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Ambassadors International Inc – ‘10-Q’ for 9/30/06

On:  Thursday, 11/9/06, at 2:55pm ET   ·   For:  9/30/06   ·   Accession #:  1193125-6-230140   ·   File #:  0-26420

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11/09/06  Ambassadors International Inc     10-Q        9/30/06    6:458K                                   RR Donnelley/FA

Document/Exhibit                   Description                      Pages   Size 

 1: 10-Q        Quarterly Report                                    HTML    391K 
 2: EX-21.1     Subsidiaries of Ambassadors International, Inc.     HTML     14K 
 3: EX-31.1     Certification of CEO                                HTML     14K 
 4: EX-31.2     Certification of CFO                                HTML     14K 
 5: EX-32.1     Certification of CEO                                HTML      8K 
 6: EX-32.2     Certification of CFO                                HTML      8K 

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2006

OR

For the transition period from                      to                     

Commission file number: 0-26420

AMBASSADORS INTERNATIONAL, INC.

(Exact Name of Registrant as Specified in Its Charter)

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 October 27, 2006 was 10,816,879.

Table of Contents

AMBASSADORS INTERNATIONAL, INC.

FORM 10-Q QUARTERLY REPORT

TABLE OF CONTENTS

Table of Contents

PART 1 – FINANCIAL INFORMATION

Ambassadors International, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except share data)

See Notes to Unaudited Condensed Consolidated Financial Statements.

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Ambassadors International, Inc.

Condensed Consolidated Statements of Operations

(in thousands, except per share data)

See Notes to Unaudited Condensed Consolidated Financial Statements.

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Ambassadors International, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

See Notes to Unaudited Condensed Consolidated Financial Statements.

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Ambassadors International, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

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”) was formed in 2006 and includes the operations of BellPort Group, Inc. (“BellPort”) which commenced operations in 2005 and Bellingham Marine Industries, Inc. (“Bellingham Marine”) which was acquired on July 21, 2006 and (iv) Ambassadors Cruise Group, LLC (“ACG”) which commenced operations in 2006.

In January 2006, the Company realigned its business segments into the following 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, (iv) Insurance, which includes the operations of Cypress Re and (v) Corporate and Other, which consists of general corporate assets (primarily cash and cash equivalents and investments) and other activities which are not directly related to our operating segments.

As of September 30, 2006, the following further describes the operations of the Company’s business segments:

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Ambassadors International, Inc.

Notes to Unaudited Consolidated Financial Statements, Continued

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. 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 U.S. generally accepted accounting principles 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, 2006 are not necessarily indicative of the results that may be expected for future periods or the year ending December 31, 2006.

The consolidated balance sheet at December 31, 2005 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements. For further information refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2005.

Accounting for Stock Options

On January 1, 2006, the Company adopted Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 123, “Share Based Payment” (“SFAS 123R”) using the modified-prospective method. Based on the terms of our stock based compensation plans, the Company did not have 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 adoption of SFAS 123R resulted in compensation expense of approximately $272,000 and $258,000 that has been classified in general and administrative expenses related to employee stock options and restricted stock, respectively, for the three months ended September 30, 2006. The adoption of SFAS 123R resulted in compensation expense of approximately $614,000 and $517,000 that has been classified in general and administrative expenses related to employee stock options and restricted stock, respectively, for the nine months ended September 30, 2006. The effects of the total compensation expense on net income was a reduction of $316,000 and $675,000 for the three and nine months ended September 30, 2006, respectively. The effects of the total compensation expense was a reduction of basic and diluted earnings per share of $0.03 and $0.03, respectively, for the three months ended September 30, 2006 and $0.06 and $0.06, respectively, for the nine months ended September 30, 2006.

As of September 30, 2006, there was approximately $268,000 and $1,010,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under our plans expected for the remainder of 2006 and in future years through 2010, respectively. This expected cost does not include the impact of any future stock-based compensation awards.

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Ambassadors International, Inc.

Notes to Unaudited Consolidated Financial Statements, Continued

The following table presents the effects on net income and earnings per share if the Company had recognized compensation expense under the fair value recognition provisions of SFAS No. 123 for the three and nine months ended September 30, 2005 (in thousands, except per share data):

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, 2006 and 2005.

Upon the adoption of SFAS 123R, expected volatility was based on historical volatilities. The risk-free interest rate is based on U.S. Treasury zero-coupon issues 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. For purposes of calculating pro forma information for periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred.

