Four Seasons Hotels Inc. reports results for fourth quarter and year end 2002
TORONTO, Four Seasons Hotels Inc. (TSX Symbol "FSH"; NYSE Symbol "FS") today reported its results for the fourth quarter of 2002 and for the year ended December 31, 2002. Net earnings for the quarter ended December 31, 2002 were $7.6 million ($0.22 basic and diluted earnings per share), as compared to $9.3 million ($0.27 basic and diluted earnings per share) for the quarter ended December 31, 2001.
TORONTO, Four Seasons Hotels Inc. (TSX Symbol "FSH"; NYSE Symbol "FS") today reported its results for the fourth quarter of 2002 and for the year ended December 31, 2002.
Net earnings for the quarter ended December 31, 2002 were $7.6 million ($0.22 basic and diluted earnings per share), as compared to $9.3 million ($0.27 basic and diluted earnings per share) for the quarter ended December 31, 2001.
For the year ended December 31, 2002, net earnings were $21.2 million ($0.61 basic earnings per share and $0.59 diluted earnings per share), as compared to $86.5 million ($2.48 basic earnings per share and $2.27 diluted earnings per share) for the year ended December 31, 2001. The financial results for 2002 included asset impairment charges and legal and other enforcement costs, net of applicable income taxes, of $19.1 million ($0.54 basic and diluted loss per share) relating to the Company's investments in Four Seasons hotels in Caracas, Sydney and Seattle. On a normalized basis(1), excluding non-recurring items (primarily the asset impairment charge and legal and other enforcement costs referred to above), net earnings for the year ended December 31, 2002 were $42.4 million ($1.21 basic earnings per share and $1.17 diluted earnings per share).
The 2001 financial results included non-recurring items, including gains on asset dispositions of $30.4 million, recovery of a loss provision of $4.8 million, $2.2 million of corporate restructuring costs, and a $2.4 million loss on redemption of the $100 million of 6% debentures. On a normalized basis(1), net earnings were $56.4 million ($1.61 basic earnings per share and $1.52 diluted earnings per share) for the year ended December 31, 2001.
"Although international political events have affected our current financial results, our business strategy remains focussed on those key areas that we believe will help us build long-term value for our shareholders," said Isadore Sharp, Chairman and Chief Executive Officer. "By concentrating on consistent and cost effective execution of the finest customer service in the industry, we believe we will enhance our competitive position and continue to raise the bar for others in the luxury segment of our industry."
HOTEL OPERATING RESULTS
Four Seasons' customer base consists of business travellers, corporate groups and leisure travellers. The delayed recovery in global economies, particularly in the United States, the continued weakness in the world equity markets, and ongoing geopolitical concerns, have negatively affected business travel on a global basis. As a result, during the quarter ended December 31, 2002, hotels continued to experience lower demand than normal, particularly from business travellers. Leisure travel demand has shown more resilience, although this segment is also below historical demand levels.
Overall, travel is being booked on a short lead-time, which makes forecasting particularly difficult. During the Company's negotiations with corporate accounts for 2003, overall rates were in line with those achieved during 2002. However, it appears that many businesses continue to operate cautiously in an uncertain environment, which is reflected in business travel plans and expectations.
Notwithstanding the soft demand environment, RevPAR(2) of the Company's worldwide Core Hotels(3), on a US dollar basis, increased 11.8% and gross operating profits increased 6.5% during the fourth quarter of 2002, as compared to the fourth quarter of 2001. The primary reason for this positive RevPAR comparison is the significant decline in travel in the fourth quarter of 2001 due to the September 2001 terrorist attacks in the United States. For the full year of 2002, RevPAR of the Company's worldwide Core Hotels, on a US dollar basis, decreased 1.9% and gross operating profits decreased 7.7%, as compared to the same period in 2001. The lower relative increase for the fourth quarter of 2002 of gross operating profits compared to RevPAR is attributable to increased labour, benefits and energy costs at the majority of the hotels under management. There was a greater relative decline in gross operating profits compared to RevPAR for the full year 2002 for the same reason. These costs are expected to increase modestly during 2003, with the exception of energy costs, which may increase more significantly in the event of military action in the Middle East, continued instability in Venezuela and other market-related conditions. During the fourth quarter of 2002, the Company's Core Hotels in Canada/Mexico/Caribbean and Europe/Middle East had a relatively high contribution to their RevPAR improvement from achieved room rate, in part because of improvements in local currencies relative to the US dollar in Europe/Middle East. As a result, these hotels had a better gross operating profit performance relative to the other Core Hotels since the flowthrough of revenue from rate improvements is higher than from occupancy gains.
