Royal Caribbean Group (RCL) — Q3 2017 Earnings Call Transcript

Thank you, operator. Good morning and thank you for joining us today for our third-quarter earnings call. Joining me here in New York are Richard Fain, our Chairman and Chief Executive Officer; Adam Goldstein, our President and Chief Operating Officer; Michael Bayley, President and CEO of Royal Caribbean International; and Carola Mengolini, our Vice President of Investor Relations. During this call, we will be referring to a few slides, which have been posted on our investor website, www.rclinvestor.com. Before we get started, I would like to refer you to our notice about forward-looking statements, which is on our first slide. During this call, we will be making comments that are forward-looking. These statements do not guarantee future performance and do involve risks and uncertainties. Examples are described in our SEC filings and other disclosures. Please note that we do not undertake to update the information in our filings as circumstances change. Also, we will be discussing certain non-GAAP financial metrics, which are adjusted as defined and a reconciliation of all non-GAAP historical items can be found on our website. Unless we state otherwise, all metrics are on a constant-currency adjusted basis. Richard will begin by providing a strategic overview of the business. I will follow with a recap of our third-quarter results, provide an update on the current booking environment and then provide guidance for the full year and fourth quarter of 2017. I will then close with our early thoughts for 2018. We will then open the call up for your questions.

Thank you, Jason, good morning, everyone. It's been an eventful quarter and certainly an eventful year and as always, I am pleased to give some commentary. I'll start by commenting on the unusual set of hurricanes we experienced this summer. I know that most of the country has moved on to other things, but this was such an unusual and such an impactful set of storms that I need to comment on it. Firstly, I would like to emphasize just how unique this series of storms was. It's highly unusual to be hit with five major hurricanes in a row under any circumstances, but these storms were unusual for another reason as well. Each of these storms followed a path that exactly matched our major trade routes. Somehow these storms seemed to know exactly when and exactly where to hit to cause the most destruction and the most misery. The devastation was heartrending. You can't look at all the damage without feeling the pain our friends had to bear and are still experiencing every day. For us, we have estimated that the direct cost of the storms was in excess of $55 million. That makes it by far the most expensive hurricane season in our 45-year history, but we and they are resilient. You can see how hard our friends in the Caribbean and Texas and in Florida have worked to return to normalcy. They have worked tirelessly to rebuild the homes and the communities that were so devastated. Communications in the Caribbeans are now greatly improved and water has largely been restored. We can attest to the living without electricity is a trial, but the situation is getting better every day and is now mainly a problem in the rural and residential areas. Fortunately, everyone seems to appreciate just how important tourism and especially cruise tourism is to the economic recovery that will be so critical going forward. The government and the local people are highly focused on bringing the tourism infrastructure back up to snuff. They know that tourism continues to be the economic driver that will speed the recovery effort and they have pushed us to reinstate our calls as quickly as possible. The travel agent community has also been a very positive force in this effort. They can get the word out better than anyone else and they have done so yet again here. I've had a chance to visit some of the hardest hit areas and I am very impressed with the progress they are making. We resumed operating cruises from San Juan almost a month ago and we returned to the destination as a port of call later this month. This Friday, we returned to St. Thomas, where our partnership to restore and enhance the iconic Magens Bay has already produced dramatic results. St. Maarten has been rapidly rebuilding and we will return there in just a few weeks. Overall, I am happy and frankly very impressed to report that the tourist areas, where our guests go, are largely back to their original state. While many residential areas that were damaged are still under repair, the tourist areas that we visit suffered less damage and have mostly been cleaned up. I am also proud of our industry's response in providing humanitarian assistance to this area. Their needs are so great that our impact is necessarily limited, but it's good to be able to give back a little to the region that has been our partner for so long. I'd like to thank our employees, who worked so hard during this challenging period, in many cases, having to do so while dealing with their own exposures at home. The logistical issues were daunting. For example, we had to make more special working arrangements in just the month of September than we would normally expect to do so in any normal three-year period. We had to reroute ships, make new provisioning arrangements and communicate with thousands of nervous travelers. Our team did it all smoothly and efficiently. Hats