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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission file number: 1-5721
LEUCADIA NATIONAL CORPORATION
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(Exact Name of Registrant as Specified in its Charter)
NEW YORK 13-2615557
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(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
315 PARK AVENUE SOUTH
NEW YORK, NEW YORK 10010
(212) 460-1900
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(Address, Including Zip Code, and Telephone Number,
Including Area Code, of Registrant's Principal Executive Offices)
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
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COMMON SHARES, PAR VALUE $1 PER SHARE NEW YORK STOCK EXCHANGE
PACIFIC EXCHANGE, INC.
7-3/4% SENIOR NOTES DUE AUGUST 15, 2013 NEW YORK STOCK EXCHANGE
8-1/4% SENIOR SUBORDINATED NOTES DUE NEW YORK STOCK EXCHANGE
JUNE 15, 2005
7-7/8% SENIOR SUBORDINATED NOTES DUE NEW YORK STOCK EXCHANGE
OCTOBER 15, 2006
Securities registered pursuant to Section 12(g) of the Act:
NONE.
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(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [x].
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [x] No [_]
Aggregate market value of the voting stock of the registrant held by
non-affiliates of the registrant at June 30, 2003 (computed by reference to the
last reported closing sale price of the Common Shares on the New York Stock
Exchange on such date): $1,496,104,000.
On March 5, 2004, the registrant had outstanding 70,867,502 Common Shares.
DOCUMENTS INCORPORATED BY REFERENCE:
Certain portions of the registrant's definitive proxy statement pursuant to
Regulation 14A of the Securities Exchange Act of 1934 in connection with the
2004 annual meeting of shareholders of the registrant are incorporated by
reference into Part III of this Report.
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1
PART I
Item 1. Business.
- ------ --------
THE COMPANY
The Company is a diversified holding company engaged in a variety of
businesses, including telecommunications, healthcare services, banking and
lending, manufacturing, real estate activities, winery operations, development
of a copper mine and property and casualty reinsurance. The Company concentrates
on return on investment and cash flow to build long-term shareholder value,
rather than emphasizing volume or market share. Additionally, the Company
continuously evaluates the retention and disposition of its existing operations
and investigates possible acquisitions of new businesses in order to maximize
shareholder value. In identifying possible acquisitions, the Company tends to
seek assets and companies that are troubled or out of favor and, as a result,
are selling substantially below the values the Company believes to be present.
Shareholders' equity has grown from a deficit of $7,700,000 at December
31, 1978 (prior to the acquisition of a controlling interest in the Company by
the Company's Chairman and President), to a positive shareholders' equity of
$2,134,200,000 at December 31, 2003, equal to a book value per common share of
the Company (a "common share") of negative $.11 at December 31, 1978 and $30.13
at December 31, 2003. The December 31, 2003 shareholders' equity and book value
per share amounts have been reduced by the $811,900,000 special cash dividend
paid in 1999.
In November 2003, pursuant to a registered exchange offer and merger
agreement, the Company acquired the balance of the outstanding common stock of
WilTel Communications Group, Inc. ("WilTel") that it did not already own for
11,156,460 of the Company's common shares. The Company had previously acquired
47.4% of the outstanding common stock of WilTel during 2002 for cash
consideration of $353,900,000, including expenses. WilTel is a
telecommunications company that owns or leases and operates a nationwide
inter-city fiber-optic network providing Internet, data, voice and video
services. Upon completion of the exchange offer and merger, WilTel became a
consolidated subsidiary of the Company.
In September 2003, the Company acquired certain businesses primarily
engaged in the provision of physical, occupational, speech and respiratory
therapy services that are operated by subsidiaries of Symphony Health Services,
LLC ("Symphony"). The purchase price was approximately $36,700,000, including
expenses, of which approximately $29,200,000 was provided by financing that is
non-recourse to the Company but is fully collateralized by Symphony's assets.
The Company has consolidated Symphony's financial condition and results of
operations since acquisition.
2
The Company's banking and lending operations have historically consisted
of making instalment loans to niche markets primarily funded by customer banking
deposits insured by the Federal Deposit Insurance Corporation (the "FDIC").
However, as a result of increased loss experience and declining profitability in
its automobile lending program, the Company stopped originating new automobile
loans in September 2001. In January 2003, the Company ceased originating loans
in all other lending programs. Operating activities at this segment are
currently limited to maximizing the amount collected from its loan portfolio and
liquidating the business in an orderly and cost efficient manner.
The Company's manufacturing operations manufacture and market
lightweight plastic netting used for a variety of purposes including, among
other things, building and construction, erosion control, agriculture,
packaging, carpet padding, filtration and consumer products.
The Company's domestic real estate operations include a mixture of
commercial properties, residential land development projects and other
unimproved land, all in various stages of development and all available for
sale.
The Company's winery operations consist of Pine Ridge Winery in Napa
Valley, California and Archery Summit in the Willamette Valley of Oregon. These
wineries primarily produce and sell wines in the luxury segment of the premium
table wine market.
The Company's copper mine development operations consist of its 72.5%
interest in MK Gold Company ("MK Gold"), a publicly traded company listed on the
NASD OTC Bulletin Board (Symbol: MKAU).
The Company's property and casualty reinsurance business is conducted
through its 16.1% common stock interest in Olympus Re Holdings, Ltd.
("Olympus"), a Bermuda reinsurance company primarily engaged in the property
excess, marine and aviation reinsurance business.
Certain of the Company's subsidiaries have substantial tax loss
carryforwards. The amount and availability of the tax loss carryforwards are
subject to certain qualifications, limitations and uncertainties as more fully
discussed in the "Notes to the Consolidated Financial Statements" and Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
As used herein, the term "Company" refers to Leucadia National
Corporation, a New York corporation organized in 1968, and its subsidiaries,
except as the context otherwise may require.
INVESTOR INFORMATION
The Company is subject to the informational requirements of the
Securities Exchange Act of 1934 (the "Exchange Act"). Accordingly, the Company
files periodic reports, proxy statements and other information with the
Securities and Exchange Commission (the "SEC"). Such reports, proxy statements
and other information may be obtained by visiting the Public Reference Room of
the SEC at 450 Fifth Street, NW, Washington, D.C. 20549 or by calling the SEC at
1-800-SEC-0330. In addition, the SEC maintains an Internet site
(http://www.sec.gov) that contains reports, proxy and information statements and
other information regarding the Company and other issuers that file
electronically. In addition, material filed by the Company can be inspected at
the offices of the New York Stock Exchange, Inc. (the "NYSE"), 20 Broad Street,
New York, NY 10005 and the Pacific Exchange, Inc., 115 Sansome Street, San
Francisco, CA 94104, on which the Company's common shares are listed.
The Company does not currently maintain a website, but expects to create
a website prior to its 2004 annual meeting of shareholders. The Company will
provide without charge upon request copies of its annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Exchange Act. Requests for such copies should be directed to: Leucadia National
Corporation, 315 Park Avenue South, New York, NY 10010 (telephone number (212)
460-1900), Attention: Corporate Secretary.
3
FINANCIAL INFORMATION ABOUT SEGMENTS
The Company's reportable segments consist of its operating units, which
offer different products and services and are managed separately. The Company's
telecommunications business is conducted by WilTel and contains two segments,
Network and Vyvx. Network owns or leases and operates a nationwide fiber optic
network over which it provides a variety of telecommunications services. Vyvx
transmits audio and video programming over the network and distributes
advertising media in physical and electronic form. The Company's other segments
include healthcare services, banking and lending, manufacturing and domestic
real estate. Healthcare services primarily include the provision of physical,
occupational, speech and respiratory therapy services. Banking and lending
operations historically made collateralized personal automobile instalment loans
to individuals who have difficulty obtaining credit, at interest rates above
those charged to individuals with good credit histories. Such loans were
primarily funded by deposits insured by the FDIC. The banking and lending
segment has ceased originating any new loans and is liquidating its business in
an orderly manner. Manufacturing operations manufacture and market lightweight
plastic netting used for a variety of purposes. The Company's domestic real
estate operations consist of a variety of commercial properties, residential
land development projects and other unimproved land, all in various stages of
development and all available for sale. Other operations primarily consist of
winery operations and development of a copper mine.
Associated companies include equity interests in entities that the
Company does not control and that are accounted for on the equity method of
accounting. Prior to the acquisition of the outstanding common stock of WilTel
that it didn't already own in November 2003, the Company accounted for its 47.4%
interest in WilTel as an associated company. Other investments in associated
companies include Olympus, a Bermuda-based reinsurance company, Berkadia LLC
("Berkadia"), a joint venture formed to facilitate the chapter 11 restructuring
of The FINOVA Group Inc. ("FINOVA"), HomeFed Corporation ("HomeFed"), a
corporation engaged in real estate activities, Jefferies Partners Opportunity
Fund II, LLC ("JPOF II") and EagleRock Capital Partners (QP), LP ("EagleRock").
Both JPOF II and EagleRock are engaged in investing and/or securities
transactions activities.
Corporate assets primarily consist of investments and cash and cash
equivalents and corporate revenues primarily consist of investment income and
securities gains and losses. Corporate assets, revenues, overhead expenses and
interest expense are not allocated to the operating units. The Company has a
manufacturing facility located in Belgium and an interest, through MK Gold, in a
copper deposit in Spain. WilTel owns or has the right to use certain cable
systems which connect its U.S. domestic network to foreign countries, and has
the right to use wavelengths in Europe which it is currently not using. In
addition to its investment in Bermuda-based Olympus, the Company also owns 36%
of the electric utility in Barbados. The Company does not have any other
material foreign operations or investments.
Except for the telecommunications segments of WilTel, the primary
measure of segment operating results and profitability used by the Company is
income (loss) from continuing operations before income taxes, minority expense
of trust preferred securities and equity in income (losses) of associated
companies. For WilTel's segments, segment profit from operations is the primary
performance measure of segment operating results and profitability. WilTel
defines segment profit from operations as income before income taxes, interest
expense, investment income, depreciation and amortization expense and other
non-operating income and expense.
The following information reconciles segment profit from operations of
the Network and Vyvx segments to the most comparable measure under generally
accepted accounting principles ("GAAP"), which is used for all other reportable
segments, for the period from November 6, 2003 through December 31, 2003 (in
millions):
Network Vyvx
--------- --------
Segment profit from operations (1) $ 13.3 $ 4.1
Depreciation and amortization expense (37.2) (2.0)
Interest expense, net of investment income (2) (4.0) (.1)
Other non-operating income (expense), net (2) 1.8 .5
--------- --------
Income (loss) from continuing operations before income taxes,
minority expense of trust preferred securities and equity in
income (losses) of associated companies $ (26.1) $ 2.5
========= ========
(1) See note (c) to segment information below.
(2) These items have been allocated to each segment based upon a formula that
considers each segment's revenues, property and equipment and headcount.
4
Certain information concerning the Company's segments for 2003, 2002 and
2001 is presented in the following table. Associated Companies are only
reflected in the table below under identifiable assets employed.
2003 2002 2001
---- ---- ----
(In millions)
Revenues (a):
Network $ 218.4 $ - $ -
Vyvx 21.2 - -
Healthcare Services 71.1 - -
Banking and Lending 62.3 95.9 122.4
Manufacturing 54.1 51.0 57.4
Domestic Real Estate 54.4 51.3 65.3
Other Operations 36.7 48.3 39.3
Corporate (b) 42.5 (4.7) 89.8
Intersegment elimination (c) (4.3) - -
--------- --------- ---------
Total consolidated revenues $ 556.4 $ 241.8 $ 374.2
========= ========= =========
Income (loss) from continuing operations
before income taxes, minority expense
of trust preferred securities and equity
in income (losses) of associated
companies:
Network (c) $ (26.1) $ - $ -
Vyvx (c) 2.5 - -
Healthcare Services (2.3) - -
Banking and Lending 8.4 1.9 (6.1)
Manufacturing 4.4 3.1 7.8
Domestic Real Estate 18.1 16.7 30.4
Other Operations (1.5) 11.7 8.2
Corporate (b) (37.5) (74.9) 32.8
--------- --------- ---------
Total consolidated income (loss) from
continuing operations before income
taxes, minority expense of trust
preferred securities and equity in income
(losses) of associated companies $ (34.0) $ (41.5) $ 73.1
======== ======== ========
Identifiable assets employed:
Network $1,628.8 $ - $ -
Vyvx 115.5 - -
Healthcare Services 54.6 - -
Banking and Lending 252.4 481.5 595.7
Manufacturing 50.8 51.5 59.3
Domestic Real Estate 165.0 106.8 176.4
Other Operations 253.4 193.7 171.2
Investments in Associated Companies:
WilTel - 340.6 -
Other Associated Companies 430.9 397.1 358.8
Net Assets of Discontinued Operations - - 44.0
Corporate 1,445.8 970.6 1,063.7
--------- --------- ---------
Total consolidated assets $4,397.2 $2,541.8 $2,469.1
========= ========= =========
(a) Revenues for each segment include amounts for services rendered and
products sold, as well as segment reported amounts classified as investment
and other income and net securities gains (losses) on the Company's
consolidated statements of operations.
5
(b) For 2003, includes a provision of $6,500,000 to write down investments in
certain available for sale securities and an investment in a non-public
security. For 2002, includes a provision of $37,100,000 to write down
investments in certain available for sale securities and an equity
investment in a non-public fund. The write down of the available for sale
securities resulted from a decline in market value determined to be other
than temporary.
(c) Eliminates intersegment revenues billed from Network to Vyvx. However, the
intersegment revenues are included in the calculation to determine the
income (loss) from continuing operations for each of Network and Vyvx.
At December 31, 2003, the Company and its consolidated subsidiaries had 5,269
full-time employees.
TELECOMMUNICATIONS
ACQUISITION
- -----------
In December 2002, the Company completed the acquisition of 44% of the
outstanding common stock of WilTel for an aggregate purchase price of
$333,500,000, including expenses. The WilTel stock was acquired by the Company
under the chapter 11 restructuring plan of Williams Communications Group, Inc.,
the predecessor of WilTel. In October 2002, in a private transaction, the
Company purchased 1,700,000 shares of WilTel common stock, on a when issued
basis, for $20,400,000. Together, these transactions resulted in the Company
acquiring 47.4% of the outstanding common stock of WilTel during 2002.
In November 2003, the Company consummated an exchange offer and merger
agreement pursuant to which all public WilTel stockholders received .4242 of a
Leucadia common share for each share of WilTel common stock. Leucadia issued
11,156,460 of its common shares in exchange for all of the WilTel common stock
that it didn't previously own. The merger agreement also provided that WilTel
stockholders receive contingent sale rights which entitle WilTel stockholders to
additional Leucadia common shares if the Company sells substantially all of
WilTel's assets or outstanding shares of capital stock prior to October 15,
2004, or consummates such a sale at a later date if the sale agreement was
entered into prior to August 21, 2004, and in either case the net proceeds
exceed the valuation ascribed to WilTel's equity in the merger transaction. The
2003 acquisition was wholly unrelated to the initial acquisition in 2002; the
Company's decision to acquire the remaining WilTel shares was based upon
developments subsequent to the initial 2002 purchase.
The aggregate purchase price for the 2003 acquisition was approximately
$425,300,000, consisting of $422,800,000 of Leucadia common shares (based on a
Leucadia stock price of $37.90 per share) and cash expenses of $2,500,000. The
purchase price does not include any amounts related to the contingent sale
rights, which would be accounted for as additional purchase price consideration
if, and when, they result in the issuance of additional Leucadia common shares
(up to an aggregate maximum of 11,000,000 additional Leucadia common shares).
Following completion of the merger, the Company has consolidated the financial
condition and results of operations of WilTel, and no longer accounts for its
investment in WilTel under the equity method of accounting. In the aggregate,
the Company invested $779,200,000 in cash and common shares issued to acquire
100% of WilTel during 2002 and 2003.
Certain telecommunications terms used throughout this section are
defined under "Telecommunications Glossary" below.
6
NETWORK
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Business Description
Through its Network segment, WilTel owns or leases and operates a
nationwide inter-city fiber-optic network. WilTel has also built a fiber-optic
network within certain cities in the U.S and has the ability to connect to
networks outside the U.S. Network provides Internet, data, voice, and video
services to companies that use high-capacity and high-speed telecommunications
in their businesses. Network sells its products to the wholesale carrier and
enterprise market segments, and many of its most significant customers provide
retail telecommunications services to consumers and businesses. Network's
fastest growing and largest revenue component is its voice business.
Network also offers rights of use in dark fiber, which is fiber that it
installs but for which it does not provide communications transmission services.
Purchasers of dark fiber rights install their own electrical and optical
transmission equipment. Network also provides space and power to collocation
customers at network centers and a variety of professional and managed services
including network design and construction, network management and network
monitoring or surveillance.
WilTel's network includes ownership interests in or rights to use:
- nearly 30,000 miles of fiber-optic cable in the U.S., of which 28,627
is currently in service;
- local fiber optic cable networks within 36 of the largest U.S. cities;
- 118 network centers located in 107 U.S. cities;
- fiber-optic cable connecting the U.S. and Mexico in California and
Texas, and the U.S. and Canada in Washington, Michigan, and New York;
- capacity on five major undersea cable systems connecting the
continental U.S. with Europe, Asia, Australia, New Zealand, Guam and
Hawaii; and
- rights to use wavelengths in Europe connecting the UK, France,
Germany, Belgium, the Netherlands, Norway, Denmark, Finland, and
Sweden. These rights have been exercised and wavelengths are available
but not currently in use.
Properties
U.S INTER-CITY NETWORK
Miles In Average Number of
The WilTel Network Route Miles Operation Fibers Per Cable
------------------ ----------- --------- ----------------
Wholly owned fiber routes, built by WilTel 16,632 16,021 123
Fiber routes jointly owned (1) 1,258 1,258 12
Fiber routes through dark fiber rights (2) 11,348 11,348 17
------ ------
Total 29,238 28,627
====== ======
(1) This category consists of Network's fiber rights in routes that have
been jointly constructed by a limited liability company in which
WilTel shares equal ownership and control with two other parties.
(2) This category consists of rights in dark fiber and conduits that
Network has obtained. Network has obtained approximately 11,348 route
miles, all of which have had fiber-optic cable installed. Network
manages the transmission equipment on the routes it acquired, and it
typically pays for the maintenance of fiber-optic strands and rights
of way.
Network also leases capacity from both long-distance and local
telecommunications carriers, including its competitors, in order to meet the
needs of its customers. Leases of capacity are distinguished from rights in dark
fiber in that capacity leases are for only a portion of the fiber capacity and
the lessor supplies and operates the equipment to transmit over the fiber.
Capacity leases are generally for terms of one month to five years, but can be
longer. Network leases from third parties less than one percent of its U.S.
network capacity currently in use. These leases are for areas where Network does
not have its own network capacity, or such capacity is not currently sufficient
to meet the expected demand.
7
WilTel commenced construction of its network in 1997, began providing
services in 1998 and had substantially completed construction in 2002. The
domestic voice network grew to 20 switches as of December 31, 2003, including
eighteen domestic switches and two gateway switches. The gateway switches offer
foreign termination and inbound domestic termination to other carrier customers.
Conduit and fiber-optic cable. The WilTel network contains multiple
conduits along more than 90% of the routes it constructed. When constructing
fiber-optic cable, the manufacturer places fiber-optic strands inside small
plastic tubes, wraps bundles of these tubes with plastic, and strengthens them
with metal. Network then places these bundles inside a conduit, which is
high-density polyethylene hollow tubing one-and-one-half to two inches in
diameter. The conduit is generally buried approximately 42 inches underground
along pipeline or other rights of way corridors. Network also uses steel casing
in high-risk areas, including railroad crossings and high-population areas,
thereby providing greater protection for the cable. The first conduit generally
contains a cable that has between 96 and 144 fibers, and the second conduit or,
where constructed, a third conduit, serves as a spare. The spare conduits allow
for future technology upgrades, potential conduit sales, and expansion of
capacity. Network generally plans to retain from 8 to 24 fibers throughout the
network for its own use, with the remainder made available for leases of dark
fiber.
Rights of way. The WilTel network was primarily constructed by digging
trenches along rights of way, or rights to use the property of others, which
Network obtained throughout the United States from various landowners.
Generally, where feasible, Network used the rights of way of pipeline companies
that WilTel believed provided greater physical protection of the fiber system
and resulted in lower construction costs than systems built over more public
rights of way. Almost all of its rights of way extend through at least 2018.
Rights of way are generally for terms of at least 20 years, and most cover
distances of less than one mile.
LOCAL NETWORK
As of December 31, 2003, Network was providing services on local
networks in 36 U.S. cities. These cities are: Anaheim, CA; Atlanta, GA;
Bakersfield, CA; Baltimore, MD; Boston, MA; Chicago, IL; Columbus, OH; Dallas,
TX; Fresno, CA; Houston, TX; Jersey City, NJ; Kansas City, KS; Laredo, TX; Los
Angeles, CA; McAllen, TX; Modesto, CA; Miami, FL; Milwaukee, WI; Minneapolis,
MN; New York, NY; Newark, NJ; Oakland, CA; Philadelphia, PA; Phoenix, AZ;
Portland, OR; Riverside, CA; Sacramento, CA; San Francisco, CA; San Jose, CA;
Santa Clara, CA; Seattle, WA; Secaucus, NJ; St. Louis, MO; Tucson, AZ; Tulsa,
OK; and Washington, D.C. WilTel also has rights to utilize 30,740 local dark
fiber miles in the U.S. through a fiber lease agreement with AboveNet
Communications, Inc. ("AboveNet", formerly Metromedia Fiber Network). In
addition, WilTel has the right to lease an additional 54,324 of dark fiber miles
anywhere that AboveNet may construct or currently owns dark fiber in the U.S. or
Europe.
Products and Services
Network's principal products and services are as follows:
Packet-based data products. These services provide connections for
Internet, data, voice, and video networks at variable capacities between two or
more points. Specific packet-based data products include ATM, Frame Relay,
Internet Protocol ("IP") transport and IP virtual private networks. These
services are generally billed on a usage basis.
Private line products. Network provides customers with fixed amounts of
point-to-point capacity at a protected or unprotected service level; a protected
service level provides customers with backup capacity should they decide to
purchase that product. These services are billed as fixed monthly fees,
regardless of usage.
8
Voice services. Network provides wholesale origination, transport and
termination, as well as calling card, directory assistance, operator assistance,
toll-free services and international termination to more than 200 countries.
Optical wave services. This service is a point-to-point service, which
has no back-up or protection capacity, and which allows a customer the exclusive
use of a portion of the transmission capacity of a fiber-optic strand rather
than the entire fiber strand. A purchaser of optical wave services installs its
own electrical interface, switching and routing equipment.
Backhaul services. Network has interconnected international cable
landing stations on the West and East Coasts with fiber optic rings capable of
terminating cable traffic at specified Network centers. These services are made
available to customers that have access to their own undersea cables and require
domestic interconnection services only.
Customers
Network offers services to both carrier and enterprise markets, and its
customers currently include Regional Bell Operating Companies, cable television
companies, Internet service providers, application service providers, data
storage service providers, managed network service providers, digital subscriber
line service providers, long distance carriers, local service providers,
utilities, governmental entities, educational institutions, international
carriers and other communications services providers who desire high-capacity
and high-speed products on a carrier services basis.
SBC Communications Inc. ("SBC"), a major communications provider in the
U.S., is WilTel's largest customer. Sales to SBC accounted for 65% of 2003
Network revenues included in the Company's consolidated statement of operations.
WilTel has entered into preferred provider agreements with SBC that extend until
2019, although the agreements may be terminated prior to then by either party
under certain circumstances. The agreements provide that:
o WilTel is SBC's preferred provider for domestic voice and data long
distance services and select international wholesale services,
requiring that SBC seek to obtain these services from WilTel before it
obtains them from any other provider; and
o SBC is WilTel's preferred provider for select local exchange and
various other services, including platform services supporting its
switched voice services network, requiring that WilTel seek to obtain
these services from SBC before it obtains them from any other
provider.
For the services each party must seek to obtain from the other, the
prices, determined separately for each product or service, generally will be
equal to the lesser of the cost of the product or service plus a specified rate
of return, the prices charged to other customers, the current market rate or, in
some circumstances, a specific rate. If either party can secure lower prices for
comparable services that the other party will not match, then that party is free
to utilize the lowest cost provider. WilTel and SBC have agreed to use a fixed
price for voice transport services (the substantial majority of WilTel's SBC
generated revenue) through January 2005. Although it is difficult to identify a
precise market price since the products and services provided to each customer
are customized to meet the needs of each customer, the Company believes that the
fixed price being charged to SBC is representative of the current market price
for voice transport services.
The methodologies that WilTel uses to determine the current market price
and the cost of the product or service upon which a specified rate of return
applies are complex and subject to different interpretations. If SBC and WilTel
are unable to agree on the methods used, the agreements with SBC provide that
any disputes be resolved through binding arbitration. If SBC were to
successfully challenge WilTel's pricing methodology in an arbitration
proceeding, resulting in a significant reduction in the voice transport price,
WilTel may not be able to continue to provide services to SBC. The Company is
unable to predict the ultimate outcome of future price discussions with SBC.
9
SBC has the right to terminate the agreements if WilTel begins to offer
certain services that are competitive with SBC's services, if WilTel materially
breaches its agreements or WilTel has a change in control without SBC's consent
(excluding the acquisition by the Company). WilTel has the right to terminate
the agreements if SBC materially breaches its agreements or SBC has a change in
control without WilTel's consent. In the event of a termination by either party
due to these actions, the terminating party has the right to receive transition
costs from the other party, not to exceed $200,000,000.
Either party may terminate a particular provider agreement if the action
or failure to act of any regulatory authority materially frustrates or hinders
the purpose of that agreement. There is no monetary remedy for such a
termination.
Sales and Marketing
Network's sales and marketing organizations target customers that
require high volumes of bandwidth to operate their businesses. The successful
acquisition of a new customer requires a high degree of technical knowledge
about both the product being sold and the customer's operation, in particular
since most of Network's products need to be specifically configured to meet the
unique needs of each customer.
Network has a centralized marketing organization that has established a
segment-wide approach to marketing and product management. The marketing
organization is responsible for advanced market planning and segmentation,
product planning and development, product marketing, advertising, lifecycle
management, product economics, pricing and competitive analysis.
Competition
The telecommunications industry is highly competitive. Some of Network's
competitors may have financial, personnel and other resources significantly
greater than those of Network. In the market for carrier services, Network
competes primarily with AT&T, MCI, Sprint, Qwest, Level 3, Global Crossing, 360
Networks and Broadwing. Many of these competitors have revenues and customer
bases far larger than those of Network. Network also competes with numerous
other service providers that focus either on a specific product or set of
products or within a geographic region. Network competes primarily on the basis
of price, network reliability, customer service and support. Network's services
within local markets in the U.S. face additional competitors, including the
traditional regional telephone companies and other local telephone companies.
The telecommunications industry has experienced a great deal of
instability during the past several years. During the 1990s, forecasts of very
high levels of future demand brought a significant number of new entrants and
new capital investments into the industry. However, many industry participants
have gone through bankruptcy, those forecasts have not materialized,
telecommunications capacity now far exceeds actual demand and the resulting
marketplace is characterized by fierce price competition as competitors seek to
secure market share. Resulting lower prices have eroded margins and have kept
many in the industry from attaining positive cash flow from operations. The
Company does not know if and when the current pricing environment will improve
or achieve stability.
VYVX
- ----
Business Description
Vyvx transmits audio and video programming for its customers over
Network's fiber-optic network and via satellite. It uses Network's fiber-optic
network to carry many live traditional broadcast and cable television events
from the site of the event to the network control centers of the broadcasters of
the event. These events include live sporting events of the major professional
sports leagues, including the last fifteen Super Bowls. For live events where
the location is not known in advance, such as breaking news stories in remote
locations, Vyvx provides an integrated satellite and fiber-optic network based
service to transmit the content to its customers. Most of Vyvx's customers for
these services contract for the service on an event-by-event basis; however,
Vyvx has some customers who have purchased a dedicated point-to-point service
which enables these customers to transmit programming at any time they wish.
10
Vyvx also distributes advertising spots and syndicated programming to
radio and television stations throughout the U.S., both electronically and in
physical form. Customers for these services can utilize a network-based method
for aggregating, managing, storing and distributing content for content owners
and rights holders.
Products and Services
Vyvx's primary products and services are as follows:
Fiber Optic and Satellite Video Transport Services. Vyvx offers
various products to provide audio and video feeds over fiber or satellite for
broadcast and production customers. These products vary in capacity provided,
frequency of use (i.e., may be provided on an occasional or dedicated basis) and
price. In 2004, Super Bowl XXXVIII was the first live broadcast event ever
carried using Vyvx's new high definition (HD) transport product.
Advertising Distribution Services. These services include:
Audio Distribution. Vyvx sends radio spots to stations via
electronic and physical distribution. Spots are distributed to over 10,000
stations in North America via the Internet using no proprietary hardware.
Video Distribution. Vyvx has the capability to electronically and
physically deliver television spots to more than 1,130 television stations
across the United States as well as broadcasters and cable networks.
Storage. Vyvx offers secure storage of media components in Vyvx's
climate-controlled storage facilities located in Burbank, Chicago and New York
City.
Customers
Vyvx sells to media content service providers and businesses that use
media content as a component of their business. It does not compete with its
media customers for retail end-users. It has approximately 2,000 customers,
including major broadcast and cable television networks, news services,
professional and collegiate sports organizations, advertising agencies and their
advertisers, television companies and movie production companies. Approximately
67% of 2003 Vyvx revenue included in the Company's consolidated statement of
operations was derived from its top 10 customers. Fox Entertainment Group, Inc.
and its parent company The News Corporation Limited, through their various news,
sports and entertainment businesses, accounted for approximately 21% of Vyvx's
revenues.
Sales and Marketing
Vyvx has sales personnel located in ten states throughout the U.S. to
provide service to its domestic and international customers. The largest sales
office is in New York City, where many of Vyvx's largest customers are based.
Competition
The Company believes that no single competitor currently exists that
offers all of the services being offered by Vyvx. Vyvx encounters smaller
competitors in the market place, each of which historically has offered only one
or two of Vyvx products.
11
TELECOMMUNICATIONS GLOSSARY
- ---------------------------
ACCESS - a long distance carriers' use of local exchange facilities to originate
or terminate long distance traffic.
ASYNCHRONOUS TRANSFER MODE (ATM) - a high-speed multiplexing and switching
technique that uses fixed cell sizes of 53 bytes each to transport voice, data
and video traffic.
BANDWIDTH - the width of or measure of capacity of a communications channel;
analog channel capacity is measured in hertz and digital channel capacity is
measured in bits per second.
CAPACITY - the information carrying ability of a telecommunications facility.
The facility determines what measure is appropriate. For example, a private
line's capacity could be measured in bits per second. A switch's capacity could
be measured in the maximum number of calls per hour.
CARRIER - a provider of communications transmission services.
CARRIER CLASS CUSTOMER - a customer who has significant bandwidth capacity
requirements that would rival the capacity requirements of a wholesale carrier.
DARK FIBER - installed fiber optic cable which is not connected to transmission
equipment and so is not capable of carrying transmission services.
FIBER-OPTIC CABLE - a transmission medium consisting of a core of glass or
plastic which is surrounded by a protective cladding, strengthening material and
an outer jacket. Signals are transmitted as light pulses, introduced into the
fiber by a light transmitter (a light emitting diode or a laser). Low data loss,
high-speed transmission, large bandwidth, small physical size, light weight and
freedom from electromagnetic interference and grounding problems are some of the
advantages offered by fiber-optic cable.
FRAME RELAY - access method for interconnecting local area networks to end
points in a wide area network; data is placed in frames of varying size, and the
technology allows for faster transmission via efficient error correction.
GATEWAY SWITCH - a switch that allows signals to cross from one network to
another.
INTERNET PROTOCAL (IP) - the communications standard used for delivering
individual data packets to their destinations by tracking the Internet addresses
of the sender and receiver.
LOCAL AREA NETWORK (LAN) - a data communications network that links together
computers and peripherals to serve users within a confined area.
MULTIPLEXING - consolidation of multiple signals into a single, complex signal
that is transmitted to a receiver; the receiver decomposes the complex signal
into its constituent elements.
NETWORK CENTER - an environmentally controlled secure location containing
equipment and staff, and space and power for collocation customers, where
various network management and control functions are conducted.
OPTICAL WAVE - see "Wavelengths" below.
SWITCH - mechanical or electronic device for making, breaking or changing the
directional flow of electrical or optical signals.
TRANSMISSION - sending electrical signals that carry information over a line to
a destination.
VIRTUAL PRIVATE NETWORK (VPN) - private, secure switched voice or data network
between two or more sites that allows them to contact each other as if they were
connected with dedicated or private line facilities but over public segments.
WAVELENGTHS - a portion of the transmission capacity of a fiber-optic cable
rather than the entire fiber cable. A purchaser of optical wave or wavelength
installs its own electrical interface, switching and routing equipment.
GOVERNMENT REGULATION
- ---------------------
Overview
WilTel is subject to significant federal, state, local and foreign
laws, regulations and orders that affect the rates, terms and conditions of
certain of its service offerings, its costs and other aspects of its operations.
Regulation of the telecommunications industry varies from state to state and
from country to country, and it changes regularly in response to technological
developments, competition, government policies and judicial proceedings. Some of
these changes and potential changes are discussed below. The Company cannot
predict the impact, nor give any assurances about the materiality of any
potential impact, that such changes may have on its business or results of
operations, nor can it guarantee that domestic or international regulatory
authorities will not raise material issues regarding its compliance with
applicable laws and regulations.
12
The Federal Communications Commission ("FCC") has jurisdiction over
WilTel's facilities and services to the extent those facilities are used in the
provision of interstate telecommunications services (services that originate and
terminate in different states) or international telecommunications services.
State regulatory commissions generally have jurisdiction over facilities and
services to the extent the facilities are used in intrastate telecommunications
services. Foreign laws and regulations apply to telecommunications that
originate or terminate in a foreign country. Generally, the FCC and state
commissions do not regulate Internet, video conferencing or certain data
services, although the underlying telecommunications services components of such
offerings may be regulated in some instances.
WilTel's operations also are subject to a variety of environmental,
building, safety, health and other governmental laws and regulations.
Federal Regulation
The Communications Act of 1934. The Communications Act of 1934, as
amended (the "Communications Act") grants the FCC authority to regulate
interstate and foreign communications by wire or radio. The Telecommunications
Act of 1996 (the "1996 Act") establishes a framework for fostering competition
in the provision of local and long distance telecommunications services. WilTel
is regulated by the FCC as a non-dominant carrier and, therefore, is subject to
less comprehensive regulation than dominant carriers under the Communications
Act. WilTel is subject to certain provisions of Title II of the Communications
Act applicable to all common carriers that require WilTel to offer service upon
reasonable request and pursuant to just and reasonable charges and practice, and
prohibit WilTel from unjustly or unreasonably discriminating in its charges or
practices. The FCC has authority to impose more stringent regulatory
requirements on non-dominant carriers. The FCC reviews its rules and regulations
from time to time, and WilTel may be subject to those new or changed rules.
WilTel has obtained authority from the FCC to provide international
services between the U.S. and foreign countries, and has registered with the FCC
as a provider of domestic interstate long distance services. WilTel believes
that it is in material compliance with applicable federal laws and regulations,
but cannot guarantee that the FCC or third parties will not raise issues
regarding its compliance with applicable laws or regulations.
Long Distance Regulation. Regulation of other carriers in the
communications industry also may affect WilTel. For example, Section 271 of the
Communications Act had prohibited Regional Bell Operating Companies ("RBOCs")
and their respective affiliates from providing long distance services between
so-called Local Access and Transport Areas ("LATAs") in their region, and
between their region and other states, until they have demonstrated to the FCC,
on a state-by-state basis, that they have satisfied certain procedural and
substantive requirements set forth in the 1996 Act. As of now, the FCC has
granted Section 271 authority to all RBOCs in each of their in-region states.
In a state where a RBOC has received authority to provide long distance
telecommunications service, Section 272 of the Communications Act requires the
RBOC to maintain a separate affiliate and to comply with certain structural and
operational safeguards for its long distance operations, all of which impose on
RBOCs significant costs related to maintaining separate equipment, employees and
processes. This separate affiliate requirement expires on a state-by-state basis
three years after the RBOC first obtained approval to provide long distance
service in a given state, unless the FCC extends the three-year period. If a
RBOC chooses to provide long distance telecommunications services without a
separate affiliate in a state where the separate affiliate requirement has
expired, the RBOC currently is subject to heightened regulation of its rates for
long distance services. The FCC is considering several options for strengthening
or weakening regulation governing the RBOCs provision of long distance
telecommunications services without a separate affiliate, as well as a proposal
to eliminate portions of the Section 272 requirements.
13
The Section 272 separate subsidiary requirement for two of WilTel's
largest customers, Verizon in New York and SBC in Texas, Oklahoma and Kansas,
has expired and has not been extended by the FCC. WilTel does not expect the FCC
to extend the requirement in any other states as the 3-year period elapses in
such states. While the RBOCs' entry into the long distance market could provide
opportunities for WilTel to sell dark fiber or lease high-volume long distance
capacity to the RBOCs, it could also allow the RBOCs to provide the same
services that WilTel currently provides, services which RBOCs currently purchase
from WilTel. Increased competition from the RBOCs could have an adverse effect
on WilTel's business, as the RBOCs will be able to market integrated local and
long distance services and may enjoy significant competitive advantages. Because
RBOCs account for more than 50% of WilTel's Network revenues, changes in a
RBOC's ability to offer long distance services could pose risks to WilTel's
business in the future, although the impact of any such change cannot be
determined at this time.
Local Service Regulation. In addition to overseeing the entry of the
RBOCs into the long distance market, the FCC was required, pursuant to the 1996
Act, to establish national rules implementing the local competition provisions
of the 1996 Act. More specifically, the 1996 Act imposed duties on all local
exchange carriers, including incumbent local exchange carriers ("ILECs") and new
entrants (sometimes referred to as competitive local exchange carriers, or
"CLECs") to provide network interconnection, reciprocal compensation, resale,
number portability and access to rights-of-way. Where WilTel provides local
telecommunications services, it must comply with these statutory obligations and
the FCC's implementing rules.
On March 2, 2004, the U.S. Court of Appeals for the District of Columbia
Circuit struck down an FCC rule that required regional telephone companies to
open their networks to competitors at reasonable rates. Although a majority of
the Commissioners has announced an intention to seek an appeal of this ruling,
should the ruling be upheld, competing telephone companies could incur higher
costs to lease parts of local networks or have to invest in their own equipment
to be able to offer local phone service. This could result in increased costs to
WilTel and certain of its customers. The impact of this ruling, possible appeal
and ultimate effect on WilTel's business or operations cannot currently be
determined.
Access Regulation. Federal regulation affects the cost and thus the
demand for long distance services through regulation of interstate access
charges, which are the local telephone companies' charges for use of their
exchange facilities in originating or terminating interstate transmissions. The
FCC regulates the interstate access rates charged to long distance carriers by
ILECs and CLECs for the local origination and termination of interstate long
distance traffic. Those access rates make up a significant portion of the cost
of providing long distance traffic. Since the 1996 Act, the FCC has restructured
the access charge system, resulting in significant downward changes in access
charge rate levels.
On May 31, 2000, the FCC adopted a proposal submitted by a coalition of
long distance companies and RBOCs, referred to as "CALLS," pursuant to which
ILEC access rates must be decreased in stages over five years. On September 10,
2001, the United States Court of Appeals for the Fifth Circuit upheld most of
the FCC's CALLS order, but remanded for further consideration portions of the
order that created a new universal service fund and that set a factor applied
annually to reduce access rates at a certain pace. WilTel cannot determine at
this time the outcome or likely effect, if any, of that remand proceeding on its
business or operations.
On April 27, 2001, the FCC issued a ruling regarding the interstate
access charges levied by CLECs on long distance carriers. Effective June 20,
2001, CLEC access charges were required to be reduced over a three-year period
to the level charged by ILECs in the competing area. The FCC-ordered reduction
in CLEC access charge rates has resulted in a substantial reduction in the
per-minute rate CLECs charge WilTel for interstate access services.
On April 19, 2001, the FCC adopted a Notice of Proposed Rulemaking
seeking to unify its inter-carrier compensation rules. The FCC proposal seeks to
address disparities in rates for access charges and reciprocal compensation (the
rates that carriers pay each other for completing calls exchanged between them).
The FCC's proposal seeks comments on a transition to a "bill and keep" system
14
pursuant to which carriers would not exchange cash compensation, but would
provide call completion services free of charge. Adoption by the FCC of a
unified inter-carrier compensation regime that adopts a "bill and keep" regime
or that otherwise reduces the rates that carriers may charge for access charges
could significantly reduce WilTel's inter-carrier compensation costs and
revenues. An inter-carrier group of telecommunications companies is seeking to
develop an industry consensus to present to the FCC, on which the FCC would then
invite additional comments. WilTel is unable to determine at this time the
outcome of the FCC proceeding and the industry effort or the resulting impact,
if any, on WilTel's business.
Voice-over-IP. In a 1998 report to Congress, the FCC suggested, but did
not conclude, that telephone calls using IP could be considered
telecommunications services. The FCC has also been asked to consider the
regulatory implications of such "voice-over-IP" technology. Certain ILECs have
asked the FCC to rule that certain transmission services, such as calls made
over the Internet, are subject to regulation as telecommunications services
including the assessment of interstate switched access charges and universal
service fund assessments. On February 5, 2003, pulver.com filed a petition for
declaratory ruling that a service offering that uses IP voice communications is
neither telecommunications nor a telecommunications service. On February 19,
2004, the FCC held that the specific "IP-to-IP" service offered by pulver.com is
an interstate information service and is neither telecommunications nor a
telecommunications service.
Several other voice-over-IP petitions have also been filed. On October
18, 2002, AT&T filed a petition for declaratory ruling that phone-to-phone IP
telephone service is an enhanced service carried over the same common Internet
backbone facilities as other public Internet traffic, that as such it is a local
service exempt from access charges, and that all other phone-to-phone IP and
voice-over-IP telephony services are exempt from access charges applicable to
circuit-switched interexchange calls unless the FCC prospectively rules
otherwise. The FCC may rule on the AT&T petition during the second quarter of
2004. In September 2003, Vonage Holdings Corporation asked the FCC to preempt
the Minnesota Public Utility Commission from regulating Vonage's services as a
telecommunications service subject to full state regulation. During 2004, both
Level 3 Communications and SBC filed petitions seeking FCC rulings on the
regulatory framework for voice-over-IP related offerings. Decisions on the Level
3 and SBC petitions are expected towards the beginning of 2005. As carriers and
their customers migrate to IP and packet-based technologies, the outcome of such
proceedings is likely to affect carrier-carrier and carrier-customer
relationships. WilTel is unable to determine at this time the outcome of any of
these proceedings or the impact, if any, they could have on its business.
Universal Service. Pursuant to the 1996 Act, in 1997 the FCC established
a significantly expanded universal service regime to subsidize the cost of
telecommunications services to high-cost areas, to low-income customers, and to
qualifying schools, libraries and rural healthcare providers. Providers of
interstate and international telecommunications services, and certain other
entities, must pay for these programs by contributing to a Universal Service
Fund (the "Fund"). The rules concerning which services are considered when
determining how much an entity is obligated to contribute to the Fund are
complex; however many of the services sold by WilTel are included in the
calculation. Current rules require contributors to make quarterly and annual
filings reporting their revenues, and the Universal Service Administrative
Company issues monthly bills for the required contribution amounts, based on a
quarterly contribution factor approved by the FCC. The FCC announced assessments
for the first quarter of 2004 of 8.7% have been reduced from 9.2% in the fourth
quarter of 2003. The contribution factor may be higher in future quarters. A
portion of WilTel's gross revenues from the provision of interstate and
international services are subject to these assessments. For the year ended
December 31, 2003, WilTel was assessed approximately $7,100,000 by the Fund.
On December 13, 2002, the FCC issued revised universal service rules and
proposed further changes to the universal service contribution methodology.
These rules, which became effective January 29, 2003 and likely will be the
subject of further reconsideration and appellate proceedings, will apply on an
interim basis while the FCC considers additional changes. One such interim rule
requires that, beginning April 1, 2003, contributions be based on contributors'
projected collected end-user telecommunications revenues, rather than on
historical gross-billed revenues. Contributors will be required to report both
historical gross-billed revenues from the prior quarter, and projected
gross-billed and collected end-user interstate and international
telecommunications revenues for the upcoming quarter. The FCC will continue to
set a quarterly contribution factor. The FCC is considering other changes to the
methodology that could result in WilTel paying a larger percentage of its
revenues to the Fund.
15
WilTel and other contributors to the federal universal service fund may
recover their contributions in any manner that is equitable and
nondiscriminatory, but may not mark up their federal universal service recovery
above the amount of the contribution factor. Carriers may recover their
contribution costs through their end-user rates, or through a line item (stated
as a flat amount or percentage), provided that the line item does not exceed the
total amount associated with the contribution factor. The recovery rules are the
subject of a petition for reconsideration pending before the FCC. The rules also
allow contributors to renegotiate contract terms that prohibit the pass-through
of universal service recovery charges. Unrecovered assessments will increase
WilTel's costs.
Detariffing. In November 1996, the FCC ordered non-dominant long
distance carriers to cease filing tariffs for domestic, long distance services.
In March 2001, the FCC imposed similar detariffing requirements with respect to
international services provided by non-dominant carriers such as WilTel.
Tariffing is a traditional requirement of telephone companies whereby such
companies publicly submit at state and federal regulatory agencies all terms,
conditions, pricing and available services governing the sale of all regulated
services to the public. The FCC has adopted further rules that require long
distance carriers to make specific public disclosures on Internet web sites of
their rates, terms and conditions for domestic interstate and international
services. The FCC's detariffing actions may significantly affect the ability of
non-dominant, interstate and international service providers such as WilTel to
rely on filed rates, terms and conditions as a means of providing notice to
customers of prices, terms and conditions under which they offer their domestic,
interstate and international services; such carriers instead will have to rely
on individually negotiated agreements with end users. Detariffing could result
in additional costs to the extent WilTel is unable to rely on posted terms and
conditions.
In 2001, a coalition of consumer-protection advocates and state
regulatory commissions filed a petition for expedited rulemaking with the FCC,
asking the FCC to require non-dominant interexchange carriers to give at least
30 days advance written notice to their presubscribed customers of any material
change to the rates, terms or conditions of a carrier-customer agreement. The
coalition argues that since detariffing took effect, customer agreements
generally offered by large long-distance carriers reserve for the carriers the
right to unilaterally change rates, terms and conditions at any time, thereby
preventing consumers from making informed decisions regarding the terms under
which they acquire service from carriers. To date, the FCC has not instituted
such a proceeding. If adopted, such requirements could constrain the ability of
WilTel to modify its rates, terms and conditions in response to competitive
market pressures.
Broadband Regulation. The FCC to date has treated Internet service
providers as enhanced service providers rather than common carriers. As such,
Internet service providers generally have been exempt from various federal and
state regulations, including the obligation to pay access charges and contribute
directly to universal service funds. On December 20, 2001, the FCC issued a
Notice of Proposed Rulemaking seeking comment on whether ILEC broadband
offerings are telecommunications services subject to Title II jurisdiction or,
as the FCC already has concluded with respect to cable modem service,
information services subject only to Title I jurisdiction. In 2003, the United
States Court of Appeals for the Ninth Circuit partially vacated the FCC's
determination that cable modem service is subject only to Title I jurisdiction,
holding that companies providing cable modem services also offer a
telecommunications service component that is subject to Title II regulation. The
FCC has sought rehearing of that decision. In a separate Notice of Proposed
Rulemaking released February 15, 2002, the FCC sought comment on issues related
to broadband access to the Internet over domestic wireline facilities, including
whether facilities-based broadband Internet access providers should be required
to contribute to support universal service. The FCC has not addressed either of
these Notices of Proposed Rulemaking and WilTel cannot determine the impact of
the Ninth Circuit decision on these proceedings.
16
State Regulation
The Communications Act severely restricts state and local governments
from enforcing any law, rule or legal requirement that prohibits or has the
effect of prohibiting any person from providing any interstate or intrastate
telecommunications service. However, states retain substantial jurisdiction over
intrastate matters, and generally have adopted regulations intended to protect
public safety and welfare, ensure the continued quality of communications
services, and safeguard the rights of consumers. Some states impose assessments
for state universal service programs and for other purposes. To the extent that
WilTel provides intrastate telecommunications services, WilTel is subject to
various state laws and regulations.
Most state public utility and public service commissions require some
form of certificate of authority or registration before offering or providing
intrastate services, including competitive local telecommunications services.
Currently, WilTel or its subsidiary, WilTel Local Network, LLC, hold
authorizations to provide such services, at least to some extent, in all 50
states and the District of Columbia.
In most states, in addition to the requirement to obtain a certificate
of authority, WilTel must request and obtain prior regulatory approval of price
lists or tariffs containing rates, terms and conditions for its regulated
intrastate services. WilTel is required to update or amend these tariffs when it
adjusts its rates or adds new products. WilTel believes that most states do not
regulate its provision of dark fiber. If a state did regulate its provision of
dark fiber, WilTel could be required to provide dark fiber in that state
pursuant to tariffs and at regulated rates.
WilTel is also subject to various reporting and record-keeping
requirements in states in which it is authorized to provide intrastate services.
Many states also require prior approval for transfers of control of certified
providers, corporate reorganizations, acquisitions of telecommunications
operations, assignment of carrier assets, carrier stock offerings and
undertaking of significant debt obligations. States generally retain the right
to sanction a service provider or to condition, modify or revoke certification
if a service provider violates applicable laws or regulations. Fines and other
penalties also may be imposed for such violations. While WilTel believes that it
is substantially in compliance with applicable state laws and regulations that
are material to its operations, it cannot guarantee that state regulatory
authorities or third parties will not raise issues with regard to its
compliance.
State regulatory commissions generally regulate the rates that ILECs
charge for intrastate services, including intrastate access services paid by
providers of intrastate long distance services. WilTel's intrastate services
compete against the regulated rates of these carriers and also utilize certain
ILEC services. State regulatory commissions also regulate the rates ILECs charge
for interconnection of network elements with, and resale of, services by
competitors. State commissions have initiated proceedings that could have the
potential to affect the rates, terms and conditions of intrastate services.
WilTel, through WilTel Local Network, LLC, has entered into or is in the process
of entering into interconnection agreements with various ILECs and the rates,
terms and conditions contained in such agreements will be affected by such state
proceedings.
Local Regulation
Some jurisdictions require WilTel to obtain street use and construction
permits and licenses and/or franchises before installing or expanding its
fiber-optic network using municipal rights-of-way. Termination of, or failure by
WilTel to renew, its existing franchise or license agreements could have a
material adverse effect on its operations. In some municipalities where WilTel
has installed or may construct facilities, it is required to pay license or
franchise fees based on a percentage of gross revenue, a flat annual fee or a
per linear foot basis. WilTel cannot guarantee that fees will remain at their
current levels following the expiration of existing franchises. In addition,
WilTel could be at a competitive disadvantage if its competitors do not pay the
same level of fees as it does. The Communications Act requires municipalities to
manage public rights of way in a competitively neutral and non-discriminatory
manner and prohibits the imposition of right-of-way fees as a means of raising
revenue. A considerable amount of litigation has challenged right-of-way fees on
the grounds that such fees violate the Communications Act. The outcome of such
litigation may affect WilTel's costs of operations.
17
Other U.S. Regulation
WilTel's operations are subject to a variety of federal, state and local
environmental, safety and health laws and governmental regulations. These laws
and regulations govern matters such as the generation, storage, handling, use
and transportation of hazardous materials, the emission and discharge of
hazardous materials into the atmosphere, the emission of electromagnetic
radiation, the protection of wetlands, historic sites and endangered species,
and the health and safety of employees. WilTel also may be subject to
environmental laws requiring the investigation and cleanup of contamination at
sites it owns or operates or at third-party waste disposal sites. Such laws
often impose liability even if the owner or operator did not know of, or was not
responsible for, the contamination.
WilTel owns or operates numerous sites in connection with its
operations. WilTel monitors compliance with environmental, safety and health
laws and regulations and believes it is in material compliance; however, it
cannot give assurances that it has been or will be in complete compliance with
these laws and regulations. WilTel may be subject to fines or other sanctions
imposed by governmental authorities if it fails to obtain certain permits or
violates their respective laws and regulations.
WilTel has ownership interests in and utilizes certain submarine cable
systems for the provision of telecommunications services. WilTel, through its
joint ownership interests, is subject to certain state and federal laws and
regulations governing the construction, maintenance and use of such facilities.
Such laws and regulations may include corridor restrictions, exclusionary zones,
undersea cable fees or right-of-way use fees for submerged lands. Increased
regulation of cable assets or assessments may affect the cost and ultimately the
demand for services provided over such facilities.
Foreign Regulation
The provision of telecommunications services in foreign countries is
also regulated and varies from country to country. Telecommunications carriers
are generally required to obtain permits, licenses or authorizations to initiate
or terminate communications in a country. Many regulatory systems have only
recently faced the issues raised by competition and are still in the process of
development. Although the services WilTel currently provides outside the U.S.
are not currently material, if WilTel expands its foreign operations it will be
subject to substantial regulatory requirements. Foreign telecommunications laws
and regulations are changing and WilTel cannot determine at this time the
impact, if any, that such future regulatory, judicial or legislative activities
may have on its business or operations.
International switched long distance traffic between two countries
historically is exchanged under correspondent agreements between carriers, each
owning network transmission facilities in their respective countries.
Correspondent agreements generally provide for, among other things, the
termination of switched traffic in, and the return of switched traffic to, the
carriers' respective countries at a negotiated accounting rate. Settlement
costs, typically one-half of the accounting rate, are reciprocal fees owed by
one international carrier to another for transporting traffic on its facilities
and terminating that traffic in the other country. The FCC and regulators in
foreign countries may regulate agreements and settlements between U.S. and
foreign carriers.
In October 2002, the FCC issued a Notice of Proposed Rulemaking to
consider further reforms to its International Settlement Policy, International
Simple Resale policy and benchmark policy, based on increased participation and
competition in the U.S.-international market, decreased settlement and end-user
rates and increased liberalization and privatization in foreign markets. The
outcome of this proceeding could result in lower rates for some international
services and increased demand for these services by some of WilTel's customers,
with a resulting increased demand for capacity on WilTel's U.S. facilities,
including its domestic network.
18
HEALTHCARE SERVICES
Business Description
In September 2003, the Company acquired Symphony for approximately
$36,700,000, including expenses. Established in 1994, Symphony provides
post-acute healthcare services, offering an extensive package of services to
owners and operators of health care facilities. Symphony provides contract
therapy, long-term care consulting and temporary staffing to skilled nursing
facilities, hospitals, sub-acute care centers, assisted living facilities,
schools and other healthcare providers. Symphony currently operates in 40
states, providing services at approximately 2,000 locations through its employee
workforce of approximately 4,900 part-time and full time skilled healthcare
professionals. The businesses owned by Symphony operate under the names
RehabWorks, Symphony Respiratory Services, NurseWorks and Polaris Group.
The principal services offered by Symphony are described below.
o Contract Therapy Services - Physical therapy, occupational
therapy, speech pathology and respiratory therapy services
provided to various health care providers and schools. Services
include compliance and clinical training, recruitment,
orientation and staffing, management information and
reimbursement expertise.
o Healthcare Staffing Services - Placement of temporary healthcare
professionals in hospitals and skilled nursing facilities
generally ranging from one day to 13-week assignments.
o Consulting Services - These services assist healthcare providers
in managing Medicare reimbursement to ensure that systems and
procedures are in place to manage costs and cash flow.
When determining how to meet their rehabilitation therapy and healthcare
staffing needs, healthcare providers are faced with an "in-source" or
"outsource" decision, to either manage the rehabilitation therapy unit in-house
or contract the service to an outside vendor. As healthcare expenditures in the
U.S. have continued to increase, healthcare providers have experienced increased
cost reduction pressures as a result of managed care and the implementation of
prospective payment systems and other changes in Medicare reimbursement. Prior
to the implementation of the prospective payment system, healthcare providers
were reimbursed for all costs including overhead. Under the current
reimbursement system, reimbursement is based upon fixed fee schedules.
Symphony's services give its customers increased flexibility in managing
staffing levels and enables them to reduce their overall costs by converting a
fixed cost into a variable cost. Contract therapy is available on a full-time,
part-time and on-call basis, and can be customized at each location according to
the particular needs of a facility or patient. Contract therapy services also
include full therapy program management with a full-time program manager who is
also a therapist and two to four professionals trained in physical and
occupational therapy or speech/language pathology. Symphony generally bills its
customers either on the basis of a negotiated patient per diem rate or a
negotiated fee schedule based on the type of service rendered. Symphony is also
the largest provider of therapy services to the Department of Education of New
York City.
Symphony's revenues and growth are affected by trends and developments
in healthcare spending, which has been increasing at an accelerated rate over
the past five years. Demographic considerations also affect the amount spent on
healthcare. Due to the increasing life expectancy of Americans, the number of
people aged 65 years or older has been growing and is expected to increase in
the future. These trends, combined with the need for healthcare providers to
find more cost effective means to deliver their services, may encourage
healthcare providers to use the services that Symphony offers.
Competition
The contract therapy and healthcare staffing services businesses compete
in national, regional and local markets with full-service staffing companies and
with specialized staffing agencies. The program management services business
competes with companies that may offer one or more of the same services and with
hospitals and skilled nursing facilities that do not choose to outsource their
acute rehabilitation and skilled nursing units, outpatient therapy programs and
contract therapy programs. The managed inpatient units and outpatient programs
are in highly competitive markets and compete for patients with other hospitals
and skilled nursing facilities.
19
There is a significant shortage of skilled healthcare professionals who
provide Symphony's services, and Symphony's revenues are significantly dependent
on its ability to attract, develop and retain qualified nurses, therapists and
other healthcare personnel who possess the skills, experience and, as required,
licensure necessary to meet the specified requirements of customers. Symphony
competes for healthcare staffing personnel, including nurses and therapists,
with other healthcare companies, as well as actual and potential customers, some
of whom seek to fill positions with either regular or temporary employees.
Government Regulation
Healthcare providers are subject to a complex array of federal, state
and local regulations which include but are not limited to Medicare and Medicaid
regulations, licensure regulations, fraud and abuse regulations, as well as
regulations regarding the confidentiality and security of health-related
information. If Symphony fails to comply with these laws it can result in civil
penalties, criminal penalties and/or exclusion from participation with programs
such as Medicare and Medicaid. Failure of Symphony's customers to meet
regulatory requirements could have an adverse impact on its business.
Symphony's customers are subject to state licensure and Medicare
certification requirements with respect to their facilities and healthcare
professionals. Symphony is also subject to these requirements when it is the
direct provider of the service. Systems are in place to assure that these
requirements are met before Symphony's healthcare professionals treat patients.
In most instances, customers participate in the Medicare and Medicaid
programs as do certain of Symphony's outpatient therapy facilities. As such,
they are subject to Medicare and Medicaid's regulations regarding quality of
care, qualifications of personnel, adequacy of physical plant, as well as
billing and payment regulations. These regulations are written, published and
administered by the Centers for Medicare and Medicaid Services and are monitored
for compliance.
Various federal and state laws prohibit the knowing and willful
submission of false claims or fraudulent claims to obtain payment from Medicare,
Medicaid or other government programs. The federal anti-kickback statute also
prohibits individuals and entities from knowingly and willfully paying,
offering, receiving or soliciting money or anything else of value in order to
induce the referral of patients or to induce a person to purchase, lease, order,
arrange for or recommend services or goods covered by Medicare, Medicaid or
other government healthcare programs.
The Balanced Budget Act of 1997 mandated the phase-in of a prospective
payment system for skilled nursing facilities and units based on resource
utilization group classifications. The Act also affected Medicare reimbursement
for outpatient rehabilitation services. All of the skilled nursing units to
which we provide management services are now fully phased in under the resource
utilization group system for skilled nursing facilities. Under the prospective
payment system, reimbursement for services is based on the lesser of the
provider's actual charge for such services or the applicable Medicare physician
fee schedule amount established by the Centers for Medicare and Medicaid
Services. This reimbursement system applies regardless of whether the therapy
services are furnished in a hospital outpatient department, a skilled nursing
facility, a physician's office, or the office of a therapist in private
practice. Under current law, an outpatient therapy program that is not
designated as being hospital provider-based is subject to annual limits on
payment for therapy services. However, these limits have been suspended through
December 31, 2005.
The Health Insurance Portability and Accountability Act of 1996 is
designed to improve efficiency in healthcare delivery by standardizing
electronic data interchange and by protecting the confidentiality and security
of an individual's health data by setting and enforcing national standards of
practice. Virtually all healthcare providers are affected by the law, which
consists of three primary areas, standards for electronic transactions, privacy
and security. The privacy rule and the standards for electronic transactions are
currently effective and the security rule is scheduled to become effective on
April 21, 2005.
20
BANKING AND LENDING
Business Description
The Company's banking and lending operations principally are conducted
through American Investment Bank, N.A. ("AIB"), a national bank subsidiary, and
American Investment Financial ("AIF"), a Utah industrial loan corporation. AIB
and AIF take money market and other non-demand deposits that are eligible for
insurance provided by the FDIC. AIB and AIF had aggregate deposits of
$145,500,000 and $392,900,000 at December 31, 2003 and 2002, respectively.
The Company's consolidated banking and lending operations had
outstanding loans (net of unearned finance charges) of $205,500,000 and
$373,600,000 at December 31, 2003 and 2002, respectively. At December 31, 2003,
47% were loans to individuals generally collateralized by automobiles; 47% were
loans to consumers, substantially all of which were collateralized by real or
personal property; 2% were loans to small businesses; and 4% were unsecured
loans.
Historically, collateralized personal automobile instalment loans were
primarily made through automobile dealerships to individuals who have difficulty
obtaining credit, at interest rates above those charged to individuals with good
credit histories. These loans were made to consumers principally to purchase
used, moderately priced automobiles, typically had an initial loan balance of
approximately $12,200, an average contractual maturity of 58 months and an
anticipated average life of 26 months. In September 2001, the Company decided to
stop originating subprime automobile loans as a result of increasing loss
experience and the increasingly difficult competitive environment. The Company's
other consumer lending programs primarily consisted of marine, recreational
vehicle, motorcycle and elective surgery loans. In January 2003, due to economic
conditions, portfolio performance and the relatively small size of these loan
portfolios and target markets, the Company stopped originating these loans as
well.
Since it ceased loan origination activities, operating activities at
this segment have been limited to maximizing the amount collected from its loan
portfolio and liquidating the business in an orderly and cost efficient manner.
In September 2003, the banking and lending segment outsourced substantially all
of its consumer loan servicing and collection functions to a third party service
provider, in order to reduce overhead costs and convert these activities into a
variable cost that declines as the size of the portfolio declines. While expense
savings were achieved, delinquency in each serviced portfolio increased during
the first 90 days after the transfer to the service provider and has not
returned to normal levels. The Company believes the deteriorating delinquency
results from the service provider not dedicating adequate resources to the
collection efforts, and it has been the Company's experience that once accounts
reach certain delinquency levels, a high percentage are eventually charged off.
As a result, the banking and lending segment recorded an additional provision
for loan losses of $4,000,000 in 2003.
In January 2004, AIB filed an application with the Office of the
Comptroller of the Currency (the "OCC"), the primary regulator of AIB, to merge
AIF into AIB. In March 2004, the OCC approved AIB's application for merger
subject to AIB submitting a written plan to the OCC specifying the steps and
timeframes AIB will use to ensure an orderly liquidation of its operations. This
condition is consistent with AIB's objectives, although AIB will not be able to
surrender its national bank charter and fully liquidate its operations until
such time as all deposit liabilities have been repaid or sold. The Company
expects that the merger will be completed during the second quarter of 2004,
will result in a further reduction in overhead costs and constitutes the next
step in the liquidation of this segment. AIB has been reducing its deposit
liabilities during the past two years, and is currently offering early
withdrawal incentives, and may eventually sell remaining deposits to another
institution. The banking and lending segment continues to have discussions with
potential purchasers of its loan portfolios, although it has not yet accepted
any offers. These discussions are expected to continue.
21
Certain information with respect to the Company's banking and lending
segment is as follows for the years ended December 31, 2003, 2002 and 2001
(dollars in thousands):
2003 2002 2001
---- ---- ----
Average loans outstanding $ 282,986 $ 440,810 $ 545,036
Interest income earned on loans $ 53,944 $ 86,018 $ 111,849
Average loan yield 19.1% 19.5% 20.5%
Average deposits outstanding $ 232,631 $ 454,497 $ 536,020
Interest expense on non-demand deposits $ 8,553 $ 18,035 $ 31,499
Average rate on non-demand deposits 3.7% 3.9% 5.9%
Net yield on interest-bearing assets 12.1% 11.5% 13.3%
Investments held by the banking and lending segment are primarily
short-term bonds and notes of the U.S. and its agencies.
It is the Company's policy to charge to income an allowance for losses
which, based upon management's analysis of numerous factors, including current
economic trends, aging of the loan portfolio, historical loss experience and
collateral value, is deemed adequate to cover probable losses on outstanding
loans. At December 31, 2003, the allowance for loan losses for the Company's
entire loan portfolio was $24,200,000 or 11.8% of the net outstanding loans,
compared to $31,800,000 or 8.5% of net outstanding loans at December 31, 2002.
The Company's policy is to charge-off an account when the property
securing the delinquent loan is repossessed and liquidated. Loans are generally
assigned to repossession when they become 60 days delinquent. Otherwise, the
Company charges off the account due to customer bankruptcy and in no event later
than the month in which it becomes 120 days delinquent. The charge-off
represents the difference between the net realizable value of the property and
the amount of the delinquent loan, including accrued interest.
Government Regulation
The Company's principal banking and lending operations are subject to
detailed supervision by state authorities, as well as federal regulation
pursuant to the Federal Consumer Credit Protection Act, the Truth in Lending
Act, the Equal Credit Opportunity Act, the Right to Financial Privacy Act, the
Community Reinvestment Act, the Fair Credit Reporting Act and regulations
promulgated by the Federal Trade Commission and the Board of Governors of the
Federal Reserve System. The Company's banking operations are subject to federal
and state regulation and supervision by, among others, the OCC, the FDIC and the
State of Utah. AIF's primary federal regulator is the FDIC.
As a result of deteriorating portfolio performance and AIB's
consequent decision to cease originating new consumer loans, in February 2003
AIB entered into a formal agreement with the OCC, agreeing to develop a written
strategic plan subject to prior OCC approval for the continued operations of
AIB, to continue to maintain certain risk-weighted capital levels, to obtain
prior approval before paying any dividends, to provide certain monthly reports
and to comply with certain other criteria. In May 2003, the OCC approved AIB's
strategic plan. AIB is also unable to accept brokered deposits during the period
the agreement remains in effect. In the event AIB fails to comply with the
agreement, the OCC would have the authority to assert formal charges and seek
other statutory remedies and AIB may also be subject to civil monetary
penalties. AIB is complying with the agreement and, given that it has ceased all
lending activities, the agreement is not expected to have a significant impact
on its operations. However, no assurance can be given that other regulatory
actions will not be taken.
22
The Competitive Equality Banking Act of 1987 ("CEBA") places certain
restrictions on the operations of AIB and restricts further acquisitions of
banks and savings institutions by the Company. CEBA does not restrict AIF as
currently operated.
MANUFACTURING
Through its plastics division, the Company manufactures and markets
lightweight plastic netting used for a variety of purposes including, among
other things, building and construction, erosion control, agriculture,
packaging, carpet padding, filtration and consumer products. The products are
primarily used to add strength to other materials or act as barriers, such as
warning fences and crop protection from birds. This division is a market leader
in netting products used in carpet cushion, turf reinforcement, erosion control,
nonwoven reinforcement and crop protection. Certain of the division's products
are proprietary, protected by patents and/or trade secrets. It markets its
products both domestically and internationally, with approximately 16% of its
2003 revenues generated by customers in Europe, Latin America, Japan and
Australia. Products are sold primarily through an employee sales force, located
in the United States and Europe. Manufacturing revenues were $53,300,000,
$50,700,000 and $53,700,000 for the years ended December 31, 2003, 2002 and
2001, respectively.
New product development focuses on market niches where the division's
proprietary technology and expertise can lead to sustainable competitive
economic advantages. Historically, this targeted product development generally
has been carried out in partnership with a prospective customer or industry
where the value of the product has been recognized. The plastics division has
also begun focusing on developing products which provide an upgrade to a current
product used by an existing customer. As an example, during 2004 the division
launched a new biodegradable product which is being sold to existing customers
in the erosion control market. Over the last several years, the plastics
division has spent approximately 2% to 5% of annual sales on the development and
marketing of new products and new applications of existing products.
The plastics division is subject to domestic and international
competition, generally on the basis of price, service and quality. Additionally,
certain products are dependent on cyclical industries, including the
construction industry. Although revenues increased by 5% in 2003, revenues
declined in each of 2002 and 2001 as compared to the prior year. Revenues in all
periods reflect the loss of certain customers to competitors on the basis of
price, as well as lower prices charged by the division. The plastics division is
attempting to develop new products, applications and markets to replace its lost
business and utilize its excess capacity. In addition, the Company has been
focusing on reducing operating and overhead costs, improving service levels and
reducing lead times.
The plastics division currently has excess manufacturing capacity. The
excess capacity results from both the loss of customers served by its U.S.
manufacturing facilities, and the failure of the division's manufacturing
facility in Belgium to achieve the level of revenues and profitability that was
originally expected. The Belgium facility, which became operational in the third
quarter of 2001, has not been able to independently develop a sizeable customer
base on its own, and the plastic division also lost a major customer for whom
the facility was expected to produce products. A new general manager has been
hired at the facility to develop and implement marketing and sales initiatives
directed at generating revenue growth.
The Company holds patents on certain improvements to the basic
manufacturing processes it uses and on applications thereof. The Company
believes that the expiration of these patents, individually or in the aggregate,
is unlikely to have a material effect on the plastics division.
23
DOMESTIC REAL ESTATE
At December 31, 2003, the Company's domestic real estate assets had a
book value of $144,300,000. The real estate operations include a mixture of
commercial properties, residential land development projects and other
unimproved land, all in various stages of development and all available for
sale. The Company's largest domestic real estate investment consists of a 90%
interest in 8 acres of unimproved land in Washington, D.C., which was acquired
in September 2003 for $53,800,000. The land is zoned for a minimum of 2,000,000
square feet of commercial office space that the Company intends to develop in
phases once acceptable tenants or purchasers are identified. The Company owns a
718-room hotel located on Waikiki Beach in Hawaii that has a book value of
$41,600,000 at December 31, 2003. The hotel was fully renovated during 2001 and
2002, and for 2003 had an occupancy rate of approximately 66% and a net average
daily room rate of $97.94. The Company secured non-recourse financing for these
two projects, which aggregated $43,800,000 as of December 31, 2003.
The Company owns 30% of the outstanding common stock of HomeFed. In
addition, as a result of a 1998 distribution to all of the Company's
shareholders, approximately 9.4% and 8.7% of HomeFed is owned by the Company's
Chairman and President, respectively. HomeFed is currently engaged, directly and
through subsidiaries, in the investment in and development of residential real
estate projects in the State of California. Its principal asset is the
master-planned community located in San Diego County, California known as San
Elijo Hills, which it purchased from the Company in 2002. The Company accounts
for its investment in HomeFed under the equity method of accounting; as of
December 31, 2003 its investment had a carrying value of $40,200,000 which is
included in investments in associated companies. HomeFed is a publicly traded
company listed on the NASD OTC Bulletin Board (Symbol: HOFD).
Certain of the Company's other real estate investments and their
respective carrying values as of December 31, 2003 include: an operating 444,000
square foot office building in Indianapolis, Indiana ($15,600,000); a proposed
95 lot residential development project located in South Walton County, Florida
($9,800,000); and an operating shopping center on Long Island, New York that has
60,000 square feet of retail space ($7,000,000).
The real estate development industry is subject to substantial
environmental, building, construction, zoning and real estate regulations that
are imposed by various federal, state and local authorities. In order to develop
its properties, the Company must obtain the approval of numerous governmental
agencies regarding such matters as permitted land uses, density, the
installation of utility services (such as water, sewer, gas, electric, telephone
and cable television) and the dedication of acreage for various community
purposes. Furthermore, changes in prevailing local circumstances or applicable
laws may require additional approvals or modifications of approvals previously
obtained. Delays in obtaining required approvals and authorizations could
adversely affect the profitability of the Company's projects.
