4. Using the financial ratios provided by eVal, evaluate any trends in Royal Caribbean?s return on equity, compare it with Carnival Cruise?s return on equity, and discuss the main causes of any differences.

Royal Caribbean Cruises Forecasting for the Love Boat: Royal Caribbean Cruises in 1998 Much like Kate Winslet leaning over the bow of the Titanic, the North American cruise industry seems poised to either take flight or suffer a precipitous fall. The number of cruise passengers has grown from 500,000 in 1970 to 5,400,000 in 1998, a compounded average of 8.9% per year. Further, as the baby boomers mature, an increasing proportion of the population will fit the profile of a typical cruise customer - someone between 40 and 59 years old earning about $60,000. But all the news isn't bright. Based on the number of new ships that have already been ordered by major operators, the number of available berths in the North American market is expected to increase by over 40% in the next five years. Will the increase in demand for cruise vacations be sufficient to fill all the cabins on these new ships? Given the large fixed costs of operating a cruise vessel and the debt necessary to fund this capacity expansion, the cruise industry risks an encounter with an iceberg as it steams into the new millennium. This case focuses on Royal Caribbean Cruises in 1998. The first part of the case asks you to conduct a detailed analysis of Royal Caribbean's past financial statements and to compare them with their rival, Carnival Cruises. The second part of the case asks you to forecast the financial performance of Royal Caribbean for the next three years. Note that the chilling effect of September 11, 2001 on the travel and vacation business occurs mostly after the three years that you will be forecasting, so you don't have to pretend that you don't know about this major event. The case material that follows will provide you with a comprehensive picture of the North American cruise industry as it stood in 1998 along with specific financial and operating details of Royal Caribbean Cruises and Carnival Cruises. There is a wealth of information available and no single correct way to put it all together in your financial analysis and forecasts. Please limit your analysis to the information available in the case. The data supporting the graphs in this case are given in the appendix. The North American Cruise Industry in 1998 Cruise ships travel the world. Royal Caribbean Cruises, for instance, offers 175 destinations on six different continents. What defines the North American market is not the destination but the point of sale. Hence, North Americans purchase their trips in North America, but may fly to any part of the world to embark on a \"North American\" cruise. While all major cruise lines offer \"Air and Sea\" options, this is really just a Professor Russell Lundholm prepared this case at the University of Michigan Business School in 2002 as the basis for class discussion. Sources for this case include the Cruise Line International Association Market Overview, Cruise Industry News, the Tourism Industry Association of America, Royal Caribbean Cruises. 1998 10-K filing and Carnival Cruises 1998 10-K filing. I thank Cheryl Fenske at the Cruise Line International Association for her help in obtaining 1998 data. convenience for their customers. The air portion is priced at cost, and this portion of the trip is handled completely by the airline. Virtually all cruise purchases take place through a local travel agent. Demand for cruise vacations has growth rapidly over the past two decades as the figure below illustrates, with the only decrease in demand occurring in 1994-1995. Further, the average length of a cruise trip has grown to approximately 6.6 days, reaching levels not experienced since the early 1980s. Because of the fixed/variable cost structure in the cruise industry, longer trips are typically more profitable than short trips, so the industry has welcomed this trend. 7 6.8 5000 6.6 4000 6.4 3000 6.2 2000 6 1000 average cruise length (days) annual cruise passengers (thousands) 6000 5.8 0 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1982 1981 1980 5.6 The North American cruise industry is composed of two very large companies and many small ones. Carnival Cruise Lines is the largest firm with 33 ships carrying 2,045,000 passengers in 1998, 38% of the North American cruise market. Royal Caribbean Cruises is the second largest company with 16 ships carrying 1,841,000 passengers in 1998, a total of 34% of the North American market. A host of smaller cruise lines make up the rest of the industry, dividing 1,542,000 passengers between 96 vessels. The relative market shares are illustrated in the figure below. 1998 Market Share 100% 1542000 80% 69107 96 60% 1841000 All Other Royal Caribbean Cruises Carnival Cruises 29800 40% 16 2045000 20% 33 39466 0% ships berths passengers The Cruise Experience The cruise industry offers a wide variety of ship sizes, luxury levels and itineraries. From small, quasi-research vessels that probe Artic passages to massive \"mega-ships\" that resemble floating Malls of America, the cruise industry offers something for everyone. The Caribbean is the most common destination for cruises sold in North America, as seen in the table below, with approximately 39% of all passengerdays devoted to this destination. However, the table also shows that there has been a significant increase in demand for trips to locations such as the Mediterranean, Alaska and Europe. The latest trend is for huge ships that carry as many as 3000 guests, and offer a wide variety of entertainment alternatives. Such vessels feature rock-climbing, ice-skating, miniature golf, cinemas, discos, spa facilities, libraries, casinos, extensive live entertainment, and entire shopping malls, all onboard the ship. The focus of these cruise alternatives is on the vessel, rather than the destination. Bob Dickinson, the president of Carnival Cruises, remarked \"Now, the cruise itself is the destination - magnificent floating resorts. To me, the itinerary is a little Green Stamp, a little extra thing.\" Destination (total bed-days) CARIBBEAN MEDITERRANEAN ALASKA BAHAMAS TRANSCANAL MEXICO WEST EUROPE BERMUDA SOUTH AMERICA TRANSATLANTIC HAWAII ALL OTHER (15 other locations) TOTAL 1987 % of Total 1995 % of Total 1998 % of Total 8,828,791 43.3% 15,254,551 42.8% 17,117,659 38.7% 841,051 4.1% 3,477,729 9.8% 5,092,530 11.5% 1,715,197 8.4% 3,008,146 8.4% 3,790,816 8.6% 1,922,386 9.4% 2,761,224 7.7% 2,891,352 6.5% 970,191 4.8% 2,277,201 6.4% 2,612,788 5.9% 1,131,462 5.6% 1,754,312 4.9% 2,421,126 5.5% 357,516 1.8% 1,582,589 4.4% 3,714,437 8.4% 1,141,121 5.6% 1,094,707 3.1% 1,094,982 2.5% 620,396 3.0% 255,830 0.7% 943,392 2.1% 339,388 1.7% 658,928 1.8% 725,040 1.6% 602,728 3.0% 601,542 1.7% 745,216 1.7% 1,906,767 9.4% 2,935,123 14.4% 3,091,374 15.2% 20,376,994 100.0% 35,661,882 100.0% 44,240,712 100% Who's Onboard Obviously different types of cruises attract different types of customers. Nonetheless, certain demographic profiles are most likely to take a cruise. The table below compares the demographic profile of those who have taken a cruise with the entire U.S. population over the age of 24. Generally, the population of past cruisers is older, wealthier and better educated than the entire population. Demographic Profile Male Female 25-under 40 years Age: 40-59 years 60 years or older Average Median Married Marital Not Married Status: Have children Household Composition: under 18 Adults only Occupants Education: Some College or less College Graduate or more $20,000-$29,999 Household $30,000-$39,999 Income: $40,000-$59,999 $60,000-$99,999 $100,000 or more Average Median Gender: Ever Cruised Past 5 Year Population Cruisers over Age 24 49% 51% 27% 42% 32% 51 yrs. 51 yrs. 76% 24% 51% 48% 28% 42% 30% 50 yrs. 51 yrs. 78% 22% 50% 49% 43% 44% 13% 43 yrs. 42 yrs. 69% 31% 37% 63% 3 35% 65% 3 54% 46% 3 42% 58% 36% 64% 54% 46% 8% 12% 32% 28% 20% $72,600 $58,500 5% 10% 31% 30% 25% $79,100 $64,500 13% 17% 31% 29% 9% $60,400 $51,800 Examining those who have cruised most recently reveals a few different types of customers, as the figure below illustrates, but most seek the relaxation and pampering that a cruise can provide. Indeed, when the recent cruiser population was asked what cruising offered that was superior to other types of vacations, the top three responses were \"being pamper,\" \"fine dining\" and \"hassle free.