XLON:0I1W Royal Caribbean Cruises Ltd Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934                 

 

For the quarterly period ended June 30, 2012                            

 

OR

 

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934                 

 

For the transition period from _____ to _____                           

 

Commission File Number: 1-11884                                              

 

ROYAL CARIBBEAN CRUISES LTD.

(Exact name of registrant as specified in its charter)

 

 

Republic of Liberia

 

98-0081645

 

 

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

1050 Caribbean Way, Miami, Florida 33132

(Address of principal executive offices) (zip code)

 

(305) 539-6000

(Registrant’s telephone number, including area code)

 

N/A

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

 

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

 

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

 

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

 

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

Smaller reporting company o

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ¨     No  x

 

There were 217,906,953 shares of common stock outstanding as of July 18, 2012.

 

 

 



            Table of Contents

 

ROYAL CARIBBEAN CRUISES LTD.

 

TABLE OF CONTENTS

 

 

 

 

Page

 

 

 

PART I. FINANCIAL INFORMATION

 

 

 

 

 

Item 1. Financial Statements

 

1

 

 

 

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

 

25

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

42

 

 

 

Item 4. Controls and Procedures

 

43

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

 

Item 1. Legal Proceedings

 

44

 

 

 

Item 1A. Risk Factors

 

44

 

 

 

Item 6. Exhibits

 

45

 

 

 

SIGNATURES

 

46

 



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

ROYAL CARIBBEAN CRUISES LTD.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(unaudited; in thousands, except per share data)

 

 

 

Quarter Ended
June 30,

 

 

 

2012

 

2011

 

Passenger ticket revenues

 

  $

1,332,207

 

  $

1,296,789

 

Onboard and other revenues

 

488,797

 

471,084

 

Total revenues

 

1,821,004

 

1,767,873

 

 

 

 

 

 

 

Cruise operating expenses:

 

 

 

 

 

Commissions, transportation and other

 

307,697

 

299,174

 

Onboard and other

 

130,981

 

134,938

 

Payroll and related

 

206,519

 

198,794

 

Food

 

109,300

 

99,149

 

Fuel

 

237,961

 

188,128

 

Other operating

 

303,556

 

265,192

 

Total cruise operating expenses

 

1,296,014

 

1,185,375

 

Marketing, selling and administrative expenses

 

247,571

 

242,258

 

Depreciation and amortization expenses

 

180,514

 

172,050

 

Operating Income

 

96,905

 

168,190

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

Interest income

 

4,972

 

6,478

 

Interest expense, net of interest capitalized

 

(89,106)

 

(92,968)

 

Other (expense) income

 

(16,424)

 

11,791

 

 

 

(100,558)

 

(74,699)

 

Net (Loss) Income

 

  $

(3,653)

 

  $

93,491

 

 

 

 

 

 

 

(Loss) Earnings per Share:

 

 

 

 

 

Basic

 

  $

(0.02)

 

  $

0.43

 

Diluted

 

  $

(0.02)

 

  $

0.43

 

 

 

 

 

 

 

Weighted-Average Shares Outstanding:

 

 

 

 

 

Basic

 

217,866

 

217,028

 

Diluted

 

217,866

 

219,370

 

 

 

 

 

 

 

Comprehensive Income (Loss)

 

 

 

 

 

Net (Loss) Income

 

  $

(3,653)

 

  $

93,491

 

Other comprehensive income (loss):

 

 

 

 

 

Foreign currency translation adjustments

 

(12,361)

 

16,521

 

Change in defined benefit plans

 

-

 

(216)

 

(Loss) Gain on cash flow derivative hedges

 

(288,252)

 

9,488

 

Total other comprehensive (loss) income

 

(300,613)

 

25,793

 

 

 

 

 

 

 

Comprehensive (Loss) Income

 

  $

(304,266)

 

  $

119,284

 

 

 

 

 

 

 

 

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

 

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Table of Contents

 

ROYAL CARIBBEAN CRUISES LTD.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(unaudited; in thousands, except per share data)

 

 

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

  Passenger ticket revenues

 

  $

2,684,445

 

  $

2,523,306

 

  Onboard and other revenues

 

971,039

 

916,562

 

  Total revenues

 

3,655,484

 

3,439,868

 

 

 

 

 

 

 

  Cruise operating expenses:

 

 

 

 

 

  Commissions, transportation and other

 

628,435

 

578,723

 

  Onboard and other

 

238,576

 

237,428

 

  Payroll and related

 

416,633

 

403,281

 

  Food

 

222,925

 

199,231

 

  Fuel

 

466,955

 

354,189

 

  Other operating

 

577,602

 

513,594

 

  Total cruise operating expenses

 

2,551,126

 

2,286,446

 

  Marketing, selling and administrative expenses

 

512,172

 

490,396

 

  Depreciation and amortization expenses

 

359,906

 

345,302

 

  Operating Income

 

232,280

 

317,724

 

 

 

 

 

 

 

  Other income (expense):

 

 

 

 

 

  Interest income

 

11,318

 

10,259

 

  Interest expense, net of interest capitalized

 

(181,772)

 

(193,593)

 

  Other (expense) income

 

(18,515)

 

37,511

 

 

 

(188,969)

 

(145,823)

 

  Net Income

 

  $

43,311

 

  $

171,901

 

 

 

 

 

 

 

  Earnings per Share:

 

 

 

 

 

  Basic

 

  $

0.20

 

  $

0.79

 

  Diluted

 

  $

0.20

 

  $

0.78

 

 

 

 

 

 

 

  Weighted-Average Shares Outstanding:

 

 

 

 

 

  Basic

 

217,725

 

216,771

 

  Diluted

 

219,217

 

219,516

 

 

 

 

 

 

 

  Comprehensive Income (Loss)

 

 

 

 

 

  Net Income

 

  $

43,311

 

  $

171,901

 

  Other comprehensive income (loss):

 

 

 

 

 

  Foreign currency translation adjustments

 

(9,021)

 

208,775

 

  Change in defined benefit plans

 

-

 

(216)

 

  (Loss) Gain on cash flow derivative hedges

 

(140,782)

 

39,389

 

  Total other comprehensive (loss) income

 

(149,803)

 

247,948

 

 

 

 

 

 

 

  Comprehensive (Loss) Income

 

  $

(106,492)

 

  $

419,849

 

 

 

 

 

 

 

 

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

 

2



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ROYAL CARIBBEAN CRUISES LTD.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

 

 

As of

 

 

 

June 30,

 

December 31,

 

 

 

2012

 

2011

 

 

 

(unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

  $

212,209

 

  $

262,186

 

Trade and other receivables, net

 

284,658

 

292,447

 

Inventories

 

146,711

 

144,553

 

Prepaid expenses and other assets

 

255,274

 

185,460

 

Derivative financial instruments

 

55,296

 

84,642

 

Total current assets

 

954,148

 

969,288

 

Property and equipment, net

 

16,887,693

 

16,934,817

 

Goodwill

 

736,280

 

746,537

 

Other assets

 

1,117,983

 

1,153,763

 

 

 

  $

19,696,104

 

  $

19,804,405

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities

 

 

 

 

 

Current portion of long-term debt

 

  $

1,156,549

 

  $

638,891

 

Accounts payable

 

316,409

 

304,623

 

Accrued interest

 

86,477

 

123,853

 

Accrued expenses and other liabilities

 

544,549

 

564,272

 

Customer deposits

 

1,705,128

 

1,436,003

 

Total current liabilities

 

3,809,112

 

3,067,642

 

Long-term debt

 

7,068,902

 

7,856,962

 

Other long-term liabilities

 

546,416

 

471,978

 

 

 

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies (Note 7)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

Preferred stock ($0.01 par value; 20,000,000 shares authorized; none outstanding)

 

-

 

-

 

Common stock ($0.01 par value; 500,000,000 shares authorized; 228,206,710 and 227,366,165 shares issued, June 30, 2012 and December 31, 2011, respectively)

 

2,282

 

2,276

 

Paid-in capital

 

3,085,662

 

3,071,759

 

Retained earnings

 

5,823,175

 

5,823,430

 

