EXHIBIT 3
Consolidated Financial Statements
(In Canadian dollars)
FOUR SEASONS HOTELS INC.
Years ended December 31, 2004 and 2003
AUDITORS' REPORT TO THE SHAREHOLDERS
We have audited the consolidated balance sheets of Four Seasons Hotels Inc. as
at December 31, 2004 and 2003 and the consolidated statements of operations,
retained earnings, cash provided by operations and cash flows for the years then
ended. These financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with Canadian generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of the Corporation as at December 31,
2004 and 2003 and the results of its operations and its cash flows for the years
then ended in accordance with Canadian generally accepted accounting principles.
KPMG LLP
Chartered Accountants
Toronto, Canada
March 14, 2005
FOUR SEASONS HOTELS INC.
Consolidated Statements of Operations
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
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2004 2003
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CONSOLIDATED REVENUES (NOTE 12) $339,788 $313,580
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MANAGEMENT OPERATIONS:
Revenues:
Fee revenues $145,831 $120,530
Reimbursed costs (note 1(l)(ii)) 72,716 75,303
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218,547 195,833
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Expenses:
General and administrative expenses (44,783) (41,008)
Reimbursed costs (note 1(l)(ii)) (72,716) (75,303)
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(117,499) (116,311)
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101,048 79,522
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OWNERSHIP AND CORPORATE OPERATIONS:
Revenues 126,726 123,214
Distributions from hotel investments 398 153
Expenses:
Cost of sales and expenses (142,872) (147,816)
Fees to Management Operations (5,883) (5,620)
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(21,631) (30,069)
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EARNINGS BEFORE OTHER OPERATING ITEMS 79,417 49,453
Depreciation and amortization (15,281) (15,011)
Other expense, net (note 13) (16,095) (25,783)
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EARNINGS FROM OPERATIONS 48,041 8,659
Interest income, net (note 10(d)) 1,494 3,350
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EARNINGS BEFORE INCOME TAXES 49,535 12,009
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Income tax expense (note 8):
Current (11,680) (2,395)
Future (4,623) (4,460)
Increase in future income tax assets - 230
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(16,303) (6,625)
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NET EARNINGS $33,232 $ 5,384
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EARNINGS PER SHARE (NOTE 11(d)) $ 0.93 $ 0.15
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DILUTED EARNINGS PER SHARE (NOTE 11(d)) $ 0.89 $ 0.15
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See accompanying notes to consolidated financial statements.
1
FOUR SEASONS HOTELS INC.
Consolidated Balance Sheets
December 31, 2004 and 2003
(In thousands of Canadian dollars)
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2004 2003 2004 2003
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ASSETS LIABILITIES AND SHAREHOLDERS' EQUITY
Current assets: Current liabilities:
Cash and cash equivalents $272,467 $170,725 Accounts payable and accrued
Receivables (note 2) 98,143 88,636 liabilities (note 9) $72,716 $61,045
Inventory 1,732 2,169 Long-term obligations due
Prepaid expenses 3,588 3,780 within oneyear (note 10) 4,533 2,587
- --------------------------------------------------- -------------------------------------------------------------
375,930 265,310 77,249 63,632
Long-term receivables (note 3) 215,517 197,635 Long-term obligations (note 10) 304,590 117,521
Investments in hotel Shareholders' equity (note 11):
partnerships and Capital stock 379,227 329,274
corporations (note 4) 158,079 157,638 Convertible notes (notes 10(a) and (b)) 50,373 178,543
Contributed surplus 11,402 5,529
Fixed assets (note 5) 72,143 75,789 Retained earnings 295,218 265,754
Equity adjustment from foreign
Investment in management currency translation (32,234) (13,593)
contracts (note 6) 218,180 203,670 -------------------------------------------------------------
703,986 765,507
Investment in trademarks and
trade names (note 7) 5,325 5,757 Commitments and contingencies (note 15)
Future income tax assets
(note 8) 4,466 13,230
Other assets 36,185 27,631
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$1,085,825 $946,660 $1,085,825 $946,660
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See accompanying notes to consolidated financial statements.
On behalf of the Board:
/s/ Isadore Sharp Director
- ------------------------
/s/ Ronald W. Osborne Director
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2
FOUR SEASONS HOTELS INC.
Consolidated Statements of Retained Earnings
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars)
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2004 2003
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Retained earnings, beginning of year $265,754 $264,016
Net earnings 33,232 5,384
Dividends declared (3,768) (3,646)
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Retained earnings, end of year $295,218 $265,754
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See accompanying notes to consolidated financial statements.
3
FOUR SEASONS HOTELS INC.
Consolidated Statements of Cash Provided by Operations
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars)
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2004 2003
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Cash provided by (used in) operations:
MANAGEMENT OPERATIONS:
Earnings before other operating items $101,048 $79,522
Items not requiring an outlay of funds 2,204 1,476
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Working capital provided by Management Operations 103,252 80,998
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OWNERSHIP AND CORPORATE OPERATIONS:
Loss before other operating items (21,631) (30,069)
Items not requiring an outlay of funds 1,221 467
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Working capital used in Ownership and Corporate
Operations (20,410) (29,602)
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82,842 51,396
Interest received 10,795 11,031
Interest paid (908) (605)
Interest paid on redemption of convertible notes
(note 10(b)) (33,057) -
Proceeds received on termination of interest rate
swap (note 10(a)) 11,267 -
Current income tax received 427 -
Change in non-cash working capital (12,607) 13,709
Other (1,396) (9,528)
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Cash provided by operations $57,363 $66,003
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See accompanying notes to consolidated financial statements.
4
FOUR SEASONS HOTELS INC.
Consolidated Statements of Cash Flows
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars)
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2004 2003
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Cash provided by (used in):
Operations $57,363 $66,003
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Financing:
Issuance of convertible notes
(note 10(a)) 329,273 -
Redemption of convertible
notes (note 10(b)) (242,644) -
Other long-term obligations, including current
portion:
Issued 45 -
Repaid (150) (200)
Issuance of shares (note 11(a)) 42,824 7,673
Dividends paid (3,690) (3,622)
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Cash provided by financing 125,658 3,851
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Capital investments:
Advances of long-term receivables (32,990) (18,239)
Receipt of long-term receivables 11,720 11,845
Hotel investments (48,529) (8,580)
Disposal of hotel investments (note 4(c)) 49,994 1,529
Purchase of fixed assets (8,360) (19,331)
Investment in trademarks, trade names and
management contracts (16,093) (2,116)
Other assets (10,683) (5,181)
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Cash used in capital investments (54,941) (40,073)
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Increase in cash and cash equivalents 128,080 29,781
Decrease in cash and cash equivalents due to
unrealized foreign exchange loss (26,338) (24,092)
Cash and cash equivalents, beginning of year 170,725 165,036
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Cash and cash equivalents, end of year $272,467 $170,725
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See accompanying notes to consolidated financial statements.
5
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
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Four Seasons Hotels Inc. ("FSHI") is incorporated under the Ontario Business
Corporations Act and, through its subsidiaries, is engaged in the management of,
and the investment in, hotels, resorts, residence clubs (interval and fractional
ownership projects) and other branded residential projects throughout the world
(note 17). In these consolidated financial statements, FSHI and its subsidiaries
are collectively referred to as the "Corporation".
At December 31, 2004, the Corporation managed 63 hotels and resorts and three
residence clubs and had various projects under construction or development, of
which the Corporation had an equity interest in 14 hotels and resorts and three
residence clubs under management and three projects under construction.
1. SIGNIFICANT ACCOUNTING POLICIES:
The Corporation's accounting policies and its standards of financial
disclosure comply with accounting principles that are generally accepted in
Canada. The major differences between Canadian and United States generally
accepted accounting principles, insofar as they apply to the Corporation,
are described in note 18.
The significant accounting policies are summarized below:
(a) Principles of consolidation:
The Corporation consolidates all of its wholly owned subsidiaries,
including its primary operating subsidiaries - Four Seasons Hotels
Limited ("FSHL"), Four Seasons Hotels and Resorts Asia Pacific Pte Ltd.
and Four Seasons Hotels and Resorts B.V.
The Corporation consolidates its 100% leasehold interests in Four
Seasons Hotel Vancouver and The Pierre in New York and, until the
termination of the lease on September 26, 2004, the Corporation also
consolidated its 100% leasehold interest in Four Seasons Hotel Berlin.
6
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
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1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(b) Translation of foreign currencies and derivative financial instruments:
Foreign currency balances of the Corporation and of foreign operations
designated as integrated are translated into domestic currencies at the
rates of exchange on the balance sheet date for monetary items and at
the rates of exchange on the date of transaction for non-monetary items.
The resulting translation gains or losses are included in the
determination of net earnings.
Revenues and expenses denominated in foreign currencies are translated
at the rates of exchange on the dates of the transactions, except for
revenues hedged by foreign exchange forward contracts, which are
translated at the contract rates, as discussed below.
The financial statements of foreign investments designated as
self-sustaining operations are translated into Canadian dollars as
follows:
(i) Assets and liabilities at rates of exchange on the balance sheet
date; and
(ii) Revenue and expense items at average rates of exchange in effect
during the year.
The resulting exchange gains and losses are deferred and included in a
separate component of shareholders' equity. A gain or loss equivalent to
a proportionate amount of the exchange gains and losses accumulated in
the separate component of shareholders' equity is recognized in income
when there has been a reduction in the net investment resulting from a
sale of part or all of the Corporation's interest in the foreign
operation, or a reduction in the shareholders' equity of the foreign
operation as a result of dividend distributions or other capital
transactions.
Derivative financial instruments are used by the Corporation in the
management of its foreign currency exposures. The Corporation does not
use derivative financial instruments for trading or speculative
purposes.
7
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
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1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
The Corporation documents all relationships between hedging instruments
and hedged items, as well as its risk management objective and strategy
for undertaking various hedge transactions. This process includes
linking all derivatives to specific assets and liabilities on the
balance sheet or to specific firm commitments or forecasted
transactions. The Corporation also assesses, both at the hedge's
inception and on an ongoing basis, whether the derivatives that are used
in hedging transactions are highly effective in offsetting changes in
fair values or cash flows of hedged items.
The Corporation enters into hedges of its foreign currency exposures on
foreign currency-denominated long-term receivables and other monetary
assets by entering into offsetting foreign exchange forward contracts,
when it is deemed appropriate. Foreign exchange translation gains and
losses on foreign currency-denominated derivative financial instruments
used to hedge foreign currency long-term receivables and other monetary
assets are accrued under other current or non-current assets or
liabilities on the balance sheet and recognized in "Other expense, net",
offsetting the respective translation losses and gains recognized on the
underlying foreign currency long-term receivables and other monetary
assets. The forward premium or discount on foreign exchange forward
contracts used to hedge foreign currency long-term receivables and other
monetary assets is amortized as an adjustment of interest expense over
the term of the forward contract.
Foreign exchange translation gains and losses on foreign
currency-denominated derivative financial instruments used to hedge
anticipated foreign currency-denominated revenues are recognized as an
adjustment of the revenues when the revenues are recorded. For foreign
exchange forward contracts used to hedge anticipated foreign
currency-denominated revenues, the portion of the forward premium or
discount on the contract relating to the period prior to recognition of
the revenues is also recognized as an adjustment of the revenues when
they are recorded. The portion of the premium or discount that relates
to the resulting accounts receivable is amortized as an adjustment of
interest expense over the remaining term of the contract.
The Corporation also enters into interest rate swaps in order to reduce
the variability to changes in the fair value of its long-term
obligations attributable to interest rate risk. These swap agreements
require the periodic exchange of payments without the exchange of the
notional principal amount on which the payments are based. The
Corporation designates its interest rate swaps as hedges of the
underlying long-term obligation. Interest expense on the long-term
obligation is adjusted to include amounts payable or receivable under
the interest rate swaps.
8
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
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1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Realized and unrealized gains or losses associated with derivative
instruments, which have been terminated or cease to be effective prior
to maturity, are deferred under other current or non-current assets or
liabilities on the balance sheet and recognized in income in the period
in which the underlying hedged transaction is recognized. In the event a
designated hedged item is sold, extinguished or matures prior to the
termination of the related derivative instrument, any realized or
unrealized gain or loss on such derivative instrument is recognized in
income.
(c) Use of estimates:
The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the year. Actual results could differ from those
estimates.
The most significant estimates that the Corporation is required to make
relate to the recoverability of its investments in (i) long-term
receivables, (ii) hotel partnerships and corporations, (iii) management
contracts, and (iv) trademarks and trade names.
The estimated recoverable amounts of these investments usually depend
upon 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 the effects of war,
terrorism, competition from other hotels, changes in travel patterns,
and other factors that affect the properties' gross operating revenue
(which is the factor on which the Corporation's base management and
royalty fee revenues are normally based) and profits (which is the
factor on which the Corporation's incentive fee revenues are normally
based).
The estimates of recoverable amounts of these investments may also
depend upon, among other things, 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 the Corporation and other factors affecting the
profitability and saleability of the properties.
