10-Q 1 rcl-3312018x10q.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2018

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 ý  No o
 
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 ý  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer x
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company o
Emerging growth company o
 
(Do not check if a smaller reporting company)
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No ý
 
There were 211,746,787 shares of common stock outstanding as of April 19, 2018.
 



ROYAL CARIBBEAN CRUISES LTD.
 
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 March 31,
 
2018
 
2017
Passenger ticket revenues
$
1,425,644

 
$
1,418,223

Onboard and other revenues
602,112

 
590,337

Total revenues
2,027,756

 
2,008,560

Cruise operating expenses:
 

 
 

Commissions, transportation and other
290,609

 
310,248

Onboard and other
99,537

 
105,994

Payroll and related
227,156

 
215,735

Food
119,642

 
121,211

Fuel
160,341

 
177,414

Other operating
278,734

 
245,222

Total cruise operating expenses
1,176,019

 
1,175,824

Marketing, selling and administrative expenses
337,361

 
317,465

Depreciation and amortization expenses
240,230

 
235,749

Operating Income
274,146

 
279,522

Other income (expense):
 

 
 

Interest income
7,733

 
6,252

Interest expense, net of interest capitalized
(67,878
)
 
(80,317
)
Equity investment income
28,752

 
11,880

Impairment loss related to Skysea Holding
(23,343
)
 

Other expense
(757
)
 
(2,611
)
 
(55,493
)
 
(64,796
)
Net Income
$
218,653

 
$
214,726

Earnings per Share:
 

 
 

Basic
$
1.03

 
$
1.00

Diluted
$
1.02

 
$
0.99

Weighted-Average Shares Outstanding:
 

 
 

Basic
212,610

 
214,870

Diluted
213,602

 
215,813

Comprehensive Income
 

 
 

Net Income
$
218,653

 
$
214,726

Other comprehensive income (loss):
 

 
 

Foreign currency translation adjustments
1,160

 
2,342

Change in defined benefit plans
7,760

 
(641
)
Gain on cash flow derivative hedges
142,530

 
22,461

Total other comprehensive income
151,450

 
24,162

Comprehensive Income
$
370,103

 
$
238,888

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


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ROYAL CARIBBEAN CRUISES LTD.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
 
As of
 
March 31,
 
December 31,
 
2018
 
2017
 
(unaudited)
 
 
Assets
 

 
 

Current assets
 

 
 

Cash and cash equivalents
$
111,245

 
$
120,112

Trade and other receivables, net
387,862

 
318,641

Inventories
110,826

 
111,393

Prepaid expenses and other assets
350,653

 
258,171

Derivative financial instruments
73,940

 
99,320

Total current assets
1,034,526

 
907,637

Property and equipment, net
21,207,786

 
19,735,180

Goodwill
288,479

 
288,512

Other assets
1,440,181

 
1,429,597

 
$
23,970,972

 
$
22,360,926

Liabilities and Shareholders’ Equity
 

 
 

Current liabilities
 
 
 
Current portion of long-term debt
$
1,144,017

 
$
1,188,514

Accounts payable
454,576

 
360,113

Accrued interest
90,388

 
47,469

Accrued expenses and other liabilities
680,397

 
903,022

Derivative financial instruments
40,314

 
47,464

Customer deposits
2,785,462

 
2,308,291

Total current liabilities
5,195,154

 
4,854,873

Long-term debt
7,664,722

 
6,350,937

Other long-term liabilities
464,300

 
452,813

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; 235,738,538 and 235,198,901 shares issued, March 31, 2018 and December 31, 2017, respectively)
2,357

 
2,352

Paid-in capital
3,390,055

 
3,390,117

Retained earnings
9,090,544

 
9,022,405

Accumulated other comprehensive loss
(182,815
)
 
(334,265
)
Treasury stock (24,008,342 and 21,861,308 common shares at cost, March 31, 2018 and December 31, 2017, respectively)
(1,653,345
)
 
(1,378,306
)
Total shareholders’ equity
10,646,796

 
10,702,303

 
$
23,970,972

 
$
22,360,926

.
 
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)
 
Quarter Ended March 31,
 
2018
 
2017
Operating Activities
 

 
 

Net income
$
218,653

 
$
214,726

Adjustments:
 

 
 

Depreciation and amortization
240,230

 
235,749

Impairment loss related to Skysea Holding
23,343

 

Net deferred income tax (benefit) expense
(1,504
)
 
610

Gain on derivative instruments not designated as hedges
(7,810
)
 
(13,812
)
Share-based compensation expense
20,164

 
17,262

Equity investment income
(28,752
)
 
(11,880
)
Amortization of debt issuance costs
10,108

 
13,256

Gain on sale of property and equipment

 
(30,902
)
Changes in operating assets and liabilities:
 

 
 

Increase in trade and other receivables, net
(10,181
)
 
(828
)
Decrease in inventories
567

 
5,391

Increase in prepaid expenses and other assets
(89,725
)
 
(32,083
)
Increase in accounts payable
110,467

 
56,373

Increase in accrued interest
42,919

 
45,206

Decrease in accrued expenses and other liabilities
(109,136
)
 
(57,344
)
Increase in customer deposits
477,878

 
333,735

Dividends received from unconsolidated affiliates
37,918

 
27,997

Other, net
(11,017
)
 
(6,930
)
Net cash provided by operating activities
924,122

 
796,526

Investing Activities
 

 
 

Purchases of property and equipment
(1,720,232
)
 
(122,783
)
Cash received on settlement of derivative financial instruments
64,487

 
13,812

Cash received on loans to unconsolidated affiliates
13,953

 
5,011

Proceeds from the sale of property and equipment

 
230,000

Other, net
(3,353
)
 
(2,440
)
Net cash (used in) provided by investing activities
(1,645,145
)
 
123,600

Financing Activities
 

 
 

Debt proceeds
2,544,737

 
1,006,000

Debt issuance costs
(41,344
)
 
(10,383
)
Repayments of debt
(1,394,222
)
 
(1,840,402
)
Purchases of treasury stock
(275,038
)
 

Dividends paid
(127,840
)
 
(102,942
)
Proceeds from exercise of common stock options
3,863

 
2,100

Other, net
1,697

 
1,233

Net cash provided by (used in) financing activities
711,853

 
(944,394
)
Effect of exchange rate changes on cash
303

 
974

Net decrease in cash and cash equivalents
(8,867
)
 
(23,294
)
Cash and cash equivalents at beginning of period
120,112

 
132,603

Cash and cash equivalents at end of period
$
111,245

 
$
109,309

Supplemental Disclosure
 

 
 

Cash paid during the period for:
 

 
 

Interest, net of amount capitalized
$
16,953

 
$
24,296


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

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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,” and “Azamara Club Cruises” refer to our wholly-owned global cruise brands. Throughout this report, we also refer to regional brands in which we hold an ownership interest, including “TUI Cruises,” “Pullmantur” and “SkySea Cruises.” However, because these regional brands are unconsolidated investments, our operating results and other disclosures herein do not include these brands unless otherwise specified. 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, 2017, including the audited consolidated financial statements and related notes included therein.
 
This Quarterly Report on Form 10-Q also includes trademarks, trade names and service marks of other companies.  Use or display by us of other parties’ trademarks, trade names or service marks is not intended to and does not imply a relationship with, or endorsement or sponsorship of us by, these other parties other than as described herein.

Note 1. General
 
Description of Business
 
We are a global cruise company.  As of March 31, 2018, we own and operate three global cruise brands: Royal Caribbean International, Celebrity Cruises and Azamara Club Cruises (collectively, our "Global Brands"). We also own a 50% joint venture interest in the German brand TUI Cruises, a 49% interest in the Spanish brand Pullmantur and a 36% interest in the Chinese brand SkySea Cruises (collectively, our "Partner Brands"). We account for our investments in our Partner Brands under the equity method of accounting.

In March 2018, we and Ctrip.com International Ltd. ("Ctrip") announced the decision to end the Skysea Holding International Ltd. ("Skysea Holding") venture. Skysea Holding expects to cease business operations by the end of 2018. The Golden Era, the ship operated by SkySea Cruises and owned by a wholly owned subsidiary of Skysea Holding, is expected to be sold to an affiliate of TUI AG, our joint venture partner in TUI Cruises, and is expected to be delivered in December 2018. Refer to Note 5. Other Assets for further information regarding our investment in SkySea Holding.

Basis for Preparation of Consolidated Financial Statements
 
The unaudited consolidated financial statements are presented pursuant to the rules and regulations of the Securities and
Exchange Commission. In our opinion, these statements include all adjustments necessary for a fair statement of the results of the interim periods reported herein. Adjustments consist only of normal recurring items, except for any discussed in the notes below. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted as permitted by such rules and regulations. Estimates are required for the preparation of financial statements in accordance with GAAP and actual results could differ from these estimates. Refer to 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, 2017 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. Refer to Note 5. 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. 




