Earnings Call Transcript - NCLH Q2 2024

Operator, Operator

Good morning, and welcome to the Norwegian Cruise Line Holdings Second Quarter 2024 Earnings Conference Call. My name is Donna, and I will be your operator. Operator provided instructions to participants regarding the call. As a reminder to all participants, this conference call is being recorded. I would now like to turn the conference over to your host, Sarah Inman. Ms. Inman, please proceed.

Sarah Inman, Investor Relations

Good morning, everyone. Thanks for joining us for our second quarter 2024 earnings and business update call. I'm joined today by Harry Sommer, President and CEO of Norwegian Cruise Line Holdings; and Mark Kempa, Executive Vice President and CFO. As a reminder, this conference call is being simultaneously webcast on the company's Investor Relations website at www.nclhltd.com/investors. Throughout the call we will refer to a slide presentation that can be found on our Investor Relations website. Both the conference call and the presentation will be available for replay for 30 days following today's call. Before we begin, I would like to cover a few items. Our press release with second quarter 2024 results was issued this morning and is available on our Investor Relations website. This call includes forward-looking statements that involve risks and uncertainties that could cause our actual results to differ materially from such statements. These statements should be considered in conjunction with the cautionary statement contained in our earnings release. Our comments may also refer to non-GAAP financial measures. A reconciliation to the most directly comparable GAAP financial measure and other associated disclosures are contained in our earnings release and presentation. With that, I'd like to turn the call over to Harry. Harry?

