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EX-32.1 - EXHIBIT 32.1 - ROYAL CARIBBEAN CRUISES LTDrcl-9302017xexhibit321.htm
EX-31.2 - EXHIBIT 31.2 - ROYAL CARIBBEAN CRUISES LTDrcl-9302017xexhibit312.htm
EX-31.1 - EXHIBIT 31.1 - ROYAL CARIBBEAN CRUISES LTDrcl-9302017xexhibit311.htm
EX-10.7 - EXHIBIT 10.7 - ROYAL CARIBBEAN CRUISES LTDrcl-9302017xexhibit107.htm

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 September 30, 2017

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 214,088,950 shares of common stock outstanding as of October 30, 2017.
 



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 September 30,
 
2017
 
2016
Passenger ticket revenues
$
1,893,152

 
$
1,899,956

Onboard and other revenues
676,392

 
663,785

Total revenues
2,569,544

 
2,563,741

Cruise operating expenses:
 

 
 

Commissions, transportation and other
409,597

 
400,933

Onboard and other
157,041

 
159,887

Payroll and related
210,764

 
214,081

Food
126,223

 
125,732

Fuel
160,752

 
178,772

Other operating
253,892

 
260,718

Total cruise operating expenses
1,318,269

 
1,340,123

Marketing, selling and administrative expenses
273,637

 
259,327

Depreciation and amortization expenses
240,150

 
229,328

Operating Income
737,488

 
734,963

Other income (expense):
 

 
 

Interest income
4,693

 
6,472

Interest expense, net of interest capitalized
(73,233
)
 
(82,610
)
Equity investment income
85,120

 
46,539

Other expense
(1,226
)
 
(12,107
)
 
15,354

 
(41,706
)
Net Income
$
752,842

 
$
693,257

Earnings per Share:
 

 
 

Basic
$
3.51

 
$
3.23

Diluted
$
3.49

 
$
3.21

Weighted-Average Shares Outstanding:
 

 
 

Basic
214,694

 
214,819

Diluted
215,824

 
215,667

Comprehensive Income
 

 
 

Net Income
$
752,842

 
$
693,257

Other comprehensive income (loss):
 

 
 

Foreign currency translation adjustments
5,889

 
4,043

Change in defined benefit plans
(1,990
)
 
(5,051
)
Gain on cash flow derivative hedges
230,245

 
95,536

Total other comprehensive income
234,144

 
94,528

Comprehensive Income
$
986,986

 
$
787,785

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


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ROYAL CARIBBEAN CRUISES LTD.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(unaudited; in thousands, except per share data)
 
Nine Months Ended September 30,
 
2017
 
2016
Passenger ticket revenues
$
4,892,760

 
$
4,794,653

Onboard and other revenues
1,880,618

 
1,792,145

Total revenues
6,773,378

 
6,586,798

Cruise operating expenses:
 

 
 

Commissions, transportation and other
1,060,176

 
1,060,391

Onboard and other
395,472

 
399,739

Payroll and related
636,861

 
671,955

Food
369,198

 
371,759

Fuel
508,914

 
531,283

Other operating
780,257

 
857,161

Total cruise operating expenses
3,750,878

 
3,892,288

Marketing, selling and administrative expenses
874,957

 
852,435

Depreciation and amortization expenses
710,836

 
661,712

Operating Income
1,436,707

 
1,180,363

Other income (expense):
 

 
 

Interest income
16,756

 
14,875

Interest expense, net of interest capitalized
(230,182
)
 
(226,803
)
Equity investment income
120,359

 
94,832

Other expense (including a $21.7 million loss related to the first quarter 2016 elimination of the Pullmantur reporting lag)
(6,546
)
 
(40,965
)
 
(99,613
)
 
(158,061
)
Net Income
$
1,337,094

 
$
1,022,302

Earnings per Share:
 

 
 

Basic
$
6.22

 
$
4.74

Diluted
$
6.19

 
$
4.72

Weighted-Average Shares Outstanding:
 

 
 

Basic
214,882

 
215,663

Diluted
215,905

 
216,575

Comprehensive Income
 

 
 

Net Income
$
1,337,094

 
$
1,022,302

Other comprehensive income (loss):
 

 
 

Foreign currency translation adjustments
14,210

 
8,423

Change in defined benefit plans
(6,280
)
 
(12,148
)
Gain on cash flow derivative hedges
381,660

 
254,624

Total other comprehensive income
389,590

 
250,899

Comprehensive Income
$
1,726,684

 
$
1,273,201

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


2


ROYAL CARIBBEAN CRUISES LTD.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
As of
 
September 30,
 
December 31,
 
2017
 
2016
 
(unaudited)
 
 
Assets
 

 
 

Current assets
 

 
 

Cash and cash equivalents
$
139,950

 
$
132,603

Trade and other receivables, net
285,332

 
291,899

Inventories
119,949

 
114,087

Prepaid expenses and other assets
200,125

 
209,716

Derivative financial instruments
52,796

 

Total current assets
798,152

 
748,305

Property and equipment, net
19,688,872

 
20,161,427

Goodwill
288,517

 
288,386

Other assets
1,323,773

 
1,112,206

 
$
22,099,314

 
$
22,310,324

Liabilities and Shareholders’ Equity
 

 
 

Current liabilities
 
 
 
Current portion of long-term debt
$
1,515,708

 
$
1,285,735

Accounts payable
384,536

 
305,313

Accrued interest
92,914

 
46,166

Accrued expenses and other liabilities
748,442

 
692,322

Derivative financial instruments
89,333

 
146,592

Customer deposits
2,226,179

 
1,965,473

Total current liabilities
5,057,112

 
4,441,601

Long-term debt
6,076,499

 
8,101,701

Other long-term liabilities
530,215

 
645,610

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; 235,134,180 and 234,613,486 shares issued, September 30, 2017 and December 31, 2016, respectively)
2,351

