FS Four Seasons Hotel

Our Business Model We have two operating segments: (i) management operations, and (ii) ownership operations. Management Operations Our strategy has been to focus on hotel management rather than ownership, and we are principally a management company. We generally manage our hotels and resorts on behalf of our property owners pursuant to separate management agreements for each property. Under our management agreements, we generally oversee, as agent for the property owner, all aspects of the day-to-day operations of the hotels and resorts, including sales and marketing, advertising, reservations, accounting, purchasing, budgeting and the hiring, training and supervising of staff. In addition, we generally provide owners with advice with respect to information technology systems and development of certain database applications, as well as, advice with respect to the design, construction and furnishing of new or renovated hotels, resorts and residences. We also provide a centralized purchasing system for goods. We generally perform these services within the guidelines contained in annual hotel operating and capital plans that are submitted to the owners of the hotels and resorts during the last quarter of the preceding year for their review and approval. For providing these services, we generally receive a variety of fees, including hotel management fees (comprised of a base fee and an incentive fee); we also receive other fees (including royalty and management fees from our residential business, fees we earn during the development of our hotels and resorts and other miscellaneous fees) and reimbursed costs(2) (including a sales and marketing charge, an advertising charge and a reservation charge). Our base fees are dependent on total revenues of all managed hotels and resorts, which consist of rooms, food and beverage, and other revenues. Our base fees are typically earned as a percentage of total revenues for each property under management. RevPAR, which relates to room revenues and does not represent total revenue of a property, provides a strong indication of changes in revenues from properties under management and is a commonly used indicator of market performance for hotels and resorts. Our incentive fees are typically earned based on the profitability of each property that we manage, but may vary depending on the specific terms of the relevant management agreement. Gross operating profit(3) changes at the hotels and resorts provide an indication of the change in each property's profitability. However, due to the variations in the calculation of incentive fees in our management agreements, there is not always a direct link between changes in gross operating profit and changes in incentive fees. We receive royalty fees for the use of our name in association with the sale of Four Seasons branded real estate. These royalties are typically based on the sales proceeds of the residences sold. We also manage Four Seasons branded and serviced residential projects pursuant to management agreements under which we oversee the management of the day-to-day operations of the completed projects in return for ongoing management fees from the owners of interests in these projects. In order to expand our portfolio of properties under management, we make investments in the form of long-term receivables, minority equity investments and investments in management contracts. In determining whether to make these investments, we consider the overall expected returns to us, including the expected management operations revenue. These investments must meet our financial criteria and have a manageable risk profile. We consider whether the structure should be in the form of an investment or an advance, and, among other things, the relative risk and returns of the investment or advance, including interest, dividends and fee income. We generally seek to limit our total long-term capital exposure to no more than 20% of the total equity required for a property. We generally structure our equity investments to be able to have our equity interest diluted if additional capital is required. Depending on the nature of the investment or advance, it will be classified on our consolidated balance sheet as "Long-term receivables", "Investments in hotel partnerships and corporations", or "Investment in management contracts". General and administrative expenses are incurred by us to provide management services, together with those items normally associated with corporate overhead, such as operations, finance, information technology, accounting, legal, development and other costs of maintaining the corporate offices. Reimbursed costs, representing the sales, marketing, advertising and central reservation expenses, are generally incurred on a cost-recovery basis to us and are a function of the number of hotels and resorts we manage. Ownership Operations As a result of our strategy to focus on hotel management, the ownership operating segment represents our remaining (and primarily minority) interests in hotels and resorts. Our earnings from ownership operations include the consolidated results of our 100% leasehold interest(4) in Four Seasons Hotel Vancouver and results for The Pierre for the first six months of 2005. In June 2005, we disposed of our interest in The Pierre and ceased managing the property on June 30, 2005, leaving Four Seasons Hotel Vancouver as our one remaining leasehold interest and the only remaining hotel whose results we consolidate. In addition, we include in ownership operations profit distributions from our other ownership interests relating to minority equity positions. Other ownership interests are discussed under "Balance Sheet Review and Analysis - Investments in Hotel Partnerships and Corporations". Our investment strategy as a public company is not to hold any majority investments in hotels and resorts. However, Four Seasons Hotel Vancouver is a long-term leasehold interest that was established at an earlier stage in our development. We currently believe that we will operate the Vancouver hotel under the existing lease agreement, until its expiry on January 31, 2020. Overview of 2006 During 2006, worldwide travel demand remained robust, and the operating results at the hotels and resorts under our management reflect this travel trend. We realized RevPAR growth, primarily as a result of improvements in achieved room rates in each of the regions in which we operate. Gross operating margins(5) at the hotels and resorts under our management also improved in 2006 as a result of revenue improvements at the hotels and resorts and effective cost management programs. There was some variation in performance among the regions in which we operate, with the properties in Europe and Middle East/Africa achieving the strongest performance. We are pleased with the growth in hotel management fee revenues in 2006, which reflects the strong operating results achieved at our Core Hotels(6) and improvements at the recently opened hotels (which are excluded from our Core Hotel statistics). Base fees increased generally in line with RevPAR improvements, and the strong growth in incentive fees is consistent with the improvement in gross operating profits at the hotels and resorts under our management. Royalty fees from our residential business increased in 2006, primarily as a result of increased revenues from the sale of residential units in Miami, Punta Mita and Costa Rica. Royalty fees are earned on the sale of residences and, as a result, vary based on the number and nature of residences sold in a given period. Our cost base is relatively small. We directly employ approximately 515 employees, the majority of whom are located in Toronto. We also have corporate offices in Geneva and Singapore and have 15 sales offices around the world. Of these corporate employees, almost half are devoted to sales and marketing activities (including our worldwide reservations service), the cost of which is reimbursed by the hotels and resorts that we manage. During 2006, we substantially completed an addition to our Toronto corporate office, which allowed us to centralize our Toronto-based staff in one location from three facilities. In addition to improving communication and efficiency, we believe this centralization should allow us to realize certain cost reducing synergies over time. On a Canadian dollar basis, during 2006, our general and administrative expenses, which are incurred primarily in Canadian dollars, increased modestly. Our costs increased on a US dollar basis due to the US dollar having declined relative to the Canadian dollar on a year-over-year basis. During late 2005 and through 2006, we purchased foreign exchange forward contracts to moderate the impact of changes in foreign currency rates over time. However, the impact of foreign currency rate movements cannot be completely eliminated. Revenues from hotel ownership declined, primarily as a result of the disposition of The Pierre mid-year 2005. With the disposition of The Pierre, we achieved a significant milestone in our long-term strategic objective as a public company of reducing exposure to hotel ownership and the associated potentially volatile impact on earnings caused by, among other things, business cycles, seasonality and event risk. In November 2006, we announced that our Board of Directors had received a proposal to pursue a transaction through which FSHI would be taken private. The Board of Directors established a special committee of independent directors to consider the proposed transaction and make recommendations to the Board. In connection with this proposal, and the resulting process leading to the execution of the acquisition agreement, we incurred in 2006 certain costs primarily relating to legal fees, financial advisory and consulting services, and certain filing fees (during the three months ended December 31, 2006, we incurred $3.4 million of expenses). Please see the "Subsequent Event" section. In 2006, as the result of the sales of our ownership interests in the Four Seasons hotels in London, Sydney and Aviara, we were repaid loans, accrued interest and investments, and after deducting transaction costs, received cash and promissory notes totalling $100.6 million. In each case we retained long-term management of these properties. In addition, during 2006 we opened new properties in the Golden Triangle (Thailand), Silicon Valley, Maldives, Lana'i and Westlake Village. Since the beginning of 2006, we added 11 new Four Seasons projects to our list of properties under construction or advanced stages of development, including new projects in Shanghai, Macau and Barbados. Operational and Financial Review and Analysis Hotel and Resort Operating Results Consistent with industry practices, we track RevPAR on a US dollar basis, and all numbers noted below reflect that practice unless otherwise noted. For the full year 2006, RevPAR of our worldwide Core Hotels increased 11.8%, as compared to 2005, reflecting improvements in each of the regions in which we manage hotels and resorts. The increase in RevPAR was attributable to a 10.6% improvement in achieved room rates and a 70 basis point increase in occupancy. For the three months ended December 31, 2006, RevPAR for our worldwide Core Hotels increased 13.9%, as compared to the same period in 2005. This increase was primarily attributable to an 11.9% improvement in achieved room rates and a 110 basis point increase in occupancy. Gross operating revenues of our worldwide Core Hotels increased 10.5% and 14.0% for the