Harry Sommer, President and CEO

Thank you, Sarah, and good morning, everyone. We appreciate you joining us today for our second quarter 2024 earnings call. This is an exciting time for Norwegian Cruise Line Holdings. The second quarter had surpassed our expectations with results exceeding guidance on all key metrics allowing us to increase our full year guidance for the third time this year. At our Investor Day, we emphasized our unwavering commitment to balancing return on experience, what we call ROX, and return on investment, or ROI. This strategy is clearly yielding results. We are witnessing robust demand with strong pricing and booking volumes, leading to record-breaking advance ticket sales. This demand, coupled with our onboard offering and high-quality service, has led to strong guest satisfaction scores while we continue to effectively control costs. These indicators affirm that our strategic approach is positioning us for sustained long-term success on our well-defined path forward for continued growth to achieve our Charting the Course strategy, which includes ambitious 2026 financial and sustainability targets. Today, I am excited to discuss some of our key milestones for the second quarter and the factors that drove our enhanced guidance for the remainder of 2024. We're thrilled to see how the pillars and initiatives under our Charting the Course strategy are moving the needle for our business. As these are strongly underpinned by our global sustainability program, Sail and Sustain, we're also excited to share the progress outlined in our recent sustainability report. Later in the call, I will hand it over to Mark, who will provide more color on our second quarter performance and updated outlook for 2024. We kicked off the second quarter with impressive momentum, continuing the positive trends from the beginning of 2024 and proudly executing on our Exceptional Performance pillar. As you can see on slide four, our second quarter results beat guidance across the board. Adjusted EBITDA grew 14% and adjusted EPS was up 33%. Notably, we hit our year-end target of decreasing net leverage by one and a half turns a full six months early. As we move forward, we remain committed to further deleveraging with a clear focus on attaining a 2026 target of mid-four times. These strong results also allowed us to raise our full-year revenue and earnings guidance. We now expect to end the year with adjusted operational EBITDA margin of 34.5%, a full 400 basis point improvement over 2023, which puts us well on the way to our 2026 target of approaching historical margin levels of 39%. We also increased our adjusted EPS guidance for the full year to $1.53, an approximate 120% increase over 2023, and an impressive step forward towards our 2026 target of $2.45. And lastly, we are on track to achieve double-digit adjusted ROIC by year-end. This acceleration in our financial results speaks volumes about our team's dedication and hard work. Turning to slide five, I want to emphasize how our Long-Term Growth Platform pillar is set to deliver measured capacity growth and optimize our fleet to drive strong financial returns. Historically, capacity growth has driven outsized revenue and adjusted EBITDA growth, and we expect this trend to continue with the incorporation of larger and more efficient, state-of-the-art vessels to our fleet, which I'll now give some updates on. Turning to slide six, we are currently focused on our next two new ships being delivered in 2025, both currently scheduled for an on-time delivery. Our first milestone in the quarter was the float-out of Norwegian Aqua, which we celebrated with our partner Fincantieri. Norwegian Aqua, the first ship in the next-generation Prima Plus class, is an evolution of the previous Prima class ship and will be 10% larger. This space allows for more innovative offerings, including the world's first-ever hybrid roller coaster and water slide, the Aqua Slide Coaster. We are also building a digital sports complex with an interactive LED floor and our most expansive 360-degree outdoor promenade, the Ocean Boulevard. We cannot wait for Aqua to make her debut in April 2025. Most recently, we also celebrated the float-out of Oceania's Allura at the Fincantieri Shipyard in Genoa. This marked the transition of the vessel from dry dock to fitting out berth, initiating the final stages of construction. Allura will redefine luxury with its designer-inspired interiors, including opulent suites, sophisticated lounges, and exceptional new dining venues. Scheduled to enter service in the Mediterranean in July 2025, she will follow her normal summer season with winter voyages in the Caribbean. Oceania was also busy this quarter with the return to service of Marina after an extensive refurbishment. This all-encompassing rejuvenation includes the addition of three new dining options and reimagined penthouse suites. And just as we add more capacity and new features on existing ships, we are also excited for enhancements to our destination and home ports. We're increasing our sailings to exciting destinations, such as Bermuda and Great Stirrup Cay, where we plan to complete construction of our two-ship pier towards the end of next year. We'll also be adding a new home port to our roster in 2025, JAXPORT, in Jacksonville, Florida. And in April 2026, NCL will make its return to Philadelphia after a 17-year hiatus. With the addition of Philadelphia, NCL will now service seven of the top ten largest metropolitan regions in the United States. We are excited about our deployment, and our guests are as well, as shown by our booking trends, which you can see on slide seven. The company continues to experience strong consumer demand. In the second quarter, we continued to see strong bookings, with our 12-month forward book position at the upper end of our optimal range on strong pricing. During the second quarter, we observed continued strength in onboard revenue as well, which was driven by our guests' continued enjoyment of our shore excursions and onboard amenities, including specialty restaurants and communication services, which had been bolstered by the continued implementation of Starlink across the fleet. Additionally, pre-booked onboard revenue per capacity day showed solid growth, increasing by 15% as more guests opted for pre-cruise purchases. And as we've seen from prior experience, higher pre-cruise spend typically results in higher overall spend throughout a guest's cruise journey. As a result, our net yield grew 6.3% during the second quarter, surpassing our guidance by a full 200 basis points. During the second quarter, about 3% of our capacity was originally scheduled to be in the Middle East region, with a high percentage of our Oceania and Regent brands scheduled to be in that region. The cancellation of these itineraries resulted in a very short resale cycle. Despite this setback, results for this quarter were strong enough to offset this, underscoring the robust demand environment for cruises and the agility and effectiveness of our team to overcome difficult challenges. Without a doubt, our financial performance exceeded our expectations, and we're therefore raising our yearly net yield growth guidance, increasing 100 basis points from 7.2% to 8.2%. It is worth noting that our occupancy guidance remains essentially unchanged as we're already guiding to full ships, so the entire increase in our guidance is on the back of stronger pricing. As such, we are anticipating strong pricing growth across all four quarters in 2024. Turning to slide eight, to continue cementing our leading position beyond 2024, I am excited to announce that our second quarter advance ticket sales surpassed the first quarter, increasing 11% year-over-year and reaching a new all-time high of $3.9 billion. This success was driven by robust pricing, a dynamic deployment mix, coupled with increased pre-sale packages and capacity growth. Now moving on to what is at the core of our Charting the Course strategy, our sustainability program, Sail and Sustain. In June, we were pleased to release our annual sustainability report. On slide nine, we summarized some of our main 2023 highlights, which underscore our commitment to integrating sustainability into our overall business approach. Some noticeable accomplishments include achieving our 2024 target to equip 50% of our fleet with shore power technology a full year early. We remain on track to equip 70% of our fleet with this technology by 2025. In fact, we recently celebrated the launch of shore power at PortMiami, making it the first major cruise port on the U.S. East Coast to offer shore power at five of its terminals, including our own Terminal B, the Pearl of Miami. We also reached our goal of testing 20% of our fleet with biodiesel blend by expanding tests to four more ships throughout 2023. Our new target is 40% of our fleet to test biodiesel by 2024. Finally, doubling down on our People Excellence pillar, we continue diversifying our sourcing, having spent over $635 million with small businesses and businesses with minority, women, veteran, or economically disadvantaged qualifications in 2023. And most recently, Forbes named us as the best American employer for women, a milestone we are particularly pleased with. Our journey does not stop here. We remain dedicated to advancing towards our Sail and Sustain targets going forward, maintaining high standards of operational excellence, and creating lasting value for our business and various stakeholders through sustainable practices. I couldn't be more proud of our entire team for all of these impressive accomplishments. With that, I'll turn it over to Mark to walk you through our financial results and outlook. Mark?