Accumulated other comprehensive loss

 

(225,741)

 

(75,938)

 

Treasury stock (10,308,683 common shares at cost, June 30, 2012 and December 31, 2011)

 

(413,704)

 

(413,704)

 

Total shareholders’ equity

 

8,271,674

 

8,407,823

 

 

 

  $

19,696,104

 

  $

19,804,405

 

 

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

 

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ROYAL CARIBBEAN CRUISES LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2012

 

2011

 

Operating Activities

 

 

 

 

 

 

 

Net income

 

  $

43,311

 

  $

171,901

 

Adjustments:

 

 

 

 

 

Depreciation and amortization

 

359,906

 

345,302

 

Loss (gain) on fuel call options

 

7,470

 

(24,803)

 

Changes in operating assets and liabilities:

 

 

 

 

 

Decrease in trade and other receivables, net

 

56,651

 

63,803

 

Increase in inventories

 

(2,451)

 

(17,316)

 

Increase in prepaid expenses and other assets

 

(58,495)

 

(83,740)

 

Increase in accounts payable

 

12,348

 

92,619

 

Decrease in accrued interest

 

(37,377)

 

(60,653)

 

Decrease in accrued expenses and other liabilities

 

(28,505)

 

(21,931)

 

Increase in customer deposits

 

224,873

 

306,070

 

Other, net

 

5,788

 

(4,510)

 

Net cash provided by operating activities

 

583,519

 

766,742

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

Purchases of property and equipment

 

(322,751)

 

(251,565)

 

Cash received on settlement of derivative financial instruments

 

4,646

 

25,250

 

Loan to unconsolidated affiliate

 

-

 

(69,682)

 

Proceeds from the sale of ships

 

-

 

345,000

 

Other, net

 

4,936

 

(3,044)

 

Net cash (used in) provided by investing activities

 

(313,169)

 

45,959

 

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

Debt proceeds

 

345,000

 

702,442

 

Debt issuance costs

 

(21,730)

 

(28,593)

 

Repayments of debt

 

(575,585)

 

(1,376,801)

 

Dividends paid

 

(65,293)

 

-

 

Proceeds from exercise of common stock options

 

1,768

 

17,923

 

Other, net

 

774

 

705

 

Net cash used in financing activities

 

(315,066)

 

(684,324)

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

(5,261)

 

3,154

 

 

 

 

 

 

 

Net (decrease) increase in cash and cash equivalents

 

(49,977)

 

131,531

 

Cash and cash equivalents at beginning of period

 

262,186

 

419,929

 

Cash and cash equivalents at end of period

 

  $

212,209

 

  $

551,460

 

 

 

 

 

 

 

Supplemental Disclosure

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest, net of amount capitalized

 

  $

194,341

 

  $

223,438

 

 

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ROYAL CARIBBEAN CRUISES LTD.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

As used in this quarterly report on Form 10-Q, the terms “Royal Caribbean,” the “Company,” “we,” “our” and “us” refer to Royal Caribbean Cruises Ltd. and, depending on the context, Royal Caribbean Cruises Ltd.’s consolidated subsidiaries and/or affiliates. The terms “Royal Caribbean International,” “Celebrity Cruises,” “Pullmantur,” “Azamara Club Cruises” and “CDF Croisières de France” refer to our cruise brands. In accordance with cruise vacation industry practice, the term “berths” is determined based on double occupancy per cabin even though many cabins can accommodate three or more passengers. This report should be read in conjunction with our annual report on Form 10-K for the year ended December 31, 2011, including the audited consolidated financial statements and related notes included therein.

 

Note 1. General

 

Description of Business

 

We are a global cruise company.  We own the Royal Caribbean International, Celebrity Cruises, Pullmantur, Azamara Club Cruises, and CDF Croisières de France cruise brands as well as the cruise brand TUI Cruises through a 50% joint venture.

 

Basis for Preparation of Consolidated Financial Statements

 

The unaudited consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  Estimates are required for the preparation of financial statements in accordance with these principles.  Actual results could differ from these estimates.  See Note 2. Summary of Significant Accounting Policies in this quarterly report on Form 10-Q and in our annual report on Form 10-K for the year ended December 31, 2011 for a discussion of our significant accounting policies.

 

All significant intercompany accounts and transactions are eliminated in consolidation. We consolidate entities over which we have control, usually evidenced by a direct ownership interest of greater than 50% and variable interest entities where we are determined to be the primary beneficiary. See Note 6. Goodwill and Other Assets for further information regarding our variable interest entities. For affiliates we do not control but over which we have significant influence on financial and operating policies, usually evidenced by a direct ownership interest from 20% to 50%, the investment is accounted for using the equity method.  We consolidate the operating results of Pullmantur and its wholly-owned brand, CDF Croisières de France, on a two-month lag to allow for more timely preparation of our consolidated financial statements.  No material events or transactions affecting Pullmantur or CDF Croisières de France, have occurred during the two-month lag period of May 2012 and June 2012 that would require disclosure or adjustment to our consolidated financial statements as of June 30, 2012.

 

We believe the accompanying unaudited consolidated financial statements contain all normal recurring accruals necessary for a fair statement.  Our revenues are seasonal and results for interim periods are not necessarily indicative of results for the entire year.

 

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Note 2. Summary of Significant Accounting Policies

 

Stock-Based Employee Compensation

 

In February 2012, we redesigned our long-term incentive award program and began to grant performance shares to our officers in lieu of stock options.  Under our prior program, our officers received a combination of stock options and restricted stock units.  Beginning in February 2012, our officers instead receive their long-term incentive awards through a combination of performance shares and restricted stock units. Each performance share award is expressed as a target number of performance shares based upon the fair market value of our common stock on the date the award is issued.  The actual number of shares underlying each award (not to exceed 200% of the target number of performance shares) will be determined based upon the Company’s achievement of a specified performance target range. For the grants made in February 2012, the performance target is diluted earnings per share (“EPS”) for the year ended December 31, 2012, as adjusted by the Compensation Committee of our Board of Directors for events that are outside of management’s control. In February 2012, we issued a target number of 327,240 performance shares which will vest on the third anniversary of the award issue date.

 

We estimate the fair value of each performance share when the grant is authorized and the related service period has commenced.  We remeasure the fair value of each of our performance shares in each subsequent reporting period until the grant date has occurred, which represents the date when the performance conditions are satisfied.  We recognize compensation cost over the vesting period based on the probability of the service and performance requirements being achieved over the vesting period adjusted for each subsequent fair value measurement. If the specified service and performance requirements are not met, compensation expense will not be recognized and any previously recognized compensation expense will be reversed.

 

For further information on our significant accounting policies, refer to our annual report on Form 10-K for the year ended December 31, 2011.

 

Recently Adopted Accounting Standards

 

In January 2012, we adopted authoritative guidance issued in 2011, the purpose of which was to achieve consistent fair value measurements and to clarify certain disclosure requirements for fair value measurements. The guidance includes clarification about when the concept of highest and best use is applicable to fair value measurements, requires quantitative disclosures about inputs used and qualitative disclosures about the sensitivity of recurring Level 3 measurements, and requires the classification of all assets and liabilities measured at fair value in the fair value hierarchy, including those assets and liabilities which are not recorded at fair value but for which fair value is disclosed.  The adoption of this guidance did not have a material impact on our consolidated financial statements.  See Note 9. Fair Value Measurements and Derivative Instruments for our disclosures required under this guidance.

 

In January 2012, we adopted authoritative guidance issued in 2011 on the presentation of comprehensive income which requires an entity to present components of net income and other comprehensive income in one continuous statement, referred to as the statement of comprehensive income, or in two separate but consecutive statements.  The new guidance eliminates the option to report other comprehensive income and its components in the statement of changes in equity.  We elected to present this information using one continuous statement.  See our consolidated statements of comprehensive income (loss) above.

 

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Other

 

Revenues and expenses include port costs that vary with guest head counts.  The amounts included in passenger ticket revenues on a gross basis were $103.8 million and $103.2 million for the second quarters of 2012 and 2011, respectively, and $216.9 million and $198.9 million for the six months ended June 30, 2012 and 2011, respectively.

