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Royal Caribbean Cruises 10-K 2008

 



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

(Mark One)          

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

 

SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2007

 

OR         

[   ]

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)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Name of each exchange on which registered

Common Stock, par value $.01 per share

New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

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

 

x large accelerated filer   [  ] accelerated filer    [  ] non-accelerated filer   [  ] smaller reporting company

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).   Yes [  ] No x

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold was $5.7 billion as of the last business day of the registrant’s most recently completed second fiscal quarter.

 

There were 213,262,240 shares of common stock outstanding as of February 12, 2008.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The information required under Part III of this report is incorporated herein by reference to registrant's definitive proxy statement for the 2008 Annual Meeting of Shareholders.


 

 

ROYAL CARIBBEAN CRUISES LTD.

 

TABLE OF CONTENTS

 

 

 

Page

 

 

PART I

 

Item 1.

Business

1

Item 1A.

Risk Factors

19

Item 1B.

Unresolved Staff Comments

24

Item 2.

Properties

24

Item 3.

Legal Proceedings

25

Item 4.

Submission of Matters to a Vote of Security Holders

26

 

 

 

PART II

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

27

Item 6.

Selected Financial Data

29

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

30

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

45

Item 8.

Financial Statements and Supplementary Data

46

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

46

Item 9A.

Controls and Procedures

46

Item 9B.

Other Information

47

 

 

 

PART III

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

48

Item 11.

Executive Compensation

48

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

48

Item 13.

Certain Relationships and Related Transactions, and Director Independence

48

Item 14.

Principal Accounting Fees and Services

48

 

 

 

PART IV

 

 

Item 15.

Exhibits and Financial Statement Schedules

49

Signatures

50

 

 

 

 




PART I

 

As used in this Annual Report on Form 10-K, the terms “Royal Caribbean,” the “Company,” “we,” “our” and “us” refer to Royal Caribbean Cruises Ltd., the term "Pullmantur” refers to Pullmantur S.A. and the terms “Royal Caribbean International,” “Celebrity Cruises,” “Pullmantur Cruises,” “Azamara Cruises” and “CDF Croisières de France” refer to our cruise brands. In accordance with cruise vacation industry practice, the term “berths” is determined based on double occupancy per cabin even though many cabins can accommodate three or more passengers.

 

Item 1. Business

 

General

 

Royal Caribbean International was founded in 1968. The current parent corporation, Royal Caribbean Cruises Ltd., was incorporated on July 23, 1985 in the Republic of Liberia under the Business Corporation Act of Liberia.

 

We are the world’s second largest cruise company operating 35 ships in the cruise vacation industry with approximately 71,200 berths as of December 31, 2007. We own five cruise brands, Royal Caribbean International, Celebrity Cruises, Pullmantur Cruises, Azamara Cruises, and CDF Croisières de France. In addition, we have a 50% investment in a joint venture with TUI Travel PLC (“TUI Travel”), formerly First Choice Holidays PLC, which operates the brand Island Cruises. Our cruise brands primarily serve the contemporary, premium and deluxe segments of the cruise vacation industry, which also includes the budget and luxury segments. Our ships operate on a selection of worldwide itineraries that call on approximately 380 destinations. We compete principally on the basis of quality of ships, quality of service, variety of itineraries and price.

 

Historically, our primary focus has been to serve the North American cruise market through our two main global cruise brands, Royal Caribbean International and Celebrity Cruises. Throughout the years, we have expanded our focus to increase international passenger sourcing by opening offices in the United Kingdom, Germany, Norway, Italy, Spain, and, during 2007, in Singapore and China.

 

We recently further expanded our global base through our 2006 acquisition of Pullmantur Cruises, which provides us with a brand to serve the cruise markets in Spain and Latin America. Our announced launch in September 2007 of CDF Croisières de France will provide us with a custom-tailored product targeted to the cruise market in France beginning in May 2008. In December 2007, we announced a joint venture with TUI AG which, subject to closing, will result in the formation of a German cruise line under the name of TUI Cruises.

 

In addition to increasing our international passenger sourcing, the launch of Azamara Cruises in 2007 provides us with a new global cruise brand designed to serve the emerging deluxe cruise segment between the premium and luxury segments, primarily in the North American cruise market. Our commitment to acquire state-of-the-art ships, along with our continuous maintenance programs and revitalizations to incorporate our current signature brand elements provides us with the flexibility to deploy our ships among our brand portfolio and expand into growing international markets.

 

Royal Caribbean International

 

Royal Caribbean International serves the contemporary and premium segments of the cruise vacation industry. The contemporary segment is served by cruises that are generally seven nights or shorter and feature a casual ambiance. The premium segment is served by cruises that are generally seven to 14 nights and appeal to the more experienced passenger who is usually more affluent. Royal Caribbean International operates 21 ships with approximately 51,500 berths, offering cruise itineraries that range from two to 18 nights. Royal Caribbean International offers a variety of itineraries to destinations worldwide, including Alaska, Asia, Australia, the Caribbean, Europe, Hawaii, Latin America and New Zealand.

 

Royal Caribbean International’s strategy is to attract an array of vacationing consumers in the contemporary segment by providing a wide variety of itineraries and cruise lengths with multiple innovative options for onboard dining, entertainment and other onboard activities. Royal Caribbean International offers a wide array of onboard services, amenities and activities, including swimming pools, sun decks, beauty salons, exercise and spa facilities, ice skating rinks, in-line skating, basketball courts, rock climbing walls, surf machines, bungee jumping trampolines, miniature golf courses, an interactive waterpark called the H2O Zone™, gaming facilities,

 

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lounges, bars, Las Vegas-style entertainment, cinemas, and “Royal Promenades” which are boulevards with shopping, dining and entertainment venues. Additionally, Royal Caribbean International offers a variety of shore excursions at each port of call. We believe that the variety and quality of Royal Caribbean International’s product offerings represent excellent value to consumers, especially to couples and families traveling with children. Because of the brand’s extensive product offerings, we believe Royal Caribbean International is well positioned to attract new consumers to the cruise vacation industry and to continue to bring passengers back for their next vacation. While the brand is positioned at the upper end of the contemporary segment, we believe that Royal Caribbean International’s quality enables it to attract consumers from the premium segment as well, thereby achieving one of the broadest market coverages of any of the major brands in the cruise vacation industry.

 

Celebrity Cruises

 

Celebrity Cruises primarily serves the premium segment of the cruise vacation industry. Celebrity Cruises operates eight ships with approximately 13,800 berths, offering various cruise itineraries that range from two to 16 nights.

 

Celebrity Cruises’ strategy is to attract experienced cruise passengers who appreciate and value the high quality, service-focused experience the brand offers. Celebrity Cruises offers a global cruise experience by providing a variety of cruise lengths and itineraries to premium destinations throughout the world and by deploying a high proportion of its fleet in seasonal markets (i.e. Alaska, Australia, Bermuda, Europe, Hawaii, New Zealand, the Panama Canal and South America). Celebrity Cruises delivers an intimate experience onboard upscale ships that offer extensive spa facilities, fine dining, personalized service, and a high staff-to-passenger ratio. These are the hallmarks of the premium cruise vacation segment.

 

Pullmantur Cruises

 

In November 2006, we completed our acquisition of Pullmantur S.A., the largest cruise operator in Spain, which we currently operate as our Pullmantur Cruises brand. Pullmantur Cruises serves the contemporary segment of the Spanish and Latin American cruise markets. Pullmantur Cruises operates four ships with approximately 4,500 berths, offering various seven-night cruise itineraries. In addition, Pullmantur Cruises has tour operations, and owns a minority interest in a small air business that operates two aircraft in support of its cruise and tour operations.

 

Pullmantur Cruises’ strategy is to attract cruise passengers by providing a variety of cruising options and land-based travel packages. Pullmantur Cruises offers a variety of cruise itineraries to the Caribbean, the Mediterranean and the Baltic. Pullmantur Cruises offers a wide variety of onboard activities and services to passengers, including exercise facilities, swimming pools, beauty salons, gaming facilities, and shopping, dining and entertainment venues. Pullmantur Cruises’ tour operations sell land-based travel packages to Spanish guests including hotels and flights primarily to Caribbean resorts, and sells land-based tour packages to Europe aimed at Latin American guests.

 

In May 2007, Zenith was redeployed from Celebrity Cruises to Pullmantur Cruises. Before its redeployment to the Pullmantur Cruises brand, Zenith underwent extensive renovations to increase the number of cabins, verandas, enlarge public areas and customize the ship for Spanish and Latin American guests.

 

In May 2007, Pullmantur Cruises purchased the 1,000-berth Pacific Star and will take possession of the ship in March 2008, at which time it will begin sailing under the name Ocean Dream. Currently, the ship is chartered under a bareboat charter to a third party.

 

Empress of the Seas and Sovereign of the Seas will be redeployed from Royal Caribbean International to Pullmantur Cruises in March 2008 and November 2008, respectively. Before redeployment to Pullmantur Cruises, each ship will undergo extensive renovations to incorporate Pullmantur Cruises’ signature elements.

 

Azamara Cruises

 

In May 2007, we introduced a new cruise brand, Azamara Cruises, designed to serve the emerging deluxe cruise segment between the premium and luxury segments of the North American cruise market. Azamara Cruises operates two ships with approximately 1,400 berths, offering various cruise itineraries that range from ten to 24 nights and appeal to the more experienced passenger who is usually more affluent.

 

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Azamara Cruises’ strategy is to attract experienced cruise passengers seeking a more intimate onboard experience, a high level of service and itineraries to a variety of unique destinations. Azamara Cruises currently offers itineraries to Bermuda, the Caribbean and the Panama Canal. Azamara Cruises will begin offering additional itineraries to Asia, Europe and South America in 2008. Azamara Cruises will also expand its itineraries with around-the-world voyages beginning in 2010. Azamara Cruises offers a wide array of onboard services, amenities and activities, including gaming facilities, fine dining and interactive entertainment venues.

 

In May 2007, Blue Dream was redeployed from Pullmantur Cruises to Azamara Cruises, and is sailing under the name Azamara Journey. In September 2007, Blue Moon was also redeployed from Pullmantur Cruises to Azamara Cruises and is sailing under the name Azamara Quest. Before redeployment to the Azamara Cruises brand, each ship underwent extensive renovations to incorporate Azamara Cruises’ signature elements.

 

CDF Croisières de France

 

In September 2007, we launched a second new cruise brand, CDF Croisières de France. CDF Croisières de France is designed to serve the contemporary segment of the French cruise market and increases our global presence by providing us with a brand custom-tailored for French cruise guests. In April 2008, Holiday Dream, a 750-berth ship, will be redeployed from Pullmantur Cruises to CDF Croisières de France to serve as its first ship and will sail under the name Bleu de France beginning in May 2008. Before redeployment to CDF Croisières de France, Holiday Dream will undergo extensive renovations to customize the ship for French guests.

 

CDF Croisières de France will offer seasonal seven-night itineraries to the Mediterranean and the Caribbean beginning in May 2008. CDF Croisières de France will offer a variety of onboard services, amenities and activities, including entertainment venues, exercise and spa facilities, fine dining, and gaming facilities.

 

Island Cruises

 

We have a joint venture with TUI Travel, one of the largest integrated tour operators in the United Kingdom. This joint venture operates Island Cruises, a cruise brand designed to serve the budget segment of the cruise vacation industry. Island Cruises offers itineraries designed to attract passengers from the United Kingdom and Brazil. Island Cruises operates a 1,500-berth ship sailing under the name Island Escape and a 1,350-berth ship sailing under the name Island Star which was formerly Celebrity Cruises’ Horizon. Celebrity Cruises charters Island Star to Island Cruises under a six-year agreement through 2011.

 

Other

 

The Scholar Ship, our education program at sea for graduate and undergraduate students, commenced its first semester during the third quarter of 2007. The Scholar Ship operates a 29,000-ton ocean liner under a seasonal vessel operating lease agreement.

 

In December 2007, we entered into a joint venture agreement with TUI AG, a European tourism and shipping company which owns 51% of TUI Travel. The completion of the joint venture is contingent on obtaining regulatory/board approvals and other customary closing conditions. If concluded, the joint venture will operate a cruise brand, TUI Cruises, designed to serve the contemporary and premium segments of the German cruise market by offering a custom-tailored product for German cruise guests. TUI Cruises is scheduled to begin service with one ship in early 2009, and intends to expand with the delivery of two newly constructed ships in 2011 and 2012.

 

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Industry

 

Cruising continues to represent a small but growing sector of the overall vacation market. Cruise lines compete with other vacation alternatives such as land-based resort hotels and sightseeing destinations for consumers’ leisure time. Demand for such activities is influenced by geo-political and general economic conditions. Industry data indicates that a significant portion of cruise passengers carried are first-time cruisers. We believe this presents an opportunity for growth and a potential for increased market share through the expansion of our fleet.

 

We estimate that the global cruise industry carried 16.6 million cruise passengers in 2007 compared to 15.3 million cruise passengers carried in 2006. According to our estimates, the global cruise market was served by an estimated 187 ships with approximately 231,000 berths at the beginning of 2003. We estimate that this capacity increased to approximately 331,000 berths on approximately 229 ships by the end of 2007. There are approximately 38 ships with an estimated 98,000 berths that are expected to be placed in service in the global cruise market between 2008 and 2011.

 

North America represents the primary source of our cruise passengers and has experienced a compound annual growth rate of approximately 8.5% since 1970. From 2003 to 2007 North America has experienced a compound annual growth rate in cruise passengers of approximately 6.0%. We estimate that North America was served by 119 ships with approximately 173,000 berths at the beginning of 2003 and by 148 ships with approximately 248,000 berths by the end of 2007. There are approximately 25 ships with an estimated 71,000 berths that are expected to be placed in service in the North American cruise market between 2008 and 2011.

 

The following table details the growth in the global and North American cruise markets in terms of cruise passengers and estimated weighted-average berths over the past five years:

 

 

 

 

Year

Global Cruise

Passengers(1)

Weighted -Average

Supply of Berths

Marketed Globally(1)

North American Cruise Passengers(2)

Weighted-Average Supply of Berths Marketed in North America(1)

2003

13,110,000

243,000

          8,195,000

183,000

2004

13,757,000

265,000

          9,108,000

207,000

2005

14,818,000

282,000

          9,909,000

216,000

2006

15,309,000

299,000

  10,080,000

227,000

2007

16,586,000

323,000

  10,330,000

242,000

__________

(1)

Source: Our estimates.

(2)

Source: Cruise Line International Association based on cruise passengers carried for at least two consecutive nights.

 

In response to experiencing more attractive pricing in certain markets outside North America, we have been redeploying some of the ships in our Royal Caribbean International and Celebrity Cruises brands from the North American market to Europe, Latin America and Asia. This redeployment has contributed to an increase in the growth of our global cruise brands outside of the North American market.

 

We compete with a number of cruise lines; however, our principal competitors are Carnival Corporation & plc, which owns, among others, Carnival Cruise Lines, Princess Cruises, Costa Cruises, Holland America Line, P&O Cruises, Cunard Line and Aida Cruises; Star Cruises; NCL Corporation Ltd., which owns, among others, Norwegian Cruise Line; Mediterranean Shipping Company, which owns MSC Cruises; Disney Cruise Line; and Oceania Cruises.

 

Our ships operate worldwide and have itineraries that call on destinations in Alaska, Asia, Australia, the Bahamas, Bermuda, California, Canada, the Caribbean, Europe, the Galapagos Islands, Hawaii, Mexico, New England, New Zealand, the Panama Canal and South America.

 

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Operating Strategies

 

Our principal operating strategies are to:

 

• increase the awareness and market penetration of our brands,

 

• continue to expand our fleet with new state-of-the-art ships, while improving the quality and innovation of our existing fleet,

 

• expand into new markets and itineraries,

 

• continue to expand and diversify our passenger mix through international passenger sourcing,

 

• utilize sophisticated revenue management systems to optimize revenue from demand for our products,

 

• continue to improve our return on invested capital and the efficiency of our operating expenditures,

 

• further improve our technological capabilities, and

 

• maintain strong relationships with travel agencies, the principal industry distribution channel, while offering direct access for consumers.

 

Brand Awareness and Market Penetration

 

We continue to increase the recognition and market penetration of our brands among consumers. Royal Caribbean International and Celebrity Cruises are established global brands in the contemporary and premium segments of the cruise vacation industry. Pullmantur Cruises is a widely recognized brand in the Spanish and Latin American contemporary cruise markets. In May 2007, we introduced a new cruise brand, Azamara Cruises, designed to serve the emerging deluxe cruise segment. In September 2007, we launched a second new cruise brand, CDF Croisières de France, which will commence operations in May 2008 and is designed to serve the contemporary segment of the French cruise market.

 

We increase brand awareness and market penetration of our Royal Caribbean International brand through communication strategies designed to emphasize its high quality and excellent-value cruise vacations. Royal Caribbean International’s communication strategies target active adults and families who are vacation enthusiasts interested in exploring new destinations and seeking new experiences. These strategies are also designed to attract first-time cruisers to the cruise vacation industry and to the Royal Caribbean International brand. In order to attract the active cruiser who is seeking new experiences as well as first-time cruisers, Royal Caribbean International provides multiple choices to guests through a wide array of itineraries, accommodations, dining options, onboard activities and shore excursions. The hallmarks of the brand include friendly and engaging service, state-of-the-art ships, family programs, entertainment, health and fitness and energizing onboard and shoreside activities designed for guests of all ages.