\" Restless Baby Boomers are newest to cruising. They are at a point in time when they may be trying different vacation experiences. Enthusiastic Baby Boomers are already convinced about cruising and its many activities. They live intense, stressful lives and look to vacations generally, and cruises in particular, for the escape and relaxation they offer. Luxury Seekers can afford, and are willing to spend money for deluxe accommodations and pampering. Consummate Shoppers are looking for the best value in a vacation and in a cruise. Explorers are well-educated, well-traveled individuals with an intellectual interest and curiosity about different destinations. Ship Buffs are the most senior segment: they have cruised extensively and expect to continue because they find the on-board experience of cruising so pleasurable and comfortable. Supply of Available Berths The supply of available berths as of 1998 was shown in the market share figure given earlier. Further, because the lead-time necessary to design and build a cruise ship is approximately three years, a reasonably accurate forecast of future supply is available for the next three years, as seen in the figure below (more detailed information about Royal Caribbean's new ships is available later in the case). It is more difficult to estimate the amount of capacity that will be retired in the future. Over the past five years, 48 ships with a total of 28,900 berths have been retired or moved out of the North American market. However, many of these retirements occurred because of a 1997 deadline to meet the heightened safety requirements imposed by the International Maritime Organization. From 1994 through 1996, retirements exceeded 7000 berths per year but have slowed considerably since then. NEW Capacity 1999 1999 2000 2000 2001 2001 ships berths ships berths ships berths Carnival Cruises (includes Holland brand) Royal Caribbean Cruises (includes Celebrity brand) All Other Cruise Lines Total New Ships/Berths total new ships total new berths 3 5480 2 6180 2 3900 7 15560 1 3100 3 5100 3 6000 7 14200 7 11 7794 16374 2 7 2800 14080 4 9 6396 16296 15 27 16990 46750 Demand for a Cruise Vacation To date only 11% of the U.S. population has ever taken a cruise. However, a recent cruise industry survey of people over the age of 24 found that 56% are interesting in cruising sometime in the future and 31% responded that they will definitely take a cruise in the next five years. Demographic trends also favor the cruise industry. As the demographic profile showed, 42% of recent cruise passengers are between the ages of 40 and 59. As the baby boomers age, this segment of the U.S. population is estimated to grow at more than three times the national population growth rate over the next three years, as seen in the figure below. annual population growth rates by age 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% -0.50% -1.00% -1.50% -2.00% age 24 and under age 25-39 age 40-59 age 60 and over Along with growth in the US population, it is possible that the amount of vacation time per individual will increase over time. Numerous studies have shown that the baby boomer generation values recreation more highly than previous generations. This is illustrated in the next figure that plots grow rates in the U.S. gross domestic product (GDP), personal consumption and recreation expenditures. As figure shows, growth in personal consumption maps closely to growth in the gross domestic product (GDP). By comparison, recreation spending has grown faster than personal consumption in every year since 1980, with the gap between the two increasing dramatically after the 1991 recession. This increase is widely attributed to the consumption tastes of the baby boomer generation. The figure also shows the 1998 Congressional Budget Office's forecasts for future GDP growth. 12.0 10.0 percentage growth 8.0 6.0 4.0 2.0 2001E 2000E 1999E 1998E 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1982 1981 1980 0.0 -2.0 -4.0 Real GDP Personal Consumption Expenditures Recreation Expenditures Finally, U.S. residents vacation far less than the citizens of all other developed countries, averaging just 13 days per year. As the figure below illustrates, even the hard-working Japanese and Koreans vacation almost twice as much as Americans. Italians, living the good life, vacation more than three times as much. It is certainly possible that Americans will increase their vacation expenditures even more in the future. Average Number of Vacation Days 45 40 35 30 25 20 15 10 5 0 Italy France Germany Brazil Austria UK Canada Korea Japan USA Appendix 1 Cruise Industry, Demographic and Macroeconomic Data Panel A: passengers and berths over time year annual passengers (thousands) average lenth of trip (days) % of passengers on 2-5 day trips available berths passenger growth % berth growth % year annual passengers (thousands) average lenth of trip (days) % of passengers on 2-5 day trips available berths passenger growth % berth growth % 1980 1431 1981 1453 6.7 29.6 41073 1.5% 1982 1471 6.9 25.3 47266 1.2% 15.1% 1983 1755 6.9 21.6 47834 19.3% 1.2% 1984 1859 6.9 22.3 52392 5.9% 9.5% 1985 2152 6.8 26.3 56771 15.8% 8.4% 1986 2624 6.4 35.1 60446 21.9% 6.5% 1987 2898 6.4 32.8 66810 10.4% 10.5% 1988 3175 6.4 32.9 72268 9.6% 8.2% 1990 1991 1992 1993 1994 1995 1996 1997 1998 3640 3979 4136 4480 4448 4378 4656 5051 5428 6.2 6.1 6.2 6.4 6.3 6.5 6.4 6.5 6.6 38.3 37.4 35.2 36.7 38 33.7 35.9 33.6 34.7 83533 86631 97539 103988 103296 105171 110292 118399 138373 0.10773 0.093132 0.039457 0.083172 -0.007143 -0.015737 0.063499 0.084837 0.074639 0.154265 0.037087 0.125913 0.066117 -0.006655 0.018152 0.048692 0.073505 0.168701 Panel B: existing and new capacity 1998 existing 1998 existing ships berths 33 39466 16 96 145 29800 69107 138373 NEW Capacity 1999 1999 2000 2000 2001 2001 ships berths ships berths ships berths total new ships total new berths Carnival Cruises (includes Holland brand) 3 5480 2 6180 2 3900 7 15560 Royal Caribbean Cruises (includes Celebrity brand) 1 3100 3 5100 3 6000 7 14200 All Other Cruise Lines Total New Ships/Berths 7 11 7794 16374 2 7 2800 14080 4 9 6396 16296 15 27 16990 46750 Panel C: destinations Destination (total bed-days) CARIBBEAN MEDITERRANEAN ALASKA BAHAMAS TRANSCANAL MEXICO WEST EUROPE BERMUDA SOUTH AMERICA TRANSATLANTIC HAWAII ALL OTHER (15 other locations) TOTAL 1987 % of Total 1995 % of Total 1998 % of Total 8,828,791 43.3% 15,254,551 42.8% 17,117,659 38.7% 841,051 4.1% 3,477,729 9.8% 5,092,530 11.5% 1,715,197 8.4% 3,008,146 8.4% 3,790,816 8.6% 1,922,386 9.4% 2,761,224 7.7% 2,891,352 6.5% 970,191 4.8% 2,277,201 6.4% 2,612,788 5.9% 1,131,462 5.6% 1,754,312 4.9% 2,421,126 5.5% 357,516 1.8% 1,582,589 4.4% 3,714,437 8.4% 1,141,121 5.6% 1,094,707 3.1% 1,094,982 2.5% 620,396 3.0% 255,830 0.7% 943,392 2.1% 339,388 1.7% 658,928 1.8% 725,040 1.6% 602,728 3.0% 601,542 1.7% 745,216 1.7% 1,906,767 9.4% 2,935,123 14.4% 3,091,374 15.2% 20,376,994 100.0% 35,661,882 100.0% 44,240,712 100% Panel D: U.S. demographics US Demographic Estimates (all amounts in thousands) 1-Jul-98 1-Jul-99 1-Jul-00 1-Jul-01 1-Jul-02 1-Jul-03 1-Jul-04 1-Jul-05 Pop ula tion, All Ag es 270,299 272,820 275,306 277,803 280,306 282,798 285,266 287,716 Sum ma ry Ind ic a tors Med ia n Ag e.......... Mea n Ag e............ 35.2 36.2 35.5 36.4 35.8 36.5 36 36.7 36.2 36.8 36.4 36.9 36.5 37.1 36.7 37.2 95,342 61,400 68,886 44,670 96,197 60,556 70,981 45,086 96,969 59,717 73,108 45,514 97,792 58,862 75,131 46,016 98,484 58,158 77,020 46,645 99,143 57,564 78,485 47,606 99,695 57,137 80,027 48,406 100,117 57,015 81,367 49,220 annual growth in population a g e 24 a nd und er