 

Note 3. Earnings Per Share

 

A reconciliation between basic and diluted earnings per share is as follows (in thousands, except per share data):

 

 

 

Quarter Ended

 

 Six Months Ended

 

 

 

June 30,

 

 

 

 June 30,

 

 

 

2012

 

2011

 

2012

 

2011

Net (loss) income for basic and diluted earnings per share

 

$ (3,653)

 

 

$ 93,491

 

$ 43,311

 

$

171,901

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

217,866

 

 

217,028

 

217,725

 

216,771

Dilutive effect of stock options and restricted stock awards

 

 

-

 

 

2,342

 

1,492

 

2,745

Diluted weighted-average shares outstanding

 

 

217,866

 

 

 

219,370

 

 

219,217

 

 

219,516

 

 

 

 

 

 

 

 

 

 

Basic (loss) earnings per share

 

$

(0.02)

 

 

$

0.43

 

$

0.20

 

$

0.79

Diluted (loss) earnings per share

 

$

(0.02)

 

 

$

0.43

 

$

0.20

 

$

0.78

 

Diluted earnings per share for the quarter and six months ended June 30, 2012 did not reflect options to purchase common stock and performance shares of an aggregate of 5.1 million and 3.1 million, respectively, because the effect of including them would have been antidilutive.  Diluted earnings per share for the quarter and six months ended June 30, 2011 did not reflect options to purchase common stock of 2.8 million and 1.8 million, respectively, because the effect of including them would have been antidilutive.

 

Note 4. Long-Term Debt

 

During the first quarter of 2012, we exercised our option under the agreement with Meyer Werft to construct the second ship of a new generation of Royal Caribbean International cruise ships, known as “Project Sunshine”.  The second ship is scheduled for delivery in the second quarter of 2015.  During 2011, we entered into credit agreements to finance the construction of the first and second Project Sunshine ships. Each facility makes available to us an unsecured term loan in an amount up to the United States dollar equivalent corresponding to approximately €595.0 million, with funding of approximately 5% remaining subject to syndication for the first ship and 50% remaining subject to syndication for the second ship prior to delivery of the applicable ship. Euler Hermes Kreditversicherungs AG (“Hermes”), the official export credit agency of Germany, has agreed to guarantee to the lender payment of 95% of the financing.  The loans will amortize semi-annually and will mature 12 years following delivery of the applicable ship.  Pursuant to the credit agreements, interest on the loans will accrue at our election (to be made prior to funding) at either a fixed rate (including applicable margin) of 4.76% or a floating rate of LIBOR plus a margin of 1.30%.  Separately, we have entered into forward-starting interest rate swap agreements which effectively convert the floating rate available to us per the credit agreements to a fixed rate (including applicable margin) of 3.74% and 3.86% for the first and second Project Sunshine ships, respectively.  See Note 9. Fair Value

 

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Measurements and Derivative Instruments for further information regarding these agreements.

 

Under the terms of our revolving credit facility due July 2016, we have the ability to increase the available capacity under the facility by $300.0 million subject to the receipt of additional or increased lender commitments.  During the first six months of 2012, we increased the capacity of this facility by $213.0 million bringing our total capacity, including our revolving credit facility due November 2014, to $1.6 billion as of June 30, 2012. In July 2012, we increased our capacity by an additional $20.0 million.

 

We have a credit agreement in place providing financing for Celebrity Reflection which is scheduled for delivery in the fourth quarter of 2012.  The credit agreement provides for an unsecured term loan for up to 80% of the purchase price of the vessel which will be 95% guaranteed by Hermes and will be funded at delivery.  The loan will have a 12-year life with semi-annual amortization, and pursuant to the credit agreement, will bear interest at our election (to be made prior to funding) of either a fixed rate of 4.13% (inclusive of the applicable margin) or a floating rate at LIBOR plus a margin of 0.40%.  Separately, we have entered into forward-starting interest rate swap agreements which effectively convert the floating rate available to us per the credit agreement to a fixed rate (including applicable margin) of 2.85%.  See Note 9. Fair Value Measurements and Derivative Instruments for further information regarding these agreements.

 

Certain of our unsecured ship financing term loans are guaranteed by the export credit agency in the respective country in which the ship is constructed.  In consideration for these guarantees, depending on the financing arrangement, we pay to the applicable export credit agency fees that range from either (1) 0.88% to 1.48% per annum based on the outstanding loan balance semi-annually over the term of the loan (subject to adjustment in certain of our facilities based upon our credit ratings) or (2) an upfront fee of approximately 2.3% to 2.37% of the maximum loan amount. We amortize the fees that are paid upfront over the life of the loan and those that are paid semi-annually over each respective payment period.  We classify these fees within Debt issuance costs in our consolidated statement of cash flows.

 

Under certain of our agreements, the contractual interest rate, facility fee and/or export credit agency fee vary with our debt rating.

 

Note 5.  Property and Equipment

 

During the second quarter of 2012, Pullmantur delivered Ocean Dream to an unrelated third party as part of a six year bareboat charter agreement.  The charter agreement provides a renewal option exercisable by the unrelated third party for an additional four years.  The charter agreement constitutes an operating lease and charter revenue is being recognized on a straight-line basis over the six year charter term.  The charter revenue recognized during the second quarter of 2012 was not material to our results of operations.

 

Note 6. Goodwill and Other Assets

 

During the fourth quarter of 2011, we performed our annual analysis to determine if the goodwill for the Pullmantur reporting unit was impaired. We estimated the fair value of the Pullmantur reporting unit using a probability-weighted discounted cash flow model. The principal assumptions used in the discounted cash flow model are projected operating results, weighted-average cost of capital, and terminal value.   Significantly impacting these assumptions are the anticipated future transfer of vessels from our other cruise brands to Pullmantur.  For example, during the first quarter of 2012, we announced the redeployment of Monarch of the Seas from Royal Caribbean International to Pullmantur. The

 

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redeployment is expected to occur in April 2013. The discounted cash flow model used our 2012 projected operating results as a base.  To that base we added future years’ cash flows assuming multiple revenue and expense scenarios that reflect the impact on Pullmantur’s reporting unit of different global economic environments beyond 2012. We assigned a probability to each revenue and expense scenario. On December 31, 2011, the estimated fair value of the Pullmantur reporting unit exceeded its carrying value.

 

We also performed the annual impairment review of our trademarks and trade names during the fourth quarter of 2011 using a discounted cash flow model and the relief-from-royalty method.  The royalty rate used is based on comparable royalty agreements in the tourism and hospitality industry.  These trademarks and trade names relate to Pullmantur and we have used the same discount rate used in valuing the Pullmantur reporting unit in our goodwill impairment test.  Based on the discounted cash flow model as of December 31, 2011, we determined the fair value of our trademarks and trade names exceeded their carrying value.

 

We are monitoring economic events in Spain for their potential impact on Pullmantur’s business and valuation.  These events continue to reinforce the uncertainty and fragility of the Spanish economy.  However, based on our current projections we do not believe an interim impairment evaluation of Pullmantur’s goodwill or trademarks and trade names is warranted as of June 30, 2012. We will evaluate these intangible assets for potential impairment ahead of our scheduled fourth quarter 2012 annual impairment test if and when future events or other information gleaned while preparing Pullmantur’s 2013 operating plan indicate deterioration in Pullmantur’s business.

 

The estimation of fair value utilizing discounted expected future cash flows includes numerous uncertainties which require our significant judgment when making assumptions of expected revenues, operating costs, marketing, selling and administrative expenses, interest rates, ship additions and retirements as well as assumptions regarding the cruise vacation industry’s competitive environment and general economic and business conditions, among other factors. Pullmantur is a brand targeted primarily at the Spanish, Portuguese and Latin American markets.  European economies continue to demonstrate instability in light of heightened concerns over sovereign debt issues as well as the impact that proposed austerity measures will have on certain markets.  The Spanish economy has been more severely impacted than many other economies around the world where we operate and there is significant uncertainty as to whether or when it will recover.  In addition, the Costa Concordia incident has had a negative impact on our earnings to date in 2012 while the impact in future years is uncertain.  If the Spanish economy weakens further or recovers more slowly than contemplated in our discounted cash flow model, if there are relatively modest changes to our projected future cash flows used in the impairment analyses, especially in Net Yields, or if certain transfers of vessels from our other cruise brands to the Pullmantur fleet do not take place, it is reasonably possible that an impairment charge of Pullmantur’s reporting unit’s goodwill, trademarks and trade name may be required.

