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Ambassadors International Inc – ‘10-Q’ for 9/30/07

On:  Friday, 11/9/07, at 3:31pm ET   ·   For:  9/30/07   ·   Accession #:  1193125-7-242301   ·   File #:  0-26420

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

11/09/07  Ambassadors International Inc     10-Q        9/30/07    5:502K                                   RR Donnelley/FA

Quarterly Report   —   Form 10-Q
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-Q        Ambassadors International, Inc. Form 10-Q           HTML    451K 
 2: EX-31.1     Section 302 Certification of Chief Executive        HTML     14K 
                          Officer                                                
 3: EX-31.2     Section 302 Certification of Interim Chief          HTML     14K 
                          Financial Officer                                      
 4: EX-32.1     Section 906 Certification of Chief Executive        HTML      9K 
                          Officer                                                
 5: EX-32.2     Section 906 Certification of Interim Chief          HTML      9K 
                          Financial Officer                                      


10-Q   —   Ambassadors International, Inc. Form 10-Q
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
"Table of Contents
"Part I Financial Information
"Financial Statements
"Condensed Consolidated Balance Sheets at September 30, 2007 (unaudited) and December 31, 2006
"Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2007 and 2006 (unaudited)
"Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006 (unaudited)
"Notes to Condensed Consolidated Financial Statements (unaudited)
"Management's Discussion and Analysis of Financial Condition and Results of Operations
"Quantitative and Qualitative Disclosures About Market Risk
"Controls and Procedures
"Part Ii Other Information
"Legal Proceedings
"Risk Factors
"Unregistered Sales of Equity Securities and Use of Proceeds
"Defaults Upon Senior Securities
"Submission of Matters to a Vote of Security Holders
"Other Information
"Exhibits
"Signatures
"Exhibit Index

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  Ambassadors International, Inc. Form 10-Q  
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


FORM 10-Q

 


 

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

 

      For the quarterly period ended September 30, 2007

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: 0-26420

 


AMBASSADORS INTERNATIONAL, INC.

(Exact Name of Registrant as Specified in Its Charter)

 


 

Delaware   91-1688605

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

1071 Camelback Street  
Newport Beach, California   92660
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s Telephone Number, Including Area Code: (949) 759-5900

 


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  x    No  ¨

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

Large accelerated filer  ¨        Accelerated filer  x        Non-accelerated filer  ¨

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

The number of shares of the registrant’s Common Stock outstanding as of November 1, 2007 was 10,823,655.

 



Table of Contents

AMBASSADORS INTERNATIONAL, INC.

FORM 10-Q QUARTERLY REPORT

TABLE OF CONTENTS

 

PART I FINANCIAL INFORMATION

  

Item 1.

   Financial Statements.   
   Condensed Consolidated Balance Sheets at September 30, 2007 (unaudited) and December 31, 2006.    1
   Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2007 and 2006 (unaudited).    2
   Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006 (unaudited).    3
   Notes to Condensed Consolidated Financial Statements (unaudited).    4

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations.    18

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk.    30

Item 4.

   Controls and Procedures.    30

PART II OTHER INFORMATION

  

Item 1.

   Legal Proceedings.    30

Item 1A.

   Risk Factors.    31

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds.    32

Item 3.

   Defaults Upon Senior Securities.    32

Item 4.

   Submission of Matters to a Vote of Security Holders.    32

Item 5.

   Other Information.    32

Item 6.

   Exhibits.    32

SIGNATURES

   33

EXHIBIT INDEX

   34

 


Table of Contents

PART I – FINANCIAL INFORMATION

Item  1. Financial Statements.

Ambassadors International, Inc.

Condensed Consolidated Balance Sheets


(in thousands, except share and per share data)

 

    

September 30,

2007

  

December 31,

2006

     (unaudited)     

Assets:

     

Current assets:

     

Cash and cash equivalents

   $ 18,915    $ 8,246

Restricted cash

     46,361      11,127

Available-for-sale securities

     2,947      37,807

Accounts and other receivables, net of allowance of $1,882 at September 30, 2007 and $918 at December 31, 2006

     40,887      25,077

Costs in excess of billings on construction contracts

     8,897      7,061

Premiums receivable

     11,076      14,549

Deferred policy acquisition costs

     —        330

Reinsurance recoverable

     1,210      2,152

Prepaid reinsurance premiums

     —        252

Inventory

     5,887      3,383

Deferred income taxes, net

     864      1,606

Prepaid costs and other current assets

     17,842      9,018
             

Total current assets

     154,886      120,608

Property and equipment, net

     220,728      118,630

Goodwill

     9,181      9,181

Other intangibles

     2,879      3,409

Deferred income taxes, net

     10,346      297

Other assets

     5,506      3,795
             

Total assets

   $ 403,526    $ 255,920
             

Liabilities:

     

Current liabilities:

     

Accounts payable

   $ 36,567    $ 18,270

Participant and passenger deposits

     49,493      17,622

Accrued and other expenses

     17,029      10,656

Billings in excess of costs on construction contracts

     13,229      4,334

Loss and loss adjustment expense reserves

     7,609      11,826

Current portion of long-term debt

     5,689      4,417

Unearned premiums

     —        1,220

Deferred gain on retroactive reinsurance

     —        19
             

Total current liabilities

     129,616      68,364

Long-term debt, net of current portion and net of discount of $2,623 and $0, respectively

     161,656      71,779

Long-term passenger and participant deposits

     5      40
             

Total liabilities

     291,277      140,183

Commitments and contingencies (Note 12)

     

Stockholders’ equity:

     

Preferred stock, $.01 par value; 2,000,000 shares authorized; none issued

     —        —  

Common stock, $.01 par value; 40,000,000 shares authorized; 10,823,155 and 10,838,179 shares issued and outstanding at September 30, 2007 and December 31, 2006, respectively

     108      107

Additional paid-in capital

     97,328      97,050

Retained earnings

     13,299      17,877

Accumulated other comprehensive income

     1,514      703
             

Total stockholders’ equity

     112,249      115,737
             

Total liabilities and stockholders’ equity

   $ 403,526    $ 255,920
             

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

 

1


Table of Contents

Ambassadors International, Inc.

Condensed Consolidated Statements of Operations


(in thousands, except per share data)

 

    

Three Months

Ended September 30,

   

Nine Months

Ended September 30,

 
     2007     2006     2007     2006  
     (unaudited)     (unaudited)  

Revenues:

        

Passenger ticket revenue

   $ 52,717     $ 30,272     $ 97,185     $ 50,647  

Onboard and other cruise revenue

     7,530       4,774       15,468       7,563  

Marine revenue

     31,984       16,725       84,033       19,145  

Travel, incentive and event related

     3,330       3,467       11,330       10,844  

Net insurance premiums earned

     84       2,341       906       7,361  
                                
     95,645       57,579       208,922       95,560  
                                

Costs and operating expenses:

        

Cruise operating expenses:

        

Compensation and benefits

     9,580       4,481       20,343       8,939  

Passenger expenses

     3,531       3,157       7,749       5,177  

Materials and services

     14,869       5,668       32,757       11,022  

Repairs and maintenance

     9,254       793       14,005       1,739  

Other cruise operating expenses

     655       2,356       2,691       4,135  
                                
     37,889       16,455       77,545       31,012  

Cost of marine revenue

     22,806       12,965       64,257       14,047  

Selling and tour promotion

     12,230       4,656       28,178       9,849  

General and administrative

     13,825       11,323       39,428       23,882  

Depreciation and amortization

     3,234       1,309       7,922       2,701  

Loss and loss adjustment expenses

     49       1,470       523       4,327  

Insurance acquisition costs and other operating expenses

     135       891       653       2,924  
                                
     90,168       49,069       218,506       88,742  
                                

Operating income (loss)

     5,477       8,510       (9,584 )     6,818  
                                

Other income (expense):

        

Interest and dividend income

     1,210       860       2,969       2,695  

Interest expense

     (2,082 )     (998 )     (5,277 )     (2,093 )

Realized gains (losses) on sale of available-for-sale securities, net

     —         338       (48 )     1,085  

Other, net

     (24 )     (3 )     360       69  
                                
     (896 )     197       (1,996 )     1,756  
                                

Income (loss) before provision (benefit) for income taxes

     4,581       8,707       (11,580 )     8,574  

Provision (benefit) for income taxes

     4,199       1,109       (9,170 )     1,036  
                                

Net income (loss)

   $ 382     $ 7,598     $ (2,410 )   $ 7,538  
                                

Earnings (loss) per share:

        

Basic

   $ 0.03     $ 0.69     $ (0.22 )   $ 0.71  

Diluted

   $ 0.03     $ 0.66     $ (0.22 )   $ 0.66  

Weighted-average common shares outstanding:

        

Basic

     11,058       10,936       11,085       10,631  

Diluted

     11,529       11,490       11,085       11,358  

Dividends per common share

   $ —       $ 0.10     $ 0.20     $ 0.30  

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

 

2


Table of Contents

Ambassadors International, Inc.

Condensed Consolidated Statements of Cash Flows (in thousands)


 

     Nine Months Ended
September 30,
 
     2007     2006  
     (unaudited)  

Cash flows from operating activities:

    

Net (loss) income

   $ (2,410 )   $ 7,538  

Adjustments to reconcile net (loss) income to net cash provided by operating activities:

    

Depreciation and amortization

     7,922       2,701  

Amortization of convertible debt offering costs

     330       —    

Stock compensation expense, net of cancellations

     1,212       1,131  

Undistributed (loss) earnings from equity investments

     (182 )     194  

Deferred income taxes

     (8,956 )     (2,461 )

Loss on sale of available-for-sale securities

     48       —    

Foreign currency translation

     744       —    

Change in assets and liabilities, net of effects of business acquisitions and dispositions:

    

Accounts and other receivables

     (15,313 )     (2,480 )

Costs in excess of billings on construction contracts

     (1,836 )     (130 )

Premiums receivable

     3,473       (1,148 )

Deferred policy acquisition costs

     330       858  

Reinsurance recoverable

     942       (213 )

Prepaid insurance premiums

     252       498  

Inventory

     (1,539 )     (1,632 )

Prepaid costs and other current assets

     (6,950 )     (2,674 )

Other assets

     (1,534 )     (51 )

Accounts payable and accrued and other expenses

     19,011       6,706  

Participant and passenger deposits

     8,870       4,372  

Billings in excess of costs on construction contracts

     8,895       (381 )

Loss and loss adjustment expense reserves

     (4,217 )     2,103  

Unearned premiums

     (1,220 )     (2,810 )

Deferred gain on retroactive insurance

     (19 )     (107 )
                

Net cash provided by operating activities

     7,853       12,014  
                

Cash flows from investing activities:

    

Proceeds from sale of available-for-sale securities

     35,257       48,321  

Purchase of available-for-sale securities

     (335 )     (20,540 )

Restricted cash

     (36,167 )     (9,600 )

Purchase of other investments

     —         (250 )

Cash paid for acquisitions of subsidiaries, net of cash received

     (10,954 )     (26,746 )

Purchase of property and equipment

     (12,658 )     (2,295 )
                

Net cash used in investing activities

     (24,857 )     (11,110 )
                

Cash flows from financing activities:

    

Proceeds from exercise of stock options

     403       2,124  

Proceeds from issuance of convertible notes

     97,000       —    

Proceeds from line of credit

     1,045       —    

Convertible debt offering costs

     (3,281 )     —    

Repurchase of common stock

     (1,577 )     —    

Common stock dividends paid

     (2,168 )     (3,187 )

Payments on long-term debt

     (63,749 )     (3,853 )
                

Net cash provided by (used in) financing activities

     27,673       (4,916 )
                

Net increase (decrease) in cash and cash equivalents

     10,669       (4,012 )

Cash and cash equivalents, beginning of year

     8,246       17,716  
                

Cash and cash equivalents, end of period

   $ 18,915     $ 13,704  
                

Non-Cash Investing and Financing Activities:

See Note 2 regarding the purchase of Windstar Cruises through assumption of debt.

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

 

3


Table of Contents

Ambassadors International, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)


 

1. Description of the Company and Basis of Presentation

The Company

Ambassadors International, Inc. (the “Company”) was founded in 1967 as a travel services company incorporated in Washington and reincorporated in Delaware in 1995. The Company operates through four wholly-owned subsidiaries: (i) Ambassadors, LLC (“Ambassadors”), which commenced operations in 1996; (ii) Cypress Reinsurance, Ltd (“Cypress Re”), which commenced operations in 2004; (iii) Ambassadors Marine Group, LLC (“AMG”), which commenced operations in 2006; and (iv) Ambassadors Cruise Group, LLC (“ACG”), which commenced operations in 2006. ACG formed a wholly-owned subsidiary, Ambassadors International Cruise Group, LLC (“AICG”) which acquired Windstar Sail Cruises Limited (“Windstar Cruises”) in April 2007.

In January 2007, the Company realigned its business segments into the following four business segments: (i) cruise, which includes the operations of ACG, (ii) marine, which includes the operations of AMG, (iii) travel and events, which includes the operations of Ambassadors, and (iv) corporate and other, which consists of general corporate assets (primarily cash and cash equivalents and investments), the operations of Cypress Re and other activities which are not directly related to the Company’s cruise, marine and travel and events operating segments.