a g e 25-39 a g e 40-59 a g e 60 a nd over 0.93% 0.90% -1.37% 3.04% 0.93% 0.91% 0.80% -1.39% 3.00% 0.95% 0.91% 0.85% -1.43% 2.77% 1.10% 0.90% 0.71% -1.20% 2.51% 1.37% 0.89% 0.67% -1.02% 1.90% 2.06% 0.87% 0.56% -0.74% 1.96% 1.68% 0.86% 0.42% -0.21% 1.67% 1.68% 24 a nd und er 25 to 39 40 to 59 60 a nd over Panel E: macroeconomic trends and estimates % growth in Personal % growth in CPI Consumption Recreation real GDP (inflation) Expenditures Expenditures 1980 -0.3 13.5 -0.4 -0.1 1981 2.3 10.3 1.2 4.0 1982 -2.1 6.2 1.2 2.4 1983 4.0 3.2 5.2 8.9 1984 7.0 4.3 5.2 9.5 1985 3.6 3.6 4.7 6.4 1986 3.1 1.9 4 8.0 1987 3.0 3.6 3.1 7.3 1988 3.8 4.1 3.9 8.0 1989 3.4 4.8 2.3 4.4 1990 1.2 5.4 1.7 3.4 1991 -0.9 4.2 -0.6 1.1 1992 2.7 3.0 2.8 5.3 1993 2.3 3.0 2.8 8.8 1994 3.5 2.6 3.1 8.0 1995 2.3 2.8 2.3 9.3 1996 3.5 3.0 2.5 7.7 1997 3.9 2.3 3.5 8.6 1998E 3.0 2.9 1999E 2.1 2.3 2000E 1.9 2.5 2001E 2.0 2.4 estimates are from the 1998 Economic and Budget Outlook from the Congressional Budget Office source: Bureau of Economic Analysis --------------------------------------------------------------------------------------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 20-F (MARK ONE) REGISTRATION STATEMENT PURSUANT TO SECTION 12(B) OR (G) OF THE SECURITIES EXCHANGE ACT OF 1934 OR [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER: 1-11884 ROYAL CARIBBEAN CRUISES LTD. (Exact name of Registrant as specified in its charter) REPUBLIC OF LIBERIA (Jurisdiction of incorporation or organization) 1050 CARIBBEAN WAY, MIAMI, FLORIDA 33132 (Address of principal executive offices) Securities registered or to be registered pursuant to Section 12(b) of the Act: TITLE OF EACH CLASS ------------------Common Stock, par value $.01 per share $3.625 Series A Convertible Preferred Stock par value $.01 per share NAME OF EACH EXCHANGE ON WHICH REGISTERED --------------------------------------New York Stock Exchange New York Stock Exchange PART I ITEM 1. DESCRIPTION OF BUSINESS GENERAL Royal Caribbean Cruises Ltd., a Liberian corporation, including its subsidiaries (the "Company"), is the world's second largest cruise company with 16 cruise ships and a total of 29,800 berths. The Company offers more than 110 different itineraries that call on more than 175 destinations on six continents. The Company operates two brands, the Royal Caribbean International brand ("Royal Caribbean International") and the Celebrity Cruises brand ("Celebrity Cruises"). The Company acquired Celebrity Cruise Lines Inc. ("Celebrity") in July 1997. The Royal Caribbean International Brand Royal Caribbean International serves the volume cruise vacation market which it categorizes as the contemporary and premium segments. The brand operates 11 cruise ships with an aggregate of 21,600 berths, offering more than 60 different cruise itineraries, that range from three to 21 nights and call on more than 140 destinations on six continents. Royal Caribbean International's strategy is to attract a broad array of vacationing consumers in the contemporary segment of the volume market by providing a wide variety of itineraries, varying cruise lengths and multiple options for dining and entertainment aboard its vessels. The Company believes that the variety and quality of Royal Caribbean International's product offering represent excellent value to consumers, especially to couples and families traveling with children. While the brand is positioned at the upper end of the contemporary segment, the Company believes that Royal Caribbean International's quality enables it to attract consumers from the premium segment as well, thereby achieving the broadest market coverage of any of the major brands in the cruise industry. The Celebrity Cruises Brand Celebrity Cruises primarily serves the premium segment of the cruise vacation market. Celebrity Cruises operates five cruise ships with an aggregate of 8,200 berths. Celebrity Cruises offers more than 40 different itineraries, that range from five to 19 nights, reaching over 80 destinations in Alaska, Bermuda, the Caribbean, Europe, Mexico, and the Panama Canal. Celebrity Cruises' strategy is to attract consumers who want an enhanced cruise vacation in terms of modern vessels, fine dining and service, large staterooms, a high staff to guest ratio, excellent spas and high technology. These are hallmarks of the premium cruise vacation market, which is Celebrity Cruises' primary target. One of Celebrity Cruises' principal objectives is to offer a premium cruise experience. As such, it also attracts consumers from the contemporary and luxury cruise categories. Both brands offer a wide array of shipboard activities, services and amenities including swimming pools, sun decks, beauty salons, exercise and massage facilities, gaming facilities, lounges, bars, show-time entertainment, retail shopping and cinemas. Although many of the shipboard activities are included in the base price of the cruise, revenues are also realized from gaming facilities, the sale of alcoholic and other beverages, retail sales and shore excursions. INDUSTRY Since 1970, cruising has been one of the fastest growing sectors of the vacation market, as the number of North American guests has grown to an estimated 5.4 million in 1998 from 0.5 million in 1970, a compound annual growth rate of approximately 9%, according to Cruise Lines International Association ("CLIA"). The Company has capitalized on the increasing popularity of cruises through an extensive fleet expansion program. The Company's revenues have increased at a compound annual growth rate of approximately 18% between 1988 and 1998. The Company's market share of North American guests carried in 1998 is estimated to have been approximately 33.9%. The following table sets forth data regarding industry and Company growth over the past five years based on guests carried for at least three consecutive nights: YEAR ---- GUESTS CARRIED ON THE COMPANY'S SHIPS(2) ---------- NORTH AMERICAN CRUISE GUESTS(1) ------------- COMPANY PERCENTAGE ---------- 1994.................................. 1995.................................. 1996.................................. 1997.................................. 1998.................................. 1,051,868 1,058,126 1,245,696 1,633,457 1,841,152 4,448,000 4,378,000 4,659,000 5,051,000 5,428,000 23.6% 24.2 26.7 32.3 33.9 (1) Source: CLIA (2) 1994 -- 1997 are proforma to include Celebrity Cruises According to CLIA and other trade publications, the North American market was served by an estimated 130 cruise ships with an aggregate capacity of approximately 102,000 berths at the end of 1993. The number of berths in the industry is estimated to have increased to approximately 128,000 berths on 122 ships by the end of 1998. There are a number of cruise ships on order with a total estimated capacity of 64,000 berths which will be placed in service between 1999 and 2004. Over the last five years, approximately 48 ships with an aggregate capacity of approximately 28,900 berths have either been retired or moved out of the North American market. Although the Company cannot predict the rate at which future retirements will occur, the Company believes ship retirements will continue due to competitive pressures and age of vessels. Cruise lines compete for consumers' disposable leisure time dollars with other vacation alternatives such as land-based resort hotels and sightseeing destinations, and public demand for such activities is influenced by general economic conditions. The Company believes that cruise guests currently represent only a small share of the vacation market and that a significant portion of cruise guests carried are "first-time cruisers." OPERATING STRATEGIES The Company's principal operating strategies are the following: (i) build the awareness and market penetration of the brands; (ii) continue to expand its fleet with state-of-the-art cruise ships; (iii) broaden its itineraries worldwide; (iv) maintain its competitive position with respect to the quality and innovation of its on-board product; (v) maintain strong relationships