FOUR SEASONS HOTELS INC.
SECOND QUARTER OF 2004
MANAGEMENT'S DISCUSSION AND ANALYSIS
THIS MANAGEMENT'S DISCUSSION AND ANALYSIS ("MD&A") FOR THE THREE MONTHS AND SIX
MONTHS ENDED JUNE 30, 2004 IS PROVIDED AS OF AUGUST 9, 2004. IT SHOULD BE READ
IN CONJUNCTION WITH THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS FOR THAT
PERIOD AND THE MD&A FOR THE YEAR ENDED DECEMBER 31, 2003 AND THE AUDITED
CONSOLIDATED FINANCIAL STATEMENTS FOR THAT PERIOD. EXCEPT AS DISCLOSED IN THIS
MD&A OR THE MD&A fOR THE THREE MONTHS ENDED MARCH 31, 2004, THERE HAS BEEN NO
MATERIAL CHANGE IN THE INFORMATION DISCLOSED IN THE MD&A FOR THE YEAR ENDED
DECEMBER 31, 2003. A SUMMARY OF CONSOLIDATED REVENUES, MANAGEMENT EARNINGS,
OWNERSHIP AND CORPORATE OPERATIONS EARNINGS AND NET EARNINGS FOR THE PAST EIGHT
QUARTERS CAN BE FOUND IN NOTE 1.
OPERATING ENVIRONMENT
SEASONALITY
Four Seasons hotels and resorts are affected by normally recurring seasonal
patterns and, for most of the properties, demand is usually lower in the period
from December through March compared to the remainder of the year. Typically,
the first quarter is the weakest quarter, and the fourth quarter is the
strongest quarter for the majority of the properties.
Our ownership operations are particularly affected by seasonal fluctuations,
with lower revenue, higher operating losses and lower cash flow in the first
quarter, as compared to the other quarters. As a result, ownership operations
usually incur an operating loss in the first quarter of each year.
Management operations are also impacted by seasonal patterns, as 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. However, this negative impact on management revenues is offset,
to some degree, by increased travel to our resorts in the period.
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HOTEL OPERATING RESULTS
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Three months ended June 30, 2004 Six months ended June 30, 2004
increase over (decrease from) increase over (decrease from)
three months ended June 30, 2003 six months ended June 30, 2003
(percentage change, on US dollar basis) (percentage change, on US dollar basis)
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Gross Gross Gross Gross
Operating Operating Operating Operating
Revenue Profit Revenue Profit
REGION RevPAR(2) (GOR) (GOP) RevPAR (GOR) (GOP)
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WORLDWIDE CORE HOTELS(3) 22.7% 19.5% 35.8% 18.4% 17.2% 33.3%
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US CORE HOTELS 8.1% 6.6% 4.9% 8.3% 7.6% 8.6%
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OTHER AMERICAS/CARIBBEAN 30.9% 28.7% 61.4% 25.0% 24.4% 49.3%
CORE HOTELS
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EUROPE CORE HOTELS 30.9% 27.9% 43.4% 29.3% 27.8% 47.8%
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MIDDLE EAST CORE HOTELS 111.4% 106.6% 376.7% 91.0% 102.8% 372.8%
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ASIA/PACIFIC CORE HOTELS 96.7% 64.8% 307.8% 44.4% 35.9% 97.1%
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Underlying these operating results:
o Business and leisure travel demand improved in the majority of the markets
in which we operate. Group meetings demand continued to lag behind business
and leisure travel demand in the quarter, and properties that typically
derive the larger portion of their business from group travel (including
Aviara and the Ritz-Carlton Chicago) experienced RevPAR declines. Excluding
the properties in Aviara and Chicago, RevPAR in the US would have increased
11.4% in the second quarter of 2004, as compared to the same period in 2003
(11.9% for the six months ended June 30, 2004, as compared to the same
period in 2003). For the second quarter of 2004, the 11.4% RevPAR
improvement is the result of a 3.5 percentage point increase in occupancy
and a 6.2% increase in achieved room rates, as compared to the same period
in 2003.
o Properties under management in Boston, Los Angeles, San Francisco, New York
and Palm Beach performed particularly well on a RevPAR basis relative to
the average for their region. These markets benefited from the increase in
both business and leisure travel demand.
o In the Other Americas/Caribbean region, the properties under management in
Toronto and Vancouver experienced a significant RevPAR increase, reflecting
a recovery from the negative impact of Severe Acute Respiratory Syndrome
("SARS") in those markets in 2003. In the second quarter of 2004, occupancy
in the region increased to 66.9% (from 51.1% in 2003) and achieved room
rates increased 4.8%, as compared to the second quarter of 2003.
o With the exception of Berlin, all of the properties in the European region
had solid RevPAR improvements as a result of improved demand in the
quarter, as compared to the first half of
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2003 when the war in Iraq had a significant negative impact on travel.
Occupancy in the European region (including Berlin) increased to 66.3% for
the quarter (from 58.1% in the same period in 2003) and achieved room rates
increased 15.4% in the three months ended June 30, 2004, as compared to the
three months ended June 30, 2003.
o All of the properties in the Middle East region had significant RevPAR
improvements as a result of improved demand and higher rates during the
quarter, as compared to the first half of 2003 when the war in Iraq had a
significant negative impact on travel. For the second quarter of 2004,
occupancy in the region increased to 69.5% from 36.4%, and achieved room
rates improved 13.9%, as compared to the second quarter of 2003.
o The significant increase in RevPAR at the properties under management in
Asia/Pacific in 2004 reflects a recovery from the negative impact of SARS
in the region in 2003. In most of the markets in the region, demand has
improved beyond budgeted levels and the levels the region was experiencing
prior to the SARS outbreak in 2003. Occupancy increased to 66.7% for the
quarter (from 35.5% in the same period in 2003) and achieved room rates
increased 10.2% in the second quarter of 2004, as compared to the same
period in 2003.
o Growth in revenues other than room revenues increased at a somewhat lower
rate than RevPAR, particularly in the Asia/Pacific region. This pattern is
consistent with other previous economic recoveries when ancillary revenues
typically had a six to nine month lag to RevPAR improvements. Recovery in
travel demand in the Asia/Pacific region began in late 2003 and it was the
last region to experience improvements.
o The significant increase in gross operating margins(4) was attributable to
revenue improvements and cost management efforts at all our properties.