9
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
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1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
These assumptions are limited by the availability of reliable comparable
data, ongoing geopolitical concerns and the uncertainty of predictions
concerning future events. Accordingly, by their nature, estimates of
recoverable amounts are subjective and do not necessarily result in
precise determinations. Should the underlying assumptions change, the
estimated recoverable amounts could change by a material amount.
(d) Cash and cash equivalents:
The Corporation's investments in cash and cash equivalents are highly
liquid, with maturities of less than 90 days. These investments include
bank deposits, guaranteed investment certificates and money market funds
held with major financial institutions.
(e) Impairment of long-term receivables:
The Corporation measures 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. For impaired long-term receivables, the Corporation
establishes 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. The Corporation applies this impairment policy individually
to all long-term receivables in the portfolio and does not aggregate
long-term receivables for the purpose of applying such policy. For
long-term receivables which are determined to be impaired, interest
income is recognized on a cash basis.
(f) Accounting for investments in hotel partnerships and corporations:
The Corporation accounts for its investments in hotel partnerships and
corporations by the cost method because either the percentage ownership
and structure does not give the Corporation significant influence over
these investments or the investments were acquired prior to May 1, 2003
with the intention that they be disposed of in the foreseeable future.
In conjunction with the issuance of Section 3475, The Canadian Institute
of Chartered Accountants ("CICA") eliminated the exception from
consolidation for a temporary controlled subsidiary. This change is
effective for fiscal years beginning on or after October 1, 2004,
irrespective of when those investments occurred (notes 4(a) and (b)).
10
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
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1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
In the event of a decline in value of an investment in the equity of a
hotel partnership or corporation that is other than temporary, the
investment is written down to the estimated recoverable amount.
(g) Capital assets:
Land, buildings, furniture, fixtures, equipment and leasehold interests
and improvements are recorded at cost.
The cost of acquiring or enhancing hotel management contracts is
capitalized and recorded as "Investment in management contracts".
The cost of trademarks and trade names includes the cost of registering
the "Four Seasons" trademarks and trade names throughout the world.
(i) Depreciation and amortization:
Depreciation of buildings is recorded on a straight-line basis
over 40 years.
Depreciation of furniture, fixtures and equipment is recorded on a
straight-line basis at rates which will fully depreciate the
assets over their estimated useful lives. The estimated composite
useful lives for furniture, fixtures and equipment range from
three to 20 years.
Amortization of leasehold interests and improvements is recorded
on a straight-line basis over the terms of the leases.
The costs allocated to trademarks and trade names, which do not
have indefinite lives, are amortized on a straight-line basis over
their useful lives.
The costs capitalized for hotel management contracts are amortized
on a straight-line basis over the terms of the contracts in
proportion to the benefits received.
11
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
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1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(ii) Impairment:
The recoverability of the unamortized cost of capital assets is
evaluated whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable from
future operations. The Corporation bases these evaluations upon
the projected future cash flows on an undiscounted basis. If the
undiscounted future cash flows are insufficient to recover the
remaining net book value, then an impairment charge is recognized
equal to the amount by which the net book value exceeds the fair
value of the asset (note 1(l)(iii)).
(h) Deferred charges:
The Corporation defers legal, consulting, travel and other costs
directly relating to the negotiation, structuring and execution of new
contracts relating to projects which, in management's judgment, have a
high probability of opening. When the property is opened, these deferred
charges are reclassified to "Investment in management contracts". If the
project is abandoned, any deferred charges are written off. The deferred
charges associated with new management contracts developed by the
Corporation are amortized on a straight-line basis over a 10-year period
commencing when the property is opened.
(i) Revenue recognition:
The consolidated revenues of the Corporation include revenues earned
from hotels, resorts, residence clubs and other branded residential
projects under long-term management contracts, revenues generated by its
consolidated leasehold hotel operations and distributions from its other
hotel investments.
12
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
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1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Revenues earned from management operations include base fees equal to a
percentage of the gross operating revenues of the managed properties and
incentive fees based on certain operating results of the managed
properties. The revenues also include fees earned relating to the
design, construction and fitting out specifications of hotels during the
development stage and purchasing fees earned, generally calculated as a
percentage of the cost of goods purchased by the managed properties
through the Corporation's centralized purchasing system. The Corporation
provides various services, including central reservation services,
worldwide sales offices and marketing programs to managed properties and
receives a charge calculated in accordance with the management
contracts. The Corporation also earns a fee for the use of its brand
name in connection with certain residential projects and residence club
properties, and for services provided in the oversight of the sales and
marketing of the residential projects and residence club units, which is
generally based on a percentage of the gross selling price of each unit.
Fees from management operations are recognized as revenue when the
services have been rendered in accordance with the terms of each
individual contract, the fees are non-refundable, the amount of the fees
is fixed or determinable, and there is reasonable assurance that the
fees are collectible. Incentive fees are accrued as earned based on the
profitability of the managed property, subject to the terms of each
individual contract. The Corporation accrues incentive fees in interim
consolidated financial statements based upon the amount that would be
due under the incentive fee formula as if the relevant management
contract was terminated at the relevant reporting date. Generally, on
termination, the Corporation's management contracts entitle the
Corporation to receive incentive fees up to the date of termination. If
a property's profitability decreases in a subsequent interim period, the
incentive fee accrued in a previous interim period could be reduced or
eliminated.
The Corporation evaluates at the inception of a contract all
deliverables to determine whether they represent separate units of
accounting. If they do, the consideration to be received by the
Corporation under the contract is allocated among the separate units of
accounting based on their relative fair values or, where fair values for
all deliverables are unavailable, based on the fair value of the
undelivered item (note 1(l)(vi)).
Revenues generated by its consolidated leasehold hotel operations are
recognized at the time of the sale or rendering of services by the
hotel.
The Corporation recognizes revenue from other hotel investments,
accounted for by the cost method, when profit distributions are
receivable from the partnerships or corporations.
13
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
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1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(j) Stock-based compensation and other stock-based payments:
In December 2003, the CICA amended Section 3870 to require entities to
account for employee stock options using the fair value-based method,
beginning January 1, 2004. Under the fair value-based method,
compensation cost of a stock option is measured at fair value at the
date of grant and is expensed over the stock option's vesting period,
with a corresponding increase to contributed surplus. When these stock
options are exercised, the proceeds, together with the amount recorded
in contributed surplus, are recorded in capital stock.
In accordance with one of the transitional alternatives permitted under
amended Section 3870, the Corporation prospectively adopted the fair
value-based method 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.
(k) Income taxes:
The Corporation uses the liability method of accounting for future
income taxes. Under the liability method, future income tax assets and
liabilities are determined based on "temporary differences" (differences
between the accounting basis and the tax basis of the assets and
liabilities), and are measured using the currently enacted, or
substantively enacted, tax rates and laws expected to apply when these
differences reverse. A valuation allowance is recorded against any
future income tax asset if it is more likely than not that the asset
will not be realized. Income tax expense or benefit is the sum of the
Corporation's provision for current income taxes and the difference
between the opening and ending balances of the future income tax assets
and liabilities.
14
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
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1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(l) Change in accounting policies:
(i) Hedging relationships:
The CICA issued Accounting Guideline No. 13, "Hedging
Relationships", which 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, the
Corporation ceased designating its US dollar forward contracts as
hedges of its US dollar revenues. These contracts were entered
into during 2002, and all of these contracts matured during 2004.
The foreign exchange gains on these contracts of $14,552, which
were deferred prior to January 1, 2004, were recognized in 2004 as
an increase of fee revenues over the course of the year. Effective
January 1, 2004, the US dollar forward contracts were
marked-to-market on a monthly basis with the resulting changes in
fair values being recorded as a foreign exchange gain or loss. The
Corporation ceasing to designate its US dollar forward contracts
as hedges of its US dollar revenues did not have an impact on its
net earnings for the year ended December 31, 2004.
(ii) Reimbursed costs:
As a result of adopting Section 1100, "Generally Accepted
Accounting Principles", which was issued by the CICA, and was
effective January 1, 2004, the Corporation included the
reimbursement of all out-of-pocket expenses in both revenues and
expenses instead of recording certain reimbursed costs as a "net"
amount. The change in the accounting treatment of reimbursed costs
resulted in an increase of both revenues and expenses for the year
ended December 31, 2004 of $42,021 (2003 - $46,077), but did not
have an impact on net earnings. In addition, for the year ended
December 31, 2003, each of fee revenues and general and
administrative expenses included certain other reimbursed costs of
$29,226. These have been reclassified to reimbursed costs in both
revenues and expenses to conform to the financial statement
presentation adopted in 2004.
15
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
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1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(iii) Impairment of long-lived assets:
The CICA issued Section 3063, "Impairment of Long-Lived Assets",
which establishes standards for the recognition, measurement and
disclosure of the impairment of long-lived assets, and replaces
the write-down provisions of Section 3061, "Property, Plant and
Equipment". In accordance with Section 3063, long-lived assets,
such as property, plant and equipment and purchased intangibles
subject to amortization, are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the
carrying amount of an asset to estimated undiscounted future cash
flows expected to be generated by the asset. If the carrying
amount of an asset exceeds its estimated future cash flows, an
impairment charge is recognized equal to the amount by which the
carrying amount of the asset exceeds the fair value of the asset.
The implementation of Section 3063, effective January 1, 2004, did
not have an impact on the consolidated financial statements of the
Corporation for the year ended December 31, 2004.
(iv) Accounting for asset retirement obligations:
The CICA issued Section 3110, "Accounting for Asset Retirement
Obligations", which requires companies to record the fair value of
an asset retirement obligation as a liability in the year in which
they incur a legal obligation associated with the retirement of
tangible long-lived assets that result from the acquisition,
construction, development and/or normal use of the assets.
Companies are also required to record a corresponding asset that
is depreciated over the life of the asset. Subsequent to the
initial measurement of the asset retirement obligation, the
obligation will be adjusted at the end of each period to reflect
the passage of time and changes in the estimated future cash flows
underlying the obligation. The implementation of Section 3110,
effective January 1, 2004, did not have an impact on the
consolidated financial statements of the Corporation for the year
ended December 31, 2004.
(v) Revenue recognition:
In December 2003, the Emerging Issues Committee ("EIC") of the
CICA issued Abstract EIC-141, "Revenue Recognition", which
provides revenue recognition guidance. The implementation of
EIC-141, effective January 1, 2004, did not have an impact on the
consolidated financial statements of the Corporation for the year
ended December 31, 2004.
16
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(vi) Revenue arrangements with multiple deliverables:
In December 2003, the EIC issued Abstract EIC-142, "Revenue
Arrangements with Multiple Deliverables", which addresses
accounting for arrangements, entered into after December 31, 2003,
where an enterprise will perform multiple revenue generating
activities. The implementation of EIC-142 did not have an impact
on the consolidated financial statements of the Corporation for
the year ended December 31, 2004.
2. RECEIVABLES:
----------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------
Trade accounts of consolidated hotels $ 5,213 $ 6,485
Receivables from hotel partnerships,
affiliates and managed hotels 68,212 60,938
Receivables relating to stock options
exercised (note 11(a)) 6,870 -
Taxes receivable 3,292 8,732
Other 14,556 12,481
----------------------------------------------------------------------------
$98,143 $88,636
----------------------------------------------------------------------------
Receivables at December 31, 2004 are recorded net of an allowance for
doubtful accounts of $3,052 (2003 - $3,338). The net bad debt expense for
the year ended December 31, 2004 was $13 (2003 - $524).
17
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
3. LONG-TERM RECEIVABLES:
----------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------
Secured cash flow bond, interest at 10%,
due 2005, pound sterling 9.7 million (a) $22,301 $22,304
Secured loans:
Secured by shares:
Interest at 10%, due 2038,
pound sterling 12.2 million (b) 28,136 28,140
Interest at 7.5%, compounded annually,
AUS $25 million (2003 - AUS $23.2 million) 23,504 22,539
Interest at 5.625%, compounded annually,
repayable over the period to 2010,
US $6.1 million 7,292 -
Secured by property:
Interest at 7%, compounded annually,
repayable over the period to 2025,
US $9.1 million
(2003 - US $9.3 million) 10,914 11,964
Interest at
LIBOR plus 0.45% to 1.25%
(2003 - LIBOR plus 0.30% to 0.45%),
compounded monthly, repayable over the
period to 2004, US $5 million (c) 6,018 6,462
Interest at 9.25%, repayable on demand
(2003 - US $7.8 million) (d) - 10,130
Interest at 8%, compounded annually, repayable
over the period to 2025, US $2.1 million
(2003 - US $2 million) 2,528 2,585
Interest at LIBOR plus 4%, repayable over
the period to 2024, US $5 million 6,018 6,462
Interest at LIBOR plus 1.85%, repayable over
the period to 2015, pound sterling 8.9 million 20,498 -
Due from officers and employees,
non-interest bearing mortgages 14,305 15,345
Unsecured loans related to managed hotels:
Interest at 7.75%, due 2010, US $15 million 18,054 19,386
Interest at 10%, compounded annually,
repayable over the period to 2061, US $10 million 12,022 13,517
Interest at 10.5%, compounded monthly,
AUS $9.9 million 9,334 9,644
Interest at 7.5%, compounded annually,
repayable on demand,
AUS $6.4 million (2003 - AUS $5.9 million) 5,988 5,751
Interest at 7%, US $2.7 million 3,247 3,487
Interest at Euribor plus 2%, due 2021,
euro 6.3 million (2003 - euro 6.6 million) 10,199 10,677
Interest at 6%, due 2009, euro 3 million 4,888 4,884
Interest at 9%, compounded annually, repayable
over the period to 2015, US $2 million 2,359 -
Non-interest bearing, including US $16.5 million
(2003 - US $16.8 million) 23,846 21,761
----------------------------------------------------------------------------
231,451 215,038
Less allowance for doubtful long-term receivables (e) (15,934) (17,403)
----------------------------------------------------------------------------
$215,517 $197,635
----------------------------------------------------------------------------
18
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
3. LONG-TERM RECEIVABLES (CONTINUED):
(a) Principal and interest on the bond are payable annually every March out
of 50% of the available cash flow (as defined in the bond indenture)
from Four Seasons Hotel London. The bond is due from an affiliate of a
shareholder of FSHI and is secured by the affiliate's investment in the
hotel.