As of September 30, 2007, the following further describes the operations of the Company’s business segments:

 

 

 

Cruise – This segment operates Majestic America Line which consists of a North American river and coastal cruise company, American West Steamboat Company (“American West”). ACG acquired American West on January 13, 2006 and the cruise-related assets of Delta Queen Steamboat Company, Inc. on April 25, 2006. American West operates a seven-ship fleet that includes the 223-passenger Empress of the North, the 142-passenger Queen of the West, the 436-passenger American Queen®, the 412-passenger Mississippi Queen® and the 176-passenger Delta Queen®. The American Queen® was not in operation for the 2006 cruise season. The Mississippi Queen® has not been in operation since it was placed into drydock in November 2006. 2008 will be the farewell season for the Delta Queen®. On June 12, 2006, ACG acquired the 48-passenger Executive Explorer, renamed Contessa, and on October 13, 2006, ACG acquired the 150-passenger Columbia Queen. On April 2, 2007, ACG, through its wholly-owned subsidiary, AICG, acquired Windstar Cruises, an international-flagged small ship cruise line that operates a three-ship fleet that includes the 312-passenger Wind Surf, 148-passenger Wind Spirit, and 148-passenger Wind Star.

The 2007 cruise schedule includes cruises through Alaska’s Inside Passage onboard the Empress of the North and Contessa, and on the Columbia and Snake Rivers onboard the Empress of the North, Columbia Queen and Queen of the West. The Company also offers historical cruises onboard the American Queen®, Delta Queen® and Mississippi Queen® on many American rivers, including the Mississippi, Ohio, Tennessee, Cumberland and Arkansas Rivers, with stops at many American historic cities, battle grounds and estates, including New Orleans, Memphis and St. Louis. Each of the Company’s cruises offers an onboard historian and naturalist and shore excursions to enhance passengers’ understanding of the wildlife, history and cultures of the areas traveled. Beginning in April 2007, the Company’s 2007 cruise schedule also includes destinations in the Greek Isles, Caribbean Islands and Costa Rica and cruises on the Mediterranean, the Adriatic, and the Panama Canal on one of the three Windstar Cruises ships.

 

   

Marine – This segment includes marina design, management and development. It also includes BellPort, acquired in February 2005, which offers shipyard operations, marina consulting and marina construction services from its locations in Newport Beach, California and in Mexico. On July 21, 2006, the Company acquired Bellingham Marine, a marina design and construction company which operates throughout the world.

 

   

Travel and Events – This segment develops, markets, and manages meetings and incentive programs for a nationwide roster of corporate clients utilizing incentive travel, merchandise award programs and corporate meeting management services. It provides comprehensive hotel reservation, registration and travel services for meetings, conventions, expositions and trade shows. It also develops, markets, and distributes event portfolio management technology solutions for corporations and large associations.

 

   

Corporate and Other – This segment consists of general corporate assets (primarily cash and cash equivalents and investments), the operations of Cypress Re and other activities which are not directly related to our cruise, marine or travel and events segments. Cypress Re reinsures property and casualty risks written by licensed United States insurers. The lines of business that are currently being reinsured include commercial auto liability, commercial physical damage and workers’ compensation. These risks are associated with members of highly selective affinity groups or associations.

 

4


Table of Contents

Ambassadors International, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)


 

Seasonality

The Company’s businesses are seasonal. Historically, the majority of the Company’s operating results were recognized in the first and second quarters of each fiscal year. As a result of the acquisitions within the Company’s cruise segment and the size of its cruise operations in relation to its overall operations, the Company expects that the majority of its operating results will be recognized in the second and third quarters of each fiscal year, which coincides with the cruising season within this new segment. The Company’s future annual results could be adversely affected if its revenue were to be substantially below seasonal norms during the second and third quarters of the year.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007 or any other future periods.

The condensed consolidated balance sheet at December 31, 2006 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements. Certain reclassifications have been made to the 2006 condensed consolidated financial statements to conform to the 2007 presentation. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K, as amended, for the year ended December 31, 2006.

Restricted Cash

The Company’s cruise passenger deposits are primarily received through credit card transactions. In 2006, the Company established a $9.6 million certificate of deposit with a bank in order to secure its processing of passenger deposits through credit cards. As of September 30, 2007, the Company had $24.0 million of additional restricted cash held by a bank in cash equivalents and a certificate of deposit as additional amounts required to secure processing of passenger deposits through credit cards. The restricted amounts were negotiated between the Company and the bank based on a percentage of the expected future volume of credit card transactions within a standard twelve-month period.

On March 27, 2007, the Company amended its credit facility with a bank to reduce its revolving line of credit from $20.0 million to $12.5 million and established a $12.5 million certificate of deposit with the bank to secure its outstanding letters of credit. The certificate amount was based on the Company’s current letters of credit then outstanding.

Revenue recognition

The Company recognizes revenue when persuasive evidence of an arrangement exists, the service fee is fixed or determinable, collectibility is reasonably assured and delivery has occurred.

    Passenger Ticket Revenue and Onboard and Other Cruise Revenues

The Company records passenger ticket revenue net of applicable discounts and recognizes passenger ticket revenue and related costs of revenue when the cruise is completed. The Company generally receives from its customers a partially refundable deposit within one week of booking a tour, with the balance typically remitted 60 days prior to the departure date. If customers cancel their trip, the nonrefundable portion of their deposit is recognized as revenue on the date of cancellation. Passenger revenue representing travel insurance purchased at the time of reservation is recognized upon the completion of the cruise or passenger cancellation, whichever is earlier and the Company’s obligation has been met. Onboard and other cruise revenue consisting of beverage and souvenir sales and optional shore excursions are deferred and recognized as revenue when the cruise is completed.

    Marine Revenue

The Company recognizes revenue for marine and related services, and shipyard related revenue in accordance with the respective contracts. Revenues from fixed-price marine construction contracts that are in excess of $10,000 in contract value are recognized on the percentage-of-completion method, measured by the percentage of cost incurred to date to the Company’s estimate of total cost for each contract. This method is used because the Company considers total cost to be the best

 

5


Table of Contents

Ambassadors International, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)


 

available measure of progress on these contracts. Revenues from fixed price marine construction contracts that are less than $10,000 in value are recognized upon completion of the contracts. Revenues from cost-plus contracts are recognized on the basis of costs incurred, plus the fee earned. An amount equal to contract costs attributable to claims is included in revenues when realization is probable and the amount can be reliably estimated.

Contract costs include all direct materials, labor and subcontractors, and those indirect costs directly related to contract performance, such as payroll taxes and employee benefits. Other indirect costs, such as equipment rental, repairs and depreciation, are treated as cost of revenues earned, but are not allocated to specific jobs. General and administrative costs are charged to expense as incurred. A provision for estimated losses on uncompleted contracts is made in the period in which such losses are determined. Changes in job performance, job conditions, estimated profitability, and final contract settlements may result in revisions to costs and income, and are recognized in the period in which the revisions are determined.

The asset, “costs in excess of billings on construction contracts,” represents revenues recognized in excess of amounts billed. The liability, “billings in excess of costs on construction contracts,” represents billings in excess of revenues recognized.

    Travel, Incentive and Event Related

The Company bills travel participants, mainly consisting of large corporations, in advance, of which the cash received is recorded as a participant deposit. The Company pays for certain direct program costs such as airfare, hotel and other program costs in advance of travel, which are recorded as prepaid program costs. Travel revenue and related costs are recognized when travel convenes and such revenue is classified as travel and incentive related. This revenue is reported on a net basis, reflecting the net effect of gross billings to the client less any direct program costs.

The Company recognizes revenue from hotel reservation, registration and related travel services when the convention operates. Revenue from the sale of merchandise is recognized when the merchandise is shipped, the service has been provided or when the redemption periods have expired. The Company defers revenue from pre-paid, certificate-based merchandise incentive programs until the Company’s obligations are fulfilled or upon management’s estimates (based upon historical trends) that it is remote that the certificate will be redeemed. These revenues are reported on a net basis, reflecting the net effect of gross billings to the client less any direct program or merchandise costs.

    Net Insurance Premiums Earned

Insurance premiums are recognized as revenue over the period of the insurance contracts in proportion to the amount of the insurance coverage provided. The insurance contracts are typically twelve months in duration and are considered short-duration contracts. Unearned premiums represent the unearned portion of the insurance contracts as of the balance sheet date.

Ceded reinsurance premiums relate to reinsurance purchased (excess of loss and aggregate stop loss) to mitigate potential losses from severe adverse loss development, both on a per accident claim basis and in the aggregate. These ceded reinsurance transactions are recognized as a reduction of premium revenue in the same manner in which the insurance contract is recognized as premium revenue.

    License Fees

The Company recognizes revenue from license fees based on a contracted percentage of total program receipts recorded from the licensing source.

Property and Equipment

Property and equipment are stated at cost, net of accumulated depreciation. The Company expenses the cost of maintenance and repairs that do not improve or extend the lives of the respective assets when incurred. Major additions and betterments are capitalized. The Company’s ships are capitalized and depreciated using the straight-line method over the expected useful life ranging up to 30 years, net of a residual value that generally is approximately 15%. Ship replacement parts are capitalized and depreciated upon being placed in service. Office and shop equipment is capitalized and depreciated using the straight-line method over the expected useful life of the equipment, ranging up to 10 years. Leasehold improvements are amortized using the straight-line method over the lesser of the expected useful life of the improvement or the term of the related lease.

The Company performs reviews for the impairment of property and equipment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When property and equipment are

 

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Ambassadors International, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)


 

sold or retired, we remove the related cost and accumulated depreciation from the accounts and recognize any gain or loss in the statement of operations. Judgments and estimates made related to property and equipment are affected by factors such as economic conditions, changes in resale values and changes in operating performance. This process requires the use of estimates and assumptions, which are subject to a high degree of judgment. If these assumptions change in the future, we may be required to record impairment charges for these assets.

Goodwill and Intangible Assets

The Company tests goodwill and intangible assets with indefinite useful lives for impairment at least annually or sooner whenever events or changes in circumstances indicate that they may be impaired. Management evaluates recoverability using both subjective and objective factors. Subjective factors include the evaluation of industry and product trends and our strategic focus. Objective factors include management’s best estimates of projected future earnings and cash flows. The Company uses a discounted cash flow model to estimate the fair market value of each of its reporting units and indefinite lived intangibles when performing its impairment tests. Assumptions used include growth rates for revenues and expenses, investment yields on deposits, any future capital expenditure requirements and appropriate discount rates. The Company established reporting units based on its current reporting structure. For purposes of testing goodwill for impairment, the Company allocated goodwill to these reporting units to the extent it related to each reporting unit. Intangible assets with definite lives are amortized over their estimated useful lives and reviewed for impairment at least annually or sooner whenever events or changes in circumstances indicate that they may be impaired. The majority of the Company’s intangible assets were assigned lives based on contract values associated with each intangible asset. The Company amortizes its acquired intangible assets with definite lives over periods ranging from 5 to 20 years depending on the contract term where applicable.

Income Taxes

The Company accounts for income taxes in accordance with the provisions of SFAS No. 109, which requires an asset and liability approach that requires the recognition of deferred tax assets and deferred tax liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. In making such determination, a review of all available positive and negative evidence must be considered, including scheduled reversal of deferred tax liabilities, projected future taxable income, tax planning strategies, and recent financial performance.

The Company provides for income taxes based on our estimate of federal, state and foreign liabilities. The Company’s estimates may include, among other items, effective rates for state and local income taxes, allowable tax credits, estimates related to depreciation and amortization expense allowable for tax purposes, and the tax deductibility of certain other items. Estimates are based on the information available to the Company at the time that the Company prepares its income tax provision.

Windstar Cruises is primarily engaged in the international operations of ships. Generally, income from the international operation of ships is subject to preferential tax regimes in the countries where the ship owning companies are incorporated and exempt from income tax in other countries where the ships call due to the application of income tax treaties or, in the case of the United States, Section 883 of the Internal Revenue Code. Income earned by the Company that is not associated with the international operation of ships, primarily the transportation, hotel and tour business of Windstar Cruises, is subject to income tax in the countries where such income is earned.

The Company believes that substantially all of Windstar Cruises’ income, with the exception of the Company’s United States source income principally from the transportation, hotel and tour business, was derived from, or incidental to, the international operation of ships, and is therefore exempt from United States federal income taxes. Section 883 is the primary provision upon which we rely to exempt most of our international ship operation earnings from United States income taxes. Accordingly, the Company’s provision for income taxes includes taxes on a portion of its ship operating income that is derived from United States source transportation, hotel and tour income.

If the Company were found not to qualify for exemption pursuant to applicable income tax treaties or under the Internal Revenue Code or if the income tax treaties or Internal Revenue Code were to be changed in a manner adverse to the Company, a larger portion of Windstar Cruises’ income could become subject to taxation.

Effective January 1, 2007, the Company adopted FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.” The company is subject to United States federal income tax as well as income tax of multiple state and foreign jurisdictions. The Company believes its tax return

 

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Ambassadors International, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)


 

positions are fully supported, but tax authorities may challenge certain positions, which may not be fully sustained. The Company assesses its income tax positions and records tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances, and information available at the reporting date. For uncertain tax positions where it is more likely than not that a tax benefit will be sustained, the Company records the greatest amount of tax benefit that has a greater than 50 percent probability of being realized upon effective settlement with a taxing authority that has full knowledge of all relevant information. For uncertain income tax positions where it is more likely than not that a tax benefit will not be sustained, no tax benefit has been recognized in the financial statements. The Company’s policy is to recognize interest and penalties that would be assessed in relation to the settlement value of unrecognized tax benefits as a component of its income tax provision.

