During 1999, we issued LYONs for $655.5 million principal amount at maturity (September 23, 2029) for gross proceeds of $172.5 million. We were entitled to redeem the LYONs commencing in September 2004 for cash equal to the issue price plus accrued interest calculated at 4½% per annum. As discussed above in ‘‘Company Operating Results — Other Income/Expense, Net’’, during the third quarter of 2004, we exercised this right and redeemed all of our LYONs for an aggregate payment of $215.5 million.
During the second quarter of 2004, we issued $250 million principal amount of convertible senior notes. We used a majority of the net proceeds from the issuance of the convertible senior notes to repay the LYONs. These notes bear interest at the rate of 1.875% per annum (payable semi-annually in arrears on January 30 and July 30 to holders of record on January 15 and July 15, beginning January 30, 2005) and will mature on July 30, 2024, unless earlier redeemed or repurchased. The notes are convertible into our Limited Voting Shares at an initial conversion rate of 13.9581 shares per $1,000 principal amount (equal to a conversion price of approximately $71.64 per Limited Voting Share), subject to adjustments in certain events, in circumstances in which (i) the Limited Voting Shares have traded for more than 130% of the conversion price for a specified period, (ii) the notes have a trading price of less than 95% of the market price of the Limited Voting Shares into which they may be converted for a specified period, (iii) we call the notes for redemption, or (iv) specified corporate transactions or a ‘‘fundamental change’’ occurs. We may choose to settle conversion in our Limited Voting Shares, cash or a combination of our Limited Voting Shares and cash. Holders of the notes will have the right to require us to purchase the notes for their principal amount plus accrued and unpaid interest on July 30, 2009, July 30, 2014 and July 30, 2019 and in connection with certain events. Repurchases of notes made on July 30, 2014 and July 30, 2019 may be made (at our option) in cash, our Limited Voting Shares or a combination of cash and our Limited Voting Shares. Subject to conversion rights, we will have the right to redeem the convertible senior notes for their principal amount, plus any accrued and unpaid interest, beginning August 4, 2009.
In accordance with Canadian GAAP, the convertible senior notes are bifurcated on our financial statements into a debt component (representing the principal value of a bond of $211.8 million, which was estimated based on the present value of a $250 million bond maturing in 2009, yielding 5.33% per annum, compounded semi-annually, and paying a coupon of 1.875% per annum) and an equity component of $36.9 million (representing the value of the conversion feature of the convertible senior notes). For further details, see note 10(a) to our consolidated financial statements.
In connection with the offering of the convertible senior notes, we entered into a five-year interest rate swap with an initial notional amount of $211.8 million, pursuant to which we agreed to receive interest at a fixed rate of 5.33% per year and pay interest at six-month LIBOR, in arrears, plus 0.4904%. In October 2004, we terminated the interest rate swap agreement and received proceeds of $9 million. The book value of the interest rate swap at the date of termination was approximately $1.5 million. The recognition of the resulting gain was deferred and is being amortized over the period to July 30, 2009.
In the second quarter of 2005, we entered into a new currency and interest rate swap agreement until July 30, 2009, pursuant to which we have agreed to receive interest at a fixed rate of 5.33% per annum on an initial notional amount of $215.8 million (C$269.2 million) and pay interest at a floating
rate of six-month Canadian Bankers Acceptances (‘‘BA’’) in arrears plus 1.1% per annum. On July 30, 2009, we will pay C$311.8 million and receive $250 million under the swap. We have designated the swap as a fair value hedge of our convertible senior notes.
Cash Flows
Cash from Operations
During the year ended December 31, 2005, we generated cash from operations of $62.6 million (before the payment related to the transition of the retirement benefit plan) and $26.5 million (after the payment related to the transition of the retirement benefit plan), as compared to $44.4 million in 2004. During the three months ended December 31, 2005, we used cash of $9.9 million from operations, as compared to generating cash of $32.3 million for the same period in 2004.
The decrease in cash from operations of $17.9 million in 2005, as compared to 2004, resulted primarily from a $36.0 million cash payment in 2005 related to the restructuring of the retirement benefit plan, $9.0 million in proceeds that were received in 2004 on the termination of the interest rate swap, an increase in taxes paid in 2005 of $6.9 million, and an increase in interest paid of $4.4 million, partially offset by the $25.8 million interest payment on redemption of the LYONs in 2004, a $10.3 million increase in interest received in 2005, and $2.3 million in 2005 arising from changes in non-cash working capital.
The decrease in cash from operations of $42.2 million in the fourth quarter of 2005, as compared to the same period in 2004, resulted primarily from a $36.0 million cash payment related to the restructuring of the retirement benefit plan. In the fourth quarter of 2005, we transitioned the majority of our senior executives and hotel and resort general managers from an unfunded defined benefit plan to a fully funded defined contribution plan (see ‘‘Other Income/Expense, Net—Retirement Benefit Plan’’ above). The transition to this defined contribution format resulted in a funding requirement of $42.2 million, of which $36.0 million was funded in 2005, and a one-time pre-tax loss of $35.5 million.
Financing Activities
In 2005, we received proceeds of $7.0 million relating to the exercise of options by employees to purchase 32,380 Limited Voting Shares, as compared to option exercise proceeds of $33.9 million in 2004 relating to the purchase of 1,367,054 Limited Voting Shares.
We paid $3.1 million and $2.8 million in dividends during 2005 and 2004, respectively, based on a dividend policy of C$0.11 per Limited Voting Share and C$0.055 per Variable Multiple Voting Share per annum, paid semi-annually in January and July.
In 2004, we issued $250.0 million (principal amount) convertible senior notes. In 2004, we also redeemed all of our LYONs for an aggregate payment of $215.5 million (see ‘‘Liquidity and Capital Resources — Convertible Notes’’ above).
Investing Activities
Long-Term Receivables
In 2005, we advanced $44.9 million, in the aggregate, as long-term receivables, including amounts to Four Seasons properties in Geneva, Toronto, Washington, Buenos Aires, and Exuma at
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Emerald Bay. Also in 2005, we were repaid $34.6 million, in the aggregate, of our long-term receivables, including repayments from Four Seasons properties in Nevis, San Francisco, and Scottsdale.
In 2004, we advanced $25.1 million, in the aggregate, as long-term receivables, including amounts to Four Seasons properties in Hampshire, Scottsdale at Troon North, and Exuma at Emerald Bay. Also in 2004, we were repaid $8.9 million, in the aggregate, of our long-term receivables, of which the largest component was $5.9 million relating to the settlement of our loan receivable from our proposed project in Sedona.
During the fourth quarter of 2005, we advanced $6.2 million, in the aggregate, as long-term receivables, including amounts to Four Seasons properties in Geneva, Bangkok and Buenos Aires. Also during the fourth quarter of 2005, we were repaid $15.2 million, in the aggregate, of which the largest component related to our loan receivable from Nevis.
During the fourth quarter of 2004, we advanced $8.4 million, in the aggregate, as long-term receivables, including amounts to Four Seasons properties in Scottsdale, Exuma and Hampshire.
Investments in Hotel Partnerships and Corporations
To fund capital requirements in properties in which we have an interest (primarily in properties under construction or development), we invested $8.7 million in 2005. These included additional investments in Four Seasons Resort Jackson Hole and Four Seasons Hotel Silicon Valley at East Palo Alto, with our equity investments in these properties being 10% and 15%, respectively, at December 31, 2005. In 2005, we realized cash of $24.6 million, from the sales of approximately 53% of our equity interest in Four Seasons Hotel Shanghai, 80% of our equity interest in Four Seasons Residence Club Scottsdale at Troon North, and all of our interests in Four Seasons Hotel Cairo at Nile Plaza and Four Seasons Hotel Amman.
The 2004 investments of $36.1 million included Four Seasons Resort Whistler (which we subsequently sold in the third quarter of 2004), Four Seasons Hotel Silicon Valley at East Palo Alto (approximate equity interest of 15%), and funding of an additional equity investment in one opened property, Four Seasons Resort Jackson Hole (approximate equity interest of 10%). In 2004, we realized cash from disposal of our investments of $38.4 million from the sale of Four Seasons Resort Whistler and the majority of our 8% investment in Four Seasons Hotel Amman.
During the fourth quarter of 2005, on a net basis, we realized cash from the disposition of our investments of $14.0 million, reflecting the sale of our interests in Four Seasons Hotel Cairo at Nile Plaza and Four Seasons Hotel Amman, and the sale of a portion of our interest in Four Seasons Hotel Miami.
During the fourth quarter of 2004, we funded $1.5 million related to our property in Jackson Hole and realized cash of $2.4 million from the sale of part of our interest in Four Seasons Resort Scottsdale at Troon North.
Investment in Management Contracts
For the full year and fourth quarter of 2005, we received total net proceeds of $10.5 million and $11.1 million, respectively, related to our investments in management contracts, including our property in Canary Wharf and our property in Newport Beach (which we ceased managing in October 2005). Of the amounts that were invested in management contracts during 2005, there was no significant investment in any individual management contract.
