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EX-32.1 - EXHIBIT 32.1 - NCL CORP Ltd.t1702272_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - NCL CORP Ltd.t1702272_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - NCL CORP Ltd.t1702272_ex31-1.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-Q 

 

 

 

(Mark One)

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

 

For the quarterly period ended June 30, 2017

 

OR

 

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

 

For the transition period from                      to                     

 

Commission File Number: 333-128780

 

 

 

NCL CORPORATION LTD.

(Exact name of registrant as specified in its charter)

  

 

 

Bermuda 20-0470163
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

 

7665 Corporate Center Drive, Miami, Florida 33126

(Address of principal executive offices) (zip code)

 

(305) 436-4000

(Registrant’s telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  ¨    No  x

 

(Note: The registrant is a voluntary filer of reports required to be filed under Section 13 or 15 (d) of the Securities Exchange Act of 1934).

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

 

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

 

Large accelerated filer ¨ Accelerated filer ¨
Non-accelerated filer x  (Do not check if a smaller reporting company) Smaller reporting company ¨
Emerging growth company ¨  

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ¨

 

There were 31,164,004 ordinary shares outstanding as of July 31, 2017. 

 

 

 

 

 

 

TABLE OF CONTENTS

 

    Page
PART I. FINANCIAL INFORMATION  
     
Item 1. Financial Statements 1
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 15
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
     
Item 4. Controls and Procedures 26
   
PART II. OTHER INFORMATION  
     
Item 1. Legal Proceedings 28
     
Item 1A. Risk Factors 28
     
Item 5. Other Information 28
     
Item 6. Exhibits 28
   
SIGNATURES 29

 

 

 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

NCL Corporation Ltd.

Consolidated Statements of Operations

(Unaudited)

(in thousands)

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Revenue                    
Passenger ticket  $938,014   $818,478   $1,724,708   $1,558,590 
Onboard and other   406,089    368,357    770,176    705,877 
Total revenue   1,344,103    1,186,835    2,494,884    2,264,467 
Cruise operating expense                    
Commissions, transportation and other   223,315    193,536    417,455    368,973 
Onboard and other   83,367    75,790    151,778    139,755 
Payroll and related   194,724    184,476    387,360    361,619 
Fuel   86,663    80,607    175,549    162,279 
Food   47,340    49,769    93,518    100,772 
Other   116,833    121,722    246,380    236,983 
Total cruise operating expense   752,242    705,900    1,472,040    1,370,381 
Other operating expense                    
Marketing, general and administrative   192,965    148,569    384,511    328,159 
Depreciation and amortization   123,141    104,610    242,346    205,905 
Total other operating expense   316,106    253,179    626,857    534,064 
Operating income   275,755    227,756    395,987    360,022 
Non-operating income (expense)                    
Interest expense, net   (64,196)   (68,420)   (117,158)   (128,174)
Other income (expense), net   (5,609)   (10,753)   (8,424)   (7,948)
Total non-operating income (expense)   (69,805)   (79,173)   (125,582)   (136,122)
Net income before income taxes   205,950    148,583    270,405    223,900 
Income tax expense   (4,509)   (484)   (5,826)   (828)
Net income  $201,441   $148,099   $264,579   $223,072 

 

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

 

 1 

 

NCL Corporation Ltd.

Consolidated Statements of Comprehensive Income

(Unaudited)

(in thousands)

  

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Net income  $201,441   $148,099   $264,579   $223,072 
Other comprehensive income:                    
Shipboard Retirement Plan   104    108    209    216 
Cash flow hedges:                    
Net unrealized income   131,519    5,007    124,236    75,457 
Amount realized and reclassified into earnings   10,244    23,781    19,949    58,331 
Total other comprehensive income   141,867    28,896    144,394    134,004 
Total comprehensive income  $343,308   $176,995   $408,973   $357,076 

 

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

 

 2 

 

NCL Corporation Ltd.

Consolidated Balance Sheets

(Unaudited)

(in thousands, except share data)

 

   June 30,
2017
   December 31,
2016
 
Assets          
Current assets:          
Cash and cash equivalents  $217,211   $126,041 
Accounts receivable, net   50,359    63,215 
Inventories   77,089    66,255 
Prepaid expenses and other assets   166,618    153,168 
Total current assets   511,277    408,679 
Property and equipment, net   10,974,087    10,117,689 
Goodwill   1,388,931    1,388,931 
Tradenames   817,525    817,525 
Other long-term assets   231,772    218,295 
Total assets  $13,923,592   $12,951,119 
Liabilities and shareholders’ equity          
Current liabilities:          
Current portion of long-term debt  $600,500   $560,193 
Accounts payable   47,178    37,946 
Accrued expenses and other liabilities   462,470    541,906 
Due to NCLH   53,623    44,104 
Advance ticket sales   1,543,869    1,172,870 
Total current liabilities   2,707,640    2,357,019 
Long-term debt   6,083,226    5,838,494 
Other long-term liabilities   200,047    267,933 
Total liabilities   8,990,913    8,463,446 
Commitments and contingencies (Note 8)          
Shareholders’ equity:          
Ordinary shares, $.0012 par value; 40,000,000 shares authorized; 31,164,004 shares issued and outstanding at June 30, 2017 and December 31, 2016   37    37 
Additional paid-in capital   3,829,922    3,796,042 
Accumulated other comprehensive income (loss)   (171,792)   (316,186)
Retained earnings   1,274,512    1,007,780 
Total shareholders’ equity   4,932,679    4,487,673 
Total liabilities and shareholders’ equity  $13,923,592   $12,951,119 

 

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

 

 3 

 

NCL Corporation Ltd.

Consolidated Statements of Cash Flows

(Unaudited)

(in thousands)

 

   Six Months Ended
June 30,
 
   2017   2016 
Cash flows from operating activities          
Net income  $264,579   $223,072 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization expense   248,618    212,268 
Loss on derivatives   375    2,866 
Deferred income taxes, net   4,732    388 
Write-off of deferred financing fees       11,427 
Provision for bad debts and inventory   535    1,115 
Share-based compensation expense   42,220    31,449 
Changes in operating assets and liabilities:          
Accounts receivable, net   12,301    (16,146)
Inventories   (10,814)   (9,674)
Prepaid expenses and other assets   (21,292)   (25,674)
Accounts payable   10,121    (10,896)
Accrued expenses and other liabilities   (28,668)   (26,112)
Advance ticket sales   400,920    358,625 
Net cash provided by operating activities   923,627    752,708 
Cash flows from investing activities          
Additions to property and equipment, net   (1,065,265)   (764,899)
Settlement of derivatives   (35,255)   (34,129)
Net cash used in investing activities   (1,100,520)   (799,028)
Cash flows from financing activities          
Repayments of long-term debt   (921,329)   (2,386,427)
Repayments to Affiliate       (18,522)
Proceeds from long-term debt   1,217,060    2,564,116 
Due to NCLH, net   9,519    10,648 
Dividends       (64,000)
Net share settlement of restricted share units   (6,187)    
Deferred financing fees and other   (31,000)   (32,330)
Net cash provided by financing activities   268,063    73,485 
Net increase in cash and cash equivalents   91,170    27,165 
Cash and cash equivalents at beginning of period   126,041    113,183 
Cash and cash equivalents at end of period  $217,211   $140,348 

 

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

 

 4 

 

NCL Corporation Ltd.

Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

(in thousands)

 

           Accumulated         
       Additional   Other       Total 
   Ordinary   Paid-in   Comprehensive   Retained   Shareholders’ 
   Shares   Capital   Income (Loss)   Earnings   Equity 
                     
Balance, December 31, 2015  $37   $3,729,628   $(414,363)  $428,057   $3,743,359 
Share-based compensation       31,449            31,449 
Dividends               (64,000)   (64,000)
Other comprehensive income, net           134,004        134,004 
Net income               223,072    223,072 
Balance, June 30, 2016  $37   $3,761,077   $(280,359)  $587,129   $4,067,884 
                          
Balance, December 31, 2016  $37   $3,796,042   $(316,186)  $1,007,780   $4,487,673 
Share-based compensation       42,220            42,220 
Change in accounting policy (share-based forfeitures)       (2,153)       2,153     
Net share settlement of restricted share units       (6,187)           (6,187)
Other comprehensive income, net           144,394        144,394 
Net income               264,579    264,579 
Balance, June 30, 2017  $37   $3,829,922   $(171,792)  $1,274,512   $4,932,679 

 

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

 

 5 

 

NCL Corporation Ltd.

Notes to Consolidated Financial Statements

(Unaudited)

 

Unless otherwise indicated or the context otherwise requires, references in this report to (i) the “Company,” “we,” “our” and “us” refer to NCLC (as defined below) and its subsidiaries (including Prestige (as defined below), except for periods prior to the consummation of the Acquisition of Prestige (as defined below)), (ii) “NCLC” refers to NCL Corporation Ltd., (iii) “NCLH” refers to Norwegian Cruise Line Holdings Ltd., (iv) “Norwegian Cruise Line” or “Norwegian” refers to the Norwegian Cruise Line brand and its predecessors, (v) “Prestige” refers to Prestige Cruises International, Inc., together with its consolidated subsidiaries, and (vi) “PCH” refers to Prestige Cruise Holdings, Inc., Prestige’s direct wholly owned subsidiary, which in turn is the parent of Oceania Cruises, Inc. (“Oceania Cruises”) and Seven Seas Cruises S. DE R.L. (“Regent”) (Oceania Cruises also refers to the brand by the same name and Regent also refers to the brand Regent Seven Seas Cruises). References to the “U.S.” are to the United States of America, “dollars” or “$” are to U.S. dollars, the “U.K.” are to the United Kingdom and “euros” or “€” are to the official currency of the Eurozone. 

 

1.Description of Business and Organization

 

NCLH is a leading global cruise company which operates the Norwegian Cruise Line, Oceania Cruises and Regent Seven Seas Cruises brands. As of June 30, 2017, we had 25 ships with approximately 50,400 Berths. We plan to introduce seven additional ships through 2025 and we have an option to introduce two additional ships for delivery in 2026 and 2027, subject to certain conditions. Norwegian Bliss and an additional Breakaway Plus Class Ship are on order for delivery in the spring of 2018 and fall of 2019. We have an Explorer Class Ship on order for delivery in the winter of 2020. Project Leonardo will introduce an additional four ships with expected delivery dates through 2025. These additions to our fleet (exclusive of the option for two additional ships) will increase our total Berths to approximately 72,300.

 

2.Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying consolidated financial statements are unaudited and, in our opinion, contain all normal recurring adjustments necessary for a fair statement of the results for the periods presented.