Pretax earnings of a foreign subsidiary or affiliate are subject to United States taxation when effectively repatriated. United States income taxes and foreign withholding taxes were not provided on undistributed earnings of foreign subsidiaries. The Company intends to reinvest these earnings indefinitely in its foreign subsidiaries. It is not practical to determine the amount of undistributed earnings or income tax payable in the event the Company repatriates all undistributed foreign earnings. However, if these earnings were distributed in the United States in the form of dividends or otherwise, the Company would be subject to additional United States income taxes and foreign withholding taxes, offset by an adjustment for foreign tax credits.

Drydocking

The Company capitalizes drydocking costs as incurred and amortizes such costs over the period to the next scheduled drydock. The Company believes that the deferral method provides a better matching of revenues and expenses. Drydocking costs are included in prepaid and other current assets and in long-term assets in the accompanying balance sheet and are amortized over the cruising season between scheduled drydockings. As of September 30, 2007, the Company had approximately $4.4 million in unamortized drydock costs that related to the 2007 season and beyond, of which, approximately $2.8 million is included in prepaid costs and other current assets and approximately $1.6 million is included in other long-term assets in the accompanying balance sheet and will be amortized over the period to the next scheduled drydock.

Accounting for Stock Options

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004) “Share Based Payment” (“SFAS No. 123R”). SFAS No.123R supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the fair value approach in SFAS No. 123R is similar to the fair value approach described in SFAS No. 123. In 2006, the Company used the Black-Scholes-Merton formula to estimate the fair value of stock options granted to employees. The Company adopted SFAS No. 123R, using the modified-prospective method, beginning January 1, 2006. Based on the terms of the Company’s plans, the Company was not required to record a cumulative effect related to its plans. The Company also elected to continue to estimate the fair value of stock options using the Black-Scholes-Merton formula.

The following table details the stock-based compensation costs included in general and administrative expense (in thousands):

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
     2007    2006    2007    2006

Compensation cost related to stock options

   $ 128      272    $ 496    $ 614

Compensation cost related to restricted stock

     293      258      715      517
                           

Total stock-based compensation costs

   $ 421    $ 530    $ 1,211    $ 1,131
                           

As of September 30, 2007, total unrecognized compensation cost related to nonvested stock-based compensation arrangements granted under the stock option plans expected for the remainder of 2007 and in future years through 2010, respectively, were approximately $0.1 million and $0.3 million. This expected cost does not include the impact of any future stock-based compensation awards.

 

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Ambassadors International, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)


 

The fair value of each option grant is estimated on the date of the grant using the Black-Scholes-Merton option pricing model with the following weighted-average assumptions used for grants as of September 30, 2007 and 2006:

     2007     2006  

Dividend yield

   0.6 %   1.3 %

Expected volatility

   60 %   53 %

Risk free interest rates

   3.9 %   4.67 %

Expected option lives

   4.5 years     4.0 years  

The expected volatility is based on historical volatilities. The risk-free interest rate is based on United States Treasury zero-coupon issue with a remaining term equal to the expected option life assumed at the date of grant. The expected term was calculated based on historical experience and represents the time period options actually remain outstanding. The Company estimated forfeitures based on historical pre-vesting forfeitures and will revise those estimates in subsequent periods if actual forfeitures differ from those estimates.

In May 2007, the Company’s stockholders approved an amendment and restatement of the Company’s 2005 Incentive Award Plan (the “Plan”) to (i) increase the maximum number of shares of the Company’s common stock that may be issued under the Plan from 600,000 to 1,200,000 shares, (ii) increase the maximum number of shares of common stock with respect to one or more awards that may be granted to any participant during any calendar year from 200,000 to 500,000 shares, (iii) increase the maximum amount that may be paid in cash pursuant to performance or incentive awards from $500,000 to $2,000,000 and (iv) revise the definition of “Fair Market Value” to equal the closing price of the Company’s common stock quoted on the Company’s listing exchange on the date an award is granted.

Dividends Declared

On September 2, 2003, the Company’s board of directors authorized a new dividend policy of paying stockholders $0.40 per share annually, distributable at $0.10 per share on a quarterly basis. The following dividends were declared in 2007 and 2006 on the dates indicated (in thousands):

Record Date

   Payment Date    Dividend Amount

2007:

     

March 12, 2007

   March 19, 2007    $ 1,084

May 21, 2007

   May 31, 2007      1,084

2006:

     

February 20, 2006

   March 2, 2006    $ 1,050

May 22, 2006

   June 1, 2006      1,065

August 16, 2006

   August 31, 2006      1,072

November 14, 2006

   November 28, 2006      1,085

The Company and its board of directors continually review the dividend policy to evaluate conditions that may affect the Company’s desire or ability to pay dividends, which are declared at the discretion of the board of directors. Subsequent to the dividend declared in May 2007, the Company’s board of directors has not approved any additional dividends for 2007.

Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. SFAS No. 157 will be effective for fiscal years beginning after November 15, 2007, which is the Company’s fiscal year 2008. The Company has not yet completed its evaluation of the potential impact of adopting SFAS No. 157 on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), which allows an entity to voluntarily choose to measure certain financial assets and liabilities at fair value. SFAS No. 159 will be effective for fiscal years beginning after November 15, 2007, which is the Company’s fiscal year 2008. The Company has not yet completed is evaluation of the potential impact of adopting SFAS No. 159 on its consolidated financial statements.

In September 2007, the FASB issued a proposed guidance, FASB Staff Position (“FSP”) APB14-a, an interpretation of APB Opinion No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants.” The proposed FSP would require an issuer of convertible debt instruments commonly referred to as Instruments B and C from EITF Issue No. 90-19, “Convertible Bonds with Issuer Option to Settle for Cash upon Conversion”, and any other

 

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Ambassadors International, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)


 

convertible instruments that allow for settlement in any combination of cash and shares at the issuer’s option to separately account for the liability and equity components of the instrument in a manner that reflects the issuer’s nonconvertible debt borrowing rate. The proposed effective date for the FSP is for fiscal years beginning after December 15, 2007 and does not permit early application. However, the proposed transition guidance requires retrospective application to all periods presented, and does not grandfather existing instruments. The Company has not yet completed its evaluation of the potential impact of adopting this proposed FSP, if issued in final form.

 

2. Business Acquisitions and Investments

On February 1, 2005, the Company acquired 100% of the outstanding stock of BellPort. BellPort, located in Newport Beach, California, is a marina services company operating facilities in both the United States and Mexico. The purchase was completed in February 2005 for the consideration of approximately $1.3 million in cash and the issuance of 184,717 shares of the Company’s common stock, of which 130,389 shares were issued to related parties. In addition to the cash and stock consideration, the Company assumed a credit facility of approximately $1.6 million that the Company paid off in full on February 11, 2005. In connection with the acquisition, the Company was granted a twelve-month option to purchase a 34% interest in BellPort Japan Company, Ltd. (“BellPort Japan”), a marina operator, owner and developer of waterfront real estate, including both residential communities and marina facilities, located in Japan. In February 2006, BellPort acquired a 34% interest in BellPort Japan through the acquisition of BellJa Holding Company, Inc., a California corporation, for approximately $300,000, and extended its license agreement with BellPort Japan through 2010. The Company recorded its proportional share of the loss from BellPort Japan of approximately $100,000 during the nine months ended September 30, 2007. As of March 31, 2007, the Company had incurred losses on its investment up to the original investment amount, resulting in zero investment balance at the end of the period. The Company is not required to contribute any funds to support the operation of this investee. On August 20, 2007, the majority shareholder increased its capital contribution in BellPort Japan resulting in dilution of the Company’s investment in BellPort Japan to 0.9%. By mutual agreement with the majority shareholder, the Company continues to maintain an option (but not obligation) to contribute capital to increase its investment to 34%.

BellPort has a 50% ownership interest in Deer Harbor WI, LLC (“DHWI”). DHWI owns a marina facility in Deer Harbor, Orcas Island, Washington. The Company recorded its proportional share of the earnings from DHWI of approximately $39,000 and losses of approximately $38,000 for the three and nine months ended September 30, 2007, respectively, and $31,000 in income and $66,000 in losses for the three and nine months ended September 30, 2006, respectively, which are included in other income, net. As of September 30, 2007 and December 31, 2006, BellPort had a note receivable from DHWI for approximately $1.9 million and $1.9 million, respectively that is classified in other assets in the accompanying balance sheet. The note is secured by a deed of trust on property and bears interest at a variable rate equal to the London Interbank Offered Rate plus 2.75% per year, adjusted annually. As of December 31, 2006, the interest rate was 8.06%. All unpaid principal and accrued and unpaid interest is due no later than November 30, 2011.

The Company accounts for its investments in BellPort Japan and DHWI on the equity method.

In order to expand its cruise offerings to include international cruise offerings, on April 2, 2007, the Company, through its wholly-owned subsidiary AICG, completed its acquisition of all of the issued and outstanding shares of Windstar Cruises from HAL Antillen N.V. (“HAL Antillen”), a unit of Carnival Corporation, plc. Under the terms of the purchase agreement, the Company paid approximately $11.3 million in cash, $60 million in seller financing and assumed approximately $28.5 million in liabilities. The $60 million in seller financing was payable over ten years at 7% and was collateralized by each of the three Windstar Cruises’ ships.

The Windstar Cruises purchase price was approximately $72.1 million. The following table summarizes the components of the Windstar Cruises purchase price (in thousands):

 

Cash consideration

   $  11,289

Seller financing

     60,000

Acquisition costs incurred

     802
      

Purchase price

   $ 72,091
      

The final purchase price is dependent on the final valuation of the assets acquired, which has not been completed, and the actual final direct acquisition costs.

 

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Ambassadors International, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)


 

In accordance with SFAS No. 141, “Business Combinations,” the acquisition has been accounted for under the purchase method of accounting. The estimates of fair value of the assets acquired and liabilities assumed are based on management’s estimates. The following table summarizes the preliminary estimated fair value of net assets acquired (in thousands):

 

Total assets acquired

   $  100,615  

Liabilities assumed

     (28,524 )
        

Net assets acquired

   $ 72,091  
        

On April 18, 2007, the Company paid off $60 million in seller financing and accrued interest of $0.1 million using proceeds from its convertible senior notes offering discussed in note 6 “Long-term obligations.”

The following unaudited pro forma information presents the Company’s summarized results of operations for the nine months ended September 30, 2007 as if the acquisition of Windstar Cruises had occurred as of January 1, 2007 instead of April 2, 2007 (in thousands, except per share data):

 

     As Reported     Pro Forma
Windstar
Cruises
   Pro Forma
Combined
 

Revenues

   $ 208,922     $ 17,463    $ 226,385  
                       

Net (loss) income

   $ (2,410 )   $ 1,080    $ (1,330 )
                       

Loss per share – basic

   $ (0.22 )      $ (0.12 )
                   

Loss per share – diluted

   $ (0.22 )      $ (0.12 )
                   

 

3. Reinsurance

In December 2003, the Company formed Cypress Re and registered it as a Class 3 Reinsurer pursuant to Section 4 of the Bermuda Monetary Authority Act to carry on business in that capacity subject to the provisions of that Act.

The Company reinsures property and casualty risks written by licensed United States insurers through Cypress Re. The lines of business that are being reinsured include commercial auto liability, commercial physical damage and workers’ compensation. These risks are associated with members of highly selective affinity groups or associations. Members whose risk is reinsured under a program must meet certain loss control program qualifications. A member of a group must pass certain pre-qualification criteria that are part of the underwriting review by a third party.

The assumed reinsurance transactions are typically reinsured through a quota share agreement in which Cypress Re agrees to accept a certain fixed percentage of premiums written from the ceding company and in general assumes the same percentage of purchased reinsurance, direct acquisition costs and ultimate incurred claims.

Cypress Re retains the first layer of risk on a per policy basis, which ranges from $250,000 to $500,000 and the third party reinsurer (through excess of loss reinsurance) retains the next layer up to the policy limits of $1.0 million. Cypress Re retains losses up to the aggregate reinsurance limit, which varies with each quota share reinsurance agreement and the third party reinsurer then pays losses in excess of Cypress Re’s aggregate reinsurance limit up to $5.0 million. Cypress Re is responsible for any additional losses in excess of the aggregate reinsurance limit.

In 2004, the Company transferred its investment interest in two insurance programs to Cypress Re. On March 29, 2004, Cypress Re entered into a reinsurance agreement that incorporated the terms and conditions of the above interest of these programs. The quota share reinsurance agreement covered a retroactive period from July 1, 2002 through March 29, 2004, as well as a prospective period from March 29, 2004 to June 30, 2004. The reinsurance agreement meets the requirements of SFAS No. 113, “Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts and has both prospective and retroactive elements.

During 2004, Cypress Re entered into additional quota share reinsurance agreements. These reinsurance agreements represent participation in selective property and casualty programs. The reinsurance agreements meet the requirements of SFAS No. 113. One of the quota share reinsurance agreements covers a retroactive period from January 1, 2003 through May 31, 2004 and a prospective period from June 1, 2004 through December 31, 2004. The other agreements contain only prospective components.

Accounting for prospective reinsurance transactions results in premiums and related acquisition costs being recognized over the remaining period of the insurance contracts reinsured. As of September 30, 2007, there were no balances in unearned premium reserves, deferred policy acquisition costs or ceded prepaid reinsurance premiums.

 

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Ambassadors International, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)


 

Accounting for retroactive reinsurance transactions results in the reinsurer reimbursing the ceding company for liabilities incurred as a result of past insurable events covered by the underlying policies reinsured. Loss and loss adjustment expenses are initially recorded at the estimated ultimate payout amount and any gain from any such transaction is deferred and amortized into income. Loss and loss adjustment expense reserves are adjusted for changes in the estimated ultimate payout and the original deferred gain is recalculated and reamortized to the balance that would have existed had the changes in estimated ultimate payout been available at the inception of the transaction, resulting in a corresponding charge or credit to income in the period that the changes in estimated ultimate payout are made. As of September 30, 2007, the deferred gain on retroactive reinsurance was fully amortized and Cypress Re recognized in income $19,000 and $100,000 of the previously deferred gain on September 30, 2007 and 2006, respectively.