 
2,346

Paid-in capital
3,375,969

 
3,328,517

Retained earnings
8,862,369

 
7,860,341

Accumulated other comprehensive loss
(526,894
)
 
(916,484
)
Treasury stock (21,059,191 and 20,019,237 common shares at cost, September 30, 2017 and December 31, 2016, respectively)
(1,278,307
)
 
(1,153,308
)
Total shareholders’ equity
10,435,488

 
9,121,412

 
$
22,099,314

 
$
22,310,324

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


3


ROYAL CARIBBEAN CRUISES LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited; in thousands)
 
Nine Months Ended September 30,
 
2017
 
2016
Operating Activities
 

 
 

Net income
$
1,337,094

 
$
1,022,302

Adjustments:
 

 
 

Depreciation and amortization
710,836

 
661,712

Net deferred income tax expense
516

 
1,601

(Gain) loss on derivative instruments not designated as hedges
(56,836
)
 
6,353

Share-based compensation expense
52,469

 
22,041

Equity investment income
(120,359
)
 
(94,832
)
Amortization of debt issuance costs
37,562

 
39,425

Gain on sale of property and equipment
(30,902
)
 

Changes in operating assets and liabilities:
 

 
 

Decrease in trade and other receivables, net
16,245

 
9,823

Increase in inventories
(6,131
)
 
(6,379
)
Decrease (increase) in prepaid expenses and other assets
10,211

 
(8,794
)
Increase (decrease) in accounts payable
77,436

 
(17,313
)
Increase in accrued interest
46,748

 
56,787

Increase in accrued expenses and other liabilities
12,870

 
17,929

Increase in customer deposits
256,855

 
197,277

Dividends received from unconsolidated affiliates
107,267

 
71,370

Other, net
2,720

 
21,650

Net cash provided by operating activities
2,454,601

 
2,000,952

Investing Activities
 

 
 

Purchases of property and equipment
(387,335
)
 
(2,313,831
)
Cash received (paid) on settlement of derivative financial instruments
57,004

 
(172,878
)
Investments in and loans to unconsolidated affiliates

 
(8,611
)
Cash received on loans to unconsolidated affiliates
31,633

 
22,470

Proceeds from the sale of property and equipment
230,000

 

Other, net (1)
(9,313
)
 
(44,709
)
Net cash used in investing activities
(78,011
)
 
(2,517,559
)
Financing Activities
 

 
 

Debt proceeds
3,682,000

 
6,038,560

Debt issuance costs
(25,987
)
 
(83,793
)
Repayments of debt
(5,598,198
)
 
(4,818,262
)
Purchases of treasury stock
(124,999
)
 
(299,959
)
Dividends paid
(309,162
)
 
(243,557
)
Proceeds from exercise of common stock options
2,499

 
1,782

Other, net
4,137

 
2,179

Net cash (used in) provided by financing activities
(2,369,710
)
 
596,950

Effect of exchange rate changes on cash
467

 
(23,480
)
Net increase in cash and cash equivalents
7,347

 
56,863

Cash and cash equivalents at beginning of period
132,603

 
121,565

Cash and cash equivalents at end of period
$
139,950

 
$
178,428

Supplemental Disclosure
 

 
 

Cash paid during the period for:
 

 
 

Interest, net of amount capitalized
$
147,789

 
$
140,335

Non-cash Investing Activities
 

 
 

Notes receivable issued upon sale of property and equipment
$

 
$
213,042


(1) Amount includes $26.0 million in 2016 related to cash included in the divestiture of our 51% interest in Pullmantur Holdings.

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

4


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 Quarterly Report on Form 10-Q, 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 Quarterly Report on Form 10-Q should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2016, 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 September 30, 2017, 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 have a minority 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.

Prior to August 2016, Pullmantur Holdings S.L. ("Pullmantur Holdings"), the parent company of the Pullmantur brand (formerly known as Royal Caribbean Holdings de España S.L.), was wholly owned by us. Effective July 31, 2016, we sold 51% of our interest in Pullmantur Holdings. We retain a 49% interest in Pullmantur Holdings as well as full ownership of the four vessels currently operated by the Pullmantur brand under bareboat charter arrangements. We account for the bareboat charters of the vessels to Pullmantur Holdings as operating leases. We also provide certain ship management services and other related services to Pullmantur Holdings.

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, 2016 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. 

Prior to January 1, 2016, we consolidated the operating results of Pullmantur Holdings on a two-month reporting lag to allow for more timely preparation of our consolidated financial statements. Effective January 1, 2016, we eliminated the two-month reporting lag to reflect Pullmantur Holding's financial position, results of operations and cash flows concurrently and consistently with the fiscal calendar of the Company (the "elimination of the Pullmantur reporting lag"). The elimination of the Pullmantur reporting lag represented a change in accounting principle which we believed to be preferable because it provided more current

5


information to the users of our financial statements. A change in accounting principle requires retrospective application, if material. The impact of the elimination of the Pullmantur reporting lag was immaterial to prior periods and was immaterial for our fiscal year ended December 31, 2016. As a result, we have accounted for this change in accounting principle in our consolidated results for the first quarter of 2016. Accordingly, the results of Pullmantur Holdings for November and December 2015 are included in our statement of comprehensive income (loss) for the nine months ended September 30, 2016. The effect of this change was a decrease to net income of $21.7 million, which has been reported within Other expense in our consolidated statements of comprehensive income (loss) for the nine months ended September 30, 2016.

Note 2. Summary of Significant Accounting Policies

Recent Accounting Pronouncements

Revenue from Contracts with Customers

In May 2014, amended GAAP guidance was issued to clarify the principles used to recognize revenue for all entities. The guidance also requires more detailed disclosures and provides additional guidance for transactions that were not comprehensively addressed in the prior accounting guidance. This guidance must be applied using one of two retrospective application methods and will be effective for our annual reporting period beginning after December 15, 2017, including interim periods therein.

