ROYAL CARIBBEAN CRUISES LTD - Quarter Report: 2013 September (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

 

For the quarterly period ended September 30, 2013

 

OR

 

 

For the transition period from            to           

 

Commission File Number: 1-11884

 

ROYAL CARIBBEAN CRUISES LTD.

(Exact name of registrant as specified in its charter)

 

 

1050 Caribbean Way, Miami, Florida 33132

(Address of principal executive offices) (zip code)

 

(305) 539-6000

(Registrant’s telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No 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.

 

 

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

 

There were 219,938,511 shares of common stock outstanding as of October 17, 2013.

 

 

Table of Contents

 

ROYAL CARIBBEAN CRUISES LTD.

 

TABLE OF CONTENTS

 

	Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements	1
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3. Quantitative and Qualitative Disclosures About Market Risk	49
Item 4. Controls and Procedures	50
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	51
Item 1A. Risk Factors	51
Item 6. Exhibits	52
SIGNATURES	53

 

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PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

ROYAL CARIBBEAN CRUISES LTD.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(unaudited; in thousands, except per share data)

 

		Quarter Ended
		September 30,
		2013			2012
Passenger ticket revenues		$	1,672,051		$	1,635,033
Onboard and other revenues		639,698			591,357
Total revenues		2,311,749			2,226,390
Cruise operating expenses:
Commissions, transportation and other		378,291			366,100
Onboard and other		178,269			166,356
Payroll and related		213,860			201,644
Food		119,104			111,315
Fuel		215,686			213,434
Other operating		311,591			289,476
Total cruise operating expenses		1,416,801			1,348,325
Marketing, selling and administrative expenses		249,954			243,877
Depreciation and amortization expenses		188,541			182,051
Restructuring and related charges		12,244			—
Operating Income		444,209			452,137
Other income (expense):
Interest income		3,299			4,744
Interest expense, net of interest capitalized		(79,654		)	(84,977		)
Extinguishment of unsecured senior notes		(4,206		)	(7,485		)
Other income		2,053			3,360
		(78,508		)	(84,358		)
Net Income		$	365,701		$	367,779
Earnings per Share:
Basic		$	1.66		$	1.69
Diluted		$	1.65		$	1.68
Weighted-Average Shares Outstanding:
Basic		219,744			217,940
Diluted		221,004			219,296
Comprehensive Income (Loss)
Net Income		$	365,701		$	367,779
Other comprehensive income (loss):
Foreign currency translation adjustments		6,164			1,331
Change in defined benefit plans		5,423			—
Gain on cash flow derivative hedges		61,573			81,322
Total other comprehensive income		73,160			82,653
Comprehensive Income		$	438,861		$	450,432

 

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

 

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ROYAL CARIBBEAN CRUISES LTD.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(unaudited; in thousands, except per share data)

 

		Nine Months Ended
		September 30,
		2013			2012
Passenger ticket revenues		$	4,432,542		$	4,319,478
Onboard and other revenues		1,673,194			1,562,396
Total revenues		6,105,736			5,881,874
Cruise operating expenses:
Commissions, transportation and other		1,017,734			994,535
Onboard and other		440,466			404,932
Payroll and related		632,758			618,277
Food		351,117			334,240
Fuel		689,809			680,389
Other operating		890,726			867,078
Total cruise operating expenses		4,022,610			3,899,451
Marketing, selling and administrative expenses		781,936			756,049
Depreciation and amortization expenses		564,089			541,957
Restructuring and related charges		13,922			—
Operating Income		723,179			684,417
Other income (expense):
Interest income		10,451			16,062
Interest expense, net of interest capitalized		(256,713		)	(266,749		)
Extinguishment of unsecured senior notes		(4,206		)	(7,485		)
Other expense		(6,037		)	(15,155		)
		(256,505		)	(273,327		)
Net Income		$	466,674		$	411,090
Earnings per Share:
Basic		$	2.13		$	1.89
Diluted		$	2.11		$	1.87
Weighted-Average Shares Outstanding:
Basic		219,450			217,797
Diluted		220,744			219,263
Comprehensive Income (Loss)
Net Income		$	466,674		$	411,090
Other comprehensive income (loss):
Foreign currency translation adjustments		369			(7,690		)
Change in defined benefit plans		10,716			—
Gain (loss) on cash flow derivative hedges		56,515			(59,460		)
Total other comprehensive income (loss)		67,600			(67,150		)
Comprehensive Income		$	534,274		$	343,940

 

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

 

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ROYAL CARIBBEAN CRUISES LTD.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

		As of
		September 30,			December 31,
		2013			2012
		(unaudited)
Assets
Current assets
Cash and cash equivalents		$	209,567		$	194,855
Trade and other receivables, net		342,021			281,421
Inventories		160,225			146,295
Prepaid expenses and other assets		258,567			207,662
Derivative financial instruments		48,295			57,827
Total current assets		1,018,675			888,060
Property and equipment, net		17,494,039			17,451,034
Goodwill		436,647			432,975
Other assets		1,136,884			1,055,861
		$	20,086,245		$	19,827,930
Liabilities and Shareholders’ Equity
Current liabilities
Current portion of long-term debt		$	1,942,849		$	1,519,483
Accounts payable		396,482			351,587
Accrued interest		120,585			106,366
Accrued expenses and other liabilities		623,664			541,722
Customer deposits		1,760,985			1,546,993
Total current liabilities		4,844,565			4,066,151
Long-term debt		5,980,912			6,970,464
Other long-term liabilities		498,684			482,566
Commitments and contingencies (Note 7)
Shareholders’ equity
Preferred stock ($0.01 par value; 20,000,000 shares authorized; none outstanding)		—			—
Common stock ($0.01 par value; 500,000,000 shares authorized; 230,223,320 and 229,080,109 shares issued, September 30, 2013 and December 31, 2012, respectively)		2,302			2,291
Paid-in capital		3,137,112			3,109,887
Retained earnings		6,103,290			5,744,791
Accumulated other comprehensive loss		(66,916		)	(134,516		)
Treasury stock (10,308,683 common shares at cost, September 30, 2013 and December 31, 2012)		(413,704		)	(413,704		)
Total shareholders’ equity		8,762,084			8,308,749
		$	20,086,245		$	19,827,930

 

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

 

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ROYAL CARIBBEAN CRUISES LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)

 