For the full year and fourth quarter of 2004, we invested a net amount of $12.1 million and $2.4 million, respectively, in investments in management contracts, including investments in Four Seasons Hotel Hampshire, Four Seasons Resort Whistler and Four Seasons Resort Costa Rica.
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Fixed Assets
Our capital expenditures were $18.7 million for the year ended December 31, 2005 and $5.9 million in the fourth quarter of 2005, as compared to $6.6 million and $2.4 million, respectively, for the same periods in 2004. In 2004, we commenced construction on our Toronto corporate office expansion, which is scheduled to be completed during 2006. Capital expenditures related to this expansion were $14.7 million in 2005 and $3.1 million in 2004. Costs to complete the facility are estimated at $30.1 million and are expected to be fully incurred in 2006.
During the fourth quarters of 2005 and 2004, our capital expenditures were $5.9 million and $2.4 million, respectively, which primarily related to our Toronto corporate office expansion.
Owners of properties that we manage are contractually responsible for funding the capital requirements of the properties, including guest room and common area renovations, and for maintaining capital reserves to fund ongoing annual maintenance capital expenditures required by the management agreements. The owners annually spend an average of between 3% and 5% of hotel gross revenues on capital expenditures to maintain properties at the Four Seasons standard (other than in newly constructed or recently renovated properties where the annual amounts generally range from 1% to 2% in the initial years of operation following opening and major refurbishment). Capital expenditures are funded primarily by working capital generated from property operations and through advances from the owners. Our share of capital expenditures in 2005 and 2004 was immaterial for the properties in which we have a minority equity interest or pursuant to management contract obligations.
Outstanding Share Data
| | | | | | |
| Designation | | Outstanding as at March 8, 2006 |
| Variable Multiple Voting Shares1 | | | 3,725,698 | |
| Limited Voting Shares | | | 33,018,768 | |
| Options to acquire Limited Voting Shares2: | | | | |
| Outstanding | | | 4,358,823 | |
| Exercisable | | | 3,385,319 | |
| Convertible Senior Notes issued June 2004 and due 20243 | | $250.5 million4 |
|
| |
| 1 | Convertible into Limited Voting Shares at any time at the option of the holder on a one-for-one basis. |
| |
| 2 | As disclosed in note 11(a) to our consolidated financial statements, pursuant to an agreement approved by the shareholders in 1989, Four Seasons has agreed to make a payment to Mr. Isadore Sharp on an arm’s length sale of control of Four Seasons Hotels Inc. that is calculated by reference to the consideration received per Limited Voting Share in the transaction and the total number of Variable Multiple Voting Shares and Limited Voting Shares outstanding at the time of sale. |
| |
| 3 | The terms of the convertible senior notes are more fully described under ‘‘Liquidity and Capital Resources — Convertible Notes’’. |
| |
| 4 | This amount is equal to the issue price of the convertible senior notes issued in June 2004 and due 2024 plus accrued interest calculated at 1.875% per annum. |
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Financial Instruments
Foreign Exchange Forward Contracts
We use derivative financial instruments in the management of our foreign currency exposures, when we believe it is appropriate. We do not use derivative financial instruments for trading or speculative purposes.
Because a significant portion of our revenues is generated in foreign currencies (the most significant currency being the US dollar, our reporting currency) and the expenditures we incur for our management operations are denominated primarily in Canadian dollars, we enter into foreign exchange forward contracts from time to time as a hedge against foreign currency fluctuations. We estimate future foreign currency cash flows on an ongoing basis and enter into foreign exchange forward contracts in proportion to the magnitude and timing of these anticipated cash flows. For a description of foreign currency-related risks, see ‘‘Operating Risks — Currency Exposure’’. We are also subject to credit risks related to the counterparties to our foreign exchange forward contracts.
As at December 31, 2005, we had foreign exchange forward contracts to convert $21.2 million of US dollars to Canadian dollars at an average rate of 1.16099 over the first six months of 2006. These foreign exchange forward contracts are marked-to-market each period, with the resulting gains or losses recorded in income in the period. As of December 31, 2005, the fair value of the outstanding contracts was $0.1 million and has been included in accounts payable and accrued liabilities on our consolidated balance sheet and in other expense, net in our consolidated statements of operations.
Currency and Interest Rate Swap
We have entered into a currency and interest rate swap agreement with a duration until July 30, 2009 pursuant to which we have agreed to receive interest at a fixed rate of 5.33% per annum on an initial notional amount of $215.8 million and pay interest at a floating rate of six-month Canadian Bankers Acceptances (‘‘BA’’) in arrears plus 1.1% per annum on an initial notional amount of C$269.3 million. On July 30, 2009, we will pay C$311.8 million and receive $250 million under the swap. We have designated the swap as a fair value hedge of our convertible senior notes (see ‘‘Liquidity and Capital Resources — Convertible Notes’’ above). A liability of $17.1 million has been recorded in our accounts in 2005 related to the swap as a fair value hedge, offsetting the translation gain on the underlying debt obligation. It is our intention to continue the swap agreement until maturity. Interest income and interest expense recognized on the swap agreement during the year was $8.0 million and C$8.3 million, respectively. Upon maturity, we will have an obligation to pay C$311.8 million to the swap counterparty and may be required to convert some or all of the proceeds of the $250 million we will receive into Canadian dollars at exchange rates which may be either more or less favourable than at December 31, 2005. The fair value of the swap as at December 31, 2005 represented a loss of $24.3 million. The difference between the fair value and the liability recorded to date has not been recorded in our accounts because the swap has been designated as a fair value hedge. The fair market value of the swap may change over time as a result of changes in the forward exchange rate between the Canadian and US dollar and/or as a result of changes in interest rates.
As part of the interest rate component of the swap agreement, we receive a fixed interest rate amount in exchange for our payment of a floating interest rate charge on the notional Canadian value of the swap. As a result, the amount we are obligated to pay is subject to changes in the six-month BA rate. By way of example, a 1% increase in the six-month BA rate would result in an increase in interest expense, on an annualized basis, of approximately C$2.8 million. Conversely, a 1% decrease in the six-month BA rate would result in a decrease in interest expense, on an annualized basis, of approximately C$2.8 million. We try to manage our exposure to changes in short-term interest rates by investing our available cash balances in short-term securities, to provide a partial offset to changes in interest expense,
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however, there can be no assurance that this practice, which is dependent upon cash balances available for investment and the short-term interest rate spreads between Canada and the US, will be effective.
Other Financial Instruments
In addition to the foreign exchange forward contracts and the currency and interest rate swap, we had the following financial instruments at December 31, 2005: cash equivalents (see ‘‘Liquidity and Capital Resources’’), long-term receivables (see ‘‘Balance Sheet Review and Analysis — Long-Term Receivables’’), convertible senior notes (see ‘‘Liquidity and Capital Resources — Convertible Notes’’) and short-term financial instruments, including current receivables and current accounts payable.
Fair Value of Financial Instruments
The estimated fair value of a financial instrument is the amount at which the instrument could be exchanged in a transaction between willing parties, other than a forced or liquidation sale. These estimates, although based on the relevant market information about the financial instrument, are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could materially affect the estimates.
As cash equivalents, current receivables, current accounts payable and certain other short-term financial instruments are all short-term in nature, their carrying amounts approximate fair values. The fair value of our 2004 convertible senior notes is based on market quotes obtained from one of our financial advisors. The fair value of foreign exchange forward contracts is estimated from quotes obtained from our counterparties for the same or similar financial instruments.
We do not have plans to sell loans receivable to third parties and we expect to realize or settle them in the ordinary course of business. The fair values of these instruments cannot be reasonably estimated because no active and liquid market exists for these instruments, and a market rate of interest (for instruments having similar terms and characteristics) that is required to be used in estimation techniques, such as discounted cash flow analysis, cannot reasonably be determined due to the unusual terms of these instruments.
The fair values of our financial instruments are as follows:
| | | | | | | | | | |
| (in millions of dollars) | | Estimated fair value | | Carrying amount |
| 2005: | | | | | | | | |
| Convertible senior notes1 | | $ | (243.0 | ) | | $ | (260.4 | ) |
| Currency and interest rate swap | | | (24.0 | ) | | | (17.1 | ) |
| Foreign exchange forward contracts | | | (0.1 | ) | | | (0.1 | ) |
| 2004: | | | | | | | | |
| Convertible senior notes1 | | | (322.0 | ) | | | (253.6 | ) |
|
| |
| 1 | The carrying amount of the convertible senior notes includes the amounts allocated to both long-term obligations and shareholders’ equity. It excludes, however, the offering expenses and underwriters’ commission related to the shareholders’ equity component of the notes of $1.3 million in 2005 (2004 − $1.3 million), which are recorded in shareholders’ equity. |
Off-Balance Sheet Arrangements
In addition to the financial instruments discussed above we have various off-balance sheet arrangements, the most significant of which are discussed below.