 

We increase brand awareness and market penetration of our Celebrity Cruises brand through a series of consumer and trade campaigns designed to broaden the recognition of its high quality cruise vacations and drive loyalty and brand preference by emphasizing the personalized service and attention its guests receive. Celebrity Cruises’ communications target cruisers who seek upscale experiences and appreciate a high staff-to-passenger ratio, spacious accommodations, fine dining and spa services.

 

We increase brand awareness and market penetration of our Pullmantur Cruises brand primarily through advertising campaigns targeted to Spanish-speaking guests in both Spain and Latin America. All customer-facing crewmembers speak Spanish, and onboard activities, services, shore excursions and menu offerings are designed to suit the preferences of this target market.

 

We are currently increasing awareness and market penetration of our Azamara Cruises brand through trade education, public relations and direct communications, designed to target the emerging deluxe cruise segment of the North American cruise market. Azamara Cruises’ communications target experienced cruise passengers who prefer a more upscale, intimate and destination-focused cruise experience on smaller ships with longer itineraries. We believe Azamara Cruises provides a more exclusive guest experience with its distinctive combination of personalized service, exceptional cuisine and exotic destinations, with unique excursions.

 

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     We will seek to increase the awareness and market penetration of our CDF Croisières de France brand through trade education, public relations and direct communications, designed to target the contemporary segment of the French cruise market. CDF Croisières de France’s communications will emphasize that its cruise product is tailored specifically to French-speaking guests. All customer-facing crewmembers will speak French, and the onboard activities and menu offerings are designed to suit their target guests’ preferences.

 

Fleet Expansion and Innovation

 

Our commitment to acquire state-of-the-art ships, along with our continuous maintenance programs and revitalizations to incorporate the current signature brand elements provides us with the flexibility to deploy our ships among our brand portfolio and expand into growing international markets. Since our first fleet expansion program in 1988, we have continued to increase our average ship size and number of available berths, which has enabled us to achieve certain economies of scale. Based on the ships currently on order, our capacity is expected to increase to approximately 97,000 berths by December 31, 2011.

 

In addition to expanding our fleet, we place a strong focus on product innovation to drive new demand for our products and stimulate repeat business from our guests. Innovation of our products is achieved by introducing new concepts on our new ships and continuously making improvements to our existing fleet. In order to offer guests a wider range of activities and amenities and to ensure consistency across our fleets, we also embarked on a program of revitalizing our older ships to update and refresh their interiors and to incorporate signature brand elements. Renovations included the addition of new balconies, verandas, dining and entertainment options, as well as extensive refurbishments to staterooms and public areas.

 

Royal Caribbean International. Founded in 1968, Royal Caribbean International was the first cruise line to design ships especially for warm water year-round cruising. Royal Caribbean International operated a modern fleet in the 1970s and early 1980s, establishing a reputation for high quality. Between 1988 and 1992, the brand tripled its capacity by embarking on its first major capital expansion program and taking delivery of three Sovereign-class ships. Each Sovereign-class ship is approximately 73,000 gross tons, ranging in size from approximately 2,300 to 2,350 berths. Royal Caribbean International began revitalizing its Sovereign-class ships in 2003 with extensive renovations to Monarch of the Seas, followed by Sovereign of the Seas in 2004 and Majesty of the Seas in early 2007. The extensive renovations to the Sovereign-class included the addition of new dining and entertainment options, the upgrade of guest suites and staterooms and the expansion of the day spa and fitness center.

 

In 1990, Royal Caribbean International took delivery of Empress of the Seas, and in 2004, Royal Caribbean International revitalized Empress of the Seas with extensive renovations including the addition of new dining and entertainment options, the upgrade of guest suites and staterooms and the expansion of the day spa and fitness center.

 

From 1995 through 1998, Royal Caribbean International took delivery of six Vision-class ships, ranging in size from approximately 1,800 to 2,000 berths. In 2005, Royal Caribbean International revitalized and lengthened Enchantment of the Seas, with the addition of a new 73-foot midsection featuring 151 additional staterooms, the addition of new dining and entertainment options and the expansion of the day spa and fitness center.

 

From 1999 through 2003, Royal Caribbean International introduced its five Voyager-class ships. Each Voyager-class ship is approximately 140,000 gross tons with approximately 3,100 berths. The Voyager-class ships introduced several product innovations to the marketplace, including the cruise vacation industry’s first horizontal atrium, the “Royal Promenade” (which is four decks tall, longer than a football field and provides entertainment, shopping and dining experiences), recreational activities such as ice skating, in-line skating, rock climbing, miniature golf and full court basketball, enhanced staterooms, expanded dining venues and a variety of intimate spaces.

 

From 2001 through 2004, Royal Caribbean International introduced its four Radiance-class ships, a progression from the brand’s Vision-class ships. Each Radiance-class ship is approximately 90,000 gross tons with approximately 2,100 berths. The Radiance-class ships incorporate many of the dining and entertainment options of the Voyager-class ships, as well as offer a wide array of unique features. These features include

 

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panoramic glass elevators facing outward to the sea, floor to ceiling glass windows offering sea views and a billiards club featuring gyroscopic billiard tables. Royal Caribbean International has adopted the product innovations of the Voyager and Radiance-class ships as signature elements of the brand.

 

In 2006, Royal Caribbean International launched the 3,600-berth Freedom of the Seas, the first of three Freedom-class ships, and the largest cruise ship in the world. The Freedom-class ships are approximately 16% larger than the Voyager-class ships and have some of the largest staterooms and balconies in the industry, flat screen televisions, cell phone services and other amenities. The launch of the Freedom-class ships also introduced several new experiences to cruising, including a surf machine and an interactive water park called the H2O ZoneTM. Royal Caribbean International took delivery of a second Freedom-class ship, Liberty of the Seas, in April 2007 and a third Freedom-class ship, Independence of the Seas, is expected to enter service in the second quarter of 2008.

 

Building upon the innovations of the Voyager and Freedom-class ships, Royal Caribbean International will introduce a new class of ships in 2009. This new class of ships, referred to as Project Genesis, will be approximately 220,000 gross tons each with approximately 5,400 berths, which is 50% larger than the capacity on the Freedom-class ships. Royal Caribbean International entered into contracts with a shipyard to build two unnamed Project Genesis class ships, expected to enter service in the fourth quarters of 2009 and 2010, respectively. See Item 1A. Risk Factors regarding shipyards.

 

Celebrity Cruises. Celebrity Cruises was founded in 1990 and operated three ships between 1992 and 1995. Between 1995 and 1997, Celebrity Cruises began its first capital expansion program, adding three Century-class ships, which range in size from approximately 1,750 to 1,850 berths. During this time, Celebrity Cruises also disposed of one of its original three ships.

 

From 2000 through 2002, Celebrity Cruises took delivery of four Millennium-class ships. Each Millennium-class ship is approximately 90,000 gross tons with approximately 2,050 berths. The Millennium-class ships are a progression from the Century-class ships and elevated Celebrity Cruises’ position in the premium segment of the marketplace. The Millennium-class ships build on the brand’s primary strengths, including gourmet dining, spacious staterooms and suites with verandas and spa facilities featuring a large hydropool with neck massage, body jets and services including “acupuncture at sea”. On the Millennium-class ships, an entire deck is dedicated to health and fitness. To further enhance the onboard experience, Celebrity Cruises offers a more intimate setting in piano, champagne, and martini bars and lounges.

 

In 2004, Celebrity Cruises continued to expand its product offerings with the launch of Celebrity Xpedition, a 100-berth ship that offers a more intimate experience onboard a smaller ship with sailings to the Galapagos Islands.

 

In 2006, in order to ensure consistency across the fleet and to incorporate many of the Millennium-class standards to one of its Century-class ships, Celebrity Cruises made extensive renovations to Celebrity Century by adding 314 new verandas, approximately 26 additional suites and staterooms, and a new specialty restaurant.

 

From 2005 to 2007, Celebrity Cruises entered into contracts with a shipyard to build four Solstice-class ships. The Solstice-class ships are a new wide-body construction class of ships, and will be approximately 122,000 gross tons each with approximately 2,850 berths. Celebrity Solstice, Celebrity Equinox, Celebrity Eclipse and an unnamed fourth ship are expected to enter service in the fourth quarter of 2008, the third quarter of 2009, the third quarter of 2010 and the third quarter of 2011, respectively. The Solstice-class ships will incorporate many new and improved design features, and will have larger staterooms averaging 215 square feet, which is larger than the average in the industry. Approximately 90% of the ships' staterooms will be outside and approximately 81% of the staterooms will have verandas.

 

Pullmantur Cruises. Pullmantur Cruises was founded in 1971 and is the largest cruise operator in Spain. Pullmantur Cruises currently operates four ships which range in size from approximately 750 to 1,400 berths. As a result of the acquisition of Pullmantur Cruises in November 2006, we have expanded our overall fleet by five ships and approximately 4,500 berths.

 

In May 2007, Pullmantur Cruises purchased the 1,000-berth Pacific Star and will take possession of the ship in March 2008, at which time the ship will begin sailing under the name Ocean Dream. The ship is currently chartered under a bareboat charter agreement to a third party.

 

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In May 2007, Zenith was redeployed from Celebrity Cruises to Pullmantur Cruises. Before redeployment to Pullmantur Cruises, Zenith underwent renovations to incorporate Pullmantur Cruises’ signature elements, while adding approximately 38 new verandas and 25 staterooms. Empress of the Seas and Sovereign of the Seas will be redeployed from Royal Caribbean International to Pullmantur Cruises in March 2008 and November 2008, respectively. Before redeployment to Pullmantur Cruises, each ship will undergo extensive renovations to incorporate Pullmantur Cruises’ signature elements.

 

Azamara Cruises. In May 2007, Blue Dream was redeployed from Pullmantur Cruises to Azamara Cruises, and is sailing under the name Azamara Journey. In September 2007, Blue Moon was also redeployed from Pullmantur Cruises to Azamara Cruises and is sailing under the name Azamara Quest. Before redeployment to the Azamara Cruises brand, each ship underwent extensive renovations to incorporate Azamara Cruises’ signature elements, while upgrading guest suites and staterooms, and adding two new specialty restaurants.

 

CDF Croisières de France. In April 2008, Holiday Dream will be redeployed from Pullmantur Cruises to CDF Croisières de France and will sail as its first ship under the name Bleu de France. Before redeployment to CDF Croisières de France, Holiday Dream will undergo extensive renovations in April 2008, including the addition of a French bistro and a spa with a sea water center, to customize the ship for French guests.

 

New Markets and Itineraries

 

Our ships operate worldwide with a selection of itineraries that call on approximately 380 ports. New ships, including both newly constructed ships and those we acquire, allow us to expand into new markets and itineraries. Our brands have expanded their mix of itineraries, while strengthening our ability to penetrate the European, Latin American and Caribbean markets further.

 

In April 2007, Royal Caribbean International dedicated Navigator of the Seas to the United Kingdom cruise market, offering itineraries to the Mediterranean sailing directly from Southampton, United Kingdom. In May 2007, Royal Caribbean International’s Voyager of the Seas returned to Barcelona, Spain offering Mediterranean itineraries. In October 2007, Royal Caribbean International introduced the Vision-class ship, Rhapsody of the Seas, to Australia, New Zealand, the South Pacific and Singapore. In December 2007, Royal Caribbean International’s Splendour of the Seas began an itinerary in South America with emphasis on Brazil, and Legend of the Seas began an itinerary in the Caribbean departing from the Dominican Republic. Also in December 2007, Celebrity Cruises introduced Celebrity Mercury to Australia and New Zealand offering open-jaw sailings between Auckland and Sydney. The brands are now offering a wide variety of cruise tours from Asia, Australia, New Zealand and South America in order to provide vacationers with a broad range of product options.

 

In 2008, we will continue to focus on the acceleration of Royal Caribbean International’s and Celebrity Cruises’ strategic positioning as global cruise brands. In April 2008, Independence of the Seas will be introduced in the United Kingdom and will offer itineraries to the Mediterranean, Ireland and the Canary Islands beginning in May 2008. In April 2008, Navigator of the Seas will begin offering sailings out of Spain and Italy. In October 2008, Rhapsody of the Seas will continue to expand itineraries into Australia and New Zealand. Celebrity Cruises will also expand itineraries into Australia and New Zealand with Celebrity Millennium beginning in November 2008. In December 2008, Legend of the Seas will begin offering sailings from Singapore and Shanghai, and Radiance of the Seas will begin offering an itinerary in South America with emphasis on Chile and Argentina. Also in December 2008, Enchantment of the Seas will begin offering itineraries to the Southern Caribbean from Panama.

 

In an effort to secure desirable berthing facilities for our ships, and to provide new or enhanced cruise destinations for our guests, from time to time we assist or invest in the development or enhancement of certain port facilities and infrastructure, including mixed-use commercial properties, located in strategic ports of call. Generally, we collaborate with local, private or governmental entities by providing management and/or financial assistance and often enter into long-term port usage arrangements. In exchange for our involvement, we generally secure preferential berthing rights for our ships.

 

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International Passengers

Passenger ticket revenues generated by sales originating in countries outside of North America were approximately 30%, 18%, and 15% of total passenger ticket revenues in 2007, 2006 and 2005, respectively. The percentage of passengers sourced outside of North America was approximately 23% in 2007 compared to approximately 13% in 2006 and approximately 12% in 2005. International passengers have grown from approximately 342,000 in 2003 to approximately 871,000 in 2007.

 

We sell and market our global brands, Royal Caribbean International, Celebrity Cruises and Azamara Cruises, to passengers outside of North America through our offices in the United Kingdom, Germany, Norway, Italy, Spain, Singapore and China. We further extend our reach with a network of 48 independent international representatives located throughout the world. Historically, our focus has been to primarily source our passengers for our global brands from North America. Currently, we are expanding our focus to sell and market our cruise brands to countries outside of North America through fleet innovation and by responding to cultural characteristics of our global passengers.

 

In addition to expanding our international passenger sourcing for our global cruise brands, we are focused on increasing our local presence in markets outside of North America by acquiring and developing brands specifically designed to provide custom-tailored products. We have a 50% investment in a joint venture with TUI Travel, one of the largest integrated tour operators in the United Kingdom. This joint venture operates a cruise brand, Island Cruises, designed to serve the budget segment of the cruise vacation industry with a seasonal product specifically tailored to guests in the United Kingdom and Brazil during their summer seasons. In November 2006, we acquired the Pullmantur Cruises brand, which sells and markets its cruises to guests primarily in Spain and Latin America. In September 2007, we launched CDF Croisières de France, designed to sell and market its product designed for guests primarily in France. In December 2007, we entered into a joint venture agreement with TUI AG, a European tourism and shipping company that owns 51% of TUI Travel. The completion of the joint venture is contingent on obtaining regulatory/board approvals and other customary closing conditions. If concluded, the joint venture will operate a cruise brand, TUI Cruises, designed to serve the contemporary and premium segments of the German cruise market by offering a custom-tailored product for German cruise guests.

 

Revenue Management

 

We believe we have one of the most advanced revenue management systems in the industry, which enables us to make more advantageous decisions about pricing, inventory management and marketing actions. We are continuously working to improve these systems and tools through increased forecasting capabilities, ongoing improvements to our understanding of price/demand relationships, and greater automation of the decision process.

 

Return on Invested Capital and Efficiency of Operating Expenditures

 

We continue to foster a corporate culture focused on the ongoing improvement of our return on invested capital and the efficiency of operating expenditures by prioritizing the identification and implementation of shipboard and shoreside cost management initiatives. We are committed to pursuing our cost management initiatives while still making ongoing innovations to our fleet. We are focused on directing our capital expenditures to investments which will provide a desirable return. Our ongoing efforts to maintain a cost management focus include the optimization of shipboard and shoreside staffing levels, and improved efficiency of fuel consumption through technology and other initiatives such as the installation of diesel engines on our eight gas turbine ships. We continue to pursue a number of other opportunistic initiatives, including the use of alternative fuel solutions, itinerary optimization, and diligent shipboard conservation efforts.

 

Technological Capabilities

 

We continue to invest in information technology to support and improve our corporate infrastructure and guest and travel trade relations. In addition to introducing Pullmantur Cruises, Azamara Cruises and CDF Croisières de France to the existing reservations infrastructure, we have focused heavily on building tools that make it easy for our trade partners to do business with us. During 2007, we completed phase one of a multi-year investment to re-launch the online trade booking tool, CruiseMatch®, which allows travel agents direct access to Royal Caribbean International’s, Celebrity Cruises’, Pullmantur Cruises’ and Azamara Cruises’ computer reservation systems. The new CruiseMatch® now offers industry-leading functionality for individual,  group

 

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and cruisetour bookings from a web-based tool on cruisingpower.com. We have also continued to build enhancements to all of our trade and guest Internet sites providing updated tools in support of all our products and services in both our existing and new markets. Most significantly, we offer our guests the ability to book and pay for shore excursions on our Royal Caribbean International, Celebrity Cruises and Azamara Cruises Internet sites. We have plans to continue to evolve this capability over the next year by adding advanced reservation capability for a wider variety of onboard amenities such as specialty dining reservations.

 

We have a range of systems that support our supply chain to the global ports that we serve, including automation in support of our warehouses as well as onboard technical purchasing. We continue to evolve our onboard systems to offer new features to our guests and provide better support for managing our shipboard employees worldwide.

 

To better align our vacations to our guests’ needs, we have built and deployed a range of new customer relationship management tools which improve our ability to respond to passenger and travel agent inquiries in a timely and accurate manner. Additionally, to help us reward our frequent guests and drive continued loyalty to our brands, we have deployed a host of new tools that better support our customer loyalty programs, the “Crown & Anchor Society” and “Captain's Club”.