Mark Kempa, Executive Vice President and CFO

Thank you, Harry, and good morning, everyone. My commentary today will focus on our very strong second quarter 2024 financial results, our improved full year 2024 guidance, and our increasingly solid financial position. Unless otherwise noted, my commentary on 2024 net yield and adjusted net cruise cost ex-fuel PCD are on a constant currency basis, and comparisons are to the same period in 2023. Let's begin with our second quarter results, which are highlighted on slide 10. In short, we exceeded guidance across the board, outpacing our targets for the quarter, starting with the top line. The results were impressive, with net yield increasing 6.3%, exceeding our guidance of 4.3% by 200 basis points. Several factors contributed to the exceptionally strong top line growth in the quarter, which included robust demand for European, Caribbean, and Alaskan sailings, where the majority of our capacity is deployed this quarter. Stronger-than-anticipated onboard revenue and close-in sailing demand. And finally, the redeployment of canceled Red Sea sailings were better than our initial expectations. Looking at costs, adjusted net cruise cost ex fuel PCD came in below guidance at 163, primarily due to the timing of certain expenses that will now fall into the third quarter. As expected, our unit cost this quarter included approximately $9 from higher dry dock days and related costs as compared to 2023. Excluding the impact of the dry docks, our adjusted net cruise cost ex fuel PCD would have been flat year-over-year, once again demonstrating our ability to fully offset the impacts of inflation with our disciplined cost savings initiatives across the entire organization. These initiatives, combined with robust top line growth, have yielded strong results. Adjusted EBITDA came in at approximately $588 million, surpassing our guidance of $555 million, resulting in a year-over-year increase of 14%. Adjusted EPS was $0.40, exceeding our guidance of $0.32, and increased 33% compared to the same quarter last year. Overall, we are extremely pleased with our second quarter performance. Strong top line growth, combined with our ongoing cost reduction initiatives, enabled us to surpass our guidance metrics for the quarter. This strong momentum positions us well as we look ahead, and as a result, we are raising our earnings guidance as highlighted on slide 11. We are thrilled to announce that for the third time this year, we have raised our full year guidance, reflecting the strong performance and strength of our business. Since our initial guidance in February, net yield growth is expected to increase 280 basis points to 8.2%, and we have maintained our adjusted net cruise cost ex fuel PCD guidance, which, excluding the impact of dry docks, is expected to be flat for the year. I will go into more detail on this a bit later in my remarks. As a result of the strong top line and sub-inflationary unit cost growth, we have increased our guidance for adjusted EBITDA by $150 million, from $2.2 billion to $2.35 billion. All of this is flowing to the bottom line, resulting in an increase in our adjusted EPS guidance of approximately 25%, underscoring our impressive operational execution and strong market demand. These results mark significant progress towards achieving our Charting the Course 2026 targets, as we outlined in May. Moving on to a more detailed look at our guidance on slide 12, we outline our expectations for the third quarter and full year, as well as the implied metrics for the fourth quarter. Starting with net yield, we anticipate net yield growth of almost 6.5% in the third quarter. This growth is driven by several factors. Over 70% of our sailings in the third quarter are in Europe and Alaska, regions where we are experiencing strong demand from North American customers. Continued strong onboard revenue trends, combined with healthy pre-booking for onboard amenities. Unlike Q2 and Q4, this quarter is unaffected by disruptions from the Middle East cancellations and rerouting. These favorable trends and our ongoing momentum have allowed us to increase our full year net guidance to 8.2%. I want to emphasize that our latest guidance implies a healthy net yield growth of 5% for the fourth quarter. This builds off of an impressive 8% growth in 2023 that was underpinned by 14% pricing. Our Q4 2024 growth also comes in the face of headwinds from rerouted Middle East sailings, which comprised 10% of our deployment in the fourth quarter and was disproportionately weighted to our luxury brands. Now, turning to our attention to adjusted net cruise costs, where our guidance remains unchanged, a true testament to the diligent efforts of the entire organization. For the third quarter, we anticipate adjusted net cruise cost ex-fuel PCD to increase by 3.3% to 156 from 151 in the same period last year. I would like to highlight a few points about the quarterly numbers, as there are many moving parts, and I will get into those yearly changes later in my remarks. First, in Q3 of last year, we recognized approximately $2 of non-recurring benefits. Second, keep in mind the timing of expenses. As I mentioned previously, our Q2 unit costs were better than expected, primarily due to timing differences of certain expenses between Q2 and Q3. Consequently, on a year-over-year basis, Q3 unit costs are up. However, this is merely a timing issue, and for the full year excluding the impact of dry docks, we still expect our unit costs to remain essentially flat and in line with our prior guidance. And third, I will mention variable compensation. We are recognizing higher variable compensation due to our business outperforming initial forecasts, and this has a disproportionate weighting in the third quarter consistent with the seasonality of our earnings. As a result of strong net yield growth and cost savings initiatives, our third quarter adjusted EBITDA is expected to be $870 million, which is driving adjusted EPS of $0.92, a 21% increase over the same period in 2023. Moving to slide 13, I'd like to revisit our net yield guidance since our Q1 results in May and highlight the confidence and strength we are seeing for the latter half of 2024. At our Investor Day, we increased our full year guidance, indicating that the majority of the uplift was expected in the second half of the year. Giving more detail on this now, we had expected that about $35 million of the $50 million adjusted gross margin improvement or an increase of 120 basis points of net yield to materialize in the second half. Today, we are raising our full year guidance once again, with an additional $35 million improvement in adjusted gross margin or 120 basis points in the second half. This positions us to achieve solid net yield growth of 5.9% in the back half of 2024. Moving to slide 14, I want to dive a bit deeper into our margin enhancement initiatives. As we stated at our Investor Day, a key pillar of our algorithm is boosting margins and reducing costs across the entire organization. And we continue to see the fruits of these efforts during 2024. During the first and second quarters, we have been able to keep our unit costs flat, excluding dry dock. And as I mentioned earlier, due to the timing, this metric will increase in the third quarter, but should decline in the fourth quarter. And as a result, our adjusted net cruise cost ex fuel PCD will be essentially flat year-over-year, fully offsetting inflation, as well as the increased variable compensation due to the company's strong performance. This speed is not easy and is the result of the tireless work of our entire organization and transformation team. I am confident that we will be able to continue this momentum in the years that come. Turning to slide 15, we can clearly see the impact of our disciplined approach to earnings and returns as outlined during our recent Investor Day. The key elements of our algorithm are straightforward. Improved net yields and rigorous cost management drive margin expansion. That margin expansion in conjunction with controlled capacity growth results in substantial adjusted EPS growth. Moreover, this adjusted EPS growth, when paired with our disciplined capital allocation strategy, allows us to prioritize debt repayment in the short to midterm. This approach not only reduces our net leverage, but also strengthens our balance sheet and enhances our adjusted ROIC, which, by the way, is on target to hit double digits this year, another important milestone toward our 2026 target of 12%. During the second quarter, we improved our trailing 12-month adjusted operational EBITDA margin to 33%. As we close out the year, we anticipate ending with a margin of 34.5%, marking a substantial improvement of 400 basis points from 2023. This progress is a significant milestone as we strive toward our target of approaching historical margins of approximately 39%. Now let's shift to our balance sheet and debt maturity profile on slide 16, which has not changed significantly since Q1. During the quarter, and as expected, our 6% 2024 exchangeable notes converted to shares. And our next maturity is our $565 million notes due 2024, which we are expecting to refinance and/or partially repay by its maturity in December. Turning over to leverage on slide 17, we are proud that we achieved our net leverage goal six months ahead of schedule, reducing our leverage by approximately one and a half turns and ending the quarter at 5.9 times. Achieving leverage in the fives is no small feat since we ended 2023 at 7.3 times. As you know, we are on a multi-year deleveraging journey to de-risk the balance sheet, targeting the mid-fours, and this quarter's results are another significant milestone in that journey. In closing, I want to emphasize that this has been an exceptional quarter where we surpassed guidance across all key metrics. This momentum has enabled us to raise our full-year guidance for the third time. This is all a testament to the strategy we outlined at our Investor Day and that I discussed earlier. We are excited about the second half of the year and remain confident in our strategy going forward. With that, I'll turn it back to Harry for closing remarks.