Nonetheless, there was continued pressure on profit margins, particularly
in the US, due to higher costs related primarily to labour (including
health care, benefits and workers' compensation), energy and insurance. The
most significant improvements were realized in the Middle East and
Asia/Pacific regions and in particular, the properties in Amman, Cairo,
Sharm el Sheikh, Bali, Chiang Mai, Maldives, Shanghai and Singapore.
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FINANCIAL REVIEW AND ANALYSIS
THREE MONTHS ENDED JUNE 30, 2004 COMPARED TO THREE MONTHS ENDED JUNE 30, 2003
MANAGEMENT OPERATIONS
Management fee revenues (excluding reimbursed costs(5)) increased 41.6%, or
$12.2 million, to $41.5 million in the three months ended June 30, 2004, as
compared to $29.3 million in the same period last year. This increase was the
result of the improvement in revenues under management resulting from RevPAR and
other revenue increases at the Core Hotels under management and an increase in
fees from recently opened hotels.
Incentive fees increased 72.7% in the three months ended June 30, 2004, as
compared to the same period in 2003, with 36 of the hotels and resorts under
management accruing incentive fees in 2004, as compared to 26 during the same
period last year. The increase in incentive fees was attributable to the
improvement in gross operating profits at the properties under management in
each of the geographic regions in which we operate.
General and administrative expenses (excluding reimbursed costs) increased to
$11.5 million in the second quarter of 2004 from $8.9 million for the same
period in 2003. During the quarter, costs related to new development and growth
opportunities, including travel costs, increased approximately $1 million. It is
expected that a significant portion of these costs, which relate to new
management opportunities, will be allocated to the specific projects. In
addition, during the quarter, as a result of the improved economic and business
environment, we held several regional and company-wide management meetings, some
of which had been postponed for the past three years. The cost of these
meetings, together with management compensation relating to profit participation
that was accrued during the second quarter of 2004 and for which there was not a
similar accrual in 2003, accounted for approximately $700,000 of the quarterly
increase.
As a result of the items described above, our management earnings before other
operating items for the second quarter of 2004 increased 47.1% to $30.1 million,
as compared to $20.5 million in the second quarter of 2003. Our management
operations profit margin(6) (excluding reimbursed costs) increased to 72.4% in
the second quarter of 2004, as compared to 69.7% in the second quarter of 2003.
OWNERSHIP AND CORPORATE OPERATIONS(7)
Operating results from ownership and corporate operations before other operating
items improved $3.7 million (68%) to a loss of $1.7 million in the second
quarter of 2004, as compared to a loss of $5.4 million in the second quarter of
2003.
RevPAR at The Pierre increased 20.1% primarily as a result of an 11.7 percentage
point improvement in occupancy in the second quarter of 2004, as compared to the
same period in 2003, reflecting higher travel demand in New York. As a result,
the operating results at The Pierre improved $2 million in the second quarter of
2004, as compared to the same period last year.
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RevPAR at Four Seasons Hotel Vancouver increased 26% during the second quarter
of 2004, as compared to the same period in 2003. As a result, the operating
results at that hotel improved $761,000 in the second quarter of 2004, as
compared to the same period last year.
Since reaching our maximum funding obligation of the stipulated minimum lease
payments at Four Seasons Hotel Berlin in August of 2003, the lease payments in
2004 have been limited to the cash flow generated by the hotel. This resulted in
a decline of $1.2 million in the operating loss from Four Seasons Hotel Berlin
in the second quarter of 2004, as compared to the same period last year. We have
been given notice of termination of the lease of the hotel by the landlord.
Based on the terms of the new lease entered into by the landlord, as disclosed
to us by the landlord, we will not exercise our right of first offer in respect
of the lease and, as a result, we will likely cease managing the hotel before
the end of the year. The termination of the lease will result in the write-off
of the net book value of our investment in the hotel of approximately $1
million.
We continue to be in discussions with the landlords of The Pierre and Four
Seasons Hotel Vancouver to determine what, if any, alternatives may be available
to modify or restructure our investments in these hotels. There can be no
assurance that acceptable alternative arrangements will be agreed upon with
respect to any or all of these hotels or what the terms of any such alternative
arrangements would be.
STOCK OPTION EXPENSE
Stock option expense for the second quarter of 2004 was $494,000, as compared to
$144,000 for the same period in 2003. Stock option expense is allocated between
Management Operations ($206,000) and Ownership and Corporate Operations
($288,000).
OTHER EXPENSE
Other expense for the second quarter of 2004 was $3 million, as compared to
$12.1 million for the same period in 2003.