 

The factors influencing the Spanish economy and Pullmantur’s operating cash flows discussed above could also affect the recoverability of Pullmantur’s deferred tax assets. As of June 30, 2012, Pullmantur had deferred tax assets of €25.4 million, or $32.3 million based on the exchange rate at June 30, 2012, resulting from net operating losses. We regularly review deferred tax assets for recoverability based on our history of earnings, expectations for future earnings, and tax planning strategies.  We believe it is more-likely-than-not that we will recover the deferred tax assets based on our expectation of future earnings and implementation of tax planning strategies.  Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income to support the amount of deferred tax assets.  It is possible we may need to establish a valuation allowance for a portion or all of the deferred tax asset

 

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balance if future earnings do not meet expectations or we are unable to successfully implement our tax planning strategies.

 

Variable Interest Entities

 

A Variable Interest Entity (“VIE”), is an entity in which the equity investors have not provided enough equity to finance the entity’s activities or the equity investors (1) cannot directly or indirectly make decisions about the entity’s activities through their voting rights or similar rights; (2) do not have the obligation to absorb the expected losses of the entity; (3) do not have the right to receive the expected residual returns of the entity; or (4) have voting rights that are not proportionate to their economic interests and the entity’s activities involve or are conducted on behalf of an investor with a disproportionately small voting interest.

 

We have determined that our 40% noncontrolling interest in Grand Bahama Shipyard Ltd. (“Grand Bahama”), a ship repair and maintenance facility in which we initially invested in 2001, is a VIE. The facility serves cruise and cargo ships, oil and gas tankers, and offshore units.  We utilize this facility, among other ship repair facilities, for our regularly scheduled drydocks and certain emergency repairs as may be required.  We have determined we are not the primary beneficiary of this facility, as we do not have the power to direct the activities that most significantly impact the facility’s economic performance. Accordingly, we do not consolidate this entity and we account for this investment under the equity method of accounting. As of June 30, 2012 and December 31, 2011, the net book value of our investment in Grand Bahama, including equity and loans, was approximately $60.8 million and $61.4 million, respectively, which is also our maximum exposure to loss as we are not contractually required to provide any financial or other support to the facility.  The majority of our loans to Grand Bahama are in non-accrual status.  During the first six months of 2012, we received approximately $4.6 million in principal and interest payments from Grand Bahama and recorded income associated with our investment in Grand Bahama.  We monitor credit risk associated with these loans through our participation on Grand Bahama’s board of directors along with our review of Grand Bahama’s financial statements and projected cash flows.  Based on this review, we believe the risk of loss associated with these loans was remote as of June 30, 2012.

 

In conjunction with our acquisition of Pullmantur in 2006, we obtained a 49% noncontrolling interest in Pullmantur Air, S.A. (“Pullmantur Air”), a small air business that operates four aircrafts in support of Pullmantur’s operations. We have determined Pullmantur Air is a VIE for which we are the primary beneficiary as we have the power to direct the activities that most significantly impact its economic performance and we are obligated to absorb its losses. In accordance with authoritative guidance, we have consolidated the assets and liabilities of Pullmantur Air.  We do not separately disclose the assets and liabilities of Pullmantur Air as they are immaterial to our June 30, 2012 and December 31, 2011 consolidated financial statements.

 

We have determined that our 50% interest in the TUI Cruises GmbH joint venture which operates the brand TUI Cruises, is a VIE. As of June 30, 2012 and December 31, 2011, our investment in TUI Cruises, including equity and loans, is substantially our maximum exposure to loss, which was approximately $269.6 million and $282.0 million, respectively, and the majority of this amount was included within other assets in our consolidated balance sheets.  We have determined that we are not the primary beneficiary of TUI Cruises.  We believe that the power to direct the activities that most significantly impact TUI Cruises’ economic performance are shared between ourselves and TUI AG.  All the significant operating and financial decisions of TUI Cruises require the consent of both parties which we believe creates shared power over TUI Cruises.  Accordingly, we do not consolidate this entity

 

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and account for this investment under the equity method of accounting.

 

In connection with our sale of Celebrity Mercury to TUI Cruises in 2011, we provided a debt facility to TUI Cruises in the amount of up to €90.0 million. The outstanding principal amount of the facility as of June 30, 2012 was €74.3 million, or approximately $94.3 million based on the exchange rate at June 30, 2012. The loan bears interest at the rate of 9.54% per annum, is payable over seven years, is 50% guaranteed by TUI AG (our joint venture partner) and is secured by second mortgages on both Mein Schiff 1 and Mein Schiff 2. In addition, we and TUI AG each guaranteed the repayment of 50% of an €180.0 million 5-year bank loan provided to TUI Cruises, of which €162.0 million remains outstanding as of June 30, 2012, in connection with the sale of the ship.  The bank loan amortizes quarterly and is secured by first mortgages on both Mein Schiff 1 and Mein Schiff 2.  Based on current facts and circumstances, we do not believe potential obligations under this guarantee are probable.

 

During 2011, TUI Cruises entered into a construction agreement with STX Finland to build its first newbuild ship, scheduled for delivery in the second quarter of 2014.  TUI Cruises has entered into a credit agreement for financing of up to 80% of the contract price of the ship. The remaining portion of the contract price of the ship will be funded through either TUI Cruises’ cash flows from operations or loans and/or equity contributions from us and TUI AG.  The construction agreement includes certain restrictions on each of our and TUI AG’s ability to reduce our current ownership interest in TUI Cruises below 37.5% through the construction period.  In addition, the credit agreement extends this restriction through 2019. TUI Cruises has an option to construct a second ship of the same class which will expire on October 31, 2012.

 

Note 7. Commitments and Contingencies

 

Capital Expenditures

 

During the first quarter of 2012, we exercised our option under the agreement with Meyer Werft to construct a second Project Sunshine ship with approximately 4,100 berths which is expected to enter service in the second quarter of 2015.

 

As of June 30, 2012, the aggregate cost of our ships on order was approximately $3.0 billion, of which we had deposited $227.9 million as of such date. Approximately 15.6% of the aggregate cost was exposed to fluctuations in the euro exchange rate at June 30, 2012.  These amounts do not include any costs associated with the construction agreement entered into by TUI Cruises to build their first newbuild ship.

 

As of June 30, 2012, the expected dates our ships on order will enter service and their approximate berths are as follows:

 

 

 

Expected to

 

Approximate

 

Ship

 

 

 

Enter Service

 

 

 

Berths

 

 

Celebrity Cruises – Solstice-class:

 

 

 

 

 

Celebrity Reflection

 

4th Quarter 2012

 

3,000

 

Royal Caribbean International – Project Sunshine:

 

 

 

 

 

Unnamed

 

4th Quarter 2014

 

4,100

 

Unnamed

 

2nd Quarter 2015

 

4,100

 

 

 

Total Berths

 

11,200

 

 

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We have committed bank financing arrangements for Celebrity Reflection and our two Project Sunshine ships, each of which include sovereign financing guarantees.  See Note 4. Long-Term Debt.

 

Litigation

 

Between August 1, 2011 and September 8, 2011, three similar purported class action lawsuits were filed against us and certain of our officers in the U.S. District Court of the Southern District of Florida.  The cases have since been consolidated and a consolidated amended complaint was filed on February 17, 2012.  The consolidated amended complaint was filed on behalf of a purported class of purchasers of our common stock during the period from October 26, 2010 through July 27, 2011 and names the Company, our Chairman and CEO, our CFO and the Presidents and CEOs of our Royal Caribbean International and Celebrity Cruises brands as defendants.  The consolidated amended complaint alleges violations of Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 as well as, in the case of the individual defendants, the control person provisions of the Securities Exchange Act.  The complaint principally alleges that the defendants knowingly made incorrect statements concerning the Company’s outlook for 2011 by not taking into proper account lagging European and Mediterranean bookings. The consolidated amended complaint seeks unspecified damages, interest, and attorneys’ fees. We filed a motion to dismiss the complaint on April 9, 2012. We believe the claims made against us are without merit and we intend to vigorously defend ourselves against them.

