Comprehensive income includes net income and changes in the fair value of derivative instruments that qualify as cash flow hedges. The cumulative changes in fair value of the derivatives are deferred and recorded as a component of accumulated other comprehensive income until the hedged transactions are realized and recognized in earnings. Comprehensive income was as follows (in thousands):
In August 2006, we announced an agreement to acquire all of the capital stock of Pullmantur S.A. (“Pullmantur”), a Madrid-based cruise and tour operator with five ships operating in Europe and Latin America. We have signed an agreement to buy all of Pullmantur’s capital stock for approximately € 430 million or approximately $559 million and have agreed to repay or refinance Pullmantur’s debt which, as of September 30, 2006, was approximately €270 million or approximately $351 million. We have committed to a bridge facility to finance the purchase price and the debt repayment or refinancing. On October 31, 2006, we announced receipt of antitrust approvals from Spain and Portugal on our acquisition of Pullmantur. The consummation of this acquisition is expected in mid-November 2006.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 the following:
• general economic and business conditions,
• vacation industry competition, including cruise vacation industry competition,
• changes in vacation industry capacity, including over capacity in the cruise vacation industry,
• 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,
• 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,
16
• the implementation of regulations in the United States requiring United States citizens to obtain passports for travel to additional foreign destinations, and
• 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.
This report should be read in conjunction with our annual report on Form 10-K for the year ended December 31, 2005.
Terminology and 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 (“Capital”). 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.
Net Yields represent Gross Yields less commissions, transportation and other expenses and onboard and other expenses (each of which is described below under the Overview heading) per APCD. We utilize Net Yields to manage our business on a day-to-day basis and 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. A reconciliation of historical 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.
17
Passenger Cruise Days represent the number of passengers carried for the period multiplied by the number of days of their respective cruises.
Overview
Our revenues consist of the following:
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, cancellation fees, sales of vacation protection insurance and pre and post tours. 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.
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 tours and related credit card fees. Concession revenues have minimal costs associated with them, as the costs related to these activities are incurred by the 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 delivery costs, net of the financial impact of fuel swap agreements.
Other operating expenses consist of operating costs such as repairs and maintenance, port costs that do not vary with passenger head counts, insurance, entertainment and all other operating costs.
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.
Recent Developments
In August 2006, we announced an agreement to acquire all of the capital stock of Pullmantur S.A. (“Pullmantur”), a Madrid-based cruise and tour operator with five ships operating in Europe and Latin America. We have signed an agreement to buy all of Pullmantur’s capital stock for approximately €430 million or approximately $559 million and have agreed to repay or refinance Pullmantur’s debt which, as of September 30, 2006, was approximately €270 million or approximately $351 million. We have committed to a bridge facility to finance the purchase price and the debt repayment or refinancing. On October 31, 2006, we announced receipt of antitrust approvals from Spain and Portugal on our acquisition of Pullmantur. The consummation of this acquisition is expected in mid-November 2006.
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Summary of Historical Results of Operations
Our demand environment remained positive during the third quarter of 2006 allowing us to achieve improved pricing for our products compared to prior year. This trend allowed us to achieve a 2.7% increase in Net Yields for the third quarter of 2006 compared to the same period in 2005. This increase in Net Yields was partially offset by increases in fuel expenses, ships refurbishment and marketing, selling and administrative expenses. In addition, third quarter of 2005 included a net gain of $44.2 million related to the redemption of our investment in First Choice. As a result, net income was $345.4 million or $1.63 per share on a diluted basis for the third quarter of 2006 compared to $374.7 million or $1.64 per share for the third quarter of 2005.
