Royal Caribbean Cruise Lines 2011 Annual Report Download - page 60

2011 ANNUAL REPORT 56
PART II
(inclusive of margin). The fair value of our floating to
fixed interest rate swap agreements was estimated to
be a liability of $11.6 million as of December 31, 2011
based on the present value of expected future
cash flows.
Market risk associated with our operating lease for
Brilliance of the Seas is the potential increase in rent
expense from an increase in sterling LIBOR rates.
Through July 2012, we have effectively changed 49%
of the operating lease obligation from a floating rate
to a fixed-rate obligation with a weighted-average
rate of 4.76% through rate fixings with the lessor. A
hypothetical one percentage point increase in sterling
LIBOR rates would increase our 2012 rent expense by
approximately $2.0 million, based on the exchange
rate at December 31, 2011.
Foreign Currency Exchange Rate Risk
Our primary exposure to foreign currency exchange
rate risk relates to our ship construction contracts
denominated in euro and our growing international
business operations. We enter into foreign currency
forward contracts and cross currency swap agreements
to manage portions of the exposure to movements
in foreign currency exchange rates.
The estimated fair value as of December 31, 2011 of
our euro-denominated forward contracts associated
with our ship construction contracts was estimated
to be a liability of $36.5 million, based on the present
value of expected future cash flows. During 2011, we
implemented a strategy for benefiting from anticipated
weakness in the euro exchange rate. As part of that
strategy we terminated our foreign currency forward
contracts for Project Sunshine to allow the exchange
rate to float within a predetermined range, essentially
creating a floor and a ceiling around our exposure to
the euro-denominated cost of the vessel. We may
adjust the range over time as we feel appropriate. We
effected the termination of a portion of the contracts
by entering into offsetting foreign currency forward
contracts. We paid $8.7 million to terminate the
remaining contracts and deferred a loss of $19.7 million
within accumulated other comprehensive income
(loss) which we will recognize within depreciation
expense over the estimated useful life of the Project
Sunshine ship. As a result, approximately 43.3% of the
aggregate cost of the ships under construction was
exposed to fluctuations in the euro exchange rate at
December 31, 2011. A hypothetical 10% strengthening
of the euro as of December 31, 2011, assuming no
changes in comparative interest rates, would result
in a $81.3 million increase in the United States dollar
cost of the foreign currency denominated ship con-
struction contracts exposed to fluctuations in the
euro exchange rate.
Our growing international business operations subject
us to an increasing level of foreign currency exchange
risk. We transact business in many different foreign
currencies and maintain investments in foreign opera-
tions which may expose us to financial market risk
resulting from fluctuations in foreign currency exchange
rates. Movements in foreign currency exchange rates
may affect the translated value of our earnings and
cash flows. We manage most of this exposure on a
consolidated basis, which allows us to take advantage
of any natural offsets. Therefore, weakness in one
particular currency might be offset by strengths in
other currencies over time. Our earnings are also sub-
ject to volatility resulting from the remeasurement of
net monetary assets and liabilities denominated in a
currency other than the United States dollar. To miti-
gate our foreign currency exchange rate exposure
resulting from our net foreign currency denominated
monetary assets and liabilities, we maintain cross
currency swap agreements, denominate a portion of
our debt in our subsidiaries’ and investments’ func-
tional currencies and enter into foreign currency
forward contracts.
At December 31, 2011, we maintained cross currency
swap agreements that effectively change €150.0 mil-
lion of our €1.0 billion debt with a fixed rate of 5.625%
to $190.9 million of debt at a fixed rate of 6.68%.
Consistent with our strategy for benefiting from antic-
ipated weakness in the euro exchange rate and to
f urther increase the portion of our €1.0 billion debt
that we utilize as a net investment hedge of our euro-
denominated investments in foreign operations, dur-
ing 2011, we terminated €250.0 million of our cross
currency swap agreements. Upon termination of these
cross currency swaps, we received net cash proceeds
of approximately $12.2 million, and we deferred a loss
of $3.5 million within accumulated other comprehensive
income (loss) which we will recognize within Interest
expense, net of capitalized interest over the remaining
life of the debt. At December 31, 2011, the estimated
fair value of our cross currency swap agreements
was an asset of approximately $7.7 million based on
the present value of expected future cash flows. A
hypothetical 10% strengthening of the euro as of
December 31, 2011, assuming no changes in compara-
tive interest rates, would result in an increase in the
fair value of the €150.0 million of fixed rate debt by
$21.7 million, offset by an increase in the fair value of
the cross currency swap agreements of $30.4 million.