full year and fourth quarter of 2006, respectively, as compared to the same periods in 2005. The improvements in revenue, combined with continued cost management efforts at the properties under our management, resulted in an 18.2% and 220 basis point increase in gross operating profits and gross operating margins, respectively, for the full year ended December 31, 2006. For the three months ended December 31, 2006, gross operating margins of our worldwide Core Hotels increased 310 basis points to 32.5%, as compared to 29.4% in the same period in 2005. With respect to our Core Hotels, the United States represents the most significant geographic area to us, with 49.6% of revenues under management for the full year 2006, followed by Europe (16.7%), Other Americas/Caribbean (14.7%), Asia/Pacific (12.8%), and the Middle East (6.2%). The following tables highlight our results of operations for our Core Hotels in each of these regions. United States Region ------------------------------------------------------------------------- Results for periods in 2006, as compared to periods in 2005 ------------------------------------------------------------------------- Gross Gross Operating Operating Gross Operating RevPAR Revenue (GOR) Profit (GOP) Margin --------------------------------------------------------------- Percentage Percentage Percentage Basis Point $ Increase Increase Increase Margin Improvement ------------------------------------------------------------------------- Fourth Quarter 298 8.4% 10.2% 17.9% 30.2% 190 ------------------------------------------------------------------------- Full Year 299 10.2% 9.8% 16.8% 30.4% 180 ------------------------------------------------------------------------- In the fourth quarter of 2006, RevPAR increased 8.4%, which was primarily attributable to increases in achieved room rates at the majority of the Core Hotels in the region. In addition, certain of the Core Hotels, including properties in Jackson Hole, Miami, Palm Beach and Philadelphia, experienced strong improvements in occupancy. The only Core Hotel in the region that had a significant decline in occupancy and RevPAR was our property in Maui, which is undergoing a renovation. As a result of improvements in RevPAR, gross operating profits and gross operating margins increased 17.9% and 190 basis points, respectively, during the fourth quarter of 2006. Excluding the results from the resort under management in Maui, RevPAR would have increased 12.2% and gross operating profits and gross operating margins would have increased 25.8% and 310 basis points, respectively, during the fourth quarter of 2006 as compared to the same period in 2005. For the full year 2006, virtually all of the properties under management in the region realized RevPAR improvements. The increases in RevPAR for 2006 were attributable to a 9.3% increase in achieved room rates as overall occupancy levels were essentially unchanged in this region. Properties under management in Austin, Los Angeles (Beverly Wilshire), New York, Philadelphia, Houston and Palm Beach realized particularly strong improvements in RevPAR, relative to the average for the region. RevPAR for the full year 2006 for the region increased 10.2% over 2005. In addition, for the full year 2006, gross operating profits and gross operating margins improved 16.8% and 180 basis points, respectively, as compared to 2005. This improvement was primarily attributable to a 9.8% increase in gross operating revenues mostly resulting from the RevPAR increase in the region. Excluding the results from our resort under management in Maui, RevPAR would have increased 11.1% and gross operating margins would have increased 220 basis points during the full year 2006. ------------------------------------------------------------------------- Other Americas/Caribbean Region ------------------------------------------------------------------------- Results for periods in 2006, as compared to periods in 2005 ------------------------------------------------------------------------- Gross Gross Operating Operating Gross Operating RevPAR Revenue (GOR) Profit (GOP) Margin --------------------------------------------------------------- Percentage Percentage Percentage Basis Point $ Increase Increase Increase Margin Improvement ------------------------------------------------------------------------- Fourth Quarter 237 14.6% 17.0% 36.3% 26.7% 380 ------------------------------------------------------------------------- Full Year 243 12.6% 12.0% 17.5% 27.8% 140 ------------------------------------------------------------------------- In the fourth quarter of 2006, all of the properties under management in the region experienced increases in RevPAR with the exception of Four Seasons Hotel Buenos Aires, which had essentially unchanged occupancy and achieved room rates. On a local currency basis RevPAR increased 13.1%. Properties under management in Costa Rica, Mexico City and Punta Mita had particularly strong improvements relative to the average for the region. As a result of improvements in RevPAR, gross operating profits and gross operating margins increased 36.3% and 380 basis points, respectively, in the fourth quarter of 2006, as compared to the same period in 2005. For the full year 2006, the 10.7% improvement in RevPAR, on a local currency basis, was primarily attributable to a 10.3% increase, on a local currency basis, in achieved room rates. For the full year 2006, all of the properties under management in the region experienced improvements in RevPAR with the exception of Four Seasons Resort Nevis, which experienced a decline in occupancy from late in the second quarter of 2006 through to early in the fourth quarter of 2006, due to travel concerns related to weather. Overall, the improvements in RevPAR led to increases in gross operating profits and gross operating margins of 17.5% and 140 basis points, respectively, as compared to 2005. Properties under management in Costa Rica and Punta Mita had particularly strong improvements in RevPAR and gross operating profits, as compared to the averages for the region. ------------------------------------------------------------------------- Europe Region ------------------------------------------------------------------------- Results for periods in 2006, as compared to periods in 2005 ------------------------------------------------------------------------- Gross Gross Operating Operating Gross Operating RevPAR Revenue (GOR) Profit (GOP) Margin --------------------------------------------------------------- Percentage Percentage Percentage Basis Point $ Increase Increase Increase Margin Improvement ------------------------------------------------------------------------- Fourth Quarter 381 24.9% 18.1% 27.1% 31.9% 230 ----------------------------------------------------------------------- Full Year 398 18.9% 10.5% 18.1% 33.7% 220 ------------------------------------------------------------------------- All of the Core Hotels in the region experienced RevPAR improvement in the fourth quarter of 2006, with the exception of Four Seasons Resort Provence at Terre Blanche, which had strong achieved room rate improvement that was offset by a reduction in occupancy. On a local currency basis, RevPAR increased 16.0%, reflecting an 11.8% increase in achieved room rates in local currency and a 20.4% increase in achieved room rates on a US dollar basis. Gross operating profits and gross operating margins increased 27.1% and 230 basis points, respectively, in the fourth quarter of 2006, as compared to the same period in 2005. This increase was primarily a result of strong RevPAR, revenue and operational improvements at the Four Seasons properties in Paris, London, Prague, Dublin and Milan. All of the Core Hotels in the region experienced RevPAR improvements for the full year 2006. The properties in Lisbon, London and Terre Blanche had particularly strong RevPAR results relative to the regional average. On a local currency basis, RevPAR increased 17.5%, reflecting a 10.2% increase in achieved room rates on a local currency basis and an 11.6% increase in achieved room rates on a US dollar basis. Gross operating profits and gross operating margins increased 18.1% and 220 basis points, respectively, for the full year 2006, as compared to the same period in 2005. Many of the properties in the region had strong improvement in gross operating margins, including properties in Budapest, Istanbul, Lisbon and Paris. The improvements in gross operating profits and gross operating margins for the region were offset in part by the impact on the profitability performance at the Four Seasons Hotel Dublin, which was undergoing a conversion of 62 hotel rooms into residential units that is now complete. ------------------------------------------------------------------------- Middle East Region ------------------------------------------------------------------------- Results for periods in 2006, as compared to periods in 2005 ------------------------------------------------------------------------- Gross Gross Operating Operating Gross Operating RevPAR Revenue (GOR) Profit (GOP) Margin --------------------------------------------------------------- Percentage Percentage Percentage Basis Point $ Increase Increase Increase Margin Improvement ------------------------------------------------------------------------- Fourth Quarter 191 41.7% 34.8% 81.2% 50.9% 1,300 ----------------------------------------------------------------------- Full Year 179 25.3% 24.5% 41.3% 50.5% 600 ------------------------------------------------------------------------- In the Middle East region, all of the properties under management had improvements in RevPAR in the fourth quarter of 2006, which were driven primarily by a 36.4% increase in achieved room rates, as compared to the same period in 2005. Four Seasons Hotel Riyadh and Four Seasons Hotel Cairo at Nile Plaza had particularly strong improvements in RevPAR, as compared to the average for the region. On a local currency basis, RevPAR and achieved room rates improved 40.4% and 35.1%, respectively, in the fourth quarter of 2006, as compared to the same period in 2005. Gross operating profits and gross operating margins increased significantly in the fourth quarter of 2006, reflecting the strong operational performance in the region. For the full year 2006, the 25.3% improvement in RevPAR was attributable to a 21.8% increase in achieved room rates and a 200 basis point improvement in occupancy, as compared to 2005. During the full year 2006, all of the properties under management in the region had RevPAR improvements, with the exception of Four Seasons Resort Sharm el Sheikh. In Sharm el Sheikh, RevPAR was essentially unchanged as a result of a decline in occupancy, as demand was adversely affected during the early part of 2006 as business continued to recover from three terrorist bombings in the prior 18 months. On a local currency basis, RevPAR and achieved room rates for the region improved 23.8% and 20.3%, respectively, for the full year 2006 as compared to the same period in 2005. Also for the full year 2006, gross operating profits and gross operating margins improved 41.3% and 600 basis points, respectively, from 2005, as all of the properties under management in the region had stronger operating results, with the exception of the resort in Sharm el Sheikh, where profitability was essentially unchanged for the reason noted above. ------------------------------------------------------------------------- Asia/Pacific Region ------------------------------------------------------------------------- Results