[FOUR SEASONS LETTERHEAD]
John M. Davison
Chief Financial Officer
November 8, 2006
VIA EDGAR
Ms. Cicely LaMothe
Accounting Branch Chief
United States Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549-4561
RE: FOUR SEASONS HOTELS INC.
FORM 40-F FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
FORM 6-K FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
FORM 6-K FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006
FILE NO. 5-52609
Dear Ms. LaMothe,
Filed herewith via Edgar is the Memorandum referenced in the letter of Four
Seasons Hotels Inc. filed with the Securities and Exchange Commission (the
"Commission") via Edgar on November 3, 2006, which Memorandum was previously
furnished to the Commission on a supplemental basis.
Sincerely,
/s/ John Davison
Memorandum Response to Question #2 in SEC Comment Letter
FOUR SEASONS HOTELS INC.
ACCOUNTING FOR THE CONVERSION FEATURES IN THE 1.875% CONVERTIBLE SENIOR
NOTES DUE 2024 - US GAAP
The following sets out the analysis of Four Seasons Hotels Inc. ("FSHI" or the
"Company") regarding the accounting for the conversion features in the 1.875%
Convertible Senior Notes Due 2024 (the "Convertible Notes") issued by the
Company on June 18, 2004 and underwritten by a syndicate including, among
others, Morgan Stanley & Co. Incorporated (as lead underwriter).
This analysis is based on the terms of the Convertible Notes set out in the Base
Trust Indenture (the "Indenture") and First Supplemental Indenture (the "First
Supplemental Indenture"), each dated as of June 18, 2004, and summarized in the
attached appendix "1.875% Convertible Senior Notes Due 2024 - Terms Pertinent to
Accounting" - capitalized terms used below and not otherwise defined herein are
as set forth therein.
In reaching our conclusions, we have considered United States generally accepted
accounting principles ("US GAAP") as set out in various US GAAP authoritative
pronouncements, in particular Accounting Principles Board Opinion No. 14 -
ACCOUNTING FOR CONVERTIBLE DEBT AND DEBT ISSUED WITH STOCK PURCHASE WARRANTS
("APB 14"); Statement of Financial Accounting Standards No. 133 - ACCOUNTING FOR
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, as amended ("FAS 133"); and EITF
Issue No. 00-19 - ACCOUNTING FOR DERIVATIVE FINANCIAL INSTRUMENTS INDEXED TO,
AND POTENTIALLY SETTLED IN, A COMPANY'S OWN STOCK ("EITF 00-19"). Other
authoritative pronouncements that we considered are: EITF Issue No. 98-5 -
ACCOUNTING FOR CONVERTIBLE SECURITIES WITH BENEFICIAL CONVERSION FEATURES OR
CONTINGENTLY ADJUSTABLE CONVERSION RATIOS ("EITF 98-5"); EITF Issue No. 01-6,
THE MEANING OF "INDEXED TO A COMPANY'S OWN STOCK" ("EITF 01-6"); EITF Issue No.
05-2 - THE MEANING OF "CONVENTIONAL CONVERTIBLE DEBT INSTRUMENT" IN ISSUE NO.
00-19; Derivatives Implementation Group Implementation Issue No. C8 - SCOPE
EXCEPTIONS: DERIVATIVES THAT ARE INDEXED TO BOTH AN ENTITY'S OWN STOCK AND
CURRENCY EXCHANGE RATES ("DIG C8").
THE ANALYSIS OF THE US GAAP TREATMENT OF THE CONVERSION FEATURES IN THE
CONVERTIBLE NOTES IS AS FOLLOWS (referred to hereinafter as the "Conversion
Option"):
1. INITIAL ACCOUNTING FOR CONVERTIBLE DEBT - GENERAL PROVISIONS OF US GAAP
The initial accounting for the issuance of convertible debt is generally
identical to accounting for debt that has no conversion feature. APB 14
states that if the debt is convertible into the common stock of the debtor
at a specified price at the option of the creditor and is sold at a price
or has a value at issuance not in excess of the face amount, no portion of
the proceeds from the issuance of convertible debt should be accounted for
as attributable to the conversion feature.
Specifically, in accordance with EITF Issue No. 98-5, if the effective
conversion price, based on the proceeds received for, or allocated to, the
convertible debt instrument, is equal to or greater than the fair value of
the entity's stock at the commitment date, no value is assigned to the
conversion feature upon issuance. In
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making this determination, the effective conversion price, and not the
stated conversion rate, in the convertible debt instrument should be used
to determine whether any value should be assigned to the conversion
feature. However, if the effective conversion price is less than the fair
value of the stock on the commitment date, the convertible debt instrument
includes a "beneficial conversion feature" for which value must be
assigned, based on the "intrinsic value" of the beneficial conversion
feature based on EITF 98-5.