off to them. As an aside, having spent time looking at the situation in the Caribbean, I am convinced that the Caribbean countries that were hit will emerge down the road stronger than they were before the storms. It's going to be a tough slog to get there, but get there they will. There is clearly a determination, not only fix what was destroyed, but to rebuild better than ever. Cruise tourism will undoubtedly be one of the drivers of that resurgence and we, at Royal Caribbean, intend to be a constructive force in that process. I'd like to turn now to the impact of the storms on our bookings. Obviously, the hurricanes interfered with our normal bookings in the area. During the several weeks of the storms, Caribbean bookings dropped precipitously, both for the hurricane period and for the period beyond. None of that is surprising, but what is surprising is how quickly our bookings in the period recovered. The drop-off in bookings was very rapid, but the recovery was also rapid. Today, virtually all our bookings in the region are back to pre-storm levels. There are exceptions, but these remain outliers. Now, this pattern of rapid recovery has implications well beyond just these storms. We believe that this unusually fast recovery may actually be a reflection of an important cultural change. We've noticed a significant change in the way people in general seem to respond to unusual events, whether those events are weather, geopolitical acts or something else. Years ago, a bad incident would have a strong and a lasting impact. Whenever something happened, our bookings would fall and they would stay down for an extended period. People seemed to curl up in a ball and obsess about whatever the issue was. It could and it did impact bookings for a really long time. Even after the event left the front page, people would persist in focusing on it. Eventually, they would move on and bookings would recover, but that process seemed to take forever. More recently, we have seen a much more sanguine response. Instead of the incident lingering for a long time, the recovery seems much quicker. People seem to be more apt today to see such events as ordinary with little impact. The events still aren't normal, but they are seen as less relevant to the broader audience. In effect, the public appears to have become inured to such one-off events. They're still interested in the event and concerned about it, but people seem to continue living their lives with less change. They move on. From a societal point of view, I have to say that it's discouraging that we've reached such a point. It's distressing that incidents are now so common that society seems to have formed a thicker skin towards them. On the other hand, as a response to the actual events, it's probably more constructive if society doesn't allow such things to interfere with our normal day-to-day existence. From a purely commercial point of view, this cultural shift is very helpful. It's much better for us if the negative impact of such incidents is so much more fleeting than in the past. Against this background, we are extremely pleased and frankly a little surprised that we are still able to stay within our EPS guidance for the year at a range of $7.35 to $7.40 a share. Indeed, a couple of months ago, when we upped the midpoint of our guidance to $7.40, we thought that we were being reasonably aggressive with our forecast and we certainly didn't expect that we would be raising it anytime soon. The fact that we have been willing to be able to withstand a $0.26 hit from the storms and still achieve this level of profitability reflects how strongly the market is performing this year. It's also nice that this performance has allowed us to reach an interesting milestone. Our Double-Double program continues to produce the forward momentum we were hoping for. Indeed, it is exciting and gratifying to note, as per our press release that we've already achieved Double-Double for the 12 months ended September 30. Specifically, for the last 12 months, our earnings have been more than twice our 2014 EPS and our ROIC exceeded 10%, all this three months ahead of schedule. As you know, the purpose of the program was to galvanize our 67,000 employees to all pull in the same direction. I am overwhelmed by how well our teams responded to the program and I'm extremely grateful for their efforts and initiatives to make the Double-Double so successful. Now, we won't declare victory until 2017 is over, but the very strong energy created by the Double-Double program has been a home run for us. We want to see that energy, that passion, continue indefinitely. Since this is the final year of the Double-Double, we wanted to develop a program that leverages the culture and the discipline instilled by that program while also including a broader set of goals. As suggested in earlier calls, these goals are focused more on the drivers of success than only the outcomes. We're calling this new journey our 2020 Vision. The 2020 Vision program calls for further improving our brands' already-excellent guest ratings, calls for raising employee engagement scores and it calls for achieving the sustainability commitments made with the World Wildlife Fund. These drivers should help us achieve double-digit earnings per share by 2020, while further improving our double-digit return on invested capital. We see 2020 Vision as our guiding focus for the organization over the coming years.