Dividends Declared

On September 2, 2003, the 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. During 2005, a dividend of approximately $1,016,000 was paid on March 15, 2005 to stockholders of record on February 28, 2005, a dividend of approximately $1,034,000 was paid on June 15, 2005 to stockholders of record on May 31, 2005, a dividend of approximately $1,042,000 was paid on September 8, 2005 to stockholders of record on August 25, 2005 and a dividend of approximately $1,042,000 was paid on December 2, 2005 to stockholders of record on November 18, 2005. During 2006, a dividend of approximately $1,050,000 was paid on March 2, 2006 to stockholders of record on February 20, 2006, a dividend of approximately $1,065,000 was paid on June 1, 2006 to stockholders of record on May 22, 2006 and a dividend of approximately $1,072,000 was paid on August 31, 2006 to stockholders of record on August 16, 2006.

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Ambassadors International, Inc.

Notes to Unaudited Consolidated Financial Statements, Continued

The Company and its Board of Directors intend to continually review the dividend policy to ensure compliance with capital requirements, regulatory limitations, the Company’s financial position and other conditions which may affect the Company’s desire or ability to pay dividends in the future.

Income Taxes

We account for income taxes in accordance with the provisions of SFAS No. 109, “Accounting for Income Taxes.” SFAS No. 109 requires an asset and liability approach which 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. As of September 30, 2006, the Company reduced its valuation allowance on its deferred tax assets by approximately $2.3 million. All available positive and negative evidence was evaluated and the Company believes that it is more likely than not that the net deferred tax assets recorded at September 30, 2006 will be realized.

Recent Accounting Pronouncements

In June 2006, the FASB issued Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109.” FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently assessing the impact of FIN No. 48 on its financial statements.

In March 2002, Ambassadors acquired a 49% ownership interest in Incentive Travel, LLC (“ITI”). ITI develops, markets and manages meetings and incentive programs for a select roster of corporate clients utilizing incentive travel and corporate meeting management services. The terms of the purchase agreement call for contingent payments through 2005 based upon actual income before income taxes multiplied by Ambassadors 49% ownership interest calculated based on a predefined multiplier. As of September 30, 2006, the Company’s obligation related to ITI’s fiscal 2005 results is estimated to be approximately $654,000, of which $443,000 remains unpaid and is accrued in the accompanying balance sheet as of September 30, 2006.

License fees earned from ITI are included in the Travel and Events segment and represent approximately zero and $105,000 for the three months ended September 30, 2006 and 2005, respectively, and $275,000 and $410,000 for the nine months ended September 30, 2006 and 2005, respectively. The Company also recorded its proportional share of the earnings (losses) and management fees from ITI of approximately $(53,000) and $353,000 for the three months ended September, 2006 and 2005, respectively, and $78,000 and $1,116,000 for the nine months ended September 30, 2006 and 2005, respectively, which are included in other income. At September 30, 2006 and 2005, the Company had approximately $352,000 and $232,000, respectively, in receivables related to license and management fees and approximately $326,000 and $237,000, respectively, in undistributed earnings from ITI.

On February 1, 2005, the Company 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 $1,280,000 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 $1,568,000 which the Company paid off in full on February 11, 2005. In connection with the acquisition, the Company was granted a

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Ambassadors International, Inc.

Notes to Unaudited Consolidated Financial Statements, Continued

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 $250,000 and extended its license agreement with BellPort Japan through 2010. The Company recorded its proportional share of the income from BellPort Japan of approximately $9,000 and $47,000 for the three and nine months ended September 30, 2006, respectively, which is included in other income.

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 also recorded its proportional share of the income (losses) from DHWI of approximately $31,000 for each of the three months ended September 30, 2006 and 2005, and $(66,000) and $(42,000) for the nine months ended September 30, 2006 and 2005, respectively, which are included in other income.

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

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 U.S. Maritime Administration. In addition, the transaction consideration consisted of 250,000 shares of the Company’s restricted common stock, which is subject to forfeiture to the Company if certain future financial targets are not met during the four years following the close of the transaction.

The American West purchase price was approximately $46.8 million. The contingent consideration of 250,000 shares of the Company’s restricted stock has not been included in the preliminary purchase price and is not expected to be included in the original cost of the acquisition due to management’s inability to conclude “beyond a reasonable doubt” that the contingent consideration will be earned. The purchase price for the acquisition is as follows (in thousands):

The final purchase price is dependent on the actual final direct acquisition costs and potential future contingent payments.