 

Our operations are seasonal and results for interim periods are not necessarily indicative of the results for the entire fiscal year. Historically, demand for cruises has been strongest during the Northern Hemisphere’s summer months. The interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2016, which are included in our most recently filed Annual Report on Form 10-K.

 

Reclassification

 

Certain amounts in prior periods have been reclassified to conform to the current period presentation.

 

Revenue and Expense Recognition

 

Revenue and expenses include port fees and taxes. The amounts included on a gross basis are $80.4 million and $71.5 million for the three months ended June 30, 2017 and 2016, respectively, and $152.1 million and $134.0 million for the six months ended June 30, 2017 and 2016, respectively.

 

Foreign Currency

 

The majority of our transactions are settled in U.S. dollars. We translate assets and liabilities of our foreign subsidiaries at exchange rates in effect at the balance sheet date. We recognized a loss of $8.1 million and a gain of $3.7 million for the three months ended June 30, 2017 and 2016, respectively, and losses of $10.8 million and $0.3 million for the six months ended June 30, 2017 and 2016, respectively.

 

Depreciation and Amortization Expense

 

The amortization of deferred financing fees is included in depreciation and amortization expense in the consolidated statements of cash flows; however, for purposes of the consolidated statements of operations they are included in interest expense, net.

 

Recently Issued Accounting Pronouncements

 

In January 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2017-04 which simplifies the test for goodwill impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. The guidance is effective for annual or any interim goodwill impairment tests in years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. We do not expect to early adopt this guidance. We are currently evaluating the impact of the adoption of this guidance to our consolidated financial statements.

 

 6 

 

In August 2016, the FASB issued ASU No. 2016-15 which amends Topic 230 (Statement of Cash Flows) to eliminate discrepancies in reporting certain items in the statement of cash flows. The guidance is effective for annual periods beginning after December 15, 2017 and interim periods within those annual periods with early adoption permitted. The transition should be made using a retrospective approach. We do not believe that the adoption of this guidance will be material to our consolidated statements of cash flows.

 

In May 2016, the FASB issued ASU No. 2016-12 which addresses improvements to the guidance on revenue from contracts from customers regarding collectability, noncash consideration, and completed contracts at transition. Additionally, it provides a practical expedient for contract modifications at transition and an accounting policy election related to the presentation of sales taxes and other similar taxes collected from customers. The effective date of this guidance is upon adoption of ASU No. 2014-09 which is presented below. We are currently evaluating the impact of the adoption of this guidance to our consolidated financial statements.

 

In May 2016, the FASB issued ASU No. 2016-11 which is a rescission of Securities and Exchange Commission guidance related to the issuance of ASU No. 2014-09 which is presented below. The effective date of this guidance is upon adoption of ASU No. 2014-09. We are currently evaluating the impact of the adoption of this guidance to our consolidated financial statements.

 

In April 2016, the FASB issued ASU No. 2016-10 which does not change the core principle of the guidance in ASU No. 2014-09 but clarifies two aspects: identifying performance obligations and the licensing implementation guidance, while retaining the related principles for those areas. The effective date of this guidance is upon adoption of ASU No. 2014-09. We are currently evaluating the impact of the adoption of this guidance to our consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02 which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors). The ASU requires lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by all leases with terms of more than 12 months. The ASU further modifies lessors’ classification criteria for leases and the accounting for sales-type and direct financing leases. The ASU will also require qualitative and quantitative disclosures designed to give financial statement users additional information on the amount, timing, and uncertainty of cash flows arising from leases. The ASU is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2018 with early adoption permitted. The ASU is to be applied using a modified retrospective approach. To evaluate the impact of the adoption of this guidance, we are currently reviewing our existing leases and evaluating contracts to determine what might be considered a lease under the new guidance.

 

In May 2014, the FASB issued ASU No. 2014-09 which requires entities to recognize revenue through the application of a five-step model, including identification of the contract, identification of the performance obligations, determination of the transaction price, allocation of the transaction price to the performance obligation and recognition of revenue as the entity satisfies the performance obligations. Entities have the option of using either a full retrospective or a modified approach to adopt the guidance.

 

In August 2015, the FASB issued ASU No. 2015-14 deferring the effective date for one year. We can elect to adopt the provisions of ASU No. 2014-09 for annual periods beginning after December 15, 2017 including interim periods within that reporting period or we can elect to early adopt the guidance as of the original effective date. We expect to adopt a modified retrospective application for annual periods beginning after December 15, 2017. We have initiated an assessment of our systems, data and processes related to the implementation of this guidance. This assessment is expected to be completed during 2017. Additionally, we are currently evaluating our performance obligations and believe that our application of the guidance could result in changes in classification and additional disclosures. We also are evaluating other criteria such as the timing of contract terms, gross and net presentation and other items that the guidance addresses.

 

3.Intangible Assets

 

The gross carrying amounts of intangible assets included within other long-term assets, the related accumulated amortization, the net carrying amounts and the weighted-average amortization periods of the Company’s intangible assets are listed in the following tables (in thousands, except amortization period):

 

   June 30, 2017 
   Gross Carrying
Amount
   Accumulated
Amortization
   Net Carrying
Amount
   Weighted-
Average
Amortization
Period (Years)
 
Customer relationships  $120,000   $(51,730)  $68,270    6.0 
Licenses   3,368    (1,171)   2,197    5.6 
Non-compete agreements   660    (660)       1.0 
Total intangible assets subject to amortization  $124,028   $(53,61)  $70,467      
License (Indefinite-lived)  $4,427                

  

 7 

 

   December 31, 2016 
   Gross Carrying
Amount
   Accumulated
Amortization
   Net Carrying
Amount
   Weighted-
Average
Amortization
Period (Years)
 
Customer relationships  $120,000   $(36,593)  $83,407    6.0 
Licenses   3,368    (807)   2,561    5.6 
Non-compete agreements   660    (495)   165    1.0 
Total intangible assets subject to amortization  $124,028   $(37,895)  $86,133      
License (Indefinite-lived)  $4,427                

 

The aggregate amortization expense is as follows (in thousands):

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Amortization expense  $7,750   $5,562   $15,665   $10,951 

 

The following table sets forth the Company’s estimated aggregate amortization expense for each of the five years below (in thousands):

 

Year ended December 31,  Amortization
Expense
 
2018  $26,163 
2019   18,489 
2020   9,906 
2021   75 
2022   75 

 

4.Accumulated Other Comprehensive Income (Loss)

 

Accumulated other comprehensive income (loss) for the six months ended June 30, 2017 was as follows (in thousands):

 

   Accumulated
Other
Comprehensive
Income (Loss)
   Change
Related to
Cash Flow
Hedges
   Change
Related to
Shipboard
Retirement
Plan
 
Accumulated other comprehensive income (loss) at beginning of period  $(316,186)  $(308,265)  $(7,921)
Current period other comprehensive income before reclassifications   124,236    124,236     
Amounts reclassified into earnings   20,158    19,949(1)   209(2)
Accumulated other comprehensive income (loss) at end of period  $(171,792)  $(164,080)(3)  $(7,712)

 

  (1) We refer you to Note 6 — “Fair Value Measurements and Derivatives” for the affected line items in the consolidated statements of operations.
  (2) Amortization of prior-service cost and actuarial loss reclassified to payroll and related expense.
  (3) Includes $44.4 million of loss expected to be reclassified into earnings in the next 12 months.

 

 8 

 

Accumulated other comprehensive income (loss) for the six months ended June 30, 2016 was as follows (in thousands):

 

   Accumulated
Other
Comprehensive
Income (Loss)
   Change
Related to
Cash Flow
Hedges
   Change
Related to
Shipboard
Retirement
Plan
 
Accumulated other comprehensive income (loss) at beginning of period  $(414,363)  $(405,945)  $(8,418)
Current period other comprehensive income before reclassifications   75,457    75,457     
Amounts reclassified into earnings   58,547    58,331(1)   216(2)
Accumulated other comprehensive income (loss) at end of period  $(280,359)  $(272,157)  $(8,202)

 

(1)We refer you to Note 6— “Fair Value Measurements and Derivatives” for the affected line items in the consolidated statements of operations.

(2)Amortization of prior-service cost and actuarial loss reclassified to payroll and related expense.

 

5.Property and Equipment, net

 

Property and equipment, net increased $856.4 million for the six months ended June 30, 2017 primarily due to the delivery of Norwegian Joy, ships under construction and ship improvement projects.

 

6.Fair Value Measurements and Derivatives

 

Fair value is defined as the price at which an orderly transaction to sell an asset or to transfer a liability would take place between market participants at the measurement date under current market conditions (that is, an exit price at the measurement date from the perspective of a market participant that holds the asset or owes the liability).

 

Fair Value Hierarchy

 

The following hierarchy for inputs used in measuring fair value should maximize the use of observable inputs and minimize the use of unobservable inputs by requiring that the most observable inputs be used when available:

 

Level 1   Quoted prices in active markets for identical assets or liabilities that are accessible at the measurement dates.
   
Level 2 Significant other observable inputs that are used by market participants in pricing the asset or liability based on market data obtained from independent sources.
   
Level 3 Significant unobservable inputs we believe market participants would use in pricing the asset or liability based on the best information available.

 

Derivatives

 

We are exposed to market risk attributable to changes in interest rates, foreign currency exchange rates and fuel prices. We attempt to minimize these risks through a combination of our normal operating and financing activities and through the use of derivatives. We assess whether derivatives used in hedging transactions are “highly effective” in offsetting changes in the cash flow of our hedged forecasted transactions. We use regression analysis for this hedge relationship and high effectiveness is achieved when a statistically valid relationship reflects a high degree of offset and correlation between the fair values of the derivative and the hedged forecasted transaction. Cash flows from the derivatives are classified in the same category as the cash flows from the underlying hedged transaction. The determination of ineffectiveness is based on the amount of dollar offset between the cumulative change in fair value of the derivative and the cumulative change in fair value of the hedged transaction at the end of the reporting period. If it is determined that a derivative is not highly effective as a hedge, or if the hedged forecasted transaction is no longer probable of occurring, then the amount recognized in accumulated other comprehensive income (loss) is released to earnings. In addition, the ineffective portion of our highly effective hedges is recognized in earnings immediately and reported in other income (expense), net in our consolidated statements of operations. There are no amounts excluded from the assessment of hedge effectiveness and there are no credit-risk-related contingent features in our derivative agreements.