Thank you, Richard. Before getting into the results, I want to discuss the impact of the unprecedented hurricanes on our key statistics. As we stated in the release this morning, the hurricane impacted our third quarter by $0.20 per share and approximately $0.06 per share for the fourth quarter for a total of $55 million for the full year. The impact from the storms, especially related to the lost APCDs, are causing some noise in our key statistics. While I'll address these aberrations when I talk about the third quarter results and fourth-quarter and full-year guidance, I wanted to recap what is happening in the underlying business. Overall, strong demand for our Europe, North America and China products, combined with strong onboard trends, are expected to offset virtually all the impact from the hurricanes. We had viewed our previous revenue guidance as reasonably aggressive, but we were pleasantly surprised by the additional strength and last-minute demand. Looking at expenses, we are ending the year roughly where we had previously expected except for costs related to the storms, including our humanitarian efforts. However, the metrics may look different for two reasons. Firstly, the storms caused us to shift the timing of some expenses from the third quarter to the fourth and in addition, the storms caused cruise cancellations, which resulted in fewer APCDs. The absolute amount of costs remained as expected, but the cost per APCD went up. I will now walk you through our results for the third quarter. We have summarized our third quarter results. For the quarter, we generated adjusted net income of $3.49 per share, which was $0.04 better than previous guidance. These results include a $0.20 negative impact related to the hurricanes. Better-than-expected close-in demand from our core products, combined with the timing of costs, more than offset the impact from the hurricanes. Our net revenue yields increased 5.3%, which was more than 1 point higher than the midpoint of our guidance. Strong close-in demand for China, Europe and North America products drove the outperformance. Onboard revenue yields were up 5% for the quarter, driven mainly by better-than-expected shore excursions and Internet packaging. While the storm-related revenue losses negatively impacted our absolute revenue for the quarter, there were essentially neutral to overall yield as the yield of the impacted sailings were similar to the quarter average. Turning to costs, net cruise costs, excluding fuel, were up 5.7%. Our cost metric came in higher than guidance, driven mainly by the reduction in APCDs. On an absolute basis, cost came in better than expected, driven by timing. Now, I will share trends we are seeing in the demand environment for the balance of 2017. As you would expect, demand for Caribbean sailings softened as the hurricanes moved to the Caribbean and Gulf beginning in late August and while Caribbean bookings are virtually back to normal, we did experience five to six weeks of softer trends. However, demand for all itineraries remained strong throughout and our total bookings have been above last year's levels since the last earnings call, both including and excluding the Caribbean. As such, we remain in a much better book position than at this point last year for the fourth quarter and are up nicely on both rate and volume. I will now discuss our full-year guidance for 2017. Net revenue yields are expected to be up approximately 6%, an improvement versus prior guidance despite the negative impact of the hurricanes, which is affecting the year by approximately 20 basis points. The combination of the outperformance in Q3 and strength in our underlying Q4 business is driving the increase in our yield guidance for the full year. Net cruise costs, excluding fuel, are expected to be up approximately 2% for the year. As I noted earlier, our actual costs, excluding the hurricane, are generally in line with our previous guidance, but the per-berth figures are distorted by the storms. We anticipate fuel expense of $686 million, down slightly relative to prior guidance. We are 65% hedged for the remainder of the year at a price of $498 per metric ton. Based on current fuel prices, interest rates and currency exchange rates, our adjusted earnings per share is expected to be in the range of $7.35 to $7.40. In summary, we were able to stay within our EPS guidance for the year at a range of $7.35 to $7.40 despite a $0.26 negative impact from the hurricanes. We've been able to accomplish this through a strong book position, solid onboard revenue trends, better fuel prices and better-than-expected performance from our joint ventures. We remain on track to exceed our Double-Double goals, which we established more than three years ago. As Richard mentioned, on a trailing 12-month basis, we have already reached these targets. The culture and disciplines established under the Double-Double program will provide the foundation for our new three-year financial targets that we are terming 2020 Vision. The Double-Double formula for success, our modest yield growth, strong cost control and moderate capacity growth, combined with improving our customer advocacy and employee engagement, is expected to further improve on our double-digit return profile and deliver double-digit earnings per share by the end of 2020. Before I walk you through our fourth-quarter guidance, I would like to elaborate on capital returns. Since our last earnings call, the company increased the quarterly dividend by $0.25 to $0.60 per share and repurchased $125 million in shares. These actions, combined with the upcoming completion of our Double-Double program and our new 2020 Vision, further reflect our commitment to continuously improve our returns for our shareholders. Now, let's turn to our guidance for the fourth quarter.

