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Item 7. 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, including, for example, under the "Risk Factors" and "Business" captions, 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 first 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 Annual Report on Form 10-K 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 Annual Report on Form 10-K and, in particular, the risks discussed under the caption "Risk Factors" in Part I, Item 1A of this report.
All forward-looking statements made in this Annual Report on Form 10-K 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 have been organized to present the following:
| • | a review of our critical accounting policies and 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 year ended December 31, 2017 compared to the same period in 2016 and the year ended December 31, 2016 compared to the same period in 2015; |
| • | a discussion of our business outlook, including our expectations for selected financial items for the first 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. |
Critical Accounting Policies
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). (Refer to Note 1. General and Note 2. Summary of Significant Accounting Policies to our consolidated financial statements under Item 8. Financial Statements and Supplementary Data). Certain of our accounting policies are deemed "critical," as they require management's highest degree of judgment, estimates and assumptions. We have discussed these accounting policies and estimates with the audit committee of our board of directors. We believe our most critical accounting policies are as follows:
Ship Accounting
Our ships represent our most significant assets and are stated at cost less accumulated depreciation and amortization. Depreciation of ships is generally computed net of a 15% projected residual value using the straight-line method over the estimated useful life of the asset, which is generally 30 years. The 30-year useful life of our newly constructed ships and 15% associated residual value are both based on the weighted-average of all major components
of a ship. Our useful life and residual value estimates take into consideration the impact of anticipated technological changes, long-term cruise and vacation market conditions and historical useful lives of similarly-built ships. In addition, we take into consideration our estimates of the weighted-average useful lives of the ships' major component systems, such as hull, superstructure, main electric, engines and cabins. Given the very large and complex nature of our ships, our accounting estimates related to ships and determinations of ship improvement costs to be capitalized require considerable judgment and are inherently uncertain. We do not have cost segregation studies performed to specifically componentize our ship systems. Therefore, we estimate the costs of component systems based principally on general and technical information known about major ship component systems and their lives and our knowledge of the cruise vacation industry. We do not identify and track depreciation by ship component systems, but instead utilize these estimates to determine the net cost basis of assets replaced or refurbished. Improvement costs that we believe add value to our ships are capitalized as additions to the ship and depreciated over the shorter of the improvements' estimated useful lives or that of the associated ship. The estimated cost and accumulated depreciation of replaced or refurbished ship components are written off and any resulting losses are recognized in Cruise operating expenses.
We use the deferral method to account for drydocking costs. Under the deferral method, drydocking costs incurred are deferred and charged to expense on a straight-line basis over the period to the next scheduled drydock, which we estimate to be a period of thirty to sixty months based on the vessel's age as required by Class. Deferred drydock costs consist of the costs to drydock the vessel and other costs incurred in connection with the drydock which are necessary to maintain the vessel's Class certification. Class certification is necessary in order for our cruise ships to be flagged in a specific country, obtain liability insurance and legally operate as passenger cruise ships. The activities associated with those drydocking costs cannot be performed while the vessel is in service and, as such, are done during a drydock as a planned major maintenance activity. The significant deferred drydock costs consist of hauling and wharfage services provided by the drydock facility, hull inspection and related activities (e.g., scraping, pressure cleaning, bottom painting), maintenance to steering propulsion, thruster equipment and ballast tanks, port services such as tugs, pilotage and line handling, and freight associated with these items. We perform a detailed analysis of the various activities performed for each drydock and only defer those costs that are directly related to planned major maintenance activities necessary to maintain Class. The costs deferred are related to activities not otherwise routinely periodically performed to maintain a vessel's designed and intended operating capability. Repairs and maintenance activities are charged to expense as incurred.
We use judgment when estimating the period between drydocks, which can result in adjustments to the estimated amortization of drydock costs. If the vessel is disposed of before the next drydock, the remaining balance in deferred drydock is written-off to the gain or loss upon disposal of vessel in the period in which the sale takes place. We also use judgment when identifying costs incurred during a drydock which are necessary to maintain the vessel's Class certification as compared to those costs attributable to repairs and maintenance which are expensed as incurred.
We believe we have made reasonable estimates for ship accounting purposes. However, should certain factors or circumstances cause us to revise our estimates of ship useful lives or projected residual values, depreciation expense could be materially higher or lower. If circumstances cause us to change our assumptions in making determinations as to whether ship improvements should be capitalized, the amounts we expense each year as repairs and maintenance costs could increase, partially offset by a decrease in depreciation expense. If we had reduced our estimated average ship useful life by one year, depreciation expense for 2017 would have increased by approximately $51.5 million. If our ships were estimated to have no residual value, depreciation expense for 2017 would have increased by approximately $215.5 million.
Valuation of Goodwill, Indefinite-Lived Intangible Assets and Long-Lived Assets
We review goodwill and indefinite-lived intangible assets for impairment at the reporting unit level annually or, when events or circumstances dictate, more frequently. The impairment review for goodwill consists of a qualitative assessment of whether it is more-likely-than-not that a reporting unit's fair value is less than its carrying amount, and if necessary, a two-step goodwill impairment test. Factors to consider when performing the qualitative assessment include general economic conditions, limitations on accessing capital, changes in forecasted operating results, changes in fuel prices and fluctuations in foreign exchange rates. If the qualitative assessment demonstrates that it is more-likely-than-not that the estimated fair value of the reporting unit exceeds its carrying value, it is not necessary to perform the two-step goodwill impairment test. We may elect to bypass the qualitative assessment and proceed directly to step
one, for any reporting unit, in any period. On a periodic basis, we elect to bypass the qualitative assessment and proceed to step one to corroborate the results of recent years' qualitative assessments. We can resume the qualitative assessment for any reporting unit in any subsequent period.
When performing the two-step goodwill impairment test, the fair value of the reporting unit is determined and compared to the carrying value of the net assets allocated to the reporting unit. We estimate the fair value of our reporting units using a probability-weighted discounted cash flow model. The estimation of fair value utilizing discounted expected future cash flows includes numerous uncertainties which require our significant judgment when making assumptions of expected revenues, operating costs, marketing, selling and administrative expenses, interest rates, ship additions and retirements as well as assumptions regarding the cruise vacation industry's competitive environment and general economic and business conditions, among other factors. The principal assumptions we use in the discounted cash flow model are projected operating results, weighted-average cost of capital, and terminal value. The discounted cash flow model uses the most current projected operating results for the upcoming fiscal year as a base. To that base, we add future years' cash flows assuming multiple revenue and expense scenarios that reflect the impact of different global economic environments beyond the base year on the reporting unit. We discount the projected cash flows using rates specific to the reporting unit based on its weighted-average cost of capital. If the fair value of the reporting unit exceeds its carrying value, no further analysis or write-down of goodwill is required. If the fair value of the reporting unit is less than the carrying value of its net assets, the implied fair value of the reporting unit is allocated to all its underlying assets and liabilities, including both recognized and unrecognized tangible and intangible assets, based on their fair value. If necessary, goodwill is then written down to its implied fair value.
The impairment review for indefinite-life intangible assets consists of a comparison of the fair value of the asset with its carrying amount. We estimate the fair value of these assets using a discounted cash flow model and various valuation methods depending on the nature of the intangible asset, such as the relief-from-royalty method for trademarks and tradenames. If the carrying amount exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. If the fair value exceeds its carrying amount, the indefinite-life intangible asset is not considered impaired. As of December 31, 2017, the carrying amount of indefinite-life intangible assets was not material. Other intangible assets assigned finite useful lives are amortized on a straight-line basis over their estimated useful lives.
