
such items and in gross bookings for the years ended December 31, 1996, 1997
and 1998 compared with the prior period. Any trends illustrated in the
following table are not necessarily indicative of future results.
<TABLE>
<CAPTION>
Percentage Increase
As a Percentage (Decrease) Over
of Net Revenues Prior Periods
-------------------------- -------------------------
Year Ended December 31, Year Ended December 31,
-------------------------- -------------------------
1995 to 1996 to 1997 to
1995 1996 1997 1998 1996 1997 1998
----- ----- ----- ----- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Results of Operations:
Non-published fares..... 96.0% 91.3% 93.7% 93.4% (11.1)% 63.4% 65.9%
Commissions............. 4.0 8.7 6.3 6.6 105.0 15.2 74.2
----- ----- ----- -----
Net revenues.......... 100.0 100.0 100.0 100.0 (6.5) 59.2 66.4
Gross profit............ 18.3 23.9 20.9 20.5 21.9 39.2 63.2
Selling, general and
administrative
expense................ 17.2 22.2 22.5 19.5 20.4 60.9 44.7
----- ----- ----- -----
Earnings (loss) from
operations........... 1.1 1.7 (1.6) 1.0 46.8 (249.8) 201.5
Net earnings (loss)..... 0.0 1.0 (1.0) 0.6 *nm (249.7) 205.6
Operating Data
(unaudited):
Gross bookings.......... -- -- -- -- 15.2% 45.1% 75.8%
</TABLE>
- --------
*nm--not meaningful
Years Ended December 31, 1998 and December 31, 1997
Net Revenues. Net revenues for the year ended December 31, 1998 increased
$68.3 million, or 66.4%, to $171.1 million. By category of net revenue, non-
published fare sales increased $63.5 million, or 65.9%, to $159.8 million, and
commissions from published fares increased $4.8 million, or 74.2%, to
$11.3 million. The increase in commissions reflected an increase of $53.0
million, or 92.5%, to $110.3 million in gross bookings of published fares,
partially offset by a decrease in commission rates from an average of 9.0% in
1997 to 7.8% in 1998.
The increase in net revenue benefited overall from industry-wide growth in
the leisure travel market and improving recognition of the Cheap Tickets brand
name from marketing and advertising efforts and word of mouth. Net revenue at
call centers also benefited from better productivity by call center reservation
agents and the opening of a fourth call center in Colorado Springs in May of
1998.
Cheap Tickets' net revenues through call centers and retail operations
(including incentive bonuses) increased $56.4 million, or 54.9%, to $159.2
million. Net revenues through the Internet
27
<PAGE>
were $11.9 million in 1998 compared with $176,000 in 1997. Net revenues through
the Internet represented 7.0% of net revenues for the year ended December 31,
1998 and 17.2% of the total increase in net revenues from 1997 to 1998.
Internet net revenues for the four quarters of operations grew as follows:
first quarter 1998, $1.2 million; second quarter 1998, $2.3 million; third
quarter 1998, $3.8 million, and fourth quarter 1998, $4.7 million.
Gross Profit. Gross profit increased $13.6 million, or 63.2%, to $35.0
million, consistent with the rate of increase of gross bookings. As a
percentage of net revenues, gross profit decreased from 20.9% to 20.5%. This
decrease was primarily attributable to a decrease in gross margins of
0.7 percentage points on non-published fares. The decrease in non-published
fare margins was primarily attributable to a contract renewal with one carrier
at a less favorable rate. A decline in the proportion of non-published fares
sold, partially offset by increased volume bonuses, also contributed to the
reduction in gross profit.
Selling, General and Administrative Expenses. For the year ended December
31, 1998, selling, general and administrative expenses increased $10.3 million,
or 44.7%, to $33.4 million, and decreased as a percentage of net revenues from
22.5% to 19.5%. The major components of these increases were compensation,
credit card and bank fees, and advertising costs. The increase in advertising
costs was primarily attributable to Cheap Tickets' website launch in October
1997, including promotions on Yahoo, Travelocity and other websites. Internet
marketing costs can be expected to increase significantly in future periods to
promote Internet sales. Credit card fees increased as a result of volume and
rate increases charged by Cheap Tickets' charge card associations. The decrease
in selling, general and administrative expenses as a percentage of net revenues
was primarily attributable to the leverage from increased sales.
In 1998, Cheap Tickets issued stock options to employees to acquire an
aggregate of 728,000 shares of Cheap Tickets' common stock of which 660,800
have an exercise price of $0.18 per share and 67,200 have an exercise price of
$1.57 per share. Total compensation associated with these options amounted to
$722,600, of which $26,325 has been charged to operations for the year ended
December 31, 1998. The remainder will be charged over the remaining five-year
vesting period of the options, with the exception of $1,062, which will be
charged at the closing of the offering, at which time 140,000 options vest by
their terms.
Net Earnings (Loss). Cheap Tickets had net earnings of $1.1 million for the
year ended December 31, 1998, compared with the prior year's loss of $1.0
million. This increase was attributable to increased net revenues, with a
proportionately lower increase in selling, general and administrative expenses,
partially offset by lower gross profit percentages.
Years Ended December 31, 1997 and December 31, 1996
Net Revenues. Net revenues increased $38.3 million, or 59.2%, to $102.8
million, primarily from continued industry-wide growth in the leisure travel
industry and enhanced recognition of the Cheap Tickets brand name from
marketing and advertising efforts. The increase was also associated with
increases in capacity, including the expansion of existing call centers and
higher reservation agent productivity.
During 1997, the increase in net revenues reflected the growth of non-
published fare sales by $37.4 million, or 63.4%, to $96.4 million. By contrast,
net revenues from commissions increased only $856,000, or 15.2%, to $6.5
million. The slower growth of net revenues from commissions was
28
<PAGE>
attributable to slower growth in gross bookings of published fares and a
decrease from 10% to 8% in commissions on published fares implemented by a
number of air carriers during 1997.
In 1997, nearly all of Cheap Tickets' net revenues were generated through
call centers, with the exception of approximately $176,000 from Internet sales
following the launch of Cheap Tickets' website in October 1997. Net revenues
from non-published fare sales in 1997 represented 62.7% of gross bookings,
compared with 55.7% in 1996.
Gross Profit. Gross profit increased $6.1 million or 39.2% to $21.5 million
and decreased as a percentage of net revenues from 23.9% to 20.9%. The 3%
decrease was primarily attributable to a reduction in published fares margins
of 2.4% of net revenues. A combination of a reduction in commissions as a
percentage of net revenues and an overall industry reduction in published fare
commission rates accounted for the decrease. A further decrease of 0.6% of net
revenues from non-published fares was the result of a termination in 1997 of
certain profitable routes and the imposition of various restrictions by a major
carrier.
Selling, General and Administrative Expenses. Cheap Tickets' selling,
general and administrative expenses increased $8.7 million, or 60.9%, to $23.1
million and increased as a percentage of net revenues from 22.2% to 22.5%.
These increases resulted primarily from increased employees and infrastructure
to support higher levels of sales. The increase in compensation and employee
benefits reflected the hiring of over 119 new employees, largely reservation
agents and, to a lesser extent, support staff. Other major components of the
increase were telephone expense, advertising costs, delivery expenses, and
credit card and bank fees. Occupancy costs also rose, with the opening of three
additional retail locations and the expansion of space in Honolulu and
Los Angeles.
Net Earnings (Loss). Cheap Tickets incurred a net loss in 1997 of $1.0
million, compared with net earnings of $674,000 in 1996. The decrease in net
earnings was primarily attributable to the decrease in gross profit as a
percentage of net revenues.
Years Ended December 31, 1996 and December 31, 1995
Net Revenues. Net revenues decreased $4.5 million, or 6.5%, to $64.6
million. The decrease corresponded to a reduction in sales of non-published
fares of $7.4 million, or 11.1%, to $59.0 million. Net revenues from
commissions increased by $2.9 million, or 105.0%, to $5.6 million. The
reduction in non-published fare sales was primarily attributable to the
termination of a contract provision with one carrier that had required Cheap
Tickets to sell non-published fares through certain travel agents at low
margins, resulting in $10.5 million in net revenues from such sales in 1995,
compared with $617,000 in 1996. The reduction in non-published fare sales was
partially offset by increased sales of published fares and the commissions
resulting therefrom. Overall gross bookings in 1996 increased $14.0 million, or
15.2% to $105.9 million, as the increase in gross bookings of published fares
exceeded the decrease in gross bookings of non-published fares.
Gross Profit. Gross profit increased $2.8 million or 21.9% to $15.4 million
and increased as a percentage of net revenues from 18.3% to 23.9%. This
increase was primarily attributable to 1) increases from published fares and
volume bonuses of 4.7% of net revenues due to an increase in the proportion of
these components as a percentage of total gross profit and 2) an increase in
non-published fares attributable to the procurement of a favorable contract
with a major carrier and cessation of the sales of low margin non-published
fares to certain travel agents.
29
<PAGE>
Selling, General and Administrative Expenses. Cheap Tickets' selling,
general and administrative expenses increased $2.4 million, or 20.4%, to $14.4
million and increased as a percentage of net revenues from 17.2% to 22.2%. The
largest component of the increase was compensation expense, which was primarily
attributable to the opening of the Lakeport call center in January 1996.
Net Earnings (Loss). Net earnings increased from $17,000 to $674,000. Higher
margins on both non-published and published fare sales contributed to the
increase. In addition, there was non-recurring income of $37,000 in 1996,
compared with non-recurring expense in 1995 of $709,000.
Seasonality and Quarterly Financial Information.
Cheap Tickets' business is seasonal due primarily to customers' leisure
travel patterns and changes in the availability of non-published fares. As a
result, Cheap Tickets typically has higher sales and gross profit in the second
and third quarters and lower sales and gross profit in the fourth quarter.
During periods of high-volume air travel, such as occur in the fourth quarter
of each year, Cheap Tickets historically has had access to fewer non-published
fares, and such fares on certain major routes may be blacked out or otherwise
unavailable. Online gross bookings may also tend to be seasonal and may decline
or grow less rapidly in the summer months. The seasonal sales cycle is fairly
predictable, but the cycle may shift year-to-year, corresponding to changes in
the economy or other factors affecting the market such as price wars. This
could lead to unusual volatility in revenues and earnings.
30
<PAGE>
The following table sets forth selected unaudited quarterly financial
information for each of the eight quarters in the period ended December 31,
1998, as well as such data expressed as a percentage of Cheap Tickets' net
revenues for the periods presented. This information has been derived from
unaudited statements of operations data that, in the opinion of management, are
stated on a basis consistent with the audited financial statements and include
all adjustments (consisting only of normal recurring adjustments) necessary for
a fair presentation of such information in accordance with GAAP. Cheap Tickets'
results of operations for any quarter are not necessarily indicative of the
results to be expected in any future period.
<TABLE>
<CAPTION>
Quarter Ended
(unaudited)
--------------------------------------------------------------------
1997 1998
---------------------------------- --------------------------------
Sept. Sept.
Mar. 31 June 30 30 Dec. 31 Mar. 31 June 30 30 Dec. 31
------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Results of operations:
Non-published fares..... $17,798 $27,126 $28,789 $22,666 $30,449 $45,722 $46,823 $36,852
Commissions............. 1,381 1,691 1,602 1,796 1,949 2,491 3,614 3,215
------- ------- ------- ------- ------- ------- ------- -------
Net revenues.......... 19,179 28,817 30,391 24,462 32,398 48,213 50,437 40,067
Cost of sales........... 15,104 22,782 24,097 19,386 25,959 39,016 39,572 31,520
------- ------- ------- ------- ------- ------- ------- -------
Gross profit............ 4,075 6,035 6,294 5,076 6,439 9,197 10,865 8,547
Selling, general and
administrative
expenses............... 4,389 5,735 6,439 6,530 6,430 8,128 9,535 9,319
------- ------- ------- ------- ------- ------- ------- -------
Net operating income.... (314) 300 (145) (1,454) 9 1,069 1,330 (772)
Other income
(deductions)........... 9 (47) 9 27 35 22 32 80
------- ------- ------- ------- ------- ------- ------- -------
Earnings (loss) before
income taxes........... (305) 253 (136) (1,427) 44 1,091 1,362 (692)
Income taxes............ (125) 104 (56) (529) 18 447 559 (283)
------- ------- ------- ------- ------- ------- ------- -------
Net earnings (loss)..... $ (180) $ 149 $ (80) $ (898) $ 26 $ 644 $ 803 $ (409)
======= ======= ======= ======= ======= ======= ======= =======
Basic earnings (loss)
per share.............. $ (0.02) $ 0.01 $ (0.01) $ (0.07) $ (0.01) $ 0.04 $ 0.05 $ (0.04)
Diluted earnings (loss)
per share.............. $ (0.02) $ 0.01 $ (0.01) $ (0.07) $ (0.01) $ 0.03 $ 0.04 $ (0.03)
</TABLE>
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Operating Data:
Gross bookings ......... $28,361 $40,764 $42,959 $41,590 $52,754 $70,431 $75,930 $71,018
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
As a Percentage of Net Revenues
Quarter Ended
(unaudited)
--------------------------------------------------------------------
1997 1998
---------------------------------- --------------------------------
Mar. 31 June 30 Sept. 30 Dec. 31 Mar. 31 June 30 Sept. 30 Dec. 31
------- ------- -------- ------- ------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Non-published fares..... 92.8% 94.1% 94.7% 92.7% 94.0% 94.8% 92.8% 92.0%
Commissions............. 7.2 5.9 5.3 7.3 6.0 5.2 7.2 8.0
----- ----- ----- ----- ----- ----- ----- -----
Net revenues.......... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Cost of sales........... 78.8 79.1 79.2 79.3 80.1 80.9 78.5 78.7
----- ----- ----- ----- ----- ----- ----- -----
Gross profit............ 21.2 20.9 20.8 20.7 19.9 19.1 21.5 21.3
Selling, general and
administrative
expenses............... 22.9 19.9 21.3 26.6 19.9 16.9 18.9 23.2
----- ----- ----- ----- ----- ----- ----- -----
Net operating income.... (1.7) 1.0 (0.5) (5.9) 0.0 2.2 2.6 (1.9)
Other income
(deductions)........... 0.1 (0.1) 0.1 0.1 0.1 0.1 0.1 0.2
----- ----- ----- ----- ----- ----- ----- -----
Earnings (loss) before
income taxes........... (1.6) 0.9 (0.4) (5.8) 0.1 2.3 2.7 (1.7)
Income taxes............ (0.7) 0.4 (0.1) (2.1) 0.0 1.0 1.1 (0.7)
----- ----- ----- ----- ----- ----- ----- -----
Net earnings (loss)..... (0.9)% 0.5% (0.3)% (3.7)% 0.1% 1.3% 1.6% (1.0)%
===== ===== ===== ===== ===== ===== ===== =====
</TABLE>
31
<PAGE>
Liquidity and Capital Resources
For the year ended December 31, 1998, Cheap Tickets generated cash from
operating activities of $2.0 million, compared with $1.5 million for the year
ended December 31, 1997. For the year ended December 31, 1998, cash generated
from operating activities was comprised principally of net earnings plus
depreciation of $1.6 million and net changes in working capital and other
accounts. For the year ended December 31, 1997, cash generated from operating
activities was comprised principally of an increase in accounts payable of $2.5
million adjusted by changes in other accounts. For that period, there was a net
loss of $1.0 million, offset by depreciation of $370,000. The primary account
payable is the weekly settlement to the Airline Reporting Corporation for
airline tickets purchased less commissions earned. This is generally a
significant balance, and the timing of the current payment relative to month-
end can cause fluctuations in month-end balances.
For 1996, Cheap Tickets generated cash from operating activities of
$411,000. This cash was generated primarily from the sum of net earnings and
depreciation of $878,000, partially offset by changes in operating accounts.
For the year ended December 31, 1998, Cheap Tickets used cash from investing
activities of $4.8 million, while in the prior period it used cash in investing
activities of $486,000. Cash used in investing activities for the year ended
December 31, 1998 included net purchases of short term marketable securities
for $4.9 million. Capital expenditures for the years ended December 31, 1998
and 1997 were $485,000 and $496,000, respectively. In 1998, Cheap Tickets
received $496,000 in proceeds from the sale of a condominium office formerly
used as a company office, of which $489,000 was used to pay the outstanding
mortgage on the property. In 1997, Cheap Tickets raised $3.9 million net of
issuance expenses from a private placement of preferred stock. In 1996, Cheap
Tickets made $1.3 million in capital expenditures, primarily consisting of the
furnishing and equipping of a new call center in Lakeport, California and the
acquisition of additional equipment.
At December 31, 1998, Cheap Tickets maintained on hand cash and cash
equivalents of $3.0 million and short term marketable securities of $4.9
million. Cheap Ticket's net working capital was $3.5 million. Cheap Tickets has
available a $3.0 million credit facility with a bank expiring on December 5,
1999. This facility accrues interest at either (1) the bank's base rate or
(2) LIBOR plus an applicable margin, at Cheap Tickets' option. There were no
drawdowns against this facility at December 31, 1998. Cheap Tickets had
outstanding long-term debt net of current installments of $586,000 and capital
lease obligations of $652,000. Long-term debt included $541,000 for a mortgage
on the Lakeport, California call center.
Cheap Tickets believes that the net proceeds from this offering, together
with its current cash and cash equivalents, short term marketable securities
and anticipated cash flow from operations will be sufficient to meet its
anticipated cash needs for the required redemption of preferred stock, working
capital, debt service and capital expenditures, at least for the foreseeable
future. Cheap Tickets has budgeted approximately $9 million for capital
expenditures in 1999 from proceeds of this offering, nearly all of which is
intended to be used for technological improvements and upgrades. Cheap Tickets
currently is seeking an increase in its bank lines, which are currently
undrawn. If cash generated from internal operations is not sufficient to
satisfy CheapTickets' liquidity requirements, Cheap Tickets may seek to
increase available bank lines or sell additional equity or debt securities. The
sale of convertible debt or equity securities could result in additional
dilution to Cheap Tickets' shareholders. There is no assurance that financing
will be available in amounts or on terms acceptable to Cheap Tickets, if at
all.
32
<PAGE>
Recently Issued Accounting Standards
In 1998, Cheap Tickets adopted SFAS No. 130 "Reporting Comprehensive
Income," SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," and SFAS No. 132, "Employers' Disclosures about Pensions and
Other Postretirement Benefits." SFAS No. 130 states that all items that are
required to be recognized under generally accepted accounting standards as
components of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. The adoption
of SFAS No. 130 did not have an effect on Cheap Tickets' financial statements
since Cheap Tickets does not have elements of comprehensive income other than
net earnings.
SFAS No. 131 requires disclosures regarding segments of an enterprise and
related information that reflects the different types of business activities in
which the enterprise engages and the different economic environments in which
it operates. The effect of implementing SFAS No. 131 was not significant as
Cheap Tickets manages its business as a single operating segment, Cheap Tickets
is domiciled entirely in the U.S. and substantially all of Cheap Tickets'
revenues are derived from the sales of airline tickets.
SFAS No. 132 standardized the disclosure requirements for pension and other
postretirement benefits. The adoption of SFAS No. 132 does not change existing
measurement or recognition standards for Cheap Tickets' defined contribution
plan and does not have a material effect on Cheap Tickets' financial
statements.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
establishes accounting and reporting standards for derivative instruments and
hedging activities. SFAS No. 133 requires the recognition of all derivative
instruments as either assets or liabilities in the statement of financial
position and measurement of those derivative instruments at fair value. SFAS
No. 133 is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999. Currently, Cheap Tickets does not hold derivative instruments or
engage in hedging activities. The adoption of this standard is not expected to
have a material effect on Cheap Tickets' financial statements.
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." In April 1998, the committee issued SOP 98-5, "Reporting on the
Costs of Start-Up Activities." These standards are effective for Cheap Tickets'
year ending December 31, 1999. Cheap Tickets has not determined the impact of
the implementation of these pronouncements.
Year 2000 Compliance.
Overview
Cheap Tickets is taking steps to address potential Year 2000 problems. Cheap
Tickets has formed a project team from its systems and technology, finance,
telecom and operations departments. The project team is responsible for
implementing the following four-phase process: (1) identifying the computer
systems and products affected; (2) contacting vendors and suppliers; (3)
determining the Year 2000 compliance status of each system and product; and (4)
implementing any necessary changes. Although Cheap Tickets does not currently
expect the impact of the Year 2000 issue will be material to systems still
under evaluation, Cheap Tickets could discover (or fail to discover) Year 2000
issues in the course of its evaluation process that would have a material and
adverse effect on Cheap Tickets' business, results of operations or financial
condition if not properly addressed.
33
<PAGE>
Cheap Tickets currently has three types of computer systems or programs
which may be affected. They include: (a) reservations database systems, (b)
PC/LAN systems and (c) non-informational technology systems. The reservations
database systems involve the computer programs and products responsible for
airline, cruise, car and hotel reservations and other transactional systems.
PC/LAN systems include Cheap Tickets' personal computer network systems. Non-
informational technology systems include systems or hardware containing
embedded technology such as micro controllers. Cheap Tickets has completed
phases one and two on these systems and is currently in the process of
completing phase three.