for periods in 2006, as compared to periods in 2005 ------------------------------------------------------------------------- Gross Gross Operating Operating Gross Operating RevPAR Revenue (GOR) Profit (GOP) Margin --------------------------------------------------------------- Percentage Percentage Percentage Basis Point $ Increase Increase Increase Margin Improvement ------------------------------------------------------------------------- Fourth Quarter 150 11.9% 12.0% 19.9% 38.8% 250 ----------------------------------------------------------------------- Full Year 135 5.0% 5.5% 10.9% 34.8% 170 ------------------------------------------------------------------------- In the Asia/Pacific region, RevPAR increased 11.9% in the fourth quarter of 2006, as compared to the same period in 2005. On a local currency basis, RevPAR improved 7.0% for the fourth quarter of 2006. Achieved room rates in the fourth quarter of 2006 improved 10.6% (5.8% on a local currency basis), as compared to the same period in 2005. Virtually all of the properties in the region experienced RevPAR improvements, with the exception of the properties in Bangkok and Chiang Mai, where occupancy levels declined due to political unrest. In particular, the properties under management in Bali, Singapore and Sydney had strong RevPAR improvements relative to the other properties in the region. The Bali properties showed strong occupancy improvements in the fourth quarter of 2006, compared to the results earlier in the year, and increased significantly over the same period last year. During the fourth quarter of 2006, gross operating profits and gross operating margins improved 19.9% and 250 basis points, respectively. Excluding the impact of the properties in Bangkok and Chiang Mai, which had reduced profitability related to the decline in RevPAR, gross operating profits and gross operating margins would have increased 26.3% and 380 basis points, respectively. For the full year 2006, RevPAR improved 5.0% on a US dollar basis and 3.6% on a local currency basis, as compared to 2005. This improvement was attributable to a 6.9% increase in achieved room rates (5.5% on a local currency basis). The majority of the properties in the region had RevPAR improvements for the full year. The most notable exceptions were the properties under management in Bali, where the market was continuing a gradual recovery from the impact of terrorist bombings and did not show strong occupancy improvements until the fourth quarter of 2006. For the full year 2006, gross operating profits and gross operating margins for the region improved 10.9% and 170 basis points, respectively, as compared to 2005 mainly due to strong profitability improvements at the properties under management in Singapore and Shanghai. ------------------------------------------------------------------------- For our 2006 to 2005 comparisons, 56 of our 73 properties were considered Core Hotels, as compared to 51 of 68 properties for our 2005 to 2004 comparisons. Of the properties not considered Core Hotels for 2006 to 2005, three properties, Four Seasons Resort Maldives at Kuda Huraa, Four Seasons Biltmore Resort Santa Barbara and Four Seasons Hotel Washington, were not included as they were undergoing extensive renovations. We have opened 12 new properties over the course of 2005 and 2006 (Four Seasons Hotel Hampshire, Four Seasons Resort Langkawi, Four Seasons Hotel Doha, Four Seasons Hotel Hong Kong, Four Seasons Resort Lana'i at Manele Bay, Four Seasons Hotel Geneva, Four Seasons Hotel Damascus, Four Seasons Tented Camp Golden Triangle, Four Seasons Hotel Silicon Valley, Four Seasons Resort Maldives at Landaa Giraavaru, Four Seasons Resort Lana'i the Lodge at Koele and Four Seasons Hotel Westlake Village). The results from these properties are not included in the comparison of Core Hotels from 2006 to 2005 because they were not open during both 2005 and 2006. In addition, Regent Taipei and Regent Kuala Lumpur are excluded from the comparisons in both years. For our 2005 to 2004 comparisons, four properties (Four Seasons Resort Maldives at Kuda Huraa, Four Seasons Biltmore Resort Santa Barbara, Four Seasons Resort Scottsdale at Troon North and Four Seasons Hotel Washington) were undergoing extensive renovations during 2005, and 11 properties had not been under management during both 2005 and 2004 and thus were not included as Core Hotels. At December 31, 2006, we had approximately 18,025 total rooms under management, as compared to approximately 17,300 rooms as at December 31, 2005. ------------------------------------------------------------------------- Approximate number of rooms under management As at December 31, ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- United States 7,445 6,845 ------------------------------------------------------------------------- Other Americas/Caribbean 2,165 2,165 ------------------------------------------------------------------------- Europe 1,960 1,960 ------------------------------------------------------------------------- Middle East 1,735 1,740 ------------------------------------------------------------------------- Asia/Pacific 4,720 4,590 ------------------------------------------------------------------------- 18,025(i) 17,300 ------------------------------------------------------------------------- --------------------------- (i) Since December 31, 2006, we have commenced management of Four Seasons Resort Koh Samui, Thailand, which has approximately 65 rooms. This property is not reflected in this table. For the full year 2006, total revenues of all managed hotels and resorts were approximately $2.9 billion, as compared to $2.6 billion in 2005, representing an increase of 15.0%. In the three months ended December 31, 2006, hotel and resort total revenues increased 18.5% to $801.6 million, as compared to $676.7 million for the same period in 2005. The increases in total revenues of all managed hotels and resorts were due to increased revenues at existing hotels as a result of general improvements in travel trends and due to an increase in revenues from recently opened hotels and resorts. Company Operating Results Revenues ------------------------------------------------------------------------- Years ended Dollar Percentage (in millions of dollars) December 31, Change Change ------------------------------------------------------------------------- 2006 over 2006 over 2006 2005 2005 2005 ------------------------------------------------------------------------- Hotel management fees Base $ 83.8 $ 73.7 $ 10.1 13.7% Incentive 40.0 27.1 12.9 47.7% ------------------------------------------------------------------------- Subtotal 123.8 100.8 23.0 22.8% ------------------------------------------------------------------------- Other fees 17.5 14.0 3.5 24.7% ------------------------------------------------------------------------- Subtotal 141.3 114.8 26.5 23.1% ------------------------------------------------------------------------- Hotel ownership revenues 33.4 65.5 (32.1) (49.0)% ------------------------------------------------------------------------- Reimbursed costs 78.7 68.0 10.7 15.7% ------------------------------------------------------------------------- Total revenues $ 253.4 $ 248.3 $ 5.1 2.0% ------------------------------------------------------------------------- -------------------------------------------- ------------------------------------------------------------------------- Three months ended Dollar Percentage (in millions of dollars) December 31, Change Change ------------------------------------------------------------------------- 2006 over 2006 over 2006 2005 2005 2005 ------------------------------------------------------------------------- Hotel management fees Base $ 22.4 $ 19.2 $ 3.2 16.6% Incentive 10.8 6.0 4.8 79.9% ------------------------------------------------------------------------- Subtotal 33.2 25.2 8.0 31.7% ------------------------------------------------------------------------- Other fees 4.2 4.1 0.1 3.9% ------------------------------------------------------------------------- Subtotal 37.4 29.3 8.1 27.9% ------------------------------------------------------------------------- Hotel ownership revenues 8.6 7.5 1.1 15.0% ------------------------------------------------------------------------- Reimbursed costs 23.7 21.7 2.0 9.1% ------------------------------------------------------------------------- Total revenues $ 69.7 $ 58.5 $ 11.2 19.3% ------------------------------------------------------------------------- -------------------------------------------- Hotel Management Fees The increases in hotel management fees for the year ended and three months ended December 31, 2006 were the result of the improvements in revenues and gross operating profits at the worldwide Core Hotels, resulting primarily from RevPAR and other revenue increases, as well as fees from new properties and increases in reimbursed costs. Base Fees Base fees increased $10.1 million (from $73.7 million to $83.8 million) for the year ended December 31, 2006, as compared to 2005. Of this increase, base fees from Core Hotels contributed $6.5 million or 64.4% of the increase. The increase in base fees from Core Hotels in 2006 represented a 9.7% increase over the base fees generated from Core Hotels in 2005. Properties that opened in 2005 and 2006 contributed base fees of $6.3 million and $1.7 million in 2006 and 2005, respectively. The $10.1 million increase in base fees in 2006 reflects a $1.8 million reduction in base fees as a result of properties that we managed in 2005 no longer being under management in 2006. Base fees increased $3.2 million (from $19.2 million to $22.4 million) for the three months ended December 31, 2006, as compared to the three months ended December 31, 2005. Of the $3.2 million increase in base fees, base fees from Core Hotels contributed $2.0 million or 63.6% of the increase. The increase in base fees from Core Hotels in the three months ended December 31, 2006 represented an 11.8% increase over the fees generated from Core Hotels in the same period in 2005. Properties that opened in 2005 and 2006 contributed base fees of $1.8 million and $1.1 million in the three months ended December 31, 2006 and 2005, respectively. The $3.2 million increase in base fees in the three months ended December 31, 2006 reflects a $0.2 million reduction in base fees as a result of properties that we managed in 2005 that we no longer managed in 2006. Incentive Fees For the full year 2006, incentive fees increased $12.9 million, as compared to 2005. Incentive fees contributed 32.4% of the total hotel management fee revenues for the full year 2006, as compared to 26.9% for the full year 2005. The increase was attributable to improvements in each of the regions we operate, with the strongest improvement being in the Middle East. The incentive fees earned from properties that opened in 2005 and 2006 represented $4.3 million of the increase in incentive fees. Due to a one-time charge at the properties under our management related to the transition of the retirement benefit plan (see "Other Income (Expenses), Net" - "Retirement Benefit Plan" below) during the three months ended December 31, 2005, incentive fees that year were reduced by approximately $1.0 million. We have the ability to earn incentive fees in virtually all(7) of the hotels and resorts that we manage. In 2006, incentive fees were earned under 49 of our 73 management agreements, as compared to 45(8) of our 68 management agreements in 2005. For the three