Highlights for the third quarter include:
| • | Total revenues for the third quarter of 2006 increased by approximately 9.0 % to $1.6 billion from total revenues of $ 1.5 billion for the same period in 2005 primarily due to a 3.8% increase in Gross Yields and a 5.0% increase in capacity. |
| • | Net Cruise Costs per APCD increased 4.5% in the third quarter of 2006 compared to the same period in 2005 primarily as a result of an increase in fuel and ship refurbishment expenses. |
| • | While we continue our efforts to mitigate increases in fuel costs, fuel expenses on an APCD basis increased by 21.4% during the third quarter of 2006 as compared to the same period in 2005. |
| • | Net Debt-to-Capital decreased to 41.2% as of September 30, 2006 as compared to 41.6% as of September 30, 2005. |
| • | We called for redemption all of our outstanding zero coupon convertible notes due May 18, 2021. The redemption period ended in October 2006 at a redemption price of $503.85 per note. Most holders of the notes elected to convert them into shares of our common stock, rather than redeem them for cash, resulting in the issuance of approximately 2.9 million shares through September 30, 2006 and approximately 1.2 million shares through the end of the redemption period for a total of approximately 4.1 million shares. |
| • | We placed an additional ship order, bringing our total number of ships on order to six for an additional capacity of approximately 21,150 berths. |
Our revenues are seasonal based on the demand for cruises. Demand is strongest for cruises during the summer months and holidays.
19
The following table presents historical operating data as a percentage of total revenues:
| Quarter Ended | Nine Months Ended |
| September 30, | September 30, |
|
|
|
| 2006 | 2005 | 2006 | 2005 |
|
|
|
|
|
| | | | |
Passenger ticket revenues | 74.0 | 73.9 | 73.8 | 74.1 |
Onboard and other revenues | 26.0 | 26.1 | 26.2 | 25.9 |
|
|
|
|
|
Total revenues | 100.0% | 100.0% | 100.0% | 100.0% |
| | | | |
Cruise operating expenses | | | | |
Commissions, transportation and other | 17.7 | 16.9 | 17.7 | 17.5 |
Onboard and other | 7.5 | 7.5 | 6.6 | 6.6 |
Payroll and related | 7.9 | 8.6 | 9.1 | 9.9 |
Food | 4.6 | 4.7 | 5.1 | 5.3 |
Fuel | 7.7 | 6.6 | 8.8 | 6.6 |
Other operating | 12.3 | 11.9 | 14.0 | 13.2 |
|
|
|
|
|
Total cruise operating expenses | 57.7 | 56.2 | 61.3 | 59.1 |
Marketing, selling and administrative expenses | 10.0 | 10.4 | 12.7 | 12.0 |
Depreciation and amortization expenses | 6.7 | 6.7 | 7.7 | 7.8 |
|
|
|
|
|
Operating income | 25.6 | 26.7 | 18.3 | 21.1 |
Other income (expense) | (4.5) | (1.8) | (3.9) | (3.9) |
|
|
|
|
|
Income before cumulative effect of a change in accounting principle | 21.1 | 24.9 | 14.4 | 17.2 |
Cumulative effect of a change in accounting principle | - | - | - | 1.4 |
|
|
|
|
|
Net income | 21.1% | 24.9% | 14.4% | 18.6% |
|
|
|
|
|
Selected historical statistical information is shown in the following table:
| Quarter Ended | Nine Months Ended |
| September 30, | September 30, |
|
|
|
| 2006 | 2005 | 2006 | 2005 |
|
|
|
|
|
Passengers Carried | 957,019 | 910,635 | 2,698,770 | 2,609,991 |
Passenger Cruise Days | 6,428,544 | 6,109,222 | 17,749,885 | 17,546,794 |
APCD | 5,865,782 | 5,588,596 | 16,543,430 | 16,347,308 |
Occupancy | 109.6% | 109.3% | 107.3% | 107.3% |
| | | | | |