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Guarantees and Commitments
As at December 31, 2005, we had provided certain guarantees in connection with properties under our management. These include guarantees in respect of four projects totalling a maximum of approximately $18.5 million, as well as a guarantee of $0.3 million for relocation costs for certain employees. We have lease guarantees in respect of Four Seasons Hotel London, as well as a lease guarantee in respect of Four Seasons Hotel Prague (see notes 15(a) and (d), respectively, to our consolidated financial statements). To the extent we are called upon to honour any one of these guarantees, we generally have either the right to be repaid from hotel operations and/or have various forms of security or recourse to the owner of the property.
We also have four other commitments totalling approximately $16.0 million to four properties under our management. In addition, during 2005, we assigned our lease and assets of The Pierre. As part of the sale of The Pierre, in accordance with statutory provisions, the purchaser agreed to assume a portion of our contribution history with a multi-employer pension fund for the unionized hotel employees (the "NYC Pension’’). This permitted us to withdraw from the NYC Pension without incurring a withdrawal liability estimated at $10.7 million. In certain limited circumstances, as a part of our agreement, we may be required to pay a portion of the purchaser’s withdrawal liability, if any. We believe that the likelihood of our being required to make a payment is remote, and have not recorded any amount as at December 31, 2005 in respect of a potential NYC Pension withdrawal liability.
During 2006, we expect to fund $1.7 million relating to one of these commitments. Our assessment of our potential liability for such matters could change as a result of, among other things, the associated risks and uncertainties.
Indemnities
Disposition Indemnification Arrangements
In connection with the sale of all or a part of our interest in a property, we may agree to provide an indemnity against claims relating to breaches of specific covenants or representations and warranties. The maximum amount of the indemnification in these transactions is generally limited to the purchase price paid for the interest being purchased. The nature of these indemnities prevents the calculation of an exact amount that may be payable to the indemnified parties.
Director and Officer Indemnification Arrangements
To the extent permitted by law, we indemnify individuals that are, or have been, directors or officers against certain claims that may be made against them as a result of their being, or having been, a director or officer at our request. We have purchased directors’ and officers’ liability insurance that may be available in respect of certain of these claims.
Other Indemnification Arrangements
In the ordinary course of our business, we enter into other agreements with third parties that may contain indemnification provisions pursuant to which the parties to the agreements agree to indemnify one
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another if certain events occur (such as, but not limited to, changes in laws and regulations or as a result of litigation claims or liabilities that arise in respect of tax or environmental matters).
The terms of our indemnification provisions vary based on the contract, which (together with the fact that any amounts that could be payable would be dependent on the outcome of future, contingent events, the nature and likelihood of which cannot be determined at this time) precludes us from making a reasonable estimate of the maximum potential amount we could be required to pay to counterparties. We believe that the likelihood that we would incur significant liability under these obligations is remote. Historically, we have not made any significant payments under such indemnification arrangements. No amount has been recorded in the consolidated financial statements with respect to these indemnification provisions. Our assessment of our potential liability could change in the future as a result of currently unforeseen circumstances.
Looking Ahead
Our business objectives for 2006 continue to focus on those aspects of our business that we believe provide the greatest potential for maximizing long-term shareholder value.
New Openings
In addition to Four Seasons Hotel Silicon Valley at East Palo Alto and Four Seasons Tented Camp Golden Triangle, Thailand, which both opened in January 2006, we expect to open nine new hotels and resorts over the course of 2006 and 2007, and re-open Four Seasons Resort Maldives at Kuda Huraa. The average term of the management contracts for these properties is 58 years, and these management contracts are expected to provide us with significant additional long-term fee income. During 2006, we expect to fund in the range of $50.0 million to $75.0 million in connection with obtaining new or enhancing existing management agreements.
Service
During 2006, we intend to maintain our focus on value to our guests by continuing to deliver our exceptional quality of service, while at the same time controlling costs. We also intend to focus on enhancing our premium service quality and rate premiums at each of the 11 Four Seasons hotels and resorts that opened over the past 24 months and the new Four Seasons projects that are expected to open in 2006.
We expect that the strong economic environment should translate into continued strength in travel demand, particularly business travel. We also expect that leisure travel demand will remain strong. On a full-year basis, we expect our average daily room rates for 2006 to exceed the rates achieved in 2005.
RevPAR and Margin Improvements
If the travel trends that we experienced in 2005 continue and exchange rates remain at current levels, we expect RevPAR, on a US dollar basis, for worldwide Core Hotels for the full year 2006 to increase in the range of 8% to 10%, as compared to 2005. We expect that this improvement will result from occupancy and pricing improvements. If current trends continue, we expect the full-year gross operating margins of our worldwide Core Hotels to increase more than 150 basis points in 2006.
Management Operations
As a result of the portfolio refinements, including our ceasing management of The Pierre and Four Seasons Hotel Newport Beach in 2005 and, our ceasing management of The Regent Kuala Lumpur later this year and renovation plans at certain hotels, including Four Seasons Resort Maui, we expect full year hotel management fee revenues to grow in line with our full year RevPAR growth expectations for
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2006. Assuming no significant changes to the US to Canadian dollar exchange rate, we expect our operating costs (which include the amounts included in general and administrative expenses in Management Operations together with corporate expenses included in Ownership Operations) should increase in the range of 6% to 8% for the full year 2006 as compared to full year 2005.
"As previously noted, we view 2006 as a transition year. The moderate growth in management fee revenue expected in 2006 reflects the loss of ongoing fee revenue from The Pierre, Newport Beach and Kuala Lumpur," said John Davison, Chief Financial Officer. "As we look beyond 2006, we expect all elements of our growth program to make a solid contribution to earnings, including strong fee improvements from existing hotels (in particular those completing renovation programs) increased fees from recently opened hotels as they stabilize, and the continued addition of exciting new Four Seasons properties around the world."
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Four Seasons Portfolio
Description of Hotels and Resorts
The following table provides an overview of the properties that we currently manage, many of which include a residential component:
| | | | | | | | | | |
| Hotel/Resort and Location | | Approximate
Number of Rooms | | Approximate
Equity Interest1 |
| United States | | | | | | | | |
| Four Seasons Hotel Atlanta, Georgia | | | 245 | | | | — | |
| Four Seasons Hotel Austin, Texas | | | 290 | | | | — | |
| Four Seasons Resort Aviara, California 2 | | | 330 | | | | 7.3 | %3 |
| The Regent Beverly Wilshire (Beverly Hills), California | | | 395 | | | | — | |
| Four Seasons Biltmore Resort (Santa Barbara), California | | | 205 | | | | — | |
| Four Seasons Hotel Boston, Massachusetts 2 | | | 275 | | | | — | |
| Four Seasons Hotel Chicago, Illinois | | | 345 | | | | — | |
| The Ritz-Carlton Hotel Chicago, Illinois | | | 435 | | | | — | |
| Four Seasons Resort and Club Dallas at Las Colinas, Texas | | | 355 | | | | — | |
| Four Seasons Hotel Houston, Texas 2 | | | 405 | | | | — | |
| Four Seasons Resort Hualalai at Historic Ka’upulehu, Hawaii | | | 245 | | | | — | |
| Four Seasons Resort Jackson Hole, Wyoming 2 | | | 140 | | | | — | 4 |
| Four Seasons Resort Lana’i at Manele Bay, Hawaii | | | 235 | | | | — | |
| Four Seasons Hotel Las Vegas, Nevada | | | 425 | | | | — | |
| Four Seasons Hotel Los Angeles, California | | | 285 | | | | — | 4 |
| Four Seasons Resort Maui at Wailea, Hawaii | | | 375 | | | | — | |