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Note 2. Summary of Significant Accounting Policies

Adoption of Accounting Pronouncements

On January 1, 2018, we adopted the guidance in Accounting Standard Codification 606 ("ASC 606"), Revenue from Contracts with Customers, and applied the guidance to all contracts using the modified retrospective method. The new standard converged wide-ranging revenue recognition concepts and requirements that lead to diversity in application for particular industries and transactions into a single revenue standard containing comprehensive principles for recognizing revenue. The cumulative effect of applying the newly issued guidance was not material and accordingly there was no adjustment made to our retained earnings upon adoption on January 1, 2018. We do not expect the newly issued guidance to have a material impact on our consolidated financial statements on an ongoing basis. The comparative information presented has not been restated and continues to be reported under the accounting standards in effect for those periods; however, due to the adoption of ASC 606, we currently present prepaid commissions as an asset within Prepaid expenses and other assets. Prior to adoption, prepaid commissions were netted against our customer deposits in our consolidated balance sheets. In order to conform to current year presentation, as of December 31, 2017, we have reclassified prepaid commissions of $64.6 million from Customer deposits to Prepaid expenses and other assets in our consolidated balance sheets. Refer to Note 3. Revenues for disclosures with respect to our revenue recognition policies.

On January 1, 2018, we adopted the guidance in Accounting Standard Update ("ASU") 2016-16, Income Taxes 740: Intra-Entity Transfers of Assets Other Than Inventory, which requires the income tax consequences of an intra-entity transfer of an asset, other than inventory, to be recognized at the time that the transfer occurs, rather than when the asset is sold to an outside party. We adopted the standard using the modified retrospective method and recorded a cumulative-effect adjustment to reduce retained earnings as of January 1, 2018 by $6.6 million, which reflects the elimination of the deferred tax asset related to intercompany asset transfers.

On January 1, 2018, we adopted the guidance in ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, that was issued to simplify and align the financial reporting of hedging relationships to the economic results of an entity’s risk management activities. We adopted the amended guidance using the modified retrospective approach. Adoption of the guidance allowed us to modify the designated risk in our fair value interest rate hedges to the benchmark interest rate component, resulting in changes to the cumulative and ongoing fair value measurement for the hedged debt. Upon adoption, we also elected to hedge the contractually specified components of our commodities purchase contracts. For our cash flow hedges, there will be no periodic measurement or recognition of ineffectiveness. For all hedges, the earnings effect of the hedging instrument will be reported in the same period  and in the same income statement line item in which the earnings effect of the hedged item is reported. As a result of the adoption of this guidance, we recorded a cumulative-effect adjustment to reduce retained earnings as of January 1, 2018 by $16.9 million. The cumulative-effect adjustment includes an increase to the debt carrying value of $14.4 million for our fair value interest rate hedges as of January 1, 2018, which reflects the cumulative fair value measurement change to debt at adoption resulting from the modified designated risk. The cumulative-effect adjustment also includes an increase to other comprehensive income of $2.5 million, which represents an increase to the deferred gain on active cash flow hedges at adoption. Additionally, the new standard requires modifications to existing presentation and disclosure requirements on a prospective basis. As such, certain disclosures for the quarter ended March 31, 2018 conform to these disclosure requirements. Refer to Note 9. Changes in Accumulated Other Comprehensive Income (Loss) and Note 10. Fair Value Measurements and Derivative Instruments for additional information.

Recent Accounting Pronouncements

Leases

In February 2016, amended GAAP guidance was issued to increase the transparency and comparability of lease accounting among organizations. For leases with a term greater than 12 months, the amendments require the lease rights and obligations arising from the leasing arrangements, including operating leases, to be recognized as assets and liabilities on the balance sheet. The amendments also expand the required disclosures surrounding leasing arrangements. The guidance must be applied using a retrospective application method and will be effective for financial statements issued for fiscal years beginning after December 15, 2018 and interim periods within those years. Early adoption is permitted. We are currently evaluating the impact of the adoption of this newly issued guidance to our consolidated financial statements.

Change in Accounting Principle - Stock-based Compensation

In January 2018, we elected to change our accounting policy for recognizing stock-based compensation expense from the graded attribution method to the straight-line attribution method for time-based stock awards. The adoption of the straight-line attribution method for time-based stock awards represents a change in accounting principle which we believe to be preferable

5


because it is the predominant method used in our industry. A change in accounting principle requires retrospective application, if material. The impact of the adoption of the straight-line attribution method to our time-based awards was immaterial to prior periods and is expected to be immaterial for our fiscal year ended December 31, 2018. As a result, we have accounted for this change in accounting principle in our consolidated results for the first quarter of 2018. The effect of this change was an increase to net income of $9.2 million, or $0.04 per share for basic and diluted earnings per share, and is reported within Marketing, selling and administrative expenses in our consolidated statements of comprehensive income (loss) for the quarter ended March 31, 2018.

Note 3. Revenues

Revenue Recognition

Revenues are measured based on consideration specified in our contracts with customers and are recognized as the related performance obligations are satisfied.

The majority of our revenues are derived from passenger cruise contracts which are reported within Passenger ticket revenues in our Consolidated Statements of Comprehensive Income (Loss). Our performance obligation under these contracts is to provide a cruise vacation in exchange for the ticket price. We satisfy this performance obligation and recognize revenue over the duration of each cruise, which range from two to 23 nights.

Passenger ticket revenues include charges to our guests for port costs that vary with passenger head counts. These type of port costs, along with port costs that do not vary by passenger head counts, are included in our operating expenses. The amounts of port costs charged to our guests and included within Passenger ticket revenues on a gross basis were $136.7 million and $134.5 million for the first quarter of 2018 and 2017, respectively.

Our total revenues also include onboard and other revenues, which consist primarily of revenues from the sale of goods and services onboard our ships that are not included in passenger ticket prices. We receive payment before or concurrently with the transfer of these goods and services to passengers during a cruise and recognize revenue at the time of transfer over the duration of the related cruise.

As a practical expedient, we have omitted disclosures on our remaining performance obligations as the duration of our contracts with customers is less than a year.

Disaggregated Revenues

The following table disaggregates our total revenues by geographic regions where we provide cruise itineraries (in thousands):
 
 
Quarter Ended March 31,
 
2018
 
2017
Total revenues by itinerary
 
 
 
North America(1)
$
1,347,260

 
$
1,352,169

Asia/Pacific(2)
532,979

 
525,856

Europe(3)

 

Other regions
77,185

 
65,232

Total revenues by itinerary
1,957,424

 
1,943,257

Other revenues(4)
70,332

 
65,303

Total revenues
$
2,027,756

 
$
2,008,560


(1) Includes the United States, Canada, Mexico and the Caribbean.

(2) Includes Southeast Asia (e.g., Singapore, Thailand and the Philippines), East Asia (e.g., China and Japan), South Asia (e.g., India and Pakistan) and Oceania (e.g., Australia and Fiji Islands) regions.

(3) Includes European countries (e.g., Nordics, Germany, France, Italy, Spain and the United Kingdom). During the quarters ended March 31, 2018 and 2017, there were no cruise itineraries in Europe.


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(4) Includes revenues of $47.4 million and $42.6 million for the quarter ended March 31 2018 and 2017, respectively, related to cancellation fees, sales of vacation protection insurance and pre- and post-cruise tours and revenues of $23.0 million and $21.8 million for the quarter ended March 31 2018 and 2017, respectively, primarily related to our bareboat charter, procurement and management related services we perform on behalf of our unconsolidated affiliates.

Passenger ticket revenues are attributed to geographic areas based on where the reservation originates. For the quarter ended March 31, 2018 and March 31, 2017, our guests were sourced from the following areas:

 
Quarter Ended March 31,
 
2018
 
2017
Passenger ticket revenues:
 
 
 
United States
60
%
 
60
%
Australia
13
%
 
12
%
All other countries (1)
27
%
 
28
%

(1) No other individual country's revenue exceeded 10% for the quarter ended March 31, 2018 and 2017, respectively.

Customer Deposits and Contract Liabilities

Our payment terms generally require an upfront deposit to confirm a reservation, with the balance due prior to the cruise. Deposits received on sales of passenger cruises are initially recorded as Customer deposits in our consolidated balance sheets and subsequently recognized as passenger ticket revenues during the duration of the cruise. ASC 606 defines a “contract liability” as an entity’s obligation to transfer goods or services to a customer for which the entity has received consideration from the customer. We do not consider customer deposits to be a contract liability until the customer no longer retains the unilateral right, resulting from the passage of time, to cancel such customer's reservation and receive a full refund. Customer deposits presented in our consolidated balance sheets include contract liabilities of $1.8 billion and $1.4 billion as of March 31, 2018 and December 31, 2017, respectively. During the quarter ended March 31, 2018, we recognized revenues related to our contract liabilities as of December 31, 2017 of $1.3 billion.
Contract Receivables and Contract Assets

Although we generally require full payment from our customers prior to their cruise, we grant credit terms to a relatively small portion of our revenue source in select markets outside of the United States. As a result, we have outstanding receivables from passenger cruise contracts in those markets. We also have receivables from credit card merchants for cruise ticket purchases and goods and services sold to guests during cruises that are collected before, during or shortly after the cruise voyage. In addition, we have receivables due from concessionaires onboard our vessels. These receivables are included within Trade and other receivables, net in our consolidated balance sheets. We have contract assets that are conditional rights to consideration for satisfying the construction services performance obligations under a service concession arrangement. As of March 31, 2018 and December 31, 2017, our contract assets were $59.5 million and $60.1 million, respectively, and were included within Other assets in our consolidated balance sheets. Given the short duration of our cruises and our collection terms, we do not have any other significant contract assets.

Assets Recognized from the Costs to Obtain a Contract with a Customer

Prepaid travel agent commissions are an incremental cost of obtaining contracts with customers that we recognize as an asset and include within Prepaid expenses and other assets in our consolidated balance sheets. Prepaid travel agent commissions increased to $80.2 million at March 31, 2018 from $64.6 million at December 31, 2017 because of increased bookings in the first quarter of 2018. Primarily all of our prepaid travel agent commissions at December 31, 2017 were expensed and reported within Commissions, transportation and other in our consolidated statements of comprehensive income (loss) for the quarter ended March 31, 2018.