In addition, Cheap Tickets has already completed all four phases for several
of its systems including SABRE reservations, TravelBase Accounting, Payroll,
Credit Card Processing Software and Credit Card Processor. Other critical
component systems, such as PC/LAN Hardware, PC/LAN Software and
Telecommunications Systems are in the process of having necessary changes made
to be Year 2000 compliant. Management anticipates that it will complete phase
four for all of Cheap Tickets' significant computer systems by the end of the
second quarter of 1999. If the systems material to Cheap Tickets' operations
have not been made Year 2000 compliant upon completion of phases three and
four, the Year 2000 issue could have a material and adverse effect on Cheap
Tickets' business, results of operations and financial condition.
Reservation Database Systems. The main supplier of the Cheap Tickets'
reservation database systems is SABRE. Currently, over 90% of Cheap Tickets'
computing transactions are processed through the SABRE systems. This includes
transactions involving airline reservations, booking, ticketing, car and hotel
rentals, cruises and accounting. SABRE has advised Cheap Tickets that it has a
Year 2000 implementation plan in place. Further, SABRE has advised Cheap
Tickets that it has already resolved Year 2000 issues for its main computer
system--the airlines reservations system. Cheap Tickets intends to implement
all changes required by SABRE for Cheap Tickets to be Year 2000 compliant by
the end of the second quarter of 1999. There can be no assurances that SABRE
will be Year 2000 compliant and that the impact of SABRE's non-compliance, if
any, would not be material.
PC/LAN Systems. Cheap Tickets is currently in the process of replacing all
of its PC/LAN computing systems with a completion date scheduled for the second
quarter of 1999. All the new PC/LAN systems being installed, including
hardware, software, applications and operating systems, have been represented
by their vendors to be Year 2000 compliant. Cheap Tickets believes that any
systems that it has not yet replaced do not present any Year 2000 concerns
because, to Cheap Tickets' knowledge, these systems already are Year 2000
compliant or will have Year 2000 upgrades available beginning in the first
quarter of 1999. In addition, Cheap Tickets is currently requiring that any new
systems it purchases meet Year 2000 compliance requirements. There can be no
assurances that such PC/LAN computing systems will be Year 2000 compliant and
that the impact of such non-compliance, if any, would not be material.
Non-Informational Technology Systems. Cheap Tickets has not yet evaluated
its non-informational technology systems. However, Cheap Tickets is working
with facilities management in each of its operational centers to seek to
achieve Year 2000 compliance for these systems before the end of the second
quarter of 1999. In addition, Cheap Tickets has not yet developed a contingency
plan in the event that any of its critical computer systems are not Year 2000
compliant by January 1, 2000.
34
<PAGE>
Based on the steps being taken and progress to date, management estimates
that the expenses for ensuring Year 2000 compliance of its computer products
and systems will not have a material adverse effect on operations or earnings,
and can be financed out of cash flow from operations. Despite such plans and
Cheap Tickets' assessment of current hardware and software, the assessment of
Cheap Tickets' current state of compliance may not be fully accurate, and Cheap
Tickets' plans for achieving full compliance with Year 2000 issues may not in
fact be fully successful. Cheap Tickets is also in the process of attempting to
verify that all of the products supplied by third-party vendors have either
resolved the Year 2000 issue or have a published plan to do so. In certain
cases, such as with SABRE, Cheap Tickets has relied in good faith on
representations and warranties regarding Year 2000 compliance provided to it by
third-party vendors of hardware and software, and on consultants. Such
representations and warranties may not be accurate in all material respects and
the advice or assessments of consultants may not be reliable. If third parties
are not able to make their systems Year 2000 compliant in a timely manner, it
could have a material and adverse effect on Cheap Tickets' business, results of
operations and financial condition. Cheap Tickets has not developed a
contingency plan to address the possibility that SABRE is unable to achieve
Year 2000 compliance and does not intend to do so.
Federal Aviation Administration Readiness. The FAA's state of Year 2000
readiness may have a significant impact on air travel on or about January 1,
2000 and for an uncertain period of time thereafter. Air travel may be affected
both by travelers' safety fears and by actual disruption caused by lack of Year
2000 readiness.
The FAA reports that it has created the FAA Year 2000 Program Office. This
office is responsible for all of the FAA's Year 2000 efforts and has
established a schedule requiring all FAA systems to be Year 2000 compliant by
June 30, 1999. In addition, according to the FAA, contingency plans are being
developed for each FAA system, and for the agency itself.
Disruption of air traffic on or about January 1, 2000, whether or not
attributable to the state of FAA Year 2000 readiness, may have an adverse
impact on Cheap Tickets. However, the effect, if any, is uncertain. Fear by
travelers of disruption could result in reduced reservations for year-end
flights and possibly less leisure travel generally at year-end. In addition, if
such fears develop, the airlines may lower prices generally or engage in fare
wars to attract customers. If the airlines did engage in such behavior, Cheap
Tickets' business could be hurt. However, if air traffic is not disrupted, and
airlines and the FAA, in fact, achieve Year 2000 readiness, air travel should
return to normal levels shortly following January 1, 2000. In such a situation,
the overall disruption to Cheap Tickets may be limited to the holiday vacation
period which includes January 1, 2000. On the other hand, a breakdown of the
air control system, or other breakdowns generally resulting in reduced air
traffic or less safe air travel, could have more serious impact on the air
travel business generally and could affect Cheap Tickets' business, results of
operations and financial condition more adversely. Management has not drawn any
conclusions about whether any such Year 2000 effect will be experienced and, if
so, how it will affect Cheap Tickets. In addition, Cheap Tickets has not
developed a contingency plan to address this situation and does not intend to
do so.
Finally, Year 2000 issues may impact other entities with which Cheap Tickets
does business, including, for example, airlines and those responsible for
maintaining telephone and Internet communications. Accordingly, Cheap Tickets
cannot predict the effect of the Year 2000 problem on such entities. If these
other entities fail to take preventive/or corrective actions in a timely
manner, the Year 2000 issue could have a material and adverse effect on Cheap
Tickets' business, results of operations and financial condition. Cheap Tickets
has not yet developed a contingency plan to address the possibility that other
entities with which it does business are unable to achieve Year 2000 compliance
and does not intend to do so.
35
<PAGE>
BUSINESS
Cheap Tickets is a leading retail seller of discount tickets for domestic
leisure air travel. In 1998, Cheap Tickets sold approximately 960,000 airline
tickets through call centers, retail stores and its Internet site at
"www.cheaptickets.com." Cheap Tickets has rights to buy these fares under
contracts from over 30 airline carriers, including America West, American,
Continental, Northwest, TWA and US Airways.
Industry Background.
Consumers in the United States spent $126 billion on travel through travel
agencies in 1997, up from $101 billion in 1995, according to the Travel Weekly
1998 U.S. Travel Agency Survey. According to the same source, the leisure
travel component of this market is also growing rapidly, as leisure travel
accounted for $64.5 billion, or 51%, of total travel in 1997. Leisure travel
bookings increased 30% from 1995 to 1997, the largest increase in recent years.
Management believes that the growth in leisure travel has been driven by a
number of factors, including an increase in disposable income levels in the
United States, the aging of the population and the availability of affordable
airfares. Airline travel (including business and leisure travel) continues to
be the largest segment of the travel industry, with $70.5 billion, or 56%, of
total travel booked through travel agencies in 1997.
Airline Ticket Sales.
Published Fares. Historically, airlines have sold tickets directly or
through travel agencies on a commission basis. The traditional travel agency
channel of distribution is highly fragmented, with few nationally recognized
brands. According to The American Society of Travel Agents, over 23,000 travel
agencies operate in more than 33,000 locations in the United States, and the
average travel agency generates approximately $3.8 million in annual gross
bookings per location.
Travel agents are compensated primarily through commissions paid by airlines
on tickets sold. Some travel agencies also charge service fees to their
customers. Travel agents generally receive commissions of 8% of total ticket
price, although these commissions are frequently capped at $25 for a domestic
U.S. one-way ticket and $50 for a domestic round trip ticket. Airlines also
generally pay approximately 5% in commissions for online sales. In addition,
travel agencies can earn performance-based incentive compensation.
Commissions are determined in the sole discretion of the airlines and are
subject to frequent change. In recent years, airlines have reduced rates and
capped per-ticket commissions generally payable to travel agencies. In
addition, they have further reduced rates and capped commissions for online
reservations. The downward pressure on commission rates may cause traditional
travel agencies to charge service fees to their customers, shift their focus to
higher margin, non-air travel services or reduce the level of customer service.
Travel agencies typically book reservations through electronic global
distribution services such as the SABRE system and Galileo International
Partnership's Apollo system. Global distribution services provide real-time
access for agents to extensive data on fares, availability, schedules and other
travel information. This data is constantly changing, with as many as one
million airfare changes made daily. Customers have historically had to rely on
travel agents to access and interpret this rapidly changing information.
Non-Published Fares. According to the American Transport Association,
airline excess capacity in the United States was 32.5% from 1995 to 1997, and
excess capacity is estimated to be 29.3% in 1998. The airlines can predict
excess capacity up to a year in advance for specific routes
36
<PAGE>
and times. Airlines are motivated to sell excess capacity at prices
substantially lower than published tariffs because the marginal cost of filling
excess seats is minimal. However, to succeed in this strategy, the airlines
need assurance that sales of excess capacity at lower prices do not erode
published fare structures. The ability to sell such seats without eroding
published fare structures is a source of incremental profits for airlines.
Management believes that it would be difficult for airlines to market their
excess capacity directly to the public at discount prices because their
discount fares would compete with their own regular published fares, and they
would also risk drawing immediate price competition from other airlines. In
fact, airlines generally have not sold excess capacity directly to the public,
except in extremely limited situations, usually involving last-minute special
offers and the use of frequent flier awards. Management believes that leisure
travelers are particularly suited to the products offered by Cheap Tickets, as
they are highly price sensitive and willing to be flexible on carriers, routes
and times of travel.
Airlines generally have sold excess capacity indirectly through
intermediaries in a manner designed not to erode their published fare
structures while at the same time maximizing incremental excess revenues. They
have accomplished this by selling excess capacity to independent third parties
under net fare contracts. The tickets are then resold by these third parties to
the public at prices set by them, generally at a substantial discount below
regularly published fares. The prices of these tickets are not published unless
they have been published directly by the reseller in the media or otherwise,
and the fares are not available from the airlines directly. Hence, they are
referred to as "non-published fares." The profit margins on non-published fare
sales generally exceed the commissions payable for sales of tickets on an
agented basis.
Non-published fares are restricted to specific routes and times, cannot be
canceled or refunded, and generally contain other restrictions which, while
making them unattractive for full-fare travelers, are acceptable to price
sensitive leisure travelers with flexible itineraries.
For international routes, management believes that the market for the sale
of non-published fares is highly competitive, with numerous participants
offering deeply discounted fares. For domestic routes, there are few sellers,
and they generally have contracts with a small number of carriers for a limited
number of routes. Among these, management believes Cheap Tickets is the leading
seller of non-published fares for regularly scheduled domestic routes. Cheap
Tickets has contracts with carriers covering most major domestic and
international routes.
The Growth of Internet Commerce, Products and Services.
The enormous growth and acceptance of the Internet as a medium of
communication and commerce presents significant opportunities for Cheap
Tickets. According to Dataquest, more than 43 million households in America
currently have Internet access and that number is projected to grow to nearly
95 million households by 2001. The factors driving this growth include the
increasing number and decreasing cost of personal computers in homes and
offices, technological innovations providing easier, faster and cheaper access
to the Internet, the proliferation of content and services being provided on
the Internet and the increasing use of the Internet by business and consumers
as a medium for conducting business.
The Internet possesses a number of unique and commercially powerful
characteristics that differentiate it from traditional media: users communicate
or access information without geographic limitations; users access dynamic and
interactive content on a real-time basis; and users communicate and interact
instantaneously. The Internet has created a dynamic and particularly attractive
medium
37
<PAGE>
for commerce, empowering customers to gather more comparative purchasing data
than is feasible with traditional commerce systems, to shop in a more
convenient manner and to interact with sellers in many new ways. Forrester
Research estimates that online retail revenues will increase from approximately
$4.8 billion in 1998 to approximately $17.4 billion by 2001.
Online Travel Market.
As a result of pressures on traditional travel distribution channels and the
emergence of new "e-commerce" opportunities, the online travel industry has
grown rapidly. The Internet provides a convenient and efficient medium for
sales of airline tickets by affording customers direct access to up-to-the-
minute travel information, including changing fares and routes, the ability to
engage in competitive shopping, and the capacity to purchase tickets. According
to Forrester Research, the online travel market is the second largest by dollar
volume and fastest growing area of Internet commerce. Online airline travel
bookings were $1.6 billion in 1998 and are expected to grow at a compounded
annual growth rate of 46%, reaching $10.6 billion in 2003.
In the online travel services market, Cheap Tickets competes for published
fares with other entities that contain similar commercial websites, such as
Expedia, which is operated by Microsoft Corporation, Travelocity, which is
operated by SABRE Group Holdings Inc., a majority-owned subsidiary of American
Airlines, Preview Travel, Inc., and Priceline.com, Inc. Many airlines also have
established commercial websites for their published fares. With limited
exceptions including Priceline.com, Inc., to management's knowledge, non-
published fares for regularly scheduled domestic routes are not currently
offered by online travel companies.
Cheap Tickets Business Strategy.
Cheap Tickets' objective is to provide travel products to leisure travelers
at discount prices and to enhance its position as a leading provider of non-
published and published fares for domestic leisure travel. Cheap Tickets also
seeks to benefit travel providers by selling airlines' otherwise unused excess
capacity at high incremental margins without diluting their published fare
structure. The principal elements of Cheap Tickets' strategy are:
Broad Selection of Discounted Fares for Customers. Cheap Tickets offers a
broad selection of non-published and published fares for regularly scheduled
domestic routes at discounted prices, which management believes is unmatched in
the industry. Cheap Tickets has access to domestic and international non-
published fares for regularly scheduled flights through contracts with over 30
carriers, including America West, American, Continental, TWA and US Airways.
Customers may book these fares up to a year in advance. Currently, Cheap
Tickets offers approximately 375,000 non-published fares at any given time for
most major domestic and international routes at discounts attractive for the
leisure traveler. In addition, through the SABRE reservations system, Cheap
Tickets offers approximately 45 million published airfares, including those of
all major domestic and international commercial airlines. Cheap Tickets' non-
published fares are integrated with these published fares on a special area of
SABRE, to which only Cheap Tickets has access, permitting Cheap Tickets'
reservation agents and its Internet customers to choose the least expensive
itinerary.
Established Direct Sale Business to Consumers. Cheap Tickets has been
selling airline tickets directly to the public since its inception in 1986 and
has an established infrastructure to execute its direct sales strategy. It
sells its tickets through call centers, retail stores and the Internet. Cheap
Tickets operates four call centers staffed by approximately 380 employees in
Colorado Springs,
38
<PAGE>
Honolulu, Los Angeles and Lakeport, California, 12 retail stores and a customer
service center in Honolulu. The call centers provide toll-free telephone
support and reservation services seven days a week at "1-800-OK-CHEAP." Online
customers can access Cheap Tickets' easy-to-use website at
"www.cheaptickets.com" at their convenience. Through its call centers, Cheap
Tickets assists online customers to ensure that they have the full benefit of
its services. Tickets are shipped on a next-day basis, and Cheap Tickets is
planning to offer "E-tickets" by mid-1999.
Established History of Yield Management for Airline Carriers. Cheap Tickets
has consistently provided an efficient distribution channel to assist carriers
in selling excess capacity without eroding fare structures. Cheap Tickets
provides airlines with a yield management solution, enabling them to increase
profits through incremental revenues accompanied by low marginal costs and, in
some cases, to gain market share at the expense of competitors. Cheap Tickets
targets leisure travelers who are willing to travel on certain routes to fill
flights which normally have a low load factor. Restrictions placed on non-
published fares allow Cheap Tickets to sell non-published fares aggressively to
the public while leaving the airlines and travel and online agencies to service
full fare customers who demand the convenience of tickets that can be exchanged
or canceled and do not have advance purchase or minimum stay requirements.
Demonstrated Ability to Match Excess Capacity to Consumer Demand. Cheap
Tickets has proven to airlines that it can efficiently match airlines' excess
capacity to consumer demand for leisure travel by selling increasing volumes of
non-published fares. From 1996 through 1998, Cheap Tickets sold non-published
fares of $59.0 million, $96.4 million, and $159.8 million, respectively.
Management believes that Cheap Tickets' track record of selling excess capacity
without compromising the airlines' fare structures provide a strong incentive
for the airlines to continue to use Cheap Tickets for sale of domestic non-
published fares.
Cheap Tickets Growth Strategy.
Cheap Tickets seeks to become the leading provider of discount travel
products and services to leisure travelers. Cheap Tickets' growth strategy is
to grow its customer base aggressively, expand strategic alliances, improve
call center productivity, broaden its leisure travel offerings and consider
possible selective acquisitions. The key elements of Cheap Tickets' growth
strategy are as follows:
Rapidly Expand Internet Bookings. Cheap Tickets intends to capitalize on its
position in selling non-published fares to rapidly expand its Internet ticket
sales. Management plans to accomplish this through increased marketing to
heighten awareness of Cheap Tickets' product offerings and the Cheap Tickets
brand. Cheap Tickets plans to broaden its online visibility and customer base
through relationships with additional Internet content, commerce and service
providers. Online access for Cheap Tickets' products began in October 1997. As
of February 22, 1999, over 575,000 online users had registered at Cheap
Tickets' website, 155,000 of them since December 1998. Internet gross bookings
grew rapidly during 1998, from $2.2 million in the first quarter to $10.8
million in the fourth quarter. Approximately 15% of Cheap Tickets' gross
bookings were made over the Internet in the fourth quarter. In 1998, Cheap
Tickets had approximately $25 million in gross bookings from 96,000 Internet
ticket sales. Management believes that Cheap Tickets' gross bookings from the
Internet will continue to grow rapidly.
Aggressively Build Brand Recognition Nationally and Internationally. Cheap
Tickets has promoted itself almost exclusively through print media, primarily
in Los Angeles, New York, San Francisco and Honolulu. In addition, a recent
customer survey commissioned by Cheap Tickets
39
<PAGE>
determined that 54% of customers learned of Cheap Tickets by word of mouth.
This has translated into relatively low customer acquisition costs. The same
survey reported that approximately 60% of Cheap Tickets' customers surveyed are
from California, New York/New Jersey and Hawaii. With Cheap Tickets having
established strong brand recognition regionally, management believes that the
demand for discounted air travel presents opportunities for it to expand
nationally. Among other initiatives, Cheap Tickets plans to broaden its news
media advertising to other cities, including Chicago, Atlanta, Denver and
St. Louis. In addition, Cheap Tickets also intends to explore avenues for
international expansion. Cheap Tickets' strategy is to promote, advertise and
broaden its brand recognition through a variety of marketing techniques.
Enhance and Expand Strategic Relationships. Cheap Tickets currently has
contractual relationships with more than 30 airlines, including America West,
American, Continental, Northwest, TWA and US Airways. These relationships give
Cheap Tickets access to non-published fares, which has helped Cheap Tickets to
become a leading seller of non-published domestic fares to consumers. Cheap
Tickets intends to continue to build these relationships through increased
sales of excess capacity and seeks new relationships with other airlines,
travel suppliers, Internet portals and travel-related website companies.
Through these existing and new strategic relationships, Cheap Tickets seeks to
broaden access to non-published fares and to reach additional customers. In
addition, Cheap Tickets intends to build on its relationship with SABRE to
enable it to continue to provide ease of access to what management believes to
be the broadest available menu of discounted fares for regularly scheduled
domestic routes.
Expand Call Center Capacity through Improved Productivity. Cheap Tickets
intends to continue to invest substantial resources in developing technological
enhancements to its call centers. These will include a more automated front-end
application for its reservation agents that will reduce errors and increase
productivity; an intelligent call routing system to link Cheap Tickets' four
call centers and to direct calls to specific agents best able to service
particular customer needs and prioritize calls to reduce hold times; and an
interactive voice response system to reduce the need for agents to answer
general questions, thereby increasing the number of calls Cheap Tickets can
service and the sales productivity of reservation agents. Management believes
that such enhancements will increase sales and substantially improve operating
efficiency.
Broaden Existing Products and Services. Cheap Tickets currently realizes 98%
of its gross bookings through airline ticket sales. However, it recently began
selling cruise tickets, auto rentals and hotel reservations. Cheap Tickets
intends to capitalize on its market presence in non-published fares, brand
recognition, Internet site, service infrastructure and customer base to promote
these additional travel products. Cheap Tickets' product expansion strategy
will be to focus on complementary products that require minimal incremental
resources to sell and distribute.
Make Selective Acquisitions. Cheap Tickets will consider the acquisition of
companies which will add to its customer base, product lines, strategic
relationships or distribution. Cheap Tickets currently has no agreements or
understandings with respect to any such acquisitions.
Products and Services.