Harry Sommer, President and CEO

Well, thank you, Mark. I want to close by reminding everyone of the ambitious targets and strategies that we laid out in Investor Day just two months ago, which are listed on slide 17. Our bold vision is to provide guests with exceptional vacation experiences, allowing them to vacation better and experience more. This vision is the foundation of our Charting the Course strategy supported by our four pillars, People Excellence, guest-centric product offering, Long-Term Growth Platform, and Exceptional Performance. These pillars are all underpinned by our commitment to sustainability through our Sail and Sustain program. This new strategy and vision lead to a simple yet powerful earnings and return algorithm that Mark discussed earlier that will help us deliver on our 2026 financial targets. Our entire management team is driven and focused on this new strategy, and I'm positive that this quarter's results gives you even greater confidence that we are on track to achieve our long-term goals. We are optimistic about our future and look forward to sharing this journey of growth and success with you. With that, I'll hand the call back over to the operator to begin our Q&A session.

Operator, Operator

Thank you, Harry. Operator provided instructions for the Q&A session. Today's first question is coming from Steven Wieczynski of Stifel. Please go ahead.

Steven Wieczynski, Analyst

Hey, guys. Good morning. Congrats on the results here. So Harry or Mark, in terms of booking trends, it seems like you're obviously well-booked out for this year. As you noted, most of your bookings today are for 2025 or beyond. Just wondering, as we look out to 2025, if you're seeing pretty much strength across all itineraries at this point, or are there certain itineraries that are getting more attention right now? Then you also noted that you're at the high end of what you call your optimal book position. Has that optimal book position changed at all, given how much further out your customers are booking these days?

Mark Kempa, Executive Vice President and CFO

I'll take that one, Steve. Harry, first off, thanks for the kind words. We were very happy with our results this quarter and our increased guidance for the year as well. Two different questions. I'll do my best to address both. On the booking trends, not really seeing any key patterns there. We're happy with the strength across the board. We're seeing good strength in the Caribbean, Europe, Alaska, exotics, all the places that we go to. We were pretty meticulous going into 2025 with our itinerary planning to do a good job at balancing our demand and supply by region of the world. We seem to generally be successful. I'll point out one thing that I'm particularly pleased with. It's Alaska and Europe for next summer. Please don't take that as a comment that I'm not pleased with anything else. We're pleased with everything. That's one area that seems to be doing particularly well and a little bit ahead of our expectations, so we're happy with that. In terms of your second comment about whether or not our view of book position has changed, I think so. I think if you were to compare this, for example, to 2019, which was the last normal year, I would say that our optimal book position is probably a little bit ahead, but I think that's just due to better analytics, better revenue management tools, better thoughts of the future. I just want to reiterate, perhaps save a question from someone else in the future. Our goal is not to be at record book positions. Our goal is to be at optimum book positions such that we can maximize yield. We don't take record book positions to the bank. We take yield to the bank. And we have calibrated our tools such that sometimes it's okay to slow down bookings in order to raise prices. And one thing that we're particularly proud of that I mentioned in my prepared remarks is we have really seen robust pricing for 2025 up significantly compared to this time last year for 2024. And that's something that obviously we're going to continue to do our best on to deliver towards our 2025 and 2026 long-term financial goals, which we mentioned on Investor Day.