We have made significant progress toward completing our evaluation of potential changes to our core revenues using the five-step model supported by the new revenue standard. Currently, we are in the process of finalizing our analysis and quantifying the effects of adoption, if any, on how we account for our customer loyalty programs and promotional offerings, as the new standard has changed the method of accounting for loyalty points from a cost-based model to a revenue deferral model using a relative stand-alone selling price method. We expect to complete this analysis and conclude our evaluation on the impact of adopting this new standard on our consolidated financial statements during the fourth quarter of fiscal 2017. Based on our assessment to date, we do not expect the adoption of the new standard to materially change the timing of recognition of our core revenues, but we do anticipate enhancing our disclosures with respect to our revenue recognition policies in compliance with the new standard.

Upon adoption, we intend to elect the modified retrospective method. This will involve applying the guidance retrospectively only to the most current period presented in the consolidated financial statements and recognizing the cumulative effect of initially applying the guidance as an adjustment to the January 1, 2018 opening balance of retained earnings.
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.

Classification of Certain Cash Receipts and Cash Payments

In August 2016, amended GAAP guidance was issued to clarify how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments are aimed at reducing the existing diversity in practice. The guidance should be applied using a retrospective transition method to each period presented and will be effective for annual periods beginning after December 15, 2017 and interim periods within those annual periods. Early adoption is permitted, including adoption in an interim period. We intend to adopt the guidance on the date of initial application, January 1, 2018. The adoption of this newly issued guidance is not expected to have a material impact to our consolidated financial statements.

Intra-Entity Transfers of Assets Other Than Inventory

In October 2016, amended GAAP guidance was issued that 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. The new guidance is effective for annual and interim reporting periods beginning after December 15, 2017. Early adoption is permitted as of the beginning of an annual period for which financial statements have not been issued. The guidance is required to be adopted retrospectively by recording a cumulative-effect adjustment to retained earnings as of the beginning of

6


the adoption period. The adoption of this newly issued guidance is not expected to have a material impact to our consolidated financial statements.

Service Concession Arrangements

In May 2017, amended GAAP guidance was issued to clarify who should be viewed as the customer under service concession arrangements. A service concession arrangement is an arrangement under which a public sector entity (“grantor”), such as a Port Authority,  grants a private entity (“operator”), such as the Company, the right to operate the grantor's infrastructure for a specified period of time. The amended guidance will require the Company to evaluate the relationship with the grantor and identify the multiple performance obligations that may exist under these concession arrangements, including consideration of construction services that may be performed, operational services, and any other maintenance or ancillary services performed under the service concession. In addition, the amended guidance will require that all revenue streams identified under such arrangements be evaluated with the grantor as the customer, irrespective of whether some of the revenues are paid by third-party users of the infrastructure under concession. The clarification will enable a more consistent application of the new Revenue from Contracts with Customers guidance,  which along with this clarification guidance, will be effective for our annual reporting period beginning after December 15, 2017, including interim periods therein. This guidance must be applied using one of two retrospective application methods. We are currently evaluating the impact of the adoption of this newly issued guidance to our consolidated financial statements.

Derivatives and Hedging

In August 2017, amended GAAP guidance was issued to simplify and improve the financial reporting of hedging relationships to better portray the economic results of an entity's risk management activities in its financial statements. In addition to changes in designation and measurement for qualifying hedge relationships, the guidance requires an entity to report the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is reported. As a result, hedge ineffectiveness will no longer be separately measured or reported. This guidance will be effective for our annual reporting period beginning after December 15, 2018, including interim periods therein. Early adoption is permitted in any interim period after issuance of this guidance. All transition requirements and elections should be applied to hedging relationships existing on the date of adoption. The effect of the adoption should be reflected as of the beginning of the fiscal year of adoption. We are currently evaluating the impact of the adoption of this newly issued guidance to our consolidated financial statements.

Other
 
Revenues and expenses include port costs that vary with guest head counts. The amounts of such port costs included in Passenger ticket revenues on a gross basis were $135.9 million and $158.7 million for the third quarters of 2017 and 2016, respectively, and $413.7 million and $443.1 million for the nine months ended September 30, 2017 and 2016, respectively.

Reclassifications

For the third quarter and nine months ended September 30, 2016, restructuring charges of $1.9 million and $6.6 million, respectively, have been reclassified into Marketing, selling and administrative expenses in the consolidated statements of comprehensive income (loss) in order to conform to the current year presentation.

For the nine months ended September 30, 2016, share-based compensation expense of $22.0 million, equity investment income of $94.8 million and amortization of debt issuance costs of $22.9 million, have been reclassified in the consolidated statements of cash flows from Other, net to Share-based compensation expense, Equity investment income and Amortization of debt issuance costs, respectively, within Net cash provided by operating activities in order to conform to the current year presentation.

Additionally, for the nine months ended September 30, 2016, amortization of debt issuance costs of $11.3 million and $5.3 million, have been reclassified from Decrease (increase) in prepaid expenses and other assets and from Increase in accrued expenses and other liabilities, respectively, in the consolidated statements of cash flows to Amortization of debt issuance costs, within Net cash provided by operating activities in order to conform to the current year presentation.


7


Note 3. Earnings Per Share
 
A reconciliation between basic and diluted earnings per share is as follows (in thousands, except per share data):
 
Quarter Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net income for basic and diluted earnings per share
$
752,842

 
$
693,257

 
$
1,337,094

 
$
1,022,302

Weighted-average common shares outstanding
214,694

 
214,819

 
214,882

 
215,663

Dilutive effect of stock options, performance share awards and restricted stock awards
1,130

 
848

 
1,023

 
912

Diluted weighted-average shares outstanding
215,824

 
215,667

 
215,905

 
216,575

Basic earnings per share
$
3.51

 
$
3.23

 
$
6.22

 
$
4.74

Diluted earnings per share
$
3.49

 
$
3.21

 
$
6.19

 
$
4.72

 
There were no antidilutive shares for the quarters and nine month periods ended September 30, 2017 and September 30, 2016.
 