 

We monitor concentrations of credit risk associated with financial and other institutions with which we conduct significant business. Credit risk, including but not limited to counterparty non-performance under derivatives and our New Revolving Loan Facility, is not considered significant, as we primarily conduct business with large, well-established financial institutions that we have established relationships with and that have credit risks acceptable to us or the credit risk is spread out among a large number of creditors. We do not anticipate non-performance by any of our significant counterparties.

 

 9 

 

The following table sets forth our derivatives measured at fair value and discloses the balance sheet location (in thousands):

 

      Asset   Liability 
  Balance Sheet location  June 30,
2017
   December 31,
2016
   June 30,
2017
   December 31,
2016
 
Fuel swaps designated as hedging instruments                       
   Prepaid expenses and other assets  $5,955   $20,288   $   $ 
   Other long-term assets   897             
   Accrued expenses and other liabilities   1,056        41,865    44,271 
   Other long-term liabilities   6,255    13,237    34,529    38,608 
Foreign currency forward contracts designated as hedging instruments                       
   Prepaid expenses and other assets   13,509        144     
   Other long-term assets   28,718    14         
   Accrued expenses and other liabilities   2,141        4,665    61,788 
   Other long-term liabilities               88,920 
Interest rate swaps designated as hedging instruments                       
   Accrued expenses and other liabilities           2,546    3,331 
   Other long-term liabilities               1,151 

 

The fair values of swap and forward contracts are determined based on inputs that are readily available in public markets or can be derived from information available in publicly quoted markets. The Company determines the value of options and collars utilizing an option pricing model based on inputs that are either readily available in public markets or can be derived from information available in publicly quoted markets. The option pricing model used by the Company is an industry standard model for valuing options and is used by the broker/dealer community. The inputs to this option pricing model are the option strike price, underlying price, risk-free rate of interest, time to expiration, and volatility. The fair value of option contracts considers both the intrinsic value and any remaining time value associated with those derivatives that have not yet settled. The Company also considers counterparty credit risk and its own credit risk in its determination of all estimated fair values. Our derivatives and financial instruments were categorized as Level 2 in the fair value hierarchy, and we had no derivatives or financial instruments categorized as Level 1 or Level 3. Our derivative contracts include rights of offset with our counterparties. We have elected to net certain assets and liabilities within counterparties when the rights of offset exist. We are not required to post cash collateral related to our derivative instruments.

 

The following table discloses the gross and net amounts recognized within assets and liabilities (in thousands):

 

June 30, 2017  Gross Amounts   Gross
Amounts
Offset
   Total Net
Amounts
   Gross
Amounts Not
Offset
   Net Amounts 
Assets  $49,079   $(144)  $48,935   $(40,103)  $8,832 
Liabilities   83,605    (9,452)   74,153    (3,609)   70,544 

 

December 31, 2016  Gross Amounts   Gross
Amounts
Offset
   Total Net
Amounts
   Gross
Amounts Not
Offset
   Net Amounts 
Assets  $20,302   $   $20,302   $(14)  $20,288 
Liabilities   238,069    (13,237)   224,832    (155,190)   69,642 

 

Fuel Swaps

 

As of June 30, 2017, we had fuel swaps maturing through December 31, 2020 which are used to mitigate the financial impact of volatility in fuel prices pertaining to approximately 1.5 million metric tons of our projected fuel purchases.

 

The effects on the consolidated financial statements of the fuel swaps which were designated as cash flow hedges were as follows (in thousands):

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Gain (loss) recognized in other comprehensive income  – effective portion  $(4,884)  $85,808   $(31,087)  $76,302 
Loss recognized in other income (expense), net – ineffective portion   (431)   (3,524)   (801)   (8,751)
Amount reclassified from accumulated other comprehensive income (loss) into fuel expense   8,584    20,440    16,587    51,577 

 

We had fuel swaps that matured which were not designated as cash flow hedges. These fuel swaps were previously designated as cash flow hedges and were dedesignated due to a change in our expected future fuel purchases mix.

 

 10 

 

The effects on the consolidated financial statements of the fuel swaps which were dedesignated and recognized into earnings were as follows (in thousands):

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Loss recognized in other income (expense), net  $   $(92)  $   $(92)
Amount reclassified from accumulated other comprehensive income (loss) into other income (expense), net       1,465        2,994 

 

Foreign Currency Options

 

We had foreign currency options that matured which consisted of call options with deferred premiums. These options were used to mitigate the financial impact of volatility in foreign currency exchange rates related to our ship construction contracts denominated in euros. If the spot rate at the date the ships were delivered was less than the strike price under these option contracts, we would have paid the deferred premium and would not exercise the foreign currency options.

 

The effects on the consolidated financial statements of the foreign currency options which were designated as cash flow hedges were as follows (in thousands):

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Amount reclassified from accumulated other comprehensive income (loss) into depreciation and amortization expense  $330   $330   $660   $660 

 

Foreign Currency Forward Contracts

 

As of June 30, 2017, we had foreign currency forward contracts which are used to mitigate the financial impact of volatility in foreign currency exchange rates related to our ship construction contracts denominated in euros. The notional amount of our foreign currency forward contracts was €1.8 billion, or $2.1 billion based on the euro/U.S. dollar exchange rate as of June 30, 2017.

 

The effects on the consolidated financial statements of the foreign currency forward contracts which were designated as cash flow hedges were as follows (in thousands): 

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Gain (loss) recognized in other comprehensive income – effective portion  $136,428   $(79,900)  $155,064   $2,611 
Gain (loss) recognized in other income (expense), net – ineffective portion   (16)   (2)   (66)   9 
Amount reclassified from accumulated other comprehensive income (loss) into depreciation and amortization expense   656    656    1,274    1,301 

 

The effects on the consolidated financial statements of foreign currency forward contracts which were not designated as cash flow hedges were as follows (in thousands):

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Loss recognized in other income (expense), net  $   $(6,133)  $   $(6,133)

 

Foreign Currency Collar

 

We had foreign currency collars that matured and were used to mitigate the volatility of foreign currency exchange rates related to our ship construction contracts denominated in euros.

 

The effects on the consolidated financial statements of the foreign currency collar which was designated as a cash flow hedge was as follows (in thousands):

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Amount reclassified from accumulated other comprehensive income (loss) into depreciation and amortization expense  $(91)  $(91)  $(182)  $(182)

 

 11 

 

The effect on the consolidated financial statements of the foreign currency collar which was not designated as a cash flow hedge was as follows (in thousands):

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Gain (loss) recognized in other income (expense), net  $   $(3,313)  $   $10,312 

 

Interest Rate Swaps

 

As of June 30, 2017, we had interest rate swap agreements to hedge our exposure to interest rate movements and to manage our interest expense. The notional amount of outstanding debt associated with the interest rate swap agreements was $250.7 million as of June 30, 2017.

 

The effects on the consolidated financial statements of the interest rate swaps which were designated as cash flow hedges were as follows (in thousands):

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Gain (loss) recognized in other comprehensive income – effective portion  $(25)  $(901)  $259   $(3,456)
Gain recognized in other income (expense), net – ineffective portion               3 
Amount reclassified from accumulated other comprehensive income (loss) into interest expense, net   765    981    1.610    1,981 

 

Long-Term Debt

 

As of June 30, 2017 and December 31, 2016, the fair value of our long-term debt, including the current portion, was $6,864.4 million and $6,525.7 million, respectively, which was $48.1 million and $11.6 million higher, respectively, than the carrying values. The difference between the fair value and carrying value of our long-term debt is due to our fixed and variable rate debt obligations carrying interest rates that are above or below market rates at the measurement dates. The fair value of our long-term debt was calculated based on estimated rates for the same or similar instruments with similar terms and remaining maturities resulting in Level 2 inputs in the fair value hierarchy. Market risk associated with our long-term variable rate debt is the potential increase in interest expense from an increase in interest rates. The calculation of the fair value of our long-term debt is considered a Level 2 input.

 

Other

 

The carrying amounts reported in the consolidated balance sheets of all other financial assets and liabilities approximate fair value.

 

7.Employee Benefits and Compensation Plans

 

Share-Based Compensation

 

As a result of NCLH’s adoption of ASU No. 2016-09, beginning in the first quarter of 2017, NCLH began accounting for forfeitures as they occur, rather than estimating expected forfeitures. Pursuant to the modified-retrospective application, the net cumulative effect of this change was recognized as a $2.2 million increase to retained earnings as of January 1, 2017 (we refer you to our consolidated statements of changes in shareholders’ equity).

 

Share Option Awards

 

The following is a summary of option activity under NCLH’s Amended and Restated 2013 Performance Incentive Plan for the six months ended June 30, 2017 (excludes the impact of 208,335 previously awarded performance-based options as no grant date has been established):

 

 12 

 

   Number of Share Option
Awards
   Weighted-Average Exercise
Price
   Weighted-
Average
Contractual Term
  

Aggregate

Intrinsic Value

 
   Time-
Based
Awards
   Performance-
Based
Awards
   Market-
Based
Awards
   Time-
Based
Awards
   Performance-
Based
Awards
   Market-
Based
Awards
   (years)   (in thousands) 
Outstanding as of January 1, 2017   7,775,058    432,978    208,333   $48.04   $23.86   $59.43    7.81   $35,429 
Granted       156,249            59.43             
Exercised   (383,203)   (59,218)       28.33    19.00             
Forfeited and cancelled   (325,030)   (93,749)       55.03    59.43             
Outstanding as of June 30, 2017   7,066,825    436,260    208,333   $48.79   $29.62   $59.43    7.44   $61,204 

 

Restricted Ordinary Share Awards

 

The following is a summary of restricted NCLH ordinary share activity for the six months ended June 30, 2017:

 

   Number of
Time-Based
Awards
   Weighted-
Average Grant
Date Fair
Value
 
Non-vested as of January 1, 2017   16,872   $7.63 
Granted        
Vested   (11,338)   5.53 
Forfeited or expired        
Non-vested and expected to vest as of June 30, 2017   5,534   $11.94 

 

Restricted Share Unit Awards

 

On March 1, 2017, NCLH granted 1.7 million time-based restricted share unit awards to our employees which vest equally over three years. Additionally, on March 1, 2017, NCLH awarded 121,000 performance-based restricted share units to certain members of our management team which vest upon the achievement of certain pre-established performance targets.