For these purposes, the conversion price is calculated by dividing the
proceeds received for, or allocated to, the convertible instrument by the
number of shares to be issued upon conversion of the debt instrument into
shares. In calculating the conversion price, proceeds should not be net of
debt issuance costs, which for this purpose include only incremental
issuance costs and direct costs paid to parties other than the creditors.
We have determined that there is no "beneficial conversion feature" in the
Convertible Notes because (1) the notes were issued at par, (2) there were
no other features of the Convertible Notes that required separate
accounting under US GAAP (e.g. no detachable warrants or other freestanding
financial instruments), and (3) the conversion price of US$ 71.64 (which is
the issue price per Convertible Note of US$ 1,000 divided by 13.9581(1)
shares - the number of Limited Voting Shares into which the Convertible
Notes are convertible) was approximately 125% of the then current market
price of FSHI's Limited Voting Shares of US$ 57.01 (on June 18, 2004, the
date at which the purchaser of the Convertible Notes was irrevocably
committed to buying the securities - i.e. the "commitment date").
2. INITIAL ACCOUNTING FOR CONVERTIBLE DEBT - "EMBEDDED DERIVATIVES"
We are also required to consider all of the provisions of the Convertible
Notes to determine if any of them may have an accounting impact. In that
regard, a convertible debt instrument may include an embedded derivative
that needs to be bifurcated and accounted for separately under the
provisions of FAS 133.
FAS 133 provides that contracts that do not in their entirety meet the
definition of a derivative instrument, such as convertible debt
instruments, may contain "embedded" derivative instruments - implicit or
explicit terms that affect some or all of the cash flows or the value of
other exchanges required by the contract in a manner similar to a
derivative instrument. The effect of embedding a derivative instrument in
another type of contract (the "host contract") is that some or all of the
cash flows or other exchanges that otherwise would be required by the host
contract, whether unconditional or contingent upon the occurrence of a
specified event, will be modified based on one or more "underlyings" -
which is defined as a specified interest rate, security price, commodity
price, foreign exchange rate, index of prices, or other variable.
- ----------
(1) The number of Limited Voting Shares into which the Convertible Notes are
convertible is subject to antidilution provisions typical of instruments of
this nature.
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FAS 133 requires that an embedded derivative instrument be separated from
the host contract and accounted for as a derivative instrument if and only
if all of the following criteria are met:
a) The economic characteristics and risks of the embedded derivative
instrument are not clearly and closely related to the economic
characteristics and risks of the host contract.
b) The contract (the "hybrid instrument") that embodies both the embedded
derivative instrument and the host contract is not remeasured at fair
value under otherwise applicable generally accepted accounting
principles with changes in fair value reported in earnings as they
occur.
c) A separate instrument with the same terms as the embedded derivative
instrument would be a derivative instrument subject to the
requirements of FAS 133.
Identifying and analyzing embedded derivative instruments can be a complex
process. The critical steps relative to the identification and analysis of
embedded derivative components are as follows:
a) identification of a contract as a hybrid instrument;
b) determination of the host contract;
c) identification of the embedded component;
d) determination of whether the embedded component meets the definition
of a derivative; and
e) determination of whether the embedded derivative warrants accounting
separate from the host contract.
Application of this analysis to the Conversion Option in the Convertible
Notes is as follows(2):
A) IDENTIFICATION OF A CONTRACT AS A HYBRID INSTRUMENT -
A common example of a hybrid instrument under FAS 133 is a debt
instrument that contains a conversion option. The Convertible Notes
include the Conversion Option. Therefore, we conclude that the
Convertible Notes are a "hybrid instrument".
B) DETERMINATION OF THE HOST CONTRACT -
A host contract is the non-derivative instrument or contract component
in a hybrid instrument. The most common types of host contracts are
debt and equity contracts. We believe that it is clear that the "host
contract" relating to the Convertible Notes is a debt contract.
- ----------
(2) The Convertible Notes contain other embedded derivatives that are unrelated
to the Conversion Option and are not addressed in this memorandum.
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C) IDENTIFICATION OF THE EMBEDDED COMPONENT -
To analyze whether the embedded component needs to be accounted for
separately from the host contract under FAS 133, we need to identify
the specific terms of both the host contract and any embedded
components. Based on our analysis of the Convertible Notes, we believe
that the Conversion Option represents a component that should be
considered separately from the host debt contract because the
Conversion Option held by the holders of the Convertible Notes gives
them a contingently exercisable contractual right to convert the
Convertible Notes into Limited Voting Shares of FSHI, which is a
characteristic not included in a pure "debt instrument".