Note 4. Property and Equipment

In March 2017, we sold Legend of the Seas to an affiliate of TUI AG, our joint venture partner in TUI Cruises. The sale resulted in a gain of $30.9 million and is reported within Other operating within Cruise operating expenses in our consolidated statements of comprehensive income (loss) for the nine months ended September 30, 2017.

In April 2016, we sold Splendour of the Seas to TUI Cruises. Concurrent with the acquisition, TUI Cruises leased the ship to the same TUI AG affiliate mentioned above, which now operates the ship. The gain recognized did not have a material effect to our consolidated financial statements and was also reported in Other operating within Cruise operating expenses in our consolidated statements of comprehensive income (loss) for the nine months ended September 30, 2016.

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 September 30, 2017, the net book value of our investment in TUI Cruises was approximately $582.5 million, primarily consisting of $379.3 million in equity and a loan of €170.4 million, or approximately $201.5 million based on the exchange rate at September 30, 2017. As of December 31, 2016, the net book value of our investment in TUI Cruises was approximately $517.0 million, primarily consisting of $323.5 million in equity and a loan of €182.3 million, or approximately $192.4 million based on the exchange rate at December 31, 2016. 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. Refer to Note 4. Property and Equipment for further information. 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 September 30, 2017, the outstanding principal amount of the loan was €100.4 million, or approximately $118.7 million based on the exchange rate at September 30, 2017. While this loan matures in May 2022, the lenders have agreed to release each shareholder's guarantee if certain conditions are met by April 2018. The loan amortizes quarterly and is secured by first mortgages on the Mein Schiff 1 and Mein Schiff 2 vessels. 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

8


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 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, 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, following the sale of our 51% interest in Pullmantur Holdings to Springwater Capital LLC ("Springwater"), we do not consolidate this entity and we account for this investment under the equity method of accounting. As of September 30, 2017, our maximum exposure to loss in Pullmantur Holdings was approximately $50.9 million consisting of loans and other receivables. As of December 31, 2016, our maximum exposure to loss in Pullmantur Holdings was approximately $40.3 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.

In conjunction with the sale of our 51% interest in Pullmantur Holdings, we agreed to provide a non-revolving working capital facility to a Pullmantur Holdings subsidiary in the amount of up to €15.0 million or approximately $17.7 million based on the exchange rate at September 30, 2017. 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 has guaranteed repayment of 51% of the outstanding amounts under the facility. As of September 30, 2017, 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 and nine months ended September 30, 2017, we made payments of $1.9 million and $7.5 million, respectively, 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 September 30, 2017, the net book value of our investment in Grand Bahama was approximately $50.4 million, consisting of $30.8 million in equity and a loan of $19.6 million. As of December 31, 2016, the net book value of our investment in Grand Bahama was approximately $47.0 million, consisting of $23.2 million in equity and a loan of $23.8 million. These amounts represent our maximum exposure to loss related to our investment in Grand Bahama. Our debt agreement with Grand Bahama was amended during the quarter ended March 31, 2016 to extend the maturity by 10 years and increase the applicable interest rate to 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 continue to classify the loan, as modified, as non-accrual status. The loan balance is included within Other assets in our consolidated balance sheets. 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 September 30, 2017.

We have determined that Skysea Holding International Ltd. ("Skysea Holding"), in which we have a 36% noncontrolling interest, is a VIE. During the second quarter of 2017, we made an equity contribution of $7.1 million which increased our equity interest from 35% to 36%. The contribution was made pursuant to a funding arrangement in which the entity's three largest investors agreed to contribute a total of $30.0 million in proportion to their equity interest in a series of installments. We have determined that we are not the primary beneficiary of Skysea Holding 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.com International Ltd, 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. Interest under these facilities, which mature in January 2030, currently accrues at a rate of 6.5% per annum. 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. As of September 30, 2017, the net book value of our investment in Skysea Holding and its subsidiaries was approximately $97.3 million, consisting of $6.5 million in equity and loans and other receivables of $90.8 million. As of December 31, 2016, the net book value of our investment in Skysea Holding and its subsidiaries was approximately $98.0 million, consisting of $9.2 million in equity and loans and other receivables of $88.8 million. The majority of these amounts were included within Other assets in our consolidated balance sheets and represent our maximum exposure to loss related to our investment in Skysea Holding.


9


The following table sets forth information regarding our investments accounted for under the equity method of accounting, including the entities discussed above, (in thousands):
 
 
Quarter Ended September 30, 2017
 
Quarter Ended September 30, 2016
 
Nine Months Ended September 30, 2017
 
Nine Months Ended September 30, 2016
Share of equity income from investments
 
$
85,120

 
$
46,539

 
$
120,359

 
$
94,832

Dividends received
 
$
49,865

 
$
47,491

 
$
107,267

 
$
71,370


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 September 30, 2017
 
Quarter Ended September 30, 2016
 
Nine Months Ended September 30, 2017
 
Nine Months Ended September 30, 2016
Revenues
 
$
14,054

 
$
9,300

 
$
39,987

 
$
17,888

Expenses
 
$
3,770

 
$
2,410

 
$
11,503

 
$
8,930


Note 6. Long-Term Debt

In October 2017, we amended and restated our $1.2 billion unsecured revolving credit facility due August 2018. The amendment reduced the applicable margin and extended the termination date to October 2022. The applicable margin and facility fee vary with our debt rating and are currently 1.175% and 0.20%, respectively. We have the ability to increase the capacity of the amended facility by an additional $500 million, subject to the receipt of additional or increased lender commitments, and to extend the termination date by up to two years, subject to lender consent. These amendments did not result in the extinguishment of debt.