		Nine Months Ended
		September 30,
		2013			2012
Operating Activities
Net income		$	466,674		$	411,090
Adjustments:
Depreciation and amortization		564,089			541,957
Loss (gain) on derivative instruments not designated as hedges		8,634			(3,052		)
Loss on extinguishment of unsecured senior notes		4,206			7,485
Changes in operating assets and liabilities:
Decrease in trade and other receivables, net		14,278			42,484
(Increase) decrease in inventories		(13,541		)	423
Increase in prepaid expenses and other assets		(28,363		)	(39,410		)
Increase in accounts payable		43,415			46,836
Increase (decrease) in accrued interest		14,219			(2,305		)
Increase in accrued expenses and other liabilities		29,496			11,688
Increase in customer deposits		131,237			80,993
Cash received on settlement of derivative financial instruments		—			69,684
Other, net		(4,240		)	4,383
Net cash provided by operating activities		1,230,104			1,172,256
Investing Activities
Purchases of property and equipment		(534,046		)	(429,309		)
Cash (paid) received on settlement of derivative financial instruments		(8,451		)	19,058
Investments in unconsolidated affiliates		(60,426		)	—
Cash payments received on loan to unconsolidated affiliate		23,372			23,512
Proceeds from sale of ship		—			9,811
Other, net		1,147			(6,395		)
Net cash used in investing activities		(578,404		)	(383,323		)
Financing Activities
Debt proceeds		1,519,464			915,000
Debt issuance costs		(51,720		)	(48,190		)
Repayments of debt		(2,065,965		)	(1,607,919		)
Dividends paid		(54,159		)	(65,293		)
Proceeds from exercise of common stock options		13,626			3,703
Other, net		1,140			1,228
Net cash used in financing activities		(637,614		)	(801,471		)
Effect of exchange rate changes on cash		626			(8,411		)
Net increase (decrease) in cash and cash equivalents		14,712			(20,949		)
Cash and cash equivalents at beginning of period		194,855			262,186
Cash and cash equivalents at end of period		$	209,567		$	241,237
Supplemental Disclosure
Cash paid during the period for:
Interest, net of amount capitalized		$	232,769		$	242,680
Non cash Investing Activities
Purchase of property and equipment through asset trade in		$	46,375		$	—

 

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

 

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ROYAL CARIBBEAN CRUISES LTD.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

As used in this Quarterly Report on Form 10-Q, the terms “Royal Caribbean,” the “Company,” “we,” “our” and “us” refer to Royal Caribbean Cruises Ltd. and, depending on the context, Royal Caribbean Cruises Ltd.’s consolidated subsidiaries and/or affiliates. The terms “Royal Caribbean International,” “Celebrity Cruises,” “Pullmantur,” “Azamara Club Cruises,” “CDF Croisières de France,” and “TUI Cruises” refer to our cruise brands. However, because TUI Cruises is an unconsolidated investment, our operating results and other disclosures herein do not include TUI Cruises unless otherwise specified.  In accordance with cruise vacation industry practice, the term “berths” is determined based on double occupancy per cabin even though many cabins can accommodate three or more passengers. This report should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2012, including the audited consolidated financial statements and related notes included therein.

 

This Quarterly Report on Form 10-Q also includes trademarks, trade names and service marks of other companies.  Use or display by us of other parties’ trademarks, trade names or service marks is not intended to and does not imply a relationship with, or endorsement or sponsorship of us by, these other parties other than as described herein.

 

Note 1. General

 

Description of Business

 

We are a global cruise company.  We own Royal Caribbean International, Celebrity Cruises, Pullmantur, Azamara Club Cruises, CDF Croisières de France and a 50% joint venture interest in TUI Cruises.

 

Basis for Preparation of Consolidated Financial Statements

 

The unaudited consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  Estimates are required for the preparation of financial statements in accordance with these principles.  Actual results could differ from these estimates.  See Note 2. Summary of Significant Accounting Policies in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2012 for a discussion of our significant accounting policies.

 

All significant intercompany accounts and transactions are eliminated in consolidation. We consolidate entities over which we have control, usually evidenced by a direct ownership interest of greater than 50%, and variable interest entities where we are determined to be the primary beneficiary. See Note 6. Goodwill and Other Assets for further information regarding our variable interest entities. For affiliates we do not control but over which we have significant influence on financial and operating policies, usually evidenced by a direct ownership interest from 20% to 50%, the investment is accounted for using the equity method.  We consolidate the operating results of Pullmantur and CDF Croisières de France on a two-month lag to allow for more timely preparation of our consolidated financial statements. No material events or transactions affecting Pullmantur or CDF Croisières de France have occurred during the two-month lag period of August and September 2013 that would require disclosure or adjustment to our consolidated financial statements as of and for the quarter ended September 30, 2013.

 

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We believe the accompanying unaudited consolidated financial statements contain all normal recurring accruals necessary for a fair statement.  Our revenues are seasonal and results for interim periods are not necessarily indicative of results for the entire year.

 

Note 2. Summary of Significant Accounting Policies

 

Property and Equipment

 

During the first quarter of 2013, we performed a review of the estimated useful lives and associated residual values of ships in our fleet approaching the last third of their estimated useful lives.  As a result, effective January 1, 2013, we revised the estimated useful lives of five ships from 30 years with a 15% associated residual value, to 35 years with a 10% associated residual value.  The change in the estimated useful lives and associated residual value was accounted for prospectively as a change in accounting estimate.  The 35-year useful life with a 10% associated residual value is based on revised estimates of the weighted-average useful life of all major ship components for these ships.  The change in estimate is consistent with our recent investments in and future plans to continue to invest in the revitalization of these ships and the use of certain ship components longer than originally estimated. The change allows us to better match depreciation expense with the periods these assets are expected to be in use.  For the third quarter of 2013, this change increased operating income and net income by $3.4 million and increased earnings per share by $0.02 per share on a basic and diluted basis.  For the nine months ended September 30, 2013, this change increased operating income and net income by $7.2 million and increased earnings per share by $0.03 per share on a basic and diluted basis.  For the full year 2013, this change is estimated to increase operating income and net income by approximately $11.0 million and earnings per share by $0.05 per share on a basic and diluted basis.  For further information on our significant accounting policies, refer to Note 2. Summary of Significant Accounting Policies in our Annual Report on Form 10-K for the year ended December 31, 2012.

 

Recently Adopted Accounting Standards

 

In January 2013, we adopted authoritative guidance regarding the periodic impairment testing of indefinite-lived intangible assets.  The new guidance allows an entity to assess qualitative factors to determine if it is more-likely-than-not that indefinite-lived intangible assets might be impaired and, based on this assessment, to determine whether it is necessary to perform the quantitative impairment tests.  The adoption of this guidance did not have an impact on our consolidated financial statements.