 

Travel Agency Support and Direct Business

 

Travel agencies generate the majority of bookings for our ships. We are committed to further developing and strengthening this very important distribution channel. Our sales teams focus on the unique qualities of each brand and provide support to the travel agency community. The Trade Support & Service department, with branded call center operations, further supports the travel agency community in designing the cruise vacation experience. Cruisingpower.com continues to be an industry-leading website exclusive to the travel agency community. In 2007, the website launched a number of new online tools designed to increase travel agent productivity. VIP CruisePass is a desktop alert designed to give travel agents alerts to special offers, weather updates, itinerary changes and latest news. EMarketing provides travel agents with a personalized link that directs customers to a video magazine or cruise planner interactive experience. EConnect is an online quoting tool that enables travel agents to send up to five online quotes to their database with real-time pricing and web-based functionality. In addition, Royal Caribbean International launched its first online training certification program, “University of Wow,” where travel agents can achieve up to an expert-level certification.

 

In 2007, we completed phase one of a multi-year investment to re-launch the online trade booking tool, CruiseMatch®. Travel agents nationwide participated in trainings in how to use the new tools offered by CruiseMatch®. The second phase of this investment will be launched in the first quarter of 2008 to offer additional functionality such as enabling travel agents to accept bookings in an existing group block, as well as group insurance. Pullmantur Cruises and Azamara Cruises were also incorporated into the online tool in 2007.

 

We have customer service representatives that are trained to assist travel agents in providing a higher level of service and Insight, the first Internet service tool of its kind in the industry, which assists agencies with productivity and enhances customer service. We currently operate reservation call centers to support our travel agent community in the United States, Canada, France, Spain and the United Kingdom offering flexibility and extended hours of operations. Call centers for the United States and Canada are located in Miramar, Florida, Wichita, Kansas and Springfield, Oregon. The call center for the United Kingdom is located in Addlestone, England. The call center for Pullmantur Cruises is located in Madrid, Spain. The call center for CDF Croisières de France is located in Paris, France.

 

We have certified vacation planners in our call centers in Miramar, Wichita and Addlestone offering cruise planning expertise and personal attention for direct bookings. In addition, direct booking channels for Royal Caribbean International, Celebrity Cruises and Azamara Cruises are available through our Internet sites at www.royalcaribbean.com, www.celebrity.com and www.azamaracruises.com. We continue to experience an increase in the use of our Internet sites and other direct booking channels as a source of our overall bookings.

 

Passenger Services

 

We offer to handle virtually all travel aspects related to passenger reservations and transportation, including arranging passenger pre- and post-hotel stay arrangements and air transportation. Our air/sea program offers passengers the choice of our standard air or custom air programs. Our standard air program allows our passengers to benefit from comprehensive relationships that we maintain with many major airlines ranging from fare negotiation and space handling to baggage transfer. Our custom air program enables passengers to customize their flight arrangements, including selection of airline, specific flights and class of service.

 

10


 

The Royal Caribbean International passenger loyalty program, Crown & Anchor Society, has over 4.5 million members worldwide and includes benefits such as a secured dedicated section in the www.royalcaribbean.com Internet site with special cruise offers and onboard amenities. The Celebrity Cruises and Azamara Cruises passenger loyalty program, Captain's Club, has over 950,000 members. Captain's Club members enjoy exclusive members-only onboard programs and amenities, and are provided with a secured area on the Celebrity Cruises web site, which communicates select product offers.

 

Operations

 

Cruise Ships and Itineraries

 

As of December 31, 2007, we operate 35 ships under four cruise brands, with a selection of worldwide itineraries ranging from two to 24 nights that call on approximately 380 destinations. Our fifth cruise brand, CDF Croisières de France, will commence operations in May 2008. Independence of the Seas and Celebrity Solstice are expected to enter revenue service in May 2008 and December 2008, respectively. In May 2007, Pullmantur Cruises purchased Pacific Star and will take possession of the ship in March 2008, at which time the ship will begin sailing under the name Ocean Dream as part of the Pullmantur Cruises brand. The ship is currently chartered under a bareboat charter agreement to a third party. The following table represents summary information concerning our ships and their areas of operation based on 2008 itineraries (subject to change):

 

Ship

Year Ship

Entered Service¹

Approximate

Berths

Primary Areas of Operation

Royal Caribbean International 

Independence of the Seas

2008

3,600

Europe, Eastern/Western Caribbean

Liberty of the Seas

 2007

3,600

Eastern/Western Caribbean

Freedom of the Seas

2006

3,600

Eastern/Western Caribbean

Jewel of the Seas

2004

2,100

Eastern/Western Caribbean, Canada/New England, Europe, Panama Canal

Mariner of the Seas

2003

3,100

Eastern/Western Caribbean

Serenade of the Seas

2003

2,100

Alaska, Southern Caribbean, Panama Canal, Hawaii

Navigator of the Seas

2002

3,100

Western Caribbean, Europe

Brilliance of the Seas

2002

2,100

Caribbean, Europe, Panama Canal

Adventure of the Seas

2001

3,100

Southern Caribbean

Radiance of the Seas

2001

2,100

Eastern/Western Caribbean, Alaska, Hawaii, Panama Canal, South America

Explorer of the Seas

2000

3,100

Caribbean, Bermuda, Canada, New England

Voyager of the Seas

1999

3,100

Western Caribbean, Europe

Vision of the Seas

1998

2,000

Alaska, Mexican Riviera

Enchantment of the Seas

1997

2,250

Western Caribbean, Southern Caribbean

Rhapsody of the Seas

1997

2,000

Australia/NZ, Asia, Alaska

Grandeur of the Seas

1996

1,950

Caribbean, Bermuda, Canada, New England

Splendour of the Seas

1996

1,800

Europe, South America

Legend of the Seas

1995

1,800

Europe, Southern Caribbean

Majesty of the Seas

1992

2,350

Bahamas

Monarch of the Seas

1991

2,350

Baja Mexico, Bahamas

Empress of the Seas²

1990

1,600

Southern Caribbean

Sovereign of the Seas²

1988

2,300

Bahamas

 

 

 

 

Celebrity Cruises

Celebrity Solstice

2008

2,850

Eastern Caribbean

  Celebrity Constellation

2002

2,050

Caribbean, Europe, Canada/New England

Celebrity Summit

2001

2,050

Europe, Southern Caribbean

 

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Celebrity Infinity                    

2001

2,050

Alaska, Panama Canal, South America, Hawaii

Celebrity Millennium

2000

2,050

Eastern Caribbean, Panama Canal, Hawaii, Alaska, Australia/NZ

Celebrity Mercury

1997

1,850

Alaska, Pacific/Northwest, Panama Canal, Hawaii, Australia/NZ

Celebrity Galaxy

1996

1,850

Southern Caribbean, Europe

Celebrity Century

1995

1,800

Western Caribbean, Europe

 Celebrity Xpedition³

2004

  100

Galapagos Islands

 

 

 

 

Pullmantur Cruises

Ocean Dream4

2008

1,000

Western Mediterranean

Sky Wonder4

2006

1,200

Eastern Mediterranean

Holiday Dream5

2005

   750

Mediterranean, Caribbean

Oceanic4

2001

1,150

Western Mediterranean

Zenith6

1992

1,400

Mediterranean

 

 

Azamara Cruises

Azamara Journey7

2004

 700

Europe, South America

Azamara Quest8

2006

 700

Asia, Caribbean, Europe, Panama Canal

Total

 

   78,650      

 

        1 The year a ship entered service refers to the year in which the ship commenced cruise revenue operations for each respective brand, which            is the same as the year the ship was built, unless otherwise noted. 

    2 Empress of the Seas and Sovereign of the Seas will be redeployed from Royal Caribbean International to Pullmantur Cruises in March                 2008 and November 2008,  respectively.

3 Celebrity Xpedition was built in 2001.

4 Ocean Dream, Sky Wonder and Oceanic were built in 1981, 1984 and 1965, respectively.

5 Holiday Dream  was built in 1981. In April 2008, Holiday Dream will be redeployed from Pullmantur Cruises to CDF Croisières de France

   and will sail as its first ship under the name Bleu de France.

6 Zenith was revitalized in 2007 and redeployed to Pullmantur Cruises in May 2007.

7 Azamara Journey (formerly Blue Dream) was built in 2000 and was redeployed from Pullmantur Cruises to Azamara Cruises in May 2007.

8 Azamara Quest (formerly Blue Moon) was built in 2000 and was redeployed from Pullmantur Cruises to Azamara Cruises in September            2007.

    

Celebrity Cruises’ Horizon, a 1,350 berth ship, was built in 1990 and is currently chartered under a six-year agreement through 2011 to Island Cruises, our joint venture with TUI Travel. In addition, Pullmantur Cruises operated Pacific and Mona Lisa under seasonal time charter agreements with third parties from April through October 2007 and from June through August 2007, respectively.

 

We have one Freedom-class ship and two ships of a new Project Genesis class on order for Royal Caribbean International. These ships are being built in Finland by Aker Yards Oy. We have four Solstice-class ships on order for Celebrity Cruises. These ships are being built in Germany by Meyer Werft. See Item 1A. Risk Factors regarding shipyards. The expected dates ships enter service and planned berths of the seven ships on order are as follows:

 

Ship

Expected to

  Enter Service

Approximate

Berths

Royal Caribbean International:

 

 

Freedom-class:

 

 

Independence of the Seas

2nd Quarter 2008

3,600

Project Genesis:

 

 

Unnamed

3rd Quarter 2009

5,400

Unnamed

3rd Quarter 2010

5,400

Celebrity Cruises:

 

 

Solstice-class:

 

 

Celebrity Solstice

4th Quarter 2008

2,850

Celebrity Equinox

3rd Quarter 2009

2,850

Celebrity Eclipse

3rd Quarter 2010

2,850

Unnamed

3rd Quarter 2011

   2,850

Total Berths

 25,800

 

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     Recently we reached an agreement with Meyer Werft to build a fifth Solstice-class ship for Celebrity Cruises, subject to certain conditions, for an additional capacity of approximately 2,850 berths, expected to enter service in the fourth quarter of 2012.

Seasonality

 

Our revenues are seasonal based on the demand for cruises. Demand is strongest for cruises during the North American summer months and holidays.

 

Passengers and Capacity

 

Selected statistical information is shown in the following table (see Terminology and Non-GAAP Financial Measures under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, for definitions) (Amounts include Pullmantur Cruises effective January 1, 2007):

 

 

Year Ended December 31,

 

2007

2006

      2005

     2004

        2003

Passengers Carried

 3,905,384

 3,600,807

3,476,287

3,405,227

2,990,607

Passenger Cruise Days

 26,594,515

 23,849,606

 23,178,560

 22,661,965

 20,064,702

Available Passenger Cruise Days (APCD)

 25,155,768

22,392,478

 21,733,724

 21,439,288

 19,439,238

Occupancy

105.7%

106.5%

106.6%

105.7%

103.2%


Cruise Pricing

 

Our cruise ticket prices include accommodations and a wide variety of activities and amenities, including meals and entertainment. Prices vary depending on the destination, cruise length, cabin category selected and the time of year the cruise takes place. Although we grant credit terms to certain travel agencies and tour operators outside of North America, our payment terms generally require an upfront deposit to confirm a reservation with the balance due prior to the sailing. During the selling period of a cruise, we continually monitor and adjust our cruise ticket prices for available passenger cabins based on demand, with the objective of maximizing net yields. Historically, we have opened cruises for sale at least one year in advance, and often as much as two years in advance. Additionally, we offer air transportation as a service for guests that elect to utilize our transportation program. Our air transportation program is available from major cities in the United States and Canada, and from select cities in Europe, mainly in the United Kingdom. Prices vary by gateway and destination. Generally, air tickets are sold to guests at prices close to cost.

 

Onboard Activities and Other Revenues

 

Our cruise brands offer modern fleets with a wide array of onboard services, amenities and activities, including swimming pools, sun decks, spa facilities (which include massage and exercise facilities), beauty salons, bungee jumping trampolines, gaming facilities, lounges, bars, Las Vegas-style entertainment, retail shopping, libraries, cinemas, conference centers, Internet cafes and shore excursions at each port of call. Royal Caribbean International offers rock climbing walls on its ships, additional activities including ice skating rinks and in-line skating on its Voyager-class ships and a surf machine and an interactive water park called the H2O Zone™ on its Freedom-class ships. While many onboard activities are included in the base price of a cruise, we realize additional revenues from, among other things, gaming, the sale of alcoholic and other beverages, gift shop items, shore excursions, photography, spa services and art auctions. Royal Caribbean International, Celebrity Cruises and Azamara Cruises offer enhanced functionality on our Internet sites for selecting shore excursions and amenities prior to embarkation. Royal Caribbean International and Celebrity Cruises also offer a catalogue gift service, which is now offered via the Internet to provide travel agents and others the opportunity to purchase gifts for guests.

 

In conjunction with our cruise vacations, we offer pre- and post-cruise hotel packages to our Royal Caribbean International, Celebrity Cruises and Azamara Cruises passengers. We also offer escorted, premium land-tour packages in Alaska, Asia, Australia, the Canadian Rockies, Europe, New Zealand and Latin America. These escorted, premium land-tour packages are offered exclusively in conjunction with our cruises marketed to our Royal Caribbean International, Celebrity Cruises and Azamara Cruises passengers through our tour operations, Royal Celebrity Tours. Pullmantur Cruises also offers land-based tour packages to Spanish and European vacation travelers including hotels and flights to Caribbean resorts and sells land based packages to Europe aimed at Latin American guests. In addition, we sell cruise vacation protection coverage, which provides passengers with coverage for trip cancellation, medical protection and baggage protection.

 

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Segment Reporting

 

We operate four cruise brands, Royal Caribbean International, Celebrity Cruises, Pullmantur Cruises, and Azamara Cruises, and launched a new brand, CDF Croisières de France, which will commence operations in May 2008. The brands have been aggregated as a single reportable segment based on the similarity of their economic characteristics as well as products and services provided. (For financial information see Item 8. Financial Statements and Supplementary Data.)

 

Employees

 

As of December 31, 2007, we employed approximately 4,461 full-time and 607 part-time employees worldwide in our shoreside operations. We also employed approximately 41,475 shipboard employees. As of December 31, 2007, approximately 80% of our shipboard employees were covered by collective bargaining agreements. We believe that our relationship with our employees is good.

 

Insurance

 

We maintain insurance on the hull and machinery of our ships, which includes additional coverage for disbursements, earnings and increased value, which are maintained in amounts related to the value of each ship. The coverage for each of the hull policies is maintained with syndicates of insurance underwriters from the British, Scandinavian, French, United States and other international insurance markets.

 

We maintain liability protection and indemnity insurance for each of our ships through either Assuranceforeningen GARD, the United Kingdom Mutual Steam Ship Assurance Association (Bermuda) Limited, Steamship Mutual Underwriting Association (Bermuda) Limited or Assuranceforeningen SKULD.

 

We maintain war risk insurance for our ships, including terrorist risk insurance, on each ship through a Norwegian war risk insurance organization. This coverage includes coverage for physical damage to the ship which is not covered under the hull policies as a result of war exclusion clauses in such hull policies. We also maintain protection and indemnity war risk coverage for risks that would be excluded by the rules of the indemnity insurance organizations, subject to certain limitations. Consistent with most marine war risk policies, under the terms of our war risk insurance coverage, underwriters can give seven days notice to us that the policy will be canceled and reinstated at higher premium rates.

 

We also maintain a form of business interruption insurance for our ships with our insurance underwriters in the event that a ship is unable to operate during scheduled cruise periods due to loss or damage to the ship arising from certain covered events that last more than a specified period of time. We also maintain insurance coverage for certain events, which would result in a delayed delivery of our contracted new ships, which we normally place starting approximately two years prior to the scheduled delivery dates.

 

Insurance coverage for shoreside property, shipboard inventory, and general liability risks are maintained with insurance underwriters in the United States and the United Kingdom. We have decided not to carry business interruption insurance for shoreside operations based on our evaluation of the risks involved and our protective measures already in place, as compared to the premium expense.

 

All insurance coverage is subject to certain limitations, exclusions and deductible levels. In addition, in certain circumstances, we co-insure a portion of these risks. Premiums charged by insurance carriers, including carriers in the maritime insurance industry, increase or decrease from time to time and tend to be cyclical in nature. These cycles are impacted both by our own loss experience and by losses incurred in direct and reinsurance markets. We historically have been able to obtain insurance coverage in amounts and at premiums we have deemed to be commercially acceptable. No assurance can be given that affordable and secure insurance markets will be available to us in the future, particularly for war risk insurance.

 

The Athens Convention relating to the Carriage of Passengers and their Luggage by Sea (1974) and the 1976 Protocol to the Athens Convention are generally applicable to passenger ships. The United States has not ratified the Athens Convention; however, with limited exceptions, the 1976 Athens Convention Protocol may be contractually enforced with respect to those of our cruises that do not call at a United States port. The International Maritime Organization Diplomatic Conference agreed upon a new Protocol to the Athens

 

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 Convention on November 1, 2002. The 2002 Protocol, which is not yet in force, substantially increases the level of compulsory insurance, which must be maintained by passenger ship operators. No assurance can be given as to if or when the 2002 Protocol will come into force. If in force, no assurance can be given that affordable and secure insurance markets will be available to provide the level of coverage required under the 2002 Protocol.