As of September 30, 2007, premiums receivable, reinsurance recoverable and loss and loss adjustment expense reserves of $0.5 million, $0.2 million and $0.4 million, respectively, related to retroactive reinsurance were recorded on the Company’s balance sheet. The September 30, 2007 loss and loss adjustment expense reserves balance includes $0.1 million for incurred but not reported claims.

Cypress Re retrocedes risk to the ceding company under specific excess and aggregate loss treaties. Cypress Re remains obligated for amounts ceded in the event that the reinsurer does not meet its obligations.

Premiums receivable at September 30, 2007 consists of funds held in trust by the ceding company of approximately $10.4 million and deferred and not yet due premiums from the ceding company of approximately $0.7 million. The funds held in trust primarily consist of high grade corporate bonds, government bonds and money market funds.

As of September 30, 2007, reinsurance recoverable and prepaid reinsurance premiums of $1.2 million and $0, respectively, relate to a single reinsurer. Cypress Re’s exposure to credit loss in the event of non-payment or non-performance is limited to these amounts.

The effect of reinsurance on premiums written and earned for the three and nine months ended September 30, 2007 was as follows (in thousands):

 

     Three Months Ended
September 30, 2007
    Nine Months Ended
September 30, 2007
 
     Written     Earned     Written     Earned  

Assumed

   $ (2 )   $ 107     $ (69 )   $ 1,151  

Ceded

     —         (23 )     7       (245 )
                                

Net premiums

   $ (2 )   $ 84     $ (62 )   $ 906  
                                

As of September 30, 2007, the Company had issued approximately $10.7 million in letters of credit related to property and casualty insurance programs that expire at various dates through 2008.

 

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Ambassadors International, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)


 

4. Inventory

The Company maintains inventory of marine construction materials, fuel, supplies, souvenirs and food and beverage products. Inventories are stated at the lower of cost or market, using standard costs, which approximates the first-in, first-out method. The components of inventory as of September 30, 2007 and December 31, 2006 were as follows (in thousands):

 

     September 30, 2007    December 31, 2006

Marine construction materials

   $ 2,361    $ 2,796

Food, souvenirs and supplies

     2,641      330

Fuel

     885      257
             
   $ 5,887    $ 3,383
             

 

5. Prepaid costs and other current assets

The components of prepaid costs and other current assets as of September 30, 2007 and December 31, 2006 were as follows (in thousands):

 

     September 30, 2007    December 31, 2006

Current portion of prepaid drydocking costs

   $ 2,757    $ 2,912

Prepaid program and tour costs

     2,278      1,670

Current portion of prepaid offering costs

     78      —  

Income tax receivable

     2,543      2,524

Deposits

     4,472      58

Other prepaid costs and other current assets

     5,714      1,854
             
   $ 17,842    $ 9,018
             

 

6. Long-term obligations

Long-term obligations as of September 30, 2007 and December 31, 2006 were as follows (in thousands):

 

     September 30, 2007    December 31, 2006

Loans secured by ship mortgages at fixed rates varying from 4.63% to 6.5% due through July 2028

   $ 69,724    $ 73,973

Secured note payable to bank at a fixed interest rate of 8.245%, due May 2010

     1,852      2,099

Amounts outstanding under secured lines of credit

     1,392      124

3.75% Convertible Senior Notes, net of discount of $2,623 and $0, respectively

     94,377      —  
             
     167,345      76,196

Less: current portion

     5,689      4,417
             

Non-current portion

     161,656      71,779
             

In conjunction with ACG’s acquisition of American West, the Company assumed approximately $41.5 million in fixed-rate, 4.63% debt payable through 2028 and guaranteed by the United States Government through the United States Maritime Administration (“MARAD”) under Title XI, Merchant Marine Act, 1936, as amended and is secured by a First Preferred Ship Mortgage on the Empress of the North. Annual principal payments of approximately $1.8 million plus accrued interest are required through July 18, 2028.

In conjunction with ACG’s acquisition of the cruise-related assets of Delta Queen, the Company assumed approximately $35.0 million of fixed-rate, 6.5% debt payable through 2020 and guaranteed by MARAD under Title XI, Merchant Marine Act, 1936, as amended, and secured by a First Preferred Ship Mortgage on the American Queen®.

 

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Ambassadors International, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)


 

Semi-annual principal payments accumulating to approximately $2.4 million annually plus accrued interest are required through June 2020.

In conjunction with the acquisition of Bellingham Marine, in July 2006, the Company assumed a $5.0 million line of credit with a bank. Interest was payable monthly at the bank’s prime rate plus 0.25%. The line of credit was collateralized by inventory, accounts receivable, and equipment of Bellingham Marine. The agreement contained certain limitations and various financial covenants. On December 28, 2006, the line of credit was paid in full and the facility was terminated. Bellingham Marine has a note payable to a bank with a balance of $1.9 million at September 30, 2007, secured by property, payable in monthly installments of approximately $16,000 including interest at a fixed rate of 8.245%, subject to certain limitations and various financial covenants, due May 10, 2010. As of September 30, 2007, the Company was in compliance with the financial covenants.

Bellingham Marine’s international operations have a $1.3 million line of credit for its Australian subsidiary with National Australia Bank Limited. Interest is payable monthly at an annual adjustable rate that is adjusted quarterly and is collateralized by substantially all of the subsidiary’s assets, including any uncalled or unpaid capital. As of September 30, 2007, there were approximately $1.0 million in borrowings on the line of credit and the interest rate as of September 30, 2007 was 7.29%. In addition, the international operations have six equipment contracts secured by the respective equipment payable in monthly installments aggregating approximately $6,000, including interest, through July 2010.

On April 3, 2007, the Company closed the sale of $97.0 million of 3.75% Convertible Senior Notes due 2027 (“Notes”) to Thomas Weisel Partners LLC (“Initial Purchaser”), in a private offering, pursuant to a purchase agreement dated March 28, 2007. A portion of the proceeds from the sale of the Notes was used to retire the $60 million in seller financing incurred in connection with the acquisition of Windstar Cruises as discussed in note 2 “Business Acquisitions and Investments.” The remaining proceeds are being used for general corporate purposes and future growth of the Company.

The Notes are convertible into shares of the Company’s common stock at an initial conversion rate of 17.8763 shares per $1,000 principal amount of the Notes (which is equivalent to an initial conversion price of approximately $55.94 per share), subject to adjustment upon the occurrence of certain events. Interest on the Notes is payable semi-annually in arrears on April 15 and on October 15 in each year, commencing October 15, 2007. The Company may redeem the Notes in whole or in part after April 15, 2012. After April 20, 2010 and prior to April 15, 2012, the Company may redeem all or a portion of the Notes only if the price of the Company’s common stock reaches certain thresholds for a specified period of time. Holders of the Notes may require the Company to purchase all or a portion of the Notes, in cash, on April 15, 2012April 15, 2017 and April 15, 2022 or upon the occurrence of specified fundamental changes (as defined in the purchase agreement dated March 28, 2007). If a holder elects to convert Notes in connection with a specified fundamental change that occurs prior to April 15, 2012, the Company will in certain circumstances increase the conversion rate by a specified number of additional shares.

In connection with the issuance of the Notes, the Initial Purchaser withheld $2.91 million in fees from the proceeds of the offering which amount is classified as long-term debt discount and amortized over a five-year period, the earliest term when the note holders have an option to require the Company to redeem the Notes. Debt offering costs amounted to $0.2 million. Both the debt discount and prepaid offering costs are being amortized over the five-year period using the effective interest rate method.

 

7. Comprehensive Income (Loss)

The components of comprehensive income (loss) are as follows (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
     2007    2006     2007     2006

Net income (loss)

   $ 382    $ 7,598     $ (2,410 )   $ 7,538

Change in unrealized gain on foreign currency translation

     347      607       744       607

Change in unrealized gain (loss) on available-for-sale securities, net of income tax expense of $0, $303, $43 and $576

     18      (57 )     67       394
                             
   $ 747    $ 8,148     $ (1,599 )   $ 8,539
                             

 

8. Earnings (Loss) Per Share

Basic earnings (loss) per share (EPS) is computed by dividing net income (loss) by the weighted average common shares outstanding. Diluted EPS includes the effect of any potential shares outstanding, which for the Company

 

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Ambassadors International, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)


 

consists of dilutive stock options and Notes. The dilutive effect of stock options is calculated using the treasury stock method with an offset from expected proceeds upon exercise of the stock options and unrecognized compensation expense. The dilutive effect of the Notes is calculated by adding back interest expense and amortized offering costs, net of taxes, that would not have been incurred assuming conversion. There are no stock options with option prices that would not be dilutive for the three and nine months ended September 30, 2007. The diluted EPS for the three and nine months ended September 30, 2007 includes the effect of conversion of the Notes into the Company’s common shares as if the conversion occurred as of the dates of issuance in April 2007. The dilutive EPS for the three and nine months ended September 30, 2007 does not include the dilutive effect of conversion of the Notes into the Company’s common shares since it would be anti-dilutive. The table below details the components of the basic and diluted EPS calculations (in thousands, except per share amounts):

 

    

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

     2007    2006    2007     2006

Numerator:

          

Net income (loss)

   $ 382    $ 7,598    $ (2,410 )   $ 7,538
                            

Denominator:

          

Weighted-average shares outstanding — basic

     11,058      10,936      11,085       10,631

Effect of dilutive securities:

          

Stock options

     471      554      —         727

Notes

     —        —        —         —  
                            

Weighted-average shares outstanding — diluted

     11,529      11,490      11,085       11,358
                            

Earnings (loss) per share:

          

Basic

   $ 0.03    $ 0.69    $ (0.22 )   $ 0.71
                            

Diluted

   $ 0.03    $ 0.66    $ (0.22 )   $ 0.66
                            

 

9. Common Stock Repurchase Program

In November 1998, the board of directors of the Company authorized the repurchase of the Company’s common stock in the open market or through private transactions, up to $20.0 million in the aggregate. In August 2006, the Company’s’ board of directors authorized an additional $10.0 million for the repurchase of the Company’s common stock in the open market or through private transactions, providing for an aggregate of $30.0 million. This repurchase program is ongoing and as of September 30, 2007, the Company had repurchased 1,102,650 shares for approximately $14.0 million. The Company repurchased 51,150 shares during the three months ended June 30, 2007 and nine months ended September 30, 2007 for approximately $1.6 million. The Company made no purchases during the three and nine months ended September 30, 2006.

 

10. Business Segments

In January 2007, the Company realigned its business segments into the following four business segments: (i) cruise, which includes the operations of ACG; (ii) marine, which includes the operations of AMG; (iii) travel and events, which includes the operations of Ambassadors; and (iv) corporate and other, which consists of general corporate assets (primarily cash and cash equivalents and investments), the insurance operations of Cypress Re and other activities that are not directly related to the Company’s cruise, marine and travel and events operating segments.

Summary of business segment information is as follows (in thousands):

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
     2007    2006    2007    2006

Revenue:

           

Cruise

   $ 60,247    $ 35,046    $ 112,653    $ 58,210

Marine

     31,984      16,725      84,033      19,145

Travel and events

     3,330      3,467      11,330      10,844

Corporate and other

     84      2,341      906      7,361
                           

Total revenue

   $ 95,645    $ 57,579    $ 208,922    $ 95,560
                           

 

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Ambassadors International, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)


 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2007     2006     2007     2006  

Operating income (loss):

        

Cruise

   $ 3,671     $ 8,717     $ (11,853 )   $ 7,284  

Marine

     3,500       1,021       5,321       1,202  

Travel and events

     30       624       1,663       2,184  

Corporate and other

     (1,724 )     (1,852 )     (4,715 )     (3,852 )
                                

Total operating (loss) income

   $ 5,477     $ 8,510     $ (9,584 )   $ 6,818  
                                

 

     September 30, 2007    December 31, 2006

Total assets:

     

Cruise

   $ 270,466    $ 126,521

Marine

     67,522      50,500

Travel and events

     16,964      15,189

Corporate and other

     48,574      63,710
             

Total assets

   $ 403,526    $ 255,920
             

 

11. Income Taxes

The Company recorded an income tax provision of $4.2 million and an income tax benefit of $9.2 million for the three and nine months ended September 30, 2007, respectively, compared to an income tax provision of $1.1 million and $1.0 million, respectively, for the three and nine months ended September 30, 2006. The effective tax benefit rate for the nine months ended September 30, 2007 was 79.2%, compared to a tax rate of 12.1% for the nine months ended September 30, 2006. The Company’s effective income tax rate for the nine months ended September 30, 2006 was lower than the statutory rate due to the reversal of approximately $2.3 million in valuation allowance on the Company’s deferred tax assets. The effective tax rate change in 2007 is primarily related to the preferential tax treatment associated with the international operation of ships, which commenced with the acquisition of Windstar Cruises in April 2007.

During the quarter ended September 30, 2007, the Company recorded a reduction to acquired intangibles of $0.1 million as a purchase accounting adjustment to income tax payable and deferred tax asset balances upon completion of pre-acquisition tax returns related to Bellingham Marine.