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Gross Yields and Net Yields were calculated as follows (in thousands, except APCD and Yields):
| Quarter Ended | Nine Months Ended |
| September 30, | September 30, |
|
|
|
| 2006 | 2005 | 2006 | 2005 |
|
|
|
|
|
Passenger ticket revenues | $1,211,758 | $1,110,394 | $3,006,928 | $ 2,871,018 |
Onboard and other revenues | 425,093 | 391,821 | 1,069,443 | 1,002,516 |
|
|
|
|
|
Total revenues | 1,636,851 | 1,502,215 | 4,076,371 | 3,873,534 |
|
|
|
|
|
Less: | | | | |
Commissions, transportation and other | 289,462 | 253,496 | 720,460 | 679,167 |
Onboard and other | 123,167 | 113,230 | 267,945 | 254,373 |
|
|
|
|
|
Net revenues | $1,224,222 | $1,135,489 | $3,087,966 | $2,939,994 |
|
|
|
|
|
| | | | |
APCD | 5,865,782 | 5,588,596 | 16,543,430 | 16,347,308 |
Gross Yields | $ 279.05 | $ 268.80 | $ 246.40 | $ 236.95 |
Net Yields | $ 208.71 | $ 203.18 | $ 186.66 | $ 179.85 |
Gross Cruise Costs and Net Cruise Costs were calculated as follows (in thousands, except APCD and costs per APCD):
| Quarter Ended | Nine Months Ended |
| September 30, | September 30, |
|
|
|
| 2006 | 2005 | 2006 | 2005 |
|
|
|
|
|
Total cruise operating expenses | $944,166 | $844,632 | $2,499,273 | $2,290,409 |
Marketing, selling and administrative expenses | 163,745 | 156,107 | 518,681 | 466,599 |
|
|
|
|
|
Gross Cruise Costs | 1,107,911 | 1,000,739 | 3,017,954 | 2,757,008 |
|
|
|
|
|
Less: | | | | |
Commissions, transportation and other | 289,462 | 253,496 | 720,460 | 679,167 |
Onboard and other | 123,167 | 113,230 | 267,945 | 254,373 |
|
|
|
|
|
Net Cruise Costs | $695,282 | $634,013 | $2,029,549 | $1,823,468 |
|
|
|
|
|
| | | | |
APCD | 5,865,782 | 5,588,596 | 16,543,430 | 16,347,308 |
Gross Cruise Costs per APCD | $ 188.88 | $ 179.07 | $ 182.43 | $ 168.65 |
Net Cruise Costs per APCD | $ 118.53 | $ 113.45 | $ 122.68 | $ 111.55 |
Net Debt-to-Capital was calculated as follows (in thousands):
| | As of |
| | September 30, |
|
|
| 2006 | 2005 |
|
|
|
Long-term debt | 4,181,502 | 3,594,102 |
Current portion of long-term debt | 268,638 | 559,285 |
|
|
|
Total long-term debt | 4,450,140 | 4,153,387 |
Less: Cash and cash equivalents | 220,538 | 189,206 |
|
|
|
Net Debt | 4,229,602 | 3,964,181 |
|
|
|
| | |
Total shareholders' equity | 6,043,134 | 5,571,139 |
Net Debt | 4,229,602 | 3,964,181 |
|
|
|
Net Debt and Capital | 10,272,736 | 9,535,320 |
|
|
|
Net Debt-to-Capital | 41.2% | 41.6% |
| | | |
21
Outlook
Full Year 2006
We expect Net Yields for the full year 2006 will increase in the range of 3% to 4% compared to 2005, which is consistent with our previous guidance.
We estimate that Net Cruise Costs per APCD for 2006 will increase approximately 6% as compared to the prior year. Higher fuel costs account for approximately 3.9 percentage points of this increase. Our current “at-the-pump” fuel price is $388 per metric ton. If fuel prices for the rest of the year remain at today’s level, the company estimates that its 2006 fuel costs (net of hedging and fuel savings initiatives) will be approximately $110 million higher than the prior year.
Depreciation and amortization is expected to be in the range of $420 to $425 million and net interest expense is expected to be in the range of $265 to $270 million.
Based upon the expectations and assumptions contained in this outlook section (including Pullmantur), we expect full year 2006 earnings per share to be in the range of $2.90 to $2.95.