Steven Wieczynski, Analyst

And Harry, maybe if I can ask one more quick one here, but you made a remark in your prepared remarks about how your Charting the Course targets are— you used the word ambitious, which I think is a pretty interesting adjective there. So maybe I'm reading too much into that remark, but as we sit here today, I mean, if you guys are targeting double-digit ROICs by the end of this year and your target out to 2026 is 12%, I mean, that doesn't seem overly ambitious to us. So maybe that's not even a question, but I'll stop there and see how you would respond to that.

Harry Sommer, President and CEO

I'm not sure I read a question in there either. So I'll try to do my best to respond. When I say they're ambitious, I mean that we believe it's the proper cadence that drives the company forward to have great results. So I wouldn't read my comments that ambitious mean that I think they're crazy optimistic, nor are they in such a way that we can't achieve them. We're very much committed and we are reiterating our support today that we're committed to hitting these targets in 2026. And I think the commentary that we gave on book position and the visibility we have into 2025 allows us to reiterate the goals that we think we're well on track to achieving now.

Steven Wieczynski, Analyst

Okay, great. Thanks, Harry. Appreciate it.

Operator, Operator

Thank you. The next question is coming from Ben Chaiken of Mizuho Securities. Please go ahead.

Benjamin Chaiken, Analyst

Hey, good morning. Thanks for taking my question. I know you called out timing as a factor between Q2 and Q3 for costs, but it sounds like some incremental progress on the cost side as well that helped offset costs both in the quarter and the year. I'm not sure if there's anything you can elaborate on. Were these essentially incremental cost saves as part of the longer term goal that you found early or maybe incremental opportunities? And I guess what I'm referring to is the incremental compensation expense, yet essentially unchanged full year cost guide. Any quantification would be super helpful. Thanks. And then I have one more.

Mark Kempa, Executive Vice President and CFO

Yes, good morning, Ben. This is Mark. So you're absolutely right. We continue to be very, very confident in achieving our cost reduction and waste elimination goals. So when you think about the full year, I think in the quarter our costs were favorable. I think it was, what, $6 million, $7 million. That's just the timing between quarters. But when you step back and you think about that on a full year basis, you are absolutely right. Due to better performance that we called out, we do have variable comp that is hitting us both in second quarter and second half of the year and disproportionately weighted to the third quarter. So all-in-all, that indicates that we're actually pacing ahead in terms of our overall $100 million goal that we had committed for this year. So we continue to find new things. We continue to hone in and eliminate waste. We're committed to that and very happy on the progress we're seeing going forward.

Benjamin Chaiken, Analyst

Got you. That's helpful. And then switching gears, thinking longer term, I know the pier will be complete in October 2025. Do you plan on making incremental investments in parallel with that opening, or do you think at least subsequent to?

Mark Kempa, Executive Vice President and CFO

I think there'll be a little bit of both. I think there'll be some parallel investments, but I think this is a long-term development plan for us. As you know, we have one of the largest private islands in the Caribbean. We have lots of real estate to build on. We have a long-term master plan. So I think you can look to see some things opening up in 2025 with the pier, and more things will come in 2026 and 2027. We are committed. We have a significant percentage, especially of our NCL fleet, visiting there in the winters and even now some in the summers as well. Perhaps you caught some of our deployment changes when we announced our 2026 deployment for NCL a couple of weeks ago. And we plan to maximize our real estate and what we believe is a competitive advantage in the Caribbean with this island.

Harry Sommer, President and CEO

And Ben, I just want to highlight that that will be over time. We are not anticipating or should you expect there's going to be some level of ramped up CapEx over the next year or two. We will make measured disciplined investments there while looking to repurpose dollars that were otherwise going to be spent within the organization. So again, it will be in a measured way and associated with returns that we would expect with such investment.

Benjamin Chaiken, Analyst

Got it. That's very helpful. Thank you.

Operator, Operator

Thank you. The next question is coming from Conor Cunningham of Melius Research. Please go ahead.

Conor Cunningham, Analyst

Hi. Thank you. Mark, just sticking with costs. So yes, the core cost performance seems to be tracking ahead. I just as you start to think about 2025, I realize you have some lingering dry dock headwinds and just any early reads on the puts and takes there. For example, the development of Jacksonville or the private island start to add incremental costs to next year in general. Just any thoughts there right now. Thank you.