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 components of the purchase price (in thousands):

On February 13, 2006, BellPort purchased certain assets related to the Newport Harbor Shipyard for $545,000. 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 25, 2006, ACG acquired the cruise-related assets of Delta Queen pursuant to an Asset Purchase Agreement, dated April 6, 2006, by and among ACG, Delta Queen Steamboat Company, Inc., American Queen Steamboat, LLC, Delta Queen Steamboat, LLC, and Mississippi Queen Steamboat, LLC. Pursuant to the

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Ambassadors International, Inc.

Notes to Unaudited Consolidated Financial Statements, Continued

purchase agreement, ACG acquired three vessels, the American Queen^®, Delta Queen^® and Mississippi Queen^®, and associated operating assets of Delta Queen for $2.75 million in cash, the assumption of approximately $9 million of passenger deposits and the assumption of approximately $35.0 million of fixed-rate, 6.5% debt payable through 2020 and guaranteed by the U.S. Maritime Administration. In addition, the transaction included contingent consideration of 100,000 shares of the Company’s 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.

The Delta Queen purchase price was approximately $48.0 million. The contingent consideration of 100,000 shares of the Company’s common stock has not been included in the preliminary purchase price and is not expected to be included in the original cost of the acquisition due to management’s inability to conclude “beyond a reasonable doubt” that the contingent consideration will be earned. The purchase price for the acquisition is as follows (in thousands):

The final purchase price is dependent on the actual final direct acquisition costs and potential future contingent payments.

On April 25, 2006, ACG acquired the $9.0 million first preferred ship mortgage on a vessel, the 150-passenger Columbia Queen, from the U.S. Maritime Administration for $5.0 million. In August 2006, ACG acquired the $5.0 million second preferred ship mortgage on the Columbia Queen, from the mortgage holder for $3.5 million. As of September 30, 2006, the mortgages held are classified as a note receivable in the accompanying balance sheet. On October 13, 2006, ACG purchased the Columbia Queen during a foreclosure auction for additional consideration of $1,000 and is anticipating on operating the vessel in the 2007 cruise season under Majestic America Line.

On June 12, 2006, ACG acquired the 48-passenger Executive Explorer for $2.5 million. The Company renamed the vessel Contessa and is anticipating on operating the vessel in the 2007 cruise season under Majestic America Line.

On July 21, 2006, AMG acquired Bellingham Marine, a marina design and construction company, through the acquisition of 100% of the outstanding stock of Nishida Tekko America Corporation (“NTAC”) from Nishida Tekko Corporation (“NTC”). The Company paid cash consideration of $6.8 million to NTC and repaid $6.2 million of outstanding debt of NTAC. Prior to the acquisition by AMG, NTAC owned 100% of Bellingham Marine. Concurrent with the acquisition, AMG acquired 49% of the outstanding stock of Bellingham Marine in satisfaction of certain debt obligations, thus leaving NTAC with a 51% equity interest in Bellingham Marine. In addition, AMG and NTC entered into an option agreement pursuant to which NTC was granted a five year option to acquire 49% of the outstanding stock of NTAC at a purchase price not to exceed $3,430,000, plus seven percent annualized interest. The effect of the option exercise would give NTC an approximate 25% interest in Bellingham Marine. The purchase price for the acquisition is as follows (in thousands):

The final purchase price is dependent on the actual final direct acquisition costs.

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Ambassadors International, Inc.

Notes to Unaudited Consolidated Financial Statements, Continued

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 components of the purchase price (in thousands):

The following is a pro forma representation of the Bellingham Marine acquisition for the three months ended September 30, 2006 as if the acquisition had occurred as of the beginning of the period through the date of acquisition (in thousands):

The following is a pro forma representation of the Delta Queen and Bellingham Marine acquisitions for the nine months ended September 30, 2006 as if the acquisitions had occurred as of the beginning of the year through the dates of acquisition (in thousands):

The Company has accounted for American West from January 13, 2006, the date of acquisition. Due to the insignificance of operations from January 1, 2006 through the date of acquisition, this period was excluded from the September 30, 2006 pro forma amounts listed above.

In December 2003, the Company formed a subsidiary, 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 the Bermuda Monetary Authority Act.

The Company reinsures property and casualty risks written by licensed U.S. 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.