(b) Principal and interest on the loan are payable annually every March out
of the other 50% of the available cash flow from Four Seasons Hotel
London (a). The loan is due from an affiliate of a shareholder of FSHI
and is secured by the affiliate's additional indirect interest in the
hotel.
(c) As at December 31, 2004 and 2003, the Corporation had fully provided for
its US $5 million ($6,018; 2003 - $6,462) loan relating to Four Seasons
Hotel Caracas, which is secured by a second mortgage and registered
against the hotel, and non-interest bearing advances of US $1.9 million
($2,270) (2003 - US $1.8 million ($2,373)). The hotel is currently
closed. The Corporation is in dispute with the owner of the hotel
regarding a variety of matters relating to the completion and ongoing
operation of the hotel, including the default on the US $5 million loan.
Formal notice of default was given to the owner. The dispute was
referred to arbitration and the arbitration tribunal declared that the
owner had failed to perform all of its obligations under the
Corporation's management agreements, including, without limitation, its
obligation to complete the hotel as a world-class luxury hotel and to
allow the Corporation to manage the hotel free from unlawful
interference of the owner. The arbitration tribunal awarded damages
totalling approximately US $8 million ($9,600), plus arbitration fees
and expenses of approximately US $240 thousand ($290). The owner has
challenged the enforcement of the decision from the arbitration
tribunal. The Corporation has not recorded any receivables arising from
the decision as at December 31, 2004. Included in "Other expense, net"
for the year ended December 31, 2004 are legal and enforcement costs
relating to the dispute of $273 (2003 - $3,721).
In addition, in 2003, the Corporation received judgment in its legal
proceedings against the owner, which involved the protection of its
proprietary materials. The court found against the owner on all matters,
including illegal computer "hacking" and unlawful and unauthorized use
of the Corporation's proprietary information, and ordered that the owner
pay to the Corporation damages totalling approximately US $4.9 million
($5,900), plus legal costs and expenses of approximately US $1.4 million
($1,700). The owner has appealed the judgment from the legal proceeding.
The Corporation has not recorded any receivable arising from the
judgment as at December 31, 2004 and 2003.
19
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
3. LONG-TERM RECEIVABLES (CONTINUED):
(d) Included in "Other expense, net" for the year ended December 31, 2004 is
a loss of $3,967 relating to the Corporation's exit from the proposed
Four Seasons project in Sedona, effectively reducing the book value of
its investment in the project to nil at December 31, 2004. This amount
included a loss of $2,647 on the settlement of the Corporation's loan
relating to the project.
(e) Changes in the allowance for doubtful long-term receivables consist of:
------------------------------------------------------------------------
2004 2003
------------------------------------------------------------------------
Balance, beginning of year $(17,403) $(25,830)
Recovery of (provision for) loss 636 (746)
Conversion to investment - 6,462
Foreign exchange gain 833 2,711
------------------------------------------------------------------------
Balance, end of year $(15,934) $(17,403)
------------------------------------------------------------------------
As at December 31, 2002, long-term receivables included a loan of US $5
million ($6,462) to the owner of The Regent Jakarta. The Corporation had
fully provided for this loan as at December 31, 2002. Pursuant to a
restructuring plan, the Corporation's unsecured loan was ultimately
converted in 2003 to an equity interest in the hotel owner equal to 2%
of the outstanding equity. As at December 31, 2004 and 2003, the
investment has been recorded in "Investments in hotel partnerships and
corporations," with a carrying value of nil.
During 2004, the Corporation recovered $145 (2003 - $1,755) on amounts
that had been written off in prior years. This recovery is recorded in
"Other expense, net".
20
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
4. INVESTMENTS IN HOTEL PARTNERSHIPS AND CORPORATIONS:
----------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------
Four Seasons Hotel Shanghai (a) $25,701 $25,701
Four Seasons Residence Club
Scottsdale (b) 8,044 8,638
Other operating properties (c) 114,951 121,065
Properties under construction
or development 9,383 2,234
----------------------------------------------------------------------------
$158,079 $157,638
----------------------------------------------------------------------------
(a) Investment in Four Seasons Hotel Shanghai:
The Corporation has approximately a 21.2% equity interest in Four
Seasons Hotel Shanghai. The Corporation is in negotiations with a
potential purchaser relating to the sale of a portion of the
Corporation's equity interest in the hotel, which would reduce the
Corporation's equity interest to below 20%. As at December 31, 2004, the
Corporation had not reduced its equity interest in the hotel, and as a
result, will begin equity accounting for its investment in the hotel
effective January 1, 2005 (note 1(f)).
(b) Investment in Four Seasons Residence Club Scottsdale:
The Corporation has approximately a 71% equity interest in Four Seasons
Residence Club Scottsdale. The Corporation is in negotiations with a
potential purchaser relating to the sale of a portion of the
Corporation's equity interest in the residence club, which would reduce
the Corporation's equity interest to below 20%. As at December 31, 2004,
the Corporation had not reduced its equity interest in the residence
club, and as a result will begin consolidating the operations of the
residence club effective January 1, 2005 (note 1(f)).
In March 2005, the Corporation sold the majority of its 71% equity
interest in the residence club for proceeds approximating book value. As
a result of the sale, the Corporation's equity interest in the residence
club is below 20%. The Corporation continues to manage this property
under a long-term management contract.
(c) Sale of ownership interests:
During 2004, the Corporation sold all of its ownership interest in Four
Seasons Resort Whistler, the majority of its 8% ownership interest in
Four Seasons Hotel Amman and all its ownership interest in land relating
to Four Seasons Resort Scottsdale for gross proceeds of approximately
$50,000. The Corporation recorded a loss on disposition of these
ownership interests of $643, which is included in "Other expense, net".
The Corporation continues to manage these properties under long-term
management contracts.
21
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
5. FIXED ASSETS:
----------------------------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------------------------
Accumulated Accumulated
depreciation depreciation
and Net book and Net book
Cost amortization value Cost amortization value
----------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------
Land $ 26,299 $ - $26,299 $27,288 $ - $27,288
Buildings 13,837 (3,441) 10,396 8,690 (2,543) 6,147
Furniture, fixtures
and equipment (a) 47,692 (20,693) 26,999 51,335 (19,156) 32,179
Leasehold interests
and improvements (a) 15,416 (6,967) 8,449 15,678 (5,503) 10,175
----------------------------------------------------------------------------------------------
$103,244 $(31,101) $72,143 $102,991 $(27,202) $75,789
----------------------------------------------------------------------------------------------
(a) During 2003, the Corporation recorded an asset impairment charge of
$3,174 related to the net book value of the fixed assets at Four Seasons
Hotel Berlin, which is included in "Other expense, net".
(b) Depreciation and amortization expense for fixed assets was $7,516 (2003
- $7,950).
6. INVESTMENT IN MANAGEMENT CONTRACTS:
----------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------
Management contracts, at cost $270,917 $252,754
Less accumulated amortization (52,737) (49,084)
----------------------------------------------------------------------------
$218,180 $203,670
----------------------------------------------------------------------------
(a) Amortization expense for management contracts was $7,082 (2003 -
$6,427).
22
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
6. INVESTMENT IN MANAGEMENT CONTRACTS (CONTINUED):
(b) During 2003, the Corporation and the owner of Four Seasons Olympic Hotel
Seattle settled their disagreement, which was subject to arbitration,
concerning the management of the hotel. Under the settlement, the
Corporation concluded its management of Four Seasons Olympic Hotel
Seattle upon the sale of the hotel, which occurred on August 1, 2003. On
closing of the sale of the hotel, the Corporation received an initial
payment, which included its share of the sale proceeds as a result of
its minority ownership interest in the hotel. The Corporation will also
receive annual payments over the next several years. A portion of these
future payments has been included in net earnings for the years ended
December 31, 2004 and 2003. In addition, $5,754 in legal and enforcement
costs were incurred during 2003 and are included in "Other expense,
net".
7. INVESTMENT IN TRADEMARKS AND TRADE NAMES:
----------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------
Trademarks and trade names, at cost $11,690 $11,814
Less accumulated amortization (6,365) (6,057)
----------------------------------------------------------------------------
$5,325 $ 5,757
----------------------------------------------------------------------------
Amortization expense for trademarks and trade names was $683 (2003 - $619).
8. INCOME TAXES:
The sources of earnings before provision for income taxes comprise the
following:
----------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------
Canada $10,654 $ 6,319
Foreign 38,881 5,690
----------------------------------------------------------------------------
$49,535 $12,009
----------------------------------------------------------------------------
23
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
8. INCOME TAXES (CONTINUED):
The provision for income taxes is as follows:
----------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------
Current:
Federal $(4,404) $ 1,588
Provincial (2,646) -
Foreign (4,630) (3,983)
----------------------------------------------------------------------------
(11,680) (2,395)
Future:
Federal (3,859) (3,543)
Provincial (1,179) (917)
Foreign 415 -
----------------------------------------------------------------------------
(4,623) (4,460)
----------------------------------------------------------------------------
Increase in future income tax assets
(Canada) - 230
----------------------------------------------------------------------------
$(16,303) $(6,625)
----------------------------------------------------------------------------
The increase in future income tax assets relates to changes in Canadian
federal and provincial income tax rates. The 2003 increase of $230 was the
result of an increase in the provincial income tax rate.
24
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
8. INCOME TAXES (CONTINUED):
Income tax expense varies from the amount computed by applying combined
Canadian federal and provincial tax rates to earnings before income taxes as
follows:
----------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------
Earnings before income taxes $49,535 $12,009
Items not deductible 39,258 44,262
----------------------------------------------------------------------------
Earnings subject to taxes $88,793 $56,271
----------------------------------------------------------------------------
Statutory Canadian federal and provincial tax rate 34.35% 35.77%
----------------------------------------------------------------------------
Expected income tax expense $(30,500) $(20,128)
Reduction in tax due to lower foreign tax rates 14,197 13,273
----------------------------------------------------------------------------
Income tax expense before effect of
change in tax rates (16,303) (6,855)
Increase in future income tax assets
due to change in tax rates - 230
----------------------------------------------------------------------------
Income tax expense $(16,303) $(6,625)
----------------------------------------------------------------------------
The significant components of future income tax expense attributable to
earnings before income taxes are as follows:
----------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------
Future income tax expense $(4,623) $(4,460)
Increase in future income tax assets due to
change in tax rates - 230
----------------------------------------------------------------------------
Net reduction in future income tax assets $(4,623) $(4,230)
----------------------------------------------------------------------------
25
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
8. INCOME TAXES (CONTINUED):
The valuation allowance for the years ended December 31, 2004 and 2003 was
$3,004. The valuation allowance results from potential limitations on the
use of tax losses in a foreign jurisdiction. In order to fully realize the
future income tax assets, the Corporation will need to generate future
taxable income of approximately $54,000. Based upon projections of future
taxable income over the years in which the future income tax assets are
deductible, management believes it is more likely than not that the
Corporation will realize the benefits of these deductible differences, net
of the existing valuation allowance. The amount of the future income tax
assets considered realizable, however, could be reduced in the near term if
estimated future taxable income during the carryforward period is reduced.