Leisure Airline Tickets. Cheap Tickets has the right to acquire non-
published fares pursuant to contracts from carriers. Cheap Tickets then resells
these tickets at profit margins which exceed the typical commissions payable
for the sale of tickets on an agented basis. The prices Cheap Tickets offers to
customers are generally at a substantial discount to published fares. Cheap
Tickets purchases
40
<PAGE>
these fares only when it resells them to customers, so that it does not have
inventory carrying costs. Cheap Tickets' non-published fares are not available
to consumers directly from the airlines and are not published, except as
advertised by Cheap Tickets. Availability of non-published fares varies from
route to route based on availability from the airline carriers. Cheap Tickets
currently offers approximately 375,000 non-published fares at any given time,
covering most major domestic and international routes. Cheap Tickets sells
these tickets with limitations and restrictions that make them unattractive for
full fare travelers, who seek the convenience of tickets that can be exchanged
or canceled and do not have advance purchase or minimum stay requirements.
In 1998, approximately 59% of Cheap Tickets' airline gross bookings were
from non-published fares. For customers who are unable to find a non-published
fare for a particular itinerary, Cheap Tickets also offers a full menu of
regularly published fares. In 1994, Cheap Tickets became the first non-airline
to file its non-published fares through the Airline Tariff Publishing
Corporation. This allows Cheap Tickets to integrate its non-published fares
with published fares in a special area of the SABRE reservations system to
which only Cheap Tickets has access. This system automatically sorts through
millions of fares, including Cheap Ticket's own non-published fares, to
identify the lowest fares available for the desired itinerary. These fares are
then posted in ascending price order for use by Cheap Tickets' reservation
agents and Internet customers.
For published fares, Cheap Tickets receives commissions on gross bookings.
Airlines generally pay commissions of 8% of total ticket price, although these
commissions are frequently capped at $25 for a domestic U.S. one-way ticket and
$50 for a domestic round trip ticket. Airlines also generally pay approximately
5% in commissions for online sales. Cheap Tickets receives commissions at least
as favorable as those received by travel agents, and with many carriers Cheap
Tickets has negotiated more favorable commission rates. In addition, Cheap
Tickets frequently benefits from performance-based override commissions.
41
<PAGE>
The following table demonstrates the breadth and availability of Cheap
Tickets' product and the cost advantages of its non-published fares. It
compares the lowest roundtrip restricted fares for all domestic routes listed
by The New York Times and The Wall Street Journal in their fare tables for the
dates shown. Cheap Tickets' fares were lower than or comparable to the lowest
available prices reported by the above publications in all the routes, with an
average discount of approximately $65.50 or 20.1%.
<TABLE>
<CAPTION>
Cheap
Lowest Tickets Cost Savings
Availability Published Lowest ---------------
Travel Segment Date(1) Source Fare(2) Fare(3) Dollars Percent
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
New York--Burlington,
Vt..................... 12/28/98 NY Times $150 $148 $ 2 1.3%
New York--Chicago....... 12/28/98 NY Times 221 185 36 16.3
New York--Ft. Myers,
Fla.................... 12/28/98 NY Times 190 178 12 6.3
New York--San Diego..... 12/28/98 NY Times 275 197 78 28.4
New York--Tucson........ 12/28/98 NY Times 398 228 170 42.7
Boston--Washington...... 12/28/98 NY Times 114 114 -- --
Denver--Las Vegas....... 12/28/98 NY Times 178 174 4 2.2
Houston--Orlando........ 12/28/98 NY Times 198 191 7 3.5
Los Angeles--Portland,
Ore.................... 12/28/98 NY Times 198 169 29 14.6
San Francisco--Austin,
Tx..................... 12/28/98 NY Times 324 173 151 46.6
New York--Los Angeles... 01/05/99 Wall St. Journal 286 218 68 23.8
Boston--San Francisco... 01/05/99 Wall St. Journal 315 268 47 14.9
Los Angeles--Dallas..... 01/05/99 Wall St. Journal 293 199 94 32.1
San Diego--Denver....... 01/05/99 Wall St. Journal 477 211 266 55.8
Boston--San Francisco... 01/05/99 Wall St. Journal 315 268 47 14.9
Atlanta--Boston......... 01/05/99 Wall St. Journal 298 140 158 53.0
Orlando--Detroit........ 01/05/99 Wall St. Journal 168 168 -- --
New York--Miami......... 01/05/99 Wall St. Journal 176 166 10 5.7
</TABLE>
- --------
(1) Represents the date on which the fares listed were available for sale.
(2) Represents the lowest roundtrip restricted fare available for the travel
segment and on the date indicated, as reported in the January 3, 1999
edition of The New York Times and the January 8, 1999 edition of The Wall
Street Journal, as applicable. The Wall Street Journal fares were stated to
be the lowest available, but not all small carriers were included. Advance
purchase, midweek departure, length of stay and other restrictions may
apply.
(3) The prices shown were those available on Cheap Tickets' reservation
database system for the dates and routes indicated.
Other Travel Products and Services. Cheap Tickets has contractual
relationships to sell cruises on Carnival Cruises and Princess Cruises. In
1998, gross bookings from cruises were approximately $3.3 million. Cheap
Tickets also has contractual relationships with major auto rental companies to
provide reservations. In 1998, gross bookings from auto rental reservations
were approximately $1.4 million. Cheap Tickets has recently entered into a
number of contracts to sell hotel room reservations. In 1998, gross bookings
from hotel reservations were negligible. Cheap Tickets sees these other travel
products and services as potential areas of future growth.
Call Center Operations. At December 31, 1998, Cheap Tickets had
approximately 380 reservation agents and other call center employees at its
four call centers. Facilities are located in Honolulu, Colorado Springs, Los
Angeles and Lakeport, California. Reservation agents at these call centers
receive all in-bound calls to Cheap Tickets' toll free number "1-800-OK-CHEAP."
On
42
<PAGE>
average, the call centers receive approximately 120,000 calls per day.
Reservation agents currently conduct fare searches for requested itineraries,
sell airline tickets, explain rules and restrictions applicable to fares and
ticket delivery details, identify retail ticket locations, and provide other
assistance. The call centers also provide customer service for both call center
customers and Internet users.
Management intends to implement its intelligent call routing and interactive
voice response technology in the second quarter of 1999 to increase the
productivity of agents by giving callers automated fare search capability and
answers to common information requests. Cheap Tickets compensates reservation
agents on an incentive basis to maximize their productivity. Call centers are
segmented into teams, which Cheap Tickets awards for the highest productivity
and operating effectiveness.
Internet Operations. Cheap Tickets' online reservations and ticketing
service through its website at "www.cheaptickets.com" provides its customers
access to information on schedules, availability and non-published and
published fares and enables them to book their own travel arrangements at their
convenience. The website is designed to provide customers with quick,
efficient, and flexible service in a manner that facilitates comparison
shopping. Cheap Tickets' online service automates the processing of customer
orders, interacts with the systems of third party travel suppliers, and allows
Cheap Tickets to gather, store and use customer and transaction information in
a comprehensive and cost-efficient manner. The website allows customers to
dispense with providing personal profile and payment information after their
initial registration. The website has permitted Cheap Tickets to expand its
customer base through better service while reducing transactional costs.
The website contains customized software applications that interface the
website with the electronic booking system and database. Cheap Tickets has
contracted with SABRE for the development and hosting of the site, the
development of the customized software applications, and access to the
electronic booking system and database. Cheap Tickets also has developed its
own proprietary customized software applications that interfaces the website
directly with the SABRE electronic booking system and database.
Cheap Tickets maintains a relational database containing information
compiled from customer profiles, shopping patterns and sales data. Cheap
Tickets analyzes information in this database to develop targeted marketing
programs and provide personalized and enhanced customer service. Its database
is scaleable to permit large transaction volumes with no significant software
changes. Cheap Tickets' systems support automated e-mail communications with
customers to facilitate confirmations of orders, provide customer support,
obtain customer feedback and engage in targeted marketing programs.
Cheap Tickets uses a combination of proprietary and industry-standard
encryption and authentication measures designed to protect a customer's
information. Cheap Tickets maintains an Internet firewall to protect its
internal systems and all credit card and other customer information.
Strategic Relationships.
Airline Relationships. Cheap Tickets currently has contracts with more than
30 airlines. In 1998, Continental accounted for approximately 25% of Cheap
Tickets' sales of non-published fares, and America West and TWA, 12% each.
Cheap Tickets sells non-published fares purchased under these contracts, with
minimum stay and advance purchase requirements, as non-refundable, non-
endorsable and non-changeable tickets and without frequent flyer mileage or
upgrades. Generally, the
43
<PAGE>
airline contracts range from one to one and a half years in length and can be
cancelled on short notice. None of these carriers has any obligation to renew
the contracts at their expiration, but Cheap Tickets has consistently been
successful in obtaining renewals. Management believes that Cheap Tickets' track
record of selling excess capacity without compromising the airlines' fare
structures provides a strong incentive for the airlines to continue to use
Cheap Tickets for the sale of domestic non-published fares. Management believes
that Cheap Tickets' success in matching excess capacity to consumer demand for
low ticket prices comes from its strategy of directing its marketing efforts to
leisure travelers and selling restricted tickets directly to the public in high
volumes through call centers and over the Internet. Although Cheap Tickets has
a consistent history of renewing its contracts, there are no assurances that
any one or several of them will be renewed.
SABRE Relationship. SABRE is a world leader in the electronic distribution
of travel-related products and services and is a leading provider of
information technology solutions for the travel and transportation industry.
SABRE's electronic booking system and database contains flight schedules,
availability, and published fare information for more than 400 airlines, 50
auto rental companies, 35,000 hotel properties, and dozens of railways, tour
companies, passenger ferries, and cruise lines located throughout the world.
Through the SABRE reservations system, Cheap Tickets offers approximately 45
million published airfares, including those of all major domestic and
international commercial airlines. In addition, SABRE's electronic booking
system and database hosts Cheap Tickets' non-published fare information through
a unique arrangement that permits Cheap Tickets to integrate its non-published
fares with published fares on a special area of the SABRE reservations system
to which only Cheap Tickets has access. This system automatically sorts through
millions of fares, including Cheap Ticket's own non-published fares, to
identify the lowest fares available for the desired itinerary. These choices
are then posted in ascending price order for use by Cheap Tickets' reservation
agents and Internet customers.
Marketing and Brand Awareness.
Cheap Tickets' marketing strategy is to aggressively build the Cheap
Tickets' brand name, enhance customer awareness and add new customers, both
through call centers and online. Cheap Tickets has established Cheap Tickets as
a leading discount travel services brand through limited marketing and
promotion. In 1998, Cheap Tickets spent $3.8 million for sales and marketing
expenses. It has promoted itself almost exclusively through print media,
primarily in Los Angeles, New York, San Francisco and Honolulu. Cheap Tickets
has advertised in The New York Times, The Washington Post, The Los Angeles
Times, The Seattle Post Intelligencer, The San Diego Tribune, and The Orange
County Register, among other publications. In addition, a recent customer
survey commissioned by Cheap Tickets determined that 54% of customers learned
of Cheap Tickets by word of mouth. Cheap Tickets' growth of Internet customers
was primarily through media advertisements and limited online advertising.
Cheap Tickets has advertised on Yahoo, Excite, Lycos, HotBot, Snap, OnSale and
Travelocity, among others. Cheap Tickets has purchased various keywords and
banners, typically under contracts of 30 to 90 days in duration. As limited
funds were spent on Internet promotions, Cheap Tickets has experienced
relatively low customer acquisition costs.
In the future, Cheap Tickets' strategy is to promote, advertise and broaden
its brand recognition through a variety of marketing techniques. In 1999, it
plans to spend a significant amount of the proceeds from this Offering to
increase advertising in news media and on leading websites. Additionally, Cheap
Tickets plans to broaden its news media advertising to Chicago, Atlanta, Denver
and St. Louis.
44
<PAGE>
Competition.
Competition for Non-Published Fares.
Sellers of Non-Published Fares. Cheap Tickets' existing direct competition
for non-published fares comes largely from companies that specialize in the
distribution of discounted fares in the form of regularly scheduled and
chartered flights. Management believes that the market for the sale of non-
published fares is highly fragmented. For international routes, it is highly
competitive, with numerous participants offering deeply discounted fares. For
domestic routes, there are few sellers, and they generally have net fare
contracts with a small number of carriers for a limited number of routes. Among
these, management believes Cheap Tickets is the leading seller of non-published
fares for regularly scheduled domestic routes. Cheap Tickets has contracts with
many carriers covering most major domestic and international routes. As the
domestic airline industry continues to evolve, other competitors could increase
their share of the market, or new ones could enter the market.
Online Travel Companies. Online travel companies are rapidly increasing
their shares of airline ticket sales, but, with limited exceptions including
Priceline.com, Inc., to management's knowledge, non-published fares for
regularly scheduled domestic routes are not currently offered by online travel
companies. If airlines were to make such fares generally available to online
travel companies, presumably they would risk eroding published fare structures.
However, there can be no assurance that one or more online companies, a number
of which possess larger customer bases, greater brand recognition and
significantly greater financial, marketing and other resources than Cheap
Tickets, will not succeed in accessing non-published fares.
Airlines and Travel Agents. Airlines do not generally offer non-published
fares directly or indirectly through affiliates or travel agents for regularly
scheduled travel, presumably to prevent the erosion of their published fare
structure. Some airlines do offer limited special discounted fares through
their Internet sites that are not generally made available to travel agents.
These fares are typically offered only on a last-minute, "special sale" basis.
In addition, some airlines offer special promotional fares, combining low base
prices and the use of frequent flyer awards. Airlines may expand their offering
of special promotional fares, enter the non-published fare market or sell non-
published tickets through travel agents.
Certain Competitive Factors Affecting Non-Published Fares.
Published fares also compete with Cheap Tickets' non-published fares. They
effectively establish price ceilings for Cheap Tickets' non-published fares.
From time to time, airlines also offer special fares, which may compete
directly with Cheap Tickets' discounted non-published fares. Direct competition
also comes from the airlines when fare wars break out.
Competition for Published Fares.
In the sale of published fares, Cheap Tickets currently competes with
airlines, traditional travel agents, online travel services and travel industry
reservation databases. The online travel services market is new, rapidly
evolving and intensely competitive, and Cheap Tickets expects such competition
to intensify in the future. In the online travel services market, Cheap Tickets
competes for published fares with similar commercial websites of other
companies, such as Expedia, which is operated by Microsoft Corporation,
Travelocity, which is operated by SABRE Group Holdings Inc., a majority-owned
subsidiary of American Airlines, Preview Travel, Inc., Cendant Corporation,
TravelWeb, which is operated by Pegasus, Internet Travel Network, Biztravel.com
and TheTrip.com, among others. Several traditional travel agencies, including
larger travel agencies such as American
45
<PAGE>
Express Travel Related Services Co. Inc., Uniglobe Travel and Carlson Wagonlit
Travel, have established, or may establish in the future, commercial websites
offering online travel services. Several airlines also have established
commercial websites to sell their tickets and offer other online travel
services.
Employees.
As of December 31, 1998, Cheap Tickets had approximately 380 reservation
agents and other call center employees, approximately 55 retail stores and
cruise employees and approximately 155 corporate and administrative employees
for a company-wide total of approximately 590 employees. Cheap Tickets' ability
to attract and retain highly qualified employees will be the principal
determinant of its success. Cheap Tickets has a policy of using performance-
based and equity-based compensation programs to reward and motivate significant
contributors among its employees. Competition for qualified personnel in the
industry is intense. There can be no assurance that Cheap Tickets' current and
planned staffing will be adequate to support its future operations or that
management will be able to hire, train, retain, motivate and manage required
personnel. Although none of Cheap Tickets' employees is represented by a labor
union, there can be no assurance that its employees will not join or form a
labor union. However, Cheap Tickets has not experienced any work stoppages and
considers its relations with its employees to be good.
Facilities.
Cheap Tickets is headquartered in Honolulu, Hawaii where it leases an
aggregate of approximately 16,100 square feet of space housing its corporate
offices and a call center. Cheap Tickets' leases for such space expire in
November 2000 and December 2003, with an option to renew such leases covering
approximately 13,300 square feet for an additional five years. Cheap Tickets
also leases an aggregate of approximately 5,400 square feet of retail or
storage space in six other locations in Hawaii. In July 1994, Cheap Tickets
entered into a lease for approximately 9,600 square feet in Los Angeles,
California, to serve as one call center. In March 1998, Cheap Tickets entered
into a lease for approximately 13,000 square feet in Colorado Springs,
Colorado, to serve as another call center. Such leases expire in September 2004
and September 2003, respectively. Cheap Tickets is currently in negotiations
for a new lease in the Colorado Springs area, which it anticipates will result
in improved cost and space efficiencies. Cheap Tickets also leases an aggregate
of approximately 8,800 square feet of retail and administrative space in five
other locations in California, approximately 975 square feet of retail space in
Seattle in one location, and approximately 1,650 square feet of retail and
administrative space in New York in two locations. Cheap Tickets owns a 20,000
square-foot facility in Lakeport, California, which serves as a fourth call
center. Cheap Tickets anticipates that it will require additional headquarters'
space within the next 12 months. There can be no assurance that such additional
space will be available on commercially reasonable terms, if at all.
Legal Proceedings.
Cheap Tickets is not currently subject to any material legal proceedings.
Cheap Tickets may from time to time become a party to various legal proceedings
arising in the ordinary course of our business. Any such proceeding against
Cheap Tickets, even if not meritorious, could result in the expenditure of
significant financial and managerial resources.
46
<PAGE>
MANAGEMENT
Directors and Executive Officers
The names, ages and positions of Cheap Tickets' directors and officers as of
February 22, 1999 are as follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Michael J. Hartley...... 49 Chairman of the Board, Chief Executive Officer and President
F. Michael Bartholomew.. 51 Chief Operating Officer
Dale K. Jorgenson....... 59 Chief Financial Officer and Vice President of Finance
Tammy A. Ishibashi...... 31 Executive Vice President of Ticket Distribution
Donald K. Klabunde...... 42 Vice President of Systems & Technology
Ronald L. McElfresh..... 49 Vice President of Online Services
Sandra T. Hartley....... 49 Vice President of Employee Relations and Director
Lester R. Stiefel....... 47 Director of Human Resources
LaMont C. Brewer........ 42 Director of Call Centers
Ronald J. Tsolis, Jr. .. 30 Director of Pricing and Yield Management
Giles H. Bateman(3)..... 53 Director, Nominee
George R. Mrkonic(3).... 46 Director, Nominee
Donald J.
Phillips(1)(2)......... 59 Director
Cece Smith(1)(2)........ 54 Director
</TABLE>
- --------
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
(3) Anticipated members of the Audit and Compensation Committees upon the
completion of the offering.
Michael J. Hartley, a co-founder of Cheap Tickets, has served as Chief
Executive Officer, President and Director of the Company since Cheap Tickets'
inception in August 1986, and has served as Chairman of the Board since January
1999. Mr. Hartley is the husband of Sandra T. Hartley, Cheap Tickets' Vice
President of Employee Relations and the uncle of Tammy A. Ishibashi, Cheap
Tickets' Executive Vice President of Ticket Distribution. Prior to founding
Cheap Tickets, Mr. Hartley founded and sold one charter airline and served as
an organizer of two other airlines.
F. Michael Bartholomew has served as Chief Operating Officer of Cheap
Tickets since January 1999. He joined the Company in December 1997 as Senior
Vice President of Operations. From April 1994 to September 1997, Mr.
Bartholomew was Vice President of Customer Management, at Providian Financial
Corporation, a $10 billion public consumer financial services company. From May
1991 to April 1994, Mr. Bartholomew was President of Sierra Technology, a
specialized management consulting company. Prior to that, Mr. Bartholomew was a
Senior Advisor of the U.S. Special Forces, Navy Seals, U.S. Navy. Mr.
Bartholomew holds a B.S. degree in Finance from St. Louis University.
Dale K. Jorgenson joined Cheap Tickets in May 1998 as Chief Financial
Officer and Vice President of Finance. Prior to that, from 1988 to 1998, he was
Chief Financial Officer and Vice President of Finance, of Interpacific Hawaii
Retail Group and DFS, Ltd. Hawaii Region, both large retail chains in Hawaii.
Prior to that, he held similar positions for 14 years with Castle & Cooke,
Inc., now Dole Food Co. Mr. Jorgenson holds a B.A. degree in Business
Administration from the University of Washington and an M.B.A. degree from
Golden Gate University. He is a certified public accountant.
47
<PAGE>
Tammy A. Ishibashi has served as Executive Vice President of Ticket
Distribution since February 1995 and is responsible for managing the retail
stores and ticket distribution process, which includes fare filings with the
Airline Tariff Publishing Corporation, ticket distribution, refunds and ARC
reporting, and for overseeing the five departments necessary to accomplish this
process. She joined Cheap Tickets as Treasurer in September 1990, a position
she held until November 1993 when she was appointed to Second Vice President.
