Hysan Development Co Ltd
Annual Report 2006

Plain-text annual report

 To build, own and manage quality buildings, and being the occupiers’ partner of choice in the provision of real estate accommodation and services, thereby delivering attractive and sustainable returns to shareholders. ~ HYSA N’S MISSION STATEME N T CONTENTS WHERE WE ARE TODAY AND FUTURE DIRECTION OUR FINANCIAL STATEMENTS AND PORTFOLIO VALUATION Competitive Advantages 2006 in Review Chairman’s Statement Special Feature: Causeway Bay’s Spirit HOW WE CREATE VALUE AND MANAGE RISKS Overview Operations Review Financial Policy Internal Control and Risk Management HOW WE GOVERN 2 4 6 18 20 32 36 Board of Directors and Senior Management 40 44 Corporate Governance Report 57 Directors’ Report Directors’ Remuneration and Interests Report Audit Committee Report 63 70 Directors’ Responsibilities for the Financial Statements Independent Auditor’s Report Consolidated Income Statement Consolidated Balance Sheet Balance Sheet Consolidated Statement of Changes in Equity Consolidated Cash Flow Statement Notes to the Consolidated Financial Statements Five-Year Financial Summary Report of the Valuer Schedule of Principal Properties Shareholder Information 72 73 74 75 77 78 80 82 121 123 124 1 HYSAN ANNUAL R EPORT 2006 2006 was another productive year for Hysan, with a healthy local economy as backdrop. As the largest commercial landlord in Causeway Bay, Hysan always recognises its roots in this most vibrant and diverse district. In our 2006 Annual Report, we pay tribute to the spirit of Causeway Bay, its ability to constantly reinvent itself, its gift for seamlessly blending businesses and tradition, and its ability to attract the dynamic people who work, visit and reside here. In this Annual Report, we also strive to further enhance the quality of information and disclosure in the following areas: our performance, how we create value and manage our risks, and our governance. At the same time, we recognise that shareholders are equally interested in knowing more about the “human” side of the equation – the values that underlie our management practices. We have, therefore, introduced our fi rst Corporate Responsibility Report. We hope thereby that our readers can better understand how we use our guiding principle of being a responsible business to defi ne how we interact with our stakeholders, including our shareholders, tenants, employees, and the community, as well as how we achieve our results. 1 HYSAN ANNUAL R EPORT 2006 Competitive Advantages Largest commercial landlord in Causeway Bay, Hong Kong’s prime offi ce and retail district Balanced portfolio of superior investment properties Quality client base with prominent multinational and strong local tenants Sustainable income with high occupancy consistently achieved BA L A NCED PORTFOLIO OF QU A LIT Y IN VE STME N T PROPERTIE S 21% 24% 55% 1% 15% 19% 37% 28% Office Retail Residential Property under redevelopment Others 3.8 million HK$32,473 million SQUARE FEET GROSS FLOOR AREA (EXCLUDING PROPERTY UNDER REDEVELOPMENT) CAPITAL VALUE Established asset enhancement programme with track record of adding value Exceptional services Strong balance sheet Financial prudence with focus on our commercial and residential customers with debts of long maturity and diversifi ed funding sources to keep risk and return in balance Eff ective corporate governance with widespread industry recognition achieved VA LUE CR E ATION Underlying Profit Attributable to Shareholders (HK$ million) Profit Excluding Asset Value Changes and Prior Year Tax Provision (HK$ million) Adjusted Shareholders’ Funds (HK$ million) 1,200 1,000 800 600 400 200 0 609 1,005 1,012 900 750 755 36,000 30,000 600 586 641 24,000 22,399 30,729 27,134 450 300 150 0 18,000 12,000 6,000 0 2004 2005 2006 2004 2005 2006 2004 2005 2006 2006 in Review • Overall turnover up 1.4%; like-for-like turnover up 8.3% • Profi t excluding asset value changes and prior year tax provision up 17.8% • Full-year dividends up 11.1% Key Financial Data Consolidated income statement (HK$ million) Turnover Finance costs Profit excluding asset value changes1 and prior year tax provision Underlying profit attributable to shareholders2 Profit attributable to shareholders Consolidated balance sheet (HK$ million) Total assets Shareholders’ funds Adjusted shareholders’ funds3 Consolidated cash flow statement (HK$ million) Net cash from operating activities Net cash from investing activities Net cash used in financing activities Net (decrease) increase in cash and cash equivalents Per share data Earnings per share, based on: Profit excluding asset value changes1 and prior year tax provision Basic (HK cents) Diluted (HK cents) Underlying profit attributable to shareholders2 Basic (HK cents) Diluted (HK cents) Profit attributable to shareholders Basic (HK cents) Diluted (HK cents) Shareholders’ returns: Dividend per share (HK cents) Shareholders’ returns per share (HK$) (Note 1) Total shareholders’ returns per share (HK$) (Note 2) Assets value: Net assets value per share (HK$) Adjusted net assets value per share3 (HK$) Net debt per share (HK$) Share information Number of shares in issue at year end (million) Weighted average number of shares (million) Highest share price (HK$) Lowest share price (HK$) Closing price at year end (HK$) 2006 2005 Change % 1,268 1,250 163 755 1,012 3,099 36,253 27,828 30,729 918 175 (2,110) (1,017) 214 641 1,005 4,121 33,991 24,667 27,134 841 2,394 (1,855) 1,380 71.60 71.53 96.03 95.94 60.94 60.90 95.60 95.54 293.96 293.70 391.87 391.62 50.00 1.60 3.81 26.37 29.12 2.31 1,055 1,054 23.95 18.60 20.35 45.00 3.25 4.83 23.42 25.76 2.75 1,053 1,052 20.50 14.40 19.20 1.4 23.8 17.8 0.7 (24.8) 6.7 12.8 13.2 9.2 (92.7) (13.7) N/A 17.5 17.5 0.4 0.4 (25.0) (25.0) 11.1 (50.8) (21.1) 12.6 13.0 16.0 0.2 0.2 16.8 29.2 6.0 4 HYS AN ANN UA L REPORT 200 6 Key Financial Data continued Investments in listed securities 2006 2005 Change % Total return (dividends received plus capital value growth) 57.3% 31.6% 81.3 Financials Average finance costs Net debt to equity Net interest coverage (times) Floating rate debt (% on total debt) Average debt maturity Bank facilities : capital market issuance 4.9% 7.9% 6.9x 64.7% 3.6% 10.7% 4.6x 49.8% 5.0 years 5.2 years 25% : 75% 47% : 53% Key Operating Data 2006 2005 Investment property value (HK$ million) Office Retail Residential Hennessy Centre (Note 3) Others Occupancy at year end Office Retail Residential Property expenses (HK$ million) Property expenses as a percentage of turnover 32,473 11,876 9,062 6,206 4,900 429 97% 99% 92% 240 19% 29,815 10,646 8,582 6,060 4,061 466 95% 99% 89% 237 19% (36.1) 26.2 50.0 29.9 (3.8) N/A Change % 8.9 11.6 5.6 2.4 20.7 (7.9) 2.1 – 3.4 (1.3) – Notes: (1) Shareholders’ return per share represents growth in share price plus dividend received per share (2) Total shareholders’ return per share represents the growth in adjusted net assets value per share plus dividend received per share (3) Hennessy Centre was vacant as at 30 September 2006 in preparation for redevelopment and was valued as such for 2006 year end In preparing the Group’s 2006 financial statements under the Hong Kong Financial Reporting Standards, the fair value model for investment properties has been adopted. Accordingly such properties were recorded at their fair values, as determined by an independent professional valuer. Fair value changes on investment properties and related deferred tax were recognised through income statement. Revaluation changes on owner occupied properties and related deferred tax arising thereon were taken to equity. Deferred tax on fair value gain has to be provided for despite no capital gains tax liability will be crystallised on disposal of those properties at the value included in the financial statements. In light of the above, management has presented other indicators for assessing the performance of the Group: (i) “Underlying profit attributable to shareholders”, effectively arrived at by adjusting for the unrealised fair value changes on investment properties and the related deferred tax on the profit figure. On the same basis, cumulative deferred tax provided on the fair value gain on investment and owner occupied properties have been added back to the shareholders’ funds when computing “Adjusted shareholders’ funds” and “Adjusted net assets value per share”, (ii) “Profit excluding asset value changes and prior year tax provision” was arrived at after further adjusting “Underlying profit attributable to shareholders” for aggregate of realised gain/loss on disposal of investment properties and available for sale investments, impairment, reversal, recovery and prior year tax provision. 1. Adjustment to underlying profit relating to asset value changes comprised realised gains on disposal of available-for- sale investments and investment properties and recognition of a recovery item totalling HK$257 million. 2. Excluded HK$2,030 million unrealised fair value gain on the investment properties portfolio net of deferred tax and minority interests, and HK$57 million on unrealised fair value gain included in an associate. 3. Adjusted for HK$2,901 million being the cumulative deferred tax provided on fair value gain on the investment and owner occupied properties attributable to shareholders as at 31 December 2006. 5 HYSAN ANNUAL R EPORT 2006 Chairman’s Statement OVERVIEW The 2006 global economy was generally favourable throughout the year, despite signs of slowdown in certain sectors of the U.S. economy towards the latter part of the year. The Hong Kong economic environment remained strong, supported by robust domestic demand and a strong fi nancial market. Grade A offi ce rental growth was underpinned by a generally limited supply and sustained demand in light of more business activities. More private consumption, in addition to spending by tourists, helped drive retail rents. Increased demand from expatriate executives ensured a steady growth for luxury residential rentals. PERFOR M A NCE Overall 2006 turnover was HK$1,268 million, up 1.4% from 2005. If the element of the Entertainment Building (disposed of at the end of 2005) is excluded, the turnover increase would be 8.3%, driven by revenue growth in all sectors (offi ce: 10.2%, retail: 6.0%, residential: 11.0%). Offi ce sector turnover saw a healthy year-on-year increase, with positive rental reversions beginning in the second half of 2005 continuing into 2006. Profi t excluding asset value changes and prior year tax provision was HK$755 million, up 17.8% from the corresponding fi gure in 2005 (2005: HK$641 million). Earnings per share, excluding asset value changes and prior year tax provision, correspondingly rose to HK71.60 cents. Peter T.C. Lee, Chairman Underlying profi t, excluding unrealised revaluation changes on investment properties and related items, was HK$1,012 million (2005: HK$1,005 million). Profi t was HK$3,099 million, 24.8% down from last year’s HK$4,121 million, due mainly to the HK$1,650 million less fair value changes on the Group’s investment properties taken to the income statement. The external valuation of the Group’s investment property portfolio increased to HK$32,473 million, up 8.9%. Adjusted shareholders’ funds rose by 13.2% to HK$30,729 million. The Board recommends the payment of a fi nal dividend of HK40.0 cents per share (2005: HK35.0 cents). Together with the interim dividend of HK10.0 cents per share (2005: HK10.0 cents), there is an aggregate distribution of HK50.0 cents per share, representing a year-on-year increase of 11.1%. Subject to shareholder approval, the fi nal dividend will be payable in cash with a scrip dividend alternative. 6 HYS AN ANN UA L REPORT 200 6 BUSIN E SS A N D SUSTAINA BILIT Y Hysan aims to apply the highest standards of professionalism to our everyday business, and plays an active part in diff erent aspects of community life. To us, the commitment to being both fi nancially successful and a responsible business is not a mutually exclusive set of targets. In our quest to deliver long-term sustainable value to our shareholders, we have to understand the wider context in which our company operates, and we therefore make decisions that balance short-term requirements and long-term concerns. These concerns include taking into consideration the impact of our actions on society and the environment. Further information on our commitment to Corporate Responsibility is set out in a separate report that we have introduced this year. DIR ECTORS A N D STAFF I would like to take this opportunity to express my thanks not only to all our Board members for their wise counsel, but also to our dedicated staff members for their valuable contribution and good work during the year. OU TLOOK Further growth in the Hong Kong economy is projected for 2007, though at a more moderate rate when compared with last year. The stabilisation of interest rates and improving employment conditions should continue to provide a favourable environment for our property investment business. Peter T.C. Lee Chairman Hong Kong, 6 March 2007 7 HYSAN ANNUAL R EPORT 2006 CAUSEWAY BAY’S Causeway Bay in the 1920’s was mostly newly reclaimed land dotted with godowns. It is now one of the SPIRIT most remarkable commercial districts in the world, spearheading Hong Kong’s dramatic development. Causeway Bay is always changing, not just to adapt, but 8 HYS AN ANN UA L REPORT 200 6 to lead. It thrives on showcasing the best and the latest, but also pauses to encompass the more traditional side of life. It acts as a dynamic crossroad for all our ultra-effi cient services, but also takes time out to host those from diff erent backgrounds who work and play here. Causeway Bay breathes a progressive and all-embracing spirit from every pore. Causeway Bay represents the best of Hong Kong in everything it does. Indeed, Causeway Bay’s spirit is Hong Kong’s true spirit. 9 HYSAN ANNUAL R EPORT 2006 CAUSEWAY BAY’S CONTRASTING ARCHITECTURE STYLES HIGHLIGHT THE DISTRICT’S EVOLUTION FROM A QUIET SUBURB TO ONE OF THE WORLD’S best known COMMERCIAL DISTRICTS. 1 0 HYS AN ANN UA L REPORT 200 6 As the heart of a dynamic city, Causeway Bay has constantly reinvented itself. Always at the forefront of CONSTANT REINVENTION progress, the area was the site of one of Hong Kong’s earliest land reclamations. Not content with hosting the city’s fi rst tram line in 1923, Causeway Bay today is a superb traffi c hub. Also with roots stretching back to probably the territory’s earliest motion picture studio in Ngan Mok Street, Causeway Bay is Hong Kong’s best known shopping and leisure destination, with a reputation enhanced by being the site of the city’s fi rst Japanese department stores and quality hotels like the Lee Gardens in the intervening years. THE DISTRICT’S GEOGRAPHICAL SUPERIORITY ENSURES CAUSEWAY BAY’S STATUS AS A transport hub CONNECTING ALL AREAS OF THE ISLAND AND BEYOND, FROM HONG KONG’S EARLY DAYS UP TO THE PRESENT. 1 1 HYSAN ANNUAL R EPORT 2006 Causeway Bay welcomes business in all its variety. While large HARMONY corporations set up regional headquarters in Causeway Bay’s towering offi ce blocks, global franchises and trend-setting boutiques share the ground fl oors along the district’s vibrant shopping streets. Causeway Bay, of course, is not all about commerce. It is also an area of time-honoured traditions that derive from both east and west. The annual fi re-dragon dance has been held at Tai Hang for over a century. The Chinese New Year fl ower market entices those from near and far with blazing colours and scents. And every day right by the shore, the Noon Day Gun can be heard piercing the cacophony of sounds along Gloucester Road. Causeway Bay eff ortlessly blends innovations with customs, creating a sense of harmony rarely found in the heart of other metropolises. 1 2 HYS AN ANN UA L REPORT 200 6 1 3 HYSAN ANNUAL R EPORT 2006 THE HUNDREDS OF THOUSANDS CROSSING HENNESSY ROAD EACH DAY COME FROM all corners of Hong Kong, AND INDEED, THE WORLD. THEY MAY BE THE BEST FINANCIAL MINDS OR MOST ORIGINAL DESIGN TALENTS. THEY MAY BE BLISSFUL YOUNGSTERS OR SPORTY YOUNG-AT-HEARTS. THEY BRING TO CAUSEWAY BAY NOTHING LESS THAN THEIR HOPES AND CHEERS. 1 4 HYS AN ANN UA L REPORT 200 6 Causeway Bay is all things to PEOPLE all people. It is home sweet home for those returning from a fruitful day at work or school, as well as a gadget heaven for sun-drenched tourists. Victoria Park, Hong Kong’s largest urban green space, is one of the focal points of the city’s community life. Aspiring football stars shoot next to gracious tai chi practitioners. Meanwhile, yachties, library dwellers, extended families, rugby fans and many more locals and visitors have staked claims to their favourite parts of Causeway Bay. All this underscores that Causeway Bay is a diverse, prosperous and open-minded district. It is simply a place for everyone. 1 5 HYSAN ANNUAL R EPORT 2006 CAUSEWAY BAY’S SHOPS, SCHOOLS AND THE WATERFRONT WELCOME PEOPLE FROM all walks of life. 1 6 HYS AN ANN UA L REPORT 200 6 A DETAILED M A NAGEME N T’S DISCUSSION A N D A NA LYSIS OF HYSA N’S 20 0 6 R E SULTS IS ORGA NISED IN TO FOUR SECTIONS: OVERVIEW OPER ATIONS R EVIEW FINA NCIA L POLICY INTERNAL CONTROL A N D RISK M A NAGEME N T This section discusses how Hysan’s internal control system manages risks. This section reviews Hysan’s business activities for the year. In addition, a review of the fi nancial results is presented. This section provides a discussion of Hysan’s fi nancial management, including fi nancing, liquidity and cash management, and interest rate management. To facilitate an understanding of Hysan’s 2006 results under Hong Kong Financial Reporting Standards, this section presents an overview that includes key profi t and asset value indicators, and reconciliation with the statutory fi gures. Pages 18 to 19 Pages 20 to 31 Pages 32 to 35 Pages 36 to 39 1 7 HYSAN ANNUAL R EPORT 2006 Overview Profit Indicators Profit excluding asset value changes and prior year tax provision Adjusted for: • Prior year tax provision Asset value changes: • Net realised gain on disposal of available-for-sale investments • Recovery of a loan to an associate • Realised fair value gain on disposal of properties 2006 HK$ million 2005 HK$ million Change HK$ million % 755 641 114 17.8 – 755 170 87 – 257 (103) 538 – – 467 467 Underlying profit attributable to shareholders 1,012 1,005 7 0.7 Adjusted for: • Group’s share of unrealised fair value changes on investment properties net of deferred tax 2,087 3,116 Profit per financial statements 3,099 4,121 (1,022) (24.8) Asset Value Indicators Adjusted shareholders’ funds 30,729 27,134 3,595 • Group’s share of cumulative deferred tax on properties revaluation (2,901) (2,467) 31.12.2006 HK$ million 31.12.2005 HK$ million Change HK$ million % 13.2 Shareholders’ funds per financial statements 27,828 24,667 3,161 12.8 1 8 HYS AN ANN UA L REPORT 200 6 WHY M A NAGEME N T GAVE A DDITIONA L PROFIT A N D N ET ASSET IN DICATORS? While the adoption of new Hong Kong Financial Reporting Standards since the 2005 fi nancial year did not lead to any change in the Group’s business operations or cashfl ow, there were signifi cant resulting changes in fi nancial reporting. The Group’s investment properties had since been recorded on a “fair-value” basis under our accounting policies and “fair value changes” that arise on valuation of investment properties will be recognised through the income statement. Additionally, deferred tax on such “fair value gain” has to be provided for despite the fact that no capital gains tax liability will arise in Hong Kong on disposal of our investment properties. The adoption of these accounting policies has resulted in a higher volatility on earnings. The increased fl uctuations in earnings, however, may pose limitations on the use of unadjusted earning fi gures, fi nancial ratios, trends and comparison against prior period(s). The eff ects are particularly signifi cant for property investors whose principal activity is to derive recurring income from the holding of assets, such as the Group’s. To assist stakeholders to better measure the Group’s performance as a property investor, management has therefore provided an additional profi t indicator by excluding principally (i) “fair value changes” of investment properties; (ii) items that are non-recurring in nature; principally being gains/losses from disposing assets, impairment, reversal, recovery and tax provisions for prior year. On this basis, “profi t excluding asset value changes and prior year tax provision” was HK$755 million, up 17.8% from last year (2005: HK$641 million). We also provide an additional net asset indicator known as “adjusted shareholders’ funds” fi gure, which is computed by adding back the Group’s share of cumulative deferred tax on property revaluation. 1 9 HYSAN ANNUAL R EPORT 2006 Operations Review OUR BUSIN E SS Hysan is principally engaged, together with its subsidiaries and joint ventures, in investment, development and management of quality properties. As at 31 December 2006, Hysan’s investment property interests totalled some 3.8 million gross square feet of high-quality offi ce, retail and residential space in Hong Kong. The redevelopment of the Hennessy Centre commenced in the fourth quarter of 2006 accounted for the year-on-year reduction of gross fl oor area. 20 0 6 PERFOR M A NCE The Group’s turnover was HK$1,268 million, up 1.4% (2005: HK$1,250 million). If the element of the Entertainment Building (disposed of at the end of 2005) is excluded, the turnover increase would be 8.3%. Michael T.H. Lee, Managing Director Profi t excluding asset value changes and prior year tax provision was HK$755 million, 17.8% up from last year (2005: HK$ 641 million). Underlying profi t, excluding unrealised revaluation changes on investment properties and related items, amounted to HK$1,012 million (2005: HK$1,005 million). Profi t for the year was down by HK$1,022 million (24.8%), to HK$3,099 million (2005: HK$4,121 million), mainly due to HK$1,650 million less fair value changes on the Group’s investment properties taken to the income statement, refl ecting a rise in asset value at a more moderate rate. PERFOR M A NCE IN DICATORS Although many factors contributed to the results of the Group’s businesses, some of the key drivers for assessment of our performance included those set out below. Performance is measured by these and other fi nancial indicators as further analysed below. Key Indicators Operations Investments in listed securities Financials 1. Occupancy rate 2. Rental income growth 3. Property expenses and as a percentage of turnover 1. Total return – comprises dividends received and capital value growth 1. Average finance costs 2. Net debt to equity 3. Net interest coverage 4. Fixed/floating debt ratio 5. Average debt maturity 6. Ratio of bank facilities and capital market issuance – as a measure of diversity of funding sources 2 0 HYS AN ANN UA L REPORT 200 6 Condensed Consolidated Income Statement for the Year Ended 31 December Turnover Property expenses Other income Administrative expenses Fair value changes on investment properties Fair value changes on financial instruments Net realised gain on disposal of available-for-sale investments Share of results of associates Finance costs Taxation – current – deferred Minority interests Profit for the year Underlying profit 2006 HK$ million 2005 HK$ million Change HK$ million 1,268 (240) 147 (111) 2,576 31 170 120 (163) (89) (469) (141) 1,250 (237) 38 (103) 4,226 (25) – 241 (214) (178) (678) (199) 18 (3) 109 (8) (1,650) 56 170 (121) 51 89 209 58 % 1.4 (1.3) 286.8 (7.8) (39.0) N/A N/A (50.2) 23.8 50.0 30.8 29.1 3,099 4,121 (1,022) (24.8) 1,012 1,005 7 0.7 Profit excluding asset value changes and prior year tax provision 755 641 114 17.8 Turnover Turnover comprised principally rental income derived from the Group’s investment properties portfolio in Hong Kong. The relevant occupancy rate, gross fl oor area and turnover of the Group’s investment properties portfolio are as follows: Key Indicator Occupancy Rate % 100 80 60 40 20 0 95 97 99 99 89 92 Office Retail Residential 2005 2006 2 1 HYSAN ANNUAL R EPORT 2006 Operations Review Gross Floor Area (million square feet) At 1.1.2005 Property disposed of on 30.12.2005 (Note 1) At 31.12.2005 Property under redevelopment vacated on 30.9.2006 (Note 2) At 31.12.2006 Notes: (1) Entertainment Building (2) Hennessy Centre Office Retail Residential 2.7 (0.1) 2.6 (0.5) 2.1 1.2 (0.1) 1.1 (0.2) 0.9 0.8 – 0.8 – 0.8 Key Indicator Turnover Office Retail Residential Others 2006 2005 Year-on-year Change From Property From Property Held at year end (1) HK$ million Held at year end (1) HK$ million Disposed(2) HK$ million Total HK$ million From Property Held at year end (1) HK$ million Total % HK$ million 509 491 232 36 462 463 209 37 1,268 1,171 39 40 – – 79 501 503 209 37 1,250 47 28 23 (1) 97 10.2 6.0 11.0 (2.7) 8.3 8 (12) 23 (1) 18 Total 4.7 (0.2) 4.5 (0.7) 3.8 % 1.6 (2.4) 11.0 (2.7) 1.4 Notes: (1) Hennessy Centre was vacant as at 30 September 2006 in preparation for redevelopment (2) Entertainment Building was disposed of on 30 December 2005 Office Sector Positive rental reversion, which began in the second half of 2005, continued into 2006. The Group was successful in concluding renewals and new leases during the year with strong growth in rental rates. Such positive reversion, together with full year contribution of renewals and new leases concluded in 2005, brought a 10.2% like-for-like offi ce revenue growth to HK$509 million. Overall offi ce sector revenue, refl ecting the impact of the disposal of the Entertainment Building on 30 December 2005, increased by 1.6%. Retail Sector Although tourist spending continued to be a signifi cant source of retail consumption, strong domestic demand on the back of favourable employment conditions and fi nancial market performance became the key driver of rental growth in the retail sector. The Group’s retail properties remained virtually fully let as at 31 December 2006. Renewals and new leases were successfully concluded with satisfactory rental rates growth during the year. A 6.0% like-for- like rental growth was recorded, since most of these renewals and new leases were completed during the second half of the year. Such rental rate increases will be translated into a full year contribution in 2007. Overall retail sector revenue, however, decreased slightly by 2.4% in light of the disposal of the Entertainment Building as at the end of 2005. 2 2 HYS AN ANN UAL REPORT 2006 Residential Sector There was a sustained demand for luxury residential properties from expatriates with more fl exible housing budgets. Year-on-year growth was HK$23 million, up 11.0% from last year. This was mainly due to higher occupancy (2006: 92%; 2005: 89%) and to increased rental levels achieved for our residential units. Property Expenses Property expenses are the costs of providing property services directly associated with the daily operations of our investment properties, being primarily related to utilities costs, building operations, front-line staff wages, repairs and maintenance. Property expenses amounted to HK$240 million (overall: up 1.3%; excluding the Entertainment Building: up 6.7%). This was mainly attributable to the increase in utilities costs and government rates, and higher direct costs incurred in revenue generation including agency costs, repairs and maintenance and building refurbishment. Overall the property expenses were maintained at 19% of turnover. Key Indicators Property expenses (HK$ million) Percentage on turnover 2006 240 19% 2005 237 19% Other Income Other income mainly comprised dividend, interest and other receivables, which amounted to HK$147 million (2005: HK$38 million). The increase was attributable to the recognition of a recovery item, higher dividend income from the Group’s listed securities investment and additional interest income derived by depositing surplus cash proceeds of the Entertainment Building received at the end of 2005. 2 3 HYSAN ANNUAL R EPORT 2006 Operations Review Administrative Expenses Administrative expenses increased by HK$8 million (7.8%) over the 2005 level. This included higher employee share option costs, which since 2005 are required to be recognised in the income statement on a cumulative basis under the applicable accounting standards, despite the fact that no cash outlay was involved. Other reasons included increased managerial staff costs and pay rises in line with the market. Fair Value Changes on Investment Properties The Group has elected the fair value model for investment properties under the Hong Kong Accounting Standard (“HKAS”) 40. As at 31 December 2006, the investment properties of the Group were revalued at HK$32,473 million (2005: HK$29,815 million), by an independent professional valuer, being 8.9% higher than the corresponding value for last year. This refl ected further increase in rentals of the Group’s existing investment properties portfolio and the redevelopment of the Hennessy Centre. Excluding additions, adjustments and disposals, fair value gain on investment properties of HK$2,576 million (2005: HK$4,226 million) were recognised in the consolidated income statement during the year. Investment Properties As at 31 December 2005 Additions and adjustments Fair value gain Disposals As at 31 December 2006 Fair Value HK$ million 29,815 84 2,576 (2) 32,473 Fair Value Changes on Financial Instruments The Group enters into hedging arrangements from time to time to hedge volatilities and pricing risks of its treasury assets and liabilities. Positive fair value changes of HK$31 million recognised in the income statement mainly represented the aggregate of the marked-to-market fair value movements of these fi nancial instruments. Net Realised Gain on Disposal of Available-For-Sale Investments The Group has been managing its treasury assets held as long-term investments with the aim of balancing the anticipated liquidity position, funding needs and capital gains. For this reason, certain available-for-sale investments were disposed of during the year resulting in a net realised gain of HK$170 million (2005: Nil). The remaining available-for-sale investment portfolio will continue to be held as the Group’s long-term investments. Share of Results of Associates The Group has 23.7% and 25.0% ownership in the Shanghai Grand Gateway and the Singapore Amaryllis Ville projects respectively. 2 4 HYS AN ANN UAL REPORT 2006 The Shanghai Grand Gateway development continued to deliver a good performance. The Group’s share of results, excluding revaluation gains, recorded a 3.5% increase year-on-year. 100% occupancy was recorded for the retail and offi ce properties. Satisfactory occupancy was achieved for the residential properties, including the luxury residential and serviced apartment development completed in 2006. Under HKAS 40, properties at Shanghai Grand Gateway have been revalued at market value by an independent professional valuer. The Group’s share of the increase in valuation, less the corresponding deferred tax thereon, amounted to HK$57 million (2005: HK$182 million). The Singapore Amaryllis Ville project continued to make a small positive contribution in 2006, refl ecting the sale of additional units and increased rental income derived from the remaining units. Finance Costs During 2006, sales proceeds from the Entertainment Building (completed on 30 December 2005) were used to further reduce the Group’s debt level. This led to a 23.8% reduction in fi nance costs to HK$163 million (2005: HK$214 million), despite the progressively increasing market interest rate. The Group also repurchased some of its fi xed rate notes and progressively reduced the proportion of its fi xed rate borrowing as part of its interest costs management programme. The Group’s average fi nance costs rose to 4.9% in 2006 (2005: 3.6%). Further discussions on fi nancial management, including fi nancing policy and fi nancial risk management are set out in the “Financial Policy” section. Taxation Tax provision was HK$558 million in 2006 (2005: HK$856 million) principally due to reduced deferred tax provision relating to lower revaluation gains on investment properties and the absence of prior year tax provision of HK$103 million. 2 5 HYSAN ANNUAL R EPORT 2006 Operations Review Condensed Consolidated Balance Sheet as at 31 December Investment properties Available for sale investments – listed Available for sale investments – unlisted Interests in associates Cash and bank balances Other assets Total assets Borrowings Taxation – current – deferred Other liabilities Total assets less liabilities Shareholders’ funds Minority interests Adjusted shareholders’ funds 2006 HK$ million 2005 HK$ million 32,473 1,678 67 1,272 385 378 29,815 1,170 86 1,147 1,402 371 36,253 33,991 (2,821) (4,301) (225) (3,349) (950) (198) (2,879) (960) 28,908 25,653 27,828 1,080 28,908 24,667 986 25,653 30,729 27,134 Change HK$ million 2,658 508 (19) 125 (1,017) 7 2,262 1,480 (27) (470) 10 3,255 3,161 94 3,255 3,595 % 8.9 43.4 (22.1) 10.9 (72.5) 1.9 6.7 34.4 (13.6) (16.3) 1.0 12.7 12.8 9.5 12.7 13.2 Investment Properties The investment properties were valued at HK$32,473 million, up by 8.9% (HK$2,658 million) from HK$29,815 million in 2005. Breakdown of the Group’s (i) investment properties value by sector as at year-end 2006 and (ii) year-on-year capital growth are as follows: Capital Value by Sector 1% Capital Growth by Sector (excluding property under redevelopment) 15% 19% 37% 28% Office Retail Residential Property under redevelopment Others 12 % 15 12 9 6 3 0 6 2 Office Retail Residential Available-For-Sale Investments Available-for-sale investments comprised principally securities listed in Hong Kong. The Hong Kong stock market reached a record high in 2006. Total returns from the Group’s listed securities portfolio, including both dividend income and capital value growth, were 57.3% (2005: 31.6%). Total fair value of our listed securities portfolio as at 31 December 2006 was HK$1,678 million (2005: HK$1,170 million). 