Future income taxes arise from temporary differences in the basis of the
Corporation's assets and liabilities for tax and financial reporting
purposes. Tax effects of these differences are as follows:
----------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------
Future income tax assets:
Investments in hotel partnerships and corporations $ 2,049 $ 5,641
Tax losses carried forward and other assets 13,590 18,158
Long-term receivables 630 2,591
Investment in trademarks and trade names 961 1,055
Long-term obligations 3,083 3,457
----------------------------------------------------------------------------
20,313 30,902
Valuation allowance (3,004) (3,004)
----------------------------------------------------------------------------
Total gross future income tax assets 17,309 27,898
Future income tax liabilities:
Investment in management contracts (7,909) (9,346)
Fixed assets (4,794) (5,322)
Accounts payable and accrued liabilities (140) -
----------------------------------------------------------------------------
Total gross future income tax liabilities (12,843) (14,668)
----------------------------------------------------------------------------
Future income tax assets $ 4,466 $13,230
----------------------------------------------------------------------------
At December 31, 2004, the Corporation had accumulated net operating losses
carried forward of approximately $25,400 (2003 - $30,600) for tax purposes,
which expire as follows:
----------------------------------------------------------------------------
2010 $18,800
2011 5,700
2024 900
----------------------------------------------------------------------------
$25,400
----------------------------------------------------------------------------
26
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
8. INCOME TAXES (CONTINUED):
The Corporation has made no provision for income taxes, or additional
foreign taxes, on the cumulative unremitted earnings of foreign
subsidiaries, which were approximately $190,800 as at December 31, 2004
(2003 - $151,400), because the Corporation does not intend to repatriate
these earnings in the foreseeable future. These earnings could become
subject to additional taxes if remitted as dividends or if the Corporation
sells its interests in the affiliates. The Corporation cannot practically
estimate the amount of additional taxes that might be payable on the
unremitted earnings.
9. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES:
----------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------
Trade accounts payable $18,658 $20,772
Payroll and employee benefits 20,568 16,941
Accrued sales, marketing and advertising 5,047 4,109
Taxes payable 11,840 8,631
Dividends payable 1,911 1,833
Other accrued liabilities 14,692 8,759
----------------------------------------------------------------------------
$72,716 $61,045
----------------------------------------------------------------------------
10. LONG-TERM OBLIGATIONS:
----------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------
Convertible notes, issued in 2004,
US $215.3 million (a) $259,155 $ -
Convertible notes, issued in 1999
(2003 - US $68.1 million) (b) - 88,029
Deferred gain on termination of interest
rate swap (a) 8,760 -
Accrued benefit liability (note 15(b)) 32,813 29,492
Other long-term obligations 8,395 2,587
----------------------------------------------------------------------------
309,123 120,108
Less amounts due within one year (4,533) (2,587)
----------------------------------------------------------------------------
$304,590 $117,521
----------------------------------------------------------------------------
27
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
10. LONG-TERM OBLIGATIONS (CONTINUED):
(a) Convertible notes, issued in 2004:
In June 2004, FSHI issued US $250 million ($341,100) principal amount of
convertible senior notes. The net proceeds of the issuance, after
deducting offering expenses and underwriters' commission, were
approximately US $241.3 million ($329,273). 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 Limited
Voting Shares of FSHI at an initial conversion rate of 13.9581 shares
per each one thousand US dollar principal amount (equal to a conversion
price of approximately US $71.64 ($86.23) 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) FSHI
calls the notes for redemption, or (iv) specified corporate transactions
or a "fundamental change" occur. In connection with a "fundamental
change" on or prior to July 30, 2009, on conversion holders of notes
will be entitled to receive additional Limited Voting Shares having a
value equal to the aggregate of the make whole premium they would have
received if the notes were purchased plus an amount equal to any accrued
but unpaid interest. FSHI may choose to settle conversion (including any
make whole premium) in Limited Voting Shares, cash or a combination of
Limited Voting Shares and cash (at its option).
On or after August 4, 2009, FSHI may (at its option) redeem all or a
portion of the notes, in whole or in part, for cash at 100% of their
principal amount, plus any accrued and unpaid interest. On each of July
30, 2009, 2014 and 2019, holders may require FSHI to purchase all or a
portion of their notes at 100% of their principal amount, plus any
accrued and unpaid interest. FSHI will pay cash for any notes so
purchased on July 30, 2009. Repurchases made by FSHI on July 30, 2014
and July 30, 2019 may be made (at its option) in cash, Limited Voting
Shares or a combination of cash and Limited Voting Shares. Upon the
occurrence of certain designated events, FSHI will be required to make
an offer to purchase the notes at 100% of their principal amount plus
any accrued and unpaid interest, and, in the case of a "fundamental
change" that is also a "change of control" occurring on or before July
30, 2009, FSHI also will pay a make whole premium. FSHI may choose to
pay the purchase price (including any make whole premium) for notes in
respect of which its offer is accepted in (at its option) cash, Limited
Voting Shares, securities of the surviving entity (if FSHI is not the
surviving corporation), or a combination of cash and shares or
securities.
28
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
10. LONG-TERM OBLIGATIONS (CONTINUED):
In accordance with Canadian generally accepted accounting principles,
the notes were bifurcated in the consolidated financial statements into
a debt component (representing the principal value of a bond of US
$211.8 million ($288,918), which was estimated based on the present
value of a US $250 million ($341,100) 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 (representing the value of the
conversion feature of the notes). Accordingly, net proceeds have been
allocated $288,918 to long-term obligations and $50,373 to shareholders'
equity. The offering expenses and underwriters' commission of
approximately $10,018 relating to the debt component, are recorded in
"Other assets". The debt component of the notes will increase for
accounting purposes at the compounded interest rate of 5.33%, less the
coupon paid of 1.875% per annum.
In connection with the offering, FSHI entered into an interest rate swap
agreement to July 30, 2009 with an initial notional amount of US $211.8
million ($288,918), pursuant to which FSHI had agreed to receive
interest at a fixed rate of 5.33% per annum and pay interest at
six-month LIBOR, in arrears, plus 0.4904%. FSHI had designated the
interest rate swap as a fair value hedge of the notes. As a result, FSHI
accounted for the payments under the interest rate swap to the date of
termination on an accrual basis, which resulted in an effective interest
rate (for accounting purposes) on the hedged notes of six-month LIBOR,
in arrears, plus 0.4904%.
In October 2004, FSHI terminated the interest rate swap agreement and
received proceeds of US $9 million ($11,267). The book value of the
interest rate swap at the date of termination was $2,024. The gain of
$9,243 was deferred for accounting purposes and is being amortized over
the next 4.75 years, which would have been the remaining swap term.
During 2004, $483 of the deferred gain was amortized and recorded as a
reduction of interest expense.
29
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
10. LONG-TERM OBLIGATIONS (CONTINUED):
(b) Convertible notes, issued in 1999:
During 1999, FSHI 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. In
accordance with Canadian generally accepted accounting principles, the
notes were bifurcated into a debt component (representing the present
value of a zero coupon bond of US $655.5 million maturing in 2029,
yielding 9% per annum, compounding semi-annually) and an equity
component (representing the value of the conversion feature of the
notes). Accordingly, net proceeds were originally allocated $68,902 to
long-term obligations and $178,574 to shareholders' equity. The offering
expenses and underwriters' commission relating to the debt component of
the notes of $2,549 were recorded in "Other assets". As at December 31,
2003, FSHI had 655,404 convertible notes outstanding.
FSHI was 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. In September 2004, FSHI redeemed for
cash all these convertible notes for US $328.73 per each one thousand US
dollar principal amount at maturity (the redemption price being the
issue price plus unpaid accrued interest to but excluding the date of
redemption) for an aggregate payment of US $215.5 million ($275,701).
In accordance with Canadian generally accepted accounting principles,
the consideration paid on the redemption was allocated to the liability
and equity components of the convertible notes based on their relative
fair values at the date of the redemption. A pre-tax accounting loss of
$14,611 was recognized related to the debt component of the convertible
notes (representing the difference between the carrying value of the
debt component and the relative fair value of the debt component and
calculated at the present value of the amount due on maturity, using an
assumed 25-year interest rate of 8.474% per annum, compounding
semi-annually). This loss was recorded in "Other expense, net" in the
consolidated statements of operations. In addition, at the interest rate
noted above, a pre-tax accounting gain of $8,160 was recognized on the
extinguishment of the equity component of the convertible notes
($178,543). The gain of $8,160 was recorded in contributed surplus. The
tax impact of the redemption of both the liability and equity components
of the convertible notes was a decrease to future income tax assets and
a decrease to contributed surplus of $4,141. The net after-tax impact on
shareholders' equity from the redemption of both the debt and equity
components of the convertible notes was a reduction of $10,592.
30
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
10. LONG-TERM OBLIGATIONS (CONTINUED):
In accordance with Canadian generally accepted accounting principles,
the cash paid on redemption of the convertible notes relating to the
interest accreted from September 1999 to September 2004, for accounting
purposes, of US $25.8 million ($33,057) on the convertible notes has
been recorded in the consolidated statements of cash provided by
operations. The remaining cash paid on redemption of US $189.7 million
($242,644) has been recorded under "Financing" in the consolidated
statements of cash flows.
(c) Bank credit facility:
During 2004, the Corporation finalized a new committed bank credit
facility of US $125 million ($150,500), which expires in September 2007.
Borrowings under this credit facility bear interest at LIBOR plus a
spread ranging between 0.875% and 2.25% in respect of LIBOR-based
borrowings (prime rate plus a spread ranging between nil and 1.25% in
respect of prime-rate borrowings), depending upon certain criteria
specified in the loan agreement. As at December 31, 2003, the
Corporation had bank credit facilities of US $212.5 million ($255,800),
which expired in 2004. As at December 31, 2004 and 2003, no amounts were
borrowed under these credit facilities. However, approximately US $10.9
million ($13,100) of letters of credit were issued under the new credit
facility as at December 31, 2004. No amounts have been drawn under these
letters of credit.
The bank credit facility contains certain covenants which require the
Corporation to maintain certain financial ratios. In addition, the bank
credit facility contains additional covenants which restrict the
Corporation's ability to borrow funds ranking superior to these
obligations and to undertake certain types of major transactions. The
Corporation was in compliance with these covenants during 2004. In
addition, the lenders may require repayment of the bank credit facility
on a change of control of FSHI.
(d) Interest income, net:
------------------------------------------------------------------------
2004 2003
------------------------------------------------------------------------
Interest income $16,911 $14,351
Interest on long-term obligations (15,093) (10,769)
Other interest expense (324) (232)
------------------------------------------------------------------------
Interest income, net $ 1,494 $ 3,350
------------------------------------------------------------------------
31
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
11. SHAREHOLDERS' EQUITY:
(a) Capital stock:
Authorized:
3,725,698 Variable Multiple Voting Shares ("VMVS"), entitling the
holder to that number of votes that results in the aggregate
votes attaching to the VMVS, representing approximately 65%
of the votes attaching to the VMVS and the Limited Voting
Shares ("LVS"), in aggregate, which, at December 31, 2004,
was 16.07 votes (2003 - 15.35 votes) per VMVS. Changes in
the number of votes attaching to the VMVS necessary to
maintain this level will occur concurrently with the issue
of additional LVS.
The VMVS rank equally with the LVS as to distributions on
liquidation, dissolution or winding-up of FSHI. Dividends
declared and paid on the VMVS are in amounts per share equal
to 50% of the dividends per share declared and paid on the
LVS, regardless of whether the number of votes attaching to
the VMVS is further increased.
VMVS are convertible into LVS on a one-for-one basis at the
option of the holder. The shares automatically convert into
LVS upon any transfer outside of the family of Isadore
Sharp, except a transfer of a majority of the shares to a
purchaser who makes an equivalent offer to purchase all
outstanding VMVS and LVS.
Unlimited LVS, voting (one vote per share) and ranking equally with
the VMVS as to distributions on liquidation, dissolution or
winding-up of FSHI.
Unlimited First Preference Shares and Second Preference Shares,
issuable in series, non-voting and ranking prior to all
other shares with respect to payment of dividends and
distributions on liquidation or winding-up of FSHI. The
dividend rate, redemption and conversion rights, if any, are
to be determined prior to issuance by the directors of FSHI.
32
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
11. SHAREHOLDERS' EQUITY (CONTINUED):
Issued:
------------------------------------------------------------------------
VMVS LVS
Stated Stated
Shares value Shares value Total
------------------------------------------------------------------------
December 31, 2002 3,982,172 $44 30,893,160 $321,557 $321,601
Options exercised - - 366,260 7,673 7,673
Conversion of VMVS (150,000) (2) 150,000 2 -
------------------------------------------------------------------------
December 31, 2003 3,832,172 42 31,409,420 329,232 329,274
Options exercised - - 1,367,054 49,953 49,953
Conversion of VMVS (106,474) (1) 106,474 1 -
------------------------------------------------------------------------
December 31, 2004 3,725,698 $41 32,882,948 $379,186 $379,227
------------------------------------------------------------------------
As at December 31, 2004, an amount of $6,870 was recorded in accounts
receivable relating to options exercised in 2004 (note 2).
At a special meeting held on December 19, 1989, the shareholders of FSHI
approved a long-term incentive plan for Mr. Isadore Sharp, the chief
executive officer of FSHI. Under this long-term incentive plan, FSHI and
its principal operating subsidiary, FSHL, have agreed that FSHL will
make a payment to Mr. Sharp on an arm's-length sale of control of FSHI.