We review our ships and other long-lived assets for impairment whenever events or changes in circumstances indicate, based on estimated undiscounted future cash flows, that the carrying amount of these assets may not be fully recoverable. We evaluate asset impairment at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. The lowest level for which we maintain identifiable cash flows that are independent of the cash flows of other assets and liabilities is at the ship level for our ships and, prior to the sale of the aircraft, at the aggregated asset group level for our aircraft. If estimated future cash flows are less than the carrying value of an asset, an impairment charge is recognized to the extent its carrying value exceeds fair value.
We estimate fair value based on quoted market prices in active markets, if available. If active markets are not available we base fair value on independent appraisals, sales price negotiations and projected future cash flows discounted at a rate estimated by management to be commensurate with the business risk. Quoted market prices are often not available for individual reporting units and for indefinite-life intangible assets. Accordingly, we estimate the fair value of a reporting unit and an indefinite-life intangible asset using an expected present value technique.
Royal Caribbean International
During the fourth quarter of 2017, we performed a qualitative assessment of the Royal Caribbean International reporting unit. Based on our qualitative assessment, we concluded that it was more-likely-than-not that the estimated fair value of the Royal Caribbean International reporting unit exceeded its carrying value and thus, we did not proceed to the two-step goodwill impairment test. No indicators of impairment exist primarily because the reporting unit's fair value has consistently exceeded its carrying value by a significant margin and forecasts of operating results generated by the reporting unit appear sufficient to support its carrying value. As of December 31, 2017, the carrying amount of goodwill attributable to our Royal Caribbean reporting unit was $286.9 million.
2015 Impairment of Pullmantur Related Assets
During the third quarter of 2015, we performed an interim impairment evaluation of Pullmantur’s goodwill and trademarks and trade names in connection with the preparation of our financial statements. As a result of this analysis, we determined that the carrying value of the Pullmantur reporting unit exceeded its fair value. Similarly, we determined that the carrying value of Pullmantur’s trademarks and trade names exceeded their fair value. Accordingly, upon the completion of the relevant impairment tests discussed above, we recognized impairment charges of $123.8 million and $174.3 million for goodwill and trademark and trade names, respectively, during the quarter ended September 30, 2015. These charges reflected the full carrying amounts of the goodwill and trademark and trade names leaving Pullmantur with no intangible assets on its books.
In conjunction with performing the two-step goodwill impairment test for the Pullmantur reporting unit, we identified that the estimated fair value of certain long-lived assets, consisting of two ships and three aircraft, was less than their carrying values. As a result of this determination, we evaluated these assets pursuant to our long-lived asset impairment test, resulting in an impairment charge of $113.2 million to write down these assets to their estimated fair values during the quarter ended September 30, 2015.
Derivative Instruments
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. Although certain of our derivative financial instruments do not qualify or are not accounted for under hedge accounting, we do not hold or issue derivative financial instruments for trading or other speculative purposes. We account for derivative financial instruments in accordance with authoritative guidance. Refer to Note 2. Summary of Significant Accounting Policies and Note 14. Fair Value Measurements and Derivative Instruments to our consolidated financial statements under Item 8. Financial Statements and Supplementary Data for more information on related authoritative guidance, the Company's hedging programs and derivative financial instruments.
We enter into foreign currency forward contracts and collars, interest rate, cross-currency and fuel swaps and options with third-party institutions in over-the-counter markets. We estimate the fair value of our foreign currency forward contracts and interest rate and cross-currency swaps using expected future cash flows based on the instruments' contract terms and published forward prices for foreign currency exchange and interest rates. We apply present value techniques and LIBOR or EURIBOR-based discount rates to convert the expected future cash flows to the current fair value of the instruments.
We estimate the fair value of our foreign currency collars using standard option pricing models with inputs based on the options' contract terms, such as exercise price and maturity, and readily available public market data, such as foreign exchange prices, foreign exchange volatility levels and discount rates.
We estimate the fair value of our fuel swaps using expected future cash flows based on the swaps' contract terms and forward prices. We derive forward prices from forward fuel curves based on pricing inputs provided by third-party institutions that transact in the fuel indices we hedge. We validate these pricing inputs against actual market transactions and published price quotes for similar assets. We apply present value techniques and LIBOR-based discount rates to convert the expected future cash flows to the current fair value of the instruments. We also corroborate our fair value estimates using valuations provided by our counterparties.
We adjust the valuation of our derivative financial instruments to incorporate credit risk.
We believe it is unlikely that materially different estimates for the fair value of our foreign currency forward contracts and interest rate, cross-currency and fuel swaps and options would be derived from other appropriate valuation models using similar assumptions, inputs or conditions suggested by actual historical experience.
Contingencies—Litigation
On an ongoing basis, we assess the potential liabilities related to any lawsuits or claims brought against us. While it is typically very difficult to determine the timing and ultimate outcome of such actions, we use our best judgment
to determine if it is probable that we will incur an expense related to the settlement or final adjudication of such matters and whether a reasonable estimation of such probable loss, if any, can be made. In assessing probable losses, we take into consideration estimates of the amount of insurance recoveries, if any, which are recorded as assets when recoverability is probable. We accrue a liability when we believe a loss is probable and the amount of loss can be reasonably estimated. Due to the inherent uncertainties related to the eventual outcome of litigation and potential insurance recoveries, it is possible that certain matters may be resolved for amounts materially different from any provisions or disclosures that we have previously made.
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. |
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 of the Pullmantur related assets, the net loss related to the elimination of the Pullmantur reporting lag, the net gain related to the 51% sale of the Pullmantur and CDF Croisières de France ("CDF") brands, restructuring charges and other initiative costs related to our Pullmantur right-sizing strategy and other restructuring initiatives.
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.
Double-Double Program refers to the multi-year Adjusted EPS and Return on Invested Capital ("ROIC") goals we publicly announced in 2014 and sought to achieve by the end of 2017. We designed this program to help us better execute and achieve our business goals by clearly articulating longer-term financial objectives. Under the Double-Double Program, we targeted Adjusted EPS of $6.78 by the end of 2017, which was double our 2014 Adjusted EPS of $3.39. We also targeted ROIC of 10% by the end of 2017 as compared to ROIC of 5.9% in 2014.
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 excludes the net gain related to the 51% sale of the Pullmantur and CDF brands, restructuring charges and other initiative costs related to our Pullmantur right-sizing strategy and other restructuring initiatives.
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. For the periods presented, Net Yields excludes initiative costs related to the sale of the Pullmantur and CDF brands.
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.
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 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.
Executive Overview
Our 2017 net income was $1.6 billion, or $7.53 per diluted share, compared to $1.3 billion, or $5.93 per diluted share, in 2016. Adjusted Net Income for 2017 was $1.6 billion, or $7.53 per diluted share, compared to $1.3 billion, or $6.08 per diluted share, in 2016. Adjusted EPS for 2017 represents the fourth straight year we achieved a record amount, growing approximately 24% compared to 2016.
The year 2017 marked the final year of our Double-Double program ("Double-Double"), which was comprised of two multi-year financial targets, including doubling our 2014 Adjusted EPS to $6.78 and achieving double-digit ROIC by the end of 2017. The Double-Double program was successful in galvanizing our large workforce and drove a real step change in performance. Our long-term commitment to grow revenue yields, manage costs and maintain steady capacity growth guided us towards the achievement of the Double-Double. We finished 2017 with Adjusted EPS of $7.53 and ROIC in excess of 10%, exceeding our Double-Double targets. During the Double-Double period, we have experienced annual Adjusted EPS growth of approximately 24%, 26% and 42% and annual ROIC growth of approximately 18%, 17% and 29%, in each of 2017, 2016 and 2015, respectively.