Other expense for the second quarter of 2004 was primarily a non-cash,
unrealized $3 million foreign exchange loss, compared to a $9.2 million foreign
exchange loss for the same period in 2003. These foreign exchange losses arose
from the translation to Canadian dollars at current exchange rates at the end of
each month of our non-Canadian dollar-denominated net monetary assets that are
not included in our designated self-sustaining subsidiaries, and local currency
foreign exchange gains and losses on net monetary assets incurred by our
designated foreign self-sustaining subsidiaries. Net monetary assets are the sum
of our foreign currency-denominated monetary assets and liabilities, which
consist primarily of cash and cash equivalents, accounts receivable, long-term
receivables and long-term obligations, as determined under Canadian generally
accepted accounting principles (GAAP).
Also included in other expense during the second quarter of 2003 were legal and
other enforcement costs of $2.9 million in connection with the disputes with the
owners of Four Seasons hotels in Caracas and Seattle. The Seattle dispute was
settled in July 2003. Although the dispute with the owner of the Caracas hotel
is outstanding, future expenses associated with the
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Caracas dispute are not expected to be significant. These disputes are more
fully described in the MD&A for the year ended December 31, 2003.
NET INTEREST INCOME
During the second quarter of 2004, we had net interest income of $666,000, as
compared to $667,000 in the second quarter of 2003. Net interest income is a
combination of $3.9 million in interest income and $3.2 million in interest
expense in the second quarter of 2004, as compared to $3.3 million and $2.6
million, respectively, for the same period in 2003. The increase in interest
income is primarily attributable to higher interest income from loans to managed
properties. The increase in interest expense is primarily attributable to higher
interest costs relating to the convertible notes and convertible senior notes.
INCOME TAX EXPENSE
Our tax expense during the second quarter of 2004 was $5 million (effective tax
rate of 22.5%), as compared to a tax recovery of $0.9 million in the second
quarter of 2003. The variation from our expected 24% tax rate is the result of
certain items not being tax effected, including a portion of the unrealized
foreign exchange gains and losses, since they will never be realized for tax
purposes. In addition, stock option expense is not deductible for Canadian tax
purposes and, as such, is not tax effected.
NET EARNINGS AND EARNINGS PER SHARE(8)
Net earnings for the quarter ended June 30, 2004 were $17.3 million ($0.49 basic
earnings per share and $0.46 diluted earnings per share), as compared to a net
loss of $1.4 million ($0.04 basic and diluted loss per share) for the quarter
ended June 30, 2003. For the three months ended June 30, 2004, diluted earnings
per share was calculated using the number of shares equal to the weighted
average number of Variable Multiple Voting Shares (3,832,172 shares; 2003 -
3,982,172 shares) and Limited Voting Shares (31,652,702 shares; 2003 -
30,931,770 shares) outstanding during the three months ended June 30, 2004, the
number of Limited Voting Shares issuable at that date pursuant to outstanding
options, calculated pursuant to the treasury stock method (1,494,286 shares;
2003 - nil shares), and the number of Limited Voting Shares into which our
outstanding convertible notes issued in September 1999 and due 2029 could be
converted (3,463,155 shares; 2003 - nil shares).
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SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO SIX MONTHS ENDED JUNE 30, 2003
MANAGEMENT OPERATIONS
Management fee revenues (excluding reimbursed costs) increased 27.7%, or $16.3
million, to $74.9 million in the six months ended June 30, 2004, as compared to
$58.6 million in the same period last year. This increase was the result of the
improvement in revenues under management resulting from RevPAR and other revenue
increases at the Core Hotels under management and an increase in fees from
recently opened hotels.
Incentive fees increased 49.2% in the six months ended June 30, 2004, as
compared to the same period in 2003, with 37 of the hotels and resorts under
management accruing incentive fees in 2004, as compared to 31 during the same
period last year. The increase in incentive fees was attributable to the
improvement in gross operating profits at the properties under management in
each of the geographic regions in which we operate.
General and administrative expenses (excluding reimbursed costs) increased to
$22.3 million for the six months ended June 30, 2004 from $18.6 million for the
same period in 2003. During the first half of 2004, costs related to new
development and growth opportunities, including travel costs, increased
approximately $1 million. It is expected that a significant portion of these
costs, which relate to new management opportunities, will be allocated to the
specific projects. In addition, during the first six months of 2004, as a result
of the improved economic and business environment, we held several regional and
company-wide management meetings, some of which had been postponed for the past
three years. The cost of these meetings, together with management compensation
relating to profit participation that was accrued during the first six months of
2004 and for which there was not similar entitlement in 2003, accounted for
approximately $1.1 million of the increase.
As a result of the items described above, our management earnings before other
operating items for the six months ended June 30, 2004 increased 31.4% to $52.6
million, as compared to $40.0 million for the six months ended June 30, 2003.
Our management operations profit margin (excluding reimbursed costs) increased
to 70.2% for the first six months of 2004, as compared to 68.2% for the same
period last year.
OWNERSHIP AND CORPORATE OPERATIONS
Operating results from ownership and corporate operations before other operating
items improved $7.2 million (38.5%) to a loss of $11.5 million in the six months
ended June 30, 2004, as compared to a loss of $18.7 million for the same period
in 2003.
RevPAR at The Pierre increased 23.2% primarily as a result of a 13.3 percentage
point improvement in occupancy in the first half of 2004, as compared to the
same period in 2003, reflecting higher travel demand in New York. As a result,
the operating results at The Pierre improved $3.9 million in the first six
months of 2004, as compared to the same period last year.
RevPAR at Four Seasons Hotel Vancouver increased 15.2% during the first six
months of 2004, as compared to the same period in 2003. As a result, the
operating results at that hotel improved $925,000 in the first six months of
2004, as compared to the same period last year.