The first portion of the payment will be an amount equal to 5% of the
product of (i) the total number of VMVS and LVS outstanding at the time
of the sale, and (ii) the per share consideration received by holders of
LVS minus $6.30. If the per share consideration received by holders of
LVS on the sale is equal to or more than 125% of the weighted average
price of LVS traded in board lots on The Toronto Stock Exchange during
the period commencing six months and ending one month before the first
public announcement of the sale, Mr. Sharp will be entitled to an
additional payment equal to 5% of the product of (i) the total number of
VMVS and LVS outstanding at the time of the sale, and (ii) the per share
consideration received by holders of LVS minus $20.84.
The right to receive the two payments may be transferred among members
of Mr. Sharp's family, their holding companies and trusts. Upon the
death of Mr. Sharp, the right to the payments passes to his legal or
personal representatives, heirs or permitted assigns.
(b) Stock option plan:
Under the Corporation's stock option plan, eligible directors,
executives and employees may be granted options to acquire LVS at a
price which is not less than the weighted average price of board lots
traded on The Toronto Stock Exchange in the five trading days preceding
the date of grant. The options are not transferable, have a term of 10
years, and generally become exercisable in varying proportions on the
first, second, third, fourth and fifth anniversaries of the date of
grant. All such options become exercisable within specified periods in
the event of retirement, termination other than for cause (including as
a result of a change of control of FSHI), incapacity or death of the
director, executive or employee.
33
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
11. SHAREHOLDERS' EQUITY (CONTINUED):
Changes in stock options for the years ended December 31, 2004 and 2003
were as follows:
------------------------------------------------------------------------
Options Weighted average Available
outstanding exercise price for grant
------------------------------------------------------------------------
Balance at December 31, 2002 5,795,677 $52.41 576,646
Granted 445,200 46.00 (445,200)
Exercised (366,260) 20.95 -
Cancelled (37,720) 68.50 37,720
------------------------------------------------------------------------
Balance at December 31, 2003 5,836,897 53.91 169,166
Additional options approved by
shareholders - - 500,000
Granted 152,900 71.16 (152,900)
Exercised (1,367,054) 36.35 -
Cancelled (58,160) 88.05 58,160
------------------------------------------------------------------------
Balance at December 31, 2004 4,564,583 $59.33 574,426
------------------------------------------------------------------------
Information relating to stock options outstanding at December 31, 2004
was as follows:
-------------------------------------------------------------------------------------
Options outstanding Options exercisable
--------------------------------------- -------------------------
Weighted Weighted Weighted
average average average
Range of exercise Options remaining life exercise Options exercisable
prices outstanding contractual price exercisable price
-------------------------------------------------------------------------------------
$16.25 - $ 32.91 296,608 2.7 years $30.25 283,286 $29.97
$37.47 - $ 49.33 1,418,134 5.1 years 46.88 1,050,454 47.23
$50.23 - $ 67.07 1,309,485 5.4 years 55.05 1,020,181 54.64
$68.80 - $ 84.00 846,980 7.3 years 73.78 188,000 76.43
$86.97 - $108.14 693,376 5.5 years 87.63 196,720 88.83
-------------------------------------------------------------------------------------
$16.25 - $108.14 4,564,583 5.5 years $59.33 2,738,641 $53.20
-------------------------------------------------------------------------------------
34
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
11. SHAREHOLDERS' EQUITY (CONTINUED):
The Corporation adopted the fair value-based method for all employee
stock options granted on or after January 1, 2003. The fair value of
stock options granted has been estimated using a Black-Scholes option
pricing model with the following assumptions: risk-free interest rates
in 2004 ranging from 2.96% to 4.39% (2003 - 4.44% to 5.02%); semi-annual
dividend per LVS in 2004 and 2003 of $0.055; volatility factor of the
expected market price of FSHI's LVS in 2004 ranging from 28% to 30%
(2003 - 32%); and expected lives of the options in 2004 and 2003 ranging
between four and seven years, depending on the level of the employee who
was granted stock options. For the options granted in 2004 and 2003, the
weighted average fair value of the options at the grant dates were
$25.32 and $18.46, respectively. For purposes of stock option expense
and pro forma disclosures, the estimated fair value of the options is
amortized to compensation expense over the options' vesting period.
Section 3870 of the CICA Handbook requires pro forma disclosure of the
effect of the application of the fair value-based method to employee
stock options granted on or after January 1, 2002 and not accounted for
using the fair value-based method. For the years ended December 31, 2004
and 2003, if the Corporation had applied the fair value-based method to
options granted from January 1, 2002 to December 31, 2002, the
Corporation's net earnings and basic and diluted earnings per share
would have been reduced to the pro forma amounts indicated below:
------------------------------------------------------------------------
2004 2003
------------------------------------------------------------------------
Stock option expense included in
compensation expense $ (2,113) $ (893)
------------------------------------------------------------------------
Net earnings, as reported $ 33,232 $ 5,384
Additional expense that would have been recorded
if all outstanding stock options granted on
or after January 1, 2002 had been expensed (3,407) (3,450)
------------------------------------------------------------------------
Pro forma net earnings $ 29,825 $ 1,934
------------------------------------------------------------------------
Earnings per share:
Basic, as reported $ 0.93 $ 0.15
Basic, pro forma 0.84 0.06
Diluted, as reported 0.89 0.15
Diluted, pro forma 0.80 0.05
------------------------------------------------------------------------
35
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
11. SHAREHOLDERS' EQUITY (CONTINUED):
(c) Contributed surplus:
Changes in contributed surplus for the years ended December 31, 2004 and
2003 were as follows:
------------------------------------------------------------------------
2004 2003
------------------------------------------------------------------------
Contributed surplus, beginning of year $5,529 $4,636
Stock option expense (b) 2,113 893
Adjustment relating to stock options exercised (259) -
Gain on redemption of the equity component of
convertible notes, net of income taxes
of $4,141 (note 10(b)) 4,019 -
------------------------------------------------------------------------
Contributed surplus, end of year $11,402 $5,529
------------------------------------------------------------------------
(d) Earnings per share:
Basic earnings per share is calculated by dividing net earnings by the
weighted average number of VMVS and LVS outstanding during the year.
Potentially issuable LVS are excluded from the calculation of basic
earnings per share, but are included in the calculation of diluted
earnings per share by application of the "treasury stock method", which
takes into account the dilution relating to LVS issuable under the
Corporation's stock option plan, and by application of the "if-converted
method", which takes into account the potential dilution relating to the
conversion of the Corporation's convertible notes. During 2004 and 2003,
no convertible notes were redeemed by the issuance of LVS.
A reconciliation of net earnings and the weighted average number of VMVS
and LVS used to calculate basic earnings per share and diluted earnings
per share is as follows:
------------------------------------------------------------------------
2004 2003
------------------------------------------------------------------------
Net Net
earnings Shares earnings Shares
------------------------------------------------------------------------
Basic earnings per share
amounts $33,232 35,647,986 $5,384 4,996,389
Effect of assumed dilutive
conversions:
Stock option plan - 1,666,230 - 870,135
------------------------------------------------------------------------
Diluted earnings per share
amounts $33,232 37,314,216 $5,384 35,866,524
------------------------------------------------------------------------
36
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
11. SHAREHOLDERS' EQUITY (CONTINUED):
The diluted earnings per share calculation excluded the effect of the
assumed conversions of 847,876 stock options to LVS, under the
Corporation's stock option plan, during the year ended December 31, 2004
(2003 - 1,958,842 stock options), as the inclusion of these conversions
resulted in an anti-dilutive effect. In addition, the dilution relating
to the assumed conversion of convertible notes (issued in 1999 and
subsequently redeemed in 2004) (note 10(b)) to 3,463,155 LVS, by
application of the "if-converted method", has been excluded from the
calculation for 2004 and 2003 as the inclusion of this conversion
resulted in an anti-dilutive effect for the years ended December 31,
2004 and 2003. There was no dilution relating to the convertible senior
notes issued in 2004 (note 10(a)) as the contingent conversion price was
not reached during 2004.
(e) Equity adjustment from foreign currency translation:
Changes in equity adjustment from foreign currency translation for the
years ended December 31, 2004 and 2003 were as follows:
------------------------------------------------------------------------
2004 2003
------------------------------------------------------------------------
Balance, beginning of year $(13,593) $32,412
Changes in exchange rates used to translate
the Corporation's net investment in foreign
self-sustaining subsidiaries (18,641) (46,005)
------------------------------------------------------------------------
Balance, end of year $(32,234) $(13,593)
------------------------------------------------------------------------
12. CONSOLIDATED REVENUES:
----------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------
Revenues from Management Operations $218,547 $195,833
Revenues from Ownership and Corporate Operations 126,726 123,214
Distribution from hotel investments 398 153
Fees from Ownership and Corporate Operations to
Management Operations (5,883) (5,620)
----------------------------------------------------------------------------
$339,788 $313,580
----------------------------------------------------------------------------
37
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
13. OTHER EXPENSE, NET:
----------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------
Loss on redemption of convertible notes (note 10(b)) $(14,611) $ -
Foreign exchange gain (loss) (note 14) 3,615 (14,703)
Provision for loss, net (notes 3(d), 3(e) and 5(a)) (3,822) (1,419)
Loss on disposal of ownership interests (note 4(c)) (643) -
Legal and enforcement costs (notes 3(c) and 6(b)) (273) (9,475)
Other expense (361) (186)
----------------------------------------------------------------------------
$(16,095) $(25,783)
----------------------------------------------------------------------------
14. FOREIGN EXCHANGE GAIN (LOSS):
During 2004, the Corporation recorded a net foreign exchange gain of $3,615
(2003 - net foreign exchange loss of $14,703), which is included in "Other
expense, net". The net foreign exchange gain in 2004 and the net foreign
exchange loss in 2003 related primarily to the foreign currency translation
gains and losses on unhedged net asset and liability positions, primarily in
US dollars, euros, pounds sterling and Australian dollars, and local
currency foreign exchange gains and losses on net monetary assets incurred
by the Corporation's designated foreign self-sustaining subsidiaries.
Effective January 1, 2004, the Corporation ceased designating its US dollar
forward contracts as hedges of its 2004 US dollar revenues, and as a result,
these contracts were marked-to-market on a monthly basis with the resulting
changes in fair values being recorded as a foreign exchange gain or loss
(note 1(l)(i)).
38
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
15. COMMITMENTS AND CONTINGENCIES:
(a) Lease commitments:
The Corporation has entered into lease agreements for certain hotel
properties and corporate offices for periods up to the year 2054.
(i) Future minimum lease payments for The Pierre in New York, Four
Seasons Hotel Vancouver and certain corporate offices (but
exclusive of any contingent rentals, occupancy costs, and lease
commitments relating to Four Seasons Hotel London, which is
discussed below), are as follows:
------------------------------------------------------------------
2005 $10,402
2006 9,595
2007 8,920
2008 8,840
2009 8,781
Subsequent to 2009 38,333
------------------------------------------------------------------
$84,871
------------------------------------------------------------------
39
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
15. COMMITMENTS AND CONTINGENCIES (CONTINUED):
(ii) The Corporation is the tenant of the land and premises
constituting Four Seasons Hotel London pursuant to the terms of a
lease (the "FS Lease") expiring on January 28, 2054. The leasehold
interest of the Corporation in the hotel is a continuing
obligation which survived the sale by the Corporation of its
ownership interest in the hotel in 1995. The Corporation has
entered into a sublease of the hotel with the entity (the
"Sub-Tenant") on whose behalf the Corporation manages the hotel.
The annual rent payable by the Corporation under the FS Lease is
currently (pound)3.9 million. The same amount of annual rent is
payable by the Sub-Tenant to the Corporation pursuant to the
sublease and is payable out of the operating accounts of the
hotel. Indirectly, the Corporation now holds a 12.5% ownership
interest in the Sub-Tenant.
Pursuant to the arrangements relating to the ownership of the
Sub-Tenant, the Corporation would be required to fund its
proportionate 12.5% share of any amounts required to ensure that
the Sub-Tenant honoured all of the obligations necessary for the
operation of the hotel, including the sublease payments, to the
extent the majority shareholder makes payment of its proportionate
share of such amounts. The Corporation has not been required
either to make payment of any amount of rent under the FS Lease
that has not first been paid to the Corporation under the sublease
or to fund any amounts under the terms of the ownership
arrangements relating to the Sub-Tenant. Historically, hotel
operating cash flow has been more than sufficient to meet the rent
obligation. In the event of a non-payment of rent under the
sublease, the Corporation would be entitled to forfeit the
sublease. The ongoing management of the hotel by the Corporation
is subject to a non-disturbance agreement with the senior lender
of the Sub-Tenant. Future minimum lease payments of the hotel,
exclusive of any contingent rentals and occupancy costs, are as
follows:
------------------------------------------------------------------
2005 $ 8,985
2006 9,100
2007 9,215
2008 9,225
2009 9,225
Subsequent to 2009 406,663
------------------------------------------------------------------
$452,413
------------------------------------------------------------------
40
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
15. COMMITMENTS AND CONTINGENCIES (CONTINUED):
(b) Pension commitments:
The Corporation maintains an unfunded multi-employer, non-contributory,
defined benefit pension plan (the "Plan") on behalf of the Corporation
and the owners of certain managed properties. The Plan provides pension
benefits for certain senior executives of the Corporation as well as
hotel and resort general managers, based on years and level of service
and annual salary.