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Note 4. Earnings Per Share
 
A reconciliation between basic and diluted earnings per share is as follows (in thousands, except per share data):
 
Quarter Ended March 31,
 
2018
 
2017
Net income for basic and diluted earnings per share
$
218,653

 
$
214,726

Weighted-average common shares outstanding
212,610

 
214,870

Dilutive effect of stock-based awards and stock options
992

 
943

Diluted weighted-average shares outstanding
213,602

 
215,813

Basic earnings per share
$
1.03

 
$
1.00

Diluted earnings per share
$
1.02

 
$
0.99

 
There were no antidilutive shares for the quarters ended March 31, 2018 and March 31, 2017.
 
Note 5. Other Assets

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 TUI Cruises GmbH, our 50%-owned joint venture, which operates the brand TUI Cruises, is a VIE. As of March 31, 2018, the net book value of our investment in TUI Cruises was approximately $627.5 million, primarily consisting of $425.4 million in equity and a loan of €162.5 million, or approximately $199.9 million based on the exchange rate at March 31, 2018. As of December 31, 2017, the net book value of our investment in TUI Cruises was approximately $624.5 million, primarily consisting of $422.8 million in equity and a loan of €166.5 million, or approximately $199.8 million based on the exchange rate at December 31, 2017. The loan, which was made in connection with the sale of Splendour of the Seas in April 2016, accrues interest at a rate of 6.25% per annum and is payable over 10 years. This loan is 50% guaranteed by TUI AG, our joint venture partner in TUI Cruises, and is secured by a first priority mortgage on the ship. The majority of these amounts were included within Other assets in our consolidated balance sheets.

 In addition, we and TUI AG have each guaranteed the repayment by TUI Cruises of 50% of a bank loan. As of March 31, 2018, the outstanding principal amount of the loan was €89.1 million, or approximately $109.6 million based on the exchange rate at March 31, 2018. The loan amortizes quarterly and is secured by first mortgages on the Mein Schiff 1 and Mein Schiff 2 vessels. In April 2018, Mein Schiff 1 was sold to an affiliate of TUI AG. The proceeds were used to repay €44.2 million of the bank loan and secure the release of the first mortgage on Mein Schiff 1. Based on current facts and circumstances, we do not believe potential obligations under our guarantee of this bank loan are probable.

Our investment amount, outstanding term loan and the potential obligations under the bank loan guarantee are substantially our maximum exposure to loss in connection with our investment in TUI Cruises. 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 and account for this investment under the equity method of accounting.

TUI Cruises has two newbuild ships on order scheduled to be delivered in each of 2018 and 2019. TUI Cruises has in place agreements for the secured financing of each of the ships on order for up to 80% of the contract price. The remaining portion of the contract price of the ships is expected to be funded through an existing €150.0 million, or approximately $184.5 million based on the exchange rate at March 31, 2018, bank facility and TUI Cruises’ cash flows from operations. The various ship construction and financing agreements include certain restrictions on each of our and TUI AG’s ability to reduce our current ownership interest in TUI Cruises below 37.55% through 2021.

We have determined that Pullmantur Holdings S.L. ("Pullmantur Holdings"), in which we have a 49% noncontrolling interest, is a VIE for which we are not the primary beneficiary, as we do not have the power to direct the activities that most significantly impact the entity's economic performance. Accordingly, we do not consolidate this entity and we account for this investment under

8


the equity method of accounting. As of March 31, 2018, our maximum exposure to loss in Pullmantur Holdings was approximately $54.6 million consisting of loans and other receivables. As of December 31, 2017, our maximum exposure to loss in Pullmantur Holdings was approximately $53.7 million consisting of loans and other receivables. These amounts were included within Trade and other receivables, net and Other assets in our consolidated balance sheets.

We have provided a non-revolving working capital facility to a Pullmantur Holdings subsidiary in the amount of up to €15.0 million or approximately $18.5 million based on the exchange rate at March 31, 2018. Proceeds of the facility, which may be drawn through July 2018, will bear interest at the rate of 6.5% per annum and are payable through 2022. Springwater Capital LLC, 51% owner of Pullmantur Holdings, has guaranteed repayment of 51% of the outstanding amounts under the facility. As of March 31, 2018, no amounts had been drawn on this facility.

We have determined that Grand Bahama Shipyard Ltd. (“Grand Bahama”), a ship repair and maintenance facility in which we have a 40% noncontrolling interest, is a VIE. This 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. During the quarter ended March 31, 2018 and March 31, 2017, we made payments of $22.3 million and $1.7 million to Grand Bahama for ship repair and maintenance services. We have determined that 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 March 31, 2018, the net book value of our investment in Grand Bahama was approximately $55.6 million, consisting of $38.7 million in equity and a loan of $16.9 million. As of December 31, 2017, the net book value of our investment in Grand Bahama was approximately $49.4 million, consisting of $32.4 million in equity and a loan of $17.0 million. These amounts represent our maximum exposure to loss related to our investment in Grand Bahama. Our loan with Grand Bahama matures on March 2025 and bears interest at the lower of (i) LIBOR plus 3.50% and (ii) 5.5%. Interest payable on the loan is due on a semi-annual basis. We have experienced strong payment performance on the loan since its amendment in 2016, and as a result completed an evaluation and review of the loan resulting in a reclassification of the loan to accrual status as of October 2017. During the quarter ended March 31, 2018, we received principal and interest payments of approximately $3.0 million. During the quarter ended March 31, 2017, we received principal payments of approximately $0.3 million. The loan balance is included within Other assets in our consolidated balance sheets. The loan is currently accruing interest under the effective yield method, which includes the recognition of previously unrecognized interest that accumulated while the loan was in non-accrual status.

We monitor credit risk associated with the loan 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 the outstanding loan is not probable as of March 31, 2018.

We have determined that Skysea Holding International Ltd. ("Skysea Holding"), in which we currently have a 36% noncontrolling interest, is a VIE for which we are not the primary beneficiary, as we do not have the power to direct the activities that most significantly impact the entity's economic performance. Accordingly, we do not consolidate this entity and we account for this investment under the equity method of accounting. In December 2014, we and Ctrip, which also owns 36% of Skysea Holding, each provided a debt facility to a wholly owned subsidiary of Skysea Holding in the amount of $80.0 million, with an applicable interest rate of 6.5% per annum, which originally matured in January 2030. The facilities, which are pari passu to each other, are each 100% guaranteed by Skysea Holding and are secured by first priority mortgages on the ship, Golden Era. Due to payment performance, the loans were classified to non-accrual status in 2017.

In March 2018, the Skysea Holding's board of directors agreed to exit the business given increasing challenges faced by the brand. We expect Skysea Holding will cease business operations by the end of 2018. In connection with the decision to dissolve the brand, SkySea Holding has agreed to sell the Golden Era to an affiliate of TUI AG, our joint venture partner in TUI Cruises.

We review our equity method investments for impairment whenever events or changes in circumstances indicate that the carrying amount of the investment may not be recoverable. Given SkySea Holding’s planned dissolution and sale of Golden Era, we reviewed the recoverability of our investment, debt facility and other receivables due from the brand. As a result of this analysis, we determined that our investment in SkySea Holding and the carrying value of our debt facility and other receivables due from the brand were impaired as of March 31, 2018 and recognized an impairment charge of $23.3 million. This impairment charge was recognized in Impairment loss related to Skysea Holding within our consolidated statements of comprehensive income (loss) for the quarter ended March 31, 2018. The charge reflects a full impairment of our investment in SkySea Holding and other receivables due to us and reduces the debt facility and the related accrued interest due to us from SkySea Holding to its net realizable value. Refer to Note 10. Fair Value Measurements and Derivative Instruments for further information on the fair value calculation of the debt facility.


9


As of March 31, 2018, the net book value of our investment in Skysea Holding and its subsidiaries was approximately $69.6 million, consisting of the remaining balance of the $80.0 million debt facility and its related accrued interest. Due to the expected sale of Golden Era in December of 2018, the amount was included within Trade and other receivables, net and represents our maximum exposure to loss related to our investment in Skysea Holding as of March 31, 2018. As of December 31, 2017, the net book value of our investment in Skysea Holding and its subsidiaries was approximately $96.0 million, which consisted of $4.4 million in equity and loans and other receivables of $91.6 million. The majority of these amounts were included within Other assets in our consolidated balance sheets and represented our maximum exposure to loss related to our investment in Skysea Holding as of December 31, 2017.

The following tables set forth information regarding our investments accounted for under the equity method of accounting, including the entities discussed above (in thousands):
 
 
Quarter Ended March 31, 2018
 
Quarter Ended March 31, 2017
Share of equity income from investments
 
$
28,752

 
$
11,880

Dividends received
 
$
37,918

 
$
27,997


 
 
As of March 31, 2018
 
As of December 31, 2017
Total notes receivable due from equity investments
 
$
291,116

 
$
314,323

Less-current portion(1)
 
95,865

 
38,658

Long-term portion(2)
 
$
195,251

 
$
275,665


(1)     Included within Trade and other receivables, net in our consolidated balance sheets.

(2)    Included within Other assets in our consolidated balance sheets.