Note 7. Commitments and Contingencies

Ship Purchase Obligations

Our future capital commitments consist primarily of new ship orders. As of September 30, 2017, we had two Quantum-class ships, two Oasis-class ships and two ships of a new generation of ships, known as "Project Icon," on order for our Royal Caribbean International brand with an aggregate capacity of approximately 30,500 berths. Additionally, as of September 30, 2017, we have four Edge-class ships on order for our Celebrity Cruises brand with an aggregate capacity of approximately 11,600 berths. The following provides further information on recent developments with respect to our ship orders.

During the second quarter of 2017, we entered into agreements with Meyer Turku to build two "Project Icon" ships. Subsequently, 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. For each ship, the official Finnish export credit agency, Finnvera, plc, has agreed to guarantee to the lenders a substantial majority of the financing, with a smaller portion of the financing to be 95% guaranteed by Euler Hermes, the official German export credit agency. The maximum loan amount under each facility is not to exceed €1.4 billion, or approximately $1.7 billion, based on the exchange rate at September 30, 2017. Interest on approximately 75% of each loan will accrue at a fixed rate of 3.56% and 3.76% for the first and the second Icon-class ships, respectively, and the balance will accrue interest at a floating rate ranging from LIBOR plus 1.10% to 1.15% and LIBOR plus 1.15% to 1.20% for the first and the second Icon-class ships, respectively. Each loan will amortize semi-annually and will mature 12 years following delivery of each ship. The first and second Icon-class ships will each have a capacity of approximately 5,650 berths and are expected to enter service in the second quarters of 2022 and 2024, respectively.

In July 2017, we entered into credit agreements for the unsecured financing of the third and fourth Edge-class ships and the fifth Oasis-class ship for up to 80% of each ship’s contract price through facilities to be guaranteed 100% by Bpifrance Assurance Export, the official export credit agency of France. Under these financing arrangements, we have the right, but not the obligation, to satisfy the obligations to be incurred upon delivery and acceptance of each ship under the shipbuilding contract by assuming, at delivery and acceptance, the debt indirectly incurred by the shipbuilder during the construction of each ship. The maximum loan amount under each facility is not to exceed €684.2 million in the case of the third Edge-class ship and the United States dollar equivalent of €714.6 million and €1.1 billion in the case of the fourth Edge-class ship and fifth Oasis-class ship, or approximately $844.7 million and $1.3 billion, respectively, based on the exchange rate at September 30, 2017. The loans will amortize semi-annually and will mature 12 years following delivery of each ship. Interest on the loans will accrue at a fixed rate of 1.28% for the third Edge-class ship and at a fixed rate of 3.18% for both, the fourth Edge-class ship and the fifth Oasis-class ship. The third

10


and fourth Edge-class ships, each of which will have a capacity of approximately 2,900 berths, are expected to enter service in the fourth quarters of 2021 and 2022, respectively. The fifth Oasis-class ship will have a capacity of approximately 5,450 berths and is expected to enter service in the second quarter of 2021.

In September 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.

As of September 30, 2017, the aggregate cost of our ships on order, not including any ships on order by our Partner Brands, was approximately $13.0 billion, of which we had deposited $323.2 million as of such date. Approximately 53.8% of the aggregate cost was exposed to fluctuations in the Euro exchange rate at September 30, 2017. 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
 
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

In September 2017, we declared a cash dividend on our common stock of $0.60 per share which was paid in October 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 April 2017 and July 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.

During the third quarter of 2016, we declared a cash dividend on our common stock of $0.48 per share which was paid in October 2016. During the first and second quarters of 2016, we declared and paid a cash dividend on our common stock of $0.375 per share. During the first quarter of 2016, we also paid a cash dividend on our common stock of $0.375 per share which was declared during the fourth quarter of 2015.

In April 2017, our board of directors authorized a 12-month common stock repurchase program for up to $500 million. The timing and number of shares to be repurchased will depend on a variety of factors including price and market conditions. Repurchases under the program may be made at management's discretion from time to time on the open market or through privately negotiated transactions. During the third quarter of 2017, we repurchased 1.0 million shares of our common stock for a total of $125.0 million in open market transactions that were recorded within Treasury stock in our consolidated balance sheets. With these repurchases, we have $375.0 million that remain available for future stock repurchase transactions under our Board approved program.


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 nine months ended September 30, 2017 and 2016 (in thousands):
 
Accumulated Other Comprehensive Income (Loss) for the Nine Months Ended September 30, 2017
 
Accumulated Other Comprehensive Income (Loss) for the Nine Months Ended September 30, 2016
 
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
$
(820,850
)
 
$
(28,083
)
 
$
(67,551
)
 
$
(916,484
)
 
$
(1,232,073
)
 
$
(26,447
)
 
$
(69,913
)
 
$
(1,328,433
)
Other comprehensive income (loss) before reclassifications
230,341

 
(7,130
)
 
14,210

 
237,421

 
(9,150
)
 
(13,521
)
 
8,423

 
(14,248
)
Amounts reclassified from accumulated other comprehensive loss
151,319

 
850

 

 
152,169

 
263,774

 
1,373

 

 
265,147

Net current-period other comprehensive income (loss)
381,660

 
(6,280
)
 
14,210

 
389,590

 
254,624

 
(12,148
)
 
8,423

 
250,899

Ending balance
$
(439,190
)
 
$
(34,363
)
 
$
(53,341
)
 
$
(526,894
)
 
$
(977,449
)
 
$
(38,595
)
 
$
(61,490
)
 
$
(1,077,534
)

The following table presents reclassifications out of accumulated other comprehensive income (loss) for the quarters and nine months ended September 30, 2017 and 2016 (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 September 30, 2017
 