| Four Seasons Hotel Miami, Florida | | | 220 | | | | 4.7 | %3 |
| Four Seasons Hotel New York, New York | | | 370 | | | | — | |
| Four Seasons Resort Palm Beach, Florida | | | 210 | | | | — | |
| Four Seasons Hotel Philadelphia, Pennsylvania | | | 365 | | | | — | |
| Four Seasons Hotel San Francisco, California 2 | | | 275 | | | | — | |
| Four Seasons Resort Scottsdale at Troon North, Arizona 2 | | | 210 | | | | 3.9 | %3,4,5 |
| Four Seasons Hotel Silicon Valley at East Palo Alto, California | | | 200 | | | | 15 | %3 |
| Four Seasons Hotel Washington, District of Columbia | | | 210 | | | | — | |
| Other Americas/Caribbean | | | | | | | | |
| Four Seasons Hotel Buenos Aires, Argentina | | | 165 | | | | — | |
| Four Seasons Resort Carmelo, Uruguay 2 | | | 45 | | | | — | |
| Four Seasons Resort Costa Rica at Peninsula Papagayo, Costa Rica 3 | | | 165 | | | | 11.4 | %6 |
| Four Seasons Resort Great Exuma at Emerald Bay, The Bahamas 3 | | | 185 | | | | — | |
| Four Seasons Hotel Mexico City, Mexico | | | 240 | | | | — | |
| Four Seasons Resort Nevis, West Indies 2 | | | 195 | | | | — | |
| Four Seasons Resort Punta Mita, Mexico 2 | | | 140 | | | | — | |
| Four Seasons Hotel Toronto, Ontario, Canada | | | 380 | | | | — | |
| Four Seasons Hotel Vancouver, British Columbia, Canada | | | 375 | | | | 100 | %6 |
| Four Seasons Resort Whistler, British Columbia, Canada 2 | | | 275 | | | | — | 4 |
| Asia/Pacific | | | | | | | | |
| Four Seasons Resort Bali at Jimbaran Bay, Indonesia | | | 145 | | | | — | |
| Four Seasons Resort Bali at Sayan, Indonesia 2 | | | 60 | | | | — | |
|
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| | | | | | | | | | |
| Hotel/Resort and Location | | Approximate
Number of Rooms | | Approximate
Equity Interest1 |
| Four Seasons Hotel Bangkok, Thailand | | | 340 | | | | — | |
| Four Seasons Resort Chiang Mai, Thailand | | | 80 | | | | — | |
| Four Seasons Tented Camp, Golden Triangle, Thailand | | | 15 | | | | — | |
| Four Seasons Hotel Hong Kong, Special Administrative Region of the People’s Republic of China 2 | | | 400 | | | | — | |
| Four Seasons Hotel Jakarta, Indonesia 2 | | | 365 | | | | 2 | %3 |
| The Regent Kuala Lumpur, Malaysia 7 | | | 470 | | | | — | |
| Four Seasons Resort Langkawi, Malaysia | | | 90 | | | | — | |
| Four Seasons Resort Maldives at Kuda Huraa, Maldives | | | 95 | | | | — | |
| Four Seasons Hotel Shanghai, People’s Republic of China | | | 440 | | | | 10 | %3,4 |
| Four Seasons Hotel Singapore, Singapore | | | 255 | | | | — | |
| The Regent Singapore, Singapore | | | 440 | | | | — | |
| Four Seasons Hotel Sydney, Australia | | | 530 | | | | 15.2 | %6 |
| Grand Formosa Regent Taipei, Taiwan | | | 540 | | | | — | |
| Four Seasons Hotel Tokyo at Chinzan-so, Japan | | | 285 | | | | — | |
| Four Seasons Hotel Tokyo at Marunouchi, Japan | | | 55 | | | | — | |
| Middle East | | | | | | | | |
| Four Seasons Hotel Amman, Jordan | | | 195 | | | | | |
| Four Seasons Hotel Cairo at The First Residence, Egypt 2 | | | 270 | | | | — | |
| Four Seasons Hotel Cairo at Nile Plaza, Egypt 2 | | | 365 | | | | | |
| Four Seasons Hotel Damascus, Syria 8 | | | 295 | | | | — | |
| Four Seasons Hotel Doha, Qatar | | | 230 | | | | — | |
| Four Seasons Hotel Riyadh, Saudi Arabia | | | 250 | | | | — | |
| Four Seasons Resort Sharm el Sheikh, Egypt 2 | | | 135 | | | | — | |
| Europe | | | | | | | | |
| Four Seasons Hotel Gresham Palace Budapest, Hungary | | | 180 | | | | 18.3 | %3 |
| Four Seasons Hotel Dublin, Ireland | | | 195 | | | | — | |
| Four Seasons Hotel Geneva, Switzerland | | | 105 | | | | — | |
| Four Seasons Hotel Hampshire, England | | | 135 | | | | — | 4 |
| Four Seasons Hotel Istanbul, Turkey | | | 65 | | | | — | 9 |
| Four Seasons Hotel The Ritz Lisbon, Portugal | | | 280 | | | | — | |
| Four Seasons Hotel Canary Wharf, England | | | 140 | | | | — | |
| Four Seasons Hotel London, England | | | 220 | | | | 12.5 | %4,6,10 |
| Four Seasons Hotel Milan, Italy | | | 120 | | | | — | |
| Four Seasons Hotel George V Paris, France | | | 245 | | | | — | |
| Four Seasons Hotel Prague, Czech Republic | | | 160 | | | | — | 4 |
| Four Seasons Resort Provence at Terre Blanche, France 2 | | | 115 | | | | — | |
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| 1 | In the ordinary course, we make investments in, or advances in respect of or to owners of, properties to obtain new management agreements or to enhance existing management agreements where we believe the overall returns will justify the investment or advance. We generally seek to limit our total long-term capital exposure to no more than 20% of the total equity required for a property. For a description of our investments in, or advances made in respect of or to owners, of properties and other commitments in respect of existing properties, including the equity investments listed in this chart, see ‘‘Balance Sheet Review and Analysis’’ and ‘‘Liquidity and Capital Resources’’ in this document. |
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| 2 | This project includes, or is expected to include, a Four Seasons branded residential component. |
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| 3 | Freehold interest. |
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| 4 | In addition to providing management services to this property, we have a guarantee or other off-balance sheet commitment in respect of this property. See ‘‘Off-Balance Sheet Arrangements’’ in this document. |
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| 5 | We have a preferred profits interest derived from previously existing subordinated loans to the resort or property of approximately $17.4 million in aggregate plus a loan in the amount of $6.0 million to an entity that owns approximately 85% of the entity that owns the hotel. |
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| 6 | Leasehold interest. |
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| 7 | We have entered into an agreement to manage a new 140 room Four Seasons hotel in Kuala Lumpur and have reached agreement with the owner of the existing Kuala Lumpur hotel to transition out of managing that Regent property over the next 12 to 18 months. |
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| 8 | The Four Seasons Hotel Damascus is located in Damascus, Syria, a country that is on the U.S. list of state sponsors of terrorism and that is subject to U.S. regulations (including prohibitions on dealings with specified entities) and legislatively mandated penalties (including export sanctions and ineligibility to receive most forms of U.S. aid or to purchase U.S. military equipment). |
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| 9 | Subject to satisfaction of certain conditions, we may invest up to $4.08 million to acquire up to an 18% interest in conjunction with a proposed expansion and renovation of Four Seasons Hotel Istanbul. |
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| 10 | Four Seasons Hotels Limited (‘‘FSHL’’) is the tenant of the land and premises constituting Four Seasons Hotel London. FSHL has entered into a sublease of the hotel with the entity on whose behalf we manage the hotel. The annual rent payable by FSHL under the lease is the same as the annual rent that is payable by the sub-tenant pursuant to the sublease. Indirectly, we now hold a 12.5% ownership interest in the sub-tenant. |
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Properties under Construction or Development
We currently have 27 properties under construction or development that are to be operated under the Four Seasons name. We expect 18 of those properties to include a residential branded component. The following table provides an overview of these properties:
| | | | | | | | | | |
| Hotel/Resort and Location1, 2 | | Approximate Number of Rooms | | Capital Commitment 3 |
| Scheduled 2006/2007 Openings | | | | | | | | |
| Four Seasons Hotel Alexandria, Egypt 4 | | 125 | | |
| Four Seasons Hotel Beirut, Lebanon | | 235 | | X |
| Four Seasons Hotel Florence, Italy | | 120 | | X |
| Four Seasons Hotel Istanbul at the Bosphorus, Turkey | | 170 | | X |
| The Lodge at Koele, Hawaii, USA 5 | | 100 | | |
| Four Seasons Hotel Macau, Special Administrative Region of the People’s Republic of China 4 | | 400 | | |
| Four Seasons Resort Maldives at Landaa Giraavaru, Maldives | | 100 | | X |
| Four Seasons Hotel Mumbai, India 4 | | 235 | | X |
| Four Seasons Hotel Westlake Village, California, USA | | 270 | | |
| Beyond 2007 | | | | |
| Four Seasons Hotel Bahrain, Bahrain | | 270 | | |
| Four Seasons Hotel Baltimore, Maryland, USA 4 | | 200 | | X |
| Four Seasons Resort Barbados, Barbados 4 | | 117 | | |
| Four Seasons Hotel Beijing, People’s Republic of China | | 325 | | X |
| Four Seasons Resort Bora Bora, French Polynesia | | 105 | | X |
| Four Seasons Hotel Dubai, United Arab Emirates 4 | | 375 | | |
| Four Seasons Hotel Kuala Lumpur, Malaysia 4 | | 140 | | |
| Four Seasons Hotel Marrakech, Morocco 4 | | 140 | | X |
| Four Seasons Resort Mauritius, Republic of Mauritius 4 | | 120 | | X |
| Four Seasons Hotel Moscow, Russia 4 | | 215 | | X |
| Four Seasons Hotel Moscow Kamenny Island, Russia 4 | | 80 | | X |