We also provide ship management services to TUI Cruises GmbH, Pullmantur Holdings and Skysea Holding. Additionally, we bareboat charter to Pullmantur Holdings the vessels currently operated by its brands, which were retained by us following the sale of our 51% interest in Pullmantur Holdings. We recorded the following as it relates to these services in our operating results within our consolidated statements of comprehensive income (loss) (in thousands):

 
 
Quarter Ended March 31, 2018
 
Quarter Ended March 31, 2017
Revenues
 
$
14,073

 
$
12,615

Expenses
 
$
3,638

 
$
3,713


Note 6. Long-Term Debt

In March 2018, we took delivery of Symphony of the Seas. We had previously entered into a financing arrangement for the United States dollar financing of this ship in January 2015. Through the financing arrangement, we had the right, but not the obligation, to satisfy the obligations to be incurred upon delivery and acceptance of the vessel under the shipbuilding contract by assuming through a novation agreement, at delivery and acceptance, the debt indirectly incurred by the shipbuilder during the construction of the ship. We borrowed a total of $1.2 billion under our previously committed unsecured term loan, which includes the execution of the novation to satisfy a portion of our final obligation under our shipbuilding agreement. The loan amortizes semi-annually over 12 years and bears interest at a fixed rate of 3.82%. In our consolidated statement of cash flows for the quarter ended March 31, 2018, the acceptance of the ship and satisfaction of our obligation under the shipbuilding contract was classified as an outflow and constructive disbursement within Investing Activities while the amounts novated and effectively advanced from our lender under our previously committed unsecured term loan were classified as an inflow and constructive receipt within Financing Activities.

In March 2018, we entered into and drew in full on a credit agreement in the amount of $130.0 million due January 2023. The loan accrues interest at a floating rate of LIBOR plus an applicable margin. The applicable margin varies with our debt rating and was 1.32% as of March 31, 2018. Amounts from the issuance of this loan were used for capital expenditures.


10


Note 7. Commitments and Contingencies

Ship Purchase Obligations

Our future capital commitments consist primarily of new ship orders. As of March 31, 2018, we had two Quantum-class ships, one Oasis-class ship and two ships of a new generation of ships, known as our Icon-class, on order for our Royal Caribbean International brand with an aggregate capacity of approximately 25,250 berths. Additionally, as of March 31, 2018, we have four ships of a new generation of ships, known as our Edge-class, and a ship designed for the Galapagos Islands on order for our Celebrity Cruises brand with an aggregate capacity of approximately 12,200 berths.

As of March 31, 2018, the aggregate cost of our ships on order, not including any ships on order by our Partner Brands, was approximately $11.7 billion, of which we had deposited $419.0 million as of such date. Approximately 55.9% of the aggregate cost was exposed to fluctuations in the Euro exchange rate at March 31, 2018. Refer to Note 10. Fair Value Measurements and Derivative Instruments for further information.

Litigation

We are routinely involved in 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 cash flows.

Other

In July 2016, we executed an agreement with Miami Dade County (“MDC”), which was simultaneously assigned to Sumitomo Banking Corporation (“SMBC”), to lease land from MDC and construct a new cruise terminal at PortMiami in Miami, Florida. The terminal is expected to be approximately 170,000 square feet and will serve as a homeport. During the construction period, SMBC will fund the costs of the terminal’s construction and land lease. Upon completion of the terminal's construction, we will operate and lease the terminal from SMBC for a five-year term. We determined that the lease arrangement between SMBC and us should be accounted for as an operating lease upon completion of the terminal.
 
If any person acquires ownership of more than 50% of our common stock or, 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 our credit facilities, which we may be unable to replace on similar terms. Our public debt securities also contain change of control provisions that would be triggered by a third-party acquisition of greater than 50% of our common stock coupled with a ratings downgrade. If this were to occur, it would have an adverse impact on our liquidity and operations.

Note 8. Shareholders’ Equity

During the first quarter of 2018, we declared a cash dividend on our common stock of $0.60 per share which was paid in April 2018. During the first quarter of 2018, we also paid a cash dividend on our common stock of $0.60 per share which was declared during the fourth quarter of 2017.

During the first quarter of 2017, we declared a cash dividend on our common stock of $0.48 per share which was paid in April 2017. During the first quarter of 2017, we also paid a cash dividend on our common stock of $0.48 per share which was declared during the fourth quarter of 2016.

In April 2017, our board of directors authorized a 12-month common stock repurchase program for up to $500.0 million that was completed in February 2018. During the first quarter of 2018, we repurchased 2.1 million shares of our common stock for a total of $275.0 million in open market transactions that were recorded within Treasury stock in our consolidated balance sheet. Our repurchases under this program, including the 1.8 million shares repurchased for $225.0 million during 2017, totaled $500.0 million.

Note 9. Changes in Accumulated Other Comprehensive Income (Loss)
 
The following table presents the changes in accumulated other comprehensive income (loss) by component for the quarters ended March 31, 2018 and 2017 (in thousands):

 
Accumulated Other Comprehensive Income (Loss) for the Quarter Ended March 31, 2018
 
Accumulated Other Comprehensive Income (Loss) for the Quarter Ended March 31, 2017
 
Changes
related to
cash flow
derivative
hedges
 
Changes in
defined
benefit plans
 
Foreign
currency
translation
adjustments
 
Accumulated other
comprehensive loss
 
Changes
related to
cash flow
derivative
hedges
 
Changes in
defined
benefit plans
 
Foreign
currency
translation
adjustments
 
Accumulated other
comprehensive loss
Accumulated comprehensive loss at beginning of the year
$
(250,355
)
 
$
(33,666
)
 
$
(50,244
)
 
$
(334,265
)
 
$
(820,850
)
 
$
(28,083
)
 
$
(67,551
)
 
$
(916,484
)
Other comprehensive income (loss) before reclassifications
127,616

 
7,417

 
1,160

 
136,193

 
(30,929
)
 
(904
)
 
2,342

 
(29,491
)
Amounts reclassified from accumulated other comprehensive loss
14,914

 
343

 

 
15,257

 
53,390

 
263

 

 
53,653

Net current-period other comprehensive income (loss)
142,530

 
7,760

 
1,160

 
151,450

 
22,461

 
(641
)
 
2,342

 
24,162

Ending balance
$
(107,825
)
 
$
(25,906
)
 
$
(49,084
)
 
$
(182,815
)
 
$
(798,389
)
 
$
(28,724
)
 
$
(65,209
)
 
$
(892,322
)

The following table presents reclassifications out of accumulated other comprehensive income (loss) for the quarters ended March 31, 2018 and 2017 (in thousands):

 
 
Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) into Income
 
 
Details About Accumulated  Other Comprehensive Income (Loss) Components
 
Quarter Ended March 31, 2018
 
Quarter Ended March 31, 2017
 
Affected Line Item in  Statements of
Comprehensive Income (Loss)
Loss on cash flow derivative hedges:
 
 

 
 
 
 
Interest rate swaps
 
$
(6,838
)
 
$
(8,857
)
 
Interest expense, net of interest capitalized
Foreign currency forward contracts
 
(3,312
)
 
(2,710
)
 
Depreciation and amortization expenses
Foreign currency forward contracts
 
42

 
(3,570
)
 
Other expense
Foreign currency collar options
 

 
(602
)
 
Depreciation and amortization expenses
Fuel swaps
 
325

 
2,277

 
Other expense
Fuel swaps
 
(5,131
)
 
(39,928
)
 
Fuel
 
 
(14,914
)
 
(53,390
)
 
 
Amortization of defined benefit plans:
 
 

 
 
 
 
Actuarial loss
 
(343
)
 
(263
)
 
Payroll and related
 
 
(343
)
 
(263
)
 
 
Total reclassifications for the period
 
$
(15,257
)
 
$
(53,653
)
 
 

11


Note 10. Fair Value Measurements and Derivative Instruments
 
Fair Value Measurements
 
The estimated fair value of our financial instruments that are not measured at fair value, categorized based upon the fair value hierarchy, are as follows (in thousands): 
 
 
Fair Value Measurements at March 31, 2018 Using
 
Fair Value Measurements at December 31, 2017 Using
Description
 
Total Carrying Amount
 
Total Fair Value
 
Level 1(1)
 
Level 2(2)
 
Level 3(3)
 
Total Carrying Amount
 
Total Fair Value
 
Level 1(1)
 
Level 2(2)
 
Level 3(3)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents(4)
 
$
111,245

 
$
111,245

 
$
111,245

 
$

 
$

 
$
120,112

 
$
120,112

 
$
120,112

 
$

 
$

Total Assets
 
$
111,245

 
$
111,245

 
$
111,245

 
$

 
$

 
$
120,112

 
$
120,112

 
$
120,112

 
$

 
$

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Long-term debt (including current portion of long-term debt)(5)
 
$
8,762,052

 
$
9,333,745

 
$

 
$
9,333,745

 
$

 
$
7,506,312

 
$
8,038,092

 
$

 
$
8,038,092

 
$

Total Liabilities
 
$
8,762,052

 
$
9,333,745

 
$

 
$
9,333,745

 
$

 
$
7,506,312

 
$
8,038,092

 
$

 
$
8,038,092

 
$


(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 the creditworthiness of the Company.
(3) Inputs that are unobservable. The Company did not use any Level 3 inputs as of March 31, 2018 and December 31, 2017.
(4) Consists of cash and marketable securities with original maturities of less than 90 days.
(5) Consists of unsecured revolving credit facilities, senior notes, senior debentures and term loans. This does not include our capital lease obligations.