Ms. Ishibashi served as a Director of Cheap Tickets from September 1990 until
February 1999. Ms. Ishibashi is the niece of Michael J. Hartley, Cheap Tickets'
Chairman of the Board, Chief Executive Officer and President, and Sandra T.
Hartley, Cheap Tickets' Vice President of Employee Relations.
Donald K. Klabunde has served as Vice President of Systems & Technology
since January 1999. He joined Cheap Tickets in February 1998 as Director of
Systems & Technology, to direct the day-to-day and strategic operation of the
information and technology department in the planning, development,
implementation, and support of technological/systems enhancements throughout
the company. Prior to joining the Company, he worked for Deluxe Corporation, a
financial services company, since 1980 in a variety of technical support and
information and technology positions. Mr. Klabunde holds a B.A. degree from the
University of Minnesota.
Ronald L. McElfresh joined Cheap Tickets in January 1998 as Vice President
of Online Services, to design, develop, implement and maintain Cheap Tickets'
website. From 1996 to 1997, he worked at Digital Island, a global Internet
service provider, as the Director of Marketing. From June 1995 to June 1996, he
served as general manager at Hawaiian On-Line GTE, an Internet company. From
October 1994 to June 1995, he worked at GTE, a telecommunications company, as
an international services product manager, where he developed and managed
telephony and worked on product development for GTE's original Internet
services. From April 1989 to July 1993, Mr. McElfresh was the Director of
Product Marketing of Brite Voice Systems, Inc., a telecommunications company.
In October 1981, Mr. McElfresh co-founded INFOCOM, a multimedia development
company, where he held various product development and marketing positions,
most recently as General Manager, until October 1987. Mr. McElfresh holds a
B.A. degree from Blackhawk College.
Sandra T. Hartley, a co-founder of Cheap Tickets, has served as Vice
President of Employee Relations since January 1999. Her responsibilities
include employee relations and benefits, corporate functions and public
relations. She served as Chief Executive Officer of Cheap Tickets from August
1986 until September 1998. From August 1986 until January 1999, she has served
as Chairman of the Board of Directors. Ms. Hartley is the wife of Michael J.
Hartley, Cheap Tickets' Chairman of the Board, Chief Executive Officer and
President, and the aunt of Tammy A. Ishibashi, Cheap Tickets' Executive Vice
President of Ticket Distribution.
Lester R. Stiefel joined Cheap Tickets in April 1998 as Director of Human
Resources, to head the human resources function and to ensure that policies and
practices comply with employment laws and regulations and company standards.
Prior to joining the company he worked at Citibank, a financial institution, as
Vice President of Senior Resources Manager from 1986 to 1998, and at The Bank
of Nova Scotia, a financial institution, from 1984 to 1986. Mr. Stiefel holds a
B.A. degree from Herbert Lehman College and a Masters degree from Yeshiva
University.
LaMont C. Brewer joined Cheap Tickets in September 1998 as Call Center
Manager for the Honolulu, Hawaii location. From February 1999, Mr. Brewer has
served as Director of Call Centers. Prior to joining Cheap Tickets, he worked
at Michigan Bell/Ameritech, a telecommunications company, since 1985 in
different positions including general manager of a 380 station call center,
48
<PAGE>
quality assurance manager and training supervisor. Mr. Brewer holds a B.A.
degree from Wayne State University.
Ronald J. Tsolis, Jr. joined Cheap Tickets in May 1998 as Director of
Pricing and Yield Management to maximize the profitability of retail fares
offered by the Company. From July 1993 to May 1998, he held management
positions in Pricing, Planning, and Sales at US Airways. Mr. Tsolis holds a
B.S. degree in Business Logistics from Pennsylvania State University.
Giles H. Bateman has been nominated to serve as a Director of Cheap Tickets
effective immediately upon the closing of this offering. He has served as a
director of CompUSA Inc. since December 1991 and as Chairman of the Board of
Directors since December 1993. Since January 1992, Mr. Bateman has been an
investor in and director of other public and private companies, including
Boatracs, Inc. and Beverages and More, Inc. In 1991, Mr. Bateman was a visiting
professor at the University of San Diego Olin Hall School of Business
Administration. Mr. Bateman was co-founder of The Price Company, the operator
of The Price Club chain of warehouse club retail superstores. He served as a
director and Chief Financial Officer of The Price Company from 1976 to 1991 and
as Vice Chairman from 1986 to 1991. Since 1998, Mr. Bateman has volunteered as
the Chairman of the Board of Trustees of The Hoffman Institute in Northern
California. Mr. Bateman holds a B.A. degree from Oxford University and an
M.B.A. degree from Harvard University.
George R. Mrkonic has been nominated to serve as a Director of Cheap Tickets
effective immediately upon the closing of this offering. He has served as the
Vice Chairman of Borders Group, Inc. since December 1994, and a director since
its formation in August 1994. He also served as President of Borders Group,
Inc. from December 1994 until January 1997. Prior to joining Borders,
Mr. Mrkonic served as Executive Vice President of Specialty Retailing Group of
Kmart Corporation, where he had overall responsibility for the specialty
retailing operations of Kmart including, among others, Borders, Inc. and Walden
Book Company, Inc., from November 1990 to November 1994. Mr. Mrkonic is also a
director of Champion Enterprises, Inc., a manufacturer and seller of
manufactured homes and Syntel, Inc., a computer software and development
company.
Donald J. Phillips has been a Director of Cheap Tickets since June 1998.
Since 1986, Mr. Phillips has been a general partner of Phillips-Smith Specialty
Retail Group, a retail venture capital investment firm. Mr. Phillips serves as
a director on the Board of Directors for several private companies, including
Garden Escape, Inc. He previously served as a director of publicly-held
retailers CompUSA, Inc., PETsMART, Inc. and A Pea in the Pod, Inc. Mr. Phillips
holds a B.B.A. degree in Economics from Western Michigan University and an
M.B.A. degree from Harvard University.
Cece Smith has been a Director of Cheap Tickets since July 1997. Since 1986,
Ms. Smith has been a general partner of Phillips-Smith Specialty Retail Group,
a retail venture capital investment firm. Ms. Smith serves as a director on the
Board of Directors of Hot Topic, Inc., a public specialty retailer of music-
related apparel and accessories for young men and women, and a number of
private retail companies. She previously served as a director of publicly-held
retailers BizMart, Inc. and A Pea in the Pod, Inc. Ms. Smith holds a B.B.A.
degree in Business Administration from the University of Michigan and an M.L.A.
degree in Liberal Arts from Southern Methodist University. Ms. Smith served as
a director from 1992 to 1997 and as Chairman from 1994 to 1996 of the Federal
Reserve Bank of Dallas.
49
<PAGE>
Members of the Board of Directors are elected each year at the Company's
annual meeting of stockholders and serve until the following annual meeting of
the stockholders and until their respective successors have been elected and
qualified.
Prior to his founding of Cheap Tickets in 1986, Mr. Hartley served from 1973
to 1978 as President and Chief Operating Officer of a commuter airline
operating within Hawaii, which he subsequently sold. From 1974 to 1978, he also
operated a Hawaii-based aviation center, which provided fuel and maintenance
services and flight instruction. In 1977, Mr. Hartley pled guilty to the charge
of conspiracy with the intent to distribute a controlled substance stemming
from an event that occurred in 1975, when he was 25. He served a 90-day work
release program and two and one half years' probation. From 1981 to 1986, Mr.
Hartley was one of several founders of two start-up Hawaii-California airlines,
Hawaii Express and Air-Hawaii. Eight months after Mr. Hartley had been
dismissed as President by a dissident board, Hawaii Express failed in 1983. Mr.
Hartley served as an outside consultant to Air Hawaii until its initial flight
in November of 1985. Air Hawaii faced major fare wars from its competitors
prior to filing for bankruptcy in the spring of 1986.
Committees of the Board of Directors
In January 1999, the Board established an Audit Committee and a Compensation
Committee. The Audit Committee monitors the corporate financial reporting and
the internal and external audits of Cheap Tickets. The Audit Committee
currently consists of Directors Phillips and Smith. The Compensation Committee
makes recommendations regarding Cheap Tickets' employee stock plans and makes
decisions concerning salaries and incentive compensation for employees and
consultants of Cheap Tickets. The Compensation Committee currently consists of
Directors Phillips and Smith. It is anticipated that Giles Bateman and George
Mrkonic will become members of both committees upon the closing of this
offering.
Director Compensation
Nonemployee directors receive $2,500 for each Board meeting and $1,000 for
each committee meeting attended in person as compensation for their services as
directors. Further, directors are reimbursed for certain reasonable expenses
incurred in attending Board or committee meetings. Each non-employee director
will receive upon joining the Company an option to acquire 1,500 shares of
common stock at an exercise price equal to the then fair market value. These
options shall vest in equal increments over three years. Each non-employee
director will also receive automatic annual grants of options to acquire
$25,000 worth of common stock based on an exercise price equal to the fair
market value of the common stock at the date of grant. Such options will vest
in equal increments over three years. For more information on Cheap Tickets'
1999 Stock Incentive Plan please refer to "Employee Stock Plans--1999 Stock
Incentive Plan" on page 54.
Compensation Committee Interlocks and Insider Participation
No interlocking relationship exists between Cheap Tickets' Board of
Directors or Compensation Committee and any member of any other company's board
of directors or compensation committee, nor has any such interlocking
relationship existed in the past.
Limitation of Liability and Indemnification Matters
Limitation of liability under Certificate of Incorporation. Pursuant to the
provisions of the Delaware General Corporation Law, Cheap Tickets' Certificate
of Incorporation provides that
50
<PAGE>
directors and officers of Cheap Tickets shall not be personally liable for
monetary damages to Cheap Tickets or its stockholders for a breach of fiduciary
duty as a director or officer, except for liability for:
. a breach of the duty of loyalty to Cheap Tickets or its stockholders;
. acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
. an act related to the unlawful stock repurchase or payment of a
dividend under Section 174 of Delaware General Corporation Law; and
. transactions from which the director or officer derived an improper
personal benefit.
The limitation of liability provided in the Certificate of Incorporation does
not affect the availability of equitable remedies such as injunctive relief or
rescission.
Indemnification Agreements. Cheap Tickets' Certificate of Incorporation, as
amended, also authorizes Cheap Tickets to indemnify its officers, directors and
other agents, by bylaws, agreements or otherwise, to the fullest extent
permitted under Delaware law. Cheap Tickets has entered into separate
indemnification agreements with its directors and officers which may, in some
cases, be broader than the specific indemnification provisions contained in the
Delaware General Corporation Law. The indemnification agreements may require
Cheap Tickets, among other things, to indemnify such officers and directors
against certain liabilities that may arise by reason of their status or service
as directors or officers (other than liabilities arising from willful
misconduct of a culpable nature), to advance their expenses incurred as a
result of any proceeding against them as to which they could be indemnified,
and to obtain directors' and officers' insurance if available on reasonable
terms.
Indemnification under Bylaws. Cheap Tickets' Bylaws, as amended, require
Cheap Tickets to indemnify its directors and officers and permit Cheap Tickets
to indemnify its other employees to the fullest extent permitted by law. Cheap
Tickets believes that indemnification under its Bylaws, as amended, covers at
least negligence and gross negligence on the part of the indemnified party.
Indemnification under the Securities Act. Insofar as indemnification for
liabilities arising under the Securities Act may be permitted to directors,
officers and controlling persons of Cheap Tickets pursuant to the foregoing
provisions, or otherwise, Cheap Tickets has been advised that in the opinion of
the Securities and Exchange Commission, such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable.
Pending indemnification proceedings. At present, there is no pending
litigation or proceeding involving a director, officer, employee or agent of
Cheap Tickets where indemnification will be required or permitted. Cheap
Tickets is not aware of any threatened litigation or proceeding which may
result in a claim for such indemnification.
51
<PAGE>
Executive Compensation--Summary Compensation Table
The following table sets forth all compensation paid by Cheap Tickets during
fiscal 1998, 1997 and 1996 to (a) Cheap Tickets' principal executive officer
during fiscal 1998, (b) up to four other most highly compensated executive
officers of Cheap Tickets during fiscal 1998, and (c) up to two additional
individuals who would have been among Cheap Tickets' four most highly
compensated executive officers, but for the fact that they were not serving as
executive officers of Cheap Tickets at the end of fiscal 1998.
<TABLE>
<CAPTION>
Long-Term
Compensation
---------------
Annual Compensation
---------------------- Securities
Name and Principal Underlying All Other
Position Year Salary(1) Bonus Options/SARs(#) Compensation($)
------------------ ---- --------- ------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Michael J. Hartley(2)... 1998 $243,783 $50,000 -- $ --
Chairman of the Board,
Chief Executive 1997 229,090 -- -- --
Officer and President 1996 154,170 15,750 -- --
Sandra T. Hartley(3).... 1998 235,500 12,500 -- --
Vice President,
Employee Relations 1997 233,050 -- -- --
1996 213,400 15,750 -- --
F. Michael
Bartholomew(4)......... 1998 165,000 41,250 -- --
Chief Operating
Officer 1997 6,875 -- -- --
1996 -- -- -- --
Dale K. Jorgenson(5).... 1998 78,366 21,875 -- --
Chief Financial
Officer and 1997 -- -- -- --
Vice President,
Finance 1996 -- -- -- --
Tammy A. Ishibashi...... 1998 100,008 25,000 -- --
Executive Vice
President, 1997 73,110 -- -- --
Ticket Distribution 1996 56,600 5,000 -- --
Paul Ouyang(6).......... 1998 201,923 -- -- --
1997 225,000 -- -- 59,854(7)
1996 28,125 -- -- 45,895(8)
</TABLE>
- --------
(1) Amounts shown are on a full-year basis and include cash and noncash
compensation.
(2) For fiscal year 1999, Mr. Hartley's annual salary will be approximately
$387,000.
(3) For fiscal year 1999, Mrs. Hartley's annual salary will be approximately
$75,000.
(4) Mr. Bartholomew's annual salary for 1997 would have been $165,000 if he had
been with Cheap Tickets for the entire year. He joined Cheap Tickets in
December 1997. For fiscal year 1999, Mr. Bartholomew's annual salary will
be approximately $190,000.
(5) Mr. Jorgenson's annual salary and bonus for 1998 would have been $150,000
and $45,000, respectively, if he had been with Cheap Tickets for the entire
year. He joined Cheap Tickets in May 1998. For fiscal year 1999, Mr.
Jorgenson's annual salary will be approximately $175,000.
(6) Mr. Ouyang was the Chief Financial Officer of Cheap Tickets until March 23,
1998, at which time he left Cheap Tickets.
(7) Includes reimbursement for legal fees and taxes.
(8) Includes compensation in the form of stock issuances.
52
<PAGE>
Option Grants During 1998
The following table sets forth certain information regarding stock options
granted in 1998 to the officers named in the table on page 52.
<TABLE>
<CAPTION>
Individual Grants
---------------------------------------------------
Potential Realizable
Value at Assumed
Annual Rates of Stock
Price Appreciation
for Option Term(4)
---------------------
Number of Percent of
Securities Total Options
Underlying Granted to
Options Employees in Exercise Price Expiration
Name Granted(1) Fiscal Year(2) Per Share Date(3) 5% 10%
- ---- ---------- -------------- -------------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
F. Michael Bartholomew.. 140,000 19.2% $0.18 11/21/07 $ 15,848 $ 40,162
Dale K. Jorgenson....... 140,000 19.2% $0.18 5/19/08 15,848 40,162
</TABLE>
- --------
(1) Options generally have a ten-year term and vest at a rate 20% per annum.
(2) Cheap Tickets granted options for a total of 728,000 shares of common stock
to employees of Cheap Tickets during 1998.
(3) Options may terminate before their expiration dates if optionee's status as
an employee or consultant is terminated or upon the optionee's death or
disability.
(4) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by rules of the Securities and Exchange Commission and do not
represent Cheap Tickets' estimate or projection of future prices of its
common stock prices. The actual value realized may be greater or less than
the potential realizable values set forth in the table.
Aggregate Option Exercises in 1998 and Year-End Option Values
The following table sets forth for each of the officers named in the table
on page 52 certain information concerning the number of shares subject to both
exercisable and unexercisable stock options as of December 31, 1998. Also
reported are values for "in-the-money" options that represent the positive
spread between the respective exercise prices of outstanding options and the
fair market value of Cheap Tickets' common stock as of December 31, 1998. None
of these officers exercised options during 1998.
<TABLE>
<CAPTION>
Number of
Securities Underlying Value of Unexercised
Unexercised Options at In-The-Money Options at
December 31, 1998 December 31, 1998(1)
------------------------- -------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Michael J. Hartley......... -- -- $ -- $ --
Sandra T. Hartley.......... -- -- -- --
F. Michael Bartholomew..... 28,000 112,000 280,560 1,122,240
Dale K. Jorgenson.......... -- 140,000 -- 1,402,800
Tammy A. Ishibashi......... -- -- -- --
Paul Ouyang................ -- -- -- --
</TABLE>
- --------
(1) Calculated by determining the difference between the fair market value of
the securities underlying the option at December 31, 1998 and the exercise
price of the named officer's option. The fair market value at December 31,
1998 was deemed to be 85% of $12.00, the mid-point of the proposed initial
public offering price range ($10.20).
Employee Stock Plans
1997 Stock Option Plan
Cheap Tickets' 1997 Stock Option Plan provides for the granting to employees
of incentive stock options within the meaning of Section 422 of the Internal
Revenue Code of 1986, as amended and for the granting of nonstatutory stock
options to employees, directors and consultants. The 1997
53
<PAGE>
plan was approved by the Board of Directors in February 1998 and by Cheap
Tickets' shareholders in April 1998. Unless terminated sooner, the 1997 plan
will terminate automatically in 2008. A total of 1,979,642 shares of common
stock were reserved for issuance pursuant to the 1997 plan. As of December 31,
1998, options to purchase 728,000 shares of common stock were outstanding under
the 1997 plan, and 1,251,642 shares of common stock remained available under
the 1997 plan. No further options will be granted under the 1997 plan after the
effective date of the offering.
The 1997 plan may be administered by the Board of Directors or a committee
of the Board, which serves as the plan administrator. The plan administrator
has the power to determine the terms of the options granted, including the
number of shares subject to each option, the exercisability thereof, and the
form of consideration payable upon such exercise.
Options granted under the 1997 plan are not generally transferable by the
optionee. Generally each option is exercisable during the lifetime of the
optionee only by him or her. Unless otherwise specified in the option
agreement, options granted under the 1997 plan must be exercised within three
months of the end of the optionee's status as an employee or consultant of
Cheap Tickets', or within twelve months after his or her termination by death
or disability, but in no event later than the expiration of the option's term.
The exercise price of all incentive stock options granted under the 1997
plan must be at least equal to the fair market value of the common stock on the
date of the grant. The exercise price of nonstatutory stock options must be at
least equal to 85% of the fair market value of the common stock on the date of
the grant. With respect to any optionee who owns stock possessing more than 10%
of the voting power of all classes of Cheap Tickets' outstanding capital stock,
the exercise price of any option must equal at least 110% of the fair market
value of the common stock on the date of the grant and the term of any option
may not exceed five years. The term of other options under the 1997 plan may
not exceed ten years. The consideration to be paid for the shares of common
stock upon exercise of an option will be determined by the plan administrator
and may include, cash, check, promissory note, shares of common stock, or the
assignment of part of the proceeds from the sale of shares acquired upon
exercise of the option.
The 1997 plan provides that in the event of a merger or a sale of all or
substantially all of Cheap Tickets' assets the plan administrator has the
authority to provide for the full automatic vesting and exercisability of each
option, including shares as to which the option would not otherwise be
exercisable. If an option becomes exercisable in full in the event of a merger
or sale of assets, the plan administrator will notify the optionee that the
option is fully exercisable for a specified period from the date of the notice,
and the option will terminate upon the expiration of that period. To the extent
the option has not been previously exercised, each option will terminate
immediately prior to the consummation of the merger or sale of assets.
During 1998, Cheap Tickets granted to F. Michael Bartholomew an option to
acquire 140,000 shares of common stock at an exercise price of $0.18 per share.
Upon the completion of this offering, the option will be fully vested and
exercisable. For more information on our capitalization before and after the
offering, please refer to "Capitalization" on page 22. For more information on
the dilution of Cheap Tickets common stock, please refer to "Dilution" on page
23.
1999 Stock Incentive Plan
Cheap Tickets' 1999 Stock Incentive Plan, which was adopted by the Board of
Directors in February 1999, is expected to be approved by Cheap Tickets'
stockholders prior to the offering. From and after the offering, all further
option grants will be made solely under the 1999 plan.
54
<PAGE>
Initially, 1,260,000 shares of common stock, plus an annual increase to be
added on the first day of Cheap Tickets' fiscal year beginning in 2000 equal to
two percent of the number of shares outstanding as of such date or a lesser
number of shares determined by the plan administrator of the 1999 plan are
reserved for issuance under the 1999 plan. However the maximum number of shares
available for grant of incentive stock options under the 1999 plan initially is
1,260,000 shares of common stock, plus an annual increase to be added on the
first day of Cheap Tickets' fiscal year beginning in 2000 equal to the lesser
of (a) 700,000 shares of common stock, (b) two percent of the number of shares
outstanding as of such date; or (c) a lesser number of shares determined by the
plan administrator of the 1999 plan.