with travel agencies, the principal industry distribution system; (vi) further expand international passenger sourcing; (vii) utilize sophisticated yield management systems (revenue optimization per berth); and (viii) further improve its technological capabilities. Brand Awareness The Company's strategy is to continue to broaden the recognition of both the Royal Caribbean International brand and the Celebrity Cruises brand in the cruise vacation marketplace. Each brand has a distinct identity and marketing focus but utilizes shared infrastructure resources. Royal Caribbean International has positioned itself in the contemporary and premium segments of the cruise vacation market and focuses on providing multiple choices to its guests through a variety of itineraries, accommodations, dining, ship activities and shore excursions. Hallmarks of the brand include friendly service, family programs, entertainment, health and fitness and activities for various age groups. Celebrity Cruises primarily serves the premium segment of the cruise vacation market. The brand is recognized for its fine dining, impeccable service, large staterooms, a high staff to guest ratio and excellent spa facilities. In 1998 and 1999 Berlitz rated Celebrity Cruises the highest rated premium cruise line in the large vessel category (over 1,000 passenger berths). Fleet Expansion Royal Caribbean International Founded in 1968, Royal Caribbean International was the first cruise line to design ships specially for warm water year round cruising. Royal Caribbean International operated a modern fleet in the 1970's and early 1980's, establishing a reputation for high quality. Between 1988 and 1992, the brand tripled its capacity by embarking on its first major capital expansion program. Royal Caribbean International committed to its second capital expansion program with orders for six Vision-class vessels, ranging in size from 1,800 to 2,000 berths, for delivery from 1995 through 1998. With the delivery of the Vision-class vessels, Royal Caribbean International's capacity increased by 61.7% to 23,000 berths at the end of 1998. Each Vision-class ship features a seven-deck atrium with glass elevators, skylights and glass walls; a pool and entertainment complex covered by a moveable glass roof; hundreds of cabins with verandahs; a two-deck main dining room; a state-of-the-art show theater; a glass-encased indoor/outdoor cafe; and a shopping mall. The ships are designed to be faster than most cruise ships which permits more flexibility in itinerary planning. Royal Caribbean International currently has three Eagle-class vessels on order for delivery in the fourth quarter of 1999, third quarter of 2000 and second quarter of 2002. The Eagle-class vessels will be the largest passenger cruise ships built to date; 142,000 tons with 3,100 berths. This new generation of vessels will be designed to provide more diverse vacation options for families and those seeking active sports and entertainment alternatives. Each Eagle-class ship features the cruise industry's first horizontal atrium which is the length of two football fields, four decks high and includes two eleven-deck atriums; recreational activities such as rock climbing and ice skating; enhanced staterooms; expanded dining options; and a variety of intimate spaces. Royal Caribbean International also has two Vantage-class vessels on order scheduled for delivery in the first quarter of 2001 and second quarter of 2002. The Vantage-class is a progression from the brand's Vision-class series and will carry approximately 2,100 guests. Beginning in 1999 through 2002, Royal Caribbean International's capacity is expected to increase 52.6% to 35,100 berths. CELEBRITY CRUISES Celebrity Cruises was founded in 1990 and operated three ships between 1992 and 1995. Between 1995 and 1997, Celebrity Cruises undertook its first capital expansion program, adding three Century-class vessels which range in size from 1,750 to 1,850 berths. Celebrity Cruises has on order four Millennium-class vessels which will have approximately 2,000 berths and are scheduled for delivery in the second quarter 2000, first quarter 2001, third quarter 2001 and second quarter 2002. The Millennium-class ships are a progression from the Century-class vessels, which have been widely accepted in the premium segment of the marketplace. This new class of vessels will build on the brands' primary strengths, including fine dining, large cabins, extensive spa facilities and impeccable service. Beginning in 2000 through 2002, Celebrity Cruises' capacity is expected to increase 97.7% to 16,200 berths. At year-end 1998, the Company's combined fleet had an average age of approximately five years, which the Company believes is the youngest of any major cruise company. On a combined basis, beginning in 1999 through 2002, the Company's year-end berth capacity is expected to increase 64.4% from 31,200 to 51,300 berths. The Company's increased average ship size and number of available berths have enabled it to achieve certain economies of scale. Larger ships allow the Company to transport more guests than smaller ships without a corresponding increase in certain operating expenses. This increase in fleet size also provides a larger revenue base to absorb its marketing, selling and administrative expenses. Worldwide Itineraries The Company's 1999 itineraries include more than 110 different itineraries that call on more than 175 destinations on six continents. New ships allow the Company to expand into new destinations, itineraries and markets. In 1999, Royal Caribbean International will be offering the "Royal Journeys" program which offers 10 global cruise itineraries visiting 41 ports in 19 countries on four continents. Celebrity Cruises is repositioning a vessel to the European market. In addition, the Company is increasing its capacity in the short cruise market in 2000 by establishing a Royal Caribbean International vessel year round in Port Canaveral to provide 3 and 4 day Bahamas cruises. Product Innovation The Company recognizes the need for new and innovative on-board products and experiences for guests, and develops these products based on guest feedback, crew suggestions and competitive product reviews. Accordingly, the Company continues to invest in design innovations on new ships and additional product offerings on its existing fleet. New offerings such as expanded dining options, and recreational activities such as rock climbing and ice skating are among the services to be offered in the future. Travel Agency Support Because essentially all the bookings for the Company's ships are made by independent travel agencies, the Company is committed to supporting the travel agency community. The Company maintains a large sales support organization including 100 district sales managers supporting both brands in North America. The Company was the first cruise company to develop an automated booking system, CruiseMatch 2000(TM). This automated reservations system allows travel agents direct access to the Company's computer reservation system to improve ease of bookings. More than 30,000 independent travel agencies worldwide can book cruises for both brands using CruiseMatch 2000(TM). The Company also offers CruiseMatch 2000 Online(R) which makes CruiseMatch 2000(TM) accessible to travel agencies through the Royal Caribbean International and Celebrity Cruises websites. In 1998, the Company launched CruiseWriter(sm), an instant collateral system that allows travel agents to customize collateral materials for their clients. In 1997, the Company also opened a reservation call center in Wichita, Kansas to offer greater flexibility and extended hours of operations. International Guests International guests continue to provide an increasing share of the Company's growth. International guests have grown from approximately 7% of total guests in 1991 to approximately 16% of total guests in 1998. One of the Company's strategies is to use fleet deployment and expanded itineraries to increase its passenger sourcing outside