12


Other Financial Instruments
 
The carrying amounts of accounts receivable, accounts payable, accrued interest and accrued expenses approximate fair value at March 31, 2018 and December 31, 2017.
 
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):
 
 
Fair Value Measurements at March 31, 2018 Using
 
Fair Value Measurements at December 31, 2017 Using
Description
 
Total
 
Level 1(1)
 
Level 2(2)
 
Level 3(3)
 
Total
 
Level 1(1)
 
Level 2(2)
 
Level 3(3)
Assets:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Derivative financial instruments(4)
 
$
391,116

 
$

 
$
391,116

 
$

 
$
320,385

 
$

 
$
320,385

 
$

Investments(5)
 
$
5

 
5

 

 

 
$
3,340

 
3,340

 

 

Total Assets
 
$
391,121

 
$
5

 
$
391,116

 
$

 
$
323,725

 
$
3,340

 
$
320,385

 
$

Liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Derivative financial instruments(6)
 
$
118,117

 
$

 
$
118,117

 
$

 
$
115,961

 
$

 
$
115,961

 
$

Total Liabilities
 
$
118,117

 
$

 
$
118,117

 
$

 
$
115,961

 
$

 
$
115,961

 
$


(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 swaps 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. 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 March 31, 2018 and December 31, 2017.
(4) Consists of foreign currency forward contracts, interest rate swaps and fuel swaps. 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 reported within Other assets in our consolidated balance sheets.
(6) Consists of foreign currency forward contracts, interest rate swaps and fuel swaps. 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 March 31, 2018 or December 31, 2017, or that will be realized in the future, and do not include expenses that could be incurred in an actual sale or settlement.

The following table presents information about the fair value of our equity method investment and note and other receivables due related to SkySea Holding, further discussed in Note 5. Other Assets, recorded at fair value on a nonrecurring basis (in thousands):

 
 
Fair Value Measurements at March 31, 2018 Using
Description
 
Total Carrying Amount
 
Total Fair Value
 
Level 3
 
Total Impairment
Equity-method investment- SkySea Holding (1)
 
$

 
$

 
$

 
$
509

Debt facility and other receivables due from Skysea Holding (2)
 
$
69,562

 
$
69,562

 
$
69,562

 
$
22,834

Total
 
$
69,562

 
$
69,562

 
$
69,562

 
$
23,343


(1) Due to the expectation that Skysea Holding will cease business operations by the end of 2018, we do not deem our investment balance to be recoverable and therefore, we estimated the fair value of our investment to be zero as of March 31, 2018.

(2) We estimated the fair value of our debt facility and other receivables due from Skysea Holding based on the fair value of the collateral of the debt facility, Skysea Holding's ship, Golden Era. During the quarter ended March 31, 2018, Skysea Holding agreed to sell Golden Era to an affiliate of TUI AG, our joint venture partner in TUI Cruises. The fair value of the ship represents the net realizable value based on the agreed upon sale price of the ship. The sale of the ship is expected to be completed in December 2018. For further information on the Skysea Holding impairment, refer to Note 5. Other Assets.


13


We have master International Swaps and Derivatives Association (“ISDA”) agreements in place with our derivative instrument counterparties. These ISDA agreements provide for final close out netting with our counterparties for all positions in the case of default or termination of the ISDA agreement. We have determined that our ISDA agreements provide us with rights of setoff on the fair value of derivative instruments in a gain position and those in a loss position with the same counterparty. We have elected not to offset such derivative instrument fair values in our consolidated balance sheets.

See Credit Related Contingent Features for further discussion on contingent collateral requirements for our derivative instruments.

The following table presents information about the Company’s offsetting of financial assets under master netting agreements with derivative counterparties:
 
 
Gross Amounts not Offset in the Consolidated Balance Sheet that are Subject to Master Netting Agreements
 
 
As of March 31, 2018
 
As of December 31, 2017
 
 
Gross Amount of Derivative Assets Presented in the Consolidated Balance Sheet
 
Gross Amount of Eligible Offsetting
Recognized
Derivative Liabilities
 
Cash Collateral
Received
 
Net Amount of
Derivative Assets
 
Gross Amount of Derivative Assets Presented in the Consolidated Balance Sheet
 
Gross Amount of Eligible Offsetting
Recognized
Derivative Assets
 
Cash Collateral
Received
 
Net Amount of
Derivative Assets
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives subject to master netting agreements
 
$
391,116

 
$
(110,989
)
 
$

 
$
280,127

 
$
320,385

 
$
(104,751
)
 
$

 
$
215,634

Total
 
$
391,116

 
$
(110,989
)
 
$

 
$
280,127

 
$
320,385

 
$
(104,751
)
 
$

 
$
215,634


The following table presents information about the Company’s offsetting of financial liabilities under master netting agreements with derivative counterparties:
 
 
Gross Amounts not Offset in the Consolidated Balance Sheet that are Subject to Master Netting Agreements
 
 
As of March 31, 2018
 
As of December 31, 2017
 
 
Gross Amount of Derivative Liabilities Presented in the Consolidated Balance Sheet
 
Gross Amount of Eligible Offsetting
Recognized
Derivative Assets
 
Cash Collateral
Pledged
 
Net Amount of
Derivative Liabilities
 
Gross Amount of Derivative Liabilities Presented in the Consolidated Balance Sheet
 
Gross Amount of Eligible Offsetting
Recognized
Derivative Liabilities
 
Cash Collateral
Pledged
 
Net Amount of
Derivative Liabilities
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives subject to master netting agreements
 
$
(118,117
)
 
$
110,989

 
$

 
$
(7,128
)
 
$
(115,961
)
 
$
104,751

 
$

 
$
(11,210
)
Total
 
$
(118,117
)
 
$
110,989

 
$

 
$
(7,128
)
 
$
(115,961
)
 
$
104,751

 
$

 
$
(11,210
)

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 seek to limit our exposure to an individual counterparty. Credit risk, including but not limited to counterparty nonperformance under derivative instruments, our 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 many of which we have long-term relationships with and which have credit risks acceptable to us or where the credit risk is spread out among a large number of counterparties. As of March 31, 2018 and December 31, 2017, we had counterparty credit risk exposure under our derivative instruments of approximately $273.4 million and $212.8 million, respectively, which were limited to the cost of replacing the contracts in the event of non-performance by the counterparties to the contracts, the majority of which are currently our lending banks. We do not anticipate nonperformance by any of our significant counterparties. In addition, we have established guidelines we follow regarding credit ratings and instrument maturities 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.

14


Derivative Instruments
 
We are exposed to market risk attributable to changes in interest rates, foreign currency exchange rates and fuel prices. We try to mitigate 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 notional amount, term and conditions of the derivative instrument with the underlying risk being hedged. Although certain of our derivative financial instruments do not qualify or are not accounted for under hedge accounting, our objective is not to hold or issue derivative financial instruments for trading or other speculative purposes. 
 
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 use 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 until the underlying hedged transactions are recognized in earnings. The foreign currency transaction gain or loss of our non-derivative financial instruments and the changes in the fair value of derivatives designated as hedges of our net investment in foreign operations and investments are recognized as a component of Accumulated other comprehensive loss along with the associated foreign currency translation adjustment of the foreign operation or investment, with the amortization of excluded components affecting earnings.
 
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 of up to three years, utilizing market data relevant to the hedge horizon of each hedge relationship. High effectiveness is achieved 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. 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.
 
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.
 
We consider the classification of the underlying hedged item’s cash flows in determining the classification for the designated derivative instrument’s cash flows. We classify derivative instrument cash flows from hedges of benchmark interest rate or hedges of fuel expense as operating activities due to the nature of the hedged item. Likewise, we classify derivative instrument cash flows from hedges of foreign currency risk on our newbuild ship payments as investing activities and derivative instrument cash flows from hedges of foreign currency risk on debt payments as financing 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 March 31, 2018 and December 31, 2017, approximately 60.9% and 57.4%, respectively, of our long-term debt was effectively fixed. We use interest rate swap agreements to modify our exposure to interest rate movements and to manage our interest expense.

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 March 31, 2018 and December 31, 2017, we maintained interest rate swap agreements on the following fixed-rate debt instruments:

15


Debt Instrument
Swap Notional as of March 31, 2018 (In thousands)
Maturity
Debt Fixed Rate
Swap Floating Rate: LIBOR plus
All-in Swap Floating Rate as of March 31, 2018
Oasis of the Seas term loan
$
140,000

October 2021
5.41%
3.87%
5.44%
Unsecured senior notes
650,000

November 2022
5.25%
3.63%
5.47%
 
$
790,000

 
 
 
 

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. At March 31, 2018 and December 31, 2017, we maintained interest rate swap agreements on the following floating-rate debt instruments:
Debt Instrument
Swap Notional as of March 31, 2018 (In thousands)
Maturity
Debt Floating Rate
All-in Swap Fixed Rate
Celebrity Reflection term loan
$
381,792

October 2024
LIBOR plus
0.40%
2.85%
Quantum of the Seas term loan
551,250

October 2026
LIBOR plus
1.30%
3.74%
Anthem of the Seas term loan
573,958

April 2027
LIBOR plus
1.30%
3.86%
Ovation of the Seas term loan 
726,250

April 2028
LIBOR plus
1.00%
3.16%
Harmony of the Seas term loan (1)
746,332

May 2028
EURIBOR plus
1.15%
2.26%
 
$
2,979,582

 
 
 
 

(1) Interest rate swap agreements hedging the Euro-denominated term loan for Harmony of the Seas include EURIBOR zero-floor matching the hedged debt EURIBOR zero-floor. Amount presented is based on the exchange rate as of March 31, 2018.