Additionally, Net Yields on a Constant-Currency basis increased for the eighth consecutive year. For the year ended December 31, 2017, our Net Yields on a Constant-Currency basis increased by 6.4%, primarily driven by increases in both ticket and onboard yields and by a benefit from the deconsolidation of the Pullmantur brand. Strong demand for Europe and North America products combined with strong onboard trends are responsible for the growth. Partly offsetting these successes was the impact of the 2017 hurricane season and China's South Korea travel restrictions.
Net onboard revenue yield in 2017 grew by 6.8% year-over-year on a Constant Currency basis. Growth came from a variety of areas, including beverage package sales, specialty restaurants, shore excursions, and our high speed onboard internet products.
We remain dedicated to finding efficiencies, identifying synergies and reducing costs, while at the same time, focusing on strategic investments in areas that will boost revenue. In 2017, our Net Cruise Costs Excluding Fuel increased by 2.0% on a Constant Currency basis compared to 2016.
The Company remains focused on improving returns for our shareholders. In 2017, we bought back $225 million shares of common stock under our $500 million share repurchase program that was announced in April 2017. We also announced a 25% increase to our common stock dividend, our fifth consecutive year with a dividend increase. In addition, during 2017, both Moody’s and S&P upgraded our senior unsecured debt rating to investment grade.
In 2018, all three of our Global Brands will each welcome a ship in the same year - a first in our history. Royal Caribbean International will welcome newbuild Symphony of the Seas in April; Azamara Club Cruises will welcome Azamara Pursuit in August; and Celebrity Cruises will welcome its newbuild Celebrity Edge in November. In 2018, we expect our capacity in the Caribbean will increase as Symphony of the Seas and Celebrity Edge join the Caribbean in the winter, Celebrity Infinity returns to the Caribbean and we upsize Jewel of the Seas to Freedom of the Seas and Enchantment of the Seas to Mariner of the Seas. As a result of Mariner of the Seas repositioning from Asia/Pacific to North America to make way for Spectrum of the Seas’ arrival in early 2019, we expect our Asia/Pacific capacity will decrease year over year and will account for 17% of our total capacity in 2018. We expect Europe will represent 17% of our capacity in 2018 with growth driven by the Symphony of the Seas' inaugural Western Mediterranean season replacing Freedom of the Seas and the addition of Azamara Pursuit.
In November 2017, we announced the order of Celebrity Flora, the brand’s first ship designed specifically for the Galapagos Islands, which we expect will sail beginning in 2019. In addition to investing in new hardware and our existing hardware through our fleet modernization programs, Royal Amplified and Celebrity Revolution, we continue to opportunistically evaluate selling or transferring older ships to further optimize our fleet. Since 2014, we have sold four ships - the sale of Celebrity Century to a subsidiary of Skysea Holdings, the sale of Ocean Dream to an unrelated third-party, the sale of Splendour of the Seas to TUI Cruises, and sale of Legend of the Seas to an affiliate of TUI AG, our joint venture partner in TUI Cruises.
After announcing our achievement of Double-Double, we thanked employees for their contribution with individual salary bonuses of five percent. Employees received equity-based awards equal to five percent of their 2017 salaries in an $80 million program called the "Thank You, Thank You Bonus." The awards, which vest over three years, went to all employees – shipboard and shoreside, full-time and part-time, domestic and overseas. Corporate officers, however, were excluded. In addition to the five percent equity-based awards, we will contribute to the Crew Welfare Fund for upgrades to crew living and recreational areas.
Results of Operations
In addition to the items discussed above under "Executive Overview," significant items for 2017 include:
| • | Both our net income and Adjusted Net Income for the year ended December 31, 2017 was $1.6 billion, or $7.53 per share on a diluted basis, respectively, as compared to both net income and Adjusted Net Income of $1.3 billion, or $5.93 and $6.08 per share on a diluted basis, respectively, for the year ended December 31, 2016. |
| • | The estimated negative impact resulting from the third quarter 2017 hurricane-related disruptions was approximately $0.26 per share on a diluted basis to our net income and Adjusted Net Income for the year ended December 31, 2017. |
| • | Total revenues increased by $281.4 million for the year ended December 31, 2017 compared to the same period in 2016 primarily due to an increase in ticket prices and onboard spending on a per passenger basis, which are further discussed below. |
| • | Total Cruise operating expenses decreased by $119.0 million for the year ended December 31, 2017 compared to the same period in 2016, primarily due to the decrease in capacity, which is further discussed below. |
Other items for 2017 include:
| • | In May 2017, TUI Cruises, our 50% joint venture, took delivery of Mein Schiff 6. |
| • | During the second quarter of 2017, we entered into agreements with Meyer Turku to build two Icon-class ships. In October 2017, we entered into credit agreements for the unsecured financing of these ships for up to 80% of each ship's contract price. Refer to Note 15. Commitments and Contingencies to our consolidated financial statements for further information. |
| • | During the third quarter of 2017, we entered into an agreement to purchase a ship for our Azamara Club Cruises brand. The sale is expected to be completed with the delivery of the ship scheduled for March 2018, and the ship is expected to enter service during the third quarter of 2018. |
| • | During the fourth quarter of 2017, we entered into a credit agreement for the unsecured financing of a ship we have on order designed for the Galapagos Islands for our Celebrity Cruises brand. Refer to Note 7. Long-Term Debt to our consolidated financial statements for further information. |
We reported net income, Adjusted Net Income, earnings per share and Adjusted Earnings per Share as shown in the following table (in thousands, except per share data):
| Year Ended December 31, | |||||||||||
| 2017 | 2016 | 2015 | |||||||||
| Net income | $ | 1,625,133 | $ | 1,283,388 | $ | 665,783 | |||||
| Adjusted Net Income | 1,625,133 | 1,314,689 | 1,065,066 | ||||||||
| Net Adjustments to Net Income - Increase | $ | — | $ | 31,301 | $ | 399,283 | |||||
| Adjustments to Net Income: | |||||||||||
| Impairment of Pullmantur related assets (1) | $ | — | $ | — | $ | 399,283 | |||||
| Net loss related to the elimination of the Pullmantur reporting lag | — | 21,656 | — | ||||||||
| Net gain related to the sale of the Pullmantur and CDF Croisières de France brands | — | (3,834 | ) | — | |||||||
| Restructuring charges | — | 8,452 | — | ||||||||
| Other initiative costs | — | 5,027 | — | ||||||||
| Net Adjustments to Net Income - Increase | $ | — | $ | 31,301 | $ | 399,283 | |||||
| Basic: | |||||||||||
| Earnings per Share | $ | 7.57 | $ | 5.96 | $ | 3.03 | |||||
| Adjusted Earnings per Share | $ | 7.57 | $ | 6.10 | $ | 4.85 | |||||
| Diluted: | |||||||||||
| Earnings per Share | $ | 7.53 | $ | 5.93 | $ | 3.02 | |||||
| Adjusted Earnings per Share | $ | 7.53 | $ | 6.08 | $ | 4.83 | |||||
| Weighted-Average Shares Outstanding: | |||||||||||
| Basic | 214,617 | 215,393 | 219,537 | ||||||||
| Diluted | 215,694 | 216,316 | 220,689 |
(1) Includes a net deferred income tax benefit of $12.0 million related to the Pullmantur impairment.