Fourth Quarter 2006
We expect Net Yields for the fourth quarter of 2006 will show year over year increases consistent with those seen in the third quarter.
We estimate that Net Cruise Costs per APCD for the fourth quarter of 2006 will decrease approximately 4% compared to the same quarter in 2005, driven mainly by the timing of drydock and marketing expenses. Our current “at-the-pump” fuel price is $388 per metric ton. If fuel prices for the rest of the quarter remain at today’s level, we estimate that our fourth quarter 2006 fuel costs (net of hedging and fuel savings initiatives) will increase approximately $5 million.
Based upon the expectations and assumptions contained in this outlook section (including Pullmantur), we expect fourth quarter earnings per share to be in the range of $0.20 to $0.25.
Quarter Ended September 30, 2006 Compared to Quarter Ended September 30, 2005
Revenues
Net revenues increased 7.8% in 2006 compared to the same period in 2005 primarily due to a 2.7% increase in Net Yields and a 5.0% increase in capacity. The increase in Net Yields was primarily due to increases in ticket prices on a per passenger basis. The increase in capacity was primarily due to the addition of Freedom of the Seas in the second quarter of 2006 and the additional capacity from the lengthening of Enchantment of the Seas in 2005. This increase was partially offset by the charter of Horizon to Island Cruises, our joint venture with First Choice Holidays PLC (“First Choice”), in October of 2005. Occupancy in 2006 was 109.6% and in 2005 was 109.3%. Gross Yields increased 3.8 % in 2006 compared to 2005 primarily due to the same reasons discussed above.
Concession revenues, included within onboard and other revenues, increased to $62.9 million in 2006 compared to $57.9 million in 2005, primarily due to the addition of the Freedom of the Seas.
22
Expenses
Net Cruise Costs increased 9.7% in 2006 compared to the same period in 2005 due to a 4.5% increase in Net Cruise Costs per APCD and a 5.0% increase in capacity. Approximately 3.3 percentage points of the increase in Net Cruise Costs per APCD was attributed to increases in fuel expenses. Total fuel expenses (net of the financial impact of fuel swap agreements) for 2006 increased 22.3% per metric ton. As a percentage of total revenues, fuel expenses were 7.7 % and 6.6 % in 2006 and 2005, respectively. The remaining percentage points of the increase in Net Cruise Costs per APCD were primarily attributed to increases in other operating expenses. Other operating expenses increased primarily due to ship refurbishment expenses, unscheduled drydocks and costs related to a cancelled sailing in the third quarter of 2006 as compared to the same period in 2005. Gross Cruise Costs increased 10.7% in 2006 compared to the same period in 2005, which was a larger percentage increase than Net Cruise Costs primarily due to an increase in average air costs and a higher proportion of passengers who purchased air transportation from us in the third quarter of 2006.
Depreciation and amortization expenses increased 8.2% in 2006 compared to the same period in 2005. The increase was primarily due to the addition of the Freedom of the Seas and ship improvements.
Other Income (Expense)
In July 2005, First Choice 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.
Gross interest expense increased to $ 77.8 million in 2006 from $69.8 million for the same period in 2005. The increase was primarily attributable to higher interest rates as well as a higher average debt level. Interest capitalized during 2006 increased to $6.0 million from $4.5 million during the same period in 2005 primarily due to a higher average level of investment in ships under construction.
Dividend income decreased approximately $1.7 million for 2006 compared to the same period in 2005 due to the redemption of our First Choice investment in the third quarter of 2005.