months ended December 31, 2006, incentive fees increased $4.8 million, as compared to the same period in 2005. As mentioned above, due to a one-time charge at the properties under our management related to the transition of the retirement benefit plan in the three months ended December 31, 2005, incentive fees in the three months ended December 31, 2005 were reduced by $1.0 million. The incentive fees earned from properties that opened in 2005 and 2006 represented $1.1 million of the increase. Incentive fees were earned from 47 of the 73 hotels and resorts under management for the three months ended December 31, 2006, as compared to 37 of the 68 hotels and resorts under management in 2005. Other Fees For the year ended December 31, 2006, other fees increased 24.7% ($3.5 million), to $17.5 million, as compared to 2005. The increase was attributable to a $2.6 million increase in residential fees primarily related to an increase in royalty fees as a result of a larger number of residential sales closing and a $0.9 million increase in other miscellaneous fees. For the three months ended December 31, 2006, other fees increased 3.9% ($0.1 million), to $4.2 million. Hotel Ownership Revenues We have a 100% leasehold interest in the Four Seasons Hotel Vancouver and, as a result, we consolidate the results of that hotel. During the first half of 2005, we also had a 100% leasehold interest in The Pierre and consolidated the results of that property. We assigned the lease of The Pierre to a third party at the end of June 2005 and, as a result, we ceased to consolidate that property at that time. Our investment strategy as a public company is not to hold any majority interests in properties. However, Four Seasons Hotel Vancouver is a long-term leasehold interest that was established at an earlier stage in our development and we expect that we will continue to operate this property under the terms of the current lease, which expires January 31, 2020. We have seven units of residential inventory at two resorts, which we acquired with the intent to resell at our book value cost during the next several years as a combination of fractional and whole home ownership residences. We do not intend for this ownership to be an ongoing business activity and expect, over time, the costs related to the sales process to be approximately equal to the proceeds from the sale of these units. The revenue associated with the sales of these units is included in hotel ownership revenues, and the cost of the sales is included in hotel ownership cost of sales and expenses. During the year ended and the three months ended December 31, 2006, we sold residential inventory for gross proceeds of $2.2 million and $0.8 million, respectively (nil proceeds for both periods in 2005). For the full year 2006, the decline in hotel ownership revenue was primarily related to our owning and consolidating 100% of The Pierre during the first six months of 2005 and our not owning and not consolidating it during any part of 2006. Hotel ownership revenue for full year 2006 relates primarily to the Four Seasons Hotel Vancouver. Revenue at that property increased 19.2% during 2006 compared to 2005, as the result of strong occupancy and rate increases at that property and the decline in the US dollar relative to the Canadian dollar, as Canadian dollar revenue from the property was translated into US dollars (on a Canadian dollar basis, revenue increased 11.4%). In the three months ended December 31, 2006, the increase in hotel ownership revenue was primarily related to a 13.9% increase in revenue from the Four Seasons Hotel Vancouver due to improved operating results at that property and the decline in the US dollar relative to the Canadian dollar, as Canadian dollar revenue from the property was translated into US dollars (on a Canadian dollar basis, revenue increased 10.2%). Reimbursed Costs As described above under "Our Business Model", reimbursed costs are incurred on a cost recovery basis to us and, as a result, we analyze our management operations excluding reimbursed costs. For the year ended and the three months ended December 31, 2006, reimbursed costs increased $10.7 million and $2.0 million, respectively, as compared to the corresponding periods in 2005. The increase in both the year ended and the three months ended December 31, 2006 was due primarily to an increase in the number of properties in the portfolio and increased costs related to increased activity, as compared to the same periods in 2005. Expenses General and Administrative Expenses The majority of our general and administrative expenses are incurred in Canadian dollars. For the year ended and the three months ended December 31, 2006, general and administrative expenses (excluding reimbursed costs) increased by 0.6% and 6.6%, respectively, on a Canadian dollar basis, as compared to the same period in 2005. As reported in US dollars, for the year ended December 31, 2006, general and administrative expenses increased 7.4% to $62.4 million, from $58.1 million in the same period of 2005. As reported in US dollars, for the three months ended December 31, 2006, general and administrative expenses increased 10.3% to $18.4 million, from $16.7 million in the same period of 2005. The greater increase on a US dollar basis was attributable to the US dollar having declined relative to the Canadian dollar. Included in general and administrative expense is $2.3 million of stock option compensation expense for each of 2006 and 2005. In addition, compensation expense of $3.0 million relating to share appreciation rights issued pursuant to phantom equity agreements was included for the full year 2006 (nil for 2005). As noted, the majority of our general and administrative expenses are incurred in Canadian dollars, while the majority of hotel management fee revenues and cash balances are in US dollars. We also incur Canadian dollar capital funding requirements, which are primarily attributable to our corporate office expansion. Accordingly, in December 2005, we began selling forward US dollars for conversion to Canadian dollars, to help fix the cost of our Canadian dollar expenditures in US dollars. The foreign exchange gains and losses arising from both the forward contracts settled and the forward contracts outstanding as at December 31, 2006, are included in "Other Income (Expenses), Net" and are discussed below. Hotel Ownership Cost of Sales and Expenses As discussed above, we consolidate 100% of the operations of Four Seasons Hotel Vancouver and, until June 30, 2005, we also consolidated the operations of The Pierre. Also as noted above, costs relating to the sale of residential units are included in hotel ownership cost of sales and expenses. Hotel ownership cost of sales and expenses declined 51.3% to $32.2 million in the year ended December 31, 2006, from $66.1 million in the same period of 2005, primarily as a result of the operations of The Pierre being consolidated until June 30, 2005, and not being consolidated in the same period of 2006. Expenses at Four Seasons Hotel Vancouver increased 9.7% in the year ended December 31, 2006, primarily as a result of the decline in the US dollar relative to the Canadian dollar, as the Canadian dollar costs are translated into US dollars for reporting purposes. On a Canadian dollar basis, expenses at Four Seasons Hotel Vancouver increased 2.5% in the year ended December 31, 2006. For the year ended December 31, 2006, costs relating to the sale of the residential units were $3.0 million. Hotel ownership cost of sales and expenses increased 6.3% to $8.4 million for the three months ended December 31, 2006, from $7.9 million in the same period of 2005, as a result of increased expenses at Four Seasons Hotel Vancouver (primarily as a result of the decline in the US dollar relative to the Canadian dollar, as the Canadian dollar costs are translated into US dollars for reporting purposes) and costs relating to the sale of the residential units. On a Canadian dollar basis, hotel ownership cost of sales and expenses increased 2.8% in the three months ended December 31, 2006. Operating Earnings Before Other Items(9) For the year ended December 31, 2006, operating earnings before other items increased 42.7% to $80.1 million, as compared to $56.1 million in the same period in 2005. As a result of the items described above, operating earnings before other items increased 57.8% to $19.3 million in the three months ended December 31, 2006, as compared to $12.3 million in the same period in 2005. Depreciation and Amortization For the year ended December 31, 2006, depreciation and amortization was $14.6 million, as compared to $11.2 million for the year ended December 31, 2005. For the three months ended December 31, 2006, depreciation and amortization was $4.7 million, as compared to $2.7 million for the same period in 2005. The increase in depreciation and amortization for the year ended and three months ended December 31, 2006, as compared to the same periods in 2005, was primarily attributable to an increase of $3.3 million and $1.6 million, respectively, in the amortization of our investment in The Ritz-Carlton Chicago management contract. We have reached an agreement with the owner of The Ritz-Carlton Chicago relating to the possible sale of that property by the owner to a third party, and the potential cessation of our management of that property, as well as the significant refurbishment of Four Seasons Hotel Chicago (which is owned by an affiliated owner). These arrangements provide the owner of The Ritz-Carlton Chicago with the option to terminate our management prior to a sale of the property, and the obligation to terminate our management upon a sale of the property. Under this arrangement we are entitled to payments in connection with both a termination of our management of the property and the owner's sale of the property. Although there is no certainty as to the sale of the property or the date of termination of our management, given the possibility it could occur in the near term, we amortized the $3.3 million difference between the expected value of the payment to be made on termination of our management and the book value of our investment in this management contract, over the last half of 2006. We may subsequently record a gain following a future sale of the property, depending on the payments we actually receive. Other Income (Expenses), Net For the year ended December 31, 2006, other expenses, net was $3.8 million, as compared to other expenses, net of $89.2 million for the same period in 2005. ------------------------------------------------------------------------- (in millions of dollars) Years ended December 31, ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Costs related to pending Arrangement Transaction $ (3.4) $ 0.0 ------------------------------------------------------------------------- Asset provisions and write-downs (3.1) (32.3) ------------------------------------------------------------------------- Foreign exchange gain (loss) 1.3 (24.6) ------------------------------------------------------------------------- Unrealized swap derivative gain 0.8 0.0 ------------------------------------------------------------------------- Gain on disposition of assets 0.6 3.2 ------------------------------------------------------------------------- Loss on retirement benefit plan transition 0.0 (35.5) ------------------------------------------------------------------------- Other expenses, net $ (3.8) $ (89.2) ------------------------------------------------------------------------- --------------------------- For