The following table presents operating results as a percentage of total revenues for the last three years:
| Year Ended December 31, | ||||||||
| 2017 | 2016 | 2015 | ||||||
| Passenger ticket revenues | 71.9 | % | 72.4 | % | 73.0 | % | ||
| Onboard and other revenues | 28.1 | % | 27.6 | % | 27.0 | % | ||
| Total revenues | 100.0 | % | 100.0 | % | 100.0 | % | ||
| Cruise operating expenses: | ||||||||
| Commissions, transportation and other | 15.5 | % | 15.9 | % | 16.9 | % | ||
| Onboard and other | 5.6 | % | 5.8 | % | 6.7 | % | ||
| Payroll and related | 9.7 | % | 10.4 | % | 10.4 | % | ||
| Food | 5.6 | % | 5.7 | % | 5.8 | % | ||
| Fuel | 7.8 | % | 8.4 | % | 9.6 | % | ||
| Other operating | 11.5 | % | 12.8 | % | 12.1 | % | ||
| Total cruise operating expenses | 55.8 | % | 59.0 | % | 61.4 | % | ||
| Marketing, selling and administrative expenses | 13.5 | % | 13.0 | % | 13.1 | % | ||
| Depreciation and amortization expenses | 10.8 | % | 10.5 | % | 10.0 | % | ||
| Impairment of Pullmantur related assets | — | % | — | % | 5.0 | % | ||
| Operating income | 19.9 | % | 17.4 | % | 10.5 | % | ||
| Other expense | (1.4 | )% | (2.3 | )% | (2.5 | )% | ||
| Net income | 18.5 | % | 15.1 | % | 8.0 | % |
Selected statistical information is shown in the following table:
| Year Ended December 31, | ||||||||
| 2017 | 2016 (1) | 2015 | ||||||
| Passengers Carried | 5,768,496 | 5,754,747 | 5,401,899 | |||||
| Passenger Cruise Days | 40,033,527 | 40,250,557 | 38,523,060 | |||||
| APCD | 36,930,939 | 37,844,644 | 36,646,639 | |||||
| Occupancy | 108.4 | % | 106.4 | % | 105.1 | % |
| (1) | Does not include November and December 2015 amounts for Pullmantur as the net Pullmantur result for those months was included within Other expense in our consolidated statements of comprehensive income (loss) for the year ended December 31, 2016, as a result of the elimination of the Pullmantur reporting lag, and did not affect Gross Yields, Net Yields, Gross Cruise Costs, Net Cruise Costs and Net Cruise Costs Excluding Fuel. Additionally, effective August 2016, we no longer include Pullmantur Holdings in these amounts. |
Gross Yields and Net Yields were calculated as follows (in thousands, except APCD and Yields):
| Year Ended December 31, | |||||||||||||||
| 2017 | 2017 On a Constant Currency basis | 2016 | 2015 | ||||||||||||
| Passenger ticket revenues | $ | 6,313,170 | $ | 6,302,600 | $ | 6,149,323 | $ | 6,058,821 | |||||||
| Onboard and other revenues | 2,464,675 | 2,462,531 | 2,347,078 | 2,240,253 | |||||||||||
| Total revenues | 8,777,845 | 8,765,131 | 8,496,401 | 8,299,074 | |||||||||||
| Less: | |||||||||||||||
| Commissions, transportation and other | 1,363,170 | 1,361,001 | 1,349,677 | 1,400,778 | |||||||||||
| Onboard and other | 495,552 | 493,790 | 493,558 | 553,104 | |||||||||||
| Net revenues including other initiative costs | 6,919,123 | 6,910,340 | 6,653,166 | 6,345,192 | |||||||||||
| Less: | |||||||||||||||
| Other initiative costs included within Net Revenues | — | — | (2,230 | ) | — | ||||||||||
| Net Revenues | $ | 6,919,123 | $ | 6,910,340 | $ | 6,655,396 | $ | 6,345,192 | |||||||
| APCD | 36,930,939 | 36,930,939 | 37,844,644 | 36,646,639 | |||||||||||
| Gross Yields | $ | 237.68 | $ | 237.34 | $ | 224.51 | $ | 226.46 | |||||||
| Net Yields | $ | 187.35 | $ | 187.12 | $ | 175.86 | $ | 173.15 |
Gross Cruise Costs, Net Cruise Costs and Net Cruise Costs Excluding Fuel were calculated as follows (in thousands, except APCD and costs per APCD):
| Year Ended December 31, | |||||||||||||||
| 2017 | 2017 On a Constant Currency basis | 2016 | 2015 | ||||||||||||
| Total cruise operating expenses | $ | 4,896,579 | $ | 4,891,324 | $ | 5,015,539 | $ | 5,099,393 | |||||||
| Marketing, selling and administrative expenses (1) | 1,186,016 | 1,189,694 | 1,100,290 | 1,086,504 | |||||||||||
| Gross Cruise Costs | 6,082,595 | 6,081,018 | 6,115,829 | 6,185,897 | |||||||||||
| Less: | |||||||||||||||
| Commissions, transportation and other | 1,363,170 | 1,361,001 | 1,349,677 | 1,400,778 | |||||||||||
| Onboard and other | 495,552 | 493,790 | 493,558 | 553,104 | |||||||||||
| Net Cruise Costs including other initiative costs | 4,223,873 | 4,226,227 | 4,272,594 | 4,232,015 | |||||||||||
| Less: | |||||||||||||||
| Net gain related to the sale of Pullmantur and CDF Croisières de France brands included within other operating expenses | — | — | (3,834 | ) | — | ||||||||||
| Other initiative costs included within cruise operating expenses and marketing, selling and administrative expenses | — | — | 2,433 | — | |||||||||||
| Net Cruise Costs | 4,223,873 | 4,226,227 | 4,273,995 | 4,232,015 | |||||||||||
| Less: | |||||||||||||||
| Fuel (2) | 681,118 | 681,114 | 713,252 | 795,801 | |||||||||||
| Net Cruise Costs Excluding Fuel | $ | 3,542,755 | $ | 3,545,113 | $ | 3,560,743 | $ | 3,436,214 | |||||||
| APCD | 36,930,939 | 36,930,939 | 37,844,644 | 36,646,639 | |||||||||||
| Gross Cruise Costs per APCD | $ | 164.70 | $ | 164.66 | $ | 161.60 | $ | 168.80 | |||||||
| Net Cruise Costs per APCD | $ | 114.37 | $ | 114.44 | $ | 112.94 | $ | 115.48 | |||||||
| Net Cruise Cost Excluding Fuel per APCD | $ | 95.93 | $ | 95.99 | $ | 94.09 | $ | 93.77 |
| (1) | For the year ended December 31, 2016, amount does not include restructuring charges of $8.5 million. |
| (2) | For the year ended December 31, 2016, amount does not include fuel expense of $0.4 million included within other initiative costs associated with the redeployment of Pullmantur’s Empress to the Royal Caribbean International brand. |
Outlook
The company does not make predictions about fuel pricing, interest rates or currency exchange rates but does provide guidance about its future business activities. On January 24, 2018, we announced the following initial full year and first quarter 2018 guidance based on the then current fuel pricing, interest rates and currency exchange rates:
Full Year 2018
| As Reported | Constant Currency | ||
| Net Yields | 2.75% to 4.75% | 1.5% to 3.5% | |
| Net Cruise Costs per APCD | 1.0% to 1.5% | 0.5% to 1.0% | |
| Net Cruise Costs per APCD, excluding Fuel | 2.0% to 2.5% | 1.5% to 2.0% | |
| Capacity Increase | 3.9% | ||
| Depreciation and Amortization | $1,053 to $1,063 million | ||
| Interest Expense, net | $280 to $290 million | ||
| Fuel Consumption (metric tons) | 1,350,100 | ||
| Fuel Expenses | $675 million | ||
| Percent Hedged (fwd consumption) | 50% | ||
| Impact of 10% change in fuel prices | $38 million | ||
| 1% Change in Currency | $18 million | ||
| 1% Change in Net Yield | $75 million | ||
| 1% Change in NCC x Fuel | $38 million | ||
| 100 basis pt. Change in LIBOR | $30 million | ||
| Adjusted Earnings per Share — Diluted | $8.55 to $8.75 |
First Quarter 2018
| As Reported | Constant Currency | ||
| Net Yields | Approx. 5.5% | 3.0% to 3.5% | |
| Net Cruise Costs per APCD | Approx. 8.5% | Approx. 7.5% | |
| Net Cruise Costs per APCD, excluding Fuel | Approx. 11.0% | Approx. 10.0% | |
| Capacity Decrease | (3.9%) | ||
| Depreciation and Amortization | $245 to $250 million | ||
| Interest Expense, net | $59 to $63 million | ||
| Fuel Consumption (metric tons) | 324,400 | ||
| Fuel Expenses | $162 million | ||
| Percent Hedged (fwd consumption) | 50% | ||
| Impact of 10% change in fuel prices | $9 million | ||
| 1% Change in Currency | $4 million | ||
| 1% Change in Net Yield | $16 million | ||
| 1% Change in NCC x Fuel | $10 million | ||
| 100 basis pt. Change in LIBOR | $5 million | ||
| Adjusted Earnings per Share — Diluted | Approx. $0.95 |
Since our earnings release on January 24, 2018, bookings have remained consistent with our previous expectations. Accordingly, our forecast has remained essentially unchanged.