With respect to 1999 awards granted to directors or officers, the 1999 plan
is administered by the Board of Directors or a committee designated by the
Board of Directors constituted to permit 1999 awards to be exempt from Section
16(b) of the Exchange Act in accordance with Rule 16b-3 thereunder. With
respect to 1999 awards granted to other participants, the 1999 plan is
administered by the Board of Directors or a committee designated by the Board
of Directors. In each case, the respective plan administrator shall determine
the provisions, terms and conditions of each 1999 awards, including, but not
limited to, the 1999 award vesting schedule, repurchase provisions, rights of
first refusal, forfeiture provisions, form of payment (cash, shares of common
stock, or other consideration) upon settlement of the 1999 award, payment
contingencies and satisfaction of any performance criteria.
The exercise price of options under the 1999 plan must be at least equal to
the fair market value of the common stock on the date of grant, and the term of
the option must not exceed ten years. The term of other 1999 awards will be
determined by the respective plan administrator. With respect to an employee
who owns stock possessing more than 10% of the voting power of all classes of
Cheap Tickets' outstanding capital stock, the exercise price of any incentive
stock option must equal at least 110% of the fair market value of the common
stock on the grant date and the term of the option must not exceed five years.
The exercise price or purchase price, if any, of other 1999 awards will be
determined based on current market prices for Cheap Tickets' common stock by
the respective plan administrator. The consideration to be paid for the shares
of common stock upon exercise or purchase of a 1999 award will be determined by
the plan administrator and may include cash, check, promissory note, shares of
common stock, or the assignment of part of the proceeds from the sale of shares
acquired upon exercise or purchase of the 1999 award.
Pursuant to the 1999 plan, the Board of Directors has adopted the 1999 Non-
Employee Director Option Program. Under this program, each non-employee
director serving on Cheap Tickets' Board of Directors upon the offering and
each non-employee director appointed to the Board following the offering will
receive an option to acquire 1,500 shares of common stock at an exercise price
per share equal to the then fair market value of the common stock at the date
of grant. In addition, following each annual stockholders' meeting commencing
with the annual meeting in 2000, each non-employee director who continues as a
director following the meeting and who has served as a director for at least
eight months will receive an option to acquire the number of shares equal to
$25,000 divided by the fair market value per share on the date of such annual
meeting rounded down to the next whole share in the case of any fractional
share. These options will vest and become exercisable in three equal
installments on each yearly anniversary of the grant date. In the event of a
merger, sale of all or substantially all of Cheap Tickets' assets, the
liquidation or dissolution of Cheap Tickets, the acquisition by any person or
related groups of persons of securities possessing more than 50% of the voting
power of Cheap Tickets' outstanding securities with certain exceptions, and
certain changes in the composition of the Board of the Directors over a period
of 36 months,
55
<PAGE>
such options will vest and become fully exercisable. The plan administrator may
provide for the full automatic vesting and exercisability of unvested options
in anticipation of such a transaction.
Each automatic option grant will have a term of ten years and will be
transferable to the extent provided in the agreement evidencing the option.
401(k) Plan
Cheap Tickets has a 401(k) plan pursuant to which eligible employees may
elect to reduce their current salary by up to the statutorily prescribed annual
limit and have the amount of such reduction contributed to the 401(k) plan.
Contributions to the 401(k) plan by Cheap Tickets are discretionary. The 401(k)
plan is intended to qualify under Section 401 of the Internal Revenue Code so
that contributions by participants to the 401(k) plan, and income earned on
plan contributions, are not taxed to participants until withdrawn from the
401(k) plan.
Employment Agreements
Cheap Tickets does not have any employment agreements with any of its key
personnel. Cheap Tickets has severance agreements with Michael J. Hartley and
Sandra T. Hartley. Each of the severance agreements requires Cheap Tickets to
pay the respective individual an amount equal to the lesser of (a) twice his or
her respective annual salary or (b) $400,000 in the event that their employment
is terminated either by Cheap Tickets without cause or by them for good reason.
CERTAIN TRANSACTIONS
During the last fiscal year, Cheap Tickets did not enter into any
transaction required to be disclosed pursuant to Item 404 of Regulation S-K.
56
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information with respect to
beneficial ownership of Cheap Tickets' common stock as of February 22, 1999,
and is adjusted to reflect the sale of the shares offered hereby by (a) each
person (or group of affiliated persons) who is known by Cheap Tickets to own
beneficially more than 5% of Cheap Tickets' common stock, (b) each of Cheap
Tickets' directors, (c) each of the Named Executive Officers, and (d) all
directors and executive officers as a group.
<TABLE>
<CAPTION>
Percentage
Beneficially
Number of Owned(1)(2)
Shares -----------------
Beneficially Before After
Name of Beneficial Owner Owned(1) Offering Offering
- ------------------------ ------------ -------- --------
<S> <C> <C> <C>
Michael J. Hartley (3)......................... 13,395,032 92.6% 64.0%
Sandra T. Hartley (4).......................... 13,395,032 92.6 64.0
Donald J. Phillips (5)......................... 2,960,552 17.0 14.1
Cece Smith (6)................................. 2,960,552 17.0 14.1
Tammy A. Ishibashi (7)......................... 704,998 4.9 3.4
Paul Ouyang (8)................................ 373,646 2.6 1.8
F. Michael Bartholomew (9)..................... 140,000 * *
Dale K. Jorgenson.............................. -- * *
All directors and executive officers as a group
(12 persons).................................. 17,200,582 97.9 81.6
</TABLE>
- --------
* Less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage ownership of that person,
shares of common stock subject to options or warrants held by that person
that are currently exercisable within 60 days of February 23, 1999 are
deemed outstanding. Such shares, however, are not deemed outstanding for
the purpose of computing the percentage ownership of each other person.
Except as indicated in the footnote to this table and pursuant to
applicable community property laws, each stockholder named in the table has
sole voting power and investment power with respect to the shares set forth
opposite such stockholder's name.
(2) Based on 14,473,676 shares of common stock outstanding prior to the
offering and 20,943,132 outstanding upon the completion of the offering
(assumes no exercise of Underwriters' over-allotment option) and the
exercise of warrants to purchase 2,969,456 shares of common stock.
(3) Includes 1,903,510 shares of common stock held by the Michael J. Hartley
Living Trust, 4,794,006 shares of common stock held by the Hartley
Investments Limited Partnership (held for the benefit of Michael J.
Hartley) and 6,697,516 shares of common stock held by Sandra T. Hartley.
Mr. Hartley is the husband of Sandra T. Hartley, Cheap Tickets' Vice
President, Employee Relations who owns 6,697,516 shares of common stock.
Mr. Hartley's address is 1440 Kapiolani Boulevard, Honolulu, Hawaii 96814.
See note (4).
(4) Includes 1,903,510 shares of common stock held by the Sandra T. Hartley
Living Trust, 4,794,006 shares of common stock held by the Hartley
Investments Limited Partnership (held for the benefit of Sandra T. Hartley)
and 6,697,516 shares of common stock held by Michael J. Hartley. Ms.
Hartley is the wife of Michael J. Hartley, Cheap Tickets' Chairman of the
Board, Chief Executive Officer and President who owns 6,697,516 shares of
common stock. Ms. Hartley's address is 1440 Kapiolani Boulevard, Honolulu,
Hawaii 96814. See note (3).
57
<PAGE>
(5) Represents warrants held by Phillips-Smith Specialty Retail Group III, L.P.
to purchase 2,960,552 shares of common stock exercisable at or within 60
days of February 22, 1999. Mr. Phillips is a co-founder and general partner
of Phillips-Smith Specialty Retail Group III, L.P. Mr. Phillips' address is
c/o Phillips-Smith Specialty Retail Group, 5080 Spectrum Drive, Suite 805,
West Addison, Texas 75001. Phillips-Smith Specialty Retail Group III, L.P.
is the holder of the majority of the 425,000 shares of mandatorily
redeemable preferred stock. See note (6).
(6) Represents warrants held by Phillips-Smith Specialty Retail Group III, L.P.
to purchase 2,960,552 shares of common stock exercisable at or within 60
days of February 22, 1999. Ms. Smith is a co-founder and general partner of
Phillips-Smith Specialty Retail Group III, L.P. Ms. Smith's address is c/o
Phillips-Smith Specialty Retail Group, 5080 Spectrum Drive, Suite 805,
West Addison, Texas 75001. Phillips-Smith Specialty Retail Group III, L.P.
is the holder of the majority of the 425,000 shares of mandatorily
redeemable preferred stock. See note (5).
(7) Ms. Ishibashi is the niece of Michael J. Hartley, Cheap Tickets' Chairman
of the Board, Chief Executive Officer and President, and Sandra T. Hartley,
Cheap Tickets' Vice President, Employee Relations. See notes (3) and (4).
(8) Represents 373,646 shares held in the name of Paul Ouyang and Deborah
Ouyang, Trustees of the Ouyang 1990 Trust.
(9) Represents stock options held by Mr. Bartholomew to purchase 140,000 shares
of common stock exercisable upon the closing of this offering, of which
28,000 are currently exercisable.
58
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of Cheap Tickets consists of 70,000,000 shares
of common stock, par value $0.001 per share and 10,000,000 shares of preferred
stock par value $0.01 per share, of which all issued and outstanding preferred
stock prior to the initial public offering shall be redeemed upon the closing
of this offering.
The following description of Cheap Tickets' capital stock does not purport
to be complete and is subject to and qualified in its entirety by Cheap
Tickets' Certificate of Incorporation and Bylaws and by the provisions of
applicable Delaware law.
The Certificate of Incorporation and Bylaws contain certain provisions that
are intended to enhance the likelihood of continuity and stability in the
composition of the Board of Directors and which may have the effect of
delaying, deferring or preventing a future takeover or change in control of
Cheap Tickets unless such takeover or change in control is approved by the
Board of Directors.
Common Stock
As of December 31, 1998, there were 14,473,676 shares of common stock
outstanding and those shares were held of record by four stockholders. Holders
of common stock are entitled to one vote per share on all matters to be voted
upon by the stockholders. Subject to preferences that may be applicable to any
outstanding preferred stock, the holders of common stock are entitled to
receive ratably such dividends, if any, as may be declared from time to time by
the Board of Directors out of funds legally available therefor. In the event of
a liquidation, dissolution or winding up of Cheap Tickets, the holders of
common stock are entitled to share ratably in all assets remaining after
payment of liabilities, subject to prior liquidation rights of preferred stock,
if any, then outstanding. The holders of common stock have the preemptive right
to purchase their pro rata portion of any additional shares of common stock
whether then or thereafter authorized. The common stock has no conversion
rights or other subscription rights. There are no redemption or sinking fund
provisions applicable to the common stock. All outstanding shares of common
stock are, and the shares of common stock to be outstanding after the offering
will be fully paid and non-assessable.
Preferred Stock
Upon the closing of this offering, 10,000,000 shares of preferred stock will
be authorized without any shares being issued and outstanding. The Board of
Directors has the authority, without further action by the stockholders, to
issue the shares of preferred stock in one or more series and to fix the
rights, preferences, privileges and restrictions thereof, including dividend
rights, conversion rights, voting rights, terms of redemption, liquidation
preferences, sinking and purchase fund provisions, and the number of shares
constituting any series and the designations of such series. The issuance of
preferred stock could adversely affect the voting power of holders of common
stock and the likelihood that such holders will receive dividend payments and
payments upon liquidation and could have the effect of delaying, deferring or
preventing a change in control of Cheap Tickets. Cheap Tickets has no present
plan to issue any additional shares of preferred stock.
Mandatorily Redeemable Preferred Stock
As of December 31, 1998, there were 425,000 shares outstanding of
mandatorily redeemable preferred stock. All of these shares will be redeemed
upon the completion of this offering.
59
<PAGE>
Options
As of December 31, 1998, (a) options to purchase a total of 728,000 shares
of common stock were outstanding; and (b) up to 1,251,642 additional shares of
common stock may be subject to options granted in the future under the 1997
Stock Option Plan. No further options will be granted under the 1997 Stock
Option Plan after the offering. Options granted after the offering will be
granted under the 1999 Stock Incentive Plan.
Warrants
As of December 31, 1998, Cheap Tickets had warrants outstanding to purchase
an aggregate of 2,969,456 shares of common stock at an aggregate exercise price
of $2,121. The warrants are subject to adjustment for stock splits, stock
dividends and the like and expire on July 15, 2002. Cheap Tickets anticipates
that the warrants will be exercised immediately prior to the closing of the
offering.
Registration Rights
As of the effective date of the registration statement, holders of 2,969,456
shares of common stock will be entitled to registration rights with respect to
their shares. Holders of such shares can require Cheap Tickets to register the
shares at any time following 180 days after the offering, subject to certain
conditions.
Delaware Anti-Takeover Law and Certain Charter Provision
Delaware Anti-Takeover Law
Cheap Tickets is subject to Section 203 of the Delaware General Corporation
Law. This is an anti-takeover law that restricts certain transactions and
business combinations between a corporation and an interested stockholder
owning 15% or more of the corporation's outstanding voting stock, for a period
of three years from the date the stockholder becomes an interested stockholder.
Subject to certain exceptions, unless the transaction is approved by the board
of directors and the holders of at least two-thirds of the outstanding voting
stock of the corporation, excluding shares held by the interested stockholder,
this law prohibits significant business transactions such as a merger with,
disposition of assets to, or receipt of disproportionate financial benefits by
the interested stockholder, or any other transaction that would increase the
interested stockholder's proportionate ownership of any class or series of the
corporation's stock. The statutory ban does not apply if, upon consummation of
the transaction in which any person becomes an interested stockholder, the
interested stockholder owns at least 85% of the outstanding voting stock of the
corporation. This calculation does not include shares held by persons who are
both directors and officers or by certain employee stock plans.
Action by Written Consent
Upon completion of this offering, Cheap Tickets' Certificate of
Incorporation will provide that the holders of two-thirds of the outstanding
voting capital stock can take action by written consent or at a duly called
annual or special meeting of stockholders. This provision may have the effect
of deterring hostile takeovers or delaying changes in control or management of
Cheap Tickets.
Transfer Agent and Registrar
The transfer agent and registrar for the common stock is American Securities
Transfer and Trust, Inc., a Colorado corporation.
60
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, Cheap Tickets will have approximately
20,943,132 shares of common stock outstanding assuming (a) no exercise of the
underwriters' over-allotment option, (b) no exercise of outstanding options,
and (c) the exercise of warrants to purchase an aggregate of 2,969,456 shares
of common stock. Effective upon the consummation of this offering, assuming no
exercise of outstanding options, Cheap Tickets will have outstanding options to
purchase approximately 728,000 shares of common stock.
Of the common stock outstanding upon completion of this offering, the
3,500,000 shares of common stock sold in this offering will be freely tradable
without restriction or further registration under the Securities Act, except
for any shares purchased by "affiliates" of Cheap Tickets, as that term is
defined under the Securities Act and the regulations promulgated thereunder.
The remaining 17,443,132 shares of common stock held by officers, directors,
employees, consultants and other stockholders of Cheap Tickets were sold by
Cheap Tickets in reliance on exemptions from the registration requirements of
the Securities Act and are "restricted securities" within the meaning of Rule
144 under the Securities Act. Any shares of common stock issued upon the
exercise of options or warrants held by any of such persons will constitute
restricted securities. None of the outstanding shares of common stock that are
restricted securities will be eligible for sale in the public market as of the
date of this prospectus in reliance on Rule 144(k) under the Securities Act.
All 17,443,132 shares of common stock held by existing stockholders are subject
to lock-up agreements with the representatives. None of the shares subject to
such lock-up agreements may be sold or transferred during the applicable lock-
up period without the consent of the underwriters except for transfers pursuant
to gifts or certain partnership distributions and similar transfers in which
the transferee enters into a substantially similar lock-up agreement. Upon the
expiration of the lock-up agreements, all of such locked-up shares will become
eligible for sale 180 days, respectively, after the date of this prospectus
subject to the provisions of Rules 144(k), 144 or 701. The representatives may,
in their sole discretion and at any time without notice, release all or any
portion of the securities subject to these lock-up agreements.
In general, under Rule 144 as currently in effect, a person, including an
affiliate, who has beneficially owned restricted securities for a period of at
least one year from the later of the date such restricted securities were
acquired from Cheap Tickets or the date they were acquired from an affiliate,
is entitled to sell, within any three-month period commencing 90 days after the
date of this prospectus, a number of shares that does not exceed the greater of
1% of the then outstanding shares of common stock or the average weekly trading
volume in the common stock during the four calendar weeks preceding such sale.
Sales under Rule 144 are also subject to certain provisions relating to the
number and notice of sale, manner of sale and the availability of current
public information about Cheap Tickets.
Further, under Rule 144(k), if a period of at least two years has elapsed
between the later of the date restricted securities were acquired from Cheap
Tickets and the date they were acquired from an affiliate of Cheap Tickets, a
holder of such restricted securities who is not an affiliate at the time of the
sale and has not been an affiliate for at least three months prior to the sale
would be entitled to sell the shares immediately after the date of this
prospectus without regard to the volume and manner of sale limitations
described above. Any employee, director or consultant to Cheap Tickets who
purchased his or her shares pursuant to a written compensation plan or contract
is entitled to rely on the resale provisions of Rule 701. This permits non-
affiliates to sell their Rule 701 shares beginning 90 days after the date of
this prospectus without having to comply with the volume limitations and
61
<PAGE>
holding period restrictions of Rule 144. As of December 31, 1998, there were
outstanding options to purchase approximately 728,000 shares which under
certain circumstances would be available for sale pursuant to Rule 701, of
which all of the shares underlying such options are subject to lock-up
agreements.
Prior to this offering, there has been no public market for the common stock
of Cheap Tickets, and any sale of substantial amounts of common stock in the
open market, or the availability of shares for sale, may adversely affect the
market price of the common stock and the ability of Cheap Tickets to raise
funds through equity offerings in the future.
As of the effective date of the registration statement, holders of 2,969,456
shares of common stock will be entitled to registration rights with respect to
their shares. Holders of such shares can require Cheap Tickets to register the
shares at any time following 180 days after the date of this prospectus,
subject to certain conditions.
62
<PAGE>
UNDERWRITING
The several underwriters named below, for which William Blair & Company,
L.L.C. and Dain Rauscher Wessels, a Division of Dain Rauscher Incorporated, are
acting as representatives, have severally agreed, subject to the terms and
conditions set forth in the underwriting agreement by and among Cheap Tickets
and the underwriters, to purchase from Cheap Tickets, and Cheap Tickets has
agreed to sell to each of the underwriters, the respective number of shares of
common stock set forth opposite each underwriters' name in the table below.
<TABLE>
<CAPTION>
Number of
Underwriter Shares
----------- ---------
<S> <C>
William Blair & Company, L.L.C. ...................................
Dain Rauscher Wessels..............................................
---------
Total............................................................
=========
</TABLE>
In the underwriting agreement, the underwriters have agreed, subject to the
terms and conditions set forth therein, to purchase all of the common stock
being sold pursuant to the Underwriting Agreement if any of the common stock
being sold pursuant to the underwriting agreement is purchased. There is,
however, no obligation to purchase the shares covered by the over-allotment
option granted in the underwriting agreement. In the event of default by any
underwriter, the underwriting agreement provides that, in certain
circumstances, the purchase commitments of the non-defaulting underwriters
shall be increased or the underwriting agreement may be terminated.
The representatives of the underwriters have advised Cheap Tickets that the
underwriters propose to offer the common stock to the public initially at the
public offering price set forth on the cover page of this prospectus and to
selected dealers at such price less a concession of not more than $ per
share. The underwriters may allow, and such dealers may re-allow, a concession
not in excess of $ per share to certain other dealers. After commencement of
the initial public offering, the public offering price and other selling terms
may be changed by the representatives.
Cheap Tickets has granted to the underwriters an option, exercisable within
30 days after the date of this prospectus, to purchase up to an aggregate of
525,000 additional shares of common stock at the same price per share to be
paid by the underwriters for the other shares offered hereby for the purpose of
covering the sale of shares in excess of the shares initially allocated in the
offering. If the underwriters purchase any such additional shares pursuant to
this option, each of the underwriters will be committed to purchase such
additional shares in approximately the same proportion as set forth in the
table above. The underwriters may exercise the option only for the purpose of
covering excess sales, if any, made in connection with the distribution of the
shares of common stock offered hereby.
Stockholders of Cheap Tickets, who hold in the aggregate 17,443,132 shares
of common stock, and Cheap Tickets have agreed that for a period of 180 days
after the date of this prospectus, without the prior written consent of the
representatives, they will not, directly or indirectly, offer, sell, assign,
transfer, encumber, pledge, contract to sell, grant an option to purchase, or
otherwise dispose of, other than by operation of law, any shares of common
stock or securities convertible or exchangeable into, or exercisable for,
common stock. This agreement does not extend to bona fide gifts to immediate
family members of such persons who agree to be bound by such restrictions, or
to limited partners or shareholders, who agree to be bound by such
restrictions. In considering a request for its consent to a sale or transfer
within the 180-day period, the representatives will take into account
63
<PAGE>
various factors, including, but not limited to, the number of shares requested
to be sold, the anticipated manner and timing of sale, the potential impact of
the sale on the market for the common stock, and market conditions generally.