The accrued benefit liability as at December 31, 2004 and the benefit
expense for the year ended December 31, 2004 were determined based on
January 1, 2004 valuations of the Plan and an extrapolation to December
31, 2004 for disclosure purposes. The Corporation uses the corridor
method to amortize actuarial gains and losses (such as changes in
actuarial assumptions and experience gains and losses). Under the
corridor method, amortization is recorded only if the accumulated net
actuarial gains or losses exceed 10% of the greater of accrued benefit
obligation and the value of the Plan assets.
Information relating to the Plan for the years ended December 31, 2004
and 2003 based on projections of employees' compensation levels to the
date of retirement were as follows:
------------------------------------------------------------------------
2004 2003
------------------------------------------------------------------------
Accrued benefit obligation, beginning of year $ 60,668 $ 52,092
Change in accrued benefit obligation:
Service cost 2,232 1,863
Interest cost 4,238 3,610
Benefits paid (1,459) (951)
Actuarial loss 4,975 4,054
------------------------------------------------------------------------
Accrued benefit obligation, end of year 70,654 60,668
Unamortized actuarial loss for changes
in assumptions (10,905) (6,189)
------------------------------------------------------------------------
Accrued benefit liability, end of year,
before allocation 59,749 54,479
Portion allocated to managed properties (26,936) (24,987)
------------------------------------------------------------------------
Accrued benefit liability, end of year,
after allocation $ 32,813 $ 29,492
------------------------------------------------------------------------
Under the Plan, the benefits expected to be paid in each of the next
five years, and in the aggregate for the five fiscal years thereafter,
to certain senior executives of the Corporation, including benefits
attributable to estimated future employee service, are approximately:
2005 - $1,300; 2006 - $2,100; 2007 - $2,500; 2008 - $2,500; 2009 -
$3,300; 2010 to 2014 - $25,800.
During part of 2003, the accrued benefit liability was financed by life
insurance policies on the lives of certain of the participants in the
Plan. During 2003, most of the policies were liquidated for cash
proceeds generally equal to their carrying value.
41
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
15. COMMITMENTS AND CONTINGENCIES (CONTINUED):
------------------------------------------------------------------------
2004 2003
------------------------------------------------------------------------
Assumptions as of December 31:
Discount rates - benefit obligation 6.00% 6.50%
Discount rates - benefit expense 6.50% 6.75%
Rates of increase in compensation levels 3.00% 3.00%
------------------------------------------------------------------------
Components of benefit expense before allocation:
Service cost $2,232 $1,863
Interest cost 4,238 3,610
Actuarial loss 4,975 4,054
------------------------------------------------------------------------
Elements of employee future benefit costs before
adjustments to recognize the long-term nature of
employee future benefit costs 11,445 9,527
Difference between actuarial loss recognized for
the year and actual actuarial loss on accrued
benefit (4,716) (4,054)
------------------------------------------------------------------------
Benefit expense before allocation 6,729 5,473
Portion allocated to managed properties (3,655) (2,803)
------------------------------------------------------------------------
Benefit expense after allocation $3,074 $2,670
------------------------------------------------------------------------
(c) Guarantees, commitments and indemnifications:
(i) Guarantees and commitments:
As at December 31, 2004, the Corporation has provided certain
guarantees and has other commitments in connection with the
properties under its management. These include four bank
guarantees in respect of four projects totalling a maximum of
$24,000, as well as a $361 guarantee of relocation costs for
certain employees. The Corporation has lease commitments in
respect of Four Seasons Hotel London, which are more fully
described in note 15(a)(ii), and Four Seasons Hotel Prague of
approximately (euro)0.8 million. In addition, the Corporation has
four other commitments totalling $29,300. The Corporation also has
guaranteed certain obligations of various officers and employees
in the aggregate amount of $296, all of which were entered into
before 2002.
42
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
15. COMMITMENTS AND CONTINGENCIES (CONTINUED):
To the extent it is called upon to honour any one of these
commitments, the Corporation generally has either the right to be
repaid from hotel operations and/or has various forms of security
or recourse to the owner of the property. The Corporation does not
anticipate funding any amount pursuant to these commitments during
2005, with the exception of $8,500 relating to its other
commitments. The Corporation's assessment of its potential
liability for such matters could change as a result of, among
other things, the associated risks and uncertainties.
(ii) Disposition indemnification arrangements:
In connection with the sale of all or a part of its interest in a
property, the Corporation and its subsidiaries may agree to
indemnify 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 that interest. The nature of these
indemnities prevents the calculation of an exact amount that may
be payable to the indemnified parties.
In the context of two of the Corporation's dispositions, the
Corporation received indemnity agreements in its favour, for its
existing guarantee obligations related to the disposed interest
that have remained outstanding notwithstanding the disposition.
The Corporation believes that the indemnification agreements in
its favour will fully indemnify the Corporation for any possible
payment under these existing guarantees.
(iii) Director and officer indemnification arrangements:
To the extent permitted by law, the Corporation and its
subsidiaries 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 the request of the Corporation or its
subsidiaries. The Corporation has purchased directors' and
officers' liability insurance that may be available in respect of
certain of these claims.
43
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
15. COMMITMENTS AND CONTINGENCIES (CONTINUED):
(iv) Other indemnification arrangements:
In the ordinary course of their business, the Corporation and its
subsidiaries enter into other agreements with third parties that
may contain indemnification provisions pursuant to which the
parties to the agreements agree to indemnify one 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
which arise in respect of tax or environmental matters).
The terms of the Corporation's 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 the Corporation from
making a reasonable estimate of the maximum potential amount the
Corporation and its subsidiaries could be required to pay to
counterparties. The Corporation believes that the likelihood that
it or its subsidiaries would incur significant liability under
these obligations is remote. Historically, the Corporation and its
subsidiaries have not made any significant payments under such
indemnifications. No amount has been recorded in the consolidated
financial statements with respect to these indemnification
provisions. The Corporation's assessment of its potential
liability could change in the future as a result of currently
unforeseen circumstances.
(d) Other commitments and contingencies:
(i) In the ordinary course of its business, the Corporation is named
as a defendant in legal proceedings resulting from incidents
taking place at hotels owned or managed by it. The Corporation
maintains comprehensive liability insurance and also requires
hotel owners to maintain adequate insurance coverage. The
Corporation believes such coverage to be of a nature and amount
sufficient to ensure that it is adequately protected from
suffering any material financial loss as a result of such claims.
(ii) A number of the Corporation's management contracts are subject to
certain performance tests which, if not met, could allow a
contract to be terminated prior to its maturity. The Corporation
generally has various rights to cure any such defaults to avoid
termination. In addition, certain management contracts are
terminable by the hotel owner on a defined change of control of
FSHI.
44
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
15. COMMITMENTS AND CONTINGENCIES (CONTINUED):
(iii) The Corporation is currently in dispute with the owner of Four
Seasons Hotel Caracas (note 3(c)) over a variety of matters.
16. FAIR VALUES OF FINANCIAL INSTRUMENTS:
The estimated fair value of a financial instrument is the amount at which
the instrument could be exchanged in a current 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 significantly 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 the Corporation's convertible notes is based on market
quotes obtained from one of the Corporation's financial advisors.
Other financial instruments held by the Corporation include long-term
receivables due from owners of managed hotels (note 3). The Corporation does
not have plans to sell these loans to third parties and expects 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) which 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.
45
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
16. FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED):
The Corporation enters into foreign exchange forward contracts that oblige
it to buy or sell specific amounts of foreign currencies at set future dates
at predetermined exchange rates. Because a significant portion of the
Corporation's revenues is derived in foreign currencies (primarily US
dollars) and expenditures incurred by the Corporation for its management
operations are denominated primarily in Canadian dollars, the Corporation
enters into such contracts from time to time to protect itself in the event
of a strengthening Canadian currency. Management estimates future foreign
currency cash flows on an ongoing basis, based on its projections of foreign
currency-denominated management fees and other transactions. Management
negotiates foreign exchange forward contracts in proportion to the magnitude
and timing of these cash flows. As at December 31, 2004, the Corporation had
no foreign exchange forward contracts outstanding (2003 - US $50 million
($80,617) at a weighted average forward exchange rate of $1.61, under 24
forward contracts, maturing over a 12-month period). The fair value of
foreign exchange forward contracts is estimated from quotes obtained from
the Corporation's counterparties for the same or similar financial
instruments.
The fair values of financial instruments are as follows:
----------------------------------------------------------------------------
Estimated Carrying
fair value amount
----------------------------------------------------------------------------
2004:
Convertible notes, issued in 2004 (a) $(388,000) $(311,337)
2003:
Convertible notes, issued in 1999 (a) (289,000) (273,433)
Foreign exchange forward contracts 15,000 604
----------------------------------------------------------------------------
(a) The carrying amount of the convertible notes includes the amounts
allocated to both long-term obligations and shareholders' equity. It
excludes, however, the offering expenses and underwriter's commission
related to the shareholders' equity component of the notes of $1,809 in
2004 (2003 - $6,861), which are recorded in "Shareholders' equity".
46
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
17. SEGMENTED INFORMATION:
The Corporation has two distinct operating segments: management operations
and ownership and corporate operations. Under its management operations
segment, the Corporation generally supervises all aspects of hotel
operations on behalf of the hotel owners, including hotel sales and
marketing, hotel reservations, hotel accounting, purchasing, budgeting and
the hiring, training and supervising of staff. For providing these services,
the Corporation typically receives a base fee calculated as a percentage of
gross revenues of the hotel. In addition, the Corporation may receive
incentive fees based on the operating performance of the hotels. Generally,
the hotels' owners, and not the Corporation, fund substantially all capital
expenditures and working capital of the hotels, including all employment and
operating costs. This segment also includes the licensing and managing of
residential projects and residence clubs. The Corporation is entitled to
receive a fee for the use of its brand name in connection with these
projects, and for services provided in the oversight of the sales and
marketing of the residential projects and residence club units. In addition,
the Corporation receives a fee from the owners of the residential projects
and residence club units for services provided in the ongoing management of
these units.
Under its ownership and corporate operations segment, the Corporation had an
equity interest in 14 hotels and resorts and three residence clubs under
management and three projects under construction as at December 31, 2004.
Earnings are primarily derived from the consolidation of its wholly owned
interests in two hotels (note 1(a)) and distributions from its other equity
interests. Generally, the ownership and corporate operations segment is
subject to greater economic fluctuations than the management operations
segment. Ownership and corporate earnings can be materially affected by,
among other things, changes in travel patterns, local wage rate factors, the
level of capital spending that is required to appropriately maintain and
renew the hotels, volatility of construction costs, the availability of
hotel financing and changes in interest rates. The Corporation structures
its ownership interests separately from its management interests so as to
enable the Corporation to dispose of ownership interests as sale
opportunities arise, without affecting its management interests.
47
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
17. SEGMENTED INFORMATION (CONTINUED):
(a) Consolidated revenues:
Revenues have been allocated to specific geographic segments based on
the location of each hotel or resort.
----------------------------------------------------------------------------------------------------------
2004 2003
---------------------------------------------------------------------------------------
Ownership Ownership
and and
corporate corporate
revenues revenues
Management and Consolidated Management and Consolidated
revenues distributions revenues revenues distributions revenues
----------------------------------------------------------------------------------------------------------
United States $ 76,948 $ 80,500 $ 157,448 $ 69,600 $ 76,506 $146,106
Other
Americas/Caribbean 19,798 31,826 51,624 12,434 26,746 39,180
Europe 25,164 14,798 39,962 21,945 20,115 42,060
Asia/Pacific 17,405 - 17,405 13,039 - 13,039
Middle East 6,516 - 6,516 3,512 - 3,512
----------------------------------------------------------------------------------------------------------
145,831 127,124 272,955 120,530 123,367 243,897
Reimbursed costs 72,716 - 72,716 75,303 - 75,303
Less intersegment
revenues (5,883) - (5,883) (5,620) - (5,620)
----------------------------------------------------------------------------------------------------------
$212,664 $127,124 $339,788 $190,213 $123,367 $313,580
----------------------------------------------------------------------------------------------------------
(b) Total assets:
------------------------------------------------------------------------
2004 2003
------------------------------------------------------------------------
United States $ 332,404 $335,375
Other Americas/Caribbean 392,933 290,098
Europe 230,568 193,393
Asia/Pacific 108,074 100,521
Middle East 21,846 27,273
------------------------------------------------------------------------
$1,085,825 $946,660
------------------------------------------------------------------------
48
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
18. RECONCILIATION TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES:
The consolidated financial statements of the Corporation for the years ended
December 31, 2004 and 2003 have been prepared in accordance with generally
accepted accounting principles as applied in Canada ("Canadian GAAP"). In
the following respects, generally accepted accounting principles as applied
in the United States ("US GAAP") differ from those applied in Canada.