2 6 HYS AN ANN UAL REPORT 2006 Interests in Associates Interests in associates increased by HK$125 million (10.9%) over last year. This represented the Group’s share of results in the Shanghai Grand Gateway and Singapore Amaryllis Ville projects. Cash and Bank Balances The cash and bank balances amounted to HK$385 million as at 2006 year-end (2005: HK$1,402 million), refl ecting the application of funds for debt repayment during the year. Borrowings The carrying amount of the Group’s gross debt stood at HK$2,821 million at 2006 year-end, a decrease of HK$1,480 million (34.4%) from HK$4,301 million as at 31 December 2005. This refl ected the Group’s debt reduction utilising cash fl ow from operations and the application of sales proceeds of the Entertainment Building and equity investment. Taxation Provision for current taxation and deferred taxation increased to HK$3,574 million in 2006 (2005: HK$3,077 million). The net increase was made up of a HK$110 million charge for the year, and HK$448 million related to additional deferred tax associated with investment properties revaluation gains, reduced by tax payments of HK$61 million. Shareholders’ Funds Shareholders’ funds increased by 12.8% from HK$24,667 million in 2005 to HK$27,828 million in 2006, mainly attributable to results for the year and revaluation gains associated with investment properties and listed securities portfolios. Adjusted shareholders’ funds rose from HK$27,134 million in 2005 to HK$30,729 million in 2006. Minority Interests The increase of HK$94 million in minority interests was attributable to increased profi t contribution as well as a revaluation surplus from Lee Gardens Two. 2 7 HYSAN ANNUAL R EPORT 2006 Operations Review Contingent Liabilities As of 31 December 2006, there were no guarantees granted to external parties, since all outstanding guarantees relating to associates and investee companies were released during the year. The Group has underwritten to its associates on cash calls to fi nance working capital requirements. Based on currently available information, management does not anticipate any major call for cash contributions in the foreseeable future. Critical Accounting Estimates The preparation of fi nancial statements requires management to make judgments, estimates and assumptions that aff ect the application of policies and reported amounts of assets and liabilities, income and expenses. The most signifi cant estimate relates to the valuation of the Group’s property investments. For details, please refer to note 4 to the fi nancial statements. Capital Expenditure and Management The Group is committed to enhancing the asset value of its investment properties portfolio through selective re-tenanting, refurbishment, repositioning and redevelopment. The Group also has in place a portfolio-wide whole-life cycle maintenance programme as part of its ongoing strategy to proactively review and implement maintenance activities. The redevelopment of Hennessy Centre, with demolition works commencing in the fourth quarter of 2006, is on schedule. This mixed offi ce/retail complex has a projected gross fl oor area of approximately 710,000 square feet. Total cash outlay of capital expenditure (excluding purchase of plant and equipment) during the review year was HK$81 million. The following graph illustrates capital expenditure patterns during the last fi ve years: Capital Expenditure HK$ million 600 480 360 240 120 0 528 399 370 104 81 2002 2003 2004 2005 2006 2 8 HYS AN ANN UAL REPORT 2006 The Group has an internal control system for scrutinising capital expenditure. Detailed analysis of expected risks and returns is submitted to division heads, executive Directors or the Board for consideration and approval, depending on strategic importance, cost/benefi t and the size of the projects. The criteria for assessment of fi nancial feasibility are generally based on net present value, pay back period and internal rate of return from projected cash fl ow. At year end, the Group had HK$3.6 billion undrawn committed bank facilities. These facilities, together with the Medium Term Note Programme, available-for-sale investments and positive cash fl ows from local and overseas operations, provide adequate fi nancial resources to fund the level of planned capital expenditure, including the Hennessy Centre redevelopment project, which the completion is expected by the end of 2009. 2 9 HYSAN ANNUAL R EPORT 2006 Operations Review BAMBOO GROVE Mid-Levels L e e G a r d e n R o P e r c i v a l S a t r e e t d Hennessy Road 500 HENNESSY ROAD (Under redevelopment) Yee Wo Street Victoria Park LEE THEATRE PLAZA LEIGHTON CENTRE ONE HYSAN AVENUE e u n e n A v a s H y LEE GARDENS TWO AIA PLAZA 111 LEIGHTON ROAD THE LEE GARDENS SUNNING PLAZA SUNNING COURT Leighton Road N BA MBOO GROVE 74 - 86 Ken nedy Road, M id-L evels A luxury residential complex in the Mid Levels, Bamboo Grove underwent major refurbishment in 2002 to enhance both the value and quality of the complex. The complex commands panoramic views of the harbour and the greenery of the Peak, and is well served by many different types of public transport. In addition to superb property management services and full club house and sports facilities, tenants also enjoy personalised Resident Services that help ensure a comfortable stay. Total Gross Floor Area: 691,546 sq.ft. Parking Spaces: 436 Number of Units: 345 Year Completed/Renovated: 1985/2002 LEIGHTON CE N T R E 7 7 L eighton Road, Causeway B ay This office and retail complex enjoys close proximity to all forms of public transport. Its central location in the Causeway Bay area makes it a much sought after location for many professional practices. Upgrading works on building facilities were completed in 2004. Total Gross Floor Area: 435,008 sq.ft. Parking Spaces: 264 Number of Floors: 28 Year Completed/Renovated: 1977/2004 LEE THE AT R E PL A ZA 99 Percival St reet, Causeway B ay Like its predecessor, Lee Theatre, the Lee Theatre Plaza is a Hong Kong landmark, being one of the city’s most popular shopping and dining complexes, and housing many of the world’s most famous lifestyle brands and restaurants. The building provides access to various kinds of transport and the MTR Causeway Bay station. Total Gross Floor Area: 317,160 sq.ft. Year Completed: 1994 Number of Floors: 26 50 0 Hen nessy Road, Causeway B ay Under redevelopment. Estimated total Projected Year of Completion: End of 2009 Gross Floor Area: Approx. 710,000 sq.ft. 3 0 HYS AN ANN UAL REPORT 2006 Hong Kong Stadium ON E HYSA N AVE N UE 1 Hysa n Avenue, Causeway B ay Located at the junction of three busy streets in the heart of Causeway Bay, this office and retail complex enjoys a prime location with a diversity of retail facilities in the surrounding area. The building underwent refurbishment of its external facade in 2002. Total Gross Floor Area: 169,019 sq.ft. Year Completed/Renovated: 1976/2002 Number of Floors: 26 THE LEE GA R DE NS 33 Hysa n Avenue, Causeway B ay The Lee Gardens is the Group’s flagship property comprising an office tower, Manulife Plaza, and a high end shopping centre. The development, close to the MTR Causeway Bay station, enjoys spectacular views of the Harbour and Happy Valley and is home to many international corporations, luxury fashion brands and renowned restaurants. Total Gross Floor Area: 902,797 sq.ft. Parking Spaces: Number of Floors: 53 Year Completed: 200 1997 LEE GA R DE NS T WO 28 Yu n P i ng Road, Causeway B ay Lee Gardens Two is an office and retail complex. The retail podium underwent a comprehensive refurbishment in 2003 and was re launched as Lee Gardens Two. The complex is conveniently linked to the neighbouring The Lee Gardens and is home to many international corporations, luxury fashion brands, renowned restaurants and a children’s concept floor. Total Gross Floor Area: 626,996 sq.ft. Parking Spaces: 176 Number of Floors: 34 Year Completed/Renovated: 1992/renovation of retail podium in 2003 SU N NING PL A ZA 10 Hysa n Avenue, Causeway B ay Designed by the renowned architect I.M. Pei, Sunning Plaza greets tenants and visitors with a spacious entrance and lift lobby. Among its retail tenants are popular food and beverage outlets, which have established the Plaza as a hub for relaxation and social recreation. Total Gross Floor Area: 279,717 sq.ft. Parking Spaces: 150 (jointly with Sunning Court) Number of Floors: 30 Year Completed: 1982 SU N NING COURT 8 Hoi P i ng Road, Causeway B ay The 19 level Sunning Court is a unique residential tower in the dynamic Causeway Bay area. Located in a pleasant environment with tree lined streets, and within easy reach of all forms of relaxation and entertainment in the surrounding district, the building provides maximum comfort for its tenants. The building underwent refurbishment of its external facade in 2003. Total Gross Floor Area: 97,516 sq.ft. Parking Spaces: 150 (jointly with Sunning Plaza) Number of Units: 59 Year Completed/Renovated: 1982/2003 AIA PL A ZA 18 Hysa n Avenue, Causeway B ay AIA Plaza is a 25 level office and retail complex at the corner of Hysan Avenue. The building boasts a bright and spacious lobby, and houses restaurants, specialty cafes and banking services. Total Gross Floor Area: 139,119 sq.ft. Year Completed: 1989 Number of Floors: 25 111 LEIGHTON ROA D 111 L eighton Road, Causeway B ay Located in a pleasant and quieter area in the heart of Causeway Bay, 111 Leighton Road is an ideal office location for professional and designer firms. The retail shops include a European kitchen concept store and fashion stores. Total Gross Floor Area: 79,905 sq.ft. Year Completed/Renovated: 1988/2004 Number of Floors: 24 3 1 HYSAN ANNUAL R EPORT 2006 Financial Policy We adhere to a policy of fi nancial prudence. Our objectives are to: • maintain a strong balance sheet by actively managing debt level and cash fl ow • secure diversifi ed funding sources from both banks and capital markets • minimise refi nancing and liquidity risks by attaining healthy debt repayment capacity, maturity profi le, and availability of banking facilities with minimum collateral on debt • manage the exposures arising from adverse market movements in interest rates and foreign exchange through appropriate hedging strategies • monitor counter-party risks by imposing proper counter-party limits and reduce fi nancial investment risks by holding quality marketable securities Key Indicators Average finance costs 2006 4.9% 2005 Movements 3.6% Interest rate hikes (the Fed fund target rate increased by 1% in 2006) Bank facilities : capital market issuance 25% : 75% 47% : 53% Application of sale proceeds from the Entertainment Building to repay bank loans Average debt maturity 5.0 years 5.2 years No significant movement Floating rate debt (% on total debt) 64.7% 49.8% Move towards longer term target of 70% floating rate amid flattened yield curve Net interest coverage (Note 1) 6.9 times 4.6 times Lower debt level outweighs Net debt to equity (Note 2) Credit ratings • Moody’s • Standard and Poor’s the impact of higher interest rates 7.9% 10.7% Reduced net debt and higher adjusted shareholders’ funds Baa1 BBB Baa1 BBB Investment grade rating unchanged Investment grade rating unchanged Notes: (1) Gross profit less administrative expenses before depreciation divided by net interest expenses (2) Gross debt less cash and cash equivalents divided by adjusted shareholders’ funds The Treasury policy manual lays down the acceptable range of operational parameters and gives guidance on the above areas in order to achieve the objective of fi nancial prudence. Treasury has an overall objective of optimisation of borrowing costs: that is, to minimise the fi nance costs subject to the constraints of the operational parameters. The cost of fi nancing was 4.9% for 2006. FINA NCING As at 31 December 2006, the total outstanding borrowings of the Group amounted to HK$2.9 billion, a decrease of 34.1% from HK$4.4 billion in 2005. All the outstanding borrowings are on unsecured and on a committed basis. The lowered debt level was attributed to cash fl ow 3 2 HYS AN ANN UA L REPORT 200 6 from operations and the non-recurring cash receipts from the sale of Entertainment Building and equity investment. The remaining balance of the proceeds was placed in bank deposits. During the year, the Group has also repurchased a total nominal amount of US$18 million of the US$200 million 10-year fi xed rate notes issued in February 2002. The repurchases were intended to make better use of the cash and eff ectively lower the net fi nance cost of the Group. The Group always takes a prudent approach towards managing its loan portfolio. On the individual loan level, the Group strives to lower the borrowing margin as far as possible; but on the portfolio level, the more important objectives are to ensure suffi cient available facilities, to diversify the funding sources and to maintain a suitable average tenor relative to the overall duration of the use of the funds. Sources of Financing at Year–End HK$ million 6,000 The Group has also established long-term relationships with a number of local and overseas banks. At present, 14 local and overseas banks have provided bilateral banking facilities to the Group and such bank borrowings accounted for about 25% of the Group’s total borrowings while the remaining 75% outstanding debts were sourced from the capital market. 4,800 3,600 2,400 1,200 0 5.3% 33.1% 37.6% 34.3% 53.0% 66.9% 60.4% 62.4% 75.3% 47.0% 24.7% 2002 2003 2004 2005 2006 Syndicated and club loans Capital market issuances Bank bilateral loans LIQUIDIT Y A N D CASH BA L A NCE The Group understands the importance of liquidity and thus places great emphasis on liquidity management. The Group’s major sources of liquidity are from the strong recurring cash fl ows of the business and the committed banking facilities. Further liquidity reserve is maintained in the form of highly liquid securities listed on the Hong Kong Stock Exchange. As at 31 December 2006, the market value of these securities totalled HK$1.7 billion and the balance of bank deposits amounted to HK$0.4 billion. Furthermore, the total undrawn committed facilities of HK$3.6 billion as at 31 December 2006, essentially allows the Group to obtain the same level of liquidity as holding the equivalent amount of cash. Other measures taken against liquidity risk due to the lack of funds for repayment of maturing debts include maintaining an evenly spread maturity profi le and reducing the concentration of debts maturing in the near term. As at 31 December 2006, 56.3% of the outstanding debts will only be due after fi ve years. Furthermore, there will not be any outstanding debt maturing within the next two years. The average maturity of the debt portfolio was about 5.0 years. Therefore, there will be no refi nancing pressure on our outstanding debts in the next few years. 3 3 HYSAN ANNUAL R EPORT 2006 Financial Policy The maturity profi le is as follows: Debt Maturities Maturing in more than two years but not more than five years Maturing in more than five years Total 2006 HK$ million 2005 HK$ million 1,270 1,639 2,909 1,956 2,419 4,375 Total debt at end of 2006 was HK$2.9 billion, HK$1.5 billion below the level in 2005. The source and application drivers leading to the lower debt are analysed below: Condensed Consolidated Cash Flow Statement Operating activities Cash generated from operations Tax paid Investing activities Disposals less additions in investment properties Interest and dividends received Disposals less additions of available for sale investments Receipts from overseas projects Others Financing activities Dividends paid Finance costs Net decrease in borrowings Others 2006 HK$ million 2005 HK$ million Change HK$ million 979 (61) 918 (80) 60 95 106 (6) 175 952 (111) 841 27 50 77 2,351 (2,431) 33 – 17 (7) 27 95 89 1 2,394 (2,219) (482) (144) (407) (200) (1,487) (1,248) 3 – (2,110) (1,855) (75) 56 (239) 3 (255) Net (decrease) increase in cash balances (1,017) 1,380 (2,397) Cash generated from operations was HK$979 million, an increase of HK$27 million from the previous year, refl ecting a stronger business performance. HK$61 million were used to pay the tax amount due during the year. Net cash generated from investing activities was HK$175 million, decreased from last year by HK$2,219 million. The change was mainly due to the disposal of Entertainment Building in 2005, while interest and dividends received, disposals less additions of available-for-sale investments and receipts from overseas projects increased by HK$211 million over 2005 comparatives. Net cash used in fi nancing activities in 2006 primarily resulted from interest payment and repayment of debt borrowings of HK$1,631 million and the payment of dividends of HK$482 million. 3 4 HYS AN ANN UA L REPORT 200 6 IN TER E ST R ATE EX POSUR E Interest expenses account for a signifi cant proportion of the Group’s total expenses. Therefore, the Group monitors its interest rate exposures closely. Depending on our medium-term projections of interest rates, an appropriate hedging strategy would be adopted to manage the exposure. 4,800 3.65% HK$ million 6,000 Debt Levels and Borrowing Costs The Group’s cost of fi nancing in 2006 was 4.9%. The Federal funds rate continued its progressive 0.25% increase during the fi rst half of 2006 and remained stable for the remainder of the year, in line with market expectations. The orderly increase has a fl attening eff ect on the forward interest rate yield curve, diminishing the fi nancial benefi t of maintaining a high level of fi xed rate debt. For this reason, the focus returned to our longer term target of 30% fi xed rate debt portion, hence some of the interest rates hedging instruments expired in 2006 were not replaced. As a result, the interest rate hedging ratio has decreased from 50.2% in 2005 to 35.3% in 2006. Average Borrowing Costs Year end Gross Debt 2.69% 2.54% 7 0 9 , 5 2 2 9 , 5 2 1 6 , 5 4 8 6 , 5 7 0 7 , 5 0 9 5 , 5 2,400 3,600 1,200 2002 2004 2003 0 Year end Net Debt (Gross debt less cash and cash equivalents) 4.90% 3.60% 5 7 3 , 4 3 7 9 , 2 9 0 9 , 2 4 2 5 , 2 2005 2006 FOR EIGN E XCHA NGE E X POSUR E The Group aims to have minimal mismatches in currency and does not speculate in currency movements. With the exception of the US$182 million 10-year notes, which have been hedged by appropriate hedging instruments, all of the Group’s other borrowings were denominated in Hong Kong dollars. Other foreign exchange exposure relates to the investments in overseas projects in Singapore and Shanghai. These foreign exchange exposures amounted to the equivalent of HK$1,283 million or 3.5% of the total assets. USE OF DERIVATIVE S The Group uses derivatives extensively to manage the volatilities and pricing risks of its treasury assets and liabilities, the bulk of which are related to hedging interest rate and foreign exchange exposures. To avoid the Group being exposed to losses arising from the use of derivatives, the potential impact of their use is evaluated thoroughly before executing the transactions. Before entering into any hedging transaction, the Group will ensure that the counterparty possesses strong investment-grade ratings so that the transaction will not expose the Group to undue credit risk. As part of our risk management, a limit on maximum risk-adjusted credit exposure is assigned to each counterparty. The level of the limit is basically in line with the credit quality of the counterparty. 3 5 HYSAN ANNUAL R EPORT 2006 Internal Control and Risk Management REVIEW OF GROUP IN TER NAL CON T ROL SYSTEM IN 20 06 The Committee of Sponsoring Organizations of the U.S. Treadway Commission (“COSO”) set down the generally recognised global framework of internal control systems. Internal control is defi ned as a process eff ected by an entity’s board, management and other personnel to provide reasonable assurance regarding the achievement of its objectives. It has fi ve components, namely, Control Environment, Risk Assessment, Control Activities, Information and Communications, and Monitoring. It is important to recognise that an internal control system aims to manage rather than eliminate risks; and to provide reasonable but not absolute assurance. Hysan’s Board of Directors has the overall responsibility to ensure that sound and eff ective internal control are maintained, while management is charged with the responsibility to design and implement an internal control system. The Group’s core operation is property leasing and management, which involves relatively simple and well-established business processes. The Group has a well-established Control Environment, emphasising high standards of corporate governance and business ethics. Its Control Activities have traditionally been built on senior management reviews (with controls being vested in the hands of a small management team); segregation of duties and physical controls. Management recognises that enhancement of our internal control system is necessary to support the continual growth of the Group. In terms of management style, we also aim to move towards a culture based on systematic and structured control principles. In this light, management has undertaken a phased review project on Group internal control system during 2006 and has enhanced its internal control system in the following ways: • Strengthening the Control Environment: management takes the view that this forms the foundation of internal control by setting the tone across the organization. • Formalising and documenting policies and procedures for all key operational, fi nancial reporting and compliance functions. • Requiring department managers to undergo a detailed self-risk assessment process using a common risk management framework, with facilitation and assistance from a reputable international accounting fi rm (“Independent Advisor”). • Engaging the Independent Advisor to assess and report on the adequacy and eff ectiveness of the established internal control arrangements by performing independent reviews and testings. Integrity and ethical value Importance of the Board of Directors CON T ROL E N VIRONME N T The Group’s Control Environment has the following components: • • • Management’s philosophy and operating style • Levels of authority and responsibility • Human resources policies 3 6 HYS AN ANN UA L REPORT 200 6  R i s k Assessment Determine impact of such identified risks on the achievement of corporate objectives C o n t i n u ous Improvement Identify and analyse risks to achievement of corporate objectives Determine how each of the other internal control components, both separately and together, mitigate such risks Specify Corporate Objectives Refine corporate objectives based on changes potentially impacting the business Hysan’s internal control system: • is designed to ensure corporate objectives are achieved • has five components that work together E E x x a a m m i i n n e e o o p p p p o o r r t t u u nities for improvement in c o n t nities for improvement in c o n t e f f e e f f e r o l r o l y y c c n n e e i i c c i i f f f f e e d d n n c tive ness a c tive ness a Monitoring • Independent review by Independent Advisor in 2006 • Will set up internal audit function in 2007 Information and Communication Implement and operate information and communication to support internal control Control Activities • Documented key control policies and processes • Facilitation by Independent Advisor Control Environment • Strong tradition of emphasising good corporate governance • Strengthened human resources policies Determine Effectiveness The Group has in place a formal Code of Ethics emphasising the key principles of “respect for people”, “ethics and business integrity” and “meeting our responsibility”. Guidelines on specifi c areas including corporate and fi nancial reporting, confl icts of interest, personal benefi ts, relations with suppliers and contractors have been issued. As part of the Group’s staff orientation programme, new personnel are informed of our Code of Ethics, corporate mission, and objectives. We also provide periodically updated information and seminars to serve as a constant reminder to staff . Relevant documents are also posted on our intranet, providing easy access for all. Suspected breaches of the Code of Ethics are reported directly to the Head of Human Resources (instead of business lines), who in turn reports to the Managing Director. The Board and management are committed to maintaining high standards of corporate governance. The Board continually enhances its eff ectiveness in fulfi lling its stewardship role including monitoring management performance. Details are set out in the separate Corporate Governance Report (page 44). Management recognises the signifi cance to address the possibility of management overriding established control policies and procedures. This is particularly important during this early stage of the Group’s formalisation of key policies and procedures, and in the context of a family-controlled company. Formal and specifi c guidelines stating the need to have minimal management overrides are communicated in meetings, which are then issued across the organisation. 3 7 HYSAN ANNUAL R EPORT 2006 Internal Control and Risk Management The Group has formalised and strengthened certain key Human Resources policies to further enhance the eff ectiveness of internal control. Development of people and of their competence, as well as segregation of duties in key people management activities including staff hiring and termination are emphasised. The recruitment process stresses eff ectiveness as well as transparency, thereby ensuring appropriate checks-and-balances between business lines and Human Resources department. Disciplinary and grievance policies are set out with transparent procedures and appropriate levels of line authority. Instances involving breaches of Code of Ethics will be handled independently of business line management. These policies have been communicated, reinforced and monitored across the organization during the review year. CON T ROL ACTIVITIE S A N D RISK ASSE SSME N T In pursuit of the objective to move towards a culture based on systematic and structured control principles, including allowing appropriate delegation of routine transactions while minimizing policy exceptions and overrides, management has further enhanced the Group’s internal control system in 2006 by taking the following steps: • Mapping control processes: management has conducted an entity-wide exercise to map all key control processes to appropriate control objectives, as derived from the Group’s Mission Statement, strategic management objectives, fi nancial/general operational controls. • Establishing ownership: process owners are identifi ed who have the responsibility of ensuring that controls exist and are in operation. • Updating policies and procedures: the process owners are also responsible for documenting and updating the relevant policies in light of self-risk assessment. A document called “risk register” is created which sets out the main strategic and operational risks that have been identifi ed, and how these are managed. The process owners are responsible for maintaining the relevant risk registers. • Setting up functional groups or committees: specifi c focus groups or committees on certain areas of control are engaged once the objectives and principles are established. Examples are the budget review committees. This exercise was accomplished in combination with a self-risk assessment process, which allowed line managers to make a more informed decision as to whether certain policies would need further refi nement. The Independent Advisor was engaged to conduct facilitated workshops and interviews to assist department managers in performing the self-risk assessment. The process owner has to assess the likelihood of the relevant risk occurring, in accordance with the Group’s risk management framework. The Managing Director and the Chief Financial Offi cer report the results of their review of the risk registers to the Audit Committee and to the Board. 3 8 HYS AN ANN UA L REPORT 200 6 As a result of the Independent Advisor’s review, certain potential improvement areas were identifi ed. These include the further strengthening of segregation of duties as well as the checks- and-balances system. Management has adopted all the recommendations and established clear timelines for implementation. Progress will be reported to the Audit Committee and the Board. MONITORING In the absence of an internal audit function, the Independent Advisor was engaged to perform an agreed review and testings. No major defi ciencies were identifi ed. The Group’s external auditors, Deloitte Touche Tohmatsu, have audited the fi nancial statements for the year ended 2006 and have reviewed the internal control systems to the extent that they considered necessary to support their audit report. Management has reviewed the need for and planned to establish an internal audit function during 2007. The scope of work of internal auditors, unlike that of the external auditors, is not restricted to risks relating to fi nancial statements. The internal auditors will perform independent reviews and provide the Audit Committee and the Board with an objective view as to the adequacy and eff ectiveness of the internal control systems established by management. This plan is also endorsed by the Independent Advisor. COM MU NICATION The signifi cance of internal control and risk management is communicated to staff members by way of internal meetings, updates and workshops. The risk assessment workshops facilitated by the Independent Advisor also raised the risk awareness of line managers. Moving forward, communication will be a key area of focus with the aim of further strengthening general risk awareness across the organisation. Management also plans to engage an independent service provider, with direct reporting line to the Audit Committee, to monitor the whistle-blowing system under the Code of Ethics. This should make staff feel even more comfortable and protected should they want to express concerns involving the management. In general, the establishment of a whistle-blowing system and an internal audit function refl ects management’s commitment to further strengthening our Control Environment. COMPLIA NCE WITH CODE OF COR POR ATE GOVER NA NCE R EQUIR EME N TS Directors acknowledge their responsibility for the Group’s internal control systems and confi rm they have reviewed and are satisfi ed as to its eff ectiveness in managing risks. In doing so, the Board has taken note of management’s reports and the fi ndings of the review performed by the Independent Advisor. Management has adopted the Independent Advisor’s recommendations aimed at further strengthening the Group’s internal control, which is a continual process. Actions are in progress in accordance with established timelines. 3 9 HYSAN ANNUAL R EPORT 2006 Board of Directors and Senior Management ST RUCT UR E THE BOA R D CHAIR M A N M A NAGING DIR ECTOR Audit Committee Emoluments Review Committee Nomination Committee Investment Committee Finance Corporate Services Property Investment Property Services Property Development CHAIR M A N Peter Ting Chang LEE (I, chairing N) J.P. IN DEPE N DE N T NON-EX ECU TIVE DEPU T Y CHAIR M A N Sir David AKERS-JONES (N, chairing A, E) G.B.M., K.B.E., C.M.G., J.P. NON-EX ECU TIVE DIR ECTORS Fa-kuang HU (E) G.B.S., C.B.E., J.P. Hans Michael JEBSEN (I) B.B.S. Anthony Hsien Pin LEE (chairing I) Chien LEE (A) Dr. Deanna Ruth Tak Yung RUDGARD M A NAGING DIR ECTOR Michael Tze Hau LEE (I) IN DEPE N DE N T NON-EX ECU TIVE DIR ECTORS Per JORGENSEN (A) Dr. Geoff rey Meou-tsen YEH (E, N) S.B.S., M.B.E., J.P., D.C.S., M.Sc., F.C.I.O.B., F.Inst.D. EXECUTIVE DIRECTOR Pauline Wah Ling YU WONG COMPA N Y SECR ETA RY Wendy Wen Yee YUNG (A) Audit Committee (E) Emoluments Review Committee (N) Nomination Committee (I) Investment Committee 4 0 HYS AN ANN UA L REPORT 200 6 BOA R D OF DIR ECTORS PETER TING CHA NG LEE Chairman (I, chairing N) J.P. Mr. Lee joined the Board in 1988, became Managing Director in 1999, and Chairman in 2001. He is a non executive director of Cathay Pacific Airways Limited, CLP Holdings Limited, Hang Seng Bank Limited, SCMP Group Limited, Maersk China Limited, and a director of a number of other companies. He is also vice president of the Real Estate Developers Association of Hong Kong. He is a member of the founding Lee family and a director of Lee Hysan Estate Company, Limited, a substantial shareholder of the Company. Mr. Lee holds a Bachelor of Science Degree in Civil Engineering from the University of Manchester and is also qualified as a Solicitor of the Supreme Court of England and Wales. He is aged 53. SIR DAVID A K ERS -JON E S Independent non-executive Deputy Chairman (N, chairing A, E) G.B.M., K.B.E., C.M.G., J.P. Sir David is Chairman of GAM Hong Kong Limited, Deputy Chairman of CNT Group Limited and a non executive director of various other companies. He is also a chairman and member of various voluntary organisations. He received his Master of Arts Degree at Oxford University. He was formerly the Chief Secretary of Hong Kong. He was appointed a Director in 1989 and became the Deputy Chairman in 2001. He is aged 79. MICHA EL TZE HAU LEE Managing Director (I) Mr. Lee joined the Board in 1990, became Chief Operating Officer in 2002, and Managing Director in 2003. He is a member of the Main Board and Growth Enterprise Market Listing Committees of The Stock Exchange of Hong Kong Limited, a member of the Securities and Futures Commission (HKEC Listing) Committee, a non executive director of Tai Ping Carpets International Limited, a director of Equestrian Events (Hong Kong) of the Games of the XXIX Olympiad Company Limited, and a Steward of Hong Kong Jockey Club. He is a member of the founding Lee family and a director of Lee Hysan Estate Company, Limited, a substantial shareholder of the Company. Mr. Lee received his Bachelor of Arts Degree from Bowdoin College and his Master of Business Administration Degree from Boston University. He is aged 45. FA-KU A NG HU Non-executive Director (E) G.B.S., C.B.E., J.P. Mr. Hu is Honorary Chairman of Ryoden Development Limited. He is also an independent non executive director of i CABLE Communications Limited. Mr. Hu holds a Bachelor of Science Degree from Shanghai Jiao Tong University. He was appointed a non executive Director in 1979 and is aged 83. HA NS MICHA EL JEBSE N Non-executive Director (I) B.B.S. Mr. Jebsen is Chairman of Jebsen and Company Limited as well as a director of other Jebsen Group companies worldwide. He is also an independent non executive director of The Wharf (Holdings) Limited. He was appointed a non executive Director in 1994 and is aged 50. 