In June 2006, the FASB issued FASB Interpretation (“FIN”) No. 48 “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement 109.” FIN 48 establishes a single model to address accounting for uncertain tax positions. FIN 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company adopted the provisions of FIN 48 on January 1, 2007. Upon adoption, the Company recognized no adjustment in its balance of unrecognized tax benefits. As of the date of adoption, the Company’s unrecognized tax benefits totaled approximately $0.7 million, of which $0.4 million would affect the effective tax rate, if recognized. There have been no significant increases or decreases in the Company’s unrecognized tax benefits during the nine months ended September 30, 2007. The Company does not expect any significant increases or decreases to its unrecognized tax benefits within 12 months of this reporting date.

The Company and its subsidiaries are subject to United States federal income tax as well as income tax of multiple state and foreign jurisdictions. With few exceptions, the Company is no longer subject to United States federal income tax examinations for years before 2004; state and local income tax examinations before 2003; and foreign income tax examinations before 2003.

The Company is not currently under Internal Revenue Service, state, local or foreign jurisdiction tax examinations.

The Company’s continuing practice is to recognize potential accrued interest and penalties related to unrecognized tax benefits within its global operations in its provision for income taxes. In conjunction with the adoption of FIN 48, the Company recognized approximately $0.2 million for the accrual of interest and penalties which are included as a component of the $0.7 million unrecognized tax benefits noted above. In the normal course of business, we provide for uncertain tax positions and adjust our unrecognized tax benefits, including related interest, accordingly. In the third quarter of 2007, those adjustments were not significant. To the extent interest and penalties are not assessed with respect to the uncertain tax positions, amounts accrued will be reduced and $27,000 will be reflected as a reduction of the overall income tax provision and $0.2 million will reduce non-current intangibles.

 

12. Commitments and Contingencies

On October 20, 2006, approximately 20 passengers of the Mississippi Queen® became sick with a stomach illness which was later determined to be a case of norovirus. The cruise stopped sailing two days earlier than originally scheduled in order to

 

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Ambassadors International, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)


 

inspect and clean the ship. The ship was released and began operations for the next scheduled cruise on October 25, 2006 and again stopped operation on October 27, 2006 due to the same norovirus on additional passengers. The Company cancelled two additional weeks of cruise sailings in order to further inspect and clean the ship. The Company received $0.6 million related to insurance recoveries under its business interruption insurance which is recorded in other income as of September 30, 2007. The Company is in the process of seeking additional insurance related recoveries with respect to these incidents; however, due to the uncertainty regarding the claims, no additional amounts were recorded as expected to be received as of September 30, 2007.

On May 14, 2007, the Empress of the North ran aground in Southeast Alaska. No passengers or crew were injured during the incident. The ship was in dry dock for damage inspection and repairs for approximately seven initial weeks. In September 2007, the ship re-entered dry dock for additional repairs for a total of four additional non-consecutive weeks. The ship ended her season on October 27, 2007 to enter her scheduled dry dock lay up period early in order to complete work on her propulsion system. The Queen of the West will assume operation of the remaining published itineraries of the Empress of the North. As of the quarter ended September 30, 2007, the Company recorded in cruise operating expenses approximately $6.1 million in costs associated with additional ship repairs, passenger relocation and crew expenses incurred as a result of the incident. These expenses were offset by estimated insurance recoveries of $4.1 million. As of September 30, 2007, the estimated impact of this incident was $5.3 million.

The Company is from time to time threatened or involved in litigation incidental to its business. The Company believes that the outcome of all current litigation will not have a material adverse effect on its business, financial condition, cash flows or results of operations.

 

13. Impairment or Disposal of Long-Lived Assets

Since 1968, Congress has granted the Delta Queen® eight consecutive exemptions from the Safety at Sea Act requirement because of fire prevention and safety enhancements made to the ship and the historic status of the Delta Queen®. The current exemption has been extended to November 1, 2008. The Company’s ability to operate the Delta Queen® was dependent upon retaining the current Congressional exemption and obtaining additional exemptions subsequent to 2008. In July 2007, the Company was made aware that the Congressional exemption would not be extended beyond 2008 and announced 2008 as the farewell season for the Delta Queen®. The Company reviewed the remaining vessel value of the Delta Queen® for impairment. Management evaluated the recoverability using both subjective and objective factors. Subjective factors included the evaluation of industry and product trends and the Company’s strategic focus. Objective factors included management’s best estimates of projected future earnings and cash flows. The Company used a discounted cash flow model using assumptions including expected revenues and expenses, investment yields on deposits, any future capital expenditure requirements and appropriate discount rates. Based on the analysis performed, the Company believes that the remaining vessel value on the Delta Queen® is recoverable and no impairment charge has been recorded as of September 30, 2007.

 

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

The following discussion of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this quarterly report. This discussion contains forward-looking statements that are subject to known and unknown risks, uncertainties and other factors that may cause our actual results to differ materially from those expressed or implied by such forward-looking statements. These risks, uncertainties and other factors include, among others, those identified under “Cautionary Note Regarding Forward-Looking Statements” and elsewhere in this quarterly report and in our annual report on Form 10-K for the year ended December 31, 2006, as amended.

We are a cruise, marine and travel and events company. Our cruise operations are conducted under our Majestic America Line brand and Windstar Cruises within our Ambassadors Cruise Group, LLC (“ACG”). Our Majestic America Line is a domestic provider of overnight passenger cruises along the inland rivers and coastal waterways of North America. Our Windstar Cruises operates three motor-sail yachts that offer sailings in the Caribbean, Europe, the Americas and the Greek Isles. Our marine business, Ambassadors Marine Group (“AMG”) is a global provider of marina design and construction services. Our marine business also offers marine operations, management and consulting services to marina owners. Our travel and events business provides event and travel services to corporations, associations and trade show companies.

During 2006, our cruise segment consisted of the operations of four United States-flagged cruise ships. Our United States cruise operations are conducted under our Majestic America Line brand. In 2007, the seven United States-flagged cruise ships were under the Majestic America Line in North America, including the Empress of the North, Queen of the West, Columbia Queen, Contessa, American Queen®, Delta Queen® and Mississippi Queen®. In 2007, we operated six of the seven ships under the Majestic America Line. The Mississippi Queen® will not operate in 2007 and 2008 will be the farewell season for the Delta Queen®. Our United States-flagged cruise ships offer a total of 1,587 passenger berths. We utilize passenger berths as our measurement of capacity on our ships. Each passenger berth represents a bed that can be sold to customers for overnight accommodations on our cruises.

On April 2, 2007, Ambassadors International Cruise Group (“AICG”) , a wholly-owned subsidiary of ACG, acquired Windstar Cruises, an international-flagged small ship cruise line consisting of three ships Wind Surf, Wind Spirit and Wind Star. These ships offer a total of 608 passenger berths.

Through AMG, we are a leading provider of marina design, manufacturing and construction services. We also offer marine operations, management and consulting services to marina owners. Our marine operations primarily consist of the operations of Bellingham Marine and Bellport Group (“Bellport”).

Our travel and events segment operates under the Ambassadors, LLC brand. We provide event services to corporations, associations and trade show companies. In addition, we develop, market and manage performance improvement programs utilizing travel incentives and merchandise awards designed to achieve specific corporate objectives, including achieving sales goals, improving productivity and attracting and retaining qualified employees. Our clients include Fortune 1000 companies and other large and small businesses.

Our corporate and other segment includes general corporate assets (primarily cash and cash equivalents and investments), our reinsurance operations, which reinsures property and casualty risks written by licensed United States insurers in the categories of commercial auto liability, commercial physical damage and workers’ compensation associated with members of highly selective affinity groups or associations, and other activities that are not directly related to our cruise, marine, and travel and events operating segments.

Critical Accounting Policies

We prepare our consolidated financial statements in accordance with United States generally accepted accounting principles (“GAAP”). The preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and costs and expenses during the period. We evaluate our estimates and judgments, including those that affect our most critical accounting policies, on an ongoing basis. We base our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances, within the framework of current accounting literature.

Our businesses are seasonal. Prior to 2006, we recognized the majority of our operating results in the first three and six month periods of each fiscal year. However, as a result of the acquisitions within ACG during 2006 and 2007, we have begun to recognize the majority of our operating results in the second and third three month periods of our fiscal year which coincides with our cruising season. Our annual results would be adversely affected if our revenue were to be substantially below seasonal norms during the second and third three month periods of our fiscal year.

 

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The following is a list of the accounting policies that we believe require the most significant judgments and estimates, and that could potentially result in materially different results under different assumptions or conditions.

Revenue Recognition

We recognize revenue when persuasive evidence of an arrangement exists, the service fee is fixed or determinable, collectibility is reasonably assured and delivery has occurred.

Passenger Ticket Revenue and Onboard and Other Cruise Revenues

We record passenger ticket revenue net of applicable discounts. We recognize passenger ticket revenue and related costs of revenue when the cruise is completed. We generally receive from our customers a partially refundable deposit within one week of booking a tour, with the balance typically remitted 60 days prior to the departure date. If customers cancel their trip, the nonrefundable portion of their deposit is recognized as revenue on the date of cancellation. Passenger revenue representing travel insurance purchased at the time of reservation is recognized upon the completion of the cruise or passenger cancellation, whichever is earlier and our obligation has been met. Onboard and other cruise revenue consisting of beverage and souvenir sales and optional shore excursions are deferred and recognized as revenue when the cruise is completed.

Marine Revenue

We recognize revenue for marine and related services, and shipyard related revenue in accordance with the respective contracts. Revenues from fixed-price marine construction contracts that are in excess of $10,000 in contract value are recognized on the percentage-of-completion method, measured by the percentage of cost incurred to date to our estimate of total cost for each contract. This method is used because we consider total cost to be the best available measure of progress on these contracts. Revenues from fixed-price marine construction contracts that are less than $10,000 in contract value are recognized upon completion of the contracts. Revenues from cost-plus contracts are recognized on the basis of costs incurred, plus the fee earned. An amount equal to contract costs attributable to claims is included in revenues when realization is probable and the amount can be reliably estimated.

Contract costs include all direct materials, labor and subcontractors, and those indirect costs directly related to contract performance, such as payroll taxes and employee benefits. Other indirect costs, such as equipment rental, repairs and depreciation, are treated as cost of revenues earned, but are not allocated to specific jobs. General and administrative costs are charged to expense as incurred. A provision for estimated losses on uncompleted contracts is made in the period in which such losses are determined. Changes in job performance, job conditions, estimated profitability, and final contract settlements may result in revisions to costs and income, and are recognized in the period in which the revisions are determined.

The asset, “costs in excess of billings on construction contracts,” represents revenues recognized in excess of amounts billed. The liability, “billings in excess of costs on construction contracts,” represents billings in excess of revenues recognized.

Travel, Incentive and Event Related

We bill travel participants, mainly consisting of large corporations, in advance, of which the cash received is recorded as a participant deposit. We pay for certain direct program costs such as airfare, hotel and other program costs in advance of travel, which are recorded as prepaid program costs. We recognize travel revenue and related costs when travel convenes and classify such revenue as travel and incentive related. This revenue is reported on a net basis, reflecting the net effect of gross billings to the client less any direct program costs.

We recognize revenue from hotel reservation, registration and related travel services when the convention operates. We recognize revenue from the sale of merchandise when the merchandise is shipped, the service has been provided or when the redemption periods have expired. We defer revenue from pre-paid, certificate-based merchandise incentive programs until our obligations are fulfilled or upon management’s estimates (based upon historical trends) that it is remote that the certificate will be redeemed. We report these revenues on a net basis, reflecting the net effect of gross billings to the client less any direct program or merchandise costs.

 

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Net Insurance Premiums Earned

Insurance premiums are recognized as revenue over the period of the insurance contracts in proportion to the amount of the insurance coverage provided. The insurance contracts are typically twelve months in duration and are considered short-duration contracts. Unearned premiums represent the unearned portion of the insurance contracts as of the balance sheet date.

Ceded reinsurance premiums relate to reinsurance purchased (excess of loss and aggregate stop loss) to mitigate potential losses from severe adverse loss development, both on a per accident claim basis and in the aggregate. These ceded reinsurance transactions are recognized as a reduction of premium revenue in the same manner in which the insurance contract is recognized as premium revenue.

License Fees

We recognize revenue from license fees based on a contracted percentage of total program receipts recorded from the licensing source.

Property and Equipment

Property and equipment are stated at cost, net of accumulated depreciation. We expense as incurred the cost of maintenance and repairs that do not improve or extend the lives of the respective assets. We capitalize major additions and betterments. Our ships are capitalized and depreciated using the straight-line method over the expected useful life ranging up to 30 years, net of a residual value that generally is approximately 15%. Ship replacement parts are capitalized and depreciated upon being placed in service. Office and shop equipment is capitalized and depreciated using the straight-line method over the expected useful life of the equipment, ranging up to 10 years. We amortize leasehold improvements using the straight-line method over the lesser of the expected useful life of the improvement or the term of the related lease.

We perform reviews for the impairment of property and equipment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When property and equipment are sold or retired, we remove the related cost and accumulated depreciation from the accounts and recognize any gain or loss in the statement of operations. Judgments and estimates made related to property and equipment are affected by factors such as economic conditions, changes in resale values and changes in operating performance. This process requires the use of estimates and assumptions, which are subject to a high degree of judgment. If these assumptions change in the future, we may be required to record impairment charges for these assets.

Drydocking

We capitalize drydocking costs as incurred and amortize such costs over the period to the next scheduled drydock. We believe that the deferral method provides a better matching of revenues and expenses. Drydocking costs are included in prepaid and other current assets and in long-term assets in the accompanying balance sheet and are amortized over the cruising season between scheduled dry dockings.