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As discussed above, since reaching our maximum funding obligation of the
stipulated minimum lease payments at Four Seasons Hotel Berlin in August of
2003, the lease payments in 2004 have been limited to the cash flow generated by
the hotel. This resulted in a decline of $3.1 million in the operating loss from
Four Seasons Hotel Berlin in the first six months of 2004.
STOCK OPTION EXPENSE
Stock option expense for the six months ended June 30, 2004 was $907,000, as
compared to $159,000 for the same period in 2003. Stock option expense is
allocated between Management Operations ($401,000) and Ownership and Corporate
Operations ($506,000).
OTHER INCOME (EXPENSE)
Other income for the six months ended June 30, 2004 was $1.3 million, as
compared to an expense of $25 million for the same period in 2003.
Included in other income for the six months ended June 30, 2004 was a non-cash,
unrealized $1.7 million foreign exchange gain, as compared to a $17.5 million
foreign exchange loss for the same period in 2003.
Also included in other income for the six months ended June 30, 2004 were legal
and other enforcement costs of $273,000 in connection with the disputes with the
owners of Four Seasons hotels in Caracas and Seattle, as compared to costs of
$7.5 million for the same period in 2003. The Seattle dispute was settled in
July 2003. Although the dispute with the owner of the Caracas hotel is
outstanding, future expenses associated with the Caracas dispute are not
expected to be significant. These disputes are more fully described in the MD&A
for the year ended December 31, 2003.
NET INTEREST INCOME
During the six months ended June 30, 2004, we had net interest income of $1.8
million, as compared to $1.3 million in the same period in 2003. Net interest
income is a combination of $7.9 million in interest income and $6.1 million in
interest expense in the first six months of 2004, as compared to $6.8 million
and $5.5 million, respectively, for the same period in 2003. The increase in
interest income is primarily attributable to higher interest income from loans
to managed properties. The increase in interest expense is primarily
attributable to higher interest costs relating to the convertible notes and
convertible senior notes.
INCOME TAX EXPENSE
Our tax expense during the first six months of 2004 was $8.2 million (effective
tax rate of 22.2%), as compared to a tax recovery of $599,000 in the same period
in 2003. The variation from our expected 24% tax rate is the result of certain
items not being tax effected, including a portion of the unrealized foreign
exchange gains and losses, since they will never be realized for
-8-
tax purposes. In addition, stock option expense is not deductible for Canadian
tax purposes and, as such, is not tax effected.
NET EARNINGS AND EARNINGS PER SHARE
Net earnings for the six months ended June 30, 2004 were $28.8 million ($0.81
basic earnings per share and $0.78 diluted earnings per share), as compared to a
net loss of $10.7 million ($0.31 basic and diluted loss per share) for the six
months ended June 30, 2003. For the six months ended June 30, 2004, diluted
earnings per share was calculated using the number of shares equal to the
weighted average number of Variable Multiple Voting Shares (3,832,172 shares;
2003 - 3,982,172 shares) and Limited Voting Shares (31,553,977 shares; 2003 -
30,916,220 shares) outstanding during the six months ended June 30, 2004, the
number of Limited Voting Shares issuable at that date pursuant to outstanding
options, calculated pursuant to the treasury stock method (1,467,988 shares;
2003 - nil shares), and the number of Limited Voting Shares into which our
outstanding convertible notes issued in September 1999 and due 2029 could be
converted (3,463,155 shares; 2003 - nil shares).
LIQUIDITY AND CAPITAL RESOURCES
FINANCING ACTIVITIES
During the quarter, we issued US$250 million (principal amount) convertible
senior notes. We intend to use the net proceeds from the sale of the convertible
senior notes to repay outstanding indebtedness and for general corporate
purposes, including the making of investments in, or advances in respect of or
to owners of, properties with a view to obtaining new management agreements or
enhancing existing management agreements. These convertible senior 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 convertible senior notes are convertible into Limited Voting
Shares of Four Seasons Hotels Inc. at an initial conversion rate of 13.9581
shares per US$1,000 principal amount (equal to a conversion price of
approximately US$71.64 per Limited Voting Share), subject to adjustments in
certain events, only when (i) the closing price of the Limited Voting Shares
measured over a specified number of trading days is more than 130% of the
conversion price, (ii) the market price of a convertible senior note measured
over a specified number of trading days is less than 95% of the closing sale
price of the Limited Voting Shares into which they may be converted, (iii) we
call the convertible senior notes for redemption, or (iv) specified corporate
transactions or a "fundamental change" has occurred. Holders of the convertible
senior notes will have the right to require us to purchase the convertible
senior notes on July 30, 2009, July 30, 2014 and July 30, 2019 and in connection
with certain events. 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 US$211.8 million, which was estimated based on the present value of
a US$250 million bond maturing in 2009, yielding 5.33% per annum, compounded
semi-annually, and paying a coupon of 1.875%
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per annum) and an equity component (representing the value of the conversion
feature of the convertible senior notes).
In connection with the offering, we have entered into a five-year interest rate
swap with an initial notional amount of US$211.8 million, pursuant to which we
have 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%. At LIBOR of approximately
2.0% (the current six-month LIBOR), this swap arrangement results in a net
effective interest rate of approximately minus 0.96% per year in respect of
US$211.8 million of the principal amount of the convertible senior notes or a
payment of approximately US$2.0 million to us. This arrangement will result in a
net interest payment to us until LIBOR increases more than approximately 100
basis points from the current level. For accounting purposes, we treat the swap
arrangement as a hedge of the interest related to the debt component of the
convertible senior notes, which will result in an effective interest rate for
accounting purposes of six-month LIBOR, in arrears, plus 0.4904%, which is the
swap interest rate.