the three months ended December 31, 2006, other income, net was $3.2 million, as compared to other expenses, net of $56.8 million for the same period in 2005. ------------------------------------------------------------------------- Three months ended (in millions of dollars) December 31, ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Costs related to pending Arrangement Transaction $ (3.4) $ 0.0 ------------------------------------------------------------------------- Asset provisions and write-downs (2.7) (25.5) ------------------------------------------------------------------------- Foreign exchange gain (loss) 7.9 (4.8) ------------------------------------------------------------------------- Unrealized swap derivative gain 0.8 0.0 ------------------------------------------------------------------------- Gain on disposition of assets 0.6 9.0 ------------------------------------------------------------------------- Loss on retirement benefit plan transition 0.0 (35.5) ------------------------------------------------------------------------- Other income (expenses), net $ 3.2 $ (56.8) ------------------------------------------------------------------------- --------------------------- Costs Related to Pending Arrangement Transaction In November 2006, we announced that our Board of Directors had received a proposal to pursue a transaction through which FSHI would be taken private. The Board of Directors established a special committee of independent directors to consider the proposed transaction and make recommendations to the Board. In connection with this proposal, and the resulting process leading to the execution of the acquisition agreement, we incurred in 2006 certain costs primarily relating to legal fees, financial advisory and consulting services, and certain filing fees (during the three months ended December 31, 2006, we incurred $3.4 million of expenses). Please see the "Subsequent Event" section. Asset Provisions and Write-Downs From time to time, we make investments in hotels and resorts under our management in the form of loans, equity and investments in management contracts in order to obtain long-term management agreements in respect of these projects. In making these investments, we assess the expected overall returns to Four Seasons, including the value created through our long-term management agreements. However, for financial reporting purposes, each discrete investment or component of an investment must be valued only in relation to the cash flow that the particular investment or component of an investment generates to Four Seasons, without regard to the ongoing value of the management agreement. For the year ended December 31, 2006, other expenses, net, included $3.1 million relating primarily to a write-down on investments in hotel partnerships and corporations. For the year ended December 31, 2005, other expenses, net, included an expense of $32.3 million relating to the provision for, and the write-down of, certain assets, including a provision for loss of $8.8 million on long-term receivables, a write-down of $17.9 million on investments in hotel partnerships and corporations, a write-down of $5.1 million on investment in management contracts and a provision for other assets of $0.5 million. For the three months ended December 31, 2006, other expenses included $2.7 million relating primarily to a write-down on investments in hotel partnerships and corporations. For the three months ended December 31, 2005, other expenses, net, included an expense of $25.5 million relating to the provision for, and the write-down of, certain assets, including a provision for loss of $8.8 million on long-term receivables, a write-down of $15.9 million on investments in hotel partnerships and corporations, a write-down of $0.6 million related to investment in management contracts and a provision for other assets of $0.2 million. Foreign Exchange Other expenses, net for the year ended December 31, 2006 included a foreign exchange gain of $1.3 million, as compared to a foreign exchange loss of $24.6 million for the year ended December 31, 2005. Other income (expenses), net for the three months ended December 31, 2006 included a foreign exchange gain of $7.9 million, as compared to a foreign exchange loss of $4.8 million for the same period in 2005. Foreign exchange gains and losses arose primarily from the translation to Canadian dollars (using current exchange rates at the end of each quarter) of our foreign currency-denominated net monetary assets, which are not included in our designated foreign self-sustaining subsidiaries. They also reflected local currency foreign exchange gains and losses on net monetary assets incurred by our designated foreign self-sustaining subsidiaries. Net monetary assets is the difference between our foreign currency-denominated monetary assets and our foreign currency-denominated monetary liabilities in each currency, and consist primarily of cash and cash equivalents, accounts receivable, long-term receivables and short-term and long-term liabilities, as determined under Canadian generally accepted accounting principles. The foreign exchange gain during the year ended and the three months ended December 31, 2006 and the foreign exchange loss during the year ended and the three months ended December 31, 2005 resulted primarily from the translation of our US dollar and British pound sterling net monetary asset positions to Canadian dollars using the current exchange rates at the end of each quarter. Our US dollar net monetary asset position increased significantly during the second quarter of 2005 as a result of entering into a currency and interest rate swap agreement relating to our convertible senior notes. The swap was designated as a fair value hedge of our convertible senior notes. In December 2006, we terminated 80% of the notional amount of the currency component of the swap and ceased hedge accounting on the remaining portion of the currency component of the swap and on the interest component of the swap. This is described below under "Liquidity and Capital Resources - Convertible Notes". As discussed above, we have entered into a program to sell forward US dollars for Canadian dollars to help us to predict the US dollar cost of our Canadian dollar general and administrative expenses and Canadian dollar capital funding requirements. All our forward contracts are being marked-to-market with the resulting changes in fair values being recorded as a foreign exchange gain or loss. Other expenses, net included a foreign exchange loss of $0.5 million and $1.8 million for the year ended and the three months ended December 31, 2006, respectively, related to the forward contracts. In 2005, foreign exchange loss of $0.1 million was included in other expenses, net for the three months ended and year ended December 31, 2005. As at December 31, 2006, we had forward contracts in place to sell forward $39.1 million of US dollars and receive Canadian dollars at a weighted average exchange rate of 1.11 Canadian dollars to a US dollar at various maturities extending to April 2008. On these outstanding forward contracts, the marked-to-market loss for the three months ended December 31, 2006 was $1.6 million, and the marked-to-market loss for the year ended December 31, 2006 was $1.5 million. These amounts are included in the $0.5 million foreign exchange loss for the year ended December 31, 2006 and $1.8 million foreign exchange loss for the three months ended December 31, 2006, as noted above. While this program of selling forward US dollars allows us to better predict the cost in US dollars of the majority of our Canadian dollar general and administrative expenses and capital funding requirements, it will not eliminate the impact of foreign currency fluctuations related to our management fees in currencies other than US dollars. It will also not eliminate foreign currency gains and losses related to un-hedged net monetary assets and liability positions. As such, our consolidated results will continue to include gains and losses related to foreign currency fluctuations. The impact of foreign currency gains and losses has been material in the past and could continue to be material in the future. The following table sets out the exchange rates obtained from the Bank of Canada: ------------------------------------------------------------------------- As at As at Average December 31, December 31, during 2005 2006 2006 ------------------------------------------------------------------------- US dollar to Canadian $1.00 0.8577 0.8581 0.8818 ------------------------------------------------------------------------- Pound sterling to Canadian $1.00 0.4991 0.4387 0.4788 ------------------------------------------------------------------------- Euro to Canadian $1.00 0.7244 0.6503 0.7024 ------------------------------------------------------------------------- Australian dollar to US $1.00 1.3630 1.2684 1.3275 ------------------------------------------------------------------------- Gain/Loss on Disposition of Assets Other expenses, net for the year ended December 31, 2006 included a net gain on the disposition of assets of $0.6 million. During the three months ended December 31, 2006, the ownership interests in three of the hotels under our management were sold. As a result of the sales, we were repaid loans, accrued interest and investments, and after deducting transaction costs, received cash and promissory notes totalling $100.6 million. In connection with these sales, we realized a $0.6 million gain. Included in other expenses, net for the year ended December 31, 2005, was a net gain of $9.4 million related to the disposition of certain investments in hotel partnerships and corporations and the exit from certain management contracts, and a loss of $6.2 million on the assignment of leases and the sale of related assets in The Pierre. Other income, net for the three months ended December 31, 2006 included a net gain on the disposition of assets of $0.6 million, as discussed above. Other expenses, net for the three months ended December 31, 2005 included a net gain of $9.9 million related to the disposition of certain investments in hotel partnerships and corporations and the exit from certain management contracts, and a loss of $0.9 million on the assignment of leases and the sale of related assets in The Pierre. Retirement Benefit Plan During the three months ended December 31, 2005, we transitioned the majority of our senior executives and hotel and resort general managers from an unfunded defined benefit retirement plan to a fully funded defined contribution retirement plan. We made the change in the retirement plan to improve the certainty and predictability related to the cost of the retirement benefits. We do not expect that the change will have a significant impact on our ongoing annual pension cost. The transition to this defined contribution format resulted in a funding requirement of $42.2 million, of which $36.0 million was funded in 2005, and a one-time pre-tax loss of $35.5 million. In addition, as a result of the costs incurred by our hotels and resorts for the transition of general manager participants, our incentive fees for 2005 were reduced by approximately $1.0 million since the funding by the hotel owners was typically deducted in calculating the amounts upon which our incentive fees are determined. We continue to maintain the unfunded, multiemployer, non-contributory, defined benefit plan on behalf of four active executives and 14 