Volatility in foreign currency exchange rates affects the United States dollar value of our earnings. Based on our highest net exposure for each quarter and the full year 2018, the top five foreign currencies are ranked below. For example, the Australian Dollar is the most impactful currency in the first and fourth quarters of 2018. Rankings are based on estimated net exposures.
| Ranking | Q1 | Q2 | Q3 | Q4 | FY 2018 | |||||
| 1 | AUD | GBP | GBP | AUD | GBP | |||||
| 2 | CAD | AUD | CNH | GBP | AUD | |||||
| 3 | GBP | CAD | EUR | CAD | CAD | |||||
| 4 | EUR | CNH | CAD | EUR | EUR | |||||
| 5 | CNH | EUR | AUD | CNH | CNH |
The currency abbreviations above are defined as follows:
| Currency Abbreviation | Currency | |
| AUD | Australian Dollar | |
| CAD | Canadian Dollar | |
| CNH | Chinese Yuan | |
| EUR | Euro | |
| GBP | British Pound |
Year Ended December 31, 2017 Compared to Year Ended December 31, 2016
In this section, references to 2017 refer to the year ended December 31, 2017 and references to 2016 refer to the year ended December 31, 2016.
Revenues
Total revenues for 2017 increased $281.4 million, or 3.3%, to $8.8 billion from $8.5 billion in 2016.
Passenger ticket revenues comprised 71.9% of our 2017 total revenues. Passenger ticket revenues increased by $163.8 million, or 2.7% from 2016, despite the impact of canceled sailings resulting from hurricane-related disruptions during the third quarter of 2017. The increase was primarily due to:
| • | an increase of $301.8 million in ticket prices primarily driven by the improvement in our ticket price on a per passenger basis due to the exit of the Pullmantur ships and the addition of Harmony of the Seas and Ovation of the Seas, as well as higher pricing on North America and Europe sailings. The increase in ticket prices on these itineraries was partially offset by lower pricing on Asia/Pacific sailings; and |
| • | the favorable effect of changes in foreign currency exchange rates related to our revenue transactions denominated in currencies other than the United States dollar of approximately $10.6 million. |
The increase in passenger ticket revenues was partially offset by a 2.4% decrease in capacity, which decreased passenger ticket revenues by $148.5 million primarily due to the sale of our majority interest in Pullmantur Holdings during the third quarter of 2016, the sale of Splendour of the Seas in the second quarter of 2016 and the sale of Legend of the Seas in first quarter of 2017, which was partially offset by an increase in capacity due to the addition of Ovation of the Seas and Harmony of the Seas into our fleet during the second quarter of 2016.
The remaining 28.1% of 2017 total revenues was comprised of Onboard and other revenues, which increased $117.6 million, or 5.0%. The increase in Onboard and other revenues was primarily due to:
| • | a $125.3 million increase in onboard revenue attributable to higher spending on a per passenger basis primarily due to our revenue enhancing initiatives, including beverage package, shore excursion and specialty restaurant sales and promotions and increased revenue associated with internet and other telecommunication service. |
| • | a $45.7 million increase in other revenue primarily due to charter revenue and management fees earned from Pullmantur Holdings. |
The increase was partially offset by a $55.6 million decrease attributable to the 2.4% decrease in capacity noted above, including the impact of canceled sailings resulting from hurricane-related disruptions during the third quarter of 2017.
Onboard and other revenues included concession revenues of $326.5 million in 2017 and $316.9 million in 2016.
Cruise Operating Expenses
Total cruise operating expenses for 2017 decreased $119.0 million, or 2.4%, to $4.9 billion in 2017 from $5.0 billion in 2016. The decrease was primarily due to:
| • | a $120.5 million decrease attributable to the 2.4% decrease in capacity noted above; |
| • | a $30.9 million gain resulting from the sale of Legend of the Seas in 2017 compared to an immaterial gain from the sale of Splendour of the Seas in 2016; |
| • | a $17.2 million decrease in air expense due to itinerary changes and lower ticket costs; |
| • | a $16.8 million decrease in vessel maintenance primarily due to the timing of scheduled drydocks; and |
| • | a $15.5 million decrease in fuel expense, excluding the impact of the decrease in capacity. Our cost of fuel (net of the financial impact of fuel swap agreements) for 2017 decreased 4.6% per metric ton compared to 2016. |
The decrease was partially offset by:
| • | a $33.8 million increase in commissions expense mainly due to the increase in ticket prices discussed above and changes in commission incentives; |
- a $19.3 million increase in head taxes primarily due to itinerary changes; and
| • | an $18.9 million increase in food expenses mainly due to our new culinary initiatives. |
Marketing, Selling and Administrative Expenses
Marketing, selling and administrative expenses for 2017 increased $77.3 million, or 7.0%, to $1.2 billion from $1.1 billion in 2016. The increase was primarily due to an increase in payroll and benefits mostly driven by higher stock prices year over year related to our performance share awards, partially offset by a decrease in expenses due to the sale of our majority interest in Pullmantur Holdings.
Depreciation and Amortization Expenses
Depreciation and amortization expenses for 2017 increased $56.3 million, or 6.3%, to $951.2 million from $894.9 million in 2016. The increase was primarily due to the addition of Ovation of the Seas and Harmony of the Seas in the second quarter of 2016, new shipboard additions associated with our ship upgrade projects and to a lesser extent, additions related to our shoreside projects. The increase was partially offset by the decrease in depreciation associated with the sale of Legend of the Seas in the first quarter of 2017 and to a lesser extent, the sale of Splendour of the Seas in the second quarter of 2016.
Other Income (Expense)
Interest expense, net of interest capitalized, decreased $7.4 million, or 2.4%, to $300.0 million in 2017 from $307.4 million in 2016. The decrease was due to a lower average debt level in 2017 compared to 2016, partially offset by higher interest rates in 2017 compared to 2016.
Equity investment income increased $27.9 million, or 21.7%, to $156.2 million in 2017 from $128.4 million in 2016 primarily due to an increase in income from TUI Cruises, one of our equity method investments.