Mark Kempa, Executive Vice President and CFO

Yes. Good morning, Conor. Look, I think when you think about 2025, we're not expecting any sort of material headwinds from our core fundamental costs, other than what we would expect against normal inflation, which again, we've been very adamant. We believe we can deliver sub-inflationary costs. But things around the island or even, I think you mentioned dry docks, when we think about dry docks year-over-year, there is no substantial step up. I think our dry dock days might change year-over-year. It's in the single digit number. Now, there may be different capacity days in terms of timing of the dry docks or similar of next year. But overall, that's not a headwind when you think about it from a 20,000-foot level. So we're focused on, as we've been saying, we're focused on our algorithm. We believe we can deliver sub-inflationary unit cost growth or better. And Q2 and our second half guidance is another testament to that, that we're on a strong path toward that course.

Harry Sommer, President and CEO

And the only additional color I'll add, as you asked specifically about Jacksonville, is we have no material investment. That's an investment led by the local community, which obviously we're going to partner with by berthing ships there long-term. But that's on their dime, so to speak, not ours.

Conor Cunningham, Analyst

Okay. Helpful. And then on the comment of booking for 2025 and just where the curve sits, in the past you've talked about the negative impact to having longer, more immersive cruises that won't let you basically get back to 2019 occupancy levels. But just given the stated demand, why wouldn't occupancy be a further tailwind into 2025, outside of you guys just pushing rate in general for yield? Thank you.

Mark Kempa, Executive Vice President and CFO

I'll just say, Conor, and I hope I get to the essence of your question. Listen, our core driver of revenue is the first and second guests in the cabin, not necessarily the third guests in the cabin. The third guest doesn't tend to pay very much. So, our focus is really more on cabin occupancy than passenger occupancy, because those third and fourth guests have a very small marginal benefit. So, once again, this really gets to optimizing yield, not necessarily optimizing an occupancy number or something along those lines.

Conor Cunningham, Analyst

That's actually helpful. Thank you.

Operator, Operator

Thank you. The next question is coming from Matthew Boss of JPMorgan. Please go ahead.

Matthew Boss, Analyst

Great, thanks. And congrats on a nice quarter. So, two-part question. Harry, on the robust demand that you cited into the back half of the year, could you elaborate on pricing power globally or just any pushback at all that you're seeing in any region? And then, Mark, with the fourth quarter net yield raised today, and if we think about demand momentum, if demand momentum continued, how linear is the 2.5 point cost spread target multi-year? Thinking if net yields were to continue to outperform your plan, how best to think about that 2.5 point cost spread?

Harry Sommer, President and CEO

Okay, those are two good questions. I'm actually going to address both of them, and then Mark will do some cleanup after my second answer. The overwhelming majority of our demand, especially on the NCL brand, but even across Oceania and Regent, comes from the North American consumer. So it really wouldn't materially impact our numbers if other regions changed a bit. So I think that's a more important answer to the question. The European and Asian consumer is only marginally important to us. But to be clear, they're doing well as well. We are happy with the demand out of Europe. We're happy with the demand out of Latin America, Australia, all the places that we sell to, and they continue to do well for us. In terms of next year, listen, 2.5% is a baseline. Obviously, we are going to do everything in our power to overachieve on yield, and we're going to do everything in our power to overachieve on cost. I mean coming in with better cost, but I think 2.5% is a very good place to start. We only announced that about two months ago. We're still focused on that for 2025 and 2026.

Mark Kempa, Executive Vice President and CFO

Yes. Matthew, just to highlight some things. So look, when we announced our targets, what I think would be important to understand is, number one, there is no hockey stick implication or assumption that we're going to do X in 2025 and we have to do Y in 2026. That was a very broad-based spread that we've committed to. So what do I mean by that? Yes, there may be some variability between quarters either upward or downward. It is very, very early when we look at 2025 and 2026. So I wouldn't get caught up on the quarterly spread. I would concentrate on the full year spread, which is what we're aiming for. And again, we're not assuming any sort of hockey stick scenario, and I think that's the important thing to keep in mind in your models and your thinking.

Matthew Boss, Analyst

It's great color. Best of luck.

Operator, Operator

Thank you. The next question is coming from Brandt Montour of Barclays. Please go ahead.

Brandt Montour, Analyst

Good morning, everybody. Thanks for taking my question. So first, on the fourth quarter implied guide, I think the fourth quarter guidance on our math for per diems is something in the low two percentage range. And I think there's Middle East there. Can you start up quantifying what the Middle East impact is on the fourth quarter in particular?

Mark Kempa, Executive Vice President and CFO

Yes, look, good morning. And as we've talked about before on the Middle East, earlier in the year, we had said the Middle East Red Sea was about a one to two point impact for the year. If you think about that on the quarters, it's disproportionately weighted to Q4 of this year because about 10% of our capacity was in that region. So I can't give you full or complete quantification for Q4 other than I would urge you to consider that it was 10% of our deployment that was disproportionately weighted on our luxury brand. So it is certainly weighing down on the fourth quarter. That said, as I've also said in my remarks, fourth quarter of last year we had 14% pricing growth and 8% yield. And even more importantly, I think when you look at the fourth quarter and the second half and you think about the progression that we've made over the last four to five months, we have continually increased our guidance for both the third and fourth quarters consistently. And I think that is a testament that we are seeing strength and we are seeing strong momentum. So I'll leave you with that, but I think we're very satisfied with where we are and hopefully we can outperform that.