North America. During 1998, the Company hired a senior vice president of international sales and marketing to further develop and expand its international sales capability. The Company carries out its international sales effort through sales offices located in London, Frankfurt, Oslo, Genoa and Paris, and a network of 38 independent international representatives located throughout the world. The Company is also able to accept bookings in various currencies. Yield Management The Company continues to develop more sophisticated pricing and yield management programs to maximize its occupancy and revenue by projecting the demand for its cruises in various passenger markets and, based on certain variables, directing its marketing efforts toward such markets. In addition to projecting demand, these programs will continue to enable the Company to react quickly to changes in market conditions. Technological Development The Company's computer system, known as Enterprise 2000, is used by both brands and provides the foundation for: (i) a sophisticated reservation system; (ii) sales tools to be used by the Company's combined field sales force; and (iii) productivity tools for travel agents. The Company has developed a corporate shoreside intranet as well as electronic ship to shore communication tools to improve its internal productivity. Both Royal Caribbean International and Celebrity Cruises have extensive websites, providing access to millions of Internet users throughout the world. SALES, MARKETING AND PASSENGER SERVICES The Company sells its cruise vacations almost exclusively through approximately 30,000 independent travel agencies worldwide. The Company maintains a large sales support organization including 100 district sales managers supporting both brands in North America. The Company also utilizes a telemarketing program in the United States and Canada called CruiseConnect to contact smaller travel agencies to inform them of new products and promotions. The Company believes that maintaining personal contact with travel agency owners, managers and front-line retail agents is crucial to retaining travel agency loyalty. The Company augments this type of contact with an extensive program of seminars designed to familiarize travel agents with the cruise industry and the marketing of cruises. Royal Caribbean International pursues a comprehensive marketing program with an emphasis on consumer advertising using the tag line, "Like no vacation on earth(sm)." Through its advertising, Royal Caribbean International positions itself as a provider of high quality, all-inclusive, cruise vacations offering a variety of destinations and, in the Company's opinion, considerable value. Royal Caribbean International attempts to convey the message that the style and level of service of its shipboard cruise experience, together with the destinations visited by its ships, is an attractive alternative to land-based vacations. Celebrity Cruises also pursues a comprehensive marketing program with an emphasis on consumer advertising using the tag line, "Exceeding expectations(sm)". An advertising campaign utilizing national television, magazines and newspapers features commercials with the theme, "Simply the Best". The Company believes that Celebrity Cruises represents enhanced value to the premium segment based on elements such as its dining experience, staff to guest ratio, cabin size, artwork, technology, AquaSpa(sm) packages and its modern fleet of ships, all of which have been built in the 1990's. OPERATIONS Cruise Ships and Itineraries The Company operates 16 ships under two brands and offers more than 110 different itineraries ranging from three to 21 nights that call on more than 175 destinations on six continents. The following table represents summary information concerning the Company's ships and their areas of operation based on 1999 itineraries (subject to change): YEAR VESSEL ENTERED SERVICE --------------- PASSENGER CAPACITY(1) ----------- ROYAL CARIBBEAN INTERNATIONAL: Voyager of the Seas(2)............. Vision of the Seas................. Enchantment of the Seas............ Rhapsody of the Seas............... 1999 1998 1997 1997 3,100 2,000 1,950 2,000 Grandeur of the Seas............... Splendour of the Seas.............. 1996 1996 1,950 1,800 Legend of the Seas................. 1995 1,800 Majesty of the Seas................ Monarch of the Seas................ Viking Serenade(3)................. Nordic Empress..................... Sovereign of the Seas.............. 1992 1991 1982/1991 1990 1988 2,350 2,350 1,500 1,600 2,250 CELEBRITY CRUISES: Mercury............................ 1997 1,850 Galaxy............................. Century............................ 1996 1995 1,850 1,750 Zenith............................. Horizon............................ 1992 1990 1,350 1,350 PRIMARY AREAS OF OPERATION ---------------------------Western Caribbean Panama Canal, Hawaii, Alaska Eastern & Western Caribbean Alaska, Southern Caribbean, Mexico, Panama Canal, Hawaii Eastern Caribbean Europe, Caribbean, Canada/New England Europe, Hawaii, Panama Canal, Mexico, Royal Journeys Western & Southern Caribbean Southern Caribbean Mexican Baja Southern Caribbean, Bermuda Bahamas Western Caribbean, Alaska, Panama Canal Southern Caribbean, Alaska Eastern & Western Caribbean, Europe Panama Canal, Bermuda Southern Caribbean, Bermuda (1) Based on double occupancy per cabin. (2) Voyager of the Seas is expected to enter service in November 1999. (3) Indicates year placed in service and year redeployed after conversion to expand capacity. At year-end 1998, the combined fleets of Royal Caribbean International and Celebrity Cruises had an average age of approximately five years, which the Company believes is the youngest of any major cruise company. New Vessels The Company has nine ships on order. The planned passenger capacity and expected delivery dates of the ships on order are as follows: VESSEL -----ROYAL CARIBBEAN INTERNATIONAL: Eagle-class Voyager of the Seas(2)................................. Explorer of the Seas................................... Adventure of the Seas.................................. Vantage-class Radiance of the Seas................................... Brilliance of the Seas................................. CELEBRITY CRUISES: Millennium-class Millennium............................................. Unnamed................................................ Unnamed................................................ Unnamed................................................ EXPECTED DELIVERY DATES ----------------- PASSENGER CAPACITY(1) ----------- 4th Quarter 1999 3rd Quarter 2000 2nd Quarter 2002 3,100 3,100 3,100 1st Quarter 2001 2nd Quarter 2002 2,100 2,100 2nd 1st 3rd 2nd 2,000 2,000 2,000 2,000 Quarter Quarter Quarter Quarter 2000 2001 2001 2002 (1) Based on double occupancy per cabin. (2) Included in table on prior page -- Cruise Ships and Itineraries. The Eagle-class vessels are being built in Turku, Finland by Kvaerner-Masa Yards which built two of the Royal Caribbean International ships. The Vantage-class vessels are being built in Papenburg, Germany by Meyer Werft, the same shipyard which built all of the Celebrity Cruises vessels. The Millennium-class vessels are being built by Chantiers de l'Atlantique in St. Nazaire, France, the same shipyard which built seven of the Royal Caribbean International ships. The aggregate contract price of the nine ships, which excludes capitalized interest and other ancillary costs, is approximately $3.6 billion. Shipboard Activities and Shipboard Revenues Both brands offer modern fleets with a wide array of shipboard activities, services and amenities including swimming pools, sun decks, spa facilities which include massage and exercise facilities, beauty salons, gaming facilities (which operate while the ships are at sea), lounges, bars, Las Vegas-style entertainment, retail shopping, libraries, cinemas, conference centers and shore excursions at each port of call. While many shipboard activities are included in the base price of a cruise, additional revenues are realized from gaming, the sale of alcoholic and other beverages, the sale of gift shop items, shore excursions, photography and spa services. Private Destinations Royal Caribbean International operates two private destinations: (i) CocoCay, an island owned by the Company and known as Little Stirrup Cay located in the Bahamas; and (ii) Labadee, a secluded peninsula leased by the Company and located on the north coast of Haiti. The facilities at CocoCay and Labadee include, among others, a variety of watersports activities, refreshment bars, artisan markets and picnic facilities. Seasonality The Company's revenues are moderately seasonal, due to variations in rates and occupancy percentages. See Note 14 to the Annual Consolidated Financial Statements. Guests and Capacity The following table sets forth the aggregate number of guests carried and the number of guests expressed as a percentage of total capacity for the Company's ships: FISCAL YEARS ------------------------------1998 1997 1996 ----------------------Number of Guests....................................... Percentage of Total Capacity.......................... 