 

In March 2013, we adopted authoritative guidance regarding the presentation of amounts reclassified from accumulated other comprehensive income to net income.  The new guidance requires an entity to present, either in a single note or parenthetically on the face of the financial statements, the effect of significant amounts reclassified from each component of accumulated other comprehensive income based on its source (e.g., the release due to cash flow hedges from interest rate contracts) and the income statement line items affected by the reclassification (e.g., interest income or interest expense).  We elected to present this information in a single note. See Note 9. Changes in Accumulated Other Comprehensive Income (Loss) for our disclosures required under this guidance.

 

In July 2013, we adopted authoritative guidance regarding the inclusion of the Fed Funds Effective Swap Rate, or Overnight Index Swap rate (“OIS”), as a benchmark interest rate for hedge accounting purposes. The new guidance permits the use of the OIS to be included as an acceptable U.S. benchmark and removes the restriction on using different benchmark rates for similar hedges. The guidance is effective prospectively for qualifying new or redesignated hedging relationships entered into on or after

 

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July 17, 2013.  The adoption of this guidance did not have an impact on our consolidated financial statements.

 

Recent Accounting Pronouncements

 

In March 2013, amended guidance was issued regarding the release of cumulative translation adjustments into net income.  The new guidance provides clarification of when to release the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets within a foreign entity.  This guidance will be effective for our interim and annual reporting periods beginning after December 15, 2013.  The adoption of this newly issued guidance is not expected to have a material impact on our consolidated financial statements, but will have an impact on the accounting for future sales of investments or changes in control of foreign entities.

 

Reclassifications

 

For the nine months ended September 30, 2012, $8.7 million has been reclassified in the consolidated statements of cash flows from other, net to loss (gain) on derivative instruments not designated as hedges within net cash flows provided by operating activities in order to conform to the current year presentation.

 

Other

 

Revenues and expenses include port costs that vary with guest head counts.  The amounts of such port costs included in passenger ticket revenues on a gross basis were $135.8 million and $128.8 million for the third quarters of 2013 and 2012, respectively, and $368.5 million and $345.7 million for the nine months ended September 30, 2013 and 2012, respectively.

 

Note 3. Earnings Per Share

 

A reconciliation between basic and diluted earnings per share is as follows (in thousands, except per share data):

 

		Quarter Ended						Nine Months Ended
		September 30,						September 30,
		2013			2012			2013			2012
Net income for basic and diluted earnings per share		$	365,701		$	367,779		$	466,674		$	411,090
Weighted-average common shares outstanding		219,744			217,940			219,450			217,797
Dilutive effect of stock options, performance share awards and restricted stock awards		1,260			1,356			1,294			1,466
Diluted weighted-average shares outstanding		221,004			219,296			220,744			219,263
Basic earnings per share		$	1.66		$	1.69		$	2.13		$	1.89
Diluted earnings per share		$	1.65		$	1.68		$	2.11		$	1.87

 

Diluted earnings per share for the quarter and nine months ended September 30, 2013 did not reflect options to purchase an aggregate of 2.2 million shares because the effect of including them would have been antidilutive.  Diluted earnings per share for the quarter and nine months ended September 30, 2012

 

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did not reflect options to purchase an aggregate of 3.3 million shares because the effect of including them would have been antidilutive.

 

Note 4. Long-Term Debt

 

In June 2013, we borrowed €365.0 million, or approximately $494.1 million based on the exchange rate at September 30, 2013, under a previously committed unsecured term loan facility.  The loan is due and payable at maturity in July 2017.  Interest on the loan accrues at a floating rate based on EURIBOR plus the applicable margin.  The applicable margin varies with our debt rating and was 3.0% as of September 30, 2013.  The proceeds of this loan were used to repay amounts outstanding under our unsecured revolving credit facilities.

 

In August 2013, we amended and restated our $525.0 million unsecured revolving credit facility due November 2014.  The amendment increased capacity under this facility to $850.0 million, reduced the applicable margin and fees and extended the termination date to August 2018.  Interest on the amended facility accrues at a floating rate based on LIBOR plus the applicable margin.  The applicable margin varies with our debt rating and was 1.75% as of September 30, 2013.  In addition, we are subject to a facility fee which varies with our debt rating and was 0.37% as of September 30, 2013.  Under the amended facility, we have the ability to increase the capacity of the facility by an additional $300.0 million from time to time subject to the receipt of additional or increased lender commitments.  In addition, we increased the capacity of our unsecured revolving credit facility due July 2016 by $20.0 million in March 2013, bringing our total capacity under this facility to $1.1 billion.  Accordingly, as of September 30, 2013, we have an aggregate revolving borrowing capacity of $2.0 billion.

 

In August 2013, we entered into a credit agreement which provides an unsecured term loan facility in an amount up to $380.0 million.  We have the ability to draw on this facility at anytime on or prior to January 20, 2014.  As of the date of this filing, we have not drawn on this facility.  All amounts borrowed under the facility will be due and payable at maturity in August 2018.  Interest on the loan accrues at a floating rate based on LIBOR plus the applicable margin.  The applicable margin varies with our debt rating and would have been 2.12% as of September 30, 2013.  In addition, we are subject to a commitment fee of 0.37% per annum of the undrawn amount.

 

We anticipate the proceeds from the agreements noted above will be used primarily as part of our refinancing strategy for our remaining maturities in 2013 and 2014.

 

In September 2013, we repurchased $21.0 million of our 11.875% unsecured senior notes due 2015. Total consideration paid in connection with the repurchase, including premium and related fees and expenses, was $24.9 million resulting in a loss on the early extinguishment of debt of approximately $4.2 million which was immediately recognized in earnings.

 

In July 2013, we entered into a credit agreement for the financing of the third Oasis-class ship, which is scheduled for delivery in the second quarter of 2016.  The credit agreement makes available to us an unsecured term loan in an amount of €892.2 million, or approximately $1.2 billion, based on the exchange rate at September 30, 2013.  Compagnie Francaise d’Assurance pour le Commerce Extérieur (“COFACE”), the official export credit agency of France, has agreed to guarantee to the lenders payment of 100% of the financing.  The loan amortizes semi-annually and will mature 12 years following delivery of the ship.  Interest on the loan will accrue at our election at either a fixed rate of 2.6% or a floating rate at EURIBOR plus a margin of 1.15%.