 

Trademarks

 

We own a number of registered trademarks related to the Royal Caribbean International, Celebrity Cruises, Pullmantur Cruises and CDF Croisières de France cruise brands and have filed applications to register trademarks related to the Azamara Cruises brand. The registered trademarks include the name “Royal Caribbean” and its crown and anchor logo, the name “Celebrity Cruises” and its “X” logo, the names “Pullmantur Cruises” and “Pullmantur”, the name “CDF Croisières de France” and the names of various cruise ships. We believe trademarks related to the Royal Caribbean International, Celebrity Cruises and Pullmantur Cruises brands are widely recognized throughout the world and have considerable value. We also believe trademarks related to our new brands, Azamara Cruises and CDF Croisières de France, will be widely recognized throughout the world and will have considerable value.

 

Regulation

 

Our ships are regulated by various international, national, state and local laws, regulations and treaties in force in the jurisdictions in which they operate. In addition, our ships are registered in the Bahamas, Malta or in the case of Celebrity Xpedition, Ecuador. Each ship is subject to regulations issued by its country of registry, including regulations issued pursuant to international treaties governing the safety of the ship and its passengers. Each country of registry conducts periodic inspections to verify compliance with these regulations. Ships operating out of United States ports are subject to inspection by the United States Coast Guard for compliance with international treaties and by the United States Public Health Service for sanitary conditions. Our ships are also subject to similar inspections pursuant to the laws and regulations of various other countries our ships visit.

 

Our ships are required to comply with international safety standards defined in the Safety of Life at Sea Convention. The Safety of Life at Sea Convention standards are revised from time to time and the most recent modifications are being phased in through 2010. We do not anticipate that we will be required to make any material expenditures in order to comply with these rules.

 

We are required to obtain certificates from the United States Federal Maritime Commission relating to our ability to satisfy liability in cases of non-performance of obligations to passengers, as well as casualty and personal injury. Pursuant to the United States Federal Maritime Commission regulations, we arrange through our insurers for the provision of guarantees aggregating $45.0 million for our ship-operating companies as a condition to obtaining the required certificates. The United States Federal Maritime Commission has proposed various revisions to the financial responsibility regulations, which could require us to significantly increase the amount of our bonds and accordingly increase our costs of compliance.

 

We are also required by the United Kingdom and other jurisdictions to establish our financial responsibility for any liability resulting from the non-performance of our obligations to passengers from these jurisdictions. In the United Kingdom, we are currently required by the United Kingdom Passenger Shipping Association and United Kingdom Civil Aviation Authority to provide performance bonds totaling approximately £55.4 million. The United Kingdom law has recently been changed effective April 1, 2008, such that we will no longer be required by the United Kingdom Civil Aviation Authority to provide such performance bonds. The impact of this change is that the total value of our performance bonds provided in the United Kingdom will be reduced to approximately £34.4 million as of that date. Beginning April 1, 2008 and thereafter, we will be required to pay to the United Kingdom Civil Aviation Authority a non-refundable tax of £1 per passenger. This change will not have a material impact on our 2008 results of operations.

 

We are subject to various United States and international laws and regulations relating to environmental protection. Under such laws and regulations, we are prohibited from, among other things, discharging certain materials, such as petrochemicals and plastics, into the waterways. We have made, and will continue to make, capital and other expenditures to comply with environmental laws and regulations. From time to time, environmental and other regulators consider more stringent regulations, which may affect our operations and increase our compliance costs. We believe that the impact of cruise ships on the global environment will continue to be an area of focus by the relevant authorities throughout the world and, accordingly, this will likely subject us to increasing compliance costs in the future.

 

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Our ships are subject to the United States Passenger Vessel Services Act (“PVSA”) which restricts US coast-wise trading by foreign-flagged cruise ships. In November 2007, the U.S. Customs and Border Protection (“CBP”) proposed an interpretive rule to the PVSA which would require that all roundtrip U.S. cruises by foreign flag vessels spend at least 48 hours in each foreign port of the cruise and that the time spent in foreign ports must be more than 50% of the time spent in all U.S. ports on the cruise. We believe that the CBP issued the proposed rule to protect Norwegian Cruise Line's operations in Hawaii by making it more difficult for foreign-flagged ships to conduct cruises going to Hawaii. However, if the rule is adopted as proposed, it could have an impact on other non-Hawaii itineraries such as Seattle-based Alaska and some Caribbean cruises, which may no longer qualify under the PVSA. If this were to occur, it could have an adverse impact on our financial condition and results of operations.

 

We are required to obtain certificates from the United States Coast Guard relating to our ability to satisfy liability in cases of water pollution. Pursuant to United States Coast Guard regulations, we arrange through our insurers for the provision of guarantees aggregating $318.0 million as a condition to obtaining the required certificates.

 

We believe that we are in material compliance with all the regulations applicable to our ships and that we have all licenses necessary to conduct our business. Health, safety, security and financial responsibility issues are, and we believe will continue to be, an area of focus by the relevant government authorities in the United States and internationally. From time to time, various regulatory and legislative changes may be proposed that could impact our operations and would likely subject us to increasing compliance costs in the future.

 

Taxation of the Company

 

United States Federal Income Tax

 

The following discussion of the application of the United States federal income tax laws to us and our subsidiaries is based on the current provisions of the United States Internal Revenue Code, Treasury Department regulations, administrative rulings, and court decisions. All of the foregoing is subject to change, and any such change could affect the accuracy of this discussion.

 

Application of Section 883 of the Internal Revenue Code

 

We and our subsidiary, Celebrity Cruises Inc., the operator of Celebrity Cruises and Azamara Cruises, are foreign corporations engaged in a trade or business in the United States, and our ship-owning subsidiaries are foreign corporations that, in many cases, depending upon the itineraries of their ships, receive income from sources within the United States. Under Section 883 of the Internal Revenue Code, certain foreign corporations are not subject to United States income or branch profits tax on United States source income derived from or incidental to the international operation of a ship or ships, including income from the leasing of such ships.

 

A foreign corporation will qualify for the benefits of Section 883 if, in relevant part: (1) the foreign country in which the foreign corporation is organized grants an equivalent exemption to corporations organized in the United States; and (2)(A) more than 50% of the value of the corporation’s capital stock is owned, directly or indirectly, by individuals who are residents of a foreign country that grants such an equivalent exemption to corporations organized in the United States, or (B) the stock of the corporation (or the direct or indirect corporate parent thereof) is “primarily and regularly traded on an established securities market” in the United States or another qualifying country such as Norway. In the opinion of our United States tax counsel, Drinker Biddle & Reath LLP, based on the representations and assumptions set forth in that opinion, we, Celebrity Cruises Inc. and our ship-owning subsidiaries qualify for the benefits of Section 883 because we and each of those subsidiaries are incorporated in Liberia or Malta, which are qualifying countries, and our common stock is primarily and regularly traded on an established securities market in the United States or Norway. If, in the future, Liberia no longer qualifies as an equivalent exemption jurisdiction or Royal Caribbean failed to qualify as a publicly traded corporation, it and all of its ship-owning or operating subsidiaries that rely on Section 883 for tax exemption on qualifying income would be subject to United States federal income tax on their United States source shipping income and income from activities incidental thereto.

 

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We believe that most of our income and the income of our ship-owning subsidiaries is derived from or incidental to the international operation of a ship or ships and, therefore, is exempt from taxation under Section 883. In 2005, final regulations became effective under Section 883, which, among other things, narrow somewhat the scope of activities that are considered by the Internal Revenue Service to be incidental to the international operation of ships. The activities listed in the regulations as not being incidental to the international operation of ships include income from the sale of air and land transportation, shore excursions and pre and post cruise tours. To the extent the income from these activities is earned from sources within the United States, that income will be subject to United States taxation; but the determination of the precise amount of such United States source income involves some uncertainties.

 

Under certain circumstances, changes in the identity, residence or holdings of our direct or indirect shareholders could cause our common stock not to be “regularly traded on an established securities market” within the meaning of the regulations under Section 883. To substantially reduce any such risk, in May 2000, our Articles of Incorporation were amended to prohibit any person, other than our two existing largest shareholders, from owning, directly or constructively as determined for purposes of Section 883(c)(3) of the Internal Revenue Code and the regulations promulgated under it, more than 4.9% of the relevant class or classes of our shares. Under Liberian law, this amendment may not be enforceable with respect to shares of common stock that were voted against the amendment or that were recorded as abstaining from the vote.

 

Also, it should be noted that Section 883 has been the subject of legislative modifications in past years that have had the effect of limiting its availability to certain taxpayers, and there can be no assurance that future legislation will not preclude us from obtaining the benefits of Section 883.

 

Taxation in the Absence of an Exemption under Section 883 of the Internal Revenue Code

 

If we, Celebrity Cruises Inc., or our ship-owning subsidiaries were to fail to meet the requirements of Section 883 of the Internal Revenue Code, or if the provision was repealed, then, as explained below, such companies would be subject to United States income taxation on a portion of their income derived from or incidental to the international operation of our ships.

 

Because we and Celebrity Cruises Inc. conduct a trade or business in the United States, we and Celebrity Cruises Inc. would be taxable at regular corporate rates on our separate company taxable income (i.e., without regard to the income of our ship-owning subsidiaries), from United States sources, which includes 100% of income, if any, from transportation that begins and ends in the United States (not including possessions of the United States), 50% of income from transportation that either begins or ends in the United States, and no income from transportation that neither begins nor ends in the United States. The legislative history of the transportation income source rules suggests that a cruise that begins and ends in a United States port, but that calls on more than one foreign port, will derive United States source income only from the first and last legs of such cruise. This conclusion is not free from doubt, however, because there are no regulations or other Internal Revenue Service interpretations of the above rules. In addition, if any of our earnings and profits effectively connected with our United States trade or business were withdrawn, or were deemed to have been withdrawn, from our United States trade or business, those withdrawn amounts would be subject to a “branch profits” tax at the rate of 30%. The amount of such earnings and profits would be equal to the aforesaid United States source income, with certain generally minor adjustments, less income taxes. We and Celebrity Cruises Inc. would also be potentially subject to tax on portions of certain interest paid by us at rates of up to 30%.

 

If Section 883 were not available to our ship-owning subsidiaries, each such subsidiary would be subject to a special 4% tax on its United States source gross transportation income, if any, each year because it does not have a fixed place of business in the United States and its income is derived from the leasing of a ship. Such United States source gross transportation income may be determined under any reasonable method, including ratios of days traveling directly to or from United States ports to total days traveling, or of the lessee’s United States source gross income from the ship (as determined under the source rules discussed in the preceding paragraph, and subject to the assumptions and qualifications set forth therein) to the lessee’s total gross income from the ship.

 

Maltese Income Tax

 

Our Pullmantur ship owner-operator subsidiaries qualify as licensed shipping organizations in Malta. No Maltese income tax is charged on the income derived from shipping activities of a licensed shipping organization. Instead, a licensed shipping organization is liable to pay a tonnage tax based on the net tonnage of

 

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the ship or ships registered under the relevant provisions of the Merchant Shipping Act. A company qualifies as a shipping organization if it engages in qualifying activities and it obtains a license from the Registrar-General to enable it to carry on such activities. Qualifying activities include, but are not limited to, the ownership, operation (under charter or otherwise), administration and management of a ship or ships registered as a Maltese ship in terms of the Merchant Shipping Act and the carrying on of all ancillary financial, security and commercial activities in connection therewith.

 

Our Maltese operations that do not qualify as licensed shipping organizations, which are not considered significant, remain subject to normal Maltese corporate income tax.

 

United Kingdom Income Tax

 

The Brilliance of the Seas is operated by a company that is strategically and commercially managed in the United Kingdom, which has elected to be subject to the United Kingdom tonnage tax regime (“U.K. tonnage tax”). Companies subject to U.K. tonnage tax pay a corporate tax on a notional profit determined with reference to the net tonnage of qualifying vessels. Normal United Kingdom corporate income tax is not chargeable on the relevant shipping profits of a qualifying U.K. tonnage tax company. The requirements for a company to qualify for the U.K. tonnage tax regime include being subject to United Kingdom corporate income tax, operating qualifying ships, which are strategically and commercially managed in the United Kingdom, and fulfilling a seafarer training requirement.

 

Relevant shipping profits include income from the operation of qualifying ships and from shipping related activities. Our United Kingdom income from non-shipping activities which do not qualify under the U.K. tonnage tax regime and which are not considered significant, remain subject to United Kingdom corporate income tax. However, Her Majesty’s Revenue & Customs (HMRC) have announced its intention to make changes to the tonnage tax legislation in the Finance Act of 2008 that include, among other things, amendments to the types of activities that qualify for the tonnage tax regime. We do not expect the impact of these changes to be material to our results of operations for the year ended December 31, 2008.

 

State Taxation

 

We, Celebrity Cruises Inc. and certain of our subsidiaries are subject to various U.S. state income taxes which are generally imposed on each state’s portion of the United States source income subject to federal income taxes. Additionally, the State of Alaska passed Ballot Initiative 2 which became effective in 2007 and which among other things subjects commercial passenger vessel income to Alaska corporate state income taxes and also imposes a 33% tax on income from onboard gambling activities. This did not have a material impact to our results of operations for the year ended December 31, 2007.

 

Other Taxation

 

We and certain of our subsidiaries are subject to income tax in the United States or other jurisdictions on income that does not qualify for exemption under Section 883 or tonnage tax regimes. The tax on such income was not material to our results of operations for the year ended December 31, 2007.

 

Website Access to Reports

 

We make available, free of charge, access to our Annual Reports, all quarterly and current reports and all amendments to those reports, as soon as reasonably practicable after such reports are electronically filed with or furnished to the Securities and Exchange Commission through our website at www.rclinvestor.com. The information contained on our website is not a part of any of these reports and is not incorporated by reference herein.

 

Executive Officers of the Company

 

Pursuant to Instruction 3 to Item 401(b) of Regulation S-K, the information regarding our executive officers is hereby included in Part I of this Annual Report on Form 10-K.

 

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Our executive officers are:

 

Name

Age

Position

Richard D. Fain

60

Chairman, Chief Executive Officer and Director

Adam M. Goldstein

48

President and Chief Executive Officer, Royal Caribbean International

Daniel J. Hanrahan

50

President and Chief Executive Officer, Celebrity Cruises and Azamara Cruises

Brian J. Rice

49

Executive Vice President and Chief Financial Officer

Harri U. Kulovaara

55

Executive Vice President, Maritime

 

Richard D. Fain has served as a director since 1979 and as our Chairman and Chief Executive Officer since 1988. Mr. Fain is Chairman of the Cruise Line International Association, an industry trade organization consisting of 16,000 travel agencies and 21 cruise lines. Mr. Fain has been involved in the shipping industry for over 25 years.

 

Adam M. Goldstein has served as President of Royal Caribbean International since February 2005 and as its President and Chief Executive Officer since September 2007. Mr. Goldstein has been employed with Royal Caribbean since 1988 in a variety of positions, including Executive Vice President, Brand Operations of Royal Caribbean International, Senior Vice President, Total Guest Satisfaction and Senior Vice President, Marketing. Mr. Goldstein served as National Chair of the Travel Industry Association of America in 2001.

 

Daniel J. Hanrahan has served as President of Celebrity Cruises since February 2005 and as its President and Chief Executive Officer since September 2007. Mr. Hanrahan also serves as President and Chief Executive Officer of Azamara Cruises. From 1999 until February 2005, Mr. Hanrahan served in a variety of positions with the Royal Caribbean International brand, including Senior Vice President, Sales and Marketing. Mr. Hanrahan is currently Chairman of the Marketing Committee for the Cruise Line International Association and a member of its executive committee.

 

Brian J. Rice has served as Executive Vice President and Chief Financial Officer since November 2006. Mr. Rice has been employed with Royal Caribbean since 1989 in a variety of positions including Executive Vice President, Revenue Performance. In such capacity, Mr. Rice was responsible for revenue management, air/sea, groups, international operations, decision support, reservations and customer service for both Royal Caribbean International and Celebrity Cruises. As part of his responsibilities, Mr. Rice oversees revenue performance.

 

Harri U. Kulovaara has served as Executive Vice President, Maritime, since January 2005. Mr. Kulovaara is responsible for fleet design and newbuild operations. Mr. Kulovaara also chairs our Maritime Safety Advisory Board. Mr. Kulovaara has been employed with Royal Caribbean since 1995 in a variety of positions, including Senior Vice President, Marine Operations, and Senior Vice President, Quality Assurance. Mr. Kulovaara is a naval architect and engineer.

 

Item 1A. Risk Factors

 

The risk factors set forth below and elsewhere in this Annual Report on Form 10-K are important factors, among others, that could cause actual results to differ from expected or historical results. It is not possible to predict or identify all such factors. Consequently, this list should not be considered a complete statement of all potential risks or uncertainties. (See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations for a note regarding forward-looking statements.)

 

We may lose business to competitors throughout the vacation market.

 

We operate in the vacation market and cruising is one of many alternatives for people choosing a vacation. We therefore risk losing business not only to other cruise lines, but also to other vacation operators, which provide other leisure options including hotels, resorts and package holidays and tours.

 

We face significant competition from other cruise lines, both on the basis of cruise pricing and also in terms of the nature of ships and services we offer to passengers. Our principal competitors within the cruise vacation industry include Carnival Corporation & plc, which owns, among others, Carnival Cruise Lines, Princess Cruises, Costa Cruises, Holland America Line, P&O Cruises, Cunard Line and Aida Cruises; Star Cruises; NCL Corporation Ltd., which owns, among others, Norwegian Cruise Line; Mediterranean Shipping Company, which owns MSC Cruises; Disney Cruise Line; and Oceania Cruises.

 

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In the event that we do not compete effectively with other vacation alternatives and cruise companies, our results of operations and financial position could be adversely affected.