Other expense decreased $30.4 million, or 85.2%, to $5.3 million in 2017 from $35.7 million in 2016. The decrease was primarily due to a net loss of $21.7 million related to the elimination of the Pullmantur reporting lag in 2016 which did not recur in 2017.
Gross and Net Yields
Gross and Net Yields increased 5.9% and 6.5% in 2017, respectively, compared to 2016 primarily due to the increase in passenger ticket and onboard and other revenues discussed above.
Gross and Net Cruise Costs
Gross Cruise Costs remained consistent in 2017 compared to 2016. Net Cruise Costs decreased 1.2% in 2017 compared to 2016 primarily due to the decrease in capacity and cruise operating expenses discussed above. Gross Cruise Costs per APCD and Net Cruise Costs per APCD increased 1.9% and 1.3% in 2017, respectively, compared to 2016. The increase was mainly due to the hurricane-related disruptions during the third quarter of 2017 which reduced our capacity; however, certain operating expenses were still incurred, negatively impacting our metrics per APCD. Net Cruise Costs Excluding Fuel per APCD increased 2.0% in 2017 compared to 2016.
Other Comprehensive Income
Other comprehensive income in 2017 was $582.2 million compared to $411.9 million in 2016. The increase of $170.3 million or 41.3% was primarily due to the Gain on cash flow derivative hedges in 2017 of $570.5 million compared to $411.2 million in 2016. The increase of $159.3 million in 2017 was primarily due to an increase in foreign currency forward contract values in 2017 compared to a decrease in 2016, which was partially offset by lower amounts of fuel swap losses reclasssified to income in 2017 and a smaller increase in fuel swap instrument values in 2017 compared to 2016.
Year Ended December 31, 2016 Compared to Year Ended December 31, 2015
In this section, references to 2016 refer to the year ended December 31, 2016 and references to 2015 refer to the year ended December 31, 2015.
Revenues
Total revenues for 2016 increased $197.3 million, or 2.4%, to $8.5 billion from $8.3 billion in 2015.
Passenger ticket revenues comprised 72.4% of our 2016 total revenues. Passenger ticket revenues increased by $90.5 million, or 1.5%. The increase was primarily due to:
| • | a 3.3% increase in capacity, which increased passenger ticket revenues by $198.1 million, net of the capacity decrease resulting from the sale of our majority interest in Pullmantur Holdings; and |
| • | an increase of $63.9 million in ticket prices primarily driven by our newest ships as well as higher pricing on Alaska and Caribbean sailings. The increase in ticket prices was partially offset by lower pricing on Mediterranean and Asia sailings. |
The increase in passenger ticket revenues was partially offset by the unfavorable effect of changes in foreign currency exchange rates related to our revenue transactions denominated in currencies other than the United States dollar of approximately $171.5 million.
The remaining 27.6% of 2016 total revenues was comprised of Onboard and other revenues, which increased $106.8 million, or 4.8%. The increase in Onboard and other revenues was primarily due to:
| • | a $70.5 million increase attributable to the 3.3% increase in capacity noted above; and |
| • | an $89.9 million increase in onboard revenue attributable to higher spending on a per passenger basis primarily due to our ship upgrade programs and other revenue enhancing initiatives, including various beverage and gaming initiatives, the promotion of specialty restaurants and the increased revenue associated with internet and other telecommunication services partially offset by a decrease in port activities revenue mainly due to itinerary changes. |
The increase was partially offset by:
| • | an approximate $16.4 million unfavorable effect of changes in foreign currency exchange rates related to our onboard and other revenue transactions denominated in currencies other than the United States dollar; and |
| • | a $37.2 million decrease in other revenues primarily related to our travel agency business that was sold in 2015 partially offset by an increase in revenue received for our bareboat charter and ship management services associated with our unconsolidated affiliates. The decrease in revenues from our travel agency business sold is mostly offset by the related decrease in travel agency expenses discussed below. |
Onboard and other revenues included concession revenues of $316.9 million in 2016 and $327.1 million in 2015.
Cruise Operating Expenses
Total cruise operating expenses for 2016 decreased $83.9 million, or 1.6%, to $5.0 billion in 2016 from $5.1 billion in 2015. The decrease was primarily due to:
| • | a $114.4 million decrease in fuel expense, excluding the impact of the increase in capacity. Our cost of fuel (net of the financial impact of fuel swap agreements) for 2016 decreased 10.3% per metric ton compared to 2015; |
| • | an approximate $40.9 million favorable effect of changes in foreign currency exchange rates related to our cruise operating expenses denominated in currencies other than the United States dollar; |
| • | a $41.2 million decrease in other expenses primarily related to our travel agency business that was sold in 2015, which mostly offsets the related decrease in travel agency revenues discussed above; |
| • | a $25.0 million decrease in air expense primarily due to the decrease in air transportation sales and lower costs; and |
| • | a $20.2 million decrease in shore excursion expense attributable to lower contractual costs incurred and the decrease in port activities revenue discussed above. |
The decrease was partially offset by a $164.7 million increase attributable to the 3.3% increase in capacity noted above.
Marketing, Selling and Administrative Expenses
Marketing, selling and administrative expenses for 2016 remained consistent compared to 2015.
Depreciation and Amortization Expenses
Depreciation and amortization expenses for 2016 increased $67.9 million, or 8.2%, to $894.9 million from $827.0 million in 2015. The increase was primarily due to the addition of Harmony of the Seas and Ovation of the Seas in the second quarter of 2016 into our fleet and the addition of Anthem of the Seas in the second quarter of 2015 and, to a lesser extent, new shipboard additions associated with our ship upgrade projects. The increase was partially offset by the sale of Splendour of the Seas in April 2016.
Impairment of Pullmantur Related Assets
During 2015, we recognized an impairment charge of $411.3 million to write down Pullmantur's goodwill to its implied fair value and to write down trademarks and trade names and certain long-lived assets, consisting of three aircraft that was then owned and operated by Pullmantur Air and two ships owned and operated by Pullmantur, to their fair value.
Other Income (Expense)
Interest expense, net of interest capitalized, decreased $29.6 million, or 10.7%, to $307.4 million in 2016 from $277.7 million in 2015. The increase was due to a higher average debt level attributable to the financing of Ovation of the Seas and Harmony of the Seas, partially offset by lower pricing on debt refinanced in 2015.
Equity investment income increased $47.3 million, or 58.4%, to $128.4 million in 2016 from $81.0 million in 2015 mainly due to the increase in income from TUI Cruises, one of our equity method investments.
Other expense in 2016 was $35.7 million compared to $24.4 million in 2015. The increase in expense of $11.2 million was primarily due to a net loss of $21.7 million related to the elimination of the Pullmantur reporting lag in 2016. The increase in other expense was partially offset by a decrease of $9.6 million in foreign exchange losses from the remeasurement of monetary assets and liabilities denominated in foreign currency.
Gross and Net Yields
Gross Yields remained consistent in 2016 compared to 2015. Net Yields increased 1.6% in 2016 compared to 2015 primarily due to the increase in passenger ticket and onboard and other revenues discussed above. Gross Yields and Net Yields increased 1.3% and 3.9%, respectively, in 2016 compared to 2015 on a Constant Currency basis.
Gross and Net Cruise Costs
Gross Cruise Costs decreased 1.1% in 2016 compared to 2015 primarily due to the decrease in fuel. Net Cruise Costs increased 1.0% in 2016 compared to 2015 primarily due to the increase in capacity, partially offset by the decrease in fuel, which are further discussed above. Gross Cruise Costs per APCD and Net Cruise Costs per APCD decreased 4.3% and 2.2%, respectively, in 2016 compared to 2015 primarily due to the decrease in fuel. Gross Cruise Costs per APCD on a Constant Currency basis decreased 3.4% in 2016 compared to 2015. Net Cruise Costs per APCD on a Constant Currency basis decreased 1.7% in 2016 compared to 2015. Net Cruise Costs Excluding Fuel per APCD remained consistent in 2016 compared to 2015 and increased 0.9% in 2016 compared to 2015 on a Constant Currency basis.