 

The following is a summary of restricted share unit activity for the six months ended June 30, 2017 (excludes the impact of 171,000 previously awarded performance-based restricted share units as no grant date was established):

 

   Number of
Time-Based
Awards
   Weighted-
Average Grant
Date Fair
Value
   Number of
Performance-
Based
Awards
   Weighted-
Average Grant
Date Fair Value
   Number of
Market-
Based
Awards
   Weighted-
Average Grant
Date Fair Value
 
Non-vested as of January 1, 2017   1,305,335   $50.38       $    50,000   $59.43 
Granted   1,750,612    50.96    37,500    49.76         
Vested   (440,508)   50.67    (15,000)   49.76         
Forfeited or expired   (36,507)   50.61    (22,500)   49.76         
Non-vested and expected to vest as of June 30, 2017   2,578,932    50.72            50,000    59.43 

 

The share-based compensation expense for the six months ended June 30, 2017 was $42.2 million of which $38.5 million was recorded in marketing, general and administrative expense and $3.7 million was recorded in payroll and related expense.

 

8.Commitments and Contingencies

 

Ship Construction Contracts

 

Project Leonardo will introduce an additional four ships with expected delivery dates through 2025 and we have an option to introduce two additional ships for delivery in 2026 and 2027, subject to certain conditions. These four ships are each approximately 140,000 Gross Tons with approximately 3,300 Berths. We have an Explorer Class Ship on order for delivery in the winter of 2020. This ship is approximately 55,000 Gross Tons and 750 Berths. We have two Breakaway Plus Class Ships on order for delivery in the spring of 2018 and fall of 2019, respectively. These ships are approximately 168,000 Gross Tons each with approximately 4,000 Berths each. The combined contract price of these seven ships was approximately €5.5 billion, or $6.3 billion based on the euro/U.S. dollar exchange rate as of June 30, 2017. We have export credit financing in place that provides financing for 80% of each ship’s contract price. For ships expected to be delivered after 2023, the contract price is subject to adjustment under certain circumstances.

 

In connection with the contracts to build the ships, we do not anticipate any contractual breach or cancellation to occur. However, if any would occur, it could result in, among other things, the forfeiture of prior deposits or payments made by us and potential claims and impairment losses which may materially impact our business, financial condition and results of operations.

 

 13 

 

Litigation

 

In the normal course of our business, various claims and lawsuits have been filed or are pending against us. Most of these claims and lawsuits are covered by insurance and, accordingly, the maximum amount of our liability is typically limited to our deductible amount.

 

Nonetheless, the ultimate outcome of the claims and lawsuits that are not covered by insurance cannot be determined at this time. We have evaluated our overall exposure with respect to all of our threatened and pending litigation and, to the extent required, we have accrued amounts for all estimable probable losses associated with our deemed exposure. We are currently unable to estimate any other potential contingent losses beyond those accrued, as discovery is not complete nor is adequate information available to estimate such range of loss or potential recovery. However, based on our current knowledge, we do not believe that the aggregate amount or range of reasonably possible losses with respect to these matters will be material to our consolidated results of operations, financial condition or cash flows. We intend to vigorously defend our legal position on all claims and, to the extent necessary, seek recovery.

 

9.Other Income (Expense), Net

 

For the three months ended June 30, 2017, other income (expense), net was a $5.6 million expense which included $8.1 million of losses due to foreign currency exchange partially offset by $2.5 million of gains primarily due to a gain from an insurance claim. For the three months ended June 30, 2016, the $10.8 million expense included $14.5 million of losses due to derivatives partially offset by $3.7 million of foreign currency exchange gains. For the six months ended June 30, 2017, the $8.4 million expense included $10.8 million of foreign currency exchange losses partially offset by $2.4 million of gains primarily due to a gain from an insurance claim. For the six months ended June 30, 2016, the $7.9 million expense included $11.8 million of losses on fuel derivatives partially offset by $3.9 million of gains which was primarily due to forward exchange derivative gains.

 

10.Supplemental Cash Flow Information

 

For the six months ended June 30, 2017 and 2016, we had non-cash investing activities in connection with property and equipment of $10.3 million and $32.0 million, respectively. For the six months ended June 30, 2017, we had non-cash investing activities in connection with capital leases of $5.4 million.

 

 14 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Cautionary Statement Concerning Forward-Looking Statements

 

Certain statements in this report constitute forward-looking statements within the meaning of the U.S. federal securities laws intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts contained, or incorporated by reference, in this report, including, without limitation, those regarding our business strategy, financial position, results of operations, plans, prospects and objectives of management for future operations (including development plans and objectives relating to our activities), are forward-looking statements. Many, but not all, of these statements can be found by looking for words like “expect,” “anticipate,” “goal,” “project,” “plan,” “believe,” “seek,” “will,” “may,” “forecast,” “estimate,” “intend” and “future” and similar words. Forward-looking statements do not guarantee future performance and may involve risks, uncertainties and other factors which could cause our actual results, performance or achievements to differ materially from the future results, performance or achievements expressed or implied in those forward-looking statements. Examples of these risks, uncertainties and other factors include, but are not limited to the impact of:

 

  adverse general economic and related factors, such as fluctuating or increasing levels of unemployment, underemployment and the volatility of fuel prices, declines in the securities and real estate markets, and perceptions of these conditions that decrease the level of disposable income of consumers or consumer confidence;
  adverse events impacting the security of travel, such as terrorist acts, armed conflict and threats thereof, acts of piracy, and other international events;
  the risks and increased costs associated with operating internationally;
  our expansion into and investments in new markets;
  breaches in data security or other disturbances to our information technology and other networks;
  the spread of epidemics and viral outbreaks;
  adverse incidents involving cruise ships;
  changes in fuel prices and/or other cruise operating costs;
  any impairment of our tradenames or goodwill;
  our hedging strategies;
  our inability to obtain adequate insurance coverage;
  our substantial indebtedness, including the ability to raise additional capital to fund our operations, and to generate the necessary amount of cash to service our existing debt;
  restrictions in the agreements governing our indebtedness that limit our flexibility in operating our business;
  the significant portion of our assets pledged as collateral under our existing debt agreements and the ability of our creditors to accelerate the repayment of our indebtedness;
  volatility and disruptions in the global credit and financial markets, which may adversely affect our ability to borrow and could increase our counterparty credit risks, including those under our credit facilities, derivatives, contingent obligations, insurance contracts and new ship progress payment guarantees;
  fluctuations in foreign currency exchange rates;
  overcapacity in key markets or globally;
  our inability to recruit or retain qualified personnel or the loss of key personnel;
  future changes relating to how external distribution channels sell and market our cruises;
  our reliance on third parties to provide hotel management services to certain ships and certain other services;
  delays in our shipbuilding program and ship repairs, maintenance and refurbishments;
  future increases in the price of, or major changes or reduction in, commercial airline services;
  seasonal variations in passenger fare rates and occupancy levels at different times of the year;
  our ability to keep pace with developments in technology;
  amendments to our collective bargaining agreements for crew members and other employee relation issues;
  the continued availability of attractive port destinations;
  pending or threatened litigation, investigations and enforcement actions;
  changes involving the tax and environmental regulatory regimes in which we operate; and
  other factors set forth under “Risk Factors” in our most recently filed Annual Report on Form 10-K, as such risk factors may be amended, supplemented or superseded from time to time by other reports we file with the Securities and Exchange Commission (the “SEC”).

 

The above examples are not exhaustive and new risks emerge from time to time. Such forward-looking statements are based on our current beliefs, assumptions, expectations, estimates and projections regarding our present and future business strategies and the environment in which we expect to operate in the future. These forward-looking statements speak only as of the date made. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statement to reflect any change in our expectations with regard thereto or any change of events, conditions or circumstances on which any such statement was based, except as required by law.

 

 15 

 

Terminology

 

This report includes certain non-GAAP financial measures, such as Net Revenue, Net Yield, Net Cruise Cost, Adjusted Net Revenue, Adjusted Net Yield, Adjusted Net Cruise Cost Excluding Fuel, Adjusted EBITDA and Adjusted Net Income. Definitions of these non-GAAP financial measures are included below. For further information about our non-GAAP financial measures including detailed adjustments made in calculating our non-GAAP financial measures and a reconciliation to the most directly comparable GAAP financial measure, we refer you to “Results of Operations” below.

 

Unless otherwise indicated in this report, the following terms have the meanings set forth below:

 

Acquisition of Prestige. In November 2014, pursuant to the Merger Agreement, we acquired Prestige in a cash and stock transaction for total consideration of $3.025 billion, including the assumption of debt.

 

Adjusted EBITDA. EBITDA adjusted for other income (expense), net and other supplemental adjustments.

 

Adjusted Net Cruise Cost Excluding Fuel. Net Cruise Cost Excluding Fuel expense adjusted for supplemental adjustments.

 

Adjusted Net Income. Net income adjusted for supplemental adjustments.

 

Adjusted Net Revenue. Net Revenue adjusted for supplemental adjustments.

 

Adjusted Net Yield. Net Yield adjusted for supplemental adjustments.

 

Bareboat Charter. The hire of a ship for a specified period of time whereby no crew or provisions are provided by the Company.

 

Berths. Double occupancy capacity per cabin (single occupancy per studio cabin) even though many cabins can accommodate three or more passengers.

 

Breakaway Class Ships. Norwegian Breakaway and Norwegian Getaway.

 

Breakaway Four Loan Facility. €729.9 million Breakaway four loan due 2029.

 

Breakaway Plus Class Ships. Norwegian Escape, Norwegian Joy, Norwegian Bliss and a fourth ship on order.

 

Business Enhancement Capital Expenditures. Capital expenditures other than those related to new ship construction and ROI Capital Expenditures.

 

Capacity Days. Available Berths multiplied by the number of cruise days for the period.

 

Constant Currency. A calculation whereby foreign currency-denominated revenue and expenses in a period are converted at the U.S. dollar exchange rate of a comparable period in order to eliminate the effects of the foreign exchange fluctuations.

 

Dry-dock. A process whereby a ship is positioned in a large basin where all of the fresh/sea water is pumped out in order to carry out cleaning and repairs of those parts of a ship which are below the water line.

 

EBITDA. Earnings before interest, taxes, and depreciation and amortization.

 

Explorer Class Ships. Regent’s Seven Seas Explorer and a second ship on order.

 

GAAP. Generally accepted accounting principles in the U.S.

 

Gross Cruise Cost. The sum of total cruise operating expense and marketing, general and administrative expense.

 

Gross Tons. A unit of enclosed passenger space on a cruise ship, such that one gross ton = 100 cubic feet or 2.831 cubic meters.

 

Gross Yield. Total revenue per Capacity Day.

 

Merger Agreement. Agreement and Plan of Merger, dated as of September 2, 2014, by and among Prestige, NCLH, Portland Merger Sub, Inc. and Apollo Management, L.P., as amended, for the Acquisition of Prestige.