The RevPAR of the US Core Hotels, on a US dollar basis, increased 10.1% and gross operating profits increased 2.1% during the fourth quarter of 2002, as compared to the fourth quarter of 2001. Within the US, hotels under management in New York, Chicago and Seattle experienced better relative demand, compared to the fourth quarter of 2001. However, The Pierre in New York experienced a decline in achieved average rate as a result of increased group business, which is typically lower rate business. The Boston, Houston and Los Angeles hotels continued to experience relatively soft demand. For 2002, RevPAR of the US Core Hotels, on a US dollar basis, decreased 3.8%, while gross operating profits decreased 11.8%, as compared to 2001.
In the fourth quarter of 2002, RevPAR of the Canada/Mexico/Caribbean Core Hotels, on a US dollar basis, increased 11%, while gross operating profits increased 12.8%, as compared to the fourth quarter of 2001. RevPAR at the two Canadian hotels under management increased modestly, as compared to the fourth quarter of 2001. The most significant RevPAR increases occurred at the two hotels under management in Mexico and at Four Seasons Resort Nevis. On a local currency basis, RevPAR of the Canada/Mexico/Caribbean Core Hotels increased 15.4% and gross operating profits increased 18.9% during the fourth quarter of 2002, as compared to the same period in 2001. For the full year of 2002, the Canada/Mexico/Caribbean Core Hotels RevPAR, on a US dollar basis, was essentially unchanged and gross operating profits decreased 3.9%, as compared to the same period in 2001. On a local currency basis, RevPAR of the Canada/Mexico/Caribbean Core Hotels increased 1.2% and gross operating profits declined 3% for 2002, as compared to 2001.
The RevPAR of the Europe/Middle East Core Hotels, on a US dollar basis, increased 21.5% and gross operating profits increased 25.2% in the fourth quarter of 2002, as compared to the same period in 2001. On a local currency basis, RevPAR of the Europe/Middle East Core Hotels increased 11.4% and gross operating profits increased 15.2% for the fourth quarter of 2002, as compared to 2001. The Four Seasons hotels in Paris, Milan, London and Istanbul each had significant RevPAR increases during the quarter. The Four Seasons hotel in Berlin continues to operate in a challenging environment, with weak demand due to excess supply in that market. For 2002, RevPAR of the Europe/Middle East Core Hotels, on a US dollar basis, increased 5.7%, as compared to 2001. On a US dollar basis, gross operating profits increased 6.7% for the full year of 2002, as compared to 2001. On a local currency basis, RevPAR of the Europe/Middle East Core Hotels was essentially unchanged and gross operating profits increased 1.6% for 2002, as compared to 2001.
During the fourth quarter of 2002, RevPAR of the Asia/Pacific Core Hotels, on a US dollar basis, increased 10% while gross operating profits increased 5.5%, as compared to the fourth quarter of 2001. On a local currency basis, RevPAR of the Asia/Pacific Core Hotels increased 6.1% while gross operating profit increased 2.6% in the fourth quarter of 2002, as compared to the same period in 2001. The majority of the hotels under the Company's management in the Asia/Pacific region experienced RevPAR improvements. The exceptions were the two Four Seasons resorts in Bali, where business has been severely impacted as a result of the terrorist event on that island in October 2002. It is expected that demand will remain weak in Bali for at least the next several months as a result of a number of posted travel warnings. During the fourth quarter of 2002, The Regent hotels in Thailand and the Four Seasons hotels in Singapore, Sydney and the resort in the Maldives all experienced significant year-over-year increases, although demand in Singapore remains reasonably weak. RevPAR of the Asia/Pacific Core Hotels, on a US dollar basis for 2002, decreased 2.4% and gross operating profits decreased 6.5%, as compared to 2001. On a local currency basis, RevPAR of the Asia/Pacific Core Hotels declined 4.2% while gross operating profit declined 8% for 2002, as compared to 2001.
"Although business conditions remain very challenging, Four Seasons generally continues to achieve industry leading room rates, while maintaining or enhancing market share and prudently managing our cost base," said Wolf Hengst, President Worldwide Hotel Operations. "During 2002 we received more awards than ever that recognize the excellence of our product offering. As importantly, we were also included for the sixth consecutive year on Fortune Magazines' '100 Best Companies to Work For'. Since we believe there is a critical link between our strategic focus on people and our ability to achieve the highest guest service standards in the industry, we are very pleased to be included in this list."