Cheap Tickets may grant options and issue common stock under existing stock
option or stock purchase plans and issue unregistered shares in connection with
any outstanding convertible securities or options during the lock-up period.
For information on shares available for sale following the offering, please
refer to "Risk Factors--Substantial sales of our common stock could adversely
affect our stock price" on pages 19 and 20.
Cheap Tickets has agreed to indemnify the underwriters and their controlling
persons against certain liabilities, including liabilities under the Securities
Act, or to contribute to payments the underwriters may be required to make in
respect thereof.
The representatives have informed Cheap Tickets that the underwriters will
not confirm, without client authorization, sales to their client accounts as to
which they have discretionary authority.
Prior to this offering, there was no public market for the common stock of
Cheap Tickets. Consequently, the initial public offering price for the common
stock will be determined by negotiations among Cheap Tickets and the
representatives. Among the factors which will be considered in such
negotiations are the prevailing market conditions, the results of operations of
Cheap Tickets in recent periods, the market capitalizations and stages of
development, and recent market prices of securities, of other companies which
Cheap Tickets and the representatives believe to be comparable to Cheap
Tickets, estimates of the business potential of Cheap Tickets, the present
state of Cheap Tickets' development, the general condition of the securities
markets at the time of this offering, and other factors which are deemed
relevant. There can be no assurance that an active trading market will develop
for the common stock or that the common stock will trade in the public market
subsequent to this offering at or above the initial public offering price.
During and after this offering, the underwriters may purchase and sell the
common stock in the open market in order to facilitate this offering.
Specifically, the underwriters may over-allot or otherwise sell more shares of
common stock than have been sold to them by Cheap Tickets pursuant to the
underwriting agreement. The underwriters may elect to cover any such excess
sales position by purchasing shares of common stock in the open market or by
exercising the over-allotment option granted to them by Cheap Tickets. The
underwriters also may impose a penalty bid, whereby selling concessions allowed
to syndicate members or other broker-dealers in respect of shares of common
stock sold in this offering for their account may be reclaimed by the syndicate
if such shares are repurchased by the syndicate in stabilizing or covering
transactions.
The activities described above may stabilize, maintain, or otherwise affect
the market price of the common stock and make such price higher than it might
otherwise be in the open market. The imposition of a penalty bid may also
affect the price of the common stock to the extent that it discourages resales
thereof. These activities, if commenced, may be discontinued at any time
without notice and may be effected on the Nasdaq Stock Market or otherwise.
Neither Cheap Tickets nor any of the underwriters makes any representation or
prediction as to whether the underwriters will engage in such transactions or
choose to discontinue any transactions engaged in or the direction or magnitude
of any effect that such transactions may have on the price of the common stock.
64
<PAGE>
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon by
Morrison & Foerster LLP, Los Angeles, California. Certain matters in connection
with this offering will be passed upon for the underwriters by Sonnenschein
Nath & Rosenthal, Chicago, Illinois. Certain other legal matters will be passed
upon by Ching & Lee, Honolulu, Hawaii.
EXPERTS
The financial statements as of December 31, 1998 and 1997 and for each of
the three years in the period ended December 31, 1998 included in this
prospectus have been so included in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in accounting and auditing.
In August 1998, Cheap Tickets selected PricewaterhouseCoopers LLP as its
principal independent auditors to replace KPMG LLP. The decision to retain
PricewaterhouseCoopers LLP was recommended by the Board of Directors. In
connection with the audit for the years ended December 31, 1996 and 1997, and
the period through August 1998, there were no disagreements with KPMG LLP on
any matter of accounting principles or practices, financial statement
disclosure or auditing scope or procedure, which, if not resolved to the
satisfaction of KPMG LLP, would have caused them to make reference to the
matter in their report. The report of KPMG LLP on the financial statements of
Cheap Tickets for the years ended December 31, 1996 and 1997 did not contain
any adverse opinion or disclaimer of opinion and was not qualified or modified
as to uncertainty, audit scope or accounting principles.
ADDITIONAL INFORMATION
Cheap Tickets has filed with the Securities and Exchange Commission a
registration statement on Form S-1 under the Securities Act with respect to the
shares of common stock offered hereby. This prospectus does not contain all of
the information set forth in the registration statement, certain parts of which
are omitted in accordance with the rules and regulations of the Commission. For
further information with respect to Cheap Tickets and the shares of common
stock offered hereby, reference is made to the registration statement.
Statements contained in this prospectus as to the contents of any contract or
other document are not necessarily complete, and in each instance reference is
made to the copy of such contract or other document filed as an exhibit to the
registration statement, each such statement being qualified in all respects by
such reference. Copies of such materials may be examined without charge at, or
obtained upon payment of prescribed fees from, the Public Reference Section of
the Commission at Room 1024 Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549 (telephone 202-942-8090), and at the Commission's
regional offices located at 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661 and at 7 World Trade Center, 13th Floor, New York New York
10048. The Commission maintains a World Wide Website that contains reports,
proxy and information statements and other information regarding registrants
that file electronically with the Commission. The address of the site is
http://www.sec.gov. Reports, proxy statements and other information concerning
Cheap Tickets may also be inspected at the National Association of Securities
Dealers, Inc. at 1735 K Street, N.W., Washington D.C. 20006.
65
<PAGE>
CHEAP TICKETS, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants.......................................... F-2
Balance Sheets............................................................. F-3
Statements of Operations................................................... F-4
Statements of Stockholders' Equity......................................... F-5
Statements of Cash Flows................................................... F-6
Notes to the Financial Statements.......................................... F-8
</TABLE>
F-1
<PAGE>
Report of Independent Accountants
The Stockholders and Board of Directors
Cheap Tickets, Inc.
In our opinion, the accompanying balance sheets and the related statements
of operations, changes in stockholders' equity and cash flows present fairly,
in all material respects, the financial position of Cheap Tickets, Inc. at
December 31, 1997 and 1998, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of Cheap Tickets' management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for the
opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Honolulu, Hawaii
February 15, 1999
F-2
<PAGE>
CHEAP TICKETS, INC.
BALANCE SHEETS
December 31, 1997 and 1998
<TABLE>
<CAPTION>
1997 1998
----------- -----------
<S> <C> <C>
Assets (Note 4)
Current Assets:
Cash and cash equivalents.......................... $ 6,254,406 $ 2,973,988
Marketable securities.............................. -- 4,935,229
Trade accounts and other receivables............... 663,969 924,348
Refundable income taxes............................ 663,209 --
Ticket inventories................................. 119,771 286,331
Other current assets............................... 259,719 725,692
----------- -----------
Total current assets............................. 7,961,074 9,845,588
Property and equipment, net (Note 3)................. 2,520,046 2,999,418
Property held for sale............................... 550,000 --
Other assets......................................... 172,470 380,846
----------- -----------
$11,203,590 $13,225,852
=========== ===========
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable................................... $ 4,385,778 $ 4,681,055
Accrued salaries................................... 337,455 399,167
Accrued vacation................................... 79,168 421,288
Accrued expenses and other liabilities............. 140,905 222,321
Current installments of long-term debt (Note 4).... 528,825 221,469
Current installments of capital lease obligations
(Note 9).......................................... 132,722 287,809
Income taxes payable............................... -- 139,640
----------- -----------
Total current liabilities........................ 5,604,853 6,372,749
Long-term debt, excluding current installments (Note
4).................................................. 598,139 585,556
Capital lease obligations, excluding current
installments (Note 9)............................... 349,542 652,359
Other noncurrent liabilities......................... 217,598 93,961
----------- -----------
Total liabilities................................ 6,770,132 7,704,625
----------- -----------
Commitments (Notes 8, 9 and 12)
Mandatorily redeemable cumulative preferred stock, $1
par value (aggregate involuntary liquidation
preference of $4,250,000, plus unpaid cumulative
dividends). Issued and outstanding 425,000 shares at
December 31, 1997 and 1998 (Note 5)................. 3,621,896 4,136,028
----------- -----------
Stockholders' Equity (Notes 5, 6, 11 and 12):
Preferred stock, $1 par value. Authorized 5,000,000
shares; none issued at December 31, 1997 and 1998
(except for 425,000 shares of mandatorily
redeemable cumulative preferred stock shown
above)............................................ -- --
Common stock, $0.01 par value. Authorized
70,000,000 shares; issued and outstanding
14,847,322 shares at December 31, 1997 and
14,473,676 shares at December 31, 1998............ 10,605 10,338
Additional paid-in capital......................... 547,017 1,246,937
Unearned compensation.............................. (19,127) (696,275)
Retained earnings.................................. 273,067 824,199
----------- -----------
Total stockholders' equity....................... 811,562 1,385,199
----------- -----------
$11,203,590 $13,225,852
=========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-3
<PAGE>
CHEAP TICKETS, INC.
STATEMENTS OF OPERATIONS
Years Ended December 31, 1996, 1997 and 1998
<TABLE>
<CAPTION>
1996 1997 1998
----------- ----------- ------------
<S> <C> <C> <C>
Non-published fares................... $58,981,893 $96,379,304 $159,845,855
Published fare commissions and
bonuses.............................. 5,613,761 6,470,082 11,268,472
----------- ----------- ------------
Net revenues........................ 64,595,654 102,849,386 171,114,327
Cost of sales......................... 49,167,998 81,370,511 136,067,182
----------- ----------- ------------
Gross profit.......................... 15,427,656 21,478,875 35,047,145
Selling, general and administrative
expenses
(Notes 10, 11 and 12)................ 14,351,321 23,091,193 33,411,112
----------- ----------- ------------
Net operating income (loss)........... 1,076,335 (1,612,318) 1,636,033
Other income (deductions):
Gain (loss) on sale or disposal of
property and equipment............. 3,680 (2,164) (48,786)
Interest income..................... 81,987 183,723 374,269
Interest expense.................... (91,488) (185,428) (148,253)
Other, net.......................... 42,185 994 (7,731)
----------- ----------- ------------
36,364 (2,875) 169,499
----------- ----------- ------------
Earnings (loss) before income taxes... 1,112,699 (1,615,193) 1,805,532
Income taxes (Note 7)................. 438,997 (606,633) 740,268
----------- ----------- ------------
Net earnings (loss)................... 673,702 (1,008,560) 1,065,264
Preferred dividends................... -- (170,000) (340,000)
Accretion of mandatorily redeemable
cumulative preferred stock discount.. -- (87,066) (174,132)
----------- ----------- ------------
Income (loss) available to common
shares............................... $ 673,702 $(1,265,626) $ 551,132
=========== =========== ============
Basic earnings (loss) per common
share................................ $ 0.05 $ (0.09) $ 0.04
=========== =========== ============
Average common shares outstanding..... 14,249,480 14,847,322 14,567,084
=========== =========== ============
Diluted earnings (loss) per common
share................................ $ 0.05 $ (0.09) $ 0.03
=========== =========== ============
Average diluted common shares
outstanding.......................... 14,249,480 14,847,322 17,920,868
=========== =========== ============
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-4
<PAGE>
CHEAP TICKETS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1996, 1997 and 1998
<TABLE>
<CAPTION>
Additional Total
Common Paid-In Unearned Retained Stockholders'
Stock Capital Compensation Earnings Equity
------- ---------- ------------ ---------- -------------
<S> <C> <C> <C> <C> <C>
Balance at December 31,
1995................... $ 1,000 $ -- $ -- $ 865,066 $ 866,066
Net earnings.......... -- -- -- 673,702 673,702
Issuance of common
stock (Note 11)...... 53 45,842 (45,895) -- --
Amortization of
unearned compensation
(Note 11)............ -- -- 3,824 -- 3,824
------- ---------- --------- ---------- ----------
Balance at December 31,
1996................... 1,053 45,842 (42,071) 1,538,768 1,543,592
Net loss.............. -- -- -- (1,008,560) (1,008,560)
Issuance of warrants
(Note 5)............. -- 510,652 -- -- 510,652
Accretion to
mandatorily
redeemable cumulative
preferred stock
redemption price
(Note 5)............. -- -- -- (87,066) (87,066)
1000-for-1 common
stock split (Note
6)................... 9,477 (9,477) -- -- --
Stock dividend (Note
6)................... 75 -- -- (75) --
Accrual of dividends
on mandatorily
redeemable cumulative
preferred stock (Note
5)................... -- -- -- (170,000) (170,000)
Amortization of
unearned compensation
(Note 11)............ -- -- 22,944 -- 22,944
------- ---------- --------- ---------- ----------
Balance at December 31,
1997................... 10,605 547,017 (19,127) 273,067 811,562
Net earnings.......... -- -- -- 1,065,264 1,065,264
Accretion to
mandatorily
redeemable cumulative
preferred stock
redemption price
(Note 5)............. -- -- -- (174,132) (174,132)
Accrual of dividends
on mandatorily
redeemable preferred
stock (Note 5)....... -- -- -- (340,000) (340,000)
Reversal of
amortization of
unearned compensation
(Note 11)............ -- -- (3,820) -- (3,820)
Forfeiture of common
stock (Note 11)...... (267) (22,680) 22,947 -- --
Stock option
compensation (Note
12).................. -- 722,600 (722,600) -- --
Amortization of
unearned stock option
compensation (Note
12).................. -- -- 26,325 -- 26,325
------- ---------- --------- ---------- ----------
Balance at December 31,
1998 .................. $10,338 $1,246,937 $(696,275) $ 824,199 $1,385,199
======= ========== ========= ========== ==========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-5
<PAGE>
CHEAP TICKETS, INC.
STATEMENTS OF CASH FLOWS
Years Ended December 31, 1996, 1997 and 1998
<TABLE>
<CAPTION>
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss).................... $ 673,702 $(1,008,560) $ 1,065,264
Adjustments to reconcile net earnings
(loss) to net cash provided by
operating activities:
Deferred income taxes................ 11,263 (19,053) (102,049)
Depreciation and amortization........ 204,552 370,237 563,514
Stock option compensation............ -- -- 26,325
Stock compensation expense
(benefit)........................... 3,824 22,944 (3,820)
Amortization of discount on
marketable securities............... -- -- (51,029)
Loss (gain) on sale or disposal of
property and equipment.............. (3,680) 2,164 48,786
Changes in--
Trade accounts and other
receivables........................ (632,912) 152,199 (269,202)
Refundable income taxes............. 39,004 (663,209) 663,209
Ticket inventories.................. (260,023) 142,998 (166,560)
Other current assets................ (42,540) (105,790) (289,087)
Other noncurrent assets............. (67,924) (26,267) (242,743)
Accounts payable.................... 384,344 2,516,670 295,276
Accrued salaries.................... 17,667 92,702 61,712
Accrued vacation.................... 18,622 31,460 342,120
Income taxes payable................ 200,336 (200,336) 139,640
Accrued expenses and other
liabilities........................ (174,119) 89,606 81,416
Other noncurrent liabilities........ 38,440 64,952 (155,284)
----------- ----------- -----------
Net cash provided by operating
activities........................ 410,556 1,462,717 2,007,488
----------- ----------- -----------
Cash flows from investing activities:
Capital expenditures................... (1,295,832) (496,406) (484,817)
Proceeds from sale of property and
equipment............................. 36,349 10,075 551,214
Purchase of marketable securities...... -- -- (4,884,200)
----------- ----------- -----------
Net cash used in investing
activities........................ (1,259,483) (486,331) (4,817,803)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of mandatorily
redeemable cumulative preferred stock
and common stock warrants, net........ -- 3,875,482 --
Decrease in bank overdraft............. (233,777) -- --
Proceeds from issuance of long-term
debt.................................. 928,213 -- 307,200
Principal payments on long-term debt... (54,019) (56,960) (627,138)
Proceeds from issuance of other debt... -- 500,000 --
Principal payments on other debt....... -- (500,000) --
Principal payments on capital lease
obligations........................... (46,117) (123,786) (150,165)
----------- ----------- -----------
Net cash provided by (used in)
financing activities.............. 594,300 3,694,736 (470,103)
----------- ----------- -----------
Net increase (decrease) in cash and
cash equivalents.................. (254,627) 4,671,122 (3,280,418)
Cash and cash equivalents at beginning
of period.............................. 1,837,911 1,583,284 6,254,406
----------- ----------- -----------
Cash and cash equivalents at end of
period................................. $ 1,583,284 $ 6,254,406 $ 2,973,988
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-6
<PAGE>
CHEAP TICKETS, INC.
STATEMENTS OF CASH FLOWS (Continued)
Years Ended December 31, 1996, 1997 and 1998
<TABLE>
<CAPTION>
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Supplemental cash flow information:
Cash paid during the year for:
Interest........................................ $ 91,488 $185,428 $145,447
Income taxes, net of refunds received........... 188,394 275,965 39,467
Noncash investing and financing activities:
Unearned compensation for stock options
granted........................................ -- -- 722,600
Satisfaction of debt obligation (Note 10)....... -- 250,000 --
Acquisitions of new equipment through capital
leases......................................... 501,423 150,744 608,069
Unearned compensation for stock compensation
arrangement (Note 11).......................... 45,895 -- --
Accrued and unpaid dividends on mandatorily
redeemable preferred stock..................... -- 170,000 340,000
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-7
<PAGE>
CHEAP TICKETS, INC.
NOTES TO THE FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Business
Cheap Tickets, Inc. ("Cheap Tickets" or "the Company") was incorporated
under the laws of the state of Hawaii on August 20, 1986, for the primary
purpose of providing travel services, including airline tickets, cruise
tickets, auto rentals, hotel reservations and other travel products. In
February 1999, Cheap Tickets reincorporated in the state of Delaware. Cheap
Tickets operates in Hawaii, California, New York and Washington, with
approximately 18%, 10% and 8% of sales activity to customers residing in the
state of Hawaii for the years ended December 31, 1996, 1997 and 1998,
respectively. Cheap Tickets deals with over 100 airline carriers. Revenues from
non-published fares through three of these airline carriers accounted for
approximately 61%, 60% and 49% of total non-published fares for the years ended
December 31, 1996, 1997 and 1998, respectively.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ significantly from those
estimates. Material estimates that are particularly susceptible to significant
change relate to the determination of the estimated fair value of property held
for sale, the valuation allowance for deferred tax assets and the allowance for
doubtful receivables. Management believes that such provisions and allowances
have been appropriately determined in accordance with generally accepted
accounting principles.
Cash Equivalents
Cheap Tickets considers all highly liquid debt securities with original
maturities of three months or less to be cash equivalents.
Marketable Securities
Cheap Tickets' marketable securities are categorized as available-for-sale
securities as defined by Statement of Financial Accounting Standards (SFAS) No.
115, "Accounting for Certain Investments in Debt and Equity Securities."
Available-for-sale securities are reported at fair value with unrealized
holding gains and losses excluded from earnings and reported in a separate
component of stockholders' equity.
Ticket Inventories
Ticket inventories, consisting of prepaid Hawaii inter-island airline
coupons, are stated at the lower of cost or market. Cheap Tickets does not
carry any other airline ticket inventories. Inventory cost is the acquisition
price of the coupons or tickets. The specific identification method is used to
determine the basis of inventory and cost of coupons or tickets removed from
inventory.
Trade Accounts and Other Receivables
Trade accounts and other receivables primarily consist of commissions and
volume bonuses from travel service providers. There were no allowances for
doubtful accounts receivable at December 31, 1997 and 1998.
F-8
<PAGE>
CHEAP TICKETS, INC.
NOTES TO THE FINANCIAL STATEMENTS--(Continued)
Property and Equipment
Property and equipment are carried at cost. Equipment held under capital
leases is stated at the lower of the present value of minimum lease payments or
estimated fair value of the equipment at the inception of the lease.
Depreciation on property and equipment is calculated on the straight-line
method over the estimated useful lives of the respective assets. Leasehold
improvements and equipment held under capital leases are amortized on the
straight-line method over the estimated useful life of the asset or the lease
term, whichever is shorter.
The estimated depreciable lives of major classes of property and equipment
are as follows:
<TABLE>
<S> <C>
Building and improvements................................... 40 years
Leasehold improvements...................................... 5 to 40 years
Furniture, fixtures and office equipment.................... 5 to 7 years
Computer equipment.......................................... 3 to 5 years
Vehicles.................................................... 5 years
</TABLE>
Property Held for Sale
In 1995, Cheap Tickets moved its Hawaii operations to larger leased
premises. The Company's commercial condominium office facility from which it
moved, was held for sale at December 31, 1997. This property was stated at
estimated fair value, less costs to sell. A write-down of $94,904 was recorded
in 1995. The property was sold in August 1998 and a loss of $56,000 was
recorded thereon.
Revenue Recognition
Revenues consist of non-published fares, commissions and overrides on
published fares, and volume bonuses from a travel service network. Non-
published fares are fares that are bought by Cheap Tickets under negotiated net
fare contracts from various airline carriers and other travel service providers
and resold to consumers at fares determined by Cheap Tickets generally at a
significant discount off published fares. Cheap Tickets also sells travel
services at regular published fares and earns a commission on such sales.