 

A class action complaint was filed in June 2011 against Royal Caribbean Cruises Ltd. in the United States District Court for the Southern District of Florida on behalf of a purported class of stateroom attendants employed onboard Royal Caribbean International cruise vessels alleging that they were required to pay other crew members to help with their duties in violation of the U.S. Seaman’s Wage Act. The lawsuit also alleges that certain stateroom attendants were required to work back of house assignments without the ability to earn gratuities in violation of the U.S. Seaman’s Wage Act. Plaintiffs seek judgment for damages, wage penalties and interest in an indeterminate amount. In May 2012, the Court granted our motion to dismiss the complaint on the basis that the applicable collective bargaining agreement requires any such claims to be arbitrated. Plaintiff has appealed this decision to the United States Court of Appeals, 11th Circuit. We believe the claims made against us are without merit and we intend to vigorously defend ourselves against them.

 

We commenced an action in June 2010 in the United States District Court for Puerto Rico seeking a declaratory judgment that Puerto Rico’s distributorship laws do not apply to our relationship with an international representative located in Puerto Rico.  In September 2010, that international representative filed a number of counterclaims against Royal Caribbean Cruises Ltd. and Celebrity Cruises Inc. alleging violations of Puerto Rico’s distributorship laws, bad faith breach of contract, tortious interference with contract, violations of various federal and state antitrust and unfair competition laws. The international representative is seeking in excess of $40.0 million on each of these counterclaims together with treble damages in the amount of $120.0 million on several of the counterclaims as well as injunctive relief and declaratory judgment. We believe that the claims made against us are without merit and we intend to vigorously defend ourselves against them.

 

Because of the inherent uncertainty as to the outcome of the proceedings described above, we are unable at this time to estimate the possible impact of these matters on us.

 

We are routinely involved in other claims typical within the cruise vacation industry. The majority of these claims are covered by insurance. We believe the outcome of such claims, net of expected insurance recoveries, will not have a material adverse impact on our financial condition or results of operations and

 

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cash flows.

 

Other

 

In July 2002, we entered into an operating lease denominated in British pound sterling for the Brilliance of the Seas.  The lease payments vary based on sterling LIBOR.  The lease has a contractual life of 25 years; however, both the lessor and we have certain rights to cancel the lease at year 18 (i.e. 2020) upon advance notice given approximately one year prior to cancellation.  In the event of early termination at year 18, we have the option to cause the sale of the vessel at its fair value and to use the proceeds towards the applicable termination payment.  Alternatively, we could opt at such time to make a termination payment of approximately ₤66.8 million, or approximately $104.8 million based on the exchange rate at June 30, 2012, and relinquish our right to cause the sale of the vessel.  Under current circumstances we do not believe early termination of this lease is probable.

 

Under the Brilliance of the Seas operating lease, we have agreed to indemnify the lessor to the extent its after-tax return is negatively impacted by unfavorable changes in corporate tax rates, capital allowance deductions and certain unfavorable determinations which may be made by United Kingdom tax authorities. These indemnifications could result in an increase in our lease payments.  We are unable to estimate the maximum potential increase in our lease payments due to the various circumstances, timing or a combination of events that could trigger such indemnifications. We have been advised by the lessor that the United Kingdom tax authorities are disputing the lessor’s accounting treatment of the lease and that the lessor and tax authorities are in discussions on the matter.  If the characterization of the lease is ultimately determined to be incorrect, we could be required to indemnify the lessor under certain circumstances.  The lessor has advised us that they believe their characterization of the lease is correct. Based on the foregoing and our review of available information, we do not believe an indemnification payment is probable.  However, if the lessor loses its dispute and we are required to indemnify the lessor, we cannot at this time predict the impact that such an occurrence would have on our financial condition and results of operations.

 

Some of the contracts that we enter into include indemnification provisions that obligate us to make payments to the counterparty if certain events occur.  These contingencies generally relate to changes in taxes, increased lender capital costs and other similar costs.  The indemnification clauses are often standard contractual terms and are entered into in the normal course of business.  There are no stated or notional amounts included in the indemnification clauses and we are not able to estimate the maximum potential amount of future payments, if any, under these indemnification clauses.  We have not been required to make any payments under such indemnification clauses in the past and, under current circumstances, we do not believe an indemnification in any material amount is probable.

 

If (i) any person other than A. Wilhelmsen AS. and Cruise Associates and their respective affiliates (the “Applicable Group”) acquires ownership of more than 30% of our common stock and the Applicable Group owns less of our common stock than such person, or (ii) subject to certain exceptions, during any 24-month period, a majority of the Board is no longer comprised of individuals who were members of the Board on the first day of such period, we may be obligated to prepay indebtedness outstanding under the majority of our credit facilities, which we may be unable to replace on similar terms.  Certain of our outstanding debt securities also contain change of control provisions that would be triggered by the acquisition of greater than 50% of our common stock by a person other than a member of the Applicable Group coupled with a ratings downgrade. If this were to occur, it would have an adverse impact on our liquidity and operations.

 

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Note 8. Shareholders’ Equity

 

During the first and second quarters of 2012, we declared and paid a cash dividend on our common stock of $0.10 per share. During the first quarter of 2012, we also paid a cash dividend on our common stock of $0.10 per share which was declared during the fourth quarter of 2011.

 

Note 9. Fair Value Measurements and Derivative Instruments

 

Fair Value Measurements

 

The estimated fair value of our financial instruments that are not measured at fair value on a recurring basis, categorized based upon the fair value hierarchy, are as follows (in thousands):

 

 

 

Fair Value Measurements
At June 30, 2012 Using

 

 

 

Fair Value Measurements
at December 31, 2011 Using

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Description

 

Total

 

Level 11

 

Level 22

 

Level 33

 

 

 

Total

 

Level 11

 

Level 22

 

Level 33

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents4

 

$

212,209

 

212,209

 

 

 

 

 

$

262,186

 

262,186

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets

 

$

212,209

 

$

212,209

 

$

 

$

 

 

 

$

262,186

 

$

262,186

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-term debt (including current portion of long-term debt)5

 

 

 

3,458,805

 

4,886,692

 

 

 

 

$

8,557,095

 

3,424,722

 

5,132,373

 

 

$

8,345,497

Total Liabilities

 

$

8,345,497

 

$

3,458,805

 

$

4,886,692

 

$

 

 

 

$

8,557,095

 

$

3,424,722

 

$

5,132,373

 

$

 

 

1.

 

Inputs based on quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access. Valuation of these items does not entail a significant amount of judgment.

2.

 

Inputs other than quoted prices included within Level 1 that are observable for the liability, either directly or indirectly. For unsecured revolving credit facilities and unsecured term loans, fair value is determined utilizing the income valuation approach. This valuation model takes into account the contract terms of our debt such as the debt maturity and the interest rate on the debt. The valuation model also takes into account our creditworthiness based on publicly available credit default swap rates.

3.

 

Inputs that are unobservable. The Company did not use any Level 3 inputs as of June 30, 2012 and December 31, 2011.

4.

 

Consists of cash and marketable securities with original maturities of less than 90 days.

5.

 

Consists of unsecured revolving credit facilities, unsecured senior notes, senior debentures and unsecured term loans. Does not include our capital lease obligations.

 

Other Financial Instruments

 

The carrying amounts of accounts receivable, accounts payable, accrued interest and accrued expenses approximate fair value at June 30, 2012 and December 31, 2011.