 

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Note 5.  Property and Equipment

 

In March 2013, our conditional agreement with STX France S.A. to build the third Oasis-class ship for Royal Caribbean International became effective.  Refer to Note 7. Commitments and Contingencies for further information.  Pullmantur’s Atlantic Star, which has been out of operation since 2009, was transferred in the first quarter of 2013 to an affiliate of STX France S.A. as part of the consideration for the third Oasis-class ship.  The Atlantic Star was transferred at carrying value, which approximated its fair value on the date of its transfer.  The transfer did not result in a gain or a loss.

 

Note 6. Goodwill and Other Assets

 

During the fourth quarter of 2012, we performed the annual impairment evaluation of our goodwill and trademarks and trade names and we recognized total impairment related charges of $413.9 million associated with our Pullmantur brand.  As of September 30, 2013, the carrying amounts of goodwill and trademarks and trade names attributable to our Pullmantur reporting unit were $149.4 million and $210.4 million, respectively.  Pullmantur is a brand targeted primarily at the Spanish, Portuguese and Latin American markets.  The persistent economic instability in these markets has created significant uncertainties in forecasting operating results and future cash flows used in our impairment analyses.  We continue to monitor economic events in these markets for their potential impact on Pullmantur’s business and valuation. However, based on our most recent projections we do not believe an interim impairment evaluation of Pullmantur’s goodwill or trademarks and trade names is warranted as of September 30, 2013.

 

If there are material changes to the projected future cash flows used in the impairment analyses, especially in Net Yields, an additional impairment charge with respect to the Pullmantur reporting unit’s goodwill and trademarks and trade names may be required.  We will evaluate these intangible assets for potential impairment during our annual impairment test scheduled for the fourth quarter of 2013.

 

Variable Interest Entities

 

A Variable Interest Entity (“VIE”) is an entity in which the equity investors have not provided enough equity to finance the entity’s activities or the equity investors (1) cannot directly or indirectly make decisions about the entity’s activities through their voting rights or similar rights; (2) do not have the obligation to absorb the expected losses of the entity; (3) do not have the right to receive the expected residual returns of the entity; or (4) have voting rights that are not proportionate to their economic interests and the entity’s activities involve or are conducted on behalf of an investor with a disproportionately small voting interest.

 

We have determined that Grand Bahama Shipyard Ltd. (“Grand Bahama”), a ship repair and maintenance facility in which we have a 40% noncontrolling interest, is a VIE. The facility serves cruise and cargo ships, oil and gas tankers, and offshore units.  We utilize this facility, among other ship repair facilities, for our regularly scheduled drydocks and certain emergency repairs as may be required.  We have determined that we are not the primary beneficiary of this facility, as we do not have the power to direct the activities that most significantly impact the facility’s economic performance. Accordingly, we do not consolidate this entity and we account for this investment under the equity method of accounting. As of September 30, 2013 and December 31, 2012, the net book value of our investment in Grand Bahama, including equity and loans, was approximately $58.9 million and $59.3 million, respectively, which is also our maximum exposure to loss as we are not contractually required to provide any

 

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financial or other support to the facility. The majority of our loans to Grand Bahama are in non-accrual status and the majority of this amount is included within other assets in our consolidated balance sheets. During the first nine months of 2013, we received approximately $3.3 million in principal and interest payments related to loans that are in accrual status from Grand Bahama and recorded income associated with our investment in Grand Bahama.  We monitor credit risk associated with these loans through our participation on Grand Bahama’s board of directors along with our review of Grand Bahama’s financial statements and projected cash flows.  Based on this review, we believe the risk of loss associated with these loans was not probable as of September 30, 2013.

 

In conjunction with our acquisition of Pullmantur in 2006, we obtained a 49% noncontrolling interest in Pullmantur Air, S.A. (“Pullmantur Air”), a small air business that operates four aircraft in support of Pullmantur’s operations. We have determined Pullmantur Air is a VIE for which we are the primary beneficiary as we have the power to direct the activities that most significantly impact its economic performance and we are obligated to absorb its losses. In accordance with authoritative guidance, we have consolidated the assets and liabilities of Pullmantur Air.  We do not separately disclose the assets and liabilities of Pullmantur Air as they are immaterial to our September 30, 2013 and December 31, 2012 consolidated financial statements.

 

We have determined that TUI Cruises GmbH, our 50%-owned joint venture, which operates the brand TUI Cruises, is a VIE. As of September 30, 2013 and December 31, 2012, our investment in TUI Cruises, including equity and loans, was approximately $344.4 million and $287.0 million, respectively, and the majority of this amount was included within other assets in our consolidated balance sheets.  In addition, we and TUI AG, our joint venture partner, have each guaranteed the repayment of 50% of an €180.0 million bank loan provided to TUI Cruises and due in 2016 (refer to further details below).  Our investment amount and the potential obligations under this guarantee are substantially our maximum exposure to loss.  We have determined that we are not the primary beneficiary of TUI Cruises.  We believe that the power to direct the activities that most significantly impact TUI Cruises’ economic performance are shared between ourselves and TUI AG.  All the significant operating and financial decisions of TUI Cruises require the consent of both parties which we believe creates shared power over TUI Cruises.  Accordingly, we do not consolidate this entity and account for this investment under the equity method of accounting.

 

In connection with our sale of Celebrity Mercury to TUI Cruises in 2011, we provided a debt facility to TUI Cruises in the amount of up to €90.0 million.  The outstanding principal amount of the facility as of September 30, 2013 was €57.1 million, or $77.3 million based on the exchange rate at September 30, 2013.  This facility bears interest at the rate of 9.54% per annum, is payable over seven years, is 50% guaranteed by TUI AG and is secured by second mortgages on both of TUI Cruises’ ships, Mein Schiff 1 and Mein Schiff 2.  As of September 30, 2013, TUI Cruises’ bank loan discussed above had a remaining balance of €139.5 million, or approximately $188.8 million based on the exchange rate at September 30, 2013.  The bank loan amortizes quarterly and is secured by first mortgages on both Mein Schiff 1 and Mein Schiff 2. Based on current facts and circumstances, we do not believe potential obligations under our guarantee of TUI Cruises’ bank loan are probable.