D) DETERMINATION OF WHETHER THE EMBEDDED COMPONENT MEETS THE DEFINITION
OF A DERIVATIVE -
For an embedded component to be accounted for separately from the host
contract, it must meet the definition of a derivative instrument in
FAS 133 as if it were a freestanding instrument. In addition, it must
not be excluded from the scope of FAS 133.
Under FAS 133, a derivative instrument is a financial instrument or
other contract that has all of the following basic characteristics:
a) The instrument or contract has (1) one or more underlyings (see
definition above), and (2) one or more notional amounts (which is
defined as a number of currency units, shares, bushels, pounds,
or other units specified in a derivative instrument) or payment
provisions, or both.
b) The instrument or contract requires no, or a small, investment at
the inception of the contract (i.e., the initial net investment
is zero, or smaller than would be required for other types of
contracts expected to have similar responses to changes in market
factors).
c) The instrument or contract requires or permits net settlement,
can readily be settled net by a means outside of the contract, or
provides for delivery of an asset that puts the recipient in a
position not substantially different from net settlement.
In our view, the Conversion Option in the Convertible Notes also meets
these criteria, namely;
(i) the underlying is the price of the Limited Voting Shares and the
notional amount is the number of Limited Voting Shares into which
the Convertible Notes are convertible;
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(ii) under the embedded component provisions of FAS 133 paragraph
12(c), the initial net investment for the hybrid instrument (US$
1,000 per Convertible Note) shall not be considered to be the
initial net investment for the embedded derivative - we
determined that the fair value of the Conversion Option in the
Convertible Notes would be substantially less than the cost of
buying the 13.9581 Limited Voting Shares that are subject to the
Conversion Option; and
(iii) the Conversion Option puts the person converting the Convertible
Notes in a position not substantially different from net cash
settlement, because they receive Limited Voting Shares that are
readily convertible into cash - the Limited Voting Shares are
listed for trading, and are actively traded, on the New York
Stock Exchange and the Limited Voting Shares that would be issued
on exercise of the Conversion Option are registered with the SEC
in the United States.
EXEMPTION FROM ACCOUNTING FOR THE CONVERSION OPTION AS A DERIVATIVE
UNDER PARAGRAPH 11(A) OF FAS 133
With respect to the Conversion Option, FAS 133 paragraph 11(a)
provides an exclusion from the scope of the Standard for contracts
that are (1) indexed to the entity's own stock, and (2) classified in
stockholders' equity.
PARAGRAPH 11(A)(1) - INDEXED TO THE ENTITY'S OWN STOCK
We understand that paragraph 286 of FAS 133 and DIG C8 clarify that
the scope exception in paragraph 11(a) is applicable to contracts that
are indexed ONLY to the issuer's own stock.
EITF Issue No. 01-6 provides guidance for determining whether certain
contingently exercisable instruments would be considered INDEXED TO A
COMPANY'S OWN STOCK within the meaning of paragraph 11(a) of FAS 133.
The instruments addressed in EITF 01-6 are freestanding financial
instruments and financial instruments with embedded features for which
settlement is based on changes in the issuing company's stock price
and one or more defined contingencies, provided that, once the
contingencies have occurred, the settlement amount is based solely on
the issuing company's stock. Under the consensus in EITF 01-6,
instruments within its scope are considered indexed solely to a
company's own stock for the issuer, provided that (1) the contingency
provisions are not based on (a) an observable market, other than the
market for the issuer's stock (if applicable), or (b) an observable
index, other than those calculated or measured solely by reference to
the issuer's own operations, and (2) once the contingent events have
occurred, the instrument's settlement amount is based solely on the
issuer's stock. Furthermore, we understand that a
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contingent conversion feature that allows for conversion in the event
the trading price of a convertible instrument is less than the trading
price of the underlying common stock multiplied by the applicable
conversion rate, such as the PARITY FEATURE of the Conversion Option
referred to in (b) below, is considered indexed solely to a company's
own stock.
The value of the Conversion Option changes based on movements in
FSHI's stock price, changes in the probability of the occurrence of
certain contingent events, and changes in the value of the debt.
The contingent events that permit the Conversion Option to become
exercisable for specified periods following each event are:
a) If the closing price of Limited Voting Shares for at least 20
consecutive trading days in the 30 consecutive trading day period
ending on the last trading day of the immediately preceding
fiscal quarter exceeds 130% of the conversion price (US$ 71.64
per share, subject to the anti-dilution provisions as noted under
Conversion Rate Adjustments in the attached appendix) in effect
on that 30th day;
b) If for any 10 consecutive trading day period the trading price
per US$1,000 principal amount of the Convertible Notes for each
day of the period was less than 95% of the product of the closing
sale price of Limited Voting Shares on that day and the
conversion rate for that day;
c) If FSHI has called the Convertible Notes for redemption;
d) Upon the occurrence of certain "Specified Corporate Transactions"
(an issue to all holders of Limited Voting Shares of certain
rights or warrants to purchase Limited Voting Shares or certain
extraordinary distributions to all holders of Limited Voting
Shares) or a fundamental change - see the description of these
terms in the attached appendix.