If US GAAP were employed, net earnings would be adjusted as follows:
----------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------
Net earnings based on Canadian GAAP $33,232 $ 5,384
Impact on net earnings of US GAAP adjustments:
Hotel partnerships and corporations (a) (9,037) (3,966)
Future income taxes (c) 6,823 (7,596)
Convertible notes (d) 16,382 (4,909)
Deferred charges (e) (4,841) (3,861)
Foreign exchange translation (g) (6,487) 53,770
Pension plan (h) (543) (488)
Stock compensation expense (m) 2,113 893
----------------------------------------------------------------------------
Net earnings based on US GAAP $37,642 $39,227
----------------------------------------------------------------------------
Basic earnings per share based on US GAAP $ 1.06 $ 1.12
----------------------------------------------------------------------------
Diluted earnings per share based on US GAAP ((i)(ii)) $ 1.01 $ 1.09
----------------------------------------------------------------------------
Weighted average shares - basic 35,647,986 34,996,389
----------------------------------------------------------------------------
Weighted average shares - diluted ((i)(ii)) 37,426,090 35,982,715
----------------------------------------------------------------------------
49
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
18. RECONCILIATION TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
(CONTINUED):
The impact of the US GAAP differences discussed above on the Corporation's
consolidated shareholders' equity is as follows:
----------------------------------------------------------------------------
2004 2003
----------------------------------------------------------------------------
Shareholders' equity based on Canadian GAAP $ 703,986 $ 765,507
Impact on shareholders' equity of US GAAP
adjustments:
Hotel partnerships and corporations (a) (89,702) (78,870)
Hotel disposition program (b) 27,842 27,842
Future income taxes (c) 10,651 (313)
Convertible notes (d) (79,579) (214,270)
Deferred charges (e) (35,700) (31,448)
Foreign exchange translation (g) 48,210 52,996
Pension plan (h) 3,688 4,231
----------------------------------------------------------------------------
Shareholders' equity based on US GAAP $589,396 $525,675
----------------------------------------------------------------------------
(a) Investments in hotel partnerships and corporations:
(i) The Corporation has minority interests (generally less than 20%)
in certain hotel partnerships which, under Canadian GAAP, the
Corporation accounts for on a cost basis (note 1(f)). Under US
GAAP (AICPA Statement of Position 78-9, "Accounting for
Investments in Real Estate Ventures"), the Corporation is required
to account for its investments in these hotel partnerships using
the equity method of accounting, pursuant to which the Corporation
records in income its proportionate share of the investee's net
earnings or loss.
(ii) Under Canadian GAAP, the Corporation accounts for its investments
in hotel partnerships and corporations, which were acquired prior
to May 1, 2003 with the intention that they be disposed of in the
foreseeable future, by the cost method, irrespective of its
percentage ownership interest (notes 1(f), 4(a) and 4(b)). Under
US GAAP, effective January 1, 2002, the Corporation accounts for
these temporary investments based on its percentage ownership
interest for each investment, as the Financial Accounting
Standards Board ("FASB") Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("FAS 144") eliminated the exception to
consolidate a temporary controlled subsidiary. As a result, the
Corporation has consolidated one temporary investment and has
equity accounted one temporary investment in 2004 and 2003 under
US GAAP.
50
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
18. RECONCILIATION TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
(CONTINUED):
(iii) During 2004, the Corporation entered into a multi-element
arrangement whereby the Corporation (i) sold its interest in a
hotel property, (ii) entered into a hotel management contract with
the purchaser, and (iii) entered into a guarantee arrangement with
the purchaser. Under Canadian GAAP, as all three elements were
entered into with the same party at the same time, the Corporation
applied EIC-142. Pursuant to the requirements of EIC-142, the
Corporation determined that the sale of the hotel property should
be accounted for as a separate unit of accounting that should be
accounted for in 2004 as the disposal of the hotel property; and
that the hotel management contract and the guarantee arrangement
should be accounted for as a combined unit of accounting, with the
related costs and revenues being recognized over the term of the
hotel management contract as management services are delivered.
Under US GAAP, the Corporation determined that Statement of
Financial Accounting Standards No. 66, "Accounting for Sales of
Real Estate", overrides the US GAAP equivalent of EIC-142
(Emerging Issues Task Force Abstract No. EITF 00-21, "Revenue
Arrangements with Multiple Deliverables") and requires the
guarantee arrangement to be accounted for as a part of the sale of
the hotel property. As a result, the Corporation's estimate of the
fair value of the payments it would likely be required to make
under the guarantee arrangement was accounted for as a reduction
of the proceeds received on the sale of the hotel property under
US GAAP.
(iv) Summarized balance sheet information of the equity method
investments, presented on a 100% basis, is as follows:
------------------------------------------------------------------
2004 2003
------------------------------------------------------------------
Current assets $111,361 $ 70,319
Long-term assets, net 433,175 498,376
------------------------------------------------------------------
$544,536 $568,695
------------------------------------------------------------------
Current liabilities $114,608 $231,919
Long-term obligations 351,956 268,647
Equity 77,972 68,129
------------------------------------------------------------------
$544,536 $568,695
------------------------------------------------------------------
Summarized results of operations of the equity method investments,
presented on a 100% basis, are as follows:
------------------------------------------------------------------
2004 2003
------------------------------------------------------------------
Revenues $247,033 $234,757
Expenses (255,929) (252,233)
------------------------------------------------------------------
Net loss $ (8,896) $(17,476)
------------------------------------------------------------------
The proportionate taxable income or loss of all hotel partnerships
is included in the taxable income of their respective partners.
Accordingly, no provisions for income taxes on such entities are
included in the above statements.
51
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
18. RECONCILIATION TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
(CONTINUED):
(b) Hotel disposition program:
In November 1993, the Corporation implemented a program to dispose of
seven hotel properties. Under Canadian GAAP, this hotel disposition
program represented the disposition of a significant portion of the
Corporation's Ownership and Corporate Operations segment; accordingly,
in both 1993 and 1994, the Corporation made an estimate as to whether it
would realize a net gain or loss on the program in total. As a result,
in 1993, the Corporation recorded a provision of $127,000 for the
estimated probable loss on the sale of the hotels included in the hotel
disposition program. The program ended in 1996, and the total net
proceeds received by the Corporation, resulting from the dispositions of
the hotels included in the program, approximated the proceeds estimated
in 1993; therefore, the program required no further gain or loss to be
recorded.
Under US GAAP, the Corporation was required to account for the hotels
remaining in the program as individual assets held for sale. This
resulted in the requirement under US GAAP to record, in 1994, a further
provision for loss on certain of the hotels remaining in the program,
with the offsetting gains on other hotels recorded when the gains were
realized. On the sale by the Corporation of its equity interest in one
of its hotels in 1995, $27,813 of the gain was deferred for US GAAP
purposes, and will be recognized in proportion to the cash payments
received on the cash flow bond received as consideration on the sale
(note 3(a)). The Corporation did not recognize any of the deferred gain
in 2004 and 2003 as no principal payments were received on the cash flow
bond. As at December 31, 2004, $21,345 of the gain continues to be
deferred.
(c) Accounting for future income taxes:
The income tax adjustment from Canadian to US GAAP results from the
differences between US GAAP and Canadian GAAP in calculating earnings
before income taxes.
52
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
18. RECONCILIATION TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
(CONTINUED):
(d) Convertible notes:
(i) Convertible notes, issued in 2004:
During 2004, FSHI issued US$250 million ($341,100) (principal
amount) senior notes convertible into Limited Voting Shares of
FSHI for net proceeds of US$241.3 million ($329,273) (note 10(a)).
Under Canadian GAAP, the notes were bifurcated into a debt
component (representing the principal value of a bond of US$211.8
million ($288,918), which was estimated based on the present value
of a US$250 million ($341,100) 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 (representing the value
of the conversion feature of the notes). Accordingly, net proceeds
have been allocated $288,918 to long-term obligations and $50,373
to shareholders' equity. The offering expenses and underwriters'
commission relating to the debt component of the notes of $10,018
were recorded in "Other assets".
Under US GAAP, gross proceeds of US$250 million ($341,100) were
recorded as long-term obligations, yielding 1.875% per annum. The
total offering expenses and underwriters' commission relating to
the notes of $11,827 were recorded in "Other assets". Accordingly,
lower interest expense of $4,332 was recognized in 2004 under US
GAAP.
(ii) Interest rate swap agreement:
In connection with the convertible notes issued in 2004, FSHI
entered into an interest rate swap agreement with an initial
notional amount of US$211.8 million ($288,918), pursuant to which
FSHI had agreed to receive interest at a fixed rate of 5.33% per
annum and pay interest at six-month LIBOR, in arrears, plus
0.4904% (note 10(a)). Under Canadian GAAP, FSHI had designated the
interest rate swap as a fair value hedge of the notes, which
resulted in an effective accounting interest rate on the hedged
notes to the date of termination of the swap, of six-month LIBOR,
in arrears, plus 0.4904%. Subsequently in 2004, FSHI terminated
the interest rate swap agreement and received proceeds of US$9
million ($11,267). Under Canadian GAAP, the gain of $9,243 was
deferred and is being amortized over the next 4.75 years, which
would have been the remaining swap term, as a reduction to
interest expense.
53
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
18. RECONCILIATION TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
(CONTINUED):
Under US GAAP, Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging
Activities" ("FAS 133"), establishes accounting and reporting
standards for derivatives and hedging. It requires that all
derivatives be recognized as either assets or liabilities at fair
value and establishes specific criteria for the use of hedging
accounting.
Under US GAAP, the interest rate swap did not meet the
requirements in order to hedge the convertible notes, and as a
result, was being marked-to-market. Accordingly, additional
interest expense of $2,591 was recognized in 2004 under US GAAP.
In addition, a gain on the marked-to-market adjustments and
termination of the swap of $11,267 was recognized in 2004 under US
GAAP.
(iii) Convertible notes, issued in 1999:
During 1999, FSHI issued US $655.5 million principal amount at
maturity (September 23, 2029) of notes convertible into Limited
Voting Shares of FSHI for gross proceeds of US $172.5 million
(note 10(b)). Under Canadian GAAP, the notes were bifurcated into
a debt component (representing the present value of a zero coupon
bond of US $655.5 million, maturing in 2029, yielding 9% per
annum, compounding semi-annually) and an equity component
(representing the value of the conversion feature of the notes).
Accordingly, net proceeds were originally allocated $68,902 to
long-term obligations and $178,574 to shareholders' equity. The
offering expenses and underwriters' commission relating to the
debt component of the notes of $2,549 were recorded in "Other
assets".
During 2004, FSHI redeemed for cash all these convertible notes
for US$328.73 per each one thousand US dollar principal amount at
maturity (the redemption price being the issue price plus interest
that was accrued but unpaid) for an aggregate payment of US$215.5
million ($275,701) (note 10(b)). Under Canadian GAAP, the
consideration paid on the redemption was allocated to the
liability and equity components of the convertible notes based on
their relative fair values at the date of the redemption. Based on
this allocation, a pre-tax accounting loss of $14,611 was
recognized, and recorded in "Other expense, net", related to the
debt component of the convertible notes, and a pre-tax accounting
gain of $8,160 was recognized, and recorded in contributed
surplus, related to the equity component of the convertible notes.
54
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
18. RECONCILIATION TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
(CONTINUED):
Under US GAAP, gross proceeds of US $172.5 million were recorded
as long-term obligations, with a yield to maturity of 4.5%,
compounding semi-annually. The total offering expenses and
underwriters' commission relating to the notes of $9,410 were
recorded in "Other assets". Accordingly, additional interest
expense of $3,355 (2003 - $4,909) was recognized under US GAAP. In
addition, under US GAAP, a pre-tax accounting loss of $7,882 was
recognized, and recorded in "Other expense, net", on the
redemption of the convertible notes, instead of the amounts
recognized above under Canadian GAAP.
In addition, under Canadian GAAP, at December 31, 2003, the
Corporation classified the debt component of the notes as a
long-term obligation. Under US GAAP, in accordance with Statement
of Financial Accounting Standards No. 6, "Classification of
Short-Term Obligations Expected to Be Refinanced", the notes would
be classified as a current liability at December 31, 2003.
(e) Deferred charges:
The Corporation defers expenditures directly related to the negotiation,
structuring and execution of new management contracts, and if the
property is opened, amortizes these deferred costs on a straight-line
basis over a 10-year period (note 1(h)). Under US GAAP, such start-up
costs are expensed.
(f) Investment in management contracts and investment in trademarks and
trade names:
On a Canadian GAAP basis, amortization expense of approximately $7,800
related to intangible assets with finite lives was recorded during the
year ended December 31, 2004 (2003 - $7,000). Amortization expense
relating to these assets is expected to be $8,000 in each of the fiscal
years 2005 through 2009.
55
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
18. RECONCILIATION TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
(CONTINUED):
(g) Foreign exchange translation:
(i) Under US GAAP, the impact on the Corporation in 2004 and 2003 of
applying FAS 133 to the accounting for the Corporation's US dollar
forward contracts was the marked-to-market of these contracts in
2002 and 2003. For US GAAP purposes, these forward exchange
contracts were not accounted for as hedges in 2002 and 2003;
therefore, the marked-to-market adjustments were recognized in
income in 2002 and 2003. Under Canadian GAAP, these forward
exchange contracts were accounted for as hedges in 2002 and 2003.