retired executives and general managers, as well as the owner of two of our managed properties. As at December 31, 2006, we had accrued $26.3 million in "Long-term obligations" in respect of this plan. This accrued defined benefit liability excludes the defined benefit obligation of the owner of the two managed properties for their current general managers. Interest Income / Interest Expense ------------------------------------------------------------------------- Years ended Dollar (in millions of dollars) December 31, Change ------------------------------------------------------------------------- 2006 over 2006 2005 2005 ------------------------------------------------------------------------- Interest income $ 22.4 $ 16.8 $ 5.6 ------------------------------------------------------------------------- Interest expense $ (14.9) $ (11.5) $ (3.4) ------------------------------------------------------------------------- The $5.6 million increase in interest income for the year ended December 31, 2006, as compared to the same period in 2005, was primarily attributable to higher deposits and higher deposit interest rates. The $3.4 million increase in interest expense for the year ended December 31, 2006, as compared to the same period in 2005, was primarily attributable to the increase in interest expense accrued relating to the currency and interest rate swap agreement we entered into in the second quarter of 2005, related to our convertible senior notes. This currency and interest rate swap agreement was designated as a fair value hedge of our convertible senior notes. In December 2006, we terminated 80% of the notional amount of the currency component of the swap, and ceased hedge accounting on the remaining portion of the currency component of the swap and on the interest component of the swap. This is described below under "Liquidity and Capital Resources - Convertible Notes". Taking into account the amortization of the gain on the terminated interest rate swap in 2004, the 2005 currency and interest rate swap and the amortization of the loss on the termination of hedge accounting on the interest component of the 2005 currency and interest rate swap, the effective interest rate on the convertible senior notes was approximately 5.2% and 5.3%, for the three months ended and year ended December 31, 2006, respectively. This represents $2.9 million of interest expense for the three months ended December 31, 2006 and $12.0 million of interest expense for the full year 2006. Taking into account the amortization of the gain on the terminated interest rate swap in 2004 and the 2005 currency and interest rate swap, the effective interest rate on the convertible senior notes was approximately 4.5% and 4.2%, for the three months ended and year ended December 31, 2005, respectively. This represents $2.5 million of interest expense for the three months ended December 31, 2005 and $9.2 million of interest expense for the full year 2005. ------------------------------------------------------------------------- Three months ended Dollar (in millions of dollars) December 31, Change ------------------------------------------------------------------------- 2006 over 2006 2005 2005 ------------------------------------------------------------------------- Interest income $ 6.5 $ 5.2 $ 1.3 ------------------------------------------------------------------------- Interest expense $ (3.6) $ (3.2) $ 0.4 ------------------------------------------------------------------------- The $1.3 million increase in interest income for the three months ended December 31, 2006, as compared to the same period in 2005, was primarily attributable to higher deposits and higher deposit interest rates. The $0.4 million increase in interest expense for the three months ended December 31, 2006, as compared to the same period in 2005, was primarily attributable to the increase in interest expense accrued relating to the currency and interest rate swap agreement we entered into in the second quarter of 2005 related to our convertible senior notes. As noted above, a portion of the currency and interest rate swap was terminated in December 2006. Income Tax Recovery (Expense) Our income tax expense during the year ended and three months ended December 31, 2006 was $18.9 million and $3.8 million, respectively (effective tax rate of 27.3% and 18.6%, respectively), as compared to income tax recovery of $10.8 million and $7.4 million, respectively (effective tax rate of 27.8% and 16.4%, respectively), for the same periods in 2005. During the three months ended and year ended December 31, 2006, we did not record approximately $1.5 million and $3.4 million, respectively, of a tax benefit related to the foreign exchange losses, due to the uncertainty associated with the utilization of those losses. In connection with the disposition of The Pierre in 2005, we recorded a tax benefit of approximately $9.4 million. Net Earnings (Loss) and Earnings (Loss) per Share For the reasons outlined above, net earnings for the year ended December 31, 2006 was $50.3 million ($1.36 basic earnings per share and $1.33 diluted earnings per share), as compared to net loss of $28.2 million ($0.77 basic and diluted loss per share) for the year ended December 31, 2005. For the reasons outlined above, net earnings for the three months ended December 31, 2006 was $16.9 million ($0.45 basic earnings per share and $0.44 diluted earnings per share), as compared to net loss of $37.8 million ($1.03 basic and diluted loss per share) for the three months ended December 31, 2005. Adjusted Net Earnings and Adjusted Earnings per Share(10) In the year ended December 31, 2006, other expenses, net of $3.8 million related primarily to the costs related to the pending Arrangement Transaction and a write-down of investments in hotel partnerships and corporations, offset by a foreign exchange gain, a gain on disposition of assets and an unrealized swap derivative gain. In the year ended December 31, 2005, other expenses, net of $89.2 million related primarily to a foreign exchange loss, a loss on retirement benefit plan transition and asset provisions and write-downs. Adjusting for other expenses, net and the applicable income taxes, adjusted net earnings were as follows: ------------------------------------------------------------------------- (in millions of dollars except per share amounts) Years ended December 31, ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Net earnings (loss) $ 50.3 $ (28.2) ------------------------------------------------------------------------- Adjustments - Other expenses, net 3.8 89.2 ------------------------------------------------------------------------- Tax effect related to foregoing adjustments 0.7 (24.6)(i) ------------------------------------------------------------------------- Adjusted net earnings $ 54.8 $ 36.4 ------------------------------------------------------------------------- --------------------------- Adjusted basic earnings per share $ 1.49 $ 0.99 ------------------------------------------------------------------------- --------------------------- Adjusted diluted earnings per share $ 1.45 $ 0.96 ------------------------------------------------------------------------- --------------------------- (i) We recorded a tax benefit associated with the loss on retirement benefit plan transition and other items included as adjustments on this schedule. In addition, in connection with the disposition of The Pierre in the second quarter of 2005, we recorded a tax benefit of approximately $9.4 million in the year ended December 31, 2005. In the three months ended December 31, 2006, other income, net of $3.2 million related primarily to a foreign exchange gain, which was offset partially by the costs related to the pending Arrangement Transaction and a write-down of investments in hotel partnerships and corporations. In the three months ended December 31, 2005, other expenses, net of $56.8 million related primarily to a loss on retirement benefit plan transition, a foreign exchange loss and asset provisions and write-downs. Adjusting for other income (expenses), net and the applicable income taxes, adjusted net earnings were as follows: ------------------------------------------------------------------------- (in millions of dollars except Three months per share amounts) ended December 31, ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Net earnings (loss) $ 16.9 $ (37.8) ------------------------------------------------------------------------- Adjustments - Other (income) expenses, net (3.2) 56.8 ------------------------------------------------------------------------- Tax effect related to foregoing adjustments (1.1) (12.0) ------------------------------------------------------------------------- Adjusted net earnings $ 12.6 $ 7.0 ------------------------------------------------------------------------- --------------------------- Adjusted basic earnings per share $ 0.34 $ 0.19 ------------------------------------------------------------------------- --------------------------- Adjusted diluted earnings per share $ 0.33 $ 0.19 ------------------------------------------------------------------------- --------------------------- Eight Quarter Summary ------------------------------------------------------------------------- (in millions of dollars except per share amounts) Fourth Quarter Third Quarter ------------------------------------------------------------------------- 2006 2005 2006 2005 ------------------------------------------------------------------------- Total revenues $ 69.7 $ 58.5 $ 58.2 $ 52.2 ------------------------------------------------------------------------- Operating earnings before other items $ 19.3 $ 12.3 $ 16.6 $ 11.7 ------------------------------------------------------------------------- Net earnings (loss) $ 16.9 $ (37.8) $ 10.9 $ (11.4) ------------------------------------------------------------------------- Basic earnings (loss) per share(11) $ 0.45 $ (1.03) $ 0.30 $ (0.31) ------------------------------------------------------------------------- Diluted earnings (loss) per share $ 0.44 $ (1.03) $ 0.29 $ (0.31) ------------------------------------------------------------------------- ------------------------------------------------------------------------- Average Canadian/US dollar foreign exchange rate used for specified quarter 1.13629 1.17478 1.12087 1.20687 ------------------------------------------------------------------------- ------------------------------------------------------------------------- (in millions of dollars except per share amounts) Second Quarter First Quarter ------------------------------------------------------------------------- 2006 2005 2006 2005 ------------------------------------------------------------------------- Total revenues $ 67.8 $ 74.5 $ 57.6 $ 63.1 ------------------------------------------------------------------------- Operating earnings before other items $ 23.7 $ 20.1 $ 20.5 $ 12.1 ------------------------------------------------------------------------- Net earnings (loss) $ 9.1 $ 15.8 $ 13.4 $ 5.2 ------------------------------------------------------------------------- Basic earnings (loss) per share(11) $ 0.25 $ 0.43 $ 0.36 $ 0.14 ------------------------------------------------------------------------- Diluted earnings (loss) per share $ 0.24 $ 0.42 $ 0.36 $ 0.14 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Average Canadian/US dollar foreign exchange rate used for specified quarter 1.12509 1.24401 1.15421 1.22652 ------------------------------------------------------------------------- The