OTHER OPERATIONS
The Company owns two wineries, Pine Ridge Winery in Napa Valley,
California and Archery Summit in the Willamette Valley of Oregon. Pine Ridge,
which was acquired in 1991, has been conducting operations since 1978, while the
Company started Archery Summit in 1993. These wineries primarily produce and
sell wines in the luxury segment of the premium table wine market. During 2003,
the wineries sold approximately 63,500 9-liter equivalent cases of wine
generating wine revenues of $13,200,000. Approximately 9% of the revenues of the
wineries and 24% of case sales were derived from a wine that is not in the
luxury segment and is made from purchased grapes. Demand for wine in the luxury
market segment can rise and fall with general economic conditions, and is also
significantly affected by available supply. Luxury wines available for sale in
any given year are dependent upon harvest yields of earlier periods, which can
fluctuate from harvest to harvest.
24
Since acquisition, the Company's investment in winery operations has
grown, principally to fund the Company's acquisition of land for vineyard
development and to increase production capacity and storage facilities at both
of the wineries. It can take up to five years for a new vineyard property to
reach full production and, depending upon the varietal produced, up to three
years after grape harvest before the wine can be sold. For the 2003 harvest,
approximately 98% of the Company's vineyards were producing grapes and the
balance was under development. Certain of the wineries' production, sales and
distribution activities are subject to regulation by agencies of both federal
and state governments. At December 31, 2003, the Company's combined net
investment in these wineries was $60,800,000.
The Company's 72.5% interest in MK Gold had a net carrying value of
$64,300,000 at December 31, 2003. MK Gold's subsidiary, Cobre Las Cruces, S.A.,
a Spanish company, holds the exploration and mineral rights to the Las Cruces
copper deposit in the Pyrite Belt of Spain. During 2003, a new feasibility study
for the project was prepared by DMT-Montan Consulting GmbH, Lurgi Metallurgie
GmbH, and Outokumpu Technology Group, which incorporates the requirements of
various local regulatory authorities. The feasibility study includes a new
proven and probable ore reserve calculation prepared by DMT which has increased
to 16.1 million metric tons of copper ore at an average grade of 6.53% copper,
overlain by 150 meters of unconsolidated overburden. The Company's prior
feasibility study conducted in 2001 estimated a proven and probable ore reserve
of 15.8 million metric tons at an average grade of 5.94% copper.
Based on the study, the capital costs of the project are now estimated
at 281 million euros ($346,400,000 at exchange rates in effect on March 9,
2004), including working capital, land purchases, and contingencies, but
excluding interest during construction and other financing costs. Cash operating
costs per pound of copper produced are expected to average 0.33 euros per pound
($.41 per pound) of copper produced. The project's capital and operating costs
will be paid for in euros, while copper revenues during the life of the mine
will be based on the U.S. dollar. Should the euro continue to appreciate against
the U.S dollar, the capital cost of the mine expressed in U.S. dollar terms
would increase, negatively impacting the project's viability and profitability.
Development of the Las Cruces project will be subject to obtaining
required permits, obtaining both debt and equity financing for the project,
engineering and construction. The amount of financing that can be obtained for
the project and its related cost will be significantly affected by the
assessment of potential lenders of the current and expected future market price
of copper. Environmental approval of the project has been obtained from the
Spanish and Andalusian government agencies. During 2003, three important water
permits and the mining concession were received, although other important
permits still need to be obtained. Assuming required permits and financing are
obtained in a timely manner, MK Gold anticipates that final design will begin in
2004, followed by construction and mine development thereafter. Copper
production is not expected to begin until 2006. Although MK Gold believes the
necessary permitting and financing will be obtained, no assurances can be given
that they will be successful. Further, there may be other political and economic
circumstances that could prevent or delay development of Las Cruces.
OTHER INVESTMENTS
In December 2003, the Company purchased all of the debt obligations
under the senior secured credit facility of ATX Communications, Inc. and certain
of its affiliates ("ATX") for $25,000,000, and also entered into an amendment to
the facility pursuant to which the Company agreed to refrain from exercising
certain of its rights under the facility, subject to certain conditions. ATX is
an integrated communications provider that offers local exchange carrier and
inter-exchange carrier telephone, Internet, high-speed data and other
communications services to business and residential customers in targeted
markets throughout the Mid-Atlantic and Midwest regions of the U.S. ATX is a
public company traded on the NASD OTC Bulletin Board (Symbol: COMMQ).
25
Concurrently with the purchase of the facility and the execution of the
amendment, the Company entered into a conversion agreement pursuant to which the
Company agreed, upon the satisfaction of certain conditions, to convert the
senior secured debt of ATX into 100% of the preferred stock (with a liquidation
preference of $25,000,000) and 100% of the common stock of a reorganized ATX. As
contemplated by these agreements, in January 2004 ATX commenced a voluntary
chapter 11 case in order to reorganize its financial affairs. The reorganization
of ATX and the implementation of the conversion agreement are subject to the
approval of the bankruptcy court. Assuming the conversion agreement is
implemented in its current form, the Company will consolidate ATX as of the date
the reorganization is completed.
The Company has an investment in Berkadia, an entity jointly owned by
the Company and Berkshire Hathaway Inc. ("Berkshire"). In 2001, Berkadia lent
$5,600,000,000 on a senior secured basis to FINOVA Capital Corporation (the
"Berkadia Loan"), the principal operating subsidiary of FINOVA, to facilitate a
chapter 11 restructuring of the outstanding debt of FINOVA and its principal
subsidiaries. Berkadia also received newly issued shares of common stock of
FINOVA representing 50% of the stock of FINOVA outstanding on a fully diluted
basis. In 2001, the Company entered into a ten-year management agreement with
FINOVA, for which it receives an $8,000,000 annual fee that it shares equally
with Berkshire. FINOVA is a financial services holding company that, prior to
its filing for bankruptcy, provided a broad range of financing and capital
markets products, primarily to mid-size businesses. Since its chapter 11
restructuring, FINOVA's business activities have been limited to the orderly
collection and liquidation of its assets and FINOVA has not engaged in any new
lending activities.
Berkadia financed the Berkadia Loan with bank financing that was
guaranteed, 90% by Berkshire and 10% by the Company (with the Company's
guarantee being secondarily guaranteed by Berkshire). All income related to the
Berkadia Loan, after payment of financing costs, was shared 90% to Berkshire and
10% to the Company. In February 2004, FINOVA fully repaid the Berkadia Loan, and
Berkadia fully repaid its bank financing, thereby eliminating the Company's
guaranty. Pursuant to the management agreement, the Company continues to manage
FINOVA, for which it receives the fee described above. Although the term of the
Company's management agreement with FINOVA extends until August 2011, the
Company cannot provide assurances that the agreement (and the fee the Company
receives) will remain in effect after November 2009, at which time FINOVA's bond
debt matures.
At December 31, 2003, the book value of the Company's investment in
Olympus was $116,000,000. Olympus was formed in 2001 to take advantage of the
lack of capacity and favorable pricing in the reinsurance market. It has entered
into a quota share reinsurance agreement with Folksamerica Reinsurance Company,
an affiliate of White Mountains Insurance Group, Ltd. ("WMIG"), and has also
entered into reinsurance transactions with other parties. When the market
opportunity to underwrite reinsurance business on favorable terms recedes, the
by-laws of Olympus include mechanisms to return its capital to its investors,
subject to Bermuda insurance regulations and other laws restricting the return
of capital. In June 2003, the Company sold 567,574 common shares of Olympus back
to Olympus pursuant to an issuer tender offer for total proceeds of $79,500,000,
and recognized a gain of $1,500,000. After completion of the tender, the
Company's interest in Olympus declined from 25% to 16.1%. For the year ended
December 31, 2003, the Company recorded $40,400,000 of pre-tax income from this
investment under the equity method of accounting.
At December 31, 2003, the book value of the Company's equity investment
in JPOF II, a registered broker-dealer, was $114,800,000. JPOF II is managed by
Jefferies & Company, Inc., a full service investment bank to middle market
companies. JPOF II invests in high yield securities, special situation
investments and distressed securities and provides trading services to its
customers and clients. For the year ended December 31, 2003, the Company
recorded $14,800,000 of pre-tax income from this investment under the equity
method of accounting; this amount was distributed to the Company in 2004.
In December 2001, the Company invested $50,000,000 in EagleRock, a
limited partnership that invests primarily in securities and other obligations
of highly leveraged, distressed and out of favor companies. At December 31,
2003, the book value of the Company's equity investment in EagleRock was
$95,400,000. For the years ended December 31, 2003 and 2002, the Company
recorded $49,900,000 of pre-tax income and $4,500,000 of pre-tax losses,
respectively, from this investment under the equity method of accounting.
EagleRock has not made any cash distributions since its inception.
26
The Company owns 375,000 common shares that represent approximately 4.2%
of WMIG. WMIG is a publicly traded, Bermuda domiciled financial services holding
company, principally engaged through its subsidiaries and affiliates in property
and casualty insurance and reinsurance. At December 31, 2003, the Company's
investment had a market value of $172,500,000.
The Company owns approximately 36% of the common stock of Light & Power
Holdings Ltd., the parent company of The Barbados Light and Power Company
Limited, the primary generator and distributor of electricity in Barbados. As of
December 31, 2003, the Company's investment of $12,100,000 was accounted for on
the cost method of accounting, due to currency exchange restrictions and stock
transfer restrictions.
The Company beneficially owns equity interests representing more than 5%
of the outstanding capital stock of each of the following domestic public
companies at March 5, 2004 (determined in accordance with Rule 13d-3 of the
Securities Exchange Act of 1934): AmeriKing, Inc. ("AmeriKing") (6.8%), Carmike
Cinemas, Inc. ("Carmike") (6%), FINOVA (25%), HomeFed (30%), International
Assets Holding Corporation (15.5%), Jackson Products, Inc. ("Jackson") (6.2%),
Jordan Industries, Inc. ("JII") (10.1%), Metrocall Holdings, Inc. (9.6%), and
ParkerVision, Inc. (6.3%). The Company also owns 19.4% of JII's Senior
Subordinated Discount Debentures due 2009 ($18,400,000 aggregate principal
amount) and 22.8% of JII Holdings Senior Secured Notes due 2007 ($39,500,000
aggregate principal amount).
From 1982 through the fourth quarter of 2002, a subsidiary of the
Company has had a partnership interest in The Jordan Company LLC and
Jordan/Zalaznick Capital Company, entities that specialized in structuring
leveraged buyouts in which the owners are given the opportunity to become equity
participants. These equity investments include AmeriKing, Carmike, Jackson, JII,
JZ Equity Partners PLC (a British company traded on the London Stock Exchange in
which the Company holds a 6.5% equity interest), and a total of 35 other private
companies. As of December 31, 2003, these investments are carried in the
Company's consolidated financial statements at $96,000,000, of which $79,800,000
relates to public companies carried at market value. The Jordan-related
partnerships were terminated at the end of 2002.
For further information about the Company's business, including the
Company's investments, reference is made to Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" of this Report and
Notes to Consolidated Financial Statements.
Item 2. Properties.
- ------ ----------
The WilTel network and its component assets are the principal properties
that WilTel operates and are described in Item 1 herein. WilTel purchased or
leased various rights of way to install its network; almost all of its rights of
way agreements extend through 2018. WilTel owns or leases sites in approximately
200 U.S. cities and towns used for office space and for its transmission,
routing and switching equipment. These facilities range in size from 2,000
square feet to 750,000 square feet and total approximately 3,800,000 square
feet, including WilTel's 750,000 square foot headquarters building located in
Tulsa, Oklahoma, which it owns.
Through its various subsidiaries, the Company owns and utilizes office
space in Salt Lake City, Utah for corporate and banking and lending activities
(totaling approximately 80,200 square feet). Subsidiaries of the Company own
facilities primarily used for manufacturing located in Georgia and Genk, Belgium
(totaling approximately 410,300 square feet) and facilities and land in
California and Oregon used for winery operations (totaling approximately 123,300
square feet and 469 acres, respectively).
The Company and its subsidiaries lease numerous manufacturing,
warehousing, office and headquarters facilities. Symphony also leases facilities
in a number of locations that are used for administrative functions and
outpatient therapy services. The facilities vary in size and have leases
expiring at various times, subject, in certain instances, to renewal options.
See Notes to Consolidated Financial Statements.
27
Item 3. Legal Proceedings.
- ------ -----------------
The Company and its subsidiaries are parties to legal proceedings that
are considered to be either ordinary, routine litigation incidental to their
business or not material to the Company's consolidated financial position. The
Company does not believe that any of the foregoing actions will have a material
adverse effect on its consolidated financial position, consolidated results of
operations or liquidity.
Item 10. Executive Officers of the Registrant.
- ------- ------------------------------------
All executive officers of the Company are elected at the organizational
meeting of the Board of Directors of the Company held annually and serve at the
pleasure of the Board of Directors. As of March 5, 2004, the executive officers
of the Company, their ages, the positions held by them and the periods during
which they have served in such positions were as follows:
NAME AGE POSITION WITH LEUCADIA OFFICE HELD SINCE
- ---- --- ---------------------- -----------------
Ian M. Cumming 63 Chairman of the Board June 1978
Joseph S. Steinberg 60 President January 1979
Thomas E. Mara 58 Executive Vice President May 1980;
and Treasurer January 1993
Joseph A. Orlando 48 Vice President and January 1994;
Chief Financial Officer April 1996
Barbara L. Lowenthal 49 Vice President and Comptroller April 1996
H.E. Scruggs 46 Vice President August 2002
Mr. Cumming has served as a director and Chairman of the Board of the
Company since June 1978 and as Chairman of the Board of FINOVA since August
2001. In addition, he has served as a director of MK Gold since June 1995. Mr.
Cumming has also been a director of Skywest, Inc., a Utah-based regional air
carrier, since June 1986 and a director of HomeFed since May 1999.
Mr. Steinberg has served as a director of the Company since December
1978 and as President of the Company since January 1979. In addition, he has
served as a director of MK Gold since June 1995, JII since June 1988, HomeFed
since August 1998 (Chairman since December 1999), FINOVA since August 2001 and
WMIG since June 2001.
Mr. Mara joined the Company in April 1977 and was elected Vice President
of the Company in May 1977. He has served as Executive Vice President of the
Company since May 1980 and as Treasurer of the Company since January 1993. In
addition, he has served as a director of MK Gold since February 2000 and
President of MK Gold since March 2004, and as a director of FINOVA since
September 2002 and Chief Executive Officer of FINOVA since September 2002.
Mr. Orlando, a certified public accountant, has served as Chief
Financial Officer of the Company since April 1996 and as Vice President of the
Company since January 1994.
Ms. Lowenthal, a certified public accountant, has served as Vice
President and Comptroller of the Company since April 1996.
Mr. Scruggs joined the Company in 1995, served as Vice President from
March 2000 through December 2001, and from August 2002 until the present. In
addition, he has served as a director of MK Gold since March 2001.
28
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters
- ------- ------------------------------------------------------------------
and Issuer Purchases of Equity Securities.
------------------------------------------
The common shares of the Company are traded on the NYSE and Pacific
Exchange, Inc. under the symbol LUK. The following table sets forth, for the
calendar periods indicated, the high and low sales price per common share on the
consolidated transaction reporting system, as reported by the Bloomberg
Professional Service provided by Bloomberg L.P.
COMMON SHARE
------------
HIGH LOW
---- ---
2002
----
First Quarter $36.04 $28.00
Second Quarter 38.16 30.95
Third Quarter 36.37 27.62
Fourth Quarter 40.27 32.85
2003
----
First Quarter $38.60 $32.59
Second Quarter 39.44 35.79
Third Quarter 39.40 36.33
Fourth Quarter 46.19 37.78
2004
----
First Quarter (through March 5, 2004) $53.75 $46.03
As of March 5, 2004, there were approximately 3,053 record holders of
the common shares.
In 2003 and 2002, the Company paid cash dividends of $.25 per common
share. The payment of dividends in the future is subject to the discretion of
the Board of Directors and will depend upon general business conditions, legal
and contractual restrictions on the payment of dividends and other factors that
the Board of Directors may deem to be relevant.
In connection with the declaration of dividends or the making of
distributions on, or the purchase, redemption or other acquisition of common
shares, the Company is required to comply with certain restrictions contained in
certain of its debt instruments. The Company's regulated subsidiaries are
restricted in the amount of distributions that can be made to the Company
without regulatory approval. For further information, see Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included in this Report.
Certain subsidiaries of the Company have significant net operating loss
carryforwards ("NOLs") and other tax attributes, the amount and availability of
which are subject to certain qualifications, limitations and uncertainties. In
order to reduce the possibility that certain changes in ownership could impose
limitations on the use of the NOLs, the Company's certificate of incorporation
contains provisions which generally restrict the ability of a person or entity
from accumulating five percent or more of the common shares and the ability of
persons or entities now owning five percent or more of the common shares from
acquiring additional common shares. The restrictions will remain in effect until
the earliest of (a) December 31, 2005, (b) the repeal of Section 382 of the
Internal Revenue Code (or any comparable successor provision) or (c) the
beginning of a taxable year of the Company to which certain tax benefits may no
longer be carried forward. The Company intends to seek shareholder approval to
extend these restrictions.
On May 14, 2002, shareholders approved the Company's reorganization from
New York, its current state of incorporation, to Bermuda. The Company continues
to evaluate the possibility of reorganizing as a Bermuda company and would not
implement the reorganization unless the estimated cost of the reorganization is
acceptable given the anticipated benefits. If the Board of Directors has not
determined to implement the reorganization before the 2005 annual meeting of
shareholders, management will either abandon the reorganization or resubmit it
for shareholder approval at the 2005 annual meeting of shareholders. In
addition, the Board of Directors may determine to abandon the reorganization for
other reasons deemed to be in the Company's best interests and/or the best
interest of its shareholders.
29
Item 6. Selected Financial Data.
- ------ -----------------------
The following selected financial data have been summarized from the
Company's consolidated financial statements and are qualified in their entirety
by reference to, and should be read in conjunction with, such consolidated
financial statements and Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" of this Report.
Year Ended December 31,
-----------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
(In thousands, except per share amounts)
SELECTED INCOME STATEMENT DATA: (a)
Revenues (b) $ 556,375 $ 241,805 $ 374,161 $ 493,408 $ 460,814
Expenses 590,404 283,330 301,079 292,105 226,171
Income (loss) from continuing operations before income
taxes, minority expense of trust preferred securities
and equity in income (losses) of associated companies (34,029) (41,525) 73,082 201,303 234,643
Income from continuing operations before minority expense
of trust preferred securities and equity in income
(losses) of associated companies (c) 10,172 103,340 84,423 133,087 195,175
Minority expense of trust preferred securities, net of
taxes (2,761) (5,521) (5,521) (5,521) (5,521)
Equity in income (losses) of associated companies, net of
taxes 76,947 54,712 (15,974) 19,040 (1,906)
Income from continuing operations 84,358 152,531 62,928 146,606 187,748
Income (loss) from discontinued operations, including gain
(loss) on disposal, net of taxes 12,696 9,092 (70,847) (30,598) 27,294
Cumulative effect of a change in accounting
principle - - 411 - -
Net income (loss) 97,054 161,623 (7,508) 116,008 215,042
Per share:
Basic earnings (loss) per common share:
Income from continuing operations $1.38 $2.74 $ 1.13 $2.64 $3.16
Income (loss) from discontinued operations, including
gain (loss) on disposal .20 .16 (1.28) (.55) .46
Cumulative effect of a change in accounting
principle - - .01 - -
------- ------ ------ ------ ------
Net income (loss) $ 1.58 $2.90 $ (.14) $2.09 $3.62
======= ====== ====== ====== ======
Diluted earnings (loss) per common share:
Income from continuing operations $ 1.37 $2.72 $ 1.13 $2.64 $3.16
Income (loss) from discontinued operations, including
gain (loss) on disposal .20 .16 (1.28) (.55) .46
Cumulative effect of a change in accounting
principle - - .01 - -
------- ------ ------ ------ ------
Net income (loss) $ 1.57 $2.88 $ (.14) $2.09 $3.62
======= ====== ======= ====== ======
30
At December 31,
---------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
(In thousands, except per share amounts)
SELECTED BALANCE SHEET DATA: (a)
Cash and investments $ 1,602,495 $ 1,043,471 $ 1,080,271 $ 998,892 $ 759,089
Total assets 4,397,164 2,541,778 2,469,087 2,417,783 2,255,239
Debt, including current maturities 1,178,834 233,073 252,279 190,486 268,736
Customer banking deposits 145,532 392,904 476,495 526,172 329,301
Shareholders' equity 2,134,161 1,534,525 1,195,453 1,204,241 1,121,988
Book value per common share $30.13 $25.74 $21.61 $21.78 $19.75
Cash dividends per common share $ .25 $ .25 $ .25 $ .25 $13.58
(a) WilTel is reflected as a consolidated subsidiary as of November 6, 2003,
the date the Company acquired the balance of the WilTel shares it did not
previously own in exchange for the issuance of 11,156,460 common shares of
the Company. In 2002, the Company acquired 47.4% of WilTel for $353,900,000
in cash, including expenses, which was accounted for by the Company under
the equity method of accounting. The Company's share of WilTel's losses
prior to November 6, 2003 is included in the caption equity in income
(losses) of associated companies ($52,087,000 for 2003 and $13,374,000 for
2002). For additional information, see Note 3 of Notes to Consolidated
Financial Statements.
(b) Includes net securities gains (losses) of $9,953,000, $(37,066,000),
$28,450,000, $124,964,000 and $16,268,000 for the years ended December 31,
2003, 2002, 2001, 2000 and 1999, respectively.
(c) As a result of the favorable resolution of various state and federal income
tax contingencies, the income tax provision reflects a benefit of
approximately $24,400,000 for 2003, $120,000,000 for 2002 and $36,200,000
for 2001.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
- ------- -----------------------------------------------------------------------
of Operations.
--------------
The purpose of this section is to discuss and analyze the Company's
consolidated financial condition, liquidity and capital resources and results of
operations. This analysis should be read in conjunction with the consolidated
financial statements and related notes which appear elsewhere in this Report.
LIQUIDITY AND CAPITAL RESOURCES
Parent Company Liquidity
Leucadia National Corporation (the "Parent") is a holding company whose
assets principally consist of the stock of its direct subsidiaries, cash and
cash equivalents and other non-controlling investments in debt and equity
securities. The Parent continuously evaluates the retention and disposition of
its existing operations and investments and investigates possible acquisitions
of new businesses in order to maximize shareholder value. Accordingly, while the
Parent does not have any material arrangement, commitment or understanding with
respect thereto (except as disclosed in this Report), further acquisitions,
divestitures, investments and changes in capital structure are possible. Its
principal sources of funds are its available cash resources, liquid investments,
bank borrowings, public and private capital market transactions, repayment of
subsidiary advances, funds distributed from its subsidiaries as tax sharing
payments, management and other fees, and borrowings and dividends from its
regulated and non-regulated subsidiaries.
31
As of December 31, 2003, the Company's readily available cash, cash
equivalents and marketable securities, excluding amounts held by its regulated
subsidiaries and non-regulated subsidiaries that are parties to agreements which
restrict the payment of dividends, totaled $1,194,500,000. This amount is
comprised of cash and short-term bonds and notes of the United States Government
and its agencies of $675,400,000 (56.6%), the equity investment in WMIG of
$172,500,000 (14.4%) (that can be sold privately or otherwise in compliance with
the securities laws and have the benefit of a registration rights agreement),
and other publicly traded debt and equity securities aggregating $346,600,000
(29%). The investment income realized from these investments is used to meet the
Parent company's short-term recurring cash requirements, which are principally
the payment of interest on its debt, tax payments and corporate overhead
expenses.
The Parent company's only long-term cash requirement is to make
principal payments on its long-term debt ($514,000,000 outstanding as of
December 31, 2003), of which $40,800,000 is due before 2013. Historically, the
Parent has used its available liquidity to make acquisitions of new businesses,
but the timing of any future acquisitions and the cost cannot be predicted.
Should the Company require additional liquidity for an acquisition or any other
purpose, the Company also has an unsecured bank credit facility of $110,000,000
that matures in 2006 and bears interest based on the Eurocurrency Rate or the
prime rate. No amounts are currently outstanding under the bank credit facility.
In addition, based on discussions with commercial and investment bankers, the
Company believes that it has the ability to raise additional funds under
acceptable conditions for use in its existing businesses or for appropriate
investment opportunities. Standard & Poor's and Duff & Phelps Inc. have rated
the Company's senior debt obligations as investment grade since 1993, while
Moody's Investors Services, Inc. rates the Company's senior debt obligations
below investment grade. Ratings issued by bond rating agencies are subject to
change at any time.
In December 2002, the Company completed a private placement of
approximately $150,000,000 of equity securities, based on a common share price
of $35.25, to mutual fund clients of Franklin Mutual Advisers, LLC, including
the funds comprising the Franklin Mutual Series Funds. The private placement
included 2,907,599 common shares and newly authorized Series A Non-Voting
Convertible Preferred Stock that were mandatorily convertible into 1,347,720
common shares within 90 days of issuance. Such shares were converted into common
shares in March 2003.
During 2003, the Company sold $275,000,000 aggregate principal amount of
its newly authorized 7% Senior Notes due 2013 in a series of private placement
transactions at 99.612% of the principal amount. The net cash proceeds from the
sale of the notes are being used for general corporate purposes. The Company has
completed registered exchange offers pursuant to which each holder of privately
placed senior notes exchanged those notes for a single issue of publicly
registered notes issued under the same indenture.
In June 2003, the Company sold 567,574 common shares of Olympus back to
Olympus for total proceeds of $79,500,000. The shares were sold to Olympus as
part of an issuer tender offer available to all of its shareholders. After
completion of the tender, the Company's interest in Olympus declined from 25% to
16.1%.
During 2003, the Company purchased two new corporate aircraft, and
received an option to sell its existing corporate aircraft, for an after tax net
cash investment of approximately $22,000,000. The aggregate purchase price for
the new aircraft is $80,000,000, of which $63,000,000 had been paid as of
December 31, 2003, $12,000,000 is due in March 2004 and the balance is due
during the third quarter of 2004. Purchase of the new aircraft enabled the
Company to reduce its then estimated 2003 federal income tax liability by
approximately $16,800,000. The option to sell its existing corporate aircraft
was exercised in January 2004 for $38,700,000, although the full amount of the
sales proceeds will not be received until the Company delivers the aircraft to
the buyer during the third quarter of 2004. The Company expects to recognize a
gain of approximately $11,600,000 when the aircraft are sold.
32
In September 2003, the Company acquired certain businesses primarily
engaged in the provision of physical, occupational, speech and respiratory
therapy services that are operated by subsidiaries of Symphony. The purchase
price was approximately $36,700,000, including expenses, of which approximately
$29,200,000 was provided by financing that is non-recourse to the Company but is
fully collateralized by Symphony's assets. In addition, at acquisition, the
lender provided an additional $5,000,000 of working capital financing to
Symphony. As of December 31, 2003, Symphony was not in compliance with a
financial covenant contained in its $50,000,000 credit facility but had obtained
a waiver from the lender that suspends application of the covenant until March
31, 2004. The Company believes it is probable Symphony will be in compliance
with the covenant at that time; however, if it isn't in compliance the lender
would have the right to accelerate the loan ($34,200,000 outstanding at December
31, 2003). The Company has consolidated Symphony's financial condition and
results of operations since acquisition.
In September 2003, the Company acquired a 90% interest in 8 acres of
unimproved land in Washington, D.C. for cash of $53,800,000. Immediately
following the acquisition, mortgage financing of $15,000,000 was obtained, which
is non-recourse to the Company, and which reduced the net cash investment in the
property to $38,800,000. Subsequent to the purchase, the mortgage lender
provided an additional $5,000,000 of such non-recourse financing, which further
reduced the Company's net cash investment. The land is zoned for a minimum of
2,000,000 square feet of commercial office space, which the Company intends to
develop in phases, once acceptable tenants or purchasers are identified.
During 2002, the Company acquired 47.4% of the outstanding common stock
of WilTel for aggregate cash consideration of $353,900,000, including expenses.
In November 2003, the Company consummated an exchange offer and merger agreement
pursuant to which all public WilTel stockholders received .4242 of a Leucadia
common share for each share of WilTel common stock. Leucadia issued 11,156,460
of its common shares in exchange for all of the WilTel common stock that it
didn't previously own. The merger agreement also provided that WilTel
stockholders receive contingent sale rights which entitle WilTel stockholders to
additional Leucadia common shares (up to an aggregate maximum of 11,000,000
additional Leucadia common shares) if the Company sells substantially all of
WilTel's assets or outstanding shares of capital stock prior to October 15,
2004, or consummates such a sale at a later date if the sale agreement was
entered into prior to August 21, 2004, and in either case the net proceeds
exceed the valuation ascribed to WilTel's equity in the merger.
The aggregate purchase price for the 2003 acquisition was
approximately $425,300,000, consisting of $422,800,000 of Leucadia common shares
and cash expenses of $2,500,000. The Company has consolidated the financial
condition and results of operations of WilTel from November 6, 2003, and it no
longer accounts for its earlier investment in WilTel under the equity method of
accounting. As of December 31, 2003, the Company's consolidated balance sheet
includes total WilTel liabilities of approximately $1,168,300,000, including
long-term indebtedness of approximately $504,400,000, none of which has been
guaranteed by the Company. For more information about the acquisition of WilTel,
including the allocation of the purchase price to the assets and liabilities
acquired, see Critical Accounting Estimates below, and Note 3 of Notes to
Consolidated Financial Statements included in this Report.
WilTel became a member of the Company's consolidated federal income tax
return as of November 6, 2003. WilTel has significant NOLs, substantially all of
which are only available to reduce the federal taxable income of WilTel and its
subsidiaries, and has substantial other tax attributes and future deductions
(primarily future depreciation deductions), some of which are also available to
reduce the federal taxable income of the Company and its other subsidiaries.
Although the amount of these future deductions that can be used to reduce the
federal taxable income of other members of the Company's consolidated tax group
is dependent upon the future taxable income of WilTel and its subsidiaries, the
Company does not expect it will have material federal income tax liabilities for
the foreseeable future. For more information about WilTel's NOLs and tax
attributes, see Note 15 of Notes to Consolidated Financial Statements included
in this Report.
33
In December 2003, the Company purchased all of the debt obligations
under the senior secured credit facility of ATX for $25,000,000, and also
entered into an amendment to the facility pursuant to which the Company agreed
to refrain from exercising certain of its rights under the facility, subject to
certain conditions. In January 2004, ATX commenced a voluntary chapter 11 case
in order to reorganize its financial affairs. Although the Company has entered
into a conversion agreement pursuant to which the senior secured debt of ATX
would be converted into 100% of the equity securities of a reorganized ATX,
implementation of the conversion agreement is subject to bankruptcy court
approval.
As of March 5, 2004, the Company is authorized to repurchase 4,448,765
common shares. Such purchases may be made from time to time in the open market,
through block trades or otherwise. Depending on market conditions and other
factors, such purchases may be commenced or suspended at any time without prior
notice.
At December 31, 2003, a maximum of $13,300,000 was available to the
Parent as dividends from its regulated subsidiaries without regulatory approval.
Cash and investments aggregating $203,700,000 are held by non-regulated
subsidiaries that are parties to agreements which restrict the payment of
dividends. For more information concerning the long-term debt of the Company and
its subsidiaries, see Note 11 of Notes to Consolidated Financial Statements. The
Parent also receives tax sharing payments from subsidiaries included in its
consolidated income tax return, including certain regulated subsidiaries.
Payments from regulated subsidiaries for dividends and tax sharing payments
totaled $3,800,000 for the year ended December 31, 2003.
Consolidated Liquidity
In 2003, net cash was used for operating activities, principally due to
corporate overhead expenses, reduced investment income, an increase in the
investment in the trading portfolio and a $10,000,000 contribution to the
Company's defined benefit pension plan. In 2002, net cash was provided by
operating activities, principally as a result of a reduction to the Company's
investment in the trading portfolio. In 2001, net cash was provided by operating
activities, principally related to distributions received from investments in
associated companies.
As of December 31, 2003, WilTel had aggregate cash and investments of
$185,800,000 (excluding investments pledged as collateral), available for use in
its operating, investing and financing activities. Substantially all of WilTel's
assets have been pledged to secure its outstanding long-term debt, principally
to secure its obligations under its credit agreement ($375,000,000 outstanding
as of December 31, 2003) and its outstanding mortgage debt ($119,100,000
outstanding at December 31, 2003).
Under WilTel's credit agreement, (which is non-recourse to the
Company) WilTel is required to make quarterly principal payments commencing in
June 2005 until final maturity in September 2006, aggregating $155,600,000 in
2005 and $219,400,000 in 2006. The WilTel credit agreement contains covenants
which require WilTel to meet certain operating targets, which it currently
meets, and restrictions which limit WilTel's ability to incur additional
indebtedness, spend funds on capital expenditures and make certain investments.
The Company currently expects that WilTel will be able to meet the operating
targets required by its credit agreement during 2004 and 2005; however,
compliance with the operating targets thereafter is uncertain. The agreement
also prohibits WilTel from paying dividends to the Company.
WilTel's mortgage debt (which is non-recourse to the Company) is
comprised of two notes, one of which requires annual principal payments of
approximately $1,000,000 per year until final maturity in 2010 (an aggregate of
$74,300,000). The other note, with a balance due of $44,800,000 as of December
31, 2003, does not require any principal or interest payments until December
2006, when all principal and accrued but unpaid interest is due (an aggregate of
$74,400,000).
34
While WilTel has no material contractual commitments for capital
expenditures, it does plan to spend significant amounts each year, principally
for network expansion, maintenance and product upgrades. In addition, WilTel may
also incur additional capital expenditures upon the acquisition of new customers
or when providing new products to existing customers. WilTel will use its
available cash resources and operating profits to fund its capital expenditure
needs.
WilTel is a party to various legal actions and claims, and has reserved
$38,400,000 for the satisfaction of all litigation. Certain of these actions
relate to the rights of way licensed to WilTel in connection with the
installation of its fiber-optic cable and seek damages from WilTel for failure
to obtain all necessary landowner consents. Additional right of way claims may
be asserted against WilTel. The Company does not believe that the ultimate
resolution of all claims, legal actions and complaints will have a material
adverse effect upon WilTel's results of operations, although unfavorable
outcomes could significantly impact WilTel's liquidity.
Based on the net cash flow currently generated by WilTel, the Company
does not expect that WilTel will have sufficient liquidity to meet all of the
principal amortization requirements on its debt during 2006. WilTel has had and
continues to have discussions with potential lenders and investment bankers
concerning a refinancing of its credit agreement in order to extend principal
amortization payments beyond the current due dates. While these discussions are
in the preliminary stages, the Company believes that it will be able to
refinance a substantial portion of WilTel's credit agreement debt, although the
precise amount that can be refinanced, the new maturity and the cost is
uncertain.
The Company's consolidated banking and lending operations had
outstanding loans (net of unearned finance charges) of $205,500,000 and
$373,600,000 at December 31, 2003 and 2002, respectively. At December 31, 2003,
47% were loans to individuals generally collateralized by automobiles; 47% were
loans to consumers, substantially all of which were collateralized by real or
personal property; 2% were loans to small businesses; and 4% were unsecured
loans. The banking and lending segment is no longer making consumer loans;
operating activities at this segment have been limited to maximizing the amount
collected from its loan portfolio and liquidating the business in an orderly and
cost efficient manner. The banking and lending segment continues to have
discussions with potential purchasers of its loan portfolios, although it has
not yet accepted any offers. These discussions are expected to continue. These
loans were primarily funded by deposits generated by the Company's
deposit-taking facilities and by brokers, which totaled $145,500,000 and
$392,900,000 as of December 31, 2003 and 2002, respectively. The cash flows
generated from the collections on its loan portfolios have been used to retire
these deposits as they matured.
In January 2004, AIB filed an application with the OCC, the primary
regulator of AIB, to merge AIF into AIB. In March 2004, the OCC approved AIB's
application for merger subject to AIB submitting a written plan to the OCC
specifying the steps and timeframes AIB will use to ensure an orderly
liquidation of its operations. The Company expects that the merger will be
completed during the second quarter of 2004, and constitutes the next step in
the liquidation of this segment. This condition is consistent with AIB's
objectives, although AIB will not be able to surrender its national bank charter
and fully liquidate its operations until such time as all deposit liabilities
have been repaid or sold. AIB has been reducing its deposit liabilities during
the past two years, and is currently offering early withdrawal incentives, and
may eventually sell remaining deposits to another institution.
Certain subsidiaries of the Company have NOLs and other tax attributes,
the amount and availability of which are subject to certain qualifications,
limitations and uncertainties. In order to reduce the possibility that certain
changes in ownership could impose limitations on the use of the NOLs, the
Company's certificate of incorporation contains provisions which generally
restrict the ability of a person or entity from accumulating five percent or
more of the common shares and the ability of persons or entities now owning five
percent or more of the common shares from acquiring additional common shares.
The restrictions will remain in effect until the earliest of (a) December 31,
2005, (b) the repeal of Section 382 of the Internal Revenue Code (or any
comparable successor provision) or (c) the beginning of a taxable year of the
Company to which certain tax benefits may no longer be carried forward. The
Company intends to seek shareholder approval to extend these restrictions.
35
As shown below, at December 31, 2003, the Company's contractual cash
obligations totaled $2,024,958,000. The Company's debt instruments require
maintenance of minimum Tangible Net Worth, limit distributions to shareholders
and limit Indebtedness and Funded Debt (as such terms are defined in the
agreements). In addition, the debt instruments contain limitations on
investments, liens, contingent obligations and certain other matters. The
Company is in compliance with all of these restrictions, and the Company has the
ability to incur additional indebtedness or make distributions to its
shareholders and still remain in compliance with these restrictions. Certain of
the debt instruments of subsidiaries of the Company also contain restrictions
which require the maintenance of financial covenants, impose restrictions on the
ability to pay dividends to the Company and/or provide collateral to the lender.
For more information, see Note 11 of Notes to Consolidated Financial Statements.
Payments Due by Period (in thousands)
------------------------------------------------------------------------------------
Less than
Contractual Cash Obligations Total 1 Year 1-3 Years 4-5 Years After 5 Years
- ---------------------------- ----- ------ --------- --------- -------------
Customer Banking Deposits $ 145,532 $ 103,331 $ 32,249 $ 9,917 $ 35
Long-Term Debt 1,178,834 23,956 528,390 38,016 588,472
Operating Leases, net of Sublease
Income 565,399 59,389 104,705 88,548 312,757
Asset Purchase Obligations 37,589 23,450 14,139 - -
Operations and Maintenance Obligations 80,931 14,095 30,666 7,666 28,504
Other Long-Term Contractual
Obligations 16,673 2,969 2,904 2,400 8,400
------------- ---------- ------------ ---------- ----------
Total Contractual Cash Obligations $ 2,024,958 $ 227,190 $ 713,053 $ 146,547 $ 938,168
============= ========== ========== ========== ==========
Material contractual obligations that are not included in the table
above are the Company's consolidated pension liability ($64,800,000) and
deferred revenue obligations ($203,900,000). Deferred revenue obligations do not
require the expenditure of material cash, and the timing of cash payments for
the pension liability, if any, cannot be predicted.
OFF-BALANCE SHEET ARRANGEMENTS
At December 31, 2003, the Company's off-balance sheet arrangements
consist of guarantees aggregating $122,200,000. The Company's guarantee of 10%
of Berkadia's financing incurred in connection with the Berkadia Loan represents
$52,500,000 of that total, all of which expired as a result of the retirement of
the Berkadia Loan in the first quarter of 2004.
Pursuant to an agreement that was entered into before the Company sold
CDS Holding Corporation ("CDS") to HomeFed in 2002, the Company agreed to
provide project improvement bonds for the San Elijo Hills project. These bonds,
which are primarily for the benefit of the City of San Marcos, California, are
required prior to the commencement of any development at the project. CDS is
responsible for paying all third party fees related to obtaining the bonds.
Should the City or others draw on the bonds for any reason, CDS and one of its
subsidiaries would be obligated to reimburse the Company for the amount drawn.
At December 31, 2003, the amount of outstanding bonds was $31,700,000,
$16,700,000 of which expires in 2004 and the remainder expires in 2005. The
Company's remaining guarantees at December 31, 2003 are $38,000,000 of
indemnifications given to lenders to certain real estate properties. The amounts
borrowed under the financings are reflected as long-term debt in the Company's
consolidated balance sheet.
36
CRITICAL ACCOUNTING ESTIMATES
The Company's discussion and analysis of its financial condition and
results of operations are based upon its consolidated financial statements,
which have been prepared in accordance with GAAP. The preparation of these
financial statements requires the Company to make estimates and assumptions that
affect the reported amounts in the financial statements and disclosures of
contingent assets and liabilities. On an on-going basis, the Company evaluates
all of these estimates and assumptions. The following areas have been identified
as critical accounting estimates because they have the potential to have a
material impact on the Company's financial statements, and because they are
based on assumptions which are used in the accounting records to reflect, at a
specific point in time, events whose ultimate outcome won't be known until a
later date. Actual results could differ from these estimates.
Loan Loss Reserves - The allowance for loan losses is established
through a provision for loan losses charged to expense. As of December 31, 2003,
the Company's allowance for loan losses was $24,200,000 or 11.8% of the related
outstanding loan receivable balance of $205,500,000. The allowance for loan
losses is an amount that the Company believes will be adequate to absorb
probable losses inherent in its portfolio based on the Company's evaluations of
the collectibility of loans as of the balance sheet date. Factors considered by
the Company include prior loan loss experience, current economic trends, aging
of the loan portfolio and collateral value. The amount recorded for the
allowance for loan losses results from numerous judgments and assumptions that
are made to estimate actual loan loss experience in the future.
In September 2003, the Company outsourced substantially all of its
consumer loan servicing and collection functions to a third party service
provider, in order to reduce overhead costs and convert these activities into a
variable cost that declines as the size of the portfolio declines. While expense
savings were achieved, delinquency in each serviced portfolio increased during
the first 90 days after the transfer to the service provider, and has not
returned to normal levels. The Company believes the deteriorating delinquency
results from the service provider not dedicating adequate resources to the
collection efforts, and it has been the Company's experience that once accounts
reach certain delinquency levels, a high percentage are eventually charged off.
As a result, the banking and lending segment recorded an additional provision
for loan losses of $4,000,000 in 2003. Although the Company believes that the
additional reserve is sufficient given the current level of delinquency in the
portfolio, any further deterioration in delinquency could result in the need to
record additional reserves.
Changes in the economy in the future could also impact the amount of
reserves required, as during periods of economic weakness, delinquencies,
defaults, repossessions, bankruptcies and losses generally increase. These
periods are often also accompanied by decreased demand for and declining values
of used automobiles securing outstanding loans, which weakens collateral
coverage and increases the severity of loss in the event of default.
Income Taxes - The Company records a valuation allowance to reduce its
deferred taxes to the amount that is more likely than not to be realized.
Historically, if the Company were to determine that it would be able to realize
its deferred tax assets in the future in excess of its net recorded amount, an
adjustment would increase income in such period. Similarly, if the Company were
to determine that it would not be able to realize all or part of its net
deferred taxes in the future, an adjustment would be charged to income in such
period. The Company also records reserves for contingent tax liabilities related
to potential exposure.
Subsequent to the acquisition of all of the outstanding common stock of
WilTel, WilTel became a member of the Company's consolidated tax return. As
discussed above, WilTel has significant tax attributes, some of which are
available to reduce the future taxable income of other members of the Company's
consolidated federal income tax return. The Company established a valuation
allowance that fully reserved for all of WilTel's net deferred tax assets,
reduced by an amount equal to the Company's current and deferred federal income
tax liabilities as of the date of acquisition (see allocation of the purchase
price in Note 3 of Notes to Consolidated Financial Statements). Except as
discussed in results of operations below, prior to recording any decrease to the
valuation allowance for the deferred tax asset, the Company will need to
demonstrate that on a pro forma combined basis with WilTel, it will have had
positive cumulative pre-tax income over a period of years. At that time, any
decrease to the valuation allowance will be based significantly upon the
Company's assumptions and projections of its future income, which are inherently
uncertain.
37
Impairment of Long-Lived Assets - The Company evaluates its long-lived
assets for impairment when events or changes in circumstances indicate, in
management's judgment, that the carrying value of such assets may not be
recoverable. The determination of whether an impairment has occurred is based on
management's estimate of undiscounted future cash flows attributable to the
assets as compared to the carrying value of the assets. If an impairment has
occurred, the amount of the impairment recognized is determined by estimating
the fair value for the assets and recording a provision for loss if the carrying
value is greater than fair value.
As of December 31, 2003, the carrying amount of the Company's investment
in the mineral rights and mining properties of MK Gold was approximately
$74,600,000. The recoverability of this asset is entirely dependent upon the
success of MK Gold's mining project at the Las Cruces copper deposit in the
Pyrite Belt of Spain. Mining will be subject to obtaining required permits,
obtaining both debt and equity financing for the project, engineering and
construction. The amount of financing that can be obtained for the project and
its related cost will be significantly affected by the assessment of potential
lenders of the current and expected future market price of copper. In addition,
the actual price of copper, the operating cost of the mine and the capital cost
to bring the mine into production will affect the recoverability of this asset.
Based on the current status of the project and MK Gold's estimate of future
financing costs and future cash flows, the Company believes the carrying amount
of its investment is recoverable. However, if the Company is unable to obtain
the permits required to begin construction of the mine and commence mining
activities, it is likely that this investment will be impaired.
As of December 31, 2003, the carrying amount of the Company's
investment in its manufacturing facility located in Belgium was approximately
$18,100,000. The Belgium facility, which became operational in the third quarter
of 2001, has not yet achieved the level of revenues and profitability originally
expected by the Company, primarily due to the segment's loss of a major
multi-national customer and insufficient demand from other customers. During
2004, a new general manager was hired at the facility, and the Company expects
that new management's development and implementation of marketing and sales
initiatives should significantly improve profitability. Based on the current
business plan, which includes a budget for 2004 and estimates of revenue growth
thereafter, the Company believes that its investment in the Belgium facility is
recoverable. However, the operation has remained in the start up phase for at
least a year longer than anticipated, and if profitability improvement is not
achieved, the carrying amount of the facility is likely to be impaired.
Acquisition of WilTel - In order to determine the fair values of
WilTel's acquired assets and liabilities, the Company utilized independent
appraisals, principally for property and equipment and identifiable intangible
assets, actuarial calculations for employee benefit obligations, market quotes,
discounted cash flow techniques and comparable sales information to determine
the fair values of assets and liabilities acquired. Significant judgments and
estimates were also made to determine the fair values of certain liabilities,
including liabilities for unfavorable contracts and deferred revenue, many of
which required the Company to make assumptions about the future. The Company has
not completed all of the analyses and studies to finalize its allocation of the
purchase price for the 2003 purchase. The Company expects to complete its
allocation of the purchase price by the end of the third quarter of 2004, and
any changes from its initial allocation could affect the values assigned to
property and equipment, intangible assets and trade payables, expense accruals
and other liabilities. However, the Company does not expect that the impact of
these changes will be material.
38
The Company engaged independent appraisers to assist in its
determination of the fair value of WilTel's property and equipment and
identifiable intangible assets and in its allocation of the fair value to the
various asset classes. The methods used to determine the fair values included
estimating WilTel's business enterprise value, utilizing both discounted cash
flow and market comparable based approaches. Property and equipment assets also
included an analysis of depreciated replacement cost and market prices. The
Company and its appraisers considered several factors to determine the fair
value of property and equipment, including local market conditions, recent fiber
transactions in the market, the size, age, condition, utility and character of
the property, the estimated cost to acquire comparable property (if comparable
property was available), the estimated cost to acquire new property, an estimate
of depreciation from use and obsolescence, the remaining expected useful life of
the assets and estimates of future network capacity utilization. The aggregate
replacement cost of new property and equipment was estimated to be approximately
$5,600,000,000. This estimate was comprised of network construction costs of
approximately $2,900,000,000 (including rights of way, conduit and fiber) and
equipment that is part of the network of approximately $1,400,000,000. The
remainder of the estimate was comprised of buildings and other equipment, which
are not necessarily industry specific. At the date of acquisition, the amount
reflected in the consolidated balance sheet for property and equipment was
$1,240,300,000.
Intangible assets that were identified by the Company to be analyzed for
separate recognition in the allocation of the purchase price consisted of the
Vyvx tradename, specific contracts with specific customers and contractual and
non-contractual customer relationships. The Vyvx tradename is well recognized,
and Vyvx has a long operating history and is the market leader in its industry.
The Company and its appraisers employed a royalty savings approach to estimate
the value of the Vyvx tradename. In this approach, a hypothetical royalty rate,
based on market licensing agreements, is used to estimate the long-term economic
benefits of the tradename under the assumption that it was not owned. As of the
date of acquisition, the amount reflected in the consolidated balance sheet for
the Vyvx tradename was $8,400,000. To determine the fair value of customer
relationships, a discounted cash flow method was used, adjusted for contributory
asset charges related to the use of tangible assets, working capital, the
tradename and the workforce. The cash flows were adjusted by an attrition factor
to recognize that customer relationships are a wasting asset. At the date of
acquisition, the amount reflected in the consolidated balance sheet for customer
relationships was $30,400,000, which primarily relates to Vyvx customers.
Since the aggregate fair values of the net assets acquired exceeded the
purchase price, under GAAP the Company is required to apply the excess to reduce
the initial fair values of certain non-current assets on a pro rata basis.
WilTel's only significant non-current assets were property and equipment and
identifiable intangible assets, and WilTel's property and equipment represented
over 90% of the non-current assets on a fair value basis. The amount of the
excess over the purchase price was significant, and substantially all of the
excess was applied to reduce the fair value of WilTel's property and equipment
and identified intangible assets. Therefore, the Company does not believe that
any reasonable changes in its assumptions and estimates used to determine the
fair values of WilTel's assets would have had a material effect on its
allocation of the purchase price. However, if in the future WilTel's operating
cash flows prove to be much less than projected, the Company could find that
either its property and equipment or identifiable intangible assets are
impaired, which would result in a charge to earnings at that time.
To determine the fair value of deferred revenue, the Company had to
assess transactions having limited activity in the current telecommunications
market environment. The Company considered market indicators related to pricing,
pricing for comparable transactions, as well as the legal obligation of the
Company to provide future services. The Company also assumed it would continue
to perform its contractual obligations through the term of its contracts.
Revenue will be recognized on these contracts as services are performed,
typically on a straight-line basis over the remaining length of the contract. In
the future, if the Company settles these obligations or they are otherwise
terminated prior to completion of the performance obligation, the Company would
likely recognize a gain equal to the carrying amount of the obligation. At the
date of acquisition, the amount reflected in the consolidated balance sheet for
deferred revenue was $201,900,000.
39
The Company evaluated the fair value of long-term commitments that are
either above or below the current market rates for similar transactions, and the
fair value of telecommunications capacity commitments that are not required
based on WilTel's current operating plans. These commitments primarily consist
of real estate leases and international capacity contracts. In order to
determine the fair values of these agreements, the Company made significant
assumptions concerning future market prices, future capacity utilization, the
ability to enter into subleasing arrangements and that the commitments will not
be terminated prior to their expiration dates. As a result, at the date of
acquisition the consolidated balance sheet reflects an accrual for unfavorable
long-term commitments of $64,400,000, determined on a present value basis. This
accrued liability will be amortized on a straight-line basis over the life of
the commitments. Results of operations in the future would be impacted by any
subsequent adjustment to this liability, which could result from negotiating a
termination or reduction of its contractual obligation with contract
counter-parties or sublease activity that is different from the Company's
original assumptions.
Telecommunications Revenue Recognition - Capacity, transmission,
video services and other telecommunications services revenues are recognized
monthly as the services are provided or revenues are earned. If at the time
services are rendered, collection is not reasonably assured either due to credit
risk, the potential for billing disputes or other reasons, revenue is not
recognized until such contingencies are resolved.
WilTel estimates the amount of services which should not be
recognized as revenue at the time the service is rendered based on its
collection experience for each type of service. Certain of WilTel's customers
represent such a high credit risk due to their difficult financial position that
revenue is not recognized until cash is received. In addition, WilTel knows from
past experience that a certain percentage of its billings will be disputed and
uses that experience to estimate the amount of expected disputes and defers
recognition of revenue at the time the service is provided. Revenues that have
not been recognized at the time service is provided are subsequently recognized
as revenue when the amounts are collected.
Contingencies - The Company accrues for contingent losses when the
contingent loss is probable and the amount of loss can be reasonably estimated.
As of December 31, 2003, the Company's consolidated balance sheet includes
litigation reserves of $38,400,000, all of which relate to WilTel litigation.
Estimating the ultimate outcome of litigation matters is inherently uncertain,
in particular because the ultimate outcome will rest on events and decisions of
others that may not be within the power of the Company to control. The Company
does not believe that any of these matters will have a material adverse effect
on its consolidated financial position, consolidated results of operations or
liquidity. However, if the amounts ultimately paid at the resolution of a
litigation matter are significantly different than the Company's recorded
reserve amount, the difference could be material to the Company's consolidated
results of operations and, with respect to WilTel, settlement amounts are likely
to be material to its liquidity.
RESULTS OF OPERATIONS
Telecommunications
The following table reconciles WilTel's segment profit from
operations to pre-tax income (loss) for the period from the January 1, 2003
through November 5, 2003, and for the period from November 6, 2003 (when WilTel
became a consolidated subsidiary) through December 31, 2003. Prior to the merger
the Company did not consolidate WilTel, and for the period from January 1, 2003
through November 5, 2003 the Company accounted for its 47.4% share of WilTel's
losses under the equity method of accounting. Since WilTel is only included in
the Company's consolidated results of operations for less than a two month
period during 2003, and since WilTel's revenues and expenses for a full year
will be very significant to the Company's consolidated statements of operations,
the period prior to consolidation is shown below for information purposes only.
However, the amounts for the pre-consolidation period are not included in the
Company's consolidated results of operations, and the two periods combined would
not equal any amounts reflected in the Company's consolidated financial
statements. The Company has filed audited financial statements of WilTel for the
period before the acquisition as financial statement schedules to this Report.
40
January 1, 2003 November 6, 2003
through November 5, 2003 through December 31, 2003
------------------------------------------ ---------------------------------------
Network Vyvx Total WilTel Network Vyvx Total WilTel
------- ---- ------------ ------- ---- ------------
(In thousands)
Operating revenues (1) $1,005,200 $ 106,200 $1,111,400 $ 211,300 $ 20,600 $ 231,900
=========== =========== =========== =========== =========== ===========
Segment profit from
operations $ 45,500 $ 16,200 $ 61,700 $ 13,300 $ 4,100 $ 17,400
Depreciation and
amortization expense (196,200) (12,300) (208,500) (37,200) (2,000) (39,200)
Interest expense, net of
investment income (2) (30,000) (700) (30,700) (4,000) (100) (4,100)
Other non-operating
income (expense), net (2) (3) 63,000 5,800 68,800 1,800 500 2,300
----------- ----------- ----------- ----------- ----------- -----------
Pre-tax income (loss) $ (117,700) $ 9,000 $ (108,700) $ (26,100) $ 2,500 $ (23,600)
=========== =========== =========== =========== =========== ===========
(1) Excludes intersegment revenues from amounts billed by Network to Vyvx of
$21,900,000 and $4,300,000 for the periods from January 1, 2003 through
November 5, 2003 and November 6, 2003 through December 31, 2003,
respectively.
(2) These items have been allocated to each segment based upon a formula that
considers each segment's revenues, property and equipment and headcount.
(3) For the period from January 1, 2003 through November 5, 2003, includes
$65,900,000 of settlement gains related to the termination of various
agreements that released WilTel from previously accrued obligations,
recoveries of previously written off receivables and a gain on the sale of
a subsidiary, each of which result from transactions which management does
not consider to be part of the current year's operating performance.
For WilTel's segments, segment profit from operations is the primary
performance measure of segment operating results and profitability. WilTel
defines segment profit from operations as income before income taxes, interest
expense, investment income, depreciation and amortization expense and other
non-operating income and expense.
Since the time that WilTel first filed for bankruptcy protection in
April 2002, WilTel has been successful in reducing and controlling both its
capital expenditures and operating costs. WilTel has reduced its headcount from
approximately 3,100 in April 2002 to 1,967 as of December 31, 2003. In addition
to lower personnel costs, WilTel has reduced its expenses for leased capacity,
and has successfully reduced selling, general and other expenses. For the period
from November 6, 2003 through December 31, 2003, consolidated amounts for WilTel
include salaries expense of $19,300,000 and selling, general and other expenses
of $27,600,000. During 2003, each of WilTel's segments reported positive segment
profits for the first time over a full year period. While it continues to make
efforts to control its costs, WilTel is seeking to acquire new customers to
increase the profitability of both segments.
Network's revenues include services provided to SBC of $141,700,000 for
the 2003 period after consolidation by the Company and $551,200,000 for the 2003
period prior to consolidation. Throughout 2003, services provided to SBC grew,
principally related to voice products. The growth in voice revenue resulted
from, in part, SBC's continued growth in long distance services in California
and SBC's launch of long distance services in other states. Network cost of
sales reflects the increase in revenues, primarily due to traffic related access
and egress costs. Network's salaries and selling, general and other expenses
during the period WilTel was consolidated by the Company reflect reduced costs
as a result of WilTel's restructuring efforts during the later part of 2002 and
throughout 2003.
41
For the period from November 6, 2003 through December 31, 2003, Vyvx
revenues and profitability reflect the holiday season, when new movie releases
tend to increase volume in the advertising distribution business. Cost of sales
reflects the level of revenues, while salaries and selling, general and other
expenses include the benefit of cost reduction efforts implemented earlier in
the year.
Healthcare Services
Prior to its acquisition by the Company, the businesses operated by
Symphony were owned by a company undergoing reorganization proceedings under
chapter 11 of the Bankruptcy Code, which made it difficult for Symphony to
attract new customers. Since its acquisition in September 2003, Symphony has
been focused on profitably growing its business and, because of the nature of
its business, attracting and hiring skilled professionals to provide its
services. During the period the Company has owned Symphony, it entered into
approximately 170 new customer contracts, while substantially retaining existing
profitable customers. Symphony also intends to look for strategic acquisitions
to increase its customer base and pool of professional service providers;
however, no assurance can be given that it will be successful in those efforts.
For the four month period from acquisition through December 31, 2003,
the pre-tax loss of the healthcare services segment was $2,300,000. During this
period, healthcare services revenues were $71,000,000 and cost of sales, which
primarily consist of salaries and employee benefits, were $61,300,000.
Legislative caps on Part B Medicare therapy, which negatively impacted
Symphony's revenues in 2003, have been removed for 2004 and 2005, and the fee
schedule for such services has also been increased by 1.5%. The increase in the
number of new facilities resulted in greater travel and training costs, and
increased costs from the employment of independent contractors to temporarily
fill open employee positions.
Banking and Lending
As stated previously, the current activities of the banking and lending
segment are limited to maximizing the amount collected from its loan portfolio
while liquidating the business in an orderly and cost efficient manner. As a
result, revenues and expenses for this segment included in the Company's
consolidated statements of operations are reflective of the continuing decrease
in the size of the loan portfolio. Pre-tax income (loss) for the banking and
lending segment was $8,400,000, $1,900,000 and ($6,100,000) for the years ended
December 31, 2003, 2002 and 2001, respectively.
Finance revenues, which reflect both the level and mix of consumer
instalment loans, decreased in each of the last two years as compared to the
prior period, as average loans outstanding were $283,000,000, $440,800,000 and
$545,000,000 during 2003, 2002 and 2001, respectively. Although finance revenues
decreased in 2003 as compared to 2002, pre-tax results increased primarily due
to a $9,300,000 reduction in interest expense, due to reduced customer banking
deposits and lower interest rates thereon, a decline in the provision for loan
losses of $19,600,000, less interest paid on interest rate swaps and lower
salaries expense and operating costs resulting from the segment's restructuring
efforts.
Although finance revenues decreased in 2002 as compared to 2001 for the
reasons described above, pre-tax results increased primarily due to a
$13,700,000 reduction in interest expense, due to reduced customer banking
deposits and lower interest rates thereon, a net change of $10,000,000 in the
accounting for the market values of interest rate swaps (discussed below), a
decline in the provision for loan losses of $7,100,000, and lower salaries
expense and operating costs resulting from the segment's restructuring efforts.
Although interest expense decreased in total, other expense does reflect higher
interest paid on interest rate swaps of $4,100,000.
42
For both 2003 and 2002, the reduction in the provision for bad debts
results from the decrease in the size of the consumer loan portfolios, although
the reserve balance at the end of the year as a percent of gross loans has been
increasing. In addition, the Company increased its allowance during the third
quarter of 2003 by $4,000,000 as a result of an increase in delinquency, which
shortly followed the outsourcing of loan collection activities.
Pre-tax results for the banking and lending segment include income
(expense) of $3,100,000, $3,500,000 and ($6,500,000) for the years ended
December 31, 2003, 2002 and 2001, respectively, resulting from mark-to-market
changes on its interest rate swaps. The Company used interest rate swaps to
manage the impact of interest rate changes on its customer banking deposits; all
of the segment's interest rate swaps matured in 2003. Although the Company
believes that these derivative financial instruments served as economic hedges,
they did not meet certain effectiveness criteria under SFAS 133 and, therefore,
were not accounted for as hedges.
Manufacturing
Pre-tax income for the manufacturing segment was $4,400,000, $3,100,000
and $7,800,000 for the years ended December 31, 2003, 2002 and 2001,
respectively. Although revenues increased by 5% in 2003, revenues declined in
each of 2002 and 2001 as compared to the prior year. Revenues in all periods
reflect the loss of certain customers to competitors on the basis of price, as
well as lower prices charged by the division for certain product lines. The
plastics division is attempting to develop new products, applications and
markets to replace its lost business and utilize its excess capacity. In
addition, the Company has been focusing on reducing operating and overhead
costs, improving service levels and reducing lead times.
The increase in manufacturing revenues in 2003 primarily resulted from
increases in the construction and consumer products markets of $6,200,000,
although revenues in the carpet padding and agricultural markets declined.
However, gross profit declined, as the increase in the price of resin, the
primary raw material used in the manufacture of the segment's products, more
than offset the revenue increase. Pre-tax results improved due to lower salaries
and selling, general and other expenses principally as a result of workforce
reductions and other cost reduction programs, cash received from government
grants and a gain from the sale of a line of business. In addition, the
impairment charge recorded in 2002 that is discussed below reduced pre-tax
results in that year.
Manufacturing revenues for the plastics division declined approximately
5% in 2002 as compared to 2001 primarily due to reductions in the consumer
products market of $3,800,000, although revenues in the construction market
increased by $1,200,000. The reductions in the consumer products market resulted
from the loss of a customer for the Asian market and for its consumer dust wipe
products, and reduced demand for one of the Company's healthcare products. Gross
profit was largely unchanged for 2002 as compared to 2001, reflecting cost
reduction initiatives that reduced labor costs, improved material utilization
and reduced non-resin raw material costs.
For the year ended December 31, 2002, the division recorded an
impairment charge of approximately $1,250,000 to write down the book value of
certain production lines that the division does not expect will be utilized over
the next several years. These lines were initially purchased to provide
additional capacity to produce a specific product for a specific customer;
however, the customer discontinued the product in 2001 and the Company no longer
believes that the cost of these lines are currently recoverable from other
business. When the division's customer discontinued the product and terminated
its contract in 2001, it was required to pay the division a termination payment
of $3,500,000, which was recognized as other income in 2001. The division did
not record an impairment charge in 2001 since its expected production volume for
these lines was anticipated to result in future cash flows that did not support
an impairment charge at that time.
43
Domestic Real Estate
Pre-tax income for the domestic real estate segment was $18,100,000,
$16,700,000 and $30,400,000 for the years ended December 31, 2003, 2002 and
2001, respectively. Pre-tax results for the domestic real estate segment are
largely dependent upon the performance of the segment's operating properties,
the current status of the Company's real estate development projects and
non-recurring gains or losses recognized when real estate assets are sold. As a
result, the results of operations for this segment in the aggregate for any
particular year are not predictable and do not follow any consistent pattern.
Revenues and pre-tax results from domestic real estate increased in 2003
as compared to 2002, primarily as a result of improved operating performance at
the Company's Hawaiian hotel. Gains recognized from sales of real estate during
2003 declined by $8,300,000, principally due to the gains on sale of real estate
of CDS prior to its sale in 2002, which is more fully discussed below. During
2003, the Company also recognized $11,100,000 of deferred gains from sales of
real estate in prior years.
Revenues from domestic real estate declined in 2002 as compared to 2001
as a result of lower gains from property sales of $16,400,000, and less rent
income of $7,300,000 largely due to the sale of one of the Company's shopping
centers in 2001 and two shopping centers during 2002. Revenues increased in 2002
from the Company's Hawaiian hotel, which the Company began operating in the
third quarter of 2001. The decline in pre-tax income also reflects greater
operating costs, principally related to the Hawaiian hotel and a $1,300,000
write-down of a mortgage receivable.
During the fourth quarter of 2002, the Company sold one of its real
estate subsidiaries, CDS, to HomeFed for a purchase price of $25,000,000,
consisting of $1,000,000 in cash and 2,474,226 shares of HomeFed's common stock,
which represented approximately 30% of the outstanding HomeFed stock. CDS's
principal asset is the master-planned community located in San Diego County,
California known as San Elijo Hills, for which HomeFed has served as the
development manager since 1998. As of December 31, 2003, the balance of the
deferred gain on the sale of CDS was approximately $7,900,000, which is being
amortized into income as the San Elijo Hills project is developed and sold.
Prior to the sale to HomeFed, the Company recognized pre-tax gains of $7,800,000
from sales of residential sites at San Elijo Hills during 2002.
Corporate and Other Operations
Investment and other income declined in 2003 as compared to 2002,
principally as a result of a non-recurring gain of $14,300,000 recognized in
2002 from the sale of the Company's thoroughbred racetrack business. Corporate
investment income also declined principally as a result of lower interest rates
in 2003 and foreign exchange gains recorded in 2002. Available corporate cash is
generally invested on a short-term basis until such time as investment
opportunities require an expenditure of funds. During 2003, income related to
accounting for the market values of Corporate's derivative financial instruments
increased by $5,600,000, and the Company also recorded income related to a
refund of foreign taxes not based on income and related interest aggregating
$5,300,000. In addition, revenues from the Company's gas operations increased in
2003 principally due to increased production and prices.
Investment and other income declined in 2002 as compared to 2001
principally due to a reduction of $17,200,000 in investment income resulting
from a decline in interest rates and a lower amount of invested assets, a
decline of $9,200,000 in revenues from the Company's gas operations principally
due to lower production and prices, and the gain recognized in 2001 of
$6,300,000 from the sale of the Company's investment in two inactive insurance
companies. Investment and other income in 2002 also includes the gain from the
sale of certain thoroughbred racetrack businesses referred to above.
44
Net securities gains (losses) for 2003 and 2002 include provisions of
$6,500,000 and $37,100,000, respectively, to write down the Company's
investments in certain available for sale securities and an investment in a
non-public security in 2003 and an equity investment in a non-public fund in
2002. The write down of the securities resulted from a decline in market value
determined to be other than temporary.
The increase in interest expense during 2003 as compared to 2002
principally results from the issuance of $275,000,000 aggregate principal amount
of 7% Senior Notes due 2013, and dividends accrued on its trust issued preferred
securities, which commencing July 1, 2003 are classified as interest expense
(shown as minority interest in prior periods) as a result of the implementation
of Statement of Financial Accounting Standards No. 150, as discussed below.
The Company established a valuation allowance that fully reserved for
all of WilTel's net deferred tax assets, reduced by an amount equal to the
Company's current and deferred federal income tax liabilities as of the date of
acquisition. The Company needed to establish the valuation allowance because, on
a pro forma combined basis, the Company is not able to demonstrate that it is
more likely than not that it will be able to realize that asset. Subsequent to
the acquisition of WilTel, any benefit realized from WilTel's deferred tax asset
will reduce the valuation allowance for the deferred tax asset; however, that
reduction is first applied to reduce the carrying amount of the acquired
non-current intangible assets of WilTel rather than reduce the income tax
provision of any component of total comprehensive income.
As a result, the statement of operations includes a net income tax
provision for the period subsequent to the acquisition of WilTel of $7,900,000
(allocated to various components of income) even though no federal income tax
for that period is due. As previously described, recording this tax provision
resulted in a reduction of the valuation allowance which was applied to reduce
the carrying amount of the acquired non-current intangible assets. Any future
realization of WilTel's deferred tax assets will continue to result in a
reduction to the non-current intangible assets until they are reduced to zero.
Income tax expense for 2003 also includes the Company's actual income tax
expense for the period prior to the acquisition of WilTel, and a benefit for the
favorable resolution of certain federal and state income tax contingencies for
which the Company had previously established reserves of $24,400,000.
Once the non-current intangible assets are reduced to zero, the Company
does not expect it will reflect a net federal income tax expense or benefit for
total comprehensive income in the aggregate until such time as the Company is
able to reduce its valuation allowance and recognize a net deferred tax asset.
Each component of other comprehensive income may reflect either a federal income
tax provision or benefit in future periods, depending upon the relative amounts
of each component; however, in the aggregate for all components the Company does
not expect to report any net federal income tax expense or benefit for the
foreseeable future.
Income taxes for 2002 reflect the reversal of tax reserves aggregating
$120,000,000, as a result of the favorable resolution of certain federal income
tax contingencies. Income taxes for 2001 reflect a benefit of $36,200,000 for
the favorable resolution of federal and state income tax contingencies.
45
Associated Companies
Equity in income (losses) of associated companies includes the
following for the years ended December 31, 2003, 2002 and 2001(in thousands):
2003 2002 2001
---- ---- ----
Berkadia $ 79,200 $ 65,600 $ (70,400)
WilTel (52,100) (13,400) -
Olympus 40,400 24,100 -
EagleRock 49,900 (4,500) -
HomeFed 16,200 400 -
JPOF II 14,800 15,200 27,100
Other (1,400) 4,000 18,700
------------ ------------ -------------
Pre-tax 147,000 91,400 (24,600)
Income tax benefit (expense) (70,100) (36,700) 8,600
------------ ------------ -------------
Equity in income (losses), net of taxes $ 76,900 $ 54,700 $ (16,000)
============ ============ =============
The increase in income from Berkadia results from greater than expected
loan payments during each of 2003 and 2002, causing an increase in the
amortization of the discount on the Berkadia loan, and the recognition in 2001
of the Company's share of FINOVA's losses under the equity method of accounting.
The book value of the Company's equity investment in Berkadia was negative
$500,000 at December 31, 2003. This negative carrying amount was amortized into
income in early 2004 when the Berkadia Loan was fully repaid. Subsequent to the
repayment of the Berkadia loan, the Company's income from this investment is
expected to be limited to its share of the annual management fee received from
FINOVA while it remains in effect, which is $4,000,000. Including amounts
received in 2004 when the Berkadia loan was repaid, the Company has received
total net cash proceeds of $88,200,000 from this investment since 2001,
including the commitment and financing fees, management fees and interest
payments related to its share of the Berkadia loan.
The Company's investment in Olympus was made in December 2001, when
Olympus commenced its operations as a newly formed Bermuda reinsurance company
primarily engaged in the property excess, marine and aviation reinsurance
business. The Company's share of its earnings has increased in 2003, reflecting
the growth in Olympus's premium revenues during its second year of operation. As
discussed above, subsequent to an issuer tender offer for its shares in June
2003, the Company's interest in Olympus has declined from 25% to 16.1%.
The equity in income (losses) of EagleRock results from both realized
and unrealized gains (losses) in its portfolio, and no cash has been distributed
by the partnership since its inception in December 2001. As more fully described
above, the Company acquired its investment in HomeFed in the fourth quarter of
2002. During 2003 HomeFed reported increased earnings from sales of real estate
principally at the San Elijo Hills project.
Prior to the acquisition of the balance of WilTel's outstanding common
stock in November 2003, the Company has recorded its share of WilTel's results
of operations under the equity method of accounting. Such amount includes the
Company's share of WilTel's income from the recognition of non-operating
settlement gains related to the termination of various agreements that released
WilTel from previously accrued obligations, recoveries of previously written off
receivables and a gain on the sale of a subsidiary. The Company's share of these
gains was approximately $31,200,000. Subsequent to the merger in November 2003,
WilTel became a consolidated subsidiary of the Company and the equity method of
accounting was no longer applied. The Company did not record a deferred tax
benefit for its share of WilTel's losses while applying the equity method as its
ability to use the capital loss to reduce the tax due on capital gains in the
future is uncertain.