During 1999, we issued US$655.5 million principal amount at maturity (September
23, 2029) of convertible notes for gross proceeds of US$172.5 million. The net
proceeds of the issuance, after deducting offering expenses and underwriters'
commission, were US$166 million. We are entitled to redeem the convertible notes
commencing in September 2004 for cash equal to the issue price plus accrued
interest calculated at 4 1/2% per annum. Holders of the convertible notes have
conversion rights, which they can exercise at any time before the maturity date
or the date of redemption of the convertible notes, pursuant to which they can
require us to issue to them 5.284 Limited Voting Shares for each US$1,000
principal amount of convertible notes. The holders of convertible notes also can
require us to repurchase the convertible notes in September 2004 for an amount
equal to the issue price plus accrued interest calculated at 4 1/2% per annum.
This right is also available in September 2009 and September 2014. We have a
choice of settling our obligation, in connection with the conversion or purchase
of the convertible notes at the option of the holder, with cash or Limited
Voting Shares.
As described above, we are entitled to redeem all or a portion of the
convertible notes at any time on or after September 23, 2004 for cash at the
issue price plus accrued interest (calculated at 4 1/2% per annum) to the date
of purchase. We have determined that, absent significant changes in market
circumstances, we will redeem all of the convertible notes that are outstanding
on September 23, 2004 for cash, which would require a cash payment to the
convertible note holders of approximately US$215.5 million, assuming that none
of the holders exercised their right to convert their convertible notes before
the redemption date. In accordance with Canadian GAAP, we allocate the
consideration paid on extinguishment of the convertible notes to the liability
and equity components based on their relative fair values at the date of the
redemption. Depending on interest rates at the date of redemption, we expect to
recognize a pre-tax accounting loss which could be in the range of $44 million
to $14 million related to the debt component of the convertible notes
(representing the difference between the carrying value of the debt component
and the allocated relative fair value of the debt component - estimated as the
present value of these zero-coupon bonds, yielding an assumed 25-year interest
rate ranging from 7.5% to 8.5% per annum, compounding semi-annually). This loss
will be recorded in the statement of operations. In addition, at the interest
rates noted above, we expect to recognize a pre-tax accounting gain on the
extinguishment of the equity component of the convertible notes which could be
in the range of approximately $32 million to $2 million. The gain will be
recorded directly in retained earnings. The amount of the gain and loss is
extremely sensitive to interest rate changes. The expected net impact on
retained earnings from the extinguishment of both the debt and equity components
of the convertible notes would be a reduction of approximately $12 million,
although the US to Canadian dollar exchange rates will affect the net impact.
During the second quarter of 2004, we finalized a committed bank credit facility
of US$100 million which expires June 2005 and replaces credit facilities of
US$212.5 million. We have agreed to maintain a minimum cash balance of at least
$75 million in our account with the agent for the facility while any liabilities
are owing under the facility. As at June 30, 2004, no amounts
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were borrowed under this credit facility. However, approximately US$14 million
of letters of credit are currently issued under those facilities. No amounts
have been drawn under these letters of credit. We believe that, absent unusual
opportunities, this bank credit facility, when combined with cash on hand and
internally generated cash flow, should be more than adequate to allow us to
finance our normal operating needs and anticipated investment commitments
related to our current growth objectives.
Primarily as a result of the completion of our offering of US$250 million
(principal amount) of convertible senior notes during the second quarter of 2004
described above and including the $75 million described above, our cash and cash
equivalents were $467.2 million as at June 30, 2004, as compared to $170.7
million as at December 31, 2003.
Long-term obligations (as determined under Canadian GAAP) increased from $120.1
million as at December 31, 2003 to $413.4 million as at June 30, 2004, primarily
as a result of the issue of the convertible senior notes in the quarter, to
accreted interest on our convertible notes (which were issued in September 1999
and due 2029) and foreign exchange translation.
CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS
We have provided certain guarantees and have other commitments in connection
with properties under our management totalling a maximum of $29.8 million. Other
than the issuance of convertible senior notes issued in June 2004 and due 2024
as discussed above and any payments that may be made in respect of our
outstanding convertible notes issued in September 1999 and due 2029 and funding
relating to our management opportunities described under "Financing Activities"
and "Investing/Divesting Activities", we do not anticipate any further material
change in respect of these commitments over the remainder of the current year.
These contractual obligations and other commitments are more fully described in
the MD&A for the year ended December 31, 2003.
CASH FROM OPERATIONS
During the three months and six months ended June 30, 2004, we generated $28.7
million and $33.6 million, respectively, from operations, as compared to $15.1
million and $37.0 million, respectively, for the same periods in 2003.
The increase in cash from operations of $13.6 million in the second quarter of
2004 resulted primarily from an increase in cash contributed by management
operations of $9.9 million, a decrease in cash used in ownership and corporate
operations of $3.9 million and a decrease in legal and enforcement costs paid of
$4 million, partially offset by an increase in working capital of $3.2 million,
primarily relating to an increased accrual relating to the incentive fee
improvement.
The decrease in cash from operations of $3.4 million in the first six months of
2004 resulted primarily from an increase in cash contributed by management
operations of $12.9 million, a decrease in cash used in ownership and corporate
operations of $7.6 million and a decrease in legal and enforcement costs paid of
$5.1 million, partially offset by an increase in working
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capital of $27.5 million, primarily as a result of income tax refund received in
the first half of 2003 and an increase in the accrual related to improved
incentive fees.
INVESTING/DIVESTING ACTIVITIES
Part of our business strategy is to invest a portion of available cash to obtain
management agreements or enhance existing management arrangements. These
investments in, or advances in respect of or to owners of, properties are made
where we believe that the overall economic return to Four Seasons justifies the
investment or advance.