4 1 HYSAN ANNUAL R EPORT 2006 Board of Directors and Senior Management PER JORGE NSE N Independent non-executive Director (A) Mr. Jorgensen is a director of A.P. Moller Maersk A/S, Denmark and a number of A.P. Moller Maersk companies in Asia, Africa and Europe. He was appointed a non executive Director in 1981 and as Independent non executive Director in 2000. He is aged 71. A N THON Y HSIE N PIN LEE Non-executive Director (chairing I) Mr. Lee is a director and substantial shareholder of the Australian listed Beyond International Limited, principally engaged in television programme production and international sales of television programmes and feature films. He is also a director of Australian listed Mariner Financial Limited, a Sydney based financial services group. He received a Bachelor of Arts Degree from Princeton University and a Master of Business Administration Degree from The Chinese University of Hong Kong. Mr. Lee is a member of the founding Lee family and a director of Lee Hysan Estate Company, Limited, a substantial shareholder of the Company. He was appointed a non executive Director in 1994 and is aged 49. CHIE N LEE Non-executive Director (A) Mr. Lee is a private investor and a non executive director of a number of companies including Swire Pacific Limited and Television Broadcasts Limited. He is a member of the founding Lee family and a director of Lee Hysan Estate Company, Limited, a substantial shareholder of the Company. Mr. Lee received a Bachelor of Science Degree in Mathematical Science, a Master of Science Degree in Operations Research and a Master of Business Administration Degree from Stanford University. Mr. Lee was appointed a non executive Director in 1988 and is aged 53. DR. DE A N NA RU TH TA K Y U NG RUDGA R D Non-executive Director Dr. Rudgard received a Master of Arts Degree, Bachelor of Medicine and of Surgery Degree from Oxford University. She is a member of the founding Lee family and a director of Lee Hysan Estate Company, Limited, a substantial shareholder of the Company. She was appointed a non executive Director in 1993 and is aged 67. DR. GEOFFR EY MEOU-TSE N YEH Independent non-executive Director (E, N) S.B.S., M.B.E., J.P., D.C.S., M.Sc., F.C.I.O.B., F.Inst.D. Dr. Yeh is former Chairman of Hsin Chong Construction Group Ltd. He is currently an independent non executive director of China Travel International Investment Hong Kong Limited. He holds a Bachelor of Science Degree from University of Illinois and a Master of Science Degree from Harvard University. Dr. Yeh was appointed a non executive Director in 1979 and as Independent non executive Director in 2001. He is aged 75. PAULIN E WAH LING Y U WONG Executive Director Mrs. Wong is responsible for the Group’s investment properties activities. Having obtained a Bachelor of Arts Degree from The University of Hong Kong, she qualified as a Fellow Member of the Chartered Institute of Housing. She joined the Company in 1981 and has over 30 years of experience in the property field. She was appointed a Director in 1991 and is aged 58. 4 2 HYS AN ANN UA L REPORT 200 6 From left to right: John Che Kong HO (Group Financial Controller)(cid:18)(cid:2)Ricky Tin For TSANG (Chief Financial Officer), Michael Tze Hau LEE (Managing Director), Peter Ting Chang LEE (Chairman), Pauline Wah Ling YU WONG (Executive Director), Wendy Wen Yee YUNG (Company Secretary), Alex Chun Wan LUI (Senior Advisor, Urban Design and Architectural Services) SE NIOR M A NAGEME N T RICKY TIN FOR TSA NG Chief Financial Offi cer Mr. Tsang is responsible for the Group’s finance. He holds a Master’s Degree in Engineering from Oxford University, is qualified as a Chartered Accountant with the Institute of Chartered Accountants in England and Wales and is a Fellow of Hong Kong Institute of Certified Public Accountants. Mr. Tsang is also a member of the Association of Corporate Treasurers in the United Kingdom. Prior to joining the Group in 2004, he held senior business and finance positions with leading financial institutions in Hong Kong and the United Kingdom. He has extensive experience in management and finance including risk management, treasury and financial control. He is aged 45. W E N DY W E N Y EE Y U NG Company Secretary Ms. Yung is responsible for the Group’s corporate services including legal and secretarial, human resources and administration, as well as corporate communications. A solicitor by training, she holds a Master of Arts Degree from Oxford University. Ms. Yung is also a Member of the Hong Kong Institute of Certified Public Accountants. She sits on the Hong Kong Selection Committee of the Rhodes Scholarships, and a number of committees of the Hong Kong Institute of Certified Public Accountants and the Hong Kong Institute of Chartered Secretaries respectively. Prior to joining the Group in 1999, she was a partner of an international law firm in Hong Kong. She is aged 45. A LEX CHU N WA N LUI Senior Advisor, Urban Design and Architectural Services Mr. Lui is responsible for the Group’s urban design and architectural services. He is a Registered Architect and an Authorised Person (Architect). He holds a Master’s Degree in City Planning from the Massachusetts Institute of Technology and a Bachelor of Architecture Degree from The University of Hong Kong. Before joining the Group in 2002, he was Professor in Architecture at the Chinese University of Hong Kong and has practised architecture and urban design for almost 30 years in Hong Kong, Singapore and the USA. He is aged 63. JOHN CHE KONG HO Group Financial Controller Mr. Ho is responsible for the Group’s financial and reporting affairs. He holds a Master of Business Administration Degree from the Chinese University of Hong Kong, and is a Fellow of the Association of Chartered Certified Accountants and the Hong Kong Institute of Certified Public Accountants. He is also a Chartered Management Accountant of The Chartered Institute of Management Accountants. Prior to joining the Group in 2005, he held financial controller positions with leading construction companies and had over 10 years of auditing experience with an international accounting firm. He is aged 39. 4 3 HYSAN ANNUAL R EPORT 2006 Corporate Governance Report ACCOU N TA BILIT Y, T R A NSPA R E NCY, IN T EGRIT Y The Board and management of the Group are committed to maintaining high standards of corporate governance. Underlying this commitment is our aim to be a responsible business. To Hysan, governance is not an exercise in compliance but a more powerful concept. The Board, as representative of our shareholders, is responsible for achieving consistent and sustainable long-term returns. We believe that such long-term success is only made possible by eff ective governance. The cornerstones of our corporate governance practices are accountability, transparency, and integrity. Best Practices in Corporate Governance in Place at Hysan Exceeded Code Provisions Hysan’s Corporate Governance Practices The Board first established a formal Corporate Governance Policy in 2004. The Board has formally designated a “senior” Independent non executive Director, Sir David Akers Jones, who currently serves as Independent non executive Deputy Chairman. [NEW] The Board has established formal mandates and responsibilities for itself, with clear division of roles with management. [NEW] The Board has established formal criteria and requirements for non executive director appointments. [NEW] Board evaluation: Chairman and non executive Directors meet at regularly scheduled sessions without presence of management. The Group has established a Corporate Disclosure Policy to guide its communications with its stakeholders in order to ensure consistent and timely disclosure. [NEW] The Group has demonstrated its commitment to transparency in shareholder reporting by publishing a separate Corporate Governance Report since 2001. This year, we have introduced a Corporate Responsibility Report. [NEW] In 2004 the Group introduced a new form of annual general meeting (“AGM”) that went beyond discharging statutory business. A detailed business review session led by the Chairman and Managing Director was established. The Group has initiated and funded a programme inviting major nominee companies to pro actively forward communication materials to shareholders at its expense. The Group has a written Code of Ethics applicable to all staff. P P P P P P P P P P 4 4 HYS AN ANN UA L REPORT 200 6 CODE PROVISIONS COMPLIANCE The Group has complied throughout the review year with the Code Provisions contained in the Code on Corporate Governance Practices (the “Corporate Governance Code”) set out in Appendix 14 of the Rules (the “Listing Rules”) Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (“Stock Exchange”), except that its Emoluments Review Committee (established since 1987) has the responsibility for determining executive Director compensation. In light of the current organisational structure and the relatively simple nature of Hysan’s business activities, the Board regards the current arrangements for the Emoluments Review Committee to determine executive Director compensation as appropriate. FOCUS IN 2006 AND CORPORATE GOVERNANCE REPORTING Hysan’s governance model seeks to combine the best of family ownership and professional management. We take the view that the element of family ownership can enable managers to take a long-term view in decision-making, whilst balancing short-term targets. We recognize, however, that appropriate checks-and-balances must be built in. In this light, we further strengthened our governance structure during 2006. New measures included establishing formal mandates for the Board and for the “senior” Independent non-executive Director, as well as setting down clear criteria for non-executive Director appointments. We recognize that eff ective governance does not stop at Board level. The Board must delegate to other executives, who in turn implement policies across the organisation. We therefore place strong emphasis on fostering an appropriate corporate culture across the Group. During the year, we began to formalize and communicate a set of corporate values to guide our staff in all their actions. The quality of disclosure has also been enhanced, notably in regard to Board activities, Board appointments, and internal control, all as a result of feedback from analysts. Detailed information on our governance structure and practices are set out in the following separate reports: • Corporate Governance Report • Audit Committee Report (Page 70) • Directors’ Remuneration and Interests Report (Page 63) • Report on Internal Control and Risk Management (Page 36) Further information relating to our underlying corporate values, and exchange of views with our “senior” Independent non-executive Director and analysts respectively are set out in a separate Corporate Responsibility Report. 4 5 HYSAN ANNUAL R EPORT 2006 Corporate Governance Report 1. HYSAN’S GOVERNANCE MODEL Hysan’s governance model is based on an eff ective combination of family ownership and professional management. Our founding shareholding family remains a major shareholder today. We take the view that this element of family ownership can enable managers to take a long-term view in decision-making, balancing the need to produce short-term results or earnings targets. In general, family owners also have a direct interest in the outcome of decisions made. This family ownership model is combined with a commitment to apply the principle of meritocracy in human resources management across the Group. Recruitment of professional management staff from outside the controlling shareholder base ensures that a wide net is cast for talent. Appropriate checks-and-balances are also built into our governance structure. These include the designation of a “senior” Independent non-executive Director and various board committees. The roles and responsibilities of the Board, non-executive Directors, and Board Committees are clearly delineated. AU THORIT Y Delegation through • clear policies and procedures • monitoring SHA R EHOLDERS BOA R D M A NAGEME N T ACCOU N TA BILIT Y Assurance through checks and balances: • monitoring • reporting 2. HOW OUR BOARD GOVERNS THE GROUP Corporate Governance Framework K EY GOVER NA NCE DOCU ME N TS There are many guidelines, policies, and procedures that support the governance framework at Hysan. The following documents are reviewed periodically and constitute key components of Hysan’s governance framework. They are available at www.hysan.com.hk. • Corporate Governance Guidelines • Board of Directors Mandate • Role requirements of non-executive Directors • Terms of Reference of various corporate governance-related Board Committees (Audit, Emoluments, and Nomination Committees) • Code of Ethics for Employees • Auditor Services Policy • Corporate Disclosure Policy To discharge its governance function in the most eff ective manner, the Board has laid down rules for its own activities in a set of Corporate Governance Guidelines. 4 6 HYS AN ANN UA L REPORT 200 6 The guidelines covers: • Mission of the Board • Board appointment and induction • Board Leadership: Chairman, Managing Director and “senior” Independent non- executive Director • “Independence” standards for outside Directors • Board authorities, delegations and discretions • Board compensation review • Board access to senior management; availability of information • Meeting procedures • Governance-related Board Committees N EW: FOR M A L BOA R D OF DIR ECTORS M A N DATE The Board is responsible for the stewardship of the Group and is accountable for ensuring that the Group and its subsidiaries are managed in such a way as to achieve the objective of prudent stewardship. The Board’s responsibility is, fi rstly, to formulate strategy and, secondly, to monitor and control operating and fi nancial performance in pursuit of the Group’s strategic objectives. The Board established a formal Board of Directors Mandate in 2007 setting out its key responsibilities in fulfi lling such stewardship roles. These include the following: DU TIE S A N D OBLIGATIONS The Board must understand and meet the duties and performance standards expected of it under applicable regulatory requirements. ST R ATEGIC PL A N NING The Board establishes, oversees and receives regular updates on the strategic direction, plans and priorities of the Group, and ensures that the Group has the necessary fi nances, people and systems in place to meet its objectives. IN TER NA L CON T ROL A N D RISK M A NAGEME N T The Board monitors and assesses procedures implemented to identify the principal risks of the Group’s business, receiving frequent updates on the same. CULT UR E A N D VA LUE S The Board promotes the culture of integrity and transparency and other corporate values. CA PITA L M A NAGEME N T The Board considers and approves Group activities relating to major capital expenditures, allocation of resources among the Group’s lines of business, and other major fi nancial activities. COR POR ATE GOVER NA NCE The Board promotes the highest standards of corporate governance. BOA R D SUCCE SSION The Board continually assesses and evaluates the skills and expertise needed on the Board. 4 7 HYSAN ANNUAL R EPORT 2006 Corporate Governance Report Matters Reserved For Board Decision The roles of the Board and of the management are separate and distinct. The Board’s role is not to manage business, which responsibility remains vested in management. Board responsibility is to test and question management, and to monitor progress. The Board and management fully appreciate their respective roles and are supportive of the development of a healthy corporate governance culture. The Board has in place a list of key matters that are to be retained for full Board decision including transactions with connected persons. These matters include: • Long-term objectives and strategies • Extension of Group activities into new business areas • Annual budgets • Preliminary announcements of interim and fi nal results • Dividends • Material banking facilities • Material acquisitions and disposals • Connected Transactions • Annual internal control assessment and • Appointments to the Board following recommendations by the Nomination Committee Where applicable, the “materiality” thresholds are based on Listing Rules requirements but they are set at lower levels, which means more stringent monetary levels. Board Focus in 2006 During 2006, the Board paid considerable attention to the development of the Group’s future growth strategy. Succession planning was considered in this light and the principle of meritocracy was formally established as the guiding principle of human resources management across the organisation. Formal role requirements for new director appointments were established. The Board also reviewed the Group’s internal control systems, which are moving towards an approach based on established principles and policies rather than concentration of power in the hands of a small number of management personnel. In this light, the Board strengthened the Board infrastructure, including formalising a Board Mandate which sets out the Board’s key responsibilities. 4 8 HYS AN ANN UA L REPORT 200 6 The Board held four meetings in 2006. Details of Directors’ attendance records are as follows: Executive Directors Peter T.C. Lee Michael T.H. Lee Pauline W.L. Yu Wong Independent non executive Directors Sir David Akers Jones Per Jorgensen Dr. Geoffrey M.T. Yeh Non executive Directors Fa kuang Hu Hans Michael Jebsen Anthony H.P. Lee Chien Lee Dr. Deanna R.T.Y. Rudgard Attendance (%) 100 100 100 100 75 100 (50 by alternate) 100 75 (75 by alternate) 100 100 100 (25 by alternate) 3. WHO IS ON THE BOARD The Board is composed of three executive and eight non-executive Directors. The Board is actively engaged in succession planning issues for both executive and non-executive roles. Diversity Hysan’s Board members bring an appropriately diverse set of experience, competencies, skills and judgment to the Board. From our experience, diversity of background and experience contributes to more eff ective Board deliberations. Skill/Experience of the Hysan Board Members Executive Directors • Top management (overall strategic direction and daily operations of Hysan) – Peter T.C. Lee (Chairman) and Michael T.H. Lee (Managing Director) • Business line – Pauline W.L. Yu Wong (Executive Director) Independent non executive Directors • Civil service – Sir David Akers Jones (Independent non executive Deputy Chairman) • Multi national corporations/global exposure – Per Jorgensen • Related business (construction) – Dr. Geoffrey M.T. Yeh Non executive Directors • Related business (real estate and investment) – F.K. Hu • Trading companies/global exposure – Hans Michael Jebsen • Finance and investment – Chien Lee and Anthony H.P. Lee • Professional – Dr. Deanna R.T.Y. Rudgard Directors’ biographies are set out on pages 41 and 42. 4 9 HYSAN ANNUAL R EPORT 2006 Corporate Governance Report BEST CORPORATE GOVERNANCE DISCLOSURE AWARDS 2006 NON-HANG SENG INDEX CATAGORY – GOLD AWARD ORGANISED BY THE HONG KONG INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS “THE 2005 REPORT OF HYSAN, IN A NUMBER OF WAYS, SETS A BENCHMARK FOR LISTED COMPANIES GENERALLY... IN A NUMBER OF ASPECTS, THE COMPANY’S CORPORATE GOVERNANCE PRACTICES EXCEED THE STANDARDS LAID DOWN BY THE CODE” EXTRACTED FROM JUDGES’ REPORT 4. BOARD INDEPENDENCE Independence The Board has established “independence” standards as contained in the Corporate Governance Guidelines. It considers “independence” as a matter of judgment and conscience. A Director is considered independent only where he is free from any business or other relationship that might interfere with the exercise of his independent judgment. The Board makes a determination concerning the “independence” of a Director each year at the time the Board approves Director nominees for inclusion in the AGM circular. If a Director joins the Board mid-year, the Board makes a determination on the new Director’s independence at that time. Currently, the Group has three Independent non-executive Directors who are identifi ed in our Annual and Interim Reports and other communications with shareholders. Dr. Geoff rey M.T. Yeh, Independent non-executive Director seeking re-election at this year’s AGM, has served the Board for more than nine years. Dr. Yeh has clearly demonstrated his willingness to exercise independent judgment and to provide objective challenges to management. There is no evidence that length of tenure is having an adverse impact on his independence. The Board therefore considers that Dr. Yeh remains independent, not- withstanding the length of his tenure. 5. DIRECTOR APPOINTMENTS AND RE-ELECTION Requirements The Nomination Committee is responsible for recommending candidates to the full Board for consideration. The Committee and, in turn, the Board reviews the skill set of the Director candidates as well as the Board as a whole. In 2007, the Board formalised the role requirements of non-executive Directors. 5 0 HYS AN ANN UA L REPORT 200 6 N EW: FOR M A L ROLE R EQUIR EME N TS OF NON-EX ECU TIVE DIR ECTORS The Board considers that its non-executive Directors have four key roles in addition to requirements applicable to all Directors: ST R ATEGY Non-executive Directors should constructively challenge, hence help develop proposals on strategy. PERFOR M A NCE Non-executive Directors should scrutinise the performance of management in meeting agreed goals and objectives. RISK Non-executive Directors should satisfy themselves on the integrity of fi nancial information and also that controls and systems of risk management are robust. PEOPLE Non-executive Directors are responsible for determining appropriate levels of remuneration for executive Directors and for succession planning. In terms of requirements, a non-executive Director must demonstrate the necessary time commitment to discharge his role eff ectively. He must also take all reasonable actions to avoid potential confl icts of interest and disclose any that may arise. In addition, an Independent non-executive Director must maintain his own independence as measured by the independence criteria for non-executive Directors agreed by the Board under its Corporate Governance Guidelines and applicable regulations. Term Non-executive Directors are appointed for a term of three years, with the qualifi cation that new Directors are required to submit themselves for re-election at the fi rst AGM following their appointment. The Group’s Articles of Association contains provisions regarding rotation of Directors so that every Director will be subject to retirement by rotation at least once every three years. Retiring Directors are subject to re-election at the general meeting at which they retire. 5 1 HYSAN ANNUAL R EPORT 2006 Corporate Governance Report 6. SERVING AS A DIRECTOR: INDUCTION, SUPPLY OF INFORMATION AND EVALUATION Induction and Update The Chairman, with the assistance of the Company Secretary, is responsible for the induction of new Board members. Directors receive induction on their appointment to the Board as appropriate, covering matters such as the operation and activities of the Group, the role of the Board and the matters reserved for its decision, the tasks and membership of the principal Board Committees, the powers delegated to those Committees, the Board’s governance policies and practices, and the latest fi nancial information about the Group. On their appointment, Directors are advised on the legal and other duties and obligations they have as directors of a listed company. Our Directors are updated on Hysan’s business, the environment in which it operates and other matters throughout their period in offi ce. The Board regularly considers the implications of their duties as directors of listed companies under the Board’s governance policies. Supply of Information The Board receives detailed quarterly reports from Managing Director, Executive Director and Chief Financial Offi cer in respect of their areas of responsibility. Appropriate key performance indicators are used to facilitate benchmarking and peer group comparison. Financial plans, including budgets and forecasts, are regularly discussed at Board meetings. From time to time, the Board also receives presentations, including from non-Board management members, on issues of signifi cance or on new opportunities for the Group. The non-executive Directors and the Chairman regularly meet without executives being present. Non-executive Directors also have access to non-Director management staff where appropriate. These ensure that the Board will be given the answers it needs. In terms of the Board process, non-executive Directors are given ample opportunity to add items to the agenda of Board meetings. “THE INCLUSION OF COMPANIES INCLUDING HYSAN ON THE TOP 10 LIST DISPELS THE PREVAILING MYTH THAT FAMILY-CONTROLLED COMPANIES DO NOT HAVE GOOD CORPORATE GOVERNANCE.” PROFESSOR STEPHEN CHEUNG YAN LEUNG PROFESSOR (CHAIR) OF FINANCE AT CITY UNIVERSITY OF HONG KONG RATED TOP 10 COMPANIES WITH BEST CORPORATE GOVERNANCE SURVEY ON CORPORATE GOVERNANCE OF HONG KONG LISTED COMPANIES 2006 – JOINTLY PRESENTED BY THE HONG KONG INSTITUTE OF DIRECTORS AND CITY UNIVERSITY OF HONG KONG 5 2 HYS AN ANN UA L REPORT 200 6 During the year, there were discussions on the diff erent information needs of the Board and Board Committees in terms of content, timing and format. For instance, there will be a greater focus on technical details in the information provided to Audit Committee members as compared to that provided to the full Board for their respective reviews of the Group’s internal control systems. Evaluation Since 2005, Hysan has in place a formal process of Board evaluation. The process takes the form of meetings between the Chairman and non-executive Directors without management being present, which meetings are held at least once a year. Two meetings were held in 2006. The Board regards such meetings as a forum in which a broad range of strategic and performance matters may be openly discussed. 7. BOARD LEADERSHIP: THE CHAIRMAN, MANAGING DIRECTOR AND “SENIOR” INDEPENDENT NON-EXECUTIVE DIRECTOR Peter T.C. Lee serves as the Chairman and Michael T.H. Lee serves as the Managing Director. The Chairman focuses on Group strategic and Board issues. The Managing Director has overall chief executive responsibility for Group operations and general development. Sir David Akers-Jones acts as the Independent non-executive Deputy Chairman of the Board, and he also chairs two of Hysan’s corporate governance related committees, namely the Audit Committee and the Emoluments Review Committee. The presence of an Independent non- executive Deputy Chairman is designed to ensure that the Board functions eff ectively and is independent of management where appropriate. N EW: THE “SE NIOR” IN DEPE N DE N T NON-E X ECU TIVE DIR EC TOR In 2007, the Board formalized the role of the “senior” Independent non-executive Director in its Corporate Governance Guidelines. The “senior” Independent non-executive Director’s role is to be available to shareholders and fellow Directors if they have concerns relating to matters that contact through the normal channels of Chairman and/or Managing Director has failed to resolve, or for which such contact is inappropriate. 8. ACCOUNTABILITY TO SHAREHOLDERS Corporate Reporting Disciplined measurement of our performance is an important aspect of our strategy to achieve long-term success. Reporting fi nancial and non-fi nancial results in a transparent fashion is critical, recognising that we are accountable to our stakeholders. A number of formal communication channels are used to account to shareholders for the performance of the Group. These include the Annual Report and Accounts, Interim Report and Accounts and press releases/announcements. 5 3 HYSAN ANNUAL R EPORT 2006 Corporate Governance Report The Board and management are committed to promoting consistent disclosure practices aimed at accurate, timely and broadly disseminated disclosure of material information about Hysan. We have established a new Corporate Disclosure Policy, which provides guidance for coordinating the disclosure of material information to investors, analysts and media as well as our processes for results announcements. This policy also identifi es who may speak on Hysan’s behalf, and outlines the responsibility for communications with various stakeholder groups. Internal Control Review The Board’s governance policies include a process for the Board to review regularly the eff ectiveness of the system of internal control as required by the Code. As part of this process, the Board and the Audit Committee requested, received and reviewed reports from management at their regular meetings. These reports enabled them to assess the eff ectiveness of the system of internal control in operation for managing signifi cant risks, including operational, fi nancial reporting and compliance risks, throughout the year. A detailed report is set out on pages 36 to 39. 9. OTHER SHAREHOLDER COMMUNICATIONS Constructive Use of AGMs The Board welcomes moves towards a more constructive use of AGMs and treats them as one of the principal avenues to enter into a dialogue with shareholders based on mutual understanding of objectives. Since 2004, we have introduced a “business review” session in addition to the statutory part of the meeting. This session is led by the Chairman and Managing Director. Topics covered at the last AGM included: Year 2005 overall business environment; governance and social responsibilities; achievements during the year; business activities review and outlook. The arrangements were positively received by shareholders. Hysan also exceeded Code Provisions in conducting the statutory business of the AGM in a number of ways. Copies of the Annual Report and fi nancial statements and related papers were dispatched to shareholders at least 35 days prior to the AGM (statutory requirement: 21 days). A comprehensive yet user-friendly AGM circular was prepared containing detailed reports on voting procedures (including procedures for demanding a poll) presented in a user-friendly “frequently-asked-questions-and-answers” format; and comprehensive information on each resolution to be proposed was provided. The Chairman also demanded a poll on all resolutions proposed. Self-funded Programme to Forward Shareholder Communication Materials via Nominee Companies There is currently no requirement in Hong Kong providing for mandatory forwarding of shareholder communication materials by nominee companies to benefi cial shareholders. Since 2005, we have initiated and funded a programme inviting major nominee companies to 5 4 HYS AN ANN UA L REPORT 200 6 pro-actively forward communication materials to shareholders at our expense. Coverage of the programme has extended by more than double since inception. Institutional Shareholders Hysan is committed to maintaining a continuing open dialogue with institutional investors and analysts in order to raise understanding and awareness of the Group’s strategy, operations, management and plans. Under the programme in 2006, the Managing Director and/or Chief Financial Offi cer participated in regular one-on-one meetings and roadshows in Hong Kong as well as overseas. 10. BOARD COMMITTEES The Corporate Governance Guidelines allocate the tasks of monitoring executive actions and assessing performance to certain governance-related Board Committees. All such committees have a majority of Independent non-executive Directors. In common with the Board, each Committee has access to independent advice and counsel as required and each is supported by the Company Secretary. A. Audit Committee Composition and Meetings Schedule Hysan’s Audit Committee is chaired by Sir David Akers-Jones, Independent non-executive Deputy Chairman and has a majority of Independent non-executive Directors. Its other members are Per Jorgensen (Independent non-executive Director) and Chien Lee (non- executive Director). All members have experience in reviewing or analysing audited fi nancial statements of public companies or major organisations. The Audit Committee meets no less than twice a year. Meetings are also attended by invitation by the Managing Director and Chief Financial Offi cer. The Committee held two meetings in 2006 with 100% attendance. 5 5 HYSAN ANNUAL R EPORT 2006 Corporate Governance Report Roles and Authority Hysan believes that crucial to the eff ective functioning of an audit committee is a clear appreciation of the separate roles of management, the external auditors and Audit Committee members. Hysan management is responsible for selecting the appropriate accounting policies and the preparation of the fi nancial statements. The external auditors are responsible for auditing and attesting to the Group’s fi nancial statements and evaluating the Group’s system of internal control to the extent that they consider necessary to support their audit report. The Audit Committee, as the delegate of the full Board, is responsible for overseeing the entire process. Activities and Report in 2006 Full details are set out in the “Audit Committee Report” on pages 70 and 71. B. Emoluments Review Committee Composition and Meetings Schedule The Group set up an Emoluments Review Committee in 1987 to review executive Director compensation. The Committee is chaired by Sir David Akers-Jones, Independent non- executive Deputy Chairman, with a majority of Independent non-executive Directors. Its current members are F.K. Hu, non-executive Director and Dr. Geoff rey M.T. Yeh, Independent non-executive Director. The Committee generally meets at least once every year. There was 100% attendance for the meeting held in 2006. Role and Authority Management makes recommendations to the Committee on Hysan’s framework for, and cost of, executive Director remuneration and the Committee then reviews these recommendations. No Director or any of his associates is involved in deciding his own remuneration. Activities and Report in 2006 Full details are set out in the “Directors’ Remuneration and Interests Report” on pages 63 to 69. C. Nomination Committee Composition In March 2005, the Board established a Nomination Committee, which is chaired by Peter T.C. Lee, Chairman of the Board, and its other members are Sir David Akers-Jones, Independent non-executive Deputy Chairman, and Dr. Geoff rey M.T. Yeh, Independent non- executive Director. The Committee meets when considered appropriate. Role and Authority The Committee has the responsibility of nominating for Board approval candidates to fi ll Board vacancies as and when they arise and of evaluating the balance of skills, knowledge and experience of the Board. 