Nevertheless, we understand that the Conversion Option would be
considered solely indexed to FSHI's own Limited Voting Shares in
accordance with the provisions of EITF 01-6 and based on the general
understanding in FAS 133 that indexation of the conversion feature to
the debt itself is not considered a form of dual indexation. In this
case, all of the contingencies are directly related to the market for
FSHI's Limited Voting Shares and, once a contingency has occurred, the
value of the Conversion Option varies only with changes in the value
of FSHI's Limited Voting Shares.
Although the conversion price of the Conversion Option is denominated
in US dollars (US$ 71.64 per share), we did not consider the Canada/US
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exchange rate to be another "index" in the Conversion Option because
(1) the Limited Voting Shares are actively traded on the New York
Stock Exchange, where the shares are quoted and traded in US dollars,
(2) all of the Convertible Notes were sold outside of Canada for
proceeds received in US dollars, and (3) interest and principal on the
Convertible Notes will be paid in US dollars. In arriving at this
conclusion we considered the guidance provided in DIG C8; FAS 133
paragraph 38; FAS 133 Basis for Conclusions, paragraphs 311 and 480;
in particular, the sentence in paragraph 480 that states: "Regardless
of the country in which the issuer of an equity security is domiciled,
that security presents no discernible foreign exchange risk to a
holder who may trade the security for a price denominated in its
functional currency."
PARAGRAPH 11(A)(2) - CLASSIFIED IN STOCKHOLDERS' EQUITY
As indicated above, the exemption provided in FAS 133, paragraph
11(a)(2) applies if the embedded derivative, were it a freestanding
instrument, would be classified in stockholders' equity. In that
regard, EITF 00-19 needs to be examined to determine whether the
multiple embedded components in the Convertible Notes would cause the
Conversion Option to meet the requirements for the paragraph 11(a)(2)
exclusion: specifically, whether the Conversion Option would be
classified in stockholders' equity if it was a freestanding
derivative. EITF 00-19 contains criteria for determining whether a
freestanding derivative is classified in equity.
The Convertible Notes permit the Company, at its option (but not at
the holder's option), to satisfy a conversion request by delivering
Limited Voting Shares or the equivalent amount of cash, or a
combination of the two. Thus, pursuant to paragraph 8 of EITF 00-19,
the Conversion Option would be classified in stockholders' equity,
provided the criteria in paragraphs 12 - 32 of EITF 00-19 are met.
However, EITF 00-19 also provides that for purposes of evaluating
whether an embedded derivative indexed solely to a company's own stock
under paragraph 11(a)(2) of FAS 133 would be classified in
stockholders' equity if freestanding, paragraphs 12 - 32 do not apply
if the hybrid contract is a "conventional" convertible debt instrument
in which the holder may only realize the value of the conversion
option by exercising the option and receiving the entire proceeds in a
fixed number of shares or the equivalent amount of cash (at the
discretion of the issuer). It is our view that the Conversion Option
in the Convertible Notes is not a "conventional" convertible debt
instrument because (1) FSHI can satisfy a conversion request in
shares, the equivalent amount of cash, or a combination of the two,
and (2) if a "fundamental change" occurs on or before July 30, 2009,
the holder would be entitled to the "Make Whole Premium", which
increases the number shares that the holder is entitled to receive on
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conversion(3). Thus, we must evaluate whether the conversion feature
of the Convertible Notes would be classified in stockholders' equity
under the paragraphs 12 - 32 of EITF 00-19.
Paragraphs 12 - 32 of EITF 00-19 provide that a derivative would be
classified in equity if the contract gives the company a choice of
net-cash settlement or settlement in its own shares (physical
settlement or net-share settlement), provided that all the following
criteria have been met:
a) The contract permits the company to settle in unregistered
shares.
b) The company has sufficient authorized and unissued shares
available to settle the contract after considering all other
commitments that may require the issuance of stock during the
maximum period the derivative contract could remain outstanding.
c) The contract contains an explicit limit on the number of shares
to be delivered in a share settlement.
d) There are no required cash payments to the counterparty in the
event the company fails to make timely filings with securities
regulators.
e) There are no required cash payments to the counterparty if the
shares initially delivered upon settlement are subsequently sold
by the counterparty and the sales proceeds are insufficient to
provide the counterparty with full return of the amount due (that
is, there are no cash settled "top-off" or "make-whole"
provisions).
f) The contract requires net-cash settlement only in specific
circumstances in which holders of shares underlying the contract
also would receive cash in exchange for their shares.
g) There are no provisions in the contract that indicate that the
counterparty has rights that rank higher than those of a
shareholder of the stock underlying the contract.
h) There is no requirement in the contract to post collateral at any
point or for any reason.