MANAGEMENT OPERATIONS
Fee revenues increased 1.6% to $39.3 million for the quarter ended December 31, 2002, as compared to $38.7 million for the same period in 2001. Fee revenues in the fourth quarters of 2002 and 2001 were well below historical levels as a result of the combined impact of weak economic and business conditions and continuing geopolitical concerns. These factors have caused significantly lower management incentive fees, which are typically calculated based on the adjusted gross operating profits of the hotels and resorts under management, and reduced fees from the Company's residential business.
Fee revenues decreased 8% to $147.9 million for the year ended December 31, 2002, as compared to $160.7 million for 2001. The Company's management incentive fees decreased 16.5% to $25.1 million for the year ended December 31, 2002, as compared to $30 million in 2001. The Company earned incentive fees from 33 out of its 57 properties during 2002, as compared to 37 of its 53 properties in 2001. Incentive fees declined primarily due to the lower levels of profitability at properties under management, resulting from the continuation of lower RevPAR and higher costs related primarily to insurance, labour, benefit and energy.
A portion of the decline in fee revenues resulted from the cessation of the Company's management of The Regent Hong Kong during 2001. For the full year of 2001, the fee revenues from The Regent Hong Kong were $2.3 million. A decline in fees from the residential business also contributed to the decline in fees during the year.
General and administrative expenses decreased by 4.9% to $17.7 million for the fourth quarter of 2002 and were essentially unchanged for the year ended December 31, 2002, as compared to the same periods in 2001. The decrease in the fourth quarter figures reflects the timing of the expenses incurred.
As a result of the items described above, management earnings before other operating items increased to $21.6 million in the fourth quarter of 2002, as compared to $20.1 million in the fourth quarter of 2001. Management earnings before other operating items decreased to $82 million for the year ended December 31, 2002, as compared to $95.3 million in 2001.
For the quarter ended December 31, 2002, the Company's management operations profit margin(4) was 54.9%, as compared to 51.9% for the same period in 2001. For 2002, the Company's profit margin on its management operations was 55.4%, as compared to 59.3% in 2001.
OWNERSHIP OPERATIONS(5)
In the fourth quarter of 2002, ownership losses before other operating items were $4.6 million, as compared to earnings of $252,000 in the fourth quarter of 2001. The decline is primarily attributable to increased losses at Four Seasons Hotel Berlin and reduced earnings from The Pierre.
The decline in operating earnings at The Pierre of $1.1 million in the fourth quarter of 2002, as compared to the fourth quarter of 2001, was primarily caused by a lower achieved average room rate and a decrease in catering revenues, combined with an increase in operating expenses. Although The Pierre experienced increased occupancy during the fourth quarter of 2002, the higher occupancy was attributable to more group business than is typical at that hotel, which resulted in a decline in achieved average room rates. In addition, operating expenses increased during the fourth quarter of 2002 due primarily to increased insurance, labour, benefit and energy costs.
The primary reasons for the loss in Berlin were weak demand, a scheduled increase in rent payments under the lease agreement, and higher operating costs. Four Seasons Hotel Berlin losses increased approximately $1.4 million during the fourth quarter of 2002, as compared to the same period in 2001, primarily as a result of weak demand in a market that has an abundant supply.
Ownership losses before other operating items were $19.6 million for the year ended December 31, 2002, as compared to ownership losses of $10.2 million for the year ended December 31, 2001. The primary contributors to the decline were larger operating losses from Four Seasons Hotel Berlin and The Pierre.
The Pierre's loss from operations for the year 2002 was $4.9 million, as compared to a loss of $708,000 in 2001 and RevPAR declined by 6.8% in 2002, as compared to 2001. The loss from Four Seasons Hotel Berlin was $3.9 million in 2002, as compared to $1.5 million in 2001, and RevPAR declined by 1.4%.
OTHER INCOME/EXPENSE
Other expenses for the fourth quarter of 2002 were $2.8 million, compared to $3.9 million for the same period in 2001. Included in other expenses during the fourth quarter of 2002 are legal and other enforcement costs of approximately $1.8 million incurred in connection with the Company's disputes relating to the Four Seasons hotels in Caracas and Seattle, which are described below. Also included in other expenses is a $1.4 million charge due to the decline in the value of certain life insurance policies that the Company holds. Certain components of the cash surrender value of these policies are linked to equity market indices, which experienced valuation declines during 2002.