 

Net Cruise Cost. Gross Cruise Cost less commissions, transportation and other expense and onboard and other expense.

 

 16 

 

Net Cruise Cost Excluding Fuel. Net Cruise Cost less fuel expense.

 

Net Revenue. Total revenue less commissions, transportation and other expense and onboard and other expense.

 

Net Yield. Net Revenue per Capacity Day.

 

Occupancy Percentage. The ratio of Passenger Cruise Days to Capacity Days. A percentage in excess of 100% indicates that three or more passengers occupied some cabins.

 

Passenger Cruise Days. The number of passengers carried for the period, multiplied by the number of days in their respective cruises.

 

New Revolving Loan Facility. $750.0 million senior secured revolving credit facility maturing on June 6, 2021, subject to an earlier springing maturity date.

 

Project Leonardo. The next generation of ships for our Norwegian brand.

 

ROI Capital Expenditures. Comprised of project-based capital expenditures which have a quantified return on investment.

 

Shipboard Retirement Plan. An unfunded defined benefit pension plan for certain crew members which computes benefits based on years of service, subject to certain requirements.

 

Non-GAAP Financial Measures

 

We use certain non-GAAP financial measures, such as Net Revenue, Adjusted Net Revenue, Net Yield, Adjusted Net Yield, Net Cruise Cost, Adjusted Net Cruise Cost Excluding Fuel, Adjusted EBITDA and Adjusted Net Income to enable us to analyze our performance. See “Terminology” for the definitions of these non-GAAP financial measures. We utilize Net Revenue and Net Yield to manage our business on a day-to-day basis and believe that they are the most relevant measures of our revenue performance because they reflect the revenue earned by us net of significant variable costs. In measuring our ability to control costs in a manner that positively impacts net income, we believe changes in Net Cruise Cost and Adjusted Net Cruise Cost Excluding Fuel to be the most relevant indicators of our performance.

 

As our business includes the sourcing of passengers and deployment of vessels outside of the U.S., a portion of our revenue and expenses are denominated in foreign currencies, particularly British pound, Canadian dollar, euro and Australian dollar which are subject to fluctuations in currency exchange rates versus our reporting currency, the U.S. dollar. In order to monitor results excluding these fluctuations, we calculate certain non-GAAP measures on a Constant Currency basis whereby current period revenue and expenses denominated in foreign currencies are converted to U.S. dollars using currency exchange rates of the comparable period. We believe that presenting these non-GAAP measures on both a reported and Constant Currency basis is useful in providing a more comprehensive view of trends in our business.

 

We believe that Adjusted EBITDA is appropriate as a supplemental financial measure as it is used by management to assess operating performance. We believe that Adjusted EBITDA is a useful measure in determining our performance as it reflects certain operating drivers of our business, such as sales growth, operating costs, marketing, general and administrative expense and other operating income and expense. Adjusted EBITDA is not a defined term under GAAP. Adjusted EBITDA is not intended to be a measure of liquidity or cash flows from operations or a measure comparable to net income as it does not take into account certain requirements such as capital expenditures and related depreciation, principal and interest payments and tax payments and it includes other supplemental adjustments.

 

In addition, Adjusted Net Revenue and Adjusted Net Yield, which exclude certain business combination accounting entries, are non-GAAP financial measures that we believe are useful as supplemental measures in evaluating the performance of our operating business and provide greater transparency into our results of operations. Adjusted Net Income is a non-GAAP financial measure that excludes certain amounts and is used to supplement GAAP net income. We use Adjusted Net Income as a key performance measure of our earnings performance. We believe that both management and investors benefit from referring to these non-GAAP financial measures in assessing our performance and when planning, forecasting and analyzing future periods. These non-GAAP financial measures also facilitate management’s internal comparison to our historical performance. The amounts excluded in the presentation of these non-GAAP financial measures may vary from period to period; accordingly, our presentation of Adjusted Net Revenue, Adjusted Net Yield and Adjusted Net Income may not be indicative of future adjustments or results. For example, for the year ended December 31, 2016, we incurred $28.0 million related to the extinguishment of debt due to the refinancing of certain credit facilities. We included this as an adjustment in the reconciliation of Adjusted Net Income since the extinguishment of debt is not representative of our day-to-day operations and we have included similar adjustments in prior periods; however, this adjustment did not occur and is not included in the periods presented within this Form 10-Q.

 

 17 

 

You are encouraged to evaluate each adjustment used in calculating our non-GAAP financial measures and the reasons we consider our non-GAAP financial measures appropriate for supplemental analysis. In evaluating our non-GAAP financial measures, you should be aware that in the future we may incur expenses similar to the adjustments in our presentation. Our non-GAAP financial measures have limitations as analytical tools, and you should not consider these measures in isolation or as a substitute for analysis of our results as reported under GAAP. Our presentation of our non-GAAP financial measures should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. Our non-GAAP financial measures may not be comparable to other companies. Please see a historical reconciliation of these measures to the most comparable GAAP measure presented in our consolidated financial statements below in the “Results of Operations” section.

 

Financial Presentation

 

Revenue from our cruise and cruise-related activities are categorized by us as “passenger ticket revenue” and “onboard and other revenue.” Passenger ticket revenue and onboard and other revenue vary according to product offering, the size of the ship in operation, the length of cruises operated and the markets in which the ship operates. Our revenue is seasonal based on demand for cruises, which has historically been strongest during the Northern Hemisphere’s summer months.

 

Passenger ticket revenue primarily consists of revenue for accommodations, meals in certain restaurants on the ship, certain onboard entertainment, and includes revenue for service charges and air and land transportation to and from the ship to the extent guests purchase these items from us. Onboard and other revenue primarily consists of revenue from gaming, beverage sales, shore excursions, specialty dining, retail sales, spa services, photo services as well as certain Bareboat Charter revenue. We record onboard revenue from onboard activities we perform directly or that are performed by independent concessionaires, from which we receive a share of their revenue.

 

Our cruise operating expense is classified as follows:

 

Commissions, transportation and other primarily consists of direct costs associated with passenger ticket revenue. These costs include travel agent commissions, air and land transportation expenses, related credit card fees, costs associated with service charges, certain port expenses and the costs associated with shore excursions and hotel accommodations included as part of the overall cruise purchase price.

 

  Onboard and other primarily consists of direct costs that are incurred in connection with onboard and other revenue. These include costs incurred in connection with gaming, beverage sales and shore excursions.

 

  Payroll and related consists of the cost of wages and benefits for shipboard employees and costs of certain inventory items, including food, for a third party that provides crew and other hotel services for certain ships.

 

  Fuel includes fuel costs, the impact of certain fuel hedges and fuel delivery costs.

 

  Food consists of food costs for passengers and crew on certain ships.

 

  Other consists of repairs and maintenance (including Dry-dock costs), ship insurance and other ship expenses.

 

Critical Accounting Policies

 

For a discussion of our critical accounting policies and estimates, see “Critical Accounting Policies” included in our Annual Report on Form 10-K for the year ended December 31, 2016 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We have made no significant changes to our critical accounting policies and estimates from those described in our Annual Report on Form 10-K for the year ended December 31, 2016.

 

However, in accordance with Item 303(a)(3)(ii) of Regulation S-K and Section V of SEC Release No. 33-8350, we are including additional disclosure which is presented below:

 

Asset Impairment

 

We review our long-lived assets, principally ships, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Assets are grouped and evaluated at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other groups of assets. We consider historical performance and future estimated results in our evaluation of potential impairment and then compare the carrying amount of the asset to the estimated future cash flows expected to result from the use of the asset. If the carrying amount of the asset exceeds the estimated expected undiscounted future cash flows, we measure the amount of the impairment by comparing the carrying amount of the asset to its fair value. We estimate fair value based on the best information available making whatever estimates, judgments and projections we considered necessary. The estimation of fair value is generally measured by discounting expected future cash flows at discount rates commensurate with the risk involved.

 

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We evaluate goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicates the carrying value of a reporting unit may not be recoverable. For our evaluation of goodwill and tradenames we use the Step 0 Test which allows us to first assess qualitative factors to determine whether it is more likely than not (i.e., more than 50%) that the fair value of a reporting unit is less than its carrying value. In order to make this evaluation, we consider the following circumstances:

 

General macroeconomic conditions such as a deterioration in general economic conditions; limitations on accessing capital; fluctuations in foreign exchange rates; or other developments in equity and credit markets;

  Industry and market conditions such as a deterioration in the environment in which an entity operates; an increased competitive environment; a decline in market-dependent multiples or metrics (in both absolute terms and relative to peers); a change in the market for an entity’s products or services; or a regulatory or political development;

  Changes in cost factors that have a negative effect on earnings and cash flows;

  Overall financial performance (for both actual and expected performance);

  Entity and reporting unit specific events such as changes in management, key personnel, strategy, or customers; litigation; or a change in the composition or carrying amount of net assets; and

  Share price of NCLH (in both absolute terms and relative to peers).

 

We believe our estimates and judgments with respect to our long-lived assets, principally ships, and goodwill and other indefinite-lived intangible assets are reasonable. Nonetheless, if there was a material change in assumptions used in the determination of such fair values or if there is a material change in the conditions or circumstances that influence such assets, we could be required to record an impairment charge. If a material change occurred, we may conduct a quantitative assessment comparing the fair value of each reporting unit to its carrying value, including goodwill. This is called the Step I Test which consists of a combined approach using the expected future cash flows and market multiples to determine the fair value of the reporting units.

 

In the third quarter of 2016, based on the performance of the Oceania Cruises reporting unit, we performed an interim goodwill impairment evaluation consisting of a Step I Test. Based on that evaluation, we determined that there was no impairment of goodwill because its fair value exceeded its carrying value. For our annual impairment evaluation, we performed a Step 0 Test for the Norwegian reporting unit and Step I Tests for the Regent Seven Seas and the Oceania Cruises reporting units. As a result of the Step 0 Test for the Norwegian reporting unit, we determined there were no factors indicating it was more likely than not (i.e., more than 50%) that the fair value of the reporting unit was less than its carrying value. Based on the results of the Step 1 Tests, we determined there was no impairment of goodwill because the fair value of the Oceania Cruises and Regent Seven Seas reporting units exceeded their carrying values by 24% and 81%, respectively. However, if the fair value of any reporting unit declines in future periods, its goodwill may become impaired at that time. As of December 31, 2016 and June 30, 2017, there was $523.0 million, $462.1 million and $403.8 million of goodwill for the Oceania Cruises, Regent Seven Seas and Norwegian reporting units, respectively. As of December 31, 2016, our annual review consisting of the Step 0 and Step I Tests supported the carrying values of these assets. Subsequent to December 31, 2016, the Company has continued to monitor the results of each of these reporting units and will perform the necessary tests should events occur or circumstances change that indicate the carrying value of a reporting unit may not be recoverable.

