Carnival Cruises 2004 Annual Report Download - page 45

Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
42 Carnival Corporation & plc
Off-Balance Sheet Arrangements
We are not a party to any off-balance sheet arrange-
ments, including guarantee contracts, retained or con-
tingent interests, certain derivative instruments and
variable interest entities, that either have, or are rea-
sonably likely to have, a current or future material effect
on our financial statements.
Foreign Currency Exchange Rate Risks
In 2003, we broadened our global presence through
Carnival plc’s foreign operations, in addition to the for-
eign currency denominated operations of our Costa sub-
sidiary. Specifically, our expanded international business
operations through P&O Cruises, Ocean Village and
Swan Hellenic in the UK and AIDA in Germany subject
us to an increasing level of foreign currency exchange
risk related to the sterling and euro because these oper-
ations have either the sterling or the euro as their func-
tional currency. Accordingly, exchange rate fluctuations
of the sterling and the euro against the dollar will affect
our reported financial results since the reporting cur-
rency for our consolidated financial statements is the
U.S. dollar and the functional currency for our interna-
tional operations is generally the local currency. Any
weakening of the U.S. dollar against these local func-
tional currencies has the financial statement effect of
increasing the U.S. dollar values reported for cruise rev-
enues and cruise expenses in our consolidated financial
statements. Strengthening of the U.S. dollar has the
opposite effect.
We seek to minimize the impact of fluctuations in
foreign currency exchange rates through our normal
operating and financing activities, including netting cer-
tain exposures to take advantage of any natural offsets
and, when considered appropriate, through the use of
derivative financial instruments. The financial impacts
of these hedging instruments are generally offset by
corresponding changes in the underlying exposures
being hedged. Our policy is to not use any financial
instruments for trading or other speculative purposes.
One of our primary foreign currency exchange rate
risks is related to our outstanding commitments under
ship construction contracts denominated in a currency
other than the functional currency of the cruise brand
that is expected to be operating the ship. These currency
commitments are affected by fluctuations in the value
of the functional currency as compared to the currency
in which the shipbuilding contract is denominated. We
generally use foreign currency swaps to manage foreign
currency exchange rate risk from ship construction
contracts (see Notes 2, 7 and 11 in the accompanying
financial statements). Accordingly, increases and
decreases in the fair value of these foreign currency
swaps offset changes in the fair value of the foreign
currency denominated ship construction commitments,
thus resulting in the elimination of such risk.
Specifically, we have foreign currency swaps for
three of our euro denominated shipbuilding contracts.
At November 30, 2004, the fair value of these foreign
currency swaps was an unrealized gain of $219 million
which is recorded, along with an offsetting $219 million
fair value liability related to our shipbuilding firm com-
mitments, on our accompanying 2004 balance sheet.
Based upon a 10% strengthening or weakening of the
U.S. dollar compared to the euro as of November 30,
2004, assuming no changes in comparative interest rates,
the estimated fair value of these foreign currency swaps
would decrease or increase by $105 million, which
would be offset by a decrease or increase of $105 million
in the U.S. dollar value of the related foreign currency
ship construction commitments resulting in no net dollar
impact to us.
However, at November 30, 2004, we also have three
shipbuilding contracts denominated in euros, one of
which has been assigned to a sterling functional currency
company and two, which are still unassigned, for which
we have not entered into any foreign currency swaps.
At current exchange rates, it is most likely that these
two contracts will be assigned to one of our cruise
brands whose functional currency is the euro or sterling.
The cost of shipbuilding orders that we may place in
the future for our cruise lines who generate their cash
flows in a currency that is different than the shipyard’s
operating currency, generally the euro, is expected to
be affected by foreign currency exchange rate fluctua-
tions. Given the decline in the U.S. dollar relative to the
euro, the U.S. dollar cost to order new cruise ships at
current exchange rates has increased significantly. If the
U.S. dollar remains at current levels or declines further,
this may affect our ability to order future new cruise
ships for U.S. dollar functional currency brands.
Finally, we consider our investments in foreign sub-
sidiaries to be denominated in relatively stable currencies
and of a long-term nature. We partially address these
exposures by denominating a portion of our debt or
entering into foreign currency swaps in our subsidiaries’
functional currencies (generally euros or sterling). Speci-
fically, we have debt of $2.2 billion in euros and $415
million in sterling and have $887 million of foreign cur-
rency swaps, whereby we have converted $251 million