For 2002, other expenses were $22.9 million, as compared to other income of $30.7 million in 2001. Included in the 2002 expenses are asset impairment charges and legal and other enforcement costs taken in connection with the Company's investments in the Four Seasons hotels in Caracas, Sydney and Seattle, which are described below, offset by a $5 million foreign exchange gain relating primarily to the Company's foreign currency working capital position and other unhedged monetary assets. The 2001 financial results included non-recurring items, including gains on asset dispositions of $30.4 million, recovery of a loss provision of $4.8 million, $2.2 million of corporate restructuring costs, and a $2.4 million loss on redemption of the $100 million of 6% debentures.
The Company is in a dispute with the owner of Four Seasons Hotel Caracas regarding a variety of matters relating to the completion and ongoing operation of the hotel, including the default on a US$5 million loan owed to the Company that is secured by a second mortgage and that is registered against the hotel. Formal notice of the default has been given to the owner. The dispute has been referred to arbitration and the arbitration proceedings have commenced.
Due to the ongoing financial difficulties of the owner of the Caracas hotel and the resulting working capital deficiencies at the hotel, Four Seasons Hotel Caracas has been closed and is expected to remain closed until the dispute is resolved and the hotel's debt and working capital arrangements can be restructured to provide sufficient funds to allow the hotel to operate on the basis specified in the Company's management agreement. The Company does not anticipate a reopening in the near term while the necessary reorganization of the capital structure of the hotel remains outstanding.
As a result of the inability to achieve a timely resolution of the dispute with the owner, the necessary reorganization of the capital structure of the hotel and the resulting indefinite closure of the hotel, the Company recorded an asset impairment charge of approximately $16.1 million relating to Caracas in the third quarter of 2002, effectively reducing its investment to nil. This charge includes expenses related to legal and other enforcement costs. The Company will continue to pursue all available remedies with the objective of protecting its management rights and its loan and allowing the hotel to resume operations under Four Seasons management on a sound financial basis.
In 2002, the owner of the Four Seasons Hotel in Seattle began marketing the hotel for sale and provided the Company with notice of termination of its management agreement in connection with the proposed sale. The Company strongly disagrees with the owner's assertion that it is entitled to sell the hotel free of the Company's management agreement. In the third quarter of 2002, the owner commenced arbitration proceedings on the matter. Those proceedings are ongoing, and a hearing date has been scheduled for the second quarter of 2003.
During the fourth quarter of 2002, the Company expensed $1.8 million of legal fees and other enforcement costs in connection with the disputes in Caracas and Seattle. The Company expects to incur approximately $4 million to $5 million in legal and other fees in the first half of 2003 in connection with these issues.
As a result of a lack of improvement in both domestic and international tourism in Australia, reduced expectations for operating results for Four Seasons Hotel Sydney, and an independent appraisal received in the third quarter of 2002 which confirmed that conditions had deteriorated such that the Company may not fully recover its investment in the hotel, the Company recorded an asset impairment charge of $7 million relating to its $45.5 million investment in that hotel.
The Company realized a net foreign exchange accounting gain in 2002 of $5 million, as compared to a $44,000 gain in 2001. The Company attempts to minimize the impact of fluctuations in foreign currencies through the use of foreign exchange forward contracts. The gain in 2002 was the result of a significant strengthening of various currencies against the Canadian dollar, relating primarily to the Company's working capital position and other unhedged monetary assets.
Included in the 2001 income are gains relating to the disposition of investments the Company held in The Regent Hong Kong and Four Seasons Hotel Prague of $30.4 million, as well as an aggregate recovery of $4.8 million of loss provisions set up in previous years for possible impairment of certain assets. During the fourth quarter of 2001, the Company recognized a loss of $2.4 million when it redeemed all of its $100 million of 6% debentures in accordance with their terms for an aggregate redemption price of $102,118,820 plus accrued and unpaid interest. Also during the fourth quarter and for the year of 2001, the Company incurred charges of $1.2 million and $2.2 million, respectively, in connection with the restructuring of certain corporate departments.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense was $3.9 million for the fourth quarter of 2002 and $14.8 million for the year ended December 31, 2002, as compared to $4.4 million and $16.2 million, respectively, for the same periods in 2001. The decrease in depreciation and amortization expense was primarily attributable to a change in the accounting standard relating to goodwill and other intangible assets that became effective January 1, 2002 and is discussed in note 1(a) to the fourth quarter consolidated financial statements. This decrease was partially offset by additional amortization expense on new management contracts. If the new accounting standard had been in place during the fourth quarter of 2001, net earnings for that quarter would have been increased by $716,000 ($0.01 basic and diluted loss per share), due to lower amortization expense. Similarly, for the year ended December 31, 2001, net earnings would have reflected an improvement of $3.0 million ($0.08 basic earnings per share and $0.07 diluted earnings per share) as a result of lower amortization expense (see reconciliation in note 1(a) to the fourth quarter consolidated financial statements).