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Ambassadors International, Inc.

Notes to Unaudited Consolidated Financial Statements, Continued

Cypress Re retains a quota share percentage of the first layer of risk on a per policy basis, which ranges from $250,000 to $500,000 and a 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 which 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 a result, unearned premium reserves, deferred policy acquisition costs and ceded prepaid reinsurance premiums of $3.0 million, $0.8 million and $0.6 million, respectively, were recorded on the balance sheet as of September 30, 2006.

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, 2006, the deferred gain on retroactive reinsurance was $44,000 and Cypress Re recognized in income $0.1 million and $0.4 million of the previously deferred gain for the nine months ended September 30, 2006 and 2005, respectively.

As of September 30, 2006, premiums receivable, reinsurance recoverable and loss and loss adjustment expense reserves of $1.3 million, $0.1 million and $0.8 million, respectively, related to retroactive reinsurance were recorded on the Company’s balance sheet. The September 30, 2006 loss and loss adjustment expense reserves balance includes $0.4 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, 2006 is comprised of funds held in trust by the ceding company of approximately $13.7 million and deferred and not yet due premiums from the ceding company of approximately $1.6 million. The funds held in trust primarily consist of high grade corporate bonds, government bonds and money market funds.

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Ambassadors International, Inc.

Notes to Unaudited Consolidated Financial Statements, Continued

As of September 30, 2006, reinsurance recoverable and prepaid reinsurance premiums of $1.5 million and $0.6 million, respectively, relate to a single reinsurer. Cypress Re’s exposure to credit loss in the event of non-payment or nonperformance is limited to these amounts.

The effect of reinsurance on premiums written and earned for the year ended September 30, 2006 was as follows (in thousands):

As of September 30, 2006, the Company has issued approximately $10,241,000 in letters of credit related to property and casualty insurance programs which expire at various dates through 2007.

The Company maintains an inventory of 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, 2006 are as follows (in thousands):

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 U.S. Government through the U.S. 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. Monthly principal payments accumulating to approximately $1.8 million annually plus accrued interest are required through July 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. Semi-annual principal payments accumulating to approximately $2.4 million annually plus accrued interest are required through June 2020.

Bellingham Marine has a $5.0 million line of credit with a bank. Interest is payable monthly at the bank’s prime rate plus 0.25%. The line of credit is collateralized by inventory, accounts receivable, and equipment of Bellingham Marine. The agreement contains certain limitations and various financial covenants. As of September 30, 2006, there was approximately $1,835,000 outstanding on the line of credit. Bellingham Marine also has a note payable to a bank, secured by property, payable in monthly installments of approximately $16,000 including interest at 8.245%, subject to certain limitations and various financial covenants, due May 10, 2010.

Bellingham Marine’s international operations has a $1.2 million line of credit with National Australia Bank Limited for its Australian subsidiary. Interest is payable monthly at 10.162%, and is collateralized by substantially all of the subsidiary’s assets, including any uncalled or unpaid capital. As of September 30, 2006,

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Ambassadors International, Inc.

Notes to Unaudited Consolidated Financial Statements, Continued

there were no borrowings on the line of credit. 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.

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

The following table presents a reconciliation of basic and diluted earnings per share (“EPS”) computations and the number of dilutive securities (stock options) that were included in the dilutive EPS computation (in thousands).

For the three months ended September 30, 2006 and 2005 there were zero and 25,000 stock options outstanding, respectively, for which the exercise price exceeded the average common stock market value. For the nine months ended September 30, 2006 and 2005 there were approximately 29,000 and 8,000 stock options outstanding, respectively, for which the exercise price exceeded the average common stock market value. The effects of the shares which would be issued upon the exercise of these options have been excluded from the calculation of diluted EPS because they are anti-dilutive.

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 Board of Directors of the Company 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, 2006, the Company has repurchased 1,051,500 shares for approximately $12.4 million. The Company made no repurchases during the three or nine months ended September 30, 2006 and 2005.

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Ambassadors International, Inc.

Notes to Unaudited Consolidated Financial Statements, Continued

In January 2006, concurrent with certain acquisitions completed subsequent to December 31, 2005, the Company realigned its business segments. As of January 2006, the Company reports the following 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, (iv) Insurance, which includes the operations of Cypress Re and (v) Corporate and Other, which consists of general corporate assets (primarily cash and cash equivalents and investments) and other activities which are not directly related to our operating segments.