46
Discontinued Operations
Wireless Messaging
In December 2002, the Company entered into an agreement to purchase
certain debt and equity securities of WebLink Wireless, Inc. ("WebLink"), for an
aggregate purchase price of $19,000,000. WebLink operated in the wireless
messaging industry, providing wireless data services and traditional paging
services. Pursuant to the agreement, the Company acquired outstanding secured
notes of WebLink with a principal amount of $36,500,000 (representing 94% of the
total outstanding debt). In April 2003, upon receipt of approval from the FCC,
the Company acquired approximately 80% of the outstanding common stock of
WebLink and commenced consolidating WebLink in its financial statements.
In the fourth quarter of 2003, WebLink sold substantially all of its
operating assets to Metrocall, Inc. for 500,000 shares of common stock of
Metrocall, Inc's parent, Metrocall Holdings, Inc. ("Metrocall"), an immediately
exercisable warrant to purchase 25,000 shares of common stock of Metrocall at
$40 per share, and a warrant to purchase up to 100,000 additional shares of
Metrocall common stock at $40 per share, subject to certain vesting criteria.
The Metrocall securities have the benefit of a registration rights agreement.
Based upon the market price of the Metrocall stock received and the fair value
of the warrants received as of the date of sale, the Company reported a pre-tax
gain of $11,500,000 on this transaction. WebLink's investment in the shares of
Metrocall common stock is classified as non-current investments at December 31,
2003 (aggregate fair value and book value of $36,900,000). During 2003, the
Company recorded $3,400,000 of income from discontinued operations relating to
WebLink.
Foreign Real Estate
In 2002, the Company sold its interest in Fidei to an unrelated third
party for total proceeds of 70,400,000 Euros ($66,200,000), which resulted in an
after tax gain on the sale reflected in results of operations of $4,500,000 (net
of income tax expense of $2,400,000) for the year ended December 31, 2002, and
an increase to shareholders' equity of $12,100,000 as of December 31, 2002. The
Euro denominated sale proceeds were not converted into U.S. dollars immediately
upon receipt. The Company entered into a participating currency derivative,
which expired later in 2002. Upon expiration, net of the premium paid to
purchase the contract, the Company received $67,900,000 in exchange for
70,000,000 Euros and recognized a foreign exchange gain of $2,000,000, which is
included in investment and other income for the year ended December 31, 2002.
Property and Casualty Insurance
In December 2001, upon approval by the Company's Board of Directors to
commence an orderly liquidation of the Empire Group, the Company classified as
discontinued operations the property and casualty insurance operations of the
Empire Group. The Empire Group had historically engaged in commercial and
personal lines of property and casualty insurance, principally in the New York
metropolitan area. The Empire Group only accepts new business that it is
obligated to accept by contract or New York insurance law; it does not engage in
any other business activities except for its claims runoff operations. The
voluntary liquidation is expected to be substantially complete by 2005. In
December 2001, the Company wrote down its investment in the Empire Group to its
estimated net realizable value based on expected operating results and cash
flows during the liquidation period, which indicated that the Company is
unlikely to realize any value once the liquidation is complete. Accordingly, the
Company recorded a $31,100,000 after-tax charge (net of taxes of $16,800,000) as
a loss on disposal of discontinued operations to fully write-off its investment.
The Company has no obligation to contribute additional capital to the Empire
Group.
47
Recently Issued Accounting Standards
In May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"), which is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. SFAS No. 150 establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. As a result of
the implementation of SFAS 150, the Company began classifying its $98,200,000 of
trust issued preferred securities as liabilities beginning July 1, 2003, and
classifies dividends accrued for these securities as interest expense. SFAS 150
does not permit restatement of prior period amounts to reflect the new
classification.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
which addresses consolidation of variable interest entities, which are entities
in which equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. FIN 46 is effective immediately for variable interest entities
created after January 31, 2003, and for variable interest entities in which an
enterprise obtains an interest after that date. In October 2003, the FASB
deferred to the fourth quarter of 2003 from the third quarter the implementation
date of FIN 46 with respect to variable interest entities in which a variable
interest was acquired before February 1, 2003. In December 2003, the FASB issued
a revision ("FIN 46R") to FIN 46 to clarify certain provisions and exempt
certain entities from its requirements. In addition, FIN 46R deferred to the
first quarter of 2004 application of its provisions to certain entities in which
a variable interest was acquired prior to February 1, 2003. The Company does not
believe that the implementation of FIN 46 will have a material effect on its
consolidated results of operations or financial condition. However, FIN 46R may
impact how the Company accounts for new investments in the future or how the
Company accounts for changes in contractual relationships among parties with an
interest in the Company's existing investments.
In December 2003, the FASB issued Statement of Financial Accounting
Standards No. 132 (revised 2003) "Employers' Disclosures about Pensions and
other Postretirement Benefits" ("SFAS 132R"), which is effective for financial
statements with fiscal years ending after December 15, 2003. The Company has
adopted SFAS 132R, which requires additional disclosures for pension and
postretirement benefit plans.
Cautionary Statement for Forward-Looking Information
Statements included in this Report may contain forward-looking
statements. Such forward-looking statements are made pursuant to the safe-harbor
provisions of the Private Securities Litigation Reform Act of 1995. Such
statements may relate, but are not limited, to projections of revenues, income
or loss, capital expenditures, plans for growth and future operations,
competition and regulation, as well as assumptions relating to the foregoing.
Forward-looking statements are inherently subject to risks and
uncertainties, many of which cannot be predicted or quantified. When used in
this Report, the words "estimates", "expects", "anticipates", "believes",
"plans", "intends" and variations of such words and similar expressions are
intended to identify forward-looking statements that involve risks and
uncertainties. Future events and actual results could differ materially from
those set forth in, contemplated by or underlying the forward-looking
statements.
48
The factors that could cause actual results to differ materially from
those suggested by any such statements include, but are not limited to, those
discussed or identified from time to time in the Company's public filings,
including:
A WORSENING OF GENERAL ECONOMIC AND MARKET CONDITIONS OR INCREASES IN
PREVAILING INTEREST RATE LEVELS, which may result in reduced sales of
our products and services, lower valuations for our associated
companies and investments or a negative impact on the credit quality
of our assets;
CHANGES IN FOREIGN AND DOMESTIC LAWS, REGULATIONS AND TAXES, which may
result in higher costs and lower revenue for our businesses, including
as a result of unfavorable political and diplomatic developments,
currency fluctuations, changes in governmental policies,
expropriation, nationalization, confiscation of assets and changes in
legislation relating to non-U.S. ownership;
INCREASED COMPETITION AND CHANGES IN PRICING ENVIRONMENTS, which may
result in decreasing revenues and/or margins, increased raw materials
costs for our plastics business, loss of market share or significant
price erosion;
CONTINUED INSTABILITY AND UNCERTAINTY IN THE TELECOMMUNICATIONS
INDUSTRY, associated with increased competition, aggressive pricing
and overcapacity;
DEPENDENCE ON KEY PERSONNEL, the loss of which would severely affect
our ability to develop and implement our business strategy;
INABILITY TO ATTRACT AND RETAIN HIGHLY SKILLED PERSONNEL, which would
make it difficult to conduct the businesses of certain of our
subsidiaries, including WilTel and Symphony;
ADVERSE LEGAL AND REGULATORY DEVELOPMENTS THAT MAY AFFECT PARTICULAR
BUSINESSES, such as regulatory developments in the telecommunications
and healthcare industries, or in the environmental area, which could
affect the Company's real estate development activities and
telecommunications business, as well as the Company's other
operations;
WEATHER RELATED CONDITIONS AND SIGNIFICANT NATURAL DISASTERS,
INCLUDING HURRICANES, TORNADOES, WINDSTORMS, EARTHQUAKES AND
HAILSTORMS, which may impact our wineries, real estate holdings and
reinsurance operations;
THE INABILITY TO REINSURE CERTAIN RISKS ECONOMICALLY, which could
result in the Company having to self-insure business risks;
CHANGES IN U.S. REAL ESTATE MARKETS, including the residential market
in Southern California and the commercial market in Washington D.C.,
which are sensitive to mortgage interest rate levels, and the vacation
market in Hawaii;
ADVERSE ECONOMIC, POLITICAL OR ENVIRONMENTAL DEVELOPMENTS IN SPAIN,
which could delay or preclude the issuance of permits necessary to
develop the Company's copper mineral rights or which could result in
increased costs of bringing the project to completion and increased
costs in financing the development of the project;
DECREASES IN WORLD WIDE COPPER PRICES, which could adversely affect
the commercial viability of the Company's mineral rights in Spain;
49
WILTEL'S DEPENDENCE ON A SMALL NUMBER OF SUPPLIERS AND HIGH-VOLUME
CUSTOMERS (INCLUDING SBC), the loss of any of which could adversely
affect WilTel's ability to generate operating profits and positive
cash flows;
CHANGES IN TELECOMMUNICATIONS LAWS AND REGULATIONS, which could
adversely affect WilTel and its customers through, for example, higher
costs, increased competition and a loss of revenue;
WILTEL'S ABILITY TO ADAPT TO TECHNOLOGICAL DEVELOPMENTS OR CONTINUED
OR INCREASED PRICING COMPETITION IN THE TELECOMMUNICATIONS INDUSTRY,
which could adversely affect WilTel's ability to generate operating
profits and positive cash flows;
WILTEL'S INABILITY TO GENERATE OPERATING PROFITS AND POSITIVE CASH
FLOWS, which could result in a default under WilTel's credit
agreement, pursuant to which substantially all of its assets are
pledged;
CURRENT AND FUTURE LEGAL AND ADMINISTRATIVE CLAIMS AND PROCEEDINGS
AGAINST WILTEL, which may result in increased costs and diversion of
management's attention;
WILTEL'S ABILITY TO ACQUIRE OR MAINTAIN RIGHTS OF WAY NECESSARY FOR
THE OPERATION OF ITS NETWORK, which could require WilTel to find
alternate routes or increase WilTel's costs to provide services to its
customers;
CHANGES IN ECONOMIC CONDITIONS INCLUDING THOSE AFFECTING REAL ESTATE
AND OTHER COLLATERAL VALUES, the continued financial stability of the
Company's borrowers and their ability to make loan principal and
interest payments;
REGIONAL OR GENERAL INCREASES IN THE COST OF LIVING, particularly in
the regions in which the Company has operations or sells its products
or services, which may result in lower sales of such products and
service; and
RISKS ASSOCIATED WITH FUTURE ACQUISITIONS AND INVESTMENTS, including
changes in the composition of the Company's assets and liabilities
through such acquisitions, diversion of management's attention from
normal daily operations of the business and insufficient revenues to
offset increased expenses associated with acquisitions.
This list of factors that may affect future performance and the accuracy
of forward-looking statements is illustrative, but is not intended to be
exhaustive. Therefore, all forward-looking statements should be evaluated with
the understanding of their inherent uncertainty. Undue reliance should not be
placed on these forward-looking statements. The Company does not undertake any
obligation to revise or update these forward-looking statements to reflect
events or circumstances that arise after the date of this Report or to reflect
the occurrence of unanticipated events.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
------- ----------------------------------------------------------
The following includes "forward-looking statements" that involve risk
and uncertainties. Actual results could differ materially from those projected
in the forward-looking statements.
The Company's market risk arises principally from interest rate risk
related to its investment portfolio, its borrowing activities and the banking
and lending activities of certain subsidiaries.
The Company's investment portfolio is primarily classified as available
for sale, and consequently, is recorded on the balance sheet at fair value with
unrealized gains and losses reflected in shareholders' equity. Included in the
Company's investment portfolio are fixed income securities, which comprised
50
approximately 76% of the Company's total investment portfolio at December 31,
2003. These fixed income securities are primarily rated "investment grade" or
are U.S. governmental agency issued or guaranteed obligations. The estimated
weighted average remaining life of these fixed income securities was
approximately 2.0 years at December 31, 2003. The Company's fixed income
securities, like all fixed income instruments, are subject to interest rate risk
and will fall in value if market interest rates increase. The Company's
investment portfolio also includes its investment in WMIG, carried at its
aggregate market value of $172,500,000. This investment is approximately 12% of
the Company's total investment portfolio, and its value is subject to change if
the market value of the WMIG stock rises or falls. At December 31, 2002, fixed
income securities comprised approximately 69% of the Company's total investment
portfolio and had an estimated weighted average remaining life of 4.6 years. At
December 31, 2003 and 2002, the Company's portfolio of trading securities was
not material.
The Company is subject to interest rate risk on its long-term fixed
interest rate debt. Generally, the fair market value of debt securities with a
fixed interest rate will increase as interest rates fall, and the fair market
value will decrease as interest rates rise.
The Company's banking and lending operations are subject to risk
resulting from interest rate fluctuations to the extent that there is a
difference between the amount of the interest-earning assets and the amount of
interest-bearing liabilities that are prepaid/withdrawn, mature or reprice in
specified periods. The principal objectives of the Company's banking and lending
asset/liability management activities are to provide maximum levels of net
interest income while maintaining acceptable levels of interest rate and
liquidity risk and to facilitate funding needs. The Company utilizes an interest
rate sensitivity model as the primary quantitative tool in measuring the amount
of interest rate risk that is present. The model quantifies the effects of
various interest rate scenarios on the projected net interest margin over the
ensuing twelve-month period. Derivative financial instruments, including
interest rate swaps, may be used to modify the Company's indicated net interest
sensitivity to levels deemed to be appropriate based on risk management policies
and the Company's current economic outlook. Counterparties to such agreements
are major financial institutions, which the Company believes are able to fulfill
their obligations; however, if they are not, the Company believes that any
losses are unlikely to be material. The banking and lending operations did not
have any derivative financial instruments at December 31, 2003.
The following table provides information about the Company's financial
instruments used for purposes other than trading that are primarily sensitive to
changes in interest rates. For investment securities and debt obligations, the
table presents principal cash flows by expected maturity dates. For the variable
rate notes receivable and variable rate borrowings, the weighted average
interest rates are based on implied forward rates in the yield curve at the
reporting date. For loans, securities and liabilities with contractual
maturities, the table presents contractual principal cash flows adjusted for the
Company's historical experience and prepayments of mortgage-backed securities.
For banking and lending's variable rate products, the weighted average variable
rates are based upon the respective pricing index at the reporting date. For
money market deposits that have no contractual maturity, the table presents
principal cash flows based on the Company's historical experience and
management's judgment concerning their most likely withdrawal behaviors. For
interest rate swaps, the table presents notional amounts by contractual maturity
date.
For additional information, see Notes 6, 11 and 20 of Notes to
Consolidated Financial Statements.
51
Expected Maturity Date
----------------------
2004 2005 2006 2007 2008
---- ---- ---- ---- ----
(Dollars in thousands)
THE COMPANY, EXCLUDING
- ----------------------
BANKING AND LENDING:
--------------------
RATE SENSITIVE ASSETS:
Available for Sale Fixed Income
Securities:
U.S. Government $ 524,499 $ 127,750 $ - $ 873 $ -
Weighted Average
Interest Rate 1.43% 1.64% - 3.63% -
Other Fixed Maturities:
Rated Investment Grade $ 55,270 $ 3,418 $ 1,666 $ - $ -
Weighted Average
Interest Rate 2.26% 5.78% 6.75% - -
Rated Less Than Investment
Grade/Not Rated $ 39,930 $ 19,282 $ 19,940 $ 31,266 $ 25,770
Weighted Average
Interest Rate 7.22% 5.51% 4.43% 6.02% 9.07%
RATE SENSITIVE LIABILITIES:
Fixed Interest Rate Borrowings $ 5,225 $ 22,835 $ 72,090 $ 4,106 $ 19,867
Weighted Average
Interest Rate 8.72% 7.57% 9.66% 6.39% 5.53%
Variable Interest Rate Borrowings $ 2,114 $ 177,739 $ 255,726 $ 11,929 $ 2,114
Weighted Average
Interest Rate 5.35% 5.65% 5.87% 5.68% 6.76%
RATE SENSITIVE DERIVATIVE
FINANCIAL INSTRUMENTS:
Euro currency swap $ 2,085 $ 2,085 $ 2,085 $ 2,085 $ 2,085
Average Pay Rate 5.89% 5.89% 5.89% 5.89% 5.89%
Average Receive Rate 7.60% 7.60% 7.60% 7.60% 7.60%
Pay Fixed/Receive Variable
Interest Rate Swap $ 2,114 $ 2,114 $ 2,114 $ 2,114 $ 2,114
Average Pay Rate 5.01% 5.01% 5.01% 5.01% 5.01%
Average Receive Rate 2.29% 3.76% 4.77% 5.25% 6.11%
OFF-BALANCE SHEET ITEMS:
Unused Lines of Credit $ - $ 7,197 $ 110,000 $ - $ -
Weighted Average
Interest Rate 3.24% 4.44% 4.60% - -
** TABLE CONTINUED **
Expected Maturity Date
----------------------
Thereafter Total Fair Value
---------- ----- ----------
THE COMPANY, EXCLUDING
- ----------------------
BANKING AND LENDING:
--------------------
RATE SENSITIVE ASSETS:
Available for Sale Fixed Income
Securities:
U.S. Government $ - $ 653,122 $ 653,122
Weighted Average
Interest Rate -
Other Fixed Maturities:
Rated Investment Grade $ 108 $ 60,462 $ 60,462
Weighted Average
Interest Rate 11.0%
Rated Less Than Investment
Grade/Not Rated $ 64,737 $ 200,925 $ 200,925
Weighted Average
Interest Rate 7.99%
RATE SENSITIVE LIABILITIES:
Fixed Interest Rate Borrowings $551,367 $ 675,490 $ 679,345
Weighted Average
Interest Rate 7.43%
Variable Interest Rate Borrowings $ 37,105 $ 486,727 $ 486,727
Weighted Average
Interest Rate 7.07%
RATE SENSITIVE DERIVATIVE
FINANCIAL INSTRUMENTS:
Euro currency swap $ 2,608 $ 13,033 $ (4,864)
Average Pay Rate 5.89%
Average Receive Rate 7.60%
Pay Fixed/Receive Variable
Interest Rate Swap $ 37,105 $ 47,675 $ (3,079)
Average Pay Rate 5.01%
Average Receive Rate 6.42%
OFF-BALANCE SHEET ITEMS:
Unused Lines of Credit $ - $ 117,197 $ 117,197
Weighted Average
Interest Rate -
** TABLE COMPLETE **
52
Expected Maturity Date
----------------------
2004 2005 2006 2007 2008
---- ---- ---- ---- ----
(Dollars in thousands)
BANKING AND LENDING:
- --------------------
RATE SENSITIVE ASSETS:
Certificates of Deposit $ 299 $ - $ - $ - $ -
Weighted Average
Interest Rate 1.80% - - - -
Fixed Interest Rate
Securities $ 3,889 $ 516 $ 187 $ 18 $ 1,686
Weighted Average
Interest Rate 8.47% 8.45% 8.43% 7.96% 5.35%
Variable Interest Rate
Securities $ 12,072 $ 11,035 $ 8,854 $ 3,490 $ 3,614
Weighted Average
Interest Rate 1.26% .91% .91% .91% .91%
Fixed Interest Rate Loans $ 83,087 $ 37,014 $ 16,846 $ 7,524 $ 8,509
Weighted Average
Interest Rate 20.75% 20.43% 18.89% 17.73% 17.72%
Variable Interest Rate
Loans $ 7,241 $ 6,072 $ 4,670 $ 4,934 $ 2,704
Weighted Average
Interest Rate 15.14% 15.03% 14.94% 15.24% 14.67%
RATE SENSITIVE LIABILITIES:
Money Market Deposits $ 12,312 $ - $ - $ - $ -
Weighted Average
Interest Rate .68% - - - -
Time Deposits $ 91,019 $ 26,273 $ 5,976 $ 9,803 $ 114
Weighted Average
Interest Rate 2.94% 6.01% 5.21% 4.55% 1.47%
Fixed Interest Rate
Borrowings $ 16,617 $ - $ - $ - $ -
Weighted Average
Interest Rate 1.19% - - - -
OFF-BALANCE SHEET ITEMS:
Unused Lines of Credit $ - $ - $ - $ - $ -
Weighted Average
Interest Rate - - - - -
** TABLE CONTINUED **
Expected Maturity Date
----------------------
Thereafter Total Fair Value
---------- ----- ----------
BANKING AND LENDING:
- --------------------
RATE SENSITIVE ASSETS:
Certificates of Deposit $ - $ 299 $ 299
Weighted Average
Interest Rate - 1.80%
Fixed Interest Rate
Securities $ 1,125 $ 7,421 $ 7,421
Weighted Average
Interest Rate 6.24% 7.42%
Variable Interest Rate
Securities $ 11,217 $ 50,282 $ 50,282
Weighted Average
Interest Rate 1.99% 1.24%
Fixed Interest Rate Loans $ 18,027 $ 171,007 $ 160,758
Weighted Average
Interest Rate 18.53% 19.96%
Variable Interest Rate
Loans $ 8,824 $ 34,445 $ 34,704
Weighted Average
Interest Rate 14.52% 14.91%
RATE SENSITIVE LIABILITIES:
Money Market Deposits $ - $ 12,312 $ 12,312
Weighted Average
Interest Rate - .68%
Time Deposits $ 35 $ 133,220 $ 136,596
Weighted Average
Interest Rate .50% 3.77%
Fixed Interest Rate
Borrowings $ - $ 16,617 $ 16,617
Weighted Average
Interest Rate - 1.19%
OFF-BALANCE SHEET ITEMS:
Unused Lines of Credit $ 17,000 $ 17,000 $ 17,000
Weighted Average
Interest Rate 1.06% 1.06%
Item 8. Financial Statements and Supplementary Data.
- ------ -------------------------------------------
Financial Statements and supplementary data required by this Item 8 are
set forth at the pages indicated in Item 15(a) below.
Item 9. Changes in and Disagreements with Accountants on Accounting and
- ------- ---------------------------------------------------------------
Financial Disclosure.
---------------------
Not applicable.
53
Item 9A. Controls and Procedures.
- ------- -----------------------
(a) The Company's management evaluated, with the participation of the
Company's principal executive and principal financial officers, the
effectiveness of the Company's disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act")), as of December 31, 2003. Based on their
evaluation, the Company's principal executive and principal financial officers
concluded that the Company's disclosure controls and procedures were effective
as of December 31, 2003.
(b) There has been no change in the Company's internal control over
financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) that occurred during the Company's fiscal quarter ended December
31, 2003, that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
PART III
Item 10. Directors and Executive Officers of the Registrant.
- ------- --------------------------------------------------
The information to be included under the caption "Election of Directors"
and "Information Concerning the Board and Board Committees" in the Company's
definitive proxy statement to be filed with the Commission pursuant to
Regulation 14A of the Exchange Act in connection with the 2004 annual meeting of
shareholders of the Company (the "Proxy Statement") is incorporated herein by
reference. In addition, reference is made to Item 10 in Part I of this Report.
Item 11. Executive Compensation.
- ------- ----------------------
The information to be included under the caption "Executive
Compensation" in the Proxy Statement is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
- ------- --------------------------------------------------------------
Equity Compensation Plan Information
The following table summarizes information regarding the Company's
equity compensation plans as of December 31, 2003. All outstanding awards relate
to the Company's common stock.
Number of securities
remaining available
for future issuance
Number of securities Weighted-average under equity
to be issued upon exercise price of compensation plans
exercise of outstanding options, outstanding options, (excluding securities
warrants and rights warrants and rights reflected in column (a))
Plan Category (a) (b) (c)
- ------------- -------------------------------- ---------------------- -------------------------
Equity compensation
plans approved by
security holders 1,286,120 $ 25.30 592,650
Equity compensation
plans not approved
by security holders - - -
---------- -------- -----------
Total 1,286,120 $ 25.30 592,650
========== ======== ==========
54
The information to be included under the caption "Present Beneficial
Ownership of Common Shares" in the Proxy Statement is incorporated herein by
reference.
Item 13. Certain Relationships and Related Transactions.
- ------- ----------------------------------------------
The information to be included under the caption "Executive Compensation
- - Certain Relationships and Related Transactions" in the Proxy Statement is
incorporated herein by reference.
Item 14. Principal Accounting Fees and Services.
- -------- --------------------------------------
The information to be included under the caption "Principal Accounting
Fees and Services" in the Proxy Statement is incorporated herein by reference.
55
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
- -------- -----------------------------------------------------------------
(a)(1)(2) Financial Statements and Schedules.
Report of Independent Auditors............................................................................... F-1
Financial Statements:
Consolidated Balance Sheets at December 31, 2003 and 2002................................................. F-2
Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and
2001 .................................................................................................. F-3
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and
2001 .................................................................................................. F-4
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 2003, 2002 and 2001....................................................................... F-6
Notes to Consolidated Financial Statements................................................................ F-7
Financial Statement Schedules:
Schedule I - Condensed Financial Information of Registrant............................................... F-51
Schedule II - Valuation and Qualifying Accounts........................................................... F-56
(3) Executive Compensation Plans and Arrangements.
---------------------------------------------
1999 Stock Option Plan (filed as Annex A to the Company's Proxy
Statement dated April 9, 1999 (the "1999 Proxy Statement")).
Amended and Restated Shareholders Agreement dated as of June 30, 2003
among the Company, Ian M. Cumming and Joseph S. Steinberg.
Leucadia National Corporation 2003 Senior Executive Annual Incentive
Bonus Plan (filed as Annex A to the Company's Proxy Statement dated
April 17, 2003 (the "2003 Proxy Statement")).
Employment Agreement made as of December 28, 1993 by and between the
Company and Ian M. Cumming (filed as Exhibit 10.17 to the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1993
(the "1993 10-K")).
Amendment, dated as of May 5, 1999, to the Employment Agreement made
as of December 28, 1993 by and between the Company and Ian M. Cumming
(filed as Exhibit 10.19 to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 2001 (the "2001 10-K")).
Employment Agreement made as of December 28, 1993 by and between the
Company and Joseph S. Steinberg (filed as Exhibit 10.18 to the 1993
10-K).
Amendment, dated as of May 5, 1999, to the Employment Agreement made
as of December 28, 1993 by and between the Company and Joseph S.
Steinberg (filed as Exhibit 10.21 to the 2001 10-K).
Leucadia National Corporation Senior Executive Warrant Plan (filed as
Annex B to the 1999 Proxy Statement).
Deferred Compensation Agreement between the Company and Thomas E. Mara
dated as of December 20, 2001 (filed as Exhibit 10.28 to the 2001
10-K).
56
(b) Reports on Form 8-K.
-------------------
The Company filed current reports on Form 8-K dated October 2, 2003,
October 16, 2003, October 30, 2003, November 5, 2003, November 6, 2003,
November 14, 2003 and December 4, 2003, which set forth information under
Item 5. Other Events and Item 7. Financial Statements and Exhibits.
The Company filed a current report on Form 8-K dated November 6, 2003
which set forth information under Item 2. Acquisition or Disposition of
Assets and Item 7. Financial Statements and Exhibits.
(c) Exhibits.
- ------------
3.1 Restated Certificate of Incorporation (filed as Exhibit 5.1
to the Company's Current Report on Form 8-K dated July 14,
1993).*
3.2 Certificate of Amendment of the Certificate of Incorporation
dated as of May 14, 2002.
3.3 Certificate of Amendment of the Certificate of Incorporation
dated as of December 23, 2002 (filed as Exhibit 3.2 to the
Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 2002 (the "2002 10-K")).*
3.4 Amended and Restated By-laws as amended through March 9,
2004.
4.1 The Company undertakes to furnish the Securities and
Exchange Commission, upon request, a copy of all instruments
with respect to long-term debt not filed herewith.
10.1 1999 Stock Option Plan (filed as Annex A to the 1999 Proxy
Statement).*
10.2 Articles and Agreement of General Partnership, effective as
of April 15, 1985, of Jordan/Zalaznick Capital Company
(filed as Exhibit 10.20 to the Company's Registration
Statement No. 33-00606).*
10.3 Fiber Lease Agreement together with Colocation and
Maintenance Agreement, each dated April 26, 2002, and each
amended October 10, 2002, and February 14, 2003, between WCL
and Metromedia Fiber National Network, Inc. (filed as
Exhibit 10.48 to WilTel's Annual Report on Form 10-K for the
fiscal year ended December 31, 2002 (the "WilTel 10-K")).*
10.4 Leucadia National Corporation Senior Executive Warrant Plan
(filed as Annex B to the 1999 Proxy Statement).*
10.5 Amended and Restated Shareholders Agreement dated as of June
30, 2003 among the Company, Ian M. Cumming and Joseph S.
Steinberg.
57
10.6 Form of Amended and Restated Revolving Credit Agreement
dated as of March 11, 2003 between the Company, Fleet
National Bank as Administrative Agent, The Chase Manhattan
Bank, as Syndication Agent, and the Banks signatory thereto,
with Fleet Boston Robertson Stephens, Inc., as Arranger
(filed as Exhibit 10.1 to the Company's Quarterly Report on
Form 10-Q for the quarterly period ended March 31, 2003).*
10.7 Purchase Agreement among Conseco, Inc., the Company, Charter
National Life Insurance Company, Colonial Penn Group, Inc.,
Colonial Penn Holdings, Inc., Leucadia Financial
Corporation, Intramerica Life Insurance Company, Colonial
Penn Franklin Insurance Company and Colonial Penn Insurance
Company dated as of April 30, 1997 (filed as Exhibit 10.1 to
the Company's Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 1997).*
10.8 Purchase Agreement among General Electric Capital
Corporation, the Company, Charter National Life Insurance
Company, Colonial Penn Group Inc. and Colonial Penn
Holdings, Inc. dated as of June 30, 1997 (filed as Annex A
to the Company's Proxy Statement dated October 3, 1997 (the
"1997 Proxy Statement")).*
10.9 Purchase Agreement by and among Allstate Life Insurance
Company, Allstate Life Insurance Company of New York,
Charter National Life Insurance Company, Intramerica Life
Insurance Company and the Company, dated February 11, 1998
(filed as Exhibit 10.16 to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1997 (the
"1997 10-K")).*
10.10 Leucadia National Corporation 2003 Senior Executive Annual
Incentive Bonus Plan (filed as Annex A to the 2003 Proxy
Statement).*
10.11 Stock Purchase Agreement by and between the Company and
Allstate Life Insurance Company dated as of December 18,
1998 (filed as Exhibit 10.14 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31,
1998 (the "1998 10-K")).*
10.12 Employment Agreement made as of December 28, 1993 by and
between the Company and Ian M. Cumming (filed as Exhibit
10.17 to the Company's 1993 10-K).*
10.13 Amendment, dated as of May 5, 1999, to the Employment
Agreement made as of December 28, 1993 by and between the
Company and Ian M. Cumming (filed as Exhibit 10.19 to the
2001 10-K).*
10.14 Employment Agreement made as of December 28, 1993 by and
between the Company and Joseph S. Steinberg (filed as
Exhibit 10.18 to the 1993 10-K).*
10.15 Amendment, dated as of May 5, 1999, to the Employment
Agreement made as of December 28, 1993 by and between the
Company and Joseph S. Steinberg (filed as Exhibit 10.21 to
the 2001 10-K).*
10.16 Management Services Agreement dated as of February 26, 2001
among The FINOVA Group Inc., the Company and Leucadia
International Corporation (filed as Exhibit 10.20 to the
2000 10-K).*
10.17 Voting Agreement, dated August 21, 2001, by and among
Berkadia LLC, Berkshire Hathaway Inc., the Company and The
FINOVA Group Inc. (filed as Exhibit 10.J to the Company's
Current Report on Form 8-K dated August 27, 2001).*
10.18 Deferred Compensation Agreement between the Company and
Thomas E. Mara dated as of December 20, 2001 (filed as
Exhibit 10.28 to the 2001 10-K).*
58
10.19 Settlement Agreement dated as of July 26, 2002, by and among
The Williams Companies Inc. ("TWC"), Williams Communications
Group, Inc. ("WCG"), CG Austria, Inc., the official
committee of unsecured creditors and the Company (filed as
Exhibit 99.2 to the Current Report on Form 8-K of WCG dated
July 31, 2002 (the "WCG July 31, 2002 8-K")).*
10.20 Investment Agreement, dated as of July 26, 2002, by and
among the Company, WCG and, for purposes of Section 7.4
only, Williams Communications, LLC ("WCL") (filed as Exhibit
99.4 to the WCG July 31, 2002 8-K).*
10.21 First Amendment, made as of September 30, 2002, to the
Investment Agreement, dated as of July 26, 2002, by and
among the Company, WCG and WCL (filed as Exhibit 99.4 to the
Current Report on Form 8-K of WCG dated October 24, 2002
(the "WilTel October 24, 2002 8-K")).*
10.22 Second Amendment, made as of October 15, 2002, to the
Investment Agreement, dated as of July 26, 2002, as amended
on September 30, 2002, by and among the Company, WCG and WCL
(filed as Exhibit 99.5 to the WilTel October 24, 2002 8-K).*
10.23 Purchase and Sale Agreement, dated as of July 26, 2002, by
and between TWC and the Company (filed as Exhibit 99.5 to
the Company's Current Report on Form 8-K dated July 31,
2002).*
10.24 Amendment, made as of October 15, 2002, to the Purchase and
Sale Agreement, dated as of July 26, 2002, by and among the
Company and TWC (filed as Exhibit 99.2 to the WilTel October
24, 2002 8-K).*
10.25 Escrow Agreement, dated as of October 15, 2002, among the
Company, TWC, WilTel and The Bank of New York, as Escrow
Agent (filed as Exhibit 99.3 to the WilTel October 24, 2002
8-K).*
10.26 Share Purchase Agreement, dated April 17, 2002 between LUK
Fidei L.L.C. and Hampton Trust PLC (filed as Exhibit 10.37
to the 2002 10-K).*
10.27 Reiterative Share Purchase Agreement, dated June 4, 2002,
among Savits AB Private, Hampton Trust Holding (Europe) SA,
John C. Jones and Herald Century Consolidated SA (filed as
Exhibit 10.38 to the 2002 10-K).*
10.28 Agreement and Plan of Merger, dated August 21, 2003, among
the Company, Wrangler Acquisition Corp. and WilTel (filed as
Exhibit 2.1 to the Company's Current Report on Form 8-K
dated August 22, 2003).*
10.29 Stock Purchase Agreement, dated as of October 21, 2002,
between HomeFed Corporation ("HomeFed") and the Company
(filed as Exhibit 10.1 to the Current Report on Form 8-K of
HomeFed dated October 22, 2002).*
10.30 Second Amended and Restated Berkadia LLC Operating
Agreement, dated December 2, 2002, by and among BH Finance
LLC and WMAC Investment Corporation (filed as Exhibit 10.40
to the 2002 10-K).*
10.31 Subscription Agreement made and entered into as of December
23, 2002 by and among the Company and each of the entities
named in Schedule I thereto (filed as Exhibit 10.41 to the
2002 10-K).*
59
10.32 Amended and Restated Alliance Agreement between Telefonos de
Mexico, S.A. de C.V. and Williams Communications, Inc.,
dated May 25, 1999 (filed as Exhibit 10.2 to WCG's Equity
Registration Statement, Amendment No. 8, dated September 29,
1999).*
10.33 Master Alliance Agreement between SBC Communications Inc.
and Williams Communications, Inc. dated February 8, 1999
(filed as Exhibit 10.10 WCG's Equity Registration Statement,
Amendment No. 1, dated May 27, 1999).*
10.34 Transport Services Agreement dated February 8, 1999, between
Southwestern Bell Communication Services, Inc. and Williams
Communications, Inc. (filed as Exhibit 10.11 to WCG's Equity
Registration Statement, Amendment No. 1, dated May 27,
1999).*
10.35 Copy of WCG's April 22, 2002, agreement with principal
creditor group (filed as Exhibit 10.1 to WCG's Current
Report on Form 8-K dated April 22, 2002 (the "WCG April 22,
2002 8-K")).*
10.36 Copy of WCG's agreement with TWC (filed as Exhibit 10.2 to
the WCG April 22, 2002 8-K).*
10.37 First Amended Joint Chapter 11 Plan of Reorganization of WCG
and CG Austria, filed with the Bankruptcy Court as Exhibit 1
to the Settlement Agreement (filed as Exhibit 99.3 to the
WCG July 31, 2002 8-K).*
10.38 Real Property Purchase and Sale Agreement among WilTel,
Williams Headquarters Building Company, Williams Technology
Center, LLC, WCL, and Williams Aircraft Leasing, LLC, dated
July 26, 2002, filed with the Bankruptcy Court as Exhibit 4
to the Settlement Agreement (filed as Exhibit 99.6 to the
WCG July 31, 2002 8-K).*
10.39 List of TWC Continuing Contracts, filed with the Bankruptcy
Court as Exhibit 5 to the Settlement Agreement (filed as
Exhibit 99.7 to the WCG July 31, 2002 8-K).*
10.40 Agreement for the Resolution of Continuing Contract Disputes
among WCG, WCL and TWC, dated July 26, 2002, filed with the
Bankruptcy Court as Exhibit 6 to the Settlement Agreement
(filed as Exhibit 99.8 to the WCG July 31, 2002 8-K).*
10.41 Tax Cooperation Agreement between WCG and TWC, dated July
26, 2002, filed with the Bankruptcy Court as Exhibit 7 to
the Settlement Agreement (filed as Exhibit 99.9 to the WCG
July 31, 2002 8-K).*
10.42 Amendment to Trademark License Agreement between WCG and
TWC, dated July 26, 2002, filed with the Bankruptcy Court as
Exhibit to the Settlement Agreement (filed as Exhibit 99.10
to the WCG July 31, 2002 8-K).*
10.43 Assignment of Rights between Williams Information Services
Corporation and WCL, dated July 26, 2002, filed with the
Bankruptcy Court as Exhibit 9 to the Settlement Agreement
(filed as Exhibit 99.11 to the WCG July 31, 2002 8-K).*
10.44 Guaranty Indemnification Agreement between WCG and TWC,
dated July 26, 2002, filed with the Bankruptcy Court as
Exhibit 10 to the Settlement Agreement (filed as Exhibit
99.12 to the WCG July 31, 2002 8-K).*
10.45 Declaration of Trust, dated as of October 15, 2002, by and
among WCG, WilTel and the Residual Trustee (filed as Exhibit
99.1 to WilTel's Current Report on Form 8-K dated October
24, 2002 (the "WilTel October 24, 2002 8-K")).*
60
10.46 Second Amended and Restated Credit and Guaranty Agreement of
WilTel, dated as of September 8, 1999, as amended and
restated as of April 25, 2001 and as further amended and
restated as of October 15, 2002 (filed as Exhibit 99.12 to
the WilTel October 24, 2002 8-K).*
10.47 Amendment No. 9, dated as of October 15, 2002, to Amended
and Restated Credit Agreement of WilTel, dated as of
September 8, 1999, and Amendment No. 1, dated as of October
15, 2002, to the Subsidiary Guarantee, dated as of September
8, 1999 (filed as Exhibit 99.13 to the WilTel October 24,
2002 8-K).*
10.48 Amended and Restated Security Agreement, dated as of April
23, 2001, as amended and restated as of October 15, 2002
(filed as Exhibit 99.14 to the WilTel October 24, 2002
8-K).*
10.49 Amendment No. 1, dated as of October 15, 2002, to the Real
Property Purchase and Sale Agreement, dated as of July 26,
2002, among Williams Headquarters Building Company, WTC,
WCL, WCG and Williams Communications Aircraft, LLC (filed as
Exhibit 99.15 to the WilTel October 24, 2002 8-K).*
10.50 Pledge Agreement dated as of October 15, 2002, by CG
Austria, Inc., as pledgor, to Williams Headquarters Building
Company, as pledgee (filed as Exhibit 10.42 to the WilTel
10-K).*
10.51 First Amendment to Master Alliance Agreement between SBC
Communications Inc. and Williams Communications, Inc., by
and between SBC Communications Inc. and WCL, effective as of
September 23, 2002 (filed as Exhibit 10.43 to the WilTel
10-K).*
10.52 First Amendment to Transport Services Agreement among
Southwestern Bell Communications Services Inc., SBC
Operations, Inc. and Williams Communications, Inc., by and
among Southwestern Bell Communications Services Inc., SBC
Operations, Inc. and Williams Communications, Inc., dated
September 29, 2000 (filed as Exhibit 10.44 to the WilTel
10-K).*
10.53 Second Amendment to Transport Services Agreement, as amended
by Amendment No. 1 dated September 29, 2000, by and among
Southwestern Bell Communications Services Inc., SBC
Operations, Inc. and WCL, effective as of June 25, 2001
(filed as Exhibit 10.45 to the WilTel 10-K).*
10.54 Third Amendment to Transport Services Agreement, as amended
by Amendment No. 1 dated September 20, 2000, and Amendment
No. 2 dated June 25, 2001, by and among Southwestern Bell
Communications Services Inc., SBC Operations, Inc. and WCL,
effective as of September 23, 2002 (filed as Exhibit 10.46
to the WilTel 10-K).*
10.55 Fiber Lease Agreement, together with Colocation and
Maintenance Agreement and Lease Agreement #2, each dated
April 26, 2002, and each amended October 10, 2002, between
Metromedia Fiber Network Services, Inc. and WCL (filed as
Exhibit 10.47 to the WilTel 10-K).*
10.56 Amendment No. 2 to Master Alliance Agreement and Amendment
No. 4 to Transport Services Agreement, dated December 31,
2003, amending the (a) Master Alliance Agreement, effective
as of February 8, 1999, as amended by Amendment No. 1
effective September 23, 2002, by and between WCL, and SBC
Communications Inc. and (b) Transport Services Agreement,
effective as of February 8, 1999, as amended by Amendment
No. 1 dated as of September 29, 2000, Amendment No. 2 and
Amendment No. 3 dated as of September 23, 2002 by and among
WCL, SBC Operations, Inc., and Southwestern Bell
Communications Services Inc.
21 Subsidiaries of the registrant.
61
23.1 Consent of PricewaterhouseCoopers LLP with respect to the
incorporation by reference into the Company's Registration
Statement on Form S-8 (File No. 2-84303), Form S-8 and S-3
(File No. 33-6054), Form S-8 and S-3 (File No. 33-26434),
Form S-8 and S-3 (File No. 33-30277), Form S-8 (File No.
33-61682), Form S-8 (File No. 33-61718), Form S-8 (File No.
333-51494) and Form S-4 (File No. 333-86018).
23.2 Consent of PricewaterhouseCoopers, with respect to the
inclusion in this Annual Report on Form 10-K the financial
statements of Olympus Re Holdings, Ltd. and with respect to
the incorporation by reference in the Company's Registration
Statements on Form S-8 (No. 2-84303), Form S-8 and S-3 (No.
33-6054), Form S-8 and S-3 (No. 33-26434), Form S-8 and S-3
(No. 33-30277), Form S-8 (No. 33-61682), Form S-8 (No.
33-61718), Form S-8 (No. 333-51494) and Form S-4 (No.
333-86018).
23.3 Consent of independent auditors from Ernst & Young LLP with
respect to the inclusion in this Annual Report on Form 10-K
of the financial statements of Berkadia LLC and with respect
to the incorporation by reference in the Company's
Registration Statements on Form S-8 (No. 2-84303), Form S-8
and S-3 (No. 33-6054), Form S-8 and S-3 (No. 33-26434), Form
S-8 and S-3 (No. 33-30277), Form S-8 (No. 33-61682), Form
S-8 (No. 33-61718), Form S-8 (No. 333-51494) and Form S-4
(No. 333-86018).
23.4 Consent of independent auditors from Ernst & Young LLP with
respect to the inclusion in this Annual Report on Form 10-K
of the financial statements of The FINOVA Group Inc. and
with respect to the incorporation by reference in the
Company's Registration Statements on Form S-8 (No. 2-84303),
Form S-8 and S-3 (No. 33-6054), Form S-8 and S-3 (No.
33-26434), Form S-8 and S-3 (No. 33-30277), Form S-8 (No.
33-61682), Form S-8 (No. 33-61718), Form S-8 (No. 333-51494)
and Form S-4 (No. 333-86018).**
23.5 Independent Auditors' Consent from KPMG LLP, with respect to
the inclusion in this Annual Report on Form 10-K of the
financial statements of Jefferies Partners Opportunity Fund
II, LLC for the three years ended December 31, 2003 and with
respect to the incorporation by reference in the Company's
Registration Statements on Form S-8 (No. 2-84303), Form S-8
and S-3 (No. 33-6054), Form S-8 and S-3 (No. 33-26434), Form
S-8 and S-3 (No. 33-30277), Form S-8 (No. 33-61682), Form
S-8 (No. 33-61718), Form S-8 (No. 333-51494) and Form S-4
(No. 333-86018).
23.6 Consent of independent auditors from BDO Seidman, LLP with
respect to the inclusion in this Annual Report on Form 10-K
of the financial statements of EagleRock Capital Partners
(QP), LP and EagleRock Master Fund and with respect to the
incorporation by reference in the Company's Registration
Statements on Form S-8 (No. 2-84303), Form S-8 and S-3 (No.
33-6054), Form S-8 and S-3 (No. 33-26434), Form S-8 and S-3
(No. 33-30277), Form S-8 (No. 33-61682), Form S-8 (No.
33-61718), Form S-8 (No. 333-51494) and Form S-4 (No.
333-86018).
23.7 Consent of independent auditors from Ernst & Young LLP with
respect to the inclusion in this Annual Report on Form 10-K
of the financial statements of WilTel Communications Group,
Inc. and with respect to the incorporation by reference in
the Company's Registration Statements on Form S-8 (No.
2-84303), Form S-8 and S-3 (No. 33-6054), Form S-8 and S-3
(No. 33-26434), Form S-8 and S-3 (No. 33-30277), Form S-8
(No. 33-61682), Form S-8 (No. 33-61718), Form S-8 (No.
333-51494) and Form S-4 (No. 333-86018).
31.1 Certification of Chairman of the Board and Chief Executive
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification of President pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
62
31.3 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chairman of the Board and Chief Executive
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.***
32.2 Certification of President pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.***
32.3 Certification of Principal Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.***
(d) Financial statement schedules.
-----------------------------
(1) Berkadia LLC financial statements as of December 31,
2003 and 2002 and for the years ended December 31, 2003
and 2002 and for the period from inception, February
26, 2001, to December 31, 2001.
(2) Olympus Re Holdings, Ltd. combined financial statements
as of December 31, 2003 and 2002 for the years ended
December 31, 2003 and 2002 and for the period from
December 3, 2001 (date of incorporation) to December
31, 2001.
(3) The FINOVA Group Inc. and subsidiaries consolidated
financial statements as of December 31, 2003 and 2002
and for the years ended December 31, 2003, 2002 and
2001.**
(4) Jefferies Partners Opportunity Fund II, LLC financial
statements as of December 31, 2003 and 2002 and for the
years ended December 31, 2003, 2002 and 2001.
(5) EagleRock Capital Partners (QP), LP financial
statements as of December 31, 2003 and 2002 and for the
year ended December 31, 2003 and for the period from
January 1, 2002 (commencement of operations) to
December 31, 2002 and EagleRock Master Fund financial
statements as of December 31, 2003 and 2002 and for the
year ended December 31, 2003 and for the period from
May 1, 2002 (commencement of operations) to December
31, 2002.
(6) WilTel Communications Group, Inc. consolidated
financial statements as of November 5, 2003 and
December 31, 2002 (Successor Company), and for the
periods from January 1, 2003 through November 5, 2003,
and November 1, 2002 through December 31, 2002
(Successor Company) and the periods January 1, 2002
through October 31, 2002, and for the year ended
December 31, 2001 (Predecessor Company).
-----------------------------
* Incorporated by reference.
** To be filed by amendment pursuant to Item 3-09(b) of Regulation S-X.
*** Furnished herewith pursuant to item 601(b)(32) of Regulation S-K.
63
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
LEUCADIA NATIONAL CORPORATION
March 12, 2004 By: /s/ Barbara L. Lowenthal
------------------------------
Barbara L. Lowenthal
Vice President and Comptroller
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated, on the date set forth above.
Signature Title
--------- -----
/s/ Ian M. Cumming Chairman of the Board
- --------------------------------------------------- (Principal Executive Officer)
Ian M. Cumming
/s/ Joseph S. Steinberg President and Director
- --------------------------------------------------- (Principal Executive Officer)
Joseph S. Steinberg
/s/ Joseph A. Orlando Vice President and Chief Financial Officer
- --------------------------------------------------- (Principal Financial Officer)
Joseph A. Orlando
/s/ Barbara L. Lowenthal Vice President and Comptroller
- --------------------------------------------------- (Principal Accounting Officer)
Barbara L. Lowenthal
/s/ Paul M. Dougan Director
- ---------------------------------------------------
Paul M. Dougan
/s/ Lawrence D. Glaubinger Director
- ---------------------------------------------------
Lawrence D. Glaubinger
/s/ James E. Jordan Director
- ---------------------------------------------------
James E. Jordan
/s/ Jesse Clyde Nichols, III Director
- ---------------------------------------------------
Jesse Clyde Nichols, III
64
EXHIBIT INDEX
3.1 Restated Certificate of Incorporation (filed as Exhibit 5.1
to the Company's Current Report on Form 8-K dated July 14,
1993).*
3.2 Certificate of Amendment of the Certificate of Incorporation
dated as of May 14, 2002.
3.3 Certificate of Amendment of the Certificate of Incorporation
dated as of December 23, 2002 (filed as Exhibit 3.2 to the
2002 10-K).*
3.4 Amended and Restated By-laws as amended through March 9,
2004.
4.1 The Company undertakes to furnish the Securities and
Exchange Commission, upon request, a copy of all instruments
with respect to long-term debt not filed herewith.
10.1 1999 Stock Option Plan (filed as Annex A to the 1999 Proxy
Statement).*
10.2 Articles and Agreement of General Partnership, effective as
of April 15, 1985, of Jordan/Zalaznick Capital Company
(filed as Exhibit 10.20 to the Company's Registration
Statement No. 33-00606).*
10.3 Fiber Lease Agreement together with Colocation and
Maintenance Agreement, each dated April 26, 2002, and each
amended October 10, 2002, and February 14, 2003, between WCL
and Metromedia Fiber National Network, Inc. (filed as
Exhibit 10.48 to the WilTel 10-K).*
10.4 Leucadia National Corporation Senior Executive Warrant Plan
(filed as Annex B to the 1999 Proxy Statement).*
10.5 Amended and Restated Shareholders Agreement dated as of June
30, 2003 among the Company, Ian M. Cumming and Joseph S.
Steinberg.
10.6 Form of Amended and Restated Revolving Credit Agreement
dated as of March 11, 2003 between the Company, Fleet
National Bank as Administrative Agent, The Chase Manhattan
Bank, as Syndication Agent, and the Banks signatory thereto,
with Fleet Boston Robertson Stephens, Inc., as Arranger
(filed as Exhibit 10.1 to the Company's Quarterly Report on
Form 10-Q for the quarterly period ended March 31, 2003).*
10.7 Purchase Agreement among Conseco, Inc., the Company, Charter
National Life Insurance Company, Colonial Penn Group, Inc.,
Colonial Penn Holdings, Inc., Leucadia Financial
Corporation, Intramerica Life Insurance Company, Colonial
Penn Franklin Insurance Company and Colonial Penn Insurance
Company dated as of April 30, 1997 (filed as Exhibit 10.1 to
the Company's Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 1997).*
10.8 Purchase Agreement among General Electric Capital
Corporation, the Company, Charter National Life Insurance
Company, Colonial Penn Group Inc. and Colonial Penn
Holdings, Inc. dated as of June 30, 1997 (filed as Annex A
to the 1997 Proxy Statement).*
65
10.9 Purchase Agreement by and among Allstate Life Insurance
Company, Allstate Life Insurance Company of New York,
Charter National Life Insurance Company, Intramerica Life
Insurance Company and the Company, dated February 11, 1998
(filed as Exhibit 10.16 to the 1997 10-K).*
10.10 Leucadia National Corporation 2003 Senior Executive Annual
Incentive Bonus Plan (filed as Annex A to the 2003 Proxy
Statement).*
10.11 Stock Purchase Agreement by and between the Company and
Allstate Life Insurance Company dated as of December 18,
1998 (filed as Exhibit 10.14 to the 1998 10-K).*
10.12 Employment Agreement made as of December 28, 1993 by and
between the Company and Ian M. Cumming (filed as Exhibit
10.17 to the Company's 1993 10-K).*
10.13 Amendment, dated as of May 5, 1999, to the Employment
Agreement made as of December 28, 1993 by and between the
Company and Ian M. Cumming (filed as Exhibit 10.19 to the
2001 10-K).*
10.14 Employment Agreement made as of December 28, 1993 by and
between the Company and Joseph S. Steinberg (filed as
Exhibit 10.18 to the 1993 10-K).*
10.15 Amendment, dated as of May 5, 1999, to the Employment
Agreement made as of December 28, 1993 by and between the
Company and Joseph S. Steinberg (filed as Exhibit 10.21 to
the 2001 10-K).*
10.16 Management Services Agreement dated as of February 26, 2001
among The FINOVA Group Inc., the Company and Leucadia
International Corporation (filed as Exhibit 10.20 to the
2000 10-K).*
10.17 Voting Agreement, dated August 21, 2001, by and among
Berkadia LLC, Berkshire Hathaway Inc., the Company and The
FINOVA Group Inc. (filed as Exhibit 10.J to the Company's
Current Report on Form 8-K dated August 27, 2001).*
10.18 Deferred Compensation Agreement between the Company and
Thomas E. Mara dated as of December 20, 2001 (filed as
Exhibit 10.28 to the 2001 10-K).*
10.19 Settlement Agreement dated as of July 26, 2002, by and among
The Williams Companies Inc. ("TWC"), Williams Communications
Group, Inc. ("WCG"), CG Austria, Inc., the official
committee of unsecured creditors and the Company (filed as
Exhibit 99.2 to the WCG July 31, 2002 8-K).*
10.20 Investment Agreement, dated as of July 26, 2002, by and
among the Company, WCG and, for purposes of Section 7.4
only, Williams Communications, LLC ("WCL") (filed as Exhibit
99.4 to the WCG July 31, 2002 8-K).*
10.21 First Amendment, made as of September 30, 2002, to the
Investment Agreement, dated as of July 26, 2002, by and
among the Company, WCG and WCL (filed as Exhibit 99.4 to the
WilTel October 24, 2002 8-K).*
10.22 Second Amendment, made as of October 15, 2002, to the
Investment Agreement, dated as of July 26, 2002, as amended
on September 30, 2002, by and among the Company, WCG and WCL
(filed as Exhibit 99.5 to the WilTel October 24, 2002 8-K).*
66
10.23 Purchase and Sale Agreement, dated as of July 26, 2002, by
and between TWC and the Company (filed as Exhibit 99.5 to
the Company's Current Report on Form 8-K dated July 31,
2002).*
10.24 Amendment, made as of October 15, 2002, to the Purchase and
Sale Agreement, dated as of July 26, 2002, by and among the
Company and TWC (filed as Exhibit 99.2 to the WilTel October
24, 2002 8-K).*
10.25 Escrow Agreement, dated as of October 15, 2002, among the
Company, TWC, WilTel and The Bank of New York, as Escrow
Agent (filed as Exhibit 99.3 to the WilTel October 24, 2002
8-K).*
10.26 Share Purchase Agreement, dated April 17, 2002 between LUK
Fidei L.L.C. and Hampton Trust PLC (filed as Exhibit 10.37
to the 2002 10-K).*
10.27 Reiterative Share Purchase Agreement, dated June 4, 2002,
among Savits AB Private, Hampton Trust Holding (Europe) SA,
John C. Jones and Herald Century Consolidated SA (filed as
Exhibit 10.38 to the 2002 10-K).*
10.28 Agreement and Plan of Merger, dated August 21, 2003, among
the Company, Wrangler Acquisition Corp. and WilTel (filed as
Exhibit 2.1 to the Company's Current Report on Form 8-K
dated August 22, 2003).*
10.29 Stock Purchase Agreement, dated as of October 21, 2002,
between HomeFed Corporation ("HomeFed") and the Company
(filed as Exhibit 10.1 to the Current Report on Form 8-K of
HomeFed dated October 22, 2002).*
10.30 Second Amended and Restated Berkadia LLC Operating
Agreement, dated December 2, 2002, by and among BH Finance
LLC and WMAC Investment Corporation (filed as Exhibit 10.40
to the 2002 10-K).*
10.31 Subscription Agreement made and entered into as of December
23, 2002 by and among the Company and each of the entities
named in Schedule I thereto (filed as Exhibit 10.41 to the
2002 10-K).*
10.32 Amended and Restated Alliance Agreement between Telefonos de
Mexico, S.A. de C.V. and Williams Communications, Inc.,
dated May 25, 1999 (filed as Exhibit 10.2 to WCG's Equity
Registration Statement, Amendment No. 8, dated September 29,
1999).*
10.33 Master Alliance Agreement between SBC Communications Inc.
and Williams Communications, Inc. dated February 8, 1999
(filed as Exhibit 10.10 WCG's Equity Registration Statement,
Amendment No. 1, dated May 27, 1999).*
10.34 Transport Services Agreement dated February 8, 1999, between
Southwestern Bell Communication Services, Inc. and Williams
Communications, Inc. (filed as Exhibit 10.11 to WCG's Equity
Registration Statement, Amendment No. 1, dated May 27,
1999).*
10.35 Copy of WCG's April 22, 2002, agreement with principal
creditor group (filed as Exhibit 10.1 to the WCG April 22,
2002 8-K).*
10.36 Copy of WCG's agreement with TWC (filed as Exhibit 10.2 to
the WCG April 22, 2002 8-K).*
67
10.37 First Amended Joint Chapter 11 Plan of Reorganization of WCG
and CG Austria, filed with the Bankruptcy Court as Exhibit 1
to the Settlement Agreement (filed as Exhibit 99.3 to the
WCG July 31, 2002 8-K).*
10.38 Real Property Purchase and Sale Agreement among WilTel,
Williams Headquarters Building Company, Williams Technology
Center, LLC, WCL, and Williams Aircraft Leasing, LLC, dated
July 26, 2002, filed with the Bankruptcy Court as Exhibit 4
to the Settlement Agreement (filed as Exhibit 99.6 to the
WCG July 31, 2002 8-K).*
10.39 List of TWC Continuing Contracts, filed with the Bankruptcy
Court as Exhibit 5 to the Settlement Agreement (filed as
Exhibit 99.7 to the WCG July 31, 2002 8-K).*
10.40 Agreement for the Resolution of Continuing Contract Disputes
among WCG, WCL and TWC, dated July 26, 2002, filed with the
Bankruptcy Court as Exhibit 6 to the Settlement Agreement
(filed as Exhibit 99.8 to the WCG July 31, 2002 8-K).*
10.41 Tax Cooperation Agreement between WCG and TWC, dated July
26, 2002, filed with the Bankruptcy Court as Exhibit 7 to
the Settlement Agreement (filed as Exhibit 99.9 to the WCG
July 31, 2002 8-K).*
10.42 Amendment to Trademark License Agreement between WCG and
TWC, dated July 26, 2002, filed with the Bankruptcy Court as
Exhibit to the Settlement Agreement (filed as Exhibit 99.10
to the WCG July 31, 2002 8-K).*
10.43 Assignment of Rights between Williams Information Services
Corporation and WCL, dated July 26, 2002, filed with the
Bankruptcy Court as Exhibit 9 to the Settlement Agreement
(filed as Exhibit 99.11 to the WCG July 31, 2002 8-K).*
10.44 Guaranty Indemnification Agreement between WCG and TWC,
dated July 26, 2002, filed with the Bankruptcy Court as
Exhibit 10 to the Settlement Agreement (filed as Exhibit
99.12 to the WCG July 31, 2002 8-K).*
10.45 Declaration of Trust, dated as of October 15, 2002, by and
among WCG, WilTel and the Residual Trustee (filed as Exhibit
99.1 to the WilTel October 24, 2002 8-K).*
10.46 Second Amended and Restated Credit and Guaranty Agreement of
WilTel, dated as of September 8, 1999, as amended and
restated as of April 25, 2001 and as further amended and
restated as of October 15, 2002 (filed as Exhibit 99.12 to
the WilTel October 24, 2002 8-K).*
10.47 Amendment No. 9, dated as of October 15, 2002, to Amended
and Restated Credit Agreement of WilTel, dated as of
September 8, 1999, and Amendment No. 1, dated as of October
15, 2002, to the Subsidiary Guarantee, dated as of September
8, 1999 (filed as Exhibit 99.13 to the WilTel October 24,
2002 8-K).*
10.48 Amended and Restated Security Agreement, dated as of April
23, 2001, as amended and restated as of October 15, 2002
(filed as Exhibit 99.14 to the WilTel October 24, 2002
8-K).*
10.49 Amendment No. 1, dated as of October 15, 2002, to the Real
Property Purchase and Sale Agreement, dated as of July 26,
2002, among Williams Headquarters Building Company, WTC,
WCL, WCG and Williams Communications Aircraft, LLC (filed as
Exhibit 99.15 to the WilTel October 24, 2002 8-K).*
68
10.50 Pledge Agreement dated as of October 15, 2002, by CG
Austria, Inc., as pledgor, to Williams Headquarters Building
Company, as pledgee (filed as Exhibit 10.42 to the WilTel
10-K).*
10.51 First Amendment to Master Alliance Agreement between SBC
Communications Inc. and Williams Communications, Inc., by
and between SBC Communications Inc. and WCL, effective as of
September 23, 2002 (filed as Exhibit 10.43 to the WilTel
10-K).*
10.52 First Amendment to Transport Services Agreement among
Southwestern Bell Communications Services Inc., SBC
Operations, Inc. and Williams Communications, Inc., by and
among Southwestern Bell Communications Services Inc., SBC
Operations, Inc. and Williams Communications, Inc., dated
September 29, 2000 (filed as Exhibit 10.44 to the WilTel
10-K).*
10.53 Second Amendment to Transport Services Agreement, as amended
by Amendment No. 1 dated September 29, 2000, by and among
Southwestern Bell Communications Services Inc., SBC
Operations, Inc. and WCL, effective as of June 25, 2001
(filed as Exhibit 10.45 to the WilTel 10-K).*
10.54 Third Amendment to Transport Services Agreement, as amended
by Amendment No. 1 dated September 20, 2000, and Amendment
No. 2 dated June 25, 2001, by and among Southwestern Bell
Communications Services Inc., SBC Operations, Inc. and WCL,
effective as of September 23, 2002 (filed as Exhibit 10.46
to the WilTel 10-K).*
10.55 Fiber Lease Agreement, together with Colocation and
Maintenance Agreement and Lease Agreement #2, each dated
April 26, 2002, and each amended October 10, 2002, between
Metromedia Fiber Network Services, Inc. and WCL (filed as
Exhibit 10.47 to the WilTel 10-K).*
10.56 Amendment No. 2 to Master Alliance Agreement and Amendment
No. 4 to Transport Services Agreement, dated December 31,
2003, amending the (a) Master Alliance Agreement, effective
as of February 8, 1999, as amended by Amendment No. 1
effective September 23, 2002, by and between WCL, and SBC
Communications Inc. and (b) Transport Services Agreement,
effective as of February 8, 1999, as amended by Amendment
No. 1 dated as of September 29, 2000, Amendment No. 2 and
Amendment No. 3 dated as of September 23, 2002 by and among
WCL, SBC Operations, Inc., and Southwestern Bell
Communications Services Inc.
21 Subsidiaries of the registrant.
23.1 Consent of PricewaterhouseCoopers LLP with respect to the
incorporation by reference into the Company's Registration
Statement on Form S-8 (File No. 2-84303), Form S-8 and S-3
(File No. 33-6054), Form S-8 and S-3 (File No. 33-26434),
Form S-8 and S-3 (File No. 33-30277), Form S-8 (File No.
33-61682), Form S-8 (File No. 33-61718), Form S-8 (File No.
333-51494) and Form S-4 (File No. 333-86018).
23.2 Consent of PricewaterhouseCoopers, with respect to the
inclusion in this Annual Report on Form 10-K the financial
statements of Olympus Re Holdings, Ltd. and with respect to
the incorporation by reference in the Company's Registration
Statements on Form S-8 (No. 2-84303), Form S-8 and S-3 (No.
33-6054), Form S-8 and S-3 (No. 33-26434), Form S-8 and S-3
(No. 33-30277), Form S-8 (No. 33-61682), Form S-8 (No.
33-61718), Form S-8 (No. 333-51494) and Form S-4 (No.
333-86018).
23.3 Consent of independent auditors from Ernst & Young LLP with
respect to the inclusion in this Annual Report on Form 10-K
of the financial statements of Berkadia LLC and with respect
to the incorporation by reference in the Company's
Registration Statements on Form S-8 (No. 2-84303), Form S-8
and S-3 (No. 33-6054), Form S-8 and S-3 (No. 33-26434), Form
S-8 and S-3 (No. 33-30277), Form S-8 (No. 33-61682), Form
S-8 (No. 33-61718), Form S-8 (No. 333-51494) and Form S-4
(No. 333-86018).
69
23.4 Consent of independent auditors from Ernst & Young LLP with
respect to the inclusion in this Annual Report on Form 10-K
of the financial statements of The FINOVA Group Inc. and
with respect to the incorporation by reference in the
Company's Registration Statements on Form S-8 (No. 2-84303),
Form S-8 and S-3 (No. 33-6054), Form S-8 and S-3 (No.
33-26434), Form S-8 and S-3 (No. 33-30277), Form S-8 (No.
33-61682), Form S-8 (No. 33-61718), Form S-8 (No. 333-51494)
and Form S-4 (No. 333-86018).**
23.5 Independent Auditors' Consent from KPMG LLP, with respect to
the inclusion in this Annual Report on Form 10-K of the
financial statements of Jefferies Partners Opportunity Fund
II, LLC for the three years ended December 31, 2003 and with
respect to the incorporation by reference in the Company's
Registration Statements on Form S-8 (No. 2-84303), Form S-8
and S-3 (No. 33-6054), Form S-8 and S-3 (No. 33-26434), Form
S-8 and S-3 (No. 33-30277), Form S-8 (No. 33-61682), Form
S-8 (No. 33-61718), Form S-8 (No. 333-51494) and Form S-4
(No. 333-86018).
23.6 Consent of independent auditors from BDO Seidman, LLP with
respect to the inclusion in this Annual Report on Form 10-K
of the financial statements of EagleRock Capital Partners
(QP), LP and EagleRock Master Fund and with respect to the
incorporation by reference in the Company's Registration
Statements on Form S-8 (No. 2-84303), Form S-8 and S-3 (No.
33-6054), Form S-8 and S-3 (No. 33-26434), Form S-8 and S-3
(No. 33-30277), Form S-8 (No. 33-61682), Form S-8 (No.
33-61718), Form S-8 (No. 333-51494) and Form S-4 (No.
333-86018).
23.7 Consent of independent auditors from Ernst & Young LLP with
respect to the inclusion in this Annual Report on Form 10-K
of the financial statements of WilTel Communications Group,
Inc. and with respect to the incorporation by reference in
the Company's Registration Statements on Form S-8 (No.
2-84303), Form S-8 and S-3 (No. 33-6054), Form S-8 and S-3
(No. 33-26434), Form S-8 and S-3 (No. 33-30277), Form S-8
(No. 33-61682), Form S-8 (No. 33-61718), Form S-8 (No.
333-51494) and Form S-4 (No. 333-86018).
31.1 Certification of Chairman of the Board and Chief Executive
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification of President pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.3 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chairman of the Board and Chief Executive
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.***
32.2 Certification of President pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.***
32.3 Certification of Principal Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.***
(d) Financial statement schedules.
-----------------------------
(1) Berkadia LLC financial statements as of December 31,
2003 and 2002 and for the years ended December 31, 2003
and 2002 and for the period from inception, February
26, 2001, to December 31, 2001.
70
(2) Olympus Re Holdings, Ltd. combined financial statements
as of December 31, 2003 and 2002 for the years ended
December 31, 2003 and 2002 and for the period from
December 3, 2001 (date of incorporation) to December
31, 2001.
(3) The FINOVA Group Inc. and subsidiaries consolidated
financial statements as of December 31, 2003 and 2002
and for the years ended December 31, 2003, 2002 and
2001.**
(4) Jefferies Partners Opportunity Fund II, LLC financial
statements as of December 31, 2003 and 2002 and for the
years ended December 31, 2003, 2002 and 2001.
(5) EagleRock Capital Partners (QP), LP financial
statements as of December 31, 2003 and 2002 and for the
year ended December 31, 2003 and for the period from
January 1, 2002 (commencement of operations) to
December 31, 2002 and EagleRock Master Fund financial
statements as of December 31, 2003 and 2002 and for the
year ended December 31, 2003 and for the period from
May 1, 2002 (commencement of operations) to December
31, 2002.
(6) WilTel Communications Group, Inc. consolidated
financial statements as of November 5, 2003 and
December 31, 2002 (Successor Company), and for the
periods from January 1, 2003 through November 5, 2003,
and November 1, 2002 through December 31, 2002
(Successor Company) and the periods January 1, 2002
through October 31, 2002, and for the year ended
December 31, 2001 (Predecessor Company).
-----------------------------
* Incorporated by reference.
** To be filed by amendment pursuant to Item 3-09(b) of Regulation S-X.
*** Furnished herewith pursuant to item 601(b)(32) of Regulation S-K.
71
REPORT OF INDEPENDENT AUDITORS
------------------------------
To the Board of Directors and
Shareholders of Leucadia National Corporation
In our opinion, based on our audits and the report of the other auditors, the
consolidated financial statements listed in the index appearing under Item
15(a)(1)(2) of this Form 10-K, present fairly, in all material respects, the
financial position of Leucadia National Corporation and Subsidiaries at December
31, 2003 and 2002, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2003, in conformity
with accounting principles generally accepted in the United States of America.
In addition, in our opinion, the financial statement schedules listed in the
index appearing under Item 15(a)(1)(2) of this Form 10-K, present fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements. These financial statements
and financial statement schedules are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedules based on our audits. We did not
audit the financial statements of WilTel, for the period from January 1, 2003
through November 5, 2003. For this period, WilTel was accounted for on the
equity method and from January 1, 2003 through November 5, 2003 had a net loss
of approximately $109,000,000, of which the Company's 47.4% share was
approximately $52,000,000. Those statements were audited by other auditors whose
report thereon has been furnished to us, and our opinion expressed herein,
insofar as it relates to the amounts included for WilTel, is based on the report
of the other auditors. We conducted our audits of these statements in accordance
with auditing standards generally accepted in the United States of America,
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatements. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits and the report of
the other auditors provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
New York, New York
March 9, 2004
F-1
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2003 and 2002
(Dollars in thousands, except par value)
2003 2002
---- ----
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 214,390 $ 418,600
Investments 714,363 185,196
Trade, notes and other receivables, net 372,104 114,579
Prepaids and other current assets 49,506 22,476
------------- -------------
Total current assets 1,350,363 740,851
Non-current investments 673,742 439,675
Notes and other receivables, net 193,459 292,843
Other assets 298,589 164,570
Property, equipment and leasehold improvements, net 1,450,099 166,207
Investments in associated companies:
WilTel Communications Group, Inc. - 340,551
Other associated companies 430,912 397,081
------------- -------------
Total $ 4,397,164 $ 2,541,778
============= =============
LIABILITIES
- -----------
Current liabilities:
Trade payables and expense accruals $ 377,473 $ 75,770
Deferred revenue 47,311 -
Other current liabilities 89,390 15,436
Customer banking deposits due within one year 103,331 283,613
Long-term debt due within one year 23,956 3,647
Income taxes payable 15,867 38,231
------------- -------------
Total current liabilities 657,328 416,697
Long-term deferred revenue 156,582 -
Other non-current liabilities 234,446 126,774
Non-current customer banking deposits 42,201 109,291
Long-term debt 1,154,878 229,426
Deferred tax liability - 16,556
------------- -------------
Total liabilities 2,245,435 898,744
------------- -------------
Commitments and contingencies
Minority interest 17,568 10,309
------------- -------------
Company-obligated mandatorily redeemable preferred securities of
subsidiary trust holding solely subordinated debt securities of the Company - 98,200
------------- -------------
SHAREHOLDERS' EQUITY
- --------------------
Series A Non-Voting Convertible Preferred Stock - 47,507
Common shares, par value $1 per share, authorized 150,000,000 shares;
70,823,502 and 58,268,572 shares issued and outstanding, after deducting
47,710,719 and 60,213,299 shares held in treasury 70,824 58,269
Additional paid-in capital 613,274 154,260
Accumulated other comprehensive income 152,251 56,025
Retained earnings 1,297,812 1,218,464
------------- -------------
Total shareholders' equity 2,134,161 1,534,525
------------- -------------
Total $ 4,397,164 $ 2,541,778
============= =============
The accompanying notes are an integral
part of these consolidated financial statements.