NET INTEREST EXPENSE/INCOME
The Company had net interest expense of $266,000 in the fourth quarter of 2002, as compared to income of $211,000 in the fourth quarter of 2001. Net interest is a combination of $4.8 million interest income, $3.3 million interest expense and $1.8 million expense relating to the purchase of forward exchange contracts in the fourth quarter of 2002, as compared to $4.3 million, $3.5 million and $598,000, respectively, for the same period in 2001.
The change in interest income is primarily due to lower cash and cash equivalents and lower interest rates earned on short-term cash deposits in the fourth quarter of 2002, as compared to the fourth quarter of 2001, offset by a provision against interest income recorded in the fourth quarter of 2001. The decline in interest expense is the result of the redemption of $100 million principal amount of unsecured debentures in November 2001 and purchases of additional forward exchange contracts.
For the same reasons as discussed above for the fourth quarter, for the year ended December 31, 2002 net interest income was $3.2 million, as compared to $6.7 million for the comparable period in 2001. The components of net interest were interest income of $18.3 million, interest expense of $11.6 million and expenses relating to the purchase of forward exchange contracts of $3.5 million in 2002, as compared to $23.3 million, $15.6 million and $972,000, respectively, during the same period in 2001.
INCOME TAX EXPENSE
The Company's effective tax rate for each of the quarters ended December 31, 2002 and 2001 was 24%. The Company's effective tax rate for the year ended December 31, 2002 was 24%, as compared to 18.6% in 2001. The lower effective tax rate for the year 2001 is primarily a result of the gain realized during the third quarter of 2001 relating to the sale of The Regent Hong Kong, which was not subject to tax.
Included in tax expense for the fourth quarter of 2001 was a $939,000 expense related to the scheduled reductions in the Canadian federal income tax rates announced in the fourth quarter of 2001, which will be implemented over the next several years. The increased tax expense ("Reduction of future income tax assets") results from the decreased income tax rates being applied to the ongoing benefit of the Company's future income tax assets.
CASH FLOW AND CAPITAL EXPENDITURES
During the fourth quarter of 2002, the Company generated $9.6 million from operations, as compared to $157,000 for the same period in 2001. The increase in cash from operations of $9.4 million in 2002 was primarily due to a decrease in non-cash working capital of $9 million, a decrease in income taxes paid of $4.4 million, an increase in cash contributed by management operations of $1.8 million, partially offset by increased cash used in ownership operations of $4.8 million and legal and enforcement costs paid in 2002 of $2.7 million.
The Company generated $41.8 million of cash from operations during the year ended December 31, 2002, as compared to $75.5 million for the year ended December 31, 2001. The decrease in cash from operations of $33.7 million in 2002 was primarily due to reduced cash contributed by management operations of $12.9 million and greater cash used in ownership operations of $12 million (as discussed above), an increase in non-cash working capital of $13.1 million and legal and enforcement costs paid in 2002 of $5 million, partially offset by a decrease in income tax paid of $7.4 million and a decrease in net interest paid of $3.6 million.
For the quarter and year ended December 31, 2002, the Company funded $31.8 million and $71 million, respectively, in new management opportunities, including amounts advanced as loans receivable, investment in hotel partnerships, investment in management contracts and investment in fixed assets as further explained below. This level of investment was consistent with the Company's business plan, with the investments made to secure new long-term management agreements or to enhance existing management agreements. During the quarter and year ended December 31, 2002, the Company made investments in a variety of projects, including Costa Rica, Jackson Hole, Scottsdale Residence Club and Orlando, amongst others.
Included in total capital investments, including amounts advanced as loans receivable, investment in hotel partnerships and investment in management contracts, of $20.1 million and $63.3 million for the quarter and year ended December 31, 2001, respectively, were approximately $17.3 million and $53.6 million of investments made during the relevant period, to obtain new long-term management contracts, including Four Seasons hotels in Miami, San Francisco, Dublin and Budapest, and to improve the terms of the existing management agreement at The Regent Bangkok.