Goodwill and Intangible Assets

We test goodwill and intangible assets with indefinite useful lives for impairment at least annually or sooner whenever events or changes in circumstances indicate that they may be impaired. Management evaluates recoverability using both subjective and objective factors. Subjective factors include the evaluation of industry and product trends and our strategic focus. Objective factors include management’s best estimates of projected future earnings and cash flows. We use a discounted cash flow model to estimate the fair market value of each of our reporting units and indefinite lived intangibles when performing our impairment tests. Assumptions used include growth rates for revenues and expenses, investment yields on deposits, any future capital expenditure requirements and appropriate discount rates. We established reporting units based on our current reporting structure. For purposes of testing goodwill for impairment, we allocated goodwill to these reporting units to the extent it related to each reporting unit. We amortize intangible assets with definite lives over their estimated useful lives and review them for impairment at least annually or sooner whenever events or changes in circumstances indicate that they may be impaired. The majority of our intangible assets were assigned lives based on contract values associated with each intangible asset. We amortize our acquired intangible assets with definite lives over periods ranging from 5 to 20 years depending on the contract term where applicable.

Deferred Policy Acquisition Costs

Deferred policy acquisition costs represent those costs, commissions and other costs of acquiring insurance, that vary with and are primarily related to the production of new and renewal insurance. These costs are deferred and amortized over the terms of the policies or reinsurance treaties to which they relate. Deferred policy acquisition costs represent those costs directly related to the unearned premiums as of the balance sheet date. We consider anticipated investment income in determining the recoverability of these costs. At September 30, 2007, the balance in our deferred policy acquisition costs was zero.

 

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Reserve for Loss and Loss Adjustment Reserves

The liability for losses and loss-adjustment expenses includes an amount determined from loss reports and individual cases and an amount for losses incurred but not reported. Such liabilities are based on estimates and, while we believe that the amount is adequate, the ultimate liability may be in excess of or less than the amounts provided. Anticipated deductible recoveries from insureds are recorded as reinsurance recoverables at the time the liability for unpaid claims is established. Other recoveries on unsettled claims, such as salvage and subrogation, are estimated by management and adjusted upon collection.

Reinsurance

In the normal course of our reinsurance business, we seek to reduce the loss that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. Amounts recoverable from reinsurers are estimated in a manner consistent with the reinsured policy.

With respect to retroactive reinsurance contracts, the amount by which the liabilities associated with the reinsured policies exceed the amounts paid is amortized to income over the estimated remaining settlement period. We account for the effects of subsequent changes in estimated or actual cash flows by adjusting the previously deferred amount to the balance that would have existed had the revised estimate been available at the inception of the reinsurance transaction, with a corresponding charge or credit to income.

Stock-Based Compensation

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share Based Payment” (“SFAS No. 123R”). SFAS No. 123R supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the fair value approach in SFAS No.123R is similar to the fair value approach described in SFAS No. 123. In 2005, we used the Black-Scholes-Merton formula to estimate the fair value of stock options granted to employees. We adopted SFAS No. 123R, using the modified-prospective method, beginning January 1, 2006. Based on the terms of our plans, we were not required to record a cumulative effect related to our plans. We also elected to continue to estimate the fair value of stock options using the Black-Scholes-Merton formula.

Use of the Black-Scholes-Merton formula to estimate the fair value of stock-based compensation requires the input of subjective assumptions. These assumptions include estimating the length of time employees will retain their vested stock options before exercising them, risk-free interest rates, our dividend yield and the volatility of our common stock price over the expected term. Changes in the subjective assumptions can materially affect the estimate of fair value of stock-based compensation and consequently, the related amount recognized on our consolidated statements of operations.

On November 10, 2005, the FASB issued FASB Staff Position SFAS No. 123R-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards” (“SFAS No.123R-3”). We elected to adopt the alternative transition method provided in SFAS No. 123R-3 for calculating the tax effects of stock-based compensation pursuant to SFAS No. 123R. The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (“APIC Pool”) related to the tax effects of employee stock-based compensation expense, and to determine the subsequent impact on the APIC Pool and consolidated statements of cash flows of the tax effects of employee stock-based compensation awards that were outstanding at our adoption of SFAS No. 123R. In addition, in accordance with SFAS No. 123R, SFAS No. 109, “Accounting for Income Taxes,” and Emerging Issues Task Force Topic D-32, “Intraperiod Tax Allocation of the Tax Effect of Pretax Income from Continuing Operations,” we have elected to recognize excess income tax benefits from stock option exercises in additional paid-in capital only if an incremental income tax benefit would be realized after considering all other tax attributes presently available to us. We measure the tax benefit associated with excess tax deductions related to stock-based compensation expense by multiplying the excess tax deductions by the statutory tax rates.

Income Taxes

We account for income taxes in accordance with the provisions of SFAS No. 109, which requires an asset and liability approach that requires the recognition of deferred tax assets and deferred tax liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. In making such determination, a review of all available positive and negative evidence must be considered, including scheduled reversal of deferred tax liabilities, projected future taxable income, tax planning strategies, and recent financial performance.

 

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We provide for income taxes based on our estimate of federal, state and foreign liabilities. Our estimates may include, among other items, effective rates for state and local income taxes, allowable tax credits, estimates related to depreciation and amortization expense allowable for tax purposes, and the tax deductibility of certain other items. Our estimates are based on the information available to us at the time that we prepare our income tax provision.

Windstar Cruises is primarily engaged in the international operations of ships. Generally, income from the international operation of ships is subject to preferential tax regimes in the countries where the ship owning companies are incorporated and exempt from income tax in other countries where the ships call due to the application of income tax treaties or, in the case of the United States, Section 883 of the Internal Revenue Code. Income we earn that is not associated with the international operation of ships, primarily the transportation, hotel and tour business of Windstar Cruises, is subject to income tax in the countries where such income is earned.

We believe that substantially all of Windstar Cruises’ income, with the exception of our United States source income principally from the transportation, hotel and tour business, was derived from, or incidental to, the international operation of ships, and is therefore exempt from United States federal income taxes. Section 883 is the primary provision upon which we rely to exempt most of our international ship operation earnings from United States income taxes. Accordingly, our provision for income taxes includes taxes on a portion of our ship operating income that is derived from United States source transportation, hotel and tour income.

If we were found not to qualify for exemption pursuant to applicable income tax treaties or under the Internal Revenue Code or if the income tax treaties or Internal Revenue Code were to be changed in a manner adverse to us, a larger portion of Windstar Cruises’ income could become subject to taxation.

Effective January 1, 2007, we adopted FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.” We are subject to United States federal income tax as well as income tax of multiple state and foreign jurisdictions. We believe our tax return positions are fully supported, but tax authorities may challenge certain positions, which may not be fully sustained. We assess our income tax positions and record tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances, and information available at the reporting date. For uncertain tax positions where it is more likely than not that a tax benefit will be sustained, we record the greatest amount of tax benefit that has a greater than 50 percent probability of being realized upon effective settlement with a taxing authority that has full knowledge of all relevant information. For uncertain income tax positions where it is more likely than not that a tax benefit will not be sustained, no tax benefit has been recognized in the financial statements. Our policy is to recognize interest and penalties that would be assessed in relation to the settlement value of unrecognized tax benefits as a component of our income tax provision.

Pretax earnings of a foreign subsidiary or affiliate are subject to United States taxation when effectively repatriated. United States income taxes and foreign withholding taxes were not provided on undistributed earnings of foreign subsidiaries. We intend to reinvest these earnings indefinitely in our foreign subsidiaries. It is not practical to determine the amount of undistributed earnings or income tax payable in the event we repatriate all undistributed foreign earnings. However, if these earnings were distributed in the United States in the form of dividends or otherwise, we would be subject to additional United States income taxes and foreign withholding taxes, offset by an adjustment for foreign tax credits.

Statistical Terminology and Information for Cruise Operations

Available Passenger Cruise Days (“APCD”)

APCD’s are our measurement of capacity and represent double occupancy per cabin multiplied by the number of cruise days for the period.

Occupancy

Occupancy, in accordance with the cruise vacation industry practice, is calculated by dividing Passenger Cruise Days by APCD. A percentage in excess of 100% indicates that three or more passengers occupied some cabins.

Passenger Cruise Days

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

 

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Selected cruise operations statistical information is as follows;

 

    

Three Months

Ended September 30,

   

Nine Months

Ended September 30,

 
     2007     2006     2007     2006  
     (unaudited)     (unaudited)  

Passengers Carried

   21,123     11,789     48,807     19,786  

Occupancy Percentage

   88.6 %   87.7 %   88.9 %   84.6 %

Passenger Cruise Days

   146,198     79,062     336,119     134,621  

APCD

   165,076     90,122     377,918     159,147  

COMPARISON OF RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2007 TO THE THREE MONTHS ENDED SEPTEMBER 30, 2006

Revenue

Total revenue for the three months ended September 30, 2007 was $95.6 million, compared to $57.6 million for the three months ended September 30, 2006. For the quarter ended September 30, 2007, the increase in revenue was primarily related to increases within our cruise and marine operations. Our cruise revenue increased $25.2 million due to the Windstar Cruises acquisition in April 2007. Our marine revenues increased $15.3 million related to the operations of Bellingham Marine that we acquired in July 2006. The increase in marine revenues was due to a longer period of operation and increased business in 2007 compared to 2006. During the quarter ended September 30, 2007, we operated nine ships compared to four ships operated during the quarter ended September 30, 2006. These increases were partially offset by a decrease of $2.3 million primarily due to decreases in net insurance premiums earned due to decreased reinsurance business in 2007.

Cruise Operating Expenses

Cruise operating expenses were $37.9 million for the three months ended September 30, 2007 compared to $16.5 million for the three months ended September 30, 2006. The increase in cruise operating expenses is related to the increase in ships operated in each period.

Cost of Marine Revenue

Cost of marine revenue was $22.8 million for the three months ended September 30, 2007 compared to $13.0 million for the three months ended September 30, 2006. 2006 expenses include the Bellingham Marine operations beginning on July 21, 2006. Prior period expenses included the operations of Bellingham Marine beginning in July 21, 2006, the date of acquisition.

Selling and Tour Promotion Expenses

Selling and tour promotion expenses were $12.2 million for the three months ended September 30, 2007 compared to $4.7 million for the three months ended September 30, 2006. The increase is due to the additional selling and marketing expenses incurred by the cruise segment, which included the Windstar Cruises acquired in April 2007.

General and Administrative Expenses

General and administrative expenses were $13.8 million for the three months ended September 30, 2007 compared to $11.3 million for the three months ended September 30, 2006. The increase is due to the additional general and administrative expenses incurred by the cruise and marine operations acquired in 2006 and the acquisition of Windstar Cruises in April 2007. As a percentage of total revenues, general and administrative expenses decreased to 14.5% for the three months ended September 30, 2007 from 19.7% for the three months ended September 30, 2006.

Depreciation and Amortization

Depreciation and amortization expenses were $3.2 million for the three months ended September 30, 2007 compared to $1.3 million for the three months ended September 30, 2006. The increase is related to the additional depreciation expense during the three months ended September 30, 2007 due to the increase in property and equipment, predominantly consisting of vessels, acquired as a result of the acquisitions completed during 2006 and 2007.

 

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Loss and Loss Adjustment Expenses

Loss and loss adjustment expenses were $49,000 for the three months ended September 30, 2007, compared to $1.5 million for the three months ended September 30, 2006. The decrease is related to the decrease in net insurance premiums earned in 2007 compared to 2006.

Insurance Acquisition Costs and Other Operating Expenses

Insurance acquisition costs and other operating expenses were $0.1 million for the three months ended September 30, 2007, compared to $0.9 million for the three months ended September 30, 2006. The decrease is related to the decrease in net insurance premiums earned in 2007 compared to 2006.

Operating Income

We recorded an operating income of $5.5 million for the quarter ended September 30, 2007, compared to $8.5 million for the quarter ended September 30, 2006. The change is the result of the changes described above.

Other Income (Expense)

Other expense for the three months ended September 30, 2007 was $0.9 million, compared to other income of $0.2 million for the three months ended September 30, 2006. The increase in other expense was mainly the result of approximately $1.1 million of interest expense on our convertible notes issued in April 2007. In the third quarter of 2006, we were favorably impacted by realized gains of $0.3 million resulting from sales of available-for-sale securities; no comparable activity was completed in the third quarter of 2007. These decreases in other income were partially offset by $0.4 million in interest income.

Income Taxes

We recorded an income tax provision of $4.2 million for the three months ended September 30, 2007, compared to $1.1 million for the three months ended September 30, 2006. The effective income tax rate for the three months ended September 30, 2007 was 91.7%, compared to an income tax rate of 12.7% for the three months ended September 30, 2006. The effective income tax rate in 2007 is primarily related to the income tax treatment associated with our international operations, primarily related to Windstar Cruises which was acquired in April 2007. We believe that substantially all of Windstar Cruises’ income, with the exception of our United States source income principally from the transportation, hotel and tour business, was derived from, or incidental to, the international operation of ships, and is therefore exempt from U.S. federal income taxes. Our tax rate for the third quarter of 2006 was lower than the statutory rate due to the reversal of approximately $2.3 million in valuation allowance on our deferred tax assets. The effective tax rate change in 2007 is primarily related to the preferential tax treatment associated with the international operation of ships which commenced with the acquisition of Windstar Cruises in April 2007.

Net Income

Net income for the three months ended September 30, 2007 was $0.4 million, compared to $7.6 million for the comparable period in 2006. The change is the result of the changes described above.