EITF 00-19 contains detailed discussion of each of these criteria,
which is not repeated herein.
- ----------
(3) This conclusion was subsequently substantiated by EITF Issue No. 05-2 -
THE MEANING OF "CONVENTIONAL CONVERTIBLE DEBT INSTRUMENT" IN ISSUE NO.
00-19.
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To consider the EITF 00-19 tests and to understand the relevant terms
and conditions of the Convertible Notes, we held discussions with our
external counsel, Wachtell, Lipton, Rosen & Katz, (US securities
counsel for FSHI) and Goodmans LLP (Canadian securities counsel) and
reviewed relevant sections of the Indenture and the First Supplemental
Indenture for the Convertible Notes.
The analysis of the criteria set out in paragraphs 12 to 32 of EITF
00-19 is set out below.
A) PARAGRAPHS 14 TO 18 - THE CONTRACT PERMITS THE COMPANY TO SETTLE
IN UNREGISTERED SHARES.
FSHI is required only to use its commercially reasonable efforts to
cause any shares issuable upon conversion of the Convertible Notes
that require registration with or approval of governmental
authority before they may be issued upon conversion to be duly
registered or approved, as the case may be (ss.4.08(b) of the First
Supplemental Indenture).
Additionally, EITF 00-19 paragraph 18 provides that if the shares
required to settle the conversion option are registered at
inception and there are no further timely filing or registration
requirements then this criteria is satisfied.
The Limited Voting Shares required to settle the Conversion Option
were registered at inception of the Convertible Notes pursuant to
the Company's shelf Registration Statement filed on Form F-10,
which registered an indeterminate number (being that number of
Limited Voting Shares as may be issuable upon conversion,
redemption, exchange or exercise of any debt securities registered
under the shelf registration having an aggregate initial offering
price not to exceed $250,000,000).
We also noted that, as a consequence of the registration of the
Limited Voting Shares underlying the Convertible Notes and pursuant
to Section 3(a)(9) of the Securities Act of 1933, as amended, there
are no further timely filing or registration requirements that are
required to be met for the Company to be able to deliver registered
shares on exercise of the Conversion Option.
We also considered whether there were any other terms of the
Convertible Notes that would be similar to a timely filing or
registration requirement. The First Supplemental Indenture (ss.
4.08 (b)) contains a covenant that requires that, so long as the
Limited Voting Shares shall be listed on the New York Stock
Exchange or the Toronto Stock Exchange, FSHI will use its
commercially reasonable efforts, if permitted by the rules of such
exchanges, to list and keep listed the Limited Voting Shares
issuable upon conversion of the Convertible Notes, and FSHI will
use its commercially reasonable efforts to list the Limited Voting
Shares required to be delivered upon conversion of the Convertible
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Notes prior to such delivery upon any other national securities
exchange upon which the outstanding Limited Voting Shares are
listed at the time of such delivery.
Accordingly, this criterion was satisfied.
B) PARAGRAPH 19 - THE COMPANY HAS SUFFICIENT AUTHORIZED AND UNISSUED
SHARES AVAILABLE TO SETTLE THE CONTRACT AFTER CONSIDERING ALL
OTHER COMMITMENTS THAT MAY REQUIRE THE ISSUANCE OF STOCK DURING
THE MAXIMUM PERIOD THE DERIVATIVE CONTRACT COULD REMAIN
OUTSTANDING.
Consistent with the corporate statute under which FSHI is governed,
FSHI's articles, authorize an unlimited number of Limited Voting
Shares for issuance. Accordingly, FSHI's capital structure does not
impose a restriction on the number of shares to be issued on
conversion.
Accordingly, this criterion was satisfied.
C) PARAGRAPHS 20 TO 24 - THE CONTRACT CONTAINS AN EXPLICIT LIMIT ON
THE NUMBER OF SHARES TO BE DELIVERED IN A SHARE SETTLEMENT.
As discussed under point (a), above, shares to be issued on
exercise of the Conversion Option have already been registered in a
sufficient, indeterminate number, and as discussed under point (b)
FSHI has unlimited authorized share capital to satisfy the
requirement to issue Limited Voting Shares upon exercise of the
Conversion Option.