Total fixed asset expenditures were $21.8 million in the fourth quarter of 2002 and $31.1 million for the year ended December 31, 2002, as compared to $2.8 million and $9.6 million, respectively, for the same periods in 2001. The increases of $19 million in the fourth quarter of 2002 and $21.5 million in the year ended December 31, 2002 were primarily due to the $17.6 million expended by the Company in connection with the purchase of land relating to its investment in Four Seasons Resort Celebration in Orlando, Florida. The remaining increase is due to increased fixed asset purchases by the Company's three consolidated hotels and by various corporate offices.
During 2002, the Company generated $4.6 million from the disposition of its interest in the Inn on the Park vacant land. During 2001, the Company also generated $88.6 million from the disposition of its equity investments in Four Seasons Hotel Prague, Four Seasons Resort Punta Mita and The Regent Hong Kong.
During 2002, the Company made normal course purchases of 337,600 of its Limited Voting Shares through the facilities of The Toronto Stock Exchange and the New York Stock Exchange for a total purchase price, including commissions, of approximately $16.5 million. The Company is currently authorized to make normal course purchases of up to an aggregate of 5% of its issued and outstanding Limited Voting Shares over a 12-month period.
During the fourth quarter of 2001, the Company redeemed its $100 million of 6% debentures for an aggregate redemption price of $102.1 million plus accrued and unpaid interest.
LIQUIDITY AND CAPITAL RESOURCES
A part of the Company's business strategy is to invest a portion of available cash to obtain new management agreements or enhance existing management arrangements. The loans or investments will only be made where the overall economic return to Four Seasons is expected to justify the investment. As a part of its ongoing balance sheet evaluation, the Company has reviewed each investment and has determined that the asset impairment charges discussed above under "Other Income/Expense" were required in respect of its investments in Four Seasons hotels in Caracas and Sydney.
As at December 31, 2002, the Company's cash and cash equivalents were $165 million, as compared to total cash and cash equivalents of $210.4 million as at December 31, 2001. The reduction in cash and cash equivalents is primarily due to funding of projects relating to new management opportunities, including Costa Rica, Jackson Hole and Orlando. Long-term obligations were $129.1 million as at December 31, 2002 as compared to $119.4 million as at December 31, 2001. The Company's debt position consists primarily of its zero coupon convertible debt that matures in 2029, which is redeemable by the Company at anytime after September of 2004. The terms and conditions of the convertible notes are described more fully in the Company's 2001 Annual Report.
LEASE AND CONTINGENT COMMITMENTS
In connection with certain of its hotel management agreements and projects under development, the Company provides limited and contingent commitments in lieu of or as security for additional equity or loan commitments. As at December 31, 2002, the Company had 11 contingent commitments that could potentially represent a maximum funding of approximately $56.3 million in 2003. Approximately six of these commitments totalling $16.6 million are for potential one-time fundings and three of these commitments totalling $19.5 million are annual maximum contingent commitments, which are expected to remain in place for at least the next five years. The remaining two of these contingent commitments totalling $20.2 million are letters of credit supporting the equity or loan commitments of the Company in respect of two projects currently under construction. To the extent it is called upon to honour any one of these contingent commitments, other than the two commitments in respect of the investments in the projects currently under construction, the Company generally has either the right to be repaid from hotel operations and/or has various forms of security or recourse to the owner of the property. The Company does not anticipate funding any amount pursuant to these commitments during 2003, other than the $20.2 million in respect of the two investments in the projects currently under construction.
STOCK OPTION EXPENSE
Effective January 1, 2002, the Canadian Institute of Chartered Accountants issued a new standard relating to the accounting for stock-based compensation and other stock-based payments. The new accounting standard requires the use of a fair value based method to account for stock-based payments to non-employees, and for employee awards that are direct awards of stock, cash or other assets, or are stock appreciation rights that call for settlement by the issuance of equity instruments, granted on or after January 1, 2002. The resulting expense would increase in future years as additional options are granted to employees.
As permitted by the new standard, the Company is continuing to apply its existing accounting policy, under which no compensation expense is recorded on the grant of stock options to employees. Consideration paid by employees on the exercise of stock options or the purchase of shares is recorded as capital stock.