COMPARISON OF RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 TO THE RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006

Revenue

Total revenue for the nine months ended September 30, 2007 was $208.9 million, compared to $95.6 million for the nine months ended September 30, 2006. The increase in revenue for the nine months ended September 30, 2007, was from an increase of $64.9 million in revenue primarily due to the acquired operations of Bellingham Marine in July 2006, and an increase of $54.4 million in revenues from our cruise segment. Approximately $47.5 million of the increase in cruise segment was due to the addition of Windstar Cruises which we acquired in April 2007. As of September 30, 2007, we operated nine ships compared to four ships as of September 30, 2006. Based on the increase in ships operated, we increased passengers carried and occupancy percentages in 2007 as compared to 2006. Our travel, incentive and event related revenue also increased $0.5 million during the nine months ended September 30, 2007 compared to the comparable period in 2006 due to an increase in business volume. These increases were partially offset by lower net insurance premiums earned of $6.5 million, as a result of decreased reinsurance business in 2007.

 

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We expect cruise-related revenues to remain at these higher levels for the remainder of 2007 compared to 2006 as a result of Windstar Cruises’ operations. We also expect that in future periods the primary source of revenue from our marine segment will be attributable to the operations of Bellingham Marine.

Cruise Operating Expenses

Cruise operating expenses were $77.5 million for the nine months ended September 30, 2007 compared to $31.0 million for the nine months ended September 30, 2006. The increase in cruise operating expenses is due to the increase in ships operated, passengers carried and overall ship operating days in 2007 compared to 2006. In addition, $23.4 million of the increase is due to the cruise operating expenses related to Windstar Cruises’ ships we acquired in April 2007.

We expect cruise operating expenses to remain at these higher levels for the remainder of 2007 compared to 2006 as a result of Windstar Cruises as well as the use of our Majestic America Line fleet.

Cost of Marine Revenue

Cost of marine revenue was $64.3 million for the nine months ended September 30, 2007 compared to $14.0 million for the nine months ended September 30, 2006. Cost of marine revenue during the nine months ended September 30, 2006 included cost of revenue for three months of shipyard operations which began in April 2006 and cost of revenue for two months of Bellingham Marine operations which began on July 21, 2006.

We expect our marine operating expenses to remain at these higher levels for the remainder of 2007 compared to 2006.

Selling and Tour Promotion Expenses

Selling and tour promotion expenses were $28.2 million for the nine months ended September 30, 2007 compared to $9.8 million for the nine months ended September 30, 2006. The increase is due to the additional selling and marketing expenses incurred by the cruise segment which included Windstar Cruises which we acquired in April 2007.

We expect selling and tour promotion expenses to remain at these higher levels for the remainder of 2007 compared to 2006 as a result of our recently completed acquisition of Windstar Cruises and a full year of operations of our Majestic America Line fleet acquired at various times during 2006. In late 2006, we launched the Majestic America Line brand. In addition, the expansion of our promotion of this brand in 2007 and increased advertising expenses to promote our full fleet of ships operating in 2007 also contributed to the increase in selling and tour promotion expenses.

General and Administrative Expenses

General and administrative expenses were $39.4 million for the nine months ended September 30, 2007 compared to $23.9 million for the nine months ended September 30, 2006. The increase is due to the additional general and administrative expenses incurred by the cruise and marine segments that began operations in 2006, including Windstar Cruises which we acquired in April 2007. As a percentage of total revenues, general and administrative expenses decreased to 18.9% for the nine months ended September 30, 2007 from 25.0% for the nine months ended September 30, 2006.

We expect general and administrative expenses to remain at these higher levels for the remainder of 2007 as a result of our recently completed acquisition of Windstar Cruises, and a full year of operations in our new cruise and marine segments following the series of acquisitions completed during 2006.

Depreciation and Amortization

Depreciation and amortization expenses were $7.9 million for the nine months ended September 30, 2007 compared to $2.7 million for the nine months ended September 30, 2006. The increase is related to the additional depreciation expense from the increase in property and equipment, predominantly consisting of vessels, acquired as a result of the acquisitions completed during 2006 and 2007.

We expect depreciation expense to remain at these higher levels for the remainder of 2007 as a result of our acquisition of Windstar Cruises as well as a full year of recognizing depreciation associated with our Majestic America Line fleet acquired at various times during 2006.

Loss and Loss Adjustment Expenses

Loss and loss adjustment expenses were $0.5 million for the nine months ended September 30, 2007, compared to $4.3 million for the nine months ended September 30, 2006. The decrease is related to the decrease in net insurance premiums

 

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earned in 2007 compared to 2006. We do not anticipate these costs to increase in 2007 as a result of not entering into any new agreements in 2006 or during the first nine months of 2007.

Insurance Acquisition Costs and Other Operating Expenses

Insurance acquisition costs and other operating expenses were $0.7 million for the nine months ended September 30, 2007, compared to $2.9 million for the nine months ended September 30, 2006. The decrease is related to the decrease in net insurance premiums earned in 2007 compared to 2006. We do not anticipate these costs to increase in 2007 as a result of not entering into any new agreements in 2006 or during the first nine months of 2007.

Operating Income (Loss)

We recorded an operating loss of $9.6 million for the nine months ended September 30, 2007, compared to operating income of $6.8 million for the nine months ended September 30, 2006. The change is the result of the changes described above.

Other Income (Expense)

Other expense for the nine months ended September 30, 2007 was $2.0 million, compared to other income of $1.8 million for the nine months ended September 30, 2006. The decrease was primarily the result of a $3.2 million increase in interest expense related to long-term debt assumed in our cruise acquisitions consummated in the first and second quarters of 2006 and interest expense on our convertible notes issued in April 2007. During the nine months ended September 30, 2006, we were favorably impacted by realized gains of $1.1 million resulting from sales of available-for-sale securities, as compared to a $48,000 loss realized during the comparable period in 2007. These increases in other expense were partially offset by $0.6 million of insurance recoveries in 2007 under our business interruption insurance on the Mississippi Queen® relating to the norovirus incident which occurred in October 2006.

Income Taxes

We recorded an income tax benefit of $9.2 million for the nine months ended September 30, 2007, compared to an income tax provision of $1.0 million for the nine months ended September 30, 2006. The effective income tax benefit rate for the nine months ended September 30, 2007 was 79.2%, compared to an income tax rate of 12.1% for the nine months ended September 30, 2006. The change in the effective income tax rate in 2007 is primarily related to the tax treatment associated with our international operations, primarily related to Windstar Cruises which we acquired in April 2007. We believe that substantially all of Windstar Cruises’ income, with the exception of our United States source income principally from the transportation, hotel and tour business, was derived from, or incidental to, the international operation of ships, and is therefore exempt from United States federal income taxes. Our income tax rate for the nine months ended September 30, 2006 was lower than the statutory rate due to the reversal of approximately $2.3 million in valuation allowance on our deferred tax rates.

Net Income (Loss)

Net loss for the nine months ended September 30, 2007 was $2.4 million, compared to net income of $7.5 million for the comparable period in 2006. The change is the result of the changes described above.

Liquidity and Capital Resources

In making an assessment of our liquidity, we believe that the items in our financial statements that are most relevant are our cash and cash equivalents and cash generated from our operating and financing activities.

Net cash provided by operating activities for the nine months ended September 30, 2007 was approximately $7.9 million, compared to $12.0 million for the nine months ended September 30, 2006. The change in net cash primarily relates to timing differences in the collection of current assets and the payment of current liabilities, primarily related to an increase in accounts receivable and accounts payable. This increase was partially offset by an increase in the net loss for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006 combined with an increase in prepaid costs primarily related to deposits and drydocking activities within our cruise segment.

Net cash used in investing activities for the nine months ended September 30, 2007 was approximately $24.9 million as compared to $11.1 million for the nine months ended September 30, 2006. The change is due to the timing differences in reinvesting matured securities, cash paid for acquisitions and the increase in restricted cash.

As of September 30, 2007, we have incurred significant capital expenditures and cost for improvements to and maintenance of our ships, and we anticipate that these expenditures and costs will remain at these higher levels for the remainder of 2007. We do not have any material commitments of capital expenditures in our marine, travel and events or insurance businesses in 2007.

 

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On February 1, 2005, we acquired 100% of the outstanding stock of BellPort. BellPort, located in Newport Beach, California, is a marina company operating facilities in both the United States and Mexico. The purchase was completed in February 2005 for consideration of approximately $1.3 million in cash and the issuance of 184,717 shares of our common stock, of which 130,389 shares were issued to related parties. In addition to the cash and stock consideration, we assumed a credit facility of approximately $1.6 million which we paid off in full on February 11, 2005. In connection with the acquisition, we were granted a twelve month option to purchase a 34% interest in BellPort Japan Company, Ltd. (“BellPort Japan”), a marina operator, owner and developer of waterfront real estate, including both residential communities and marina facilities, located in Japan. In February 2006, BellPort acquired a 34% interest in BellPort Japan through the acquisition of BellJa Holding Company, Inc., a California corporation, for approximately $0.3 million and extended its license agreement with BellPort Japan through 2010. On August 20, 2007, the majority shareholder increased its capital contribution in BellPort Japan resulting in dilution of our investment in BellPort Japan to 0.9%. By mutual agreement with the majority shareholder, we continue to maintain an option, but not obligation, to contribute capital to increase our investment to 34%.

On January 13, 2006, ACG acquired American West. Under the terms of the agreement, ACG acquired the membership interests of American West for one dollar, repaid debt of approximately $4.3 million and assumed approximately $41.5 million in fixed-rate, 4.63% debt payable through 2028 and guaranteed by the United States Maritime Administration. In addition, the transaction consideration consisted of 250,000 shares of our restricted common stock, which is subject to forfeiture to us if certain future financial targets are not met during the four years following the close of the transaction.

On April 25, 2006, ACG acquired the cruise-related assets and liabilities of Delta Queen for $2.8 million in cash, the assumption of passenger deposits and the assumption of approximately $35.0 million of fixed-rate, 6.50% debt payable through 2020 and guaranteed by the United States Maritime Administration. In addition, the transaction included contingent consideration of 100,000 shares of our common stock, to be granted to Delta Queen Steamboat Company, Inc. if certain future financial targets are met in any of the three years following the close of the transaction. No shares related to the contingent consideration were issued in 2006 or the nine months ended September 30, 2007.

On February 13, 2006, BellPort purchased certain assets related to the Newport Harbor Shipyard for $0.5 million. Concurrent with the asset purchase, BellPort entered into a long term agreement to lease and operate the shipyard facility beginning April 1, 2006 and ending March 31, 2011.

On April 2, 2007, ACG, through its wholly-owned subsidiary, AICG acquired Windstar Cruises for $11.3 million in cash, $60 million in seller financing and assumed approximately $28.5 million in liabilities. The $60 million in seller financing was subsequently paid off on April 17, 2007, with the proceeds from the convertible note offering by which we had raised $97.0 million in April 2007. The 3.75% senior convertible notes are due on April 15, 2027. Interest on the notes is payable semi-annually in arrears on April 15 and October 15 in each year, commencing October 15, 2007. The notes are convertible into shares of Ambassadors’ common stock, par value $0.01 per share, at an initial conversion rate of 17.8763 shares per $1,000 principal amount of the notes (which is equivalent to an initial conversion price of approximately $55.94 per share), subject to adjustment upon the occurrence of certain events. Interest on the notes is payable semi-annually in arrears on April 15 and October 15 in each year, commencing October 15, 2007. We may redeem the notes in whole or in part after April 15, 2012. We may also redeem all or a portion of the notes after April 20, 2010 and prior to April 15, 2012, only if the price of our common stock reaches certain thresholds for a specified period of time. Holders of the notes may require us to purchase all or a portion of the notes, in cash, on April 15, 2012April 15, 2017 and April 15, 2022 or upon the occurrence of specified fundamental changes as defined in the purchase agreement dated March 28, 2007. If a holder elects to convert notes in connection with a specified fundamental change that occurs prior to April 15, 2012, we will in certain circumstances increase the conversion rate by a specified number of additional shares.

Net cash provided by financing activities for the nine months ended September 30, 2007 was approximately $27.7 million, compared to $4.9 million used in financing activities for the nine months ended September 30, 2006. Net cash provided by financing activity in 2007 included $97.0 million from our convertible debt offering offset by $60.1 million used to repay the seller financing debt incurred in the acquisition of Windstar Cruises and related accrued interest and $3.3 million toward payment of convertible debt offering costs. Activity for the nine months ended September 30, 2007 and 2006 also consisted of cash dividends totaling $0.20 per share and $0.30 per share paid to common stockholders in the nine-month period ended September 30, 2007 and 2006, respectively.

 

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On September 2, 2003, our board of directors authorized a new dividend policy paying stockholders $0.40 per share annually, distributable at $0.10 per share on a quarterly basis. The following dividends have been declared in 2007 and 2006 on the dates indicated (in thousands):

 

Record Date

   Payment Date    Dividend Amount

2007:

     

March 12, 2007

   March 19, 2007    $ 1,084

May 21, 2007

   May 31, 2007      1,084

2006:

     

February 20, 2006

   March 2, 2006    $ 1,050

May 22, 2006

   June 1, 2006      1,065

August 16, 2006

   August 31, 2006      1,072

November 14, 2006

   November 28, 2006      1,085

We and our board of directors continually review the dividend policy to evaluate conditions that may affect our desire or ability to pay dividends, which are declared at the discretion of the board of directors. Subsequent to the dividend declared in May 2007, the board of directors has not approved any additional dividends for 2007.