 

Overcapacity within the cruise vacation industry, a reduction in demand or geo-political and economic uncertainties could have a negative impact on revenues, result in impairment of assets and may adversely affect our results of operations.

 

Cruising capacity has grown in recent years and we expect it to increase further as the major cruise vacation companies introduce new ships. Demand for cruises has been and is expected to continue to be dependent on the strength of the economies in the countries in which we market our products, the public’s attitude towards the safety of travel and the geo-political climate. Economic or political changes may reduce demand for cruise vacations and may lead to reduced occupancy and/or price discounting. For instance, the current weakening of the U.S. economy and the tighter credit markets could have an adverse effect on vacationers’ discretionary income and consumer confidence, which could result in a lower demand for cruises, lower cruise prices and lower onboard revenues, all of which would adversely affect our revenues. In turn, these results could have a negative impact on revenues, result in impairment of assets and may adversely affect our financial position and results of operations.

 

Fears of terrorist attacks, war and other hostilities and the spread of contagious diseases could have a negative impact on our results of operations.

 

Events such as terrorist attacks, war and other hostilities and the resulting political instability, travel restrictions, the spread of contagious diseases and concerns over safety, health and security aspects of traveling have had, and could have in the future, a significant adverse impact on demand and pricing in the travel and vacation industry. These events could also impact our ability to source qualified crew from throughout the world at competitive costs and, therefore, increase our shipboard employee costs.

 

Incidents or adverse publicity concerning the cruise vacation industry or unusual weather conditions could affect our reputation and harm our future sales and results of operations.

 

The operation of cruise ships involves the risk of accidents, illnesses and other incidents which may bring into question passenger safety, health, security and vacation satisfaction and thereby adversely affect future industry performance. Incidents involving cruise ships, adverse media publicity concerning the cruise vacation industry or unusual weather patterns or natural disasters, such as hurricanes and earthquakes, could impact demand and consequently have an adverse impact on our results of operations.

 

Environmental, health and safety, financial responsibility and other maritime regulations could affect operations and increase operating costs.

 

The United States and various state and foreign government or regulatory agencies have enacted or are considering new environmental regulations or policies that could adversely impact the cruise vacation industry. Some environmental groups have lobbied for more stringent regulation of cruise ships and have generated negative publicity about the cruise vacation industry and its environmental impact. In addition, we are subject to various international, national, state and local laws, regulations and treaties that govern, among other things, safety standards applicable to our ships, health and sanitary standards applicable to our passengers, security standards on board our ships and at the ship/port interface areas, and financial responsibilities to our passengers. These issues are, and we believe will continue to be, an area of focus by the relevant authorities throughout the world. This could result in the enactment of more stringent regulation of cruise ships that would subject us to increasing compliance costs in the future.

 

In November 2007, the U.S. Customs and Border Protection (“CBP”) proposed an interpretive rule to the United States Passenger Vessel Services Act (“PVSA”) which would require that all roundtrip U.S. cruises by foreign flag vessels spend at least 48 hours in each foreign port of the cruise and that the time spent in foreign ports must be more than 50% of the time spent in all U.S. ports on the cruise. We believe that the CBP issued the proposed rule to protect Norwegian Cruise Line's operations in Hawaii by making it more difficult for foreign-flagged ships to conduct cruises going to Hawaii. However, if the rule is adopted as proposed, it could

 

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be construed to apply to other non-Hawaii itineraries such as Seattle-based Alaska and some Caribbean cruises, which may no longer qualify under the PVSA. If this was to occur, it could have an adverse impact on our financial condition and results of operations.

 

We may not be able to obtain financing on terms that are favorable or consistent with our expectations.

 

To fund our capital expenditures and scheduled debt payments, we rely on a combination of cash flows provided by operations, drawdowns under our available credit facilities, the incurrence of additional indebtedness and the sales of equity or debt securities in private or public securities markets. Our credit ratings impact our ability to obtain financing in financial markets and the terms of the financing. Any lowering of our credit ratings may have adverse consequences on our ability to access the financial markets and/or on our cost of financings. In addition, interest rates and our ability to obtain financing are dependent on many economic and political factors beyond our control. Accordingly, we cannot be sure that our cash flows from operations and additional financings will be available in accordance with our expectations.

 

Conducting business internationally may result in increased costs and other risks.

 

We operate our business internationally and plan to continue to develop our international presence. Operating internationally exposes us to a number of risks. Examples include political risks and risk of increases in duties and taxes as well as changes in laws and policies affecting cruising, vacation or maritime businesses, or governing the operations of foreign-based companies. Additional risks include currency fluctuations, interest rate movements, imposition of trade barriers and restrictions on repatriation of earnings. If we are unable to address these risks adequately, our financial position and results of operations could be adversely affected.

 

We have ship construction contracts, which are denominated in euros. While we have entered into euro-denominated forward contracts to manage a portion of the currency risk associated with these ship construction contracts, we are exposed to fluctuations in the euro exchange rate for the portion of the ship construction contracts that has not been hedged. If the shipyard is unable to perform under the related ship construction contract, any foreign currency hedges that were entered into to manage the currency risk would need to be terminated. Termination of these contracts could result in a significant loss.

 

Ship construction delays or mechanical faults may result in cancellation of cruises or unscheduled drydocks and repairs and thus adversely affect our results of operations.

 

We depend on shipyards to construct and deliver our cruise ships on a timely basis and in good working order. The sophisticated nature of building a ship involves risks. Delays or mechanical faults in ship construction have in the past and may in the future result in delays or cancellation of cruises or necessitate unscheduled drydocks and repairs of ships. We have, for example, experienced mechanical problems with the pod propulsion units on certain ships and there can be no assurance that we will not experience such problems in the future. Delays or cancellations of cruise ships may also adversely impact our ability to maintain our contractual minimum commitments to our ports. These events and any related adverse publicity could result in lost revenue, increased operating expenses, or both, and thus adversely affect our results of operations.

 

Shipyard financial difficulties or insolvencies, shortages in available shipbuilding facilities and component parts due to strong demand for shipbuilding services within the industry, and industry consolidations may cause delivery delays or price increases that could adversely affect our results of operations.

 

Conditions in the shipyard industry over which we have no control can affect our financial results. For example, we regularly introduce new ships to our fleet, and regularly repair and refurbish our existing fleet. The timely delivery of new ships and our ability to repair and refurbish our fleet can be adversely affected by factors such as shipyard financial difficulties, shortages in shipbuilding component parts and capacity constraints at qualified shipyard repair facilities. Delivery delays and cancelled deliveries can adversely affect our results of operations, as can any constraints on our ability to repair and maintain our ships on a timely basis. In addition, the cruise shipyard industry is undergoing consolidation, which could result in stronger bargaining power on the part of the shipyards, and thus higher prices for our ships.

 

 

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Aker Yards Oy, the shipyard that is building Independence of the Seas and our two Project Genesis class ships, announced a lowering of its projected profits and delays in the construction of its vessels. We have engaged in discussions with Aker Yards Oy to assess the impact of this situation on the ships they are building for us. Based on such discussions, we do not expect that this situation will have a material impact on our results of operations. However, in the event that the financial situation of Aker Yards Oy deteriorates further, it could have a material impact on the delivery and costs associated with our Project Genesis class ships and our future results of operations.

 

Our operating costs and taxes could increase due to market forces and economic or political factors beyond our control.

 

Our operating costs, including fuel, food, payroll, insurance and security costs are subject to increases due to market forces and economic or political instability or other factors beyond our control. Increases in these operating costs could adversely affect our profitability. In addition, United States state and local authorities as well as foreign authorities periodically consider increases in taxes. The implementation of these and other taxes could also cause an increase in our costs.

 

The Office of the Attorney General for the State of Florida is conducting a review of our temporary fuel supplement that we implemented in the fourth quarter of 2007 on our Royal Caribbean International, Celebrity Cruises, and Azamara Cruises brands. We are cooperating with the Attorney General’s office in connection with this review and investigation. At this time, we are unable to determine the impact of this item on our 2008 consolidated financial statements.

 

Unavailability of ports of call may adversely affect our results of operations.

 

We believe that port destinations are a major reason why passengers choose to go on a particular cruise or on a cruise vacation. The availability of ports is affected by a number of factors, including, but not limited to, existing capacity constraints, security concerns, adverse weather conditions and natural disasters, financial limitations on port development, exclusivity arrangements that ports may have with our competitors, local governmental regulations and local community concerns about port development and other adverse impacts on their communities from additional tourists. Any limitations on the availability of our ports of call or on the availability of shore excursion and other service providers at such ports could adversely affect our results of operations.

 

Price increases for commercial airline service for our passengers or major changes or reduction in commercial airline service could undermine our ability to provide reasonably priced vacation packages to our guests.

 

Many of our guests depend on scheduled commercial airline services to transport them to or from the ports where our cruises embark or disembark. Increases in the price of airfare would increase the overall price of the cruise vacation to our guests which may adversely impact demand for our cruises. In addition, changes in the availability of commercial airline services could adversely affect our ability to fly our passengers to or from our cruise ships which could adversely affect our results of operations.

 

A change in our tax status under the United States Internal Revenue Code, or other jurisdictions, may have adverse effects on our income.

 

We and a number of our subsidiaries are foreign corporations that derive income from a United States trade or business and/or from sources within the United States. Drinker Biddle & Reath LLP, our United States tax counsel, has delivered to us an opinion, based on certain representations and assumptions set forth in it, to the effect that this income, to the extent derived from or incidental to the international operation of a ship or ships, is exempt from United States income tax pursuant to Section 883 of the Internal Revenue Code. We believe that most of our income (including that of our subsidiaries) is derived from or incidental to the international operation of a ship or ships.

 

In 2005, final regulations under Section 883 became effective, which narrowed somewhat the scope of activities that are considered by the Internal Revenue Service to be incidental to the international operation of ships. To the extent the income from non-incidental activities is earned from sources within the United States, that income will be subject to United States taxation; but the determination of the precise amount of such United States source income involves some uncertainties.

 

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     It should also be noted that the provisions of Section 883 are subject to change at any time by legislation. Moreover, changes could occur in the future with respect to the identity, residence or holdings of our direct or indirect shareholders that could affect our eligibility for the Section 883 exemption. Accordingly, there can be no assurance that we will continue to be exempt from United States income tax on United States source shipping income in the future. If we were not entitled to the benefit of Section 883, we and our subsidiaries would be subject to United States taxation on a portion of the income derived from or incidental to the international operation of our ships, which would reduce our net income. See Taxation of the Company above for a discussion of such taxation in the absence of an exemption under Section 883.

 

Finally, changes in the income tax laws affecting our operations in Malta, the United Kingdom or elsewhere could result in higher income taxes being charged against our operations, resulting in lower net income.

 

We are controlled by principal shareholders that have the power to determine our policies, management and actions requiring shareholder approval.

 

As of February 12, 2008, A. Wilhelmsen AS., a Norwegian corporation indirectly owned by members of the Wilhelmsen family of Norway, owned approximately 20.1% of our common stock and Cruise Associates, a Bahamian general partnership indirectly owned by various trusts primarily for the benefit of certain members of the Pritzker family and a trust primarily for the benefit of certain members of the Ofer family, owned approximately 15.6% of our common stock. A. Wilhelmsen AS. and Cruise Associates have the power to determine, among other things:

 

• our policies and the policies of our subsidiaries,

 

• the persons who will be our directors and officers, and

 

• actions requiring shareholder approval.

 

A. Wilhelmsen AS. and Cruise Associates are parties to a shareholders’ agreement. The agreement provides that our board of directors will consist of the following persons:

 

• four nominees of A. Wilhelmsen AS.,

 

• four nominees of Cruise Associates and

 

• our Chief Executive Officer.

 

During the term of the shareholders’ agreement, certain corporate actions require the approval of at least one director nominated by A. Wilhelmsen AS. and one director nominated by Cruise Associates. Our principal shareholders are not prohibited from engaging in a business that may compete with our business, subject to certain exceptions. If any person other than A. Wilhelmsen AS. and Cruise Associates, our two principal shareholders, acquires ownership of more than 30% of our common stock and our two principal shareholders, in the aggregate, own less of our common stock than such person and do not collectively have the right to elect, or to designate for election, at least a majority of the board of directors, we may be obligated to prepay indebtedness outstanding under the majority of our credit facilities, which we may be unable to replace on similar terms. If this were to occur, it could have an adverse impact on our liquidity and operations.

 

The holders of our common stock may experience a decrease in the value of their equity interest as a result of the sale of currently restricted shares of our common stock into the public market.

 

A substantial number of shares of our common stock were either issued by us in private transactions not involving a public offering or are held by our affiliates and, therefore the sale of these securities is subject to restrictions under the Securities Act of 1933 (“Securities Act”). These shares include the 20.1% shares of our common stock held by A. Wilhelmsen AS. and the 15.6% held by Cruise Associates. No predictions can be made as to the effect, if any, that market sales of such shares, or the availability of such shares for future market sales, will have on the market price of our common stock prevailing from time to time. Sales of substantial amounts of our common stock, or the perceptions that such sales could occur, could materially adversely affect the prevailing market price for our common stock and could impair our ability to raise capital through an offering of equity securities. Each of A. Wilhelmsen AS. and Cruise Associates has the right, pursuant to a registration rights agreement, to require us, subject to certain qualifications, to effect the registration under the Securities Act of all or part of their shares of common stock which would allow these shares to be sold into the public market.

 

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We are not a United States corporation and our shareholders may be subject to the uncertainties of a foreign legal system in protecting their interests.

 

Our corporate affairs are governed by our Restated Articles of Incorporation and By-Laws and by the Business Corporation Act of Liberia. The provisions of the Business Corporation Act of Liberia resemble provisions of the corporation laws of a number of states in the United States. However, while most states have a fairly well developed body of case law interpreting their respective corporate statutes, there are very few judicial cases in Liberia interpreting the Business Corporation Act of Liberia. For example, the rights and fiduciary responsibilities of directors under Liberian law are not as clearly established as the rights and fiduciary responsibilities of directors under statutes or judicial precedent in existence in certain United States jurisdictions. Thus, our public shareholders may have more difficulty in protecting their interests with respect to actions by management, directors or controlling shareholders than would shareholders of a corporation incorporated in a United States jurisdiction.

 

Litigation, enforcement actions, fines or penalties could adversely impact our financial condition or results of operations and/or damage our reputation.

Our business is subject to various United States and international laws and regulations that could lead to enforcement actions, fines, civil or criminal penalties or the assertion of litigation claims and damages. In addition, improper conduct by our employees or agents could damage our reputation and/or lead to litigation or legal proceedings that could result in civil or criminal penalties, including substantial monetary fines. In certain circumstances it may not be economical to defend against such matters and/or a legal strategy my not ultimately result in us prevailing in a matter. Such events could lead to an adverse impact on our financial condition or results of operations.

 

Item 1B. Unresolved Staff Comments

 

None.

 

Item 2. Properties

 

Information about our cruise ships, including their size and primary areas of operation, may be found within the Operating Strategies - Fleet Expansion and Innovation section and the Operations - Cruise Ships and Itineraries section in Item 1. Business. Information regarding our cruise ships under construction, estimated expenditures and financing may be found within the Future Capital Commitments and Funding Sources sections of Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Our principal executive office and shoreside operations are located at the Port of Miami, Florida where we lease three office buildings totaling approximately 359,000 square feet from Miami-Dade County, Florida, under long-term leases with initial terms expiring in various years in and after 2011. We also lease offices in Addlestone, England, which are used primarily to administer our Royal Caribbean International and Celebrity Cruises’ operations in Europe, an office in Madrid, Spain to administer our Pullmantur Cruises operations and offices in Singapore and Shanghai to administer our Royal Caribbean International and Celebrity Cruises’ Asia/Pacific operations.

 

We lease an office building in Springfield, Oregon totaling approximately 163,000 square feet, which is used as a call center for reservations. In addition, we lease an office building in Wichita, Kansas totaling approximately 95,000 square feet, which is used as a call center for reservations and customer service.

 

We lease two buildings in Miramar, Florida totaling approximately 178,000 square feet. One building is used primarily as additional office space and the other building is used as a call center for reservations.

 

The lease of our current logistics center will expire in December 2008. We recently leased a building in Weston, Florida totaling approximately 267,000 square feet which will primarily serve as our logistics center, beginning in October 2008.

 

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Royal Caribbean International operates two private destinations: (i) an island we own in the Bahamas which we call CocoCay; and (ii) Labadee, a secluded peninsula which we lease and is located on the north coast of Haiti.

 

Item 3. Legal Proceedings

 

In April 2005, a purported class action lawsuit was filed in the United States District Court for the Southern District of Florida alleging that Celebrity Cruises improperly requires its cabin stewards to share guest gratuities with assistant cabin stewards. The suit sought payment of damages, including penalty wages under the U.S. Seaman’s Wage Act. In March 2006, the Southern District of Florida dismissed the suit and held that the case should be arbitrated pursuant to the arbitration provision in Celebrity’s collective bargaining agreement. In June 2007, the United States 11th Circuit Court of Appeals affirmed the District Court’s order dismissing the suit and subsequently denied the plaintiff’s petition for re-hearing and petition for re-hearing enbanc. In January 2008, the United States Supreme Court denied the plaintiff’s petition requesting that the Court grant certiorari jurisdiction over the action. We are not able at this time to estimate the impact of this proceeding.

 

In January 2006, a purported class action lawsuit was filed in the United States District Court for the Southern District of New York alleging that we infringed rights in copyrighted works and other intellectual property by presenting performances on our cruise ships without securing the necessary licenses. The suit seeks payment of damages, disgorgement of profits and a permanent injunction against future infringement. In April 2006, we filed a motion to sever and transfer the case to the United States District Court for the Southern District of Florida. The motion is pending. We are not able at this time to estimate the impact of this proceeding.