Accordingly, this criterion was satisfied.
D) PARAGRAPH 25 - THERE ARE NO REQUIRED CASH PAYMENTS TO THE
COUNTERPARTY IN THE EVENT THE COMPANY FAILS TO MAKE TIMELY
FILINGS WITH THE SEC.
There are no required cash payments with respect to the Conversion
Option in the event FSHI fails to make timely filings with the SEC
or with Canadian securities regulators. See also discussion in
point (a) above dealing with the listing covenants.
Accordingly, this criterion was satisfied.
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E) PARAGRAPH 26 - THERE ARE NO REQUIRED CASH PAYMENTS TO THE
COUNTERPARTY IF THE SHARES INITIALLY DELIVERED UPON SETTLEMENT
ARE SUBSEQUENTLY SOLD BY THE COUNTERPARTY AND THE SALES PROCEEDS
ARE INSUFFICIENT TO PROVIDE THE COUNTERPARTY WITH FULL RETURN OF
THE AMOUNT DUE (THAT IS, THERE ARE NO CASH SETTLED "TOP-OFF" OR
"MAKE-WHOLE" PROVISIONS).
Neither the Indenture nor the First Supplemental Indenture includes
a covenant on the part of FSHI to make incremental payments if
Limited Voting Shares initially delivered upon settlement are
subsequently sold by the counterparty and the sales proceeds are
insufficient to provide the counterparty with full return of the
amount due.
Holders of the Convertible Notes may be entitled to a Make Whole
Premium if holders exercise the Conversion Option upon the
occurrence of a "fundamental change" on or before July 30, 2009. If
a Make Whole Premium is required, FSHI can satisfy it by the
issuance of additional Limited Voting Shares or cash at FSHI's
option in lieu of some or all of those shares -- there is no
requirement for FSHI to pay it in cash. The additional shares to be
issued in these circumstances is that number of Limited Voting
Shares having a value equal to the aggregate of the Make Whole
Premium plus accrued and unpaid interest.
EITF 00-19 paragraph 26 indicates that if the make-whole provision
can be net-share settled and the maximum number of shares that
could be required to be delivered under the contract (including
those under the make-whole premium) is fixed and less than the
number of available authorized shares, a make-whole provision would
not preclude equity classification. As noted above, the Make Whole
Premium can be settled in shares at FSHI's option and, as discussed
under point (a) above, shares to be issued on exercise of the
Conversion Option have already been registered in a sufficient,
indeterminate number and as discussed under point (b) FSHI has
unlimited authorized share capital.
Accordingly, this criterion was satisfied.
F) PARAGRAPHS 27 AND 28 - THE CONTRACT REQUIRES NET-CASH SETTLEMENT
ONLY IN SPECIFIC CIRCUMSTANCES IN WHICH HOLDERS OF SHARES
UNDERLYING THE CONTRACT ALSO WOULD RECEIVE CASH IN EXCHANGE FOR
THEIR SHARES.
EITF 00-19 paragraph 27 provides that if a change-in-control
provision requires that the counterparty receive the same form of
consideration (for example, cash, debt, or other assets) as
stockholders', permanent equity classification would not be
precluded.
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Holders can exercise the Conversion Option in connection with a
"fundamental change". In this case, if the Conversion Option is
exercised, the holder of Convertible Notes will receive either
Limited Voting Shares based on the conversion ratio (i.e. 13.9581
Limited Voting Shares/US$1,000 principal amount), if the Conversion
Option is exercised before the record date for the fundamental
change, or the kind and amount of cash, securities and other assets
or property that the holder would have received if the holder had
held shares immediately before the fundamental change, if the
Conversion Option is exercised after that date, plus in either case
the Make Whole Premium, if applicable, discussed in points (c) and
(e) above. While FSHI can, at its option, pay cash in lieu of
issuing some or all of the Limited Voting Shares, FSHI would only
be required to pay cash if holders of Limited Voting Shares
received cash in connection with the fundamental change.
Accordingly, this criterion was satisfied.
G) PARAGRAPHS 29 TO 31 - THERE ARE NO PROVISIONS IN THE CONTRACT
THAT INDICATE THAT THE COUNTERPARTY HAS RIGHTS THAT RANK HIGHER
THAN THOSE OF A SHAREHOLDER OF THE STOCK UNDERLYING THE CONTRACT.
We considered whether there are any terms of the Convertible Notes
related solely to the Conversion Option that would indicate that
holders strictly in their capacity as Conversion Option holders
have rights IN RESPECT OF SHARES OF FSHI that rank higher than
those of a shareholder. We are not aware of any such terms. (This
does not apply to the principal portion of the debt, but only to
the embedded Conversion Option and the shares to be delivered on
conversion).