5 6 HYS AN ANN UA L REPORT 200 6 Directors’ Report The Directors submit their report together with the audited financial statements for the year ended 31 December 2006, which were approved by the Board of Directors on 6 March 2007. PRINCIPAL ACTIVITIES The principal activities of the Group continued throughout 2006 to be property investment, management and development. Details of the Group’s associates and principal subsidiaries at 31 December 2006 are set out in notes 18 and 38 respectively to the financial statements. An analysis of Group’s turnover is set out in note 6 to the financial statements. As the Group’s turnover is derived principally from rental income and wholly in Hong Kong, no segment financial analysis is provided. A detailed review of the development of the business of the Group during the year, and likely future developments, is set out in Chairman’s Statement and Management’s Discussion and Analysis of the Annual Report. RESULTS AND APPROPRIATIONS The results of the Group for the year ended 31 December 2006 are set out in the consolidated income statement on page 74. An interim dividend of HK10 cents per share amounting to HK$105,460,624 was paid to shareholders during the year. The Board of Directors recommends the payment of a final dividend of HK40 cents per share with a scrip alternative to the shareholders on the register of members on 8 May 2007, absorbing HK$422,054,964. The ordinary dividends proposed and paid in respect of the full year 2006 will absorb HK$527,515,588, the balance of the profit will be retained. RESERVES Movements during the year in the reserves of the Group and the Company are set out in the consolidated statement of changes in equity on pages 78 and 79 and note 30 to the financial statements respectively. INVESTMENT PROPERTIES All of the Group’s investment properties were revalued by an independent professional valuer at 31 December 2006. The revaluation resulted in a surplus as compared to carrying amount of HK$2,575,610,978 and is recognised in the consolidated income statement. Details of movements during the year in the investment properties of the Group and the Company are set out in note 14 to the financial statements. Details of the major investment properties of the Group at 31 December 2006 are set out in the section under “Schedule of Principal Properties” of the Annual Report. PROPERTY, PLANT AND EQUIPMENT Details of movements during the year in the property, plant and equipment of the Group and the Company are set out in note 15 to the financial statements. SHARE CAPITAL During the year, the Company issued a total of 1,876,568 ordinary shares. Details of movements in the share capital of the Company are set out in note 29 to the financial statements. CORPORATE GOVERNANCE The Company is committed to maintaining a high standard of corporate governance and, save as otherwise stated and explained in the Corporate Governance Report, has complied throughout the year with the code provisions of the Code on Corporate Governance Practice (the “Code”) as set out in Appendix 14 of the Rules Governing the Listing of Securities (the “Listing Rules”) on The Stock Exchange of Hong Kong Limited (the “Stock Exchange”). Further information on the Company’s corporate governance practices is set out in the following separate reports: (a) “Corporate Governance Report” (page 44) – it gives detailed information on the Company’s compliance with the Code, and adoption of local and international best practices; (b) “Directors’ Remuneration and Interests Report” (page 63) – it gives detailed information of Directors’ remuneration and interests (including information on Director’s compensation, service contracts, Directors’ interests in shares; contracts and competing business); 5 7 HYSAN ANNUAL R EPORT 2006 Directors’ Report continued CORPORATE GOVERNANCE continued (c) “Audit Committee Report” (page 70) – it sets out terms of reference, work performed and findings of the Audit Committee for the review year; (d) “Report on Internal Control and Risk Management” (page 36) – it sets out the Company’s framework on internal control and risks assessment including methodology, control activities, work done during the year and further steps to be done; (e) “Corporate Responsibility Report” – it sets out the Company’s corporate values and Corporate Responsibility Policy underlying its commitment to maintaining a high standard of corporate governance. THE BOARD The Board currently comprises Peter T.C. Lee, Chairman, Michael T.H. Lee, Managing Director and Pauline W.L. Yu Wong, Executive Director and eight other non executive Directors. Sir David Akers Jones acts as the Independent non executive Deputy Chairman, also chairing the corporate governance committees, namely, the Audit Committee and Emoluments Review Committee. The biographies of the Directors as at the date of this Report appear on pages 41 and 42. Under the Company’s current Articles of Association, one third (or such other number as may be required under applicable legislation) of the Directors; and where the applicable number is not an integral number, to be rounded upwards, who have been longest in office shall retire from office by rotation. Details on Board changes effective as from the conclusion of the forthcoming Annual General Meeting (“AGM”) including particulars of Directors seeking re-election at the AGM are set out in the accompanying circular to shareholders. On 12 April 2006, Timothy John Smith was appointed as alternate Director for Per Jorgensen in place of Charles Gary Wellins. Save as the aforesaid, Raymond Liang ming Hu, Li Kam Wing and V nee Yeh served as alternate Directors throughout the year. The Company has received from each Independent non executive Director an annual confirmation of his independence pursuant to Rule 3.13 of the Listing Rules and the Company considered all of them to be independent. DIRECTORS’ INTERESTS IN SHARES Details of Directors’ interests in shares of the Company are set out in Directors’ Remuneration and Interests Report on pages 63 to 69. SUBSTANTIAL SHAREHOLDERS’ AND OTHER PERSONS’ INTERESTS IN SHARES As at 31 December 2006, the interests or short positions of Substantial Shareholders and Other Persons of the Company, in the shares of the Company as recorded in the register required to be kept under section 336 of the Securities and Futures Ordinance (“SFO”), or as otherwise notified to the Company, were as follows: Aggregate long positions in shares and underlying shares of the Company Name Capacity Lee Hysan Estate Company, Limited Beneficial owner and interests of controlled corporations No. of ordinary shares held 433,130,735 (Note 1) Lee Hysan Company Limited Interests of controlled corporations 433,130,735 (Note 1) % of the issued share capital * 41.05 41.05 * The percentages have been compiled based on the total number of shares of the Company in issue as at 31 December 2006 (i.e. 1,055,137,409 ordinary shares). Note: (1) These interests represent the same block of shares of the Company. 270,118,724 shares were held by Lee Hysan Estate Company, Limited (“LHE”) and 163,012,011 shares were held by certain subsidiaries of LHE. LHE is a wholly owned subsidiary of Lee Hysan Company Limited. Apart from the above, no other interest or short position in the shares or underlying shares of the Company were recorded in the register required to be kept under section 336 of the SFO as at 31 December 2006. 5 8 HYS AN ANN UA L REPORT 200 6 RELATED PARTY TRANSACTIONS The Group entered into certain transactions with parties regarded as “Related Parties” under applicable accounting principles. These mainly relate to contracts entered into by the Group in the ordinary course of business, which contracts were negotiated on normal commercial terms and on an arm’s length basis. Further details are set out in note 36 to the financial statements. Some of these transactions also constitute “Continuing Connected Transactions” under the Listing Rules, as identified below. CONTINUING CONNECTED TRANSACTIONS Certain transactions entered into by the Group constituted continuing connected transactions (the “Transactions”) under the Listing Rules. Details of the Transactions are set out as follows: I. Lease granted by the Group (a) Lee Gardens Two, 28 Yun Ping Road, Hong Kong (“Lee Gardens Two”) The following lease arrangements were entered into by Barrowgate Limited, a 65.36% subsidiary of the Company and property owner of Lee Gardens Two, as landlord with the following connected persons: Connected person Date of agreement Terms Premises Annual consideration (Note 1) (i) Jebsen and Company Limited (Note 2) 10 September 2003 4 years commencing from 1 September 2003 Office units at 28th to 31st Floors 2006: HK$14,138,718 2007: HK$ 9,572,328 (on pro rata basis) (ii) Hang Seng Bank 3 September 2004 2 years and Limited (Note 2) (iii) Hang Seng Bank Limited 7 June 2006 (Note 3) 16 days commencing from 15 September 2004 3 years commencing from 1 October 2006 Shop units at Ground Floor and Basement Shop units at Ground Floor and Lower Ground Floor (iv) MF Jebsen International Limited (Note 4) 23 April 2004 and a Supplemental Deed of 12 July 2004 4 years commencing Office units from 1 February 2004 at 24th and 25th Floors and 3 years and 7 months commencing from 1 July 2004 2006: HK$ 7,377,192 (on pro rata basis) 2006: HK$ 3,296,994 (on pro rata basis) 2007: HK$13,267,560 2008: HK$13,267,560 2009: HK$ 9,950,670 (on pro rata basis) 2006: HK$ 6,286,699 2007: HK$ 6,596,532 2008: HK$ 549,711 (on pro rata basis) (v) Chickeeduck Retail 18 December 2003 3 years (Hong Kong) Limited (Note 5) commencing from 7 November 2003 Shop units on the 2006: HK$ 1,115,900 (on pro rata basis) Second Floor 5 9 HYSAN ANNUAL R EPORT 2006 Directors’ Report continued CONTINUING CONNECTED TRANSACTIONS continued I. Lease granted by the Group continued (b) Bamboo Grove, 7486 Kennedy Road, Hong Kong (“Bamboo Grove”) The following leases were entered into by Kwong Wan Realty Limited, a wholly owned subsidiary of the Company and property owner of Bamboo Grove as landlord, with Lee Hysan Estate Company, Limited (“Lee Hysan Estate”), a substantial shareholder of the Company (holding 41.05% interest) and Atlas Corporate Management Limited, a wholly owned subsidiary of Lee Hysan Estate. Details of the leases are set out below: Connected person Date of agreement Terms Premises (i) Lee Hysan Estate 12 January 2004 Company, Limited (Note 6) (ii) Lee Hysan Estate 9 November 2005 Company, Limited 2 years commencing from 16 January 2004 2 years commencing from 1 November 2005 An apartment and 2 carparking spaces An apartment and 1 carparking space Annual consideration (Note 1) 2006: HK$ 52,011 (on pro rata basis) 2006: HK$2,644,800 (Note 7) (iii) Atlas Corporate Management Limited (Note 8) 14 December 2005 2 years (Formal tenancy agreement executed on 5 January 2006) commencing from 16 January 2006 An apartment and 2 carparking spaces 2006: HK$1,706,575 (on pro rata basis) (Note 9) (c) One Hysan Avenue, Causeway Bay, Hong Kong The following lease arrangement was entered into by OHA Property Company Limited, a wholly owned subsidiary of the Company and property owner of One Hysan Avenue, with Atlas Corporate Management Limited. Details of the lease are set out below: Connected person Date of agreement Terms Premises Atlas Corporate Management Limited 9 November 2005 3 years commencing from 1 November 2005 Whole of 21st Floor Annual consideration (Note 1) 2006: HK$1,378,518 2007: HK$1,397,664 2008: HK$1,164,720 (on pro rata basis) II. Provision of leasing and property management services to a non wholly owned subsidiary regarding Lee Gardens Two The following management agreements were entered into by Hysan Leasing Company Limited and Hysan Property Management Limited, both being wholly owned subsidiaries of the Company, with Barrowgate Limited for the provision of services to Lee Gardens Two, including (i) leasing, marketing and lease administration services; and (ii) property management services: Terms Premises Annual consideration from 1 April 2004 3 years commencing Whole premise of HK$13,667,068 (i) and HK$2,224,452 (ii) (Note 10) (renewable for a further 3 years) Lee Gardens Two Connected person Barrowgate Limited Date of agreement 25 February 2004 and a Supplemental Appointment Letter of 19 July 2004 6 0 HYS AN ANN UA L REPORT 200 6 CONTINUING CONNECTED TRANSACTIONS continued Notes: (1) The annual consideration are based on current rates of rental and operating charges and (for retail premises) promotional levies for each of the relevant financial years. The rental and operating charges and promotional levies (as the case may be) are payable monthly in advance. (2) Jebsen and Company Limited and Hang Seng Bank Limited are beneficial substantial shareholders of Barrowgate Limited having equity interest of 10% and 24.64% respectively in Barrowgate Limited. (3) This is a renewal of the lease mentioned under I(a)(ii) above. (4) MF Jebsen International Limited is considered a connected person by virtue of its being a company controlled by an associate of a non executive Director of the Company. (5) Chickeeduck Retail (Hong Kong) Limited is considered a connected person by virtue of its being a company controlled by an associate of a non executive Director of the Company. The lease expired on 6 November 2006 and was not renewed. (6) The lease expired on 15 January 2006. A new lease for the same premise was entered by Atlas Corporate Management Limited (see I(b)(iii) for details). (7) The monthly management fees were revised with effect from 1 January 2007 while the rental remained unchanged. The annual consideration based on current rates for the rental and management fees for the financial year of 2007 in relation to the remaining term of the lease is HK$2,221,900. (8) This is a new lease of the same premise mentioned in I(b)(i) above. (9) The monthly management fees were revised with effect from 1 January 2007 while the rental remained unchanged. The annual consideration based on current rates for the rental and management fees for each of the financial year of 2007 and 2008 in relation to the remaining term of the lease are HK$1,792,920 and HK$72,295 respectively. (10) These represent the actual considerations for the year ended 31 December 2006, calculated on the basis of the fee schedules as prescribed in the respective management agreements. All the Transactions were entered in the ordinary and usual course of business of the respective companies after due negotiations on an arm’s length basis with reference to the prevailing market conditions. Announcements were published regarding the Transactions (other than that referred to in section I(a)(v)) in accordance with the Listing Rules. The Stock Exchange has granted a waiver for the Transactions referred to in section I(a)(iv) and section II above by virtue of Rule 14A.42 from strict compliance with the requirements of Rules 14A.35, 14A.45 to 14A.47 of the Listing Rules on condition that details of the Transactions be included in the Company’s subsequent published annual report for financial years in which the relevant Transactions are subsisting. Pursuant to Rule 14A.38 of the Listing Rules, the Board of Directors engaged the auditors of the Company to perform certain agreed upon procedures in respect of the Transactions of the Group to assist the Directors to evaluate whether the Transactions: 1. have received the approval from the Board of Directors; 2. were in accordance with the pricing policies of the Company where the Transactions involve provision of goods and services by the Company; 3. have been entered into in accordance with the agreement governing such Transactions; and 4. have not exceeded the cap stated in the relevant announcements. 6 1 HYSAN ANNUAL R EPORT 2006 Directors’ Report continued CONTINUING CONNECTED TRANSACTIONS continued The auditors have reported their factual findings on these procedures to the Board of Directors that the samples the auditors selected for the Transactions were in agreement in respect of items 1, 3 & 4 above and that according to the samples the auditors selected, in respect of item 2, the rent charged to the connected persons were either the same or fall within or slightly above the range of rental offered to independent third parties. All Independent non executive Directors of the Company have reviewed the Transactions and the report of the auditors and confirmed that the respective contracts and terms of the Transactions are: 1. in the ordinary and usual course of business of the Company; 2. on normal commercial terms; and 3. in accordance with the relevant agreement governing them on terms that are fair and reasonable and in the commercial interests of the Group as a whole. INTEREST IN CONTRACTS OF SIGNIFICANCE The lease arrangement between Barrowgate Limited, a non wholly owned subsidiary, and Jebsen and Company Limited also constitutes a contract of significance due to the annual consideration of the lease having a percentage ratio of 1.1% from the calculation of the revenue test (the percentage ratio for assets ratio and consideration ratio are 0.04% and 0.07% respectively). Details of the transaction are set out under I (a)(i) of Continuing Connected Transactions. MAJOR CUSTOMERS AND SUPPLIERS The aggregate turnover attributable to the Group’s five largest customers was less than 30% of total turnover. Details of the Group’s transactions with its major suppliers during the year are set out below: The largest supplier Five largest suppliers in aggregate Percentage of the Group’s total purchases 16% 32% Save otherwise disclosed, no Director, their associates or shareholders (which to the knowledge of the Directors own more than 5% of the Company’s issued share capital) were interested, at any time during the year, in the Group’s five largest suppliers. PURCHASES, SALE OR REDEMPTION OF THE COMPANY’S LISTED SECURITIES During the year, neither the Company nor its subsidiaries had purchased, sold or redeemed any of the Company’s listed securities. PUBLIC FLOAT Based on the information that is publicly available to the Company and within the knowledge of the Directors, the Company has maintained the prescribed amount of public float during the year and up to the date of this report as required under the Listing Rules. DONATIONS During the year, the Group made donations totalling HK$1,693,790 for charitable and non-profit-making organisations. AUDITORS A resolution for the re appointment of Messrs. Deloitte Touche Tohmatsu as auditors of the Company is to be proposed at the forthcoming AGM. By order of the Board Peter T.C. Lee Chairman Hong Kong, 6 March 2007 6 2 HYS AN ANN UA L REPORT 200 6 Directors’ Remuneration and Interests Report DIRECTOR COMPENSATION Executive Director emoluments The Board first established the Emoluments Review Committee in 1987 to review and determine the remuneration of executive Directors. The Committee is chaired by Sir David Akers Jones, Independent non executive Deputy Chairman, and has a majority of Independent non executive Directors. Its other members are F.K. Hu and Dr. Geoffrey M.T. Yeh (Independent non executive Director). Management makes recommendations to the Committee on the Company’s framework for, and cost of, executive Director remuneration and the Committee then reviews these recommendations. On matters other than those concerning him, the Chairman or Managing Director may be invited to Committee meetings. No Director is involved in deciding his own remuneration. The Group’s remuneration policy seeks to provide a fair market remuneration in a form and value to attract, retain and motivate high quality staff and at the same time to reflect the importance of aligning awards with shareholder interests. Remuneration packages are set at levels to ensure comparability and competitiveness with Hong Kong based companies competing within a similar talent pool, with particular emphasis on the property industry. Independent professional advice will be sought to supplement internal resources where appropriate. Following a review completed in November 2003 by the Committee, the Company has developed a policy that involves top management (the Chairman and Managing Director) having a remuneration package consisting of several remuneration components. The fixed part of the package is a combination of basic salary and benefits. The proportion of performance based compensation has been increased under this new structure. In addition, there are arrangements for a long term incentive plan. The new levels of remuneration, taking effect as from December 2003, reflected comparator market information and advice from independent consultants (Watson Wyatt Hong Kong Limited). Such salary levels would be reviewed by the Committee on an annual basis. The Committee met in March 2006 to review the executive Director compensation packages. There was 100% attendance without any executive Director presence. Details are set out in note 7 to the financial statements. The most recent meeting of the Committee was held in March 2007 to review executive Director compensation packages. Details of Directors’ (including individual executive Directors) emoluments and options are set out in notes 7 and 37 respectively to the financial statements. Non executive Director emoluments The Directors’ fees are subject to shareholder approval at general meeting. The non executive Directors (including the Independent non executive Directors) received fees totalling HK$1,100,000 and the Independent non executive Deputy Chairman received a total annual fee of HK$230,000 for 2006 (Please refer to note 7 to the financial statements). Taking into consideration the level of responsibility, experience and abilities required of the Directors, and fees offered for similar positions in comparable companies, new levels of Directors’ fees were reviewed and approved at the AGM held on 10 May 2005: Board of Directors Chairman Deputy Chairman Director Audit Committee Chairman Member Other Committees Chairman Member Per annum HK$ 140,000 120,000 100,000 60,000 30,000 30,000 20,000 6 3 HYSAN ANNUAL R EPORT 2006 Directors’ Remuneration and Interests Report continued DIRECTOR COMPENSATION continued Non executive Director emoluments continued The non executive Directors received no other compensation from the Group except for the fees disclosed above. None of the non executive Directors receive any pension benefits from the Company, nor do they participate in any bonus or incentive scheme. Long term incentives: Share Option Schemes The Company has granted options under two executive share option schemes. The purpose of both schemes was to strengthen the link between individual staff and shareholder interests. The power of grant to executive Directors is vested in the Emoluments Review Committee and endorsed by all Independent non executive Directors as required under the Listing Rules. As approved by the Board, either the Chairman or the Managing Director may make grants to management staff below executive Director level. Key terms of the share option schemes of the Company are summarised as follows: The 1995 Share Option Scheme (“the 1995 Scheme”) The 1995 scheme was approved by shareholders on 28 April 1995 and had a term of 10 years. It expired on 28 April 2005. All outstanding options granted under the 1995 Scheme will continue to be valid and exercisable in accordance with the provisions of the 1995 Scheme. As at 31 December 2006, shares issuable under options granted under the 1995 scheme was 1,751,333, representing less than 0.17% of the issued share capital of the Company. The maximum entitlement of each participant is substantially below the limit set out under the scheme rules (being 25% of the maximum number of shares in respect of which options may at any time be granted under the 1995 Scheme). The exercise price was initially fixed at 80% of the average of the closing prices of the shares on the Stock Exchange for the 20 trading days immediately preceding the date of grant or the nominal value of a share whichever is the greater. The exercise price for options granted after 1 September 2001 was amended to comply with amendments to the Listing Rules. Consideration to be paid on each grant of option is HK$1.00, with full payment for exercise price to be made on exercise of the relevant option. Grants made prior to 8 March 2005 are subject to a five year vesting period and a bar on the exercise of options within the first two years of their issue. The 2005 Share Option Scheme (“the 2005 Scheme”) The Company adopted a new share option scheme (the “2005 Scheme” and together with the 1995 Scheme are referred to as “the Schemes”) at the AGM held on 10 May 2005, which has a term of 10 years and will expire on 9 May 2015. The maximum number of shares in respect of which options may be granted under the 2005 Scheme and any other share option scheme of the Company shall not exceed such number of shares as required under the Listing Rules, currently being 10% of the shares in issue (being 104,996,365 shares) as at 10 May 2005, the date of the AGM approving the 2005 Scheme. Under the Listing Rules, a listed issuer may seek approval by its shareholders in general meetings for “refreshing” the 10% limit under the scheme. The limit on the number of shares which may be issued upon exercise of all outstanding options granted and yet to be exercised under the 2005 Scheme and any other share option scheme of the Company must not exceed 30% of the shares in issue from time to time (or such number of shares as required under the Listing Rules). No options may be granted if such grant will result in this 30% limit being exceeded. The maximum entitlement of each participant under the 2005 Scheme must not during any 12 month period exceed such number of shares as required under the Listing Rules (which is 1% of the total shares in issue as at the date of shareholders’ approval). The exercise price shall be at least the highest of (i) the closing price of the shares as stated in the Stock Exchange’s daily quotations sheet on the date of grant; (ii) the average of the closing prices of the shares as stated in the Stock Exchange’s daily quotations sheets for the five business days immediately preceding the date of grant; and (iii) the nominal value of the shares. Consideration to be paid on each grant of option is HK$1.00, with full payment for exercise price to be made on exercise of the relevant option. 6 4 HYS AN ANN UA L REPORT 200 6 DIRECTOR COMPENSATION continued Long term incentives: Share Option Schemes continued Grant and vesting structures With effect from 8 March 2005, the Board has approved a new grant and vesting structure. Grants will be made on a periodic basis. Vesting period is three years in equal proportion. Size of grant will be determined by reference to base salary multiple and job grades. A clear performance criterion will be a key driver. The Board will review the grant and vesting structures from time to time. Grant movements during the year During the year, a total of 659,000 shares options were granted under the 2005 Scheme. As at 31 December 2006, an aggregate of 2,830,333 shares are issuable under options granted under the Schemes, representing approximately 0.27% of the issued share capital of the Company. As at the date of this Report, 99,277,765 shares are issuable under the Schemes, regarding options granted which remain unexercised and options to be granted under the 2005 Scheme, representing 9.41% of the issued share capital. Details of options granted and outstanding under the Schemes during the year are as follows: Changes during the year Name 1995 Scheme Executive Director Peter T.C. Lee (Note 1) Balance as at 1.1.2006 Date of grant Granted Exercised Cancelled/ Balance as at lapsed 31.12.2006 Exercise price HK$ Exercise period 1,350,000 7.1.1999 Nil Nil Nil 1,350,000 9.22 7.1.2001 – 6.1.2009 Eligible employees (Note 2) 535,000 30.3.2005 Nil 128,267 (Note 4) 5,400 (Note 5) 401,333 15.85 30.3.2005 – 29.3.2015 2005 Scheme Executive Director Michael T.H. Lee (Note 3) 240,000 10.5.2005 Nil Nil Nil 240,000 Nil 30.3.2006 188,000 Nil Nil 188,000 16.60 10.5.2005 – 9.5.2015 22.00 30.3.2006 – 29.3.2016 (Note 7) Eligible employees (Note 2) 144,000 9.8.2005 Nil 48,000 (Note 6) Nil 96,000 18.79 9.8.2005 – 8.8.2015 120,000 12.10.2005 Nil Nil Nil 120,000 18.21 12.10.2005 – 11.10.2015 Nil 30.3.2006 361,000 Nil 36,000 (Note 5) 325,000 22.00 30.3.2006 – 29.3.2016 (Note 7) Nil 26.6.2006 110,000 Nil Nil 110,000 20.11 26.6.2006 – 25.6.2016 (Note 8) 2,389,000 659,000 176,267 41,400 2,830,333 6 5 HYSAN ANNUAL R EPORT 2006 Directors’ Remuneration and Interests Report continued DIRECTOR COMPENSATION continued Long term incentives: Share Option Schemes continued Grant movements during the year continued Notes: (1) Options granted to Peter T.C. Lee were under the 1995 Scheme with a holding period of 2 years and a vesting period of 5 years. (2) Eligible Employees are working under employment contracts that are regarded as “continuous contracts” for the purposes of the Employment Ordinance. The options granted under the Schemes have vesting periods of 3 years in equal proportions. (3) Options granted to Michael T. H. Lee were under the 2005 Scheme with a vesting period of 3 years in equal proportions. (4) The weighted average closing price of the shares of the Company immediately before the dates on which the options were exercised was HK$22.09. (5) These options lapsed during the year upon the resignation of certain Eligible Employees. (6) The weighted average closing price of the shares of the Company immediately before the dates on which the options were exercised was HK$21.00. (7) The closing price of the shares of the Company immediately before the date of grant (as of 29 March 2006) was HK$22.45. (8) The closing price of the shares of the Company immediately before the date of grant (as of 23 June 2006) was HK$20.25. Apart from the above, the Company had not granted any share option under the Schemes to any other persons as required to be disclosed under Rule 17.07 of the Listing Rules. Particulars of the Company’s share option schemes are set out in note 37 to the financial statements. Value of share options Pursuant to Rule 17.08 of the Listing Rules, the value of the share options granted during the year is as follows to be expensed through the Group’s income statement over the three year vesting period of the options. The Company has used the Black Scholes option pricing model (the “Model”) to value the share options granted during the year. The Model is one of the commonly used models to estimate the fair value of an option. The value of an option varies with different variables of certain subjective assumptions. Any change in the variables so adopted may materially affect the estimation of the fair value of an option. Details of the fair values of share options determined at the date of grant using the Model with significant variables and assumptions are as follows: Closing share price at the date of grant Risk free rate (Note 1) Expected life of option (Note 2) Expected volatility (Note 3) Expected dividend per annum (Note 4) Date of grant 30.3.2006 26.6.2006 HK$22.00 HK$20.00 4.539% 4.915% 10 years (till 29 March 2016) (till 25 June 2016) 10 years 27.04% 32.00% HK$0.390 HK$0.392 Estimated fair values of options granted HK$4,271,220 HK$859,247 6 6 HYS AN ANN UA L REPORT 200 6 DIRECTOR COMPENSATION continued Long term Incentives: Share Option Schemes continued Value of share options continued Notes: (1) Risk free rate: being the approximate yields of 10 year Exchange Fund Notes traded on the date of grant, matching the expected life of each option. (2) Expected life of option: being the period of 10 years commencing on the date of grant, adjusted based on management’s best estimates for the effects of non transferability, exercise restriction and behavioural consideration. (3) Expected volatility: being the approximate historical volatility of closing prices of the share of the Company in the past one year immediately before the date of grant. (4) Expected dividend per annum: being the approximate average annual cash dividend for the past five financial years. SERVICE CONTRACTS No Director proposed for re election at the forthcoming AGM has a service contract with the Company or any of its subsidiaries that is not determinable by the Group within one year without payment of compensation (other than statutory compensation). DIRECTORS’ INTERESTS IN SHARES As at 31 December 2006, the interests and short positions of the Directors and Alternate Director in the shares, underlying shares or debentures of the Company and its associated corporations (within the meaning of Part XV of the Securities and Futures Ordinance (“SFO”)) as recorded in the register required to be kept under section 352 of the SFO; or as otherwise notified to the Company and the Stock Exchange pursuant to the Model Code for Securities Transactions by Directors of Listed Issuers (“Model Code”), are set out below: Aggregate long positions in shares and underlying shares of the Company Name Personal interests Family interests Corporate interests Other interests % of the issued share capital * Total No. of ordinary shares held Peter T.C. Lee 2,000,000 Michael T.H. Lee 1,023,233 Fa kuang Hu – Hans Michael Jebsen 60,000 Per Jorgensen 6,726 Chien Lee 850,000 Deanna Ruth Tak Yung 1,871,600 Rudgard Pauline Wah Ling Yu Wong 194,000 Geoffrey Meou tsen Yeh 256,702 V nee Yeh (alternate to Geoffrey Meou tsen Yeh) 43,259 – – – – – – – – – – – – 255,012 (Note 1) 2,432,914 (Note 2) – – – – – – – – – 2,000,000 0.190 1,023,233 0.097 255,012 0.024 – 2,492,914 0.236 – – – – – – 6,726 0.001 850,000 0.081 1,871,600 0.177 194,000 0.018 256,702 0.024 43,259 0.004 * This percentage has been compiled based on the total number of shares of the Company in issue (i.e. 1,055,137,409 ordinary shares) as at 31 December 2006. 