disposition of our interest in The Pierre during 2005 affects the comparative amounts. Net earnings for each quarter were impacted by, among other things, the fluctuation of the US dollar against the Canadian dollar over the course of 2006 and 2005 (resulting in foreign exchange gains and losses upon the translation to Canadian dollars of non-Canadian dollar-denominated net monetary assets not included in our designated self-sustaining operations) (See "Company Operating Results - Other Income (Expenses), Net"). In addition, as discussed under "Other Income (Expenses), Net", during the fourth quarter of 2005, we wrote down certain of our investments and transitioned our retirement benefit plan. The impact of certain of these items is highlighted in the following table: ------------------------------------------------------------------------- (in millions of dollars) Fourth Quarter Third Quarter ------------------------------------------------------------------------- 2006 2005 2006 2005 ------------------------------------------------------------------------- Costs related to pending Arrangement Transaction $ (3.4) $ - $ - $ - ------------------------------------------------------------------------- Asset provisions and write-downs (2.7) (25.5) (0.7) (4.6) ------------------------------------------------------------------------- Foreign exchange gain (loss) 7.9 (4.8) 1.3 (16.2) ------------------------------------------------------------------------- Unrealized swap derivative gain 0.8 - - - ------------------------------------------------------------------------- Gain (loss) on disposition of assets 0.6 9.0 - (0.3) ------------------------------------------------------------------------- Loss on retirement benefit plan transition - (35.5) - - ------------------------------------------------------------------------- Other income (expenses), net $ 3.2 $ (56.8) $ 0.6 $ (21.1) ------------------------------------------------------------------------- ------------------------------------------- ------------------------------------------------------------------------- (in millions of dollars) Second Quarter First Quarter ------------------------------------------------------------------------- 2006 2005 2006 2005 ------------------------------------------------------------------------- Costs related to pending Arrangement Transaction $ - $ - $ - $ - ------------------------------------------------------------------------- Asset provisions and write-downs 0.6 (0.1) (0.3) (1.9) ------------------------------------------------------------------------- Foreign exchange gain (loss) (7.4) (3.3) (0.5) (0.4) ------------------------------------------------------------------------- Unrealized swap derivative gain - - - - ------------------------------------------------------------------------- Gain (loss) on disposition of assets - (5.2) - (0.4) ------------------------------------------------------------------------- Loss on retirement benefit plan transition - - - - ------------------------------------------------------------------------- Other income (expenses), net $ (6.8) $ (8.6) $ (0.8) $ (2.7) ------------------------------------------------------------------------- ------------------------------------------- Balance Sheet Review and Analysis Corporate Strategy Relating to Investments An important part of our overall objectives as a public company has been and would continue to be to maintain the strength of our balance sheet. Accordingly, we intend to continue to be disciplined in the allocation of our capital. Our capital investment plans remain focused on allocating the majority of our capital for investment opportunities that are intended to establish new long-term management contracts in key destinations or enhance existing management arrangements. We make investments in, or advances in respect of or to owners of, properties with a view to obtaining management agreements or enhancing existing management agreements where we believe the overall returns will justify the investment or advance. These investments must meet our financial criteria considering all sources of cash flow (including management fees), certain minimum return hurdles and a manageable risk profile. We consider whether the structure should be in the form of an investment or an advance and, among other things, the relative risk and returns of the investment or advance, including interest, dividends and fee income. As a public company, we generally seek to limit our total long-term capital exposure to no more than 20% of the total equity required for a property and can typically choose to have our equity interest diluted if additional capital is required. We attempt to structure our equity interests separately from our management interests to enable us to dispose of equity interests as opportunities arise, without affecting our management interests. Depending on the nature of the investment or advance, it will be characterized on our consolidated balance sheet as "Long-term receivables", "Investments in hotel partnerships and corporations" or "Investment in management contracts". As part of our ongoing balance sheet evaluation, we reviewed our significant investments and advances at December 31, 2006 and 2005 and determined that certain write-downs were required with respect to certain of our investments. These charges are discussed under "Company Operating Results - Other Income (Expenses), Net". Long-Term Receivables Included on our balance sheet as at December 31, 2006 is $153.2 million (2005 - $175.4 million) of long-term receivables relating primarily to advances in respect of, and to owners of, properties that we manage, including secured and unsecured long-term receivables relating to our managed properties in Punta Mita, Hampshire, Sydney, Geneva, Prague, Toronto, Scottsdale, Buenos Aires, Costa Rica and the Maldives. In addition, the 2005 long-term receivables included advances in respect of our managed property in London, which was repaid in 2006. Investments in Hotel Partnerships and Corporations Included on our balance sheet as at December 31, 2006 is $65.6 million (2005 - $99.9 million) related to investments in hotel partnerships and corporations. For a listing of hotels and resorts under management in which we have equity investments, see "Four Seasons Portfolio - Description of Hotels and Resorts". We account for these equity investments on a cost basis because either the percentage ownership or the structure does not give us significant influence over these investments. Each of our investments in hotel partnerships and corporations individually represents less than 5% of our total assets, and none of these investments individually is material to us. We are not liable for any further obligations relating to these investments, other than any commitment discussed under "Four Seasons Portfolio - Properties under Construction or Development", "Liquidity and Capital Resources", and "Off-Balance Sheet Arrangements". Investment in Management Contracts Included in our balance sheet as at December 31, 2006 is $187.9 million (2005 - $164.9 million) relating to our investment in management contracts. The largest component of these amounts relates to management contracts acquired during the Regent transaction in 1992, including the management contracts for the Four Seasons hotels in New York and Milan and Four Seasons Resort Bali at Jimbaran Bay. The most significant amounts advanced for individual management contracts include amounts advanced in the context of obtaining or improving the management contracts for Four Seasons properties in Paris, Scottsdale, Hampshire, San Francisco, Jackson Hole, Nevis and Chicago. Fixed Assets Included on our balance sheet as at December 31, 2006 is $81.5 million (2005 - $64.9 million) relating to our fixed assets. A majority of this amount relates to the land, building, and furniture, fixtures, and equipment for our corporate office in Toronto. Also included in fixed assets at December 31, 2006 is $5.2 million (2005 - $6.2 million), representing a majority of our investment in Four Seasons Hotel Vancouver. Liquidity and Capital Resources As at December 31, 2006, our cash and cash equivalents were $358.9 million, as compared to $242.2 million as at December 31, 2005. Our 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. We have a committed bank credit facility of $125 million, which expires at the earlier of September 2007 or upon a change of control, including one that would arise at the consummation of our currently pending Arrangement Transaction. 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, 2006, no amounts were borrowed under the credit facility. However, approximately $1.6 million of letters of credit were issued under the facility. No amounts have been drawn under these letters of credit. We believe that, absent unusual opportunities, this bank credit facility, when combined with cash on hand and internally generated cash flow, should be more than adequate to allow us to finance our normal operating needs and anticipated investment commitments related to our current growth objectives. Our commitments include the contractual obligations and other commitments described below in this "Liquidity and Capital Resources" section as well as those described under "Off-Balance Sheet Arrangements" and "Four Seasons Portfolio - Properties under Construction or Development". Contractual Obligations ------------------------------------------------------------------------- Payments Due by Period Contractual ------------------------------------------------- Obligations Less (in millions than 1 - 3 4 - 5 After of dollars) Total 1 year years years 5 years ------------------------------------------------------------------------- Convertible Notes(i) $ 252.0 $ 2.0 $ 250.0 $ - $ - ------------------------------------------------------------------------- Currency and Interest Rate Swap(ii) 6.8 1.0 5.8 - - ------------------------------------------------------------------------- Operating Leases(iii) 37.9 4.8 7.0 5.8 20.3 ------------------------------------------------------------------------- Other Long-Term Obligations(iv) 9.1 9.1 - - - ------------------------------------------------------------------------- Retirement Benefit Plan(v) 26.3 1.3 2.8 3.3 18.9 ------------------------------------------------------------------------- Total Contractual Obligations(vi) $ 332.1 $ 18.2 $ 265.6 $ 9.1 $ 39.2 ------------------------------------------------------------------------- ------------------------------------------------- (i) The amount represents the principal amount plus accrued interest at December 31, 2006. See "Convertible Notes". (ii) The amount represents the fair value of the swap as at December 31, 2006. (iii) This amount excludes the future minimum lease payments in connection with Four Seasons Hotel London and includes the future minimum lease payments in connection with Four Seasons Hotel Vancouver. See note 14(a) to our consolidated financial statements. (iv) This amount includes our contractual obligations related to the expansion of our Toronto corporate office, as well as other long- term obligations. (v) We continue to maintain the unfunded multiemployer, non-contributory, defined benefit plan on behalf of four active executives and 14 retired executives and general managers, as well as the owner of two of our managed properties. As at December 31, 2006, we have accrued a defined benefit liability of $26.3 million in "Long-term obligations" in respect of this plan. This accrued defined