These interest rate swap agreements are accounted for as cash flow hedges.
 
The notional amount of interest rate swap agreements related to outstanding debt as of March 31, 2018 and December 31, 2017 was $3.8 billion.
 
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, our foreign currency denominated debt and our international business operations. We enter into foreign currency forward contracts, to manage portions of the exposure to movements in foreign currency exchange rates. As of March 31, 2018, the aggregate cost of our ships on order, not including any ships on order by our Partner Brands, was approximately $11.7 billion, of which we had deposited $419.0 million as of such date. At March 31, 2018 and December 31, 2017, approximately 55.9% and 54.0%, respectively, of the aggregate cost of the ships under construction was exposed to fluctuations in the Euro exchange rate. The majority of our foreign currency forward contracts, collar options and cross currency swap agreements are accounted for as cash flow, fair value or net investment hedges depending on the designation of the related hedge.

On a regular basis, we enter into foreign currency forward contracts and, from time to time, we utilize cross-currency swap agreements 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 first quarter of 2018, we maintained an average of approximately $770.5 million of these foreign currency forward contracts. These instruments are not designated as hedging instruments. Changes in the fair value of the foreign currency forward contracts resulted in a gain, of approximately $5.6 million and $13.8 million during the quarters ended March 31, 2018 and March 31, 2017, respectively, that were recognized in earnings within Other expense in our consolidated statements of comprehensive income (loss).

We consider our investments in our foreign operations to be denominated in relatively stable currencies and of a long-term nature. As of March 31, 2018, we maintained foreign currency forward contracts and designated them as hedges of a portion of our net investments primarily in TUI cruises of €101.0 million, or approximately $124.2 million based on the exchange rate at March 31, 2018. These forward currency contracts mature in October 2021.


16


The notional amount of outstanding foreign exchange contracts including our forward contracts as of March 31, 2018 and December 31, 2017 was $4.0 billion and $4.6 billion, respectively.

Non-Derivative Instruments

We also address the exposure of our investments in foreign operations by denominating a portion of our debt in our subsidiaries’ and investments’ functional currencies and designating it as a hedge of these subsidiaries and investments. We had designated debt as a hedge of our net investments primarily in TUI Cruises of approximately €301.0 million, or approximately $370.6 million, as of March 31, 2018. As of December 31, 2017, we had designated debt as a hedge of our net investments in TUI Cruises of approximately €246.0 million, or approximately $295.3 million.

 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 to mitigate the financial impact of fluctuations in fuel prices.
 
Our fuel swap agreements are accounted for as cash flow hedges. At March 31, 2018, we have hedged the variability in future cash flows for certain forecasted fuel transactions occurring through 2022. As of March 31, 2018 and December 31, 2017, we had the following outstanding fuel swap agreements:
 
Fuel Swap Agreements
 
As of March 31, 2018
 
As of December 31, 2017
 
(metric tons)
2018
512,800

 
673,700

2019
668,500

 
668,500

2020
531,200

 
531,200

2021
224,900

 
224,900

2022

 

 
Fuel Swap Agreements
 
As of March 31, 2018
 
As of December 31, 2017
 
(% hedged)
Projected fuel purchases:
 

 
 

2018
50
%
 
50
%
2019
47
%
 
46
%
2020
36
%
 
36
%
2021
14
%
 
14
%
2022

 

 
At March 31, 2018 and December 31, 2017, $19.7 million and $23.7 million, respectively, of estimated unrealized net loss associated with our cash flow hedges pertaining to fuel swap agreements were expected to be reclassified to earnings from Accumulated other comprehensive loss within the next twelve months. Reclassification is expected to occur as the result of fuel consumption associated with our hedged forecasted fuel purchases.

The fair value and line item caption of derivative instruments recorded within our consolidated balance sheets were as follows:

17


 
 
Fair Value of Derivative Instruments
 
 
Asset Derivatives
 
Liability Derivatives
 
 
Balance Sheet Location
 
As of March 31, 2018
 
As of December 31, 2017
 
Balance Sheet Location
 
As of March 31, 2018
 
As of December 31, 2017
 
 
 
Fair Value
 
Fair Value
 
 
Fair Value
 
Fair Value
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives designated as hedging instruments under ASC 815-20(1)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
Other assets
 
$
38,096

 
$
7,330

 
Other long-term liabilities
 
$
47,251

 
$
46,509

Foreign currency forward contracts
 
Derivative financial instruments
 
42,688

 
68,352

 
Derivative financial instruments
 
1,390

 

Foreign currency forward contracts
 
Other assets
 
235,802

 
158,879

 
Other long-term liabilities
 
12,426

 
6,625

Fuel swaps
 
Derivative financial instruments
 
22,061

 
13,137

 
Derivative financial instruments
 
31,235

 
38,488

Fuel swaps
 
Other assets
 
38,562

 
51,265

 
Other long-term liabilities
 
15,180

 
13,411

Total derivatives designated as hedging instruments under 815-20
 
 
 
377,209

 
298,963

 
 
 
107,482

 
105,033

Derivatives not designated as hedging instruments under ASC 815-20
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
Derivative financial instruments
 
$
4,361

 
$
9,945

 
Derivative financial instruments
 
$
2,369

 
$
2,933

Foreign currency forward contracts
 
Other assets
 
4,413

 
2,793

 
Other long-term liabilities
 
2,762

 
1,139

Fuel swaps
 
Derivative financial instruments
 
4,830

 
7,886

 
Derivative financial instruments
 
5,320

 
6,043

Fuel swaps
 
Other Assets
 
303

 
798

 
Other long-term liabilities
 
184

 
813

Total derivatives not designated as hedging instruments under 815-20
 
 
 
13,907

 
21,422

 
 
 
10,635

 
10,928

Total derivatives
 
 
 
$
391,116

 
$
320,385

 
 
 
$
118,117

 
$
115,961


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

The location and amount of gain or (loss) recognized in income on fair value and cash flow hedging relationships were as follows (in thousands):


18


 
 
 
 
Quarter Ended March 31, 2018
Quarter Ended March 31, 2017
 
 
 
 
 
Fuel Expense
 
Depreciation and Amortization Expenses
 
Interest Income (Expense)
 
Other Income (Expense)
 
Fuel Expense
 
Depreciation and Amortization Expenses
 
Interest Income (Expense)
 
Other Income (Expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total amounts of income and expense line items presented in the statement of financial performance in which the effects of fair value or cash flow hedges are recorded
 
160,341
 
240,230
 
(60,145)
 
(757
)
 
177,414
 
235,749
 
(74,065)
 
(2,611
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The effects of fair value and cash flow hedging:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gain or (loss) on fair value hedging relationships in Subtopic 815-20
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hedged items
 
n/a
 
n/a
 
13,182
 
n/a
 
n/a
 
n/a
 
n/a
 
2,457

 
 
 
Derivatives designated as hedging instruments
 
n/a
 
n/a
 
(12,570)
 
n/a
 
n/a
 
n/a
 
1,173
 
(1,531
)
 
Gain or (loss) on cash flow hedging relationships in Subtopic 815-20
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income
 
n/a
 
n/a
 
(6,838)
 
n/a
 
n/a
 
n/a
 
(8,857)
 
n/a
 
 
 
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income as a result that a forecasted transaction is no longer probable of occurring
 
n/a
 
n/a
 
n/a
 
n/a
 
n/a
 
n/a
 
n/a
 
n/a
 
 
Commodity contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Amount of gain or (loss) reclassified from accumulated other comprehensive loss into income
 
(5,131)
 
n/a
 
n/a
 
325

 
(39,928)
 
n/a
 
n/a
 
2,277

 
 
 
Amount excluded from effectiveness testing recognized in earnings based on changes in fair value
 
n/a
 
n/a
 
n/a
 
n/a
 
n/a
 
n/a
 
n/a
 
n/a

 
 
Foreign exchange contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income
 
n/a
 
(3,312)
 
n/a
 
42

 
n/a
 
(3,312)
 
n/a
 
(3,570
)
 
 
 
Amount excluded from effectiveness testing recognized in earnings based on changes in fair value
 
n/a
 
n/a
 
n/a
 
n/a

 
n/a
 
n/a
 
n/a
 
n/a


The carrying value and line item caption of non-derivative instruments designated as hedging instruments recorded within our consolidated balance sheets were as follows:

 
 
 
 
Carrying Value
Non-derivative instrument designated as
hedging instrument under ASC 815-20
 
Balance Sheet Location
 
As of March 31, 2018
 
As of December 31, 2017
(In thousands)
 
 
 
 
 
 
Foreign currency debt
 
Current portion of long-term debt
 
$
88,353

 
$
70,097

Foreign currency debt
 
Long-term debt
 
281,907

 
225,226

 
 
 
 
$
370,260

 
$
295,323


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 (loss) was as follows:

19


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
 
Amount of Gain (Loss)
Recognized in
Income on Derivative
Amount of Gain (Loss)
Recognized in
Income on Hedged Item
Quarter Ended March 31, 2018
 
Quarter Ended March 31, 2017
 
Quarter Ended March 31, 2018
 
Quarter Ended March 31, 2017
(In thousands)
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
Interest expense, net of interest capitalized
 
$
(12,570
)
 
$
1,173

 
$
13,182

 
$

Interest rate swaps
 
Other expense
 

 
(1,531
)
 