 

Quarterly Overview

 

Norwegian Joy was delivered in April 2017. The ship is approximately 168,000 Gross Tons with approximately 3,880 Berths.

 

Three months ended June 30, 2017 (“2017”) compared to three months ended June 30, 2016 (“2016”)

 

Total revenue increased 13.3% to $1.3 billion compared to $1.2 billion.

 

Net Revenue increased 13.1% to $1.0 billion compared to $0.9 billion.

 

Net income was $201.4 million, compared to $148.1 million.

 

Operating income was $275.8 million compared to $227.8 million.

 

Adjusted Net Income was $235.7 million in 2017, which included $34.3 million of adjustments primarily consisting of expenses related to non-cash compensation and certain other adjustments. Adjusted Net Income was $195.4 million in 2016, which included $47.3 million of adjustments primarily consisting of expenses related to deferred financing fees, derivatives, non-cash compensation and certain other adjustments.

 

Adjusted EBITDA improved 21.0% to $425.6 compared to $351.8 million.

 

 19 

 

We refer you to our “Results of Operations” below for a calculation of Net Revenue, Adjusted Net Income and Adjusted EBITDA.

 

Results of Operations

 

The following table sets forth operating data as a percentage of total revenue:

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Revenue                    
Passenger ticket   69.8%   69.0%   69.1%   68.8%
Onboard and other   30.2%   31.0%   30.9%   31.2%
Total revenue   100.0%   100.0%   100.0%   100.0%
Cruise operating expense                    
Commissions, transportation and other   16.6%   16.3%   16.7%   16.3%
Onboard and other   6.2%   6.4%   6.1%   6.2%
Payroll and related   14.5%   15.5%   15.5%   16.0%
Fuel   6.4%   6.8%   7.0%   7.2%
Food   3.5%   4.2%   3.8%   4.4%
Other   8.7%   10.3%   9.9%   10.4%
Total cruise operating expense   55.9%   59.5%   59.0%   60.5%
Other operating expense                    
Marketing, general and administrative   14.4%   12.5%   15.4%   14.5%
Depreciation and amortization   9.2%   8.8%   9.7%   9.1%
Total other operating expense   23.6%   21.3%   25.1%   23.6%
Operating income   20.5%   19.2%   15.9%   15.9%
Non-operating income (expense)                    
Interest expense, net   (4.8)%   (5.8)%   (4.7)%   (5.7)%
Other income (expense), net   (0.4)%   (0.9)%   (0.3)%   (0.3)%
Total non-operating income (expense)   (5.2)%   (6.7)%   (5.0)%   (6.0)%
Net income before income taxes   15.3%   12.5%   10.9%   9.9%
Income tax expense   (0.3)%   %   (0.3)%   %
Net income   15.0%   12.5%   10.6%   9.9%

 

The following table sets forth selected statistical information:

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Passengers carried   569,857    574,838    1,098,211    1,126,313 
Passenger Cruise Days   4,517,788    4,237,020    8,748,306    8,522,314 
Capacity Days   4,189,750    3,974,508    8,220,366    7,965,450 
Occupancy Percentage   107.8%   106.6%   106.4%   107.0%

 

Net Revenue, Adjusted Net Revenue, Gross Yield, Net Yield and Adjusted Net Yield were calculated as follows (in thousands, except Capacity Days and Yield data):

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2017
Constant
Currency
   2016   2017   2017
Constant
Currency
   2016 
Passenger ticket revenue  $938,014   $948,291   $818,478   $1,724,708   $1,742,798   $1,558,590 
Onboard and other revenue   406,089    406,089    368,357    770,176    770,176    705,877 
Total revenue   1,344,103    1,354,380    1,186,835    2,494,884    2,512,974    2,264,467 
Less:                              
Commissions, transportation and other expense   223,315    225,429    193,536    417,455    421,947    368,973 
Onboard and other expense   83,367    83,367    75,790    151,778    151,778    139,755 
Net Revenue   1,037,421    1,045,584    917,509    1,925,651    1,939,249    1,755,739 
Non-GAAP Adjustment:                              
Deferred revenue (1)           297            757 
Adjusted Net Revenue  $1,037,421   $1,045,584   $917,806   $1,925,651   $1,939,249   $1,756,496 
Capacity Days   4,189,750    4,189,750    3,974,508    8,220,366    8,220,366    7,965,450 
Gross Yield  $320.81   $323.26   $298.61   $303.50   $305.70   $284.29 
Net Yield  $247.61   $249.56   $230.85   $234.25   $235.91   $220.42 
Adjusted Net Yield  $247.61   $249.56   $230.92   $234.25   $235.91   $220.51 

 

(1)Reflects deferred revenue fair value adjustments related to the Acquisition of Prestige that were made pursuant to business combination accounting rules.

 

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Gross Cruise Cost, Net Cruise Cost, Net Cruise Cost Excluding Fuel and Adjusted Net Cruise Cost Excluding Fuel were calculated as follows (in thousands, except Capacity Days and per Capacity Day data):

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2017
Constant
Currency
   2016   2017   2017
Constant
Currency
   2016 
Total cruise operating expense  $752,242   $754,209   $705,900   $1,472,040   $1,476,176   $1,370,381 
Marketing, general and administrative expense   192,965    193,534    148,569    384,511    385,399    328,159 
Gross Cruise Cost   945,207    947,743    854,469    1,856,551    1,861,575    1,698,540 
Less:                              
Commissions, transportation and other expense   223,315    225,429    193,536    417,455    421,947    368,973 
Onboard and other expense   83,367    83,367    75,790    151,778    151,778    139,755 
Net Cruise Cost   638,525    638,947    585,143    1,287,318    1,287,850    1,189,812 
Less: Fuel expense   86,663    86,663    80,607    175,549    175,549    162,279 
Net Cruise Cost Excluding Fuel   551,862    552,284    504,536    1,111,769    1,112,301    1,027,533 
Less Non-GAAP Adjustments:                              
Non-cash deferred compensation (1)   823    823    792    1,646    1,646    1,583 
Non-cash share-based compensation (2)   24,017    24,017    16,204    42,220    42,220    31,449 
Severance payments and other fees (3)           869    2,399    2,399    2,899 
Acquisition of Prestige expenses (4)   250    250    1,273    500    500    2,514 
Other (5)   1,606    1,606        1,606    1,606     
Adjusted Net Cruise Cost Excluding Fuel  $525,166   $525,588   $485,398   $1,063,398   $1,063,930   $989,088 
                               
Capacity Days   4,189,750    4,189,750    3,974,508    8,220,366    8,220,366    7,965,450 
Gross Cruise Cost per Capacity Day  $225.60   $226.21   $214.99   $225.85   $226.46   $213.24 
Net Cruise Cost per Capacity Day  $152.40   $152.50   $147.22   $156.60   $156.67   $149.37 
Net Cruise Cost Excluding Fuel per Capacity Day  $131.72   $131.82   $126.94   $135.25   $135.31   $129.00 
Adjusted Net Cruise Cost Excluding Fuel per Capacity Day  $125.35   $125.45   $122.13   $129.36   $129.43   $124.17 

 

(1)Non-cash deferred compensation expenses related to the crew pension plan and other crew expenses, which are included in payroll and related expense.
(2)Non-cash share-based compensation expenses related to equity awards, which are included in marketing, general and administrative expense and payroll and related expense.
(3)Severance payments and other expenses related to restructuring costs and other severance arrangements, which are included in marketing, general and administrative expense.
(4)Expenses related to the Acquisition of Prestige, which are included in marketing, general and administrative expense.
(5)Expenses primarily related to a legal settlement, which are included in marketing, general and administrative expense.

 

 21 

 

Adjusted Net Income was calculated as follows (in thousands):

 

   Three Months Ended 
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Net income   201,441    148,099    264,579    223,072 
Non-GAAP Adjustments:                    
Non-cash deferred compensation (1)   823    792    1,646    1,583 
Non-cash share-based compensation (2)   24,017    16,204    42,220    31,449 
Severance payments and other fees (3)       869    2,399    2,899 
Acquisition of Prestige expenses (4)   250    1,273    500    2,514 
Deferred revenue (5)       297        757 
Amortization of intangible assets (6)   7,568    5,267    15,136    10,535 
Derivative adjustment (7)       10,911        (1,185)
Deferred financing fees and other (8)       11,714        11,714 
Other (9)   1,606        1,606     
Adjusted Net Income  $235,705   $195,426   $328,086   $283,338 

 

  (1) Non-cash deferred compensation expenses related to the crew pension plan and other crew expenses, which are included in payroll and related expense.
  (2) Non-cash share-based compensation expenses related to equity awards, which are included in marketing, general and administrative expense and payroll and related expense.
  (3) Severance payments and other expenses related to restructuring costs and other severance arrangements, which are included in marketing, general and administrative expense.
  (4) Expenses related to the Acquisition of Prestige, which are included in marketing, general and administrative expense.
  (5) Deferred revenue fair value adjustments related to the Acquisition of Prestige that were made pursuant to business combination accounting rules, which are primarily included in passenger ticket revenue.
  (6) Amortization of intangible assets related to the Acquisition of Prestige, which are included in depreciation and amortization expense.
  (7) Losses and net gains for the fair value adjustment of a foreign exchange collar which does not receive hedge accounting and losses due to the dedesignation of certain fuel swaps. These adjustments are included in other income (expense), net.
  (8) Expenses primarily related to the write-off of deferred financing fees related to the refinancing of certain credit facilities, which are included in interest expense, net.
  (9) Expenses primarily related to a legal settlement, which are included in marketing, general and administrative expense.

 

EBITDA and Adjusted EBITDA were calculated as follows (in thousands):

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Net income  $201,441   $148,099   $264,579   $223,072 
Interest expense, net   64,196    68,420    117,158    128,174 
Income tax expense   4,509    484    5,826    828 
Depreciation and amortization expense   123,141    104,610    242,346    205,905 
EBITDA   393,287    321,613    629,909    557,979 
Other expense (1)   5,609    10,753    8,424    7,948 
Non-GAAP Adjustments:                    
Non-cash deferred compensation (2)   823    792    1,646    1,583 
Non-cash share-based compensation (3)   24,017    16,204    42,220    31,449 
Severance payments and other fees (4)       869    2,399    2,899 
Acquisition of Prestige expenses (5)   250    1,273    500    2,514 
Deferred revenue (6)       297        757 
Other (7)   1,606        1,606     
Adjusted EBITDA  $425,592   $351,801   $686,704   $605,129 

 

(1) Primarily consists of gains and losses, net for derivative contracts and foreign currency exchanges.
(2) Non-cash deferred compensation expenses related to the crew pension plan and other crew expenses, which are included in payroll and related expense.
(3) Non-cash share-based compensation expenses related to equity awards, which are included in marketing, general and administrative expense and payroll and related expense.