Other Comprehensive Income (Loss)
Other comprehensive income in 2016 was $411.9 million compared to a loss of $431.4 million in 2015. The change of $843.4 million was primarily due to the Gain on cash flow derivative hedges in 2016 of $411.2 million compared to the Loss on cash flow derivative hedges of $406.0 million in 2015. The gain in 2016 resulted mostly from the reclassification of losses to earnings during 2016 from fuel cash flow hedges. In addition, there was an increase in the fair value of our fuel swaps in 2016 as a result of higher forward fuel prices. The loss in 2015 was primarily due to the decrease in the fair value of our fuel swaps and of our foreign currency forward contracts as a
result of decreases in fuel prices and forward currency rates, somewhat offset by the reclassification of losses to earnings during 2015 from fuel cash flow hedges.
Future Application of Accounting Standards
Refer to Note 2. Summary of Significant Accounting Policies to our consolidated financial statements under Item 8. Financial Statements and Supplementary Data for further information on Recent Accounting Pronouncements.
Liquidity and Capital Resources
Sources and Uses of Cash
Cash flow generated from operations provides us with a significant source of liquidity. Net cash provided by operating activities increased $357.9 million to $2.9 billion in 2017 compared to $2.5 billion in 2016. The increase in cash provided by operating activities was primarily attributable to an increase in proceeds from customer deposits, an increase in cash receipts from onboard spending and a decrease in fuel costs in 2017 compared to 2016. Additionally, dividends received from unconsolidated affiliates increased by $33.7 million.
Net cash provided by operating activities increased $570.3 million to $2.5 billion in 2016 compared to $1.9 billion in 2015. The increase in cash provided by operating activities was primarily attributable to an increase in proceeds from customer deposits, an increase in cash receipts from onboard spending and a decrease in fuel costs in 2016 compared to 2015. Additionally, dividends received from unconsolidated affiliates increased by $42.6 million.
Net cash used in investing activities decreased $2.5 billion to $213.6 million in 2017 compared to $2.7 billion in 2016. The decrease was primarily attributable to a decrease in capital expenditures of $1.9 billion due to ship deliveries in 2016, Ovation of the Seas and Harmony of the Seas, compared to no ship deliveries in 2017. In addition, we received $230.0 million of proceeds from the sale of property and equipment in 2017 which did not occur in 2016. Furthermore, during 2017, we received cash of $63.2 million on settlements on our foreign currency forward contracts compared to cash paid of $213.2 million during 2016.
Net cash used in investing activities increased $981.9 million to $2.7 billion in 2016 compared to $1.7 billion in 2015. The increase was primarily attributable to an increase in capital expenditures of $881.0 million in 2016 compared to the same period in 2015 primarily due to the deliveries of Ovation of the Seas and Harmony of the Seas in 2016. Additionally, cash repayments received on loans to our unconsolidated affiliates decreased $86.0 million in 2016 compared to the same period in 2015 mainly due to TUI Cruises repaying in 2015 the outstanding balance of the debt facility we originally provided to them in 2011.
Net cash used in financing activities was $2.7 billion in 2017 compared to Net cash provided in financing activities of $243.8 million in 2016. The change was primarily attributable to a decrease in debt proceeds of $1.5 billion, an increase in debt repayments of $1.5 billion and a higher amount of dividends paid during 2017 compared to 2016, partially offset by a decrease of stock repurchases of $75.0 million during 2017 compared to 2016. The decrease in debt proceeds was primarily due to the $841.8 million unsecured term loan borrowed in April 2016 to finance Ovation of the Seas and the €700.7 million and $226.1 million unsecured term loans borrowed in May 2016 to finance Harmony of the Seas that did not recur in 2017 and lower drawings on our revolving credit facilities during 2017 compared to 2016, partially offset by $800 million in proceeds received from unsecured senior notes issued during 2017 which did not occur in 2016. The increase in repayment of debt was primarily due to higher payments on our revolving credit facilities.
Net cash provided by financing activities was $243.8 million in 2016 compared to Net cash used in financing activities of $253.5 million in 2015. The change was primarily attributable to an increase in debt proceeds of $2.9 billion during 2016 compared to 2015, partially offset by an increase in repayment of debt of $2.2 billion, an increase in stock repurchases of $100.0 million and an increase in dividends paid of $66.3 million during 2016 compared to 2015. The increase in debt proceeds was primarily due to the $841.8 million unsecured term loan borrowed in April 2016 to finance Ovation of the Seas, the €700.7 million and $226.1 million unsecured term loans borrowed in May
2016 to finance Harmony of the Seas, the $200.0 million unsecured term loan borrowed in April 2016 and higher drawings on our revolving credit facilities during 2016 compared to the $742.1 million unsecured term loan borrowed in April 2015 to finance Anthem of the Seas. The increase in repayment of debt was primarily due to higher payments on our revolving credit facilities.
Future Capital Commitments
Our future capital commitments consist primarily of new ship orders. As of December 31, 2017, we have two Quantum-class ships, two Oasis-class ships and two ships of a new generation, known as our Icon-class, on order for our Royal Caribbean International brand with an aggregate capacity of approximately 30,500 berths. Additionally, we have four ships of a new generation, 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 11,700 berths. For each of these orders, we have committed unsecured financing arrangements in place covering 80% of the cost of the ship, almost all of which include sovereign financing guarantees. Furthermore, during 2017, we entered into an agreement to purchase a ship for our Azamara Club Cruises brand that is scheduled to be delivered in March 2018 and expected to enter service during the third quarter of 2018.
As of December 31, 2017, the aggregate cost of our ships on order, not including the TUI Cruises' ships on order, was approximately $13.3 billion, of which we had deposited $465.7 million as of such date. Approximately 54.0% of the aggregate cost was exposed to fluctuations in the Euro exchange rate at December 31, 2017. (Refer to Note 14. Fair Value Measurements and Derivative Instruments and Note 15. Commitments and Contingencies to our consolidated financial statements under Item 8. Financial Statements and Supplementary Data).
As of December 31, 2017, anticipated overall capital expenditures, based on our existing ships on order, are approximately $3.4 billion for 2018, $2.1 billion for 2019, $2.5 billion for 2020 and $2.5 billion for 2021.
Contractual Obligations
As of December 31, 2017, our contractual obligations were as follows (in thousands):
| Payments due by period | |||||||||||||||||||
| Less than | 1-3 | 3-5 | More than | ||||||||||||||||
| Total | 1 year | years | years | 5 years | |||||||||||||||
| Operating Activities: | |||||||||||||||||||
| Operating lease obligations(1) | $ | 241,468 | $ | 29,420 | $ | 44,191 | $ | 22,644 | $ | 145,213 | |||||||||
| Interest on long-term debt(2) | 1,275,346 | 250,600 | 415,000 | 292,665 | 317,081 | ||||||||||||||
| Other(3) | 879,206 | 214,444 | 282,570 | 150,003 | 232,189 | ||||||||||||||
| Investing Activities: | 0 | ||||||||||||||||||
| Ship purchase obligations(4) | 10,888,494 | 2,368,806 | 3,063,165 | 4,089,153 | 1,367,370 | ||||||||||||||
| Financing Activities: | 0 | ||||||||||||||||||
| Long-term debt obligations(5) | 7,506,312 | 1,185,038 | 2,047,882 | 2,012,922 | 2,260,470 | ||||||||||||||
| Capital lease obligations(6) | 33,139 | 3,476 | 7,210 | 8,395 | 14,058 | ||||||||||||||
| Other(7) | 21,552 | 8,868 | 11,217 | 1,467 | — | ||||||||||||||
| Total | $ | 20,845,517 | $ | 4,060,652 | $ | 5,871,235 | $ | 6,577,249 | $ | 4,336,381 |
(1) We are obligated under noncancelable operating leases primarily for offices, warehouses and motor vehicles. Amounts represent contractual obligations with initial terms in excess of one year.