Harry Sommer, President and CEO

And the only additional color I'll add is we managed to drive yield and not just price, and we're guiding now to mid-single-digit yield growth year-over-year, which considering that we're guiding at strong growth for Q2 and Q3, we don't view that as a material difference. We don't go 6% one quarter and 5% another quarter as anything other than the normal ebbs and flows of business. So I think the conversation about some sort of deceleration can be put to rest. We have continued momentum.

Brandt Montour, Analyst

Thanks for that, Harry and Mark. So on a follow-up question, Marriott this morning talked about seeing a slightly lower ancillary spend across the system. The U.S. was implicated in that again, broad based, but slight. You guys have your own real-time cash register. Are you seeing any wobbles or wavers in onboard spend over the last year? Sorry for the short-term question, but it's topical.

Mark Kempa, Executive Vice President and CFO

Sure. I'll give you a short answer and then a longer answer. So the short answer is no. We are seeing no decrease in onboard spend. In fact, as we mentioned in our prepared remarks, the preselling of onboard is actually up considerably over the prior period that we comped to. The slightly longer answer is you need to keep in mind a couple of factors. The huge value gap between hotel ADRs and cruise line yields. At our Investor Day, we referenced a 40% value gap, which still means we have tremendous runway to catch up to hotels. We consider that a long-term tailwind for the company. Also, because our booking pattern is so much further in advance, we have lots of opportunities to engage with our consumer and discuss with them the value of being on our ship. I mentioned the fact that the people are in our product the whole time, unlike a hotel where people come and go. Guests are on the ship for extended periods of their vacation, which gives us a tailwind as well. So overall, the short answer is no cracks, no deterioration. If anything, it continues to be strong and more long-term there are fundamental things that work in our favor that make our business quite a bit more resilient than hotels in the ancillary/onboard spend category.

Brandt Montour, Analyst

Perfect. Thanks, everyone.

Operator, Operator

My apologies. My mic was muted. The next question is coming from Vincent Ciepiel of Cleveland Research Company. Please go ahead.

Vincent Ciepiel, Analyst

Great. So really encouraging to hear about the positive revision of the fourth quarter. And I think you used the word robust to describe what you're seeing for pricing for 2025. So it sounds like things are setting up pretty well for that low to mid-single-digit yield growth range that you target. Could you comment on how you think new hardware and maybe any itinerary or geographic type changes could impact yield for next year? Is it something that you think will be accretive, neutral, or dilutive to yield? How should we be thinking about that?

Harry Sommer, President and CEO

Thanks, Vince. I think the reiteration of the low to mid-single-digit yield growth for next year is spot on and that continues to be our goal for 2025 and 2026. When we look at our deployment mix for 2025 versus 2024, there are some changes on the margin, but it's not a substantial change year-over-year. Obviously, we didn't have any new hardware come online this year, which would be a tailwind for next year. We have two ships coming on next year, one a little earlier, one towards the back half of the year. So I don't think that new ships will have a material impact as well. I think most of what you see next year is going to be organic based on marketing, demand, tweaking revenue management tools and just being more effective at executing in the company. So I don't think there's any huge one-time or ancillary items that will materially impact yield for next year.

Vincent Ciepiel, Analyst

Thanks. And an unrelated follow-up on loyalty, I know this is something that we've talked about briefly in the past. Just curious where you guys are at in that process, and if you've given more thought or are already taking steps to help reward folks for staying within the brand family across the portfolio of brands?

Mark Kempa, Executive Vice President and CFO

Good question, but it's not really something we're prepared to talk about yet. Obviously, what we see in the industry is on our radar screen, and we're studying it, but not really in a place to comment at the current time.

Vincent Ciepiel, Analyst

Okay, thank you.

Operator, Operator

Thank you. The next question is coming from James Hardiman of Citi. Please go ahead.

James Hardiman, Analyst

Hey, good morning, and thanks for taking my questions. So, you've done a great job the last couple quarters and really implied in the guidance for the year on the cost front, basically keeping that cruise cost flat ex-dry dock. Maybe help us think through how long you can continue to do that. For example, was there a disproportionate benefit from some of the cost saves that would inevitably slow next year? And conversely, how should we think about inflation next year, or could that flat ex-dry dock trend continue for longer?

Mark Kempa, Executive Vice President and CFO

Good morning, James. Thanks for the question. As we've stated and committed, we're targeting $300 million of savings over the course of the three years through 2026. We're confident in that. It doesn't mean it's in the bag, but it's an ever-evolving journey. We think we have the right tools, the right culture in place, we're seeing changes in the organization, and we're starting to eliminate waste effectively. When you think about next year, what is inflation? We generally think of inflation as somewhere around 3%, and of course that could be up or down. But our goal is to mitigate some or all of that. To date, our performance indicates we are doing well on that track, and we're actually ahead for 2024. It's a bit early to commit on what 2025 is going to look like, but we have a lot of runway, a lot of annualization from initiatives that started this year that will get full annualization next year. So we're feeling comfortable on our targets and are laser-focused on eliminating waste while preserving the guest experience and product we're known to deliver.