| Four Seasons Hotel New Orleans, Louisiana, USA 4 | | 240 | | X |
| Four Seasons Resort Puerto Rico, Puerto Rico 4 | | 250 | | X |
| Four Seasons Hotel Seattle, Washington, USA 4 | | 150 | | X |
| Four Seasons Hotel Shanghai at Pudong, People’s Republic of China 4 | | 190 | | X |
| Four Seasons Hotel Taipei, Taiwan 4 | | 275 | | |
| Four Seasons Hotel Toronto, Ontario, Canada 4 | | 265 | | |
| Four Seasons Resort Vail, Colorado, USA 4 | | 120 | | X |
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| 1 | Information concerning hotels, resorts and branded residential components under construction or under development is based upon agreements and letters of intent and may change prior to the completion of the project. We have estimated the dates of scheduled openings based upon information provided by the various developers. There can be no assurance that the dates of scheduled openings will be achieved, that estimated capital commitments will not change or that these projects will be completed. In particular, where a property is scheduled to open near the end of a year there is a greater possibility that the year of opening could be changed. |
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| 2 | We have made an investment in Orlando, Florida, which we expect to include a Four Seasons branded residential component. The financing for this project has not yet been completed and therefore a scheduled opening date cannot be established at this time. |
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| 3 | The aggregate capital commitment for the properties indicated is $142.6 million, of which $2.6 million has been funded and $19 million is expected to be funded in the remainder of 2006. These amounts include capital commitments in respect of Four Seasons branded residential projects under construction or development. |
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| 4 | We expect this project to include a Four Seasons branded residential component. |
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| 5 | The Lodge at Koele is expected to be rebranded as Four Seasons Resort Lana’i at Koele in 2006 when the necessary renovations are completed. |
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Three–Year Review
| | | | | | | | | | | | | | |
| (In millions of dollars except per share amounts and unless otherwise noted) | | 2005 | | 2004 | | 2003 |
| Statements of Operations Data: | | | | | | | | | | | | |
| Consolidated revenues 1 | | $ | 248.3 | | | $ | 261.3 | | | $ | 225.1 | |
| Management operations: | | | | | | | | | | | | |
| Revenues (excluding reimbursed costs) | | $ | 117.2 | | | $ | 112.0 | | | $ | 86.4 | |
| Management earnings before other operating items | | | 76.0 | | | | 77.5 | | | | 56.9 | |
| Ownership operations and corporate expenses: | | | | | | | | | | | | |
| Revenues | | | 65.3 | | | | 97.4 | | | | 88.6 | |
| Distribution from hotel investments | | | 0.1 | | | | 0.3 | | | | 0.1 | |
| Ownership operations and corporate expenses before other operating items | | | (18.0 | ) | | | (16.6 | ) | | | (21.0 | ) |
| Earnings before other operating items 2 | | | 58.0 | | | | 60.9 | | | | 35.9 | |
| Depreciation and amortization | | | (11.2 | ) | | | (11.8 | ) | | | (10.7 | ) |
| Other expense, net 3 | | | (89.2 | ) | | | (11.9 | ) | | | (17.7 | ) |
| Earnings (loss) from operations 4 | | | (42.4 | ) | | | 37.2 | | | | 7.5 | |
| Interest income, net | | | 3.4 | | | | 1.1 | | | | 2.4 | |
| Earnings (loss) before income taxes 5 | | | (39.0 | ) | | | 38.3 | | | | 9.9 | |
| Income tax recovery (expense) | | | 10.8 | | | | (12.6 | ) | | | (5.0 | ) |
| Net earnings (loss) | | $ | (28.2 | ) | | $ | 25.7 | | | $ | 4.9 | |
| Earnings (loss) per share: | | | | | | | | | | | | |
| Basic | | $ | (0.77 | ) | | $ | 0.72 | | | $ | 0.14 | |
| Diluted | | $ | (0.77 | ) | | $ | 0.69 | | | $ | 0.14 | |
Weighted average number of shares
(millions): | | | | | | | | | | | | |
| Limited Voting Shares | | | 32.9 | | | | 31.8 | | | | 31.1 | |
| Variable Multiple Voting Shares | | | 3.7 | | | | 3.8 | | | | 3.9 | |
| Cash Flow Data: | | | | | | | | | | | | |
| Cash provided by operations | | $ | 26.5 | | | $ | 44.4 | | | $ | 47.1 | |
| Cash provided by financing | | | 3.9 | | | | 82.6 | | | | 3.0 | |
| Cash used in capital investments | | | (10.2 | ) | | | (41.2 | ) | | | (28.1 | ) |
| Balance Sheet Data: | | | | | | | | | | | | |
| Cash and cash equivalents | | | 242.2 | | | $ | 226.4 | | | $ | 132.1 | |
| Total assets | | | 880.2 | | | | 902.1 | | | | 732.5 | |
| Long-term obligations | | | 273.8 | | | | 253.0 | | | | 90.9 | |
| Shareholders’ equity | | | 546.7 | | | | 584.9 | | | | 592.3 | |
| Other Data: | | | | | | | | | | | | |
Total revenues of all managed hotels and
resorts6 | | $ | 2,559.7 | | | $ | 2,240.9 | | | $ | 1,856.1 | |
| Management operations profit margin (excluding reimbursed costs and the impact of foreign exchange forward contracts) | | | 64.0 | % | | | 65.8 | % | | | 63.5 | % |
| Market price per share at year-end (C$) | | $ | 57.84 | | | $ | 98.11 | | | $ | 66.33 | |
| Cash dividends declared per share (C$): | | | | | | | | | | | | |
| Limited Voting Shares | | $ | 0.11 | | | $ | 0.11 | | | $ | 0.11 | |
| Variable Multiple Voting Shares | | $ | 0.055 | | | $ | 0.055 | | | $ | 0.055 | |
| Shares outstanding (millions): | | | | | | | | | | | | |
| Limited Voting Shares | | | 32.9 | | | | 32.9 | | | | 31.4 | |
|
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| | | | | | | | | | | | | | |
| (In millions of dollars except per share amounts and unless otherwise noted) | | 2005 | | 2004 | | 2003 |
| Variable Multiple Voting Shares | | | 3.7 | | | | 3.7 | | | | 3.8 | |
| Market capitalization at year-end (C$) | | $ | 2,119.3 | | | $ | 3,591.7 | | | $ | 2,337.6 | |
| Employees 7 | | | 30,900 | | | | 31,300 | | | | 28,640 | |
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| 1 | Consolidated revenues are comprised of revenues from management operations, revenues from ownership operations (which includes corporate expenses) and distributions from hotel investments, less fees from ownership operations to management operations. |
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| 2 | Earnings before other operating items is equal to net earnings plus (i) income tax expense plus (ii) interest expense less (iii) interest income plus (iv) other expense less (v) other income plus (vi) depreciation and amortization. Earnings before other operating items is a non-GAAP measure and is not intended to represent cash flow from operations, as defined by Canadian GAAP, and it should not be considered as an alternative to net earnings, cash flow from operations or any other measure of performance prescribed by GAAP. Our earnings before other operating items may also not be comparable to earnings before other operating items used by other companies, which may be calculated differently. We consider earnings before other operating items to be a meaningful indicator of our operations and we use it as a measure to assess our operating performance. It is included because we believe it can be useful in measuring our ability to service debt, fund capital expenditures and expand our business. Earnings before other operating items is also used by investors, analysts and our lenders as a measure of our financial performance. |
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| 3 | Other expense, net is comprised of net loss on transition of the retirement benefit plan, asset provisions and write-down of investments, foreign exchange gain/loss, gain/loss on disposition of assets, legal and enforcement costs and loss on redemption of LYONs. |
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| 4 | Earnings from operations represent earnings before other operating items less (i) depreciation and amortization plus (ii) other income less (iii) other expense. |
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| 5 | Earnings before income taxes represent earnings from operations plus (i) interest income less (ii) interest expense. |
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| 6 | Total revenues of all managed hotels and resorts consist of rooms, food and beverage, telephone and other revenues of all the hotels and resorts that we manage. |
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| 7 | We directly employ, and are financially responsible for, approximately 520 people at our various corporate offices, worldwide sales offices and central reservations office. Of these corporate employees, almost half are devoted to sales and marketing activities (including our worldwide reservations service), the cost of which is reimbursed by the hotels and resorts that we manage. In addition, there are approximately 30,900 employees located at the 70 hotels and resorts that we manage, many of which include a residential component. All costs relating to these property-based employees, including wages, salaries and health and insurance benefits, are the responsibility of the property owners and are generally paid out of the operating cash flow of the property. |
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Operating Risks
Our business is subject to many risks and uncertainties, including those discussed below.