F-2
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2003, 2002 and 2001
(In thousands, except per share amounts)
2003 2002 2001
---- ---- ----
REVENUES:
- ---------
Telecommunications $ 231,930 $ - $ -
Healthcare 71,039 - -
Manufacturing 53,327 50,744 53,667
Finance 55,091 87,812 113,422
Investment and other income 135,035 140,315 178,622
Net securities gains (losses) 9,953 (37,066) 28,450
------------ ------------ -----------
556,375 241,805 374,161
------------ ------------ -----------
EXPENSES:
- ---------
Cost of sales:
Telecommunications 167,653 - -
Healthcare 61,280 - -
Manufacturing 38,998 33,963 36,803
Interest 43,550 33,547 47,763
Salaries 58,394 41,814 42,611
Depreciation and amortization 58,598 17,266 17,258
Selling, general and other expenses 161,931 156,740 156,644
------------ ------------ -----------
590,404 283,330 301,079
------------ ------------ -----------
Income (loss) from continuing operations before income taxes, minority
expense of trust preferred securities and equity in income (losses) of
associated companies (34,029) (41,525) 73,082
------------ ------------ -----------
Income tax (benefit) provision:
Current (20,451) (116,817) 30,362
Deferred (23,750) (28,048) (41,703)
------------ ------------ -----------
(44,201) (144,865) (11,341)
------------ ------------ -----------
Income from continuing operations before minority expense of trust preferred
securities and equity in income (losses) of associated
companies 10,172 103,340 84,423
Minority expense of trust preferred securities, net of taxes (2,761) (5,521) (5,521)
Equity in income (losses) of associated companies, net of taxes 76,947 54,712 (15,974)
------------ ------------ -----------
Income from continuing operations 84,358 152,531 62,928
Income (loss) from discontinued operations, net of taxes 5,198 4,580 (39,742)
Gain (loss) on disposal of discontinued operations, net of taxes 7,498 4,512 (31,105)
------------ ------------ -----------
Income (loss) before cumulative effect of a change in accounting principle 97,054 161,623 (7,919)
Cumulative effect of a change in accounting principle - - 411
------------ ------------ -----------
Net income (loss) $ 97,054 $ 161,623 $ (7,508)
============ ============ ===========
Basic earnings (loss) per common share:
Income from continuing operations $1.38 $ 2.74 $ 1.13
Income (loss) from discontinued operations .08 .08 (.72)
Gain (loss) on disposal of discontinued operations .12 .08 (.56)
Cumulative effect of a change in accounting principle - - .01
------------ ------------ -----------
Net income (loss) $1.58 $ 2.90 $ (.14)
============ ============ ===========
Diluted earnings (loss) per common share:
Income from continuing operations $1.37 $ 2.72 $ 1.13
Income (loss) from discontinued operations .08 .08 (.72)
Gain (loss) on disposal of discontinued operations .12 .08 (.56)
Cumulative effect of a change in accounting principle - - .01
------------ ------------ -----------
Net income (loss) $1.57 $ 2.88 $ (.14)
============ ============ ===========
The accompanying notes are an integral
part of these consolidated financial statements.
F-3
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2003, 2002 and 2001
(In thousands)
2003 2002 2001
---- ---- ----
Net cash flows from operating activities:
- -----------------------------------------
Net income (loss) $ 97,054 $ 161,623 $ (7,508)
Adjustments to reconcile net income (loss) to net cash provided by (used for)
operations:
Cumulative effect of a change in accounting principle - - (411)
Deferred income tax benefit (23,847) (28,048) (35,291)
Depreciation and amortization of property, equipment and leasehold improvements 65,723 21,624 21,551
Other amortization (primarily related to investments) (4,624) (5,427) (18,183)
Provision for doubtful accounts 20,098 36,248 43,263
Net securities (gains) losses (9,953) 37,066 (28,450)
Equity in (income) losses of associated companies (76,947) (54,712) 15,974
Distributions from associated companies 25,359 43,807 123,871
Gain on disposal of real estate, property and equipment, and other assets (23,429) (35,051) (48,407)
(Gain) loss on disposal of discontinued operations (7,498) (4,512) 31,105
Investments classified as trading, net (8,133) 48,990 (6,675)
Net change in:
Trade, notes and other receivables (18,306) 10,681 574
Prepaids and other assets (10,687) (1,021) (3,055)
Trade payables and expense accruals (10,996) 11,936 (34,940)
Other liabilities (18,931) (4,243) (1,925)
Deferred revenue 2,045 - -
Income taxes payable (14,276) (137,327) (13,180)
Other (3,158) 2,934 6,941
Net change in net assets of discontinued operations (3,994) (5,384) 63,982
-------------- -------------- --------------
Net cash provided by (used for) operating activities (24,500) 99,184 109,236
-------------- -------------- --------------
Net cash flows from investing activities:
- ----------------------------------------
Acquisition of property, equipment and leasehold improvements (84,665) (17,106) (13,543)
Acquisition of and capital expenditures for real estate investments (67,925) (20,748) (38,377)
Proceeds from disposals of real estate, property and equipment, and other assets 111,134 108,146 187,629
Increase in cash related to acquisition of WilTel, Symphony and WebLink,
net of cash invested 114,524 - -
Proceeds from disposal of discontinued operations, net of expenses - 66,241 -
Reduction in cash related to sale of subsidiary, net of cash proceeds from sale (4,466) (18,979) -
Advances on loan receivables (2,981) (81,650) (262,388)
Principal collections on loan receivables 138,259 174,718 186,626
Advances on notes receivables (2,279) (2,390) (9,593)
Collections on notes receivables 14,176 4,373 39,790
Investments in associated companies (22,350) (375,307) (186,782)
Capital distributions from associated companies 7,174 - -
Purchases of investments (other than short-term) (1,655,294) (1,143,361) (1,014,015)
Proceeds from maturities of investments 555,148 657,487 696,340
Proceeds from sales of investments 683,752 548,249 201,840
-------------- -------------- --------------
Net cash used for investing activities (215,793) (100,327) (212,473)
-------------- -------------- --------------
(continued)
The accompanying notes are an integral
part of these consolidated financial statements.
F-4
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
For the years ended December 31, 2003, 2002 and 2001
(In thousands)
2003 2002 2001
---- ---- ----
Net cash flows from financing activities:
- -----------------------------------------
Net change in customer banking deposits $ (245,845) $ (82,351) $ (45,928)
Issuance of long-term debt, net of issuance costs 304,509 6,145 71,496
Reduction of long-term debt (7,002) (13,265) (10,555)
Issuance of convertible preferred shares - 47,507 -
Issuance of common shares 1,293 102,535 517
Purchase of common shares for treasury (61) (115) (45)
Dividends paid (17,706) (13,841) (13,829)
------------ ------------ ------------
Net cash provided by financing activities 35,188 46,615 1,656
------------ ------------ ------------
Effect of foreign exchange rate changes on cash 895 (94) (564)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (204,210) 45,378 (102,145)
Cash and cash equivalents at January 1, 418,600 373,222 475,367
------------ ------------ ------------
Cash and cash equivalents at December 31, $ 214,390 $ 418,600 $ 373,222
============ ============ ============
Supplemental disclosures of cash flow information:
- -------------------------------------------------
Cash paid during the year for:
Interest $ 40,856 $ 34,681 $ 51,232
Income tax payments (refunds), net $ (5,098) $ 17,314 $ 11,885
Non-cash investing activities:
- -----------------------------
Common stock issued for acquisition of WilTel Communications Group, Inc. $ 422,830 $ - $ -
The accompanying notes are an integral
part of these consolidated financial statements.
F-5
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the years ended December 31, 2003, 2002 and 2001
(In thousands, except par value and per share amounts)
Series A
Non-Voting Common Accumulated
Convertible Shares Additional Other
Preferred $1 Par Paid-In Comprehensive Retained
Stock Value Capital Income (Loss) Earnings Total
----------- ----------- ------------- ------------- -------- -----
BALANCE, JANUARY 1, 2001 $ - $ 55,297 $ 54,340 $ 2,585 $ 1,092,019 $ 1,204,241
------------
Comprehensive income:
Net change in unrealized gain (loss)
on investments, net of taxes of $9,537 17,850 17,850
Net change in unrealized foreign exchange
gain (loss), net of taxes of $882 (5,366) (5,366)
Net change in unrealized gain (loss) on
derivative instruments (including the
cumulative effect of a change in accounting
principle of $1,371), net of taxes of $219 (407) (407)
Net loss (7,508) (7,508)
------------
Comprehensive income 4,569
------------
Exercise of options to purchase common shares 23 494 517
Purchase of stock for treasury (2) (43) (45)
Dividends ($.25 per common share) (13,829) (13,829)
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2001 - 55,318 54,791 14,662 1,070,682 1,195,453
------------
Comprehensive income:
Net change in unrealized gain (loss)
on investments, net of taxes of $14,215 26,331 26,331
Net change in unrealized foreign exchange
gain (loss), net of taxes of $1,691 16,375 16,375
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $724 (1,343) (1,343)
Net income 161,623 161,623
------------
Comprehensive income 202,986
------------
Issuance of convertible preferred shares 47,507 47,507
Issuance of common shares 2,908 98,585 101,493
Exercise of options to purchase common shares 46 996 1,042
Purchase of stock for treasury (3) (112) (115)
Dividends ($.25 per common share) (13,841) (13,841)
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2002 47,507 58,269 154,260 56,025 1,218,464 1,534,525
------------
Comprehensive income:
Net change in unrealized gain (loss)
on investments, net of taxes of $55,738 103,776 103,776
Net change in unrealized foreign exchange
gain (loss), net of taxes of $701 7,739 7,739
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $888 (1,650) (1,650)
Net change in minimum pension liability,
net of taxes of $7,345 (13,639) (13,639)
Net income 97,054 97,054
------------
Comprehensive income 193,280
------------
Issuance of common shares on acquisition of
WilTel Communications Group, Inc. 11,156 411,674 422,830
Conversion of convertible preferred shares into
common shares (47,507) 1,348 46,159 -
Exercise of options to purchase common shares 53 1,240 1,293
Purchase of stock for treasury (2) (59) (61)
Dividends ($.25 per common share) (17,706) (17,706)
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2003 $ - $ 70,824 $ 613,274 $ 152,251 $ 1,297,812 $ 2,134,161
============ ============ ============ ============ ============ ============
The accompanying notes are an integral
part of these consolidated financial statements.
F-6
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of Operations:
--------------------
The Company is a diversified holding company engaged in a variety of businesses,
including telecommunications, healthcare services, banking and lending,
manufacturing, real estate activities, winery operations, and property and
casualty reinsurance, principally in markets in the United States, and
development of a copper mine in Spain.
The Company's telecommunications operations are conducted through WilTel
Communications Group, Inc. ("WilTel"), which owns or leases and operates a
nationwide inter-city fiber-optic network providing Internet, data, voice and
video services to companies that use high-capacity and high-speed
telecommunications in their businesses. WilTel has also built a fiber-optic
network within certain cities in the U.S. and has the ability to connect to
networks outside the U.S. WilTel operates in two segments, Network and Vyvx.
The Company's healthcare services operations primarily provide contract therapy,
long-term care consulting and temporary staffing to skilled nursing facilities,
hospitals, sub-acute care centers, assisted living facilities, schools, and
other healthcare providers. Healthcare services are provided by subsidiaries of
Symphony Health Services, LLC ("Symphony").
The Company's banking and lending operations have historically consisted of
making instalment loans to niche markets primarily funded by customer banking
deposits insured by the Federal Deposit Insurance Corporation ("FDIC"); the
principal lending activities have consisted of providing collateralized personal
automobile loans to individuals with poor credit histories. However, as a result
of increased loss experience and declining profitability in its auto lending
program, the Company stopped originating new subprime automobile loans in
September 2001 and ceased originating all other consumer loans in January 2003.
The Company is in the process of liquidating this business.
The Company's manufacturing operations manufacture and market lightweight
plastic netting used for a variety of purposes including, among other things,
building and construction, erosion control, agriculture, packaging, carpet
padding, filtration and consumer products. In addition to its domestic
operations, the manufacturing segment owns and operates a manufacturing and
sales facility in Belgium.
The Company's domestic real estate operations include a mixture of commercial
properties, residential land development projects and other unimproved land, all
in various stages of development and all available for sale.
The Company's winery operations consist of two wineries, Pine Ridge Winery in
Napa Valley, California and Archery Summit in the Willamette Valley of Oregon,
which primarily produce and sell wines in the luxury segment of the premium
table wine market.
The Company's copper mine development operations consist of its 72.5% interest
in MK Gold Company ("MK Gold"), a company that is traded on the NASD OTC
Bulletin Board (Symbol: MKAU).
2. Significant Accounting Policies:
-------------------------------
(a) Critical Accounting Estimates: The preparation of financial statements in
conformity with generally accepted accounting principles ("GAAP") requires the
Company to make estimates and assumptions that affect the reported amounts in
the financial statements and disclosures of contingent assets and liabilities.
On an on-going basis, the Company evaluates all of these estimates and
assumptions. The following areas have been identified as critical accounting
estimates because they have the potential to have a material impact on the
Company's financial statements, and because they are based on assumptions which
are used in the accounting records to reflect, at a specific point in time,
events whose ultimate outcome won't be known until a later date. Actual results
could differ from these estimates.
F-7
2. Significant Accounting Policies, continued:
-------------------------------
Loan Loss Reserves - The allowance for loan losses is established through a
provision for loan losses charged to expense. The allowance for loan losses is
an amount that the Company believes will be adequate to absorb probable losses
inherent in its portfolio based on the Company's evaluations of the
collectibility of loans as of the balance sheet date. Factors considered by the
Company include prior loan loss experience, current economic trends, aging of
the loan portfolio and collateral value. The amount recorded for the allowance
for loan losses results from numerous judgments and assumptions that are made to
estimate actual loan loss experience in the future.
Income Taxes - The Company records a valuation allowance to reduce its deferred
taxes to the amount that is more likely than not to be realized. Historically,
if the Company were to determine that it would be able to realize its deferred
tax assets in the future in excess of its net recorded amount, an adjustment
would increase income in such period. Similarly, if the Company were to
determine that it would not be able to realize all or part of its net deferred
taxes in the future, an adjustment would be charged to income in such period.
The Company also records reserves for contingent tax liabilities related to
potential exposure.
Subsequent to the acquisition of all of the outstanding common stock of WilTel
in November 2003, WilTel became a member of the Company's consolidated tax
return. WilTel has significant net operating loss carryforwards (NOLs) and other
tax attributes, some of which are available to reduce the future taxable income
of other members of the Company's consolidated federal tax return. Except for
the recognition of WilTel's deferred federal income tax assets in an amount
equal to the Company's current and deferred federal income tax liabilities as of
the date of acquisition (see allocation of the purchase price in Note 3), the
Company has recorded a full valuation allowance with respect to WilTel's net
deferred tax assets.
Impairment of Long-Lived Assets - The Company evaluates its long-lived assets
for impairment when events or changes in circumstances indicate, in management's
judgment, that the carrying value of such assets may not be recoverable. The
determination of whether an impairment has occurred is based on management's
estimate of undiscounted future cash flows attributable to the assets as
compared to the carrying value of the assets. If an impairment has occurred, the
amount of the impairment recognized is determined by estimating the fair value
for the assets and recording a provision for loss if the carrying value is
greater than fair value.
As of December 31, 2003, the carrying amount of the Company's investment in the
mineral rights and mining properties of MK Gold was approximately $74,600,000.
The recoverability of this asset is entirely dependent upon the success of MK
Gold's mining project at the Las Cruces copper deposit in the Pyrite Belt of
Spain. Mining will be subject to obtaining required permits, obtaining both debt
and equity financing for the project, engineering and construction. The amount
of financing that can be obtained for the project and its related cost will be
significantly affected by the assessment of potential lenders of the current and
expected future market price of copper. In addition, the actual price of copper,
the operating cost of the mine and the capital cost to bring the mine into
production will affect the recoverability of this asset. Based on the current
status of the project and MK Gold's estimate of future financing costs and
future cash flows, the Company believes the carrying amount of its investment is
recoverable.
As of December 31, 2003, the carrying amount of the Company's investment in its
manufacturing facility located in Belgium was approximately $18,100,000. The
Belgium facility, which became operational in the third quarter of 2001, has not
yet achieved the level of revenues and profitability originally expected by the
Company, primarily due to the segment's loss of a major multi-national customer
and insufficient demand from other customers. During 2004, a new general manager
was hired at the facility, and the Company expects that new management's
development and implementation of marketing and sales initiatives should
significantly improve profitability. Based on the current business plan, which
includes a budget for 2004 and estimates of revenue growth thereafter, the
Company believes that its investment in the Belgium facility is recoverable.
However, the operation has remained in the start up phase for at least a year
longer than anticipated, and if profitability improvement is not achieved, the
carrying amount of the facility is likely to be impaired.
F-8
2. Significant Accounting Policies, continued:
-------------------------------
Acquisition of WilTel - Under GAAP, the Company's acquisition of WilTel is
treated as a step acquisition. On each occasion that the Company acquired
WilTel's common stock, it recorded its investment in WilTel's underlying assets
and liabilities at their fair value, but the adjustment to fair values is made
only to the extent of the percentage of WilTel stock acquired at the time. The
Company utilized independent appraisals, principally for property and equipment
and identifiable intangible assets, actuarial calculations for employee benefit
obligations, market quotes, discounted cash flow techniques and comparable sales
information to determine the fair values of assets and liabilities acquired for
each purchase. Significant judgments were made to estimate fair values of
certain liabilities, including liabilities for unfavorable contracts and
deferred revenue, many of which require an estimate of future events. Since the
aggregate fair values of the net assets acquired exceeded the purchase price,
GAAP required that the excess be applied to reduce the initial fair values of
certain non-current assets on a pro rata basis.
(b) Consolidation Policy: The consolidated financial statements include the
accounts of the Company and all majority-owned entities except for those in
which control does not rest with the Company due to the significant
participating or controlling rights of other parties. All intercompany
transactions and balances are eliminated in consolidation.
Associated companies are investments in equity interests of entities that the
Company does not control and that are accounted for on the equity method of
accounting.
Certain amounts for prior periods have been reclassified to be consistent with
the 2003 presentation.
(c) Cash Equivalents: The Company considers short-term investments, which have
maturities of less than three months at the time of acquisition, to be cash
equivalents. Cash and cash equivalents include short-term investments of
$79,100,000 and $267,900,000 at December 31, 2003 and 2002, respectively.
(d) Investments: At acquisition, marketable debt and equity securities are
designated as either i) held to maturity, which are carried at amortized cost,
ii) trading, which are carried at estimated fair value with unrealized gains and
losses reflected in results of operations, or iii) available for sale, which are
carried at estimated fair value with unrealized gains and losses reflected as a
separate component of shareholders' equity, net of taxes.
Held to maturity investments are made with the intention of holding such
securities to maturity, which the Company has the ability to do. Estimated fair
values are principally based on quoted market prices.
Investments with an impairment in value considered to be other than temporary
are written down to estimated fair value. The writedowns are included in "Net
securities gains (losses)" in the Consolidated Statements of Operations. The
cost of securities sold is based on average cost.
(e) Property, Equipment and Leasehold Improvements: Property, equipment and
leasehold improvements are stated at cost, net of accumulated depreciation and
amortization. Depreciation and amortization are provided principally on the
straight-line method over the estimated useful lives of the assets or, if less,
the term of the underlying lease.
(f) Revenue Recognition:
Telecommunications: Capacity, transmission, video services and other
telecommunications services revenues are recognized monthly as the services are
provided or revenues are earned. If at the time services are rendered,
collection is not reasonably assured either due to credit risk, the potential
for billing disputes or other reasons, revenue is not recognized until such
contingencies are resolved. Amounts billed in advance of the service month are
recorded as deferred revenue. Revenues that have been deferred for long-term
telecommunications service contracts are amortized using the straight-line
method over the life of the related contract. The Company
F-9
2. Significant Accounting Policies, continued:
-------------------------------
classifies as current the amount of deferred revenue that will be recognized
into revenue over the next twelve months.
Grants of indefeasible rights of use ("IRUs") of constructed but unlit fiber, or
dark fiber, in exchange for cash, are accounted for as operating leases, and the
cash received is recognized as revenue over the term of the IRU. The Company is
obligated under dark fiber IRUs and other capacity agreements to maintain its
network in efficient working order and in accordance with industry standards.
Customers are obligated for the term of the agreement to pay monthly fees for
operating and maintenance costs. The Company recognizes these monthly fees as
revenue as services are provided.
Telecommunications cost of sales include leased capacity, right of way costs,
access and egress charges, other third party circuit costs, satellite
transponder lease costs, and package delivery costs and blank tape media costs
related to advertising distribution services. WilTel does not defer installation
costs.
Prior to the Company's acquisition, WilTel had entered into transactions such as
buying, selling, swapping and/or exchanging capacity, conduit and fiber to
complete and compliment its network. Depending upon the terms of the agreement,
certain transactions were accounted for as pure asset swaps with no revenue and
no cost recognition while certain transactions were accounted for as both
revenue and cost over the corresponding length of time for each agreement. If
the exchange was not essentially the culmination of an earning process,
accounting for an exchange of a nonmonetary asset was based on the recorded
amount of the nonmonetary asset relinquished, and therefore no revenue and cost
was recorded. Payments received for the installation of conduit under joint
build construction contracts were generally recorded as a recovery of the
applicable construction costs. Revenues under multiple element contracts were
recognized based on the respective fair values of each individual element within
the multiple element contract. Revenues from conduit and duct sales were
recognized at time of delivery and acceptance and when all significant
contractual obligations have been satisfied and collection is reasonably
assured. While WilTel applied the accounting policies described in this
paragraph to transactions prior to the Company's acquisition of WilTel in 2003,
WilTel has had no material transactions of the type described in this paragraph
subsequent to its acquisition by the Company.
Other: Healthcare revenues are recognized when the services are provided.
Revenue from loans made by the banking and lending operations is recognized over
the term of the loan to provide a constant yield on the daily principal balance
outstanding. Manufacturing revenues are recognized when title passes, which is
generally upon shipment of goods. Revenue from the sale of real estate is
recognized when title passes.
(g) Income Taxes: The Company provides for income taxes using the liability
method. The future benefit of certain tax loss carryforwards and future
deductions is recorded as an asset. A valuation allowance is provided if
deferred tax assets are not considered to be more likely than not to be
realized.
(h) Derivative Financial Instruments: On January 1, 2001, the Company adopted
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities", as amended ("SFAS 133"). Under SFAS 133,
the Company reflects its derivative financial instruments in its balance sheet
at fair value. The Company has utilized derivative financial instruments to
manage the impact of changes in interest rates on its customer banking deposits
and certain debt obligations, hedge net investments in foreign subsidiaries and
manage foreign currency risk on certain available for sale securities. Although
the Company believes that these derivative financial instruments are practical
economic hedges of the Company's risks, except for the hedge of the net
investment in foreign subsidiaries, they do not meet the effectiveness criteria
under SFAS 133, and therefore are not accounted for as hedges.
F-10
2. Significant Accounting Policies, continued:
-------------------------------
In accordance with the transition provisions of SFAS 133, the Company recorded
income from a cumulative effect of a change in accounting principle of $411,000,
net of taxes, in results of operations for the year ended December 31, 2001 and
recorded a loss of $1,371,000, net of taxes, as a cumulative effect of a change
in accounting principle in accumulated other comprehensive income. No transition
adjustment remained at December 31, 2003. Amounts recorded as income (charges)
to investment and other income as a result of accounting for its derivative
financial instruments in accordance with SFAS 133 were $3,500,000, $(1,700,000)
and $(2,300,000) for the years ended December 31, 2003, 2002 and 2001,
respectively. Net unrealized losses on derivative instruments were $3,400,000
and $1,800,000 at December 31, 2003 and 2002, respectively.
(i) Translation of Foreign Currency: Foreign currency denominated investments
and financial statements are translated into U.S. dollars at current exchange
rates, except that revenues and expenses are translated at average exchange
rates during each reporting period; resulting translation adjustments are
reported as a component of shareholders' equity. Net foreign exchange gains were
$2,500,000 for 2002 and not material for 2003 and 2001. Net unrealized foreign
exchange gains (losses) were $7,500,000 and $(200,000) at December 31, 2003 and
2002, respectively.
(j) Stock-Based Compensation: Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("SFAS 123"), establishes a fair
value method for accounting for stock-based compensation plans, either through
recognition in the statements of operations or disclosure. As permitted, the
Company applies APB Opinion No. 25 and related Interpretations in accounting for
its plans. Accordingly, no compensation cost has been recognized in the
statements of operations for its stock-based compensation plans.
Had compensation cost for the Company's stock option plans been recorded in the
statements of operations consistent with the provisions of SFAS 123, the Company
would have recognized compensation cost of $800,000, $600,000 and $400,000 in
2003, 2002 and 2001, respectively.
(k) Recently Issued Accounting Standards: In May 2003, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards No.
150, "Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity" ("SFAS 150"), which is effective for financial
instruments entered into and modified after May 31, 2003, and otherwise was
effective at the beginning of the first interim period beginning after June 15,
2003. SFAS 150 establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. As a result of the implementation of SFAS 150, the Company began
classifying its $98,200,000 of trust issued preferred securities as liabilities
beginning July 1, 2003, and classifies dividends accrued for these securities as
interest expense. SFAS 150 does not permit restatement of prior period amounts
to reflect the new classification.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"), which
addresses consolidation of variable interest entities, which are entities in
which equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. FIN 46 is effective immediately to variable interest entities
created after January 31, 2003, and to variable interest entities in which an
enterprise obtains an interest after that date. In October 2003, the FASB
deferred to the fourth quarter of 2003 from the third quarter the implementation
date of FIN 46 with respect to variable interest entities in which a variable
interest was acquired before February 1, 2003. In December 2003, the FASB issued
a revision ("FIN 46R") to FIN 46 to clarify certain provisions and exempt
certain entities from its requirements. In addition, FIN 46R deferred to the
first quarter of 2004 application of its provisions to certain entities in which
a variable interest was acquired prior to February 1, 2003. The Company does not
expect that the implementation of FIN 46 and FIN 46R will have a material effect
on its consolidated results of operations or financial condition.
F-11
2. Significant Accounting Policies, continued:
-------------------------------
In December 2003, the FASB issued Statement of Financial Accounting Standards
No. 132 (revised 2003) "Employers' Disclosures about Pensions and Other
Postretirement Benefits" ("SFAS 132R"), which is effective for financial
statements with fiscal years ending after December 15, 2003. The Company has
adopted SFAS 132R, which requires additional disclosures for pension and
postretirement benefit plans.
3. Acquisitions:
------------
In 2002, the Company completed the acquisition of 44% of the outstanding common
stock of WilTel for an aggregate purchase price of $333,500,000, including
expenses. The WilTel stock was acquired by the Company under the chapter 11
restructuring plan of Williams Communications Group, Inc., the predecessor of
WilTel. In October 2002, in a private transaction, the Company purchased
1,700,000 shares of WilTel common stock, on a when issued basis, for
$20,400,000. Together, these transactions resulted in the Company acquiring
47.4% of the outstanding common stock of WilTel during 2002.
In November 2003, the Company consummated an exchange offer and merger agreement
pursuant to which all public WilTel stockholders received .4242 of a Leucadia
common share for each share of WilTel common stock. Leucadia issued 11,156,460
of its common shares in exchange for all of the WilTel common stock that it
didn't previously own. The merger agreement also provided that WilTel
stockholders receive contingent sale rights which entitle WilTel stockholders to
additional Leucadia common shares if the Company sells substantially all of
WilTel's assets or outstanding shares of capital stock prior to October 15,
2004, or consummates such a sale at a later date if the sale agreement was
entered into prior to August 21, 2004, and in either case the net proceeds
exceed the valuation ascribed to WilTel's equity in the merger transaction. The
2003 acquisition was wholly unrelated to the initial acquisition in 2002; the
Company's decision to acquire the remaining WilTel shares was based upon
developments subsequent to the initial 2002 purchase.
The aggregate purchase price for the 2003 acquisition was approximately
$425,300,000, consisting of $422,800,000 of Leucadia common shares and cash
expenses of $2,500,000. The purchase price does not include any amounts related
to the contingent sale rights, which would be accounted for as additional
purchase price consideration if, and when, they result in the issuance of
additional Leucadia common shares (up to an aggregate maximum of 11,000,000
additional Leucadia common shares). The execution of the merger agreement on
August 21, 2003 created a measurement date for accounting purposes which is used
to determine the per share value of the Leucadia common shares issued. The
Company averaged the closing prices of its common shares for the five business
day period commencing two business days before and ending two business days
after the merger agreement was executed. That average, $37.90 per share, was
used to calculate the aggregate value of the Leucadia common shares issued.
Following completion of the merger, the Company has consolidated the financial
condition and results of operations of WilTel, and no longer accounts for its
initial investment in WilTel under the equity method of accounting. The
condensed WilTel balance sheet as of the date of acquisition is presented below.
It reflects amounts for the acquisition of the WilTel common stock in 2003, and
amounts for the acquisition of 47.4% of WilTel's common stock in 2002, all of
which were determined based on the estimated fair value of the assets acquired
and liabilities assumed as of the date of each acquisition. The carrying amount
of the Company's initial 2002 cash investment in WilTel of $353,900,000,
including expenses, has been subsequently reduced by $65,400,000, representing
the Company's share of WilTel's losses under the equity method of accounting.
The
F-12
3. Acquisitions, continued:
------------
aggregate net investment in WilTel shown below of $713,800,000 consists of the
carrying amount of the Company's equity investment in WilTel as of November 5,
2003 ($288,500,000) and the aggregate purchase price of the acquisition pursuant
to the merger ($425,300,000). All amounts are in thousands.
As of
November 6, 2003
----------------
Assets:
Current assets:
Cash and cash equivalents $ 97,900
Investments 93,600
Trade, notes and other receivables, net 240,400
Prepaids and other current assets 62,200
---------------
Total current assets 494,100
Non-current investments 30,100
Property and equipment 1,240,300
Intangible assets 38,800
Other assets 38,800
---------------
Total assets 1,842,100
---------------
Liabilities:
Current liabilities:
Trade payables and expense accruals 247,000
Deferred revenue 47,400
Other current liabilities 121,700
Long-term debt due within one year 4,000
---------------
Total current liabilities 420,100
Long-term deferred revenue 154,500
Other non-current liabilities 138,100
Long-term debt 502,700
---------------
Total liabilities 1,215,400
---------------
626,700
Allocation to consolidated deferred income taxes 87,100
---------------
Net investment in WilTel $ 713,800
===============
Of the $38,800,000 of acquired intangible assets, $8,400,000 was related to
Vyvx's tradename (with a weighted-average useful life of approximately fifteen
years) and $30,400,000 was related to customer relationships (with a
weighted-average useful life of approximately thirteen years), primarily Vyvx
customers. See Note 8 for more information concerning intangible asset activity
subsequent to the acquisition.
The Company has not completed all of the analyses and studies to finalize its
allocation of the purchase price for the 2003 purchase. The Company expects to
complete its allocation of the purchase price by the end of the third quarter of
2004, and any changes from its initial allocation could affect the values
assigned to property and equipment, intangible assets and trade payables,
expense accruals and other liabilities. However, the Company does not expect
that the impact of these changes will be material.
F-13
3. Acquisitions, continued:
------------
Unaudited pro forma operating results for the Company, assuming the acquisition
of 100% of WilTel had occurred as of the beginning of each year presented below
are as follows (in thousands, except per share amounts):
2003 2002
---- ----
Revenues $ 1,738,200 $ 1,447,000
Income (loss) before extraordinary items and cumulative effect of a
change in accounting principles $ 75,400 $ (318,300)
Net income (loss) $ 75,400 $ (326,900)
Per share:
Basic $1.07 $(4.89)
Dilutive $1.06 $(4.89)
Pro forma adjustments include an increase to 2003 depreciation expense of
$3,100,000 related to the adjustment to fair value of property and equipment at
acquisition, which fair value adjustment is assumed amortized over an average
life of 15 years and, for the 2002 period, a reduction of $235,000,000 to
WilTel's historical depreciation expense, as the historical carrying amount of
WilTel's property and equipment as of January 1, 2002 was nearly $3.1 billion
more than the amount allocated to property and equipment assumed in the pro
forma financial statements. Accordingly, depreciation expense was substantially
reduced on a pro forma basis since the actual depreciation expense recorded on a
much larger asset would not have been recorded on a pro forma basis.
The pro forma adjustments for 2002 also include the reversal of certain
statement of operations activity as a result of WilTel's emergence from
bankruptcy, including the reversal of the gain recognized upon the discharge of
WilTel's indebtedness ($4.3 billion), the reversal of the net charge recognized
upon WilTel's application of fresh start accounting adjustments to the
historical carrying amounts of its assets and liabilities ($2.1 billion) and the
reversal of historical interest expense related to all debt that was converted
to equity under WilTel's bankruptcy plan. For both periods, the pro forma
adjustments included an adjustment to reduce the Company's historical federal
income tax provision (2003 - $38,200,000 and 2002 - $12,900,000), as losses
generated by WilTel reduced or eliminated the Company's historical income, and
the reversal of the Company's recognition of its share of WilTel's losses under
the equity method of accounting as a result of the pro forma consolidation.
The unaudited pro forma data for WilTel is not indicative of future results of
operations or what would have resulted if the acquisitions had actually occurred
as of the beginning of the periods presented. Unaudited pro forma data is not
included for Symphony as the amounts were not material.
In September 2003, the Company acquired Symphony for approximately $36,700,000,
including expenses, of which approximately $29,200,000 was provided by financing
that is non-recourse to the Company but is fully collateralized by Symphony's
assets. In addition, at acquisition, the lender provided an additional
$5,000,000 of working capital financing to Symphony. The Company has
consolidated Symphony's financial condition and results of operations since
acquisition.
In September 2003, the Company acquired a 90% interest in 8 acres of unimproved
land in Washington, D.C. for cash of $53,800,000. Immediately following the
acquisition, mortgage financing of $15,000,000 was obtained, which is
non-recourse to the Company, which reduced the net cash investment in the
property to $38,800,000. Subsequent to the acquisition, the mortgage lender
provided an additional $5,000,000 of such non-recourse financing, which further
reduced the Company's net cash investment. The land is zoned for a minimum of
2,000,000 square feet of commercial office space, which the Company intends to
develop in phases, once acceptable tenants or purchasers are identified.
F-14
3. Acquisitions, continued:
------------
In December 2003, the Company purchased all of the debt obligations under the
senior secured credit facility of ATX Communications, Inc. and certain of its
affiliates ("ATX") for $25,000,000, and also entered into an amendment to the
facility pursuant to which the Company agreed to refrain from exercising certain
of its rights under the facility, subject to certain conditions. ATX is an
integrated communications provider that offers local exchange carrier and
inter-exchange carrier telephone, Internet, high-speed data and other
communications services to business and residential customers in targeted
markets throughout the Mid-Atlantic and Midwest regions of the United States.
ATX is a public company traded on the NASD OTC Bulletin Board (Symbol: COMMQ).
Concurrently with the purchase of the facility and the execution of the
amendment, the Company entered into a conversion agreement pursuant to which the
Company agreed, upon the satisfaction of certain conditions, to convert the
senior secured debt of ATX into 100% of the preferred stock (with a liquidation
preference of $25,000,000) and 100% of the common stock of a reorganized ATX. As
contemplated by these agreements, in January 2004 ATX commenced a voluntary
chapter 11 case in order to reorganize its financial affairs. The reorganization
of ATX and the implementation of the conversion agreement are subject to the
approval of the bankruptcy court. Assuming the conversion agreement is
implemented in its current form, the Company will consolidate ATX as of the date
the reorganization is completed.
4. Investments in Associated Companies:
-----------------------------------
The Company has investments in several Associated Companies. The amounts
reflected as equity in income (losses) of associated companies in the
consolidated statements of operations are net of income tax provisions
(benefits) of $70,100,000, $36,700,000 and $(8,600,000) for the years ended
December 31, 2003, 2002 and 2001, respectively.
During 2000, the Company invested $100,000,000 in the equity of a limited
liability company, Jefferies Partners Opportunity Fund II, LLC ("JPOF II"), that
is a registered broker-dealer. JPOF II is managed by Jefferies & Company, Inc.,
a full service investment bank to middle market companies. JPOF II invests in
high yield securities, special situation investments and distressed securities
and provides trading services to its customers and clients. For the years ended
December 31, 2003, 2002 and 2001, the Company recorded $14,800,000, $15,200,000
and $27,100,000, respectively, of pre-tax income from this investment under the
equity method of accounting. These earnings were distributed by JPOF II as
dividends shortly after the end of each year.
In December 2001, the Company invested $127,500,000 for an approximate 25%
common stock interest in Olympus Re Holdings, Ltd. ("Olympus"), a newly formed
Bermuda reinsurance company primarily engaged in the property excess, marine and
aviation reinsurance business. In June 2003, the Company sold 567,574 common
shares of Olympus back to Olympus for total proceeds of $79,500,000. The Company
recognized a $1,500,000 gain on the sale which is reflected in other income for
the year ended December 31, 2003. The shares were sold to Olympus as part of an
issuer tender offer available to all of its shareholders. After completion of
the tender, the Company's interest in Olympus declined from 25% to 16.1%. The
Company will continue to account for this investment under the equity method of
accounting based upon the Company's ability to exercise significant influence.
For the years ended December 31, 2003 and 2002, the Company recorded $40,400,000
and $24,100,000, respectively, of pre-tax income from this investment under the
equity method of accounting.
F-15
4. Investments in Associated Companies, continued:
-----------------------------------
In December 2001, the Company invested $50,000,000 in EagleRock Capital Partners
(QP), LP ("EagleRock"), a limited partnership that invests primarily in
securities and other obligations of highly leveraged, distressed and out of
favor companies. For the years ended December 31, 2003 and 2002, the Company
recorded $49,900,000 of pre-tax income and $4,500,000 of pre-tax losses,
respectively, from this investment under the equity method of accounting. The
income reported by the partnership for 2003 results from both realized and
unrealized gains in its portfolio, and no cash has been distributed by the
partnership since its inception.
In October 2002, the Company sold one of its real estate subsidiaries, CDS
Holding Corporation ("CDS"), to HomeFed Corporation ("HomeFed") for a purchase
price of $25,000,000, consisting of $1,000,000 in cash and 2,474,226 shares of
HomeFed's common stock, which represented approximately 30% of HomeFed's
outstanding common stock. At December 31, 2003 and 2002, the deferred gain on
this sale was $7,900,000 and $12,100,000, respectively, which is being
recognized into income as CDS's principal asset, the real estate project known
as San Elijo Hills, is developed and sold. For the year ended December 31, 2003,
the Company recorded $16,200,000 of pre-tax income from this investment under
the equity method of accounting. HomeFed is engaged, directly and through
subsidiaries, in the investment in and development of residential real estate
projects in the State of California. HomeFed is a publicly traded company listed
on the NASD OTC Bulletin Board (Symbol: HOFD).
In November 2002, the Company sold its approximately 40% equity interest in
certain thoroughbred racetrack businesses to a third party for net proceeds of
$28,000,000. The sale resulted in a pre-tax gain of $14,300,000. As part of the
transaction, the Company has an approximately 15% profits interest in a joint
venture formed with the buyer of the businesses to pursue the potential
development and management of gaming ventures in Maryland, including slot
machines and video lottery terminals (if authorized by state law). The Company
has no funding obligations for this joint venture.
The following table provides summarized data with respect to the Associated
Companies accounted for on the equity method of accounting included in results
of operations for the three years ended December 31, 2003, except for Berkadia
LLC ("Berkadia") and WilTel which are separately summarized below. (Amounts are
in thousands.)
2003 2002
---- ----
Assets $ 2,062,300 $ 1,597,700
Liabilities 812,600 584,800
------------ ------------
Net assets $ 1,249,700 $ 1,012,900
============ ============
The Company's portion of the reported net assets $ 411,900 $ 387,600
============ ============
2003 2002 2001
---- ---- ----
Total revenues $ 890,900 $ 479,200 $ 277,700
Income from continuing operations before extraordinary items $ 374,700 $ 133,400 $ 79,900
Net income $ 374,700 $ 136,600 $ 96,700
The Company's equity in net income $ 119,900 $ 39,200 $ 45,800
The Company has not provided any guarantees, nor is it contingently liable for
any of the liabilities reflected in the above table. All such liabilities are
non-recourse to the Company. The Company's exposure to adverse events at the
investee companies is limited to the book value of its net investment.
F-16
4. Investments in Associated Companies, continued:
-----------------------------------
In August 2001, Berkadia, an entity jointly owned by the Company and Berkshire
Hathaway Inc., loaned $5,600,000,000 on a senior secured basis to FINOVA Capital
Corporation (the "Berkadia Loan"), the principal operating subsidiary of The
FINOVA Group Inc. ("FINOVA"), to facilitate a chapter 11 restructuring of the
outstanding debt of FINOVA and its principal subsidiaries. Berkadia also
received 61,020,581 newly issued shares of common stock of FINOVA (the "FNV
Shares"), representing 50% of the stock of FINOVA outstanding on a fully diluted
basis. The Berkadia Loan was collateralized by substantially all of the assets
of FINOVA and its subsidiaries and guaranteed by FINOVA and substantially all of
the subsidiaries of FINOVA and FINOVA Capital. Berkadia financed the Berkadia
Loan with bank financing that was guaranteed, 90% by Berkshire Hathaway and 10%
by the Company (with the Company's guarantee being secondarily guaranteed by
Berkshire Hathaway), and that was also secured by Berkadia's pledge of the
$5,600,000,000 five year senior secured promissory note from FINOVA Capital to
Berkadia issued pursuant to the Berkadia Loan. As of December 31, 2003,
principal payments had reduced the amount outstanding under the Berkadia Loan
and Berkadia's financing to $525,000,000. In February 2004, FINOVA fully repaid
the Berkadia Loan, and Berkadia fully repaid its bank financing, thereby
eliminating the Company's guaranty.
During 2001, Berkadia was paid a $60,000,000 commitment fee by FINOVA Capital
upon execution of the commitment, and a $60,000,000 funding fee upon funding of
the Berkadia Loan. The Company's share of these fees, $60,000,000 in the
aggregate, was distributed to the Company shortly after the fees were received.
In addition, FINOVA Capital has reimbursed Berkadia, Berkshire Hathaway and the
Company for all fees and expenses incurred in connection with Berkadia's
financing of its funding obligation under the commitment. In connection with the
funding commitment, in February 2001, FINOVA entered into a ten-year management
agreement with the Company, for which the Company receives an annual fee of
$8,000,000. The management agreement remains in effect subsequent to the
repayment of the Berkadia Loan.
Under the agreement governing Berkadia, the Company and Berkshire Hathaway have
agreed to equally share the commitment fee, funding fee and all management fees.
All income related to the Berkadia Loan, after payment of financing costs, will
be shared 90% to Berkshire Hathaway and 10% to the Company. For 2003, 2002 and
2001, the Company recorded income of $4,400,000, $6,600,000 and $3,900,000,
respectively, representing 10% of the net interest spread on the Berkadia Loan
and the net interest savings. All of this income has been distributed to the
Company.
In August 2001, Berkadia transferred $5,540,000,000 in cash to FINOVA Capital,
representing the $5,600,000,000 loan reduced by the funding fee of $60,000,000.
As indicated above, in exchange for these funds, Berkadia received a
$5,600,000,000 note from FINOVA Capital and the FNV Shares. Under GAAP, Berkadia
was required to allocate the $5,540,000,000 cash transferred, reduced by the
previously received $60,000,000 commitment fee, between its investment in the
Berkadia Loan and the FNV Shares, based upon the relative fair values of the
securities received. Further, the fair value of the FNV Shares was presumed to
be equal to the trading price of the stock on the day Berkadia received the FNV
Shares, with only relatively minor adjustments allowed for transfer restrictions
and the inability of the traded market price to account for a large block
transfer. The requirement to use the trading price as the basis for the fair
value estimate resulted in an initial book value for the FNV Shares of
$188,800,000, which was far in excess of the $17,600,000 aggregate book net
worth of FINOVA on the effective date of the Plan, and was inconsistent with the
Company's view that the FINOVA common stock has a very limited value. Based on
this determination of fair value, Berkadia recorded an initial investment in the
FNV Shares of $188,800,000 and in the Berkadia Loan of $5,291,200,000.
The allocation of $188,800,000 to the investment in the common stock of FINOVA,
plus the $120,000,000 of cash fees received, were recorded and reflected as a
discount from the face amount of the Berkadia Loan. The discount is being
amortized to income over the life of the Berkadia Loan under the effective
interest method.
F-17
4. Investments in Associated Companies, continued:
-----------------------------------
Subsequent to acquisition, Berkadia accounted for its investment in the FINOVA
common stock under the equity method of accounting. Berkadia's recognition of
its share of FINOVA's losses was suspended once the carrying amount of
Berkadia's equity interest in FINOVA was reduced to zero during 2001.
Principally as a result of the terrorist attacks on September 11, 2001, Berkadia
recorded its share of FINOVA's losses in an amount that reduced Berkadia's
investment in FINOVA's common stock to zero. This non-cash loss recorded by
Berkadia is being reversed by Berkadia's accretion of the non-cash portion of
the discount on the Berkadia Loan discussed above.
During 2002, Berkadia gave its consent to FINOVA to use up to $300,000,000 of
cash to repurchase certain subordinated notes rather than make mandatory
prepayments of the Berkadia Loan. In consideration for its consent, FINOVA and
Berkadia agreed that they would share equally in the net interest savings
resulting from any repurchase. The Company's share of the net interest savings
is reflected in the table below.
The Company accounts for its investment in Berkadia under the equity method of
accounting because it does not control Berkadia. Although the Company has no
cash investment in Berkadia, since it guaranteed 10% of the third party
financing provided to Berkadia, the Company records its share of any losses
recorded by Berkadia, up to the amount of the Company's guarantee. For the years
ended December 31, 2003 and 2002 and for the period from the effective date of
the Plan to December 31, 2001, the Company's equity in the income (loss) of
Berkadia consists of the following (in thousands):
2003 2002 2001
---- ---- ----
Net interest spread on the Berkadia Loan - 10% of total $ 2,400 $ 6,100 $ 3,900
Net interest savings 2,000 500 -
Amortization of Berkadia Loan discount related to cash fees -
50% of total 29,100 22,900 7,800
Amortization of Berkadia Loan discount related to FINOVA
stock - 50% of total 45,700 36,100 12,300
Share of FINOVA loss under equity method - 50% of total - - (94,400)
----------- ----------- -----------
Equity in income (loss) of associated companies - Berkadia $ 79,200 $ 65,600 $ (70,400)
=========== =========== ===========
The loss recorded by the Company related to its share of Berkadia's equity
method loss in FINOVA in 2001 is a non-cash loss that is being reversed over the
term of the Berkadia Loan as Berkadia accretes the discount on the Berkadia Loan
into income. The net carrying amount of the Company's investment in Berkadia was
negative $500,000 and $72,100,000, as of December 31, 2003 and 2002,
respectively, which is included in "Other non-current liabilities" in the
consolidated balance sheets. The negative carrying amounts are due to Berkadia's
distribution of the commitment and funding fees and its recognition of its share
of FINOVA's losses under the equity method of accounting, partially offset by
the Company's share of Berkadia's income related to the Berkadia loan. As a
result of the application of these accounting rules, the negative carrying
amount of the Company's investment in Berkadia effectively represents an
unamortized discount on the Berkadia Loan, which is being amortized to income
over the term of the loan.
F-18
4. Investments in Associated Companies, continued:
-----------------------------------
The following table provides certain summarized data with respect to Berkadia at
December 31, 2003 and 2002 and for the years ended December 31, 2003 and 2002
and for the period from the effective date of the Plan through December 31,
2001. (Amounts are in thousands.)
2003 2002
---- ----
Assets $ 526,400 $ 2,030,700
Liabilities 525,600 2,177,700
------------ --------------
Net assets $ 800 $ (147,000)
============ ==============
2003 2002 2001
---- ---- ----
Total revenues $ 198,800 $ 245,200 $ (52,100)
Income (loss) from continuing operations before extraordinary
items and cumulative effect of a change in accounting
principle $ 180,400 $ 180,900 $ (110,100)
Net income (loss) $ 180,400 $ 180,900 $ (110,100)
During 2003, the amortization of the Berkadia loan discount increased
significantly as a result of principal payments on the Berkadia loan that were
greater than expected.
Prior to its acquisition in 2003 of the remaining shares of WilTel's outstanding
common stock, the Company accounted for its 47.4% interest in WilTel under the
equity method of accounting. For the period January 1, 2003 through November 5,
2003, (the day before the acquisition was consummated) and for the period from
the initial 2002 purchase through December 31, 2002, the Company recorded
$52,100,000 and $13,400,000, respectively, of pre-tax losses from this
investment under the equity method of accounting. The amounts recorded in 2003
include the Company's share of WilTel's income from the recognition of
non-operating settlement gains related to the termination of various agreements
that released WilTel from previously accrued obligations, recoveries of
previously written off receivables and a gain on the sale of a subsidiary. The
Company's share of these gains was approximately $31,200,000, for which no tax
provision was recorded. The book value of the Company's investment in WilTel was
$340,600,000 at December 31, 2002.
The following table provides certain summarized data with respect to WilTel at
December 31, 2002, and for the periods from January 1, 2003 through November 5,
2003, and from the initial 2002 purchase through December 31, 2002. (Amounts are
in thousands.)
2002
----
Assets:
Current $ 552,700
Non-current 1,509,600
-----------
Total assets 2,062,300
-----------
Liabilities:
Current 533,400
Non-current 839,200
-----------
Total liabilities 1,372,600
-----------
Net assets $ 689,700
===========
2003 2002
---- ----
Total revenues $ 1,111,400 $ 191,700
Loss from continuing operations before extraordinary items $ (108,700) $ (61,000)
Net loss $ (108,700) $ (61,000)
The Company's equity in net loss $ (52,100) $ (13,400)
F-19
5. Discontinued Operations:
-----------------------
In December 2001, upon approval by the Company's Board of Directors to commence
an orderly liquidation of the Empire Group, the Company classified as
discontinued operations the property and casualty insurance operations of the
Empire Group. The Empire Group had historically engaged in commercial and
personal lines of property and casualty insurance, principally in the New York
metropolitan area. The Empire Group only accepts new business that it is
obligated to accept by contract or New York insurance law; it does not engage in
any other business activities except for its claims runoff operations. In
December 2001, the Company wrote down its investment in the Empire Group to its
estimated net realizable value based on expected operating results and cash
flows during the liquidation period, which indicated that the Company is
unlikely to realize any value once the liquidation is complete. Accordingly, the
Company recorded a $31,100,000 after-tax charge (net of taxes of $16,800,000) as
a loss on disposal of discontinued operations to fully write-off its investment.
The Company has no obligation to contribute additional capital to the Empire
Group.
During the second quarter of 2002, the Company sold its interest in Fidei, its
foreign real estate subsidiary, to an unrelated third party for total proceeds
of 70,400,000 Euros ($66,200,000), which resulted in an after tax gain on the
sale reflected in results of operations of $4,500,000 (net of income tax expense
of $2,400,000) for the year ended December 31, 2002, and an increase to
shareholders' equity of $12,100,000 as of December 31, 2002. The Euro
denominated sale proceeds were not converted into U.S. dollars immediately upon
receipt. The Company entered into a participating currency derivative, which
expired in September 2002. Upon expiration, net of the premium paid to purchase
the contract, the Company received $67,900,000 in exchange for 70,000,000 Euros
and recognized a foreign exchange gain of $2,000,000, which is included in
investment and other income for the year ended December 31, 2002.
In December 2002, the Company entered into an agreement to purchase certain debt
and equity securities of WebLink Wireless, Inc. ("WebLink"), for an aggregate
purchase price of $19,000,000. WebLink operated in the wireless messaging
industry, providing wireless data services and traditional paging services.
Pursuant to the agreement, the Company acquired outstanding secured notes of
WebLink with a principal amount of $36,500,000 (representing 94% of total
outstanding debt). In April 2003, upon receipt of approval from the FCC, the
Company acquired approximately 80% of the outstanding common stock of WebLink
and commenced consolidating WebLink in its financial statements.
In November 2003, WebLink sold substantially all of its operating assets to
Metrocall, Inc. in exchange for 500,000 shares of common stock of Metrocall,
Inc's parent, Metrocall Holdings, Inc. ("Metrocall"), an immediately exercisable
warrant to purchase 25,000 shares of common stock of Metrocall at $40 per share,
and a warrant to purchase up to 100,000 additional shares of Metrocall common
stock at $40 per share, subject to certain vesting criteria. Based upon the
market price of the Metrocall stock received and the fair value of the warrants
received as of the closing, the Company reported a gain of $7,500,000 on this
transaction (net of taxes of $4,000,000) and in the fourth quarter of 2003
classified WebLink as a discontinued operation. The Company's investment in the
shares of Metrocall common stock is classified as non-current investments at
December 31, 2003.
During 2003, the Company settled certain tax payment responsibilities with the
purchaser of Colonial Penn Insurance Company. Income from discontinued
operations for the year ended December 31, 2003 includes a payment of $1,800,000
from the purchaser to reimburse the Company for tax payments previously made.
F-20
5. Discontinued Operations, continued:
-----------------------
A summary of the results of discontinued operations is as follows for the three
year period ended December 31, 2003 (in thousands):
2003 2002 2001
---- ---- ----
Revenues:
Wireless messaging revenues $ 57,900 $ - $ -
Insurance revenues and commissions - - 64,078
Investment and other income 266 12,904 46,921
Net securities gains (losses) - (364) 12,419
------------- ------------- -------------
58,166 12,540 123,418
------------- ------------- -------------
Expenses:
Wireless messaging network operating expenses 31,354 - -
Provision for insurance losses and policy benefits - - 125,984
Amortization of deferred policy acquisition costs - - 16,965
Interest - 2,163 7,437
Salaries 9,947 505 6,744
Selling, general and other expenses 11,650 2,721 24,743
------------- ------------- -------------
52,951 5,389 181,873
------------- ------------- -------------
Income (loss) before income taxes 5,215 7,151 (58,455)
Income tax provision (benefit) 17 2,571 (18,713)
------------- ------------- -------------
Income (loss) from discontinued operations, net of taxes $ 5,198 $ 4,580 $ (39,742)
============= ============= =============
6. Investments:
-----------
A summary of investments classified as current assets at December 31, 2003 and
2002 is as follows (in thousands):
2003 2002
------------------------------- ---------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
------------ ------------ ----------- -----------
Investments available for sale $ 606,387 $ 623,570 $ 134,728 $ 134,246
Trading securities 74,923 86,392 49,888 48,036
Other investments, including accrued interest income 4,401 4,401 2,914 2,914
------------ ------------ ----------- -----------
Total current investments $ 685,711 $ 714,363 $ 187,530 $ 185,196
============ ============ =========== ===========
F-21
6. Investments, continued:
-----------
The amortized cost, gross unrealized gains and losses and estimated fair value
of available for sale investments classified as current assets at December 31,
2003 and 2002 are as follows (in thousands):
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------- --------
2003
- ----
Bonds and notes:
United States Government agencies and authorities $ 524,326 $ 225 $ 52 $ 524,499
All other corporates 78,190 17,010 - 95,200
Other fixed maturities 3,871 - - 3,871
---------- ---------- ---------- ----------
Total $ 606,387 $ 17,235 $ 52 $ 623,570
========== ========== ========== ==========
2002
- ----
Bonds and notes:
United States Government agencies and authorities $ 98,669 $ 105 $ - $ 98,774
Foreign governments 2,978 63 - 3,041
All other corporates 23,690 239 889 23,040
Other fixed maturities 9,391 - - 9,391
---------- ---------- ---------- ----------
Total $ 134,728 $ 407 $ 889 $ 134,246
========== ========== ========== ==========
Certain information with respect to trading securities at December 31, 2003 and
2002 is as follows (in thousands):
2003 2002
------------------------------- --------------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
----------- ------------ ----------- ------------
Fixed maturities - corporate bonds and notes $ 69,923 $ 80,516 $ 45,225 $ 44,204
Equity securities - preferred stocks 3,680 3,983 2,382 2,076
Other investments 1,320 1,893 2,281 1,756
----------- ------------ ----------- ------------
Total trading securities $ 74,923 $ 86,392 $ 49,888 $ 48,036
=========== ============ =========== ============
A summary of non-current investments at December 31, 2003 and 2002 is as follows
(in thousands):
2003 2002
-------------------------------- ------------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
----------- ------------ ----------- ------------
Investments available for sale $ 420,947 $ 655,178 $ 349,843 $ 435,615
Other investments 18,564 18,564 4,060 4,060
----------- ------------ ----------- ------------
Total non-current investments $ 439,511 $ 673,742 $ 353,903 $ 439,675
=========== ============ =========== ============
F-22
6. Investments, continued:
-----------
The amortized cost, gross unrealized gains and losses and estimated fair value
of non-current investments classified as available for sale at December 31, 2003
and 2002 are as follows (in thousands):
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
2003
- ----
Bonds and notes:
United States Government agencies and authorities $ 176,587 $ 108 $ 431 $ 176,264
States, municipalities and political subdivisions 2,799 6 - 2,805
Foreign governments 1,511 155 - 1,666
All other corporates 108,045 56,753 277 164,521
Other fixed maturities 690 - - 690
---------- ---------- ---------- ----------
Total fixed maturities 289,632 57,022 708 345,946
---------- ---------- ---------- ----------
Equity securities:
Preferred stocks 993 - - 993
Common stocks:
Banks, trusts and insurance companies 91,154 111,245 - 202,399
Industrial, miscellaneous and all other 38,810 66,672 - 105,482
---------- ---------- ---------- ----------
Total equity securities 130,957 177,917 - 308,874
---------- ---------- ---------- ----------
Other 358 - - 358
---------- ---------- ---------- ----------
$ 420,947 $ 234,939 $ 708 $ 655,178
========== ========== ========== ==========
2002
- ----
Bonds and notes:
United States Government agencies and authorities $ 96,616 $ 732 $ 206 $ 97,142
States, municipalities and political subdivisions 8,530 21 388 8,163
Foreign governments 1,514 185 - 1,699
All other corporates 122,485 23,379 6,447 139,417
Other fixed maturities 4,738 - - 4,738
---------- ---------- ---------- ----------
Total fixed maturities 233,883 24,317 7,041 251,159
---------- ---------- ---------- ----------
Equity securities:
Preferred stocks 4,103 304 - 4,407
Common stocks:
Banks, trusts and insurance companies 93,373 60,745 10,192 143,926
Industrial, miscellaneous and all other 18,484 18,878 1,239 36,123
---------- ---------- ---------- ----------
Total equity securities 115,960 79,927 11,431 184,456
---------- ---------- ---------- ----------
$ 349,843 $ 104,244 $ 18,472 $ 435,615
========== ========== ========== ==========
F-23
6. Investments, continued:
-----------
The amortized cost and estimated fair value of non-current investments
classified as available for sale at December 31, 2003, by contractual maturity
are shown below. Expected maturities are likely to differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
Estimated
Amortized Fair
Cost Value
----------- -----------
(In thousands)
Due after one year through five years $ 212,049 $230,655
Due after five years through ten years 20,397 49,927
Due after ten years 9,206 17,794
----------- -----------
241,652 298,376
Mortgage-backed securities 47,980 47,570
----------- -----------
$ 289,632 $345,946
=========== ===========
In May 2001, the Company invested $75,000,000 in a new issue of restricted
convertible preference shares of White Mountains Insurance Group, Ltd. ("WMIG").
In August 2001, upon approval by WMIG's shareholders, these securities were
converted into 375,000 common shares which represent approximately 4.2% of WMIG.
WMIG is a publicly traded, Bermuda domiciled financial services holding company,
principally engaged through its subsidiaries and affiliates in property and
casualty insurance and reinsurance. At December 31, 2003 and 2002, the Company's
investment in WMIG, which is reflected in non-current investments available for
sale, had a market value of $172,500,000 and $121,100,000, respectively.
At December 31, 2003, non-current investments also included publicly traded
common stock equity interests of 11.0% in Carmike Cinemas, Inc., 6.3% in
ParkerVision, Inc. and 9.2% in Metrocall.
Net unrealized gains on investments were $161,800,000, $58,000,000 and
$31,700,000 at December 31, 2003, 2002 and 2001, respectively. Reclassification
adjustments included in comprehensive income for the three year period ended
December 31, 2003 are as follows (in thousands):
2003 2002 2001
---- ---- ----
Unrealized holding gains arising during the period, net of
tax provision of $56,896, $12,558 and $12,665 $ 105,861 $ 23,253 $ 23,653
Less: reclassification adjustment for (gains) losses included in net
income, net of tax provision (benefit) of $1,158, $(1,657) and $3,128 (2,085) 3,078 (5,803)
------------ ------------ ------------
Net change in unrealized gain on investments, net of tax
provision of $55,738, $14,215 and $9,537 $ 103,776 $ 26,331 $ 17,850
============ ============ ============
F-24
6. Investments, continued:
-----------
The following table shows the Company's investments' gross unrealized losses and
fair value, aggregated by investment category, all of which have been in a
continuous unrealized loss position for less than 12 months, at December 31,
2003 (in thousands):
Unrealized
Description of Securities Fair Value Losses
- ------------------------- ---------- ------
United States Government agencies and authorities $ 162,878 $ 483
Corporate bonds 4,954 277
---------- ----------
Total temporarily impaired securities $ 167,832 $ 760
========== ==========
The unrealized losses on the United States Government agencies and authorities
relate to approximately fifteen securities all of which were purchased
subsequent to March 2003. The unrealized losses on the corporate bonds primarily
relate to two securities purchased in December 2003.
At December 31, 2003 and 2002, securities with book values aggregating
$26,300,000 and $1,400,000, respectively, were on deposit with various
regulatory authorities. Securities with book values of $11,100,000 and
$4,800,000 at December 31, 2003 and 2002, respectively, collateralized certain
swap agreements, and securities with a book value of $24,200,000 at December 31,
2003 collateralized certain debt obligations and a related letter of credit.
Additionally, at December 31, 2002, securities with a book value of
$165,300,000, collateralized a letter of credit issued in connection with the
sale of the Colonial Penn Insurance Company (the letter of credit was returned
to the Company during 2003 and the collateral was released).
7. Trade, Notes and Other Receivables, Net:
---------------------------------------
A summary of trade, notes and other receivables, net at December 31, 2003 and
2002 is as follows (in thousands):
2003 2002
---- ----
Current trade, notes and other receivables, net:
Trade receivables $ 300,659 $ 7,173
Federal income tax receivable 25,648 -
Instalment loan receivables, net of unearned finance charges of
$112 and $1,598 (a) 22,461 87,622
Receivables related to securities 2,451 4,430
Receivables relating to real estate activities 3,640 16,288
Other 22,568 8,506
------------- ------------
377,427 124,019
Allowance for doubtful accounts (5,323) (9,440)
------------- ------------
Total current trade, notes and other receivables, net $ 372,104 $ 114,579
============= ============
Non-current notes and other receivables, net:
Instalment loan receivables, net of unearned finance charges of
$16 in 2002 (a) $ 182,991 $ 285,982
Receivables relating to real estate activities 15,767 16,432
Other 16,279 13,720
------------- ------------
215,037 316,134
Allowance for doubtful accounts (21,578) (23,291)
------------- ------------
Total non-current notes and other receivables, net $ 193,459 $ 292,843
============= ============
F-25
7. Trade, Notes and Other Receivables, Net, continued:
---------------------------------------
(a) Contractual maturities of instalment loan receivables at December 31, 2003
were as follows (in thousands): 2004 - $22,500; 2005 - $46,300; 2006 - $53,500;
2007 - $14,900; and 2008 and thereafter - $68,300. Experience shows that a
substantial portion of such notes will be repaid or renewed prior to contractual
maturity. Accordingly, the foregoing is not to be regarded as a forecast of
future cash collections.
8. Other Assets:
------------
A summary of other assets at December 31, 2003 and 2002 is as follows (in
thousands):
2003 2002
---- ----
Real Estate $ 144,273 $ 85,188
Intangibles:
Mineral rights 48,404 42,899
Tradename, net of accumulated amortization of $85 3,427 -
Customer relationships, net of accumulated amortization of $351 12,459 -
Mining properties 26,215 16,443
Deposits 39,719 1,403
Other 24,092 18,637
------------- -----------
$ 298,589 $ 164,570
============= ===========
The intangible asset associated with mineral rights relates to the Las Cruces
mineral rights of MK Gold. These mineral rights will be amortized using the
units-of-production method once production at the Las Cruces project commences.
As more fully described in Note 3, tradename and customer relationship
intangible assets were recognized in connection with the acquisition of WilTel,
and are being amortized on a straight-line basis over their weighted-average
useful lives. Amortization expense for intangible assets was $400,000 for 2003.
The Company's total comprehensive income in 2003 subsequent to the acquisition
of WilTel enabled it to realize a portion of WilTel's acquired deferred tax
assets which had been fully reserved for at acquisition. The resulting reduction
in the valuation allowance for deferred tax assets of $22,500,000 was applied to
reduce the recorded amount of WilTel's identifiable intangible assets on a pro
rata basis. The estimated aggregate future amortization expense for the
tradename and customer relationship intangible assets for each of the next five
years is $1,200,000.
F-26
9. Property, Equipment and Leasehold Improvements, Net:
---------------------------------------------------
A summary of property, equipment and leasehold improvements, net at December 31,
2003 and 2002 is as follows (in thousands):
Depreciable
Lives
(in years) 2003 2002
----------- ---- ----
Network equipment (including fiber, optronics and capacity IRUs) 3-20 $ 793,338 $ -
Right of way 20 95,813 -
Buildings and leasehold improvements 5-30 383,040 127,125
Machinery and equipment 2-25 89,598 77,068
Corporate aircraft 10 140,033 54,181
Computer equipment and software 2-5 58,304 6,710
General office furniture and fixtures 2-13 30,165 7,653
Construction in progress N/A 15,799 3,464
Other 3-7 9,728 7,493
------------- -------------
1,615,818 283,694
Accumulated depreciation and amortization (165,719) (117,487)
------------- -------------
$ 1,450,099 $ 166,207
============= =============
In January 2004, the Company exercised an option to sell two of its corporate
aircraft for total proceeds of approximately $38,700,000. The Company expects to
transfer title to the aircraft during the third quarter of 2004, and will
recognize a gain of approximately $11,600,000 at that time.
F-27
10. Trade Payables, Expense Accruals and Other Liabilities:
------------------------------------------------------
A summary of trade payables, expense accruals and other liabilities at December
31, 2003 and 2002 is as follows (in thousands):
2003 2002
---- ----
Trade payables and expense accruals:
Trade payables $ 147,624 $ 9,043
Payables related to securities 48,816 26,379
Accrued compensation, severance and other employee benefits 59,913 20,124
Taxes other than income 31,950 609
Accrued interest payable 20,833 3,652
Amount due on purchase of corporate aircraft 17,000 -
Other 51,337 15,963
------------- ------------
$ 377,473 $ 75,770
============ ============
Other current liabilities:
Litigation reserves $ 38,362 $ -
Unfavorable contract commitments 12,981 -
Liabilities related to real estate activities - 5,264
Asset retirement obligations 1,017 -
Other 37,030 10,172
------------ ------------
$ 89,390 $ 15,436
============ ============
Other non-current liabilities:
Investment in Berkadia $ 468 $ 72,106
Unfavorable contract commitments 43,317 -
Asset retirement obligations 29,432 -
Postretirement and postemployment benefits 9,861 10,362
Pension liability 64,786 -
Liabilities related to real estate activities 9,117 13,684
Other 77,465 30,622
------------ ------------
$ 234,446 $ 126,774
============ ============
The Company's asset retirement obligations relate primarily to two categories of
WilTel's assets:
o Fiber and Conduit - The Company has right of way agreements which generally
require the removal of fiber and conduit upon the termination of those
agreements.
o Technical Sites - The Company leases land for technical sites and leases
space at technical sites along its network. Termination of these lease
agreements normally requires removal of equipment and other assets, and
restoration of the lease property to its original condition.
The Company recorded WilTel's asset retirement obligation of $28,500,000 as of
the date the merger was consummated on November 6, 2003. Activity subsequent to
the acquisition in 2003 was not significant. The fair value of the Company's
assets that are legally restricted for purposes of settling asset retirement
obligations at December 31, 2003 is $16,300,000.
F-28
11. Indebtedness:
------------
The principal amount, stated interest rate and maturity of debt outstanding at
December 31, 2003 and 2002 are as follows (dollars in thousands):
2003 2002
---- ----
Parent Company Debt:
Senior Notes:
Bank credit facility $ - $ -
7 3/4% Senior Notes due 2013, less debt discount of $481 and $531 99,519 99,469
7% Senior Notes due 2013, less debt discount of $1,016 273,984 -
Subordinated Notes:
8 1/4% Senior Subordinated Notes due 2005 19,101 19,101
7 7/8% Senior Subordinated Notes due 2006, less debt discount of
$31 and $42 21,645 21,634
Company-obligated mandatorily redeemable preferred securities
of subsidiary trust holding solely subordinated debt securities
of the Company 98,200 -
Subsidiary Debt:
WilTel Credit Agreement 375,000 -
One Technology Center ("OTC") Notes due 2004 through 2010
with a weighted average interest rate of 8.1% 119,125 -
Aircraft financing 47,675 49,789
Industrial Revenue Bonds (with variable interest) 9,815 9,815
Capital leases due 2004 through 2014 with a weighted average
interest rate of 11.7% 8,481 -
Other due 2004 through 2016 with a weighted average interest
rate of 5.2% 106,289 33,265
------------- -------------
Total debt 1,178,834 233,073
Less: current maturities (23,956) (3,647)
------------- -------------
Long-term debt $ 1,154,878 $ 229,426
============= =============
Parent Company Debt:
At December 31, 2003, the Company had an unsecured bank credit facility of
$110,000,000, which bears interest based on the Eurocurrency Rate or the prime
rate and matures in 2006. At December 31, 2003, no amounts were outstanding
under this bank credit facility.
In June 2003, the Company sold $200,000,000 principal amount of its newly
authorized 7% Senior Notes due 2013 in a private placement at 99.612% of the
principal amount. In each of August, November and December 2003, the Company
sold $25,000,000 principal amount ($75,000,000 in the aggregate) of its newly
authorized 7% Senior Notes due 2013 in private placements at 99.612% of the
principal amount. These notes have substantially identical terms as the notes
sold in June. The Company has completed a series of registered exchange offers
for all of these notes that converted the various issues of privately placed
notes into a single issue of publicly registered notes issued under the same
indenture.
F-29
11. Indebtedness, continued:
------------
In January 1997, the Company sold $150,000,000 aggregate liquidation amount of
8.65% trust issued preferred securities ("Trups") of its wholly-owned
subsidiary, Leucadia Capital Trust I (the "Trust"). These Company-obligated
mandatorily redeemable preferred securities have an effective maturity date of
January 15, 2027 and represent undivided beneficial interests in the Trust's
assets, which consist solely of $154,600,000 principal amount of 8.65% Junior
Subordinated Deferrable Interest Debentures due 2027 of the Company. Considered
together, the "back-up undertakings" of the Company related to the Trups
constitute a full and unconditional guarantee by the Company of the Trust's
obligations under the preferred securities. During 1998, a subsidiary of the
Company repurchased $51,800,000 aggregate liquidation amount of the Trups for
$42,200,000, plus accrued interest. The difference between the purchase price
and the book value was credited directly to shareholders' equity, net of taxes.
As a result of the implementation of SFAS 150, the Company began classifying the
Trups as liabilities on July 1, 2003, and classifies dividends accrued for these
securities as interest expense. SFAS 150 does not permit restatement of prior
period amounts to reflect the new classification.
In 2004, the Company liquidated the Trust and commenced a distribution to the
Trups holders the 8.65% Junior Subordinated Deferrable Interest Debentures held
by the Trust in exchange for their Trups securities. The distribution will be
completed by March 31, 2004, and will not have any effect on the total debt of
the Company.