Quarter Ended September 30, 2016
 
Nine Months Ended September 30, 2017
 
Nine Months Ended September 30, 2016
 
Affected Line Item in  Statements of
Comprehensive Income (Loss)
Loss on cash flow derivative hedges:
 
 

 
 
 
 

 
 
 
 
Interest rate swaps
 
$
(7,860
)
 
$
(11,953
)
 
$
(24,580
)
 
$
(32,019
)
 
Interest expense, net of interest capitalized
Foreign currency forward contracts
 
(2,710
)
 
(2,710
)
 
(8,130
)
 
(5,408
)
 
Depreciation and amortization expenses
Foreign currency forward contracts
 
(1,512
)
 
(3,465
)
 
(9,187
)
 
(10,206
)
 
Other expense
Foreign currency forward contracts
 

 

 

 
(207
)
 
Other operating
Foreign currency collar options
 
(602
)
 
(601
)
 
(1,806
)
 
(1,806
)
 
Depreciation and amortization expenses
Fuel swaps
 
1,758

 
2,760

 
6,533

 
9,356

 
Other expense
Fuel swaps
 
(32,386
)
 
(64,654
)
 
(114,149
)
 
(223,484
)
 
Fuel
 
 
(43,312
)
 
(80,623
)
 
(151,319
)
 
(263,774
)
 
 
Amortization of defined benefit plans:
 
 

 
 
 
 
 
 
 
 
Actuarial loss
 
(293
)
 
(285
)
 
(850
)
 
(1,373
)
 
Payroll and related
 
 
(293
)
 
(285
)
 
(850
)
 
(1,373
)
 
 
Total reclassifications for the period
 
$
(43,605
)
 
$
(80,908
)
 
$
(152,169
)
 
$
(265,147
)
 
 

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 September 30, 2017 Using
 
Fair Value Measurements at December 31, 2016 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)
 
$
139,950

 
$
139,950

 
$
139,950

 
$

 
$

 
$
132,603

 
$
132,603

 
$
132,603

 
$

 
$

Total Assets
 
$
139,950

 
$
139,950

 
$
139,950

 
$

 
$

 
$
132,603

 
$
132,603

 
$
132,603

 
$

 
$

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Long-term debt (including current portion of long-term debt)(5)
 
$
7,557,801

 
$
8,111,168

 
$

 
$
8,111,168

 
$

 
$
9,347,051

 
$
9,859,266

 
$

 
$
9,859,266

 
$

Total Liabilities
 
$
7,557,801

 
$
8,111,168

 
$

 
$
8,111,168

 
$

 
$
9,347,051

 
$
9,859,266

 
$

 
$
9,859,266

 
$


(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 September 30, 2017 and December 31, 2016.
(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 September 30, 2017 and December 31, 2016.
 
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 September 30, 2017 Using
 
Fair Value Measurements at December 31, 2016 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)
 
$
221,258

 
$

 
$
221,258

 
$

 
$
19,397

 
$

 
$
19,397

 
$

Investments(5)
 
$
3,237

 
3,237

 

 

 
$
3,576

 
3,576

 

 

Total Assets
 
$
224,495

 
$
3,237

 
$
221,258

 
$

 
$
22,973

 
$
3,576

 
$
19,397

 
$

Liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Derivative financial instruments(6)
 
$
189,163

 
$

 
$
189,163

 
$

 
$
373,497

 
$

 
$
373,497

 
$

Total Liabilities
 
$
189,163

 
$

 
$
189,163

 
$

 
$
373,497

 
$

 
$
373,497

 
$


(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, cross currency 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. Fair value for foreign currency collar options is determined by using standard option pricing models with inputs based on the options’ contract terms, such as exercise price and maturity, and readily available public market data, such as foreign exchange curves, foreign exchange volatility levels and discount rates. All derivative instrument fair values take into account the creditworthiness of the counterparty and the Company.
(3)
Inputs that are unobservable. The Company did not use any Level 3 inputs as of September 30, 2017 and December 31, 2016.
(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 September 30, 2017 or December 31, 2016, or that will be realized in the future, and do not include expenses that could be incurred in an actual sale or settlement.

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.

13


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 September 30, 2017
 
As of December 31, 2016
 
 
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
 
$
221,258

 
$
(117,065
)
 
$

 
$
104,193

 
$
19,397

 
$
(19,397
)
 
$

 
$

Total
 
$
221,258

 
$
(117,065
)
 
$

 
$
104,193

 
$
19,397

 
$
(19,397
)
 
$

 
$


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 September 30, 2017
 
As of December 31, 2016
 
 
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
 
$
(189,163
)
 
$
117,065

 
$

 
$
(72,098
)
 
$
(373,497
)
 
$
19,397

 
$
7,213

 
$
(346,887
)
Total
 
$
(189,163
)
 
$
117,065

 
$

 
$
(72,098
)
 
$
(373,497
)
 
$
19,397

 
$
7,213

 
$
(346,887
)

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 September 30, 2017, we had counterparty credit risk exposure under our derivative instruments of approximately $101.6 million, which was 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. As of December 31, 2016, we did not have any exposure under our derivative instruments. 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.
 
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. The determination of ineffectiveness is based on the amount of dollar offset between the change in fair value of the derivative instrument and the change in fair value of the hedged item at the end of the reporting period. If it is determined that a derivative is not highly effective as a hedge or hedge accounting is discontinued, any change in fair value of the derivative since the last date at which it was determined to be effective is recognized in earnings. In addition, the ineffective portion of our highly effective hedges is immediately recognized in earnings and reported in Other expense in our consolidated statements of comprehensive income (loss).
 
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 September 30, 2017 and December 31, 2016, approximately 48.8% and 40.5%, 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.