 

 22 

 

(4) Severance payments and other expenses related to restructuring costs and other severance arrangements, which are included in marketing, general and administrative expense.
(5) Expenses related to the Acquisition of Prestige, which are included in marketing, general and administrative expense.
(6) Deferred revenue fair value adjustments related to the Acquisition of Prestige that were made pursuant to business combination accounting rules, which are primarily included in passenger ticket revenue.
(7) Expenses primarily related to a legal settlement, which are included in marketing, general and administrative expense.

 

Three months ended June 30, 2017 (“2017”) compared to three months ended June 30, 2016 (“2016”)

 

Revenue

 

Total revenue increased 13.3% to $1.3 billion in 2017 compared to $1.2 billion in 2016 primarily due to an increase in Capacity Days. Gross Yield increased 7.4%. Net Revenue increased 13.1% in 2017 to $1.0 billion from $0.9 billion in 2016 due to an increase in Capacity Days of 5.4%, an increase in Net Yield of 7.3% and an increase in Occupancy Percentage. The increase in Capacity Days was primarily due to a reduction in the amount of Dry-docks in 2017 compared to 2016 and the delivery of Seven Seas Explorer in June 2016. The increase in Gross Yield and Net Yield was primarily due to an increase in passenger ticket pricing and higher onboard and other revenue. Adjusted Net Revenue, in 2016, includes a deferred revenue fair value adjustment of $0.3 million related to the Acquisition of Prestige. On a Constant Currency basis, Net Yield and Adjusted Net Yield increased 8.1% in 2017 compared to 2016.

 

Expense

 

Gross Cruise Cost increased 10.6% in 2017 compared to 2016 due to an increase in total cruise operating expense and marketing, general and administrative expenses. Total cruise operating expense increased 6.6% in 2017 compared to 2016 primarily due to the increase in Capacity Days as discussed above and crew payroll and related costs which was partially offset by a decrease in repairs and maintenance including Dry-dock expenses. Total other operating expense increased 24.9% in 2017 compared to 2016 due to an increase in marketing, general and administrative expenses and an increase in depreciation and amortization expense. Marketing, general and administrative expenses increased primarily due to an increase in advertising and marketing expenses as well as an increase in share-based compensation. Depreciation and amortization expense increased primarily due to ship improvement projects and the ship additions. On a Capacity Day basis, Net Cruise Cost increased 3.5% (3.6% on a Constant Currency basis) primarily due to an increase in marketing, general and administrative expenses partially offset by a reduction in maintenance and repairs including Dry-dock expenses. Adjusted Net Cruise Cost Excluding Fuel per Capacity Day increased 2.6% (2.7% on a Constant Currency basis) primarily due to the increase in expenses discussed above.

 

Interest expense, net was $64.2 million in 2017 compared to $68.4 million in 2016. Interest expense for 2017 reflects an increase in average debt balances outstanding primarily associated with the delivery of new ships and newbuild installments, as well as higher interest rates due to an increase in LIBOR. Interest expense for 2016 included a write-off of $11.4 million of deferred financing fees related to the refinancing of certain of our credit facilities in 2016.

 

Other income (expense), net was an expense of $5.6 million in 2017 compared to an expense of $10.8 million in 2016. In 2017, the expense was primarily related to losses on foreign currency exchange and unrealized and realized losses on derivatives partially offset by income from an insurance settlement. In 2016, the expense was primarily related to unrealized and realized losses on fuel derivative hedge contracts and foreign exchange derivative contracts partially offset by gains on foreign currency exchange.

 

In 2017, we had an income tax expense of $4.5 million compared to $0.5 million in 2016.

 

Six months ended June 30, 2017 (“2017”) compared to six months ended June 30, 2016 (“2016”)

 

Revenue

 

Total revenue increased 10.2% to $2.5 billion in 2017 compared to $2.3 billion in 2016 primarily due to an increase in Capacity Days. Gross Yield increased 6.8%. Net Revenue increased 9.7% in 2017 to $1.9 billion from $1.8 billion in 2016 due to an increase in Capacity Days of 3.2% and an increase in Net Yield of 6.3%. The increase in Capacity Days was primarily due to the delivery of Seven Seas Explorer in June 2016, Sirena joining our fleet in April 2016 and a reduction in the amount of Dry-docks in 2017 compared to 2016. The increase in Gross Yield and Net Yield was primarily due to an increase in passenger ticket pricing and higher onboard and other revenue. Adjusted Net Revenue, in 2016, includes a deferred revenue fair value adjustment of $0.8 million related to the Acquisition of Prestige. On a Constant Currency basis, Net Yield and Adjusted Net Yield increased 7.0% in 2017 compared to 2016.

 

 23 

 

Expense

 

Gross Cruise Cost increased 9.3% in 2017 compared to 2016 due to an increase in total cruise operating expense and marketing, general and administrative expenses. Total cruise operating expense increased 7.4% in 2017 compared to 2016 primarily due to the increase in Capacity Days as discussed above and crew payroll and related costs. Total other operating expense increased 17.4% in 2017 compared to 2016 due to an increase in marketing, general and administrative expenses and depreciation and amortization expense. Marketing, general and administrative expenses increased primarily due to an increase in advertising and marketing expenses as well as an increase in share-based compensation expense. Depreciation and amortization expense increased primarily due to the ship improvement projects and the ship additions. On a Capacity Day basis, Net Cruise Cost increased 4.8% (4.9% on a Constant Currency basis) due to an increase in marketing, general and administrative expenses and crew payroll and related costs. Adjusted Net Cruise Cost Excluding Fuel per Capacity Day increased 4.2% on an actual and on a Constant Currency basis primarily due to the increase in expenses discussed above.

 

Interest expense, net was $117.2 million in 2017 compared to $128.2 million in 2016. Interest expense for 2017 reflects higher interest rates driven by an increase in LIBOR, as well as an increase in average debt balances outstanding primarily associated with the delivery of new ships and newbuild installments. Interest expense for 2016 included a write-off of $11.4 million of deferred financing fees related to the refinancing of certain of our credit facilities in 2016.

 

Other income (expense), net was an expense of $8.4 million in 2017 compared to an expense of $7.9 million in 2016. In 2017, the expense was primarily related to losses on foreign currency exchange and unrealized and realized losses on derivatives partially offset by income from an insurance settlement. In 2016, the expense was primarily related to unrealized and realized losses on fuel swap derivative hedge contracts and losses on foreign exchange partially offset by gains on foreign exchange derivative hedge contracts.

 

In 2017, we had an income tax expense of $5.8 million compared to $0.8 million in 2016.

 

Liquidity and Capital Resources

 

General

 

As of June 30, 2017, our liquidity was $967.2 million consisting of $217.2 million in cash and cash equivalents and $750.0 million under our New Revolving Loan Facility. Our primary ongoing liquidity requirements are to finance working capital, capital expenditures and debt service.

 

As of June 30, 2017, we had a working capital deficit of $2.2 billion. This deficit included $1.5 billion of advance ticket sales, which represents the revenue we collect in advance of sailing dates, and accordingly, are substantially more like deferred revenue balances rather than actual current cash liabilities. Our business model, along with our New Revolving Loan Facility, allows us to operate with a working capital deficit and still meet our operating, investing and financing needs.

 

We evaluate potential sources of additional liquidity, including the capital markets, in the ordinary course of business. We believe that prevailing market conditions, particularly in the debt capital markets, are generally favorable. We will continue to evaluate opportunities to optimize our capital structure, taking into consideration our current and expected capital requirements, our assessment of prevailing market conditions and expectations regarding future conditions, and the contractual and other restrictions to which we are subject.

 

Sources and Uses of Cash

 

In this section, references to “2017” refer to the six months ended June 30, 2017 and references to “2016” refer to the six months ended June 30, 2016.

 

Net cash provided by operating activities was $923.6 million in 2017 as compared to $752.7 million in 2016. The net cash provided by operating activities included timing differences in cash receipts and payments relating to operating assets and liabilities. Net income increased to $264.6 million in 2017 from $223.1 million in 2016. Advance ticket sales was $400.9 million in 2017 compared to $358.6 million in 2016.

 

Net cash used in investing activities was $1.1 billion in 2017 primarily related to payments for the delivery of Norwegian Joy, ship improvements and shoreside projects. Net cash used in investing activities was $0.8 billion in 2016 primarily related to payments for the delivery of Seven Seas Explorer, ship improvements, ships under construction and shoreside projects.

 

Net cash provided by financing activities was $268.1 million in 2017 primarily due to the proceeds from our Breakaway Four Loan Facility partially offset by the repayments of other loan facilities, our net repayment of our New Revolving Loan Facility and deferred financing fees and other. Net cash provided by financing activities was $73.5 million in 2016 primarily due to net proceeds of our New Revolving Loan Facility and other loan facilities partially offset by the issuance of a dividend for the repurchase of NCLH’s ordinary shares in 2016 and deferred financing fees and other in 2016.

 

Future Capital Commitments

 

Future capital commitments consist of contracted commitments, including ship construction contracts, and future expected capital expenditures necessary for operations. As of June 30, 2017, our anticipated capital expenditures were $0.3 billion for the remainder of 2017, $1.4 billion for the year ending December 31, 2018 and $1.2 billion for the year ending December 31, 2019, of which we have export credit financing in place for the expenditures related to ship construction contracts of $48.2 million for the remainder of 2017, $0.8 billion for 2018 and $0.6 billion for 2019.

 

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Project Leonardo will introduce an additional four ships with expected delivery dates through 2025 and we have an option to introduce two additional ships for delivery in 2026 and 2027, subject to certain conditions. These four ships are each approximately 140,000 Gross Tons with approximately 3,300 Berths. We have an Explorer Class Ship on order for delivery in the winter of 2020. This ship is approximately 55,000 Gross Tons and 750 Berths. We have two Breakaway Plus Class Ships on order for delivery in the spring of 2018 and fall of 2019, respectively. These ships are approximately 168,000 Gross Tons each with approximately 4,000 Berths each. The combined contract price of these seven ships was approximately €5.5 billion, or $6.3 billion based on the euro/U.S. dollar exchange rate as of June 30, 2017. We have export credit financing in place that provides financing for 80% of each ship’s contract price. For ships expected to be delivered after 2023, the contract price is subject to adjustment under certain circumstances.