During the first six months of 2004, we funded $71 million in such management
opportunities, including amounts advanced as loans receivable and investments in
hotel partnerships such as Hampshire, Whistler and Palo Alto. This level of
investment was consistent with our business plan, with the investments being
made to secure new long-term management agreements or to enhance existing
management arrangements.
In July 2004, we sold our 8% interest in Four Seasons Hotel Amman and our 100%
interest in Four Seasons Resort Whistler (substantially all of which was
acquired during the quarter). On a combined basis, we received proceeds of
approximately $47 million, which approximated book value. We continue to manage
the properties under long-term management contracts.
During the remaining six months of 2004, we expect to fund approximately $35
million in respect of investments in, or advances to, various projects,
including additional funding in Palo Alto, properties in Washington and Geneva
and the expansion of corporate office facilities.
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OUTSTANDING SHARE DATA
- --------------------------------------------------------------------------------
DESIGNATION OUTSTANDING AS AT
AUGUST 5, 2004
- --------------------------------------------------------------------------------
Variable Multiple Voting Shares(a) 3,832,172
- --------------------------------------------------------------------------------
Limited Voting Shares 31,853,658
- --------------------------------------------------------------------------------
Options to acquire Limited Voting Shares:
- --------------------------------------------------------------------------------
Outstanding 5,498,799
- --------------------------------------------------------------------------------
Exercisable 2,822,751
- --------------------------------------------------------------------------------
Convertible Notes issued September 1999 and due 2029(b) US$214.2 million(c)
- --------------------------------------------------------------------------------
Convertible Senior Notes issued June 2004 and due 2024(d) US$250.6 million(e)
- --------------------------------------------------------------------------------
a) Convertible into Limited Voting Shares at any time at the option of the
holder on a one-for-one basis.
b) Subject to adjustment in certain circumstances, each US$1,000 principal
amount of notes is convertible, at the option of the holder, into 5.284
Limited Voting Shares (3,463,155 Limited Voting Shares in aggregate).
We have the right to acquire notes that are tendered for conversion for
cash equal to the then fair market value of the underlying Limited
Voting Shares.
c) This amount is equal to the issue price of the convertible notes issued
September 1999 and due 2029 plus accrued interest calculated at 4.5%
per annum.
d) Details on the convertible senior notes are more fully described under
"Financing Activites".
e) This amount is equal to the issue price of the convertible senior notes
issued June 2004 and due 2024 plus accrued interest calculated at
1.875% per annum.
LOOKING AHEAD
The MD&A for the year ended December 31, 2003 provided certain forward-looking
information regarding our expectations for 2004.
Based on the travel trends that we experienced in the first and second quarter
of 2004 and that we currently are observing, we expect RevPAR for worldwide Core
Hotels in the third quarter to increase more than 10%, as compared to the same
period last year. We expect that this improvement will result from occupancy and
pricing improvements in all geographic regions in the third quarter of 2004.
CHANGES IN ACCOUNTING POLICIES
In December 2001, the Canadian Institute of Chartered Accountants ("CICA")
issued an accounting guideline relating to hedging relationships. The guideline
establishes requirements for the identification, documentation, designation and
effectiveness of hedging relationships and was effective for fiscal years
beginning on or after July 1, 2003. Effective January 1, 2004, we ceased
designating our US dollar forward contracts as hedges of our US dollar revenues.
These contracts were entered into during 2002, and all of these contracts will
mature during 2004. The foreign exchange gains on these contracts of $14.6
million, which were deferred prior to January 1, 2004, will be recognized
throughout 2004 as an increase of fee revenues. Effective January 1, 2004, our
US dollar forward contracts are being marked-to-market on a monthly basis with
the resulting changes in fair values being recorded as a foreign exchange gain
or loss. The impact of ceasing to designate our US dollar forward
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contracts as hedges of our US dollar revenues was to decrease net earnings by
$205,000 and $376,000, respectively, for the three months and six months ended
June 30, 2004 and to increase receivables by $6.6 million and accounts payable
and accrued liabilities by $7.2 million as at June 30, 2004.
As a result of adopting the CICA Section 1100, "Generally Accepted Accounting
Principles", which was issued in 2003 and was effective for 2004, we began
recording all reimbursed costs in revenue on a gross, rather than net, basis.
These costs include marketing, reservations, and advertising charges, as well as
the out-of-pocket expense charges, which we charge to properties under
management on a cost recovery basis. For the second quarter of 2003, reimbursed
costs have also been reclassified on a consistent basis and included in
revenues.
Effective January 1, 2004, we also adopted the following accounting standards:
Accounting for Asset Retirement Obligations, Impairment of Long-Lived Assets,
Revenue Recognition and Revenue Arrangements with Multiple Deliverables, all of
which are more fully described in the MD&A for the year ended December 31, 2003.
The application of these accounting treatments did not have a material impact on
our interim financial statements. See also note 1 to the interim consolidated
financial statements.
CRITICAL ACCOUNTING ESTIMATES
Under Canadian GAAP, we are 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.
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 are 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
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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.
For investments in hotel partnerships and corporations, we determine if there is
an impairment in value by reviewing periodic independent valuations and the
undiscounted cash flows of the related property. In the event of a decline in
value of the investment that is other than temporary, the investment is written
down to its estimated recoverable amount.
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
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 and future cash flows 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 revenue and
profits. Estimates of recoverable amounts and future cash flows 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 salability of the properties and our investments.
These assumptions, estimates and evaluations are subject to the availability of
reliable comparable data, ongoing geopolitical concerns and the uncertainty of
predictions concerning future events. Accordingly, estimates of recoverable
amounts and future cash flows are 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.