 

Assets and liabilities that are recorded at fair value have been categorized based upon the fair value hierarchy.  The following table presents information about the Company’s financial instruments recorded at fair value on a recurring basis (in thousands):

 

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Fair Value Measurements
at June 30, 2012 Using

 

 

 

Fair Value Measurements
at December 31, 2011 Using

 

 

 

 

 

 

 

 

 

Description

 

Total

 

Level 11

 

Level 22

 

Level 33

 

 

 

Total

 

Level 11

 

Level 22

 

Level 33

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative financial instruments4

 

$

156,105

 

 

156,105

 

 

 

 

$

201,130

 

 

201,130

 

 

Investments5

 

$

6,975

 

6,975

 

 

 

 

 

$

6,941

 

6,941

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets

 

$

163,080

 

$

6,975

 

$

156,105

 

$

 

 

 

$

208,071

 

$

6,941

 

$

201,130

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative financial instruments6

 

$

195,593

 

 

195,593

 

 

 

 

$

84,344

 

 

84,344

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Liabilities

 

$

195,593

 

$

 

$

195,593

 

$

 

 

 

$

84,344

 

$

 

$

84,344

 

$

 

 

1.

 

Inputs based on quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access. Valuation of these items does not entail a significant amount of judgment.

2.

 

Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. For foreign currency forward contracts, interest rate, cross currency and fuel swaps, fair value is derived using valuation models that utilize the income valuation approach. These valuation models take into account the contract terms, such as maturity as well as other inputs, such as foreign exchange rates and curves, fuel types, fuel curves and interest rate yield curves. For fuel call options, fair value is determined by using the prevailing market price for the instruments consisting of published price quotes for similar assets based on recent transactions in an active market. Fair value for foreign currency collar options is determined by using standard option pricing models with inputs based on the options’ contract terms, such as exercise price and maturity, and readily available public market data, such as foreign exchange curves, foreign exchange volatility levels and discount rates. All derivative instrument fair values take into account the creditworthiness of the counterparty and the Company.

3.

 

Inputs that are unobservable. The Company did not use any Level 3 inputs as of June 30, 2012 and December 31, 2011.

4.

 

Consists of foreign currency forward contracts, interest rate, cross currency, fuel swaps and fuel call options. Please refer to the “Fair Value of Derivative Instruments” table for breakdown by instrument type.

5.

 

Consists of exchange-traded equity securities and mutual funds.

6.

 

Consists of interest rate, fuel swaps, foreign currency forward contracts and collar options. Please refer to the “Fair Value of Derivative Instruments” table for breakdown by instrument type.

 

The reported fair values are based on a variety of factors and assumptions.  Accordingly, the fair values may not represent actual values of the financial instruments that could have been realized as of June 30, 2012 or December 31, 2011, or that will be realized in the future, and do not include expenses that could be incurred in an actual sale or settlement.

 

Concentrations of Credit Risk

 

We monitor our credit risk associated with financial and other institutions with which we conduct significant business and, to minimize these risks, we select counterparties with credit risks acceptable to us and we limit our exposure to any individual counterparty.  Credit risk, including but not limited to counterparty nonperformance under derivative instruments, our revolving credit facilities and new ship progress payment guarantees, is not considered significant, as we primarily conduct business with large, well-established financial institutions, insurance companies and export credit agencies with which we have long-term relationships and which have credit risks acceptable to us or where the credit risk is

 

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spread out among a large number of counterparties. In addition, our exposure under foreign currency forward contracts, foreign currency collar options, fuel call options, interest rate and fuel swap agreements was approximately $30.9 million as of June 30, 2012, and is limited to the cost of replacing the contracts in the event of non-performance by the counterparties to the contract, all of which are currently our lending banks.  We do not anticipate nonperformance by any of our significant counterparties. In addition, we have established guidelines regarding credit ratings and instrument maturities that we follow to maintain safety and liquidity. We do not normally require collateral or other security to support credit relationships; however, in certain circumstances this option is available to us.

 

Derivative Instruments

 

We are exposed to market risk attributable to changes in interest rates, foreign currency exchange rates and fuel prices.  We manage these risks through a combination of our normal operating and financing activities and through the use of derivative financial instruments pursuant to our hedging practices and policies.  The financial impact of these hedging instruments is primarily offset by corresponding changes in the underlying exposures being hedged.  We achieve this by closely matching the amount, term and conditions of the derivative instrument with the underlying risk being hedged.  Although certain of our derivative financial instruments do not qualify for hedge accounting, we do not hold or issue derivative financial instruments for trading or other speculative purposes.  We monitor our derivative positions using techniques including market valuations and sensitivity analyses.

 

We enter into various forward, swap and option contracts to manage our interest rate exposure and to limit our exposure to fluctuations in foreign currency exchange rates and fuel prices. These instruments are recorded on the balance sheet at their fair value and the vast majority are designated as hedges.  We also have non-derivative financial instruments designated as hedges of our net investment in our foreign operations and investments.

 

At inception of the hedge relationship, a derivative instrument that hedges the exposure to changes in the fair value of a firm commitment or a recognized asset or liability is designated as a fair value hedge.  A derivative instrument that hedges a forecasted transaction or the variability of cash flows related to a recognized asset or liability is designated as a cash flow hedge.

 

Changes in the fair value of derivatives that are designated as fair value hedges are offset against changes in the fair value of the underlying hedged assets, liabilities or firm commitments.  Gains and losses on derivatives that are designated as cash flow hedges are recorded as a component of accumulated other comprehensive (loss) income until the underlying hedged transactions are recognized in earnings.  The foreign currency transaction gain or loss of our non-derivative financial instruments designated as hedges of our net investment in foreign operations and investments are recognized as a component of accumulated other comprehensive (loss) income along with the associated foreign currency translation adjustment of the foreign operation.

 

On an ongoing basis, we assess whether derivatives used in hedging transactions are “highly effective” in offsetting changes in the fair value or cash flow of hedged items.  We use the long-haul method to assess hedge effectiveness using regression analysis for each hedge relationship under our interest rate, foreign currency and fuel hedging programs.  We apply the same methodology on a consistent basis for assessing hedge effectiveness to all hedges within each hedging program (i.e. interest rate, foreign currency and fuel). We perform regression analyses over an observation period commensurate with the contractual life of the derivative instrument, up to three years for interest rate and foreign currency relationships and four years for fuel relationships.  High effectiveness is achieved

 

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when a statistically valid relationship reflects a high degree of offset and correlation between the changes in the fair values of the derivative instrument and the hedged item. The determination of ineffectiveness is based on the amount of dollar offset between the change in fair value of the derivative instrument and the change in fair value of the hedged item at the end of the reporting period.  If it is determined that a derivative is not highly effective as a hedge or hedge accounting is discontinued, any change in fair value of the derivative since the last date at which it was determined to be effective is recognized in earnings. In addition, the ineffective portion of our highly effective hedges is recognized in earnings immediately and reported in other income (expense) in our consolidated statements of comprehensive income.

 

Cash flows from derivative instruments that are designated as fair value or cash flow hedges are classified in the same category as the cash flows from the underlying hedged items. In the event that hedge accounting is discontinued, cash flows subsequent to the date of discontinuance are classified within investing activities.  Cash flows from derivative instruments not designated as hedging instruments are classified as investing activities.

 

Interest Rate Risk

 

Our exposure to market risk for changes in interest rates relates to our long-term debt obligations including future interest payments.  At June 30, 2012 and December 31, 2011, approximately 40% of our long-term debt was effectively fixed and approximately 60% was floating.  We use interest rate swap agreements to modify our exposure to interest rate movements and to manage our interest expense.  We manage the risk that changes in interest rates will have either on the fair value of debt obligations or on the amount of future interest payments by monitoring changes in interest rate exposures and by evaluating hedging opportunities.

 

Market risk associated with our long-term fixed rate debt is the potential increase in fair value resulting from a decrease in interest rates.  We use interest rate swap agreements that effectively convert a portion of our fixed-rate debt to a floating-rate basis to manage this risk.  At June 30, 2012 and December 31, 2011, we maintained interest rate swap agreements that effectively changed $350.0 million of debt with a fixed rate of 7.25% to LIBOR-based floating rate debt plus a margin of 1.72%, for an interest rate that was approximately 2.46% and 2.49% as of June 30, 2012 and December 31, 2011, respectively.  Additionally, at June 30, 2012 and December 31, 2011, we maintained interest rate swap agreements on the $420.0 million fixed rate portion of our Oasis of the Seas unsecured amortizing term loan.  The interest rate swap agreements effectively changed the balance of the unsecured term loan, which was $332.5 million as of June 30, 2012, with a fixed rate of 5.41% to LIBOR-based floating rate equal to LIBOR plus 3.87%, currently approximately 4.6%. These interest rate swap agreements are accounted for as fair value hedges.