 

During 2011 and 2012, TUI Cruises entered into construction agreements with STX Finland to build its first and second newbuild ships, scheduled for delivery in the second quarter of 2014 and the second quarter of 2015, respectively.  TUI Cruises has entered into credit agreements for the financing of up to 80% of the contract price of each ship. The remaining portion of the contract price of the ships will be funded through either TUI Cruises’ cash flows from operations and/or loans and/or equity contributions from us and TUI AG.  The construction agreements for the ships include certain restrictions on each of

 

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our and TUI AG’s ability to reduce our current ownership interest in TUI Cruises below 37.5% through the construction periods.  In addition, the credit agreements extend this restriction through 2019.

 

Note 7. Commitments and Contingencies

 

Capital Expenditures

 

In September 2013, our agreement with Meyer Werft to build the third Quantum-class ship for Royal Caribbean International became effective.  We received a commitment for the unsecured financing of the ship for up to 80% of the ship’s contract price.  Euler Hermes Deutschland AG (“Hermes”), the official export credit agency of Germany, has agreed to guarantee to the lenders payment of 95% of the financing.  The ship will have a capacity of approximately 4,150 berths and is expected to enter service in the second quarter of 2016.

 

As of September 30, 2013, the aggregate cost of our ships on order was approximately $4.7 billion, of which we had deposited $335.7 million as of such date. Approximately 45.0% of the aggregate cost was exposed to fluctuations in the euro exchange rate at September 30, 2013.  (See Note 10. Fair Value Measurements and Derivative Instruments). In October 2013, we entered into foreign currency forward contracts to hedge additional amounts related to the cost of our ships on order denominated in euros. As of the date of this filing, approximately 36.7% of the aggregate cost was exposed to fluctuations in the euro exchange rate.

 

Our brands, including our 50% joint venture, TUI Cruises, have six ships on order.  As of September 30, 2013, the expected dates that our ships on order will enter service and their approximate berths are as follows:

 

Ship		Expected to Enter Service		Approximate Berths
Royal Caribbean International —
Quantum-class:
Quantum of the Seas		4th Quarter 2014		4,150
Anthem of the Seas		2nd Quarter 2015		4,150
Unnamed		2nd Quarter 2016		4,150
Oasis-class:
Unnamed		2nd Quarter 2016		5,400
TUI Cruises —
Mein Schiff 3		2nd Quarter 2014		2,500
Mein Schiff 4		2nd Quarter 2015		2,500
		Total Berths		22,850

 

Litigation

 

Between August 1, 2011 and September 8, 2011, three similar purported class action lawsuits were filed against us and certain of our current and former officers in the United States District Court of the Southern District of Florida.  The cases were consolidated and a consolidated amended complaint was filed on February 17, 2012.  The consolidated amended complaint was filed on behalf of a purported class of purchasers of our common stock during the period from October 26, 2010 through July 27, 2011 and named the Company, our Chairman and CEO, our Vice Chairman, the President and CEO of our Royal Caribbean International brand and the former President and CEO of our Celebrity Cruises brand as defendants.  The consolidated amended complaint alleged violations of Section 10(b) of the Securities

 

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Exchange Act of 1934 and SEC Rule 10b-5 as well as, in the case of the individual defendants, the control person provisions of the Securities Exchange Act.  The complaint principally alleged that the defendants knowingly made incorrect statements concerning the Company’s outlook.  The consolidated amended complaint sought unspecified damages, interest, and attorneys’ fees. We filed a motion to dismiss the complaint for failure to state a claim on April 9, 2012.  On April 18, 2013, the district judge granted our motion and ordered the case dismissed with prejudice.  Plaintiffs did not appeal this order and the case is now closed.

 

A class action complaint was filed in June 2011 against Royal Caribbean Cruises Ltd. in the United States District Court for the Southern District of Florida on behalf of a purported class of stateroom attendants employed onboard Royal Caribbean International cruise vessels alleging that they were required to pay other crew members to help with their duties in violation of the U.S. Seaman’s Wage Act. The lawsuit also alleges that certain stateroom attendants were required to work back of house assignments without the ability to earn gratuities in violation of the U.S. Seaman’s Wage Act. Plaintiffs seek judgment for damages, wage penalties and interest in an indeterminate amount. In May 2012, the Court granted our motion to dismiss the complaint on the basis that the applicable collective bargaining agreement requires any such claims to be arbitrated. Plaintiffs have appealed this decision to the United States Court of Appeals, 11th Circuit. We believe the appeal is without merit as are the underlying claims made against us and we intend to vigorously defend ourselves against them. Because of the inherent uncertainty as to the outcome of the proceeding described above, we are unable at this time to estimate the possible impact of this matter 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 and cash flows.

 

Other

 

In July 2002, we entered into an operating lease denominated in British pound sterling for the Brilliance of the Seas.  The lease payments vary based on sterling LIBOR and are included in other operating expenses in our consolidated statements of comprehensive income (loss). Brilliance of the Seas lease expense amounts were approximately ₤3.1 million and ₤3.5 million, or approximately $4.8 million and $5.5 million, for the quarter ended September 30, 2013 and September 30, 2012, respectively, and were approximately ₤9.2 million and ₤11.5 million, or approximately $14.1 million and $18.3 million for the nine months ended September 30, 2013 and September 30, 2012, respectively.  The lease has a contractual life of 25 years; however, both the lessor and we have certain rights to cancel the lease at year 18 (i.e. 2020) upon advance notice given approximately one year prior to cancellation.  In the event of early termination at year 18, we have the option to cause the sale of the vessel at its fair value and to use the proceeds towards the applicable termination payment.  Alternatively, we could opt at such time to make a termination payment of approximately ₤65.4 million, or approximately $105.9 million based on the exchange rate at September 30, 2013, and relinquish our right to cause the sale of the vessel. Under current circumstances we do not believe early termination of this lease is probable.

 

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 the United

 

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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. The United Kingdom tax authorities are disputing the lessor’s accounting treatment of the lease and the lessor and tax authorities are in discussions on the matter.  If the characterization of the lease by the lessor is ultimately determined to be incorrect, we could be required to indemnify the lessor under certain circumstances.  The lessor has advised us that they believe their characterization of the lease is correct. Based on the foregoing and our review of available information, we do not believe an indemnification payment is probable.  However, if the lessor loses its dispute and we are required to indemnify the lessor, we cannot at this time predict the impact that such an occurrence would have on our financial condition and results of operations.

 

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.