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.
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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, 2003, the most significant tax bases estimate
that would be affected by differences in interpretation of tax laws was the
accumulated net operating losses carried forward of $30.6 million.
For every material future tax asset, we evaluate the likelihood of whether some
portion or all of the asset will not be realized. 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, 2003, the future
income tax asset was $13.2 million, net of a valuation allowance of $3.0
million.
ADDITIONAL INFORMATION
Additional information about us (including our most recent annual information
form, MD&A and our audited financial statements for the year ended December 31,
2003) is available on SEDAR at www.sedar.com.
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1. Eight Quarter Summary:
- ----------------------- ----------------------- ------------------------ ---------------------- ----------------------
(In millions of Second Quarter First Quarter Fourth Quarter Third Quarter
dollars except per
share amounts)
- ----------------------- ----------------------- ------------------------ ---------------------- ----------------------
- ----------------------- ------------ ---------- ------------ ----------- ----------- ---------- ----------- ----------
2004 2003(a) 2004 2003(a) 2003(a) 2002 2003(a) 2002
- ----------------------- ------------ ---------- ------------ ----------- ----------- ---------- ----------- ----------
Consolidated revenues(b) $97.0 $80.8 $75.3 $72.4 $87.9 $92.9 $72.6 $76.1
- ----------------------- ------------ ---------- ------------ ----------- ----------- ---------- ----------- ----------
Earnings (loss)
before other
operating items:
- ----------------------- ------------ ---------- ------------ ----------- ----------- ---------- ----------- ----------
Management 30.1 20.5 22.5 19.6 20.7 21.6 18.8 15.5
operations
- ----------------------- ------------ ---------- ------------ ----------- ----------- ---------- ----------- ----------
Ownership and (1.7) (5.5) (9.7) (13.2) (2.0) (4.6) (9.4) (6.6)
corporate operations
- ----------------------- ------------ ---------- ------------ ----------- ----------- ---------- ----------- ----------
Net earnings (loss):
- ----------------------- ------------ ---------- ------------ ----------- ----------- ---------- ----------- ----------
Total $17.3 $(1.4) $11.5 $(9.3) $11.7 $ 7.6 $4.4 $(12.3)
- ----------------------- ------------ ---------- ------------ ----------- ----------- ---------- ----------- ----------
Basic earnings $0.49 $(0.04) $ 0.33 $(0.27) $0.33 $ 0.22 $0.13 $(0.35)
(loss) per share(c)
- ----------------------- ------------ ---------- ------------ ----------- ----------- ---------- ----------- ----------
Diluted earnings $0.46 $(0.04) $ 0.31 $(0.27) $0.32 $ 0.22 $0.12 $(0.35)
(loss) per share(c)
- ----------------------- ------------ ---------- ------------ ----------- ----------- ---------- ----------- ----------
a) In December 2003, the CICA amended Section 3870 of its Handbook to require entities to account for employee stock options
using the fair value-based method, beginning January 1, 2004. In accordance with one of the transitional alternatives
permitted under amended Section 3870, in the fourth quarter of 2003 we prospectively adopted the fair value-based method
with respect to all employee stock options granted on or after January 1, 2003. Accordingly, options granted prior to that
date continue to be accounted for using the settlement method, and results for each of the quarters in 2002 have not been
restated. In accordance with the new standard, however, the reported results for the first three quarters of 2003 are
required to be restated. The prospective application of adopting the fair value-based method effective January 1, 2003
resulted in the following restatements: 1st Quarter 2003 -- no effect on net loss or basic and diluted loss per share; 2nd
Quarter 2003 -- increase in net loss of $0.1 million and no effect on basic and diluted loss per share; 3rd Quarter and 4th
Quarter 2003 -- in each quarter, a decrease in net earnings of $0.4 million and a decrease in basic and diluted earnings
per share of $0.01 for each quarter.
b) As a result of adopting Section 1100, "Generally Accepted Accounting Principles", which was issued by the CICA in July
2003, and was effective January 1, 2004, we have included the reimbursement of all out-of-pocket expenses in both revenues
and expenses instead of recording certain reimbursed costs as a "net" amount. As a result of this change, consolidated
revenues have been restated as follows: 1st Quarter 2003 - increase of $11.3 million; 2nd Quarter 2003 - increase of $10.9
million; 3rd Quarter 2003 - increase of $10.3 million; 4th Quarter 2003 - increase of $12.6 million; 3rd Quarter 2002 -
increase of $13.9 million; 4th Quarter 2002 - increase of $16.0 million.
c) Quarterly computations of per share amounts are made independently on a quarter-by-quarter basis and may not be identical
to annual computations of per share amounts.
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2. RevPAR is defined as average room revenue per available room. RevPAR is a
commonly used indicator of market performance for hotels and resorts and
represents the combination of the average daily room rate per room occupied
and the average occupancy rate achieved during the period. RevPAR does not
include food and beverage or other ancillary revenues generated by a hotel
or resort. RevPAR is the most commonly used measure in the lodging industry
to measure the period-over-period performance of comparable properties.
3. The term "Core Hotels" means hotels and resorts under management for the
full year of both 2004 and 2003. However, if a "Core Hotel" has undergone or
is undergoing an extensive renovation program in one of those years that
materially affects the operation of the property in that year, it ceases to
be included as a "Core Hotel" in either year. Changes from the 2003/2002
Core Hotels are the additions of Four Seasons Hotel Amman, Four Seasons
Resort Sharm el Sheikh, Four Seasons Hotel Shanghai and Four Seasons Hotel
Tokyo at Marunouchi and the deletion of Four Seasons Biltmore Resort (Santa
Barbara), which is undergoing an extensive renovation program in 2004.