1,841,152 105.2% 1,465,450 104.2% 973,602 101.3% In accordance with cruise industry practice, total capacity is determined based on double occupancy per cabin even though some cabins accommodate three or four guests; accordingly, a percentage in excess of 100% indicates that more than two guests occupied some cabins. Cruise Pricing The Company's cruise prices include a wide variety of activities and amenities, including all meals and entertainment. Prices vary depending on the destination, cruise length, cabin category selected and the time of year the voyage takes place. Additionally, the Company offers "Air add-ons" for guests that elect to utilize the Company's Air/Sea Program. Air add-ons vary by gateway and destination and are available from cities in the United States, Canada and Europe. Furthermore, the Company sells trip cancellation insurance which provides guests with insurance coverage for trip cancellation, medical protection and baggage protection. SUPPLIERS The Company's largest purchases are for airfare, food and related items, advertising, diesel fuel, hotel supplies and products related to passenger accommodations. Most of the supplies required by the Company are available from numerous sources at competitive prices. The Company's largest operating cost is air transportation for its guests. None of the Company's suppliers provided goods or services representing in excess of 10% of the Company's revenues in 1998. EMPLOYEES As of December 31, 1998, the Company and its subsidiaries employed approximately 2,300 full-time and 400 part-time employees in shoreside operations worldwide. The Company and its subsidiaries also employ approximately 18,300 crew and staff for its vessels. As of December 31, 1998, approximately 70% of the Company's shipboard employees are covered by collective bargaining agreements. The Company believes that its relationship with its employees is good. TAXATION OF THE COMPANY The following discussion of the application to the Company and its subsidiaries of the United States federal income tax laws is based on the current provisions of the Internal Revenue Code of 1986, as amended, (the "Code"), proposed, temporary and final Treasury Department regulations, administrative rulings and court decisions. All of the foregoing are subject to change, and any change thereto could affect the accuracy of this discussion. Application of Section 883 of the Code The Company and its wholly owned subsidiary, Celebrity Cruises Inc. ("CCI"), are foreign corporations that are engaged in a trade or business in the United States, and the Company's vessel-owning subsidiaries are foreign corporations that, in many cases, depending upon the itineraries of their vessels, receive income from sources within the United States. Under Section 883 of the Code, certain foreign corporations are not subject to United States income or branch profits tax on United States source income derived from or incidental to the international operation of a ship or ships, including income from the leasing of such ships. ITEM 2. DESCRIPTION OF PROPERTY For a description of the Company's cruise ships, see "Item 1. Description of Business -- Operations -- Cruise Ships and Itineraries." The Company leases three office buildings on the Port of Miami from Dade County, Florida. Two of the buildings have initial terms of 20 years which began in 1991 and 1995, respectively, and the third building has an initial term of 17 years which began in 1998. The Company also leases a building in Wichita, Kansas which is used as an additional reservation center with an initial term of ten years beginning in 1997. The Company leases space for its international sales offices in London, Oslo, Frankfurt, Genoa and Paris. Royal Caribbean International operates two private destinations, (i) CocoCay, an island owned by the Company and known as Little Stirrup Cay located in the Bahamas and (ii) Labadee, a secluded peninsula leased by the Company and located on the north coast of Haiti. The Company owns one building in San Juan, Puerto Rico and leases a second building in St. Thomas, Virgin Islands for Royal Caribbean International's Crown and Anchor Clubs. These facilities, which are exclusively for Royal Caribbean International's guests, provide a rest stop where guests can check packages, get refreshments or make phone calls. The Company believes that its facilities are adequate for its current needs. ITEM 3. LEGAL PROCEEDINGS In June 1998, the Company entered into a plea agreement with the U.S. Department of Justice settling previously filed charges contained in two indictments pending in the U.S. District of Puerto Rico and the Southern District of Florida, respectively. The indictments, which pertained to events that occurred in 1994 and prior years, contained a total of 11 felony counts related to improper disposal of oil-contaminated bilge water and attempts to conceal such activities from the U.S. Coast Guard. Under the plea agreement, the Company pled guilty to eight of the 11 counts and paid $9.0 million. The Company was also placed on probation for up to five years and has implemented a Court supervised Environmental Compliance Plan. The U.S. government is continuing its investigation of the Company's bilge water and other waste disposal practices through federal grand jury proceedings in Anchorage, Alaska, Los Angeles, California, Miami, Florida and New York, New York. In February 1999, the Company was indicted by the grand jury in Los Angeles on charges that it presented false oil record books for one of its vessels to the U.S. Coast Guard three times during 1994 and the Company has pled guilty to these charges. Each of the three counts in the indictment carries a maximum fine of $500,000, subject to increase under certain circumstances. Although the Company is not able at this time to estimate the timing or impact of these continuing investigations, the Company may be subject to additional charges for violations of U.S. law. The Company is routinely involved in other claims typical to the cruise industry. The majority of these claims are covered by insurance. Management believes the outcome of such other claims which are not covered by insurance would not have a material adverse effect upon the Company's financial condition or results of operations. ITEM 9. 