Geopolitical, Economic and Lodging Industry Conditions
We focus exclusively on the luxury segment of the lodging industry, which is subject to operating risks inherent in the industry. These risks include, among other things:
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| • | changes in general, local and industry-specific economic and financial conditions, such as the airline industry, |
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| • | periodic overbuilding in the industry or a specific market, |
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| • | varying levels of demand for rooms and related services (including food and beverage and function space), |
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| • | competition from other properties, |
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| • | changes in travel patterns, |
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| • | the recurring need for renovation, refurbishment and improvement of hotel and resort properties, |
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| • | changes in wages, benefits, prices, construction and maintenance, insurance and operating costs that may result from inflation or otherwise, |
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| • | government regulations, |
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| • | changes in taxes and interest rates, |
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| • | the availability and cost of financing for operating or capital requirements, |
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| • | extreme weather conditions, |
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| • | infectious diseases, and |
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| • | war, civil unrest, terrorism, international conflict and political instability. |
We operate and have interests in luxury hotels, resorts and serviced and branded residential projects in many areas of the world and our revenues are dependent upon the results of the individual properties. The conditions listed above can have, and have from time to time had, a significant adverse impact upon individual properties or particular regions. A period of economic recession or downturn in any of the world’s primary outbound travel markets could materially and adversely affect, and have from time to time materially and adversely affected, our business, results of operations and financial condition, including fee revenue and ownership earnings. An economic downturn generally affects ownership results to a significantly greater degree than management results due to the high fixed costs associated with hotel ownership.
Competition
The luxury segment of the hotel and resort industry is subject to intense competition, both for guests and for the acquisition of new management agreements. Competition for guests arises primarily from other luxury hotel chains, individual luxury hotels and resorts and a limited number of luxury properties
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operated by larger hotel chains. That competition is primarily based on, among other things, brand name recognition, location, room rates and quality of service and accommodations. Demographic, geographic and other changes in specific market conditions could materially and adversely affect the convenience or desirability of the locales in which hotels and resorts that we manage are located.
We compete for management opportunities with other operators of luxury hotels. We believe that our ability to obtain management agreements is based primarily on the value and quality of our management services, brand name recognition and the economic advantages to the hotel owner of retaining our management services and using our brand name. We also believe that an owner’s assessment of the economic advantages of retaining our management services and using our brand name is, in part, a function of the success of the hotels and resorts currently under management by us. Competitive factors also include relationships with hotel owners and investors, marketing support, reservation system capacity and the ability to make investments that may be necessary to obtain management agreements. Our failure to compete successfully for expansion opportunities or to attract and maintain relationships with current hotel owners could materially and adversely affect our business, results of operations and financial condition.
Dependence on Management Agreements
Management agreements expire in the ordinary course, and may in certain circumstances be renegotiated and be subject to termination upon the occurrence of specified events. Failure to obtain new management agreements or maintain existing management agreements could materially and adversely affect our business, results of operations and financial condition. We manage hotels and resorts for various owners subject to the terms of each property’s management agreements. Those agreements generally can be terminated by the non-defaulting party upon default in payment or unremedied failure to comply with the terms of the agreements unless, in most cases, such default or unremedied failure was caused by typical force majeure events. Most of the management agreements are subject to performance tests that, if not met, could allow the agreements to be terminated by the owner prior to the expiration of their respective terms. The failure to maintain the standards specified in the agreement or to meet the other terms and conditions of an agreement, including a performance test, could result in the loss or cancellation of a management agreement. Typically, but not in all cases, we have certain rights to cure a default to avoid termination. Substantially all of the management agreements include typical force majeure events, which, if they were to occur would prevent the termination of the management agreements. Some management agreements also can be terminated, subject in certain cases, to a payment to us, upon a change in use of the property or upon a sale by the owner to a new owner who does not wish to retain the existing agreement.
In the event of bankruptcy involving a property and foreclosure, a management agreement may be terminated in most jurisdictions, unless the lender has executed a non-disturbance agreement that is enforceable under applicable bankruptcy laws. We generally have non-disturbance agreements with the lenders to owners of hotels and resorts that we manage. Where no non-disturbance agreement is in place or where it is not enforceable under applicable bankruptcy laws, the risk of loss of a management agreement increases where the owner incurs debt at the property level that cannot be serviced adequately. In some jurisdictions, particularly in the United States, management agreements have been construed by courts to create an agency relationship that is terminable by the owner, notwithstanding any provision of the agreement that purports to make the agreement not terminable under such circumstances. In such circumstances, we would generally have an unsecured claim for breach of contract against the owner of the hotel or its trustee in bankruptcy.
Management agreements for hotels and resorts we manage have varying remaining terms (including extension periods that we may elect) and have remaining terms averaging of approximately 52 years. Renewal of management agreements at the end of their term is the subject of negotiation between us and the relevant owners. There can be no assurance that any particular management agreement or agreements will be renewed or with respect to the terms and conditions of any renewal.
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Dependence on Property Owners
As a result of our strategic decision to focus on management as opposed to ownership of hotel and resort properties, our growth opportunities are dependent in part on our ability to establish and maintain satisfactory relationships and enhance those relationships with existing and new property owners. Those growth opportunities are also dependent on access to capital by these investors. In 2005, one owner had an ownership interest in a combination of hotels, resorts and serviced and branded residential properties managed by Four Seasons that represented in excess of 10% of our hotel management fees. A failure by us to maintain satisfactory relationships with any owner or owners of a significant number of properties could have a material adverse effect on our business, results of operations and financial condition.
Risk Associated with Expansion, Growth and New Construction
An element of our business strategy is to increase the number of hotels and resorts under management. That expansion is dependent upon a number of factors, including the identification of appropriate management opportunities, competing successfully for the management agreements relating to those opportunities, availability of financing for new developments and timely completion of construction of new hotels and resorts (or the refurbishment of existing properties) that are, or are to be, managed by us.
From time to time, the hotel industry has experienced periods during which financial institutions generally have been reluctant to provide financing for the construction of real estate properties, including hotels and resorts. There can be no assurance that we will be able to obtain financing for projects or that the terms on which such financing can be obtained will be acceptable to us. The inability to obtain financing for a project could cause cancellation of, or short-term interruption in, the progress or completion of properties under construction or development.
Additionally, any construction project entails significant construction risks that could delay or result in a substantial increase in the cost of construction. The opening of newly constructed properties, in particular, is contingent upon, among other things, receipt of all required licences, permits and authorizations, including local land use permits, building and zoning permits, health and safety permits and liquor licences. Changes or concessions required by regulatory authorities could also involve significant additional costs and delays or prevent completion of construction or opening of a project. As a result of the global nature of our business, these regulatory matters arise in a number of jurisdictions, many of which have distinctive regulatory regimes.
Investments in and Advances to Managed and Owned Properties
We have made investments in, and/or advances in respect of or to owners of, hotels and resorts that we manage, to enable us to acquire the management agreements for those properties or to enhance the terms of those agreements. Currently, we hold an ownership interest in, or have made advances in respect of, 33 of the 70 hotels and resorts that we manage. We also have one remaining leasehold interest in the Four Seasons Hotel Vancouver. We also have made, or expect to make in the near term, investments in, or advances in respect of or to owners of, 17 of the 27 properties under construction or development. The book value of total investments and advances as at December 31, 2005 was approximately $409 million.
In addition to the risks associated with the operation of a hotel, we are subject to risks generally related to owning and leasing real estate in connection with these properties. These risks include, among others, adverse changes in general or local economic conditions, local real estate market conditions, property and income taxes, interest rates, the availability, cost and terms of financing, the financial stability of the property owner, liability for long-term lease obligations, the availability and costs of insurance coverage, the potential for uninsured casualty and other losses, the impact of present or future legislation or regulation (including those relating to the environment), adverse changes in zoning laws and other regulations, civil unrest, terrorism, war and political instability. In addition, these investments in real
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estate are relatively illiquid and our ability to dispose of our ownership interests, particularly our leasehold interests, in response to changes in economic or other conditions may be limited. Further, advances to owners of properties are typically subordinated and, in any event, may be subject to loss in the event of insolvency of the owner to which an advance was made. Any of these factors could result in material operating losses by us or a particular hotel or resort and possibly the whole or partial loss of our investment in the property or the inability to collect advances outstanding. Holding an interest in a hotel also introduces risks associated with funding of capital expenditures and incurring our proportionate share of any operating losses. Where cash and working capital reserves provided by hotel operations are insufficient, debt service, major repairs, renovations, refurbishments, alterations or other capital expenditures generally must be funded by the owners of the hotels and resorts, including us in some cases.
Debt Rating Risks
Our corporate rating is currently investment grade (BBB−) as rated by Standard & Poor’s. Our senior unsecured debt is currently rated by three debt rating agencies (Standard & Poor’s: BBB− with stable outlook; Moody’s: Baa3 with stable outlook; Dominion Bond Rating Service: BBB with stable outlook). A negative change in either global economic or political events may result in the rating agencies downgrading the rating and/or outlook for many of the lodging companies, including us, which would result in an increase in our borrowing costs. In addition, pricing of any amounts drawn under our syndicated bank credit facilities (which are undrawn but under which $1.6 million of letters of credit were issued at December 31, 2005) includes a spread to LIBOR ranging between 0.875% and 2.25%, depending upon the ratings from Standard & Poor’s and Moody’s and certain financial ratios.