The Company recognizes that the granting of options to employees represents a cost, but believes that it is prudent to wait for the anticipated releases from the various accounting bodies regarding the required accounting treatment of stock based compensation prior to changing its method of accounting. For the quarter and year ended December 31, 2002, if the Company were to have adopted the fair value based method, the impact would have been an increased compensation expense of $832,000 and $1.8 million, respectively, a decrease in basic earnings per share of $0.02 and $0.06, respectively, and a decrease in diluted earnings per share of $0.02 and $0.05, respectively.
DEVELOPMENT UPDATE
During 2003, the Company is scheduled to open six new Four Seasons hotels and resorts in Riyadh, Budapest, Exuma (the Bahamas), Hampshire (England), Jackson Hole and Miami. Consistent with the Company's business strategy, the Company has made and will be making investments in certain of these properties by way of loans or minority equity investments.
"We continue to be encouraged by the number of quality projects that are being brought to us by our development partners. We are fortunate to have partners that have a very long investment horizon and a clear understanding that it takes many years to design and build a Four Seasons hotel. As a result, notwithstanding the challenging near-term operating environment, Four Seasons projects continue to be planned, developed and built," said Kathleen Taylor, President Worldwide Business Operations. "With six new Four Seasons hotels scheduled to open in 2003 and a further nine scheduled to open in 2004, we are in an exciting period of growth for the Four Seasons brand with the additions of these important new hotels."
LOOKING AHEAD
The Company's business plan objectives for 2003 continue to focus on those aspects of the business which provide the greatest potential contribution to long-term free cash flow; including continued opening of new Four Seasons properties, maintaining and enhancing market share, maintaining room rates and increasing the rate premiums of the new and recently opened Four Seasons properties.
In 2003, Four Seasons expects to open six new properties. The average life of the management contracts for these properties is 71 years. As such, these management contracts are expected to provide the Company with long-term significant fee income and no investment obligations in respect of these properties beyond its initial committed capital.
One of Four Seasons' objectives is to be recognized as the company which operates the finest hotel in every area in which it is located. A key measurement of this objective is market share premium. In spite of the economic downturn, Four Seasons believes that it has maintained or enhanced market share in each of the regions in which it operates. As an example, as calculated by Smith Travel Research, where 100 represents fair market share, Four Seasons improved its market share in the US market from 117 in 2000, to 122 in 2001 and maintained this level in 2002. The objective for 2003 is to maintain or enhance this market share premium, while maintaining rates.
The Company believes that maintaining rates will be one of the most important factors in being well-positioned for the increase in travel demand that should occur with global economic recovery. Over the past two years, Four Seasons has been generally successful at maintaining room rates at the levels achieved in 2000, which were the highest room rates ever achieved by the Company, without sacrificing occupancy to its competitors. During 2003, the Company will focus on maintaining its value arrangement with its guests by continuing to deliver its exceptional quality of service and maintaining room rates, while at the same time controlling costs. The Company will also be focussed on establishing a market leadership position for each of the 10 new Four Seasons hotels and resorts which opened over the past 24 months and the six new Four Seasons projects which are expected to open in 2003 and building rate premiums in those locations.
During 2003, the gross operating profit margins at the hotels and resorts under management are expected to decline due to cost increases for expenses such as employee benefits, energy and insurance, which are largely beyond the control of Four Seasons. The overall impact on margins is expected to decline by 100 to 150 basis points in 2003. Over the past few years, the Company has maintained overall gross operating profit margins, which we believe have led the upper-upscale and luxury segment of the lodging industry.
Hotel ownership operations are expected to continue to be challenged by the current operating environment. The operating profitability of The Pierre, and the Four Seasons hotels in Vancouver and Berlin is unlikely to improve in 2003. Macro events may cause a greater loss from hotel ownership operations in 2003 than in 2002. Nevertheless, the Company will endeavor to improve the operating results of these properties through changes to their operations or through the restructuring of the relevant leases in each of the three cases. The Company continues to attempt to mitigate its exposure to hotel ownership by limiting investments to minority positions less than 20%.
The Company will continue to pursue legal remedies to enforce its contracts and security in the disputes with the owners of the Four Seasons hotels in Seattle and Caracas. The aggregate costs of these arbitrations and related proceedings in 2003 will likely be in the range of $4 million to $5 million which are expected to be weighted toward the first half of the year. The value of the long-term management contracts in these markets justifies these significant costs. The Company remains confident that an acceptable resolution will be achieved in both of these disputes.
The Company's effective tax rate is expected to be 24% in 2003.