Effective January 1, 2004, under Canadian GAAP, the Corporation
ceased designating its US dollar forward contracts as hedges of
its US dollar revenues and, as a result, the US dollar forward
contracts were marked-to-market as of that date (note 1(I)(i)). In
2004, this accounting treatment was the same as under US GAAP. All
of these forward contracts matured during 2004. The difference in
accounting treatment in 2002 and 2003 resulted in a lower foreign
exchange gain in 2004, under US GAAP, of $14,441 (2003 - higher
foreign exchange gain of $14,024).
(ii) Under US GAAP, the US dollar amount of convertible notes allocated
to long-term obligations is higher than under Canadian GAAP
((d)(i) and (iii)). The US dollar monetary liabilities are,
therefore, higher under US GAAP, which resulted in an increase in
the foreign exchange gain in 2004, under US GAAP, of $7,954 (2003
- $39,746).
(h) Pension plan:
Under Canadian GAAP, the Corporation, effective January 1, 2000, changed
its accounting policy relating to the accounting for future employee
benefits, including pension benefits, to comply with the new Canadian
GAAP standard for accounting for pension plans. The Corporation adopted
the new standard for pension benefits retroactively, without restating
the financial statements of prior periods. This eliminated substantially
all of the differences between US and Canadian GAAP relating to the
accounting for pension benefits.
56
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
18. RECONCILIATION TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
(CONTINUED):
The only remaining significant difference between US and Canadian GAAP
relates to the treatment of actuarial gains and losses. Under Canadian
GAAP, the transitional provisions relating to the new Canadian GAAP
standard for accounting for pension plans permitted the impact of the
change of the new standard to be accounted for retroactively, without
restatement of prior years' financial statements. As a result, the
Corporation recorded in 2000 a charge to retained earnings, representing
the differences between the amount accrued by the Corporation under the
prior accounting standard and the actuarial obligation as measured under
the new standard, which included the net unamortized actuarial losses as
at December 31, 1999. Under US GAAP, the net unamortized actuarial
losses as at December 31, 1999 are amortized, on a straight-line basis,
over the expected average remaining service life of employees expected
to receive benefits under the Plan.
(i) New accounting standards adopted in 2004:
(i) Consolidation of variable interest entities:
In January 2003, the FASB issued Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"), and in
December 2003 issued FIN 46R, an amendment of FIN 46. In June
2003, the CICA issued Accounting Guideline No. 15, "Consolidation
of Variable Interest Entities" ("AcG-15"). FIN 46R and AcG-15
establish criteria to identify variable interest entities ("VIE")
and the primary beneficiary of such entities. Entities that
qualify as VIEs must be consolidated by their primary beneficiary.
All other holders of significant variable interests in a VIE must
disclose the nature, purpose, size and activity of the VIE, as
well as their maximum exposure to losses as a result of
involvement with a VIE. FIN 46R was effective January 1, 2004 for
the Corporation for VIEs created before February 1, 2003, but was
effective immediately for VIEs created after January 31, 2003. The
implementation of FIN 46R did not have an impact on the
consolidated financial statements for either 2003 or 2004. AcG-15
is applicable to all VIEs and will be effective for the
Corporation for fiscal periods beginning after December 31, 2004.
57
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
18. RECONCILIATION TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
(CONTINUED):
(ii) Diluted earnings per share:
In December 2004, the Emerging Issues Task Force of the FASB
issued Issue No. 04-8, "The Effect of Contingently Convertible
Instruments on Diluted Earnings per Share" ("EITF 04-8"), which
requires the application of the "if-converted method", under US
GAAP, to account for the potential dilution relating to the
conversion of contingently convertible instruments, such as FSHI's
convertible senior notes (note 10(a)). EITF 04-8 is effective for
reporting periods ending after December 15, 2004.
Under US GAAP, the dilution relating to the conversion of FSHI's
convertible senior notes to 3,489,525 Limited Voting Shares, by
application of the "if-converted method", has been excluded from
the calculation of 2004 diluted earnings per share as the
inclusion of this conversion resulted in an anti-dilutive effect
for the year ended December 31, 2004.
Under Canadian GAAP, the potential dilution of the conversion of
FSHI's convertible senior notes is excluded from the calculation
of diluted earnings per share, as the contingent conversion price
was not reached during 2004 (note 11(d)).
(j) Recent accounting standards issued but not yet adopted:
(i) Share-based payment:
In December 2004, the FASB issued Statement of Financial
Accounting Standards No. 123 (revised 2004), "Share-Based Payment"
("FAS 123R"), which requires an entity to recognize in the income
statement the grant-date fair value of stock options and other
equity-based compensation issued to employees. FAS 123R eliminates
an entity's ability to account for share-based compensation
transactions using the intrinsic value method of accounting in APB
Opinion No. 25, "Accounting for Stock Issued to Employees", which
was permitted under Statement of Financial Accounting Standards
No. 123 ("FAS 123"), as originally issued. Entities that adopt the
fair value-based method of accounting must use either the modified
prospective or modified retrospective transition method. FAS 123R
is substantially the same as Section 3870 of the CICA Handbook
(note 1(j)), but is not required to be adopted by the Corporation,
under US GAAP, until January 1, 2006.
58
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
18. RECONCILIATION TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
(CONTINUED):
(ii) Real estate time-sharing transactions:
The FASB issued Statement of Financial Accounting Standards No.
152, "Accounting for Real Estate Time-Sharing Transactions: an
Amendment of FASB Statements No. 66 and 67" ("FAS 152"), which
amends FASB Statement No. 66, "Accounting for Sales of Real
Estate", to reference accounting and reporting guidance for real
estate time-sharing transactions that is provided in AICPA
Statement of Position 04-02, "Accounting for Real Estate
Time-Sharing Transactions" ("SOP 04-02"). FAS 152 also amends FASB
Statement No. 67, "Accounting for Costs and Initial Rental
Operations of Real Estate Projects" ("FAS 67"), so that the
guidance in FAS 67 about incidental operations and costs incurred
to sell real estate projects does not apply to real estate
time-sharing transactions. Both FAS 152 and SOP 04-02 will be
effective for the Corporation for fiscal years beginning after
June 15, 2005.
(k) Statements of cash provided by operations and cash flows:
(i) For Canadian GAAP purposes, the Corporation's statements of cash
provided by operations show intermediate subtotals, and only show
the total change in non-cash operating assets and liabilities. US
GAAP does not permit intermediate subtotals in cash provided by
operations, and requires the statement to show the details of
changes in non-cash operating assets and liabilities.
In addition, the above adjustments to US GAAP earnings relating to
temporary controlled subsidiaries ((a)(ii)), interest on
convertible notes redeemed ((d)(iii)) and deferred charges (e)
would also affect cash provided by operations, as well as cash
used in financing and cash used in capital investments.
Under Canadian GAAP, the proceeds received on termination of the
interest rate swap are recorded as cash provided by operations.
Under US GAAP, the proceeds are recorded as cash provided by
capital investments ((d)(ii)).
59
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
18. RECONCILIATION TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
(CONTINUED):
As a result, cash provided by operations would be presented as
follows on a US GAAP basis:
------------------------------------------------------------------
2004 2003
------------------------------------------------------------------
Net earnings based on US GAAP $37,642 $39,227
Adjustments:
Depreciation and amortization 12,816 12,802
Unrealized foreign exchange loss (gain) 2,872 (39,067)
Provision for loss 2,101 1,552
Loss on disposal of hotel investments 7,890 -
Gain on termination of interest rate swap (11,267) -
Loss on redemption of convertible notes 7,882 -
Equity in losses of and distributions
from hotel investments 740 2,807
Minority interest (428) (472)
Future income taxes (2,200) 11,826
Other 215 861
Interest paid on redemption of convertible
notes (54,986) -
Change in non-cash working capital:
Accounts and notes receivable (4,366) 25,178
Inventory 867 2,961
Prepaid expenses and other assets 1,020 1,688
Accounts payable and accrued liabilities 20,733 3,758
Foreign currency translation effect on
non-cash working capital (4,492) (877)
------------------------------------------------------------------
Cash provided by operations based on US GAAP $17,039 $62,244
------------------------------------------------------------------
60
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
18. RECONCILIATION TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
(CONTINUED):
(ii) As a result of the above adjustments, the major captions on the
Corporation's statements of cash flows on a Canadian GAAP basis
are reconciled to a US GAAP basis as follows:
------------------------------------------------------------------
2004 2003
------------------------------------------------------------------
Cash provided by operations based on
Canadian GAAP $ 57,363 $ 66,003
Temporary controlled subsidiary 1,513 2,706
Termination of interest rate swap (11,267) -
Redemption of convertible notes (21,929) -
Deferred charges (8,641) (6,465)
------------------------------------------------------------------
Cash provided by operations based on US GAAP $ 17,039 $ 62,244
------------------------------------------------------------------
Cash provided by financing based on
Canadian GAAP $125,658 $ 3,851
Temporary controlled subsidiary (1,987) (5,893)
Redemption of convertible notes 21,929 -
------------------------------------------------------------------
Cash provided by (used in) financing
based on US GAAP $145,600 $ (2,042)
------------------------------------------------------------------
Cash used in capital investments based on
Canadian GAAP $(54,941) $(40,073)
Temporary controlled subsidiary - 4,724
Termination of interest rate swap 11,267 -
Deferred charges 8,641 6,465
------------------------------------------------------------------
Cash used in capital investments based on
US GAAP $(35,033) $(28,884)
------------------------------------------------------------------
Increase in cash based on US GAAP $127,606 $ 31,318
------------------------------------------------------------------
61
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
18. RECONCILIATION TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
(CONTINUED):
(l) Comprehensive income:
Statement of Financial Accounting Standards No. 130 ("FAS 130")
establishes standards under US GAAP for reporting and displaying
comprehensive income and its components (revenues, expenses, gains and
losses) in a full set of general-purpose financial statements. FAS 130
requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be reported
in a financial statement that is displayed with the same prominence as
other financial statements.
FAS 130 requires companies to (i) classify items of other comprehensive
income by their nature in a financial statement, and (ii) display the
accumulated balance of other comprehensive income separately from
capital stock, contributed surplus and retained earnings in the
shareholders' equity section of the balance sheet.
The statements of comprehensive income for the years ended December 31,
2004 and 2003 would be presented as follows on a US GAAP basis:
------------------------------------------------------------------------
2004 2003
------------------------------------------------------------------------
Net earnings based on US GAAP $37,642 $ 39,227
Other comprehensive loss, net of income taxes:
Foreign currency translation loss (19,847) (54,490)
------------------------------------------------------------------------
Comprehensive income (loss) based on US GAAP $17,795 $(15,263)
------------------------------------------------------------------------
The accumulated other comprehensive income balances for the years ended
December 31, 2004 and 2003 would be presented as follows on a US GAAP
basis:
------------------------------------------------------------------------
Balance, December 31, 2002 $ 34,197
Foreign currency translation loss (54,490)
------------------------------------------------------------------------
Balance, December 31, 2003 (20,293)
Foreign currency translation loss (19,847)
------------------------------------------------------------------------
Balance, December 31, 2004 $(40,140)
------------------------------------------------------------------------
62
FOUR SEASONS HOTELS INC.
Notes to Consolidated Financial Statements (continued)
Years ended December 31, 2004 and 2003
(In thousands of Canadian dollars except share amounts)
- --------------------------------------------------------------------------------
18. RECONCILIATION TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
(CONTINUED):
(m) Stock-based compensation plan:
FAS 123 provides guidance on the accounting for stock-based compensation
plans under US GAAP, such as the Corporation's stock option plan (note
11(b)). As allowed by FAS 123, the Corporation has decided to continue
to use Accounting Principles Board Opinion No. 25 ("APB 25"),
"Accounting for Stock Issued to Employees", in accounting for its stock
option plan, and as a result, no stock option expense was recorded under
US GAAP. Under Canadian GAAP, stock option expense was recorded for all
options issued on or after January 1, 2003.
For the years ended December 31, 2004 and 2003, had compensation expense
for the Corporation's stock-based compensation plan been determined
based on the fair value at the grant dates for stock options issued
under the plan after December 31, 1994, the Corporation's US GAAP net
earnings, US GAAP basic earnings per share and US GAAP diluted earnings
per share would have been adjusted to the pro forma amounts indicated
below:
------------------------------------------------------------------------
2004 2003
------------------------------------------------------------------------
Net earnings in accordance with US GAAP,
as reported $ 37,642 $ 39,227
Deduct pro forma stock option expense (24,899) (31,291)
------------------------------------------------------------------------
Pro forma net earnings $ 12,743 $ 7,936
------------------------------------------------------------------------
Earnings per share:
Basic, as reported $ 1.06 $ 1.12
Basic, pro forma 0.36 0.23
Diluted, as reported 1.01 1.09
Diluted, pro forma 0.35 0.23
------------------------------------------------------------------------
63