Nine Months Ended September 30, 2006 Compared to Nine Months Ended September 30, 2005
Revenues
Net revenues increased 5.0% in 2006 compared to the same period in 2005 primarily due to a 3.8% increase in Net Yields and a 1.2% increase in capacity. The increase in Net Yields was primarily due to increases in ticket prices on a per passenger basis. The increase in capacity was primarily due to the addition of Freedom of the Seas in the second quarter of 2006 and the additional capacity from the lengthening of Enchantment of the Seas in 2005. This increase was partially offset by the charter of Horizon to Island Cruises, our joint venture with First Choice Holidays PLC (“First Choice”), in October of 2005, and the revitalization of Century, which was out of service for 30 days during the nine-month period ended September 30, 2006. Occupancy was 107.3% in 2006 and in 2005. Gross Yields increased 4.0% in 2006 compared to 2005 primarily due to the same reasons discussed above for Net Yields.
Concession revenues, included within onboard and other revenues, increased to $171.4 million in 2006 as compared to $161.9 million in 2005, primarily due to the addition of the Freedom of the Seas.
23
Expenses
Net Cruise Costs increased 11.3% in 2006 compared to the same period in 2005 due to a 10.0% increase in Net Cruise Costs per APCD and a 1.2% increase in capacity. Approximately 5.4 percentage points of the increase in Net Cruise Costs per APCD was attributed to increases in fuel costs as compared to the same period in 2005. Total fuel expenses (net of the financial impact of fuel swap agreements) for 2006 increased 39.8% per metric ton. As a percentage of total revenues, fuel costs were 8.8% and 6.6% in 2006 and 2005, respectively. The remaining percentage points of the increase in Net Cruise Costs per APCD were primarily attributed to increases in other operating expenses and marketing, selling and administrative expenses. Other operating expenses increased primarily due to ship refurbishment expenses and expenses associated with the revitalization of Century. Ship refurbishment expenses increased due to unscheduled drydocks during the nine month period ended September 30, 2006 as compared to the same period in 2005. Marketing, selling and administrative expenses increased primarily due to inflationary and other cost pressures. Gross Cruise Costs increased 9.5% in 2006 compared to the same period in 2005, which was a lower percentage increase than Net Cruise Costs primarily due to lower commission expenses as a result of an increase in direct business.
Depreciation and amortization expenses increased 4.2% in 2006 compared to the same period in 2005. The increase was primarily due to the addition of the Freedom of the Seas, ship improvements and shore-side additions.
Other Income (Expense)
In July 2005, First Choice 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.
Gross interest expense decreased to $ 215.5 million in 2006 from $ 221.1 million for the same period in 2005. The decrease was primarily attributable to a lower average debt level, partially offset by higher interest rates. Interest capitalized during 2006 increased to $ 19.3 million from $11.8 million during the same period in 2005 primarily due to a higher average level of investment in ships under construction.
In January 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 million from Alstom and released them from the suit, which remains pending against Rolls Royce. The $38 million settlement resulted in a gain of $36 million, net of reimbursements to insurance companies.
Dividend income decreased approximately $14.2 million for 2006 compared to the same period in 2005 due to the redemption of our First Choice investment in the third quarter of 2005.
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. 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 for the nine month period ended September 30, 2005.
24
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 $908.0 million for the first nine months of 2006 compared to $983.8 million for the same period in 2005. The decrease was primarily due to the payment of $121.2 million of accreted interest in connection with the repurchase of our LYONs partially offset by an increase in customer deposits and accrued expenses and other liabilities.
Net cash used in investing activities was $1.1 billion for the first nine months of 2006 compared to net cash provided by investing activities of $23.1 million for the same period in 2005. The change was primarily due to an increase in capital expenditures and the purchase of $100.0 million of notes from First Choice. Our capital expenditures increased to approximately $1.0 billion in the first nine months of 2006 from $320.6 million for the same period in 2005, primarily due to the delivery of Freedom of the Seas and ships under construction. Capital expenditures for the first nine months of 2005 were primarily related to ships under construction. In addition, we received $348.1 million in cash from the redemption of our investment in First Choice during the first nine months of 2005.