Yeah. Hey, guys. Good morning. Hope you're all doing well. These are outstanding results. I guess the first question is going to be around the 2020 Vision. When you break it down, I know you're going to hate me saying this, but it does actually seem conservative at the first glance with only kind of 11% to 12% EPS growth through 2020. At this point, I think consensus is already kind of north of $10 a share for 2019. So, can you help us think either what analysts are getting too aggressive with or maybe help us think about some of the drivers you've embedded in your thought-process?

Hey, Steve. We won't hate you and also not surprised by the question. So, I think, as we look at the 2020 Vision, again, what we're seeing specifically is that we expect our earnings to be in the double-digits by 2020. We're not giving a specific target of a specific number, but I'll tell you, I would say that the foundation which is moderate yield growth, good cost control, moderate capacity growth, that is what we believe from what we've seen in the past is that kind of formula to success. So, I don't think we're trying to guide to a specific number. What we're trying to do is again pivot the organization to coordinates that are based on that formula that get you to double-digit earnings.

Steven, it's Richard, and if I could just add something to that, and yes, we won't hate you, but first of all, I think there aren't many companies that are giving three-year targets with – you said only 11% to 12% growth rates. I think that's pretty good in the first place. But I also think – I like to emphasize that these programs really aren't intended to be financial targets for the investment community. This is something that really that we use for our employees, for ourselves to drive how we manage the business. And it's really intended to focus on the drivers of success, on the good performance of our fleet, the satisfaction of our guests, the engagement of our crew, et cetera. And so, the financial metrics come out of that, but internally, I think that was really the success of the Double-Doubles, was it got everybody pushing to the things that would make us successful. And so, I would just emphasize that. I understand it needs to have that financial metrics as well and those are important and that's also part of what we need to communicate to our people. But I would just like to say, I think we feel quite good about the 2020 program and think it will drive us to continue to excel.

Okay. Got you. And then, second question, I don't know if Rich or Jason wants to take this, but it seems right now there's this perceived notion out there from a bunch of investors that there could be first quarter Caribbean weakness for 2018 given the storm impact. Can you guys address that and maybe help us understand if that's something you're seeing at this point?

Yeah, sure, Steve. Certainly, as we mentioned in our remarks, yeah, there were five to six weeks of softness in demand and obviously that would be specifically around the Caribbean. So, what I would lead you to that we've said that we expect to be up on both a rate and volume basis for 2018. I would add that we were actually up quite nicely on both rate and volume for the first quarter and the Caribbean is contributing to that.

Okay. Got you. And if I can sneak one more quick one. Richard, you obviously have your pulse on Washington, D.C., and there's obviously been a lot of chatter out there around potential tax policy changes. Can you guys just give us an update in terms of how you're thinking about any potential changes coming down the pike?

Hi, Steve. Well, obviously, we, like probably every other company and industry in America, is watching very carefully what's happening in Washington. Our industry association, CLIA, and our tax advisors are clearly spearheading that. We're not expecting any changes at this point, but this is a fluid situation. We have to watch every day. The cruise industry, although we're growing and we're proud of our success and where we've come over the last 50 years, is still a very small industry in the scope of the types of things that seem to be on the radar screen for the politicians in Washington. So, at this point, I would say the outlook is positive for us.

Thanks, guys. Great results.