Cheap Tickets recognizes revenues and commissions when earned, which is at
the time the reservation is ticketed and payment is received. Such revenues are
reported net of an allowance for cancellations and refunds. Due to the
restrictive nature of Cheap Tickets' sales, which are generally noncancelable
and nonrefundable, cancellations and refunds are not significant.
Volume bonus and override revenues are recognized at the end of each monthly
or quarterly measurement period if the specified target has been achieved.
Advertising
Advertising costs are expensed as incurred. Advertising expenses amounted to
$1,453,392, $2,495,325 and $3,823,150 for the years ended December 31, 1996,
1997 and 1998, respectively.
F-9
<PAGE>
CHEAP TICKETS, INC.
NOTES TO THE FINANCIAL STATEMENTS--(Continued)
Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and for operating loss and tax credit carryforwards. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected
to be recovered or settled. The effect on deferred tax assets and liabilities
of a change in tax rates is recognized in income in the period that includes
the enactment date.
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
Cheap Tickets adopted the provisions of SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,"
effective January 1, 1996. SFAS No. 121 requires that long-lived assets and
certain identifiable intangibles be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows
(undiscounted and without interest) expected to be generated by the asset. If
such assets are considered to be impaired, the impairment to be recognized is
measured as the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell. Adoption of this
Statement did not have a material impact on Cheap Tickets' financial position,
results of operations, or liquidity.
Fair Value of Financial Instruments
The fair values of Cheap Tickets' long-term debt approximates carrying
values based on current financing for similar loans available to the Company.
The fair values of marketable securities are based on quoted prices.
Accounting for Stock Based Compensation
The Company accounts for employee stock based compensation in accordance
with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued
to Employees" and related interpretations, as permitted by SFAS No. 123,
"Accounting for Stock Based Compensation."
F-10
<PAGE>
CHEAP TICKETS, INC.
NOTES TO THE FINANCIAL STATEMENTS--(Continued)
Per Share Data
The following is a reconciliation of the numerator and denominators of the
basic and diluted earnings (loss) per common share:
<TABLE>
<CAPTION>
Income Shares Per Share
Years ended December 31, (Numerator) (Denominator) Amount
------------------------ ----------- ------------- ---------
<S> <C> <C> <C>
1996:
Basic
Income available to common shares.... $ 673,702 14,249,480 $ 0.05
======
Effect of dilutive securities.......... -- --
----------- ----------
Diluted
Net income and assumed conversions... $ 673,702 14,249,480 $ 0.05
=========== ========== ======
<CAPTION>
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
<S> <C> <C> <C>
1997:
Basic
Loss available to common shares...... $(1,265,626) 14,847,322 $(0.09)
======
Effect of dilutive securities.......... -- --
----------- ----------
Diluted
Net loss and assumed conversions..... $(1,265,626) 14,847,322 $(0.09)
=========== ========== ======
<CAPTION>
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
<S> <C> <C> <C>
1998:
Basic
Income available to common shares.... $ 551,132 14,567,084 $ 0.04
======
Effect of dilutive securities
Common stock warrants................ -- 2,969,456
Stock options........................ -- 384,328
----------- ----------
Diluted
Net loss and assumed conversions..... $ 551,132 17,920,868 $ 0.03
=========== ========== ======
</TABLE>
Net earnings (loss) per share is computed using the weighted average number
of common and common equivalent shares outstanding during the period. Warrants
to purchase 2,969,456 shares of common stock were outstanding in 1997 but were
not included in the computation of diluted loss per share for the year ended
December 31, 1997 since it would have had an antidilutive effect. Such warrants
had a dilutive effect for the year ended December 31, 1998.
F-11
<PAGE>
CHEAP TICKETS, INC.
NOTES TO THE FINANCIAL STATEMENTS--(Continued)
New Pronouncements
In 1998, Cheap Tickets adopted SFAS No. 130 "Reporting Comprehensive
Income," SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," and SFAS No. 132, "Employers' Disclosures about Pensions and
Other Postretirement Benefits." SFAS No. 130 states that all items that are
required to be recognized under generally accepted accounting standards as
components of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. The adoption
of SFAS No. 130 did not have an effect on Cheap Tickets' financial statements
since the Company does not have elements of comprehensive income other than net
earnings.
SFAS No. 131 requires disclosures regarding segments of an enterprise and
related information that reflects the different types of business activities in
which the enterprise engages and the different economic environments in which
it operates. The effect of implementing SFAS No. 131 was not significant as
Cheap Tickets manages its business as a single operation segment, is domiciled
entirely in the U.S. and substantially all of the Company's revenues are
derived from sales of airline tickets.
SFAS No. 132 standardized the disclosure requirements for pension and other
postretirement benefits. The adoption of SFAS No. 132 (which does not change
existing measurement or recognition standards for Cheap Tickets' defined
contribution plan) did not have a material effect on Cheap Tickets' financial
statements.
In June 1998, FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative instruments and hedging activities. SFAS No.
133 requires the recognition of all derivative instruments as either assets or
liabilities in the statement of financial position and measurement of those
derivative instruments at fair value. SFAS No. 133 is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999. Currently, Cheap
Tickets does not hold derivative instruments or engage in hedging activities.
The adoption of this standard is not expected to have a material effect on
Cheap Tickets' financial statements.
In March 1998, the Accounting Standards Executive Committee (AcSEC) of the
American Institute of Certified Public Accountants (AICPA) issued Statement of
Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use." In April 1998, the AcSEC issued SOP 98-5,
"Reporting on the Costs of Start-Up Activities." These standards are effective
for Cheap Tickets' year ending December 31, 1999. Cheap Tickets has not
determined the impact of the implementation of these pronouncements.
Reclassifications
Certain amounts in the 1997 financial statements have been reclassified to
conform with the 1998 presentation. These reclassifications had no effect on
net loss as previously reported.
2. Marketable Securities
Marketable securities at December 31, 1998 comprised U.S. government agency
debt securities having contractual maturities of less than one year. The fair
value of the debt securities approximated amortized cost. There were no sales
of securities in 1996, 1997 and 1998.
F-12
<PAGE>
CHEAP TICKETS, INC.
NOTES TO THE FINANCIAL STATEMENTS--(Continued)
3. Property and Equipment
A summary of property and equipment at December 31, 1997 and 1998 is as
follows:
<TABLE>
<CAPTION>
1997 1998
---------- ----------
<S> <C> <C>
Land.................................................. $ 158,239 $ 158,239
Building improvements................................. 741,761 741,761
Leasehold improvements................................ 339,807 358,737
Furniture, fixtures and office equipment (Note 9)..... 2,089,861 3,088,240
Vehicles.............................................. 122,916 122,916
---------- ----------
3,452,584 4,469,893
Less accumulated depreciation and amortization........ 932,538 1,470,475
---------- ----------
$2,520,046 $2,999,418
========== ==========
</TABLE>
Depreciation and amortization amounted to $204,552, $370,237 and $563,514
for the years ended December 31, 1996, 1997 and 1998, respectively.
4. Debt
Long-term debt at December 31, 1997 and 1998 consists of the following:
<TABLE>
<CAPTION>
1997 1998
---------- --------
<S> <C> <C>
Bank Debt-
3.125% above an indexed rate (total rate of 8.125% at
December 31, 1998) note payable in monthly installments of
$5,773 including interest, due May 1, 2012, collateralized
by a first mortgage on land and building.................. $ 585,816 $564,890
1.5% above bank's base rate mortgage note, payable in
monthly installments of $6,000 including interest,
collateralized by property held for sale. The note was
repaid in 1998............................................ 496,316 --
10% note payable in monthly installments of $1,413
including interest, balance due January 26, 2001,
collateralized by a vehicle............................... 44,832 31,785
Other-
8.25% note payable in monthly installments of $13,930
including interest, due February 28, 2000................. -- 210,350
---------- --------
Total long-term debt..................................... 1,126,964 807,025
Less current installments of long-term debt................ 528,825 221,469
---------- --------
Long-term debt, excluding current installments............. $ 598,139 $585,556
========== ========
</TABLE>
F-13
<PAGE>
CHEAP TICKETS, INC.
NOTES TO THE FINANCIAL STATEMENTS--(Continued)
The aggregate maturities of long-term debt subsequent to December 31, 1998
are as follows:
<TABLE>
<S> <C>
Year ending December 31
1999.............................................................. $221,469
2000.............................................................. 69,774
2001.............................................................. 29,995
2002.............................................................. 30,935
2003.............................................................. 33,545
Later years....................................................... 421,307
--------
$807,025
========
</TABLE>
Cheap Tickets has available a $3,000,000 credit facility with a bank
expiring on December 5, 1999. Borrowings under the credit facility accrue
interest at either (1) the bank's base rate (7.75% at December 31, 1998) or
(2) LIBOR plus an applicable margin, as defined, at the Company's option. The
credit facility is collateralized by deposit accounts with the bank, accounts
receivable, inventory, furniture and equipment and intangible assets. The
credit facility contains restrictive covenants which include requirements to
maintain minimum tangible net worth and meet certain financial ratios. There
were no outstanding borrowings under the credit facility at December 31, 1997
and 1998.
5. Mandatorily Redeemable Cumulative Preferred Stock
In July 1997, Cheap Tickets issued and sold 425,000 shares of mandatorily
redeemable cumulative preferred stock, with detachable warrants to purchase an
aggregate of 2,969,456 shares of common stock of Cheap Tickets at an aggregate
exercise price of $2,121, in exchange for cash consideration of $4,250,000
(the "Equity Transaction").
The net proceeds of $3,875,482, after reflecting transaction costs of
$374,518, were allocated between the warrants and preferred stock based on
their relative fair values, resulting in an allocation of $510,652 and
$3,364,830 to the warrants and preferred stock, respectively. The value
attributable to the warrants was recorded as additional paid-in capital. The
excess of the redemption value of the preferred stock of $4,250,000 over the
initial carrying value of $3,364,830 is being accreted by periodic charges to
retained earnings through July 25, 2002. The accretion amounted to $87,066 and
$174,132 for the years ended December 31, 1997 and 1998, respectively.
The preferred stock has a par value of $1 per share, is nonvoting and
accrues cumulative annual dividends of $.80 per share. The dividends are
payable in quarterly installments commencing on July 25, 2002. Accrued
dividends amounted to $170,000 and $340,000 for the years ended December 31,
1997 and 1998, respectively. Undeclared cumulative dividends amounted to
$170,000 and $510,000 as of December 31, 1997 and 1998, respectively, and have
been accrued as an addition to preferred stock in the accompanying balance
sheets. The preferred stock has a liquidation preference such that in the
event of any liquidation, dissolution or winding up of the Company, the
preferred stockholders will be entitled to redeem each share for $10, plus all
accrued and unpaid dividends thereon as of the liquidation date before any
distribution to other stockholders. Accordingly, retained earnings may be
restricted at the liquidation date if the amounts due to the preferred
stockholders exceed the carrying value of the preferred stock.
F-14
<PAGE>
CHEAP TICKETS, INC.
NOTES TO THE FINANCIAL STATEMENTS--(Continued)
Mandatory quarterly redemption of the lesser of one-twelfth of the largest
number of shares of preferred stock outstanding at any time prior to July 25,
2002, or the number of shares outstanding on such scheduled redemption date,
commences on July 25, 2002, at $10 per share, plus accrued and unpaid dividends
thereon. Upon the closing of an initial public offering of Cheap Tickets'
common stock, the sale of substantially all of the assets of the Company, or
consolidation or merger involving Cheap Tickets, the Company will be required
to redeem all outstanding shares of the preferred stock, plus all accrued and
unpaid dividends thereon. Cheap Tickets also has the option to redeem all or
part of the outstanding shares of preferred stock at any time for $10 per
share, plus accrued and unpaid dividends thereon as of the date Cheap Tickets
decides to redeem such shares. All redemptions will be settled with cash. Cheap
Tickets does not have the option to settle redemptions with common stock.
Redemption requirements, excluding accrued and unpaid dividends, subsequent
to December 31, 1998 are as follows:
<TABLE>
<S> <C>
Year ending December 31
1999............................................................ $ --
2000............................................................ --
2001............................................................ --
2002............................................................ 708,333
2003............................................................ 1,416,667
Later years..................................................... 2,125,000
----------
$4,250,000
==========
</TABLE>
6. Stockholders' Equity
Common Stock Warrants
The detachable common stock warrants issued in conjunction with the
mandatorily redeemable cumulative preferred stock (see Note 5) are currently
exercisable and provide the preferred stockholders the option to purchase an
aggregate of 2,969,456 shares of common stock of Cheap Tickets at an aggregate
exercise price of $2,121. The number of shares purchasable on the exercise of
the warrants will be proportionately adjusted in the event of stock dividends,
distributions, subdivisions, combinations, or other changes in common stock,
warrants, issuance of convertible securities or other rights, as more fully
described in the warrant agreement. Appropriate adjustments will also be made
to the purchase price payable per share, but the aggregate purchase price
payable of $2,121 shall remain the same. The warrants expire on July 15, 2002,
except that the warrants terminate immediately upon the closing of an initial
public offering of Cheap Tickets' common stock, the sale of substantially all
of the assets of Cheap Tickets, or the consolidation or merger of Cheap Tickets
in which at least 50% of the voting power of Cheap Tickets is transferred. In
addition to any adjustments made to the number of shares purchasable as
previously described, if immediately prior to the first to occur of an initial
public offering, a sale or an acquisition (each, a "Transfer") and if the value
of the consideration to be received by the warrant holder for its shares
(assuming exercise of the warrant) in connection with the Transfer plus all
dividends received by the warrant holder on its preferred stock as of the date
of the Transfer are less than the redemption value of the warrant holder's
preferred stock multiplied by 1.25n, where n equals the number of years
(rounded to the
F-15
<PAGE>
CHEAP TICKETS, INC.
NOTES TO THE FINANCIAL STATEMENTS--(Continued)
nearest one hundredth of a year) between the date of the Transfer and the issue
date of the warrant, then the number of shares purchasable on the exercise of
the warrant shall be increased to eliminate such deficiency. The increase
necessary to eliminate such deficiency may not result in the warrant holders
owning over 30% of the common stock on a fully diluted basis as of the date of
the Transfer. In such case, all additional sums necessary to eliminate such
deficiency shall be paid by the Company to the warrant holder in cash upon, and
as a condition to the consummation of, the Transfer.
Common Stock
On June 24, 1997, Cheap Tickets' Board of Directors approved an amendment to
Cheap Tickets' articles of incorporation wherein the authorized common stock of
Cheap Tickets was increased from 5,000 shares at $1 par value to 5,000,000
shares at $0.01 par value, and to effect a 1000-for-1 stock split. In
connection with the stock split, $9,477 was transferred to common stock from
additional paid-in capital, representing the adjustment to reflect the
aggregate common stock par value subsequent to the aforementioned amendment.
Subsequent to the stock split, a stock dividend was declared and issued to
the common stockholders on a pro rata basis so that the common stock warrants,
if and when exercised, would reflect a 15% common equity interest, considering
the shares of common stock outstanding and the 1,979,642 shares of common stock
to be reserved for issuance under the stock option plan established in April
1998 (see Note 12).
In connection with Cheap Tickets' planned initial public offering of its
common stock in February 1999, the authorized common stock of Cheap Tickets was
increased from 5,000,000 shares at $0.01 par value to 70,000,000 shares at
$0.001 par value. The Company also effected a 14-for-one stock split.
In these financial statements, all per share amounts and number of shares
have been restated to reflect the stock splits and stock dividend described
above.
As described in Note 11, 373,646 shares were forfeited by an officer upon
his resignation in March 1998.
Preferred Stock
In February 1999, the authorized preferred stock of Cheap Tickets was
increased from 5,000,000 shares at $1 par value to 10,000,000 shares at $0.01
par value. The board of directors has the authority to issue shares of
preferred stock in one or more series and to fix the rights, preferences,
privileges and restrictions thereof, including dividend rights, conversion
rights, voting rights, terms of redemption, and liquidation preferences.
Restriction on Declaration and Payment of Dividends
In connection with the Equity Transaction, written approval from a majority
of the holders of preferred stock, common stock warrants, and common stock
issued upon exercise of warrants, is required for the declaration or payment of
dividends to common stockholders.
F-16
<PAGE>
CHEAP TICKETS, INC.
NOTES TO THE FINANCIAL STATEMENTS--(Continued)
7. Income Taxes
Income tax expense (benefit) for the years ended December 31, 1996, 1997 and
1998 was as follows:
<TABLE>
<CAPTION>
Federal State Total
--------- --------- ---------
<S> <C> <C> <C>
Years ended December 31
1996:
Current................................ $ 340,761 $ 86,973 $ 427,734
Deferred............................... 8,889 2,374 11,263
--------- --------- ---------
$ 349,650 $ 89,347 $ 438,997
========= ========= =========
1997:
Current................................ $(468,136) $(119,444) $(587,580)
Deferred............................... (15,465) (3,588) (19,053)
--------- --------- ---------
$(483,601) $(123,032) $(606,633)
========= ========= =========
1998:
Current................................ $ 741,237 $ 101,080 $ 842,317
Deferred............................... (54,232) (47,817) (102,049)
--------- --------- ---------
$ 687,005 $ 53,263 $ 740,268
========= ========= =========
</TABLE>
Deferred tax benefit for the year ended December 31, 1997 includes a tax
benefit of $36,247 for operating loss carryforwards. The actual income tax
expense (benefit) for the years ended December 31, 1996, 1997 and 1998 differed
from the expected income tax expense (benefit) computed by applying the U.S.
federal income tax rate of 34% to earnings (loss) before income taxes due to
the following:
<TABLE>
<CAPTION>
1996 1997 1998
-------- --------- --------
<S> <C> <C> <C>
Federal "expected" income tax expense
(benefit).................................... $378,318 $(549,166) $613,881
State franchise and income taxes, net of
federal income tax effect.................... 60,679 (81,201) 93,888
Other......................................... -- 23,734 32,499
-------- --------- --------
$438,997 $(606,633) $740,268
======== ========= ========
</TABLE>
F-17
<PAGE>
CHEAP TICKETS, INC.
NOTES TO THE FINANCIAL STATEMENTS--(Continued)
The tax effects of temporary differences that give rise to deferred tax
assets and deferred tax liabilities at December 31, 1997 and 1998 are presented
below:
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Deferred tax assets:
Allowance for decline in value of property held for sale
not deductible for tax purposes......................... $ 38,121 $ --
Accrued rent not deductible for tax purposes............. 27,203 21,201
Accrued vacation not deductible for tax purposes......... 31,211 165,145
State tax credit carryforward............................ -- 34,129
Unearned compensation not deductible for tax purposes.... -- 10,319
Net operating loss carryforward.......................... 36,247 --
-------- --------
Total gross deferred tax assets........................ 132,782 230,794
-------- --------
Deferred tax liabilities:
Property and equipment, principally due to differences
between accounting and tax depreciation and
amortization............................................ (59,662) (63,166)
Unearned compensation deductible for tax purposes........ (7,541) --
-------- --------
Total gross deferred tax liabilities................... (67,203) (63,166)
-------- --------
Net deferred tax asset................................. $ 65,579 $167,628
======== ========
Deferred tax assets and liabilities are presented in the
accompanying balance sheets as follows:
Other current assets..................................... $ 31,211 $199,274
Other noncurrent assets.................................. 34,368 --
Other noncurrent liabilities............................. -- (31,646)
-------- --------
$ 65,579 $167,628
======== ========
</TABLE>
There was no valuation allowance provided for deferred tax assets as of
December 31, 1996, 1997 and 1998. In assessing the realizability of deferred
tax assets, management considers whether it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income, and tax planning strategies in
making this assessment. Based upon the level of historical taxable income and
projections for future taxable income over the periods which the deferred tax
assets are deductible, management believes it is more likely than not Cheap
Tickets will realize the benefits of these deductible differences. The amount
of the deferred tax asset considered realizable, however, could be reduced in
the near term if estimates of future taxable income are reduced.
8. Profit Sharing and 401(k) Plan
Cheap Tickets sponsors a defined contribution profit sharing plan covering
all employees who attained the age of 20 and completed one year of service.
Vesting occurs at a rate of 20% per year commencing in the second year of
participation. Contributions to the plan were at the discretion of the board of
directors. Cheap Tickets did not contribute to the plan in 1996.
F-18
<PAGE>
CHEAP TICKETS, INC.
NOTES TO THE FINANCIAL STATEMENTS--(Continued)
Effective January 1, 1997, Cheap Tickets converted the profit sharing plan
into a qualified 401(k) defined contribution plan. The 401(k) defined
contribution plan allows for voluntary participant contributions of up to 15%
of eligible compensation. Employer contributions are discretionary and fully
vest to the participant upon the participant's completion of seven years of
service. Cheap Tickets did not contribute to the 401(k) defined contribution
plan in 1997 and 1998.
