May 15, 2000
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
FORWARD-LOOKING INFORMATION
The matters discussed in this Form 10-Q include forward-looking statements that involve risks or uncertainties. While forward-looking statements are sometimes presented with numerical specificity, they are based on various assumptions made by management regarding future circumstances over many of which the Company has little or no control. A number of important factors, including those identified above under the caption "Risk Factors" in the Company's 1999 Form 10-K which hereby is incorporated by reference, as well as factors discussed elsewhere in this Form 10-Q, could cause the Company's actual results to differ materially from those in forward-looking statements or financial information. Actual results may differ from forward-looking results for a number of reasons, including the following: (i) changes in general economic conditions and other factors that affect demand for travel products or services; (ii) changes in the vacation travel industry; (iii) changes in the Company's relationships with travel suppliers; (iv) competitive factors (including changes in travel distribution methods); and (v) the success of the Company's operating and growth strategies (including the ability to integrate acquisitions into Company operations, the ability of acquired companies to achieve satisfactory operating results and the ability of the Company to manage the transition to an integrated information platform). Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected.
Overview
Global Vacation Group, Inc., and Subsidiaries ("GVG" or the "Company") assembles air, hotel, rental car and other travel components in bulk and provides complete vacations to travelers through retail travel distributors, such as travel agents, and other distribution channels including the Internet and affinity groups. In March 1998, the Company was recapitalized and between March 1998 and June 1999 acquired the stock or assets of seven other vacation providers and one information system provider. Through these acquisitions, GVG acquired the outstanding capital stock of Haddon Holidays, Inc. ("Haddon"), Classic Custom Vacations ("Classic"), Globetrotters, Inc. ("Globetrotters"), Friendly Holidays, Inc. ("Friendly"), Island Resort Tours, Inc. ("Island"), International Travel & Resorts, Inc. ("ITR"), substantially all the assets of MTI Vacations, Inc. ("MTI"), and Trase Miller Solutions, Inc. ("Trase Miller") (collectively, the "Acquisitions" or the "Acquired Businesses"). The consideration for the Acquisitions consisted primarily of cash. Each acquisition has been accounted for under the purchase method of accounting. The accompanying financial statements for the three months ended March 31, 2000 and 1999 include the results of operations for each of the Acquisitions from their respective acquisition dates.
Net revenues include commissions and markups on travel products and services, volume bonuses received from travel suppliers, cancellation fees and other ancillary fees such as travel waiver premiums and are
generally recognized upon the commencement of travel. For the three months ended March 31, 2000 and 1999, the Company had net revenues of $27.4 million and $22.8 million, respectively, and net loss, before extraordinary charges, of $2.9 million and $1.5 million, respectively, derived from a total dollar value of travel products and services of $120.4 million and $96.2 million, respectively.
Operating expenses include travel agent commissions, salaries, credit card merchant fees, telecommunications, advertising and other costs associated with the selling and processing of travel reservations, products and services. Commission payments to travel agents are typically based on a percentage of the price paid for the travel product or service, but in certain circumstances are fixed dollar amounts. Reservations agents are compensated either on an hourly basis, a commission basis or a combination of the two. The Company's telephone costs primarily relate to the cost of incoming calls on toll-free numbers. General and administrative expenses consist primarily of compensation and benefits to administrative and other non-sales personnel, fees for professional services, and other general office expenses.
The Company derives a significant portion of its pre-tax results from interest earned on funds related to customer deposits and prepayments for vacation products. Generally, the Company requires a deposit within one week of making a travel reservation. Reservations are typically made two to three months prior to departure. Additionally, for packaged tours, the Company generally requires that the entire cost of the vacation be paid in full 45 to 60 days before departure, unless reservations are made closer to departure. While terms vary, the Company generally pays for the vacation components after the customer's departure. In the period between receipt of a deposit or prepayment and the payment of related expenses, these funds are invested in cash and investment-grade securities. This cycle is typical in the packaged tour industry and earnings generated on deposits and prepayments are integral to the Company's operating model and pricing strategies. For the three-month periods ending March 31, 2000 and 1999, the Company had interest income of $529,000 (1.9% of net revenues) and $455,000 (2.0% of net revenues), respectively.
The following table summarizes the Company's historical results of operations as a percentage of net revenues for the three months ended each of March 31, 2000 and 1999.
RESULTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED MARCH 31,
2000 1999
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Amount % Amount %
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Net revenues $27,352 100.0% $22,759 100.0%
Operating expenses 27,367 100.1 21,421 94.1
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Gross profit (15) (0.1) 1,338 5.9
General and administrative expenses 2,418 8.8 3,067 13.5
Depreciation and amortization 1,851 6.8 1,046 4.6
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Loss from operations (4,284) (15.7) (2,775) (12.2)
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Interest income 529 1.9 455 2.0
Interest expense (1,148) (4.2) (144) (0.6)
Other, net (12) -- 9 --
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Loss before income taxes and extraordinary item (4,915) (18.0) (2,455) (10.8)
Income tax benefit 2,018 7.4 917 4.0
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Loss before extraordinary item (2,897) (10.6) (1,538) (6.8)
Extraordinary item, net of income tax benefit of $144 -- -- (257) (1.1)
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Net loss $ (2,897) (10.6)% $ (1,795) (7.9)%
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Net revenues for the three months ended March 31, 2000 and 1999, were $27.4 million and $22.8 million, respectively, which reflects the combined net revenues of the Company and the Acquired Businesses after the respective dates of acquisition. The increase in net revenues of 20.2% for the three months ended March 31, 2000 were primarily due to the full quarter effect of the 1999 acquired businesses and increased sales at the Classic Custom Vacations brand.
The Company's net revenues generally are highest in the second and third quarters of the year, while its expenses, as a percentage of net revenues, generally are highest in the first and fourth quarters.
Operating expenses for the three months ended March 31, 2000 and 1999, were $27.4 million and $21.4 million, respectively, or 100.1% and 94.1%, respectively, of net revenues. The increase in operating expenses is due to the product roll out of Better Homes and Gardens in test markets and increased advanced bookings during the three months ended March 31, 2000 in comparison to the three months ended March 31, 1999. In addition, the operations related to 1999 acquisitions are not as impacted by seasonality changes and maintain relatively flat levels of operating expenses from quarter to quarter.
General and administrative expenses for the three months ended March 31, 2000 and 1999 were $2.4 million and $3.1 million, respectively, or 8.8% and 13.5%, respectively, of net revenues. The decrease in general and administrative expenses of 21.2% is primarily due to decreases in professional fees and outside services and the integration of certain operations of the Acquired Businesses into other brands.
Depreciation and amortization for the three months ended March 31, 2000 and 1999 was $1.9 million and $1.0 million or 6.8% and 4.6%, respectively, of net revenues. The increase is due to the amortization of goodwill and certain intangible assets and depreciation of the technology platform acquired in the 1999 Acquisitions.
Interest income for the three months ended March 31, 2000 and 1999 was $529,000 and $455,000, respectively, or 1.9% and 2.0%, respectively, of net revenues. The increase is due to greater levels of invested cash and generally higher rates of returns for the three months ended March 31, 2000 in comparison to the three months ended March 31, 1999.
Interest expense for the three months ended March 31, 2000 and 1999 was $1.1 million and $144,000, respectively. The increase is due to higher levels of borrowings from the Company's credit facility in the three months ended March 31, 2000 in comparison to the same period in March 31, 1999 due to the 1999 acquisitions. In addition, the average borrowing rate on debt for the three months ended March 31, 2000 was higher due to U.S. financial market conditions and changes in the Company's credit facility in comparison to the same period ended March 31, 1999.
The benefit for income taxes for the three months ended March 31, 2000 and 1999 was $2.0 million and $917,000, respectively, at tax rates of 41.1% for 2000 and 37.4 % for 1999.
Net loss for the three months ended March 31, 1999 includes an extraordinary charge of $257,000, net of tax benefit of $144,000, related to the restructuring of the Company's credit facility.
Net loss for the three months ended March 31, 2000 and 1999 was $2.9 million and $1.8 million, respectively, or 10.6%, and 7.9%, respectively, of net revenues.
LIQUIDITY AND CAPITAL RESOURCES
The Company receives advance payments and deposits prior to commencement of travel. The Company's pricing of its products and services is determined, in part, based upon the amount and timing of advance payments received. A number of states have regulations with respect to the financial security and handling of customer deposits made in advance of travel. The Company believes it is in compliance with all applicable regulations relating to customer deposits. The Company's investment policy and its credit facility restrict investments to investment-grade securities.
The Company's operating results during the year ended December 31, 1999 required the Company to restructure its credit facility agreement (the "Second Amended Agreement") with the Lenders. The Second Amended Agreement changes the previously established acquisition line of credit into a revolving line and adjusts the total capacity of the facility to $41 million with maturity on January 31, 2002. The facility allows for cash borrowings of up to $35 million and for the issuance of standby letters of credit up to a total of $10 million. The total commitment and amount available for cash borrowings are scheduled to reduce by $5 million on January 14, 2000, December 31, 2000 and December 31, 2001 with the final $26 million at maturity. In December 1999, the Company made a voluntary permanent prepayment of $5 million satisfying the January 14, 2000 scheduled reduction. Under the Second Amended Agreement, the Company will continue to pay interest at an alternate base rate advances ("ABR Advances") or eurodollar advances ("Eurodollar Advances") plus an applicable margin. Through October 1, 2000 the applicable ABR and Eurodollar Advance Margins are 2.25 and 3.50 percent, respectively.