 
2,457

 
 
 
 
$
(12,570
)
 
$
(358
)
 
$
13,182

 
$
2,457


The fair value and line item caption of derivative instruments recorded within our consolidated balance sheets for the cumulative basis adjustment for fair value hedges were as follows (in thousands):

Line Item in the Statement of Financial PositionWhere the Hedged Item is Included
 
Carrying Amount of the Hedged Assets/(Liabilities)
 
Cumulative amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Assets/(Liabilities)
 
As of March 31, 2018
 
As of December 31, 2017
 
As of March 31, 2018
 
As of December 31, 2017
 
 
 
 
 
 
 
 
 
Current portion of long-term debt and Long-term debt
 
$
751,014

 
$
749,155

 
$
(33,274
)
 
$
(34,813
)
 
 
$
751,014

 
$
749,155

 
$
(33,274
)
 
$
(34,813
)

The effect of derivative instruments qualifying and designated as cash flow hedging instruments on the consolidated financial statements was as follows:
Derivatives
under ASC 815-20  Cash Flow Hedging Relationships
 
Amount of Gain (Loss) Recognized in
Accumulated Other
Comprehensive Income (Loss) on Derivative 
(Effective Portion)
 
Location of
Gain (Loss)
Reclassified
from
Accumulated
Other Comprehensive
Loss into Income
(Effective
Portion)
 
Amount of Gain (Loss) Reclassified from
Accumulated Other Comprehensive Income (Loss) into Income  (Effective Portion)
Quarter Ended March 31, 2018
 
Quarter Ended March 31, 2017
 
 
Quarter Ended March 31, 2018
 
Quarter Ended March 31, 2017
(In thousands)
 
 

 
 

 
 
 
 

 
 

Interest rate swaps
 
$
37,191

 
$
(2,489
)
 
Interest expense, net of interest capitalized
 
$
(6,838
)
 
$
(8,857
)
Foreign currency forward contracts
 
95,366

 
2,129

 
Depreciation and amortization expenses
 
(3,312
)
 
(2,710
)
Foreign currency forward contracts
 

 

 
Other expense
 
42

 
(3,570
)
Foreign currency collar options
 

 

 
Depreciation and amortization expenses
 

 
(602
)
Fuel swaps
 

 

 
Other expense
 
325

 
2,277

Fuel swaps
 
(4,941
)
 
(30,569
)
 
Fuel
 
(5,131
)
 
(39,928
)
 
 
$
127,616

 
$
(30,929
)
 
 
 
$
(14,914
)
 
$
(53,390
)

Gain (Loss) Recognized in Income (Net Investment Excluded Components) (1)
 
 
(In thousands)
 
 

Net inception fair value at January 1, 2018
 
$
(11,335
)
Fair value at March 31, 2018
 
(8,861
)
Change in fair value at March 31, 2018

(2,474
)
Amount of gain recognized in income for the quarter ended March 31, 2018
 
744

Amount of gain recognized in accumulated other comprehensive loss

$
(1,730
)


20


(1) Represents amounts excluded from the assessment of effectiveness for which the difference between changes in fair value and periodic amortization is recorded in other comprehensive income.

The effect of non-derivative instruments qualifying and designated as net investment hedging instruments on the consolidated financial statements was as follows:
 
 
Amount of Gain (Loss) Recognized in Other Comprehensive Income (Loss)
Non-derivative instruments under ASC 815-20 Net
Investment Hedging Relationships
 
Quarter Ended March 31, 2018
 
Quarter Ended March 31, 2017
(In thousands)
 
 

 
 

Foreign Currency Debt
 
$
(8,244
)
 
$
4,369

 
 
$
(8,244
)
 
$
4,369


There was no amount recognized in income (ineffective portion and amount excluded from effectiveness testing) for the quarters March 31, 2018 and March 31, 2017, respectively.

The effect of derivatives not designated as hedging instruments on the consolidated financial statements was as follows:
 
 
 
 
Amount of Gain (Loss) Recognized in Income on Derivatives
Derivatives Not Designated as Hedging
Instruments under ASC 815-20
 
Location of
Gain (Loss) Recognized in
Income on Derivatives
 
Quarter Ended March 31, 2018
 
Quarter Ended March 31, 2017
(In thousands)
 
 
 
 

 
 

Foreign currency forward contracts
 
Other expense
 
$
5,635

 
$
13,812

Fuel swaps
 
Other expense
 
(30
)
 
(60
)
Fuel swaps
 
Fuel
 
2,205

 

 
 
 
 
$
7,810

 
$
13,752

 
Credit Related Contingent Features
 
Our current interest rate derivative instruments may require us to post collateral if our Standard & Poor’s and Moody’s credit ratings are below specified levels. Specifically, if on the fifth anniversary of executing a derivative instrument, or on any succeeding fifth-year anniversary, our credit ratings for our senior unsecured debt were to be rated below BBB- by Standard & Poor’s and Baa3 by Moody’s, then the counterparty may periodically demand that we post collateral in an amount equal to the difference between (i) the net market value of all derivative transactions with such counterparty that have reached their fifth year anniversary, to the extent negative, and (ii) the applicable minimum call amount.

The amount of collateral required to be posted following such event will change as, and to the extent, our net liability position increases or decreases by more than the applicable minimum call amount. If our credit rating for our senior unsecured debt is subsequently equal to or above BBB- by Standard & Poor’s or Baa3 by Moody’s, then any collateral posted at such time will be released to us and we will no longer be required to post collateral unless we meet the collateral trigger requirement at the next fifth-year anniversary. At March 31, 2018, four of our interest rate derivative instruments had reached their fifth anniversary; however, our senior unsecured debt credit rating was BBB- by Standard & Poor’s and Baa3 by Moody’s and, accordingly, we were not required to post any collateral as of such date.

21



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Cautionary Note Concerning Forward-Looking Statements
 
The discussion under this caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this document includes "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact, including statements regarding guidance (including our expectations for the second quarter and full year of 2018 and our earnings and yield estimates for 2018 set forth under the heading "Outlook" below), business and industry prospects or future results of operations or financial position, made in this Quarterly Report on Form 10-Q are forward-looking. Words such as "anticipate," "believe," "could," "estimate," "expect," "goal," "intend," "may," "plan," "project," "seek," "should," "will," "driving" and similar expressions are intended to further identify any of these forward-looking statements. Forward-looking statements reflect management's current expectations but they are based on judgments and are inherently uncertain. Furthermore, they are subject to risks, uncertainties and other factors that could cause our actual results, performance or achievements to differ materially from the future results, performance or achievements expressed or implied in those forward-looking statements. Examples of these risks, uncertainties and other factors include, but are not limited to, those discussed in this Quarterly Report on Form 10-Q and, in particular, the risks discussed under the caption "Risk Factors" in Part II, Item 1A herein.
 
All forward-looking statements made in this Quarterly Report on Form 10-Q speak only as of the date of this document.  Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
 
Overview
 
The discussion and analysis of our financial condition and results of operations has been organized to present the following:

a review of our financial presentation, including discussion of certain operational and financial metrics we utilize to assist us in managing our business;

a discussion of our results of operations for the quarter ended March 31, 2018 compared to the same period in 2017;

a discussion of our business outlook, including our expectations for selected financial items for the second quarter and full year of 2018; and

a discussion of our liquidity and capital resources, including our future capital and contractual commitments and potential funding sources.
 

22


Critical Accounting Policies

For a discussion of our critical accounting policies, refer to Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations within our Annual Report on Form 10-K for the year ended December 31, 2017.


Seasonality
 
Our revenues are seasonal based on demand for cruises. Demand is strongest for cruises during the Northern Hemisphere’s summer months and holidays. In order to mitigate the impact of the winter weather in the Northern Hemisphere and to capitalize on the summer season in the Southern Hemisphere, our brands have focused on deployment to the Caribbean, Asia and Australia during that period.

Financial Presentation
 
Description of Certain Line Items
 
Revenues
 
Our revenues are comprised of the following:

Passenger ticket revenues, which consist of revenue recognized from the sale of passenger tickets and the sale of air transportation to and from our ships; and

Onboard and other revenues, which consist primarily of revenues from the sale of goods and/or services onboard our ships not included in passenger ticket prices, cancellation fees, sales of vacation protection insurance and pre- and post-cruise tours. Onboard and other revenues also includes revenues we receive from independent third party concessionaires that pay us a percentage of their revenues in exchange for the right to provide selected goods and/or services onboard our ships as well as revenues received for our bareboat charter, procurement and management related services we perform on behalf of our unconsolidated affiliates.
 
Cruise Operating Expenses
 
Our cruise operating expenses are comprised of the following:

Commissions, transportation and other expenses, which consist of those costs directly associated with passenger ticket revenues, including travel agent commissions, air and other transportation expenses, port costs that vary with passenger head counts and related credit card fees;

Onboard and other expenses, which consist of the direct costs associated with onboard and other revenues, including the costs of products sold onboard our ships, vacation protection insurance premiums, costs associated with pre- and post-cruise tours and related credit card fees as well as the minimal costs associated with concession revenues, as the costs are mostly incurred by third-party concessionaires and costs incurred for the procurement and management related services we perform on behalf of our unconsolidated affiliates;

Payroll and related expenses, which consist of costs for shipboard personnel (costs associated with our shoreside personnel are included in Marketing, selling and administrative expenses);

Food expenses, which include food costs for both guests and crew;

Fuel expenses, which include fuel and related delivery, storage and emission consumable costs and the financial impact of fuel swap agreements; and

Other operating expenses, which consist primarily of operating costs such as repairs and maintenance, port costs that do not vary with passenger head counts, vessel related insurance, entertainment and gains and /or losses related to the sale of our ships, if any.
 