 

In connection with the contracts to build the ships, we do not anticipate any contractual breaches or cancellation to occur. However, if any would occur, it could result in, among other things, the forfeiture of prior deposits or payments made by us and potential claims and impairment losses which may materially impact our business, financial condition and results of operations.

 

Capitalized interest for the three and six months ended June 30, 2017 was $7.1 million and $15.6 million, respectively, and for the three and six months ended June 30, 2016 was $8.9 million and $16.0 million, respectively, primarily associated with the construction of our newbuild ships.

 

Off-Balance Sheet Transactions

 

None.

 

Contractual Obligations

 

As of June 30, 2017, our contractual obligations with initial or remaining terms in excess of one year, including interest payments on long-term debt obligations, were as follows (in thousands):

 

   Total   Less than
1 year
   1-3 years   3-5 years   More than
5 years
 
Long-term debt (1)  $6,816,695   $600,500   $1,239,407   $3,265,429   $1,711,359 
Operating leases (2)   144,595    15,893    30,692    28,449    69,561 
Ship construction contracts (3)   6,070,769    1,103,593    1,366,011    1,078,537    2,522,628 
Port facilities (4)   252,159    42,996    61,018    49,043    99,102 
Interest (5)   1,054,239    235,590    404,680    243,136    170,833 
Other (6)   174,101    52,545    70,832    31,534    19,190 
Total  $14,512,558   $2,051,117   $3,172,640   $4,696,128   $4,592,673 

 

  (1) Includes premiums aggregating $0.5 million. Also includes capital leases. The amount excludes deferred financing fees which are included in the consolidated balance sheets as an offset to long-term debt.
  (2) Primarily for offices, motor vehicles and office equipment.
  (3) For our newbuild ships based on the euro/U.S. dollar exchange rate as of June 30, 2017. Export credit financing is in place from syndicates of banks.
  (4) Primarily for our usage of certain port facilities.
  (5) Includes fixed and variable rates with LIBOR held constant as of June 30, 2017.
  (6) Future commitments for service, maintenance and other Business Enhancement Capital Expenditure contracts.

 

The table above does not include $1.6 million of unrecognized tax benefits.

 

Other

 

Certain service providers may require collateral in the normal course of our business. The amount of collateral may change based on certain terms and conditions.

 

As a routine part of our business, depending on market conditions, exchange rates, pricing and our strategy for growth, we regularly consider opportunities to enter into contracts for the building of additional ships. We may also consider the sale of ships, potential acquisitions and strategic alliances. If any of these were to occur, they may be financed through the incurrence of additional permitted indebtedness, through cash flows from operations, or through the issuance of debt, equity or equity-related securities.

 

Funding Sources

 

Certain of our debt agreements contain covenants that, among other things, require us to maintain a minimum level of liquidity, as well as limit our net funded debt-to-capital ratio, maintain certain other ratios and restrict our ability to pay dividends. Substantially all of our ships and other property and equipment are pledged as collateral for certain of our debt. We believe we were in compliance with these covenants as of June 30, 2017.

 

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The impact of changes in world economies and especially the global credit markets can create a challenging environment and may reduce future consumer demand for cruises and adversely affect our counterparty credit risks. In the event this environment deteriorates, our business, financial condition and results of operations could be adversely impacted.

 

We believe our cash on hand, expected future operating cash inflows, additional available borrowings under our New Revolving Loan Facility and our ability to issue debt securities or additional equity securities, will be sufficient to fund operations, debt payment requirements, capital expenditures and maintain compliance with covenants under our debt agreements over the next twelve-month period. There is no assurance that cash flows from operations and additional financings will be available in the future to fund our future obligations.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

General

 

We are exposed to market risk attributable to changes in interest rates, foreign currency exchange rates and fuel prices. We attempt to minimize these risks through a combination of our normal operating and financing activities and through the use of derivatives. The financial impacts of these derivative instruments are primarily offset by corresponding changes in the underlying exposures being hedged. We achieve this by closely matching the notional, term and conditions of the derivatives with the underlying risk being hedged. We do not hold or issue derivatives for trading or other speculative purposes. Derivative positions are monitored using techniques including market valuations and sensitivity analyses.

 

Interest Rate Risk

 

As of June 30, 2017, we had interest rate swap agreements to hedge our exposure to interest rate movements and to manage our interest expense. As of June 30, 2017, 61% of our debt was fixed and 39% was variable, which includes the effects of the interest rate swaps. The notional amount of outstanding debt associated with the interest rate swap agreements as of June 30, 2017 was $250.7 million. Based on our June 30, 2017 outstanding variable rate debt balance, a one percentage point increase in annual LIBOR interest rates would increase our annual interest expense by approximately $26.3 million excluding the effects of capitalization of interest.

 

Foreign Currency Exchange Rate Risk

 

As of June 30, 2017, we had foreign currency derivatives to hedge the exposure to volatility in foreign currency exchange rates related to our ship construction contracts denominated in euros. These derivatives hedge the foreign currency exchange rate risk on a portion of the payments on our ship construction contracts. The payments not hedged aggregate €3.5 billion, or $4.0 billion based on the euro/U.S. dollar exchange rate as of June 30, 2017. We estimate that a 10% change in the euro as of June 30, 2017 would result in a $0.4 billion change in the U.S. dollar value of the foreign currency denominated remaining payments.

 

Fuel Price Risk

 

Our exposure to market risk for changes in fuel prices relates to the forecasted purchases of fuel on our ships. Fuel expense, as a percentage of our total cruise operating expense, was 11.5% and 11.4% for the three months ended June 30, 2017 and 2016, respectively, and 11.9% and 11.8% for the six months ended June 30, 2017 and 2016, respectively. We use fuel derivative agreements to mitigate the financial impact of fluctuations in fuel prices and as of June 30, 2017, we had hedged approximately 76%, 65%, 48% and 26% of our remaining 2017, 2018, 2019 and 2020, respectively, projected metric tons of fuel purchases. We estimate that a 10% increase in our weighted-average fuel price would increase our anticipated 2017 fuel expense by $15.5 million. This increase would be partially offset by an increase in the fair value of our fuel swap agreements of $9.0 million. Fair value of our derivative contracts is derived using valuation models that utilize the income valuation approach. These valuation models take into account the contract terms such as maturity, as well as other inputs such as fuel types, fuel curves, creditworthiness of the counterparty and the Company, as well as other data points.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Our management has evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, as of June 30, 2017. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based upon management’s evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2017 to provide reasonable assurance that the information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that it is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

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Changes in Internal Control Over Financial Reporting

 

There have been no changes in our internal control over financial reporting during the quarter ended June 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Limitations on the Effectiveness of Controls

 

It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system will be met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there is only the reasonable assurance that our controls will succeed in achieving their goals under all potential future conditions.

 

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

In the normal course of our business, various claims and lawsuits have been filed or are pending against us. Most of these claims and lawsuits are covered by insurance and, accordingly, the maximum amount of our liability is typically limited to our deductible amount.

 

Nonetheless, the ultimate outcome of these claims and lawsuits that are not covered by insurance cannot be determined at this time. We have evaluated our overall exposure with respect to all of our threatened and pending litigation and, to the extent required, we have accrued amounts for all estimable probable losses associated with our deemed exposure. We are currently unable to estimate any other potential contingent losses beyond those accrued, as discovery is not complete nor is adequate information available to estimate such range of loss or potential recovery. However, based on our current knowledge, we do not believe that the aggregate amount or range of reasonably possible losses with respect to these matters will be material to our consolidated results of operations, financial condition or cash flows. We intend to vigorously defend our legal position on all claims and, to the extent necessary, seek recovery.

 

Item 1A. Risk Factors

 

We refer you to our 2016 Annual Report on Form 10-K for a discussion of the risk factors that affect our business and financial results. We wish to caution the reader that the risk factors discussed in “Item 1A. Risk Factors” in our 2016 Annual Report on Form 10-K, elsewhere in this report or other SEC filings, could cause future results to differ materially from those stated in any forward-looking statements.

 

Item 5. Other Information

 

None.

 

Item 6. Exhibits

 

2.1 Agreement and Plan of Merger, dated as of September 2, 2014, by and among Prestige Cruises International, Inc., Norwegian Cruise Line Holdings Ltd., Portland Merger Sub, Inc. and Apollo Management, L.P. (incorporated herein by reference to Exhibit 2.1 to Norwegian Cruise Line Holdings Ltd.’s Form 8-K filed on September 4, 2014 (File No. 001-35784))
   
2.2 Amendment No. 1 to the Agreement and Plan of Merger, dated as of October 6, 2014, by and among Prestige Cruises International, Inc., Norwegian Cruise Line Holdings Ltd., Portland Merger Sub, Inc. and Apollo Management, L.P. (incorporated herein by reference to Exhibit 2.1 to Norwegian Cruise Line Holdings Ltd.’s Form 8-K filed on October 8, 2014 (File No. 001-35784))
   
31.1* Certification of the President and Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934
   
31.2* Certification of the Executive Vice President and Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934
   
32.1** Certifications of the President and Chief Executive Officer and the Executive Vice President and Chief Financial Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934 and Section 1350 of Chapter 63 of Title 18 of the United States Code
   
101* The following unaudited consolidated financial statements are from NCL Corporation Ltd.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2017, formatted in Extensible Business Reporting Language (XBRL), as follows:
   
(i)   the Consolidated Statements of Operations for the three and six months ended June 30, 2017 and 2016;
   
(ii)   the Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2017 and 2016;
   
(iii)   the Consolidated Balance Sheets as of June 30, 2017 and December 31, 2016;
   
(iv)   the Consolidated Statements of Cash Flows for the six months ended June 30, 2017 and 2016;
   
(v)   the Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2017 and 2016; and
   
(vi)   the Notes to the Consolidated Financial Statements, tagged in summary and detail.
   
* Filed herewith.
** Furnished herewith.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

  NCL CORPORATION LTD.
  (Registrant)
     
  By: /s/ Frank J. Del Rio 
  Name: Frank J. Del Rio
  Title: President and Chief Executive Officer
    (Principal Executive Officer)
     
  By: /s/ Wendy A. Beck 
  Name: Wendy A. Beck
  Title: Executive Vice President and Chief Financial Officer
    (Principal Financial Officer)

 

Dated: August 9, 2017

 

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