Great. Thanks. So, I was interested in the commentary that Q3 came in better because of the close-in strength in Europe and China and North America, but one question each on China and Europe. First in China, will you expect yields to actually be positive for the full year or just sort of better than what you had thought? And then, is the lack of capacity growth next year in China changing your conversations there about price with the charter sellers and where those commitments are going? And then, on Europe, I was just curious about the close-in strength, because one would sort of expect that because airfare has to be – in other words, I guess I was going to ask to that European strength is driven by European sourcing or North American sourcing, just I would think the airfare component would make it tough to do last minute and just thinking about the fact that you're going to have European supply growth next year to help us think about that.

Hey, Robin. I'll just take the first point on China yields for this year and I'll let Michael talk about what he – or his point of view on China with there being lower capacity for next year. Obviously, we haven't and we don't guide specifically by market. So, the comment around strong close-in demand was relative to our expectations and it's a trend that we had been seeing creeping up, but it was even better than we had expected in the third quarter and also with that going into the fourth quarter. And I'll let Michael talk about 2018.

Hi, Robin. Yeah, we're kind of encouraged a little bit by the capacity reduction in the China market in 2018 and there's also the rumors with regards to South Korea opening up and we're all waiting to hear if there will be an announcement on that. So, when you combine those two factors together and you look at the work that we've been doing on building distribution and opening up all of the channels, we feel quite good about China in 2018. And we know we have good years and then some bumpy years, but we're feeling as if 2018 is looking quite promising. On Europe, there's always that switchover time on the sourcing for European product. It sources typically very well out of the North American market and the closer you get into sailing, then we tend to source more out of the European markets. One of the things that we've got in 2018, of course, is Symphony of the Seas will be introduced into Europe and will be sailing out of Barcelona. We're very encouraged by the forward bookings for Symphony of the Seas and it's outperforming Harmony at the moment.

Okay. Great. And then, maybe just one final clarification on the double-digit earnings, I just want to make sure that it's really – you mentioned double-digit earnings, not double-digit earnings growth rate. So, I'm assuming that means at least $10 a share, which would actually be above that 10% earnings growth. I just want to clarify that, what you mean by that and I'm curious how much share repo you're including in that. Thanks.

Yes. So, Robin, as it relates to the target, the target is double-digit earnings per share between now and 2020. Now, to get to double-digit earnings, you need to have double-digit earnings growth rate as well, but the target is specifically around earnings. And then, as it relates to share repurchase, the goal is based off of how we see the underlying performance, a moderate yield growth, good cost control and moderate capacity growth.

Okay. Great. Now, that's helpful. Thanks.

Great. Thanks. Just two questions. The first, so when would you expect booking trends to fully normalize where passengers are maybe not a little bit concerned about going to the Caribbean? And then, sort of the second part to that is some of the other regions were a lot stronger and then – or we started strong. Do you think that some of your North American passengers are, let's say, foregoing booking Caribbean cruises and deciding to go elsewhere like Europe or Alaska?

Hi, Greg. We're already seeing booking trends return to normal on pre-hurricane levels. So, we've already seen that kind of correction take place. And then, with regards to this, the idea that maybe people are booking other destinations other than Caribbean, I mean that happens in the normal give and take of a year anyway, that people do switch out destinations, but we haven't seen anything noticeable in terms of a trend occurring with regards to that idea.

Yeah. Right. And then, the level of also promotional activity, I'm assuming that's elevated to spur demand in the Caribbean for the fourth quarter and first quarter of 2018. How long would you expect that to last assuming that it is elevated? Is that just in the next few months and then, things should be very normalized?

Yes. I mean, it's funny you bring that up. I don't feel like our promotional activity has been any greater or any lesser. After the hurricanes passed, we did have more promotional activity for a short period of time, but now, we've gone into our regular kind of promotional calendar cadence that is quite typical as we push into Q4 and as we look at how we're booking into 2018. So, it's really returned to its normal levels. And, of course, just as a reminder, we have our price integrity program that we're very pleased with and that's also helping us out.

Hey. Good morning, everybody. I have a question surrounding capital expenditures actually, given that they have bumped up a bit and I know you guys mentioned that, that was going to be mostly surrounding this Royal Amplified and Celebrity Revolution program. And I assume a lot of those efforts tie into some of the evolving consumer behaviors that you discussed earlier. So, will you talk a little bit about what the majority of that delta and spend is going to and then, if maybe some of that is tied into some of the technology that you're planning to launch? Thanks.