Subsidiary Debt:
WilTel's obligations under its credit agreement are secured by substantially all
of its assets other than those assets securing the OTC notes and the aircraft
capital lease, for which the credit agreement lenders have a second priority
lien and security interest. The WilTel credit agreement is repayable in
instalments of principal beginning in June 2005 through September 2006 and
currently bears interest either at the prime rate plus a margin of 3.5% or LIBOR
plus a margin of 4.5%, at the Company's option. In July 2004, the margin, in
each case, will increase by 1%. At December 31, 2003, the credit agreement had
an interest rate of 5.6875%. WilTel's credit agreement also permits WilTel to
provide others with cash deposits and/or asset liens in an amount up to
$30,000,000 in the aggregate. As of December 31, 2003, $25,200,000 of deposits
has been provided to other parties. WilTel's credit agreement also allows WilTel
to obtain cash-collateralized letters of credit in the aggregate amount of
$45,000,000, reduced by the amount of any outstanding cash deposits or liens. As
of December 31, 2003, $12,500,000 of such letters of credit was outstanding.
The WilTel credit agreement contains covenants that require WilTel to meet
certain operating targets, which it currently meets, and restrictions that limit
WilTel's ability to incur additional indebtedness, spend funds on capital
expenditures and make certain investments. The Company currently expects that
WilTel will be able to meet the operating targets required by its credit
agreement during 2004 and 2005; however, compliance with the operating targets
thereafter is uncertain. The agreement also prohibits WilTel from paying
dividends to the Company.
The OTC notes are full recourse notes to WilTel and are secured by a first
priority mortgage lien and security interest in WilTel's headquarters building
(except for network related assets in the building) and other ancillary assets.
In addition, the OTC notes are secured by a second lien and security interest in
$13,100,000 of restricted securities (which are classified as other non-current
investments). The notes consist of (1) a 7% note with a remaining principal
balance of $74,300,000 that provides for monthly payments of principal for the
first 90 months (based on a 360 month amortization table), with the remaining
unpaid principal balance due and payable in April 2010 and (2) a $44,800,000
note with accrued interest paid in kind and capitalized once annually, with the
original principal balance and all capitalized and accrued paid in kind interest
(totaling $74,400,000 at maturity) due and payable in December 2006. The second
note carries a fixed interest rate of 10% through 2003, and each year thereafter
the interest rate increases 2% per year resulting in an interest rate of 16% in
2006.
The WilTel debt is non-recourse to Leucadia and has not been guaranteed by
Leucadia.
F-30
11. Indebtedness, continued:
------------
During 2001, a subsidiary of the Company borrowed $53,100,000 secured by certain
of its corporate aircraft. This debt bears interest based on a floating rate,
requires monthly payments of principal and interest and matures in ten years.
The interest rate at December 31, 2003 was 2.6%. The subsidiary has entered into
an interest rate swap agreement for this financing, which fixed the interest
rate at approximately 5.7%. The subsidiary would have paid $3,100,000 and
$4,300,000 at December 31, 2003 and 2002, respectively, if the swap were
terminated. Changes in interest rates in the future will change the amounts to
be received under the agreement, as well as interest to be paid under the
related variable debt obligation. The Parent company has guaranteed this
financing.
Capital leases primarily consist of a sale-leaseback transaction related to
WilTel's corporate aircraft entered into in May 2003. WilTel recorded a capital
lease obligation representing the present value of the future minimum lease
payments during the lease term. The aircraft were sold for approximately
$21,000,000 in cash and leased back for a period of ten years. Under the terms
of the transaction, approximately $5,300,000 from the cash proceeds is held as
cash collateral by the owner-lessor for the lease, which is reflected in the
balance sheet in other non-current assets.
A subsidiary of the Company obtained loan commitments totaling $25,000,000 to
finance the renovation of its Hawaiian hotel. Included in other subsidiary debt
are outstanding borrowings under this facility of $23,800,000 and $24,900,000 at
December 31, 2003 and 2002, respectively. The financing bears interest at a rate
of 8.05% through September 1, 2005, at which time the rate is adjusted based on
the three year treasury index to a new fixed rate through maturity. The
borrowing matures in 2008 and is secured by the hotel but otherwise is
non-recourse to the Company.
Symphony has a $50,000,000 revolving credit facility, of which $34,200,000 was
outstanding at December 31, 2003, and is included above in other subsidiary
debt. This financing, which is secured by all of Symphony's assets but otherwise
is non-recourse to the Company, matures in 2006 and bears interest based on
LIBOR plus 3.85%. At December 31, 2003, the interest rate on this facility was
4.97%. As of December 31, 2003, Symphony is not in compliance with a financial
covenant contained in its credit facility. Symphony has obtained a waiver from
the lender that suspends application of the covenant until March 31, 2004. The
Company believes it is probable Symphony will be in compliance with the covenant
at that time; however, if it doesn't comply, the lender would have the right to
accelerate the maturity of the loan.
Other subsidiary debt also includes a mortgage financing of $20,000,000 obtained
in September and October 2003, which otherwise is non-recourse to the Company,
in connection with the acquisition of a 90% interest in 8 acres of unimproved
land in Washington D.C. The financing matures in 2005 and bears interest based
on LIBOR plus 3%. At December 31, 2003, the interest rate on this facility was
4.12%.
The Company's debt instruments require maintenance of minimum Tangible Net
Worth, limit distributions to shareholders and limit Indebtedness and Funded
Debt, all as defined in the agreements. In addition, the debt instruments
contain limitations on investments, liens, contingent obligations and certain
other matters. As of December 31, 2003, cash dividends of approximately
$612,300,000 would be eligible to be paid under the most restrictive covenants.
Substantially all of WilTel's assets (with an aggregate book value of
$1,744,300,000) are pledged as collateral under WilTel's debt agreements. All of
Symphony's assets (with an aggregate book value of $54,600,000) are pledged as
collateral under Symphony's debt agreement. Property, equipment and leasehold
improvements of the manufacturing division (with a net book value of $6,200,000)
are pledged as collateral for Industrial Revenue Bonds; and $173,300,000 of
other assets (primarily property) are pledged for other indebtedness aggregating
$118,000,000. In addition, the Industrial Revenue Bond obligation is secured by
a letter of credit which is fully collateralized by securities with a book value
of $11,100,000.
F-31
11. Indebtedness, continued:
------------
Interest rate agreements were used to manage the potential impact of changes in
interest rates on customer banking deposits. Under interest rate swap
agreements, the Company had agreed with other parties to pay fixed rate interest
amounts and receive variable rate interest amounts calculated by reference to an
agreed notional amount. The variable interest rate portion of the swaps was a
specified LIBOR interest rate. These interest rate swaps expired in 2003. The
Company would have paid $3,100,000 at December 31, 2002 on retirement of these
agreements.
Counterparties to interest rate and currency swap agreements are major financial
institutions, that management believes are able to fulfill their obligations.
Management believes any losses due to default by the counterparties are likely
to be immaterial.
The aggregate annual mandatory redemptions of debt during the five year period
ending December 31, 2008 are as follows (in thousands): 2004 - $24,000; 2005 -
$200,600; 2006 - $327,800; 2007 - $16,000; and 2008 - $610,400.
At December 31, 2003, customer banking deposits include $37,000,000 aggregate
amount of time deposits in denominations of $100,000 or more.
The weighted average interest rate on short-term borrowings (consisting of
customer banking deposits and subsidiary revolving credit agreements) was 3.4%
and 3.5% at December 31, 2003 and 2002, respectively.
12. Common Shares, Stock Options and Preferred Shares:
-------------------------------------------------
The Board of Directors from time to time has authorized acquisitions of the
Company's common shares. In December 1999, the Company's Board of Directors
increased to 6,000,000 the maximum number of shares that the Company is
authorized to purchase. During the three year period ended December 31, 2003,
the Company acquired 6,235 common shares at an average price of $35.28 per
common share. As of December 31, 2003, the Company is authorized to repurchase
4,488,765 common shares.
In December 2002, the Company completed a private placement of approximately
$150,000,000 of equity securities, based on a common share price of $35.25, to
mutual fund clients of Franklin Mutual Advisers, LLC, including the funds
comprising the Franklin Mutual Series Funds. The Company issued 2,907,599 of the
Company's common shares and newly authorized Series A Non-Voting Convertible
Preferred Stock, that were converted into 1,347,720 common shares in March 2003.
During 2003, the Company issued 11,156,460 of its common shares in connection
with the acquisition of WilTel. These securities represent 15.8% of the
Company's outstanding common shares at December 31, 2003.
The Company has a fixed stock option plan which provides for grants of options
or rights to non-employee directors and certain employees up to a maximum grant
of 300,000 shares to any individual in a given taxable year. The maximum number
of common shares which may be acquired through the exercise of options or rights
under this plan cannot exceed 1,200,000. The plan provides for the issuance of
stock options and stock appreciation rights at not less than the fair market
value of the underlying stock at the date of grant. Options generally become
exercisable in five equal annual instalments starting one year from date of
grant. No stock appreciation rights have been granted.
During the second quarter of 2000, pursuant to shareholder approval, warrants to
purchase 400,000 common shares were issued to each of the Company's Chairman and
President. The warrants are exercisable through May 15, 2005 at an exercise
price of $23.95 per common share (105% of the closing price of a common share on
the date of grant).
F-32
12. Common Shares, Stock Options and Preferred Shares, continued:
-------------------------------------------------
A summary of activity with respect to the Company's stock options for the three
years ended December 31, 2003 is as follows:
Common Weighted Available
Shares Average Options For Future
Subject Exercise Exercisable Option
to Option Prices at Year-End Grants
--------- ------ ----------- ------
Balance at January 1, 2001 391,750 $22.64 10,000 808,250
============ ============
Granted 4,000 $33.14
Exercised (22,850) $22.63
Cancelled (46,500) $22.63
------------
Balance at December 31, 2001 326,400 $22.77 58,663 850,750
============ ============
Granted 312,500 $30.80
Exercised (46,030) $22.63
Cancelled (39,800) $24.15
------------
Balance at December 31, 2002 553,070 $27.22 81,545 578,050
============ ============
Granted 4,000 $38.54
Exercised (52,350) $24.69
Cancelled (18,600) $28.65
------------
Balance at December 31, 2003 486,120 $27.53 152,608 592,650
============ ============ ============
The weighted-average fair value of the options granted was $9.44 per share for
2003, $7.91 per share for 2002 and $9.46 per share for 2001 as estimated on the
date of grant using the Black-Scholes option-pricing model with the following
assumptions: (1) expected volatility of 29.9% for 2003, 30.3% for 2002 and 29.7%
for 2001; (2) risk-free interest rates of 2.3% for 2003, 3.5% for 2002 and 4.9%
for 2001; (3) expected lives of 4.0 years for 2003, 3.7 years for 2002 and 4.0
years for 2001; and (4) dividend yields of .6% for 2003 and .8% for 2002 and
2001.
The following table summarizes information about fixed stock options outstanding
at December 31, 2003:
Options Outstanding Options Exercisable
------------------------------------------------ --------------------------
Common Weighted Weighted Common Weighted
Shares Average Average Shares Average
Range of Subject Remaining Exercise Subject Exercise
Exercise Prices to Option Contractual Life Price to Option Price
- --------------- --------- ---------------- ----- --------- -----
$22.63 - $22.81 200,220 2.3 years $22.65 102,508 $22.66
$30.74 273,900 4.5 years $30.74 47,100 $30.74
$33.14 4,000 2.4 years $33.14 2,000 $33.14
$35.23 4,000 3.4 years $35.23 1,000 $35.23
$38.54 4,000 4.4 years $38.54 - $ -
At December 31, 2003 and 2002, 592,650 and 578,050, respectively, of the
Company's common shares were reserved for stock options and 800,000 of the
Company's common shares were reserved for warrants.
At December 31, 2003 and 2002, 6,000,000 and 5,999,990, respectively, of
preferred shares (redeemable and non-redeemable), par value $1 per share, were
authorized and not issued.
F-33
13. Net Securities Gains (Losses):
-----------------------------
The following summarizes net securities gains (losses) for each of the three
years in the period ended December 31, 2003 (in thousands):
2003 2002 2001
---- ---- ----
Net realized gains (losses) on securities $ 15,762 $ (1,126) $ 28,138
Write-down of investments (a) (6,485) (37,053) (1,907)
Net unrealized gains on trading securities 676 1,113 2,219
------------- ------------ ----------
$ 9,953 $ (37,066) $ 28,450
============= ============ ==========
(a) Includes a provision to write down investments in certain available for sale
securities in 2003 and 2002, an investment in a non-public security in 2003 and
an equity investment in a non-public fund in 2002.
Proceeds from sales of investments classified as available for sale were
$683,700,000, $649,000,000 and $186,000,000 during 2003, 2002 and 2001,
respectively. Gross gains of $17,700,000, $20,500,000 and $15,000,000 and gross
losses of $2,100,000, $21,000,000 and $2,900,000 were realized on these sales
during 2003, 2002 and 2001, respectively.
14. Other Results of Operations Information:
---------------------------------------
Investment and other income for each of the three years in the period ended
December 31, 2003 consists of the following (in thousands):
2003 2002 2001
---- ---- ----
Interest on short-term investments $ 3,182 $ 7,647 $ 14,187
Interest on fixed maturities 13,700 17,604 28,075
Interest on notes receivable 4,692 5,903 3,005
Other investment income 7,052 8,300 14,817
Gains on sale and foreclosure of real estate and other assets,
net of costs 24,347 39,320 48,559
Rental income 24,142 19,311 18,344
MK Gold product and service income 1,441 4,841 7,299
Refund of foreign taxes, not based on income, including accrued
interest 5,295 - -
Winery revenues 13,839 16,433 13,736
Other 37,345 20,956 30,600
----------- ----------- ----------
$ 135,035 $ 140,315 $ 178,622
=========== =========== ===========
Taxes, other than income or payroll, amounted to $7,400,000, $3,900,000 and
$5,800,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
Advertising costs amounted to $2,100,000, $1,400,000 and $2,500,000 for the
years ended December 31, 2003, 2002 and 2001, respectively.
F-34
15. Income Taxes:
------------
The principal components of deferred taxes at December 31, 2003 and 2002 are as
follows (in thousands):
2003 2002
---- ----
Deferred Tax Asset:
Securities valuation reserves $ 116,449 $ 45,714
Property and equipment 680,039 -
Deferred revenue 78,666 -
Other assets 88,126 -
Foreign NOL carryover 78,023 -
NOL carryover 1,296,156 -
Other liabilities 114,765 49,801
--------------- ------------
2,452,224 95,515
Valuation allowance (2,315,776) (49,551)
--------------- ------------
136,448 45,964
--------------- ------------
Deferred Tax Liability:
Unrealized gains on investments (85,253) (29,701)
Depreciation (25,273) (15,864)
Other (25,922) (16,955)
--------------- ------------
(136,448) (62,520)
--------------- ------------
Net deferred tax liability $ - $ (16,556)
=============== ============
As of December 31, 2003, WilTel had $3,408,000,000 of federal NOLs, none of
which expire prior to 2019, $193,000,000 of capital loss carryforwards, of which
$88,000,000, $900,000, $34,000,000 and $70,000,000 will expire in 2004, 2005,
2006 and 2007, respectively, and $223,000,000 of foreign NOLs, as well as
various state NOLs, that expire at various dates. The potential benefit from the
capital loss carryforward is not reflected in the table above. WilTel also has
substantial other tax attributes and future deductions (primarily future
depreciation deductions), some of which are also available to reduce the federal
taxable income of the Company and its other subsidiaries. In addition, at
December 31, 2003, WebLink had $143,000,000 of federal NOLs, none of which
expire prior to 2023. Substantially all of WilTel's and WebLink's NOLs are only
available to reduce the federal taxable income of WilTel and WebLink and each of
their respective subsidiaries. Uncertainties that may affect the utilization of
the loss carryforwards include future operating results, tax law changes,
rulings by taxing authorities regarding whether certain transactions are taxable
or deductible and expiration of carryforward periods.
The Company established a valuation allowance that fully reserved for all of
WilTel's net deferred tax assets, reduced by an amount equal to the Company's
current and deferred federal income tax liabilities as of the date of
acquisition. The Company needed to establish the valuation allowance because, on
a pro forma combined basis, the Company is not able to demonstrate that it is
more likely than not that it will be able to realize that asset. Subsequent to
the acquisition of WilTel, any benefit realized from WilTel's deferred tax asset
will reduce the valuation allowance for the deferred tax asset; however, that
reduction is first applied to reduce the carrying amount of the acquired
non-current intangible assets of WilTel rather than reduce the income tax
provision of any component of total comprehensive income.
Once the non-current intangible assets are reduced to zero, the Company does not
expect it will reflect a net federal income tax expense or benefit for total
comprehensive income in the aggregate until such time as the Company is able to
reduce its valuation allowance and recognize a net deferred tax asset. Each
component of other comprehensive income may reflect either a federal income tax
provision or benefit in future periods, depending upon the relative amounts of
each component; however, in the aggregate for all components the Company does
not expect to report any net federal income tax expense or benefit for the
foreseeable future.
F-35
15. Income Taxes, continued:
------------
Under certain circumstances, the value of the NOLs and future deductions could
be substantially reduced if certain changes in ownership were to occur. In order
to reduce this possibility, the Company's certificate of incorporation includes
a charter restriction, which prohibits transfers of the Company's common stock
under certain circumstances.
The provision (benefit) for income taxes for each of the three years in the
period ended December 31, 2003 was as follows (in thousands):
2003 2002 2001
---- ---- ----
State income taxes $ (876) $ 750 $ 500
Federal income taxes:
Current (19,748) (117,617) 29,812
Deferred (23,750) (28,048) (41,703)
Foreign income taxes (currently payable) 173 50 50
-------------- -------------- --------------
$ (44,201) $ (144,865) $ (11,341)
============== ============== ==============
The table below reconciles the expected statutory federal income tax to the
actual income tax benefit (in thousands):
2003 2002 2001
---- ---- ----
Expected federal income tax $ (11,910) $ (14,534) $ 25,579
State income taxes, net of federal income tax benefit 587 488 325
Resolution of tax contingencies (24,407) (119,778) (36,234)
Recognition of additional tax benefits (6,998) (9,360) -
Other (1,473) (1,681) (1,011)
-------------- -------------- --------------
Actual income tax benefit $ (44,201) $ (144,865) $ (11,341)
============== ============== ==============
Reflected above as recognition of additional tax benefits and resolution of tax
contingencies are reductions to the Company's income tax provision for the
favorable resolution of certain federal and state income tax contingencies. The
Internal Revenue Service has completed its audit of the Company's consolidated
federal income tax returns for the years 1996 through 1999, without any material
payment required from the Company. The statute of limitations with respect to
all years through 1999 has expired.
16. Pension Plans and Postretirement Benefits:
-----------------------------------------
The information presented below for defined benefit pension plans and
postretirement benefits is presented separately for the Company and WilTel. The
Company presents the information separately since WilTel still has some active
participants in its plan and investment strategies, assumptions and results are
significantly different.
F-36
16. Pension Plans and Postretirement Benefits, continued:
-----------------------------------------
The Company:
Prior to 1999, the Company maintained defined benefit pension plans covering
employees of certain units who also met age and service requirements. Effective
December 31, 1998, the Company froze its defined benefit pension plans. A
summary of activity with respect to the Company's defined benefit pension plan
for 2003 and 2002 is as follows (in thousands):
2003 2002
---- ----
Projected Benefit Obligation:
Projected benefit obligation at January 1, $ 52,482 $ 52,705
Interest cost (a) 3,299 3,548
Actuarial loss 4,536 2,672
Benefits paid (5,238) (6,443)
----------- -----------
Projected benefit obligation at December 31, $ 55,079 $ 52,482
=========== ===========
Change in Plan Assets:
Fair value of plan assets at January 1, $ 45,905 $ 48,760
Actual return on plan assets 1,891 2,976
Employer contributions 10,000 728
Benefits paid (5,238) (6,443)
Administrative expenses (114) (116)
----------- -----------
Fair value of plan assets at December 31, $ 52,444 $ 45,905
=========== ===========
Funded Status $ (2,635) $ (6,577)
Unrecognized prior service cost 53 56
Unrecognized net loss from experience differences and
assumption changes 15,253 9,813
----------- -----------
Net amount recognized $ 12,671 $ 3,292
=========== ===========
(a) Includes charges to expense of $1,100,000 and $1,200,000 for 2003 and 2002,
respectively, relating to discontinued operations obligations.
As of December 31, 2003, $15,300,000 of the net amount recognized in the
consolidated balance sheet was reflected as a charge to accumulated other
comprehensive income and $2,600,000 was reflected as accrued pension cost. Since
the Company froze its defined benefit pension plan, the accumulated benefit
obligation is the same as the projected benefit obligation. No contributions are
expected to be made in 2004 related to the Company's defined benefit pension
plan.
Pension expense related to the defined benefit pension plan charged to
operations included the following components (in thousands):
2003 2002 2001
---- ---- ----
Interest cost $ 2,247 $ 2,361 $ 2,459
Expected return on plan assets (1,947) (1,947) (2,153)
Actuarial loss 258 76 -
Amortization of prior service cost 3 3 3
----------- ----------- -----------
Net pension expense $ 561 $ 493 $ 309
=========== =========== ===========
F-37
16. Pension Plans and Postretirement Benefits, continued:
-----------------------------------------
At December 31, 2003, the plan's assets consist of U.S. government and agencies
bonds (71.7%), investment grade bonds (26.2%) and cash equivalents (2.1%).
The defined benefit pension plan assets are invested in short-term investment
grade fixed income investments in order to maximize the value of its invested
assets by minimizing exposure to changes in market interest rates. This
investment strategy provides the Company with more flexibility in managing the
plan should interest rates rise and result in a decrease in the discounted value
of benefit obligations. The current investment strategy only permits investments
in investment grade securities with a final average maturity target of one and
one-half years.
To develop the assumption for the expected long-term rate of return on plan
assets, the Company considered historical returns and future expectations. Over
the three and five year periods ending December 31, 2002, the compound annual
returns on the plan's assets averaged 6.8% and 6.5%, respectively. Based on this
information, a 6.5% expected long-term rate of return on plan assets was
selected.
Several subsidiaries provide certain health care and other benefits to certain
retired employees under plans which are currently unfunded. The Company pays the
cost of postretirement benefits as they are incurred. Amounts charged to expense
were not material in each of the three years ended December 31, 2003.
A summary of activity with respect to the Company's postretirement plans for
2003 and 2002 is as follows (in thousands):
2003 2002
---- ----
Accumulated postretirement benefit obligation at January 1, $ 5,250 $ 5,536
Interest cost 289 345
Contributions by plan participants 168 180
Actuarial (gain) loss (30) 176
Benefits paid (871) (796)
Plan amendments (384) (191)
---------- ----------
Accumulated postretirement benefit obligation at December 31, 4,422 5,250
Unrecognized prior service cost 588 316
Unrecognized net actuarial gain 1,757 1,923
---------- ----------
Accrued postretirement benefit obligation $ 6,767 $ 7,489
========== ==========
The Company expects to spend $400,000 on postretirement benefits during 2004. At
December 31, 2003, the assumed health care cost trend rate for 2004 used in
measuring the accumulated postretirement benefit obligation is 11.5% and, at
December 31, 2002, such rate for 2003 was 8.5%. At December 31, 2003 and 2002,
the assumed health care cost trend rates were assumed to decline to an ultimate
rate of 5.0% by 2013 and 2010, respectively. If the health care cost trend rates
were increased or decreased by 1%, the accumulated postretirement obligation as
of December 31, 2003 would have increased or decreased by $200,000. The effect
of these changes on interest cost for 2003 would be immaterial.
F-38
16. Pension Plans and Postretirement Benefits, continued:
-----------------------------------------
The Company uses a December 31 measurement date for its plans. The assumptions
used relating to the defined benefit plan and postretirement plans are as
follows:
Pension Benefits Other Benefits
---------------- --------------
2003 2002 2003 2002
---- ---- ---- ----
Discount rate used to determine
benefit obligation at December 31, 5.75% 6.50% 6.00% 6.50%
Weighted-average assumptions used
to determine net cost for years ended
December 31:
Discount rate 6.50% 7.00% 6.50% 7.00%
Expected long-term return on plan assets 6.50% 7.00% N/A N/A
WilTel:
WilTel maintains defined benefit pension plans and a postretirement plan
covering certain employees who met certain age and service requirements.
Employees hired subsequent to April 2001 are not eligible to participate in
WilTel's defined benefit pension plan. Employees hired subsequent to December
31, 1991 are not eligible to participate in WilTel's postretirement benefits
plan. A summary of activity with respect to WilTel's defined benefit pension
plan from November 6, 2003 (date of acquisition) through December 31, 2003 is as
follows (in thousands):
Projected Benefit Obligation:
Projected benefit obligation at November 6, 2003 $ 120,151
Interest cost 1,075
Service cost 575
Actuarial loss 8,661
Benefits paid (550)
------------
Projected benefit obligation at December 31, 2003 $ 129,912
============
Change in Plan Assets:
Fair value of plan assets at November 6, 2003 $ 65,126
Actual return on plan assets 3,185
Benefits paid (550)
------------
Fair value of plan assets at December 31, 2003 $ 67,761
============
Funded Status $ (62,151)
Unrecognized net actuarial loss 6,117
------------
Net amount recognized $ (56,034)
============
The accumulated benefit obligation for WilTel's defined benefit plan was
$129,500,000 at December 31, 2003. As of December 31, 2003, $5,700,000 of the
net amount recognized in the consolidated balance sheet was reflected as a
charge to accumulated other comprehensive income and $61,700,000 was reflected
as accrued pension cost.
Employer contributions expected to be paid to the plan in 2004 are $5,000,000.
F-39
16. Pension Plans and Postretirement Benefits, continued:
-----------------------------------------
WilTel's pension expense for the period from November 6, 2003 (date of
acquisition) through December 31, 2003 related to the defined benefit pension
plan charged to operations included the following components (in thousands):
Interest cost $ 1,075
Service cost 575
Expected return on plan assets (640)
-----------
Net pension expense $ 1,010
===========
WilTel's plans' assets consist primarily of equity securities (77.3%) and debt
securities (17.2%) at December 31, 2003.
The investment objectives of WilTel's plan emphasize long-term capital
appreciation as a primary source of return and current income as a supplementary
source.
WilTel's target allocation is as follows:
Interim Target Long-term Target
-------------- ----------------
Equity securities:
Large cap stocks 38% 40%
Small cap stocks 22% 10%
International stocks 20% 20%
----- -----
Total equity securities 80% 70%
Fixed income/bonds 20% 30%
----- -----
Total 100% 100%
===== =====
The interim target was established in order to balance speed and caution in
transitioning to the long-term allocations, lowering the risk of selling low and
buying high and shifting the portfolio to the long-term targets under the right
market conditions.
Investment performance objectives are based upon a benchmark index or mix of
indices over a market cycle. The investment strategy designates certain
investment restrictions for domestic equities, international equities and fixed
income securities. These restrictions include the following:
o For domestic equities, there will generally be no more than 5% of any
manager's portfolio at market in any one company and no more than 150%
of any one sector of the appropriate index for any manager's
portfolio. Restrictions are also designated on outstanding market
value of any one company at 5%.
o For international equities, there will be no more than 8% in any one
company in a manager's portfolio, no fewer than three countries in a
manager's portfolio, no more than 10% of the portfolio in countries
not represented in the EAFE index, no more than 150% of any one sector
of the appropriate index and no currency hedging is permitted.
o Fixed income securities will all be rated BBB- or better at the time
of purchase, there will be no more than 8% at market in any one
security (U.S. government and agency positions excluded), no more than
a 30-year maturity in any one security and investments in standard
collateralized mortgage obligations are limited to 10%.
F-40
16. Pension Plans and Postretirement Benefits, continued:
-----------------------------------------
To develop the assumption for the expected long-term rate of return on plan
assets, WilTel considered historical returns and future expectations, including
a more conservative expectation of future returns and asset allocation targets
as WilTel's closed participant population grows closer to retirement age. Based
on this information, a 7.0% expected long-term rate of return on plan assets was
selected.
A summary of activity with respect to WilTel's postretirement plans from
November 6, 2003 (date of acquisition) through December 31, 2003 is as follows
(in thousands):
Accumulated postretirement benefit obligation at November 6, 2003 $ 1,442
Interest cost 13
Service cost 18
Contributions by plan participants 3
Actuarial loss 315
Benefits paid (7)
----------
Accumulated postretirement benefit obligation at December 31, 2003 1,784
Unrecognized net actuarial loss (315)
----------
Accrued postretirement benefit obligation $ 1,469
==========
WilTel's postretirement benefit expense for the period from date of acquisition
through December 31, 2003 was not material.
WilTel's cash cost for its postretirement plan during 2004 is not expected to be
material.
The health care cost trend rate assumed for 2004 is 12%, declining to an
ultimate rate of 5% by 2012. If the health care cost trend rates were increased
or decreased by 1%, WilTel's accumulated postretirement obligation as of
December 31, 2003 would have increased or decreased by $300,000 and $200,000,
respectively. The effect of these changes on the aggregate of service and
interest cost for 2003 would be immaterial.
WilTel uses a December 31 measurement date for its plans. The assumptions used
relating to WilTel's defined benefit plan and postretirement plan for 2003 are
as follows:
Pension Other
Benefits Benefits
-------- --------
Weighted-average assumptions used to determine
benefit obligation at December 31, 2003:
Discount rate 6.00% 6.00%
Rate of compensation increase 3.50% 3.50%
Weighted-average assumptions used to determine
net cost for the period ended December 31, 2003:
Discount rate 6.25% 6.25%
Expected long-term return on plan assets 7.00% N/A
Rate of compensation increase 3.50% 3.50%
The Company and its consolidated subsidiaries (including WilTel) have defined
contribution pension plans covering certain employees. Contributions and costs
are a percent of each covered employee's salary. Amounts charged to expense
related to such plans were $2,200,000, $1,600,000 and $1,800,000 for the years
ended December 31, 2003, 2002 and 2001, respectively.
F-41
17. Commitments:
-----------
The Company and its subsidiaries rent office space and office equipment under
noncancellable operating leases with terms varying from one to twenty years. In
addition, WilTel enters into noncancellable operating leases for rights of way
along its fiber network, network centers and off-network capacity. Rental
expense (net of sublease rental income) was $14,100,000 in 2003, $5,200,000 in
2002 and $4,700,000 in 2001. Future minimum annual rentals (exclusive of real
estate taxes, maintenance and certain other charges) under these leases at
December 31, 2003 are as follows (in thousands):
2004 $ 60,900
2005 56,600
2006 51,200
2007 48,600
2008 42,500
Thereafter 313,200
-------------
573,000
Less: sublease income (7,600)
-------------
$ 565,400
============
In connection with the sale of certain subsidiaries and certain non-recourse
financings, the Company has made or guaranteed the accuracy of certain
representations. No material loss is expected in connection with such matters.
Pursuant to an agreement that was entered into before the Company sold CDS to
HomeFed in 2002, the Company agreed to provide project improvement bonds for the
San Elijo Hills project. These bonds, which are primarily for the benefit of the
City of San Marcos, California, are required prior to the commencement of any
development at the project. CDS is responsible for paying all third party fees
related to obtaining the bonds. Should the City or others draw on the bonds for
any reason, CDS and one of its subsidiaries would be obligated to reimburse the
Company for the amount drawn. At December 31, 2003, $31,700,000 was outstanding
under these bonds, $16,700,000 of which expires in 2004 and the remainder
expires in 2005.
SBC Communications Inc. ("SBC"), a major communications provider in the U.S., is
WilTel's largest customer. Sales to SBC accounted for 65% of 2003 Network
revenues included in the Company's consolidated statement of operations. WilTel
has entered into preferred provider agreements with SBC that extend until 2019,
although the agreements may be terminated prior to then by either party under
certain circumstances. The agreements provide that:
o WilTel is SBC's preferred provider for domestic voice and data long
distance services and select international wholesale services,
requiring that SBC seek to obtain these services from WilTel before it
obtains them from any other provider; and
o SBC is WilTel's preferred provider for select local exchange and
various other services, including platform services supporting its
switched voice services network, requiring that WilTel seek to obtain
these services from SBC before it obtains them from any other
provider.
For the services each party must seek to obtain from the other, the prices,
determined separately for each product or service, generally will be equal to
the lesser of the cost of the product or service plus a specified rate of
return, the prices charged to other customers, the current market rate or, in
some circumstances, a specific rate. If either party can secure lower prices for
comparable services that the other party will not match, then that party is free
to utilize the lowest cost provider. WilTel and SBC have agreed to use a fixed
price for voice transport services (the substantial majority of WilTel's SBC
generated revenue) through January 2005.
F-42
17. Commitments, continued:
-----------
SBC has the right to terminate the agreements if WilTel begins to offer certain
services that are competitive with SBC's services, if WilTel materially breaches
its agreements or WilTel has a change in control without SBC's consent
(excluding the acquisition by the Company). WilTel has the right to terminate
the agreements if SBC materially breaches its agreements or SBC has a change in
control without WilTel's consent. In the event of a termination by either party
due to these actions, the terminating party has the right to receive transition
costs from the other party, not to exceed $200,000,000.
Either party may terminate a particular provider agreement if the action or
failure to act of any regulatory authority materially frustrates or hinders the
purpose of that agreement. There is no monetary remedy for such a termination.
Each of WilTel and Symphony are limited by debt agreements in the amount of
dividends and other transfers of funds that are available to the Company. The
banking and lending subsidiaries are limited by regulatory requirements and
agreements in the amount of dividends and other transfers of funds that are
available to the Company. Principally as a result of such restrictions, the net
assets of these subsidiaries which are subject to limitations on transfer of
funds to the Company were approximately $669,100,000 at December 31, 2003.
18. Litigation:
----------
The Company and its subsidiaries are parties to legal proceedings that are
considered to be either ordinary, routine litigation incidental to their
business or not material to the Company's consolidated financial position. The
Company does not believe that any of the foregoing actions will have a material
adverse effect on its consolidated financial position, consolidated results of
operations or liquidity.
WilTel is a party to various legal actions and claims, and has reserved
$38,400,000 for the satisfaction of all litigation. Certain of these actions
relate to the rights of way licensed to WilTel in connection with the
installation of its fiber-optic cable and seek damages from WilTel for failure
to obtain all necessary landowner consents. Additional right of way claims may
be asserted against WilTel. The Company does not believe that the ultimate
resolution of all claims, legal actions and complaints will have a material
adverse effect upon WilTel's results of operations, although unfavorable
outcomes could significantly impact WilTel's liquidity.
19. Earnings (Loss) Per Common Share:
--------------------------------
For each of the three years in the period ended December 31, 2003, there were no
differences in the numerators for the basic and diluted per share computations
for income from continuing operations. These numerators were $84,400,000,
$152,500,000 and $62,900,000 for 2003, 2002 and 2001, respectively. The
denominators for basic per share computations were 61,264,000, 55,667,000, and
55,309,000 for 2003, 2002 and 2001, respectively. There were no differences for
the denominators for diluted per share computations except for the dilutive
effect of 437,000, 349,000 and 295,000 options and warrants for 2003, 2002 and
2001, respectively. Due to the nature of their rights and their nominal
liquidation value, the Series A Non-Voting Convertible Preferred shares were
treated as common shares and were included in the denominator for basic and
diluted per share computations for 2002.
F-43
20. Fair Value of Financial Instruments:
-----------------------------------
The following table presents fair value information about certain financial
instruments, whether or not recognized on the balance sheet. Fair values are
determined as described below. These techniques are significantly affected by
the assumptions used, including the discount rate and estimates of future cash
flows. The fair value amounts presented do not purport to represent and should
not be considered representative of the underlying "market" or franchise value
of the Company. The methods and assumptions used to estimate the fair values of
each class of the financial instruments described below are as follows:
(a) Investments: The fair values of marketable equity securities, fixed maturity
securities and investments held for trading purposes (which include securities
sold not owned) are substantially based on quoted market prices, as disclosed in
Note 6.
(b) Cash and cash equivalents: For cash equivalents, the carrying amount
approximates fair value.
(c) Notes receivables: The fair values of variable rate notes receivable are
estimated to be the carrying amount.
(d) Loan receivables of banking and lending subsidiaries: The fair value of loan
receivables of the banking and lending subsidiaries is estimated by discounting
the future cash flows using the current rates at which similar loans would be
made to borrowers with similar credit ratings for the same remaining maturities.
(e) Customer banking deposits: The fair value of customer banking deposits is
estimated using rates currently offered for deposits of similar remaining
maturities.
(f) Long-term and other indebtedness: The fair values of non-variable rate debt
are estimated using quoted market prices and estimated rates which would be
available to the Company for debt with similar terms. The fair value of variable
rate debt is estimated to be the carrying amount.
(g) Derivative instruments: The fair values of the interest rate swap and
currency rate swap agreements are based on rates currently available for similar
agreements.
F-44
20. Fair Value of Financial Instruments, continued:
-----------------------------------
The carrying amounts and estimated fair values of the Company's financial
instruments at December 31, 2003 and 2002 are as follows (in thousands):
2003 2002
---- ----
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
Financial Assets:
Investments:
Current $ 714,363 $ 714,363 $ 185,196 $ 185,196
Non-current 673,742 673,742 439,675 439,675
Cash and cash equivalents 214,390 214,390 418,600 418,600
Notes receivable:
Current 2,283 2,283 13,808 13,808
Non-current 16,142 16,142 16,432 16,432
Loan receivables of banking and lending
subsidiaries, net of allowance:
Current 19,803 21,086 79,065 80,388
Non-current 161,413 174,376 262,691 267,250
Financial Liabilities:
Customer banking deposits:
Current 103,331 104,904 283,613 289,752
Non-current 42,201 44,004 109,291 109,815
Debt:
Current 23,956 23,988 3,647 3,723
Non-current 1,154,878 1,158,701 229,426 235,189
Securities sold not owned 48,816 48,816 26,379 26,379
Company-obligated mandatorily redeemable
preferred securities of subsidiary trust
holding solely subordinated debt securities
of the Company - - 98,200 98,200
Derivative Instruments:
Interest rate swaps (3,079) (3,079) (7,386) (7,386)
Foreign currency swaps (4,943) (4,943) (1,679) (1,679)
21. Concentration of Credit Risk:
----------------------------
As of December 31, 2003, accounts receivable due from SBC, WilTel's largest
customer, represented approximately 30.2% of the Company's trade receivables.
For the period from date of acquisition of WilTel through December 31, 2003,
telecommunications revenues relating to SBC represented approximately 25.5% of
the Company's total revenues.
F-45
22. Segment Information:
-------------------
The Company's reportable segments consist of its operating units, which offer
different products and services and are managed separately. The Company's
telecommunications business is conducted by WilTel and contains two segments,
Network and Vyvx. Network owns or leases and operates a nationwide fiber optic
network over which it provides a variety of telecommunications services. Vyvx
transmits audio and video programming over the network and distributes
advertising media in physical and electronic form. The Company's other segments
include healthcare services, banking and lending, manufacturing and domestic
real estate. Healthcare services primarily include the provision of physical,
occupational, speech and respiratory therapy services. Banking and lending
operations historically made collateralized personal automobile instalment loans
to individuals who have difficulty obtaining credit, at interest rates above
those charged to individuals with good credit histories. Such loans were
primarily funded by deposits insured by the FDIC. The banking and lending
segment has ceased originating any new loans and is liquidating its business in
an orderly manner. Manufacturing operations manufacture and market lightweight
plastic netting used for a variety of purposes. The Company's domestic real
estate operations consist of a variety of commercial properties, residential
land development projects and other unimproved land, all in various stages of
development and all available for sale. Other operations primarily consist of
winery operations and development of a copper mine.
Associated companies include equity interests in entities that the Company does
not control and that are accounted for on the equity method of accounting. Prior
to the acquisition of the outstanding common stock of WilTel that it didn't
already own in November 2003, the Company accounted for its 47.4% interest in
WilTel as an associated company. Other investments in associated companies
include Olympus, Berkadia, JPOF II and EagleRock. Both JPOF II and EagleRock are
entities engaged in investing and/or securities transactions activities.
Corporate assets primarily consist of investments and cash and cash equivalents
and corporate revenues primarily consist of investment income and securities
gains and losses. Corporate assets, revenues, overhead expenses and interest
expense are not allocated to the operating units. The Company has a
manufacturing facility located in Belgium and an interest, through MK Gold, in a
copper deposit in Spain. WilTel owns or has the right to use certain cable
systems which connect its U.S. domestic network to foreign countries, and has
the right to use wavelengths in Europe which it is currently not using. In
addition to its investment in Bermuda-based Olympus, the Company owns 36% of the
electric utility in Barbados. The Company does not have any other material
foreign operations or investments.
Except for the telecommunications segments of WilTel, the primary measure of
segment operating results and profitability used by the Company is income (loss)
from continuing operations before income taxes, minority expense of trust
preferred securities and equity in income (losses) of associated companies. For
WilTel's segments, segment profit from operations is the primary performance
measure of segment operating results and profitability. WilTel defines segment
profit from operations as income before income taxes, interest expense,
investment income, depreciation and amortization expense and other non-operating
income and expense.
F-46
22. Segment Information, continued:
-------------------
The following information reconciles segment profit from operations of the
Network and Vyvx segments to the most comparable GAAP measure which is used for
all other reportable segments, for the period from November 6, 2003 through
December 31, 2003 (in millions):
Network Vyvx
------- ----
Segment profit from operations (1) $ 13.3 $ 4.1
Depreciation and amortization expense (37.2) (2.0)
Interest expense, net of investment income (2) (4.0) (.1)
Other non-operating income (expense), net (2) 1.8 .5
--------- --------
Income (loss) from continuing operations before income
taxes, minority expense of trust preferred securities
and equity in income (losses) of associated companies $ (26.1) $ 2.5
========= ========
(1) See note (c) to segment information below.
(2) These items have been allocated to each segment based upon a formula that
considers each segment's revenues, property and equipment and headcount.
Certain information concerning the Company's segments for 2003, 2002 and 2001 is
presented in the following table. Associated Companies are only reflected in the
table below under identifiable assets employed.
F-47
22. Segment Information, continued:
-------------------
2003 2002 2001
---- ---- ----
(In millions)
Revenues (a):
Network $ 218.4 $ - $ -
Vyvx 21.2 - -
Healthcare Services 71.1 - -
Banking and Lending 62.3 95.9 122.4
Manufacturing 54.1 51.0 57.4
Domestic Real Estate 54.4 51.3 65.3
Other Operations 36.7 48.3 39.3
Corporate (b) 42.5 (4.7) 89.8
Intersegment elimination (c) (4.3) - -
------------ ------------ ------------
Total consolidated revenues $ 556.4 $ 241.8 $ 374.2
============ ============ ============
Income (loss) from continuing operations
before income taxes, minority expense
of trust preferred securities and equity
in income (losses) of associated companies:
Network (c) $ (26.1) $ - $ -
Vyvx (c) 2.5 - -
Healthcare Services (2.3) - -
Banking and Lending 8.4 1.9 (6.1)
Manufacturing 4.4 3.1 7.8
Domestic Real Estate 18.1 16.7 30.4
Other Operations (1.5) 11.7 8.2
Corporate (b) (37.5) (74.9) 32.8
------------ ------------ ------------
Total consolidated income (loss) from
continuing operations before
income taxes, minority expense of
trust preferred securities and
equity in income (losses) of associated
companies $ (34.0) $ (41.5) $ 73.1
============ ============ ============
Identifiable assets employed:
Network $ 1,628.8 $ - $ -
Vyvx 115.5 - -
Healthcare Services 54.6 - -
Banking and Lending 252.4 481.5 595.7
Manufacturing 50.8 51.5 59.3
Domestic Real Estate 165.0 106.8 176.4
Other Operations 253.4 193.7 171.2
Investments in Associated Companies:
WilTel - 340.6 -
Other Associated Companies 430.9 397.1 358.8
Net Assets of Discontinued Operations - - 44.0
Corporate 1,445.8 970.6 1,063.7
------------ ------------ ------------
Total consolidated assets $ 4,397.2 $2,541.8 $ 2,469.1
============ ============ ============
F-48
22. Segment Information, continued:
-------------------
(a) Revenues for each segment include amounts for services rendered and
products sold, as well as segment reported amounts classified as
investment and other income and net securities gains (losses) on the
Company's consolidated statements of operations.
(b) For 2003, includes a provision of $6,500,000 to write down investments in
certain available for sale securities and an investment in a non-public
security. For 2002, includes a provision of $37,100,000 to write down
investments in certain available for sale securities and an equity
investment in a non-public fund. The write down of the available for sale
securities resulted from a decline in market value determined to be other
than temporary.
(c) Eliminates intersegment revenues billed from Network to Vyvx. However, the
intersegment revenues are included in the calculation to determine the
income (loss) from continuing operations for each of Network and Vyvx.
F-49
23. Selected Quarterly Financial Data (Unaudited):
---------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(In thousands, except per share amounts)
2003:
Revenues $ 56,899 $ 67,330 $ 76,093 $ 356,053
============ ============ ============ ============
Income (loss) from continuing operations $ (13,786) $ 11,483 $ 54,647 $ 32,014
============ ============ ============ ============
Income (loss) from discontinued operations, net of taxes $ - $ 3,934 $ 1,443 $ (179)
============ ============ ============ ============
Gain on disposal of discontinued operations, net of taxes $ - $ - $ - $ 7,498
============ ============ ============ ============
Net income (loss) $ (13,786) $ 15,417 $ 56,090 $ 39,333
============ ============ ============ ============
Basic earnings (loss) per common share:
Income (loss) from continuing operations $ (.23) $ .19 $ .92 $ .49
Income (loss) from discontinued operations - .07 .02 -
Gain on disposal of discontinued operations - - - .12
------------ ------------ ------------ ------------
Net income (loss) $ (.23) $ .26 $ .94 $ .61
============ ============ ============ ============
Number of shares used in calculation 59,618 59,630 59,642 64,946
============ ============ ============ ============
Diluted earnings (loss) per common share:
Income (loss) from continuing operations $ (.23) $ .19 $ .91 $ .49
Income (loss) from discontinued operations - .07 .02 -
Gain on disposal of discontinued operations - - - .11
------------ ------------ ------------ ------------
Net income (loss) $ (.23) $ .26 $ .93 $ .60
============ ============ ============ ============
Number of shares used in calculation 59,618 60,069 60,072 65,452
============ ============ ============ ============
2002:
Revenues $ 57,567 $ 70,317 $ 52,373 $ 61,548
============ ============ ============ ============
Income (loss) from continuing operations $ 11,303 $ 19,429 $ (2,484) $ 124,283
============ ============ ============ ============
Income from discontinued operations, net of taxes $ 1,440 $ 3,140 $ - $ -
============ ============ ============ ============
Gain on disposal of discontinued operations, net of taxes $ - $ 4,512 $ - $ -
============ ============ ============ ============
Net income (loss) $ 12,743 $ 27,081 $ (2,484) $ 124,283
============ ============ ============ ============
Basic earnings (loss) per common share:
Income (loss) from continuing operations $ .20 $ .35 $ (.04) $ 2.20
Income from discontinued operations .03 .06 - -
Gain on disposal of discontinued operations - .08 - -
----------- ----------- ----------- -----------
Net income (loss) $ .23 $ .49 $ (.04) $ 2.20
============ ============ ============ ============
Number of shares used in calculation 55,320 55,336 55,346 56,420
============ ============ ============ ============
Diluted earnings (loss) per common share:
Income (loss) from continuing operations $ .20 $ .35 $ (.04) $ 2.19
Income from discontinued operations .03 .06 - -
Gain on disposal of discontinued operations - .08 - -
------------ ------------ ------------ ------------
Net income (loss) $ .23 $ .49 $ (.04) $ 2.19
============ ============ ============ ============
Number of shares used in calculation 55,588 55,694 55,346 56,871
============ ============ ============ ============
The Internal Revenue Service has completed the audit of the Company's
consolidated federal income tax returns for the years 1996 through 1999, without
any material tax payment required from the Company. Income taxes reflect a
benefit for the favorable resolution of certain income tax contingencies for
which the Company had previously established reserves of $13,900,000 for the
fourth quarter of 2003 and $120,000,000 for the fourth quarter of 2002.
In 2003 and 2002, the totals of quarterly per share amounts do not equal annual
per share amounts because of changes in outstanding shares during the year.
F-50
Schedule I - Condensed Financial Information of Registrant
LEUCADIA NATIONAL CORPORATION
BALANCE SHEETS
December 31, 2003 and 2002
(Dollars in thousands, except par value)
2003 2002
---- ----
ASSETS
Cash and cash equivalents $ 53,957 $ 317,443
Investments 880,695 344,462
Trade, notes and other receivables, net 42,001 26,507
Prepaids and other assets 10,483 9,037
Investments in associated companies and investments in and advances
to/from subsidiaries, net 1,788,127 1,182,269
------------- -------------
Total $ 2,775,263 $ 1,879,718
============= =============
LIABILITIES
Trade payables and expense accruals $ 31,391 $ 26,064
Other liabilities 81,107 42,877
Debt, including current maturities 512,449 140,204
Income taxes payable 16,155 37,848
------------- -------------
Total liabilities 641,102 246,993
------------- -------------
Commitments and contingencies
Company-obligated mandatorily redeemable preferred securities of
subsidiary trust holding solely subordinated debt securities of the Company - 98,200
------------- -------------
Shareholders' Equity
Series A Non-Voting Convertible Preferred Stock - 47,507
Common shares, par value $1 per share, authorized 150,000,000 shares;
70,823,502 and 58,268,572 shares issued and outstanding, after deducting
47,710,719 and 60,213,299 shares held in treasury 70,824 58,269
Additional paid-in capital 613,274 154,260
Accumulated other comprehensive income 152,251 56,025
Retained earnings 1,297,812 1,218,464
------------- -------------
Total shareholders' equity 2,134,161 1,534,525
------------- -------------
Total $ 2,775,263 $ 1,879,718
============= =============
See notes to this schedule.
F-51
Schedule I - Condensed Financial Information of Registrant, continued
LEUCADIA NATIONAL CORPORATION
STATEMENTS OF OPERATIONS
For the years ended December 31, 2003, 2002 and 2001
(In thousands, except per share amounts)
2003 2002 2001
---- ---- ----
REVENUES:
Investment and other income $ 19,854 $ 14,771 $ 37,495
Intercompany investment income 17,872 6,996 9,934
Net securities gains (losses) 800 (31,504) 619
------------ ------------ ------------
38,526 (9,737) 48,048
------------ ------------ ------------
EXPENSES:
Interest 24,651 11,481 12,983
Intercompany interest expense 27,667 26,474 26,363
Salaries 11,559 11,695 7,699
Other expenses 24,436 21,332 16,460
------------ ------------ ------------
88,313 70,982 63,505
------------ ------------ ------------
Loss from continuing operations before income taxes, minority expense of
trust preferred securities and equity in income of
associated companies and subsidiaries (49,787) (80,719) (15,457)
Income tax benefit 41,832 148,030 41,644
------------ ------------ ------------
Income (loss) from continuing operations before minority expense of trust
preferred securities and equity in income of associated
companies and subsidiaries (7,955) 67,311 26,187
Minority expense of trust preferred securities, net of taxes (2,761) (5,521) (5,521)
Equity in income of associated companies and subsidiaries,
net of taxes 95,074 90,741 42,262
------------ ------------ ------------
Income from continuing operations 84,358 152,531 62,928
Equity in income (loss) from discontinued operations, net of taxes 5,198 4,580 (39,742)
Equity in gain (loss) on disposal of discontinued operations, net of taxes 7,498 4,512 (31,105)
------------ ------------ ------------
Income (loss) before cumulative effect of a change in accounting principle 97,054 161,623 (7,919)
Cumulative effect of a change in accounting principle - - 411
------------ ------------ ------------
Net income (loss) $ 97,054 $ 161,623 $ (7,508)
============ ============ ============
Basic earnings (loss) per common share:
Income from continuing operations $ 1.38 $ 2.74 $ 1.13
Income (loss) from discontinued operations .08 .08 (.72)
Gain (loss) on disposal of discontinued operations .12 .08 (.56)
Cumulative effect of a change in accounting principle - - .01
------------ ------------ ------------
Net income (loss) $ 1.58 $ 2.90 $ (.14)
============ ============ ============
Diluted earnings (loss) per common share:
Income from continuing operations $ 1.37 $ 2.72 $ 1.13
Income (loss) from discontinued operations .08 .08 (.72)
Gain (loss) on disposal of discontinued operations .12 .08 (.56)
Cumulative effect of a change in accounting principle - - .01
------------ ------------ ------------
Net income (loss) $ 1.57 $ 2.88 $ (.14)
============ ============ ============
See notes to this schedule.
F-52
Schedule I - Condensed Financial Information of Registrant, continued
LEUCADIA NATIONAL CORPORATION
STATEMENTS OF CASH FLOWS
For the years ended December 31, 2003, 2002 and 2001
(In thousands)
2003 2002 2001
---- ---- ----
Net cash flows from operating activities:
- -----------------------------------------
Net income (loss) $ 97,054 $ 161,623 $ (7,508)
Adjustments to reconcile net income (loss) to net cash used for operations:
Cumulative effect of a change in accounting principle - - (411)
Other amortization (primarily related to investments) (432) (2,406) (11,626)
Net securities (gains) losses (800) 31,504 (619)
Equity in (earnings) losses of associated companies and subsidiaries (107,770) (99,833) 28,585
Distributions from associated companies 1,271 643 -
Gain on sale of other assets (1,532) - -
Net change in:
Miscellaneous receivables 1,902 2,180 (1,708)
Prepaids and other assets 84 (757) 2,185
Trade payables and expense accruals 6,405 6,627 (5,130)
Other liabilities (14,213) (1,229) 879
Income taxes payable (18,155) (136,850) (47,179)
Other (459) 4,860 (1,231)
-------------- -------------- --------------
Net cash used for operating activities (36,645) (33,638) (43,763)
-------------- -------------- --------------
Net cash flows from investing activities:
- -----------------------------------------
Dividends received from subsidiaries 2,500 11,782 2,310
Investment in and advances to/from subsidiaries (108,045) 97,936 369,388
Proceeds from sale of other assets 79,460 1,000 -
Advances on notes receivables (1,470) - -
Collections on notes receivables 10,000 2,000 -
Investments in associated companies (11,070) (354,091) (177,670)
Purchases of investments (other than short-term) (1,355,282) (882,710) (937,188)
Proceeds from maturities of investments 384,901 609,521 665,666
Proceeds from sales of investments 520,774 404,053 69,436
-------------- -------------- --------------
Net cash used for investing activities (478,232) (110,509) (8,058)
-------------- -------------- --------------
(continued)
See notes to this schedule.
F-53
Schedule I - Condensed Financial Information of Registrant, continued
LEUCADIA NATIONAL CORPORATION
STATEMENTS OF CASH FLOWS, continued
For the years ended December 31, 2003, 2002 and 2001
(In thousands)
2003 2002 2001
---- ---- ----
Net cash flows from financing activities:
- -----------------------------------------
Issuance of long-term debt, net of issuance costs $ 267,865 $ - $ -
Issuance of convertible preferred shares - 47,507 -
Issuance of common shares 1,293 102,535 517
Purchase of common shares for treasury (61) (115) (45)
Dividends paid (17,706) (13,841) (13,829)
------------ ------------ ------------
Net cash provided by (used for) financing activities 251,391 136,086 (13,357)
------------ ------------ ------------
Net decrease in cash and cash equivalents (263,486) (8,061) (65,178)
Cash and cash equivalents at January 1, 317,443 325,504 390,682
------------ ------------ ------------
Cash and cash equivalents at December 31, $ 53,957 $ 317,443 $ 325,504
============ ============ ============
Supplemental disclosures of cash flow information:
- -------------------------------------------------
Cash paid during the year for:
Interest $ 21,566 $ 11,420 $ 12,922
Income tax payments (refunds), net $ (6,232) $ 17,072 $ 10,945
Non-cash investing activities:
- -----------------------------
Common stock issued for acquisition of WilTel Communications Group, Inc. $ 422,830 $ - $ -
See notes to this schedule.
F-54
Schedule I - Condensed Financial Information of Registrant, continued
LEUCADIA NATIONAL CORPORATION
NOTES TO SCHEDULE
A. The notes to consolidated financial statements of Leucadia National
Corporation and Subsidiaries are incorporated by reference to this
schedule.
B. The statements of shareholders' equity are the same as those presented for
Leucadia National Corporation and Subsidiaries.
C. Equity in the income (losses) of associated companies and subsidiaries is
after reflecting income taxes recorded by the subsidiaries. The income tax
benefit recorded by the parent company includes benefits for the favorable
resolution of certain federal and state income tax contingencies of
$24,400,000, $120,000,000 and $36,200,000 for 2003, 2002 and 2001,
respectively.
D. Federal income taxes payable has not been allocated to the individual
subsidiaries.
E. The aggregate annual mandatory redemptions of debt during the five year
period ending December 31, 2008 are as follows (in thousands): 2004 - $0;
2005 - $19,100; 2006 - $21,600; 2007 - $0; and 2008 - $0.
F-55
Schedule II - Valuation and Qualifying Accounts
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
For the years ended December 31, 2003, 2002 and 2001
(In thousands)
Additions Deductions
------------------------ -----------
Charged
Balance at to Costs Balance
Beginning and Write at End
Description of Period Expenses Recoveries Offs of Period
----------- --------- -------- ---------- ---------- ---------
2003
----
Loan receivables of
banking and lending
subsidiaries $ 31,848 $ 16,411 $ 12,175 $ 36,198 $ 24,236
Trade, notes and other
receivables 883 3,687 123 2,028 2,665
---------- ---------- ---------- ---------- ----------
Total allowance for
doubtful accounts $ 32,731 $ 20,098 $ 12,298 $ 38,226 $ 26,901
========== ========== ========== ========== ==========
2002
----
Loan receivables of
banking and lending
subsidiaries $ 35,695 $ 36,027 $ 9,646 $ 49,520 $ 31,848
Trade, notes and other
receivables 623 221 179 140 883
---------- ---------- ---------- ---------- ----------
Total allowance for
doubtful accounts $ 36,318 $ 36,248 $ 9,825 $ 49,660 $ 32,731
========== ========== ========== ========== ==========
2001
----
Loan receivables of
banking and lending
subsidiaries $ 27,364 $ 43,125 $ 8,519 $ 43,313 $ 35,695
Trade, notes and other
receivables 663 138 16 194 623
---------- ---------- ---------- ---------- ----------
Total allowance for
doubtful accounts $ 28,027 $ 43,263 $ 8,535 $ 43,507 $ 36,318
========== ========== ========== ========== ==========
F-56
FINANCIAL STATEMENTS
Berkadia LLC (a joint venture between Berkshire Hathaway Inc.
and Leucadia National Corporation)
Years ended December 31, 2003, 2002 and 2001
Berkadia LLC
Financial Statements
Years ended December 31, 2003, 2002 and 2001
Contents
Report of Independent Auditors................................................1
Audited Financial Statements
Balance Sheets................................................................2
Statements of Operations and Changes in Members' Equity (Deficit).............3
Statements of Cash Flows......................................................4
Notes to Financial Statements.................................................5
Report of Independent Auditors
The Members of Berkadia LLC
We have audited the accompanying balance sheets of Berkadia LLC (the "Company")
as of December 31, 2003, and 2002 and the related statements of operations and
changes in members' equity (deficit) and cash flows for the years ended December
31, 2003 and 2002 and the ten-month period ended December 31, 2001. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Berkadia LLC at December 31,
2003 and 2002 and the results of its operations and changes in members' equity
(deficit) and cash flows for the years ended December 31, 2003 and 2002 and for
the ten-month period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States.
/s/ Ernst & Young LLP
Phoenix, Arizona
February 20, 2004
1
Berkadia LLC
Balance Sheets
December 31
2003 2002
--------------- --------------
(In thousands)
Assets
Cash $ - $ -
Loan receivable due from FINOVA, net of discount 524,025 2,024,503
Interest and facilities fee receivable 2,392 6,155
--------------- --------------
Total assets $ 526,417 $ 2,030,658
=============== ===============
Liabilities and members' equity (deficit)
Liabilities:
Long-term debt $ 525,000 $ 2,175,000
Interest and facility fee payable 570 2,693
--------------- --------------
Total liabilities 525,570 2,177,693
Members' equity (deficit) 847 (147,035)
--------------- ---------------
Total liabilities and members' equity (deficit) $ 526,417 $ 2,030,658
=============== ===============
See accompanying notes.
2
Berkadia LLC
Statements of Operations and Changes in Members' Equity (Deficit)
Ten-month
Year ended period ended
December 31, December 31,
2003 2002 2001
--------------- ------------ --------------
(In thousands)
Revenue
Interest income and amortization of loan discount $ 198,790 $ 245,167 $ 136,734
--------------- ------------ -------------
Total revenue 198,790 245,167 136,734
Expenses
Equity loss in FINOVA - - 188,800
Interest expense 18,394 64,287 57,990
--------------- ------------ -------------
Total expenses 18,394 64,287 246,790
--------------- ------------ -------------
Net income 180,396 180,880 (110,056)
Members' equity (deficit), beginning of period (147,035) (261,765) -
Distributions to members (32,514) (66,150) (151,709)
--------------- ------------ -------------
Members' equity (deficit), end of period $ 847 $(147,035) $(261,765)
=============== ============ =============
See accompanying notes.
3
Berkadia LLC
Statements of Cash Flows
Ten-month
Year ended period ended
December 31, December 31,
2003 2002 2001
--------------- ------------- -------------
(In thousands)
Operating activities
Net income (loss) $ 180,396 $ 180,880 $ (110,056)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Equity loss in FINOVA -- -- 188,800
Amortization of loan discount (149,522) (118,028) (40,276)
Net change in:
Receivables 3,763 9,090 (15,244)
Payables (2,123) (5,793) 8,486
--------------- ----------- -----------
Net cash provided by operating activities 32,514 66,149 31,710
Investing activities
Loan to FINOVA, net -- -- (5,480,000)
Loan repayment from FINOVA 1,650,000 2,725,000 700,000
--------------- ----------- -----------
Net cash provided by (used in) investing activities 1,650,000 2,725,000 (4,780,000)
Financing activities
Issuance of long-term debt -- -- 5,600,000
Repayment of long-term debt (1,650,000) (2,725,000) (700,000)
Distributions to members (32,514) (66,150) (151,709)
--------------- ----------- -----------
Net cash provided by (used in) financing activities (1,682,514) (2,791,150) 4,748,291
--------------- ----------- -----------
Net increase (decrease) in cash -- (1) 1
Cash and cash equivalents at beginning of period -- 1 --
--------------- ----------- -----------
Cash and cash equivalents at end of period $ -- $ -- $ 1
=============== =========== ===========
Supplemental disclosure of noncash investing activities
Allocation of loan receivable due from FINOVA to equity
investment in FINOVA shares $ -- $ -- $ 188,800
=============== =========== ===========
See accompanying notes.
4
Berkadia LLC
Notes to Financial Statements
December 31, 2003, 2002 and 2001
1. Formation and Nature of Operations
Berkadia LLC (the "Company" or "Berkadia") was formed on February 26, 2001 as a
joint venture between Berkshire Hathaway Inc. ("Berkshire") and Leucadia
National Corporation ("Leucadia"). Berkshire and Leucadia through their
respective wholly owned affiliates hold the interests in the Company and are
referred to as the "Members".
The principal business purpose of the Company was to lend up to $6,000,000,000
on a senior secured basis to FINOVA Capital Corporation ("FINOVA Capital"), the
principal operating subsidiary of The FINOVA Group Inc. ("FINOVA"), to
facilitate a chapter 11 restructuring of the outstanding debt of FINOVA and its
principal subsidiaries. On August 10, 2001, the bankruptcy court confirmed the
Chapter 11 reorganization plan for the FINOVA companies (the "Plan"). On August
21, 2001, the effective date of the Plan, the Company loaned $5,600,000,000 par
amount on a senior secured basis to FINOVA Capital (the "Berkadia Loan").
Concurrent with the loan, the Company received 61,020,581 newly issued shares of
common stock of FINOVA (the "Shares"), representing 50 percent of the
outstanding stock of FINOVA.
The Berkadia Loan is collateralized by substantially all of the assets of FINOVA
and its subsidiaries and guaranteed by FINOVA and substantially all of the
subsidiaries of FINOVA. The Company borrowed the entire amount required to
finance the Berkadia Loan from a consortium of lenders led by Fleet Bank (the
"Fleet Loan"). The Fleet Loan is guaranteed, 90 percent by Berkshire Hathaway
and 10 percent by Leucadia (with Leucadia's guarantee being secondarily
guaranteed by Berkshire), and is also secured by the Company's pledge of the
Berkadia Loan.
The Company was paid a $60,000,000 commitment fee by FINOVA Capital upon
execution of the loan commitment in February 2001, and a $60,000,000 fee upon
funding of the Berkadia Loan on August 21, 2001. Under the operating agreement
governing the Company, Berkshire and Leucadia share equally in the commitment
fee, funding fee and any proceeds realized from the Shares. Interest on the
Berkadia Loan, after payment of interest on the Fleet Loan, is allocated 90
percent to Berkshire and 10 percent to Leucadia. To date, all cash received by
the Company, after payment of any financing costs, has been distributed to the
Members. In addition, FINOVA Capital has reimbursed the Company and the Members,
for all fees and expenses incurred in connection with their commitments. Fees
reimbursed to the Company aggregated $11,950,000 during 2001. There were no such
fees in 2002 or 2003.
5
Berkadia LLC
Notes to Financial Statements (continued)
1. Formation and Nature of Operations (continued)
The Members have not contributed any equity capital to the Company, and the
Company does not currently anticipate that any capital contributions will be
required in the future. Decisions concerning the management of the business and
affairs of the Company generally require the consent of all Members. However,
Berkshire makes any and all decisions with respect to the Berkadia Loan in its
sole and absolute discretion.
Upon FINOVA's emergence from bankruptcy in 2001, each of Berkshire and Leucadia
designated two persons to serve on FINOVA's reconstituted board of directors.
From and after the effective date of the Plan, the Company, Berkshire and
Leucadia are not entitled to designate FINOVA board members.
During 2002, several structural changes to the Company were executed, which were
intended to simplify the ownership structure of the Company and to provide a
debt-free vehicle for the Berkadia members to use to pursue other investments.
These changes did not alter the ownership interests in the Company, ultimately
held by Berkshire and Leucadia, and resulted in no gains or losses or other
changes to member's accumulated deficit. Among the changes, the Company
effectively distributed all of its right, title and interest in and to the
Shares to an entity formed by the Members (Berkadia Equity Holdings LLC). As a
result, other than the loan receivable from FINOVA, the Company no longer has
any other financial interest in FINOVA.
2. Significant Accounting Policies
(a) Use of Estimates in Preparing Financial Statements: The preparation of
financial statements in conformity with accounting principles generally
accepted in the United States ("GAAP") requires management to make
estimates and assumptions that affect (i) the reported amounts of assets
and liabilities, (ii) the disclosure of contingent assets and liabilities
at the date of the financial statements and (iii) the reported amounts of
revenues and expenses during the reporting period. Actual results could
differ from those estimates.
(b) Loan Receivable from FINOVA: The Berkadia Loan is carried net of
unamortized discount related to the commitment fee, the funding fee and the
amount of the Berkadia Loan allocated to Berkadia's investment in the
Shares. The discount is accreted into investment income over the life of
the Berkadia Loan through the effective interest method. FINOVA is current
with respect to all amounts due to the Company under the Berkadia Loan. As
of December 31, 2003, there was no allowance for losses on the Berkadia
Loan.
6
Berkadia LLC
Notes to Financial Statements (continued)
2. Significant Accounting Policies (continued)
(c) Investment in FINOVA Shares: Berkadia accounted for its investment in the
Shares under the equity method. Under the equity method, Berkadia
recognized its proportionate share of FINOVA's net income or loss. For the
period August 21 through September 30, 2001, FINOVA incurred significant
operating losses primarily as a result of the September 11 terrorist
attack. Berkadia's share of such losses far exceeded the cost allocated to
the Shares, which was based upon the relative fair values of the Shares and
the Berkadia Loan as of August 21, 2001. The application of the equity
method was suspended once the carrying amount of Shares was reduced to
zero. As a result of the structural changes to the Company in 2002
discussed in Note 1, Berkadia possesses no financial interests in the
Shares.
(d) Income taxes: The Company does not file an income tax return. Each Member
is responsible for the tax liability, if any, deriving from the taxable
income allocated to such Member. Accordingly, no provision for income taxes
has been reflected in these financial statements.
3. Berkadia Loan
The Berkadia Loan bears interest payable monthly, at the Eurodollar Rate plus
2.25 percent. All unpaid principal and accrued interest is due at maturity on
August 20, 2006. For the year ended December 31, 2003, the weighted-average
interest rate was 3.55 percent. FINOVA and substantially all of its direct and
indirect subsidiaries (except those that are contractually prohibited from
acting as a guarantor) have guaranteed FINOVA Capital's repayment of the
Berkadia Loan. The guarantees are secured by substantially all of the assets of
FINOVA and its subsidiaries.
On August 21, 2001, the Company transferred $5,540,000,000 in cash to FINOVA
Capital, representing the $5,600,000,000 loan reduced by the funding fee of
$60,000,000. As indicated above, in exchange for these funds, the Company
received a $5,600,000,000 note from FINOVA Capital and the Shares. The Company
allocated the $5,540,000,000 cash transferred, reduced further by the
$60,000,000 commitment fee received in February 2001, between its investment in
the Berkadia Loan and the Shares, based upon the respective relative fair values
of the Berkadia Loan and the Shares. As a result, the Berkadia Loan was recorded
at an initial value of $5,291,200,000, which is net of a discount related to the
commitment and funding fees of $120,000,000 and the cost allocated to the Shares
of $188,800,000.
7
Berkadia LLC
Notes to Financial Statements (continued)
3. Berkadia Loan (continued)
The terms of the Berkadia Loan permit FINOVA to retain a reserve of cash and
cash equivalents in an amount not to exceed the sum of (a) 125 percent of the
projected operating expenses for the next fiscal quarter, (b) unfunded customer
commitments expected to be funded over the next two fiscal quarters, (c) taxes
payable during the next fiscal quarter, (d) interest, loan fees and other
amounts due on the Berkadia Loan during the next fiscal quarter, (e) an amount
equal to all payments of principal, interest or fees relating to other permitted
indebtedness that will, by their terms, become due and payable in cash during
the next fiscal quarter, and (f) such other reserves as are necessary in
FINOVA's good faith judgment and as approved in advance by the Company for the
operations of FINOVA. Any amount in excess of the cash reserve is paid to the
Company to reduce the principal amount of the loan on a quarterly basis.
During 2002, the Company gave its consent to FINOVA to use up to $300 million of
cash to repurchase certain subordinated notes rather than make mandatory
prepayments of the Berkadia Loan. In consideration for its consent, FINOVA and
the Company agreed that they would share equally in the net interest savings
resulting from any repurchase. As a result of repurchases made by FINOVA during
2003 and 2002, the Company recognized approximately $6.8 million and $1.6
million, respectively, in interest income related to the net interest savings.
For the years ended December 31, 2003, and 2002 the Company received $1.650
billion and $2.725 billion, respectively, in loan repayments from FINOVA. On
February 9, 2004, FINOVA prepaid the entire remaining outstanding balance of the
Berkadia Loan.
4. Fleet Loan
The Fleet Loan bears interest payable monthly, at a rate generally equal to the
cost of funds for the lenders' conduit facilities plus 0.25 percent. The
lenders' cost of funds rate is expected to be substantially equal to the
Eurodollar Rate that is used to determine the interest rate on the Berkadia
Loan. For the year ended December 31, 2003, the weighted-average interest rate
was 1.54 percent. All unpaid principal and accrued interest is due at maturity
on August 20, 2006.
As discussed in Note 4, FINOVA has prepaid the remaining Berkadia Loan balance
in 2004. Accordingly, the remaining $525 million balance of the Fleet Loan was
prepaid by Berkadia in 2004.
5. Members' Capital
For the years ended December 31, 2003 and 2002, the Company distributed
substantially all of its available cash to its Members, aggregating $32.5
million and $66.2 million, respectively. For the two-year period, $87.4 million
was distributed to Berkshire Members and $11.3 million to Leucadia Members.
8
PRICEWATERHOUSECOOPERS
- --------------------------------------------------------------------------------
OLYMPUS RE HOLDINGS, LTD.
(Incorporated in Bermuda)
Combined Financial Statements
DECEMBER 31, 2003, 2002 AND 2001
(expressed in U.S. dollars)
PRICEWATERHOUSECOOPERS
- --------------------------------------------------------------------------------
PRICEWATERHOUSECOOPERS
Chartered Accountants
Dorchester House
7 Church Street
Hamilton
Bermuda HM 11
Telephone +1 (441) 295 2000
Facsmile +1 (441) 295 1242
January 27, 2004
REPORT OF INDEPENDENT AUDITORS
TO THE SHAREHOLDERS OF
OLYMPUS RE HOLDINGS, LTD.