 

If (i) any person other than A. Wilhelmsen AS. and Cruise Associates and their respective affiliates (the “Applicable Group”) acquires ownership of more than 33% of our common stock and the Applicable Group owns less of our common stock than such person, or (ii) subject to certain exceptions, during any 24-month period, a majority of the Board is no longer comprised of individuals who were members of the Board on the first day of such period, we may be obligated to prepay indebtedness outstanding under the majority of our credit facilities, which we may be unable to replace on similar terms.  Certain of our outstanding debt securities also contain change of control provisions that would be triggered by the acquisition of greater than 50% of our common stock by a person other than a member of the Applicable Group coupled with a ratings downgrade. If this were to occur, it would have an adverse impact on our liquidity and operations.

 

Note 8. Shareholders’ Equity

 

In September 2013, we declared a cash dividend on our common stock of $0.25 per share which was paid in the fourth quarter of 2013.  We declared and paid a cash dividend on our common stock of $0.12 per share during the first and second quarters of 2013.

 

During the third quarter of 2012, we declared a cash dividend on our common stock of $0.12 per share which was paid in the fourth quarter of 2012.  We declared and paid a cash dividend on our common stock of $0.10 per share during the first and second quarters of 2012. During the first quarter of 2012, we also paid a cash dividend on our common stock of $0.10 per share which was declared during the fourth quarter of 2011.

 

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Note 9. Changes in Accumulated Other Comprehensive Income (Loss)

 

The following table presents the changes in accumulated other comprehensive income (loss) by component for the nine months ended September 30, 2013 (in thousands):

 

		Changes related to cash flow derivative hedges			Changes in defined benefit plans			Foreign currency translation adjustments			Accumulated other comprehensive loss
Accumulated comprehensive loss at beginning of the year		$	(84,505	)	$	(34,823	)	$	(15,188	)	$	(134,516	)
Other comprehensive income before reclassifications		109,154			8,774			369			118,297
Amounts reclassified from accumulated other comprehensive loss		(52,639		)	1,942			—			(50,697		)
Net current-period other comprehensive income		56,515			10,716			369			67,600
Ending balance		$	(27,990	)	$	(24,107	)	$	(14,819	)	$	(66,916	)

 

The following table presents reclassifications out of accumulated other comprehensive income (loss) for the quarter and nine months ended September 30, 2013 (in thousands):

 

		Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income
Details about Accumulated Other Comprehensive Income (Loss) Components		Quarter Ended September 30, 2013			Nine Months Ended September 30, 2013			Affected Line Item in Statements of Comprehensive Income (Loss)
Gain (loss) on cash flow derivative hedges:
Cross currency swaps		$	(890	)	$	(2,641	)	Interest expense, net of interest capitalized
Foreign currency forward contracts		(449		)	(1,348		)	Depreciation and amortization expenses
Foreign currency forward contracts		19,089			18,612			Other income (expense)
Foreign currency forward contracts		(217		)	(222		)	Interest expense, net of interest capitalized
Fuel swaps		12,002			38,238			Fuel
		29,535			52,639
Amortization of defined benefit plans:
Actuarial loss		(438		)	(1,315		)	Payroll and related
Prior service costs		(209		)	(627		)	Payroll and related
		(647		)	(1,942		)
Total reclassifications for the period		$	28,888		$	50,697

 

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Note 10. Fair Value Measurements and Derivative Instruments

 

Fair Value Measurements

 

The estimated fair value of our financial instruments that are not measured at fair value on a recurring basis, categorized based upon the fair value hierarchy, are as follows (in thousands):

 

		Fair Value Measurements at September 30, 2013 Using												Fair Value Measurements at December 31, 2012 Using
Description		Total			Level 1(1)			Level 2(2)			Level 3(3)			Total			Level 1(1)			Level 2(2)			Level 3(3)
Assets:
Cash and cash equivalents(4)		$	209,567		209,567			—			—			$	194,855		194,855			—			—
Total Assets		$	209,567		$	209,567		$	—		$	—		$	194,855		$	194,855		$	—		$	—
Liabilities:
Long-term debt (including current portion of long-term debt)(5)		$	8,225,926		3,212,399			5,013,527			—			$	8,859,310		3,917,398			4,941,912			—
Total Liabilities		$	8,225,926		$	3,212,399		$	5,013,527		$	—		$	8,859,310		$	3,917,398		$	4,941,912		$	—

 

(1)                   Inputs based on quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access.  Valuation of these items does not entail a significant amount of judgment.

(2)                   Inputs other than quoted prices included within Level 1 that are observable for the liability, either directly or indirectly.  For unsecured revolving credit facilities and unsecured term loans, fair value is determined utilizing the income valuation approach.  This valuation model takes into account the contract terms of our debt such as the debt maturity and the interest rate on the debt.  The valuation model also takes into account our creditworthiness based on publicly available credit default swap rates.

(3)                   Inputs that are unobservable.  The Company did not use any Level 3 inputs as of September 30, 2013 and December 31, 2012.

(4)                   Consists of cash and marketable securities with original maturities of less than 90 days.

(5)                   Consists of unsecured revolving credit facilities, unsecured senior notes, senior debentures and unsecured term loans.  Does not include our capital lease obligations.

 

Other Financial Instruments

 

The carrying amounts of accounts receivable, accounts payable, accrued interest and accrued expenses approximate fair value at September 30, 2013 and December 31, 2012.

 

Assets and liabilities that are recorded at fair value have been categorized based upon the fair value hierarchy.  The following table presents information about the Company’s financial instruments recorded at fair value on a recurring basis (in thousands):

 

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		Fair Value Measurements At September 30, 2013 Using												Fair Value Measurements at December 31, 2012 Using
Description		Total			Level 1(1)			Level 2(2)			Level 3(3)			Total			Level 1(1)			Level 2(2)			Level 3(3)
Assets:
Derivative financial instruments(4)		$	128,484		—			128,484			—			$	96,489		—			96,489			—
Investments(5)		$	5,985		5,985			—			—			$	6,231		6,231			—			—
Total Assets		$	134,469		$	5,985		$	128,484		$	—		$	102,720		$	6,231		$	96,489		$	—
Liabilities:
Derivative financial instruments(6)		$	106,262		—			106,262			—			$	85,119		—			85,119			—
Total Liabilities		$	106,262		$	—		$	106,262		$	—		$	85,119		$	—		$	85,119		$	—

 

(1)                   Inputs based on quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access.  Valuation of these items does not entail a significant amount of judgment.