 

We have a lawsuit pending in the Circuit Court for Miami-Dade County, Florida against Rolls Royce, co-producer of the Mermaid pod-propulsion system on Millennium-class ships, for the recurring Mermaid pod failures. Alstom Power Conversion, the other co-producer of the pod-propulsion system, settled out of this suit in January 2006 for $38.0 million. The $38.0 million settlement resulted in a gain of $36.0 million, net of reimbursements to insurance companies, which we recorded within other income in our consolidated statements of operations for the year ended December 31, 2006. We are not able at this time to estimate the outcome of the Rolls Royce proceeding.

 

Celebrity Cruises has been awarded damages in connection with its pending case in New York federal court against Essef Corp. for claims stemming from a 1994 outbreak of Legionnaires’ disease on one of Celebrity Cruises’ ships. The award reflects the culmination of two jury trials held in June 2006 and June 2007, respectively, as most recently modified by the trial judge in January 2008. Judgment has not yet been entered and when entered, the judgment is subject to appeal. The award would result in a net payment to Celebrity Cruises (after costs and payment to insurers) of approximately $15.0 million. We are not able at this time to estimate the outcome of this proceeding, and as of December 31, 2007, no amount of this award has been recognized in our consolidated financial statements.

 

In July 2006, a purported class action lawsuit was filed in the United States District Court for the Central District of California alleging that we failed to timely pay crew wages and failed to pay proper crew overtime. The suit seeks payment of damages, including penalty wages under the U.S. Seaman’s Wage Act and equitable relief damages under the California Unfair Competition Law. In December 2006, the District Court granted our motion to dismiss the claim and held that it should be arbitrated pursuant to the arbitration provision in Royal Caribbean’s collective bargaining agreement. In January 2007, the plaintiffs appealed the order to the United States Ninth Circuit Court of Appeals. We are not able at this time to estimate the impact of this proceeding on us.

 

The Miami District Office of the U.S. Equal Employment Opportunity Commission (“EEOC”) has alleged that certain of our shipboard employment practices do not comply with U.S. employment laws. In June 2007, the EEOC proposed payment of monetary sanctions and certain remedial actions. We are reviewing the matter with the EEOC, and no legal proceedings have been initiated. We do not believe that this matter will have a material adverse impact on our financial condition or results of operations.

 

25



The Office of the Attorney General for the State of Florida is conducting a review of our fuel supplement that we implemented in the fourth quarter of 2007 on our Royal Caribbean International, Celebrity Cruises and Azamara cruise brands. In addition, we have been informed that the same office is conducting an investigation to determine whether there is or has been a violation of state or Federal anti-trust laws in connection with the setting by us and other cruise line operators of our respective fuel supplements. We are cooperating with the Attorney General’s office in connection with this review and investigation. We are not able at this time to estimate the impact of this review and investigation on us.    

 

In February 2008, a purported class action lawsuit was filed in the United States District Court for the Southern District of Florida. The lawsuit alleges, among other things, that we, other cruise lines and a trade association violated Federal anti-trust laws or state deceptive and unfair trade practices laws by conspiring to fix the prices of the fuel supplements announced by the various cruise lines or misleading consumers as to the relationship between each cruise line’s fuel costs and the fuel supplements it is charging its customers. We are not able at this time to estimate the impact of this proceeding on us.

 

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

 

Item 4. Submission of Matters to a Vote of Security Holders

 

None.

 

26


PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market Information

 

Our common stock is listed on the New York Stock Exchange (“NYSE”) and the Oslo Stock Exchange (“OSE”) under the symbol “RCL”. The table below sets forth the intra-day high and low prices of our common stock as reported by the NYSE and the OSE for the two most recent years by quarter:

 

 

 

        NYSE

Common Stock

      OSE

Common Stock(1)

 

High

Low

High

Low

2007

Fourth  Quarter

  $43.45  

 $37.52

  243.50

  205.00

Third Quarter

42.53

36.03

251.00

203.50

Second Quarter

44.62

40.43

268.00

244.00

First Quarter

   45.34   

38.68

290.00

243.00

2006

Fourth  Quarter

$43.97

    $38.06

282.00

243.00

Third Quarter

39.28

32.47

260.00

203.50

Second Quarter

43.86

35.00

280.00

213.00

First Quarter

46.77

40.59

316.50

271.00

__________

(1)

Denominated in Norwegian kroner.


Holders

 

As of February 12, 2008 there were 1,058 record holders of our common stock. Since certain of our shares are held indirectly, the foregoing number is not representative of the number of beneficial owners.

 

Dividends

 

We declared cash dividends on our common stock of $0.15 per share in each of the quarters of 2007 and 2006.

 

Holders of our common stock have an equal right to share in our profits in the form of dividends when declared by our board of directors out of funds legally available for the distribution of dividends. Holders of our common stock have no rights to any sinking fund.

 

There are no exchange control restrictions on remittances of dividends on our common stock. Since (1) we are and intend to maintain our status as a nonresident Liberian entity under the Revenue Code of Liberia (2000) and the regulations thereunder, and (2) our ship-owning subsidiaries are not now engaged, and are not in the future expected to engage, in any business in Liberia, including voyages exclusively within the territorial waters of the Republic of Liberia, under current Liberian law, no Liberian taxes or withholding will be imposed on payments to holders of our securities other than to a holder that is a resident Liberian entity or a resident individual or an individual or entity subject to taxation in Liberia as a result of having a permanent establishment within the meaning of the Revenue Code of Liberia (2000) in Liberia.

 

The declaration of dividends shall at all times be subject to the final determination of our board of directors that a dividend is prudent at that time in consideration of the needs of the business. The shareholders agreement provides that A. Wilhelmsen AS. and Cruise Associates will from time to time consider our dividend policy with due regard for the interests of the shareholders in maximizing the return on their investment and our ability to pay such dividends. The shareholders agreement also provides that payment of dividends will depend, among other factors, upon our earnings, financial position and capital requirements and the income and other tax liabilities of A. Wilhelmsen AS., Cruise Associates and their respective affiliates relating to their ownership of common stock.

 

27


 

Issuer Purchases of Equity Securities

 

None.

 

Performance Graph

 

The following graph compares the performance of the Company’s common stock with the performance of the Standard & Poor’s 500 Composite Stock Index and the Dow Jones U.S. Travel and Leisure Index for a five year period by measuring the changes in common stock prices from December 31, 2002 to December 31, 2007.

 

_________________________________________________________________________

 

12/02

12/03

12/04

12/05

12/06

12/07

Royal Caribbean Cruises Ltd.

$ 100.00

$ 213.36

$ 337.80

$ 283.05

$ 263.86

$ 274.59

S&P 500

$ 100.00

$ 128.68

$ 142.69

$ 149.70

$ 173.34

$ 182.87

Dow Jones US Travel & Leisure

$ 100.00

$ 142.61

$ 183.31

$ 186.31

$ 228.12

$ 224.91

 

 

The stock performance graph assumes for comparison that the value of the Company’s Common Stock and of each index was $100 on December 31, 2002 and that all dividends were reinvested. Past performance is not necessarily an indicator of future results.

 

 

28


 

Item 6. Selected Financial Data

 

The selected consolidated financial data presented below for the years 2003 through 2007 and as of the end of each such year, are derived from our audited financial statements and should be read in conjunction with those financial statements and the related notes.

 

 

Year Ended December 31,

 

    2007

 

2006

 

2005

 

2004

 

2003

 

(in thousands, except per share data)

Operating Data:

 

 

 

 

 

 

Total revenues

$      6,149,139

 

$   5,229,584

 

$     4,903,174

 

$    4,555,375

 

$     3,784,249

Operating income

901,335

 

858,446

 

871,565

 

753,589

 

526,185

Income before cumulative effect   of a change in accounting   principle

603,405

633,922

663,465

474,691

280,664

Cumulative effect of a change in   accounting principle¹

-

-

52,491

- -

Net income

603,405

 

633,922

 

715,956

 

474,691

 

280,664

Per Share Data — Basic:

 

 

 

 

 

 

 

 

 

Income before cumulative effect   of a change in accounting   principle

$              2.84

$           3.01

 

$             3.22

$            2.39

1.45

Cumulative effect of a change in   accounting principle¹

-

-

0.25

-

-

Net income

$              2.84

 

$           3.01

 

$             3.47

 

 $            2.39

 

$             1.45

Weighted-average shares

212,784

 

210,703

 

206,217

 

198,946

 

194,074

Per Share Data — Diluted:

 

 

 

 

 

 

Income before cumulative effect   of a change in accounting   principle

$             2.82

$             2.94

$            3.03

$             2.26

$             1.42

Cumulative effect of a change in   accounting principle¹

-

-

$            0.22

-

-

Net income

$             2.82

 

$             2.94

 

$            3.26

 

$             2.26

 

$             1.42

Weighted-average shares and   diluted shares

214,255

221,485

234,714

234,580

211,175

Dividends declared per common   shares

$             0.60

$             0.60

$            0.56

$             0.52

$             0.52

Balance Sheet Data:

  

 

 

 

 

 

Total assets

$    14,982,281

 

$   13,393,088

 

$   11,255,771

 

$   11,964,084

 

$   11,322,742

Total debt, including capital         leases

5,698,272

 

5,413,744

 

4,154,775

 

5,731,944

 

5,835,804

Common stock

2,235

 

2,225

 

2,165

 

2,012

 

1,961

Total shareholders’ equity

6,757,343

 

6,091,575

 

5,554,465

 

4,804,520

 

4,262,897

1In the third quarter of 2005, we changed our method of accounting for drydocking costs from the accrual in advance to the deferral method (see Note 2. Summary of Significant Accounting Policies to our consolidated financial statements under Item 8. Financial Statements and Supplementary Data.)

 

29


 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Cautionary Note Concerning Factors That May Affect Future Results

 

Certain statements under this caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this document constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. Words such as “expect,” “anticipate,” “goal,” “project,” “plan,” “believe,” “seek” and similar expressions are intended to identify these forward-looking statements. Forward-looking statements do not guarantee future performance and may involve risks, uncertainties and other factors, which 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 under Item 1A. Risk Factors as well as the following:

 

• general economic and business conditions,

 

• vacation industry competition and changes in industry capacity and overcapacity,

 

• the impact of tax laws and regulations affecting our business or our principal shareholders,

 

• the impact of changes in other laws and regulations affecting our business,

 

• the impact of pending or threatened litigation,

 

• the delivery of scheduled new ships,

 

• emergency ship repairs,

 

• the impact of problems encountered at shipyards, including industrial actions, shipyard insolvency or financial difficulties,

 

• the impact on prices of new ships due to shortages in available shipyard facilities, component parts and shipyard consolidations,

 

• negative incidents involving cruise ships including those involving the health and safety of passengers,

 

• reduced consumer demand for cruises as a result of any number of reasons, including geo-political and economic uncertainties and the unavailability of air service,

 

• fears of terrorist attacks, armed conflict and the resulting concerns over safety and security aspects of traveling,

 

• the impact of the spread of contagious diseases,

 

• the availability under our unsecured revolving credit facility, cash flows from operations and our ability to obtain new borrowings and raise new capital on terms that are favorable or consistent with our expectations to fund operations, debt payment requirements, capital expenditures and other commitments,

 

• changes in our stock price or principal shareholders,

 

• the impact of changes in operating and financing costs, including changes in foreign currency, interest rates, fuel, food, payroll, insurance and security costs,

 

• weather.

 

The above examples are not exhaustive and new risks emerge from time to time. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

30


 

Critical Accounting Policies

 

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. (See 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. Depreciation of ships is generally computed net of a 15% projected residual value using the straight-line method over estimated service lives of primarily 30 years. Improvement costs that we believe add value to our ships are capitalized as additions to the ship and depreciated over the improvements’ estimated useful lives. 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. Repairs and maintenance activities are charged to expense as incurred. 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. 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. (See Note 2. Summary of Significant Accounting Policies to our consolidated financial statements under Item 8. Financial Statements and Supplementary Data).

 

Our service 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 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.

 

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 service 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 30-year ship service life by one year, depreciation expense for 2007 would have increased by approximately $25.0 million. If our ships were estimated to have no residual value, depreciation expense for 2007 would have increased by approximately $98.5 million.

 

Valuation of Long-Lived Assets, Goodwill and Indefinite-Lived Intangible Assets

 

We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be fully recoverable. The assessment of possible impairment is based on our ability to recover the carrying value of our asset based on our estimate of its undiscounted future cash flows. If these estimated future cash flows are less than the carrying value of the asset, an impairment charge would be recognized for the difference between the asset’s estimated fair value and its carrying value.

 

The determination of fair value is based on quoted market prices in active markets, if available. Such markets are often not available for used cruise ships. Accordingly, we also base fair value on independent appraisals, sales price negotiations and projected future cash flows discounted at a rate determined by management to be commensurate with the business risk. The estimation of fair value utilizing discounted forecasted cash flows includes numerous uncertainties which require our significant judgment when making assumptions of revenues, operating costs, marketing, selling and administrative expenses, interest rates, ship additions and retirements, cruise vacation industry competition and general economic and business conditions, among other factors.

 

31


 

Goodwill and other indefinite-lived intangible assets are reviewed annually, or when events or circumstances dictate, more frequently. The impairment review for goodwill consists of a two- step process of first determining the fair value of the reporting unit and comparing it to the carrying value of the net assets allocated to the reporting unit. If the fair value of the reporting unit exceeds the 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 the net assets, the implied fair value of the reporting unit is allocated to all the 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 indefinite-life intangible asset impairment review consists of a comparison of the fair value of the indefinite-life intangible asset with its carrying amount. 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.

 

The fair value of a reporting unit and an indefinite-life intangible asset is based on quoted market prices if available. Quoted market prices are often not available for individual reporting units and for indefinite-life intangible assets. Accordingly, we base the fair value of a reporting unit and an indefinite-life intangible asset on an expected present value technique, which is often the best technique available to estimate fair value. The expected present value technique for a reporting unit and an indefinite-life intangible asset consists of estimating expected future cash flows discounted using a rate commensurate with the business risk. 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 competition and general economic and business conditions, among other factors.

 

We believe we have made reasonable estimates and judgments in determining whether our long-lived assets and intangible assets have been impaired; however, if there is a material change in the assumptions used in our determination of fair values or if there is a material change in the conditions or circumstances influencing fair value, we could be required to recognize a material impairment charge.

 

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. 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.

 

Terminology

 

Our revenues are seasonal based on demand for cruises. Demand is strongest for cruises during the North American summer months and holidays. Our revenues consist of the following items:

 

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

 

Onboard and other revenues 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, pre- and post-cruise tours, Pullmantur Cruises’ land-based tours and hotel and air packages. Also included are 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.

 

32


 

Our cruise operating expenses consist of the following:

 

Commissions, transportation and other expenses 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 consist of the direct costs associated with onboard and other revenues. These costs include the cost of products sold onboard our ships, vacation protection insurance premiums, costs associated with pre- and post-cruise tours and related credit card fees. These costs also include minimal costs associated with concession revenues, as the costs are mostly incurred by third party concessionaires.

 

Payroll and related expenses consist of costs for shipboard personnel.

 

Food expenses include food costs for both passengers and crew.

 

Fuel expenses include fuel and related delivery and storage costs, including the financial impact of fuel swap agreements.

 

Other operating expenses consist primarily of operating costs such as repairs and maintenance, port costs that do not vary with passenger head counts, vessel operating lease costs, costs associated with Pullmantur Cruises’ land-based tours, vessel related insurance and entertainment.

 

We do not allocate payroll and related costs, food costs, fuel costs or other operating costs 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.

 

Non-GAAP Financial Measures

 

Available Passenger Cruise Days (“APCD”) are our measurement of capacity and represent double occupancy per cabin multiplied by the number of cruise days for the period.

 

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 represent Gross Cruise Costs excluding commissions, transportation and other expenses and onboard and other expenses (each of which is described below under the Overview heading). In measuring our ability to control costs in a manner that positively impacts net income, we believe changes in Net Cruise Costs to be the most relevant indicator of our performance. A reconciliation of historical Gross Cruise Costs to Net Cruise Costs is provided below under Summary of Historical Results of Operations. We have not provided a quantitative reconciliation of projected Gross Cruise Costs to projected Net Cruise Costs due to the significant uncertainty in projecting the costs deducted to arrive at this measure. Accordingly, we do not believe that reconciling information for such projected figures would be meaningful.

 

Net Debt-to-Capital is a ratio which represents total long-term debt, including current portion of long-term debt, less cash and cash equivalents (“Net Debt”) divided by the sum of Net Debt and total shareholders' equity. We believe Net Debt and Net Debt-to-Capital, along with total long-term debt and shareholders' equity are useful measures of our capital structure. A reconciliation of historical Debt-to-Capital to Net Debt-to-Capital is provided below under Summary of Historical Results of Operations.

 

Net Revenues represent total revenues less commissions, transportation and other expenses and onboard and other expenses (each of which is described under the Overview 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 it is the most relevant measure of our pricing performance because it reflects 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

 

33


 

Gross Yields to Net Yields is provided below under Summary of Historical Results of Operations. We have not provided a quantitative reconciliation of projected Gross Yields to projected Net Yields due to the significant uncertainty in projecting the costs deducted to arrive at this measure. Accordingly, we do not believe that reconciling information for such projected figures would be meaningful.

 

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.