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

Summary of business segment total assets as of September 30, 2006 is as follows (in thousands):

On March 24, 2006, the Empress of the North ran aground in Washougal, Washington. No passengers or crew were injured during the grounding. The vessel was in dry dock for damage inspection and repairs for approximately four weeks. The vessel was released and began operations on April 16, 2006. As of September 30, 2006, the Company recorded in cruise operating expenses approximately $2.7 million in costs associated with vessel repairs, passenger relocation and crew expenses incurred as a result of the grounding. These expenses were offset by insurance recoveries of $1.6 million received in the second quarter of 2006. The Company estimates that the overall negative impact of the cancelled revenue related to this incident to be approximately $1.7 million.

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Ambassadors International, Inc.

Notes to Unaudited Consolidated Financial Statements, Continued

On October 20, 2006, approximately 20 passengers of the Mississippi Queen became ill with flu like symptoms and were taken to a local hospital. The cruise stopped sailing two days earlier than originally scheduled in order to inspect and clean the vessel. The vessel 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 flu like symptoms on additional passengers. The Company anticipates canceling two additional weeks of cruise sailings in order to further inspect and clean the vessel. The Company is in the process of estimating overall negative impact of the cancelled revenue related to this incident.

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The following discussion of the Company’s financial condition and the results of operations should be read in conjunction with the 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 the Company’s 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, 2005.

The Company is a cruise, marine, travel and events and reinsurance company. Ambassadors Cruise Group, LLC (“ACG”), a wholly-owned subsidiary of the Company, operates American West Steamboat Company (“American West”), which offers cruises through Alaska’s Inside Passage and on the Columbia and Snake rivers, and DQSC Operations, LLC (“Delta Queen”), which offers cruises on many of America’s best known rivers, including the Mississippi, Ohio, Tennessee, Cumberland and Arkansas rivers with stops at many of America’s most historic cities, battle grounds and estates. American West and Delta Queen have been combined under one brand, Majestic America Line. Ambassadors Marine Group, LLC (“AMG”), a wholly-owned subsidiary of the Company, operates BellPort Group, Inc. (“BellPort”), which provides marina management, development, consulting services and shipyard operations throughout the United States and Mexico, and Bellingham Marine Industries, Inc. (“Bellingham Marine”), a marina design and construction company, which we acquired on July 21, 2006. Ambassadors, LLC (“Ambassadors”), a wholly-owned subsidiary of the Company, provides travel and event services for corporations, associations and tradeshows. Cypress Reinsurance, Ltd (“Cypress Re”), a wholly-owned subsidiary of the Company, reinsures property and casualty risks written by licensed U.S. insurers.

Critical Accounting Policies

Our consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these 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 which impact our most critical accounting policies, on an ongoing basis. We base our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, within the framework of current accounting literature.

Our businesses are seasonal. Historically, we have recognized the majority of our operating results in the first and second quarters of each fiscal year. As a result of the acquisitions within ACG, we anticipate that beginning in 2006 the majority of our operating results will be recognized in the second and third quarters of each 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 quarters of the year.

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 Cruise Onboard and Other Revenues

Passenger ticket revenue is recorded net of applicable discounts. Passenger ticket revenue and related costs of revenue are recognized 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. When customers cancel their trip, the nonrefundable portion of their deposit is recognized as revenue

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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. Passenger fares and on board revenue are comprised of beverage and souvenir sales and optional shore excursions and are deferred and recognized as revenue when the cruise is completed.

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. The Company recognizes travel revenue and related costs when travel convenes and classifies 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.

Revenue from hotel reservation, registration and related travel services are recognized 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. Revenue from pre-paid, certificate-based merchandise incentive programs is deferred 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.

Revenue from software and technology related events is derived from a combination of license and maintenance fees and services provided with enterprise software tools. The services provided include hosting of data, development and workflow configuration. Revenue from contracts with multiple elements is recognized using the “residual method” in accordance with Statement of Position (“SOP”) 97-2, “Software Revenue Recognition” as amended by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.” Revenue from development contracts is recognized in accordance with SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.” Such development contracts pertain to a combination of customization and enhancement programs of the Company’s event software performed at the request of clients. These contracts cover program periods of three to nine months and do not involve significant revisions to estimates due to their short-term nature. At September 30, 2006, the Company had one short-term development contract that was in the completion phase of the agreement. Revenue from contracts relating to only maintenance or hosting of data is recognized on the straight-line basis over the period that the services are provided.