(2)                   Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.  For foreign currency forward contracts, interest rate swaps, cross currency swaps and fuel swaps, fair value is derived using valuation models that utilize the income valuation approach.  These valuation models take into account the contract terms, such as maturity, as well as other inputs, such as foreign exchange rates and curves, fuel types, fuel curves and interest rate yield curves.  For fuel call options, fair value is determined by using the prevailing market price for the instruments consisting of published price quotes for similar assets based on recent transactions in an active market. Fair value for foreign currency collar options is determined by using standard option pricing models with inputs based on the options’ contract terms, such as exercise price and maturity, and readily available public market data, such as foreign exchange curves, foreign exchange volatility levels and discount rates. All derivative instrument fair values take into account the creditworthiness of the counterparty and the Company.

(3)                   Inputs that are unobservable.  The Company did not use any Level 3 inputs as of September 30, 2013 and December 31, 2012.

(4)                   Consists of foreign currency forward contracts, foreign currency collar options, interest rate swaps, fuel swaps and purchased fuel call options.  Please refer to the “Fair Value of Derivative Instruments” table for breakdown by instrument type.

(5)                   Consists of exchange-traded equity securities and mutual funds.

(6)                   Consists of interest rate swaps, fuel swaps, foreign currency forward contracts, foreign currency collar options, and sold fuel call options.  Please refer to the “Fair Value of Derivative Instruments” table for breakdown by instrument type.

 

The reported fair values are based on a variety of factors and assumptions.  Accordingly, the fair values may not represent actual values of the financial instruments that could have been realized as of September 30, 2013 or December 31, 2012, or that will be realized in the future, and do not include expenses that could be incurred in an actual sale or settlement.

 

Concentrations of Credit Risk

 

We monitor our credit risk associated with financial and other institutions with which we conduct significant business and, to minimize these risks, we select counterparties with credit risks acceptable to us and we seek to limit our exposure to an individual counterparty.  Credit risk, including but not limited to counterparty nonperformance under derivative instruments, our credit facilities and new ship progress payment guarantees, is not considered significant, as we primarily conduct business with large, well-established financial institutions, insurance companies and export credit agencies many of which we have long-term relationships and which have credit risks acceptable to us or where the credit risk is spread out among a large number of counterparties. In addition, our exposure under foreign currency

 

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forward contracts, foreign currency collar options, fuel call options, interest rate and fuel swap agreements was approximately $48.7 million and $60.8 million as of September 30, 2013 and December 31, 2012, respectively, and was limited to the cost of replacing the contracts in the event of non-performance by the counterparties to the contracts, all of which are currently our lending banks.  We do not anticipate nonperformance by any of our significant counterparties. In addition, we have established guidelines regarding credit ratings and instrument maturities that we follow to maintain safety and liquidity. We do not normally require collateral or other security to support credit relationships; however, in certain circumstances this option is available to us.

 

Derivative Instruments

 

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 impact of these hedging instruments is 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.  Although certain of our derivative financial instruments do not qualify or are not accounted for under hedge accounting, we do not hold or issue derivative financial instruments for trading or other speculative purposes.  We monitor our derivative positions using techniques including market valuations and sensitivity analyses.

 

We enter into various forward, swap and option contracts to manage our interest rate exposure and to limit our exposure to fluctuations in foreign currency exchange rates and fuel prices. These instruments are recorded on the balance sheet at their fair value and the vast majority are designated as hedges.  We also have non-derivative financial instruments designated as hedges of our net investment in our foreign operations and investments.

 

At inception of the hedge relationship, a derivative instrument that hedges the exposure to changes in the fair value of a firm commitment or a recognized asset or liability is designated as a fair value hedge.  A derivative instrument that hedges a forecasted transaction or the variability of cash flows related to a recognized asset or liability is designated as a cash flow hedge.

 

Changes in the fair value of derivatives that are designated as fair value hedges are offset against changes in the fair value of the underlying hedged assets, liabilities or firm commitments.  Gains and losses on derivatives that are designated as cash flow hedges are recorded as a component of accumulated other comprehensive income (loss) until the underlying hedged transactions are recognized in earnings.  The foreign currency transaction gain or loss of our non-derivative financial instruments designated as hedges of our net investment in foreign operations and investments are recognized as a component of accumulated other comprehensive income (loss) along with the associated foreign currency translation adjustment of the foreign operation.

 

On an ongoing basis, we assess whether derivatives used in hedging transactions are “highly effective” in offsetting changes in the fair value or cash flow of hedged items.  We use the long-haul method to assess hedge effectiveness using regression analysis for each hedge relationship under our interest rate, foreign currency and fuel hedging programs.  We apply the same methodology on a consistent basis for assessing hedge effectiveness to all hedges within each hedging program (i.e. interest rate, foreign currency and fuel). We perform regression analyses over an observation period of up to three years, utilizing market data relevant to the hedge horizon of each hedge relationship. High

 

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effectiveness is achieved when a statistically valid relationship reflects a high degree of offset and correlation between the changes in the fair values of the derivative instrument and the hedged item. The determination of ineffectiveness is based on the amount of dollar offset between the change in fair value of the derivative instrument and the change in fair value of the hedged item at the end of the reporting period.  If it is determined that a derivative is not highly effective as a hedge or hedge accounting is discontinued, any change in fair value of the derivative since the last date at which it was determined to be effective is recognized in earnings. In addition, the ineffective portion of our highly effective hedges is immediately recognized in earnings and reported in other income (expense) in our consolidated statements of comprehensive income (loss).

 

Cash flows from derivative instruments that are designated as fair value or cash flow hedges are classified in the same category as the cash flows from the underlying hedged items. In the event that hedge accounting is discontinued, cash flows subsequent to the date of discontinuance are classified within investing activities.  Cash flows from derivative instruments not designated as hedging instruments are classified as investing activities.

 

We consider the classification of the underlying hedged item’s cash flows in determining the classification for the designated derivative instrument’s cash flows. We classify derivative instrument cash flows from hedges of benchmark interest rate or hedges of fuel expense as operating activities due to the nature of the hedged item. Likewise, we classify derivative instrument cash flows from hedges of foreign currency risk on our newbuild ship payments as investing activities. Cash flows from derivative instruments not designated under hedge accounting, such as our fuel call options, are classified as investing activities.

 

Interest Rate Risk

 

Our exposure to market risk for changes in interest rates relates to our long-term debt obligations including future interest payments.  At September 30, 2013, approximately 40.4% of our long-term debt was effectively fixed as compared to 45.8% as of December 31, 2012.  We use interest rate swap agreements to modify our exposure to interest rate movements and to manage our interest expense.