In our opinion, the accompanying combined balance sheets and the related
combined statements of income, shareholders' equity, comprehensive income and
cash flows present fairly, in all material respects, the financial position of
Olympus Re Holdings, Ltd. at December 31, 2003 and 2002, and the results of its
operations and its cash flows for the years ended December 31, 2003 and 2002 and
the period from December 3, 2001 (date of incorporation) to December 31, 2001 in
conformity with accounting principles generally accepted in the United States of
America. These combined financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
combined financial statements based on our audits. We conducted our audits of
these combined financial statements in accordance with auditing standards
generally accepted in the United States of America which require that we plan
and perform the audit to obtain reasonable assurance about whether the combined
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the combined financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall combined
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
CHARTERED ACCOUNTANTS
MAILING ADDRESS: PO BOX HM 1171, Hamilton, Bermuda HM EX.
A list of partners can be obtained from the above address
OLYMPUS RE HOLDINGS, LTD.
Combined Balance Sheets
AS OF DECEMBER 31, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
2003 2002
$ $
-----------------------------------------
ASSETS
Cash and cash equivalents 36,083,597 64,156,759
Investments (note 3) 764,622,198 599,123,769
Investment income due and accrued 8,367,373 6,684,911
Premiums receivable 167,458,000 76,489,609
Deferred acquisition costs 46,732,324 23,318,087
Other assets 259,518 158,188
-----------------------------------------
1,023,523,010 769,931,323
-----------------------------------------
LIABILITIES
Loss and loss adjustment expense reserves (note 4) 114,317,141 44,707,594
Unearned premiums 142,792,737 74,365,214
Accounts payable and accrued expenses 591,308 581,289
Investment trades pending - 2,455,041
Advisory fees payable (note 5) 47,017,307 25,170,228
-----------------------------------------
304,718,493 147,279,366
-----------------------------------------
SHAREHOLDERS' EQUITY
Common voting shares (4,385,714 shares issued and outstanding) (note 7) 43,857 51,000
Additional paid-in capital (note 7) 438,527,543 509,949,000
Accumulated other comprehensive income 11,515,650 16,105,280
Retained earnings 268,717,467 96,546,677
-----------------------------------------
718,804,517 622,651,957
-----------------------------------------
1,023,523,010 769,931,323
-----------------------------------------
APPROVED BY THE BOARD OF DIRECTORS
------------------------- Director ------------------------- Director
The accompanying notes are an integral part
of these combined financial statements.
OLYMPUS RE HOLDINGS, LTD.
Combined Statements of Income
FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002 AND THE PERIOD FROM DECEMBER 3,
2001 (DATE OF INCORPORATION) TO DECEMBER 31, 2001
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
2003 2002 2001
$ $ $
-------------------------------------------------------
REVENUES
Gross premiums written 523,178,240 298,522,087 -
-------------------------------------------------------
Net premiums written 523,178,240 298,522,087 -
Net change in unearned premiums (68,427,525) (74,365,214) -
-------------------------------------------------------
Net premiums earned 454,750,715 224,156,873 -
-------------------------------------------------------
Net investment income 20,897,961 18,002,285 232,594
Net realized gains on investments 5,130,298 2,969,859 -
-------------------------------------------------------
TOTAL REVENUES 480,778,974 245,129,017 232,594
-------------------------------------------------------
EXPENSES
Losses and loss expenses (note 4) 104,344,698 57,901,965 -
Commissions 165,860,912 78,078,362 -
Premium taxes and fees 4,141,391 2,184,366 -
Other underwriting expenses 3,629,805 750,726 -
Incorporation costs - - 8,632,780
General and administrative expenses 2,059,983 1,236,605 30,130
-------------------------------------------------------
TOTAL EXPENSES 280,036,789 140,152,024 8,662,910
-------------------------------------------------------
NET INCOME (LOSS) FOR THE PERIOD 200,742,185 104,976,993 (8,430,316)
-------------------------------------------------------
The accompanying notes are an integral part
of these combined financial statements.
OLYMPUS RE HOLDINGS, LTD.
Combined Statements of Shareholders's Equity
FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002 AND THE PERIOD FROM DECEMBER 3,
2001 (DATE OF INCORPORATION) TO DECEMBER 31, 2001
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
ACCUMULATED
ADDITIONAL OTHER RETAINED TOTAL
COMMON PAID-IN COMPREHENSIVE EARNINGS SHAREHOLDER'S
VOTING SHARES CAPITAL INCOME (DEFICIT) EQUITY
$ $ $ $ $
----------------------------------------------------------------------------------------------
Issuance of common shares 51,000 509,949,000 - - 510,000,000
Net loss for the period - - - (8,430,316) (8,430,316)
----------------------------------------------------------------------------------------------
BALANCE AS OF DECEMBER 31, 2001 51,000 509,949,000 - (8,430,316) 501,569,684
Net income for the year - - - 104,976,993 104,976,993
Change in unrealized appreciation
(depreciation) on marketable
investments - - 16,105,280 - 16,105,280
----------------------------------------------------------------------------------------------
BALANCE AS OF DECEMBER 31, 2002 51,000 509,949,000 16,105,280 96,546,677 622,651,957
Net income for the year - - - 200,742,185 200,742,185
Change in unrealized appreciation
(depreciation) on marketable
investments - - (4,589,630) - (4,589,630)
Repurchase of common voting
shares (note 7) (7,143) (71,421,457) - (28,571,395) (99,999,995)
----------------------------------------------------------------------------------------------
BALANCE AS OF DECEMBER 31, 2003 43,857 438,527,543 11,515,650 268,717,467 718,804,517
----------------------------------------------------------------------------------------------
The accompanying notes are an integral part
of these combined financial statements.
OLYMPUS RE HOLDINGS, LTD.
Combined Statements of Comprehensive Income
FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002 AND THE PERIOD FROM DECEMBER 3,
2001 (DATE OF INCORPORATION) TO DECEMBER 31, 2001
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
2003 2002 2001
$ $ $
------------------------------------------------------
NET INCOME (LOSS) FOR THE PERIOD 200,742,185 104,976,993 (8,430,316)
OTHER COMPREHENSIVE INCOME
Change in unrealized appreciation (depreciation)
on marketable investments (4,589,630) 16,105,280 -
------------------------------------------------------
COMPREHENSIVE INCOME (LOSS) FOR THE PERIOD 196,152,555 121,082,273 (8,430,316)
------------------------------------------------------
The accompanying notes are an integral part
of these combined financial statements.
OLYMPUS RE HOLDINGS, LTD.
Combined Statements of Cash Flows
FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002 AND THE PERIOD FROM DECEMBER 3,
2001 (DATE OF INCORPORATION) TO DECEMBER 31, 2001
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
2003 2002 2001
$ $ $
-------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) for the period 200,742,185 104,976,993 (8,430,316)
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities
Gain on sale of investments (5,130,298) (2,969,859) -
Net amortization of premium/discount on fixed maturities 5,936,259 3,087,459 -
Investment income due and accrued (1,682,462) (6,664,862) (20,049)
Incorporation cost payable - (7,883,231) 7,883,231
Premiums receivable (90,968,391) (76,489,609) -
Deferred acquisition costs (23,414,237) (23,318,087) -
Other assets (101,330) (158,188) -
Loss and loss adjustment expense reserves 69,609,547 44,707,594 -
Unearned premiums 68,427,523 74,365,214 -
Accounts payable and accrued expenses 10,019 551,289 30,000
Investment trades pending (2,455,041) 2,455,041 -
Advisory fees payable 21,847,079 25,170,228 -
-------------------------------------------------------------
Cash provided by (used in) operating activities 242,820,853 137,829,982 (537,134)
-------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments (735,713,760) (1,066,976,281) -
Proceeds from sales of investments 564,819,740 483,840,192 -
-------------------------------------------------------------
Cash used in investing activities (170,894,020) (583,136,089) -
-------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Purchase of shares through buy-back agreement (99,999,995) - -
Proceeds from issuance of common shares - 150,000 509,850,000
-------------------------------------------------------------
Cash (used in) provided by financing activities (99,999,995) 150,000 509,850,000
-------------------------------------------------------------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (28,073,162) (445,156,107) 509,312,866
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 64,156,759 509,312,866 -
-------------------------------------------------------------
CASH AND CASH EQUIVALENTS - END OF PERIOD 36,083,597 64,156,759 509,312,866
-------------------------------------------------------------
The accompanying notes are an integral part
of these combined financial statements.
OLYMPUS RE HOLDINGS, LTD.
Notes to Combined Financial Statements
DECEMBER 31, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
1. NATURE OF THE BUSINESS
Olympus Re Holdings, Ltd. and its subsidiaries (the "Company") were
incorporated under the laws of Bermuda on December 3, 2001 and commenced
operations on January 1, 2002. The Company's principal operating subsidiary
is Olympus Reinsurance Company, Ltd. ("Olympus Re"). Olympus Re is
registered as a Class 4 insurer under The Insurance Act 1978, amendments
thereto and related regulations ("The Act"). The Company's bye-laws provide
that the Board of Directors of Olympus Re shall consist of persons who
first have been elected as designated directors by a resolution in a
general meeting of the shareholders of the Company. The Board of Directors
of the Company must then vote all shares of Olympus Re owned by the Company
to elect such designated directors as Olympus Re directors. The bye-law
provisions with respect to the removal of directors of Olympus Re operate
similarly.
The Company, through Olympus Re, writes reinsurance business on a global
basis with an emphasis on property excess business. During the year ended
December 31, 2003, this was through two main sources, quota share
reinsurance agreements with a U.S. reinsurance company (see note 6) and an
underwriting advisory contract. The purpose of these quota share agreements
is to produce primarily property reinsurance. Olympus Re's underwriting
advisory contract is with a non-U.S. advisor (see note 5) to recommend
excess property and marine reinsurance business and consult on the quota
share agreements. The non-U.S. advisor is related to the previously
mentioned U.S. reinsurance company through common ownership. During 2002,
business written was primarily through the quota share reinsurance
agreement with a U.S. reinsurance company as described above.
2. SIGNIFICANT ACCOUNTING POLICIES
Olympus Re's Board of Directors, who are elected as described above, have
unilateral authority to manage the affairs of Olympus Re, except for
certain actions that require approval by the Company as sole shareholder.
Since the Company and Olympus Re are under the common control of the
shareholders of the Company, the accompanying financial statements have
been prepared on a combined basis, rather than on a consolidated basis, in
accordance with ARB No. 51 (see note 2(g)). The combined financial
statements include the financial statements of Olympus Re Holdings Ltd. and
its wholly-owned subsidiary Olympus Re. All significant inter-company
balances have been eliminated on combination.
These combined financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America.
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts of assets and liabilities, as well
as disclosure of contingent assets and liabilities as at the balance sheet
date. Estimates also affect the reported amounts of income and expenses for
the reporting period. Actual results could differ from those estimates.
The following is a summary of the significant accounting policies adopted
by the Company:
(a) PREMIUMS AND UNEARNED PREMIUMS
The Company records premiums based on cession statements received.
These cession statements earn premium income evenly over the term of
the underlying reinsurance contract, in proportion to the risk
assumed. The portion of the premium related to the unexpired portion
of the contract at the end of the fiscal period is reflected in
unearned premiums.
(1)
OLYMPUS RE HOLDINGS, LTD.
Notes to Combined Financial Statements
DECEMBER 31, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
Certain reinsurance premiums assumed are estimated based on information
provided by the underlying ceding companies. The information used in
establishing these estimates is reviewed and subsequent adjustments are
taken into income in the period in which they are determined. These
premiums are earned over the terms of the related reinsurance contracts.
(b) DEFERRED ACQUISITION COSTS
The Company records acquisition costs based on cessions statements
received, in addition to its own direct acquisition costs.
Policy acquisition costs are comprised of ceding commissions, brokerage,
premium taxes and other expenses that relate directly to the acquisition of
premiums. These costs are deferred and amortized over the terms of the
related contracts. Deferred policy acquisition costs are reviewed to
determine if they are recoverable from future underwriting profits,
including investment income. If such costs are estimated to be
unrecoverable, they are expensed.
(c) LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
The Company records loss and loss adjustment expenses based on cessions
statements received. The reported amounts for incurred but not reported
losses are also separately reviewed by the Company. Loss and loss
adjustment expense reserves, including losses incurred but not reported and
provisions for settlement expenses, includes amounts determined from losses
reported to the Company, and management estimates. Due to limited
historical experience, industry data is relied upon in the reserving
process.
A significant portion of the Company's business is in the property
catastrophe market and programs with higher layers of risks. Reserving for
losses in such programs is inherently complicated in that losses in excess
of the attachment level of the underlying policies are characterized by
high severity and low frequency. This limits the volume of industry claims
experience available from which to reliably predict ultimate losses
following a loss event.
The Company uses industry data and professional judgment to estimate the
ultimate loss from reinsurance contracts exposed to a loss event. Delays in
reporting losses to the Company together with the potential for unforeseen
adverse developments may result in losses and loss expenses significantly
greater or less than the reserve provided at the time of the loss event.
Loss and loss adjustment reserve estimates are regularly reviewed and
updated, as new information becomes known to the Company. Any resulting
adjustments are included in income in the period in which they become
known.
(d) CASH AND CASH EQUIVALENTS
Cash and cash equivalents include debt securities and time deposits with a
maturity of three months or less from the date of purchase.
(2)
OLYMPUS RE HOLDINGS, LTD.
Notes to Combined Financial Statements
DECEMBER 31, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
(e) INVESTMENTS
The Company's investments in fixed maturities are classified as
"available-for-sale" and are carried at fair value, based on quoted market
prices. Unrealized gains and losses are included within accumulated other
comprehensive income in shareholders' equity.
Net investment income is stated net of investment management and custody
fees. Interest income is recognized on the accrual basis and includes the
amortization of premium or discount on fixed interest securities purchased
at amounts different from their par value.
Gains and losses on investments are included in investment income when
realized. Investments are recorded on a trade date basis and the cost of
securities sold is determined on the first-in, first-out basis.
Investments are reviewed periodically to determine if they have sustained
an impairment of value that is considered to be other than temporary. The
identification of potentially impaired investments involves significant
management judgment, which includes the determination of their fair value
and the assessment of whether any decline in value is other than temporary.
If investments are determined to be impaired, a loss is charged to the
income statement in that period.
(f) FOREIGN CURRENCY
Monetary assets and liabilities denominated in foreign currencies have been
translated to U.S. dollars at the rates of exchange prevailing at the
balance sheet date. Income and expense transactions originating in foreign
currencies are translated at the rates of exchange prevailing on the date
of the transaction. Gains and losses on foreign currency translation are
included in income.
(g) NEW ACCOUNTING PRONOUNCEMENTS
In January 2003 the FASB issued FASB Interpretation No. 46, Consolidation
of variable interest entities - an interpretation of ARB No. 51 ("FIN 46").
FIN 46 clarifies the accounting and reporting for certain entities in which
equity investors do not have the characteristics of a controlling financial
interest. As disclosed in notes 1 and 2 these financial statements are
prepared on a combined rather than consolidated basis based on the fact
that Olympus Re's and the Company's Bye-laws provide certain restrictions
relating to the election of directors of Olympus Re. In December 2003, the
FASB issued a revision ("FIN 46R") to FIN 46 to clarify certain provisions
and exempt certain entities from its requirements. The Company will no
longer be required to adopt FIN 46, however, it will be required to adopt
FIN 46R for the first interim or annual reporting period beginning after
December 15, 2004. The impact of adopting FIN 46R will be to present the
financial statements as consolidated beginning in the period ending March
31, 2005. This is not expected to have any impact on the Company's net
income or net shareholders' equity as presented in these financial
statements.
(3)
OLYMPUS RE HOLDINGS, LTD.
Notes to Combined Financial Statements
DECEMBER 31, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
3. INVESTMENTS
2003
UNREALIZED UNREALIZED ESTIMATED
COST GAIN LOSS FAIR VALUE
$ $ $ $
------------------------------------------------------------------------------
U.S. government and agency 499,191,600 5,856,272 - 505,047,872
Corporate 202,200,619 5,389,124 - 207,589,743
Mortgage-backed securities 51,714,329 270,254 - 51,984,583
------------------------------------------------------------------------------
753,106,548 11,515,650 - 764,622,198
------------------------------------------------------------------------------
2002
UNREALIZED UNREALIZED ESTIMATED
COST GAIN LOSS FAIR VALUE
$ $ $ $
------------------------------------------------------------------------------
U.S. government and agency 351,457,556 9,286,371 - 360,743,927
Corporate 143,334,311 6,499,571 - 149,833,882
Mortgage-backed securities 88,226,622 333,785 14,447 88,545,960
------------------------------------------------------------------------------
583,018,489 16,119,727 14,447 599,123,769
------------------------------------------------------------------------------
The estimated fair value of fixed interest securities and equities is based
on quoted market values. All mortgage-backed securities in an unrealized
loss position at December 31, 2002 have been so continuously for a period
of less than 12 months.
The Company did not have any investments in a single corporate security
which exceeded 1.6% and 2.1% of total fixed interest securities as of
December 31, 2003 and 2002, respectively.
The following table sets forth certain information regarding the investment
ratings of the company's fixed interest securities portfolio as of December
31, 2003 and 2002.
2003 2002
--------------------------------- ----------------------------------
AMORTIZED AMORTIZED
COST COST
RATINGS $ % $ %
------------------------------------------------------------------------------
U.S. government and agency 499,191,600 66 353,912,597 60
AAA 46,743,994 6 65,367,410 11
AA 87,868,424 12 67,472,319 12
A 119,302,530 16 93,134,771 16
BBB - - 3,131,392 1
------------------------------------------------------------------------------
753,106,548 100 583,018,489 100
------------------------------------------------------------------------------
(4)
OLYMPUS RE HOLDINGS, LTD.
Notes to Combined Financial Statements
DECEMBER 31, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
The amortized cost and estimated fair value amounts for fixed interest
securities held at December 31, 2003 are shown by contractual maturity.
Actual maturity may differ from contractual maturity because certain
borrowers have the right to call or prepay certain obligations with or
without call or prepayment penalties.
AMORTIZED ESTIMATED
COST FAIR VALUE
$ $
-------------------------------------------
Due within one year 45,055,955 45,141,000
Due after one year through five years 582,255,933 593,040,115
Due after five years through ten years 74,080,331 74,456,500
-------------------------------------------
701,392,219 712,637,615
Mortgage-backed securities 51,714,329 51,984,583
-------------------------------------------
753,106,548 764,622,198
-------------------------------------------
The components of net investment income are as follows:
2003 2002 2001
$ $ $
--------------------------------------------------------------
Interest on fixed maturities 27,758,971 20,691,286 -
Net amortization of premium/discount on fixed maturities (5,936,259) (3,087,459) -
Interest on cash and cash equivalents 557,713 1,592,238 232,594
--------------------------------------------------------------
22,380,425 19,196,065 232,594
Net investment expenses (1,482,464) (1,193,780) -
--------------------------------------------------------------
20,897,961 18,002,285 232,594
--------------------------------------------------------------
During 2003 and 2002, proceeds from sales of available-for-sale securities
were $564,819,740 and $483,840,192 respectively. Gross realized gains were
$5,548,574 and $3,361,350 and gross realized losses were $418,276 and
$391,491 for the years end December 31, 2003 and 2002 respectively.
White Mountain Advisors, LLC receives a management fee at an annual rate of
0.2% of net invested assets.
In the normal course of business, the Company provides collateral in
accordance with certain reinsurance agreements. The Company has cash
equivalents of $54,453 and $10,339,521 and investments of $201,128,202 and
$65,214,300 in trusts, as of December 31, 2003 and 2002, respectively, held
as collateral.
(5)
OLYMPUS RE HOLDINGS, LTD.
Notes to Combined Financial Statements
DECEMBER 31, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
4. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
Loss and loss adjustment expense reserves are estimates subject to
variability, and the variability could be material in the near term. The
variability arises because all events affecting the ultimate settlement of
claims have not taken place and may not take place for some time.
Variability can be caused by receipt of additional claim information,
changes in judicial interpretation of contracts or significant changes in
the severity or frequency of claims from historical trends. Loss and loss
adjustment expenses estimates are based on all relevant information
available to the Company. Methods of estimation are used which the Company
believes produce reasonable results given current information.
Reserve activity for loss and loss expenses is summarized below:
2003 2002
$ $
------------------------------------------
BALANCE - BEGINNING OF YEAR 44,707,594 -
Less: Amounts recoverable from reinsurers - -
------------------------------------------
Net balance - Beginning of year 44,707,594 -
------------------------------------------
Net claims and claims expenses incurred for the year related to:
Current year 110,104,123 57,901,965
Prior year (5,759,425) -
------------------------------------------
104,344,698 57,901,965
------------------------------------------
Net paid claims and claims expenses for the year related to:
Current year 17,069,797 13,194,371
Prior year 17,665,354 -
------------------------------------------
34,735,151 13,194,371
------------------------------------------
Net balance - End of year 114,317,141 44,707,594
Plus: Amounts recoverable from reinsurers - -
------------------------------------------
BALANCE - END OF YEAR 114,317,141 44,707,594
------------------------------------------
The December 31, 2003 and 2002 year end balance is comprised of provisions
for reported claims of $33,300,789 and $10,536,402 and provisions for
claims incurred but not reported of $81,016,352 and $34,171,192,
respectively.
5. ADVISORY FEES PAYABLE
Advisory fees payable represents override commission and profit commissions
payable, including a 20% profit commission payable to the non-U.S.
advisors, White Mountains Underwriting Limited, for all business on which
they advise.
(6)
OLYMPUS RE HOLDINGS, LTD.
Notes to Combined Financial Statements
DECEMBER 31, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
6. MAJOR CUSTOMERS
During the years ended December 31, 2003 and 2002, the Company derived 90%
and 99%, respectively, of its premiums written from Folksamerica
Reinsurance Company ("Folksamerica") for which the Company pays an override
commission. Commencing in 2003, the Company derived 8% of its premiums
written from business recommended by White Mountains Underwriters for which
the Company pays a 12% override commission. Folksamerica and White
Mountains Underwriters are wholly-owned subsidiaries of White Mountains
Insurance Group Ltd., which is a minority shareholder of the Company
through a 50% joint venture, and is also the parent of the Company's
investment advisors, White Mountain Advisors, LLC. Included in premiums
receivable for the years ended December 31, 2003 and 2002 were amounts of
$157,980,421 and $76,475,537, respectively, due from Folksamerica.
7. CAPITAL STOCK
(a) AUTHORIZED SHARES
The Company's authorized share capital is 20,000,000 common shares of
the par value $0.01 each.
(b) COMMON STOCK
At December 31, 2003 and 2002, the total issued and outstanding shares
of the Company were 4,385,714 and 5,100,000, respectively, with a par
value of $0.01. The holders of the ordinary shares are entitled to
receive dividends and are allocated one vote per share, provided that,
if the controlled shares of any shareholder (excluding Leucadia
National Corporation) constitute 9.5 percent or more of the
outstanding common shares of the Company, only a fraction of the vote
will be allowed so as not to exceed 9.5 percent. There are various
restrictions on the ability of shareholders to dispose of their
shares.
In the period to December 31, 2001, the Company received cash of
$509,850,000 in respect of subscriptions of common shares. On January
2, 2002, payment of the remaining outstanding subscriptions totaling
$150,000 was received from shareholders. Following receipt of the
outstanding subscriptions payments, all issued and outstanding common
voting shares were fully paid.
In the year ended December 31, 2003, the Company used $99,999,995 to
repurchase a total of 714,286 shares.
8. TAXATION
BERMUDA
The Company has received an undertaking from the Bermuda government
exempting it from all local income, withholding and capital gains taxes
until March 28, 2016. At the present time no such taxes are levied in
Bermuda.
UNITED STATES
The Company does not consider itself to be engaged in trade or business in
the United States and, accordingly, does not expect to be subject to United
States income tax.
(7)
OLYMPUS RE HOLDINGS, LTD.
Notes to Combined Financial Statements
DECEMBER 31, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
9. STATUTORY REQUIREMENTS
Under The Act, Olympus Re is required to prepare Statutory Financial
Statements and to file a Statutory Financial Return. The Act also requires
Olympus Re to meet certain minimum capital and surplus requirements. To
satisfy these requirements, Olympus Re was required to maintain a minimum
level of statutory capital and surplus of $261,589,120, $149,261,044 and
$100,000,000 at December 31, 2003, 2002 and 2001 respectively. Olympus Re's
statutory capital and surplus was $668,937,898, $593,312,822 and
$494,999,111 at December 31, 2003, 2002 and 2001 respectively.
Statutory capital and surplus as reported under The Act is different from
shareholders' equity as determined in conformity with accounting principles
generally accepted in the United States of America ("GAAP") due to certain
items that are capitalized under GAAP but expensed under The Act.
Olympus Re is also required to maintain a minimum liquidity ratio, which
was met for the years ended December 31, 2003 and 2002 and the period ended
December 31, 2001.
(8)
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
(WITH INDEPENDENT AUDITORS' REPORT THEREON)
Independent Auditors' Report
The Members
Jefferies Partners Opportunity Fund II, LLC:
We have audited the accompanying statements of financial condition of Jefferies
Partners Opportunity Fund II, LLC (the Fund) as of December 31, 2003 and 2002
and the related statements of earnings, changes in members' equity, and cash
flows for each of the years in the three-year period ended December 31, 2003.
These financial statements are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Jefferies Partners Opportunity
Fund II, LLC as of December 31, 2003 and 2002 and the results of its operations
and its cash flows for each of the years in the three-year period ended December
31, 2003 in conformity with accounting principles generally accepted in the
United States of America.
KPMG LLP
Los Angeles, California
January 26, 2004, except as to note 8
of the notes to the financial statements,
which is as of February 13, 2004.
2
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Statements of Financial Condition
December 31, 2003 and 2002
2003 2002
--------------- ---------------
Assets
Cash and cash equivalents $ 59,494,963 51,922,332
Receivable from affiliated brokers and dealers 7,726,682 8,674,598
Securities owned 91,758,964 106,371,906
Other assets 2,567,342 1,505,781
--------------- ---------------
Total assets $ 161,547,951 168,474,617
=============== ===============
Liabilities and Members' Equity
Securities sold, not yet purchased $ 2,601,400 1,907,586
Payable to affiliated brokers and dealers 9,194,501 16,274,366
Payable to Jefferies & Company, Inc. 639,504 540,078
Accrued expenses and other liabilities 201,740 102,347
--------------- ---------------
Total liabilities 12,637,145 18,824,377
--------------- ---------------
Members' equity:
Members' capital, net 126,255,099 126,255,099
Retained earnings 22,655,707 23,395,141
--------------- ---------------
Total members' equity 148,910,806 149,650,240
--------------- ---------------
Total liabilities and members' equity $ 161,547,951 168,474,617
=============== ===============
See accompanying notes to financial statements.
3
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Statements of Earnings
Years ended December 31, 2003, 2002, and 2001
2003 2002 2001
---------------- ---------------- ---------------
Revenues:
Principal transactions (net of direct trading
expenses) $ 17,319,861 17,644,923 33,881,772
Interest 6,326,007 6,917,318 9,086,866
---------------- ---------------- ---------------
Total revenues 23,645,868 24,562,241 42,968,638
---------------- ---------------- ---------------
Expenses:
General and administrative 1,015,358 1,070,544 1,160,728
Management fee 1,061,434 1,046,280 937,384
Interest 518,539 655,445 388,207
---------------- ---------------- ---------------
Total expenses 2,595,331 2,772,269 2,486,319
---------------- ---------------- ---------------
Net earnings $ 21,050,537 21,789,972 40,482,319
================ ================ ===============
See accompanying notes to financial statements.
4
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Statements of Changes in Members' Equity
Years ended December 31, 2003, 2002, and 2001
Members' Retained Total members'
capital, net earnings equity
-------------- -------------- --------------
Balance, December 31, 2000 $ 124,275,099 27,098,621 151,373,720
Capital contributions from members, net 1,980,000 -- 1,980,000
Distributions -- (25,513,451) (25,513,451)
Net earnings -- 40,482,319 40,482,319
-------------- ------------- -------------
Balance, December 31, 2001 126,255,099 42,067,489 168,322,588
Distributions -- (40,462,320) (40,462,320)
Net earnings -- 21,789,972 21,789,972
-------------- ------------- -------------
Balance, December 31, 2002 126,255,099 23,395,141 149,650,240
Distributions -- (21,789,971) (21,789,971)
Net earnings -- 21,050,537 21,050,537
-------------- ------------- -------------
Balance, December 31, 2003 $ 126,255,099 22,655,707 148,910,806
============== ============= =============
See accompanying notes to financial statements.
5
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Statements of Cash Flows
Years ended December 31, 2003, 2002, and 2001
2003 2002 2001
------------- ------------- --------------
Cash flows from operating activities:
Net earnings $ 21,050,537 21,789,972 40,482,319
------------- ------------- --------------
Adjustments to reconcile net earnings to net cash provided
by operating activities:
Amortization of financing costs 107,644 107,644 106,463
Changes in assets and liabilities:
Decrease in receivable from affiliated brokers and dealers 947,916 3,475,010 8,533,617
Decrease (increase) in securities owned 14,612,942 18,702,934 (16,527,734)
Decrease (increase) in other assets (1,169,205) 277,550 1,046,071
(Decrease) increase in securities sold, not yet purchased 693,814 255,298 (5,112,697)
(Decrease) increase in payable to affiliated brokers and
dealers (7,079,865) (1,619,104) 7,340,711
(Decrease) increase in payable to Jefferies &
Company, Inc. 99,426 (361,781) (463,730)
Increase in accrued expenses and other liabilities 99,393 12,185 25,956
------------- ------------- --------------
8,312,065 20,849,736 (5,051,343)
------------- ------------- --------------
Net cash provided by operating activities 29,362,602 42,639,708 35,430,976
------------- ------------- --------------
Cash flows from financing activities:
Proceeds from bank loans 5,625,000 16,400,000 --
Repayment of bank loans (5,625,000) (16,400,000) --
Capital contributions from members, net -- -- 1,980,000
Distributions (21,789,971) (40,462,320) (25,513,451)
------------- ------------- --------------
Net cash used in financing activities (21,789,971) (40,462,320) (23,533,451)
------------- ------------- --------------
Net increase in cash and cash equivalents 7,572,631 2,177,388 11,897,525
Cash and cash equivalents at beginning of year 51,922,332 49,744,944 37,847,419
------------- ------------- --------------
Cash and cash equivalents at end of year $ 59,494,963 51,922,332 49,744,944
============= ============= ==============
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ 441,255 719,280 348,383
See accompanying notes to financial statements.
6
JEFFERIES PARTNERS OPPORTUNITY FUND II, LLC
Notes to Financial Statements
December 31, 2003 and 2002
(1) Summary of Significant Accounting Policies
Jefferies Partners Opportunity Fund II, LLC (the Fund) is a Delaware
limited liability company. The Fund commenced operations on January 19,
2000. The investment objective of the Fund is to generate returns for its
members by making, holding, and disposing of a diverse portfolio of
primarily below investment grade debt and equity investments. The Fund
was established to offer members the opportunity to participate in the
trading, investment, and brokerage activities of the High Yield
Department of Jefferies & Company, Inc. (Jefferies). The Fund employs a
trading and investment strategy substantially similar to that
historically employed by Jefferies' High Yield Department. The Fund
acquires, actively manages, and trades a diverse portfolio of primarily
noninvestment grade investments consisting of the following three asset
groups: High Yield Debt, Special Situation Investments, and, to a lesser
extent, Bank Loans. The Fund has appointed Jefferies to serve as manager
to the Fund (the Manager). The Fund participates in the trading and
investment activities of the High Yield Department on a pari passu basis
with Jefferies. To permit such participation, the Fund has been
registered as a broker-dealer under the Securities Exchange Act of 1934
and with the National Association of Securities Dealers.
The Fund will be in effect until January 18, 2007, unless extended for up
to three successive one-year terms by the vote of the Manager and a
majority of the member interests.
The Fund, in connection with its activities as a broker-dealer, does not
hold funds or securities for customers. Accordingly, the computation for
determination of reserve requirements pursuant to Rule 15c3-3 has been
omitted.
(a) Cash and Cash Equivalents
Cash equivalents consist of money market funds, which are part of
the cash management activities of the Fund, and generally mature
within 90 days. At December 31, 2003 and 2002, such cash
equivalents amounted to $57,820,030 and $50,687,097, respectively.
(b) Fair Value of Financial Instruments
Substantially all of the Fund's financial instruments are carried
at fair value or amounts approximating fair value. Assets,
including cash and cash equivalents, securities borrowed, and
certain receivables, are carried at fair value or contracted
amounts which approximate fair value due to the short period to
maturity. Similarly, liabilities, including certain payables, are
carried at amounts approximating fair value. Securities owned and
securities sold, not yet purchased, are valued at quoted market
prices, if available. For securities without quoted prices, the
reported fair value is estimated by using various sources of
information, including quoted prices for comparable securities.
(c) Securities Transactions
The Fund records its securities transactions on a trade-date
basis. Securities owned and securities sold, not yet purchased,
are valued at market, and unrealized gains or losses are reflected
in revenues from principal transactions in the statements of
earnings.
7
(d) Contributions
Capital contributions are recorded net of placement fees. Each
member is charged a one-time placement fee of 1% of gross
contributions.
(e) Federal and State Income Taxes
Under current federal and applicable state limited liability
company laws and regulations, limited liability companies are
treated as partnerships for tax reporting purposes and,
accordingly, are not subject to income taxes. Therefore, no
provision for income taxes has been made in the Fund's financial
statements. For tax purposes, income or losses are included in the
tax returns of the members.
(f) Allocation of Income and Expense
Income and expense are allocated 100% to the members based on the
pro rata share of their capital contributed to the Fund, until the
total allocation equals the aggregate member preferred return of
8% of contributed capital. All remaining income and expense are
allocated 80% to the members and 20% to the Manager.
(g) Commitments
As of December 31, 2003, the Company had unfunded commitments of
$1,435,715 under a revolving credit facility. On January 15, 2004,
the Fund sold the revolving credit facility and the remaining
unfunded commitments.
(h) Use of Estimates
Management of the Fund has made a number of estimates and
assumptions relating to the reporting of assets and liabilities,
the disclosure of contingent assets and liabilities, and the
reported amounts of revenues and expenses to prepare these
financial statements in conformity with accounting principles
generally accepted in the United States of America. Actual results
could differ from those estimates.
8
(2) Receivable from, and Payable to, Affiliated Brokers and Dealers
The following is a summary of the major categories of receivable from,
and payable to, affiliated brokers and dealers as of December 31, 2003
and 2002:
2003 2002
----------------- -----------------
Receivable from affiliated brokers and dealers:
Securities failed to deliver $ 4,742,178 8,262,962
Securities borrowed 1,642,040 324,780
Other 1,342,464 86,856
----------------- -----------------
$ 7,726,682 8,674,598
================= =================
Payable to affiliated brokers and dealers:
Securities failed to receive $ 9,159,503 8,700,819
Other 34,998 7,573,547
----------------- -----------------
$ 9,194,501 16,274,366
================= =================
The Fund borrows securities to cover short sales, from which the Fund
derives interest revenue. See note 5.
(3) Securities Owned and Securities Sold, Not Yet Purchased
The following is a summary of the market value of major categories of
securities owned and securities sold, not yet purchased, as of December
31, 2003 and 2002:
At December 31, 2003:
Securities
Securities sold, not yet
owned purchased
----------------- -----------------
Corporate debt securities $ 76,461,843 2,601,400
Corporate equity securities 15,297,121 --
----------------- -----------------
$ 91,758,964 2,601,400
================= =================
At December 31, 2002:
Securities
Securities sold, not yet
owned purchased
----------------- -----------------
Corporate debt securities $ 92,563,394 1,907,586
Corporate equity securities 13,808,512 --
----------------- -----------------
$ 106,371,906 1,907,586
================= =================
9
(4) Revolving Credit Facility
In June 2003, the Fund renewed a revolving credit facility agreement to
be used in connection with the Fund's investing activities. At December
31, 2003 and 2002, $85,200,000 was available under the terms of the
revolving credit facility agreement. The revolving credit facility
expires in June 2004, but provides for annual extensions. Advances under
this facility bear interest at the lender's commercial paper rate plus
115 basis points. The Fund incurs a liquidity fee on the total amount
available under the revolving credit facility. For the years ended
December 31, 2003, 2002, and 2001, the Fund was charged a liquidity fee
of $323,938, $323,937, and $321,290, respectively, a program fee of
$159,273, $112,570, and $66,917, respectively, and an administrative fee
of $278, $2,360, and $0, respectively, which are included in interest
expense. During the years ended December 31, 2003 and 2002, the Fund
borrowed, and subsequently repaid, $5,625,000 and $16,400,000,
respectively, under the revolving credit facility. For the years ended
December 31, 2003, 2002, and 2001, the Fund was charged interest of
$15,501, $216,578, and $0, respectively, on balances borrowed under the
revolving credit facility. At December 31, 2003 and 2002, there were no
outstanding balances under the revolving credit facility.
The Fund incurred costs in securing the revolving credit facility. These
costs have been capitalized and are being amortized over seven years. At
December 31, 2003 and 2002, the net unamortized costs of $331,903 and
$439,548, respectively, are included in other assets. For the years ended
December 31, 2003, 2002, and 2001, amortization expense of $107,644,
$107,644, and $106,463, respectively, is included in general and
administrative expenses.
(5) Related Party Transactions
At December 31, 2003 and 2002, members' capital included an investment in
the Fund by Jefferies of $27,159,268. Additionally, Jefferies, in its
capacity as Manager, contributed $1,000 of capital for the right to
participate in 20% of the Fund's earnings in excess of an 8% preferred
return paid to the members.
At December 31, 2003 and 2002, receivable from affiliated brokers and
dealers included $6,084,642 and $8,349,818, respectively, due from
Jefferies and $1,642,040 and $324,780, respectively, due from Helfant
Group, Inc., an affiliate of Jefferies.
For the years ended December 31, 2003, 2002, and 2001, interest income
included $2,347, $7,000, and $50,461, respectively, of income received
from Helfant Group, Inc. related to stock borrow transactions.
At December 31, 2003 and 2002, payable to affiliated brokers and dealers
included $9,194,501 and $16,274,366, respectively, due to Jefferies.
At December 31, 2003 and 2002, payable to Jefferies of $639,504 and
$540,078, respectively, is for amounts due for direct trading expenses
and general and administrative expenses. For the years ended December 31,
2003, 2002, and 2001, direct trading expenses of $5,817,297, $7,143,763,
and $9,916,512, respectively, is net against principal transactions
revenue. The Fund reimburses Jefferies for general and administrative
expenses based on the Fund's pro rata portion of actual charges incurred.
For the years ended December 31, 2003, 2002, and 2001, reimbursed
expenses of $598,679, $791,839, and $929,905, respectively, are included
in general and administrative expenses.
For the year ended December 31, 2003, the Fund was charged interest of
$19,549 by Jefferies related to securities failed to receive. The Fund
was not charged interest on securities failed to receive in 2002 and
2001.
Jefferies, in its capacity as Manager, receives a management fee equal to
1% per annum of the sum of 100% of the average balance of securities
owned and 98% of the average balance of securities sold, not yet
purchased.
Placement fees of 1% of capital contributions are paid to Jefferies. For
the year ended December 31, 2001, a placement fee of $20,000 was paid.
There were no capital contributions during the years ended December 31,
2003 and 2002.
10
(6) Financial Instruments
(a) Off-Balance Sheet Risk
The Fund has contractual commitments arising in the ordinary
course of business for securities sold, not yet purchased. These
financial instruments contain varying degrees of off-balance sheet
risk whereby the market values of the securities underlying the
financial instruments may be in excess of, or less than, the
contract amount. The settlement of these transactions is not
expected to have a material effect upon the Fund's financial
statements.
(b) Credit Risk
In the normal course of business, the Fund is involved in the
execution, settlement, and financing of various principal
securities transactions. Securities transactions are subject to
the risk of counterparty nonperformance. However, transactions are
collateralized by the underlying security, thereby reducing the
associated risk to changes in the market value of the security
through settlement date.
The Fund seeks to control the risk associated with these
transactions by establishing and monitoring collateral and
transaction levels daily.
(c) Concentration of Credit Risk
The Fund's activities are executed exclusively with Jefferies.
Concentrations of credit risk can be affected by changes in
economic, industry, or geographical factors. The Fund seeks to
control its credit risk and the potential risk concentration
through a variety of reporting and control procedures including
those described in the preceding discussion of credit risk.
(7) Net Capital Requirement
The Fund is subject to the Securities and Exchange Commission Uniform Net
Capital Rule (Rule 15c3-1), which requires the maintenance of minimum net
capital. The Fund has elected to use the alternative method permitted by
Rule 15c3-1, which requires that the Fund maintain minimum net capital,
as defined, equal to the greater of $250,000 or 2% of aggregate debit
balances arising from customer transactions, as defined.
At December 31, 2003, the Fund had net capital of $80,211,549, which was
$79,961,549 in excess of required net capital.
(8) Subsequent Event
On February 13, 2004, the Fund made a distribution to the Fund members of
$21,050,538.
11
EAGLEROCK CAPITAL
PARTNERS (QP), LP
================================================================================
FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 AND 2002
EAGLEROCK CAPITAL
PARTNERS (QP), LP
================================================================================
FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 AND 2002
1
CONTENTS
================================================================================
EAGLEROCK CAPITAL PARTNERS (QP), LP
INDEPENDENT AUDITORS' REPORT 3
FINANCIAL STATEMENTS:
Statements of assets and liabilities 4
Statements of operations 5
Statements of changes in partners' capital 6
Statements of changes in net assets 7
Summary of business and significant accounting policies 8-9
Notes to financial statements 10-12
EAGLEROCK MASTER FUND 13
INDEPENDENT AUDITORS' REPORT 14
FINANCIAL STATEMENTS:
Statements of assets and liabilities 15
Condensed schedule of investments - December 31, 2003 16-20
Condensed schedule of investments - December 31, 2002 21-24
Statements of operations 25
Statements of changes in partners' capital 26
Statements of changes in net assets 27
Summary of business and significant accounting policies 28-29
Notes to financial statements 30-32
2
INDEPENDENT AUDITORS' REPORT
The Partners
EagleRock Capital Partners (QP), LP
New York, New York
We have audited the accompanying statements of assets and liabilities of
EagleRock Capital Partners (QP), LP (a limited partnership) as of December 31,
2003 and 2002, and the related statements of operations, changes in partners'
capital, and changes in net assets for the years then ended. These financial
statements are the responsibility of the Partnership's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of EagleRock Capital Partners
(QP), LP as of December 31, 2003 and 2002, and the results of its operations,
changes in partners' capital and its changes in net assets for the years then
ended, in conformity with accounting principles generally accepted in the United
States of America.
BDO Seidman, LLP
New York, New York
January 16, 2004
3
EAGLEROCK CAPITAL PARTNERS (QP), LP
STATEMENTS OF ASSETS AND LIABILITIES
================================================================================
December 31, 2003 2002
------------------------------------------ ----------------- -----------------
ASSETS
Investment in EagleRock Master Fund $102,776,970 $46,721,895
LIABILITIES
Due to EagleRock Master Fund (Note 2) 906,051 321,529
------------------------------------------ ----------------- -----------------
NET ASSETS (PARTNERS' CAPITAL) $101,870,919 $46,400,366
------------------------------------------ ----------------- -----------------
See accompanying summary of business and significant accounting
policies and notes to financial statements.
4
EAGLEROCK CAPITAL PARTNERS (QP), LP
STATEMENTS OF OPERATIONS
Year ended December 31, 2003 2002
----------------------------------------------------- ------------------- --------------------
INVESTMENT INCOME (LOSS):
Equity in net income (loss) from investment
in EagleRock Master Fund $56,055,075 $(4,571,210)
Interest income - 2,523,401
Dividend income - 35,692
----------------------------------------------------- ------------------- --------------------
TOTAL INVESTMENT INCOME (LOSS) 56,055,075 (2,012,117)
----------------------------------------------------- ------------------- --------------------
EXPENSES:
Interest - 2,030,350
Management fee (Note 2) 584,522 489,495
Dividends - 39,571
Other - 19,704
----------------------------------------------------- ------------------- --------------------
TOTAL EXPENSES 584,522 2,579,120
----------------------------------------------------- ------------------- --------------------
NET INVESTMENT INCOME (LOSS) 55,470,553 (4,591,237)
NET REALIZED GAIN ON INVESTMENTS - 19,651
----------------------------------------------------- ------------------- --------------------
NET INCOME (LOSS) (NOTE 1) $55,470,553 $(4,571,586)
----------------------------------------------------- ------------------- --------------------
See accompanying summary of business and significant
accounting policies and notes to financial statements.
5
EAGLEROCK CAPITAL PARTNERS (QP), LP
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
Years ended December 31, 2003 and 2002
------------------------------------------ ------------------------- -------------------------- --------------------------
General partner Limited partner Total
------------------------------------------ ------------------------- -------------------------- --------------------------
BALANCE, JANUARY 1, 2002 $ - $ - $ -
Capital contributions 971,952 50,000,000 50,971,952
Net loss (Note 1):
Pro rata allocation (86,758) (4,484,828) (4,571,586)
------------------------------------------ ------------------------- -------------------------- --------------------------
BALANCE, DECEMBER 31, 2002 885,194 45,515,172 46,400,366
Net income (Note 1):
Pro rata allocation 1,074,563 54,395,990 55,470,553
Performance allocation 4,991,114 (4,991,114) -
Profit participation allocation (521,806) 521,806 -
------------------------------------------ ------------------------- -------------------------- --------------------------
BALANCE, DECEMBER 31, 2003 $6,429,065 $95,441,854 $101,870,919
------------------------------------------ ------------------------- -------------------------- --------------------------
See accompanying summary of business and significant
accounting policies and notes to financial statements.
6
EAGLEROCK CAPITAL PARTNERS (QP), LP
STATEMENTS OF CHANGES IN NET ASSETS
Year ended December 31, 2003 2002
----------------------------------------------------------------------------- --------------------- ---------------------
INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS:
Net investment income (loss) $ 55,470,553 $ (4,591,237)
Net realized gain on investments - 19,651
----------------------------------------------------------------------------- --------------------- ---------------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 55,470,553 (4,571,586)
CAPITAL TRANSACTIONS:
Capital contributions - 50,971,952
----------------------------------------------------------------------------- --------------------- ---------------------
TOTAL INCREASE 55,470,553 46,400,366
NET ASSETS, BEGINNING OF YEAR 46,400,366 -
----------------------------------------------------------------------------- --------------------- ---------------------
NET ASSETS, END OF YEAR $101,870,919 $46,400,366
----------------------------------------------------------------------------- --------------------- ---------------------
See accompanying summary of business and significant
accounting policies and notes to financial statements.
7
EAGLEROCK CAPITAL PARTNERS (QP), LP
SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
===============================================================================
BUSINESS EagleRock Capital Partners (QP), L.P.
("Partnership") is a Delaware limited partnership
organized to invest and trade in securities and
other investment vehicles and instruments. On May
1, 2002, the Partnership contributed all of its
net assets to a related entity, EagleRock Master
Fund, in exchange for a pro rata share of equity
in that partnership. The financial statements of
EagleRock Master Fund are included elsewhere in
this report and should be read with the
Partnership's financial statements.
SIGNIFICANT ACCOUNTING
POLICIES Investment in EagleRock Master Fund
The investment in EagleRock Master Fund is
accounted for under the equity method, which
reflects the Partnership's proportionate interest
in the net assets and net income of EagleRock
Master Fund. Valuation of the investments held by
EagleRock Master Fund is discussed in the notes to
the EagleRock Master Fund financial statements
included elsewhere in this report. The percentage
of EagleRock Master Fund partners' capital owned
by the Partnership at December 31, 2003 and 2002
was approximately 91% and 99%, respectively.
Investment Transactions
The Partnership records all security transactions
and related expenses on a trade date basis.
Revenues and expenses are recorded on the accrual
basis. Dividends are recorded on the ex-dividend
date and interest is accrued in the period earned.
Income Taxes
No income tax provision has been made in the
accompanying financial statements since the
partners are required to report their respective
shares of the Partnership income in their
individual income tax returns.
8
EAGLEROCK CAPITAL PARTNERS (QP), LP
SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
===============================================================================
Use of Estimates
The preparation of financial statements in
conformity with generally accepted accounting
principles requires management to make estimates
and assumptions that affect the reported amounts
of assets and liabilities and disclosure of
contingent assets and liabilities at the date of
the financial statements and the reported amounts
of revenues and expenses during the year. Actual
results could differ from those estimates.
Reclassifications
Certain amounts in 2002 have been reclassified to
conform to the 2003 presentation.
9
EAGLEROCK CAPITAL PARTNERS (QP), LP
NOTES TO FINANCIAL STATEMENTS
================================================================================
1. ALLOCATION OF NET The net income (loss) for the years ended December
INCOME (LOSS) AND 31, 2003 and 2002 is allocated to each partner in
PERFORMANCE accordance with the ratio of the capital account
ALLOCATION of each partner to the total of all capital
accounts at the beginning of each fiscal period.
At the end of each performance period, 20% of net
income in excess of cumulative loss is reallocated
to the capital accounts of Mariel Capital
Management, LLC ("General Partner") as a
performance allocation. The General Partner may,
at its discretion, waive or alter this allocation.
For the sole limited partner of the Partnership, a
separate agreement exists stating that at the end
of each performance period, 10% of net income in
excess of cumulative loss is reallocated to the
capital account of the General Partner. For the
year ended December 31, 2003, the performance
allocation was $4,991,114. There was no
performance allocation for the year ended December
31, 2002.
In consideration of the limited partner's
contribution, the limited partner is entitled to
receive 5% of any performance allocation paid to
the General Partner by the Partnership (the
"Profit Participation Allocation"). Starting June
1, 2003, the limited partner is entitled to 10% of
any performance allocation paid to the General
Partner by the Partnership. The General Partner
may, at its discretion, increase this fee. For the
year ended December 31, 2003, the Profit
Participation Allocation was $521,806. There was
no profit participation allocation for the year
ended December 31, 2002.
2. DUE TO EAGLEROCK Management Fees
MASTER FUND
EagleRock Capital Management, LLC ("Investment
Manager") serves as the Investment Manager of the
Partnership. The Partnership incurs a quarterly
fee payable at the beginning of each quarter equal
to .375% of the capital account balance of each
limited partner as of the close of the preceding
quarter. The General Partner may, at its
discretion, reduce or eliminate this fee.
Management fees are paid by EagleRock Master Fund
and are discussed in the notes to EagleRock Master
10
EAGLEROCK CAPITAL PARTNERS (QP), LP
NOTES TO FINANCIAL STATEMENTS
================================================================================
Fund's financial statements included elsewhere in
this report. For the sole limited partner of the
Partnership, a separate agreement exists stating
that the Partnership incur a quarterly fee payable
at the beginning of each quarter equal to .25% of
the capital account balance of the limited partner
as of the close of the preceding quarter. For the
year ended December 31, 2002, management fees were
$489,495. Due to the inception date of the
EagleRock Master Fund being May 1, 2002, only a
portion of this amount ($321,529) was payable to
the Master Fund. For the year ended December 31,
2003, the Partnership's management fees were
$584,522. As of December 31, 2003 an aggregate
amount of $906,051 was due to EagleRock Master
Fund.
3. FINANCIAL HIGHLIGHTS The financial highlights table represents the
Partnership's financial performance for the years
ended December 31, 2003 and 2002 are as follows:
Limited partner 2003 2002
------------------------------------------------ ---------------------- ----------------------
Total return before performance fee allocation 119.51% (8.97)%
and profit participation allocation
Performance fee allocation, net of profit
participation allocation (9.82) -
------------------------------------------------ ---------------------- ----------------------
Total return after
performance fee
allocation and profit
participation allocation (a) 109.69% (8.97)%
------------------------------------------------ ---------------------- ----------------------
Operating expense ratio (b) 1.28% 1.02%
Performance fee allocation, net of profit
participation allocation 9.82 -
------------------------------------------------ ---------------------- ----------------------
Total expenses and performance fee 11.10% 1.02%
allocation, net of profit
participation allocation
------------------------------------------------ ---------------------- ----------------------
Net investment income ratio (c) -% .96%
------------------------------------------------ ---------------------- ----------------------
11
EAGLEROCK CAPITAL PARTNERS (QP), LP
NOTES TO FINANCIAL STATEMENTS
================================================================================
----------
The financial highlights disclosed above are
calculated based on the following criteria:
(a) Total return is computed based on the
change in value during the year of a
theoretical investment made at the
beginning of the year. The total return
is shown net of operating expenses,
management fees and the performance fee
allocation, net of profit participation
allocation.
An individual partner's return may vary
from the above returns based on
participation in hot issues, different
management fee and performance fee
arrangements and the timing of capital
transactions.
(b) The operating expense ratio is
calculated by dividing the total
operating expenses by the net assets of
a theoretical investment made at the
beginning of the year. The operating
expense ratio is based on the expenses
allocated to each limited partner prior
to the effects of any performance fee
allocation, net of profit participation
allocation. For the purpose of this
calculation, expenses do not include
dividend and interest expense.
The expense ratios attributable to an
individual partner's account may vary
based on different management fee and
performance fee arrangements and the
timing of capital transactions.
(c) The net investment income ratio is
calculated by dividing the net
investment income by the net assets of a
theoretical investment made at the
beginning of year. The net investment
income ratio is based on the net
investment income allocated to a limited
partner prior to the effects of an
incentive allocation. The net investment
income ratio attributable to an
individual partner's account may vary
based on timing of capital transactions.
12
EAGLEROCK MASTER FUND
================================================================================
FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 2003 AND
PERIOD FROM MAY 1, 2002 (COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 2002
13
INDEPENDENT AUDITORS' REPORT
The Partners
EagleRock Master Fund
New York, New York
We have audited the accompanying statements of assets and liabilities, including
the condensed schedule of investments, of EagleRock Master Fund as of December
31, 2003 and 2002, and the related statements of operations, changes in
partners' capital, and changes in net assets for the year ended December 31,
2003 and the period from May 1, 2002 (commencement of operations) to December
31, 2002. These financial statements are the responsibility of the Partnership's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of EagleRock Master Fund as of
December 31, 2003 and 2002, and the results of its operations, changes in
partners' capital and changes in net assets for the year ended December 31, 2003
and the period from May 1, 2002 (commencement of operations) to December 31,
2002, in conformity with accounting principles generally accepted in the United
States of America.
BDO Seidman, LLP
New York, New York
January 16, 2004
14
EAGLEROCK MASTER FUND
STATEMENTS OF ASSETS AND LIABILITIES
December 31, 2003 2002
---------------------------------------------------------- -------------------- --------------------
ASSETS
Investments in securities, at fair value
(cost $247,328,617 and $83,345,632)
(Notes 1 and 4) $284,340,077 $73,758,789
Dividends and interest receivable 1,003,483 1,126,743
Due from affiliates (Note 3) 954,130 326,552
Other 13,805 29,951
---------------------------------------------------------- -------------------- --------------------
286,311,495 75,242,035
---------------------------------------------------------- -------------------- --------------------
LIABILITIES
Securities sold, not yet purchased, at fair value
(proceeds of sales $66,145,693 and
$16,371,250) (Notes 1 and 4) 63,107,264 12,795,316
Due to broker (Note 1) 109,802,714 15,175,071
Dividends and interest payable 795,178 197,030
---------------------------------------------------------- -------------------- --------------------
173,705,156 28,167,417
---------------------------------------------------------- -------------------- --------------------
NET ASSETS (PARTNERS' CAPITAL) $112,606,339 $47,074,618
---------------------------------------------------------- -------------------- --------------------
See accompanying summary of business and significant accounting
policies and notes to financial statements.
15
EAGLEROCK MASTER FUND
CONDENSED SCHEDULE OF INVESTMENTS
December 31, 2003
---------------------------------------------------------------------------------------------------- ---------------------
Number of shares/face Description (% of net assets of $112,606,339) Fair value
---------------------- ----------------------------------------------------------------------------- ---------------------
INVESTMENTS IN SECURITIES:
Common stock (161.07%):
United States (145.31%):
Building materials (.29%) $ 322,784
Business services (13.32%) 15,001,695
Capital equipment (3.09%) 3,479,129
Chemicals (3.47%) 3,902,702
Consumer cyclical (2.37%) 2,666,493
Consumer non-cyclical (6.47%) 7,281,674
Electronics (18.03%) 20,307,414
Energy (4.22%) 4,756,272
Financial services (6.86%) 7,725,724
Food packaging (6.42%) 7,224,658
Food processing (19.02%):
6,839,651 Darling International (16.77%) 18,877,437
Other (2.25%) 2,538,795
Health and death care (7.47%) 8,409,119
Index (.34%) 380,009
Media, entertainment and leisure (13.80%) 15,543,613
Mining and metals (4.14%) 4,663,134
Other (.31%) 348,000
Pharmaceuticals (6.67%) 7,506,548
Telecommunications (5.76%) 6,484,440
Transportation and defense (5.53%) 6,228,761
Utilities (2.01%) 2,262,357
Wireless communications (15.74%):
2,051,730 Nextwave Telecom (5.83%) 6,565,536
Other (9.91%) 11,156,695
---------------------- ----------------------------------------------------------------------------- ---------------------
TOTAL COMMON STOCK - UNITED STATES (COST $138,787,395) 163,632,989
---------------------- ----------------------------------------------------------------------------- ---------------------
See accompanying summary of business and significant accounting
policies and notes to financial statements.
16
EAGLEROCK MASTER FUND
CONDENSED SCHEDULE OF INVESTMENTS
December 31, 2003
------------------------------------------------------------------------------------------------------- --------------------------
Number of shares/face Description (% of net assets of $112,606,339) Fair value
---------------------- -------------------------------------------------------------------------------- --------------------------
INVESTMENTS IN SECURITIES (CONTINUED):
Common stock (161.07%) (continued):
Bermuda (5.20%):
Pharmaceuticals (1.97%) $ 2,223,916
Telecommunications (3.23%) 3,636,234
---------------------- -------------------------------------------------------------------------------- --------------------------
TOTAL COMMON STOCK - BERMUDA (COST $3,670,524) 5,860,150
---------------------- -------------------------------------------------------------------------------- --------------------------
Canada (1.41%):
Electronics (1.25%) 1,411,154
Mining and metals (.16%) 179,410
---------------------- -------------------------------------------------------------------------------- --------------------------
TOTAL COMMON STOCK - CANADA (COST $1,557,864) 1,590,564
---------------------- -------------------------------------------------------------------------------- --------------------------
Norway (7.51%):
Energy (7.51%):
198,305 Petroleum Geo Svcs ASA New Sponsored ADR (6.43%) 7,238,133
Other (1.08%) 1,216,494
---------------------- -------------------------------------------------------------------------------- --------------------------
TOTAL COMMON STOCK - NORWAY (COST $3,482,011) 8,454,627
---------------------- -------------------------------------------------------------------------------- --------------------------
South Africa (1.63%):
Mining and metals (1.63%) 1,834,504
---------------------- -------------------------------------------------------------------------------- --------------------------
TOTAL COMMON STOCK - SOUTH AFRICA (COST $1,586,277) 1,834,504
---------------------- -------------------------------------------------------------------------------- --------------------------
TOTAL COMMON STOCK (COST $149,084,071) 181,372,834
---------------------- -------------------------------------------------------------------------------- --------------------------
Long-term debt securities (81.18%):
United States (70.25%):
Building materials(1.97%) 2,220,000
Business services (2.50%) 2,817,900
Chemicals (7.27%) 8,190,000
Consumer cyclical (.09%) 99,000
Consumer non-cyclical (2.86%) 3,220,000
Electronics (5.00%) 5,635,000
Financial services (1.89%) 2,123,250
Food packaging (4.13%) 4,650,000
Health and death care (1.88%) 2,115,000
Index (.27%) 300,000
Media, entertainment and leisure (7.61%) 8,566,500
---------------------- -------------------------------------------------------------------------------- --------------------------
See accompanying summary of business and significant
accounting policies and notes to financial statements.
17
EAGLEROCK MASTER FUND
CONDENSED SCHEDULE OF INVESTMENTS
December 31, 2003
------------------------------------------------------------------------------------------------------------ -------------------
Number of shares/face Description (% of net assets of $112,606,339) Fair value
---------------------- ------------------------------------------------------------------------------------- -------------------
INVESTMENTS IN SECURITIES (CONTINUED): Long-term debt
securities (81.18%) (continued):
United States (70.25%) (continued):
Mining and metals (15.51%):
6,815,000 AK Steel Corp. - 7.75% - 02/15/09 (5.12%) 5,764,809
27,000,000 WCI Steel - 10% - 12/1/04 (7.19%) 8,100,000
Other (3.20%) 3,602,250
Telecommunications (4.81%) 5,412,786
Transportation and defense (1.83%) 2,056,530
Utilities (12.64%) 14,229,500
---------------------- ------------------------------------------------------------------------------------- -------------------
TOTAL LONG-TERM DEBT SECURITIES - UNITED STATES (COST $72,625,658) 79,102,525
---------------------- ------------------------------------------------------------------------------------- -------------------
Canada (.64%):
Transportation and defense (.64%) 720,000
---------------------- ------------------------------------------------------------------------------------- -------------------
TOTAL LONG-TERM DEBT SECURITIES - CANADA (COST $336,360) 720,000
---------------------- ------------------------------------------------------------------------------------- -------------------
England (1.13%):
Telecommunications (.04%) 50,000
Transportation and defense (1.09%) 1,225,000
---------------------- ------------------------------------------------------------------------------------- -------------------
TOTAL LONG-TERM DEBT SECURITIES - ENGLAND (COST $1,186,428) 1,275,000
---------------------- ------------------------------------------------------------------------------------- -------------------
Italy (5.85%):
Consumer non-cyclical (5.85%) 6,585,877
---------------------- ------------------------------------------------------------------------------------- -------------------
TOTAL LONG-TERM DEBT SECURITIES - ITALY (COST $11,907,247) 6,585,877
---------------------- ------------------------------------------------------------------------------------- -------------------
Mexico (1.28%):
Wireless communications (1.28%) 1,445,184
---------------------- ------------------------------------------------------------------------------------- -------------------
TOTAL LONG-TERM DEBT SECURITIES - MEXICO (COST $1,667,528) 1,445,184
---------------------- ------------------------------------------------------------------------------------- -------------------
Norway (2.03%):
Energy (2.03%) 2,284,866
---------------------- ------------------------------------------------------------------------------------- -------------------
TOTAL LONG-TERM DEBT SECURITIES - NORWAY (COST $1,285,279) 2,284,866
---------------------- ------------------------------------------------------------------------------------- -------------------
TOTAL LONG-TERM DEBT SECURITIES (COST $89,008,500) 91,413,452
---------------------- ------------------------------------------------------------------------------------- -------------------
---------------------- ------------------------------------------------------------------------------------- -------------------
See accompanying summary of business and significant
accounting policies and notes to financial statements.
18
EAGLEROCK MASTER FUND
CONDENSED SCHEDULE OF INVESTMENTS
December 31, 2003
------------------------------------------------------------------------------------------------------------ ----------------------
Number of shares/face Description (% of net assets of $112,606,339) Fair value
---------------------- ------------------------------------------------------------------------------------- ----------------------
INVESTMENTS IN SECURITIES (CONTINUED):
Preferred stock (8.82%):
United States (8.82%):
Basic materials (.18%) $ 202,500
Consumer cyclical (2.40%) 2,699,377
Energy (.50%) 566,352
Food packaging (.98%) 1,101,692
Media, entertainment and leisure (2.58%) 2,901,755
Telecommunications (1.91%) 2,150,449
Utilities (.27%) 308,966
---------------------- ------------------------------------------------------------------------------------- ----------------------
TOTAL PREFERRED STOCK (COST $7,521,319) 9,931,091
---------------------- ------------------------------------------------------------------------------------- ----------------------
Options purchased (1.44%) (cost $1,714,726):
United States (1.44%) 1,622,700
---------------------- ------------------------------------------------------------------------------------- ----------------------
TOTAL INVESTMENTS IN SECURITIES (COST $247,328,617) $284,340,077
---------------------- ------------------------------------------------------------------------------------- ----------------------
SECURITIES SOLD, NOT YET PURCHASED:
Common stock (20.15%):
United States (20.01%):
Building materials (.50%) $ 566,694
Business services (.32%) 362,540
Consumer cyclical (.80%) 905,457
Consumer non-cyclical (1.20%) 1,347,921
Electronics (.41%) 466,711
Energy (.09%) 98,485
Financial services (1.50%) 1,690,031
Food packaging (1.50%) 1,686,427
Food processing (.13%) 151,236
Health and death care (.91%) 1,026,682
Index (5.23%):
52,740 Standard and Poors Depository Receipts (5.21%) 5,868,907
Other (.02%) 21,690
Media, entertainment and leisure (1.06%) 1,196,503
Mining and metals (.42%) 472,770
Pharmaceuticals (.77%) 870,344
Telecommunications (.19%) 211,950
---------------------- ------------------------------------------------------------------------------------- ----------------------
See accompanying summary of business and significant
accounting policies and notes to financial statements.
19
EAGLEROCK MASTER FUND
CONDENSED SCHEDULE OF INVESTMENTS
December 31, 2003
-------------------------------------------------------------------------------------------------------------- --------------------
Number of shares/face Description (% of net assets of $112,606,339) Fair value
---------------------- --------------------------------------------------------------------------------------- --------------------
SECURITIES SOLD, NOT YET PURCHASED (CONTINUED):
Common stock (20.15%) (continued):
United States (20.01%)(continued):
Transportation and defense (1.77%) $ 1,989,252
Utilities (.06%) 62,224
Wireless communications (3.14%) 3,537,424
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL COMMON STOCK - UNITED STATES (PROCEEDS $22,234,389) 22,533,248
---------------------- --------------------------------------------------------------------------------------- --------------------
Canada (.03%):
Electronics (.03%) 38,458
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL COMMON STOCK - CANADA (PROCEEDS $27,199) 38,458
---------------------- --------------------------------------------------------------------------------------- --------------------
Norway (.11%):
Energy (.11%) 123,078
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL COMMON STOCK - NORWAY (PROCEEDS $519,501) 123,078
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL COMMON STOCK (PROCEEDS $22,781,089) 22,694,784
---------------------- --------------------------------------------------------------------------------------- --------------------
Long-term debt securities (35.54%):
United States (35.54%):
Business services (1.76%) 1,980,000
Capital equipment (4.56%) 5,139,000
Chemicals (12.96%) 14,591,230
Consumer non-cyclical (.86%) 970,000
Electronics (1.84%) 2,075,000
Energy (.43%) 489,500
Food packaging (5.33%) 6,005,250
Mining and metals (2.97%) 3,346,000
Transportation and defense (3.41%) 3,845,000
Utilities (1.40%) 1,580,000
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES (PROCEEDS $42,846,445) 40,020,980
---------------------- --------------------------------------------------------------------------------------- --------------------
Options written (.35%) (proceeds $518,159):
United States (.35%) 391,500
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL SECURITIES SOLD, NOT YET PURCHASED (PROCEEDS $66,145,693) $ 63,107,264
---------------------- --------------------------------------------------------------------------------------- --------------------
See accompanying summary of business and significant
accounting policies and notes to financial statements.
20
EAGLEROCK MASTER FUND
CONDENSED SCHEDULE OF INVESTMENTS
December 31, 2002
------------------------------------------------------------------------------------------------------------ ----------------------
Number of shares/face Description (% of net assets of $47,074,618) Fair value
---------------------- ------------------------------------------------------------------------------------- ----------------------
INVESTMENTS IN SECURITIES:
Common stock (62.04%):
United States (59.85%):
Business services (16.01%):
197,800 Strategic Distribution Inc (5.34%) $ 2,512,060
236,450 Washington Group International Inc. (8.01%) 3,771,378
Other (2.55%) 1,202,101
Chemicals (.13%) 61,920
Consumer cyclical (1.27%) 597,015
Consumer non-cyclical (3.53%) 1,661,162
Electronics (6.05%) 2,849,108
Energy (2.93%) 1,380,482
Financial services (.27%) 126,555
Food packaging (1.38%) 648,200
Food processing (1.41%) 664,944
Health and death care (5.81%) 2,737,310
Index (.67%) 317,628
Media, entertainment and leisure (2.23%) 1,041,700
Mining and metals (5.80%) 2,709,226
Pharmaceuticals (2.00%) 943,056
Telecommunications (3.62%) 1,703,131
Transportation and defense (3.63%) 1,708,121
Utilities (.72%) 340,670
Wireless communications (2.55%) 1,199,853
---------------------- ------------------------------------------------------------------------------------- ----------------------
TOTAL COMMON STOCK - UNITED STATES (COST $34,480,768) 28,175,620
---------------------- ------------------------------------------------------------------------------------- ----------------------
Canada (.93%):
Energy (.93%) 436,296
---------------------- ------------------------------------------------------------------------------------- ----------------------
TOTAL COMMON STOCK - CANADA (COST $488,610) 436,296
---------------------- ------------------------------------------------------------------------------------- ----------------------
South Africa (1.26%):
Mining and metals (1.26%) 593,300
---------------------- ------------------------------------------------------------------------------------- ----------------------
TOTAL COMMON STOCK - SOUTH AFRICA (COST $620,370) 593,300
---------------------- ------------------------------------------------------------------------------------- ----------------------
TOTAL COMMON STOCK (COST $35,589,748) 29,205,216
---------------------- ------------------------------------------------------------------------------------- ----------------------
---------------------- ------------------------------------------------------------------------------------- ----------------------
See accompanying summary of business and significant
accounting policies and notes to financial statements.
21
EAGLEROCK MASTER FUND
CONDENSED SCHEDULE OF INVESTMENTS
December 31, 2002
-------------------------------------------------------------------------------------------------------------- --------------------
Number of shares/face Description (% of net assets of $47,074,618) Fair value
---------------------- --------------------------------------------------------------------------------------- --------------------
INVESTMENTS IN SECURITIES (CONTINUED):
Long-term debt securities (87.58%):
United States (83.71%):
Building materials(1.65%) $ 777,600
Consumer non-cyclical (10.01%):
4,750,000 Rite Aid Corp 7.125% 1/15/07 (8.41%) 3,960,550
Other (1.60%) 752,500
Electronics (8.26%):
4,500,000 Xerox Capital Trust 8.00% 2/1/27 (5.38%) 2,531,250
Other (2.88%) 1,357,500
Financial services (4.96%): 2,336,400
Food packaging (5.96%):
4,000,000 Crown Cork and Seal Inc 8.00% 4/15/23 (5.96%) 2,806,800
Media, entertainment and leisure (4.64%) 2,184,200
Mining and metals (21.52%):
7,720,000 Weirton Steel 10.75% 6/1/05 (11.07%) 5,211,000
6,067,000 Weirton Steel 11.375% 7/1/04 (9.73%) 4,580,585
Other (.72%) 339,875
Telecommunications (13.87%)
2,712,000 Qwest Services 14.00% 2/15/14 (6.22%) 2,928,960
Other (7.65%) 3,602,810
Transportation and defense (6.05%) 2,847,030
Utilities (6.77%) 3,187,850
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES - UNITED STATES (COST $43,629,160) 39,404,910
---------------------- --------------------------------------------------------------------------------------- --------------------
Bermuda (2.54%):
Media, entertainment and leisure (.15%) 68,775
Telecommunications (2.39%) 1,125,250
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES - BERMUDA (COST $757,809) 1,194,025
---------------------- --------------------------------------------------------------------------------------- --------------------
---------------------- --------------------------------------------------------------------------------------- --------------------
See accompanying summary of business and significant
accounting policies and notes to financial statements.