 

Executive Overview

 

Over the past five years, we have experienced higher passenger ticket prices and onboard revenues while maintaining strong occupancies. As a result, Net Yields have grown from $146.63 in 2003 to $183.64 in 2007. The industry’s focus has shifted so that a larger portion of the revenue growth has come from markets outside of North America. We have responded to this shift by redeploying some of our ships to certain international markets such as Europe, Latin America and Asia, as well as focusing on the continued development of our international passenger sourcing. As a result, our passenger ticket revenues generated by sales originating outside of North America has increased from approximately 19% in 2003 to 30% in 2007. Due to the recent recovery in North American bookings and continued strengthening internationally, we expect to see further yield improvements in 2008, in spite of the current weakening of the U.S. economy and the tighter credit markets. These current economic conditions, however, could eventually have an adverse effect on vacationers’ discretionary income and consumer confidence, which could result in a lower demand for cruises, lower cruise prices and lower onboard revenues in the future.

 

From 2003 through 2007, the cruise industry has been adversely impacted directly and indirectly by substantial increases in fuel prices. In 2003, fuel cost per metric ton was $204, whereas in 2007, our fuel cost per metric ton was $455, an increase of 123%.  If our fuel cost per metric ton in 2007 had remained at 2003's level, our fuel expenses would have been approximately $300 million lower in 2007.  In addition, fuel and other factors have caused cost increases elsewhere including transportation, food products and other commodities.  We have been able to partially mitigate this increase in these costs with our hedging program and energy saving initiatives. Also, we implemented a temporary fuel supplement in 2008; however, we believe this fuel supplement will be partially offset by reductions in ticket prices. We believe higher and volatile fuel prices are a factor that will continue to impact our results of operations for the foreseeable future. Despite these pressures, we continue to focus on cost savings initiatives and expect to limit increases in our Net Cruise Costs on an APCD basis (excluding fuel) to 1% to 2% in 2008.

 

The Company expects to continue the expansion of its international passenger sourcing and the development and growth of its innovative fleet of ships. As of December 31, 2007, we had signed agreements with two shipyards providing for the construction of seven additional cruise ships. These new ships are expected to continue to help us maintain our current position within the worldwide cruise industry. The year-over-year percentage increase in our capacity for fiscal 2008, 2009, 2010 and 2011, is currently planned to be 5.1%, 9.3%, 11.4% and 6.4% respectively.

 

34


 

Summary of Historical Results of Operations

 

Total revenues increased 17.6% to $6.1 billion from total revenues of $5.2 billion in 2006 primarily due to a 12.3% increase in capacity and a 4.7% increase in Gross Yields. Net Yields increased by approximately 3.3% compared to the same period in 2006. The increase in Net Yields was primarily due to the addition of Pullmantur’s tour business which provides additional revenues without corresponding capacity and, to a lesser extent, a positive pricing environment. The increase in total revenues was offset by an increase in expenses primarily due to the increase in capacity and the acquisition of Pullmantur as well as an increase in interest expense. As a result, our net income was $603.4 million or $2.82 per share on a fully diluted basis in 2007 compared to $633.9 million or $2.94 per share on a fully diluted basis in 2006.

 

Highlights for 2007 included:

 

Total revenues increased 17.6% to $6.1 billion from total revenues of $5.2 billion in 2006 primarily due to a 12.3% increase in capacity and a 4.7% increase in Gross Yields. Net Yields increased by approximately 3.3% compared to the same period in 2006.

 

Net Cruise Costs per APCD increased 6.6% compared to 2006.

 

Our Net Debt-to-Capital ratio decreased to 44.7% in 2007 from 46.6% in 2006. Similarly, our Debt-to-Capital ratio decreased to 45.7% in 2007 from 47.1% in 2006.

 

We issued €1.0 billion, or approximately $1.3 billion, of 5.625% senior unsecured notes due 2014 at a price of 99.638% of par. The net proceeds from the offering were used to retire our unsecured bridge loan facility obtained to finance our acquisition of Pullmantur Cruises and to repay a portion of the outstanding balance on our unsecured revolving credit facility.

 

We took delivery of Liberty of the Seas, Royal Caribbean International’s second Freedom-class ship, which was financed with a $589.0 million unsecured term loan.

 

We placed two additional ship orders, one for Royal Caribbean International and one for Celebrity Cruises, bringing our total number of ships on order to seven for an additional capacity of approximately 25,800 berths.

 

We purchased the 1,000-berth Pacific Star and will take possession of the ship in March 2008 at which time the ship will begin sailing under the name Ocean Dream.

 

We launched a new brand, Azamara Cruises, designed to serve the emerging deluxe cruise segment of the North American cruise market. Blue Dream and Blue Moon were redeployed from Pullmantur Cruises to Azamara Cruises and are sailing under the names Azamara Journey and Azamara Quest, respectively.

 

We redeployed Zenith from Celebrity Cruises to Pullmantur Cruises.

 

We amended and restated our unsecured revolving credit facility to increase the amount available from $1.0 billion to $1.2 billion, reduce the effective interest rate to LIBOR plus 0.485%, change the 0.175% commitment fee to a 0.140% facility fee and extend the maturity date from March 27, 2010 to June 29, 2012.

 

We launched a second new brand, CDF Croisières de France, designed to serve the contemporary segment of the French cruise market with sailings beginning in May 2008. In April 2008, Holiday Dream will be redeployed from Pullmantur Cruises to CDF Croisières de France and will sail under the name Bleu de France.

 

35


 

We reported historical total revenues, operating income, income before cumulative effect of a change in accounting principle, cumulative effect of a change in accounting principle, net income and earnings per share as shown in the following table (in thousands, except per share data):

 

Year Ended December 31,

 

2007

2006

2005

 

 

 

 

Total revenues

$6,149,139

$5,229,584

$4,903,174

 

Operating income

$ 901,335

$858,446

$871,565

Income before cumulative effect of a change in

accounting principle

 

$603,405

 

    $633,922

 

$663,465

Cumulative effect of a change in accounting

principle1

 -

 

        -

52,491

Net income

$603,405

$633,922

$715,956

 

 

 

 

Basic earnings per share:

 

 

 

Income before cumulative effect of a change in

accounting principle

$2.84

$3.01

$3.22

Cumulative effect of a change in accounting

principle1

$      -

$      -

$0.25

Net income

$2.84

$3.01

$3.47

 

 

 

 

Diluted earnings per share:

 

 

 

Income before cumulative effect of a change in

accounting principle

$2.82

$2.94

$3.03

Cumulative effect of a change in accounting

principle1

$      -

$      -

$0.22

Net income

$2.82

$2.94

$3.26

 

1In the third quarter of 2005, we changed our method of accounting for drydocking costs from the accrual in advance to the deferral method (see Note 2. Summary of Significant Accounting Policies to our consolidated financial statements under Item 8. Financial Statements and Supplementary Data.)

 

36


 

The following table presents historical operating data as a percentage of total revenues for the last three years:

 

Year Ended December 31,

 

  2007

  2006

  2005

 

Passenger ticket revenues

72.0

 73.4

73.6

Onboard and other revenues

        28.0

            26.6  

          26.4 

Total revenues

   100.0%

     100.0%

   100.0%

 

Cruise operating expenses

 

 

 

Commissions, transportation and other

 18.3

  17.6

  17.5

Onboard and other

6.6

 6.3

 6.3

Payroll and related

9.5

   9.6

 10.4

Food

5.3

 5.3

 5.5

Fuel

8.9

 9.2

 7.5

Other operating

          16.2  

              14.1  

           13.8

Total cruise operating expenses

         64.8

            62.1

  61.0

Marketing, selling and administrative expenses

 12.7

  13.4

  13.0

Depreciation and amortization expenses

            7.8  

               8.1  

              8.2 

Operating income

 14.7

  16.4

  17.8

Other expense

          (4.9) 

               (4.3)  

            (4.3)

Income before cumulative effect of a change in   accounting principle

 

 9.8

12.1

13.5

Cumulative effect of a change in accounting principle

           -

                -

              1.1  

Net income

              9.8%  

 12.1%   

14.6% 

 

Selected historical statistical information is shown in the following table:

 

 

                  Year Ended December 31,              

 

2007

2006

2005

 

 

 

 

Passengers Carried

3,905,384

3,600,807

3,476,287

Passenger Cruise Days

26,594,515

23,849,606

23,178,560

APCD

25,155,768

22,392,478

21,733,724

Occupancy

105.7%

106.5%

106.6%

 

 

37


 

Gross Yields and Net Yields were calculated as follows (in thousands, except APCD and Yields):

 

             Year Ended December 31,

 

2007

 

2006

 

         2005

 

 

 

 

 

 

Passenger ticket revenues

$4,427,384

 

 $3,838,648

 

   3,609,487   

Onboard and other revenues

1,721,755  

 

1,390,936  

 

    1,293,687  

Total revenues

6,149,139  

 

5,229,584   

 

   4,903,174 

Less:

 

 

Commissions, transportation and other

1,124,022

 

917,929

 

    858,606   

Onboard and other

405,637   

 

331,218  

 

308,611 

Net revenues

$4,619,480   

 

$3,980,437  

 

 $3,735,957   

 

 

 

 

 

 

APCD

25,155,768

 

22,392,478

 

 21,733,724    

Gross Yields

$244.44

 

$233.54

 

 $225.60    

Net Yields

$183.64

 

$177.76

 

 $171.90    


Gross Cruise Costs and Net Cruise Costs were calculated as follows (in thousands, except APCD and costs per APCD):

 

             Year Ended December 31,

 

2007

 

2006

 

2005

 

 

 

 

 

 

Total cruise operating expenses

 $3,981,698

 

$3,249,629

 

 $2,994,232

Marketing, selling and administrative expenses

783,040  

 

699,864  

 

635,308  

Gross Cruise Costs

4,764,738  

 

3,949,493  

 

3,629,540  

Less:

 

 

Commissions, transportation and other

1,124,022

 

917,929

 

         858,606

Onboard and other

405,637  

 

331,218  

 

308,611  

Net Cruise Costs

$3,235,079  

 

$2,700,346  

 

$2,462,323  

 

 

 

 

 

 

APCD

25,155,768

 

22,392,478

 

21,733,724

Gross Cruise Costs per APCD

$189.41

 

$176.38

 

$167.00

Net Cruise Costs per APCD

$128.60

 

$120.59

 

$113.30

 

Net Debt-to-Capital was calculated as follows (in thousands):

  As of December 31,

 

2007

2006   

Long-term debt, net of current portion

$5,346,547

$5,040,322

Current portion of long-term debt

351,725

373,422

Total debt

5,698,272  

5,413,744   

Less: Cash and cash equivalents

  230,784 

   104,520

Net Debt

        $5,467,488 

 $5,309,224 

 

 

 

Total shareholders' equity

$6,757,343  

$6,091,575  

Total debt

5,698,272

5,413,744

Total debt and shareholders' equity

12,455,615

11,505,319

Debt-to-Capital

45.7%  

47.1%  

Net Debt

5,467,488

5,309,224

Net Debt and shareholders' equity

$12,224,831

$11,400,799

Net Debt-to-Capital

44.7%  

46.6%  



38


 

Outlook

 

      On January 30, 2008, we announced the following guidance for the full year and first quarter of 2008:

 

Full Year 2008

 

      We announced that bookings have been better than expected given the current economic conditions. We expected Net Yields to increase approximately 4% compared to 2007.

 

We expected Net Cruise Costs per APCD to increase approximately 2% compared to 2007. Excluding fuel, we expected Net Cruise Costs per APCD to increase in the range of 1% to 2% compared to 2007.

 

We do not forecast fuel prices and our cost outlook for fuel is based on current “at-the-pump” prices including any hedge impacts. If fuel prices for the full year 2008 remain at the level of January 30, 2008, fuel expenses for the full year 2008 would be approximately $595.0 million or $484 per metric ton. For the full year 2008, our fuel expense is 45% hedged and a 10% change in the market price of fuel would result in a change in fuel costs of approximately $35.0 million for the full year 2008, after taking into account existing hedges.

 

We expected a 5.1% increase in capacity in 2008, primarily driven by the addition of Independence of the Seas, which will enter service in May 2008, a full year of Liberty of the Seas, the addition of Pacific Star, which will enter service during the first quarter of 2008 and the addition of Celebrity Solstice, which will enter service in December 2008.

 

Depreciation and amortization expenses were expected to be in the range of $525.0 million to $545.0 million, and interest expense was expected to be in the range of $340.0 million to $360.0 million.

 

Based on the expectations contained in this Outlook section, and assuming that fuel prices remain at the level of the January 30, 2008 “at-the-pump” prices, we expected full year 2008 earnings per share to be in the range of $3.20 to $3.40.

 

First Quarter 2008

 

      As announced on January 30, 2008, we expected Net Yields will increase approximately 7% compared to 2007.

 

We expected Net Cruise Costs per APCD to increase approximately 1% compared to 2007. Excluding fuel, we expected Net Cruise Costs per APCD to decrease in the range of 1% to 2% compared to 2007.

 

We do not forecast fuel prices and our cost outlook for fuel is based on current “at-the-pump” prices including any hedge impacts. If fuel prices for the first quarter of 2008 remain at the level of January 30, 2008, fuel expenses for the first quarter of 2008 would be approximately $145.0 million or $492 per metric ton. For the first quarter of 2008, our fuel expense is 52% hedged and a 10% change in the market price of fuel would result in a change in fuel costs of approximately $8.0 million for the first quarter of 2008, after taking into account existing hedges.

 

We expected an 8.8% increase in capacity, primarily driven by the addition of Liberty of the Seas, which entered service in May 2007.

 

Depreciation and amortization expenses were expected to be in the range of $123.0 million to $128.0 million and interest expense was expected to be in the range of $82.0 million to $87.0 million.

 

Based on the expectations contained in this Outlook section, and assuming that fuel prices remain at the level of the January 30, 2008 “at-the-pump” prices, we expected first quarter 2008 earnings per share to be in the range of $0.30 to $0.35.

 

39


 

Update to Outlook

 

Since our January 30, 2008 announcement, we have evaluated major changes in our operating environment including booking trends, fuel prices, the impact of our fuel supplement and other factors. Based on our evaluation of these factors, our outlook for the year remains substantially unchanged and we continue to expect full year 2008 earnings per share to be in the range of $3.20 to $3.40. Mainly due to a shift in the timing of certain expenses, we now believe first quarter earnings per share will be in the range of  $0.25 to $0.30.

 

Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

 

Revenues

 

Net Revenues increased 16.1% in 2007 compared to 2006 due to a 12.3% increase in capacity and a 3.3% increase in Net Yields. The increase in capacity was primarily attributed to the addition of Pullmantur Cruises’ fleet, the addition of Liberty of the Seas, which entered service in May 2007 and a full year of Freedom of the Seas. This increase was partially offset by the revitalization of Majesty of the Seas during the first quarter of 2007 which was out of service for 28 days and an increase in the number of days ships were in drydock during 2007 as compared to 2006. The increase in Net Yields was primarily due to the addition of Pullmantur’s tour business which provides additional revenues without corresponding capacity and, to a lesser extent, an increase in ticket prices on a per passenger basis. This increase was partially offset by a decrease in onboard revenues primarily due to an expanded cruise season in certain markets and itinerary changes for certain ships where guests spend less onboard our ships. Occupancy in 2007 was 105.7% compared to 106.5% in 2006. Gross Yields increased 4.7% in 2007 compared to 2006, which was a larger percentage increase than Net Yields primarily due to increases in commissions, transportation, other expenses and onboard and other expenses. The increase in commissions, transportation and other expenses was primarily due to Pullmantur Cruise’s higher commission expenses. This increase was also due to increases in these direct costs as a result of an expanded cruise season in certain markets and itinerary changes for certain ships. The increase in onboard and other expenses was primarily due to increases in shore excursions and land-tour packages sold to our guests as a result of an expanded cruise season in certain markets and itinerary changes for certain ships as well as the acquisition of Pullmantur.

 

Onboard and other revenues included concession revenues of $239.3 million and $234.5 million in 2007 and 2006, respectively. The increase in concession revenues was primarily due to the increase in capacity mentioned above.

 

Expenses

 

Net Cruise Costs increased 19.8% in 2007 compared to 2006 due to a 12.3% increase in capacity mentioned above and a 6.6% increase in Net Cruise Costs per APCD. The increase in Net Cruise Costs per APCD was primarily due to increases in other operating expenses. Other operating expenses increased primarily due to the addition of Pullmantur’s tour business which adds costs without corresponding capacity. Gross Cruise Costs increased 20.6% in 2007 compared to 2006, primarily due to the same reasons discussed above for Net Cruise Costs.

 

Depreciation and amortization expenses increased 14.6% in 2007 compared to 2006. The increase was primarily due to the addition of the Pullmantur fleet and the addition of Liberty of the Seas, which entered service in May 2007. The increase was also due to the incremental depreciation as a result of the addition of Freedom of the Seas, which entered service in June 2006, shore side additions and ship improvements.

 

Other Income (Expense)

 

Interest expense, net of interest capitalized, increased to $333.8 million in 2007 from $267.9 million in 2006. Gross interest expense increased to $373.7 million in 2007 from $295.7 million in 2006. The increase was primarily due to a higher average debt level. Interest capitalized increased to $39.9 million in 2007 from $27.8 million in 2006 primarily due to a higher average level of investment in ships under construction. These amounts are recorded in interest expense, net of interest capitalized.

 

40


 

Other income decreased to $15.8 million in 2007 from $28.1 million in 2006. The decrease was primarily due to a $36.0 million gain on the settlement of a lawsuit in 2006 that did not recur in 2007, partially offset by a gain of $23.1 million related to certain derivative instruments associated with our ship construction firm commitments denominated in euros that did not qualify for hedge accounting treatment.