 

Market risk associated with our long-term floating rate debt is the potential increase in interest expense from an increase in interest rates.  We use interest rate swap agreements that effectively convert a portion of our floating-rate debt to a fixed-rate basis to manage this risk.  During the second quarter of 2012, we entered into forward-starting interest rate swap agreements that hedge the anticipated unsecured amortizing term loans that will finance our purchase of the first and second Project Sunshine ships. Forward-starting interest rate swaps hedging the first Project Sunshine ship loan will effectively convert $735.0 million of the anticipated loan balance from LIBOR plus 1.30% to a fixed rate of 3.74% (inclusive of margin) beginning in October 2014. Forward-starting interest rate swaps hedging the second Project Sunshine ship loan will effectively convert $725.0 million of the anticipated loan balance from LIBOR plus 1.30% to a fixed rate of 3.86% (inclusive of margin) beginning in April 2015.  These interest rate swap agreements are accounted for as cash flow hedges.

 

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In addition, at June 30, 2012 and December 31, 2011, we maintained forward-starting interest rate swap agreements that beginning April 2013 effectively convert the interest rate on the Celebrity Reflection unsecured amortizing term loan balance of approximately $627.2 million from LIBOR plus 0.40% to a fixed-rate of 2.85% (inclusive of margin).  These interest rate swap agreements are accounted for as cash flow hedges.

 

The notional amount of interest rate swap agreements related to outstanding debt and on our current financing arrangements as of June 30, 2012 and December 31, 2011 was $2.8 billion and $1.3 billion, respectively.

 

Foreign Currency Exchange Rate Risk

 

Derivative Instruments

 

Our primary exposure to foreign currency exchange rate risk relates to our ship construction contracts denominated in euros and our growing international business operations.  We enter into foreign currency forward contracts, collar options and cross currency swap agreements to manage portions of the exposure to movements in foreign currency exchange rates.  Approximately 15.6% and 43.3% of the aggregate cost of the ships under construction was exposed to fluctuations in the euro exchange rate at June 30, 2012 and December 31, 2011, respectively.  The majority of our foreign currency forward contracts, collar options and cross currency swap agreements are accounted for as cash flow or fair value hedges depending on the designation of the related hedge.

 

During the first quarter of 2012, we terminated a portion of our foreign currency forward contracts for Celebrity Reflection because their maturity dates were not aligned with the ship’s delivery date. Simultaneously, we entered into new foreign currency forward contracts that were aligned with the ship’s delivery date and designated the contracts as cash flow hedges.  We effected the termination of the contracts by entering into offsetting foreign currency forward contracts.  Neither the original nor the offsetting foreign currency forward contracts are designated as hedging instruments.  As a result, subsequent changes in the fair value of the original and offsetting foreign currency forward contracts are recognized in earnings immediately and are reported within other income (expense) in our consolidated statements of comprehensive income.  We deferred a loss of $10.8 million within accumulated other comprehensive income (loss) and a gain of $1.7 million within accrued expenses and other liabilities for the terminated contracts. Once the ship is placed in service, the net deferred loss of $9.1 million will be recognized as an increase to depreciation expense over the estimated useful life of the vessel.

 

During the second quarter of 2012, we entered into foreign currency collar options to hedge a portion of our foreign currency exposure on the construction contract price for the second Project Sunshine ship.  These foreign currency collar options are accounted for as cash flow hedges and mature in April 2015.

 

At June 30, 2012 and December 31, 2011, we maintained cross currency swap agreements that effectively change €150.0 million of our €1.0 billion Eurobonds with a fixed rate of 5.625% to $190.9 million of debt at a fixed rate of 6.68%.

 

On a regular basis, we enter into foreign currency forward contracts to minimize the volatility resulting from the remeasurement of net monetary assets and liabilities denominated in a currency other than our functional currency or the functional currencies of our foreign subsidiaries. During the second quarter of 2012, we maintained an average of approximately $322.8 million of these foreign currency forward contracts.  These instruments are not designated as hedging instruments.   Changes in the fair

 

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value of the foreign currency forward contracts are recognized in earnings within other income (expense) in our consolidated statements of comprehensive income.

 

The notional amount of outstanding foreign exchange contracts including our forward contracts, cross currency swap agreements and collar options as of June 30, 2012 and December 31, 2011 was $2.0 billion and $0.9 billion, respectively.

 

Non-Derivative Instruments

 

We consider our investments in our foreign operations to be denominated in relatively stable currencies and of a long-term nature.  We partially address the exposure of our investments in foreign operations by denominating a portion of our debt in our subsidiaries’ and investments’ functional currencies.  As of June 30, 2012 and December 31, 2011, we have assigned debt of approximately €626.5 million and €665.0 million, or approximately $795.1 million and $863.2 million, respectively, as a hedge of our net investments in Pullmantur and TUI Cruises.

 

Fuel Price Risk

 

Our exposure to market risk for changes in fuel prices relates primarily to the consumption of fuel on our ships.  We use fuel swap agreements and fuel call options to mitigate the financial impact of fluctuations in fuel prices.

 

Our fuel swap agreements are accounted for as cash flow hedges.  At June 30, 2012, we have hedged the variability in future cash flows for certain forecasted fuel transactions occurring through 2016.  As of June 30, 2012 and December 31, 2011, we have entered into the following fuel swap agreements:

 

 

 

Fuel Swap Agreements

 

 

 

As of
June 30,
2012

 

As of
December 31,
2011

 

 

 

(metric tons)

 

2012

 

388,300

 

738,000

 

2013

 

755,300

 

644,000

 

2014

 

535,000

 

418,000

 

2015

 

321,000

 

284,000

 

2016

 

104,370

 

-

 

 

 

 

Fuel Swap Agreements

 

Projected fuel purchases for year:

 

As of
June 30,
2012

 

As of
December 31,
2011

 

 

 

(% hedged)

 

2012

 

57%

 

55%

 

2013

 

54%

 

47%

 

2014

 

38%

 

30%

 

2015

 

22%

 

20%

 

2016

 

7%

 

0%

 

 

At June 30, 2012 and December 31, 2011, $29.5 million and $78.5 million, respectively, of estimated unrealized net gains associated with our cash flow hedges pertaining to fuel swap agreements were expected to be reclassified to earnings from other accumulated comprehensive (loss) income within the next twelve months.  Reclassification is expected to occur as the result of fuel consumption associated with our hedged forecasted fuel purchases.

 

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Additionally, as of June 30, 2012 and December 31, 2011, we maintained fuel call options on a total of 1.0 million barrels of fuel oil which mature in 2013 in order to provide protection in the event fuel prices exceed the options’ exercise prices.  Our fuel call options are not designated as hedging instruments. As a result, changes in the fair value of our fuel call options are recognized in earnings immediately and are reported in other income (expense) in our consolidated statements of comprehensive income (loss).  As of June 30, 2012 and December 31, 2011, the fuel call options represented 9% of our projected 2013 fuel requirements.