Net cash provided by financing activities was $319.8 million in the first nine months of 2006 compared to net cash used in financing activities of $1.4 billion for the same period in 2005. The change was primarily due to an increase in net proceeds from debt issuances. During the first nine months of 2006, we received net proceeds of approximately $890.5 million from a public offering consisting of $550.0 million of 7.0% senior unsecured notes due 2013, and $350.0 million of 7.25% senior unsecured notes due 2016. In addition, we drew the full amount of a 7-year, $570 million unsecured term loan due through 2013 and drew $340 million on our revolving credit facility. During the first nine months of 2006, we made debt repayments on various loan facilities and capital leases of approximately $1.3 billion including $530.6 million to redeem in full the accreted balance of our remaining outstanding LYONs, $260.0 million in payments towards our $1.0 billion revolving credit facility and $153.7 million prepayment of term loan secured by a certain Celebrity ship. In June 2006, as part of an ASR transaction, we purchased 4.2 million shares of our common stock from an investment bank at an initial price of $39.15 per share. Total consideration paid to repurchase such shares, including commission and other fees, was approximately $164.6 million. The forward sale agreement matured in August 2006. During the term of the forward sale agreement, the investment bank purchased shares of our common stock in the open market to settle its obligation related to the shares borrowed from third parties and sold to us. On August 17, 2006 and upon settlement of the agreement, we received 369,972 additional shares of our common stock which reduced the settlement price of the ASR transaction from an initial price of $39.15 per share to $35.99 per share. The incremental shares were recorded in shareholders’ equity as a component of treasury stock (see Note 6. Shareholders’ Equity). During the first nine months of 2006, we received $19.2 million in connection with the exercise of common stock options and we paid cash dividends on our common stock of $63.5 million. Net Debt-to-Capital decreased to 41.2% in the first nine months of 2006 compared to 41.6% for the same period in 2005.
In September 30, 2006, we called for redemption all of our outstanding zero coupon convertible notes due May 18, 2021. The redemption period ended in October 2006 at a redemption price of $503.85 per note. Most holders of the notes elected to convert them into shares of our common stock, rather than redeem them for cash, resulting in the issuance of approximately 2.9 million shares through September 30, 2006 and approximately 1.2 million shares through the end of the redemption period for a total of approximately 4.1 million shares.
25
Interest capitalized during the first nine months of 2006 increased to $19.3 million from $11.8 million for the same period in 2005 due to a higher average level of investment in ships under construction.
Future Capital Commitments
As of September 30, 2006, we had on order two Freedom-class ships and one ship of a new class designated for Royal Caribbean International, and three Solstice-class ships designated for Celebrity Cruises, for an aggregate additional capacity of approximately 21,150 berths. The aggregate cost of the six ships on order is approximately $5.3 billion, of which we have deposited $367.3 million as of September 30, 2006. Approximately 10.5% of the aggregate cost of the ships was exposed to fluctuations in the euro exchange rate at September 30, 2006.
As of September 30, 2006, we anticipated overall capital expenditures, including the six ships on order, will be approximately $1.2 billion for 2006, $1.3 billion for 2007, $1.8 billion for 2008, $2.0 billion for 2009 and $1.0 billion for 2010.