Government Regulation
We are subject to laws, ordinances and regulations relating to, among other things, taxes, environmental matters, the preparation and sale of food and beverages, accessibility for disabled persons and general building and zoning requirements in the various jurisdictions in which we manage hotels and resorts. Owners and managers of hotels and resorts also may be subject to laws governing the relationship with employees, including minimum wage requirements, overtime, working conditions and work permit requirements. In addition, the properties we manage (and in, or in respect of which, we may have made advances or investments) may be located in countries (such as Syria), which may from time to time be subject to international trade restrictions, regulations or other forms of economic or political sanction. Compliance with these laws can affect the revenues and profits of properties managed by us or could materially and adversely affect our business, results of operations and financial condition.
Four Seasons, as the current or previous owner or operator of certain hotels, could be liable for investigation and clean-up of contamination and other corrective or remedial action under various laws, ordinances and regulations relating to environmental matters. These laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the condition requiring environmental response and whether the party is currently or formerly the owner or manager of the property. The presence of contamination from hazardous or toxic substances, or the failure to properly remediate a contaminated property, may affect the ability to use the property for its intended purpose, to sell or rent the property, or to borrow using the property as collateral. Persons who arrange for the disposal or treatment of hazardous or toxic substances also may be liable for the cost of removal or remediation of substances at the disposal or treatment facility. In connection with the operation and ownership of various properties, we could be held liable for the cost of remedial action with respect to environmental matters. We are not aware of any potential material environmental liabilities for which we will be responsible with respect to any of the properties which we currently manage or previously managed.
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Pursuant to the management agreements to which we are a party, the owner is responsible for the costs and expenses of the employees at each hotel and for all costs, expenses and liabilities incurred in connection with the operation of the hotel, including compliance with government regulations. However, as the manager, we may be contingently liable for certain liabilities in respect of which we do not maintain insurance, including certain workers’ compensation claims, environmental liabilities and, in respect of hotels in the United States, claims arising under the Americans with Disabilities Act.
We generally obtain indemnities from the owners of the hotels that we manage in respect of these liabilities. The value of those indemnities is dependent upon, among other things, the financial condition of the owners who have provided them.
Political Risk
We currently manage and in some cases have an ownership interest in hotels and resorts in 31 countries and currently have development plans to open hotels and resorts in nine additional countries around the world. In certain of these countries, from time to time, the related assets and revenues may be exposed to political and other risks associated with foreign investment. In some jurisdictions, at certain times, there may be a risk that we may have difficulty enforcing our contractual rights relating to our assets including our non-disturbance agreements and any security relating to our loan receivables if due process of law is not respected.
Insurance
Our management agreements require the hotels and resorts that we manage to be insured against property damage, business interruption and liability at the expense of the owner of the property. Under these policies we are also typically insured against loss of fee income in the event of a temporary business interruption at any of the hotels and resorts that we manage. We also maintain our own insurance coverage in respect of liability, in excess of that obtained at the property level. In addition, we obtain indemnities from the owners of the hotels and resorts that we manage in respect of damages caused by acts, omissions and liabilities of the employees of the property or of Four Seasons, other than damages resulting from certain actions of Four Seasons and certain senior management personnel. Insurance premiums are continuing to increase and underwriters are imposing increasingly restrictive terms and conditions. All lines of coverage generally have been affected; however, commercial properties generally continue to be the most difficult to insure. Exposures for terrorism, cyber perils and toxic mould are now common exclusions. If we were held liable for amounts exceeding the limits of our insurance coverage or for claims outside the scope of that coverage or if the indemnities were insufficient for any reason, including as a result of the owner’s or indemnitor’s financial condition, our business, results of operations and financial condition could be materially and adversely affected.
Legal Proceedings
In the ordinary course of our business, we are named as a defendant in legal proceedings resulting from incidents taking place at properties we manage or in which we have an ownership interest. We maintain comprehensive liability insurance and also require owners to maintain adequate insurance coverage as described above under ‘‘Insurance’’. We believe such coverage to generally be of a nature and amount sufficient to ensure that we are adequately protected from suffering material financial loss as a result of such claims.
Currency Exposure
We have entered into management agreements with respect to hotels throughout the world and accordingly, earn revenue and make investments and advances in many foreign currencies. Our most
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significant currency is US dollars, as more than half of our revenues and assets currently are US dollar-denominated, as are the majority of our investment commitments. However, we incur the majority of our costs in Canadian dollars and our most significant liability (which is related to our convertible senior notes) is a Canadian dollar obligation.
In 2005, we adopted US dollars as our reporting currency. This means that our Canadian dollar consolidated financial statements are translated into US dollars for reporting purposes. Our consolidated statements of operations, consolidated statements of cash provided by operations and consolidated statements of cash flow are translated using the weighted average exchange rates for the period, and assets and liabilities are converted from Canadian dollars into US dollars at the foreign exchange rate applicable at the balance sheet date.
We have not changed our functional currency, which remains Canadian dollars, or the functional currencies of any of our subsidiaries. As a result, while US dollar reporting will minimize the currency fluctuations related to the majority of our US dollar management fee revenues, it will not eliminate the impact of foreign currency fluctuations related to our management fees in other currencies, or our general and administrative expenses, which are incurred primarily in Canadian dollars. It will also not eliminate foreign currency gains and losses related to un-hedged net monetary assets and liability positions. As such, our consolidated results will continue to include gains and losses related to foreign currency fluctuations. The impact of foreign currency gains and losses has been material in the past and could continue to be material in the future.
We endeavour to match foreign currency revenues to costs and investment commitments to provide a natural hedge against currency fluctuations, although there can be no assurance that these measures will be effective in the management of those risks. We also endeavour to manage our currency exposure through, among other things, the use of foreign exchange forward contracts. As at December 31, 2005, we held $21.2 million in foreign exchange forward contracts for the sale of US dollars into Canadian dollars to meet our operating needs. In addition, certain currencies are subject to exchange controls or are not freely tradeable and as a result are relatively illiquid. We attempt to minimize our foreign currency risk by monitoring our cash position, keeping fee receivables current, monitoring the political and economic climate and considering whether to insure convertibility risk in each country in which we manage a property. In certain properties, the foreign currency risk is further mitigated by pricing room rates in US dollars. However, no assurances can be given as to whether our strategies relating to currency exposure will be successful or that foreign exchange fluctuations will not materially adversely affect our business, results of operations and financial condition.
Seasonality/Quarterly Predictability
Our hotels and resorts are generally affected by normally recurring seasonal patterns and, for most of the properties, demand is typically lower in December through March than during the remainder of the year.
Management operations are seasonal in nature, as fee revenues are affected by the seasonality of hotel and resort revenues and operating results. Urban hotels generally experience lower revenues and operating results in the first quarter, which has a negative impact on management revenues. However, this negative impact on management revenues generally is offset, to some degree, by increased travel to resorts in that quarter and may be offset to a greater extent as the portfolio of resort properties that we manage increases. However, seasonality can be affected by specific local events that can cause, and from time to time have caused, unanticipated disruptions to the operations of certain of the properties we manage.
In addition, certain management fees, in particular incentive fees and residential royalty fees, are difficult to predict both in terms of timing and amount and can be impacted to a greater extent than other elements of our business by economic cycles, interest rate levels and other external factors. Although the majority of our management fees are based on the total revenues of the properties we manage and as a result are
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easier to predict, fluctuations in our incentive fees and residential royalty fees can cause volatility in our earnings, particularly as measured from quarter to quarter.
Our hotel ownership position is also affected by seasonal fluctuations, with lower revenue, operating profit and cash flow in the first quarter; ownership positions typically incur an operating loss in the first quarter of each year. Typically, the third quarter has been the strongest quarter for the Four Seasons Hotel Vancouver.
Intellectual Property
In the highly competitive service industry in which we operate, trade names, trademarks, service marks and logos are very important in the sales and marketing of those services. We have a significant number of trade names, trademarks, service marks and logos, and significant time and effort are expended each year on surveillance, registration and protection of our trade names, trademarks, service marks and logos. The loss or infringement of any of our trade names, trademarks, service marks or logos could have a material and adverse effect on our business, results of operations and financial condition.
Risks Associated with the Four Seasons Branded Residential Business
We currently license and manage Four Seasons branded residential projects, including whole ownership and fractional ownership, in many of our existing hotel and resort locations. We are expanding our presence in the luxury segment of the whole ownership and fractional ownership business with a number of other projects under development. Our ability to successfully develop and sell interests in the residential units that are built, and the various fees earned by us from each residential project, could be materially and adversely affected by one or any combination of the factors described in this ‘‘Operating Risks’’ section. Although we believe that we are in compliance in all material respects with applicable laws and regulations to which the marketing, sale and operation of Four Seasons branded residential projects are currently subject, changes in these requirements or a determination by a regulatory authority that we are not in compliance could materially and adversely affect our business, results of operations and financial condition.