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.

Marine Revenue

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

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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 Company recognizes shipyard related revenue upon the completion and delivery of services performed.

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.

License Fees

Revenue from license fees is recognized based on a contracted percentage of total program receipts recorded from the licensing source.

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. The Company considers anticipated investment income in determining the recoverability of these costs. At September 30, 2006, management believes its deferred policy acquisition costs are recoverable.

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 business, Cypress Re seeks 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. The effects of subsequent changes in estimated or actual cash flows are accounted for 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.

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Property and Equipment

Property and equipment are stated at cost, net of accumulated depreciation. Cost of maintenance and repairs which do not improve or extend the lives of the respective assets are expensed as incurred. Major additions and betterments are capitalized. The vessels are capitalized and depreciated using the straight-line method over the expected useful life ranging up to 30 years, net of a residual value which generally approximate 15%. Vessel replacement parts are 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 sold or retired, the related cost and accumulated depreciation are removed from the accounts and any gain or loss is recognized in the statement of operations.

Goodwill and Intangible Assets

Goodwill and intangible assets with indefinite useful lives are tested 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 the Company’s 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, goodwill has been allocated 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.

Foreign Currency Transactions

Bellingham Marine consists of five foreign subsidiaries in Australia, New Zealand, Europe and Southeast Asia. The financial statements of these foreign entities were denominated in a foreign currency and then translated to U.S. dollars. Balance sheet accounts have been translated using the current rate of exchange at the balance sheet date. Results of operations have been translated using the average rates prevailing throughout the year. Translation gains or losses resulting from the changes in the exchange rates from year-to-year are accumulated in a separate component of stockholders’ equity. Gains or losses resulting from foreign currency transactions are identified separately in the statement of 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 123R”). SFAS 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 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 123R, using the modified-prospective method, beginning January 1, 2006. Based on the terms of our plans, we did not have 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.

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Income Taxes

We account for income taxes in accordance with the provisions of SFAS No. 109, “Accounting for Income Taxes.” SFAS No. 109 requires an asset and liability approach which 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. As of September 30, 2006, the Company reduced its valuation allowance on its deferred tax assets. All available positive and negative evidence was evaluated and the Company believes that it is more likely than not that the net deferred tax assets recorded at September 30, 2006 will be realized.

COMPARISON OF RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2006 TO THE THREE MONTHS ENDED SEPTEMBER 30, 2005

Revenue

Total revenue for the three months ended September 30, 2006 was $57.6 million, compared to $6.4 million for the three months ended September 30, 2005. For the quarter ended September 30, 2006, the increase in revenue resulted from the addition of revenue from our cruise segment, which began operations on January 13, 2006, and an increase in revenue from our marine segment. For the quarter ended September 30, 2006, our cruise segment revenue was $35.0 million. Our marine revenue increased $16.5 million compared to the comparable period of 2005 as a result of the addition of our Bellingham Marine operations which commenced on July 21, 2006 and our shipyard operations which began on April 1, 2006. In addition, travel, incentive and event related revenue increased $0.5 million due to an increase in the total number of events operated during the period. These increases were partially offset by lower net insurance premiums earned of $0.7 million from our insurance segment due to a decrease in premiums earned on existing insurance programs and lower license fees earned from the licensing source within the travel and events segment of $0.1 million due to overall lower business volume of the source.

Cruise Operating Expenses

Cruise operating expenses were $16.5 million for the three months ended September 30, 2006, representing direct expenses incurred with owning and operating the American West and Delta Queen cruise lines acquired in January 2006 and April 2006, respectively. There was no comparable cruise activity for the 2005 period. We anticipate cruise related expenses to increase in future periods in relation to cruise revenue generated.

Cost of Marine Revenue

Cost of marine revenue was $13.0 million for the three months ended September 30, 2006, representing direct expenses incurred with our Bellingham Marine operations which commenced on July 21, 2006 and our shipyard operations which began on April 1, 2006. There was no comparable marine activity for the 2005 period. We anticipate marine related expenses to increase in future periods in relation to marine revenue generated.

Selling and Tour Promotion Expenses

Selling and tour promotion expenses were $4.7 million for the quarter ended September 30, 2006, compared to $0.7 million for the comparable quarter of 2005. The increase is due to the additional selling and marketing expenses incurred by the cruise segment which began operations in January 2006.

General and Administrative Expenses