4. Gross operating margin represents gross operating profit as a percentage of
gross operating revenue.
5. The following table illustrates the impact of adopting the new accounting
standard (CICA Section 1100 - "Generally Accepted Accounting Principles", as
it relates to the reimbursement of out-of-pocket costs) on a pro forma basis
in the quarters for 2003 as if the new standard was applicable during that
time.
- ----------------------------------------------------------------------------------------------------------------------
(In thousands of dollars) 2003
- ----------------------------------------------------------------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
- ----------------------------------------------------------------------------------------------------------------------
Revenues:
- ----------------------------------------------------------------------------------------------------------------------
Fee revenues $29,305 $29,351 $28,822 $33,052
- ----------------------------------------------------------------------------------------------------------------------
Cost reimbursements previously included in fee revenues* 6,925 7,381 7,395 7,525
- ----------------------------------------------------------------------------------------------------------------------
Additional cost reimbursements 11,526 11,190 10,469 12,892
- ----------------------------------------------------------------------------------------------------------------------
Total revenues 47,756 47,922 46,686 53,469
- ------------ ---------------------------------------------------------------------------------------------------------
Operating costs and expenses:
- ----------------------------------------------------------------------------------------------------------------------
General and administrative expenses 9,736 8,901 9,980 12,391
- ----------------------------------------------------------------------------------------------------------------------
Reimbursed costs 18,451 18,571 17,864 20,417
- ----------------------------------------------------------------------------------------------------------------------
Total expenses 28,187 27,472 27,844 32,808
- ----------------------------------------------------------------------------------------------------------------------
Total earnings from Management operations before other operating $19,569 $20,450 $18,842 $20,661
items
- ----------------------------------------------------------------------------------------------------------------------
* Marketing and reservation fees were included in both fee revenues and general and administrative expenses
in 2003 and earlier years.
6. The management operations profit margin represents management operations
earnings before other operating items, as a percent of management
operations revenue, excluding reimbursed costs.
7. Included in ownership and corporate operations are the consolidated
revenues and expenses from our 100% leasehold interests in The Pierre in
New York, Four Seasons Hotel Vancouver and Four Seasons Hotel Berlin,
distributions from other ownership interests in properties that Four
Seasons manages and corporate overhead expenses related, in part, to these
ownership interests.
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8. Adjusted net earnings is equal to net earnings (loss) plus (i) foreign
exchange loss, less (ii) foreign exchange gain, plus (iii) asset impairment
charge, each tax-effected as applicable. Adjusted net earnings, as we
calculate it, may not be comparable to adjusted net earnings used by other
companies, which may be calculated differently. In addition, adjusted net
earnings is not intended to represent net earnings as defined by Canadian
GAAP and should not be considered an alternative to net earnings or any
other measure of performance prescribed by Canadian GAAP. It is included
because we believe it can assist in the period-over-period comparability of
our financial performance.
A reconciliation of net earnings (the nearest Canadian GAAP measure to
adjusted net earnings) to adjusted net earnings is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
(UNAUDITED) JUNE 30, JUNE 30,
(IN THOUSANDS OF DOLLARS) 2004 2003 2004 2003
--------------------------------------------------------------------------------------------------------------
NET EARNINGS (LOSS) $ 17,334 $ (1,414) $ 28,808 $ (10,702)
ADJUSTMENTS:
Foreign exchange loss (gain) 2,969 9,235 (1,661) 17,502
Net asset impairment charge* 42 2,898 351 7,539
TAX EFFECT OF ADJUSTMENTS (1,174) (1,910) (583) (3,024)
-------------------------------------------------------------
ADJUSTED NET EARNINGS $ 19,171 $ 8,809 $ 26,915 $ 11,315
=============================================================
ADJUSTED BASIC EARNINGS PER SHARE $ 0.54 $ 0.25 $ 0.76 $ 0.32
=============================================================
ADJUSTED DILUTED EARNINGS PER SHARE $ 0.51 $ 0.25 $ 0.73 $ 0.32
=============================================================
*INCLUDES LEGAL AND ENFORCEMENT COSTS.
* * *
All dollar amounts referred to in this document are Canadian dollars unless
otherwise noted. The financial statements are prepared in accordance with
Canadian generally accepted accounting principles.
* * *
This document contains "forward-looking statements" within the meaning of
federal securities laws, including RevPAR, profit margin and earnings trends;
statements concerning the number of lodging properties expected to be added in
this and future years; expected investment spending; and similar statements
concerning anticipated future events results, circumstances, performance or
expectations that are not historical facts. These statements are not guarantees
of future performance and are subject to numerous risks and uncertainties,
including those described in our annual information form and management's
discussions and analysis. Those risks and uncertainties include the rate and
extent of the current economic recovery and the rate and extent of the lodging
industry's recovery from the terrorist attacks of September 11, 2001 and
subsequent terrorist attacks, Severe Acute Respiratory Syndrome (SARS), the
civil unrest in Iraq and elsewhere, supply and demand changes for hotel rooms
and residential properties, competitive conditions in the lodging industry,
relationships with clients and property owners, and the availability of capital
to finance growth. Many of these risks and uncertainties can affect our actual
results and could cause our actual results to differ materially from those
expressed or implied in any forward-looking statement made by us or on our
behalf. All forward-looking statements in this document are qualified by these
cautionary statements. These statements are made as of the date of this document
and, except as required by applicable law, we undertake no obligation to
publicly update or revise any forward-looking statement, whether as a result of
new information, future events or otherwise.
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