Dependence on Key Employees
Our success depends in part on the continued service of our senior executives, who have an average tenure of approximately 22 years with Four Seasons. In particular, our senior management is responsible for the development and/or maintenance of ongoing relationships with new and existing investors in the properties that are managed by us. The unanticipated departure of individuals responsible for those relationships could have a material and adverse effect on, among other things, relationships affecting properties that are, or that may be, managed by us.
Critical Accounting Estimates
The significant accounting policies used by us in preparing our consolidated financial statements are described in note 1 to our consolidated financial statements and should be read to ensure a proper understanding and evaluation of the estimates and judgments made by management in preparing those financial statements. Our consolidated financial statements are prepared in accordance with Canadian GAAP. We also prepare a reconciliation to United States generally accepted accounting principles, which is included as note 18 to the consolidated financial statements.
Under Canadian GAAP, we are also required to make estimates when we account for and report assets, liabilities, revenues and expenses, and contingencies. We are also required to evaluate the estimates that we use.
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We base our estimates on past experience and other factors that we believe are reasonable under the circumstances. Because this process of estimation involves varying degrees of judgment and uncertainty, the amounts currently reported in the financial statements could, in the future, prove to be inaccurate.
We believe the following critical accounting estimates involve the more significant judgments and estimates used in the preparation of our consolidated financial statements.
Recoverability of Investments
Estimates are required to be used by management to assess the recoverability of our investments in long-term receivables, hotel partnerships and corporations, management contracts, and trademarks and trade names.
Long-term receivables are reviewed for impairment when significant events or circumstances occur, including, but not limited to, the following: changes in general economic trends, defaults in interest or principal payments, deterioration in a borrower’s financial condition or creditworthiness (including severe losses in the current year or recent years), or a significant decline in the value of the security underlying a loan. We measure the impairment of long-term receivables based on the present value of expected future cash flows (discounted at the original effective interest rate) or the estimated fair value of the collateral. If an impairment exists, we establish a specific allowance for doubtful long-term receivables for the difference between the recorded investment and the present value of the expected future cash flows or the estimated fair value of the collateral. We apply this impairment policy individually to all long-term receivables and do not aggregate long-term receivables for the purpose of applying this policy.
Investments in hotel partnerships and corporations are written down to their estimated recoverable amount in the event of a decline in value that is other than temporary.
Investments in management contracts and investments in trademarks and trade names are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of investments in management contracts or investments in trademarks and trade names may not be recoverable. Recoverability is measured by a comparison of the carrying amount of the investment to estimated undiscounted future cash flows expected to be generated by the investment. If the carrying amount of the investment exceeds its estimated undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the investment exceeds its fair value.
Estimates of recoverable amounts, future cash flows, and fair values are based on estimates of the profitability of the related managed properties, which, in turn, depend upon assumptions regarding future conditions in the general or local hospitality industry, including competition from other hotels, changes in travel patterns, and other factors that affect the properties’ gross operating revenues and profits. Estimates of recoverable amounts, future cash flows, and fair values may also depend upon, among other things, periodic independent valuations, assumptions regarding local real estate market conditions, property and income taxes, interest rates and the availability, cost and terms of financing, the impact of present or future legislation or regulation, debt incurred by the properties that rank ahead of debt owed to us, owners’ termination rights under the terms of the management agreements, disputes with owners, and other factors affecting the profitability and saleability of the properties (including the proposed timing of a sale) and our investments. Estimates of recoverable amounts can also be affected by variations in historical and current foreign exchange rates.
These assumptions, estimates and evaluations are among other things, subject to the availability of reliable comparable data, ongoing geopolitical concerns and the uncertainty of predictions concerning future events. Accordingly, estimates of recoverable amounts, future cash flows, and fair values are
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subjective and may not ultimately be achieved. Should the underlying circumstances change, the estimated recoverable amounts and future cash flows could change by a material amount.
Fixed Assets
Fixed assets include land, buildings, furniture, fixtures, equipment and leasehold interests and improvements (including our 100% leasehold interest in Four Seasons Hotel Vancouver), which are all recorded at cost. Our fixed assets are reviewed for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. An impairment loss will be recorded if the projected undiscounted future cash flows from the fixed assets are less than the net book value of the fixed assets. Impairment losses are measured by the excess of the book value over the fair value of the asset. Future cash flows are forecasted on an asset specific basis based on our intentions with respect to the asset, historical results and recent trends or events that may impact the asset’s future performance, including general economic conditions, property and income taxes, the impact of present or future legislation or regulation, and other factors affecting the recoverability of the fixed assets. As discussed above under ‘‘Operational and Financial Review and Analysis — Overview — Ownership Operations (which includes Corporate Expenses)’’, we continue to review our options in respect of Four Seasons Hotel Vancouver to determine what, if any, alternatives may be available to modify or restructure our operation of, or investment in, this hotel.
Retirement Benefit Plan
We maintain an unfunded, multi-employer, non-contributory, defined benefit retirement plan on behalf of four active executives and 14 retired executives and general managers, as well as the owners of two of our managed properties (see ‘‘Other Income/Expense, Net — Retirement Benefit Plan’’ discussed above). The accrued benefit liability of $25.8 million that is recorded on our balance sheet in ‘‘Long-term obligations’’ as at December 31, 2005 excludes the accrued benefit liability owed by the owners of the two managed properties in respect of the general managers of those properties. Due to the long-term nature of the defined benefit plan, the calculation of benefit expenses and liabilities depends on various assumptions, such as discount rates, expected rates of increase in future compensation levels, retirement age, and mortality. These assumptions are determined by management and are reviewed annually by the actuaries. Actual future experience that differs from the assumed or future changes in assumptions may affect the amounts of benefit liability and expense. For further details on our retirement plan expense and liability, see note 15(b) of our consolidated financial statements.
Income Taxes
We account for income taxes using the liability method and calculate our income tax provision based on the expected tax treatment of transactions recorded in our consolidated financial statements. Under this method, future tax assets and liabilities are recognized based on differences between the bases of assets and liabilities used for financial statement and income tax purposes, using substantively enacted tax rates. In determining the current and future components of the tax provision, management interprets tax legislation in a variety of jurisdictions and makes assumptions about the expected timing of the reversal of future tax assets and liabilities. If our interpretations differ from those of the tax authorities, enacted tax rates change or the timing of reversals is not as anticipated, the tax provision could materially increase or decrease in future periods.
In measuring the amount of future income tax assets and liabilities, we are periodically required to develop estimates of the tax basis of assets and liabilities. In circumstances where the applicable tax laws and regulations are either unclear or subject to ongoing varying interpretations, changes in these estimates could occur that could materially affect the amounts of future income tax assets and liabilities recorded in our consolidated financial statements. For the year ended December 31, 2005, the most
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significant tax basis estimate that would be affected by differences in interpretation of tax laws was the accumulated net operating losses carried forward of $43.0 million.
For every material future tax asset, we evaluate the likelihood of realization of some portion or all of the asset. This evaluation is based on, among other things, expected levels of future taxable income and the pattern and timing of reversals of temporary timing differences that give rise to future tax assets and liabilities. If, based on the available evidence, we determine that it is more likely than not (a likelihood of more than 50%) that all or some portion of a future tax asset will not be realized, we record a valuation allowance against that asset. For the year ended December 31, 2005, the future income tax asset was $14.4 million, net of a valuation allowance of $10.5 million.
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Recent Canadian Accounting Standards Issued but Not Yet Adopted
Non-Monetary Transactions
In June 2005, the CICA issued Section 3831, ‘‘Non-Monetary Transactions’’, which introduces new requirements for non-monetary transactions entered into on or after January 1, 2006. The amended requirements will result in non-monetary transactions being measured at fair values unless certain criteria are met, in which case, the transaction is measured at carrying value. As this standard is to be implemented for non-monetary transactions entered into on or after January 1, 2006, the impact of adoption of this standard will depend upon future non-monetary transactions.
Financial Instruments
In January 2005, the CICA issued Section 1530 ‘‘Comprehensive Income’’, Section 3855 ‘‘Financial Instruments — Recognition and Measurement’’, and Section 3865 ‘‘Hedges’’. These standards are effective for fiscal years beginning on or after October 1, 2006. The impact of adoption of these standards is not yet determinable, as it will be dependent on our unsettled positions, hedging strategies, and on market volatility at the time of transition.
Disclosure Controls and Procedures
Our senior management, which includes the Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in the rules of the Securities and Exchange Commission and the policies of the Canadian Securities Administrators) and has concluded that such disclosure controls and procedures are effective.
Additional Information
Additional information about us (including our most recent Annual Information Form) is available on SEDAR at www.sedar.com.
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