benefit liability excludes the defined benefit liability of the owner of the two managed properties for their current general managers. (vi) This does not include the amounts that are disclosed as capital commitments in the chart under "Four Seasons Portfolio - Properties under Construction or Development". Convertible Notes During the second quarter of 2004, we issued $250 million principal amount of convertible senior notes. We used a majority of the net proceeds from the issuance of these convertible senior notes to repay previously issued convertible notes. These notes bear interest at the rate of 1.875% per annum (payable semi-annually in arrears on January 30 and July 30 to holders of record on January 15 and July 15, beginning January 30, 2005) and will mature on July 30, 2024, unless earlier redeemed or repurchased. The notes are convertible into our Limited Voting Shares at an initial conversion rate of 13.9581 shares per $1,000 principal amount (equal to a conversion price of approximately $71.64 per Limited Voting Share), subject to adjustments in certain events, in circumstances in which (i) the Limited Voting Shares have traded for more than 130% of the conversion price for a specified period, (ii) the notes have a trading price of less than 95% of the market price of the Limited Voting Shares into which they may be converted for a specified period, (iii) we call the notes for redemption, or (iv) specified corporate transactions or a "fundamental change" occurs. We may choose to settle conversion in our Limited Voting Shares, cash or a combination of our Limited Voting Shares and cash. Holders of the notes will have the right to require us to purchase the notes for their principal amount plus accrued and unpaid interest on July 30, 2009, July 30, 2014 and July 30, 2019 and in connection with certain events. Repurchases of notes made on July 30, 2014 and July 30, 2019 may be made (at our option) in cash, our Limited Voting Shares or a combination of cash and our Limited Voting Shares. Subject to conversion rights, we will have the right to redeem the convertible senior notes for their principal amount, plus any accrued and unpaid interest, beginning August 4, 2009. The Arrangement Transaction, if completed, would result in a "fundamental change". As a result, holders may convert the notes during the period from and after the tenth day prior to the anticipated closing date of the Arrangement Transaction until and including the close of business on the later of the 10th day after the actual closing date and the 30th business day after notice of an offer to repurchase the notes has been mailed, as described below. Upon such conversion, holders of the notes would be entitled to receive, subject to our right to make a cash payment in lieu of some or all of the Limited Voting Shares that otherwise would be issued, 13.9581 Limited Voting Shares for each $1,000 principal amount of notes and an additional number of Limited Voting Shares equal to (a) the sum of a make whole premium and an amount equal to any accrued but unpaid interest to, but not including, the conversion date, divided by (b) the average of the closing sale price (or, in certain circumstances, an average of bid and ask prices) of the Limited Voting Shares on the NYSE for the ten trading days before the conversion date. If the Arrangement Transaction is completed, FSHI will be required to make an offer to repurchase the notes at a purchase price equal to the principal amount of the notes plus a make whole premium (as described above), and an amount equal to any accrued and unpaid interest to, but not including, the date of repurchase. FSHI must make this offer by providing a notice to the trustee and the holders of notes within 30 days of the completion of the Arrangement Transaction. In accordance with Canadian GAAP, the convertible senior notes are bifurcated on our consolidated financial statements into a debt component (representing the principal value of a bond of $211.8 million, which was estimated based on the present value of a $250.0 million bond maturing in 2009, yielding 5.33% per annum, compounded semi-annually, and paying a coupon of 1.875% per annum) and an equity component of $36.9 million (representing the value of the conversion feature of the convertible senior notes). For further details, see note 10(a) to our consolidated financial statements. In connection with the offering of the convertible senior notes, we entered into a five-year interest rate swap with an initial notional amount of $211.8 million, pursuant to which we agreed to receive interest at a fixed rate of 5.33% per year and pay interest at six-month LIBOR, in arrears, plus 0.4904%. In October 2004, we terminated the interest rate swap agreement and received proceeds of $9.0 million. The book value of the interest rate swap at the date of termination was approximately $1.5 million. The recognition of the resulting gain was deferred and is being amortized over the period to July 30, 2009. In the second quarter of 2005, we entered into a new currency and interest rate swap agreement until July 30, 2009, pursuant to which we had agreed to receive interest at a fixed rate of 5.33% per annum on an initial notional amount of $215.8 million (C$269.2 million) and pay interest at a floating rate of six-month Canadian Bankers Acceptances ("BA") in arrears plus 1.1% per annum. Pursuant to this agreement, we had agreed that on July 30, 2009, we would pay C$311.8 million and would receive $250.0 million under the swap. We had designated the swap as a fair value hedge of our convertible senior notes. In December 2006, we terminated 80% of the notional amount of the currency component of the currency and interest rate swap agreement relating to the final exchange of principal by making a payment of $21.0 million. The book value of the terminated portion of the swap at the date of termination was C$19.5 million ($17.0 million). The loss of C$4.6 million ($4.0 million) was deferred for accounting purposes and recorded in "Other assets", and is being amortized over the period to July 30, 2009, which would have been the maturity date of the swap agreement. The amortization of the deferred loss is being recorded as a foreign exchange loss. Under the amended swap, we will pay C$62.4 million and receive $50.0 million on July 30, 2009. There were no other changes to the original swap, including the notional amounts relating to the exchange of interest. In the event the convertible senior notes are settled as a result of the pending Arrangement Transaction, the revised currency and interest rate swap will be terminated at the same time. As a result of the partial termination of the swap, we no longer met all of the conditions for designating the amended swap as a fair value hedge of the convertible senior notes, and therefore ceased hedge accounting as at that date. The unrealized loss relating to the remaining notional amount of the currency component of the swap of C$1.2 million ($1.0 million) and the unrealized loss relating to the notional amount of the interest component of the swap of C$2.1 million ($1.8 million) were deferred for accounting purposes and recorded in "Other assets". These deferred losses are being amortized over the period to July 30, 2009. The amortization of the deferred loss relating to the currency component of the swap is being recorded as a foreign exchange loss and the amortization of the deferred loss relating to the interest component of the swap is being recorded as interest expense. The amended swap is being marked-to-market on a monthly basis and accrued under "Long-term obligations", with the resulting changes in fair values being recognized in "Other expenses, net". Arrangement Transaction An aggregate amount of approximately $3.8 billion will be required to fund the transactions under the Arrangement Transaction. This aggregate amount will be funded from the proceeds of $750.0 million of acquisition debt financing, approximately $2.75 billion of equity contributions, and a majority of cash balances of Four Seasons. Cash Flows Cash Provided by Operations During the year ended December 31, 2006, we generated cash from operating activities of $78.0 million, as compared to $26.5 million in 2005. During the three months ended December 31, 2006, we generated cash of $20.4 million from operating activities, as compared to using cash of $9.9 million for the same period in 2005. The increase in cash from operating activities of $51.5 million in the year ended December 31, 2006, as compared to 2005, resulted primarily from higher earnings generated from our management business, a net increase from 2005 of $25.1 million in non-cash working capital and a reduction of taxes paid of $5.4 million as compared to 2005. In addition, cash provided by operating activities in 2006 was reduced by a cash payment of $21.0 million related to the partial termination of our currency and interest rate swap, as compared to a reduction in 2005 of $36.0 million for the cash payment related to the retirement benefit plan transition from an unfunded defined benefit plan to a fully funded defined contribution plan for a substantial number of the participants. The increase in cash from operating activities of $30.3 million in the three months ended December 31, 2006, as compared to the same period in 2005, resulted primarily from higher earnings generated from our management business and a net increase from 2005 of $12.3 million in non-cash working capital. In addition, cash provided by operating activities in 2006 was reduced by a cash payment of $21.0 million related to the partial termination of our currency and interest rate swap, as compared to a reduction in 2005 of $36.0 million for the cash payment related to the retirement benefit plan transition as discussed above. Investing Activities Long-Term Receivables In the year ended December 31, 2006, we advanced $25.6 million, in the aggregate, as long-term receivables, including amounts to Four Seasons properties in Geneva, Toronto, Punta Mita, and the Maldives. Also in 2006, we were repaid $65.3 million, in the aggregate, of our long-term receivables, including repayments from Four Seasons properties in London, Washington, Cairo and Sydney. In the year ended December 31, 2005, we advanced $44.9 million, in the aggregate, as long-term receivables, including amounts to Four Seasons properties in Geneva, Toronto, Washington, Buenos Aires, and Exuma at Emerald Bay. Also in 2005, we were repaid $34.6 million, in the aggregate, of our long-term receivables, including repayments from Four Seasons properties in Nevis, San Francisco, and Scottsdale. During the three months ended December 31, 2006, we advanced $3.8 million, in the aggregate, as long-term receivables, including amounts to Four Seasons properties in Punta Mita and Toronto. Also during the three months ended December 31, 2006, we were repaid $50.9 million, in the aggregate, of which the largest component related to our long-term receivables relating to the Four Seasons Hotel London. During the three months ended December 31, 2005, we advanced $6.2 million, in the aggregate, as long-term receivables, including amounts to Four Seasons properties in Geneva, Bangkok and Buenos Aires. Also during the three months ended December 31, 2005, we were repaid $15.2 million, in the aggregate, of which the largest component related to our loan receivable from Nevis. DATASOURCE: Four Seasons Hotels and Resorts CONTACT: PRNewswire - - 03/12/2007

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