Accordingly, this criterion was satisfied.
H) PARAGRAPH 32 - THERE IS NO REQUIREMENT IN THE CONTRACT TO POST
COLLATERAL AT ANY POINT OR FOR ANY REASON.
There are no requirements to post collateral related to the
Conversion Option.
Accordingly, this criterion was satisfied.
Based on the analysis above, the criteria in paragraphs 12-32 have
been met and the Conversion Option would be classified in equity if it
were evaluated as a hypothetical freestanding derivative instrument.
Accordingly, the Conversion Option would not be accounted for as a
derivative in accordance with paragraph 11(a) of FAS 133.
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E) DETERMINATION OF WHETHER THE EMBEDDED DERIVATIVE WARRANTS
ACCOUNTING SEPARATE FROM THE HOST CONTRACT -
In light of our conclusions that the Conversion Option, despite
the fact that it would be a derivative on a stand-alone basis,
and that it would not be clearly and closely related to a debt
host contract, meets the exemption in FAS 133 paragraph 11(a), we
concluded that the Conversion Option is not required to be
accounted for separate from the debt host contract.
3. INITIAL AND SUBSEQUENT ACCOUNTING FOR CONVERTIBLE DEBT - ACCOUNTING FOR THE
CONVERSION OPTION AS AN "EMBEDDED DERIVATIVE"
Based on the above analysis, we concluded that the Convertible Notes should
be accounted for in accordance with APB 14; accordingly, no portion of the
proceeds from the issuance of the Convertible Notes should be accounted for
as attributable to the Conversion Option, and the Convertible Notes should
be accounted for solely as debt instruments.
MEMORANDUM RESPONSE TO QUESTION #2 IN SEC COMMENT LETTER
APPENDIX
1.875% CONVERTIBLE SENIOR NOTES DUE 2024 - TERMS PERTINENT TO ACCOUNTING
1) STRUCTURE - 1.875% contingently convertible senior notes - interest payable
semi-annually, in arrears, January 30 and July 30 of each year, beginning
January 30, 2005.
2) TERM - 20 years
3) MATURITY - July 30, 2024
4) ISSUE PRICE - US$ 1,000 per Convertible Note (plus any accrued interest).
5) PRINCIPAL AMOUNT - US$ 1,000 per Convertible Note
6) OPTIONAL REDEMPTION - FSHI may redeem the Convertible Notes at any time on
or after August 4, 2009 for 100% of the principal amount of the Convertible
Notes, plus accrued but unpaid interest - i.e. US$ 1,000, plus accrued and
unpaid interest, for cash.
7) CONVERSION RIGHTS - The Convertible Notes are convertible at the holder's
option at any time for 13.9581 Limited Voting Shares per US$ 1,000, subject
to adjustment in certain circumstances (this rate is referred to as the
"Conversion Rate") - resulting in an effective conversion price of
approximately US$ 71.64 per share (subject to adjustment in certain
circumstances); in the following circumstances:
a) during any fiscal quarter, if the closing price of Limited Voting
Shares for at least 20 consecutive trading days in the 30 consecutive
trading day period ending on the last trading day of the immediately
preceding fiscal quarter exceeds 130% of the conversion price
currently US$ 71.64 per share in effect on that 30th trading day;
b) during the five consecutive trading day period immediately following
any 10 consecutive trading day period in which the trading price per
US$ 1,000 principal amount of the notes for each day of the period was
less than 95% of the product of the closing sale price of Limited
Voting Shares on that day and the conversion rate for that day;
provided that if, on the date of conversion the closing sale price of
Limited Voting Shares is greater than the conversion price, FSHI will
deliver to a holder of Convertible Notes surrendered for conversion in
lieu of a number of Limited Voting Shares (or cash or a combination of
cash and Limited Voting Shares) based on the conversion price, that
number of Limited Voting Shares or, at FSHI's option, cash or a
combination of cash and Limited Voting Shares, with a value equal to
the principal amount of the notes surrendered for conversion plus
accrued and unpaid interest up to, but not including, the conversion
date (this feature is referred to as the "parity feature");
c) if FSHI has called the notes for redemption; or
d) upon the occurrence of certain Specified Corporate Transactions (an
issue to all holders of Limited Voting Shares of certain rights or
warrants to purchase Limited
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Voting Shares or certain extraordinary distributions to all holders of
Limited Voting Shares) or a fundamental change - see below.
8) OPTIONAL SETTLEMENT ON CONVERSION - FSHI may, at its option, in lieu of
delivering Limited Voting Shares upon conversion of all or a portion of the
notes, elect to pay cash or a combination of cash and Limited Voting
Shares.