An important objective for the Company in these uncertain circumstances is to maintain the strength of its balance sheet. As such, the Company intends to continue to be disciplined in the allocation of its capital. The Company will also seek to dispose of certain of its minority positions which could contribute further cash reserves in the near term. The capital investment plans for the Company remain focussed on allocating the majority of its capital for investment opportunities that establish new long-term contracts in key destinations. Total capital spending is expected to be approximately US$45 million to US$55 million in 2003, including investments planned for Costa Rica, Whistler, Hampshire and Jackson Hole. This amount includes the letters of credit totalling $20.2 million supporting the commitment of the Company to invest in two of these projects as disclosed under "Lease and Contingent Commitments".
The current operating environment involves unprecedented levels of uncertainty. The Company will continue to provide appropriately detailed historic and current information, as well as management's views on key operating trends, progress on long-term strategies and other information that is intended to assist shareholders in assessing the future prospects for Four Seasons business. However, as a result of the high levels of uncertainty in the macroeconomic environment, the Company is declining to give a specific forecast for earnings per share for 2003 at this time. In general, the Company expects its business model to perform at or above industry levels consistent with past experience.
CONCLUSION
"The lodging industry continues to experience very challenging demand conditions, and we expect this to continue in 2003, particularly with the potential threat of war in the near term," said Douglas L. Ludwig, Chief Financial Officer and Executive Vice President. "These conditions and their impact on our industry are impossible to predict with any confidence. We will continue to focus on building the long-term value potential of Four Seasons. We are taking steps designed to achieve a rapid improvement of operating cash flow when the economy turns. We maintain a strong balance sheet, and we are opening many great new hotels under new long-term management agreements. We are also preserving the integrity of our room rates and profit margins so that our incentive fees should rebound significantly when the lodging industry begins to see occupancy levels increase. We do not believe that the intrinsic value of Four Seasons has been diminished by the current environment and we will continue to take steps to maximize the long-term cash flow potential of the Company."
1. Normalized net earnings is equal to net earnings plus
(i) restructuring costs, plus (ii) loss on redemption of debt, less
(iii) recovery of losses, less (iv) gain on sale of investments, less
(v) certain net foreign exchange gains, each tax-affected as
applicable.
A reconciliation of net earnings to normalized net earnings is as
follows:
Three months ended Years ended
(Unaudited) December 31, December 31,
(In thousands of dollars) 2002 2001 2002 2001
Net earnings $ 7,637 $ 9,317 $ 21,231 $ 86,486
Normalized adjustments:
Asset impairment charges
and legal and other
enforcement costs
(Caracas/Sydney/Seattle) 1,784 - 25,091
Loss (gain) on sale of
hotel investments 50 254 1,409 (30,398)
Non-recurring foreign
exchange gain - (1,365) - (1,365)
Provision for
(recovery of) loss 1,361 139 1,305 (4,778)
Loss on redemption of debt - 2,350 - 2,350
Restructuring costs 91 1,173 91 2,172
Tax effect of normalized
adjustments (789) (597) (6,695) 1,928
Normalized net earnings $ 10,134 $ 11,271 $ 42,432 $ 56,395
Normalized basic earnings
per share $ 0.29 $ 0.32 $ 1.21 $ 1.61
Normalized diluted
earnings per share $ 0.29 $ 0.32 $ 1.17 $ 1.52
2. RevPAR is defined as average room revenue per available room. RevPAR
is a commonly used indicator of market performance for hotels and
resorts and represents the combination of average daily room rate and
the average occupancy rate achieved during the period. RevPAR does
not include food and beverage or other ancillary revenues generated
by a hotel or resort.
3. The term "Core Hotels" means hotels and resorts under management for
the full year of both 2002 and 2001. Changes from the 2001/2000 Core
Hotels are the additions of Four Seasons Resort Nevis and Four
Seasons Hotel Cairo at The First Residence, and the deletion of The
Regent Jakarta (which closed for repairs in February 2002 following
damage from extensive flooding).
4. The management operations profit margin represents management
earnings, before other operating items, as a percent of management
operations revenue.
5. Included in ownership operations earnings (losses) are the
consolidated revenues and expenses from the Company's 100% leasehold
interests in The Pierre in New York, Four Seasons Hotel Vancouver and
Four Seasons Hotel Berlin, distributions from minority ownership
interests in properties that Four Seasons manages and corporate
overhead expenses.
All dollar amounts referred to in this press release are Canadian dollars unless otherwise noted. The financial statements are prepared in accordance with Canadian generally accepted accounting principles.