15


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 September 30, 2017 and December 31, 2016, we maintained interest rate swap agreements on the following fixed-rate debt instruments:
Debt Instrument
Swap Notional as of September 30, 2017 (In thousands)
Maturity
Debt Fixed Rate
Swap Floating Rate: LIBOR plus
All-in Swap Floating Rate as of September 30, 2017
Oasis of the Seas term loan
$
157,500

October 2021
5.41%
3.87%
5.29%
Unsecured senior notes
650,000

November 2022
5.25%
3.63%
4.95%
 
$
807,500

 
 
 
 

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 September 30, 2017 and December 31, 2016, we maintained interest rate swap agreements on the following floating-rate debt instruments:
Debt Instrument
Swap Notional as of September 30, 2017 (In thousands)
Maturity
Debt Floating Rate
All-in Swap Fixed Rate
Celebrity Reflection term loan
$
409,063

October 2024
LIBOR plus
0.40%
2.85%
Quantum of the Seas term loan
581,875

October 2026
LIBOR plus
1.30%
3.74%
Anthem of the Seas term loan
604,167

April 2027
LIBOR plus
1.30%
3.86%
Ovation of the Seas term loan 
760,833

April 2028
LIBOR plus
1.00%
3.16%
Harmony of the Seas term loan (1)
751,362

May 2028
EURIBOR plus
1.15%
2.26%
 
$
3,107,300

 
 
 
 

(1) Interest rate swap agreements hedging the Euro-denominated term loan for Harmony of the Seas include EURIBOR zero-floors matching the hedged debt EURIBOR zero-floor. Amount presented is based on the exchange rate as of September 30, 2017.

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 September 30, 2017 and December 31, 2016 was $3.9 billion and $4.0 billion, respectively.
 
Foreign Currency Exchange Rate Risk

Derivative Instruments
 
Our primary exposure to foreign currency exchange rate risk relates to our ship construction contracts denominated in Euros, our foreign currency denominated debt and our international business operations. We enter into foreign currency forward contracts, collar options and cross currency swap agreements to manage portions of the exposure to movements in foreign currency exchange rates. As of September 30, 2017, the aggregate cost of our ships on order, not including the TUI Cruises' ships on order and those subject to conditions to effectiveness, was approximately $13.0 billion, of which we had deposited $323.2 million as of such date. At September 30, 2017 and December 31, 2016, approximately 53.8% and 66.7%, 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 third quarter of 2017, we maintained an average of approximately $823.0 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 (loss), of approximately $22.0 million and $(2.5) million during the quarters ended September 30, 2017 and September 30, 2016, respectively, and approximately $57.1 million and $(11.8) million, during the nine months ended September 30, 2017 and September 30, 2016, respectively, that were recognized in earnings within Other expense in our consolidated statements of comprehensive income (loss).


16


We consider our investments in our foreign operations to be denominated in relatively stable currencies and of a long-term nature. As of September 30, 2017, we maintained foreign currency forward contracts and designated them as hedges of a portion of our net investment in TUI cruises of €101.0 million, or approximately $119.4 million based on the exchange rate at September 30, 2017. These forward currency contracts mature in October 2021.

The notional amount of outstanding foreign exchange contracts including our forward contracts as of September 30, 2017 and December 31, 2016 was $4.1 billion and $1.3 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 in TUI Cruises of approximately €241.0 million, or approximately $284.9 million, as of September 30, 2017.

 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 September 30, 2017, we have hedged the variability in future cash flows for certain forecasted fuel transactions occurring through 2021. As of September 30, 2017 and December 31, 2016, we had the following outstanding fuel swap agreements:
 
Fuel Swap Agreements
 
As of September 30, 2017
 
As of December 31, 2016
 
(metric tons)
2017
218,600

 
799,065

2018
756,700

 
616,300

2019
668,500

 
521,000

2020
531,200

 
306,500

2021
224,900

 

 
Fuel Swap Agreements
 
As of September 30, 2017
 
As of December 31, 2016
 
(% hedged)
Projected fuel purchases:
 

 
 

2017
65
%
 
60
%
2018
56
%
 
44
%
2019
47
%
 
35
%
2020
36
%
 
20
%
2021
14
%
 

 

17


At September 30, 2017 and December 31, 2016, $81.7 million and $138.5 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:
 
 
Fair Value of Derivative Instruments
 
 
Asset Derivatives
 
Liability Derivatives
 
 
Balance Sheet Location
 
As of September 30, 2017
 
As of December 31, 2016
 
Balance Sheet Location
 
As of September 30, 2017
 
As of December 31, 2016
 
 
 
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
 
$
1,760

 
$
5,246

 
Other long-term liabilities
 
$
52,611

 
$
57,679

Foreign currency forward contracts
 
Derivative financial instruments
 
45,583

 

 
Derivative financial instruments
 

 
5,574

Foreign currency forward contracts
 
Other assets
 
136,534

 

 
Other long-term liabilities
 
4,479

 
68,165

Fuel swaps
 
Derivative financial instruments
 
7,213

 

 
Derivative financial instruments
 
81,981

 
129,486

Fuel swaps
 
Other assets
 
29,721

 
13,608

 
Other long-term liabilities
 
40,517

 
95,125

Total derivatives designated as hedging instruments under 815-20
 
 
 
220,811

 
18,854

 
 
 
179,588

 
356,029

Derivatives not designated as hedging instruments under ASC 815-20
 
 
 
 
 
 
 
 
 
 
 
 
Fuel swaps
 
Derivative financial instruments
 

 

 
Derivative financial instruments
 
7,352

 
11,532

Fuel swaps
 
Other Assets
 
447

 
543

 
Other long-term liabilities
 
2,223

 
5,936

Total derivatives not designated as hedging instruments under 815-20
 
 
 
447

 
543

 
 
 
9,575

 
17,468

Total derivatives
 
 
 
$
221,258

 
$
19,397

 
 