James Hardiman, Analyst

Got it. And then obviously it's early to handicap 2025 on demand and cost. But can you help corral us on some of the below-the-line items as we think about interest expense, share count, DNA for next year? Your balance sheet is changing with some converts. Any help with that math so we could be in the same ballpark?

Mark Kempa, Executive Vice President and CFO

Yes. So first on share count, I think we've been guiding to about 515 million or 516 million fully diluted. I would expect that number to be very similar next year because that does assume that all of our convertibles that are out on the horizon are converted to shares. That is not our intention for our 2027s, as we've always said. But the 2025 convertibles, we expect to convert to shares because we don't have another option. In terms of DNA, I think our DNA generally runs probably about 9.5% or so of gross revenue and I would anticipate that it's going to be in that same zone going forward. In terms of interest, I think we continue to make progress. We're guiding to about $760 million or so this year. As we continue to pay down debt, hopefully we can take out some debt early with our 2024 December maturity. I think we can continue to see some improvement on that front. I'm not going to give you a specific number on it, but think about where we are this year, $730 million to $740 million. I think that would probably be a consistent percent of gross revenue or better.

James Hardiman, Analyst

Got it. Really helpful. Thanks, Mark.

Operator, Operator

Thank you. The next question is coming from Lizzie Dove of Goldman Sachs. Please go ahead.

Lizzie Dove, Analyst

Hi there. Thanks so much for taking the question, and congrats on a nice set of results. I just wanted to ask about the algorithm for net yield. It feels like maybe the gross side of things in terms of air and ticket was a touch lower than expected, but really nice commissions leverage that you got there. So any change in how you're thinking about that longer term, and how much more room to go is there on that commissions leverage? Is that coming from more direct bookings or changing demographics that you're seeing? Any help there would be great. Thank you.

Harry Sommer, President and CEO

Thank you, Lizzie. I understand how you drew the conclusion you did that the benefit was based on commissions or direct bookings. What's not the case is that the entire benefit we saw in that line was the result of better air purchasing. We bundle air on Oceania and Regent, and anywhere between 35% and 60% of our guests depending on the brand and the region. As we're able to buy air more effectively, we pass on the savings to the guests, which results in lower gross revenue and lower air costs that show up in the commissions, transportation, and other line. We get better net revenue because we believe our air program is a competitive advantage in driving demand. For us, having higher net revenue and lower gross revenue is actually a huge benefit because it means we're buying air more effectively and sharing those savings with guests, allowing for a more robust demand environment. In terms of how much more leverage there may be on buying air better, we have a team focused on this. We continue to contract with new carriers, both domestic and international, which gives us more choices to offer our guests. I don't think we've run the entire course on that, and while it doesn't necessarily show up directly in cost savings as accounted for, it is part of the transformation initiatives we have and contributes to long-term benefits.

Lizzie Dove, Analyst

Okay, thank you. That's helpful.

Harry Sommer, President and CEO

I think we have time for one more question.

Operator, Operator

Thank you. Our next question is coming from Daniel Politzer of Wells Fargo. Please go ahead.

Daniel Politzer, Analyst

Hey, good morning, everyone. Thanks for taking my question. I just wanted to follow up on the difference between gross and net. As we think about the remainder of the year, and obviously you've given that net yield guidance, should we think about transportation and airfare cost continuing to be down year-over-year? Or should gross and net be changing at a similar pace for the rest of the year?

Mark Kempa, Executive Vice President and CFO

I think generally speaking, to the extent we can continue to improve on that line item, we're going to continue to improve on it. Obviously, we are at the mercy of some market volatility in terms of whatever air does. But I think it's a reasonable assumption that we're going to continue to work hard on that and see improvements. There is some variability there, but we expect continued focus and potential improvements.

Daniel Politzer, Analyst

Got it. And then, obviously, you reached your net leverage goal early this quarter. How should we think about the year-end net leverage target at this point? Any way to help us as we think about working capital and other moving pieces in terms of your balance sheet and cash flow?

Mark Kempa, Executive Vice President and CFO

I think the way to think about it is it provides us another solid milestone toward our 2026 target of mid-fours. I think generally the models out there know what our debt is and net debt is, and you have a good handle on where our EBITDA is. We are making progress and we think by year-end we're going to see significant improvements quarter after quarter.

Daniel Politzer, Analyst

Got it. Thanks so much.

Harry Sommer, President and CEO

Okay. Once again, I want to thank everyone for joining us today. We'll be around to answer any questions you may have. Have a great day and we look forward to seeing you in our next call. Thanks, everyone.

Operator, Operator

Thank you. This concludes today's event. You may disconnect your lines or log off the webcast at this time, and enjoy your day.