9) REDEMPTION OF NOTES AT THE OPTION OF THE HOLDERS - Holders of the
Convertible Notes have the right to require FSHI to purchase all or a
portion of the Convertible Notes on July 30, 2009, 2014 and 2019 for 100%
of the principal amount of the Convertible Notes to be redeemed, plus any
accrued but unpaid interest. FSHI is to pay the purchase price for any
Convertible Notes repurchased on July 30, 2009 in cash. FSHI may choose to
pay the purchase price of any Convertible Notes repurchased on July 30,
2014 and July 30, 2019, at its option, in cash, Limited Voting Shares, or a
combination of cash and Limited Voting Shares.
10) MAKE WHOLE PREMIUM - If a "fundamental change" occurs on or before July 30,
2009, holders of Convertible Notes will be entitled to a Make Whole Premium
upon the repurchase of the notes (if the fundamental change is also a
"change of control") or through the conversion of Convertible Notes in
connection with a fundamental change. FSHI may satisfy the Make Whole
Premium, at its option, in cash, Limited Voting Shares or, in certain
circumstances, the consideration into which all or substantially all of the
Limited Voting Shares has been converted in connection with the fundamental
change (or any combination thereof). The amount of the Make Whole Premium,
if any, will be a specified percentage of the Principal Amount of the
Convertible Notes, based on the "stock price" and the effective date of the
"fundamental change". Holders of Convertible Notes will not be entitled to
the make whole premium if the "stock price" is less than US$ 55.11 or more
than US$ 150.00. If the Make Whole Premium relates to a conversion as a
result of a fundamental change, the Make Whole Premium results in an
increase in the number of Limited Voting Shares into which the Notes are
convertible.
11) OFFER TO PURCHASE UPON A DESIGNATED EVENT - Upon a "fundamental change" or
"termination of trading", FSHI will be required to offer to purchase all
outstanding Convertible Notes at a purchase price equal to 100% of the
principal amount of the notes plus accrued but unpaid interest. FSHI may
choose to pay the purchase price, at its option, in cash, Limited Voting
Shares, securities of the surviving entity if FHSI is not the surviving
corporation, or a combination of cash and the applicable securities. FSHI's
obligation to make an offer will not arise in respect of a fundamental
change or termination of trading that occurs on or before the day that is
five years plus a day after the last date of the issuance of the
Convertible Notes unless it is a "change in control". With respect to a
fundamental change occurring on or before July 30, 2009 and giving rise to
an offer to purchase, FHSI also will pay a Make Whole Premium, as described
above.
a) A "fundamental change" is any transaction or event, whether by means
of an exchange offer, liquidation, tender offer, consolidation,
merger, combination, reclassification, recapitalization or otherwise,
in connection with which all or substantially all of the Limited
Voting Shares are exchanged for, converted into,
Page 16
acquired for or constitute solely the right to receive, consideration
that is not all or substantially all common shares that are:
i) listed on, or immediately after the transaction or event will be
listed on, the Toronto Stock Exchange or a United States national
securities exchange; or
ii) approved, or immediately after the transaction or event will be
approved, for quotation on the Nasdaq National Market or any
similar United States system of automated dissemination of
quotations of securities prices.
b) A "termination of trading" will be deemed to have occurred if the
Limited Voting Shares (or other securities or property into which the
Convertible Notes then are convertible are neither listed for trading
on the Toronto Stock Exchange or a United States national securities
exchange nor approved for trading on the Nasdaq National Market or any
similar United States system of automated dissemination of quotations
of securities prices.
12) LIMITATIONS ON FSHI OPTIONAL SETTLEMENT - FSHI may not pay the purchase
price upon a "Redemption of Notes at the Option of the Holders" or a "Offer
to Purchase Upon a Designated Event" in Limited Voting Shares (or the
applicable shares or securities or a combination of the applicable shares
or securities and cash) unless FSHI satisfies certain conditions prior to
the purchase date, including:
a) registration of the Limited Voting Shares (or the applicable shares or
securities or a combination of the applicable shares or securities) to
be issued upon purchase of the notes under the Securities Act and the
Exchange Act, if required;
b) qualification of Limited Voting Shares (or the applicable shares or
securities or a combination of the applicable shares or securities) to
be issued upon purchase of the notes under applicable state securities
laws, if necessary, or the availability of an exemption therefrom; and
c) listing of the Limited Voting Shares (or the applicable shares or
securities or a combination of the applicable shares or securities) to
be issued upon purchase of the notes on the Toronto Stock Exchange or
a United States national securities exchange or quotation of the
applicable shares or securities on the Nasdaq National Market System
or any similar United States system of automated dissemination of
quotation of securities prices.