 

The fair value and line item caption of derivative instruments recorded were as follows:

 

Fair Value of Derivative Instruments

 

 

 

 

Asset Derivatives

 

 

 

Liability Derivatives

 

 

 

 

 

 

 

As of
June 30,
2012

 

As of
December 31,
2011

 

 

 

 

 

 

As of
June 30,
2012

 

As of
December 31,
2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance
Sheet
Location

 

 

Fair Value

 

Fair Value

 

 

 

Balance Sheet
Location

 

 

Fair Value

 

Fair Value

 

In thousands

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives designated as hedging instruments under ASC 815-201

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

 

Other Assets

 

 

$

65,729

 

$

65,531

 

 

 

Other long-term liabilities

 

 

$

41,147

 

$

11,369

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cross currency swaps

 

 

Other Assets

 

 

-

 

2,914

 

 

 

Other long-term liabilities

 

 

2,140

 

-

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

 

Derivative Financial Instruments

 

 

211

 

1,895

 

 

 

Accrued expenses and other liabilities

 

 

39,895

 

31,775

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

 

Other Assets

 

 

-

 

-

 

 

 

Other long-term liabilities

 

 

11,035

 

-

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency collar options

 

 

Other Assets

 

 

-

 

-

 

 

 

Other long-term liabilities

 

 

6,906

 

-

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fuel swaps

 

 

Derivative Financial Instruments

 

 

37,413

 

82,747

 

 

 

Accrued expenses and other liabilities

 

 

5,994

 

-

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fuel swaps

 

 

Other Assets

 

 

11,003

 

26,258

 

 

 

Other long-term liabilities

 

 

40,160

 

29,213

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total derivatives designated as hedging instruments under 815-20

 

 

 

 

$

114,356

 

$

179,345

 

 

 

 

 

 

$

147,277

 

$

72,357

 

 

Derivatives not designated as hedging instruments under ASC 815-20

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

 

Derivative Financial Instruments

 

 

$

13,931

 

$

-

 

 

 

Accrued expenses and other liabilities

 

 

$

22,857

 

$

-

 

Foreign currency forward contracts

 

 

Other Assets

 

 

18,912

 

5,414

 

 

 

Other long-term liabilities

 

 

25,459

 

11,987

 

Fuel call options

 

 

Derivative Financial Instruments

 

 

3,741

 

-

 

 

 

Accrued expenses and other liabilities

 

 

-

 

-

 

Fuel call options

 

 

Other Assets

 

 

5,165

 

16,371

 

 

 

Other long-term liabilities

 

 

-

 

-

 

Total derivatives not designated as hedging instruments under 815-20

 

 

 

 

 

$

41,749

 

$

21,785

 

 

 

 

 

 

$

48,316

 

$

11,987

 

Total derivatives

 

 

 

 

 

$

156,105

 

$

201,130

 

 

 

 

 

 

$

195,593

 

$

84,344

 

 

1 Accounting Standard Codification 815-20 “Derivatives and Hedging”.

 

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The carrying value and line item caption of non-derivative instruments recorded was as follows:

 

 

 

 

 

 

Carrying Value

 

Non-derivative instrument
designated as hedging instrument
under ASC 815-20

 

Balance Sheet
Location

 

 

As of June 30,
2012

 

As of December 31,
2011

 

In thousands

 

 

 

 

 

 

 

 

Foreign currency debt

 

Long-term debt

 

 

$

795,120  

 

$

863,217  

 

 

 

 

 

 

$

795,120  

 

$

863,217  

 

 

 

The effect of derivative instruments qualifying and designated as hedging instruments and the related hedged items in fair value hedges on the consolidated statements of comprehensive income was as follows:

 

 

 

 

 

Amount of Gain (Loss) Recognized in
Income on Derivative

 

Amount of Gain (Loss) Recognized in
Income on Hedged Item

 

Derivatives and
related Hedged
Items under ASC
815-20 Fair Value
Hedging Relationships

 

Location of
Gain (Loss)
Recognized in
Income on
Derivative and
Hedged Item

 

Quarter
Ended
June 30,
2012

 

Quarter
Ended
June 30,
2011

 

Six
Months
Ended
June 30,
2012

 

Six
Months
Ended
June 30,
2011

 

Quarter
Ended
June 30,
2012

 

Quarter
Ended
June 30,
2011

 

Six
Months
Ended
June 30,
2012

 

Six
Months
Ended
June 30,
2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In thousands

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

Interest expense, net of interest capitalized

 

$

4,880

 

$

4,444

 

$

9,862

 

$

8,881

 

$

7,107

 

$

7,971

 

$

14,367

 

$

15,594

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

Other income (expense)

 

5,959

 

7,333

 

1,416

 

1,374

 

(5,616)

 

(6,933)

 

(1,902)

 

(1,043)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Other income (expense)

 

 

(10)

 

 

22,901

 

 

(28)

 

 

(23,720)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

10,839

 

$

11,767

 

$

11,278

 

$

33,156

 

$

1,491

 

$

1,010

 

$

12,465

 

$

(9,169)

 

 

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The effect of derivative instruments qualifying and designated as hedging instruments in cash flow hedges on the consolidated financial statements was as follows:

 

 

 

Amount of Gain (Loss) Recognized in OCI on
Derivative (Effective Portion)

 

Location of
Gain (Loss)
Reclassified

 

Amount of Gain (Loss) Reclassified from
Accumulated OCI into Income (Effective
Portion)

Derivatives under
ASC 815-20 Cash
Flow Hedging
Relationships

 

Quarter
Ended
June 30,
2012

 

Quarter
Ended
June 30,
2011

 

Six
Months
Ended
June 30,

2012

 

Six
Months
Ended
June 30,
2011

 

from
Accumulated
OCI into
Income
(Effective
Portion)

 

Quarter
Ended
June 30,
2012

 

Quarter
Ended
June 30,
2011

 

Six
Months
Ended
June 30,
2012

 

Six

Months
Ended
June 30,
2011

In thousands

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cross currency swaps

 

$ (8,783)

 

$  13,691

 

$ (12,370)

 

$  38,578

 

Other income (expense)

 

$ (9,800)

 

$ 13,760

 

$ (12,721)

 

$  44,720

Interest rate swaps

 

(35,478)

 

 

(30,924)

 

 

Other income (expense)

 

 

 

 

Foreign currency forward contracts

 

(47,758)

 

44,307

 

(30,050)

 

112,156

 

Depreciation and amortization expenses

 

(196)

 

(175)

 

(392)

 

(349)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

 

 

 

(12,375)

 

Other income (expense)

 

(239)

 

(71)

 

(477)

 

191

Foreign currency collar options

 

(12,564)

 

 

(12,564)

 

 

Depreciation and amortization expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fuel swaps

 

(165,746)

 

14,464

 

(4,479)

 

193,479

 

Fuel

 

28,158

 

42,427

 

63,985

 

78,501

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$(270,329)

 

$  72,462

 

$ (90,387)

 

$331,838

 

 

 

$  17,923

 

$ 55,941

 

$   50,395

 

$123,063

 

 

 

 

Location of Gain (Loss)
Recognized in Income

 

Amount of Gain (Loss) Recognized in Income on Derivative (Ineffective Portion
and Amount Excluded from Effectiveness testing)

Derivatives under ASC
815-20 Cash Flow
Hedging Relationships

 

on Derivative
(Ineffective Portion and
Amount Excluded from
Effectiveness Testing)

 

Quarter Ended
June 30, 2012

 

Quarter Ended
June 30, 2011

 

Six Months Ended
June 30, 2012

 

Six Months Ended
June 30, 2011

In thousands

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cross currency swaps

 

Other income (expense)

 

(234)

 

 

(234)

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

Other income (expense)

 

 

(71)

 

 

(70)

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Other income (expense)

 

(16)

 

1,661

 

(9)

 

2,689

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

Other income (expense)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency collar options

 

Other income (expense)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fuel swaps

 

Other income (expense)

 

(4,418)

 

1,685

 

(3,889)

 

6,769

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  $

(4,739)

 

  $

3,346

 

  $

(4,202)

 

  $

 9,458

 

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The effect of non-derivative instruments qualifying and designated as hedging instruments in net investment hedges on the consolidated financial statements was as follows:

 

 

 

Amount of Gain (Loss) Recognized in OCI
(Effective Portion)

 

Location of
Gain (Loss)
in Income

 

Amount of Gain (Loss) Recognized in
Income (Ineffective Portion and Amount
Excluded from Effectiveness Testing)

Non-derivative
instruments under
ASC 815-20 Net
Investment
Hedging

Relationships

 

Quarter
Ended
June 30,
2012

 

Quarter
Ended
June 30,
2011

 

Six
Months
Ended
June 30,
2012

 

Six
Months
Ended
June 30,
2011