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", may constitute "forward-looking statements" under the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are not guarantees of future performance and involve known and unknown risks, uncertainties and other factors, which may cause the actual results, performance or achievements to differ materially from the future results, performance or achievements expressed or implied in such forward-looking statements. Such factors include inter alia general economic and business conditions, cruise industry competition, the impact of tax laws and regulations affecting the Company and its principal shareholders, changes in other laws and regulations affecting the Company, delivery schedule of new vessels, emergency ship repairs, incidents involving cruise vessels at sea, changes in interest rates, Year 2000 compliance and weather. GENERAL Summary Royal Caribbean Cruises Ltd. (the "Company") reported improved revenues, operating income, net income and earnings per share for the year ended December 31, 1998 as shown in the table below. The improvements were driven primarily by capacity increases resulting from the acquisition of Celebrity Cruise Lines Inc. ("Celebrity") in July 1997, and additions to the Royal Caribbean International brand as well as improved revenue per available lower berth ("Yield"). Net income for 1998 included a $9.0 million charge related to a plea agreement with the U.S. Department of Justice in the second quarter and a reduction in earnings of approximately $9.0 million related to the grounding of Monarch of the Seas in the fourth quarter. Also included in net income for 1998 is a $31.0 million gain on the sale of Song of America and a $32.0 million write-down of Viking Serenade to reflect its estimated fair market value. Net income for 1997 included an extraordinary loss of $7.6 million resulting from the early extinguishment of debt as well as a gain of $4.0 million from the sale of Sun Viking. Accordingly, on a comparable basis, before these items, earnings increased to $349.8 million or $1.93 per share in 1998, from $178.7 million or $1.17 per share in 1997. FOR THE YEAR ENDED DECEMBER 31, -----------------------------------------1998 1997 1996 ---------------------------------(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Revenues................................................... Operating Income........................................... Net Income................................................. Basic Earnings Per Share................................... Diluted Earnings Per Share................................. $2,636,291 488,735 330,770 $1.90 $1.83 $1,939,007 303,555 175,127 $1.17 $1.15 $1,357,325 217,033 150,866 $1.19 $1.17 Selected Statistical Information Passengers Carried......................................... Passenger Cruise Days...................................... Occupancy Percentage...................................... 1998 ---------- 1997 ---------- 1996 ---------- 1,841,152 11,607,906 105.2% 1,465,450 8,759,651 104.2% 973,602 6,055,068 101.3% Fleet Expansion The Company's fleet expansion continued in 1998 with the delivery of the last of the six Vision-class vessels in the Royal Caribbean International fleet, Vision of the Seas, in April 1998. With the delivery of these six ships and the acquisition of Celebrity in 1997, the Company's capacity has increased approximately 119.3% from 14,228 berths at December 31, 1994 to 31,200 at December 31, 1998. The Company has nine ships on order. See table given earlier for details on capacity and delivery dates. The Eagle-class vessels will be the largest passenger cruise ships built to date. The Vantage-class vessels are a progression from Royal Caribbean International's Vision-class vessels, while the Millennium-class vessels are a progression from Celebrity Cruises' Century-class vessels. Between 1998 and 2002, the Company's year-end berth capacity is expected to increase 64.4% from 31,200 to 51,300 berths. In May 1998, the Company sold Song of America for $94.5 million and recognized a gain on the sale of $31.0 million. The Company operated the vessel under a charter agreement until March 1999. RESULTS OF OPERATIONS: The following table presents operating data as a percentage of revenues: FOR THE YEAR ENDED DECEMBER 31, --------------------1998 1997 1996 ------------Revenues.................................................... Expenses: Operating................................................. Marketing, selling and administrative..................... Depreciation and amortization............................. Operating Income............................................ Other Income (Expense)...................................... Income Before Extraordinary Item............................ 100.0% 100.0% 100.0% 60.5 13.6 7.4 ----18.5 (6.0) ----12.5% ===== 62.9 14.0 7.4 ----15.7 (6.3) ----9.4% ===== 63.0 14.3 6.7 ----16.0 (4.9) ----11.1% ===== YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997 Revenues Revenues increased 36.0% to $2.6 billion compared to $1.9 billion in 1997. The increase in revenues was primarily due to a 31.2% increase in capacity and a 3.6% increase in Yield. The acquisition of Celebrity (which occurred in July 1997) accounted for approximately two-thirds of the capacity increase, while additions to the Royal Caribbean International fleet accounted for the balance of the increase. The increase in Yield was due to an increase in occupancy levels to 105.2% as compared to 104.2% in 1997 as well as an increase in cruise ticket per diems, partially offset by a reduction in shipboard revenue per diems. The reduction in shipboard revenue per diems is due to the inclusion of Celebrity's results for the full year 1998 as compared to six months in 1997. Celebrity derives a higher percentage of its shipboard revenue from concessionaires than does Royal Caribbean International, resulting in a dilutive effect on the per diem. Concessionaires pay a net commission to the Company which is recorded as revenue, in contrast to in-house operations, where shipboard revenues and the related cost of sales are recorded on a gross basis. Expenses Operating expenses increased 30.7% in 1998 to $1.6 billion as compared to $1.2 billion in 1997. The increase in operating expenses was primarily due to the increase in capacity. Included in operating expenses is a $9.0 million charge related to the plea agreement with the U.S. Department of Justice. As a percentage of revenues, operating expenses decreased 2.4% in 1998 due to improved ticket pricing as well as the inclusion of Celebrity results for the full year of 1998 versus six months of 1997. Celebrity's operating expenses as a percentage of revenues were lower than Royal Caribbean International's due to lower shipboard cost of sales as a result of the higher use of concessionaires onboard Celebrity vessels as discussed above. Marketing, selling and administrative expenses increased 31.9% in 1998 to $359.2 million from $272.4 million in 1997. The increase was primarily due to the acquisition of Celebrity as well as higher advertising and staffing costs. As a percentage of revenues, marketing, selling and administrative expenses decreased to 13.6% in 1998 as a result of economies of scale. Depreciation and amortization increased to $194.6 million in 1998 from $143.8 million in 1997. The increase was primarily due to the acquisition of Celebrity as well as additions to the Royal Caribbean International fleet. Other Income (Expense) Interest expense, net of capitalized interest, increased to $167.9 million in 1998 as compared to $128.5 million in 1997. The increase is due to the increase in the average debt level as a result of the Company's fleet expansion program as well as the acquisition of Celebrity in July 1997. Included in Other income (expense) in 1998 is a $31.0 million gain from the sale of Song of America as well as a $32.0 million charge related to the write-down to fair market value of Viking Serenade. Based on the Company's strategic objective to maintain a modernized fleet, the unique circumstances of this vessel and indications of the current value of Viking Serenade, the Company recorded a write-down of the carrying value to its current estimated fair market value. The Company continues to operate and depreciate the vessel which is classified as part of Property and Equipment on the balance sheet. On December 15, 1998, Monarch of the Seas experienced significant damage to the ship's hull and equipment, resulting in the ship being out of service until mid-March 1999. The incident resulted in a net reduction in earnings of