In the ordinary course of business we may from time to time be required to enter into letters of credit related to our insurance programs and for our travel related programs with airlines, travel providers and travel reporting agencies. As of September 30, 2007, we had outstanding approximately $10.7 million in letters of credit related to property and casualty insurance programs which are scheduled to expire at various dates through 2008. As of September 30, 2007, we had outstanding approximately $1.6 million in letters of credit related to cruise business operations which expire in the fourth quarter of 2007. As of September 30, 2007, we had outstanding approximately $0.1 million in letters of credit related to travel and event business operations that expire at various dates through the fourth quarter of 2007.

Under Bermuda regulations, Cypress Re is required to maintain a surplus of 20% of gross written premiums or 10% of loss and loss adjustment expense reserves, whichever is greater. As of September 30, 2007, Cypress Re had $4.1 million of contributed capital from us, which is in excess of the required statutory capital, and surplus of $0.8 million.

In November 1998, our board of directors authorized the repurchase of up to an aggregate of $20.0 million of our common stock in the open market or through private transactions. In August 2006, our board of directors authorized an additional $10.0 million for the repurchase of our common stock in the open market or through private tractions, providing for an aggregate of $30.0 million. This repurchase program is ongoing and as of September 30, 2007, we had repurchased 1,102,650 shares for approximately $14.0 million. We repurchased 51,150 shares during the three months ended June 30, 2007 and nine months ended September 30, 2007. No shares were repurchased during the nine months ended September 30, 2006. We do not believe that any future repurchases will have a significant impact on our liquidity.

We believe that cash, cash equivalents, available-for-sale securities and cash flows from operations will be sufficient to meet our anticipated operating cash needs for at least the next twelve months. We continue to pursue further acquisitions of related travel and performance improvement, service and other businesses, although no assurance can be given that definitive agreements for any acquisition will be entered into or, if they are entered into, that any acquisition will be consummated on terms favorable to us. We could use cash and financing sources discussed herein, or financing sources that subsequently become available, to fund additional acquisitions or investments. In addition, we may consider issuing additional debt or equity securities in the future to fund potential acquisitions or investments, to refinance existing debt, or for general corporate purposes. If a material acquisition or investment is completed, our operating results and financial condition could change materially in future periods. However, no assurance can be given that additional funds will be available on satisfactory terms, or at all, to fund such activities.

The following table aggregates all contractual commitments and commercial obligations that affect our financial condition and liquidity position as of September 30, 2007:

 

    

Payments Due by Period

(dollars in thousands)

     Total    Less than
1 year
   1-3 years    3-5 years    More than
5 years

Contractual Obligations:

              

Long-term debt and other obligations

   $ 264,409    $ 12,942    $ 24,918    $ 50,103    $ 176,446

Operating leases

     4,947      2,010      2,637      300      —  
                                  

Total contractual cash obligations

   $ 269,356    $ 14,952    $ 27,555    $ 50,403    $ 176,446
                                  

 

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Trends and Uncertainties

The results of operations and financial position of our business may be affected by a number of trends or uncertainties that have, or that we reasonably expect could have, a material effect on income from continuing operations, cash flows and financial position. Such trends and uncertainties include the repercussions of the war in Iraq or terrorist acts, our acquisition of or investment in complementary businesses and significant changes in estimates for potential claims or other general estimates related to our reinsurance business. We will also, from time to time, consider the acquisition of or investment in businesses, services and technologies that might affect our liquidity requirements.

Cautionary Note Regarding Forward-Looking Statements

Statements contained in this quarterly report on Form 10-Q that are not historical in nature are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. A forward-looking statement may contain words such as “expect,” “anticipate,” “outlook,” “could,” “target,” “project,” “intend,” “plan,” “believe,” “seek,” “estimate,” “should,” “may,” “assume,” “continue,” and variations of such words and similar expressions. These statements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict. We caution you that actual outcomes and results may differ materially from what is expressed, implied, or forecast by our forward looking statements. We have based our forward-looking statements on our management’s beliefs and assumptions based on information available to our management at the time the statements are made. Such risks and uncertainties include, among others:

 

   

our ability to effectively and efficiently operate our cruise operations;

 

   

customer cancellation rates;

 

   

competitive conditions in the industries in which we operate;

 

   

marketing expenses;

 

   

extreme weather conditions;

 

   

timing of and costs related to acquisitions;

 

   

the impact of new laws and regulations affecting our business;

 

   

negative incidents involving cruise ships, including those involving the health and safety of passengers;

 

   

cruise ship maintenance problems and emergency ship repairs;

 

   

reduced consumer demand for vacations and cruise vacations;

 

   

changes in fuel, food, payroll, insurance and security costs;

 

   

the availability of raw materials;

 

   

our ability to enter into profitable marina construction contracts;

 

   

changes in relationships with certain travel providers;

 

   

changes in vacation industry capacity;

 

   

the mix of programs and events, program destinations and event locations;

 

   

the introduction and acceptance of new programs and program and event enhancements by us and our competitors;

 

   

other economic and geo-political factors and other considerations affecting the travel industry;

 

   

changes in United States maritime tax laws;

 

   

potential claims related to our reinsurance business; and

 

   

the potentially volatile nature of the reinsurance business.

The information contained in this document is not a complete description of our business or the risks associated with an investment in our common stock. Before deciding to buy or maintain a position in our common stock, you should carefully review and consider the various disclosures we made in this report, and in our other materials filed with the Securities and Exchange Commission that discuss our business in greater detail and that disclose various risks, uncertainties and other factors that may affect our business, results of operations or financial condition. In particular, you should review our annual report on Form 10-K for the year ended December 31, 2006, as amended, filed with the Securities and Exchange Commission and the “Risk Factors” we included in that report.

 

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Any of the factors described above could cause our financial results, including our net income or loss or growth in net income or loss to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially.

We disclaim any obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

 

Item  3. Quantitative and Qualitative Disclosures About Market Risk.

We are exposed to changes in financial market conditions in the normal course of business due to our use of certain financial instruments. Market risk generally represents the risk that losses may occur in the values of financial instruments as a result of movements in interest rates and equity prices.

There have been no material changes in the reported market risks or the overall credit risk of our portfolio since December 31, 2006. See further discussion of these market risks and related financial instruments in our annual report on Form 10-K for the year ended December 31, 2006, as amended.

 

Item  4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act of 1934 reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and that such information 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. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our disclosure controls and procedures are designed to provide a reasonable level of assurance of reaching our desired disclosure control objectives. Also, we have investments in certain unconsolidated entities. As we do not control or manage these entities, our disclosure controls and procedures with respect to such entities are necessarily substantially more limited than those we maintain with respect to our consolidated subsidiaries.

As required by Securities and Exchange Commission Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There were no changes during the quarter ended September 30, 2007 that have materially affected or are reasonably likely to materially affect, our internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934.

PART II – OTHER INFORMATION

 

Item  1. Legal Proceedings.

We are not a party to any material pending legal proceedings. We are from time to time threatened or involved in litigation incidental to our business. We believe that the outcome of all current litigation will not have a material adverse effect on our business, financial condition, cash flows or results of operations.

 

30


Table of Contents
Item  1A. Risk Factors.

Item 1A of Part I of our Form 10-K for the year ended December 31, 2006, as amended. summarizes various material risks that investors should carefully consider before deciding to buy or maintain an investment in our securities. Any of those risks, if they actually occur, would likely harm our business, financial condition and results of operations and could cause the trading price of our common stock to decline. In April 2007, we sold of an aggregate of $97.0 million of 3.75% Convertible Senior Notes maturing on April 15, 2027 (“Notes”) to Thomas Weisel Partners LLC. Risks associated with or resulting from the Notes offering include:

 

   

The price of our common stock, and therefore the price of the Notes, may fluctuate significantly, which may make it difficult for holders to resell our convertible notes or our common stock when desired or at attractive prices.

 

   

Changes in our credit ratings or the financial and credit markets could adversely affect the market price of the Notes and our common stock.

 

   

Conversion of the Notes could dilute the ownership of existing stockholders.

 

   

Provisions of the Notes could discourage an acquisition of us by a third party.

 

   

Since the Notes are effectively subordinated in right of payment to all of our current and future secured indebtedness and to all secured and unsecured liabilities of our subsidiaries, our ability to satisfy our obligations under the Notes may be limited. As of September 30, 2007, we had approximately $167.2 million of debt outstanding and the aggregate amount of indebtedness including the $97.0 million in convertible debt and other liabilities of our subsidiaries of approximately $72.8 million (excluding intercompany liabilities and liabilities of a type not required to be recorded on the balance sheet in accordance with GAAP). The indenture governing the Notes does not prohibit our subsidiaries from incurring indebtedness in the future.

 

   

In addition, our ability to service our debt is limited since we are dependent on our subsidiaries for our operating cash flows. Our subsidiaries are separate legal entities and have no obligation, contingent or otherwise, to pay any amount due pursuant to the Notes or to make any funds available for that purpose.

 

   

We may not have the ability to repurchase or redeem the Notes when required under the terms of the notes. The entire outstanding principal amount of the Notes or a portion of it may be payable in cash by us during the term of the Notes or at maturity. We cannot assure you that we will have sufficient financial resources or be able to arrange financing to pay the repurchase price of the notes on any date that we would be required to do so under the terms of the Notes. In addition, if we did not have sufficient cash to meet our obligations, while we could seek to obtain third-party financing to pay for any amounts due in cash upon such events, third-party financing may not be available on commercially reasonable terms, if at all.

 

   

There are no financial covenants in the indenture and we are not restricted from paying dividends or issuing or repurchasing our securities under the indenture. If we or our subsidiaries were to incur additional debt or liabilities, our ability to pay our obligations on the Notes could be adversely affected. As of September 30, 2007, we had approximately $167.2 million of debt outstanding and the aggregate amount of indebtedness including the $97.0 million in convertible debt and other liabilities of our subsidiaries of approximately $72.8 million (excluding intercompany liabilities and liabilities of a type not required to be recorded on the balance sheet in accordance with GAAP). We cannot assure you that we will be able to generate sufficient cash flow to pay the interest on our debt, including the Notes, or that future working capital, borrowings or equity financing will be available to pay or refinance any such debt.

 

   

We are not restricted from issuing additional shares of common stock during the life of the Notes. If we issue additional shares of common stock, the price of our common stock, and in turn, the price of the Notes may decline.

 

   

The registration rights agreement that we entered into with the holders of the Notes required that we cause a shelf registration statement covering the resale of the Notes and the underlying shares of common stock to be declared effective by October 30, 2007 and also required that the registration statement remain effective until the earlier of April 3, 2009 or the date those securities are no longer deemed registrable securities within the meaning of the registration rights agreement. The registration statement was declared effective on October 2, 2007. However, if we fail to meet the continuing effectiveness obligation, additional interest will accrue as follows: (a) 0.25% of the aggregate principal amount of the Notes per annum to and including the 90th day after the registration default; and (b) 0.50% of the aggregate principal amount of the Notes per annum from and after the 91st day after the registration default. If Notes that are registrable securities are converted into shares of common stock that are restricted securities, any additional interest will accrue on such shares at the rates described above, applied to the conversion price at that time.

 

31


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Item  2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

 

Item  3. Defaults Upon Senior Securities.

None.

 

Item  4. Submission of Matters to a Vote of Security Holders.

None.

 

Item  5. Other Information.

None.

 

Item  6. Exhibits.

 

 

Exhibit No.   

Description

31.1    Certification of Chief Executive Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1)
31.2    Certification of Interim Chief Financial Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1)
32.1    Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)
32.2    Certification of Interim Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)

(1) Attached hereto.

 

32


Table of Contents

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.

 

 

AMBASSADORS INTERNATIONAL, INC.

(Registrant)

Date: November 9, 2007   By:   /s/ Laura L. Tuthill
   

Laura L. Tuthill

Interim Chief Financial Officer,

Vice President and Chief Accounting Officer

(Principal Financial Officer and Duly Authorized Officer)

 

33


Table of Contents

Exhibit Index

 

Exhibit No.   

Description

31.1    Certification of Chief Executive Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1)
31.2    Certification of Interim Chief Financial Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1)
32.1    Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)
32.2    Certification of Interim Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)

(1) Attached hereto.

 

34


Dates Referenced Herein   and   Documents Incorporated by Reference

This ‘10-Q’ Filing    Date    Other Filings
7/18/28
4/15/27
4/15/22
4/15/17
4/15/12
11/30/118-K
3/31/114
5/10/103,  4
4/20/10
4/3/09
11/1/0810-Q
12/31/0710-K
12/15/07
11/15/073,  3/A,  4,  4/A,  8-K
Filed on:11/9/078-K
11/1/07
10/30/078-K
10/27/07
10/15/07
10/2/07
For Period End:9/30/07
8/20/07
6/30/0710-Q
5/31/07
5/21/07
5/14/07
4/18/07DEF 14A
4/17/078-K
4/3/078-K
4/2/078-K,  8-K/A,  PRE 14A
3/31/0710-Q
3/28/078-K
3/27/078-K
3/19/07
3/12/07
1/1/07
12/31/0610-K,  10-K/A,  5
12/28/06
11/28/06
11/14/06
10/27/06
10/25/068-K
10/20/06
10/13/06
9/30/0610-Q
8/31/06
8/16/06
7/21/068-K,  8-K/A
6/12/06
6/1/06
5/22/06
4/25/068-K,  8-K/A
4/1/06
3/2/06
2/20/06
2/13/06SC 13G/A
1/13/064,  8-K,  8-K/A
1/1/06
11/10/05SC 13D/A
2/11/055,  SC 13G/A
2/1/054,  8-K
12/31/0410-K,  5
6/30/0410-Q,  3
6/1/04
5/31/04
3/29/0410-K/A
9/2/034,  8-K
1/1/03
7/1/02
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