Norwegian Cruise Line Holdings Ltd. quarterly report, Q2 FY2016

Norwegian Cruise Line Holdings Ltd. — Q2 2016 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2016; comparisons are with the corresponding 2015 periods. Amounts are in U.S. dollars; financial-statement amounts below are in millions unless noted.

Business context and reporting period

NCLH operates Norwegian Cruise Line, Oceania Cruises and Regent Seven Seas Cruises. Its fleet comprised 24 ships with approximately 46,500 berths at quarter-end. Sirena joined the fleet in April and Seven Seas Explorer was delivered in June. Cruise demand is seasonal, and interim results may not indicate full-year performance.

Financial and operating performance

Metric	Q2 2016	Q2 2015	Six months 2016	Six months 2015
Total revenue	$1,186.8	$1,085.4	$2,264.5	$2,023.6
Operating income	$227.0	$217.4	$358.3	$277.7
Net income	$145.2	$158.5	$218.5	$137.0
Diluted EPS	$0.64	$0.69	$0.96	$0.60
Operating margin	19.1%	20.0%	15.8%	13.7%
Net margin	12.2%	14.6%	9.6%	6.8%

Q2 revenue rose 9.3%; management attributed growth to added capacity and improved pricing. Net Revenue, a company-defined non-GAAP measure, increased 11.2% to $917.5 million. Capacity Days rose 9.4% and Net Yield rose 1.7%; occupancy was 106.6% versus 108.7%.
For the six months, revenue increased 11.9%; Net Revenue grew 14.5% to $1.756 billion, with Capacity Days up 10.8% and Net Yield up 3.4%.
Q2 Adjusted EBITDA was $351.1 million versus $313.4 million; six-month Adjusted EBITDA was $603.9 million versus $510.7 million. Adjusted EPS was $0.85 versus $0.75 in Q2 and $1.22 versus $1.02 for six months. These are non-GAAP measures.
Q2 cruise operating expenses increased 7.6%; marketing, general and administrative expense rose to $149.3 million from $107.2 million. Net Cruise Cost per Capacity Day increased 6.5%; Adjusted Net Cruise Cost Excluding Fuel per Capacity Day rose 4.0%.
Lower fuel prices helped: Q2 average fuel price fell 15.9% to $469 per metric ton; the six-month average fell 16.4% to $453. Fuel expense was $80.6 million in Q2 and $162.3 million for six months.
Interest expense, net was $68.4 million in Q2 and $128.2 million for six months, up from $52.4 million and $103.4 million, respectively. Drivers included higher average debt, higher LIBOR and an $11.4 million write-off of deferred financing fees.

Cash flow, debt and liquidity

Six-month operating cash flow was $748.0 million, compared with $711.7 million. Investing cash outflow was $799.0 million, including $764.9 million of net property and equipment additions, primarily for Seven Seas Explorer, ship improvements and construction.
Financing cash flow was positive $81.0 million, reflecting debt proceeds and repayments, financing costs and $50.0 million of treasury-share purchases. Cash increased by $30.0 million to $146.0 million.
At June 30, balance-sheet debt was approximately $6.553 billion: $581.8 million current and $5.971 billion long-term. Total liabilities were $8.839 billion. The company reported $817.0 million of liquidity, comprising $146.0 million cash and $671.0 million available under its revolving facility.
Working capital deficit was $2.2 billion, including $1.4 billion in advance ticket sales. Management said advance ticket sales are deferred revenue-like balances and that its business model and revolving facility support operating with this deficit.
In June, NCLC refinanced and amended its senior secured credit facilities, increasing the revolving facility from $625 million to $750 million and increasing the term loan facility to $1.51 billion; both generally mature in June 2021, subject to springing maturity provisions linked to 2019 and 2020 notes. The company also obtained a $373.6 million loan for Seven Seas Explorer at 3.43%, maturing in 2028.
Management believed cash, expected operating inflows and borrowing access would fund operations, debt service and capital needs over the next 12 months, while noting there is no assurance future cash flows or financing will be available. The company reported covenant compliance at quarter-end.

Material changes, outlook and risks

Q2 GAAP net income and diluted EPS declined year over year despite revenue and operating-income growth. For the six-month period, net income and EPS increased. Q2 comparisons were affected by the prior-year $34.3 million contingent-consideration benefit; the six-month 2015 comparison included a $43.4 million benefit.
New ships and added capacity supported revenue growth but increased capital needs. Expected capital expenditures were $0.2 billion for the remainder of 2016 and $1.3 billion in each of 2017 and 2018. Export-credit financing was in place for a portion of shipbuilding costs. Three Breakaway Plus ships were contracted for delivery in 2017–2019, and another Explorer Class ship was expected in winter 2020.
The filing provides no specific earnings or revenue guidance. Management cited improved pricing and capacity growth, and said it expected to meet near-term funding needs; it also warned that planned capital spending will increase depreciation and amortization.
Fuel, foreign exchange and interest-rate exposure remain significant. At quarter-end, 55% of debt was fixed and 45% variable; a one-percentage-point LIBOR increase was estimated to raise annual interest expense by about $30.1 million. Fuel hedges covered approximately 88%, 82%, 55% and 50% of projected purchases for the remainder of 2016, 2017, 2018 and 2019. Unhedged ship-payment exposure was €506.4 million; a 10% euro move was estimated to change its dollar value by $56.2 million.
The company flagged uncertainty from the U.K. vote to leave the EU, including currency volatility, potential regulatory changes and possible effects on passenger demand. Other stated risks include consumer and economic weakness, fuel and operating costs, substantial debt, shipbuilding delays, safety incidents, litigation, regulatory changes and possible impairment of goodwill or tradenames.
Shipbuilding contract breaches or cancellations could lead to forfeited deposits, claims or impairment losses. Pending litigation outcomes could not be estimated beyond accrued probable losses; most claims were insured, subject to deductibles.
Disclosure controls were assessed as effective; no material change in internal control over financial reporting was reported. A prior-period cash-flow presentation revision increased 2015 operating and investing cash flows by $18.5 million each and was determined not material.

Key facts for investors to verify

Whether revenue and yield gains persist and offset rising non-fuel costs, particularly marketing, compensation and ship-related expenses.
Debt refinancing terms, springing maturity triggers, covenant headroom, variable-rate exposure and the availability of stated revolving-credit liquidity.
Cash funding and financing coverage for the large 2016–2018 capital program and contracted ship deliveries.
Fuel and currency hedge coverage, hedge accounting effects, and the potential cash and earnings impact of market movements.
Adjustments underlying Adjusted EBITDA, Adjusted EPS and other non-GAAP measures, including the refinancing-fee write-off and unusually large share-based compensation.
Developments in Brexit-related demand and currency exposure, litigation, shipbuilding commitments and any impairment indicators.