So, hi, Jamie. It's Richard. Most of that are the two ship modernization programs that you cited. It's been something and we found we've been very successful with that in some of the ones we've been doing over the last few years. So, this is a continuation of that. Some of the things that we've done on our newer ships are just really very impactful in terms of consumer trends and what they want. And so, that's very much a part of it. So, that's the bulk of it actually. There is also some of it that is related to our technological investments, in particular our digital investments, which we call Excalibur. So, we've talked about that. We have an investment day, where we're going to be talking about that in detail, but we see those technological investments. We've frankly already been making a lot, but I think we see the need increasing. And so, that is part of the increase that you're referring to.

Hi, Jamie. It's Michael. I mean we're seeing really all over kind of a lift in onboard spend coming from all segments and we think that's reflected really in consumer confidence and how well the stock market is doing. So, whether it's the higher-end customer or mid-level, everybody is spending a little bit more at the moment.

And, Jamie, just to add, I mean I think one trend in which we talked about in our remarks is one thing you see across the board is you're seeing people spend much more money on experiences than on things like retail as an example. So, my commentary around shore excursion or Internet or beverage more things that are experiential in nature than something out of the gift shop is where you see this change and that's not just in the higher-end, it's really kind of across all classes.

Hi, Jamie. Yes, it does. Interestingly, when we talk about the two programs, Celebrity Revolution and Royal Amplified, really a lot of the thinking that's going into that is really thinking through how our guests spend is changing and you'll start to see that when we bring these ships out of the modernization, the program that we've really reallocated space to generate better revenues in areas that we see guests now naturally gravitating to.

Hey. Thanks for the question. I have kind of a high-level question, maybe for Richard or whoever wants to jump in, but it sounds, Richard, like you're painting a very positive secular picture of the industry in general, spending trends, which would seemingly suggest that yields could continue to improve, maybe not obviously the rates of this year, because of one-time events, but certainly very strongly. And I'm just wondering, how do you square that strength with what appears to be a long-term internal goal of moderate yield growth? You said you're trying to pivot the organization to certain coordinates. Are you pivoting them to like a 2% to 4% range or you actually trying to get them to push a little bit more aggressively to the higher-end of that range?

Well, David, thank you. I think you summarized my view accurately. I do think that the underlying strength of the industry is powerful and I think that will continue. I just think one needs to be a little bit realistic about how quickly you can move those things. And so, we think, obviously, we are not trying to direct the organization to a level of yield increase. We clearly want to maximize that. What we want to pivot the organization to is to provide the things that will drive consumer to our travel agents and to our website and basically to buy cruises. And hopefully that will result in continued strong yield improvement. So, by saying moderate yield increase, I think we are really trying to telegraph that to get strong results, we don't need staggeringly large yield improvements. We are an industry where if we can get relatively moderate yield increases, that results in really very strong bottom line growth. But obviously if we can break out of the 2% to 4% range, as we did this year, we intend to exercise every effort we know how to accomplish that.

Hi. Good morning, I'm glad to have snuck in. Two quick questions. On the equity investment income, that was up a lot year-over-year. So, maybe if you could touch on what was driving that. And secondarily, I feel like you guys cite Internet every quarter now and I don't know if you've given this before, but I don't recall, what percent of passengers now are taking up your option to have the Internet available to them at sea? And have you taken any price on that or is that really a penetration metric that we are looking at?

Hi, Sharon. On the equity income side, it's really mainly the story around our joint ventures. TUI would obviously be the leader of that, but we also have a joint venture with Pullmantur now and it's really those are the kind of underlying drivers on below the line. And then, on the Internet side, no, we don't give a percent in terms of how that number has grown over time, but it is a combination of both rate and penetration and that it is driving up our Internet as well as we keep introducing new things that attract people to use more bandwidth on the ships. Thank you all for your participation and interest in the company. Carola will be available for any follow-ups you might have and we really wish you all a great day. Take care.