6 7 HYSAN ANNUAL R EPORT 2006 Directors’ Remuneration and Interests Report continued DIRECTORS’ INTERESTS IN SHARES continued Aggregate long positions in shares and underlying shares of the Company continued Notes: (1) Such shares were held by a company which was wholly owned by Fa kuang Hu and he was deemed to have beneficial interests in all these shares. (2) Such shares were held through a corporation in which Hans Michael Jebsen was a member entitled to exercise no less than one third of the voting power at general meeting. Certain executive Directors of the Company have been granted share options under the Company’s Share Option Schemes (details are set out in the section headed “Long term incentives: Share Options Schemes” above). These constitute interests in underlying shares of equity derivatives of the Company under the SFO. Aggregate long positions in shares of associated corporations Listed below are certain Directors’ interests in the shares of Barrowgate Limited (“Barrowgate”), a 65.36% subsidiary of the Company, and Parallel Asia Engineering Company Limited (“PAECL”), a 25% associate of the Company. Name Hans Michael Jebsen Fa kuang Hu Raymond Liang ming Hu (alternate to Fa kuang Hu) No. of ordinary shares held Corporate interests Other interests % of the issued share capital Total 1,000 – 1,000 10 (Note 1) – – 5,000 5,000 50 (Note 2) 5,000 5,000 50 (Note 2) Notes: (1) Jebsen and Company Limited (“Jebsen and Company”) held a 10% interest in the issued share capital in Barrowgate through a wholly owned subsidiary. Hans Michael Jebsen was deemed to be interested in the shares of Barrowgate by virtue of being the controlling shareholder of Jebsen and Company. (2) Ryoden Development Limited (“Ryoden Development”) held a 50% interest in the issued share capital in PAECL through a wholly owned subsidiary. Fa kuang Hu and Raymond Liang ming Hu were deemed to be interested in the shares of PAECL by virtue of their interests as a founder and/or beneficiaries of a discretionary trust which had an indirect controlling interest in Ryoden Development. Apart from the above, no other interest or short position in the shares, underlying shares or debentures of the Company or any associated corporations as at 31 December 2006 were recorded in the register required to be kept under Section 352 of the SFO; or as otherwise notified to the Company and the Stock Exchange pursuant to the Model Code. Compliance of the Model Code for Securities Transactions by Directors of Listed Issuers (“Model Code”) The Company has adopted the Model Code set out in Appendix 10 to the Listing Rules as its own code of conduct regarding Director’s securities transactions. All Directors have confirmed, following specific enquiry by the Company, that they have complied with the required standards set out in the Model Code throughout the review year. DIRECTORS’ INTERESTS IN CONTRACTS During the review year, certain Directors are parties to contracts with the Group. These contracts constitute Related Party Transactions, Connected Transactions or Contracts of Significance under applicable accounting or regulatory rules (details are disclosed in the Directors’ Report). 6 8 HYS AN ANN UA L REPORT 200 6 DIRECTORS’ INTERESTS IN COMPETING BUSINESS The Group is engaged principally in the property investment, development and management of high quality investment properties in Hong Kong. The following Directors (excluding Independent non executive Directors) are considered to have interests in other activities (“Deemed Competing Business”) that compete or are likely to compete with the said core business of the Group, all within the meaning of the Listing Rules. For the reasons stated below, and coupled with the diligence of the Group’s Independent non executive Directors and the Audit Committee, the Group is capable of carrying on its business independent of and on an arm’s length from the Deemed Competing Business. (i) Peter T.C. Lee, Anthony H.P. Lee, Chien Lee, Michael T.H. Lee and Dr. Deanna R.T.Y. Rudgard are members of the founding Lee family whose range of general investment activities include property investments in Hong Kong and overseas. In light of the size and dominance of the portfolio of the Group, such disclosed Deemed Competing Business is considered immaterial. (ii) F.K. Hu (and his alternate, Raymond L.M. Hu) are directors and have an indirect substantial interest in Designcase Limited and its subsidiaries, which are engaged in investment holding, property investment and development, property agency and management, project management in both the People’s Republic of China and Hong Kong. (iii) Hans Michael Jebsen (and his alternate, Li Kam Wing) hold the offices of directors in each of Jebsen and Company Limited and Jebsen China Services Limited (the “Companies”) and some of their subsidiaries, of which their business activities include, inter alia, investment holding and property investment in both the People’s Republic of China and Hong Kong. Mr. Jebsen is also a substantial shareholder of the Companies. Mr. Jebsen is an independent non executive director of The Wharf (Holdings) Limited whose business includes, inter alia, property investment, development and management in both the People’s Republic of China and Hong Kong. (iv) Chien Lee is an independent non executive director of Swire Pacific Limited whose business includes, inter alia, property investment and trading in Hong Kong, Mainland China and USA. The Company’s management team is separate and independent from that of the companies identified in (ii), (iii) and (iv) above. In addition, save and except Peter T.C. Lee and Michael T.H. Lee, the relevant Directors have non executive roles and are not involved in the Company’s day to day operations and management. By order of the Board Wendy W.Y. Yung Company Secretary Hong Kong, 6 March 2007 6 9 HYSAN ANNUAL R EPORT 2006 Audit Committee Report Audit Committee Report The Audit Committee has three members. It is chaired by the Independent non executive Deputy Chairman, Sir David Akers Jones. Under its terms of reference, the Committee oversees the Company’s financial reporting process; it also reviews the Company’s internal control and risk management system, its relationship with external auditors. The Committee presents a report to the Board on its findings after each Committee meeting. The Committee held two meetings during 2006, on 6 March and 7 August. A meeting was also held on 5 March 2007 to consider the consolidated financial statements for the year ended 31 December 2006. All members attended the above meetings. Significant matters relating to financial statements and activities of the Group for the year ended 31 December 2006, as reviewed and discussed in the relevant meetings, include the following: Financial reporting In the process of financial reporting, management is responsible for the preparation of Group financial statements including the selection of suitable accounting policies. External auditors are responsible for auditing and attesting to Group financial statements and evaluating Group’s system of internal control in such regard. The Committee oversees the respective work of management and external auditors to endorse the processes and safeguards employed by them. • August 2006 : • March 2007 : The Committee reviewed and recommended to the Board of Directors for approval the unaudited financial statements for the first six months of 2006, prior to public announcement and filing. The Committee received reports from and met with external auditors to discuss the scope of their review and findings. The Committee had discussions with management on significant judgments affecting Group’s financial statements. The Committee reviewed and discussed with management and external auditors the 2006 consolidated financial statements included in the 2006 Annual Report, prior to public announcement and filing. The Committee received reports from and met with the external auditors to discuss the general scope of their audit work and findings, including their assessment of Group’s internal control in this light. The Committee had discussions with management with regard to significant judgments affecting the Group financial statements. Based on these review and discussions, and the report of the external auditors, the Audit Committee recommended to the Board of Directors approval of the consolidated financial statements for the year ended 31 December 2006, with the Auditors’ Report thereon. 7 0 7 0 HYS AN ANN UA L REPORT 200 6 HYS AN ANN UA L REPORT 200 6 Review of internal control and risk management systems • March 2007 : The Committee reviewed the Group’s internal control and risks management processes and is satisfied as to their effectiveness in managing risks. In doing so, the Committee has taken note of management’s reports and an independent review performed by a reputable international accounting firm (“Independent Advisor”). The Committee also noted that the Independent Advisor had identified improvement areas aimed at further strengthening the Group’s internal control system, which is a continual process. Management had confirmed to the Committee that all recommendations would be implemented in accordance with established timelines. Relationship with external auditors • March 2007 : The Committee reviewed and considered the terms of engagement of the external auditors including assessing their independence and objectivity. Factors considered include the arrangement for lead audit partner rotation, and the provision of non audit services by the auditors. The Committee recommended to the Board that the shareholders be asked to re appoint Deloitte Touche Tohmatsu as the Group’s external auditors for 2007. The Committee noted that management had adopted the Auditor Services Policy prohibiting the engagement of external auditors to perform certain activities that would impair their independence or objectivity. In the year ended 31 December 2006, external auditors received a total fee of HK$2,128,550 (Audit Services: HK$1,620,000; Non Audit Services HK$301,100; tax compliance: HK$207,450). Members of the Audit Committee David Akers Jones Chairman Per Jorgensen Chien Lee Hong Kong, 6 March 2007 7 1 HYSAN ANNUAL R EPORT 2006 Directors’ Responsibilities for the Financial Statements The Companies Ordinance requires the Directors to prepare financial statements for each financial year which give a true and fair view of the state of affairs of the Company and of the Group as at the end of the financial year and of their respective profit or loss for the year then ended. In preparing the financial statements, the Directors are required to: (a) select suitable accounting policies and apply them on a consistent basis, making judgments and estimates that are prudent, fair and reasonable; (b) state the reasons for any significant departure from accounting standards; and (c) prepare the financial statements on the going concern basis, unless it is not appropriate to presume that the Company and the Group will continue in business for the foreseeable future. The Directors are responsible for keeping proper accounting records, for safeguarding the assets of the Company and of the Group and for taking reasonable steps for the prevention and detection of fraud and other irregularities. 7 2 HYS AN ANN UA L REPORT 200 6 Independent Auditor’s Report TO THE MEMBERS OF HYSAN DEVELOPMENT COMPANY LIMITED 希慎興業有限公司 (incorporated in Hong Kong with limited liability) We have audited the consolidated financial statements of Hysan Development Company Limited (the “Company”) and its subsidiaries (collectively referred to as the “Group”) set out on pages 74 to 120, which comprise the consolidated and Company’s balance sheets as at 31 December 2006, and the consolidated income statement, the consolidated statement of changes in equity and the consolidated cash flow statement for the year then ended, and a summary of significant accounting policies and other explanatory notes. Directors’ responsibility for the consolidated financial statements The directors of the Company are responsible for the preparation and the true and fair presentation of these consolidated financial statements in accordance with Hong Kong Financial Reporting Standards issued by the Hong Kong Institute of Certified Public Accountants and the Hong Kong Companies Ordinance. This responsibility includes designing, implementing and maintaining internal control relevant to the preparation and the true and fair presentation of the consolidated financial statements that are free from material misstatement, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances. Auditor’s responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audit and to report our opinion solely to you, as a body, in accordance with section 141 of the Hong Kong Companies Ordinance and for no other purpose. We do not assume responsibility towards or accept liability to any other person for the contents of this report. We conducted our audit in accordance with Hong Kong Standards on Auditing issued by the Hong Kong Institute of Certified Public Accountants. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance as to whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and true and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by the directors, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements give a true and fair view of the state of affairs of the Company and of the Group as at 31 December 2006 and of the Group’s profit and cash flows for the year then ended in accordance with Hong Kong Financial Reporting Standards and have been properly prepared in accordance with the Hong Kong Companies Ordinance. Deloitte Touche Tohmatsu Certified Public Accountants Hong Kong, 6 March 2007 7 3 HYSAN ANNUAL R EPORT 2006 Consolidated Income Statement For the year ended 31 December 2006 Turnover Property expenses Gross profit Other income Administrative expenses Finance costs Fair value changes on investment properties Fair value changes on financial instruments Net realised gain on disposal of available for sale investments Share of results of associates Profit before taxation Taxation Profit for the year Attributable to: Equity holders of the parent Minority interests Dividends Dividends paid Dividends proposed Earnings per share Basic Diluted Notes 6 2006 HK$’000 2005 HK$’000 1,268,115 (240,561 ) 1,249,796 (237,351 ) 9 18 10 11 12 13 1,027,554 147,089 (111,336 ) (162,762 ) 2,575,611 31,395 170,277 120,053 1,012,445 38,327 (102,889 ) (214,585 ) 4,226,005 (24,777 ) – 241,358 3,797,881 (558,342 ) 5,175,884 (856,583 ) 3,239,539 4,319,301 3,098,789 140,750 4,120,555 198,746 3,239,539 4,319,301 474,147 420,213 422,055 368,641 293.96 cents 391.87 cents 293.70 cents 391.62 cents 7 4 HYS AN ANN UA L REPORT 200 6 Consolidated Balance Sheet At 31 December 2006 Non current assets Investment properties Property, plant and equipment Prepaid lease payments Investments in associates Amount due from an associate Available for sale investments Derivative financial instruments Other receivables Current assets Amount due from an associate Derivative financial instruments Accounts receivable and other receivables Time deposits Cash and bank balances Current liabilities Derivative financial instruments Accounts payable and accruals Rental deposits from tenants Amounts due to minority shareholders Advances from investees Taxation payable Net current assets Total assets less current liabilities Non current liabilities Borrowings Derivative financial instruments Amounts due to minority shareholders Rental deposits from tenants Deferred taxation Net assets Notes 2006 HK$’000 2005 HK$’000 14 15 16 18 18 19 20 21 18 20 21 22 22 20 23 27 25 26 20 27 28 32,473,158 69,309 122,933 443,569 186,117 1,745,427 2,474 21,571 29,815,430 69,477 123,096 333,514 171,131 1,256,100 32,004 29,549 35,064,558 31,830,301 642,338 2,315 158,831 381,971 3,031 642,596 14,195 102,273 1,401,230 284 1,188,486 2,160,578 39,495 198,736 102,418 327,256 54,060 225,781 64,057 217,358 121,604 – 54,068 198,139 947,746 655,226 240,740 1,505,352 35,305,298 33,335,653 2,820,621 44,560 – 183,282 3,348,828 4,300,523 39,802 327,256 135,009 2,879,451 6,397,291 7,682,041 28,908,007 25,653,612 7 5 HYSAN ANNUAL R EPORT 2006 Consolidated Balance Sheet continued At 31 December 2006 Capital and reserves Share capital Reserves Equity attributable to equity holders of the parent Minority interests Note 29 2006 HK$’000 2005 HK$’000 5,275,687 22,552,019 5,266,304 19,400,992 27,827,706 1,080,301 24,667,296 986,316 28,908,007 25,653,612 The consolidated financial statements on pages 74 to 120 were approved and authorised for issue by the Board of Directors on 6 March 2007 and are signed on its behalf by: Peter T.C. Lee Director David Akers Jones Director 7 6 HYS AN ANN UA L REPORT 200 6 Balance Sheet At 31 December 2006 Non current assets Investment properties Property, plant and equipment Investments in subsidiaries Investments in associates Available for sale investments Other receivables Current assets Accounts receivable and other receivables Amounts due from subsidiaries Time deposits Cash and bank balances Current liabilities Accounts payable and accruals Rental deposits from tenants Amounts due to subsidiaries Taxation payable Net current assets Total assets less current liabilities Non current liabilities Rental deposits from tenants Deferred taxation Net assets Capital and reserves Share capital Reserves Notes 2006 HK$’000 2005 HK$’000 14 15 17 18 19 21 21 24 22 22 23 24 28 – 7,187 5 3 2,031 1,642 4,061,000 9,466 5 3 2,031 9,685 10,868 4,082,190 2,413 13,016,557 46,545 3,964 5,342 7,949,195 1,189,010 178 13,069,479 9,143,725 21,724 27 104,371 68,024 24,381 15,162 21,280 83,220 194,146 144,043 12,875,333 8,999,682 12,886,201 13,081,872 – 161 5,969 490,077 161 496,046 12,886,040 12,585,826 29 30 5,275,687 7,610,353 5,266,304 7,319,522 12,886,040 12,585,826 The financial statements on pages 74 to 120 were approved and authorised for issue by the Board of Directors on 6 March 2007 and are signed on its behalf by: Peter T.C. Lee Director David Akers Jones Director 7 7 HYSAN ANNUAL R EPORT 2006 Consolidated Statement of Changes in Equity For the year ended 31 December 2006 Attributable to equity holders of the parent Employee share based Share compensation reserve HK$’000 Investment revaluation reserve HK$’000 premium HK$’000 Share capital HK$’000 Asset revaluation reserve HK$’000 At 1 January 2005 5,249,818 1,380,278 Fair value changes on available for sale investments Surplus on revaluation of buildings for own use Share of reserve of an associate Exchange differences on translation of an overseas associate Net gain on cash flow hedges Deferred taxation arising on revaluation of properties Net income recognised directly in equity Release of revaluation surplus on disposal of land and buildings Profit for the year Total recognised income and expenses for the year Issue of shares pursuant to scrip dividend scheme Premium on issue of shares pursuant to scrip dividend scheme Share issue expenses Recognition of equity settled share based payments Final dividend for 2004 distributed Interim dividend for 2005 distributed Dividend for 2005 declared – – – – – – – – – – 16,486 – – – – – – – – – – – – – – – – – 40,186 (40 ) – – – – – – 2,171 – – – – – – – – – – – – – – – 540,781 10,737 255,473 – – – – – – 1,256 – – – (220 ) 255,473 1,036 – – (10,508 ) – 255,473 (9,472 ) – – – – – – – – – – – – – – At 31 December 2005 5,266,304 1,420,424 2,171 796,254 1,265 Fair value changes on available for sale investments Surplus on revaluation of buildings for own use Share of reserve of an associate Exchange differences on translation of an overseas associate Net loss on cash flow hedges Deferred taxation arising on revaluation of properties Net income recognised directly in equity Transfer to profit and loss on disposal of available for sale investments Profit for the year Total recognised income and expenses for the year Issue of shares pursuant to scrip dividend scheme Premium on issue of shares pursuant to scrip dividend scheme Exercise of share options Premium on issue of shares on exercise of share options Share issue expenses Recognition of equity settled share based payments Share options lapsed during the year Final dividend for 2005 distributed Interim dividend for 2006 distributed Dividend for 2006 declared – – – – – – – – – – 8,502 – – – – – – – – – – – – 881 29,841 – – – – – – – – – – – – – – – – – – – – – 3,031 (32 ) – – – – – (978 ) – 4,382 (13 ) – – – 686,782 – – – – – – 1,565 – – – (274 ) 686,782 1,291 (170,277 ) – – – 516,505 1,291 – – – – – – – – – – – – – – – – – – – – At 31 December 2006 5,275,687 1,453,264 5,562 1,312,759 2,556 7 8 HYS AN ANN UA L REPORT 200 6 Attributable to equity holders of the parent Hedging reserve HK$’000 Translation reserve HK$’000 Capital redemption reserve HK$’000 General reserve HK$’000 Dividend reserve HK$’000 Retained profits HK$’000 Total HK$’000 Minority interests HK$’000 Total HK$’000 (32,720 ) (7,379 ) 154,995 100,000 314,989 12,869,747 20,581,246 830,870 21,412,116 – – – – 67,652 – – – 212 2,532 – – 67,652 2,744 – – – – 67,652 2,744 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 255,473 1,256 212 2,532 67,652 (220 ) 326,905 – – – – – – – 255,473 1,256 212 2,532 67,652 (220 ) 326,905 10,508 – – – 4,120,555 4,120,555 – – 198,746 4,319,301 – 4,131,063 4,447,460 198,746 4,646,206 – – 16,486 – 16,486 – – – (314,989 ) (105,224 ) 473,865 – – – – – (473,865 ) 40,186 (40 ) 2,171 (314,989 ) (105,224 ) – – – – – (43,300 ) – 40,186 (40 ) 2,171 (314,989 ) (148,524 ) – 34,932 (4,635 ) 154,995 100,000 368,641 16,526,945 24,667,296 986,316 25,653,612 – – – – (32,643 ) – – – 286 4,702 – – (32,643 ) 4,988 – – – – (32,643 ) 4,988 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 686,782 1,565 286 4,702 (32,643 ) (274 ) 660,418 – – – – – – – 686,782 1,565 286 4,702 (32,643 ) (274 ) 660,418 (170,277 ) – – – 3,098,789 3,098,789 – (170,277 ) 140,750 3,239,539 – 3,098,789 3,588,930 140,750 3,729,680 – – – – – – 8,502 29,841 881 – – – 8,502 29,841 881 – – – – (368,641 ) (105,461 ) 527,516 – – – 13 (45 ) – (527,516 ) 2,053 (32 ) 4,382 – (368,686 ) (105,461 ) – – – – – – (46,765 ) – 2,053 (32 ) 4,382 – (368,686 ) (152,226 ) – 2,289 353 154,995 100,000 422,055 19,098,186 27,827,706 1,080,301 28,908,007 7 9 HYSAN ANNUAL R EPORT 2006 Consolidated Cash Flow Statement Consolidated Cash Flow Statement For the year ended 31 December 2006 For the year ended 31 December 2006 Operating activities Profit before taxation Adjustments for: Finance costs Share of results of associates Interest income Dividend income Depreciation Amortisation of prepaid lease payments Share based payment Loss on disposal of property, plant and equipment Revaluation deficit (reversal of revaluation deficit) on building for own use Fair value changes on investment properties Fair value changes on financial instruments Net realised gain on disposal of available for sale investments Recovery of a loan to an associate Operating cash flows before movements in working capital Decrease in accounts receivable and other receivables (Decrease)/increase in accounts payable and accruals Increase in rental deposits from tenants Cash generated from operations Hong Kong profits tax paid Net cash from operating activities Investing activities Interest received Dividends received from available for sale investments Additions to available for sale investments Additions to property, plant and equipment Additions to investment properties Proceeds on disposal of available for sale investments Proceeds on disposal of property, plant and equipment Proceeds on disposal of investment properties Repayment from associates Repayment from investees Recovery of a loan to an associate Proceeds on disposal of subsidiaries Note 2006 HK$’000 2005 HK$’000 3,797,881 5,175,884 162,762 (120,053 ) (18,075 ) (41,101 ) 6,738 163 4,382 432 214,585 (241,358 ) (2,914 ) (33,714 ) 5,787 163 2,171 9 58 (2,575,611 ) (31,395 ) (170,277 ) (87,043 ) (65 ) (4,226,005 ) 24,777 – – 928,861 28,370 (6,920 ) 29,087 979,398 (61,597 ) 919,320 15,991 6,036 10,527 951,874 (111,418 ) 917,801 840,456 22,983 37,376 (92,240 ) (5,555 ) (81,465 ) 187,465 60 1,491 258 18,562 87,043 – 2,228 30,564 – (6,811 ) (370,387 ) – – 41,569 – 17,390 – 2,679,567 31 Net cash from investing activities 175,978 2,394,120 8 0 8 0 HYS AN ANN UA L REPORT 200 6 HYS AN ANN UA L REPORT 200 6 Financing activities Share issue expenses Interest paid Bank charges Medium Term Note Programme expenses Other finance costs Dividends paid Dividends paid to minority shareholders of subsidiaries New unsecured bank loans Repayment of unsecured bank loans Purchase of fixed rate notes Net proceeds from issue of zero coupon notes Proceeds on exercise of share options Net cash used in financing activities Net (decrease) increase in cash and cash equivalents Cash and cash equivalents at 1 January Cash and cash equivalents at 31 December Analysis of the balances of cash and cash equivalents Time deposits Cash and bank balances 2006 HK$’000 2005 HK$’000 (32 ) (135,359 ) (7,379 ) (1,083 ) – (435,696 ) (46,765 ) – (1,336,500 ) (150,411 ) – 2,934 (40 ) (188,181 ) (10,079 ) (972 ) (890 ) (363,539 ) (43,300 ) 10,000 (1,455,600 ) – 197,615 – (2,110,291 ) (1,854,986 ) (1,016,512 ) 1,379,590 1,401,514 21,924 385,002 1,401,514 381,971 3,031 1,401,230 284 385,002 1,401,514 8 1 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements Notes to the Consolidated Financial Statements For the year ended 31 December 2006 For the year ended 31 December 2006 1. GENERAL The Company is a public listed company incorporated in Hong Kong and its shares are listed on The Stock Exchange of Hong Kong Limited. The addresses of the registered office and principal place of business of the Company are disclosed on inside back cover of the Annual Report. The consolidated financial statements are presented in Hong Kong dollars, which is the same as the functional currency of the Company. The principal activities of the Company and its subsidiaries (the “Group”) are property investment, management and development. 2. APPLICATION OF NEW AND REVISED HONG KONG FINANCIAL REPORTING STANDARDS (“HKFRSs”) In the current year, the Group has applied, for the first time, a number of new standards, amendments and interpretations (“new HKFRSs”) issued by the Hong Kong Institute of Certified Public Accountants (“HKICPA”) that are either effective for accounting periods beginning on or after 1 December 2005 or 1 January 2006. The adoption of the new HKFRSs had no material effect on how the results and financial position for the current or prior accounting periods have been prepared and presented. Accordingly, no prior period adjustment has been required. The Group has not early applied the following new standard, amendment or interpretations that have been issued but are not yet effective. The directors of the Company anticipate that the application of these new standard, amendment or interpretations will have no material impact on the results and the financial position of the Group. HKAS 1 (Amendment) HKFRS 7 HK(IFRIC) – INT 7 HK(IFRIC) – INT 8 HK(IFRIC) – INT 9 HK(IFRIC) – INT 10 HK(IFRIC) – INT 11 Capital disclosures 1 Financial instruments: Disclosures 1 Applying the restatement approach under HKAS 29 Financial Reporting in Hyperinflationary Economies 2 Scope of HKFRS 2 3 Reassessment of Embedded Derivatives 4 Interim Financial Reporting and Impairment 5 HKFRS 2: Group and Treasury Share Transactions 6 1 Effective for accounting periods beginning on or after 1 January 2007. 2 Effective for accounting periods beginning on or after 1 March 2006. 3 Effective for accounting periods beginning on or after 1 May 2006. 4 Effective for accounting periods beginning on or after 1 June 2006. 5 Effective for accounting periods beginning on or after 1 November 2006. 6 Effective for accounting periods beginning on or after 1 March 2007. 3. SIGNIFICANT ACCOUNTING POLICIES The consolidated financial statements have been prepared on the historical cost basis except for certain properties and financial instruments, which are measured at revalued amounts or fair values, as explained in the accounting policies set out below. The consolidated financial statements have been prepared in accordance with HKFRSs issued by the HKICPA. In addition, the consolidated financial statements include applicable disclosures required by the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited and by the Hong Kong Companies Ordinance. Basis of consolidation The consolidated financial statements incorporate the financial statements of the Company and entities controlled by the Company (its subsidiaries). Control is achieved where the Company has the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. The results of subsidiaries acquired or disposed of during the year are included in the consolidated income statement from the effective date of acquisition or up to the effective date of disposal, as appropriate. Where necessary, adjustments are made to the financial statements of subsidiaries to bring their accounting policies into line with those used by other members of the Group. 8 2 8 2 HYS AN ANN UA L REPORT 200 6 HYS AN ANN UA L REPORT 200 6 3. SIGNIFICANT ACCOUNTING POLICIES continued Basis of consolidation continued All intra group transactions, balances, income and expenses are eliminated on consolidation. Minority interests in the net assets of consolidated subsidiaries are presented separately from the Group’s equity therein. Minority interests in the net assets consist of the amount of those interests at the date of the original business combination and the minority’s share of changes in equity since the date of the combination. Losses applicable to the minority in excess of the minority’s interest in the subsidiary’s equity are allocated against the interests of the Group except to the extent that the minority has a binding obligation and is able to make an additional investment to cover the losses. Investments in subsidiaries Investments in subsidiaries are included in the Company’s balance sheet at cost less any identified impairment loss. The results of subsidiaries are accounted for by the Company on the basis of dividends received during the year. Investments in associates The results, assets and liabilities of associates are incorporated in these consolidated financial statements using the equity method of accounting. Under the equity method, investments in associates are carried in the consolidated balance sheet at cost as adjusted for post acquisition changes in the Group’s share of the profit or loss and of changes in equity of the associate, less any identified impairment loss. When the Group’s share of losses of an associate equals or exceeds its interest in that associate (which includes any long term interests that, in substance, form part of the Group’s net investment in the associate), the Group discontinues recognising its share of further losses. An additional share of losses is provided for and a liability is recognised only to the extent that the Group has incurred legal or constructive obligations or made payments on behalf of that associate. Any excess of the Group’s share of the net fair value of the identifiable assets, liabilities and contingent liabilities over the cost of acquisition, after reassessment, is recognised immediately in profit or loss. Where a group entity transacts with an associate of the Group, profits and losses are eliminated to the extent of the Group’s interest in the relevant associate. Property, plant and equipment Property, plant and equipment are stated at cost/deemed cost or fair value less subsequent accumulated depreciation and accumulated impairment losses. For leasehold land and building classified as an investment property under fair value model which is then transferred to owner occupied property, the property interest is stated at a deemed cost equal to its fair value at the date of change in use. Buildings held for use in the production or supply of goods or services, or for administrative purposes, are stated in the balance sheet at their revalued amount, being the fair value at the date of revaluation less any subsequent accumulated depreciation and any subsequent accumulated impairment losses. Revaluations are performed with sufficient regularity such that the carrying amount does not differ materially from that which would be determined using fair values at the balance sheet date. Any revaluation increase arising on revaluation of buildings is credited to the asset revaluation reserve, except to the extent that it reverses a revaluation decrease of the same asset previously recognised as an expense, in which case the increase is credited to the consolidated income statement to the extent of the decrease previously charged. A decrease in net carrying amount arising on revaluation of an asset is dealt with as an expense to the extent that it exceeds the balance, if any, on the asset revaluation reserve relating to a previous revaluation of that asset. On the subsequent sale or retirement of a revalued asset, the attributable revaluation surplus is transferred to retained profits. Depreciation is provided to write off the cost or fair value of items of property, plant and equipment over their estimated useful lives and after taking into account of their estimated residual value, using the straight line method. An item of property, plant and equipment is derecognised upon disposal or when no future economic benefits are expected to arise from the continued use of the asset. Any gain or loss arising on derecognition of the asset (calculated as the difference between the net disposal proceeds and the carrying amount of the item) is included in the consolidated income statement in the year in which the item is derecognised. 