approximately $9.0 million, or $0.05 per share in the fourth quarter of 1998. This reduction is comprised of lost revenue, net of related variable expenses, of $5.2 million, and costs associated with repairs to the ship, passenger transportation and lodging, commissions and various other costs, net of estimated insurance recoveries, of $3.8 million. The costs of $3.8 million were included in Other income (expense) for the quarter and year ended December 31, 1998. Included in Other income (expense) in 1997 is a $4.0 million gain from the sale of Sun Viking. Extraordinary Item Included in 1997 is an extraordinary charge of $7.6 million or $0.05 per share related to the early extinguishment of debt. YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996 Revenues Revenues increased 42.9% in 1997 to $1.9 billion compared to $1.4 billion in 1996 as a result of a 40.7% increase in capacity as well as an increase in Yield. The acquisition of Celebrity contributed 22.1% of the capacity increase while additions to the Royal Caribbean International fleet accounted for 18.6% of the increase. Yield for the year increased 1.5% over 1996 as a result of an increase in occupancy. Occupancy levels increased to 104.2% in 1997 as compared to 101.3% in 1996. Expenses Operating expenses increased 42.7% to $1.2 billion in 1997 as compared to $854.5 million in 1996. This increase in operating expenses was primarily due to the 40.7% increase in capacity and higher variable costs associated with the increased occupancy. Marketing, selling and administrative expenses increased 39.9% in 1997 to $272.4 million versus $194.6 million in 1996. The increase was primarily due to the acquisition of Celebrity, an increase in staffing and additional advertising costs. These expenses decreased as a percentage of revenues in 1997 as a result of the economies of scale achieved with the increase in capacity. Depreciation and amortization increased to $143.8 million in 1997 from $91.2 million in 1996. The increase was primarily due to the acquisition of Celebrity as well as additions to the Royal Caribbean International fleet. Other Income (Expense) Interest expense, net of capitalized interest, increased to $128.5 million in 1997 from $76.5 million in 1996. The increase was a result of an increase in the average debt level associated with the Company's fleet expansion program and from the acquisition of Celebrity in July 1997. Other income (expense) in 1997 includes a gain of $4.0 million from the sale of Sun Viking as compared to 1996 which includes a gain of $10.3 million from the sale of Song of Norway. Extraordinary Item In May 1997, the Company redeemed the remaining $104.5 million of 11 3/8% Senior Subordinated Notes and incurred an extraordinary charge of $7.6 million, or $0.05 per share on the early extinguishment of debt. LIQUIDITY AND CAPITAL RESOURCES Sources and Uses of Cash The Company generated substantial cash flows resulting in net cash provided by operating activities of $526.9 million in 1998 as compared to $434.1 million in 1997 and $299.5 million in 1996. The increase was primarily due to higher net income as well as timing differences in cash payments relating to operating assets and liabilities. In March 1998, the Company issued $150.0 million of 6.75% Senior Notes due 2008 and $150.0 million of 7.25% Senior Debentures due 2018. The net proceeds to the Company were approximately $296.1 million. In March 1998, the Company issued 6,100,690 shares of common stock. The net proceeds to the Company were approximately $165.5 million. (See Note 7 -- Shareholders' Equity.) During the year ended December 31, 1998, the Company's capital expenditures were approximately $557.0 million as compared to $1.1 billion during 1997 and $722.4 million during 1996. The largest portion of capital expenditures related to the delivery of Vision of the Seas in 1998, delivery of Rhapsody of the Seas, Enchantment of the Seas and Mercury in 1997, delivery of Splendour of the Seas and Grandeur of the Seas in 1996, as well as progress payments for ships under construction during 1998, 1997 and 1996. Also included in capital expenditures are shoreside capital expenditures and costs for vessel refurbishing to maintain consistent fleet standards. The Company received proceeds of $94.5 and $100.0 million from the sale of vessels during 1998 and 1997, respectively. Capitalized interest decreased to $15.0 million in 1998, from $15.8 million in 1997 and $15.9 million in 1996. The decrease during 1998 was due to a reduction in the level of construction-in-progress expenditures associated with the Company's fleet expansion program. During 1998, the Company paid quarterly cash dividends on its common stock totaling $55.2 million as well as quarterly cash dividends on its preferred stock, totaling $12.5 million. During 1997, the Company paid quarterly cash dividends totaling $40.8 and $9.2 million on its common stock and preferred stock, respectively. The Company made principal payments totaling approximately $335.1 and $245.4 million under various term loans and capital leases during 1998 and 1997, respectively. Future Commitments The Company currently has nine ships on order for an additional capacity of 21,500 berths. The aggregate contract price of the nine ships, which excludes capitalized interest and other ancillary costs, is approximately $3.6 billion, of which the Company deposited $144.6 million during 1998 and $74.3 million during 1997. Additional deposits are due prior to the dates of delivery of $237.4 million in 1999, $88.1 million in 2000 and $25.0 million in 2001. The Company anticipates that overall capital expenditures will be approximately $997, $1,196, and $1,368 million for 1999, 2000 and 2001, respectively. The Company has $2.5 billion of long-term debt of which $127.9 million is due during the twelve month period ending December 31, 1999. (See Note 6 -- Long-Term Debt.) In addition, the Company continuously considers potential acquisitions, strategic alliances and adjustments to its fleet composition, including the acquisition or disposition of vessels. If any such acquisitions, strategic alliances and adjustments to its fleet composition were to occur, they would be financed through the issuance of additional shares of equity securities, by the incurrence of additional indebtedness or from cash flows from operations. Funding Sources As of December 31, 1998, the Company's liquidity was $1.2 billion consisting of $172.9 million in cash and cash equivalents and $1.0 billion available under its $1.0 billion unsecured revolving credit facility (the "$1 Billion Revolving Credit Facility"). The capital expenditures and scheduled debt payments will be funded through a combination of cash flows provided by operations, drawdowns under the $1 Billion Revolving Credit Facility, and sales of securities in private or public securities markets. In addition, the agreements related to the ships scheduled for delivery subsequent to 1999 require the shipyards to make available export financing for up to 80% of the contract price of the vessels. The Company's cash management practice is to utilize excess cash to reduce outstanding balances on the $1 Billion Revolving Credit Facility, and to the extent the cash balances exceed the amounts drawn under the $1 Billion Revolving Credit Facility, the Company invests in short-term securities. Other The Company enters into interest rate swap agreements to manage interest costs as part of its liability risk management program. The differential in interest rates to be paid or received under these agreements is recognized in income as part of interest expense over the life of the contracts. The objective of the program is to modify the Company's exposure to interest rate movements. The Company continuously evaluates its debt portfolio, including its interest rate swap agreements, and makes periodic adjustments to the mix of fixed rate and floating rate debt based on its view of interest rate movements. (See Note 12 -- Financial Instruments.) Impact of Year 2000 The "Year