Contractual Obligations and Off-Balance Sheet Arrangements
As of September 30, 2006, 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)(2) | $4,405,024 | $268,011 | $803,090 | $1,445,134 | $1,888,789 |
Capital lease obligations(3) | 45,116 | 627 | 1,679 | 2,210 | 40,600 |
Operating lease obligations(4)(5) | 564,393 | 61,987 | 106,611 | 92,977 | 302,818 |
Ship purchase obligations(6) | 4,305,446 | 767,274 | 2,994,141 | 544,031 | — |
Other(7) | 388,835 | 89,034 | 120,368 | 58,650 | 120,783 |
|
|
|
|
|
|
Total | $9,708,814 | $1,186,933 | $4,025,889 | $2,143,002 | $2,352,990 |
|
|
|
|
|
|
| | | | | |
| (1) | Amounts exclude interest, except for the accreted value of our zero coupon convertible notes. |
| (2) | The $37.0 million accreted value of the zero coupon convertible notes at September 30, 2006 is included in the one to three years category. These accreted values were calculated based on the number of notes outstanding at September 30, 2006. We may choose to pay any amounts in cash or common stock or a combination thereof. |
| (3) | Amounts exclude interest. |
| (4) | We are obligated under noncancelable operating leases primarily for a ship, offices, warehouses, computer equipment and motor vehicles. |
| (5) | Under the Brilliance of the Seas lease agreement, we may be required to make a termination payment of approximately £126 million, or approximately $236.0 million based on the exchange rate at September 30, 2006, if the lease is canceled in 2012. This amount is included in the more than five years category. |
| (6) | Amounts represent contractual obligations with initial terms in excess of one year. |
| (7) | 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. |
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 and capital allowance deductions. These indemnifications could result in an increase in our lease payments. We are unable to estimate the maximum potential increase in such lease payments due to the various circumstances, timing or combination of events that could trigger such indemnifications. Under current circumstances we do not believe an indemnification in any material amount is probable.
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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.
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.
Funding Sources
As of September 30, 2006, our liquidity was $1.0 billion consisting of approximately $0.2 billion in cash and cash equivalents and $0.8 billion available under our unsecured revolving credit facility. We have contractual obligations of approximately $1.2 billion due during the twelve-month period ending September 30, 2007. We anticipate these contractual obligations could be funded through a combination of cash 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, and fixed charge coverage ratio and limit our debt-to-capital ratio. We were in compliance with all covenants as of September 30, 2006.
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 3. Quantitative and Qualitative Disclosures About Market Risk
For a discussion of certain market risks related to our business, see Part II, Item 7A. Quantitative and Qualitative Disclosures About Market Risk in our annual report on Form 10-K for the year ended December 31, 2005. There have been no significant developments or material changes with respect to our exposure to the market risks previously reported in Form 10-K.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We carried out under the supervision and with the participation of our management, including our Chairman and Chief Executive Officer and Executive Vice President and Chief Financial Officer, an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Exchange Act Rule 13a-15(e), as of the end of the period covered by this report and concluded that those controls and procedures were effective.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 and 15d-15 during the quarter ended September 30, 2006 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system will be met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there is only reasonable assurance that our controls will succeed in achieving their goals under all potential future conditions.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
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 46 USC Section 10313 and equitable relief damages under the California Unfair Competition Law. We are not able at this time to estimate the impact of this proceeding on us. However, we believe that we have meritorious defenses and we intend to vigorously defend against this action.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information about repurchases of common stock during the quarter ended September 30, 2006:
| Total Number of Shares | Average Price Paid | Total Number of Shares Purchased as Part of Publicly Announced Plans or | Maximum Number of Shares that May Yet Be Purchased Under the Plans or |
Period | Purchased | Per Share | Programs | Programs |
|
|
|
|
|
July 1 to July 31 | - | - | - | - |
August 1 to August 31 | 369,972(a) | $35.99 | 369,972 | - |
September 1 to September 30 | - | - | - | - |
(a) We purchased these shares in connection with the settlement of the Accelerated Share transaction (see Note 6. Shareholders' Equity).
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Item 5. Other Information
On October 31, 2006, we announced that Chief Financial Officer Mr. Luis E. Leon will retire from the Company and that Executive Vice President Brian Rice will succeed him as Chief Financial Officer. The Company will pay Mr. Leon $1,955,000 and provide certain other customary benefits. Mr. Leon will assist in the transition which is expected to be completed before the end of 2006.
Item 6. Exhibits
| 31 | Certifications required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities and |
| Exchange Act of 1934. | |
| | | |
32 Certifications pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code.
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ROYAL CARIBBEAN CRUISES LTD.
| /s/ LUIS E. LEON |
|
| Luis E. Leon | |
| Executive Vice President and | |
| Chief Financial Officer | |
| | | | | | |
Date: October 31, 2006
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