8 3 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 3. SIGNIFICANT ACCOUNTING POLICIES continued Investment properties On initial recognition, investment properties are measured at cost, including any directly attributable expenditure. Subsequent to initial recognition, investment properties are measured using the fair value model. Gains or losses arising from changes in the fair value of investment property are included in profit or loss for the period in which they arise. An investment property is derecognised upon disposal or when the investment property is permanently withdrawn from use or no future economic benefits are expected from its disposals. Any gain or loss arising on derecognition of the asset (calculated as the difference between the net disposal proceeds and the carrying amount of the asset) is included in the consolidated income statement in the year in which the item is derecognised. Prepaid lease payments Prepaid lease payments of land under operating lease are charged to the consolidated income statement on straight line basis over the lease terms. Leases Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classified as operating leases. The Group as lessor Rental income from operating leases is recognised in the consolidated income statement on a straight line basis over the term of the relevant lease. Initial direct costs incurred in negotiating and arranging an operating lease are added to the carrying amount of the leased asset and recognised as an expense on a straight line basis over the lease term. The Group as lessee Rentals payable under operating leases, including the leasehold interests in land, are charged to profit or loss on a straight line basis over the term of the relevant lease. Benefits received and receivable as an incentive to enter into an operating lease are recognised as a reduction of rental expense over the lease term on a straight line basis. Foreign currencies In preparing the financial statements of each individual group entity, transactions in currencies other than the functional currency of that entity (foreign currencies) are recorded in its functional currency (i.e. the currency of the primary economic environment in which the entity operates) at the rates of exchanges prevailing on the dates of the transactions. At each balance sheet date, monetary items denominated in foreign currencies are retranslated at the rates prevailing on the balance sheet date. Non monetary items carried at fair value that are denominated in foreign currencies are retranslated at the rates prevailing on the date when the fair value was determined. Non monetary items that are measured in terms of historical cost in a foreign currency are not retranslated. Exchange differences arising on the settlement of monetary items, and on the translation of monetary items, are recognised in profit or loss in the period in which they arise, except for exchange differences arising on a monetary item that forms part of the Group’s net investment in a foreign operation, in which case, such exchange differences are recognised in equity in the consolidated financials statements. Exchange differences arising on the retranslation of non monetary items carried at fair value are included in profit or loss for the period except for differences arising on the retranslation of non monetary items in respect of which gains and losses are recognised directly in equity, in which cases, the exchange differences are also recognised directly in equity. For the purposes of presenting the consolidated financial statements, the assets and liabilities of the Group’s foreign operations are translated into the presentation currency of the Company (i.e. Hong Kong dollars) at the rate of exchange prevailing at the balance sheet date, and their income and expenses are translated at the average exchange rates for the year, unless exchange rates fluctuate significantly during the period, in which case, the exchange rates prevailing at the dates of transactions are used. Exchange differences arising, if any, are recognised as a separate component of equity (the translation reserve). Such exchange differences are recognised in profit or loss in the period in which the foreign operation is disposed of. 8 4 HYS AN ANN UA L REPORT 200 6 3. SIGNIFICANT ACCOUNTING POLICIES continued Taxation Income tax expense represents the sum of the tax currently payable and deferred tax. The tax currently payable is based on taxable profit for the year. Taxable profit differs from profit as reported in the consolidated income statement because it excludes items of income or expense that are taxable or deductible in other years and it further excludes items that are never taxable or deductible. The Group’s liability for current tax is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date. Deferred tax is recognised on differences between the carrying amounts of assets and liabilities in the consolidated financial statements and the corresponding tax base used in the computation of taxable profit, and is accounted for using the balance sheet liability method. Deferred tax liabilities are generally recognised for all taxable temporary differences and deferred tax assets are recognised to the extent that it is probable that taxable profits will be available against which deductible temporary differences can be utilised. Such assets and liabilities are not recognised if the temporary difference arises from goodwill or from the initial recognition (other than in a business combination) of other assets and liabilities in a transaction that affects neither the taxable profit nor the accounting profit. Deferred tax liabilities are recognised for taxable temporary differences arising on investments in subsidiaries and associates, except where the Group is able to control the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future. The carrying amount of deferred tax assets is reviewed at each balance sheet date and reduced to the extent that it is no longer probable that sufficient taxable profits will be available to allow all or part of the asset to be recovered. Deferred tax is calculated at the tax rates that are expected to apply in the period when the liability is settled or the asset realised. Deferred tax is charged or credited to profit or loss, except when it relates to items charged or credited directly to equity, in which case the deferred tax is also dealt with in equity. Impairment At each balance sheet date, the Group reviews the carrying amounts of its assets to determine whether there is any indication that those assets have suffered an impairment loss. If the recoverable amount of an asset is estimated to be less than its carrying amount, the carrying amount of the asset is reduced to its recoverable amount. An impairment loss is recognised as an expense immediately, unless the relevant asset is carried at a revalued amount under another Standard, in which case the impairment loss is treated as a revaluation decrease under that Standard. Where an impairment loss subsequently reverses, the carrying amount of the asset is increased to the revised estimate of its recoverable amount, such that the increased carrying amount does not exceed the carrying amount that would have been determined had no impairment loss been recognised for the asset in prior years. A reversal of an impairment loss is recognised as income immediately, unless the relevant asset is carried at revalued amount under another Standard, in which case the reversal of the impairment loss is treated as a revaluation increase under that other Standard. Retirement benefit costs Payments to the Mandatory Provident Fund Scheme (“MPF Scheme”) are charged as an expense when employees have rendered service entitling them to the contributions. Revenue recognition Revenue is measured at the fair value of the consideration received or receivable. Rental income is recognised on a straight line basis over the relevant lease term. Management fee income and security service income are recognised when services are rendered. Dividend income from investments is recognised when the shareholders’ right to receive dividend has been established. Interest income from a financial asset is accrued on a time basis, by reference to the principal outstanding and at the effective interest rate applicable, which is the rate that exactly discounts the estimated future cash receipts through the expected life of the financial asset to that asset’s net carrying amount. 8 5 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 3. SIGNIFICANT ACCOUNTING POLICIES continued Borrowing costs All borrowing costs are recognised as and included in finance costs in the consolidated income statement in the period in which they are incurred. Financial instruments Financial assets and financial liabilities are recognised on the balance sheet when a group entity becomes a party to the contractual provisions of the instrument. Financial assets and financial liabilities are initially measured at fair value. Transaction costs that are directly attributable to the acquisition or issue of financial assets and financial liabilities (other than financial assets and financial liabilities at fair value through profit or loss) are added to or deducted from the fair value of the financial assets or financial liabilities, as appropriate, on initial recognition. Transaction costs directly attributable to the acquisition of financial assets or financial liabilities at fair value through profit or loss are recognised immediately in profit or loss. Financial assets The Group’s financial assets are classified as one of the three categories, including financial assets at fair value through profit or loss, loans and receivables and available for sale financial assets. All regular way purchases or sales of financial assets are recognised and derecognised on a trade date basis. Regular way purchases or sales are purchases or sales of financial assets that require delivery of assets within the time frame established by regulation or convention in the marketplace. The accounting policies adopted in respect of each category of financial assets are set out below. Financial assets at fair value through profit or loss Financial assets at fair value through profit or loss comprise derivative financial instruments that are not designated as hedging instruments and are classified as held for trading. At each balance sheet date subsequent to initial recognition, financial assets at fair value through profit or loss are stated at fair value, with changes in fair value recognised directly in profit or loss in the period in which they arise. The fair value of a derivative financial instrument is classified as a non current asset if the remaining maturity of the derivative contract is more than 12 months and as a current asset if the remaining maturity of the derivative contract is less than 12 months. Loans and receivables Loans and receivables are non derivative financial assets with fixed or determinable payments that are not quoted in an active market. At each balance sheet date subsequent to initial recognition, loans and receivables including accounts receivable and other receivables, bank balances, time deposits and amounts due from associates are carried at amortised cost using the effective interest method, less any identified impairment losses. An impairment loss is recognised in profit or loss when there is objective evidence that the asset is impaired, and is measured as the difference between the asset’s carrying amount and the present value of the estimated future cash flows discounted at the original effective interest rate. Impairment losses are reversed in subsequent periods when an increase in the asset’s recoverable amount can be related objectively to an event occurring after the impairment was recognised, subject to a restriction that the carrying amount of the asset at the date the impairment is reversed does not exceed what the amortised cost would have been had the impairment not been recognised. Available for sale financial assets Available for sale financial assets are non derivatives that are either designated as such or not classified as loans and receivables and financial assets at fair value through profit or loss. At each balance sheet date subsequent to initial recognition, available for sale financial assets are measured at fair value. Changes in fair value are recognised in equity, until the financial asset is disposed of or is determined to be impaired, at which time, the cumulative gain or loss previously recognised in equity is removed from equity and recognised in profit or loss. Any impairment losses on available for sale financial assets are recognised to profit or loss. Impairment losses on available for sale equity investments will not reverse to profit or loss in subsequent periods. For available for sale debt investments, impairment losses are subsequently reversed if an increase in the fair value of the investment can be objectively related to an event occurring after recognition of the impairment loss. For available for sale equity investments that do not have a quoted market price in an active market and whose fair value cannot be reliably measured, they are measured at cost less any identified impairment losses at each balance sheet date subsequent to initial recognition. An impairment loss is recognised in profit or loss when there is objective evidence that the asset is impaired. The amount of the impairment loss is measured as the difference between the carrying amount of the asset and the present value of the estimated future cash flows discounted at the current market rate of return for a similar financial asset. Such impairment losses will not reverse in subsequent periods. 8 6 HYS AN ANN UA L REPORT 200 6 3. SIGNIFICANT ACCOUNTING POLICIES continued Financial liabilities and equity Financial liabilities and equity instruments issued by a group entity are classified according to the substance of the contractual arrangements entered into and the definitions of a financial liability and an equity instrument. An equity instrument is any contract that evidences a residual interest in the assets of the group after deducting all of its liabilities. The Group’s financial liabilities are generally classified into financial liabilities at fair value through profit or loss and other financial liabilities. The accounting policies adopted in respect of financial liabilities and equity instruments are set out below. Financial liabilities at fair value through profit or loss Financial liabilities at fair value through profit or loss comprise derivative financial instruments that are not designated as hedging instruments. At each balance sheet date subsequent to initial recognition, financial liabilities at fair value through profit or loss are stated at fair value, with changes in fair value recognised directly in profit or loss in the period in which they arise. The fair value of a derivative financial instrument is classified as a non current liability if the remaining maturing of the derivative contract is more than 12 months and as a current liability if the remaining maturity of the derivative contract is less than 12 months. Financial liabilities Financial liabilities including borrowings, amounts due to minority shareholders, accounts payable and advances from investees are subsequently measured at amortised cost, using the effective interest method. In respect of the fixed rate notes, the carrying amounts are further adjusted for the gain or loss attributable to the hedged risk. Equity instruments Equity instruments issued by the Company are recorded at the proceeds received, net of direct issue costs. Derivative financial instruments and hedging Derivatives are initially recognised at fair value at the date a derivative contract is entered into and are subsequently remeasured to their fair value at each balance sheet date. The resulting gain or loss is recognised in profit or loss immediately unless the derivative is designated and effective as a hedging instrument, in which event the timing of the recognition in profit or loss depends on the nature of the hedge relationship. The Group designates certain derivatives to hedge its exposure against interest rate and foreign exchange rate fluctuation. Embedded derivatives Derivatives embedded in other financial instruments or other host contracts are treated as separate derivatives when their risks and characteristics are not closely related to those of the host contracts and the combined contracts are not measured at fair value with changes in fair value recognised in profit or loss. Hedge accounting The Group designates certain derivatives as hedging instruments as either fair value hedge or cash flow hedge. At the inception of the hedge relationship, the entity documents the relationship between the hedging instrument and hedged item, along with its risk management objectives and its strategy for undertaking various hedge transactions. Furthermore, at the inception of the hedge and on an ongoing basis, the Group documents whether the hedging instrument that is used in a hedging relationship is highly effective in offsetting changes in fair values or cash flows of the hedged item. Fair value hedge Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in profit or loss immediately, together with any changes in the fair value of the hedged item that is attributable to the hedged risk. Hedge accounting is discontinued when the Group revokes the hedging relationship, the hedging instrument expires or is sold, terminated, or exercised, or no longer qualifies for hedge accounting. The adjustment to the carrying amount of the hedged item arising from the hedged risk is amortised to profit or loss from that date. 8 7 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 3. SIGNIFICANT ACCOUNTING POLICIES continued Cash flow hedge The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges are deferred in equity. The gain or loss relating to the ineffective portion is recognised immediately in profit or loss. Amounts deferred in equity are recycled in profit or loss in the periods when the hedged item is recognised in profit or loss. Hedge accounting is discontinued when the Group revokes the hedging relationship, the hedging instrument expires or is sold, terminated, or exercised, or no longer qualifies for hedge accounting. For a hedge of the foreign currency risk of a firm commitment, when the hedging instrument expires or is sold, terminated, or exercised, or no longer qualifies for hedge accounting, the cumulative gain or loss that was deferred in equity from the period when the hedge was effective shall remain separately recognised in equity until the hedged risk affects profit or loss. Derecognition Financial assets are derecognised when the rights to receive cash flows from the assets expire or, the financial assets are transferred and the Group has transferred substantially all the risks and rewards of ownership of the financial assets. On derecognition of a financial asset, the difference between the asset’s carrying amount and the sum of the consideration received and receivable and the cumulative gain or loss that had been recognised directly in equity is recognised in profit or loss. Financial liabilities are derecognised when the obligation specified in the relevant contract is discharged, cancelled or expires. The difference between the carrying amount of the financial liability derecognised and the consideration paid and payable is recognised in profit or loss. Equity settled share based payment transactions The fair value of services received determined by reference to the fair value of share options granted at the grant date is expensed on a straight line basis over the vesting period, with a corresponding increase in equity (Employee share based compensation reserve). At each balance sheet date, the Group revises its estimates of the number of options that are expected to ultimately vest. The impact of the revision of the estimates, if any, is recognised in profit or loss, with a corresponding adjustment to employee share based compensation reserve. At the time when the share options are exercised, the amount previously recognised in employee share based compensation reserve will be transferred to share premium. When the share options are forfeited after the vesting date or are still not exercised at the expiry date, the amount previously recognised in employee share based compensation reserve will be transferred to retained profits. The Group has applied HKFRS 2 “Share based payments” to share options granted on or after 1 January 2005. The above policy is applied to all equity settled share based payments that were granted after 7 November 2002 and vested after 1 January 2005. In relation to share options granted before 1 January 2005, the Group chooses not to apply HKFRS 2 with respect to share options granted on or before 7 November 2002 and vested before 1 January 2005, no amount has been recognised in the financial statements in respect of the other equity settled shared based payments. 8 8 HYS AN ANN UA L REPORT 200 6 4. KEY SOURCES OF ESTIMATION UNCERTAINTY In the process of applying the Group’s accounting policies, which are described in note 3 above, management has made various estimates based on past experience, expectations of the future and other information. The key sources of estimation uncertainty that can significantly affect the amounts recognised in the financial statements are set out below. Estimate of fair value of investment properties As described in note 14, the investment properties were revalued at the balance sheet date on market value existing use basis by independent professional valuers. Such valuations were based on certain assumptions, which are subject to uncertainty and might materially differ from the actual results. In making the judgement, the Group considers information from current prices in an active market for similar properties and uses assumptions that are mainly based on market conditions existing at each balance sheet date. Fair values of financial instruments Financial instruments such as interest rate, foreign exchange and equity derivative instruments are carried at the balance sheet at fair value. The best evidence of fair value is quoted prices in an active market, where quoted prices are not available for a particular financial instrument, the Group uses the market values determined by independent financial institutions or internal or external valuation models to estimate the fair value. The use of methodologies, models and assumptions in pricing and valuing these financial assets and liabilities is subjective and requires varying degrees of judgment by management, which may result in significantly different fair values and results. All significant financial valuation models are strictly controlled and regularly recalibrated and vetted. 5. FINANCIAL INSTRUMENTS Financial risk management objectives and policies The Group’s major financial instruments include cash and bank balances, time deposits, accounts receivable, equity investments, amount due from an associate, other receivables, borrowings, accounts payable, amounts due to minority shareholders and derivative financial instruments. The Company’s major financial instruments include cash and bank balances, time deposits, other receivables and amounts due from/to subsidiaries. Details of these financial instruments are disclosed in respective notes. The risks associated with these financial instruments and the policies on how to mitigate these risks are set out below. The management manages and monitors these exposures to ensure appropriate measures are implemented on a timely and effective manner. Market risk (i) Currency risk The Group aims to minimize its currency risk and does not speculate in currency movements. The majority of the Group’s and the Company’s assets by value are located and all rental income are derived in Hong Kong, and denominated in Hong Kong dollars. At year end 2006, all of the Group’s debts were denominated in Hong Kong dollars with the exception of the US$182 million 10 year fixed rate notes. The Group has entered into appropriate hedging instruments to hedge against the potential currency risk (see note 20). Other than 10 year fixed rates notes which are exposed to currency risk, the Group has no other significant currency risk. (ii) Interest rate risk The Group manages its interest rate exposure based on interest rate level and outlook as well as potential impact on the Group’s financial position arising from volatility. Interest rate swap is the hedging instrument most commonly used by the Group to manage the interest rate exposure (see note 20 for details). At year end 2006, about 64.7% of the Group’s gross debts were effectively on a floating rate basis. The ratio could change with changes to the interest rate trend going forward. The Group’s policy is to maintain the proportion of borrowings in fixed rates and floating rates within an appropriate range. Accordingly, the Group entered into (i) interest rate swaps to hedge the interest rate risk of these Group’s floating borrowings including bank loans and floating rate notes; (ii) cross currency swaps to hedge the interest rate risk of certain of the Group’s fixed rate notes. 8 9 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 5. FINANCIAL INSTRUMENTS continued Financial risk management objectives and policies continued (iii) Other price risk The Group’s available for sale investments in listed securities are measured at fair value at each balance sheet date with reference to the listed share price. Therefore, the Group is exposed to equity price risks and the management will monitor the price movements and take appropriate actions when it is required. As at 31 December 2006, the Group has entered equity derivatives to hedge the price risk arising from certain listed securities. The equity derivatives are not designated as hedging instrument and hence are measured at fair value through profit or loss. Credit risk The Group’s and the Company’s credit risks are primarily attributable to amount due from an associate, time deposits, rent receivable from tenants and counterparty financial obligations in derivative financial instrument. The Group’s and the Company’s maximum exposure to credit risk which will cause a financial loss to the Group and the Company due to failure to discharge an obligation by the counterparties and financial guarantees issued by the Group and the Company is arising from: (a) the carrying amount of the respective recognised financial assets as stated in the consolidated and Company’s balance sheets; and (b) the amount disclosed in note 33 Contingent Liabilities. The Group’s and the Company’s time deposits and bank balances are deposited with banks of high credit quality in Hong Kong and the Group and the Company has exposure limit to any single financial institution. For rent receivable from tenants, credit checks are part of the normal leasing process and stringent monitoring procedures are in place to deal with overdue debts. In addition, the Group reviews the recoverable amount of each individual trade debt at each balance sheet date to ensure that adequate impairment losses are made for irrecoverable amounts. To mitigate counterparty risk, the Group enters into derivative contracts only with sound financial institutions with strong investment grade credit ratings, limits exposure to each, and monitors each’s rating regularly. The Group and the Company have no significant concentration of credit risk, with exposure spread over a number of counterparties and customers. Fair value The fair value of financial assets and financial liabilities are determined as follows: • • • the fair value of financial assets and financial liabilities with standard terms and conditions and traded on active liquid markets are determined with reference to the published price quotations; the fair values of the club debentures have been determined by reference to the recent transaction prices of similar club debentures; the fair value of other financial assets and financial liabilities (excluding derivative instruments) are determined in accordance with generally accepted pricing models based on discounted cash flow analysis using prices from observable current market transactions; and the fair value of derivative instruments, are calculated using quoted prices from independent financial institutions. Where such prices are not available, the fair value of a non option derivative is estimated using discounted cash flow analysis and the applicable yield curve. For an option derivative, the fair value is estimated using option pricing model (for example, the black scholes model). The directors consider that the carrying amounts of non derivative financial assets and financial liabilities approximate their fair value, except for the carrying amount of US$182 million (approximate to HK$1,415 million) fixed rate notes (note 26(c)) with fair value of US$193 million (approximate to HK$1,504 million). 9 0 HYS AN ANN UA L REPORT 200 6 6. TURNOVER Turnover comprises: Gross rental income from investment properties Management fee and security service income 2006 HK$’000 2005 HK$’000 1,267,576 539 1,249,392 404 1,268,115 1,249,796 As the Group’s turnover is derived principally from rental income and wholly in Hong Kong, no segment financial analysis is provided. 7. DIRECTORS’ REMUNERATION Directors’ fees Other emoluments: Basic salaries, housing and other allowances Bonus Share based payments (note 37) Retirement benefits scheme contributions 2006 HK$’000 1,510 10,581 2,485 1,171 251 2005 HK$’000 1,135 10,423 2,499 524 233 15,998 14,814 Remuneration paid or payable to each of the eleven (2005: twelve) Directors were as follows: For the year ended 31 December 2006 Basic salaries, housing and other allowances HK$’000 Directors’ fees HK$’000 (Note) Share based Retirement benefits scheme Bonus HK$’000 payments contributions HK$’000 HK$’000 Total HK$’000 Executive Directors Peter T.C. Lee (note a) Michael T.H. Lee (note b) Pauline W.L. Yu Wong Non executive Directors Fa kuang Hu Hans Michael Jebsen Anthony Hsien Pin Lee Chien Lee Dr. Deanna Ruth Tak Yung Rudgard Independent non executive Directors Sir David Akers Jones Per Jorgensen Dr. Geoffrey Meou tsen Yeh 190 120 100 120 120 130 130 100 230 130 140 4,213 3,599 2,769 1,213 1,027 245 – 1,171 – 12 12 227 5,628 5,929 3,341 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 120 120 130 130 100 230 130 140 1,510 10,581 2,485 1,171 251 15,998 9 1 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 7. DIRECTORS’ REMUNERATION continued For the year ended 31 December 2005 Basic salaries, housing and other allowances HK$’000 Directors’ fees HK$’000 (Note) Share based Retirement benefits scheme Bonus HK$’000 payments contributions HK$’000 HK$’000 Total HK$’000 Executive Directors Peter T.C. Lee (note a) Michael T.H. Lee (note b) Pauline W.L. Yu Wong Non executive Directors Fa kuang Hu Hans Michael Jebsen Anthony Hsien Pin Lee Chien Lee Dr. Deanna Ruth Tak Yung Rudgard Independent non executive Directors Sir David Akers Jones Per Jorgensen Dr. Geoffrey Meou tsen Yeh David Muir Turnbull # 136 85 75 85 85 90 100 75 157 100 95 52 4,146 3,538 2,739 1,200 1,020 279 – 524 – 12 12 209 5,494 5,179 3,302 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 85 85 90 100 75 157 100 95 52 # David Muir Turnbull appointed as Independent non executive Director on 11 May 2005 and resigned on 12 December 2005. 1,135 10,423 2,499 524 233 14,814 9 2 HYS AN ANN UA L REPORT 200 6 7. DIRECTORS’ REMUNERATION continued Notes: Directors’ fees breakdown of each of the Directors is set out below: Emoluments Investment Nomination Review Board Committee Committee Committee Committee HK$’000 HK$’000 HK$’000 HK$’000 Audit HK$’000 Total 2006 HK$’000 Total 2005 HK$’000 Executive Directors Peter T.C. Lee Michael T.H. Lee Pauline W.L. Yu Wong Non executive Directors Fa kuang Hu Hans Michael Jebsen Anthony Hsien Pin Lee Chien Lee Dr. Deanna Ruth Tak Yung Rudgard Independent non executive Directors Sir David Akers Jones Per Jorgensen Dr. Geoffrey Meou tsen Yeh David Muir Turnbull 140 100 100 100 100 100 100 100 120 100 100 – – – – – – – 30 – 60 30 – – 1,160 120 – – – 20 – – – – 30 – 20 – 70 20 20 – – 20 30 – – – – – – 30 – – – – – – – 20 – 20 – 190 120 100 120 120 130 130 100 230 130 140 – 136 85 75 85 85 90 100 75 157 100 95 52 90 70 1,510 1,135 (a) Year 2005: The Emoluments Review Committee reviewed his 2005 fixed base salary and determined his performance based bonus in March 2005. In the light of the recent salary review completed in November 2003, management did not receive any salary increment. Accordingly, his fixed base package remains HK$4,146,000 during the year. The stated bonus figure includes adjustment for 2004 bonus accrued in 2004 accounts (following finalisation of bonus by the Emoluments Review Committee in March 2005), and 2005 target bonus figure pending finalisation by the Emoluments Review Committee after year end in March 2006. Year 2006: The Emoluments Review Committee reviewed his 2006 fixed base salary and determined his performance based bonus in March 2006. It was decided to make an increment on such base salary as from April 2006. Accordingly, his fixed base package (including housing allowance which amount remains unchanged) paid during the year was HK$4,213,000. The stated bonus figure includes adjustment for 2005 bonus accrued in 2005 accounts (following finalisation of bonus by the Emoluments Review Committee in March 2006), and 2006 target bonus figure pending finalisation by the Emoluments Review Committee after year end in March 2007. (b) Year 2005: The Emoluments Review Committee reviewed his 2005 fixed base salary and determined his performance based bonus in March 2005. In the light of the recent salary review completed in November 2003, management did not receive any salary increment. Accordingly, his fixed base package remains HK$3,538,000 during the year. The stated bonus figure includes adjustment for 2004 bonus accrued in 2004 accounts (following finalisation of bonus by the Emoluments Review Committee in March 2005), and 2005 target bonus figure pending finalisation by the Emoluments Review Committee after year end in March 2006. Year 2006: The Emoluments Review Committee reviewed his 2006 fixed base salary and determined his performance based bonus in March 2006. It was decided to make an increment on his base salary as from April 2006. Accordingly, his fixed base package (including housing allowance which amount remains unchanged) paid during the year was HK$3,599,000. The stated bonus figure includes adjustment for 2005 bonus accrued in 2005 accounts (following finalisation of bonus by the Emoluments Review Committee in March 2006), and 2006 target bonus figure pending finalisation by the Emoluments Review Committee after year end in March 2007. 