23


We do not allocate payroll and related expenses, food expenses, fuel expenses or other operating expenses to the expense categories attributable to passenger ticket revenues or onboard and other revenues since they are incurred to provide the total cruise vacation experience.

Selected Operational and Financial Metrics
 
We utilize a variety of operational and financial metrics which are defined below to evaluate our performance and financial condition. As discussed in more detail herein, certain of these metrics are non-GAAP financial measures. These non-GAAP financial measures are provided along with the related GAAP financial measures as we believe they provide useful information to investors as a supplement to our consolidated financial statements, which are prepared and presented in accordance with GAAP. The presentation of non-GAAP financial information is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP.
 
Adjusted Earnings per Share ("Adjusted EPS") represents Adjusted Net Income divided by weighted average shares outstanding or by diluted weighted average shares outstanding, as applicable. We believe that this non-GAAP measure is meaningful when assessing our performance on a comparative basis.
 
Adjusted Net Income represents net income excluding certain items that we believe adjusting for is meaningful when assessing our performance on a comparative basis. For the periods presented, these items included the impairment loss related to Skysea Holding and the impact of the change in accounting principle related to the recognition of stock-based compensation expense from the graded attribution method to the straight-line attribution method for time-based stock awards.

Available Passenger Cruise Days (“APCD”) is our measurement of capacity and represents double occupancy per cabin multiplied by the number of cruise days for the period , which excludes canceled cruise days and drydock days. We use this measure to perform capacity and rate analysis to identify our main non-capacity drivers that cause our cruise revenue and expenses to vary.
 
Gross Cruise Costs represent the sum of total cruise operating expenses plus marketing, selling and administrative expenses.
 
Gross Yields represent total revenues per APCD.
 
Net Cruise Costs and Net Cruise Costs Excluding Fuel represent Gross Cruise Costs excluding commissions, transportation and other expenses and onboard and other expenses and, in the case of Net Cruise Costs Excluding Fuel, fuel expenses (each of which is described above under the Description of Certain Line Items heading). In measuring our ability to control costs in a manner that positively impacts net income, we believe changes in Net Cruise Costs and Net Cruise Costs Excluding Fuel to be the most relevant indicators of our performance. A reconciliation of historical Gross Cruise Costs to Net Cruise Costs and Net Cruise Costs Excluding Fuel is provided below under Results of Operations. For the periods presented, Net Cruise Costs exclude the impact of the change in accounting principle related to the recognition of stock-based compensation expense from the graded attribution method to the straight-line attribution method for time-based stock awards, which was included within Marketing, selling and administrative expenses.

Net Revenues represent total revenues less commissions, transportation and other expenses and onboard and other expenses (each of which is described above under the Description of Certain Line Items heading).
 
Net Yields represent Net Revenues per APCD. We utilize Net Revenues and Net Yields to manage our business on a day-to-day basis as we believe that they are the most relevant measures of our pricing performance because they reflect the cruise revenues earned by us net of our most significant variable costs, which are commissions, transportation and other expenses and onboard and other expenses. A reconciliation of historical Gross Yields to Net Yields is provided below under Results of Operations
 
Occupancy, in accordance with cruise vacation industry practice, is calculated by dividing Passenger Cruise Days by APCD.  A percentage in excess of 100% indicates that three or more passengers occupied some cabins.
 
Passenger Cruise Days represent the number of passengers carried for the period multiplied by the number of days of their respective cruises.

Return on Invested Capital ("ROIC") is defined to mean “Operating Profit” divided by “Invested Capital,” whereby (i) “Operating Profit” is  adjusted operating income (including income from equity pick-ups and related items) minus taxes, and (ii) “Invested Capital” is the most recent five-quarter average of total debt (i.e., current portion of long-term debt plus long-term debt) plus shareholders equity. This is effective as of January 1, 2018.


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We believe Net Yields, Net Cruise Costs and Net Cruise Costs Excluding Fuel are our most relevant non-GAAP financial measures. However, a significant portion of our revenue and expenses are denominated in currencies other than the United States dollar. Because our reporting currency is the United States dollar, the value of these revenues and expenses can be affected by changes in currency exchange rates. Although such changes in local currency prices are just one of many elements impacting our revenues and expenses, they can be an important element. For this reason, we also monitor Net Yields, Net Cruise Costs and Net Cruise Costs Excluding Fuel as if the current periods’ currency exchange rates had remained constant with the comparable prior periods’ rates, or on a “Constant Currency” basis.
 
It should be emphasized that Constant Currency is primarily used for comparing short-term changes and/or projections. Changes in guest sourcing and shifting the amount of purchases between currencies can change the impact of the purely currency-based fluctuations.
 
The use of certain significant non-GAAP measures, such as Net Yields, Net Cruise Costs and Net Cruise Costs Excluding Fuel, allows us to perform capacity and rate analysis to separate the impact of known capacity changes from other less predictable changes which affect our business. We believe these non-GAAP measures provide expanded insight to measure revenue and cost performance in addition to the standard GAAP based financial measures. There are no specific rules or regulations for determining non-GAAP and Constant Currency measures, and as such, there exists the possibility that they may not be comparable to other companies within the industry.

We have not provided a quantitative reconciliation of (i) projected Total revenues to projected Net Revenues, (ii) projected Gross Yields to projected Net Yields, (iii) projected Gross Cruise Costs to projected Net Cruise Costs and projected Net Cruise Costs Excluding Fuel and (iv) projected Net Income and Earnings per Share to projected Adjusted Net Income and Adjusted Earnings per Share because preparation of meaningful GAAP projections of Total revenues, Gross Yields, Gross Cruise Costs, Net Income and Earnings per Share would require unreasonable effort. Due to significant uncertainty, we are unable to predict, without unreasonable effort, the future movement of foreign exchange rates, fuel prices and interest rates inclusive of our related hedging programs. In addition, we are unable to determine the future impact of restructuring expenses or other non-core business related gains and losses which may result from strategic initiatives. These items are uncertain and could be material to our results of operations in accordance with GAAP. Due to this uncertainty, we do not believe that reconciling information for such projected figures would be meaningful.

Results of Operations
 
Summary
 
Net income and Adjusted Net Income for the first quarter of 2018 was $218.7 million and $232.8 million, or $1.02 and $1.09 per share on a diluted basis, respectively, compared to both net income and Adjusted Net Income of $214.7 million, or $0.99 per share on a diluted basis, respectively, for the first quarter of 2017.
 
Significant items for the quarter ended March 31, 2018 include:

Total revenues, excluding the favorable effect of changes in foreign currency exchange rates, decreased $19.4 million for the quarter ended March 31, 2018 as compared to the same period in 2017. The decrease was primarily due to the decrease in capacity, partially offset by the increase in ticket prices, which are further discussed below.

The effect of changes in foreign currency exchange rates related to our passenger ticket and onboard and other revenue transactions denominated in currencies other than the United States dollar, resulted in an increase in total revenues of $38.6 million for the quarter ended March 31, 2018 compared to the same period in 2017.

Total cruise operating expenses, excluding the unfavorable effect of changes in foreign currency exchange rates, decreased $10.6 million for the quarter ended March 31, 2018 as compared to the same period in 2017. The decrease was primarily due to the decrease in capacity further discussed below, partially offset by the gain of $30.9 million recognized on the sale of Legend of the Seas in March 2017 that did not recur in 2018.

The effect of changes in foreign currency exchange rates related to our cruise operating expenses, denominated in currencies other than the United States dollar, resulted in an increase in total operating expenses of $10.8 million for the quarter ended March 31, 2018 compared to the same period in 2017.


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The recognition of an impairment loss of $23.3 million related to the Skysea Holding investment, debt facility and other receivables due, which is reported within Impairment loss related to SkySea Holding within our consolidated statements of comprehensive income (loss). Refer to Note 5. Other Assets for further discussion on the impairment.

Other Items

In March 2018, we took delivery of Symphony of the Seas. To finance the purchase, we borrowed $1.2 billion under a previously committed unsecured term loan. Refer to Note 6. Long-Term Debt to our consolidated financial statements for further information. The ship entered service at the end of the first quarter of 2018.

In March 2018, we completed the purchase of Azamara Pursuit. The ship is expected to enter service during the third quarter of 2018.

We entered into and drew in full on a credit agreement in the amount of $130.0 million. Refer to Note 6. Long-Term Debt to our consolidated financial statements for further information.

Operating results for the quarter ended March 31, 2018 compared to the same period in 2017 are shown in the following table (in thousands, except per share data):
 
Quarter Ended March 31,
 
2018
 
2017
 
 
 
% of Total
Revenues
 
 
 
% of Total
Revenues
Passenger ticket revenues
$
1,425,644

 
70.3
 %
 
$
1,418,223

 
70.6
 %
Onboard and other revenues
602,112

 
29.7
 %
 
590,337

 
29.4
 %
Total revenues
2,027,756

 
100.0
 %
 
2,008,560

 
100.0
 %
Cruise operating expenses:
 

 
 

 
 

 
 

Commissions, transportation and other
290,609

 
14.3
 %
 
310,248

 
15.4
 %
Onboard and other
99,537

 
4.9
 %
 
105,994

 
5.3
 %