 

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

 

Revenues

 

Net Revenues increased 6.5% in 2006 compared to 2005 due to a 3.4% increase in Net Yields and a 3.0% increase in capacity. The increase in Net Yields was primarily due to higher cruise ticket prices, onboard spending and revenue associated with the charter of Horizon to Island Cruises, our joint venture with TUI Travel. Higher cruise ticket prices were primarily attributable to a strong demand environment. The increase in capacity was primarily attributed to the addition of Freedom of the Seas in 2006 and the lengthening of Enchantment of the Seas in 2005. This increase was partially offset by the charter of Horizon to Island Cruises. Occupancy in 2006 was 106.5% compared to 106.6% in 2005. Gross Yields increased 3.5% in 2006 compared to 2005 primarily due to the same reasons discussed above for Net Yields.

 

Onboard and other revenues included concession revenues of $234.5 million and $223.0 million in 2006 and 2005, respectively. The increase in concession revenues was primarily due to the increase in capacity mentioned above and higher amounts spent per passenger onboard.

 

Expenses

 

Net Cruise Costs increased 9.7% in 2006 compared to 2005 due to a 6.4% increase in Net Cruise Costs per APCD and the 3.0% increase in capacity mentioned above. Approximately 4.0 percentage points of the increase in Net Cruise Costs per APCD were attributed to increases in fuel expenses. Total fuel expenses (net of the financial impact of fuel swap agreements) increased 28.2% per metric ton in 2006 as compared to an increase of 46.0% per metric ton in 2005. As a percentage of total revenues, fuel expenses were 9.2% and 7.5% in 2006 and 2005, respectively. The remaining 2.4 percentage points of the increase in Net Cruise Costs per APCD were primarily attributed to increases in marketing, selling and administrative expenses associated with personnel costs. Gross Cruise Costs increased 8.8% in 2006 compared to 2005, which was a lower percentage increase than Net Cruise Costs primarily due to lower trip insurance expenses a result of lower trip insurance premiums and lower commission expenses as a result of an increase in direct business.

 

Depreciation and amortization expenses increased 4.9% in 2006 compared to 2005. The increase was primarily due to the addition of Freedom of the Seas, ship improvements and shore side additions.

 

Other Income (Expense)

 

Gross interest expense increased to $295.7 million in 2006 from $287.4 million in 2005. The increase was primarily attributable to higher interest rates, partially offset by lower average debt levels. Interest capitalized increased to $27.8 million in 2006 from $17.7 million in 2005 primarily due to a higher average level of investment in ships under construction.

 

During 2006, we partially settled a pending lawsuit against Rolls Royce and Alstom Power Conversion, co-producers of the mermaid pod-propulsion system on Millennium-class ships, for the recurring Mermaid pod failures. Under the terms of the partial settlement, we received $38.0 million from Alstom and released them from the suit, which remains pending against Rolls Royce. The $38.0 million settlement resulted in a gain of $36.0 million, net of reimbursements to insurance companies.

 

In July 2005, TUI Travel redeemed in full its 6.75% convertible preferred shares. We received $348.1 million in cash, resulting in a net gain of $44.2 million, primarily due to foreign exchange.

 

Dividend income decreased approximately $14.2 million for 2006 compared to 2005 due to the redemption of our TUI Travel investment in the third quarter of 2005.

 

41


 

Cumulative Effect of a Change in Accounting Principle

 

In the third quarter of 2005, we changed our method of accounting for drydocking costs from the accrual in advance to the deferral method (see Note 2. Summary of Significant Accounting Policies to our consolidated financial statements under Item 8. Financial Statements and Supplementary Data). The change resulted in a one-time gain of $52.5 million, or $0.22 per share on a diluted basis, to recognize the cumulative effect of the change on prior years, which we reflected as part of our results in 2005. Other than this one-time gain, the change did not have a material impact on our consolidated statements of operations.

 

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 was $1.3 billion in 2007 and $948.5 million in 2006. The increase was primarily a result of an increase in customer deposits of $184.7 million and an increase in accrued expenses and other liabilities of $150.2 million. The increase in customer deposits was primarily due to incremental deposits received for our recently acquired and soon to be delivered ships. This increase was also due to higher ticket prices and the timing of scheduled drydocks as compared to 2006. The increase in accrued expenses and other liabilities was due to the timing of payments of interest and other short-term liabilities. The increase in net cash provided by operating activities was also due to $121.2 million in payments of accreted interest on the LYONs repurchase in 2006 that did not recur in 2007.

 

Net cash used in investing activities decreased to $1.2 billion in 2007 from $1.8 billion in 2006. The decrease was primarily due to $553.3 million related to the purchase of Pullmantur, net of cash acquired, during 2006 that did not recur in 2007. The decrease was also due to the purchase of $100.0 million of notes from TUI Travel during 2006 which were repaid in 2007. The decrease was partially offset by an increase in capital expenditures which were $1.3 billion in 2007, compared to $1.2 billion in 2006. Capital expenditures were primarily related to the purchase of Pacific Star, the deliveries of Liberty of the Seas in 2007 and Freedom of the Seas in 2006 as well as progress payments for ships under construction in both years.

 

Net cash provided by financing activities was $36.6 million in 2007 compared to $879.7 million in 2006. The decrease was primarily due to a decrease in proceeds from debt issuances of $998.9 million and an increase in repayments of debt of $20.0 million. The decrease was also partially offset by $164.6 million of treasury stock purchased during 2006 that did not recur in 2007. During 2007, we received net proceeds of €990.9 million, or $1.3 billion, from a bond offering consisting of €1.0 billion, or $1.3 billion, of 5.625% senior unsecured notes due 2014. In addition, we received $589.0 million through an unsecured term loan due through 2014 to purchase Liberty of the Seas and drew $50.0 million on our unsecured revolving credit facility. During 2007, we made debt repayments on various loan facilities and capital leases, including a payment of $906.5 million to retire the €701.0 million outstanding balance on our unsecured bridge loan facility. In addition, we made $465.0 million in payments towards our unsecured revolving credit facility, a payment of $200.0 million to retire our 7% unsecured senior notes due 2007, and a payment of $61.2 million to repay term loans secured by two Celebrity ships. During 2007 and 2006 we received $19.6 million and $23.0 million, respectively, in connection with the exercise of common stock options and we paid cash dividends on our common stock of $98.3 million and $124.5 million, respectively. Net Debt-to-Capital decreased to 44.7% in 2007 compared to 46.6% in 2006. Similarly, our Debt-to-Capital ratio decreased to 45.7% in 2007 from 47.1% in 2006.

 

Interest capitalized during 2007 increased to $39.9 million from $27.8 million in 2006 primarily due to a higher average level of investment in ships under construction.

 

Future Capital Commitments

 

Our future capital commitments consist primarily of new ship orders. As of December 31, 2007, we had one Freedom-class ship and two ships of a new Project Genesis class designated for Royal Caribbean International and four Solstice-class ships, designated for Celebrity Cruises, on order for an aggregate additional capacity of approximately 25,800 berths. The aggregate cost of the seven ships is approximately $7.0 billion, of which we have deposited $499.6 million as of December 31, 2007. Approximately 7.7% of the aggregate cost of ships was exposed to fluctuations in the euro exchange rate at December 31, 2007. (See Note 13. Fair Value of Financial Instruments to our consolidated financial statements under Item 8. Financial Statements and Supplementary Data).

 

42


 

As of December 31, 2007 we anticipated overall capital expenditures, including the seven ships on order, will be approximately $1.9 billion for 2008, $2.0 billion for 2009, $2.2 billion for 2010, and $1.0 billion for 2011.

 

Recently we reached an agreement with Meyer Werft to build a fifth Solstice-class ship for Celebrity Cruises, subject to certain conditions, for an additional capacity of approximately 2,850 berths, expected to enter service in the fourth quarter of 2012. Based on current exchange rates, we estimate the all-in cost of this ship will be approximately $320,000 per berth. This amount is not included in the anticipated overall capital expenditures reflected above.

 

Contractual Obligations and Off-Balance Sheet Arrangements

 

As of December 31, 2007, our contractual obligations were as follows (in thousands):

 

 

                                            Payments due by period                                            

 

Less than 1

   1-3

 3-5   

More than 5

 

Total

 year

years

years

   years

Long-term debt obligations(1)

    $5,645,940

 $348,402

 $1,044,574

 $929,375

 $3,323,589

Capital lease obligations(1)

52,332

3,323

6,344

3,747

38,918

Operating lease obligations(2)(3)

545,747

67,042

112,938

329,540

36,227

Ship purchase obligations(4)

5,571,652

1,490,376

3,407,191

674,085

Other(5)

   630,440

123,722 

139,601  

 136,869

230,248 

Total

$12,446,111

$2,032,865

$4,710,648

$2,073,616

$3,628,982

(1)

Amounts exclude interest.

 

(2)

We are obligated under noncancelable operating leases primarily for a ship, offices, warehouses and motor vehicles.

(3)

Under the Brilliance of the Seas lease agreement, we may be required to make a termination payment of approximately £126.0 million, or approximately $250.3 million, based on the exchange rate at December 31, 2007, if the lease is canceled in 2012. This amount is included in the three to five years category. (See Note 14. Commitments and Contingencies to our consolidated financial statements under Item 8. Financial Statements and Supplementary Data.)

(4)

Amounts represent contractual obligations with initial terms in excess of one year.

(5)

Amounts 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.

 

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. 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.

 

Under the Brilliance of the Seas operating lease, we have agreed to indemnify the lessor to the extent its after-tax return is negatively impacted by unfavorable changes in corporate tax rates, capital allowance deductions and certain unfavorable determinations which may be made by United Kingdom tax authorities. These indemnifications could result in an increase in our lease payments. We are unable to estimate the maximum potential increase in our lease payments due to the various circumstances, timing or a combination of events that could trigger such indemnifications. Under current circumstances we do not believe an indemnification in any material amount is probable.

 

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

 

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 Sources

 

As of December 31, 2007, our liquidity was $1.4 billion consisting of approximately $0.2 billion in cash and cash equivalents and $1.2 billion available under our unsecured revolving credit facility. (See Note 6. Long-Term Debt to our consolidated financial statements under Item 8. Financial Statements and Supplementary Data.) We have contractual obligations of approximately $2.0 billion due during the twelve-month period ending December 31, 2008. We anticipate these contractual obligations could be funded through a combination of cash

 

43


 

flows from operations, drawdowns under our available unsecured revolving credit facility, the incurrence of additional indebtedness and the sales of equity or debt securities in private or public securities markets. Although we believe our existing unsecured revolving credit facility, cash flows from operations, our ability to obtain new borrowings and/or raise new capital or a combination of these sources will be sufficient to fund operations, debt payment requirements, capital expenditures and other commitments over the next twelve-month period, there can be no assurances that these sources of cash will be available in accordance with our expectations.

 

Our financing agreements contain covenants that require us, among other things, to maintain minimum net worth, fixed charge coverage ratio and limit our net debt-to-capital ratio. We were in compliance with all covenants as of December 31, 2007.

 

If any person other than A. Wilhelmsen AS. and Cruise Associates, our two principal shareholders, acquires ownership of more than 30% of our common stock and our two principal shareholders, in the aggregate, own less of our common stock than such person and do not collectively have the right to elect, or to designate for election, at least a majority of the board of directors, we may be obligated to prepay indebtedness outstanding under the majority of our credit facilities, which we may be unable to replace on similar terms. If this were to occur, it could have an adverse impact on our liquidity and operations.

 

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

Financial Instruments and Other

 

General

 

We are exposed to market risk attributable to changes in interest rates, foreign currency exchange rates and fuel prices. We manage these risks through a combination of our normal operating and financing activities and through the use of derivative financial instruments pursuant to our hedging practices and policies. The financial impacts of these hedging instruments are primarily offset by corresponding changes in the underlying exposures being hedged. We achieve this by closely matching the amount, term and conditions of the derivative instrument with the underlying risk being hedged. We do not hold or issue derivative financial instruments for trading or other speculative purposes. We monitor our derivative positions using techniques including market valuations and sensitivity analyses. (See Note 13. Fair Value of Financial Instruments to our consolidated financial statements under Item 8. Financial Statements and Supplementary Data.)

 

Interest Rate Risk

 

Our exposure to market risk for changes in interest rates relates to our long-term debt obligations and our operating lease for Brilliance of the Seas. At December 31, 2007, 58% of our long-term debt was effectively fixed and 42% was floating. We enter into interest rate swap agreements to modify our exposure to interest rate movements and to manage our interest expense and rent expense.

 

Market risk associated with our long-term fixed rate debt is the potential increase in fair value resulting from a decrease in interest rates. At December 31, 2007, our interest rate swap agreements effectively changed $350.0 million of fixed rate debt with a weighted-average fixed rate of 7.25% to LIBOR-based floating rate debt, and €1.0 billion of fixed rate debt with a weighted-average fixed rate of 5.625% to EURIBOR-based floating rate debt. We have cross currency swap agreements that effectively change €300.0 million of the €1.0 billion floating EURIBOR-based debt to floating LIBOR-based debt. (See Foreign Currency Exchange Rate Risk for further information). The estimated fair value of our long-term fixed rate debt at December 31, 2007, was $5.0 billion using quoted market prices, where available, or using the present value of expected future cash flows. The fair value of our associated interest rate swap agreements was estimated to be an asset of $23.4 million as of December 31, 2007 based on the present value of expected future cash flows. A hypothetical one percentage point decrease in interest rates at December 31, 2007 would increase the fair value of our long-term fixed rate debt, by approximately $99.5 million, net of an increase in the fair value of the associated interest rate swap agreements.

 

Market risk associated with our long-term floating rate debt is the potential increase in interest expense from an increase in interest rates. A hypothetical one percentage point increase in interest rates would increase our 2008 interest expense by approximately $19.3 million, assuming no change in exchange rates.

 

Market risk associated with our operating lease for Brilliance of the Seas is the potential increase in rent expense from an increase in sterling LIBOR rates. As of January 2008, we have effectively changed 50% of the operating lease obligation from a floating rate to a fixed rate obligation with a weighted-average rate of 4.76% through rate fixings with the lessor. A hypothetical one percentage point increase in sterling LIBOR rates would increase our 2008 rent expense by approximately $2.2 million, based on the exchange rate at December 31, 2007.

 

Foreign Currency Exchange Rate Risk

 

Our primary exposure to foreign currency exchange rate risk relates to our ship construction firm commitments denominated in euros. We enter into euro-denominated forward contracts to manage this risk. The estimated fair value of such euro-denominated forward contracts at December 31, 2007, was a net unrealized gain of approximately $413.7 million, based on the present value of expected future cash flows. At December 31, 2007, approximately 7.7% of the aggregate cost of the ships was exposed to fluctuations in the euro exchange rate. A hypothetical 10% strengthening of the euro as of December 31, 2007, assuming no changes in comparative interest rates, would result in a $620.3 million increase in the United States dollar cost of the foreign currency denominated ship construction contracts. This increase would be largely offset by an increase in the fair value of our euro-denominated forward contracts.

 

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As discussed above, we have cross currency swap agreements that effectively change €300.0 million of floating EURIBOR-based debt to $389.1 million of floating LIBOR-based debt at December 31, 2007. (See Interest Rate Risk for further information). The estimated fair value of these cross currency swap agreements at December 31, 2007, was an asset of approximately $54.0 million based on the present value of expected future cash flows. A hypothetical 10% strengthening of the euro as of December 31, 2007, assuming no changes in comparative interest rates, would result in an increase in the fair value of the €300.0 million of floating EURIBOR-based debt by $43.8 million, offset by an increase in the fair value of the cross currency swap agreements of $44.7 million.

 

Also, we consider our investments in foreign subsidiaries to be denominated in relatively stable currencies and of a long-term nature. We partially address the exposure of our investments in foreign subsidiaries by denominating a portion of our debt in our subsidiaries’ functional currencies (generally euros). Specifically, we have assigned debt of approximately €466.0 million, or approximately $679.9 million, as a hedge of our net investment in Pullmantur and, accordingly, have included approximately $64.0 million of foreign-currency transaction losses in the foreign currency translation adjustment component of accumulated other comprehensive income (loss) at December 31, 2007. A hypothetical 10% increase or decrease in the December 31, 2007 foreign currency exchange rate would increase or decrease the fair value of our assigned debt by $68.0 million, which would be offset by a corresponding decrease or increase in the U.S. dollar value of our net investment.

 

Fuel Price Risk

 

Our exposure to market risk for changes in fuel prices relates to the consumption of fuel on our ships. Fuel cost (net of the financial impact of fuel swap agreements), as a percentage of our total revenues, was approximately 8.9% in 2007, 9.2% in 2006 and 7.5% in 2005. We use fuel swap agreements to mitigate the financial impact of fluctuations in fuel prices. As of December 31, 2007, we had fuel swap agreements to pay fixed prices for fuel with an aggregate notional amount of approximately $223.9 million, maturing through 2009. The estimated fair value of these contracts at December 31, 2007 was an unrealized gain of $68.6 million. We estimate that a hypothetical 10% increase in our weighted-average fuel price from that experienced during the year ended December 31, 2007 would increase our 2008 fuel cost by approximately $57.4 million. This increase would be partially offset by an increase in the fair value of our fuel swap agreements maturing in 2008 of approximately $20.8 million.

 

Item 8. Financial Statements and Supplementary Data

 

Our Consolidated Financial Statements and Quarterly Selected Financial Data are included beginning on page F-1 of this report.

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None.

 

Item 9A. Controls a