 
$
189,163

 
$
373,497


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

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 September 30, 2017
 
As of December 31, 2016
(In thousands)
 
 
 
 
 
 
Foreign currency debt
 
Current portion of long-term debt
 
$
69,023

 
$
61,601

Foreign currency debt
 
Long-term debt
 
215,863

 
249,624

 
 
 
 
$
284,886

 
$
311,225


18


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:
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 September 30, 2017
 
Quarter Ended September 30, 2016
 
Nine Months Ended September 30, 2017
 
Nine Months Ended September 30, 2016
 
Quarter Ended September 30, 2017
 
Quarter Ended September 30, 2016
 
Nine Months Ended September 30, 2017
 
Nine Months Ended September 30, 2016
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
Interest expense, net of interest capitalized
 
$
600

 
$
1,737

 
$
2,642

 
$
6,075

 
$

 
$

 
$

 
$
7,203

Interest rate swaps
 
Other expense
 
(545
)
 
(7,662
)
 
3,275

 
28,592

 
1,013

 
7,423

 
(841
)
 
(24,878
)
 
 
 
 
$
55

 
$
(5,925
)
 
$
5,917

 
$
34,667

 
$
1,013

 
$
7,423

 
$
(841
)
 
$
(17,675
)

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 September 30, 2017
 
Quarter Ended September 30, 2016
 
Nine Months Ended September 30, 2017
 
Nine Months Ended September 30, 2016
 
 
Quarter Ended September 30, 2017
 
Quarter Ended September 30, 2016
 
Nine Months Ended September 30, 2017
 
Nine Months Ended September 30, 2016
(In thousands)
 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

 
 

Interest rate swaps
 
$
(3,154
)
 
$
6,598

 
$
(24,703
)
 
$
(126,505
)
 
Interest expense, net of interest capitalized
 
$
(7,860
)
 
$
(11,953
)
 
$
(24,580
)
 
$
(32,019
)
Foreign currency forward contracts
 
122,211

 
11,405

 
221,861

 
22,715

 
Depreciation and amortization expenses
 
(2,710
)
 
(2,710
)
 
(8,130
)
 
(5,408
)
Foreign currency forward contracts
 

 

 

 

 
Other expense
 
(1,512
)
 
(3,465
)
 
(9,187
)
 
(10,206
)
Foreign currency forward contracts
 

 

 

 

 
Other operating
 

 

 

 
(207
)
Foreign currency collar options
 

 

 

 

 
Depreciation and amortization expenses
 
(602
)
 
(601
)
 
(1,806
)
 
(1,806
)
Fuel swaps
 

 

 

 

 
Other expense
 
1,758

 
2,760

 
6,533

 
9,356

Fuel swaps
 
67,878

 
(3,090
)
 
33,183

 
94,640

 
Fuel
 
(32,386
)
 
(64,654
)
 
(114,149
)
 
(223,484
)
 
 
$
186,935

 
$
14,913

 
$
230,341

 
$
(9,150
)
 
 
 
$
(43,312
)
 
$
(80,623
)
 
$
(151,319
)
 
$
(263,774
)


19


Derivatives under ASC 815-20 
Cash Flow Hedging Relationships
 
Location of Gain (Loss)
Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)
 
Amount of Gain (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)
Quarter Ended September 30, 2017
 
Quarter Ended September 30, 2016
 
Nine Months Ended September 30, 2017
 
Nine Months Ended September 30, 2016
(In thousands)
 
 
 
 

 
 

 
 

 
 

Interest rate swaps
 
Other expense
 

 
90

 

 
(1,152
)
Foreign currency forward contracts
 
Other expense
 
75

 

 
100

 
(57
)
Fuel swaps
 
Other expense
 
3,351

 
(8
)
 
1,014

 
(3,949
)
 
 
 
 
$
3,426

 
$
82

 
$
1,114

 
$
(5,158
)

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) (Effective Portion)
Non-derivative instruments under ASC 815-20 Net
Investment Hedging Relationships
 
Quarter Ended September 30, 2017
 
Quarter Ended September 30, 2016
 
Nine Months Ended September 30, 2017
 
Nine Months Ended September 30, 2016
(In thousands)
 
 

 
 

 
 

 
 

Foreign Currency Debt
 
$
7,949

 
$
(3,382
)
 
$
34,206

 
$
1,313

 
 
$
7,949

 
$
(3,382
)
 
$
34,206

 
$
1,313


There was no amount recognized in income (ineffective portion and amount excluded from effectiveness testing) for the quarters and nine months ended September 30, 2017 and September 30, 2016, 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 September 30, 2017
 
Quarter Ended September 30, 2016
 
Nine Months Ended September 30, 2017
 
Nine Months Ended September 30, 2016
(In thousands)
 
 
 
 

 
 

 
 

 
 

Foreign currency forward contracts
 
Other expense
 
$
21,951

 
$
(2,464
)
 
$
57,019

 
$
(11,712
)
Fuel swaps
 
Other expense
 
(175
)
 
(1,172
)
 
(255
)
 
(1,224
)
 
 
 
 
$
21,776

 
$
(3,636
)
 
$
56,764

 
$
(12,936
)
 
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 September 30, 2017, 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. As of December 31, 2016, two of our interest rate derivative instruments had reached their fifth anniversary. As our unsecured debt credit rating at December 31, 2016 was below BBB-/Baa3, we had posted $7.2 million in collateral as of such date. Consistent with the provisions of our interest rate derivatives instruments, all collateral that was posted with our counterparties was returned upon reaching investment grade.

20


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 fourth quarter and full year of 2017 and our earnings and yield estimates for 2017 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 and nine months ended September 30, 2017 compared to the same periods in 2016;

a discussion of our business outlook, including our expectations for selected financial items for the fourth quarter and full year of 2017; and

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

21


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, 2016.

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.
 
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.

22



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 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.
 
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-da