9. Lease Commitments
Cheap Tickets is obligated under capital leases for office equipment that
expire at various dates through 2004. At December 31, 1997 and 1998, the gross
amounts of office equipment and related accumulated amortization recorded under
capital leases are as follows:
<TABLE>
<CAPTION>
1997 1998
-------- ----------
<S> <C> <C>
Office equipment....................................... $652,167 $1,260,237
Less accumulated amortization (amortization expense
charged to depreciation and amortization)............. 144,570 384,869
-------- ----------
$507,597 $ 875,368
======== ==========
</TABLE>
Cheap Tickets has noncancelable operating leases, primarily for office
space, that expire at various dates through 2009. These leases generally
contain renewal options for periods ranging from one to five years. Rent
expense incurred for all operating leases amounted to $519,560, $851,709, and
$1,175,289 for the years ended December 31, 1996, 1997 and 1998, respectively.
Future minimum lease payments under noncancelable operating leases and
future minimum capital lease payments as of December 31, 1998 are as follows:
<TABLE>
<CAPTION>
Capital Operating
Leases Leases
---------- ----------
<S> <C> <C>
Year ending December 31
1999................................................ $ 335,435 $ 923,400
2000................................................ 321,287 933,100
2001................................................ 268,323 621,700
2002................................................ 56,371 532,500
2003................................................ 49,133 533,300
Later years......................................... 14,435 1,984,400
---------- ----------
Total minimum lease payments...................... 1,044,984 $5,528,400
==========
Less amounts representing interest (at rates ranging
from 7.75% to 14.05%)................................ 104,816
----------
Present value of net minimum capital lease
payments........................................... 940,168
Less current installments of capital lease
obligations.......................................... 287,809
----------
Capital lease obligations, excluding current
installments....................................... $ 652,359
==========
</TABLE>
F-19
<PAGE>
CHEAP TICKETS, INC.
NOTES TO THE FINANCIAL STATEMENTS--(Continued)
10. Incentive Reimbursements from Local Governments
In 1996, Cheap Tickets commenced operations of a new reservation center in
Lakeport, California. As an incentive for Cheap Tickets to operate at the
location, the local government agreed to reimburse Cheap Tickets for certain
payroll costs related to training. Estimated reimbursements associated with
payroll costs incurred of approximately $458,000 and $28,000 in 1996 and 1997,
respectively, have been recorded by Cheap Tickets as a reduction of selling,
general and administrative expenses in the accompanying statements of
operations. At December 31, 1996, $353,164 of these incentive reimbursements
were to be collected from the local government. In 1997, $250,000 of the
incentive reimbursements receivable was settled by offsetting the receivable
with an outstanding debt obligation to the local government of $250,000, with
the remaining receivable balance collected in full. No gain or loss was
recognized on the offsetting of such amounts.
Additional incentives provided by the local government included the waiver
of certain expenses, including lease rent and property taxes totaling
approximately $99,000 and $12,000 in 1996 and 1997, respectively. Cheap Tickets
also received $95,400 associated with additional lease rent incentives in 1996
and had recorded this amount as a reduction of selling, general and
administrative expenses in 1996.
11. Stock Compensation Arrangement
In November 1996, Cheap Tickets entered into a Restricted Stock Grant and
Shareholder Agreement (Agreement) whereby 747,292 shares of common stock, after
giving effect to the stock splits and a common stock dividend (see Note 6),
were granted to an officer of Cheap Tickets as compensation for his employment.
There was a two year vesting period whereby the shares vested 50 percent after
each year of service with Cheap Tickets. The estimated fair value of the common
stock shares on the date of grant of $45,895 was being amortized as
compensation expense over the two year vesting period.
In March 1998, the officer resigned from Cheap Tickets. In connection with
the resignation, the officer forfeited his nonvested shares of common stock
issued under the Agreement. Such forfeited common stock amounted to 373,646
shares. The officer's forfeiture of the common shares resulted in a benefit of
$3,820 in 1998 for the recovery of compensation expense previously taken and
decreases in common stock and additional paid-in capital of $267 and $22,680,
respectively.
12. Stock Option Plans
Cheap Tickets established a stock option plan in April 1998 which provides
for a maximum of 1,979,642 shares of common stock to be issued under the plan.
In 1998 Cheap Tickets granted options for 728,000 shares of common stock
with exercise prices less than the estimated market prices on the grant dates.
The weighted-average grant-date fair value of options granted in 1998 was
$1.30. The estimated compensation cost for these options amounted to $722,600
at the grant dates. Stock option compensation expense, included in selling,
general and administrative expenses, was $26,325 for the year ended December
31, 1998. The remaining unamortized compensation cost of $696,275 at
December 31, 1998 will be amortized over the future vesting periods of the
options. The granted options have a five year vesting period, however, options
F-20
<PAGE>
CHEAP TICKETS, INC.
NOTES TO THE FINANCIAL STATEMENTS--(Continued)
to purchase up to 140,000 shares will fully vest should Cheap Tickets complete
an initial public offering of its stock. The granted options have a ten-year
exercise period from the date of the grant.
The following table summarizes activity under the stock option plan for 1998
and the status at December 31, 1998.
<TABLE>
<CAPTION>
Options Outstanding
---------------------
Average
Exercise
Shares Price
---------- ----------
<S> <C> <C>
Balance at December 31, 1997......................... -- $ --
Options granted...................................... 728,000 0.31
---------- --------
Balance at December 31, 1998......................... 728,000 $ 0.31
========== ========
</TABLE>
At December 31, 1998, options for 660,800 shares have an exercise price of
$0.18 per share with a weighted average remaining contractual life of 9.4 years
and options for 67,200 shares have an exercise price of $1.57 per share with a
weighted-average remaining contractual life of 9.8 years. No options were
exercisable at December 31, 1998.
Under SFAS No. 123, the fair value of each grant was estimated on the grant
date using the minimum value method based on the following weighted-average
assumptions:
<TABLE>
<S> <C>
Expected dividend yield.......................................... 0.00%
Risk-free interest rate.......................................... 5.80%
Expected life of the options..................................... 10 years
</TABLE>
Compensation cost has been charged against income for the stock option plan
under APB No. 25. The pro forma net income and pro forma earnings per share for
the year ended December 31, 1998 had Cheap Tickets elected to adopt the fair-
value based method of accounting prescribed by SFAS No. 123 is presented below:
<TABLE>
<S> <C>
Net income:
As reported.................................................. $1,065,264
Pro forma.................................................... $1,061,513
Basic earnings per share:
As reported ................................................. $ 0.04
Pro forma.................................................... $ 0.04
Diluted earnings per share:
As reported.................................................. $ 0.03
Pro forma.................................................... $ 0.03
</TABLE>
Cheap Tickets is establishing another stock option plan which is expected to
be approved by Cheap Tickets' stockholders prior to Cheap Tickets' planned
initial public offering of its common stock.
F-21
<PAGE>
[CHEAP TICKETS, INC. LOGO WITH
PICTURES OF WORLDWIDE DESTINATIONS]
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
which is set forth in this prospectus. We are offering to sell shares of
common stock and seeking offers to buy shares of common stock only in
jurisdictions where offers and sales are permitted. The information contained
in this prospectus is accurate only as of the date of this prospectus,
regardless of the time of delivery of the prospectus or of any sale of common
stock.
-----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary....................................................... 3
Summary Financial Data................................................... 5
Risk Factors............................................................. 7
Forward Looking Statements............................................... 20
Use of Proceeds.......................................................... 21
Dividend Policy.......................................................... 21
Capitalization........................................................... 22
Dilution................................................................. 23
Selected Financial Data.................................................. 24
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 26
Business................................................................. 36
Management............................................................... 47
Certain Transactions..................................................... 56
Principal Stockholders................................................... 57
Description of Capital Stock............................................. 59
Shares Eligible for Future Sale.......................................... 61
Underwriting............................................................. 63
Legal Matters............................................................ 65
Experts.................................................................. 65
Additional Information................................................... 65
Index to Financial Statements............................................ F-1
</TABLE>
-----------------
Until , 1999 (25 days after the date of this prospectus), all dealers
effecting transactions in the registered securities, whether or not
participating in this distribution, may be required to deliver a prospectus.
This is in addition to the obligation of dealers to deliver a prospectus when
acting as underwriters and with respect to their unsold allotments or
subscriptions.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
3,500,000 Shares
www.cheaptickets.com
Common Stock
-----------------
PROSPECTUS
, 1999
-----------------
William Blair & Company
Dain Rauscher Wessels
a division of Dain Rauscher Incorporated
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
The following is an itemized list of the estimated expenses to be incurred
in connection with the Offering of the securities being offered hereunder other
than underwriting discounts and commissions.
<TABLE>
<CAPTION>
Amount
to be Paid
----------
<S> <C>
Registration fee.................................................. $ 15,985
NASD filing fee................................................... 6,250
Nasdaq National Market listing fee................................ 60,000
Printing and Engraving expenses................................... 150,000
Legal fees and expenses........................................... 300,000
Blue Sky qualification fees and expenses.......................... 5,000
Accounting fees and expenses...................................... 100,000
Directors' and Officers' liability insurance...................... 100,000
Transfer Agent and registrar fees................................. 15,000
Miscellaneous..................................................... 47,765
--------
Total........................................................... $800,000
========
</TABLE>
Item 14. Indemnification of Directors and Officers
Section 145 of the DGCL contains detailed provisions on indemnification of
directors and officers against expenses, judgments, fines and amounts paid in
settlement, actually and reasonably incurred in connection with legal
proceedings. Section 102(a)(7) of the DGCL permits a provision in the
certificate of incorporation of each corporation organized thereunder, such as
the Company, eliminating or limiting, with certain exceptions, the personal
liability of a director of the corporation or its stockholders for monetary
damages for breach of fiduciary duty as a director. The Certificate of
Incorporation of the Company eliminates the liability of each of its directors
to its stockholders or the Company for monetary damages for breach of fiduciary
duty to the full extent provided by the Delaware General Corporation Law (the
"DGCL"), as such law exists or may hereafter be amended.
Indemnification applies to any threatened, pending or completed action, suit
or proceeding, whether, civil, criminal, administrative or investigative.
Indemnification may include all expenses (including attorneys' fees, judgments,
fines, ERISA excise taxes and amounts paid in settlement) reasonably incurred
by the indemnified person.
Reference is made to the following documents filed as exhibits to this
Registration Statement regarding relevant indemnification provisions described
above and elsewhere herein:
<TABLE>
<CAPTION>
Exhibit
Document Number
-------- -------
<S> <C>
Form of Underwriting Agreement...................................... 1.1
Certificate of Incorporation........................................ 3.1
Form of First Amended and Restated Certificate of Incorporation..... 3.2
Bylaws.............................................................. 3.3
Form of First Amended and Restated Bylaws........................... 3.4
Form of Indemnification Agreements.................................. 10.4
</TABLE>
II-1
<PAGE>
Item 15. Recent Sales of Unregistered Securities
From January 1, 1996 through December 31, 1998, the Company has issued and
sold the following securities: (a) the Company issued and sold 5,950,000 shares
of 8% Mandatorily Redeemable Preferred Stock and warrants to purchase up to
2,969,456 shares of Common Stock to Phillips-Smith Specialty Retail Group III,
L.P. and Craig Foley for an aggregate purchase price of $4,250,000; and (b) the
Company issued 373,646 shares of Common Stock to a former officer of the
Company as compensation with an aggregate value of $22,948.
The issuances described about were deemed exempt from registration under the
Securities Act in reliance upon Sections 4(2) or 3(a) of the Securities Act.
The recipients of securities in each such transaction represented their
intentions to acquire the securities for investment only and not with a view to
or for sale in connection with any distribution thereof and appropriate legends
were affixed to the share certificates issued in such transactions. All
recipients had adequate access, through their relationships with the Company,
to information about the Company.
Item 16. Exhibits and Financial Statements
(a) Exhibits and Financial Statement Schedules
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
1.1* Form of Underwriting Agreement.
3.1* Certificate of Incorporation.
3.2* Form of First Amended and Restated Certificate of Incorporation.
3.3* Bylaws.
3.4* Form of First Amended and Restated Bylaws.
4.1* Specimen Stock Certificate.
5.1* Opinion of Morrison & Foerster LLP.
10.1* 1997 Stock Option Plan.
10.2* 1999 Stock Option Plan.
10.3* Form of Severance Agreement for Michael J. Hartley and Sandra T.
Hartley.
10.4* Form of Indemnification Agreement.
10.5* The Commerce Tower Office Lease dated July 2, 1995 between Tosei Shoji
Co. and Cheap Tickets, Inc., as amended by the 1st Amendment to the
Commerce Tower Office Lease dated June 14, 1996 and the 2nd Amendment
to the Commerce Tower Office Lease dated October 9, 1997.
10.6* Sublease dated June 1, 1998 between Levi Straus & Co. and Cheap
Tickets, Inc.
10.7* Lease Agreement dated January 19, 1994 between Airport Center
Associates LP and Cheap Tickets, Inc., as amended by the 1st Amendment
to Lease dated July 20, 1994 and the 2nd Amendment to Lease dated
April 25, 1997.
10.8* Lease dated March 31, 1998 between Executive Tower of Colorado
Springs, LLC and Cheap Tickets, Inc.
10.9+ 1994 Net Fare/Commission Agreement dated October 18, 1993 between
Continental Airlines, Inc. and Cheap Tickets, Inc., as amended by
Addendum dated November 12, 1998.
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
10.10+* 1999 Net Consolidator Agreement dated November 1, 1998 between Trans
World Airlines, Inc. and Cheap Tickets, Inc.
10.11+* Consolidator Agreement dated December 14, 1998 between America West
Airlines, Inc. and Cheap Tickets, Inc.
10.12* Credit Agreement dated November 26, 1997 between Bank of Hawaii and
Cheap Tickets, Inc., as amended by First Loan Modification Agreement
dated as of June 15, 1998; and Security Agreement dated November 26,
1997 between Bank of Hawaii and Cheap Tickets, Inc.
10.13+* Subscriber Agreement dated December 31, 1998 between The SABRE Group,
Inc. and Cheap Tickets, Inc., as amended by Amendment No. 1 to SABRE
Subscriber Agreement dated December 31, 1998.
10.14+* Agreement for Negotiated Fares Maintenance dated July 15, 1994 between
SABRE Travel Information Network and CTI Corporation.
10.15* Sabre TravelBase System Lease Agreement between SABRE Travel
Information Network and Cheap Tickets, Inc.
23.1 Consent of PricewaterhouseCoopers LLP.
23.2* Consent of Morrison & Foerster LLP (included in the opinion filed
herewith as Exhibit 5.1).
24.1* Power of attorney (included on the signature page).
27.1* Financial Data Schedule.
99.1* Consent of Giles H. Bateman dated as of January 19, 1999.
99.2* Consent Letter of KPMG LLP dated January 19, 1999.
99.3* Consent of George R. Mrkonic dated as of February 23, 1999.
99.4 Consent of Ching & Lee dated as of March 18, 1999.
</TABLE>
- --------
* Previously filed.
+ Portions have been omitted pursuant to a confidential treatment request.
(b) Financial Statement Schedules
No schedules are included because the information required to be set forth
therein is not applicable or is shown in the financial statements or notes
thereto.
Item 17. Undertakings
In accordance with Rule 430A of Regulation C under the Securities Act of
1933, as amended (the "Securities Act"), the undersigned registrant hereby
undertakes:
(a) To provide to the underwriter at the closing specified in the
underwriting agreements certificates in such denominations and registered
in such names as required by the underwriter to permit prompt delivery to
each purchaser.
(b) That insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling
persons of the registrant pursuant to the provisions described under Item
15 above, or otherwise, the registrants have been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as
II-3
<PAGE>
expressed in the Securities Act and is, therefore, unenforceable. In the
event that a claim for indemnification against such liabilities (other than
the payment by the registrants of expenses incurred or paid by a director,
officer or controlling person of either registrant in the successful
defense of any action, suit or proceeding) is asserted by such director,
officer or controlling person in connection with the securities being
registered, the registrants will, unless in the opinion of their counsel
the matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be
governed by the final adjudication of such issue.
(c) That, for purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as part of
this Registration Statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the registrants pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
(d) That, for the purpose of determining any liability under the
Securities Act, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Amendment No. 3 to the Registration Statement
to be signed on its behalf by the undersigned, thereunto duly authorized in the
City of Honolulu, County of Honolulu, State of Hawaii, as of March 18, 1999.
CHEAP TICKETS, INC.
/s/ Michael J. Hartley
By: _________________________________
Chief Executive Officer and
President
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Amendment No. 3 to the Registration Statement
to be signed on its behalf by the undersigned, thereunto duly authorized in the
City of Honolulu, County of Honolulu, State of Hawaii, as of March 18, 1999.
<TABLE>
<CAPTION>
Signature Title
--------- -----
<S> <C> <C>
/s/ Michael J. Hartley Chief Executive Officer,
____________________________________ President and Chairman of
Michael J. Hartley the Board of Directors
/s/ Dale K. Jorgenson Vice President of Finance
____________________________________ and Chief Financial Officer
Dale K. Jorgenson
* Executive Vice President
____________________________________
Tammy A. Ishibashi
* Director
____________________________________
Sandra T. Hartley
* Director
____________________________________
Donald J. Phillips
* Director
____________________________________
Cece Smith
</TABLE>
/s/ Michael J. Hartley
*By: __________________________
Attorney-in-Fact
II-5
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
1.1* Form of Underwriting Agreement.
3.1* Certificate of Incorporation.
3.2* Form of First Amended and Restated Certificate of Incorporation.
3.3* Bylaws.
3.4* Form of First Amended and Restated Bylaws.
4.1* Specimen Stock Certificate.
5.1* Opinion of Morrison & Foerster LLP.
10.1* 1997 Stock Option Plan.
10.2* 1999 Stock Option Plan.
Form of Severance Agreement for Michael J. Hartley and Sandra T.
10.3* Hartley.
10.4* Form of Indemnification Agreement.
10.5* The Commerce Tower Office Lease dated July 2, 1995 between Tosei Shoji
Co. and Cheap Tickets, Inc., as amended by the 1st Amendment to the
Commerce Tower Office Lease dated June 14, 1996 and the 2nd Amendment
to the Commerce Tower Office Lease dated October 9, 1997.
10.6* Sublease dated June 1, 1998 between Levi Straus & Co. and Cheap
Tickets, Inc.
10.7* Lease Agreement dated January 19, 1994 between Airport Center
Associates LP and Cheap Tickets, Inc., as amended by the 1st Amendment
to Lease dated July 20, 1994 and the 2nd Amendment to Lease dated
April 25, 1997.
10.8* Lease dated March 31, 1998 between Executive Tower of Colorado
Springs, LLC and Cheap Tickets, Inc.
10.9+* 1994 Net Fare/Commission Agreement dated October 18, 1993 between
Continental Airlines, Inc. and Cheap Tickets, Inc., as amended by
Addendum dated November 12, 1998.
10.10+* 1999 Net Consolidator Agreement dated November 1, 1998 between Trans
World Airlines, Inc. and Cheap Tickets, Inc.
10.11+* Consolidator Agreement dated December 14, 1998 between America West
Airlines, Inc. and Cheap Tickets, Inc.
10.12* Credit Agreement dated November 26, 1997 between Bank of Hawaii and
Cheap Tickets, Inc., as amended by First Loan Modification Agreement
dated as of June 15, 1998; and Security Agreement dated November 26,
1997 between Bank of Hawaii and Cheap Tickets, Inc.
10.13+* Subscriber Agreement dated December 31, 1998 between The SABRE Group,
Inc. and Cheap Tickets, Inc., as amended by Amendment No. 1 to SABRE
Subscriber Agreement dated December 31, 1998.
10.14+* Agreement for Negotiated Fares Maintenance dated July 15, 1994 between
SABRE Travel Information Network and CTI Corporation.
10.15* SABRE TravelBase System Lease Agreement between SABRE Travel
Information Network and Cheap Tickets, Inc.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
23.1 Consent of PricewaterhouseCoopers LLP.
23.2* Consent of Morrison & Foerster LLP (included in the opinion filed
herewith as Exhibit 5.1).
24.1* Power of attorney (included on the signature page).
27.1* Financial Data Schedule.
99.1* Consent of Giles H. Bateman dated as of January 19, 1999.
99.2* Consent Letter of KPMG LLP dated January 19, 1999.
99.3* Consent of Geroge R. Mrkonic dated as of February 23, 1999.
99.4 Consent of Ching & Lee dated as of March 18, 1999.
</TABLE>
- --------
* Previously filed.
+ Portions have been omitted pursuant to a confidential treatment request.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in this Registration Statement on Form S-1 (File
No. 333-70841) of our report dated February 15, 1999 on our audits of the
financial statements of Cheap Tickets, Inc. We also consent to the references
to our firm under the captions "Experts" and "Selected Financial Data."
/s/ PricewaterhouseCoopers LLP
Honolulu, Hawaii
March 17, 1999
<PAGE>
EXHIBIT 99.4
CONSENT OF EXPERT
We consent to the inclusion in this Registration Statement on Form S-1 (File
No. 333-70841) of references to our firm under the captions "Experts."
/s/ Ching & Lee
Honolulu, Hawaii
March 17, 1999