22
EAGLEROCK MASTER FUND
CONDENSED SCHEDULE OF INVESTMENTS
December 31, 2002
-------------------------------------------------------------------------------------------------------------- --------------------
Number of shares/face Description (% of net assets of $47,074,618) Fair value
---------------------- --------------------------------------------------------------------------------------- --------------------
INVESTMENTS IN SECURITIES (CONTINUED): Long-term debt
securities (87.58%) (continued):
England (1.34%):
Telecommunications (.32%) $ 150,000
Transportation and defense (1.02%) 479,063
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES - ENGLAND (COST $724,700) 629,063
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES (COST $45,111,669) 41,227,998
---------------------- --------------------------------------------------------------------------------------- --------------------
Preferred stock (4.55%):
United States (4.55%):
Consumer cyclical (1.99%) 936,250
Media, entertainment and leisure (2.45%) 1,153,875
Mining and metals (.11%) 54,000
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL PREFERRED STOCK (COST $1,592,306) 2,144,125
---------------------- --------------------------------------------------------------------------------------- --------------------
Options purchased (2.51%) (cost $1,051,909):
United States (2.51%) 1,181,450
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL INVESTMENTS IN SECURITIES (COST $83,345,632) $73,758,789
---------------------- --------------------------------------------------------------------------------------- --------------------
SECURITIES SOLD, NOT YET PURCHASED:
COMMON STOCK (10.49%):
United States (10.49%):
Consumer cyclical (1.27%) $ 595,800
Electronics (1.04%) 491,862
Food packaging (2.04%) 960,603
Index (.67%) 317,628
Media, entertainment and leisure (.46%) 216,980
Mining and metals (2.48%) 1,168,790
Transportation and defense (1.45%) 682,240
Utilities (1.07%) 505,300
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL COMMON STOCK - UNITED STATES (PROCEEDS $4,807,913) 4,939,203
---------------------- --------------------------------------------------------------------------------------- --------------------
---------------------- --------------------------------------------------------------------------------------- --------------------
See accompanying summary of business and significant
accounting policies and notes to financial statements.
23
EAGLEROCK MASTER FUND
CONDENSED SCHEDULE OF INVESTMENTS
December 31, 2002
-------------------------------------------------------------------------------------------------------------- --------------------
Number of shares/face Description (% of net assets of $47,074,618) Fair value
---------------------- --------------------------------------------------------------------------------------- --------------------
SECURITIES SOLD, NOT YET PURCHASED (CONTINUED):
LONG-TERM DEBT SECURITIES (16.64%):
United States (14.03%):
Consumer cyclical (1.95%) $ 917,500
Energy (2.17%) 1,020,563
Mining and metals (8.68%) 4,087,600
Transportation and defense (1.23%) 577,500
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES - UNITED STATES (PROCEEDS $10,479,996) 6,603,163
---------------------- --------------------------------------------------------------------------------------- --------------------
Spain (2.61%):
Telecommunications (2.61%) 1,230,000
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES - SPAIN (PROCEEDS $1,020,795) 1,230,000
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL LONG-TERM DEBT SECURITIES (PROCEEDS $11,500,791) 7,833,163
---------------------- --------------------------------------------------------------------------------------- --------------------
OPTIONS WRITTEN (.05%) (PROCEEDS $62,546):
United States (.05%) 22,950
---------------------- --------------------------------------------------------------------------------------- --------------------
TOTAL SECURITIES SOLD, NOT YET PURCHASED (PROCEEDS $16,371,250) $12,795,316
---------------------- --------------------------------------------------------------------------------------- --------------------
See accompanying summary of business and significant
accounting policies and notes to financial statements.
24
EAGLEROCK MASTER FUND
STATEMENTS OF OPERATIONS
Period from May 1, 2002
(commencement of
YEAR ENDED DECEMBER 31, operations) to
2003 December 31, 2002
------------------------------------------------------------------------------ -------------------------- -------------------------
INVESTMENT INCOME:
Interest $ 4,615,738 $ 3,479,481
Dividends 2,119,247 103,225
------------------------------------------------------------------------------ -------------------------- -------------------------
TOTAL INVESTMENT INCOME 6,734,985 3,582,706
------------------------------------------------------------------------------ -------------------------- -------------------------
EXPENSES:
Interest on securities sold, not yet purchased 3,806,639 1,079,424
Dividends on securities sold, not yet purchased 557,251 124,820
Other 125,723 50,847
------------------------------------------------------------------------------ -------------------------- -------------------------
TOTAL EXPENSES 4,489,613 1,255,091
------------------------------------------------------------------------------ -------------------------- -------------------------
NET INVESTMENT INCOME 2,245,372 2,327,615
NET REALIZED GAIN (LOSS) ON INVESTMENTS 10,157,003 (602,156)
NET CHANGE IN UNREALIZED GAIN (LOSS) ON INVESTMENTS 46,378,281 (6,328,391)
------------------------------------------------------------------------------ -------------------------- -------------------------
NET INCOME (LOSS) (NOTE 2) $58,780,656 $(4,602,932)
------------------------------------------------------------------------------ -------------------------- -------------------------
See accompanying summary of business and significant
accounting policies and notes to financial statements.
25
EAGLEROCK MASTER FUND
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
Year ended December 31, 2003 and period from May 1, 2002
(commencement of operations) to December 31, 2002
-----------------------------------------------------------------------------------------------------------------------------------
EagleRock Capital EagleRock Capital Total
Partners QP, L.P. Partners, L.P.
---------------------------------------------------- ------------------------- -------------------------- -------------------------
BALANCE, MAY 1, 2002 $ - $ $ -
Capital contributions 51,293,105 966,397 52,259,502
Capital withdrawals - (581,952) (581,952)
Net loss (Note 2):
Pro rata allocation (4,571,210) (31,722) (4,602,932)
---------------------------------------------------- ------------------------- -------------------------- -------------------------
BALANCE, DECEMBER 31, 2002 46,721,895 352,723 47,074,618
Capital contributions - 6,800,000 6,800,000
Capital withdrawals - (48,935) (48,935)
Net income (Note 2):
Pro rata allocation 56,055,075 2,725,581 58,780,656
---------------------------------------------------- ------------------------- -------------------------- -------------------------
BALANCE, DECEMBER 31, 2003 $102,776,970 $9,829,369 $112,606,339
---------------------------------------------------- ------------------------- -------------------------- -------------------------
See accompanying summary of business and significant
accounting policies and notes to financial statements.
26
EAGLEROCK MASTER FUND
STATEMENTS OF CHANGES IN NET ASSETS
Period from May 1, 2002
(commencement of
YEAR ENDED DECEMBER 31, operations) to
2003 December 31, 2002
------------------------------------------------------------------------------ -------------------------- -------------------------
INCREASE IN NET ASSETS RESULTING FROM OPERATIONS:
Net investment income $ 2,245,372 $ 2,327,615
Net realized gain (loss) on investments 10,157,003 (602,156)
Net change in unrealized gain (loss) on investments 46,378,281 (6,328,391)
------------------------------------------------------------------------------ -------------------------- -------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 58,780,656 (4,602,932)
------------------------------------------------------------------------------ -------------------------- -------------------------
CAPITAL TRANSACTIONS:
Capital contributions 6,800,000 52,259,502
Capital withdrawals (48,935) (581,952)
------------------------------------------------------------------------------ -------------------------- -------------------------
NET INCREASE IN CAPITAL TRANSACTIONS 6,751,065 51,677,550
------------------------------------------------------------------------------ -------------------------- -------------------------
TOTAL INCREASE 65,531,721 47,074,618
NET ASSETS, BEGINNING OF PERIOD 47,074,618 -
------------------------------------------------------------------------------ -------------------------- -------------------------
NET ASSETS, END OF PERIOD $112,606,339 $47,074,618
------------------------------------------------------------------------------ -------------------------- -------------------------
See accompanying summary of business and significant
accounting policies and notes to financial statements.
27
EAGLEROCK MASTER FUND
SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
===============================================================================
BUSINESS EagleRock Master Fund ("Partnership") is a
Delaware partnership which commenced operations on
May 1, 2002. The Partnership invests and trades in
securities and other investment vehicles and
instruments. The Partnership was formed when two
related limited partnerships, EagleRock Capital
Partners (QP), LP and EagleRock Capital Partners,
LP, contributed their net assets in exchange for a
pro rata share of the limited partnership interest
based on the net assets contributed at that date.
SIGNIFICANT ACCOUNTING
POLICIES Investment Transactions
The Partnership records all security transactions
and related expenses on a trade date basis.
Revenues and expenses are recorded on the accrual
basis. Dividends are recorded on the ex-dividend
date and interest is accrued in the period earned.
Investment Valuation
Securities and other investments listed or traded
on a national securities exchange or on the
national market system of NASDAQ are valued at
their last sales price on the date of valuation or
if there has been no sale on that date, at the
mean of the bid and ask prices supplied by market
making broker-dealers at the close of business.
Securities and other investments for which
quotations are not readily available are valued at
estimated fair value as determined in good faith
by the general partner. The resulting unrealized
gains and losses are reflected in the statement of
operations.
Accounting for Derivative Instruments and Hedging
Activities
The Partnership recognizes all derivatives as
either assets or liabilities in the statement of
assets and liabilities and measures those
instruments at fair value. Fair values for
derivatives traded on a national exchange,
principally certain options, are based on quoted
market prices.
28
EAGLEROCK MASTER FUND
SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
===============================================================================
The Partnership uses purchased and written option
contracts as part of its investment strategy to
manage market risk. Option contracts are
contractual agreements that give the purchaser the
right, but not the obligation, to purchase or sell
a financial instrument at a predetermined exercise
price. In return for this right, the purchaser
pays a premium to the seller of the option. By
selling or writing options, the Partnership
receives a premium and becomes obligated during
the term of the option to purchase or sell a
financial instrument at a predetermined exercise
price if the option is exercised, and assumes the
risk of not being able to enter into a closing
transaction if a liquid secondary market does not
exist. Option contracts are recorded in the
statement of assets and liabilities at fair value
as discussed above. Gains and losses on option
contracts are recorded in the statement of
operations in net realized and unrealized
gain/loss on securities.
Income Taxes
No income tax provision has been made in the
accompanying financial statements since the
partners are required to report their respective
shares of the Partnership income in their
individual income tax returns.
Use of Estimates
The preparation of financial statements in
conformity with generally accepted accounting
principles requires management to make estimates
and assumptions that affect the reported amounts
of assets and liabilities and disclosure of
contingent assets and liabilities at the date of
the financial statements and the reported amounts
of revenues and expenses during the reporting
period. Actual results could differ from those
estimates.
Reclassifications
Certain amounts in 2002 have been reclassified to
conform to the 2003 presentation.
29
EAGLEROCK MASTER FUND
NOTES TO FINANCIAL STATEMENTS
================================================================================
1. DUE TO BROKER The Partnership has an agreement with a brokerage
firm to carry its customer account. The broker has
custody of the Partnership's securities and, from
time to time, cash balances, which may be due from
this broker.
These securities and/or cash positions serve as
collateral for any amounts due to broker as well
as collateral for securities sold short or
purchased on margin.
The Partnership is subject to credit risk if the
broker is unable to repay balances due or deliver
securities in its custody.
2. ALLOCATION OF NET
INCOME (LOSS) The net income (loss) for the year ended December
31, 2003 and period ended December 31, 2002 is
allocated to each partner in accordance with the
ratio of the capital account of each partner to
the total of all capital accounts at the beginning
of each fiscal period.
3. DUE FROM
AFFILIATES Management Fees
EagleRock Capital Management, LLC ("Investment
Manager") serves as the Investment Manager of the
Partnership. The Partnership pays a quarterly
management fee on behalf of its two limited
partnerships. As of December 31, 2003 and 2002,
due from limited partnerships were $954,130 and
$326,552, respectively.
4. FINANCIAL
INSTRUMENTS WITH
OFF-BALANCE
SHEET RISK The Partnership invests in marketable securities
and is exposed to market risks resulting from
changes in the fair value of their investments.
Derivative financial instruments are used by the
Partnership to help manage such market risk.
30
EAGLEROCK MASTER FUND
NOTES TO FINANCIAL STATEMENTS
================================================================================
Securities sold, not yet purchased by the
Partnership, may give rise to off-balance sheet
risk. The Partnership may sell a security it does
not own in anticipation of a decline in the fair
value of that security. When the Partnership sells
a security short, it must borrow the security sold
short. A gain, limited to the price at which the
Partnership sold the security short, or a loss,
unlimited in amount, will be recognized upon the
termination of a short sale. The Partnership has
recorded this obligation in the financial
statements at the December 31, 2003 market value
of these securities. There is an element of market
risk in that, if the securities increase in value,
it will be necessary to purchase the securities at
a cost in excess of the price reflected in the
statement of assets and liabilities. The amounts
reflected in investments in securities owned and
securities sold, not yet purchased include
$29,528,151 and $2,206,843 of identical securities
held both long and short at December 31, 2003 and
2002, respectively.
The Partnership is exposed to credit-related
losses in the event of nonperformance by
counterparties to financial instruments, but it
does not expect any counterparties to fail to meet
their obligations. The aggregate credit exposure
related to the derivative financial instruments of
the Partnership is equal to the fair value of the
contracts with positive fair values as of December
31, 2003.
5. FINANCIAL
HIGHLIGHTS The financial highlights table represents the
Partnership's financial performance for the years
ended December 31, 2003 and 2002 are as follows:
Partner 2003 2002
---------------------------------- ----------------- -----------------
Total return (a) 120.81% (9.54)%
---------------------------------- ----------------- -----------------
Operating expense ratio (b) 3.05% .73%
---------------------------------- ----------------- -----------------
Net investment income ratio (c) 7.66% 4.60%
---------------------------------- ----------------- -----------------
31
EAGLEROCK MASTER FUND
NOTES TO FINANCIAL STATEMENTS
================================================================================
-----------------
The financial highlights disclosed above are calculated
based on the following criteria:
(a) Total return is computed based on the change in value during
the year of a theoretical investment made at the beginning
of the year. The total return is shown net of operating
expenses. There is no performance fee allocated to the
Partnership.
An individual partner's return may vary from the above
returns based on participation in hot issues, different fee
arrangements and the timing of capital transactions.
(b) The operating expense ratio is calculated by dividing the
total operating expenses by the net assets of a theoretical
investment made at the beginning of the year. The operating
expense ratio is based on the expenses allocated to each
limited partner. For the purpose of this calculation,
expenses do not include dividend and interest expense on
securities sold, not yet purchased.
The expense ratios attributable to an individual partner's
account may vary based on different fee arrangements and the
timing of capital transactions.
(c) The net investment income ratio is calculated by dividing
the net investment income by the net assets of a theoretical
investment made at the beginning of year. The net investment
income ratio is based on the net investment income allocated
to a limited partner. The net investment income ratio
attributable to an individual partner's account may vary
based on timing of capital transactions.
6. SUBSEQUENT From January 1, 2004 through January 16, 2004, there were
CAPITAL approximately $205,000 in capital contributions. There were
TRANSACTIONS no capital withdrawals.
32
REPORT OF INDEPENDENT AUDITORS
To the Stockholder of WilTel Communications Group, Inc.
We have audited the accompanying consolidated balance sheets of WilTel
Communications Group, Inc. as of November 5, 2003 and December 31, 2002
(Successor Company), and the related consolidated statements of operations,
stockholders' equity (deficit), and cash flows for the period from January 1,
2003 to November 5, 2003 (Successor Company), the period from November 1, 2002
to December 31, 2002 (Successor Company), the period from January 1, 2002 to
October 31, 2002 and year ended December 31, 2001 (Predecessor Company). These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of WilTel
Communications Group, Inc. at November 5, 2003 and December 31, 2002 (Successor
Company), and the consolidated results of its operations and its cash flows for
the period from January 1, 2003 to November 5, 2003 (Successor Company), the
period from November 1, 2002 to December 31, 2002 (Successor Company), the
period from January 1, 2002 to October 31, 2002 and year ended December 31, 2001
(Predecessor Company), in conformity with accounting principles generally
accepted in the United States.
Ernst & Young LLP
Tulsa, Oklahoma
February 20, 2004
1
WILTEL COMMUNICATIONS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
Successor Company
------------------------------------
As of As of
November 5, December 31,
2003 2002
------------ ---------------
(In thousands)
Assets
Current assets:
Cash and cash equivalents.............................................. ..$ 208,286 $ 291,288
Receivables less allowance of $5,036,000 ($610,000 in 2002)............... 235,950 180,768
Notes receivable.......................................................... 425 55,114
Prepaid assets and other.................................................. 62,239 25,525
------------- -------------
Total current assets........................................................ 506,900 552,695
Property, plant and equipment, net.......................................... 1,236,743 1,460,010
Other assets and deferred charges.......................................... 51,919 49,568
------------- -------------
Total assets............................................................... $ 1,795,562 $ 2,062,273
============= =============
Liabilities and stockholders' equity
Current liabilities:
Accounts payable.......................................................... $ 183,313 $ 184,759
Deferred revenue.......................................................... 47,858 61,312
Accrued liabilities....................................................... 187,756 235,782
Long-term debt due within one year........................................ 4,021 51,503
------------ -------------
Total current liabilities................................................... 422,948 533,356
Long-term debt.............................................................. 502,746 517,986
Long-term deferred revenue................................................. 154,498 178,978
Other liabilities........................................................... 135,824 136,932
Minority interest in consolidated subsidiary................................ -- 5,290
Contingent liabilities and commitments
Stockholders' equity:
WilTel common stock, $0.01 par value, 200 million shares
authorized, 50 million shares outstanding in 2003 and 2002.............. 500 500
Capital in excess of par value............................................ 749,500 749,500
Accumulated deficit....................................................... (169,795) (61,049)
Accumulated other comprehensive income (loss)............................. (659) 780
------------ -------------
Total stockholders' equity.................................................. 579,546 689,731
------------ -------------
Total liabilities and stockholders' equity................................. $ 1,795,562 $ 2,062,273
============ =============
See accompanying notes.
2
WILTEL COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Successor Company Predecessor Company
------------------------------- --------------------------------
Period from
January 1, Two Months Ten Months Year
2003 through Ended Ended Ended
November 5, December 31, October 31, December 31,
2003 2002 2002 2001
------------ ----------- ------------ ------------
(In thousands, except per share amounts)
Revenues ...................................................$ 1,111,415 $ 191,656 $ 1,000,007 $ 1,185,521
Operating expenses:
Cost of sales ............................................ 901,293 171,605 862,405 1,029,455
Selling, general and administrative....................... 145,580 27,712 179,321 285,771
Provision for doubtful accounts........................... 4,199 787 20,118 26,020
Depreciation and amortization............................. 208,480 44,294 460,989 467,118
Asset impairments and restructuring charges.............. -- 8,572 28,483 2,979,925
Other expense (income), net.............................. (1,298) (6,242) 19,182 (58,402)
-------------- ------------ ------------- -------------
Total operating expenses............................... 1,258,254 246,728 1,570,498 4,729,887
-------------- ------------ ------------- -------------
Loss from operations ....................................... (146,839) (55,072) (570,491) (3,544,366)
Interest accrued............................................ (34,708) (7,221) (199,202) (525,850)
Interest capitalized........................................ -- -- 3,600 71,126
Investing income (loss):
Interest and other ....................................... 4,010 511 20,327 47,829
Equity losses ............................................ -- -- (2,710) (35,522)
Income (loss) from investments............................ -- -- 1,575 (95,722)
Minority interest in loss of consolidated subsidiary........ 2,378 802 12,530 25,533
Gain on the purchase of long-term debt...................... -- -- -- 296,896
Gain on sale of consolidated subsidiary..................... 21,089 -- -- --
Other income (loss), net.................................... 45,347 (66) 564 (160)
Reorganization items, net................................... -- -- 2,066,032 --
-------------- ------------ ------------- -------------
Income (loss) before income taxes........................... (108,723) (61,046) 1,332,225 (3,760,236)
Benefit (provision) from income taxes....................... (23) (3) (1,030) (50,121)
-------------- ------------ ------------- -------------
Income (loss) before cumulative effect of change in
accounting principle...................................... (108,746) (61,049) 1,331,195 (3,810,357)
Cumulative effect of change in accounting principle......... -- -- (8,667) --
-------------- ------------ ------------- -------------
Net income (loss)........................................... (108,746) (61,049) 1,322,528 (3,810,357)
Preferred stock dividends and amortization of preferred
stock issuance costs...................................... -- -- (5,473) (17,568)
-------------- ------------ ------------- -------------
Net income (loss) attributable to common stockholders...... $ (108,746) $ (61,049) $ 1,317,055 $ (3,827,925)
============== ============ ============= =============
Basic and diluted earnings (loss) per share:
Income (loss) before cumulative effect of change in
accounting principle attributable to common
stockholders......................................... .$ (2.17) $ (1.22) $ 2.66 $ (7.86)
Cumulative effect of change in accounting principle....... -- -- (.01) --
-------------- ------------ ------------- ------------
Net income (loss) attributable to common stockholders... $ (2.17) $ (1.22) $ 2.65 $ (7.86)
============== ============ ============= ============
Weighted average shares outstanding....................... 50,000 50,000 497,621 487,048
See accompanying notes.
3
WILTEL COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Accumulated
Capital in Other
Common Excess of Accumulated Comprehensive
Stock Par Value Deficit Income (Loss) Total
----- --------- ------- ------------- -----
(In thousands)
Predecessor Company:
Balance, December 31, 2000........................... $ 4,636 $ 2,659,136 $ (1,494,549) $ 44,049 $ 1,213,272
Net loss........................................... -- -- (3,810,357) -- (3,810,357)
Other comprehensive income (loss):
Net unrealized depreciation of marketable
equity securities, net of reclassification
adjustment for net losses realized in net loss. -- -- -- (83,012) (83,012)
Foreign currency translation adjustments, net -- -- --
of reclassification adjustment for losses
realized in net loss................................ 27,452 27,452
----------
Comprehensive loss.................................... (3,865,917)
Agreement with The Williams Companies, Inc. (see
Note 13)............................................ 243 1,201,660 -- -- 1,201,903
Stock award transactions.............................. 4 5,367 -- -- 5,371
Preferred stock dividends and amortization of
preferred stock issuance costs....................... -- (17,568) -- -- (17,568)
Common stock issued to pay preferred stock
dividends.......................................... 27 13,830 -- -- 13,857
Other.................................................. -- 40 -- -- 40
-------- ----------- ---------- ----------- ----------
Balance, December 31, 2001............................. 4,910 3,862,465 (5,304,906) (11,511) (1,449,042)
Net income........................................... -- -- 1,322,528 -- 1,322,528
Other comprehensive income (loss):
Net unrealized depreciation of marketable
equity securities, net of reclassification
adjustment for gains realized in net income.... -- -- -- (7,401) (7,401)
Foreign currency translation adjustments............ -- -- -- 2,440 2,440
---------
Comprehensive income................................. 1,317,567
Agreement with The Williams Companies, Inc. (see
Note 13)........................................... -- 42,937 -- -- 42,937
Stock award transactions............................. 3 5,953 -- -- 5,956
Preferred stock dividends and amortization of
preferred stock issuance costs....................... -- (5,473) -- -- (5,473)
Common stock issued to pay preferred stock
dividends.......................................... 19 4,142 -- -- 4,161
Preferred stock converted to common stock............ 29 83,865 -- -- 83,894
Reorganization adjustments.......................... (4,961) (3,993,889) 3,982,378 16,472 --
-------- ----------- ---------- ----------- -----------
Balance, October 31, 2002.............................. -- -- -- -- --
Successor Company:
Issuance of WilTel common stock...................... 500 749,500 -- -- 750,000
Net loss............................................. -- -- (61,049) -- (61,049)
Other comprehensive income (loss):
Foreign currency translation adjustments............ -- -- -- 780 780
-----------
Comprehensive loss................................... -- -- -- -- (60,269)
-------- ----------- ---------- ----------- -----------
Balance, December 31, 2002............................. 500 749,500 (61,049) 780 689,731
Net loss............................................. -- -- (108,746) -- (108,746)
Other comprehensive loss:
Foreign currency translation adjustments............ -- -- -- (781) (781)
Minimum pension liability adjustment................ -- -- -- (658) (658)
-----------
Comprehensive loss................................... -- -- -- -- (110,185)
-------- ----------- ---------- ----------- -----------
Balance, November 5, 2003............................ $ 500 $ 749,500 $ (169,795) $ (659) $ 579,546
======== =========== ========== =========== ===========
See accompanying notes.
4
WILTEL COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Successor Company Predecessor Company
------------------------------ -------------------------
Period from
January 1, Two Months Ten Months Year
2003 through Ended Ended Ended
November 5, December 31, October 31, December 31,
2003 2002 2002 2001
---- ---- ---- ----
(In thousands)
Operating activities
Net income (loss).............................................. $ (108,746) $ (61,049) $1,322,528 $ (3,810,357)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Cumulative effect of change in accounting principle.............. -- -- 8,667 --
Depreciation and amortization ................................... 208,480 44,294 460,989 467,118
Provision from deferred income taxes............................. -- -- 1,005 50,057
Non-cash asset impairments and restructuring items............... -- -- -- 2,957,004
Non-cash reorganization items:
Gain on the discharge of liabilities.......................... -- -- (4,339,342) --
Fresh start valuation of assets and liabilities............... -- -- 2,154,464 --
Write-off of deferred financing costs and debt discounts...... -- -- 102,446 --
Gain on forgiveness of interest............................... -- -- (65,649) --
Provision for loss on investments................................ -- -- -- 204,887
Provision for doubtful accounts.................................. 4,199 787 20,118 26,020
Equity losses.................................................... -- -- 2,710 35,522
Gain on sales of property and other assets....................... (1,502) -- (2,731) (45,519)
Gain on sales of investments..................................... -- -- (666) (109,243)
Gain on the purchase of long-term debt........................... -- -- -- (296,896)
Minority interest in loss of consolidated subsidiary............. (2,378) (802) (12,530) (25,533)
Gain on sale of consolidated subsidiary.......................... (21,089) -- -- --
Cash provided by (used in) changes in:
Receivables.................................................... (39,003) 9,001 204,344 (174,213)
Prepaid and other current assets............................... (37,686) 26,607 (30,489) (9,389)
Accounts payable............................................... 16,766 18,091 (48,719) (63,200)
Current deferred revenue....................................... (7,339) (9,536) 16,595 (15,634)
Accrued liabilities............................................ (26,288) (33,385) 103,297 88,442
Long-term deferred revenue..................................... (25,453) (2,986) (17,747) 190,001
Other.......................................................... (1,967) (3,181) (1,654) 14,228
---------- ------------- ---------- ------------
Net cash used in operating activities.............................. (42,006) (12,159) (122,364) (516,705)
Financing activities
Proceeds from long-term debt....................................... -- -- 12,586 2,487,683
Payments on and purchase of long-term debt......................... (20,098) (3,900) (633,180) (570,989)
Investment by Leucadia National Corporation........................ -- 150,000 -- --
Proceeds from issuance of common stock, net of expenses............ -- -- 9,452 18,904
Debt issue costs................................................... -- -- (531) (42,743)
Preferred stock dividends paid..................................... -- -- (4,161) (18,076)
Contribution to subsidiary from minority interest shareholders..... -- -- -- 31,694
---------- ------------- ---------- ------------
Net cash provided by (used in) financing activities................ (20,098) 146,100 (615,834) 1,906,473
5
WILTEL COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
Successor Company Predecessor Company
------------------------------ -------------------------
Period from
January 1, Two Months Ten Months Year
2003 through Ended Ended Ended
November 5, December 31, October 31, December 31,
2003 2002 2002 2001
---- ---- ---- ----
(In thousands)
Investing activities
Property, plant and equipment:
Capital expenditures............................................. (47,530) (6,434) (76,903) (1,389,294)
Proceeds from net tax refunds, settlements and sales............. 32,671 1,130 48,473 165,625
Changes in accrued liabilities................................... (12,533) (5,585) (82,484) (138,498)
Proceeds from sale of consolidated subsidiary...................... 19,575 -- -- --
Restricted investments............................................. (13,081) -- -- --
Purchase of investments............................................ -- -- (220,209) (2,479,988)
Proceeds from sales of investments................................. -- 630 1,121,796 2,157,029
Acquisition of businesses (primarily property, plant and
equipment)...................................................... -- -- -- (38,687)
Other.............................................................. -- -- (907) 3,455
---------- --------- --------- -----------
Net cash provided by (used in) investing activities................ (20,898) (10,259) 789,766 (1,720,358)
Discontinued operations
Net cash provided by operating activities.......................... -- -- -- 17,719
Net cash provided by investing activities.......................... -- -- -- 215,021
---------- --------- --------- -----------
Net cash provided by discontinued operations....................... -- -- -- 232,740
---------- --------- --------- -----------
Increase (decrease) in cash and cash equivalents................... (83,002) 123,682 51,568 (97,850)
Cash and cash equivalents at beginning of period................... 291,288 167,606 116,038 213,888
---------- --------- --------- -----------
Cash and cash equivalents at end of period........................ $ 208,286 $ 291,288 $ 167,606 $ 116,038
========== ========= ========= ===========
See accompanying notes.
6
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Leucadia Exchange Offer -- Basis of Presentation -- Summary of Significant
Accounting Policies
Leucadia Exchange Offer
Effective November 6, 2003, WilTel Communications Group, Inc. ("WilTel")
and Leucadia National Corporation ("Leucadia") consummated an exchange offer and
a merger agreement pursuant to which all WilTel stockholders received 0.4242 of
a Leucadia common share for each share of WilTel common stock. Leucadia issued
11,156,460 of its common shares in exchange for all of the WilTel common shares
that it did not previously own. Upon completion of the back-end merger, WilTel
ceased to be a public company and is consolidated by Leucadia effective November
6, 2003.
The merger agreement also provided that WilTel stockholders receive
contingent sale rights, which entitle WilTel stockholders to additional Leucadia
common shares if Leucadia sells substantially all of WilTel's assets or
outstanding shares of capital stock prior to October 15, 2004, or consummates
such a sale at a later date if the sale agreement was entered into prior to
August 21, 2004, and in either case, the net proceeds exceed the valuation
ascribed to WilTel's equity in the merger transaction.
Basis of Presentation
2003 Presentation
The financial statements presented for 2003 are as of and for the period
from January 1, 2003 through November 5, 2003, which represents the financial
position and results of operations and cash flows prior to the acquisition by
Leucadia.
Emergence from the Chapter 11 Proceedings in October 2002
On April 22, 2002, Williams Communications Group, Inc. ("WCG") and CG
Austria, Inc. (collectively, the "Debtors") filed petitions for relief under
Chapter 11 of title 11 of the United States Code (the "Bankruptcy Code") in the
United States Bankruptcy Court for the Southern District of New York (the
"Bankruptcy Court"). On September 30, 2002, the Bankruptcy Court entered an
order confirming the Second Amended Joint Chapter 11 Plan of Reorganization of
the Debtors (the "Plan"), effective on October 15, 2002 (the "Effective Date").
Pursuant to the Plan and the confirmation order, WilTel Communications Group,
Inc. ("WilTel" and, together with its direct and indirect subsidiaries, the
"Company") emerged on October 15, 2002 as the successor to WCG.
WCG was a non-operating holding company whose principal asset was 100% of
the membership interest in Williams Communications, LLC ("WCL"), which changed
its name to WilTel Communications, LLC in January 2003. In connection with the
consummation of the Plan (as described in Note 19), WCG transferred
substantially all of its assets to WilTel on October 15, 2002. WCL is an
operating company, which owns or leases and operates a nationwide inter-city
fiber-optic network, extended locally and globally, to provide Internet, data,
voice and video services. Information on WilTel's operations by segment and
geographic area is included in Note 2. In addition, WCL is the direct or
indirect parent of all the remaining subsidiaries of the Company, including CG
Austria, Inc., a non-operating holding company with direct and indirect interest
in certain foreign subsidiaries of the Company. WCL was not included in the
chapter 11 proceedings.
The Company became subject to the provisions of Statement of Position
("SOP") 90-7, "Financial Reporting by Entities in Reorganization under the
Bankruptcy Code," upon commencement of the chapter 11 proceedings. SOP 90-7
required that revenues, expenses, realized gains and losses and provisions for
losses resulting from the reorganization and restructuring of the Company be
reported separately as reorganization items in the consolidated statement of
operations. Interest expense on liabilities subject to compromise and preferred
stock dividends ceased to accrue upon commencement of the chapter 11
proceedings.
7
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company emerged from the chapter 11 proceedings in October 2002 and
implemented fresh start accounting under the provisions of SOP 90-7 effective
October 31, 2002 to coincide with its normal monthly financial closing cycle.
Under SOP 90-7, the net reorganization value of the Company was allocated to its
assets and liabilities, its accumulated deficit was eliminated and new equity
was issued according to the Plan. The Company recorded a $2.2 billion
reorganization charge to adjust the historical carrying value of its assets and
liabilities to fair value reflecting the allocation of the Company's
reorganization value of approximately $1.3 billion. The Company also recorded a
$4.3 billion gain on the discharge of debt pursuant to the Plan. In addition,
changes in accounting principles that would be required in the financial
statements within twelve months following emergence from the chapter 11
proceedings were adopted in the Company's fresh start financial statements. See
Note 20 for a presentation of the impact of implementing fresh start accounting
on WCG's consolidated balance sheet as of October 31, 2002.
The Company's emergence from the chapter 11 proceedings resulted in a new
reporting entity with no retained earnings or accumulated deficit as of October
31, 2002. Accordingly, the Company's consolidated financial statements for
periods prior to November 1, 2002 are not comparable to consolidated financial
statements presented on or subsequent to October 31, 2002. For periods prior to
November 1, 2002, the financial results have been separately presented under the
label "Predecessor Company" and for periods subsequent to October 31, 2002 the
financial results have been separately presented under the label "Successor
Company" as required by SOP 90-7. The Predecessor Company is also referred to as
"WCG" and the Successor Company is also referred to as "WilTel".
Prior to April 2001, The Williams Companies, Inc. ("TWC") owned 100% of
WCG's outstanding Class B common stock which gave TWC approximately 98% of the
voting power of WCG. In March 2001, TWC's Board of Directors approved a tax-free
spin-off of WCG to TWC's shareholders. On April 23, 2001, TWC distributed
approximately 95% of the WCG common stock it owned to holders of TWC common
shares on a pro rata basis (see Note 13).
Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts in the financial statements and
disclosures of contingent assets and liabilities. On an on-going basis, the
Company evaluates all of these estimates and assumptions. Actual results could
differ from those estimates.
Principles of consolidation
The consolidated financial statements include the accounts of the Company
and its majority-owned subsidiaries. In addition, the Company also consolidated
a subsidiary that it controlled but owned less than 50% of the voting common
stock, until it was sold in 2003 (see Note 5).
Revenue Recognition
Network
- -------
Capacity, transmission, video services and other telecommunications
services revenues are recognized monthly as the services are provided or
revenues are earned. If at the time services are rendered collection is not
reasonably assured either due to credit risk, the potential for billing
disputes, or other reasons, revenue is not recognized until such contingencies
8
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
are resolved. Amounts billed in advance of the service month are recorded as
deferred revenue. Payments received for the installation of conduit under joint
build construction contracts are generally recorded as a recovery of the
applicable construction costs. Revenues under multiple element contracts are
recognized based on the respective fair values of each individual element within
the multiple element contract. Revenues from conduit and duct sales are
recognized at time of delivery and acceptance and when all significant
contractual obligations have been satisfied and collection is reasonably
assured.
Grants of indefeasible rights of use, or IRUs, of constructed but unlit
fiber, or dark fiber, in exchange for cash, are accounted for as operating
leases, since the Company's IRUs generally do not transfer title to the fibers
under lease to the lessee. If title is transferred to the lessee, the
transaction would be accounted for as a sales-type lease.
Cost of sales includes operating and maintenance costs, leased capacity,
right-of-way costs, access charges, other third party circuit costs, satellite
transponder lease costs, and package delivery costs and blank tape media costs
related to ads distribution services. Operating and maintenance costs include
the costs of network management functions and personnel that provide network
fault indication, performance information, data and diagnosis functions, field
operations, network planning and engineering as well as the cost of contract
maintenance. WilTel does not defer installation costs.
The Company has entered into transactions such as buying, selling, swapping
and/or exchanging capacity, conduit and fiber to complete and compliment its
network. Depending upon the terms of the agreement, certain transactions are
accounted for as pure asset swaps with no revenue and no cost recognition while
certain transactions are accounted for as both revenue and cost over the
corresponding length of time for each agreement. If the exchange is not
essentially the culmination of an earning process, accounting for an exchange of
a nonmonetary asset is based on the recorded amount of the nonmonetary asset
relinquished, and therefore no revenue and cost is recorded in accordance with
Accounting Principles Board ("APB") Opinion No. 29. Examples of transactions
cited by APB Opinion No. 29 that are not the culmination of the earnings process
include exchange of productive assets for similar productive assets or for an
equivalent interest in similar productive assets.
Revenues that have been deferred for long-term service contracts are
amortized using the straight-line method over the life of the related contract.
The Company classifies as current the amount of deferred revenue that will be
recognized into revenue over the next twelve months.
Revenues that have been deferred for long-term service contracts that are
subsequently terminated or included as part of an overall settlement agreement
have been recognized in other operating income for periods prior to November 1,
2002 and other income for periods subsequent to October 31, 2002.
Vyvx
- ----
Transmission and video services revenues are recognized monthly as the
services are provided. Amounts billed in advance of the service month are
recorded as deferred revenue.
Provision for Doubtful Accounts
A provision for doubtful accounts is recorded when the collectibility of a
specific customer's receivable balance becomes at risk due to a deterioration in
the customer's financial condition or evidence that recovery of the past due
receivable balance is unlikely. In addition, the Company maintains a general
reserve based on past collection history. An accounts receivable balance is
written-off against the allowance for doubtful accounts when reasonable
collection efforts have been exhausted and the balance is deemed worthless.
9
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Cash and Cash Equivalents
Cash and cash equivalents include demand and time deposits, certificates of
deposit and other marketable securities that are readily convertible to known
amounts of cash and so near maturity that it presents insignificant risk of
changes in value because of changes in interest rates.
Property, Plant and Equipment
Property, plant and equipment is recorded at cost. Depreciation is computed
primarily on the straight-line method over estimated useful lives with the
exception of assets acquired through capital leases, which are depreciated over
the lesser of the estimated useful lives or the term of the lease. In accordance
with fresh start accounting, the book value of property, plant and equipment was
adjusted to its fair value and the Company also established new useful lives.
Impairment of Long-Lived Assets
The Company evaluates its long-lived assets, including related intangibles,
of identifiable business activities for impairment when events or changes in
circumstances indicate, in management's judgment, that the carrying value of
such assets may not be recoverable. The determination of whether an impairment
has occurred is based on management's estimate of undiscounted future cash flows
attributable to the assets as compared to the carrying value of the assets. If
an impairment has occurred, the amount of the impairment recognized is
determined by estimating the fair value for the assets and recording a provision
for loss if the carrying value is greater than fair value.
For assets identified to be disposed of in the future, the carrying value
of these assets is compared to the estimated fair value less the cost to sell to
determine if an impairment is required. Until the assets are disposed of, an
estimate of the fair value is redetermined when related events or circumstances
change.
Income Taxes
Prior to the spin-off of WCG from TWC in April 2001, WCG's operations were
included in TWC's consolidated federal income tax return. A tax sharing
agreement existed between WCG and TWC to allocate and settle among themselves
the consolidated federal income tax liability. Deferred income taxes were
allocated from TWC using the liability method and were provided on all temporary
differences between the financial basis and allocated tax basis of WCG's assets
and liabilities. Valuation allowances were established to reduce deferred tax
assets to an amount that was more likely than not be realized.
Effective with the spin-off of WCG from TWC in April 2001, the existing tax
sharing agreement with TWC was amended to address pre spin-off tax attributes.
Under the amendment, TWC retained all rights and obligations with respect to tax
attributes of WCG for all periods prior to WCG's initial public offering. In the
event of any final determination with respect to a WCG tax attribute that arose
from the time of WCG's initial public offering to the date of the spin-off of
WCG from TWC, WCG would pay TWC for any determination resulting in a detriment
as compared to previous amounts filed and TWC would pay WCG for any
determination resulting in favorable tax consequences as compared to amounts
filed. Tax attributes of WCG arising subsequent to the spin-off date are rights
and obligations of WCG. The tax sharing agreement was further amended in July
2002 by the Tax Cooperation Agreement, which provides that upon emergence from
bankruptcy WCG has no responsibility for indemnification of TWC for pre-spinoff
tax items.
Earnings (Loss) Per Share
The Company's basic earnings (loss) per share is based on the sum of the
average number of common shares outstanding and deferred shares, if any. Diluted
earnings (loss) per share includes any dilutive effect of stock options and
convertible preferred stock. For WCG, diluted earnings (loss) per common share
is the same as the basic calculation as the inclusion of any stock options and
convertible preferred stock would be antidilutive. Stock options and convertible
preferred stock of 7.6 million shares and 10.6 million shares for the ten months
ended October 31, 2002 and for the year ended December 31, 2001, respectively,
have been excluded from the computation of diluted earnings (loss) per common
share. For WilTel, the basic and diluted earnings (loss) per share is the same
as it does not have any dilutive securities outstanding.
10
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Stock Options
Prior to emergence from bankruptcy, the Company's employee stock-based
awards were accounted for under the provisions of APB Opinion No. 25 and related
interpretations. The Company's fixed plan common stock options generally did not
result in compensation expense because the exercise price of the stock options
equaled the market price of the underlying stock on the date of grant. As of
November 5, 2003 and December 31, 2002, WilTel did not have any stock-based
awards outstanding.
Foreign Currency Translation
The functional currency of the Company is the U.S. dollar. Generally, the
functional currency of the Company's foreign operations is the applicable local
currency for each foreign subsidiary. Assets and liabilities of foreign
subsidiaries are translated at the spot rate in effect at the applicable
reporting date, and the combined statements of operations are translated at the
average exchange rates in effect during the applicable period. The resulting
cumulative translation adjustment is recorded as a separate component of other
comprehensive income.
Transactions denominated in currencies other than the functional currency
are recorded based on exchange rates at the time such transactions arise.
Subsequent changes in exchange rates result in transaction gains and losses,
which are reflected in the statement of operations.
Recently Issued Accounting Standards
In December 2003, the Financial Accounting Standards Board issued SFAS No.
132 "Employers' Disclosures about Pensions and Other Postretirement Benefits"
("SFAS 132R"), which is effective for financial statements with fiscal years
ending after December 15, 2003. The Company has adopted SFAS 132R, which
requires additional disclosures to those required in the original Statement 132.
2. Segment Disclosures
The Company's reportable segments are Network and Vyvx.
Network owns or leases and operates a nationwide inter-city fiber-optic
network. Network has also built a fiber-optic network within certain cities in
the U.S. and has the ability to connect to networks outside the U.S., including
Asia, Australia, Canada, Europe, Guam, Mexico and New Zealand. Network provides
Internet, data, voice and video services to companies that use high-capacity and
high-speed telecommunications in their businesses. Network sells its products to
the wholesale carrier and enterprise market segments, and many of its most
significant customers provide retail telecommunications services to consumers
and business enterprises. Network also offers rights of use in dark fiber, which
is fiber that it installs but for which it does not provide communications
transmission services. Network also provides space and power to collocation
customers at network centers and a variety of professional and managed services
to customers including network design and construction, network management and
network monitoring or surveillance.
Vyvx transmits audio and video programming for its customers over Network's
fiber-optic network and via satellite. Vyvx transmits live traditional broadcast
and cable television events from the site of the event to the network control
centers of the broadcasters of the event. In addition, Vyvx provides an
integrated satellite and fiber-optic network based service to transmit live
content from remote locations to its customers. Vyvx also distributes
advertising spots and syndicated programming to radio and television stations
throughout the U.S., both electronically and in physical form. Customers for
these services can utilize a network-based method for aggregating, managing,
storing and distributing content owners and right holders.
11
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Other includes certain corporate assets not attributable to a specific
segment such as cash and cash equivalents.
The Company evaluates performance based upon segment profit (loss) from
operations, which represents earnings before interest, income taxes,
depreciation and amortization and other unusual or non-cash items, such as asset
impairments and restructuring charges, equity earnings or losses and minority
interest. Segment loss from operations for 2001 also excludes lease costs
attributable to an operating lease covering a portion of the Company's
fiber-optic network ("operating lease costs"). A reconciliation of segment loss
from operations to loss from operations is provided below. Intercompany sales
are generally accounted for as if the sales were to unaffiliated third parties.
The following tables present certain financial information concerning the
Company's reportable segments.
Successor Company:
Network Vyvx Eliminations Total
------- ---- ------------ -----
(In thousands)
Period from January 1, 2003 through
November 5, 2003
Revenues:
Capacity and other........................$ 1,005,175 $ 106,240 $ -- $ 1,111,415
Intercompany.............................. 21,885 (21,885) --
----------- ----------- ----------- -----------
Total segment revenues.......................$ 1,027,060 $ 106,240 $ (21,885) $ 1,111,415
=========== =========== =========== ===========
Costs of sales:
Capacity and other........................ 856,110 45,183 -- 901,293
Intercompany.............................. -- 21,885 (21,885) --
----------- ----------- ----------- -----------
Total cost of sales..........................$ 856,110 $ 67,068 $ (21,885) $ 901,293
=========== =========== =========== ===========
Segment profit:
Income (loss) from operations.............$ (150,710) $ 3,871 $ -- $ (146,839)
Adjustments to reconcile income (loss)
from operations to segment profit:
Depreciation and amortization.......... 196,230 12,250 -- 208,480
----------- ----------- ----------- -----------
Segment profit...............................$ 45,520 $ 16,121 $ -- $ 61,641
=========== =========== =========== ===========
Additions to long-lived assets...............$ 45,772 $ 1,758 $ -- $ 47,530
Network Vyvx Eliminations Total
------- ---- ------------ -----
(In thousands)
Two Months Ended December 31, 2002
Revenues:
Capacity and other........................$ 168,615 $ 23,041 $ -- $ 191,656
Intercompany.............................. 5,052 20 (5,072) --
----------- ----------- ----------- -----------
Total segment revenues.......................$ 173,667 $ 23,061 $ (5,072) $ 191,656
=========== =========== =========== ===========
Costs of sales:
Capacity and other........................$ 159,705 $ 11,900 $ -- $ 171,605
Intercompany.............................. 20 5,052 (5,072) --
----------- ----------- ----------- -----------
Total cost of sales..........................$ 159,725 $ 16,952 $ (5,072) $ 171,605
=========== =========== =========== ===========
Segment profit (loss):
Loss from operations......................$ (50,718) $ (4,354) $ -- $ (55,072)
Adjustments to reconcile loss from
operations to segment profit (loss):
Depreciation and amortization.......... 41,589 2,705 -- 44,294
Other:
Asset impairments and
restructuring charges.............. 6,423 2,149 -- 8,572
----------- ----------- ----------- -----------
Segment profit (loss)........................$ (2,706) $ 500 $ -- $ (2,206)
=========== =========== =========== ===========
Additions to long-lived assets...............$ 6,256 $ 178 $ -- $ 6,434
12
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Predecessor Company:
Network Vyvx Other Eliminations Total
------- ---- ----- ------------ -----
(In thousands)
Ten Months Ended October 31, 2002
Revenues:
Capacity and other........................$ 879,011 $ 120,996 $ -- $ -- $ 1,000,007
Intercompany.............................. 32,588 149 -- (32,737) --
----------- ----------- ----------- ----------- -----------
Total segment revenues.......................$ 911,599 $ 121,145 $ -- $ (32,737) $ 1,000,007
=========== =========== =========== =========== ===========
Costs of sales:
Capacity and other........................$ 783,418 $ 78,987 $ -- $ -- $ 862,405
Intercompany.............................. 149 32,588 -- (32,737) --
----------- ----------- ----------- - ----------- -----------
Total cost of sales..........................$ 783,567 $ 111,575 $ -- $ (32,737) $ 862,405
=========== =========== =========== =========== ===========
Segment loss:
Loss from operations......................$ (477,190) $ (82,892) $ (10,409) $ -- $ (570,491)
Adjustments to reconcile loss from
operations to segment loss:
Depreciation and amortization.......... 415,422 45,567 -- -- 460,989
Other:
Asset impairments and
restructuring charges.............. 19,689 8,363 431 -- 28,483
Contingent liabilities............... 40,800 -- 13,500 -- 54,300
Settlement gains..................... (11,202) -- -- -- (11,202)
Exit cost reserves no longer
required........................... -- -- (3,573) -- (3,573)
Other................................ (1,532) -- -- -- (1,532)
----------- ----------- ----------- ----------- -----------
Segment loss.................................$ (14,013) $ (28,962) $ (51) $ -- $ (43,026)
=========== =========== =========== =========== ===========
Additions to long-lived assets...............$ 73,743 $ 3,160 $ -- $ -- $ 76,903
Network Vyvx Other Eliminations Total
------- ---- ----- ------------ -----
(In thousands)
Year Ended December 31, 2001
Revenues:
External customers: $ 9,101 $ -- $ -- $ -- $ 9,101
Dark Fiber..............................
Capacity and other...................... 1,012,098 164,322 -- -- 1,176,420
----------- ----------- ----------- ----------- -----------
Total external customers.................. 1,021,199 164,322 -- -- 1,185,521
Intercompany............................ 56,641 380 -- (57,021) --
----------- ----------- ----------- ----------- -----------
Total segment revenues.......................$ 1,077,840 $ 164,702 $ -- $ (57,021) $ 1,185,521
=========== =========== =========== =========== ===========
Costs of sales:
Dark fiber................................$ 3,177 $ -- $ -- $ -- $ 3,177
Capacity and other........................ 929,157 97,121 -- -- 1,026,278
Intercompany.............................. 380 56,641 -- (57,021) --
----------- ----------- ----------- ----------- -----------
Total cost of sales..........................$ 932,714 $ 153,762 $ -- $ (57,021) $ 1,029,455
=========== =========== =========== =========== ===========
Segment loss:
Loss from operations......................$(3,425,095) $ (116,931) $ (2,340) $ -- $(3,544,366)
Adjustments to reconcile loss from
operations to segment loss:
Depreciation and amortization.......... 433,032 33,607 479 -- 467,118
Operating lease costs................. 35,214 -- -- -- 35,214
Other:
Asset impairments and
restructuring charges.............. 2,928,648 51,277 -- 2,979,925
Gain on sale of assets............... (46,079) -- -- -- (46,079)
Other................................ -- -- (1,500) -- (1,500)
----------- ----------- ----------- ----------- -----------
Segment loss.................................$ (74,280) $ (32,047) $ (3,361) $ -- $ (109,688)
=========== =========== =========== =========== ===========
Additions to long-lived assets...............$ 1,318,990 $ 68,678 $ 1,626 $ -- $ 1,389,294
13
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Total Assets
-------------------------------
Successor Company
-------------------------------
As of As of
November 5, December 31,
2003 2002
----------- -------------
(In thousands)
Network.................................. $1,433,578 $1,577,372
Vyvx..................................... 54,246 82,819
Other.................................... 307,738 402,082
---------- ----------
Total assets........................... $1,795,562 $2,062,273
========== ==========
The following geographic area data includes revenues from external
customers based on origin of services rendered and long-lived assets based upon
physical location for the following periods.
Successor Company Predecessor Company
-------------------------------- --------------------------------
Period from
January 1, 2003 Two Months Ten
through Ended Months Ended Year Ended
November 5, December 31, October 31, December 31,
2003 2002 2002 2001
---------------- ------------ ------------ -----------
(In thousands)
Revenues from external customers:
United States..............................$ 1,062,387 $ 179,328 $ 943,451 $ 1,125,319
Other....................................... 49,028 12,328 56,556 60,202
------------ ---------- ---------- -------------
Total.......................................$ 1,111,415 $ 191,656 $1,000,007 $ 1,185,521
============ ========== ========== ===========
Successor Predecessor
Company Company
-------------- -----------------
As of November 5, As of December 31,
2003 2002
--------------- ------------------
(In thousands)
Long-lived assets:
United States........................$ 1,230,613 $ 1,403,541
Other................................ 6,130 56,469
------------ ------------
Total..................................$ 1,236,743 $ 1,460,010
============ ============
Long-lived assets are comprised of property, plant and equipment.
For the period from January 1, 2003 through November 5, 2003, one of
Network's customers exceeded 10% of the Company's revenue with sales of
approximately $552 million. In 2002, one of Network's customers exceeded 10% of
the Company's revenues with sales of approximately $73 million and $442 million
for the two months ended December 31, 2002 and for the ten months ended October
31, 2002, respectively. In 2001, two of Network's customers exceeded 10% of the
Company's revenues with sales from each customer of approximately $402 million
and $122 million, respectively.
14
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Other Operating Expense (Income), Net
Transactions included in segment profit (loss)
Other operating income of $6.2 million and $18.8 million for the two months
ended December 31, 2002 and the ten months ended October 31, 2002, respectively,
consisted primarily of cash settlement gains related to the termination of
various agreements.
In 2001, other operating income of $10.8 million primarily included cash
settlement gains of $28.7 million related to the termination of various
agreements, partially offset by expenses related to a loss provision on notes
receivable of $12.0 million and severance charges of $4.7 million.
Transactions excluded from segment profit (loss)
Other operating expense of $38.0 million for the ten months ended October
31, 2002 primarily included a $54.3 million accrual for contingent liabilities
partially offset by non-cash settlement gains related to the termination of
various agreements of $8.3 million, a $3.6 million credit from the determination
that remaining liabilities accrued for exit costs established in previous years
related to various business sales and abandonments were no longer required, and
income of $2.9 million related to revisions of estimated costs associated with
the sale of the single strand of lit fiber in fourth quarter 2001.
WCG had other operating income of $47.6 million in 2001. In October 2001,
WCG and WorldCom, Inc. ("WorldCom") reached an agreement in which WCG sold to
WorldCom the single strand of lit fiber that WCG had retained when it sold the
majority of its predecessor network to WorldCom in 1995. In exchange for
granting title of the fiber to WorldCom, WCG received cash of $143.6 million
from WorldCom resulting in a gain to WCG in fourth quarter 2001 of $46.1
million. WCG did not record any revenue from this sale. WCG purchased from
WorldCom a 20-year IRU of capacity on WorldCom's network for $100 million. The
agreement for the sale of the single strand of lit fiber and the purchase of the
IRU settled ongoing disputes of operational matters dating back to 1995.
4. Investing Income
Predecessor Company
Marketable equity securities
A loss of $89.8 million was recognized in 2001 related to write-downs of
certain marketable equity security investments resulting from management's
determination that the decline in the value of these investments was other than
temporary.
Certain marketable equity securities were sold for proceeds of $7.0 million
and $104.5 million for the ten months ended October 31, 2002 and for the year
ended December 31, 2001, respectively. Gross realized gains of $0.7 million and
$63.7 million were recognized for the ten months ended October 31, 2002 and for
the year ended December 31, 2001, respectively, and gross realized losses of
$40.5 million were recognized in 2001.
Income of $40.9 million was recorded in 2001 from the change in market
value of cashless collars on certain marketable equity securities in accordance
with SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" as amended since the cashless collars did not qualify as a hedge.
All of the cashless collars were terminated in 2001 yielding proceeds of $40.9
million.
15
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Cost-based and equity-method investments
The Company's equity losses were $2.7 million and $35.5 million for the ten
months ended October 31, 2002 and for the year ended December 31, 2001,
respectively. Equity losses in 2001 included $20.0 million of equity losses
related to WCG's equity investment in iBEAM Broadcasting Corp. ("iBEAM") in
third quarter 2001. WCG purchased the assets of iBEAM out of bankruptcy in
December 2001. In addition, equity losses related to WCG's investment in Algar
Telecom Leste, S.A. ("ATL") were $10.4 million in 2001. WCG sold its investment
in ATL in 2001 as discussed below.
A loss of $117.8 million was recognized in 2001 related to write-downs of
certain cost-based and equity-method investments resulting from management's
estimate that the decline in the value of these investments was other than
temporary.
WCG entered into an agreement with America Movil, S.A. de C.V. in second
quarter 2001 to sell its remaining economic interest in ATL. The transaction
closed in third quarter 2001 and WCG received $309.6 million in cash with an
additional $90.0 million due from America Movil, S.A. de C.V. on May 15, 2002. A
gain of $45.1 million was recognized from the sale. In February 2002, America
Movil, S.A. de C.V. prepaid its note from the sale of ATL by paying a discounted
amount of $88.8 million.
5. Gain on Sale of Consolidated Subsidiary
At the time the Company implemented fresh start accounting, the net assets
of PowerTel, a consolidated subsidiary, were assumed to have minimal value based
on assessments by management and its financial advisor assisting with the
potential sale of the Company's ownership interest in PowerTel. Important
elements of that assessment included PowerTel's struggles to maintain compliance
with its bank covenants, and the assessment that improvements in market
conditions or improved operations during the periods following fresh start,
neither which could be predicted with certainty, would be required in order to
ascribe a higher value.
In August 2003, market conditions improved such that WilTel successfully
entered into agreements to sell its ownership interest in PowerTel. WilTel sold
its common and preferred stock interest to TVG Consolidation Holdings SPRL for
20 million Australian dollars (or $13.1 million). In addition, WilTel also
settled its intercompany receivable from PowerTel for 10 million Australian
dollars (or $6.5 million). The proceeds from the sale of the PowerTel stock were
placed in a restricted bank account pursuant to the terms of agreements related
to the Company's One Technology Notes outstanding. Accordingly, the Company has
classified the restricted investments ($13.1 million as of November 5, 2003) as
other noncurrent assets. The sale resulted in a non-recurring gain of $21.1
million. Net loss attributable to PowerTel was $1.6 million for the period ended
November 5, 2003.
6. Other Income, Net
Other income, net of $45.3 million for the period from January 1, 2003
through November 5, 2003 includes non-recurring, non-operating settlement gains
of $28.5 million related to the termination of various agreements. As a result
of the termination of the agreements, the Company will no longer be required to
perform the contractual obligations that were the basis for the recording of the
deferred revenue performance obligations. In addition, other income, net
includes $16.8 million of non-recurring, non-operating gains primarily related
to the termination of arrangements previously accrued as unfavorable commitments
in fresh start accounting and recoveries of various receivables previously
written off.
16
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7. Benefit (Provision) from Income Taxes
The benefit (provision) from income taxes includes:
Successor Company Predecessor Company
-------------------------------- --------------------------------
Period from
January 1, 2003 Two Months Ten
through Ended Months Ended Year Ended
November 5, December 31, October 31, December 31,
2003 2002 2002 2001
---------------- ------------ ------------ -----------
(In thousands)
Current:
Federal........................................$ -- $ -- $ -- $ --
State.......................................... (23) (3) (25) (64)
Foreign........................................ -- -- -- --
------- ------- --------- --------
(23) (3) (25) (64)
Deferred:
Federal........................................ -- -- (850) (41,916)
State.......................................... -- -- (155) (8,145)
Foreign........................................ -- -- -- 4
------- ------- --------- --------
-- -- (1,005) (50,057)
------- ------- --------- --------
Total provision from income taxes................$ (23) $ (3) $ (1,030) $(50,121)
======= ======= ========= ========
The U.S. and foreign components of income (loss) before income taxes are as
follows:
Successor Company Predecessor Company
-------------------------------- --------------------------------
Period from
January 1, 2003 Two Months Ten
through Ended Months Ended Year Ended
November 5, December 31, October 31, December 31,
2003 2002 2002 2001
---------------- ------------ ------------ -----------
(In thousands)
United States.................................. $(127,993) $ (60,625) $ 1,146,955 $(3,618,728)
Foreign........................................... 19,270 (421) 185,270 (141,508)
--------- ---------- ------------ -----------
Total income (loss) before income taxes........ $(108,723) $ (61,046) $ 1,332,225 $(3,760,236)
========= ========== ============ ===========
The Company's undistributed earnings from non U.S. subsidiaries in 2003,
2002 and 2001 have been accounted for as if fully repatriated.
17
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Reconciliations from the benefit (provision) from income taxes at the
federal statutory rate to the provision from income taxes are as follows:
Successor Company Predecessor Company
-------------------------------- --------------------------------
Period from
January 1, 2003 Two Months Ten
through Ended Months Ended Year Ended
November 5, December 31, October 31, December 31,
2003 2002 2002 2001
---------------- ------------ ------------ -----------
(In thousands)
Benefit (provision) at statutory rate............$ 38,053 $ 21,366 $(466,279) $ 1,316,083
Increases (reductions) resulting from:
State income taxes............................. (15) -- (119) (5,335)
Foreign operations............................. 6,745 (147) 64,845 (46,547)
Goodwill amortization.......................... -- -- -- (866)
Non-deductible costs related to asset sales.... -- -- -- (5,426)
Non-deductible reorganization expenses......... (1,750) (566) (11,736) --
Valuation allowance adjustments................ (42,913) (19,920) (964,313) (1,108,965)
Tax provisions allocated from
TWC.......................................... -- -- -- (200,718)
Non-taxable gain on debt discharge, net........ -- -- 1,377,623 --
Other-- net................................... (143) (736) (1,051) 1,653
--------- ---------- ---------- ------------
Provision from income taxes......................$ (23) $ (3) $ (1,030) $ (50,121)
========= ========== ========== ============
Significant components of deferred tax assets and liabilities are as follows:
Successor Company
---------------------------------
As of As of
November 5, December 31,
2003 2002
---------- ------------
(In thousands)
Deferred tax assets:
Deferred revenues.................................................. $ 76,895 $ 64,661
Property, plant and equipment, including impairments................. 633,820 832,691
Investments, including impairments................................... 90,104 105,260
Other asset impairments.............................................. 151,962 172,948
Reserves............................................................. 60,726 73,576
Net operating loss carryforward...................................... 1,281,030 1,039,321
Other................................................................ 6,136 13,738
----------- ----------
2,300,673 2,302,195
----------- ----------
Valuation allowance.................................................... (2,300,673) (2,250,621)
----------- ----------
Total deferred tax assets............................................. -- 51,574
Deferred tax liabilities:
Other............................................................... -- 51,574
------------ -----------
Total deferred tax liabilities........................................ -- 51,574
------------ ----------
Net deferred tax liability........................................... $ -- $ --
============ ==========
18
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As of November 5, 2003, the Company had $3.3 billion of federal net
operating losses, of which $859.9 million, $1.2 billion, $535.2 million and
$647.0 million expire in 2019, 2020, 2021 and 2022, respectively, and $402.3
million of estimated capital loss carryforwards, of which $209.3 million, $88.5
million, $0.9 million, $34.0 million and $69.7 million will expire in 2003,
2004, 2005, 2006 and 2007, respectively, and $222.9 million of foreign net
operating losses as well as various state net operating losses that expire at
various dates. Valuation allowances have been established that fully reserve the
net deferred tax assets. Uncertainties that may affect the utilization of the
loss carryforwards include future operating results, tax law changes, rulings by
taxing authorities regarding whether certain transactions are taxable or
deductible and expiration of carryforward periods. The valuation allowance
change for the period from January 1, 2003 through November 5, 2003 and the year
ended 2002 was an increase of $50.1 million and $964.3 million, respectively.
If the Company had filed a separate federal income tax return for all
periods presented, the tax provision would have been unchanged.
8. Employee Benefit Plans
Pension and Other Postretirement Benefit Plans
WilTel provides both funded and unfunded noncontributory defined benefit
pension plans to substantially all of its employees who were employed prior to
April 24, 2001. The funded pension plan provides defined benefits based on
amounts credited to employees on a cash balance formula. The formula takes into
account age, compensation, social-security-wage base and benefit service with
the company. An additional unfunded, unqualified pension plan is offered to
pension plan participants with earnings in excess of $200,000.
WilTel also has an unfunded other postretirement benefit plan covering
employees who were employed prior to January 1, 1992. This health care plan is
contributory with participants' contributions adjusted annually. Benefits are
paid to eligible employees with 10 years of service and aged 55 years or older
when leaving the company.
Obligations and Funded Status
The following table presents the changes in benefit obligations and plan
assets for pension benefits and other postretirement benefits for the WilTel
Plans for the periods indicated. It also presents a reconciliation of the funded
status of these benefits to the amount recognized in the accompanying
consolidated balance sheet.
19
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Pension Benefits
-------------------------------------------------
Successor Company Predecessor Comany
------------------------------ ------------------
Period from
January 1, Two Months Ten Months
2003 through Ended Ended
November 5, December 31, October 31,
2003 2002 2002
---- ---- ----
(In thousands)
Change in benefit obligation:
Benefit obligation at beginning of period.........................$ 97,812 $ 110,373 $ 89,063
Service cost...................................................... 5,090 897 4,535
Interest cost..................................................... 6,556 1,229 5,754
Actuarial (gain) loss............................................. 15,470 (11,652) 22,120
Benefits paid..................................................... (4,777) (308) (6,433)
Plan curtailment.................................................. -- (2,727) (3,629)
Discharge of Solutions non-qualified plan obligation
through bankruptcy proceedings.................................. -- -- (1,037)
---------- --------- ----------
Benefit obligation at end of period................................. 120,151 97,812 110,373
---------- --------- -----------
Change in plan assets:
Fair value of plan assets at beginning of period.................. 57,360 57,912 75,832
Actual return on plan assets...................................... 9,298 (244) (12,140)
Employer contribution............................................. 3,245 -- 652
Benefits paid..................................................... (4,777) (308) (6,433)
---------- --------- -----------
Fair value of plan assets at end of period.......................... 65,126 57,360 57,911
---------- --------- -----------
Funded status....................................................... (55,025) (40,452) (52,462)
Unrecognized net actuarial gain..................................... (818) (10,678) --
---------- --------- -----------
Net accrued benefit cost............................................$ (55,843) $ (51,130) $ (52,462)
========== ========= ===========
Amounts recognized in the Consolidated Balance Sheet consist
of:
Accrued benefit cost $ (56,501) $ (51,130) $ (52,462)
Accumulated other comprehensive income (before tax) 658 -- --
---------- --------- -----------
Net accrued benefit cost $ (55,843) $ (51,130) $ (52,462)
========== ========= ===========
Accumulated benefit obligation $ 119,797 $ 94,898 $ 106,272
========== ========= ===========
20
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Other Postretirement Benefits
-------------------------------------------------
Successor Company Predecessor Comany
------------------------------ ------------------
Period from
January 1, Two Months Ten Months
2003 through Ended Ended
November 5, December 31, October 31,
2003 2002 2002
---- ---- ----
(In thousands)
Change in benefit obligation:
Benefit obligation at beginning of period.........................$ 2,033 $ 2,550 $ 4,081
Service cost...................................................... 111 18 112
Interest cost..................................................... 92 28 144
Plan participants' contributions.................................. 15 1 3
Actuarial gain.................................................... (767) -- (1,485)
Benefits paid..................................................... (42) (10) (24)
Plan curtailment.................................................. -- (554) (281)
------------ --------- --------
Benefit obligation at end of period................................. 1,442 2,033 2,550
------------ --------- --------
Change in plan assets:
Employer contribution............................................. 27 9 22
Plan participants' contributions.................................. 15 1 3
Benefits paid..................................................... (42) (10) (25)
------------ --------- --------
Fair value of plan assets at end of period.......................... -- -- --
------------ --------- --------
Funded status....................................................... (1,442) (2,033) (2,550)
Unrecognized net actuarial gain..................................... (749) -- --
------------ --------- --------
Net accrued benefit cost............................................$ (2,191 $ (2,033) $ (2,550)
============ ========= ========
The net accrued benefit cost for other postretirement benefits is included
in the accompanying balance sheet as accrued employee cost within accrued
liabilities.
Components of Net Periodic Benefit Cost
The following tables present net pension expense and other postretirement
benefit expense for the WilTel Plans.
Successor Company Predecessor Company
-------------------------------- --------------------------------
Period from
January 1, 2003 Two Months Ten
through Ended Months Ended Year Ended
November 5, December 31, October 31, December 31,
2003 2002 2002 2001
---------------- ------------ ------------ -----------
(In thousands)
Components of net period pension expense:
Service cost..............................................$ 5,090 $ 897 $ 4,535 $ 4,921
Interest cost.............................................. 6,556 1,229 5,754 5,365
Expected return on plan assets............................. (3,688) (731) (6,404) (6,991)
Amortization of prior service credit....................... -- -- 72 9
Recognized net actuarial gain.............................. -- -- 129 (489)
Curtailment charge (credit)................................ -- (2,727) 246 (1,374)
-------- ---------- --------- ----------
Net periodic pension expense (income)................. 7,958 (1,332) 4,332 1,441
Fresh start valuation adjustment.......................... -- -- 39,207 --
Discharge of Solutions non-qualified plan obligation...... -- -- (1,037) --
-------- ---------- --------- ----------
Total pension cost (income)...........................$ 7,958 $ (1,332) $ 42,502 $ 1,441
======== ========== ========= ==========
Additional information:
Increase in minimum liability included in other
comprehensive income (before taxes) $ 658 $ -- $ -- $ --
======== ========== ========= ==========
21
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Successor Company Predecessor Company
-------------------------------- --------------------------------
Period from
January 1, 2003 Two Months Ten
through Ended Months Ended Year Ended
November 5, December 31, October 31, December 31,
2003 2002 2002 2001
---------------- ------------ ------------ -----------
(In thousands)
Components of net periodic postretirement benefit expense:
Service cost..............................................$ 111 $ 18 $ 112 $ 156
Interest cost............................................. 92 28 144 171
Amortization of prior service credit...................... -- -- 52 43
Recognized net actuarial (gain) loss...................... (18) -- 3 (16)
Curtailment charge (credit)............................... -- (554) 8 --
-------- --------- --------- ----------
Net periodic pension expense........................... 185 (508) 319 354
Fresh start valuation adjustment......................... -- -- 274 --
-------- --------- --------- ----------
Total postretirement cost..............................$ 185 $ (508) $ 593 $ 354
======== ========= ========= ==========
Assumptions
The following are the weighted-average assumptions used to determine
pension benefit obligations as of the measurement date indicated:
Pension Benefit Obligation
--------------------------------------------------
Predecessor
Successor Company Company
------------------------- ------------
November 5, December 31, October 31,
2003 2002 2002
---- ---- ----
Discount rate................................................. 6.25% 6.75% 6.75%
Rate of compensation increase................................. 3.50% 3.50% 5.00%
The following are the weighted-average assumptions utilized to determine
net periodic pension benefit cost for the period ended indicated:
Net Periodic Pension Benefit Cost
---------------------------------------------------------------
Successor Company Predecessor Company
------------------------------ --------------------------
Period from
January 1, 2003 Two Ten Months
through Months Ended Ended Year Ended
November 5, December 31, October 31, December 31,
2003 2002 2002 2001
---- ---- ---- ----
Discount rate................................................. 6.75% 6.75% 7.50% 7.50%
Expected return on plan assets................................ 7.00% 7.00% 9.50% 10.00%
Rate of compensation increase................................. 3.50% 5.00% 5.00% 5.00%
The general approach for determining the expected long-term
rate-of-return-on-assets assumption is to review the asset allocation targets
and their corresponding historic weighted-average returns and adjust those rates
as necessary to properly reflect capital market expectations. With the aid of a
computer model, average returns, average volatility, correlations of asset
classes to each other, and minimum and maximum allocation constraints were
analyzed over several historic periods (the period 1926-2001, post-war period
1952-2001 and the ten years to December 2001). These historic returns were then
adjusted in order to reflect a more conservative expectation of future returns
and asset allocation targets reflective of the closed participant population
growing closer to retirement age.
22
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following are the weighted-average assumptions used to determine other
postretirement benefit obligations as of the period ended indicated:
Other Postretirement Benefits
--------------------------------------------------
Predecessor
Successor Company Company
----------------- -----------
Period from
January 1, Two Months Ten Months
2003 through Ended Ended
November 5, December 31, October 31,
2003 2002 2002
---- ---- ----
Discount rate.................................................. 6.25% 6.75% 6.75%
The following are the weighted-average assumptions utilized to determine
net periodic other postretirement benefit cost for the period ended indicated:
Other Post Retirement Benefits
---------------------------------------------------------------
Successor Company Predecessor Company
------------------------------ --------------------------
Period from
January 1, 2003 Two Ten Months
through Months Ended Ended Year Ended
November 5, December 31, October 31, December 31,
2003 2002 2002 2001
---- ---- ---- ----
Discount rate.....................................................6.75% 6.75% 7.50% 7.50%
The annual assumed rate of increase in the health care cost trend rate for
2004 is 12% which systematically decreases to 5% by 2012.
The various nonpension postretirement benefit plans which WilTel sponsors
provide for retiree contributions and contain other cost-sharing features such
as deductibles and coinsurance. The accounting for these plans anticipates
future cost-sharing changes to the written plans that are consistent with
WilTel's expressed intent to increase the retiree contribution rate generally in
line with health care cost increases.