The Second Amended Agreement also revised the requirements of the Company to meet certain financial ratios and covenants, including minimum EBITDA, minimum customer deposit coverage, interest coverage, and limitations on capital expenditures. The Company received relief from the fixed charge ratio and leverage ratio until October 1, 2000. In exchange for these waivers, the Company agreed to a fee equal to 1.5% of the outstanding credit facility. The Second Amended Agreement also contains an additional fee provision of up to 1.5% of outstanding borrowings if the Company does not raise a minimum of $25 million in equity. The additional fee is earned by the Lenders in 0.25% increments at 90, 120, 150, 180, 240, and 300 days from
October 28, 1999. During the three months ended March 31, 2000, the Company paid $270,000 of these additional fees.
As of March 31, 2000 of the total facility commitment of $36 million and maximum available for cash borrowings of $30 million, the Company had $29.4 million of outstanding borrowings and has issued $5.7 million in standby letters of credit leaving $0.6 million available for cash borrowings or up to $0.9 million available to secure standby letters of credit. The facility allows for additional letters of credit up to a total of $10 million provided that such additional letters of credit are secured by cash deposited with the Lenders. As of March 31, 2000, the Company's average interest rate on outstanding borrowings was approximately 9.85% excluding the effects of amortization of deferred financing costs.
Net cash provided by operating activities for the three months ended March 31, 2000 was $22.4 million as compared to $6.1 million in net cash provided by operating activities in the first three months of 1999. The increase of approximately $16.3 million in operating cash flows relates primarily to the increase in customer deposits in the first three months of 2000 in relation to the same time period in 1999. The increase in customer deposits relates to increased advance bookings and the effect of the 1999 acquisitions.
The Company made capital expenditures of $909,000 in the first three months of 2000 and $1.1 million in the three months ended March 31, 1999. The Company used $2.3 million of cash, net of cash acquired, for acquisitions in the three months ended March 31, 1999. The Company borrowed approximately $10.3 million from its credit facility to finance the acquisition of Friendly Holidays for the period ended March 31, 1999.
Management has seen strong advance bookings for year 2000 The positive trend in year 2000 booking patterns is a result of strong advance bookings at Classic Custom Vacations from existing products, the recent introduction of a Mexico vacation product line and expansion of Caribbean, U.S. and European destination products. The Company's in-bound travel brand, Allied Tours, also continues to post slow growth as a result of continued softness in the Latin American and Asian economies while the corrections at the Globetrotters brand will take time to stabilize and result in positive sales improvement.
The success and future of the Company is dependent on its ability to maximize revenue growth and profitability from its Classic Custom Vacations and Allied Tours brands, while turning around the performance of its Globetrotters brand. Management believes that it has addressed the integration driven operating problems at Globetrotters. If, however, management is unsuccessful in its efforts at Globetrotters, then the Company may be required to restructure some of its operations. If the Company is required to restructure or sell certain of its operations, there can be no assurances that the carrying value of the Company's assets will be fully realized.
New Accounting Standards
In June 1998, the Financials Accounting and Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." The Statement establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. SFAS No. 133 was initially proposed to be effective for all fiscal years beginning after June 15, 1999, however the FASB issued SFAS No. 137 "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133", and the effective date of this SFAS has been deferred until issuance by the FASB. Management has not yet determined the impact of adopting this statement, but' believes it will not have a material impact upon the Company's results of operations or financial position.
In January 2000, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin
("SAB") No. 101, "Revenue Recognition." The Bulletin provides guidance for applying generally accepted accounting principles to revenue recognition, presentation and disclosure in financial statements filed with the SEC. SAB No. 101 is effective no later than the second quarter for fiscal years beginning after December 15, 1999. Management has not yet determined the impact of adopting this statement.
ITEM 3.
Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to market risk from changes in interest rates. The Company prices its products and services, in part, based upon the interest income expected to be received from investing customer deposits and advance payments. The Company's investment policy and the terms of the Company's credit facility restrict the Company to investing these deposits and advance payments only in investment-grade securities. A failure of these investment securities to perform at their historical levels could reduce the interest income realized by the Company, which could have a material adverse effect on the business, financial condition and results of operations of the Company.
Borrowings under the Company's credit facility are also sensitive to changes in interest rates. The fair value of any fixed rate debt is subject to change as a result of movements in interest rates. Such changes could have material adverse effect on the Company's financial position, and results of operations and could also impact the Company's ability to successfully complete acquisitions.