9 3 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 8. EMPLOYEES’ EMOLUMENTS The five highest paid individuals included three (2005: three) Directors, details of whose remuneration are set out in note 7 above. The remuneration of the remaining two (2005: two) individuals is detailed as follows: 2006 HK$’000 4,922 1,208 758 24 2005 HK$’000 4,762 656 726 24 6,912 6,168 2006 No. of employees 2005 No. of employees – 1 1 2 1 1 – 2 2006 HK$’000 2005 HK$’000 37,470 – 25,651 107,605 10,970 63,429 34,129 15,988 108,720 9,401 181,696 231,667 (21,783 ) (9,634 ) (31,417 ) 7,379 1,083 4,021 (924 ) (32,562 ) (33,486 ) 10,079 972 5,353 162,762 214,585 Basic salaries, housing and other allowances Share based payments Bonus Retirement benefits scheme contributions Their emoluments were within the following bands: HK$2,500,001 to HK$3,000,000 HK$3,000,001 to HK$3,500,000 HK$3,500,001 to HK$4,000,000 9. FINANCE COSTS Interest on – bank loans, overdraft and other loans: wholly repayable within five years not repayable within five years – floating rate notes – fixed rate notes – zero coupon notes (imputed interests) Net interest received on derivative financial instruments (Note) – due within five years – due after five years Bank charges Medium Term Note Programme expenses Others Note: Fair value changes excluded accrued interest in derivative financial instruments for the year. 9 4 HYS AN ANN UA L REPORT 200 6 10. TAXATION Hong Kong profits tax for the year (Over) underprovision in prior years Prior years provision Deferred tax (note 28) – changes in fair value on investment properties – changes in fair value on disposed leasehold properties – other temporary differences 2006 HK$’000 90,163 (924 ) – 2005 HK$’000 75,270 25 103,000 89,239 178,295 448,378 – 20,725 668,351 (4,903 ) 14,840 469,103 678,288 558,342 856,583 Hong Kong profits tax is calculated at 17.5% of the estimated assessable profit for both years. The taxation for the year can be reconciled to the profit before taxation per the consolidated income statement as follows: Profit before taxation Tax at the Hong Kong profits tax rate of 17.5% Tax effect of expenses not deductible for tax purposes Tax effect of utilisation of estimated tax losses not previously recognised Tax effect of income not taxable for tax purposes Tax effect of estimated tax loss not provided Tax effect of deferred tax assets not recognised Tax effect of share of results of associates (Over) underprovision in prior years Prior years provision Others 2006 HK$’000 2005 HK$’000 3,797,881 5,175,884 664,629 1,254 (16,980 ) (62,224 ) 1,753 143 (21,009 ) (924 ) – (8,300 ) 905,779 19,721 (29,002 ) (103,487 ) 195 10,436 (42,237 ) 25 103,000 (7,847 ) Taxation for the year 558,342 856,583 In addition to the amount charged to the consolidated income statement, deferred tax relating to the revaluation of the Group’s leasehold buildings has been charged directly to equity (see note 28). At the date of issue of the consolidated financial statements, the Group has disputes with the Hong Kong Inland Revenue Department regarding additional tax assessments for prior years. A tax provision of HK$193 million has been made in previous years. However, it remains the Directors’ view that there still have ample grounds to contest the assessments based on tax principles as well as facts and the Group will continue to pursue the objection against the additional assessments vigorously. 9 5 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 11. PROFIT FOR THE YEAR Profit for the year has been arrived at after charging (crediting): Staff costs Retirement benefits scheme contributions (note 32) Forfeited contributions (note 32) Share based payments Amortisation of prepaid lease payments Depreciation for property, plant and equipment Revaluation deficit (reversal of revaluation deficit) on building for own use Auditor’s remuneration Gross rental income from investment properties Less: Direct operating expenses that generated rental income Direct operating expenses that did not generate rental income Dividends from – listed investments – unlisted investments Interest income Share of tax of an associate (included in share of results of associates) Recovery of a loan to an associate Loss on disposal of property, plant and equipment Net foreign exchange (gain) loss 12. DIVIDENDS Dividends recognised as distribution during the year: Interim dividend paid – HK10 cents per share (2005: HK10 cents) Additional prior year’s dividend paid on exercise of share options subsequent to 31 December 2005 2005 Final dividend paid – HK35 cents per share 2004 Final dividend paid – HK30 cents per share 2006 HK$’000 2005 HK$’000 133,976 5,230 (2,876 ) 4,382 131,354 5,301 (3,789 ) 2,171 140,712 135,037 163 6,738 58 1,770 163 5,787 (65 ) 1,740 (1,267,576 ) 234,156 6,405 (1,249,392 ) 233,575 3,776 (1,027,015 ) (1,012,041 ) (41,081 ) (20 ) (41,101 ) (18,075 ) 57,090 (87,043 ) 432 (287 ) (33,714 ) – (33,714 ) (2,914 ) 107,646 – 9 19 2006 HK$’000 2005 HK$’000 105,461 105,224 45 368,641 – – – 314,989 474,147 420,213 Final dividend proposed – HK40 cents per share (2005: HK35 cents) 422,055 368,641 The 2006 final dividend of HK40 cents (2005: HK35 cents) per share has been proposed by the Directors and is subject to approval by the shareholders in general meeting. The proposed final dividend for 2006 will be payable in cash with a scrip dividend alternative. 9 6 HYS AN ANN UA L REPORT 200 6 12. DIVIDENDS continued During the year, scrip dividend alternatives were offered to shareholders in respect of the 2005 final and 2006 interim dividends. These alternatives were accepted by the shareholders as follows: Dividends: Cash Share alternative (note 29) 2006 Interim HK$’000 2005 Final HK$’000 95,430 10,031 340,330 28,311 105,461 368,641 13. EARNINGS PER SHARE The calculation of the basic and diluted earnings per share attributable to the ordinary equity holders of the parent is based on the following data: Earnings for the purposes of basic and diluted earnings per share (profit for the year attributable to equity holders of the parent) Weighted average number of ordinary shares for the purposes of basic earnings per share Effect of dilutive potential ordinary shares: Share options Weighted average number of ordinary shares for the purposes of diluted earnings per share 2006 HK$’000 2005 HK$’000 3,098,789 4,120,555 2006 ’000 2005 ’000 1,054,166 1,051,502 924 682 1,055,090 1,052,184 The computation of diluted earnings per share does not assume the exercise of certain of the Company’s outstanding share options as the exercise prices are higher than the average market price per share. For the purpose of assessing the underlying performance of the Group, the management is of the view that the profit for the year should be adjusted for fair value changes on investment properties and related deferred taxation in arriving at “Underlying profit attributable to equity holders of the parent”. In 2006, net realised gain on disposal of available for sale investments and investment properties and recovery of a loan to an associate should also be adjusted in arriving at “Profit excluding asset value changes attributable to the equity holders of the parent”. In 2005, net realised gain on disposal of investment properties and prior year tax provision was adjusted in arriving at “Profit excluding asset value changes and prior year tax provision attributable to the equity holders of the parent”. The difference between the underlying profit, profit excluding asset value changes and profit attributable to equity holders of the parent as shown in the consolidated income statement for the year is reconciled as follows: 9 7 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 13. EARNINGS PER SHARE continued Profit attributable to equity holders of the parent as shown in the consolidated income statement Gain arising from fair value changes on investment properties Increase in deferred taxation in relation to fair value gain on investment properties Gain arising from fair value changes on investment properties net of related deferred taxation attributable to minority interests Gain arising from fair value changes on investment properties net of related deferred taxation from an associate Underlying profit attributable to equity holders of the parent Recovery of a loan to an associate Net realised gain on disposal of available for sale investments Realised fair value gain on disposal of investment properties Profit excluding asset value changes attributable to equity holders of the parent 2006 HK$’000 Earnings per share (Basic) HK cents 3,098,789 (2,575,420 ) 293.96 (244.31 ) 448,378 42.54 97,019 9.20 (56,521 ) (5.36 ) 1,012,245 (87,043 ) (170,277 ) (191 ) 96.03 (8.26 ) (16.15 ) (0.02 ) 754,734 71.60 Profit attributable to equity holders of the parent as shown in the consolidated income statement Gain arising from fair value changes on investment properties Less: Gain arising from fair value changes on disposed 2005 HK$’000 2005 HK$’000 4,120,555 (4,226,005 ) Earnings per share (Basic) HK cents 391.87 (401.90 ) investment properties 467,019 (3,758,986 ) 44.41 Increase in deferred taxation in relation to fair value gain on investment properties Gain arising from fair value changes on investment properties net of related deferred taxation attributable to minority interests Gain arising from fair value changes on investment properties net of related deferred taxation from an associate Underlying profit attributable to equity holders of the parent Prior year tax provision Realised fair value gain on disposal of investment properties Profit excluding asset value changes and prior year tax provision attributable to equity holders of the parent 668,351 63.56 156,874 14.92 (181,523 ) (17.26 ) 1,005,271 103,000 (467,453 ) 95.60 9.80 (44.46 ) 640,818 60.94 9 8 HYS AN ANN UA L REPORT 200 6 14. INVESTMENT PROPERTIES Fair Value At 1 January Additions Adjustment resulted from cost variation Disposals Transfer to a group company Reclassified from buildings (note 15) Reclassified to buildings (note 15) Fair value changes The Group The Company 2006 HK$’000 2005 HK$’000 2006 HK$’000 2005 HK$’000 29,815,430 84,816 (1,208 ) (1,491 ) – – – 2,575,611 27,916,790 385,662 (761 ) (2,727,166 ) – 30,500 (15,600 ) 4,226,005 4,061,000 – – – (4,061,000 ) – – – 3,510,000 220 – – – – – 550,780 At 31 December 32,473,158 29,815,430 – 4,061,000 The carrying value of investment properties shown above comprises: Leasehold land in Hong Kong: – Medium term lease – Long lease The Group The Company 2006 HK$’000 2005 HK$’000 2006 HK$’000 2005 HK$’000 5,640,000 26,833,158 5,500,000 24,315,430 32,473,158 29,815,430 – – – – 4,061,000 4,061,000 The fair value of the Group’s investment properties at 31 December 2006 have been arrived at on the basis of a valuation carried out on that date by Knight Frank Petty Limited, an independent qualified professional valuer not connected with the Group. Knight Frank Petty Limited has appropriate qualifications and recent experiences in the valuation of similar properties in the relevant locations. The valuation, which conforms to Hong Kong Institute of Surveyors Valuation Standards on Properties, was arrived at by reference to comparable market transactions and rental yield for similar properties. All of the Group’s property interests held under operating leases to earn rentals or for capital appreciation purposes are measured using the fair value model and are classified and accounted for as investment properties. 9 9 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 15. PROPERTY, PLANT AND EQUIPMENT Buildings in Hong Kong under long lease HK$’000 Furniture, fixtures and equipment HK$’000 Computers HK$’000 Motor vehicles HK$’000 Total HK$’000 69,592 – – (30,500 ) 15,600 344 – 55,036 – – 110 44,897 4,288 (147 ) 17,362 2,523 (4 ) 1,131 – – – – – (70 ) 48,968 4,634 (2,305 ) – – – – (28 ) 19,853 921 (66 ) – – – – – 1,131 – – – 132,982 6,811 (151 ) (30,500 ) 15,600 344 (98 ) 124,988 5,555 (2,371 ) 110 The Group Cost or valuation At 1 January 2005 Additions Disposals Reclassified to investment properties (note 14) Reclassified from investment properties (note 14) Surplus on revaluation Disposal of subsidiaries At 31 December 2005 Additions Disposals Surplus on revaluation At 31 December 2006 55,146 51,297 20,708 1,131 128,282 Comprising: At cost At valuation 2006 Accumulated depreciation At 1 January 2005 Provided for the year Eliminated on disposals Eliminated on revaluation Disposal of subsidiaries At 31 December 2005 Provided for the year Eliminated on disposals Eliminated on revaluation – 55,146 51,297 – 20,708 – 1,131 – 73,136 55,146 55,146 51,297 20,708 1,131 128,282 – 977 – (977 ) – – 1,397 – (1,397 ) 40,747 1,921 (140 ) – (53 ) 42,475 2,319 (1,819 ) – 9,037 2,889 (2 ) – (19 ) 11,905 3,022 (60 ) – 1,131 – – – – 1,131 – – – 50,915 5,787 (142 ) (977 ) (72 ) 55,511 6,738 (1,879 ) (1,397 ) At 31 December 2006 – 42,975 14,867 1,131 58,973 Net book values At 31 December 2006 55,146 8,322 5,841 At 31 December 2005 55,036 6,493 7,948 – – 69,309 69,477 1 0 0 HYS AN ANN UA L REPORT 200 6 15. PROPERTY, PLANT AND EQUIPMENT continued Furniture, fixtures and equipment HK$’000 Computers HK$’000 Motor vehicles HK$’000 Total HK$’000 The Company Cost At 1 January 2005 Additions Disposals At 31 December 2005 Additions Disposals At 31 December 2006 Accumulated depreciation At 1 January 2005 Provided for the year Eliminated on disposals At 31 December 2005 Provided for the year Eliminated on disposals At 31 December 2006 Net book values At 31 December 2006 At 31 December 2005 20,958 1,425 (111 ) 22,272 519 (1,314 ) 16,687 2,439 – 19,126 874 (66 ) 1,131 – – 1,131 – – 38,776 3,864 (111 ) 42,529 1,393 (1,380 ) 21,477 19,934 1,131 42,542 19,903 669 (111 ) 20,461 674 (1,198 ) 8,717 2,754 – 11,471 2,876 (60 ) 1,131 – – 1,131 – – 29,751 3,423 (111 ) 33,063 3,550 (1,258 ) 19,937 14,287 1,131 35,355 1,540 5,647 1,811 7,655 – – 7,187 9,466 The above items of property, plant and equipment are depreciated on a straight line basis at the following rate per annum: Buildings Furniture, fixtures and equipment Computers Motor vehicles Over the shorter of the term of the lease, or 40 years 20% 20% 25% The buildings of the Group were revalued at 31 December 2006 by Knight Frank Petty Limited, an independent professional valuer, on market value basis. The surplus and deficit arising on revaluation of HK$1,565,000 and HK$58,000 (2005: surplus of HK$1,256,000 and HK$65,000) has been credited to the asset revaluation reserve and charged to consolidated income statement respectively. If the buildings of the Group had not been revalued, they would have been included in these financial statements at cost less accumulated depreciation at HK$51,737,000 (2005: HK$53,350,000). 1 0 1 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 16. PREPAID LEASE PAYMENTS The Group’s prepaid lease payments represent leasehold land in Hong Kong held under long lease. The leasehold land is amortised on a straight line basis over the lease terms. 17. INVESTMENTS IN SUBSIDIARIES Unlisted shares, at cost The Company 2006 HK$’000 5 2005 HK$’000 5 Details of the principal subsidiaries held by the Company at 31 December 2006 are set out in note 38. 18. INVESTMENTS IN ASSOCIATES/AMOUNTS DUE FROM ASSOCIATES Unlisted cost of investment in associates Share of post acquisition profits and reserves, net of dividend received Less: Impairment loss The Group The Company 2006 HK$’000 2005 HK$’000 2006 HK$’000 2005 HK$’000 2,629 2,629 452,298 342,243 454,927 (11,358 ) 344,872 (11,358 ) 443,569 333,514 3 – 3 – 3 3 – 3 – 3 The amounts due from associates are unsecured and interest free. At the balance sheet date, amounts due from associates amounting to HK$186,117,000 (2005: HK$171,131,000) and HK$642,338,000 (2005: HK$642,596,000) are not recoverable within one year and are recoverable within one year respectively. The aggregate attributable share of results of the associates is based on the unaudited management accounts for the year ended 31 December 2006. 1 0 2 HYS AN ANN UA L REPORT 200 6 18. INVESTMENTS IN ASSOCIATES/AMOUNTS DUE FROM ASSOCIATES continued Details of the Group’s associates at 31 December 2006 are as follows: Name of associate Form of business structure Place of incorporation/ registration and operation Class of share held/ registered capital Percentage of issued capital/ registered capital held Parallel Asia Engineering Company Limited Private limited company Hong Kong Share 25 Wingrove Investment Pte Ltd. Private company limited by shares Singapore Share 25 * Country Link Enterprises Limited (“Country Link”) Private limited company Hong Kong Share 26.3 * Shanghai Kong Hui Property Development Co., Ltd. Sino Foreign equity joint venture The People’s US$165,000,000 # Republic of China 23.7 * Shanghai Grand Gateway Plaza Property Management Co., Ltd. Sino Foreign equity joint venture The People’s Republic of China US$140,000 # 23.7 * * Indirectly held # Registered capital The summarised financial information in respect of the Group’s associates is set out below: Principal activity Investment holding Property development and leasing Investment holding Property development and leasing Property management Total assets Total liabilities Net assets Group’s share of net assets of associates Turnover Profit for the year Group’s share of results of associates for the year 2006 HK$’000 2005 HK$’000 6,928,251 (4,721,330 ) 6,531,050 (4,777,200 ) 2,206,921 1,753,850 454,927 344,872 668,956 523,376 456,662 828,116 120,053 241,358 1 0 3 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 19. AVAILABLE-FOR-SALE INVESTMENTS Listed investments: – Equity securities listed in Hong Kong Unlisted investments: – Club debentures Less: Impairment loss – Unlisted shares Less: Impairment loss Amounts due therefrom Total Carrying amount analysed for reporting purposes as: Non current Unlisted investments: – Club debentures Less: Impairment loss The Group 2006 HK$’000 2005 HK$’000 1,677,913 1,170,295 2,831 (800 ) 2,831 (800 ) 2,031 2,031 117,385 (60,333 ) 117,385 (60,333 ) 57,052 8,431 57,052 26,722 65,483 83,774 67,514 85,805 1,745,427 1,256,100 1,745,427 1,256,100 The Company 2006 HK$’000 2005 HK$’000 2,831 (800 ) 2,831 (800 ) 2,031 2,031 Carrying amount analysed for reporting purpose as: Non current 2,031 2,031 At the balance sheet date, all available for sale investments are stated at fair value except for those unlisted equity securities. The unlisted equity investments represent investments in unlisted equity securities issued by private entities incorporated in Singapore. They are measured at cost less impairment at each balance sheet date because the range of reasonable fair value estimates is so significant that the management is of the opinion that their fair values cannot be measured reliably. 1 0 4 HYS AN ANN UA L REPORT 200 6 20. DERIVATIVE FINANCIAL INSTRUMENTS The Group’s net fair values of derivative financial instruments at 31 December 2006 were as follows: Current Interest rate swaps Cash flow hedges Not designated as hedges Foreign exchange derivatives Cash flow hedges Not designated as hedges Equity derivatives Not designated as hedges Non current Interest rate swaps Cash flow hedges Fair value hedges Not designated as hedges Foreign exchange derivatives Cash flow hedges Not designated as hedges Cross currency swap Fair value hedges The Group 2006 Assets HK$’000 2006 Liabilities HK$’000 2005 Assets HK$’000 2005 Liabilities HK$’000 879 504 932 – – – – – 13,411 136 571 77 – – – – – (39,495 ) – (64,057 ) 2,315 (39,495 ) 14,195 (64,057 ) – – – – (3,529 ) – 1,299 – (815 ) (31,913 ) 18,522 – 718 2,395 – – (10,812 ) – – (24,194 ) 1,175 (8,303 ) 10,369 (4,796 ) 2,474 (44,560 ) 32,004 (39,802 ) Total 4,789 (84,055 ) 46,199 (103,859 ) Interest rate swaps The aggregate notional amount of the outstanding interest rate swaps as at 31 December 2006 was HK$1,164,238,000 (2005: HK$2,423,492,000). Those instruments comprise fixed to floating interest rate swaps, floating to fixed interest rate swaps and average HIBOR swaps. The floating to fixed interest rate swaps were designated as hedging the interest rate risk of the floating borrowings including bank loans and the floating rate notes. The fixed to floating interest rate swap was entered into to hedge the fair value risk of the zero coupon notes. The average HIBOR swaps do not qualify for hedge accounting. At the balance sheet date, fair value gains of HK$873,000 (2005: HK$31,965,000) from the interest rate swaps under cash flow hedges have been deferred in equity and are expected to be released to the consolidated income statement at various dates during the lives of the swaps when the hedged interest payable occur. The maturity periods of interest rate swaps at notional amount at 31 December 2006 were as follows: Within one year Between one and five years Beyond five years The Group 2006 HK$’000 2005 HK$’000 948,983 – 215,255 970,000 1,248,983 204,509 1,164,238 2,423,492 1 0 5 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 20. DERIVATIVE FINANCIAL INSTRUMENTS continued Interest rate swaps continued At 31 December 2006, the floating to fixed interest rate swaps locked in the interest rates ranging from 2.11% to 2.45% (2005: 2.11% to 2.85%). The average HIBOR swaps swapped the HIBOR into average HIBOR with the effective rates for the year ranging from 3.98% to 4.44% (2005: 0.3% to 4.1%). The fixed to floating swap converted a fixed rate of 5.19% to HIBOR plus 0.69% for both years. The above derivatives are measured at fair value, as calculated by the present value of the estimated future cash flow at each balance sheet date or as determined by independent financial institutions. Foreign exchange derivatives The aggregate notional amount of the outstanding foreign exchange derivatives at 31 December 2006 was HK$1,605,831,000 (2005: HK$1,711,097,000). Those instruments, which comprise forward foreign exchange contracts, cross currency swaps and net basis swaps, are mainly used for managing the foreign exchange risk of the outstanding US$182 million (2005: US$200 million) fixed rate notes. Out of the US$182 million (2005: US$200 million), the foreign exchange exposures on the principal and the coupons of the US$117 million (2005: US$135 million) fixed rate notes are hedged by the cross currency swaps. The forward foreign exchange contracts are mainly designated to hedge the foreign exchange rate risk arising from the coupon payments of the remaining US$65 million (2005: US$65 million) fixed rate notes. The net basis swaps which are used to eliminate the foreign exchange exposures on the principal part of the US$65 million (2005: US$65 million) fixed rate notes were not designated as hedging instruments for hedge accounting purpose. At 31 December 2006, fair value gains of HK$1,416,000 (2005: HK$2,966,000) from the forward foreign exchange contracts under cash flow hedges have been deferred in equity and are expected to be released to the consolidated income statement at various dates when the coupon payments of the US$65 million (2005: US$65 million) fixed rate notes occur. The maturity periods of the foreign exchange derivatives at notional amount at 31 December 2006 were as follows: Within one year Between one and five years Beyond five years The Group 2006 HK$’000 2005 HK$’000 34,275 137,526 1,434,030 48,722 102,398 1,559,977 1,605,831 1,711,097 The above derivatives are measured at fair value, as calculated by the foreign exchange rates and the present value of the estimated future cash flow at each balance sheet date. Equity derivatives The aggregate notional amount of the outstanding equity derivatives at 31 December 2006 was HK$95,205,000 (2005: HK$196,300,000). The existing equity derivatives were not designated as hedging instrument according to HKAS 39. The above derivatives are measured at fair value, as determined by an independent financial institution. 21. ACCOUNTS RECEIVABLE AND OTHER RECEIVABLES Accounts receivable are mainly in respect of rents which are normally received in advance. Rents in arrears of the Group and the Company as at 31 December 2006 and 2005 were aged less than 90 days. 22. TIME DEPOSITS AND CASH AND BANK BALANCES Time deposits and cash and bank balances comprise cash and short term bank deposits carrying effective interest ranging from 3.7% to 3.9% (2005: 3.5% to 4.0%) with an original maturity of three months or less. 1 0 6 HYS AN ANN UA L REPORT 200 6 23. ACCOUNTS PAYABLE AND ACCRUALS Accounts payable and accruals of the Group as at 31 December 2006 and 2005 were aged less than 90 days. 24. AMOUNTS DUE FROM/TO SUBSIDIARIES The amounts are unsecured, interest free and are recoverable on demand. 25. ADVANCES FROM INVESTEES The advances are unsecured, interest free and are repayable within one year. 26. BORROWINGS The analysis of the carrying amount of borrowings is as follows: Bank loans Floating rate notes Fixed rate notes Zero coupon notes Notes: (a) Bank loans Bank loans, unsecured The bank loans are repayable as follows: More than two years, but not exceeding five years More than five years Notes (a) (b) (c) (d) The Group 2006 HK$’000 2005 HK$’000 720,000 548,730 1,337,323 214,568 2,056,500 548,213 1,499,591 196,219 2,820,621 4,300,523 The Group 2006 HK$’000 2005 HK$’000 720,000 2,056,500 720,000 – 1,406,500 650,000 Amounts due after one year shown under non current liabilities 720,000 2,056,500 At the balance sheet date, all the above bank loans are variable rate borrowings with effective interest rates (which are also equal to contracted interest rates) ranging from 4.39% to 4.58% (2005: 4.53% to 4.74%) denominated in Hong Kong Dollars. Interest is normally refixed at every one to six months. At 31 December 2006, the interest rate risk of certain bank loans was hedged by interest rate swaps (floating to fixed interest rate swaps) (see note 20). (b) Floating rate notes Floating rate notes The Group 2006 HK$’000 2005 HK$’000 548,730 548,213 Hysan (MTN) Limited, a wholly owned subsidiary of the Company, issued HK$550 million five year floating rate notes in 2004. The notes, which are guaranteed as to principal and interest by the Company, bear effective interest rates (which are equal to contracted interest rates) ranging from 4.24% to 5.04% (2005: 0.65% to 4.60%) and are repayable in full in 2009. The Group has entered into an interest rate swap to hedge against the interest rate risk of certain floating rate notes (see note 20). 1 0 7 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 26. BORROWINGS continued Notes: continued (c) Fixed rate notes Fixed rate notes Less: Notes repurchased and cancelled Net gain attributable to hedged risks (Note) The Group 2006 HK$’000 2005 HK$’000 1,555,406 (140,398 ) (77,685 ) 1,553,967 – (54,376 ) 1,337,323 1,499,591 Hysan (MTN) Limited, a wholly owned subsidiary of the Company, issued US$200 million 10 year fixed rate notes in February 2002. The notes, which are guaranteed as to principal and interest by the Company, bear an effective interest rate (which is equal to contracted interest rate) of 7% per annum and are repayable in full in February 2012. During the year ended 31 December 2006, a total nominal amount of US$18 million has been repurchased and cancelled. As at 31 December 2006, the outstanding nominal amount of the notes was US$182 million. The Group has entered into forward foreign exchange contracts to hedge against the foreign exchange rate risk of the coupon payments of the US$65 million fixed rate notes and the contracts are accounted for as cash flow hedges (see note 20). The Group has also entered into cross currency swaps to hedge against the interest rate and foreign exchange rate risk in relation to the principal repayment and coupon payments of US$117 million (2005: US$135 million) of the fixed rate notes under fair value hedge (see note 20). Note: The HK$77,685,000 (2005: HK$54,376,000) represented gains in fair value of the hedged interest rate and foreign exchange rate risk of the US$117 million (2005: US$135 million) fixed rate notes that were designated as the hedged instrument of fair value hedge. (d) Zero coupon notes Zero coupon notes Less: Net gain attributable to hedged risk (Note) The Group 2006 HK$’000 2005 HK$’000 218,202 (3,634 ) 207,114 (10,895 ) 214,568 196,219 Hysan (MTN) Limited, a wholly owned subsidiary of the Company, issued 15 year zero coupon notes of nominal amount of HK$430 million at an issue price of around 46.37% in February 2005. The notes, which are guaranteed as to the nominal amount by the Company, bear an effective yield (which is equal to contracted yield) at the rate of 5.19% per annum and are repayable at par in February 2020. Hysan (MTN) Limited has the option to redeem the notes on 7 February 2015 at a price of about 77.4% of the nominal amount. The Group has entered into interest rate swap to hedge against the interest rate risk of the zero coupon notes under fair value hedges (see note 20). Note: The HK$3,634,000 (2005: HK$10,895,000) represented gains in fair value attributable to the hedged interest rate risk of the zero coupon notes under fair value hedge. 27. AMOUNTS DUE TO MINORITY SHAREHOLDERS The amounts are unsecured, interest free and are repayable within one year. At 31 December 2005, the amounts were classified as non current and were not repayable within one year. 1 0 8 HYS AN ANN UA L REPORT 200 6 28. DEFERRED TAXATION The following are the major deferred tax liabilities (assets) recognised by the Group and the Company and movements thereon during the year: Accelerated tax depreciation HK$’000 Revaluation of properties HK$’000 Retirement benefits scheme contributions HK$’000 Tax losses HK$’000 Total HK$’000 222,713 1,993,852 (1 ) (15,621 ) 2,200,943 The Group At 1 January 2005 Charge to income for the year (Note 10) Charge to equity for the year At 31 December 2005 Charge to income for the year (Note 10) Charge to equity for the year 1,236 – 663,448 220 223,949 2,657,520 19,906 – 448,378 274 At 31 December 2006 243,855 3,106,172 The Company At 1 January 2005 Charge to income for the year At 31 December 2005 Credit to income for the year At 31 December 2006 1 – – – – – 13,603 – 678,288 220 (2,018 ) 2,879,451 819 – 469,103 274 (1,199 ) 3,348,828 Accelerated tax depreciation HK$’000 Revaluation of properties HK$’000 Total HK$’000 9,069 1,338 383,284 96,386 392,353 97,724 10,407 (10,246 ) 479,670 (479,670 ) 490,077 (489,916 ) 161 – 161 At 31 December 2006, the Group has unused estimated tax losses of HK$456 million (2005: HK$556 million) available for offset against future profits. A deferred tax asset has been recognised in respect of HK$7 million (2005: HK$12 million) of such losses. No deferred tax asset has been recognised in respect of the remaining estimated tax losses of HK$449 million (2005: HK$544 million) as the utilisation of these estimated tax losses is uncertain. These estimated tax losses may be carried forward indefinitely. At 31 December 2006, the Group has deductible temporary differences of HK$49 million (2005: HK$60 million). No deferred tax asset has been recognised in relation to such deductible temporary differences as it is not probable that taxable profit will be available against which the deductible temporary differences can be utilised. The Company does not have any unused tax loss as at balance sheet date. 1 0 9 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 29. SHARE CAPITAL Ordinary shares of HK$5 each Authorised: At 1 January and 31 December Issued and fully paid: At 1 January Issue of shares pursuant to scrip dividend scheme Exercise of share options Number of shares Share capital 2006 ’000 2005 ’000 2006 HK$’000 2005 HK$’000 1,450,000 1,450,000 7,250,000 7,250,000 1,053,261 1,049,964 5,266,304 5,249,818 1,700 176 3,297 – 8,502 881 16,486 – At 31 December 1,055,137 1,053,261 5,275,687 5,266,304 On 9 June 2006 and 3 October 2006 respectively, the Company issued and allotted a total of 1,217,135 shares and 483,166 shares of HK$5 each in the Company at HK$23.26 and HK$20.76 to the shareholders who elected to receive shares in the Company in lieu of cash for the 2005 final and 2006 interim dividends pursuant to the scrip dividend scheme announced by the Company on 9 May 2006 and 29 August 2006. During the year, options to subscribe for a total of 128,267 shares and 48,000 shares were exercised at the exercise prices of HK$15.85 and HK$18.79 per share respectively. Details of options outstanding and movements during the year are set out in note 37. These shares rank pari passu in all respects with other shares in issue. None of the Company’s subsidiaries purchased, sold or redeemed any of the Company’s listed securities during the year. 1 1 0 HYS AN ANN UA L REPORT 200 6 30. RESERVES OF THE COMPANY The distributable reserves of the Company as at 31 December 2006 amounted to HK$5,574,477,000, being its retained profits and general reserve at that date (2005: HK$3,111,988,000, excluded unrealised fair value changes on investment properties and related deferred taxation). Capital Share redemption reserve HK$’000 premium HK$’000 General reserve HK$’000 (Note) Employee Dividend share based reserve compensation HK$’000 HK$’000 Retained profits HK$’000 Total HK$’000 1,380,278 154,995 100,000 314,989 – 5,103,500 7,053,762 At 1 January 2005 Premium on issue of shares pursuant to scrip dividend scheme Share issue expenses Recognition of equity settled share based payments Final dividend for 2004 distributed Interim dividend for 2005 distributed Dividend for 2005 declared Profit for the year 40,186 (40 ) – – – – – – – – – – – – – – – – – – – – – – – – (314,989 ) 2,171 – – – – – 40,186 (40 ) 2,171 (314,989 ) (105,224 ) 473,865 – – – – – (473,865 ) 643,656 (105,224 ) – 643,656 At 31 December 2005 Premium on issue of shares pursuant to scrip dividend scheme Premium on issue of shares on exercise of share options Share issue expenses Share options lapsed during the year Recognition of equity settled share based payments Final dividend for 2005 distributed Interim dividend for 2006 distributed Dividend for 2006 declared Profit for the year 1,420,424 154,995 100,000 368,641 2,171 5,273,291 7,319,522 29,841 3,031 (32 ) – – – – – – – – – – – – – – – – – – – – – – – – – – – 29,841 (978 ) – – – 2,053 (32 ) (13 ) 13 – 4,382 – 4,382 – (368,641 ) – – – (105,461 ) 527,516 – – – – – (45 ) (368,686 ) – (527,516 ) 728,734 (105,461 ) – 728,734 At 31 December 2006 1,453,264 154,995 100,000 422,055 5,562 5,474,477 7,610,353 Note: General reserve was set up from the transfer of retained profits. 