The health care cost trend rate assumption has a significant effect on the
amounts reported. A one-percentage-point change in assumed health care cost
trend rates would have the following effects:
1-Percentage-Point
------------------
Increase Decrease
-------- --------
(In thousands)
Effect on total of service and interest cost components.......................... $ 5 $ (4)
Effect on postretirement benefit obligation...................................... $ 259 $ (209)
23
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Plan Assets
The following table presents WilTel's pension plan asset allocations:
Successor Company Predecessor Company
-------------------------------- ---------------------------------
Period from
January 1, 2003 Two
through Months Ended Ten Months Ended Year Ended
November 5, December 31, October 31, December 31,
2003 2002 2002 2001
---- ---- ---- ----
Equity securities:
Large cap stocks.........................34% 25% 27% 26%
Small cap stocks.........................23% 21% 20% 22%
International stocks.....................21% 29% 29% 33%
--- --- --- ---
Total equity securities................78% 75% 76% 81%
Fixed income/bonds ..........................22% 25% 24% 19%
--- --- --- ---
Total................................100% 100% 100% 100%
The investment objectives of WilTel's plan emphasize long-term capital
appreciation as a primary source of return. Current income is a supplementary
source of return. The target allocation was recently approved by the Investment
Committee to be as follows:
Interim Long-term
Target Target
------ ------
Equity securities:
Large cap stocks.............................. 38% 40%
Small cap stocks.............................. 22% 10%
International stocks.......................... 20% 20%
--- ---
Total equity securities................... 80% 70%
Fixed income/bonds ............................. 20% 30%
--- ---
Total........ ............................100% 100%
The Investment Committee established the interim target in order to balance
speed and caution in transitioning to the long-term allocations, lowering the
risk of selling low and buying high and shifting the portfolio to the long-term
targets under the right market conditions.
Investment performance objectives are based upon a benchmark index or mix
of these indices over a market cycle. The benchmark is as follows:
S&P 500 Index................................................. 25%
Russell 2000 Index............................................ 22%
EAFE Index.................................................... 33%
Merrill Lynch Domestic Master Bond Index ..................... 20%
---
Total....................................................100%
Investment performance objectives are based upon a benchmark index or mix
of indices over a market cycle. The investment strategy designates certain
investment restrictions for domestic equities, international equities and fixed
income securities. These restrictions include the following:
o For domestic equities, there will generally be no more than 5% of any
manager's portfolio at market in any one company and no more than 150% of
any one sector of the appropriate index for any manager's portfolio.
Restrictions are also designated on outstanding market value of any one
company at 5%.
24
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
o For international equities, there will be no more than 8% in any one
company in a manager's portfolio, no fewer than three countries in a
manager's portfolio, no more than 10% of the portfolio in countries not
represented in the EAFE index, no more than 150% of any one sector of the
appropriate index and no currency hedging is permitted.
o Fixed income securities will all be rated BBB- or better at the time of
purchase, there will be no more than 8% at market in any one security (US
government and agency positions excluded), no more than a 30-year maturity
in any one security, and investments in standard collateralized mortgage
obligations are limited to 10%.
Pension Plan Contributions
WilTel expects to contribute $5 million to its pension plan in 2004.
Defined Contribution Plan
Beginning January 1, 2001, the Company established and continues to
maintain a defined contribution plan for its employees. Prior to January 1,
2001, the Company's employees were included in various defined contribution
plans maintained by TWC. The Company's costs related to these plans were $5.3
million, $1.6 million, $9.0 million and $12.1 million for the period from
January 1, 2003 through November 5, 2003, for the two months ended December 31,
2002, for the ten months ended October 31, 2002 and in 2001, respectively. These
costs fluctuate as a result of changes in the eligible employee base.
9. Property, Plant and Equipment
Property, plant and equipment is summarized as follows:
Successor Company
-----------------------------
As of As of
Depreciable November 5, December 31,
Lives* 2003 2002
------ ---- ----
(In years) (In thousands)
Network equipment (including fiber, optronics and
capacity IRUs)...................................................3-20 $ 958,077 $ 951,744
Right-of-way...................................................... 20 127,439 127,508
Buildings and leasehold improvements............................10-30 140,915 140,960
Computer equipment and software..................................2-3 130,629 124,330
General office furniture and fixtures............................5-8 43,468 61,947
Construction in progress.....................................Not.applicable 28,949 35,455
Other...........................................................Various 48,555 61,850
----------- -----------
1,478,032 1,503,794
Less accumulated depreciation and amortization................... (241,289) (43,784)
----------- -----------
$ 1,236,743 $ 1,460,010
=========== ===========
*As of November 5, 2003
Depreciation expense of $205.6 million, $43.8 million, $461.0 million and
$459.4 million was recorded for the period from January 1, 2003 through November
5, 2003, for the two months ended December 31, 2002, for the ten months ended
October 31, 2002 and for the year ended December 31, 2001, respectively.
25
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
10. Accounts Payable, Accrued Liabilities and Other Noncurrent Liabilities
The Company's cash accounts reflect credit balances to the extent checks
written have not been presented for payment. The amounts of these credit
balances included in accounts payable were $19.5 million and $21.9 million as of
November 5, 2003 and December 31, 2002, respectively.
Accrued liabilities consisted of the following:
Successor Company
As of As of
November 5, December 31,
2003 2002
----------- ------------
(In thousands)
Litigation............................................................. $ 82,576 $ 93,109
Employee costs......................................................... 27,076 35,446
Taxes, other than income taxes........................................ 30,870 32,074
Unfavorable contractual commitments................................... 18,702 33,977
Other.................................................................. 28,532 41,176
----------- ---------
$ 187,756 $ 235,782
=========== =========
Other noncurrent liabilities consisted of the following:
Successor Company
As of As of
November 5, December 31,
2003 2002
----------- ------------
(In thousands)
Employee costs........................................................ $ 64,585 $ 60,882
Unfavorable contractual commitments.................................. 39,246 44,976
Other................................................................ 31,993 31,074
----------- ----------
$ 135,824 $ 136,932
=========== ==========
11. Asset Retirement Obligations
The Company's asset retirement obligations relate primarily to two
categories of assets:
Fiber and Conduit - The Company has right-of-way agreements which generally
require the removal of fiber and conduit upon the termination of those
agreements.
Technical Sites - The Company leases land for technical sites and leases
space at technical sites along its network. Termination of these lease
agreements normally requires removal of equipment and other assets, and
restoration of the lease property to its original condition.
The estimation of the fair value of asset retirement obligations requires
the significant use of estimates regarding the amounts and timing of expected
cash flows. The fair value of the asset retirement obligations was calculated
using credit-adjusted risk-free rates ranging from 8% to 14%, which were
assigned based upon the expected timing of cash flows for each respective
obligation.
The fair value of the Company's assets that are legally restricted for
purposes of settling asset retirement obligations at November 5, 2003, is $16.5
million, which is classified in property, plant and equipment.
26
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Reconciliation of the asset retirement obligation is as follows:
Successor Company
---------------------------
As of As of
November 5, December 31,
2003 2002
---- ----
(In thousands)
Beginning balance............................ $ 26,270 $ 25,743
Liabilities incurred......................... 473 --
Liabilities settled.......................... (197) --
Accretion expense............................ 2,886 527
Revisions in estimated cash flows............ (975) --
----------- --------
$ 28,457 $ 26,270
=========== ========
The Company adopted SFAS No. 143 relating to asset retirement obligations
as part of implementing fresh start accounting as required by SOP 90-7 and
recorded a cumulative effect of change in accounting principle of $8.7 million
in 2002 (net of a zero tax provision). The cumulative effect of change in
accounting principle represents accretion and depreciation expense the Company
would have recorded had the provisions of SFAS No. 143 been in effect on the
dates the obligations were incurred.
If the Company had adopted SFAS No. 143 on January 1, 2001, it would have
recorded a liability of $20.6 million. Accretion expense for the year ended
December 31, 2001 and for the ten months ended October 31, 2002 would have been
$2.6 million and $2.5 million, respectively. The liability as of December 31,
2001 would have been $23.2 million.
12. Debt
Long-term debt consisted of the following:
Weighted Successor Company
Average As of As of
Interest November 5, December 31,
Rate* 2003 2002
----- ---- ----
(In thousands)
Exit Credit Agreement....................................... 5.7% $ 375,000 $ 375,000
OTC Notes................................................... 8.1% 119,249 141,663
PowerTel.................................................... -- -- 44,353
Other, primarily capital leases............................. 10.8% 12,518 8,473
--------- -----------
506,767 569,489
Less current maturities..................................... (4,021) (51,503)
--------- -----------
Long-term debt............................................. $ 502,746 $ 517,986
========= ===========
* As of November 5, 2003
A description of the Company's debt obligations listed in the table above
is as follows:
27
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Exit Credit Agreement
On October 15, 2002, WCL and the credit facility lenders entered into the
Exit Credit Agreement. The Exit Credit Agreement combined the term loans under
the previous credit facility into one loan repayable in installments of
principal beginning in June 2005 through September 2006 and currently bears
interest at either the Prime rate plus a margin of 3.50% or LIBOR plus a margin
of 4.50%, at the Company's option. In July 2004, the margin, in each case, will
increase 1%. In October 2003, WCL locked in a rate of 5.69% for three months
based on LIBOR. The Exit Credit Agreement does not provide for revolving loans
for WCL. Among other things, the Exit Credit Agreement provides for:
o a security interest in all of the domestic assets of the Company, except
for those assets secured under the OTC Notes and the aircraft capital lease
in which the lenders have a second priority lien and security interest;
o prepayment of the term loans from cash proceeds received from refinancing
all or a portion of the Exit Credit Agreement, a sale leaseback transaction
(not otherwise permitted), issuance of debt (not otherwise permitted), or
asset sales (not otherwise permitted);
o prepayment of the term loans equal to 100% of excess cash flows and 50% of
cash proceeds received from the sale of equity, formation of a joint
venture or any other similar transaction;
o the Company meeting certain financial targets, as defined;
o aggregate dollar limitations on certain activities such as indebtedness,
investments and capital expenditures;
o the Company making certain representations and warranties, including the
existence of no material adverse effect, as defined;
o restrictions on the ability of WCL to transfer funds to WilTel, except for
certain payments as outlined in the Exit Credit Agreement; and
o the ability for WCL to request up to $45 million in cash-collateralized
letters of credit, less the amount of cash deposits and pledges made to
third parties in an amount not to exceed $30 million. The total of cash
collateralized letters of credit, plus cash deposits and pledges made to
third parties, outstanding as of November 5, 2003 was $37.3 million.
Amounts held as collateral for outstanding letters of credit are reflected
primarily in other noncurrent assets.
WCL is the obligor under the Exit Credit Agreement and has pledged
substantially all of its assets to secure its obligations under that agreement.
In addition, WCL's obligations are guaranteed by WilTel and secured by
substantially all of the assets of the Company. The Exit Credit Agreement ranks
senior to the Company's other debt.
Sale and subsequent leaseback to TWC and the OTC Notes
In September 2001, the Company sold its headquarters building and other
ancillary assets to TWC for approximately $276 million in cash. Concurrent with
the sale, the Company leased its headquarters building for a period of ten years
and other ancillary assets for a period of three to ten years with varying
payment terms.
28
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As discussed in Note 19, the sale and subsequent leaseback agreement was
terminated and replaced with the OTC Notes of approximately $145 million. The
OTC Notes consist of: (1) a $100 million note at a fixed annual interest rate of
7.0%, with monthly payments for the first 90 months (based on a 360 month
amortization schedule) and with the entire remaining unpaid principal balance
due and payable on April 1, 2010 and (2) a $44.8 million note with accrued
interest paid in kind ("PIK Interest") and capitalized once annually, with the
original principal balance and all capitalized and accrued PIK Interest
(totaling $74.4 million at maturity) due and payable on December 29, 2006. The
second note carries a fixed interest rate of 10.0% through 2003, and each year
thereafter the interest rate increases 2.0% resulting in an interest rate of 16%
in the final year of 2006. The $100 million note was reduced by payments made of
$3.1 million during the period from October 15, 2002 to the close of the escrow
in December 2002. The OTC Notes are full recourse notes and are secured by the
OTC Mortgage, under which TWC was granted a first priority mortgage lien and
security interest in the headquarters building and other ancillary assets. In
addition, the OTC Notes are secured by a second lien and security interest in
the proceeds resulting from the sale of the Company's ownership interest in
PowerTel (see Note 5).
The OTC Notes were reduced in third quarter 2003 by the net cash proceeds
of $15.1 million from the Aircraft Capital Lease transaction per the terms of
the OTC Notes agreement and by $6.5 million related to the final settlement and
payment terms pursuant to an agreement for the purchase of the One Technology
Center building.
Scheduled Debt Maturities
Scheduled maturities of debt as of November 5, 2003 to November 5th of the
year presented below are as follows (in thousands):
2004................................. $ 4,021
2005................................. 85,701
2006................................. 294,041
2007................................ 46,401
2008................................. 1,754
Thereafter............................ 74,849
-------------
$ 506,767
=============
The scheduled maturities table above excludes the payment of the PIK
interest of $29.6 million in 2006 from the OTC Notes.
Cash payments for interest, net of amounts capitalized, were $25.8 million,
$5.2 million, $115.7 million and $381.7 million for the period from January 1,
2003 through November 5, 2003, for the two months ended December 31, 2002, for
the ten months ended October 31, 2002 and for the year ended December 31, 2001
respectively. These payments include commitment fees relating to the Company's
credit facility of $1.1 million, $0.1 million, $6.2 million and $7.5 million for
the period from January 1, 2003 through November 5, 2003, for the two months
ended December 31, 2002, for the ten months ended October 31, 2002 and for the
year ended December 31, 2001, respectively.
13. Stockholders' Equity
In 2001, TWC's Board of Directors approved a tax-free spin-off of WCG to
TWC's shareholders. TWC owned 24,265,892 shares of WCG Class A common stock
outstanding and 395,434,965 shares of Class B common stock outstanding which it
converted to Class A shares prior to the spin-off. After the close of the market
on April 23, 2001, TWC distributed 398,500,000 shares, or approximately 95%, of
the WCG common stock it owned, to holders of TWC common shares on a pro rata
basis by distributing approximately 0.822399 of a share of WCG Class A common
stock as a dividend on each share of TWC common stock outstanding on the record
date.
Prior to the spin-off, TWC and WCG entered into an agreement that, among
other things, resulted in the transfer of ownership of a building under
construction and other assets from TWC to WCG, a commitment to fund the
completion of the building, the conversion of the TWC note into paid in capital
and the issuance of 24.3 million shares of WCG Class A common stock. WCG's total
equity increased by $42.9 million and $1.2 billion in 2002 and 2001,
respectively, as a result of this transaction.
As discussed in Note 19, pursuant to the terms of the Plan, all of WCG's
Class A common stock was cancelled and 50 million shares of WilTel common stock
was issued upon emergence from the chapter 11 proceedings. In addition, certain
transfer restrictions apply to transactions in WilTel common stock as discussed
in Note 19.
29
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
14. Accumulated Other Comprehensive Income
The table below presents changes in the components of accumulated other
comprehensive income (loss).
Unrealized Foreign
Appreciation Currency Minimum
(Depreciation) Translation Pension
of Securities Adjustments Liability Total
------------- ----------- --------- -----
(In thousands)
Predecessor Company:
Balance as of December 31, 2000............................$ 89,218 $ (45,169) $ -- $ 44,049
Current period change:
Pre-income tax amount.................................... (202,698) (42,794) -- (245,492)
Reclassification adjustment for net losses realized in
net loss............................................... 66,648 70,246 -- 136,894
Income tax benefit....................................... 53,038 -- -- 53,038
----------- --------- ----------- ----------
(83,012) 27,452 -- (55,560)
----------- -------- ----------- ----------
Balance as of December 31, 2001............................ 6,206 (17,717) -- (11,511)
Change for the ten months ended October 31, 2002:
Pre-income tax amount.................................... (7,743) 2,440 -- (5,303)
Reclassification adjustment for net gains realized in
net loss............................................... (663) -- -- (663)
Income tax benefit....................................... 1,005 -- -- 1,005
----------- --------- ----------- ----------
(7,401) 2,440 -- (4,961)
Reorganization adjustments................................. 1,195 15,277 -- 16,472
----------- --------- ----------- ---------
Balance as of October 31, 2002............................. -- -- -- --
Successor Company:
Change for the two months ended December 31, 2002.......... -- 780 -- 780
----------- --------- ----------- ----------
Balance as of December 31, 2002............................ -- 780 -- 780
Change for the period from January 1, 2003 through
November 5, 2003:
Pre-income tax amount.................................... -- (82) (658) (740)
Reclassification adjustment for net gains realized in
net loss............................................... -- (699) -- (699)
----------- --------- ----------- ----------
Balance as of November 5, 2003.............................$ -- $ (1) $ (658) $ (659)
=========== ========= =========== ==========
In 2001, WCG realized a foreign currency loss of $70.2 million, of which
$66.4 million related to the sale of ATL (see Note 4).
15. Leases
Future minimum annual rentals under noncancellable operating leases as of
November 5, 2003 are payable as follows (in thousands):
Total
-----
2004.................................................... $ 53,444
2005.................................................... 49,999
2006.................................................... 44,850
2007.................................................... 42,516
2008.................................................... 38,025
Thereafter.............................................. 259,233
-----------
Total minimum annual rentals............................ $ 488,067
===========
Total capacity expense incurred from leasing from a third party's network
(off-network capacity expense) was $35.4 million, $11.9 million, $92.1 million
and $208.2 million for the period from January 1, 2003 through November 5, 2003,
the two months ended December 31, 2002, the ten months ended October 31, 2002
and for the year ended December 31, 2001, respectively. All other rent expense
was $29.2 million, $6.4 million, $42.2 million and $51.4 million for the period
from January 1, 2003 through November 5, 2003, the two months ended December 31,
2002, the ten months ended October 31, 2002 and for the year ended December 31,
2001, respectively.
30
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
16. Related Party Transactions
Transactions with Former Executive Officers
As part of the spin-off from TWC, WCG inherited a long-established loan
program from TWC under which TWC extended loans to its executives to purchase
TWC stock (the "Executive Loans"). At the time of the spin-off, six WCG
executives had outstanding loans with TWC, and as part of the spin-off, the
Executive Loans were transferred to WCG. As of December 31, 2001, the
outstanding balance of these loans were $19.9 million, all which were considered
long-term receivables.
Effective December 31, 2001, the Compensation Committee of the Board of
Directors of WCG established a program to award annual retention bonuses over a
period of five years in the aggregate amount of $13 million to certain
executives to be applied, after deduction of applicable withholding taxes,
solely against their respective outstanding principal loan balances. The
agreements executed under this program were subsequently amended in conjunction
with the Plan.
Under the amended retention bonus agreements, the Company reimbursed
interest payments owed by the WCG executives as of January 1, 2002. In addition,
the Company became responsible for paying all taxes, limited to an aggregate
total of $20 million, associated with interest and principal payments under the
retention bonus agreements, as well as any taxes incurred as a result of the
payment of taxes by the Company. Under a separate amendment, all retention bonus
payments vested upon consummation of the transactions included in the Plan, but
still are to be paid out over the first through fourth anniversaries of the
Effective Date, unless accelerated as a result of death or disability of the
payee. Any officers who were parties to retention bonus agreements were not
eligible to participate in the Company's otherwise applicable change in control
severance plan. The Company recorded an expense of $23.3 million for the ten
months ended October 31, 2002 related to the retention bonus agreements, $10.4
million of this expense was recorded to selling, general and administrative
expense for costs prior to WCG commencing chapter 11 proceedings and the
remaining $12.9 million was recorded to reorganization expense for costs after
WCG commenced chapter 11 proceedings. For the period from January 1, 2003
through November 5, 2003, tax gross-up estimates were reduced by $1 million
offsetting selling, general and administrative expense. As of November 5, 2003,
the Company has accrued liabilities of $2.5 million and other long-term
liabilities of $2.9 million representing taxes to be paid by the Company related
to the retention bonus agreements.
On October 10, 2002, the Bankruptcy Court approved a settlement agreement
between WCG and John C. Bumgarner, a former officer of WCG who participated in
the TWC loan program. The agreement provided that WCG would settle a $6.9
million employee loan plus accrued interest in return for the loan's collateral
of 238,083 shares of TWC common stock and 195,798 shares of WCG common stock and
approximately $7 million of face value of WCG's Senior Redeemable Notes. As a
result of the surrender of the Senior Redeemable Notes by Mr. Bumgarner, no
shares of WilTel common stock were distributed under the Plan to Mr. Bumgarner.
In addition, Mr. Bumgarner will provide consulting services at no cost to the
Company for a period of three years from the date of his retirement. The Company
recorded a loss of approximately $7 million to provision for doubtful accounts
for the ten months ended October 31, 2002 related to the agreement.
31
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company also recorded $12.1 million to reorganization expense for the
ten months ended October 31, 2002 related to an employee incentive program that
was adopted to retain employees during the Company's restructuring process, of
which $3.9 million and $0.7 million related to former officers of the Company
and current officers of the Company, respectively. As of November 5, 2003, the
Company had no liabilities related to the employee retention incentive program.
Leucadia
On November 27, 2002, WilTel entered into a one-year Restructuring Services
Agreement with Leucadia effective as of October 16, 2002 which later expired in
October 2003. Under the terms of this agreement, Leucadia provides restructuring
advice to WilTel with respect to management, operations, future business
opportunities, and other matters to be mutually determined between Leucadia and
WilTel. Leucadia does not receive any compensation for its services rendered
under this agreement, but is reimbursed for all expenses incurred in connection
with its performance under the agreement.
17. Commitments and Contingencies
Commitments
The Company has historically entered into various telecommunications
equipment agreements in connection with its fiber-optic network. As of November
5, 2003, the Company's remaining purchase obligations under its remaining
purchase agreements are not significant.
Litigation
The Company is subject to various types of litigation in connection with
its business and operations.
Department of Labor Investigation
In April 2003, the Company received written notice from the United States
Department of Labor that it is exercising its authority under Section 504 of the
Employee Retirement Income Security Act of 1974 ("ERISA") to conduct periodic
investigations of employee benefit plans to determine whether such plans conform
with the provisions of ERISA and other applicable regulations. The stated scope
of the review covers the Williams Communications Investment Plan (a defined
contribution plan) for a time period extending from 1998 through the present
date. In January 2004, the Company received a subpoena from the United States
Department of Labor requiring the production of related documents. The Company
is cooperating fully with the Department of Labor. At this time, neither the
length of the review nor likely outcome of the investigation can be determined.
The Company believes that all of its actions with respect to employee benefit
plans have been in full compliance with ERISA and other applicable regulations.
Right of Way Class Action Litigation
A number of suits attempting to achieve class action status seek damages
and other relief from the Company based on allegations that the Company
installed portions of its fiber-optic cable without all necessary landowner
consents. These allegations relate to the use of rights of way licensed by
railroads, state departments of transportation and others controlling
pre-existing right-of-way corridors. The putative members of the class in each
suit are those owning the land underlying or adjoining the right-of-way
corridors. Similar actions have been filed against all major carriers with
fiber-optic networks. It is likely that additional actions will be filed. The
Company believes it obtained sufficient rights to install its cable. It also
believes that the class action suits are subject to challenge on procedural
grounds.
32
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company and other major carriers are seeking to settle the class action
claims referenced above relating to the railroad rights of way through an agreed
class action. These companies initially sought approval of a settlement in a
case titled Zografos et al. vs. Qwest Communications Corp., et al., filed in the
U.S. District Court for the District of Oregon on January 31, 2002. On July 12,
2002, the Oregon Court dismissed the action. Thereafter, on September 4, 2002,
an existing case titled Smith, et al., vs. Sprint, et al., pending in the U.S.
District Court for the Northern District of Illinois, was amended to join the
Company and two other telecommunications companies as defendants. On July 25,
2003, the judge in this case issued an order preliminarily approving a proposed
settlement agreement and issued an injunction, which stayed other putative class
action railroad rights of way cases against the Company. Two of the intervening
plaintiffs filed appeals, which were consolidated. If this settlement withstands
potential challenges by plaintiffs' counsel, it will settle the majority of the
putative nationwide and statewide class actions related to the railroad
right-of-way claims. Based on the Company's estimate of a likely settlement
range, the Company has accrued $16.6 million as of November 5, 2003.
Other right of way claims may be asserted against the Company. The Company
cannot quantify the impact of all such claims at this time. Thus, WilTel cannot
be certain that an unfavorable outcome of other potential right-of-way claims
will not have a material adverse effect.
Platinum Equity Dispute
In March 2001, the Company sold its Solutions segment to Platinum Equity
LLC ("Platinum Equity") for a sales price that was subject to adjustment based
upon a computation of the net working capital of the business as of March 31,
2001. A dispute arose between the companies with respect to the net working
capital amount as defined in the agreement. Pursuant to the provisions of the
sale agreement, the parties submitted the dispute to binding arbitration before
an independent public accounting firm.
In September 2002, Platinum Equity filed suit in the District Court of
Oklahoma County, State of Oklahoma, against the Company alleging various
breaches of representations and warranties related to the sale of the Solutions
segment and requested a ruling that no payment was due under a promissory note
issued by Platinum Equity at the time of purchase until all disputes were
resolved. Many of the claims alleged by Platinum Equity in this suit are the
same claims asserted by Platinum Equity in the net working capital dispute.
Discovery in this suit is ongoing, with the trial expected to begin sometime in
Spring 2004.
In May 2003, the arbitrator rendered a determination of the adjustment
amount under the net working capital dispute, and an order entry of judgment was
entered against Platinum Equity in the amount of approximately $38 million,
which represented the amount that Platinum Equity owed under the promissory
note, offset by the net working capital adjustment determined by the arbitrator.
The Company adjusted the carrying amount of the note receivable to $38 million
by offsetting amounts previously accrued for the net working capital dispute. In
July 2003, the Company collected approximately $39 million, including interest,
from Platinum Equity related to the judgment. The receipt of the $39 million
does not resolve all of the issues between Platinum Equity and the Company as
neither company has waived any of the claims currently pending in the litigation
discussed above. The Company continues to believe that it is adequately reserved
or accrued with respect to its receivable and payable positions with Platinum
Equity.
Thoroughbred Technology and Telecommunications, Inc. vs. WCL
Thoroughbred Technology and Telecommunications, Inc. ("TTTI") filed suit on
July 24, 2001, against WCL in a case titled Thoroughbred Technology and
Telecommunications, Inc. vs. Williams Communications, LLC f/k/a Williams
Communications, Inc., Civil Action No. 1:01-CV-1949-RLV, pending in the U.S.
District Court for the Northern District of Georgia, Atlanta Division. TTTI
alleged claims that included breach of contract with respect to a fiber-optic
installation project that TTTI was constructing for itself and other parties,
including WCL, with respect to certain conduit segments including a
three-conduit segment between Cleveland, Ohio and Boyce, Virginia. TTTI sought
specific performance to require that WCL take title to the Cleveland-Boyce
segment and pay TTTI in excess of $36 million plus pre-judgment interest for
such purchase. WCL alleged various defenses, including significant warranty and
breach of contract claims against TTTI.
33
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
On May 9, 2002, the trial court determined that WCL did not have the right
to terminate the contract with respect to the Cleveland-Boyce segment, but
deferred ruling on TTTI's remedy until a later time. In a series of rulings on
January 27, 2003, the court ordered, among other things, (1) that WCL's claims
against TTTI for breach of contract and construction deficiencies for certain of
the telecommunications routes constructed by TTTI be heard by an arbitration
panel; and (2) that WCL close the purchase of the Cleveland-Boyce segment and
pay TTTI the sum of $36.3 million plus pre-judgment interest for such purchase.
The court denied WCL's motion for a stay of the proceedings while the
construction claims against TTTI are adjudicated through arbitration and further
denied the Company's request to stay closing on the Cleveland-Boyce segment
pending an appeal of the trial court's decision. WCL sought and obtained a stay
of the trial court's order compelling a closing of the Cleveland-Boyce segment
from the United States Court of Appeals for the 11th Circuit thereby staying
WCL's obligation to close the transaction until the appeal is decided. The stay
granted by the Court of Appeals was conditioned on the posting of an appropriate
supersedeas bond by the Company, which was posted by the Company in March 2003
in the approximate amount of $44.1 million. The Company posted the bond, which
was docketed by the trial court on March 13, 2003. WCL prosecuted its appeal of
the trial court's decision while pursuing its arbitration claims of construction
defects against TTTI. Oral arguments in the appeal were scheduled for November
2003.
Subsequent to November 5, 2003, the parties reached a settlement of their
disputes, which resulted in a payment of $37.5 million to TTTI and the transfer
of title to WCL of conduits on the Cleveland-Boyce segment. All settlement
documents were executed in November 2003, and this matter has been concluded.
StarGuide
On October 12, 2001, StarGuide Digital Networks ("StarGuide") sued WCG in
the United States District Court for Nevada for infringement of three patents
relating to streaming transmission of audio and video content. Subsequently,
StarGuide added WCL as a party to the action. StarGuide seeks compensation for
past infringement, an injunction against infringing use, and treble damages due
to willful infringement. On July 1, 2002, StarGuide initiated a second patent
suit against WCL with respect to a patent that is a continuation of the patents
at issue in the prior litigation. The two actions have been consolidated. In
July 2003, the parties reached a settlement, and this case was dismissed by
joint agreement. The settlement did not have a material impact on the Company's
results of operations, financial position or cash flows.
WilTel Shareholder Derivative Lawsuits
On May 15, 2003, the first of several shareholder derivative class actions
was filed against WilTel, the nine members of WilTel's Board of Directors and
Leucadia National Corporation ("Leucadia"). Currently, the Company has been
served with notice of eight (8) shareholder derivative class actions: four (4)
in Clark County, Nevada, one (1) in Washoe County, Nevada, two (2) in New York
County, New York and one (1) in Tulsa County, Oklahoma. Each of the lawsuits
sets forth substantially the same allegations of breach of fiduciary duty in
connection with Leucadia's proposed exchange offer announced on May 15, 2003.
Amended complaints were filed in each of the lawsuits based upon Leucadia's
withdrawal of its initial offer and Leucadia's subsequent offers. On October 15,
2003, subject to approval from directors and officers insurance carriers, the
parties in these cases reached an agreement in principle to settle all cases. On
February 4, 2004, the proposed settlement in one of the New York County cases
was approved by the trial court. The amount of the settlement is $300,000
representing Plaintiffs' attorney fees and expenses and is not material to the
financial statements of WilTel. The settlement proceeds will be paid upon the
expiration of the time period within which the matter may be appealed.
34
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Summary
The Company is a party to various other claims, legal actions, and
complaints arising in the ordinary course of business. In the opinion of
management, upon the advice of legal counsel, the ultimate resolution of all
claims, legal actions, and complaints, after consideration of amounts accrued,
insurance coverage, or other indemnification arrangements, is not expected to
have a materially adverse effect upon the Company's future financial position or
results of operations, although unfavorable outcomes in the items discussed
above could significantly impact the Company's liquidity.
Other
SBC
SBC is the Company's largest customer (comprising 54 percent, 47 percent
and 37 percent of Network's revenues for the period from January 1, 2003 through
November 5, 2003 and the year ended December 31, 2002 and 2001, respectively).
The Company has entered into preferred provider agreements with SBC that extends
until 2019, although the agreements may be terminated prior to then by either
party under certain circumstances. The agreements provide that:
o the Company is SBC's preferred provider for domestic voice and data
long distance services and select international wholesale services,
requiring that SBC seek to obtain these services from the Company
before it obtains them from any other provider; and
o SBC is the Company's preferred provider for select local exchange and
various other services, including platform services supporting its
switched voice services network, requiring that the Company seek to
obtain these services from SBC before it obtains them from any other
provider.
For the services each party must seek to obtain from the other, the prices,
determined separately for each product or service, generally will be equal to
the lessor of the cost of the product or service plus a specified rate of
return, the prices charged to other customers, the current market rate or, in
some circumstances, a specific rate. If either party can secure lower prices for
comparable services that the other party will not match, then that party is free
to utilize the lowest cost provider. Subsequent to November 5, 2003, the Company
and SBC have agreed to use a fixed price for voice transport services (the
substantial majority of SBC generated revenue) through January 2005. Although it
is difficult to identify a precise market price since the products and services
provided to each customer are customized to meet the needs of each customer, the
fixed price currently charged to SBC is representative of the current market
price for the voice transport service currently provided to SBC.
The methodology that the Company uses to determine the current market rate
and to determine the cost of the product or service upon which a specified rate
of return applies are complex and subject to different interpretations. If SBC
and the Company are unable to agree on the methods used, the agreements with SBC
provide that any disputes are resolved through binding arbitration. If SBC
successfully challenged the Company's pricing methodology in an arbitration
proceeding, resulting in a significant reduction in the voice transport price,
the Company may not be able to continue to provide services to SBC. The Company
is unable to predict the ultimate outcome of future price discussions with SBC.
SBC has the right to terminate the agreements if the Company begins to
offer certain services that are competitive with SBC's services, if the Company
materially breaches its agreements or the Company has a change in control
without SBC's consent. The Company has the right to terminate the agreements if
SBC materially breaches its agreements or SBC has a change in control without
the Company's consent. In the event of a termination by either party due to
these actions, the terminating party has the right to receive transition costs
from the other party, not to exceed $200 million.
Either party may terminate a particular provider agreement if the action or
failure to act of any regulatory authority materially frustrates or hinders the
purpose of that agreement. There is no monetary remedy for such a termination.
35
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
18. Financial Instruments
Fair Value Methods
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts reported in the balance
sheet approximate fair value due to the short-term maturity of these
instruments.
Notes receivables: The carrying amounts reported in the balance sheet
approximate fair value due to the short-term maturity of these instruments.
Long-term debt: The carrying amounts reported in the balance sheet
approximate fair value due to the long-term debt outstanding being primarily
variable-rate debt.
Concentration of Credit Risk
The Company's cash equivalents include high-quality securities placed with
various major financial institutions with high credit ratings. The Company's
investment policy limits its credit exposure to any one issuer/obligor.
The Company's customers include numerous corporations. The Company serves a
wide range of customers, of which SBC comprises approximately 38% of its net
accounts receivable balance as of November 5, 2003. There are no other
customers, which are individually significant to its business. While sales to
these various customers are generally unsecured, the financial condition and
creditworthiness of customers are routinely evaluated.
19. Bankruptcy Proceedings
Overview of the Chapter 11 Proceedings
On April 22, 2002, the Debtors filed petitions for relief under the
Bankruptcy Code in the Bankruptcy Court. On September 30, 2002, the Bankruptcy
Court entered an order confirming the Second Amended Joint Chapter 11 Plan of
Reorganization of the Debtors (the "Plan"), effective on October 15, 2002 (the
"Effective Date"). The confirmation order was subject to certain conditions
including gaining necessary FCC regulatory approvals to transfer control of
licenses from WCG to the Company. Prior to the Effective Date, WCG, WCL, and the
Company applied to and received from the FCC special temporary authority to
transfer control of all licenses to the Company. The granting of the special
temporary authority from the FCC allowed the Company to emerge from the chapter
11 proceedings on the Effective Date subject to an escrow agreement discussed
below.
A copy of the Plan was filed as Exhibit A to Exhibit 99.2 to WCG's Current
Report on Form 8-K, dated August 13, 2002. Modifications to the Plan were filed
as Exhibit 99.3 to WCG's Current Report on Form 8-K, dated September 30, 2002
(the "Confirmation Date 8-K"). A copy of the Confirmation Order was filed as
Exhibit 99.1 to the Confirmation Date 8-K.
Described below is a summary of certain significant agreements and
important events that have occurred in and following the bankruptcy
reorganization. The summary should be read in conjunction with and is qualified
in its entirety by reference to the Plan and the material transaction documents
discussed herein and made available as exhibits to WCG's and WilTel's public
filings, including those filed with the SEC.
36
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Plan of Reorganization
On September 30, 2002, the Bankruptcy Court approved and entered an order
confirming the Plan, which had been proposed by the Debtors, the official
committee of unsecured creditors (the "Committee") and Leucadia National
Corporation ("Leucadia"). The Plan was designed to meet the requirements of the
Settlement Agreement (described in greater detail below) and the pre-petition
Restructuring Agreement. By implementing both the Settlement Agreement and the
Restructuring Agreement, the Plan allowed WCG to raise the $150 million new
investment from Leucadia. That additional investment allowed WCG to further
reduce its secured debt without sacrificing working capital (see below for a
discussion of the Escrow Agreement and the ultimate release from escrow of the
$150 million investment).
Settlement Agreement
On July 26, 2002, TWC, the Committee, and Leucadia entered into a
settlement agreement (the "Settlement Agreement") that provided for, among other
things, (a) the mutual release of each of the parties, (b) the purchase by
Leucadia of TWC's unsecured claims against WCG (approximately $2.35 billion face
amount) for $180 million, (c) the satisfaction of such TWC claims and a $150
million investment in the Company by Leucadia in exchange for 44% of the
outstanding WilTel common stock, and (d) modification of WCG's sale and
subsequent leaseback transaction covering the WCG headquarters building and
modification of the TWC Continuing Contracts (as defined in the Settlement
Agreement). An order approving the Settlement Agreement was issued on August 23,
2002.
TWC's unsecured claims of $2.35 billion related to arrangements between WCG
and TWC and primarily consisted of the following:
Senior Reset Note Claim: Approximately $1.4 billion of those claims related
to the Trust Notes, which were senior secured notes issued by a WCG subsidiary
in March 2001. The proceeds from the sale of the Trust Notes were (i)
transferred to WCG in exchange for WCG's $1.5 billion 8.25% senior reset note
due 2008 (the "Senior Reset Note") and (ii) contributed by WCG as capital to WCL
to provide liquidity following the tax-free spin-off from TWC. Obligations of
WCG and its affiliates under the Trust Notes were secured by the Senior Reset
Note and were effectively guaranteed by TWC. In July 2002, TWC exchanged $1.4
billion of new senior unsecured notes of TWC (the "New TWC Notes") for all of
the outstanding Trust Notes. TWC, as agent under the Trust Notes indenture, had
the right to sell the Senior Reset Note to achieve the highest reasonably
available market price and the Bankruptcy Court found that the TWC sale of the
TWC Assigned Claims to Leucadia met this requirement.
ADP Claims: In 1998, WCG entered into an operating lease agreement covering
a portion of its fiber-optic network referred to as an asset defeasance program
("ADP"). The total cost of the network assets covered by the lease agreement was
$750 million. Pursuant to the ADP, WCG had the option to purchase title to those
network assets at any time for an amount roughly equal to the original purchase
price, and TWC was expressly obligated to pay the purchase price under an
intercreditor agreement entered into by TWC in connection with the then-existing
WCL credit facility. In March 2002, WCG exercised its purchase option, and TWC
funded the purchase price of approximately $754 million. In exchange for this
payment from TWC, the intercreditor agreement provided that TWC was entitled to
either the issuance of WCG equity or WCG unsecured subordinated debt (meaning
debt that was subordinate in priority to WCL's pre-petition credit facility),
each on terms reasonably acceptable to the lenders under WCL's pre-petition
credit facility. On March 29, 2002, WCG tendered an unsecured note to TWC for
approximately $754 million that was not accepted by TWC. Any and all causes of
action of TWC or any of its direct or indirect subsidiaries against a Debtor
relating to the ADP were resolved pursuant to the terms of the Settlement
Agreement.
37
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Pre-Spin Services Claims: The terms of the Settlement Agreement also
resolved "Pre-Spin Services Claims" of TWC arising from a Services Agreement
entered into between WCG and TWC when WCG was a wholly-owned subsidiary of TWC.
Pursuant to this agreement, TWC and certain of its affiliates performed payroll,
administrative, and related services for WCG and its affiliates. Pre-Spin
Services Claims were also resolved pursuant to the Settlement Agreement.
The Settlement Agreement also resolved WCG's defaults under the sale and
subsequent leaseback transaction (discussed below) as a result of WCG's
bankruptcy filing, thus negating any threat or risk that the Company would be
evicted or otherwise lose possession of its headquarters due to the bankruptcy.
SBC Stipulation
On September 25, 2002, the Bankruptcy Court approved a stipulation
agreement (the "Stipulation Agreement") between the Company and SBC conditioned
upon the consummation of the Plan. The Stipulation Agreement provided for the
necessary SBC approval of the Plan and resolved change-of-control issues that
SBC had raised regarding WCG's spin-off from TWC. At the same time, SBC and WCL
executed amendments to their alliance agreements.
Purchase of Headquarters Building
In connection with the spin-off of WCG by TWC in 2001, TWC and WCG entered
into a sale and leaseback transaction for WCG's headquarters building and
certain real and personal property, including two corporate aircraft (the
"Building Purchase Assets"), as a result of which TWC purchased the Building
Purchase Assets and leased them back to WCG. Pursuant to an agreement between
WCG and TWC, among others, dated July 26, 2002, (as amended, the "Real Property
Purchase and Sale Agreement"), WCG repurchased the Building Purchase Assets from
TWC for an aggregate purchase price of approximately $145 million (the "Purchase
Price").
The Purchase Price consisted of promissory notes issued by Williams
Technology Center, LLC ("WTC"), the Company, and WCL to TWC (the "OTC Notes").
One note for $100 million is due April 1, 2010; the other note for $44.8 million
is due December 29, 2006. The obligations of WTC, WilTel, and WCL under the OTC
Notes may be subject to reduction, depending on the disposition of certain
aircraft leases described in greater detail in the Real Property Purchase and
Sale Agreement. Obligations of WTC, WilTel, and WCL under the OTC Notes were
secured by, and made pursuant to, a mortgage agreement (the "OTC Mortgage"),
under which WTC granted a first priority mortgage lien and security interest to
TWC in all of its right, title and interest in, to and under the headquarters
building and related real and personal property.
The Settlement Agreement also contemplated that the lenders under the
Company's credit facility would receive a second priority mortgage lien and
security interest in those same assets. The Real Property Purchase and Sale
Agreement also provided that the OTC Notes are secured in part by a second lien
and security interest in the Company's interests in PowerTel. See Note 12 for a
further discussion of the terms of the OTC Notes.
As described below, consummation of the transactions contemplated by the
Real Property Purchase and Sale Agreement were conditioned upon satisfaction of
the terms of the Escrow Agreement (as defined below).
Transactions on the Effective Date
On the Effective Date, pursuant to the Plan and the confirmation order,
WilTel emerged as the successor to WCG and issued an aggregate of 22,000,000
shares of WilTel common stock to Leucadia and an aggregate of 27,000,000 shares
of WilTel common stock to a grantor trust (the "Residual Trust") among WCG,
WilTel, and Wilmington Trust Corporation, as trustee (the "Residual Trustee") on
behalf of certain creditors of WCG. An additional 1,000,000 shares of WilTel
common stock were issued to WCG in connection with a "channeling injunction"
that could potentially benefit securities holders involved in a class action
proceeding against WCG.
38
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
WilTel issued shares of its common stock to Leucadia under the Plan in two
distributions. First, pursuant to a Purchase and Sale Agreement, dated as of
July 26, 2002, between Leucadia and TWC (amended on October 15, 2002), Leucadia
acquired from TWC certain claims that TWC had against WCG (the "TWC Assigned
Claims") for a purchase price of $180 million paid in the form of a letter of
credit issued by Fleet Bank (the "TWC Letter of Credit") and WilTel issued
11,775,000 shares of its common stock to Leucadia in satisfaction of such claims
in accordance with the Plan.
Second, pursuant to an Investment Agreement by and among Leucadia, WCG, and
WCL, dated as of July 26, 2002 (amended on October 15, 2002), on the Effective
Date Leucadia invested $150 million in the Company in exchange for 10,225,000
shares of WilTel common stock (the "New Investment"). Leucadia paid $1,000 of
the purchase price in cash to WilTel and delivered the remainder, in the form of
a letter of credit issued by JP Morgan Chase Bank (the "Company Letter of
Credit").
Leucadia delivered the TWC Letter of Credit and the Company Letter of
Credit into an escrow account established pursuant to an Escrow Agreement (the
"Escrow Agreement") dated as of October 15, 2002, among the Company, Leucadia,
TWC, and The Bank of New York as Escrow Agent. The Escrow Agreement provided for
the release of the Letters of Credit (and documents related to the Real Property
Purchase and Sale Agreement) upon receipt, prior to February 28, 2003, of
approval from the FCC for the transfer of control to the Company of the licenses
that had been temporarily issued to WCL prior to the Effective Date. Failure to
obtain FCC approval by February 28, 2003, in accordance with the terms of the
Escrow Agreement would have resulted in an "unwind" of the New Investment and
the purchase of the TWC Assigned Claims. However, following receipt of the FCC
approval on November 25, 2002, the proceeds of the Company Letter of Credit were
paid to the Escrow Agent for disbursement to the Company in accordance with the
terms of the Escrow Agreement, and the proceeds of the TWC Letter of Credit were
paid to the Escrow Agent for disbursement to TWC.
WCG continues to exist as a separate corporate entity, formed in the State
of Delaware, in order to liquidate any residual assets and wind up its affairs.
On the Effective Date, WCG transferred substantially all of its assets to
WilTel. The other Debtor, CG Austria, continues to exist as a separate corporate
entity, incorporated in the State of Delaware, and owned solely by WCL.
The Exit Credit Agreement
On the Effective Date, WCL and the lenders under its credit facility (the
"Lenders") entered into a credit agreement (the "Exit Credit Agreement") that
combined the term loans under the previous credit facility into one loan for
$375 million (paid down throughout the bankruptcy from a pre-petition balance of
$975 million). See Note 12 for a further discussion of the terms of the Exit
Credit Agreement.
Capitalization, Corporate Governance, and Leucadia Agreements
Pursuant to the Plan and a Stockholders Agreement, dated October 15, 2002,
between Leucadia and the Company (the "Stockholders Agreement"), the Company's
Board of Directors was comprised of four members designated by Leucadia, four
members designated by the Official Committee of Unsecured Creditors of WCG, and
the Chief Executive Officer of the Company, Jeff K. Storey, who was elected as
Chief Executive Officer of the Company and became a member of the Board of
Directors on October 31, 2002. Pursuant to the Stockholders Agreement, so long
as Leucadia beneficially owned at least 20% of the outstanding common stock of
WilTel, it would be entitled to nominate four members of the Board of Directors.
If Leucadia beneficially owned less than 20% but more than 10% of the
outstanding common stock of WilTel, it would be entitled to nominate one member
to the Board of Directors. In addition, the Stockholders Agreement provided
that, until October 15, 2004, Leucadia would vote all of its shares of WilTel
common stock in favor of Committee designees to the Board. Until October 15,
2004, any replacement of a Committee designee will occur through a nominating
process detailed at Section 3.4 of the Stockholders Agreement.
39
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Pursuant to the Stockholders Agreement, for a period of five years from the
Effective Date of the Plan, Leucadia would not acquire or agree to acquire any
of the Company's securities except (a) with prior approval by a majority of the
members of the Board of Directors that are independent or by holders of a
majority of the Company voting securities that are not owned by Leucadia voting
together as a single class, (b) in connection with certain other acquisitions,
so long as Leucadia would not hold in excess of 49% of the Company's voting
securities following such acquisition or (c) a Permitted Investor Tender Offer
(as defined in the Stockholders Agreement). The Leucadia exchange offer
described in Note 1 was a Permitted Investor Tender Offer approved by WilTel's
Board of Directors in August 2003 when the Board approved the merger agreement.
In addition, the Stockholders Agreement was terminated upon the consummation of
the merger by Leucadia.
The WilTel articles of incorporation (the "Charter") provided that 200
million shares of common stock were authorized for issuance (of which 50 million
shares were issued under the Plan and are outstanding), and 100 million shares
of preferred stock were authorized for issuance (of which no shares were issued
and outstanding).
Leucadia has entered into a Registration Rights Agreement with the Company
by which the Company has granted Leucadia certain rights to obligate the Company
to register for sale under the Securities Act of 1933, the shares owned by
Leucadia or its affiliates, including the shares issued pursuant to the Plan.
Leucadia and the Company have entered into a Stockholder Rights and Co-Sale
Agreement (the "Co-Sale Agreement") by which, among other things, certain WilTel
holders (any of the approximately 2,500 holders who submitted an affidavit
within 90 days after the Effective Date, or their Permitted Transferee under the
Co-Sale Agreement, who maintain beneficial ownership of at least 100 shares of
common stock received pursuant to the Plan) will be eligible to participate in
(i) issuances of Securities (as defined in the Co-Sale Agreement) to Leucadia
until the fifth anniversary of the Effective Date and (ii) any transfer (other
than transfers to affiliates of Leucadia and Exempt Transactions (as defined in
the Co-Sale Agreement)) by Leucadia of shares of WilTel common stock
representing 33% or more of the WilTel common stock outstanding. In addition,
two such holders each paid $25,000 to the Company (with the submission of the
affidavit referred to above) to be eligible to participate in proposed issuances
or actual issuances of Other Securities (as defined in the Co-Sale Agreement) to
Leucadia until the fifth anniversary of the Effective Date. The Co-Sale
Agreement was terminated upon the consummation of the merger by Leucadia.
On October 28, 2002, Leucadia purchased in a private transaction 1.7
million shares of WilTel's common stock as reported on Schedule 13-D filed on
October 30, 2002, which brought Leucadia's ownership interest in WilTel to
47.4%.
The "Five-Percent Limitation" on Stock Ownership
As required by the Plan, the Charter imposes certain restrictions on the
transfer of "Corporation Securities" (as defined in the Charter, including
common stock, preferred stock, and certain other interests) with respect to
persons who are, or become, five-percent shareholders of the Company, as
determined in accordance with applicable tax laws and regulations (the
"Five-percent Ownership Limitation"). The Five-percent Ownership Limitation
provides that any transfer of, or agreement to transfer, Corporation Securities
prior to the end of the effectiveness of the restriction (as described below)
shall be prohibited if either (y) the transferor holds five percent or more of
the total fair market value of the Corporation Securities (a "Five-percent
Shareholder") or (z) to the extent that, as a result of such transfer (or any
series of transfers of which such transfer is a part), either (1) any person or
group of persons shall become a Five-percent Shareholder, or (2) the holdings of
any Five-percent Shareholder shall be increased, excluding issuances of WilTel
common stock under the Plan and certain other enumerated exceptions. Each
certificate representing shares of WilTel common stock bears a legend that
re-states the applicable provisions of the Charter.
40
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Five-percent Ownership Limitation will not apply to: (i) certain
transactions approved by the WilTel Board, (ii) an acquisition by Leucadia of
shares of the Corporation Securities that, as a percentage of the total shares
outstanding, is not greater than the difference between 49% and the percentage
of the total shares outstanding acquired by Leucadia or any of its subsidiaries
in the Plan, plus any additional Corporation Securities acquired by Leucadia and
its subsidiaries, and (iii) certain other transactions specified in the Charter
if, prior to the transaction, the WilTel Board or a duly authorized committee
thereof determines in good faith upon request of the transferor or transferee
that the transaction meets certain specified criteria. The Five-percent
Ownership Limitation did not apply to the merger by Leucadia since the merger
agreement was approved by the WilTel Board.
The Charter also prohibits the issuance of non-voting equity securities.
Additional Effective Date Transactions
In addition, the following transactions, among others, occurred on the
Effective Date pursuant to the Plan (capitalized terms used but not defined
herein have the meaning ascribed to them in the Plan):
o All of the Restated Credit Documents were executed and delivered and
became effective, and $350 million was paid to the Lenders thereunder.
o Each of the transactions that comprised the TWC Settlement occurred or
were implemented and became binding and effective in all respects
(subject to the Escrow Agreement), including:
- documents to effect the sale by Williams Headquarters Building
Company of the Building Purchase Assets to WTC pursuant to the
Real Property Purchase and Sale Agreement were deposited into
escrow with The Bank of New York, as Escrow Agent, and
subsequently delivered when the $330 million proceeds of the
Leucadia New Investment and purchase of TWC Assigned Claims were
released to the Company and TWC, respectively, pursuant to the
terms of the Escrow Agreement;
- all of the releases contemplated by the TWC Settlement became
binding and effective, including releases whereby WCG, WCG's
current and former directors and officers, and the Committee
released TWC and its current and former directors, officers, and
agents; in addition, TWC released WCG and WCG's current and
former directors and officers, including the claims that TWC
alleged it had against WCG's non-debtor subsidiaries; and
- all other transactions contemplated under the TWC Settlement were
consummated.
o As contemplated by the Settlement Agreement, the confirmation
order provided an injunction with respect to (a) channeling all
personal claims of WCG's unsecured creditors against TWC and
deeming them satisfied from the consideration provided by TWC
under the Settlement Agreement; and (b) channeling all remaining
securities actions against WCG's officers and directors to a
"fund" consisting of up to 2% of WilTel's common stock and the
right to collect under WCG's director and officer liability
insurance policies.
o Pursuant to the Settlement Agreement, TWC transferred to WCG all
of its rights in the "WilTel" and "WilTel Turns Up Worldwide"
marks, and in exchange WCG agreed to amend the term of the
Trademark License Agreement, dated April 23, 2001, between TWC
and WCG, to two years following the Effective Date, at which time
the Company would no longer have the right to use the "Williams"
mark, the "Williams Communications" mark, and certain other
"Williams" related marks. The transfer of these rights was
effectuated through an Assignment of Rights Agreement between
Williams Information Services Corporation ("WISC") and WCL
pursuant to which WISC agreed to grant, sell, and convey to WCL
all of its right, title, and interest in the United States and
Canada to the trademarks "WilTel" and "WilTel Turns Up
Worldwide."
41
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
o WCG has various administrative service and support contracts with
TWC. The Settlement Agreement provides for the continuation of
only those contracts between WCG and the TWC entities that WCG
views as favorable (the "TWC Continuing Contracts"), as well as
modification to certain of those TWC Continuing Contracts to
waive any rights to an unfavorable alteration of contract terms
due to the New Investment or the transactions contemplated by the
Plan.
All other payments, deliveries and other distributions to be made pursuant
to the Plan or the Restated Credit Documents on or as soon as practicable after
the Effective Date were made or duly provided for.
20. Adoption of Fresh Start Accounting
As discussed in Note 19, the Company emerged from bankruptcy on October 15,
2002. Pursuant to the provisions of SOP 90-7, the Company adopted the provisions
of fresh start accounting on October 31, 2002 to coincide with its normal
monthly financial closing cycle. Under fresh start accounting, the net
reorganization value of the Company was allocated among the Company's individual
assets and liabilities based upon their relative fair values, which were
primarily based upon independent appraisals.
In conjunction with formulating the Plan, the Company was required to
estimate its post-confirmation reorganization value. The Company's financial
advisors assisted in the valuation utilizing methodologies that were based upon
the cash flow projections and business plan as contemplated by the Predecessor
Company. These methodologies incorporated discounted cash flow techniques, a
comparison of the Company and its projected performance to market values of
comparable companies and a comparison of the Company and its projected
performance to values of past transactions involving comparable entities. The
cash flow valuations utilized five-year projections discounted at a weighted
average cost of capital of approximately 27.5%, including a terminal value equal
to a multiple of projected fifth year operating results, together with the net
present value of the five-year projected cash flows. Based upon these analyses,
upon emergence from the chapter 11 proceedings, the reorganization value for the
Company was estimated to be approximately $1.3 billion, which was within the
range of reorganization values contained in the Company's disclosure statement
filed in the chapter 11 proceedings. This reorganization value was reflected in
the Company's consolidated balance sheet upon emergence from the chapter 11
proceedings as post-emergence debt of approximately $573 million and an equity
value of $750 million. The Company's post-emergence debt was valued at the
present value of amounts expected to be paid, which was principally the face
amount. The Company's total common equity value was determined by reference to
the implied value of the equity derived from Leucadia's purchase of 44% of the
Company for $330 million.
The reorganization value was allocated to the Company's net assets in
relation to their fair values similar to the procedures specified in SFAS 141,
"Business Combinations." The Company recorded $2.2 billion in reorganization
items to record its net assets to fair value primarily consisting of the
following:
o an adjustment to property, plant and equipment of approximately
$2.4 billion to reflect its fair value;
o an adjustment to deferred revenue of approximately $210 million
to reflect the estimated value of such contracts as if they were
entered into on the Effective Date;
42
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
o a liability for long-term commitments not representative of
current market conditions of approximately $84 million for
commitments that were either above current market rates or for
capacity not required based on the Company's business plans
primarily related to real estate leases and domestic and
international capacity contracts; and
o an adjustment in the benefit obligation of approximately $40
million to record unrecognized prior service costs and actuarial
gains (losses) through October 31, 2002.
The allocation of net reorganization value to assets and liabilities
required significant judgment and assumptions. For example, the Company engaged
an independent appraiser to assist in its determination that the fair value of
its long-lived assets was approximately $1.5 billion and in its allocation of
the fair value to the various asset classes. The Company and the appraiser
considered several factors, such as local market conditions; the size and
character of the property; the estimated cost to acquire comparable property (if
comparable property was available); the estimated cost to acquire new property,
less the loss of value (depreciation) resulting from physical, functional and
economic obsolescence; contractual relationships; the remaining expected useful
life of the assets and estimates of future network capacity utilization. To the
extent actual results are different than the assumptions the Company made,
future results of operations could be impacted either positively or negatively.
The aggregate replacement cost of new property, plant and equipment was
estimated to be approximately $6 billion. This estimate was comprised of a
significant network construction cost element of approximately $3 billion
(including rights of way, conduit and fiber) and equipment that is part of the
network of approximately $1.5 billion. The network construction and related
equipment are both industry specific. The remaining balance of the estimate was
comprised of buildings and other equipment, which are not necessarily industry
specific. Functional and economic obsolescence factors reduced the aggregate
value of the property, plant and equipment by approximately $4 billion and
primarily reflected the current abundance of capacity in the telecommunications
industry for network-related assets. Estimates of fair values were further
reduced to account for the age of the Company's assets. If the assumptions used
by the Company were changed to result in a different estimate of fair value, the
Company's financial position and results of operations could be materially
different. For example, if upon using different assumptions the estimate of fair
value was lowered, the Company would have likely recognized some amount of
goodwill and less property, plant and equipment upon emergence from its chapter
11 proceedings in its statement of financial position, which would have also
resulted in lower depreciation expense in the future. Conversely, if upon using
different assumptions the estimate of fair value was greater than the amount
determined, there would have been minimal impact on the Company's current
financial position or future results of operations, since any such increase in
value would reduce the Company's initial estimated value of its long-term
assets, which in this case was property, plant and equipment.
In addition, the net assets of PowerTel were assumed to have minimal value
based on assessments by management and its financial advisor assisting with the
potential sale of the Company's ownership interest in PowerTel. An important
element of that assessment included PowerTel's struggles to maintain compliance
with its bank covenants. In August 2003, market conditions improved such that
the Company sold its ownership interest in PowerTel resulting in a gain of $21.1
million as discussed in Note 5.
The fair value adjustment to reflect the new carrying value for deferred
revenue of approximately $253 million required a determination of fair value for
transactions having limited activity in the current telecommunications market
environment. The fair value adjustment considered market indicators related to
pricing, quotes from third parties, pricing for comparable transactions as well
as the legal obligation of the Company to provide future services in accordance
with EITF 01-3, "Accounting in a Purchase Business Combination for Deferred
Revenue of an Acquiree." The Company also assumed it would continue to perform
its contractual obligations through the term of its contracts. Revenue will be
recognized on these contracts as services are performed, typically on a
straight-line basis over the remaining length of the contract. Future results of
operations could be impacted by the early termination of the Company's
obligations to the extent the contracts are rejected through a customer
bankruptcy proceeding or otherwise settled prior to completing the Company's
performance obligation.
43
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
An $84 million liability, on a net present value basis, was recorded for
unfavorable long-term commitments that are either above the current market rates
for similar transactions (net of certain contracts that are below current market
rates) or for telecommunications capacity that is not required based on the
Company's revised business plans. These commitments primarily consist of real
estate leases and domestic and international capacity contracts. The accrual for
these unfavorable commitments includes significant assumptions pertaining to
future market prices, future capacity utilization, the ability to enter into
subleasing arrangements and that the commitments will not be terminated prior to
their expiration dates. The accrued liability will be amortized on a
straight-line basis over the life of the commitments. However, future results of
operations could be impacted by a subsequent adjustment to the accrued liability
as a result of the Company terminating or reducing its contractual obligation as
a result of subsequent agreements with contract counter-parties or sublease
activity different from the Company's original assumptions.
The impact of the Plan and fresh start accounting on the Predecessor's
consolidated balance sheet as of October 31, 2002 is as follows:
Successor
Company
(a) (b) Fresh Start (e) After
Predecessor New Debt Accounting Escrow Escrow
Company Investment Restructuring Adjustments Release Release
------- ---------- ------------- ----------- ------- -------
(In millions)
Assets
Current assets:
Cash and cash equivalents $ 517.6 $ -- $ (350.0) $ -- $ 150.0 $ 317.6
Receivables 171.8 -- (1.8) 11.1 (c) -- 181.1
Notes receivable 55.0 -- -- -- -- 55.0
Other 69.0 -- (0.9) (13.8) (c) -- 54.3
---------- --------- ----------- ---------- --------- ---------
Total current assets 813.4 -- (352.7) (2.7) 150.0 608.0
Property, plant and equipment, net 3,910.1 -- -- (2,408.0) (c) -- 1,502.1
Other assets and deferred charges, net 73.6 -- (3.3) (20.3) (c) -- 50.0
---------- --------- ----------- ---------- --------- ----------
Total assets $ 4,797.1 $ -- $ (356.0) $ (2,431.0) $ 150.0 $ 2,160.1
========== ========= =========== ========== ========= =========
Liabilities and stockholders' equity (deficit)
Current liabilities:
Current liabilities not subject to
compromise:
Accounts payable $ 168.2 $ -- $ (0.5) $ (0.1) (c) $ -- $ 167.6
Deferred revenue 100.6 -- -- (25.4) (c) -- 75.2
Accrued liabilities 228.8 -- (0.2) 43.2 (c) -- 271.8
Long-term debt due within one year 380.1 -- (373.1) -- -- 7.0
---------- --------- ----------- ---------- --------- ---------
Total current liabilities not --
subject to compromise 877.7 -- (373.8) 17.7 521.6
Current liabilities subject to
compromise 243.0 -- (243.0) -- -- --
---------- --------- ----------- ---------- --------- ---------
Total current liabilities 1,120.7 -- (616.8) 17.7 -- 521.6
Long-term debt 640.8 -- (74.6) -- -- 566.2
Long-term deferred revenue 362.1 -- -- (184.4) (c) -- 177.7
Other liabilities 51.9 -- -- 87.7 (c) -- 139.6
Long-term liabilities subject to
compromise 4,603.9 -- (4,603.9) -- -- --
Minority interest in consolidated
Subsidiary 36.5 -- -- (31.5) (c) -- 5.0
6.75% redeemable cumulative
convertible preferred stock 166.1 -- -- (166.1) (d) -- --
Stockholders' equity (deficit):
Common stock 5.0 0.1 0.4 (5.0) (d) -- 0.5
Capital in excess of par value 3,993.9 149.9 599.6 (3,993.9) (d) -- 749.5
Subscriptions receivable -- (150.0) -- -- 150.0 --
Accumulated deficit (6,167.3) -- 4,339.3 1,828.0 (d) -- --
Other comprehensive loss (16.5) -- -- 16.5 (d) -- --
---------- --------- ----------- ---------- --------- ---------
Total stockholders' equity (deficit) (2,184.9) -- 4,939.3 (2,154.4) 150.0 750.0
---------- --------- ----------- ---------- --------- ---------
Total liabilities and stockholders'
equity (deficit) $ 4,797.1 $ -- $ (356.0) $ (2,431.0) $ 150.0 $ 2,160.1
========== ========= =========== ========== ========= =========
44
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Explanations of the adjustment columns in the consolidated balance sheet
are as follows:
(a) To record the $150 million investment by Leucadia as a subscription
receivable until the proceeds placed in escrow were released.
(b) To reflect the $350 million prepayment on the credit facility, the
discharge of liabilities subject to compromise, the replacement of the sale
and subsequent leaseback debt with the OTC Notes and issuance of WilTel
common stock upon consummation of the Plan resulting in a gain on the
reorganization of $4.3 billion.
(c) To reflect the fair value of net assets as of October 31, 2002.
(d) To reflect the cancellation of WCG's Class A common stock and the 6.75%
redeemable cumulative convertible preferred stock and the elimination of
accumulated deficit and other comprehensive loss.
(e) To reflect the release of the $150 million Leucadia investment from escrow
in December 2002.
21. Reorganization Items, Net
Reorganization items, which consist of items incurred by WCG as a result of
reorganization under the Bankruptcy Code, are as follows for the ten months
ended October 31, 2002:
Predecessor
(In thousands)
Reorganization items, net:
Gain on the discharge of liabilities (a) $ 4,339,342
Fresh start adjustments to fair value (b)............... (2,154,464)
Gain on forgiveness of interest (c).................... 73,898
Write-off of deferred financing costs (d).............. (92,391)
Write-off of debt discounts (d)........................ (10,055)
Retention bonus agreements with former officers (e).... (12,926)
Retention incentive expense (e)........................ (12,108)
Professional fees and other (f)....................... (68,109)
Interest income (g)................................... 2,845
-----------
$ 2,066,032
===========
Explanations of the reorganization items in the table above are as follows:
(a) The gain on the discharge of liabilities subject to compromise
primarily included the Senior Redeemable Notes of approximately $2.4
billion, the Trust Notes of $1.4 billion, the ADP Claims of
approximately $754 million, the Pre-Spin Services Claims of $100
million, the replacement of the sale and subsequent leaseback debt
with the OTC Notes of approximately $97 million and accrued interest
of approximately $137 million, partially offset by the issuance of
$600 million of WilTel common stock.
(b) See Note 20 for a discussion of the adjustments to record net assets
to fair value in fresh start accounting.
(c) As discussed in Note 19, in March 2002, certain provisions of the
indenture related to the Trust Notes were amended. The amendment,
among other things, provided that TWC would make the required March
and September 2002 interest payments on behalf of WCG to WCG Note
Trust, and WCG would not be required to reimburse TWC for these
interest payments. Since the interest accrued on these notes through
March 2002 was not a claim in the chapter 11 proceedings, WCG
recognized a gain of $73.9 million ($0.15 per share) for the ten
months ended October 31, 2002 in accordance with SOP 90-7.
45
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(d) For the ten months ended October 31, 2002, the Company wrote off
deferred financing costs and debt discounts associated with
liabilities subject to compromise and a portion of the deferred
financing costs associated with the Company's credit facility to
reorganization items in accordance with SOP 90-7 since the deferred
financing costs and debt discounts do not have a remaining useful life
as a result of the chapter 11 proceedings.
(e) As discussed in Note 16, the Company has recorded $12.9 million in
reorganization expense for the ten months ended October 31, 2002
primarily related to taxes on the retention bonus agreements with
former officers in place, inasmuch as the Company committed to pay
pursuant to those agreements an aggregate of up to $20 million for
taxes incurred by the beneficiaries of those agreements. In addition,
the Company recorded $12.1 million for the ten months ended October
31, 2002 pursuant to an employee incentive program that was adopted to
retain employees during the Company's restructuring process.
(f) Professional fees and other primarily consists of professional fees
for legal and financial advisory services in connection with the
reorganization.
(g) The Company recognized interest income of $2.8 million for the ten
months ended October 31, 2002 on accumulated cash that the Company did
not disburse as a result of the chapter 11 proceedings.
22. Asset Impairments and Restructuring Charges
2002
Asset impairments and restructuring charges of $8.6 million for the two
months ended December 31, 2002 included $8.4 million for severance related
expenses. Asset impairments and restructuring charges of $28.5 million for the
ten months ended October 31, 2002 included $21.6 million for severance related
expenses and $4.0 million related to the early termination or settlement of
lease agreements. The Company had workforce reductions of approximately 1,400
employees in 2002 and paid out approximately $26 million relating to severance
in 2002.
During the first three quarters of 2002, the Company compared estimated
future net cash flows associated with its long-lived assets with the remaining
basis of such long-lived assets on a going concern basis, and determined its
remaining basis in its long-lived assets was recoverable through future cash
flows. Estimates of future net cash flows used for potential impairment analysis
were consistent with estimates used by the Company's financial advisors to
arrive at the Company's reorganization value and included assumptions regarding
decreased prices for the Company's products and services, significant increases
in sales quantities in periods beyond 2002 and that the Company would continue
to have adequate liquidity. It was determined that no impairment was necessary
for the ten months ended October 31, 2002. The adoption of fresh start
accounting resulted in a reduction in the Company's carrying value of long-lived
assets by approximately $2.4 billion and is reported as a reorganization item.
The reorganization value was based on a discounted cash flow methodology, as
required, whereas the impairment tests utilized undiscounted cash flows, as
required. This is the primary reason no impairment was necessary during the
first three quarters of 2002, and a reduction in the carrying value of
long-lived assets was necessary at the adoption of fresh start accounting.
46
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2001
During and subsequent to fourth quarter 2001, several industry events
occurred, including high profile bankruptcies of companies such as Global
Crossing Ltd. and Enron Corp. and other actions by WCG's peer group, along with
a continuing downward spiral of valuations associated with telecom companies. As
a result of the combination of industry events, conditions specific to WCG and
as part of its preparation of a comprehensive plan to restructure and
de-leverage its balance sheet, management revised its plans and intentions with
regard to the use of certain long-lived assets, and accordingly, revised its
estimates of future cash flows associated with these long-lived assets. Certain
assets were considered excess, and WCG measured future cash flows based on
disposition. These assets were impaired as described below using the present
value of future cash flows for fair value. Other long-lived assets were
currently in use or projected to be in use and these assets were not impaired
under SFAS 121 based on management's latest estimates of future cash flows.
These estimates included assumptions regarding decreased prices for WCG's
products and services, significant increases in sales quantities in periods
beyond 2002 and that WCG had adequate liquidity.
These events also resulted in abandoning or suspending projects because of
a reduced workforce or uncertainties related to the availability of funding to
complete the projects and limited growth profiles because of uncertainties that
were inherent in WCG's business. This analysis resulted in impairments for the
year ended December 31, 2001 as follows:
(In millions)
Dark fiber and conduit (a)............................ $ 1,876
Optronics equipment (b)............................... 336
International assets and undersea cable (c)........... 256
Wireless capacity, net (d)............................ 215
Abandoned projects and other (e)...................... 211
Goodwill and other intangible assets (f).............. 86
-----------
Total impairment of long-lived assets............. $ 2,980
===========
Explanations of the items in the table above are as follows:
(a) WCG assumed that on various routes it would keep 8 to 24 fibers for
its internal use. Previous assumptions were that WCG would keep an
average of 24 fibers for its own use. WCG's fourth quarter 2001
impairment charge of approximately $1.9 billion considered this change
and revised estimates of future cash flows for all excess fiber and
conduit.
(b) Because of increasingly lower prices for excess optronics, WCG
recorded a fourth quarter 2001 impairment charge of approximately $186
million. WCG had previously recorded a third quarter 2001 impairment
charge of approximately $150 million related to excess optronics.
(c) As of December 31, 2001, WCG had ownership interests in a number of
international routes in process of completion for which the funding of
that completion was in doubt. In addition, the completion or expected
completion of several undersea cable systems had negatively impacted
prices. Because of these conditions, WCG did not believe it would
recover its investment in these international assets. As such, WCG
recorded a fourth quarter 2001 impairment charge of approximately $256
million on international routes.
(d) WCG had previously entered into a strategic relationship with Winstar
Communications, Inc. ("Winstar"). WCG planned to use wireless
technology to provide high capacity local exchange and internet access
services to companies located in buildings not served by fiber optic
cable. However, in 2001 Winstar filed for bankruptcy protection and
the assets were subsequently purchased by another company.
Accordingly, WCG fully impaired its basis in the Winstar capacity that
it had previously purchased by recording a net fourth quarter 2001
impairment charge of approximately $215 million.
(e) WCG recorded a fourth quarter 2001 impairment charge of approximately
$181 million primarily representing the write-off of project costs
that would not be completed because of funding constraints and/or
personnel reductions. WCG had previously recorded a third quarter 2001
charge of approximately $30 million for similar items.
(f) WCG recorded a fourth quarter 2001 impairment charge of approximately
$75 million representing the remaining balances of its goodwill and
other intangibles. WCG had previously recorded a third quarter 2001
impairment charge of approximately $11 million related to goodwill
associated with its satellite operations.
47
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The impairments discussed above related to the Network segment with the
exception of goodwill and other intangibles of which $51.3 million related to
the Vyvx segment.
23. Discontinued Operations
On January 25, 2001, WCG's Board of Directors authorized a plan for its
management to divest the Solutions segment. On January 29, 2001, WCG signed an
agreement to sell the domestic, Mexican and Canadian professional services
operations of the Solutions segment to Platinum Equity. This sale closed on
March 31, 2001 for approximately $100 million in cash and an interest-bearing
$75 million promissory note receivable. Accordingly, the Solutions segment was
reflected as discontinued operations in the Income Statement in 2000 and cash
proceeds from the sale was reflected in the Statement of Cash Flows in 2001. See
Note 17 for further discussion of the promissory note with Platinum Equity.
On March 27, 2001, WCG signed an agreement to sell its remaining Canadian
operations of the Solutions segment to Telus Corporation. The sale closed in
second quarter 2001 for approximately $38 million in cash and was reflected in
the Statement of Cash Flows in 2001.
48