 

Market risk associated with our long-term fixed rate debt is the potential increase in fair value resulting from a decrease in interest rates.  We use interest rate swap agreements that effectively convert a portion of our fixed-rate debt to a floating-rate basis to manage this risk.  At September 30, 2013 and December 31, 2012, we maintained interest rate swap agreements on the $420.0 million fixed rate portion of our Oasis of the Seas unsecured amortizing term loan.  The interest rate swap agreements effectively changed the interest rate on the balance of the unsecured term loan, which was $297.5 million as of September 30, 2013, from a fixed rate of 5.41% to a LIBOR-based floating rate equal to LIBOR plus 3.87%, currently approximately 4.30%. These interest rate swap agreements are accounted for as fair value hedges.

 

During the second quarter of 2013, we entered into interest rate swap agreements that effectively changed the interest rate on the $650.0 million unsecured senior notes due 2022, from a fixed rate of 5.25% to a LIBOR-based floating rate equal to LIBOR plus 3.63%, currently approximately 3.90%.  These interest rate swap agreements are accounted for as fair value hedges.

 

Market risk associated with our long-term floating rate debt is the potential increase in interest expense from an increase in interest rates.  We use interest rate swap agreements that effectively convert a portion of our floating-rate debt to a fixed-rate basis to manage this risk.  At September 30, 2013 and

 

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December 31, 2012, we maintained forward-starting interest rate swap agreements that hedge the anticipated unsecured amortizing term loans that will finance our purchase of Quantum of the Seas and Anthem of the Seas. Forward-starting interest rate swaps hedging the Quantum of the Seas loan will effectively convert the interest rate for $735.0 million of the anticipated loan balance from LIBOR plus 1.30% to a fixed rate of 3.74% (inclusive of margin) beginning in October 2014. Forward-starting interest rate swaps hedging the Anthem of the Seas loan will effectively convert the interest rate for $725.0 million of the anticipated loan balance from LIBOR plus 1.30% to a fixed rate of 3.86% (inclusive of margin) beginning in April 2015.  These interest rate swap agreements are accounted for as cash flow hedges.

 

In addition, at September 30, 2013 and December 31, 2012, we maintained interest rate swap agreements that effectively converted the interest rate on a portion of the Celebrity Reflection unsecured amortizing term loan balance of approximately $627.2 million from LIBOR plus 0.40% to a fixed rate (including applicable margin) of 2.85% through the term of the loan.  These interest rate swap agreements are accounted for as cash flow hedges.

 

The notional amount of interest rate swap agreements related to outstanding debt and on our current unfunded financing arrangements as of September 30, 2013 and December 31, 2012 was $3.0 billion and $2.4 billion, respectively.

 

Foreign Currency Exchange Rate Risk

 

Derivative Instruments

 

Our primary exposure to foreign currency exchange rate risk relates to our ship construction contracts denominated in euros, our foreign currency denominated debt and our international business operations.  We enter into foreign currency forward contracts, collar options and cross currency swap agreements to manage portions of the exposure to movements in foreign currency exchange rates.  As of September 30, 2013, the aggregate cost of our ships on order was approximately $4.7 billion, of which we had deposited $335.7 million as of such date.  Approximately 45.0% and 49.7% of the aggregate cost of the ships under construction was exposed to fluctuations in the euro exchange rate at September 30, 2013 and December 31, 2012, respectively.  In October 2013, we entered into foreign currency forward contracts to hedge additional amounts related to the cost of our ships on order denominated in euros. As of the date of this filing, approximately 36.7% of the aggregate cost was exposed to fluctuations in the euro exchange rate.  The majority of our foreign currency forward contracts, collar options and cross currency swap agreements are accounted for as cash flow or fair value hedges depending on the designation of the related hedge.

 

During the second quarter of 2013, we entered into foreign currency forward contracts to hedge €365.0 million of our €745.0 million 5.625% unsecured senior notes due January 2014. These foreign currency forward contracts are accounted for as cash flow hedges and mature January 2014.

 

On a regular basis, we enter into foreign currency forward contracts to minimize the volatility resulting from the remeasurement of net monetary assets and liabilities denominated in a currency other than our functional currency or the functional currencies of our foreign subsidiaries. During the third quarter of 2013, we maintained an average of approximately $436.4 million of these foreign currency forward contracts.  These instruments are not designated as hedging instruments.  Changes in the fair value of the foreign currency forward contracts, of approximately $16.9 million and $4.5 million, during the quarter ended September 30, 2013 and September 30, 2012, respectively, and approximately $(8.6)

 

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million and $8.7 million, during the nine months ended September 30, 2013 and September 30, 2012, respectively, were recognized in earnings within other income (expense) in our consolidated statements of comprehensive income (loss).

 

The notional amount of outstanding foreign exchange contracts including our forward contracts and collar options as of September 30, 2013 and December 31, 2012 was $2.1 billion and $1.2 billion, respectively.

 

Non-Derivative Instruments

 

We consider our investments in our foreign operations to be denominated in relatively stable currencies and of a long-term nature.  We partially address the exposure of our investments in foreign operations by denominating a portion of our debt in our subsidiaries’ and investments’ functional currencies and designating it as a hedge of these subsidiaries and investments.  We had designated debt as a hedge of our net investments in Pullmantur and TUI Cruises of approximately €488.3 million and €481.7 million, or approximately $661.0 million and $635.1 million, as of September 30, 2013 and December 31, 2012, respectively.

 

Fuel Price Risk

 

Our exposure to market risk for changes in fuel prices relates primarily to the consumption of fuel on our ships.  We use fuel swap agreements and fuel call options to mitigate the financial impact of fluctuations in fuel prices.

 

Our fuel swap agreements are accounted for as cash flow hedges.  At September 30, 2013, we have hedged the variability in future cash flows for certain forecasted fuel transactions occurring through 2017.  As of September 30, 2013 and December 31, 2012, we had the following outstanding fuel swap agreements:

 

		Fuel Swap Agreements
		As of September 30, 2013		As of December 31, 2012
		(metric tons)
2013		214,000		755,000
2014		762,000		635,000
2015		590,000		363,000
2016		298,000		104,000
2017		74,000		—

 

		Fuel Swap Agreements
		As of September 30, 2013		As of December 31, 2012
		(% hedged)
Projected fuel purchases for year:
2013		63	%	55	%
2014		56	%	45	%
2015		40	%	25	%
2016		20	%	7	%
2017		5	%	—

 

At September 30, 2013 and December 31, 2012, $10.6 million and $47.2 million, respectively, of estimated unrealized net gains associated with our cash flow hedges pertaining to fuel swap agreements were expected to be reclassified to earnings from accumulated other comprehensive income (loss) within

 

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