1 1 1 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 31. DISPOSAL OF SUBSIDIARIES The net assets of the wholly owned subsidiaries at the date of disposal were as follows: Net assets disposed of Investment properties Property, plant and equipment Other receivables, prepayments and deposits Accounts receivable Accounts payable and accruals Rental deposits from tenants Amounts due to group companies Total consideration Satisfied by: Cash Amounts due to group companies waived 2006 HK$’000 2005 HK$’000 – – – – – – – – – – – 2,699,341 26 3,839 602 (445 ) (23,796 ) (1,149,264 ) 1,530,303 2,679,567 (1,149,264 ) 1,530,303 Net cash inflow arising on disposal: Cash consideration received during the year ended 31 December 2005 – 2,679,567 In 2005, the disposed wholly owned subsidiaries contributed HK$455,550,000 and HK$2,679,567,000 to the Group’s profit and cash flows respectively. 32. RETIREMENT BENEFITS PLANS With effect from 1 December 2000, the Group set up an enhanced MPF scheme (the “Enhanced MPF Scheme”), a defined contribution scheme, for all qualifying employees. The Enhanced MPF Scheme is registered with the Mandatory Provident Fund Schemes Authority under Section 124 (1) of the Mandatory Provident Fund Schemes (General) Regulation. Pursuant to the rules of the Enhanced MPF Scheme, the Group’s contributions to the plan are based on fixed percentages of members’ salaries, ranging from 5% of MPF Relevant Income to 15% of basic salary. Members’ mandatory contributions are fixed at 5% of MPF Relevant Income, in compliance with MPF legislation. Total contributions made by the Group during the year amounted to HK$5,230,000 (2005: HK$5,301,000). Forfeited contributions for the year amounted to HK$2,876,000 (2005: HK$3,789,000) were refunded to the Group. 1 1 2 HYS AN ANN UA L REPORT 200 6 33. CONTINGENT LIABILITIES At the balance sheet date, there were contingent liabilities in respect of the following: Corporate guarantee to a third party in respect of the sale of the interest in an associate Corporate guarantee to subsidiaries – for issue of floating rate notes – for issue of fixed rate notes – for issue of zero coupon notes Undertaking given to a bank in proportion to shareholding regarding facilities granted to a joint venture property project of an associate Guarantees to banks to provide financing facilities to – an associate – subsidiaries The Group The Company 2006 HK$ million 2005 HK$ million 2006 HK$ million 2005 HK$ million 4.1 4.0 4.1 4.0 – – – – – – – – – 550.0 1,415.2 430.0 550.0 1,550.9 430.0 86.7 – – 56.0 – – 720.0 56.0 2,056.5 34. CAPITAL COMMITMENTS At the balance sheet date, the Group and the Company had capital commitments in respect of the following: The Group The Company 2006 HK$ million 2005 HK$ million 2006 HK$ million 2005 HK$ million Investment properties: Authorised but not contracted for 1,011.9 – Contracted but not provided for 152.9 69.0 – – – 33.5 35. LEASE COMMITMENTS The Group and the Company as lessee At the balance sheet date, the Group and the Company had commitments for future minimum lease payments under non cancellable operating leases which fall due as follows: Within one year In the second to fifth year inclusive The Group The Company 2006 HK$’000 2005 HK$’000 – – – – – – 2006 HK$’000 14,665 20,166 34,831 2005 HK$’000 4,602 1,445 6,047 Operating lease payments represent rentals payable by the Company to its subsidiaries for its staff quarters and office premises which are negotiated and fixed for two years and three years respectively. 1 1 3 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 35. LEASE COMMITMENTS continued The Group and the Company as lessor At the balance sheet date, the Group and the Company had contracted with tenants for the following future minimum lease payments: Within one year In the second to fifth year inclusive After five years The Group The Company 2006 HK$’000 2005 HK$’000 2006 HK$’000 830,532 1,134,218 52,791 735,027 874,567 66,897 2,017,541 1,676,491 – – – – 2005 HK$’000 92,906 54,877 – 147,783 Operating lease payments represent rentals receivable by the Group from its investment properties. Leases are negotiated and rentals are fixed for an average of one to three years. 36. RELATED PARTY TRANSACTIONS AND BALANCES Related party transactions During the year, the Group has the following transactions with related parties: Expenses paid to Gross rental income from Construction cost paid for investment properties Notes (a) (b) (c) Substantial shareholder Directors 2006 HK$’000 2005 HK$’000 2006 HK$’000 – – 142 2005 HK$’000 73 5,953 4,669 23,283 22,705 – – – 10,894 At the balance sheet date, the Group has the following balances with related parties: Expenses payable to Construction cost payable to Amount due to a minority shareholder Notes (a) (c) (d) Substantial shareholder Directors 2006 HK$’000 2005 HK$’000 – – – – – – 2006 HK$’000 – 2005 HK$’000 48 1,554 1,554 94,443 94,443 Notes: (a) These transactions were provision of services carried out in the normal course of business. (b) The Group has, in the ordinary course of its business, entered into lease agreements with related parties to lease premises for varying periods. The leases were entered into in the normal course of business. (c) Dr. Geoffrey M.T. Yeh (and his alternate, V nee Yeh) are substantial shareholders and V nee Yeh is also Chairman of Hsin Chong Construction Group Ltd., whose wholly owned subsidiary, Hsin Chong Construction (Asia) Limited (“Hsin Chong Asia”), entered into a main contract with a subsidiary of the Company relating to the renovation project of Lee Gardens Two. The sum represented the sum paid to, or as the case may be, outstanding balances due under the main contract with Hsin Chong Asia. To the best of the Company’s knowledge having made due enquiries, substantially the whole of such contracts were sub contracted by Hsin Chong Asia to other sub contractors. The sum is not the indicative of the amount actually derived by Hsin Chong Asia under the relevant contract, which amount is substantially less than the relevant contract sum. (d) The sum represents outstanding loan advanced by Jebsen and Company Limited to a non wholly owned subsidiary of the Group, Barrowgate Limited, in proportion to its shareholding for general funding purpose. The amount is unsecured, interest free and is repayable within one year. At 31 December 2005, the amount was classified as non current and was not repayable within one year. Hans Michael Jebsen is a director and shareholder of Jebsen and Company Limited. 1 1 4 HYS AN ANN UA L REPORT 200 6 36. RELATED PARTY TRANSACTIONS AND BALANCES continued Related party transactions continued At the balance sheet date, the Company has the following balances with related parties: Amounts due from subsidiaries Less: Allowances on amounts due therefrom Amounts due to subsidiaries 2006 HK$’000 2005 HK$’000 13,345,557 (329,000 ) 8,278,195 (329,000 ) 13,016,557 7,949,195 104,371 21,280 Details of amounts due from and due to subsidiaries are set out in note 24 to the financial statements. Compensation of key management personnel The remuneration of directors and other members of key management of the Group and the Company during the year was as follows: Salaries and other short term employee benefits Share based payments Retirement benefits scheme contributions 2006 HK$’000 24,628 3,310 299 2005 HK$’000 21,125 1,498 265 28,237 22,888 The remuneration of the Directors and key executives is determined by the Emoluments Review Committee and Managing Director respectively having regard to the performance of individuals and market trends. 37. SHARE-BASED PAYMENT TRANSACTIONS Equity settled share option scheme The 1995 Share Option Scheme (“the 1995 Scheme”) The Company operates an Executive Share Option Scheme which was approved by shareholders on 28 April 1995 and had a term of 10 years. The 1995 Scheme expired on 28 April 2005. All outstanding options granted under the 1995 Scheme will continue to be valid and exercisable in accordance with the provisions of the 1995 Scheme. The purpose of the 1995 Scheme was to strengthen the links between individual staff and shareholder interests. Under the 1995 Scheme, options may be granted to employees of the Company or any of its wholly owned subsidiaries selected by the Board at its discretion to subscribe for ordinary shares of the Company. The maximum number of shares in respect of which options may be granted under the 1995 Scheme (together with shares issued and issuable under the scheme) is 3% of the issued share capital of the Company (excluding shares issued pursuant to the scheme and any other share option scheme) from time to time. The maximum number of shares issued under the scheme and other scheme will not exceed 10% of the issued share capital of the Company from time to time (excluding shares issued pursuant to the scheme and any other share option scheme). The maximum entitlement of each participant under the 1995 Scheme is 25% of the maximum number of shares in respect of which options may at any time be granted under the 1995 Scheme. Under the 1995 Scheme, the exercise price was initially fixed at 80% of the average of the closing prices of the shares on the Stock Exchange for the 20 trading days immediately preceding the date of grant or the nominal value of a share whichever is the greater. The exercise price for options granted after 1 September 2001 was amended to comply with amendments to the Listing Rules. Consideration to be paid on each grant of option is HK$1.00, with full payment for exercise price to be made on exercise of the relevant option. Grants made prior to 8 March 2005 are subject to a five year vesting period and a bar on the exercise of options within the first two years of their issue. 1 1 5 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 37. SHARE-BASED PAYMENT TRANSACTIONS continued Equity settled share option scheme continued The 2005 Share Option Scheme (“the 2005 Scheme”) The Company adopted a new share option scheme (the “2005 Scheme” and together with the 1995 Scheme are referred to as “the Schemes”) at the Annual General Meeting (“AGM”) held on 10 May 2005, which has a term of 10 years and will expire on 9 May 2015. The purpose of the 2005 Scheme is to provide an incentive for employees of the Company and its wholly owned subsidiaries to work with commitment towards enhancing the value of the Company and its shares for the benefit of its shareholders. Under the 2005 Scheme, options may be granted to employees of the Company or any wholly owned subsidiaries (including executive Directors) and such other persons as the Board may consider appropriate from time to time on the basis of their contribution on the development and growth of the Company and the subsidiaries to subscribe for ordinary shares of the Company. The maximum number of shares in respect of which options may be granted under the 2005 Scheme and any other share option scheme of the Company shall not exceed such number of shares as required under the Listing Rules, currently being 10% of the shares in issue (being 104,996,365 shares) as at 10 May 2005, the date of the AGM approving the 2005 Scheme. Under the Listing Rules, a listed issuer may seek approval by its shareholders in general meeting for “refreshing” the 10% limit under the scheme. The limit on the number of shares which may be issued upon exercise of all outstanding options granted and yet to be exercised under the 2005 Scheme and any other share option scheme of the Company must not exceed 30% of the shares in issue from time to time (or such number of shares as required under the Listing Rules). No options may be granted if such grant will result in this 30% limit being exceeded. The maximum entitlement of each participant under the 2005 Scheme must not during any 12 month period exceed such number of shares as required under the Listing Rules (which is 1% of the total shares in issue as at the date of shareholders’ approval). The exercise price shall be at least the highest of (i) the closing price of the shares as stated in the Stock Exchange’s daily quotations sheet on the date of grant; (ii) the average of the closing prices of the shares as stated in the Stock Exchange’s daily quotations sheets for the five business days immediately preceding the date of grant; and (iii) the nominal value of the shares. Consideration to be paid on each grant of option is HK$1.00, with full payment for exercise price to be made on exercise of the relevant option. Grant and vesting structures With effect from 8 March 2005, the Board has approved a new grant vesting structure. Grants will be made on a periodic basis. Vesting period is three years in equal proportion. Size of grant will be determined by reference to base salary multiple and job grades. A clear performance criterion will be a key driver. The Board will review the grant and vesting structures from time to time. 1 1 6 HYS AN ANN UA L REPORT 200 6 37. SHARE-BASED PAYMENT TRANSACTIONS continued Grant and vesting structures continued The following table discloses movements of the Company’s share options held by the Directors and employees during the current year: Name 1995 Scheme Executive Director Peter T.C. Lee (note a) Balance as at 1.1.2006 Date of grant Changes during the year Balance Cancelled/ Granted Exercised lapsed 31.12.2006 as at Exercise price HK$ 1,350,000 7.1.1999 Nil Nil Nil 1,350,000 9.22 Exercise period 7.1.2001– 6.1.2009 Eligible employees 535,000 30.3.2005 Nil 128,267 (note d) 5,400 401,333 (note e) 15.85 30.3.2005 – 29.3.2015 (note b) 2005 Scheme Executive Director Michael T.H. Lee (note c) 240,000 10.5.2005 Nil Nil 30.3.2006 188,000 Nil Nil Nil 240,000 Nil 188,000 16.60 10.5.2005 – 9.5.2015 22.00 30.3.2006 – 29.3.2016 9.8.2005 – 8.8.2015 (note g) 18.79 Eligible employees 144,000 9.8.2005 (note b) 120,000 12.10.2005 Nil Nil 48,000 (note f) Nil Nil 96,000 Nil 120,000 18.21 12.10.2005 – Nil 30.3.2006 361,000 Nil 26.6.2006 110,000 Nil Nil 36,000 325,000 (note e) Nil 110,000 2,389,000 659,000 176,267 41,400 2,830,333 (note g) 11.10.2015 22.00 30.3.2006 – 29.3.2016 20.11 26.6.2006 – 25.6.2016 (note h) Notes: (a) Options granted to Peter T.C. Lee were under the 1995 Scheme with a holding period of 2 years and a vesting period of 5 years in equal proportions (i.e. 20% of the options will be vested in each year). (b) Eligible Employees are working under employment contracts that are regarded as “continuous contracts” for the purposes of the Employment Ordinance. The options granted under the Schemes have vesting periods of 3 years in equal proportions (i.e. 33% of the options will be vested in the first year, second year and third year respectively). (c) Options granted to Michael T.H. Lee were under the 2005 Scheme with a vesting period of 3 years in equal proportions. (d) The weighted average closing price of the shares of the Company immediately before the dates on which the options was exercised was HK$22.09. (e) The options for 41,400 shares lapsed during the year upon the resignation of certain Eligible Employees. (f) The weighted average closing price of the shares of the Company immediately before the dates on which the options were exercised was HK$21.00. (g) The closing price of the shares of the Company immediately before the date of grant (as of 29 March 2006) was HK$22.45. (h) The closing price of the shares of the Company immediately before the date of grant (as of 23 June 2006) was HK$20.25. 1 1 7 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 37. SHARE-BASED PAYMENT TRANSACTIONS continued Grant and vesting structures continued The following table discloses movements of the Company’s share options held by the Directors and employees in prior year: Name 1995 Scheme Executive Directors Peter T.C. Lee Balance as at 1.1.2005 Date of grant Changes during the year Balance Cancelled/ Granted Exercised lapsed 31.12.2005 as at Exercise price HK$ 1,350,000 7.1.1999 Nil Nil Nil 1,350,000 9.22 Exercisable period (note) 7.1.2001 – 6.1.2009 Eligible employees Nil 30.3.2005 675,000 Nil 140,000 535,000 15.85 30.3.2005 – 29.3.2015 2005 Scheme Executive Directors Michael T.H. Lee Nil 10.5.2005 240,000 Eligible employees Nil 9.8.2005 144,000 Nil 12.10.2005 120,000 Nil Nil Nil Nil 240,000 Nil 144,000 Nil 120,000 18.79 16.60 10.5.2005 – 9.5.2015 9.8.2005 – 8.8.2015 18.21 12.10.2005 – 11.10.2015 1,350,000 1,179,000 Nil 140,000 2,389,000 Note: As at 31 December 2005, options granted to Peter T.C. Lee are subject to a five year vesting period and a bar on the exercise of options within the first two years of their issue. All other options are subject to a vesting period of 3 years in equal proportions. The Group has applied HKFRS 2 “Share based Payments” to account for its share options granted after 7 November 2002 and vested after 1 January 2005. In accordance with HKFRS 2, fair value of share options granted to employees determined at the date of grant is expensed over the vesting period, with a corresponding adjustment to the Group’s employee share based compensation reserve. In the current year, the Group recognised the share option expenses of HK$4,382,000 (2005: HK$2,171,000) in relation to share options granted by the Company, of which HK$1,171,000 (2005: HK$524,000) related to a Director (see note 7), with a corresponding adjustment recognised in the Group’s employee share based compensation reserve. The Company has used the Black Scholes option pricing model (the “Model”) to value the share options granted during the year. The Model is one of the commonly used models to estimate the fair value of an option. The variables and assumptions used in computing the fair value of the share options are based on the directors’ best estimate. The value of an option varies with different variables of certain subjective assumptions. Any change in the variables so adopted may materially affect the estimation of the fair value of an option. 1 1 8 HYS AN ANN UA L REPORT 200 6 37. SHARE-BASED PAYMENT TRANSACTIONS continued Grant and vesting structures continued Details of the fair values of share options determined at the date of grant using the Model with significant variables and assumptions are as follows: Closing share price at the date of grant Exercise price Risk free rate (note a) Expected life of option (note b) Expected volatility (note c) Date of grant 30.3.2006 26.6.2006 HK$22.00 HK$20.00 HK$22.00 HK$20.11 4.539% 4.915% 10 years (till 29 March 2016) 10 years (till 25 June 2016) 27.04% 32.00% Expected dividend per annum (note d) HK$0.390 HK$0.392 Estimated fair values of options granted HK$4,271,220 HK$859,247 Closing share price immediately before date of grant HK$22.45 HK$20.25 Notes: (a) Risk free rate: being the approximate yields of 10 year Exchange Fund Notes traded on the date of grant, matching the expected life of each option. (b) Expected life of option: being the period of 10 years commencing on the date of grant, adjusted based on management’s best estimates for the effects of non transferability, exercise restriction and behavioural consideration. (c) Expected volatility: being the approximate historical volatility of closing prices of the share of the Company in the past one year immediately before the date of grant. (d) Expected dividend per annum: being the approximate average annual cash dividend for the past five financial years. 1 1 9 HYSAN ANNUAL R EPORT 2006 Notes to the Consolidated Financial Statements continued For the year ended 31 December 2006 38. PRINCIPAL SUBSIDIARIES Name of subsidiary Admore Investments Limited Golden Capital Investment Limited HD Treasury Limited HD Treasury Management Limited Hysan China Holdings Limited Hysan Leasing Company Limited Hysan Treasury Limited Hysan (MTN) Limited Hysan Property Management Limited Kwong Hup Holding Limited Kwong Wan Realty Limited Minsal Limited Mondsee Limited Stangard Limited Teamfine Enterprises Limited Tohon Development Limited Bamboo Grove Recreational Services Limited Earn Extra Investments Limited Gearup Investments Limited HD Investment Limited Kochi Investments Limited Lee Theatre Realty Limited Leighton Property Company Limited Main Rise Development Limited OHA Property Company Limited Perfect Win Properties Limited Silver Nicety Company Limited Barrowgate Limited Place of incorporation/ operation Hong Kong Hong Kong Hong Kong Hong Kong British Virgin Islands Hong Kong Hong Kong British Virgin Islands/ Hong Kong Hong Kong British Virgin Islands Hong Kong Hong Kong Hong Kong Hong Kong Hong Kong Hong Kong Hong Kong Hong Kong Hong Kong British Virgin Islands British Virgin Islands Hong Kong Hong Kong Hong Kong Hong Kong Hong Kong Hong Kong Hong Kong Proportion of nominal value of issued share capital held by the Company directly indirectly Issued share capital HK$2 HK$2 HK$2 HK$2 HK$1 HK$2 HK$2 US$1 HK$2 HK$1 HK$1,000 HK$2 HK$2 HK$300,000 – – – – – – – – – – – – – – HK$2 HK$2 HK$2 HK$1 HK$1 HK$1 – – 100% 100% 100% 100% HK$1 100% HK$10 HK$2 100% 100% HK$2 HK$2 HK$2 HK$20 HK$10,000 100% 100% 100% 100% 65.36% 100% 100% 100% 100% Principal activities Investment holding Investment holding Treasury operation Treasury operation 100% Investment holding 100% Leasing administration 100% 100% Treasury operation Treasury operation 100% Property management 100% Investment holding 100% 100% 100% 100% 100% 100% – Property investment Property investment Property investment Provision of security services Investment holding Property investment Resident club management – – – – – – – – – – – Property investment Property development Investment holding Capital market investment Property investment Property investment Investment holding Property investment Property investment Property investment Property investment The Directors are of the opinion that a complete list of all subsidiaries and their particulars will be of excessive length and therefore the above table contains only those subsidiaries which materially affected the results or assets of the Group. Other than floating rate notes, fixed rate notes and zero coupon notes issued by Hysan (MTN) Limited as disclosed in note 26, none of the subsidiaries had issued any debt securities at the year end. 1 2 0 HYS AN ANN UA L REPORT 200 6 Five-Year Financial Summary For the year ended 31 December 2006 HK$ million 2005 HK$ million 2004 HK$ million (Note) 2003 HK$ million (Note) 2002 HK$ million (Note) Condensed consolidated income statement Turnover Property expenses Gross Profit Net realised gain on disposal of available for sale investments Other income Share of results of associates Release of negative goodwill of associates Impairment loss arising from interests in associates Impairment loss reversed on (arising from) investments in securities Administrative expenses Finance costs Fair value changes on investment properties Fair value changes on financial instruments Taxation Minority interests Profit for the year Underlying profit for the year Profit excluding asset value changes and prior year tax provision Dividends Dividends paid Dividends proposed Dividend per share (HK cents) Earnings per share (HK$), based on: Profit for the year – Basic – Diluted Underlying profit for the year Profit excluding asset value changes and prior year tax provision Performance Indicators Net debt to equity Net interest coverage (times) Net assets value per share (HK$) Adjusted net assets value per share (HK$) Net debt per share (HK$) Year end share price (HK$) 1,268 (240 ) 1,028 170 147 120 – – – (111 ) (163 ) 1,250 (237 ) 1,013 – 38 241 – – – (103 ) (214 ) 2,576 4,226 31 (558 ) (141 ) 3,099 1,012 (25 ) (856 ) (199 ) 4,121 1,005 755 641 474 422 50.00 2.94 2.94 0.96 0.72 7.9% 6.9x 26.37 29.12 2.31 20.35 420 369 45.00 3.92 3.92 0.96 0.61 10.7% 4.6x 23.42 25.76 2.75 19.20 1,154 (259 ) 895 15 27 39 2 – 63 (96 ) (162 ) – – (140 ) (34 ) 609 609 586 381 315 40.00 0.58 0.58 0.58 0.56 24.9% 5.5x 19.59 21.33 5.32 16.35 1,139 (239 ) 900 48 25 10 2 – – (92 ) (168 ) – – (165 ) (26 ) 534 534 534 378 277 36.50 0.51 0.51 0.51 0.51 31.8% 5.2x 16.51 17.78 5.66 12.00 1,233 (236 ) 997 – 16 – – (10 ) (1 ) (86 ) (220 ) – – (108 ) (55 ) 533 533 586 392 274 36.50 0.52 0.52 0.52 0.57 29.9% 4.5x 18.34 N/A 5.49 5.80 Definition: Net debt to equity: Net interest coverage: Net assets value/Adjusted net assets value per share: Net debt per share: Underlying profit: Profit excluding asset value changes and prior year tax provision: gross debt less cash and cash equivalents divided by adjusted shareholders’ funds (for 2002: divided by shareholders’ funds) gross profit less administrative expenses before depreciation divided by net interest expenses shareholders’ funds / adjusted shareholders’ funds divided by number of issued shares at year end gross debt less cash and cash equivalents divided by number of issued shares at year end profit adjusted for group’s share of unrealised fair value changes on investment properties net of deferred tax. underlying profit adjusted for aggregate of realised gain/loss on disposal of investment properties and available for sale investments, impairment, reversal, recovery and prior year tax provision Adjusted shareholders’ funds: shareholders’ funds adjusted for cumulative deferred tax provided on fair value changes on properties 1 2 1 HYSAN ANNUAL R EPORT 2006 Five-Year Financial Summary continued At 31 December Condensed consolidated balance sheet Investment properties Available for sale investments/ Investments in securities Interests in associates Cash and bank balances Other assets 2006 HK$ million 2005 HK$ million 2004 HK$ million (Note) 2003 HK$ million (Note) 2002 HK$ million (Note) 32,473 29,815 27,917 24,162 24,841 1,745 1,272 385 378 1,256 1,147 1,402 371 1,018 855 22 335 941 850 15 302 1,484 61 23 146 Total assets 36,253 33,991 30,147 26,270 26,555 Borrowings Taxation Other liabilities (2,821 ) (3,574 ) (950 ) (4,301 ) (3,077 ) (960 ) (5,603 ) (2,332 ) (815 ) (5,914 ) (1,708 ) (779 ) (5,696 ) (240 ) (768 ) Total assets less liabilities 28,908 25,653 21,397 17,869 19,851 Shareholders’ funds Minority interests 27,828 1,080 24,667 986 20,566 831 17,227 642 18,975 876 28,908 25,653 21,397 17,869 19,851 Adjusted shareholders’ funds 30,729 27,134 22,399 18,553 N/A Note: The figures for 2003 and 2004 have been restated to reflect the prior year adjustments arising from (i) reclassification of certain investment properties of the Group to property, plant and equipment as a result of application of HKAS 40; (ii) recognition of deferred taxation in respect of revalued investment properties in accordance with HK(SIC) INT – 21; and (iii) reclassification of leasehold interests in land to prepaid lease payments under operating leases according to HKAS 17. The figures for 2002 have not been restated with respect to these HKASs and HK(SIC) INT, and therefore are not strictly comparable. 1 2 2 HYS AN ANN UA L REPORT 200 6 Report of the Valuer To the Board of Directors Hysan Development Company Limited Dear Sirs, Annual revaluation of investment properties as at 31 December 2006 In accordance with your appointment of Knight Frank Petty Limited to value the investment properties in Hong Kong owned by Hysan Development Company Limited and its subsidiaries, we are pleased to advise that the market value of the properties as at 31 December 2006 was in the approximate sum of Hong Kong Dollars Thirty Two Billion Four Hundred Seventy Three Million One Hundred and Fifty Eight Thousand Only (i.e. HK$32,473,158,000). The properties have been valued individually, on market value basis, by reference to comparable market transactions and on the basis of capitalisation of the net income with due allowance for the reversionary income and redevelopment potential, without allowances for any expenses or taxation which may be incurred in effecting a sale. Yours faithfully, Knight Frank Petty Limited Hong Kong, 23 February 2007 1 2 3 HYSAN ANNUAL R EPORT 2006 Schedule of Principal Properties As at 31 December 2006 INVESTMENT PROPERTIES Address Lot No. 1. The Lee Gardens 33 Hysan Avenue Causeway Bay Hong Kong Sec. DD of I.L. 29, Sec. L of I.L. 457, Sec. MM of I.L. 29, the R.P. of Sec. L of I.L. 29, and the R.P. of I.L. 457 Use Category of the lease Percentage held by the Group Commercial Long lease 100% 2. Bamboo Grove I.L. 8624 Residential Long lease 100% 74 86 Kennedy Road Mid Levels Hong Kong 3. Lee Gardens Two 28 Yun Ping Road Causeway Bay Hong Kong 4. Leighton Centre 77 Leighton Road Causeway Bay Hong Kong Sec. G of I.L. 29, Sec. A, O, F and H of I.L. 457, the R.P. of Sec. C, D, E and G of I.L. 457, Subsec. 1 of Sec. C, D, E and G of I.L. 457, Subsec. 2 of Sec. E of I.L. 457 and Subsec. 1, 2, 3 and the R.P. of Sec. C of I.L. 461 Commercial Long lease 65.36% Sec. B, C and the R.P. of I.L. 1451 Commercial Long lease 100% 5. Lee Theatre Plaza I.L. 1452, the R.P. of I.L. 472 and 476 Commercial Long lease 100% 99 Percival Street Causeway Bay Hong Kong 6. Sunning Plaza 10 Hysan Avenue Causeway Bay Hong Kong 7. Sunning Court 8 Hoi Ping Road Causeway Bay Hong Kong 8. One Hysan Avenue 1 Hysan Avenue Causeway Bay Hong Kong The R.P. of Subsec. 1 of Sec. J of I.L. 29, Subsec. 2 of Sec. J of I.L. 29 and the R.P. of Sec. J of I.L. 29 The R.P. of Subsec. 1 of Sec. J of I.L. 29, Subsec. 2 of Sec. J of I.L. 29 and the R.P. of Sec. J of I.L. 29 Commercial Long lease 100% Residential Long lease 100% The R.P. of Sec. GG of I.L. 29 Commercial Long lease 100% 9. AIA Plaza Sec. N of I.L. 457 and Sec. LL of I.L. 29 Commercial Long lease 100% 18 Hysan Avenue Causeway Bay Hong Kong 10. 111 Leighton Road 111 Leighton Road Causeway Bay Hong Kong 11. 500 Hennessy Road * Causeway Bay Hong Kong Sec. KK of I.L. 29 Commercial Long lease 100% Sec. FF of I.L. 29 and the R.P. of Marine Lot 365 Commercial Long lease 100% * The property is currently under redevelopment. Demolition work on the existing building which commenced in October 2006 is currently underway. The site has a registered site area of approximately 47,738 square feet. The new development (500 Hennessy Road) has a projected gross floor area of around 710,000 square feet and is targetted for completion in late 2009. 1 2 4 HYS AN ANN UA L REPORT 200 6 Shareholder Information FINANCIAL CALENDAR Full year results announced Ex dividend date for final dividend Share registers closed Annual General Meeting Record date for final dividend Despatch of scrip dividend circular and election form Despatch of final dividend warrants / definitive share certificates 2007 interim results to be announced * subject to change 6 March 2007 2 May 2007 4 to 8 May 2007 8 May 2007 8 May 2007 (on or about) 15 May 2007 (on or about) 12 June 2007 15 August 2007 * DIVIDEND The Board recommends the payment of a final dividend of HK 40 cents per share. Subject to shareholder approval, the final dividend will be payable in cash with a scrip dividend alternative to shareholders on the register of members as at Tuesday, 8 May 2007. The scrip dividend alternative is conditional upon the granting by the Listing Committee of The Stock Exchange of Hong Kong Limited of the listing of and permission to deal in the new shares to be issued pursuant thereto. A circular containing details of the scrip dividend and the form of election will be mailed to shareholders on or about Tuesday, 15 May 2007. Shareholders who elect for the scrip dividend, in lieu of the cash dividend, in whole or in part, shall return the form of election to the Company’s Registrars on or before Tuesday, 5 June 2007. Definitive share certificates in respect of the scrip dividend and cheques (for those shareholders who do not elect for scrip dividend) will be despatched to shareholders on or about Tuesday, 12 June 2007. The share register will be closed from Friday, 4 May 2007 to Tuesday, 8 May 2007, both dates inclusive. In order to qualify for the proposed final dividend, all transfer documents accompanied by the relevant share certificates must be lodged with the Company’s Registrars not later than 4:00 p.m. on Thursday, 3 May 2007. SHARE LISTING Hysan’s shares are listed on The Stock Exchange of Hong Kong Limited. It has a sponsored American Depositary Receipts (ADR) Programme in the New York market. SHAREHOLDER SERVICES For enquiries about share transfer and registration, please contact the Company’s Registrars: Standard Registrars Limited 26/F., Tesbury Centre, 28 Queen’s Road East, Wanchai, Hong Kong Telephone: (852) 2980 1768 Facsimile : (852) 2861 1465 Holders of the Company’s ordinary shares should notify the Registrars promptly of any change of their address. The Annual Report is printed in English and Chinese language and is available on our website at www.hysan.com.hk. Shareholders may at any time choose to receive the Annual Report in printed form in either the English or Chinese language or both or by electronic means. Shareholders who have chosen to receive the Annual Report using electronic means and who for any reason have difficulty in receiving or gaining access to the Annual Report will promptly upon request be sent a printed copy free of charge. Shareholders may at any time change their choice of the language or means of receipt of the Annual Report by notice in writing to the Company’s Registrars at the address above. The Change Request Form may be downloaded from the Company’s website at www.hysan.com.hk. INVESTOR RELATIONS For enquiries relating to investor relations, please email to investor@hysan.com.hk or write to the Company at: STOCK CODE The Stock Exchange of Hong Kong Limited: 00014 Bloomberg: 14HK Reuters: 0014.HK Ticket Symbol for ADR Code: HYSNY CUSIP reference number: 449162304 Investor Relations Hysan Development Company Limited 49/F., The Lee Gardens, 33 Hysan Avenue Hong Kong Telephone: (852) 2895 5777 Facsimile: (852) 2577 5153 OUR WEBSITE Press releases and other information of the Group can be found at our internet website: “www.hysan.com.hk” 

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