(2) Long-term debt obligations mature at various dates through fiscal year 2028 and bear interest at fixed and variable rates. Interest on variable-rate debt is calculated based on forecasted debt balances, including the impact of interest rate swap agreements, using the applicable rate at December 31, 2017. Debt denominated in other currencies is calculated based on the applicable exchange rate at December 31, 2017.
(3) Amounts primarily represent future commitments with remaining terms in excess of one year to pay for our usage of certain port facilities, marine consumables, services and maintenance contracts. Amounts do not include the PortMiami lease further discussed below under Off-Balance Sheet Arrangements.
(4) Amounts do not include potential obligations which remain subject to cancellation at our sole discretion.
(5) Amounts represent debt obligations with initial terms in excess of one year. Debt denominated in other currencies is calculated based on the applicable exchange rate at December 31, 2017.
(6) Amounts represent capital lease obligations with initial terms in excess of one year.
(7) Amounts represent fees payable to sovereign guarantors in connection with certain of our export credit debt facilities and facility fees on our revolving credit facilities.
Please refer to Funding Needs and Sources for discussion on the planned funding of the above contractual obligations.
As a normal part of our business, depending on market conditions, pricing and our overall growth strategy, we continuously consider opportunities to enter into contracts for the building of additional ships. We may also consider the sale of ships or the purchase of existing ships. We continuously consider potential acquisitions and strategic alliances. If any of these were to occur, they would be financed through the incurrence of additional indebtedness, the issuance of additional shares of equity securities or through cash flows from operations.
Off-Balance Sheet Arrangements
We and TUI AG have each guaranteed repayment of 50% of a bank loan provided to TUI Cruises which is due 2022. Notwithstanding this, the lenders have agreed to release each shareholder’s guarantee if certain conditions are met by April 2018. As of December 31, 2017, €95.1 million, or approximately $114.2 million based on the exchange rate at December 31, 2017, remains outstanding. Based on current facts and circumstances, we do not believe potential obligations under this guarantee are probable.
TUI Cruises has entered into various ship construction and credit agreements that 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.
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.
Some of the contracts that we enter into include indemnification provisions that obligate us to make payments to the counterparty if certain events occur. These contingencies generally relate to changes in taxes, increased lender capital costs and other similar costs. The indemnification clauses are often standard contractual terms and are entered into in the normal course of business. There are no stated or notional amounts included in the indemnification clauses and we are not able to estimate the maximum potential amount of future payments, if any, under these indemnification clauses. We have not been required to make any payments under such indemnification clauses in the past and, under current circumstances, we do not believe an indemnification obligation is probable.
As of December 31, 2017, other than the items described above, we are not party to any other off-balance sheet arrangements, including guarantee contracts, retained or contingent interest, certain derivative instruments and variable interest entities, that either have, or are reasonably likely to have, a current or future material effect on our financial position.
Funding Needs and Sources
We have significant contractual obligations of which our debt service obligations and the capital expenditures associated with our ship purchases represent our largest funding needs. As of December 31, 2017, we had approximately $4.1 billion in contractual obligations due through December 31, 2018 of which approximately $1.2 billion relates to debt maturities, $0.3 billion relates to interest on long-term debt and $2.4 billion relates to ship purchase payments, including the final installments payable due upon the deliveries of Symphony of the Seas and Celebrity Edge in the
first and fourth quarters of 2018, respectively. We have historically relied on a combination of cash flows provided by operations, drawdowns under our available credit facilities, the incurrence of additional debt and/or the refinancing of our existing debt and the issuance of additional shares of equity securities to fund these obligations.
We had a working capital deficit of $3.9 billion and $3.7 billion as of December 31, 2017 and December 31, 2016, respectively. Included within our working capital deficit is $1.2 billion and $1.3 billion of current portion of debt, including capital leases, as of December 31, 2017 and December 31, 2016, respectively. Similar to others in our industry, we operate with a substantial working capital deficit. This deficit is mainly attributable to the fact that, under our business model, a vast majority of our passenger ticket receipts are collected in advance of the applicable sailing date. These advance passenger receipts remain a current liability until the sailing date. The cash generated from these advance receipts is used interchangeably with cash on hand from other sources, such as our revolving credit facilities and other cash from operations. The cash received as advanced receipts can be used to fund operating expenses for the applicable future sailing or otherwise, pay down our revolving credit facilities, invest in long term investments or any other use of cash. In addition, we have a relatively low-level of accounts receivable and rapid turnover results in a limited investment in inventories. We generate substantial cash flows from operations and our business model, along with our unsecured revolving credit facilities, has historically allowed us to maintain this working capital deficit and still meet our operating, investing and financing needs. We expect that we will continue to have working capital deficits in the future.
As of December 31, 2017, we had liquidity of $2.2 billion, consisting of approximately $0.1 billion in cash and cash equivalents and $2.1 billion available under our unsecured revolving credit facilities. We anticipate that our cash flows from operations and our current financing arrangements, as described above, will be adequate to meet our capital expenditures and debt repayments over the next twelve-month period.
In April 2017, Moody's changed our senior unsecured debt credit rating to Baa3 with a stable outlook. Consistent with the provisions of our interest rate derivatives instruments, all collateral that was posted with our counterparties as of that date was returned in April 2017. In addition, the interest margins and guarantee premium payable under certain of our credit agreements were automatically reduced in accordance with their terms.
On April 28, 2017, we announced that our Board of Directors authorized a twelve-month common stock repurchase program for up to $500 million. As of December 31, 2017, we have $275.0 million that remains available for future common stock repurchase transactions under this Board approved program. Future repurchases may be made at management's discretion from time to time on the open market or through privately negotiated transactions. Repurchases under the program are expected to be funded from available cash or borrowings under our revolving credit facilities. Refer to Note 8. Shareholders' Equity to our consolidated financial statements for further information.
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.
Debt Covenants
Certain of our financing agreements contain covenants that require us, among other things, to maintain minimum net worth of at least $8.0 billion, a fixed charge coverage ratio of at least 1.25x and limit our net debt-to-capital ratio to no more than 62.5%. The fixed charge coverage ratio is calculated by dividing net cash from operations for the past four quarters by the sum of dividend payments plus scheduled principal debt payments in excess of any new financings for the past four quarters. Our minimum net worth and maximum net debt-to-capital calculations exclude the impact of Accumulated other comprehensive loss on Total shareholders' equity. We were well in excess of all debt covenant requirements as of December 31, 2017. The specific covenants and related definitions can be found in the applicable debt agreements, the majority of which have been previously filed with the Securities and Exchange Commission.
Dividends
In December 2017, we declared a cash dividend on our common stock of $0.60 per share which was paid in the first quarter of 2018. We declared a cash dividend on our common stock of $0.60 per share during the third quarter of 2017 which was paid in the fourth quarter of 2017. During the first and second quarters of 2017, we declared a cash dividend on our common stock of $0.48 per share which was paid in the second and third quarters of 2017, respectively. 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.
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