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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2005
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
(Exact name of registrant as specified in its Charter)
New York 13-2615557
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
315 Park Avenue South, New York, New York 10010-3607
(Address of principal executive offices) (Zip Code)
(212) 460-1900
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
______________________
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
YES X NO
----- -----
APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding
of each of the issuer's classes of common stock, at April 29, 2005: 107,625,828.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
March 31, 2005 and December 31, 2004
(Dollars in thousands, except par value)
March 31, December 31,
2005 2004
--------- -----------
(Unaudited)
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 693,603 $ 486,948
Investments 953,475 1,106,322
Trade, notes and other receivables, net 346,090 414,552
Prepaids and other current assets 53,777 52,127
----------- -----------
Total current assets 2,046,945 2,059,949
Non-current investments 698,408 726,782
Notes and other receivables, net 13,886 16,906
Other assets 221,348 203,096
Property, equipment and leasehold improvements, net 1,321,645 1,332,876
Investments in associated companies 455,029 460,794
----------- -----------
Total $ 4,757,261 $ 4,800,403
=========== ===========
LIABILITIES
- -----------
Current liabilities:
Trade payables and expense accruals $ 402,289 $ 407,350
Deferred revenue 51,548 52,632
Other current liabilities 88,641 94,956
Customer banking deposits due within one year 16,463 18,472
Debt due within one year 71,284 68,237
Income taxes payable 14,204 17,690
----------- -----------
Total current liabilities 644,429 659,337
Long-term deferred revenue 162,633 161,206
Other non-current liabilities 205,603 213,309
Non-current customer banking deposits 5,471 6,119
Long-term debt 1,480,509 1,483,504
----------- -----------
Total liabilities 2,498,645 2,523,475
----------- -----------
Commitments and contingencies
Minority interest 17,801 18,275
----------- -----------
SHAREHOLDERS' EQUITY
- --------------------
Common shares, par value $1 per share, authorized 150,000,000 shares;
107,613,828 and 107,600,403 shares issued and outstanding, after deducting
42,386,172 and 42,399,597 shares held in treasury 107,614 107,600
Additional paid-in capital 598,712 598,504
Accumulated other comprehensive income 115,465 136,138
Retained earnings 1,419,024 1,416,411
----------- -----------
Total shareholders' equity 2,240,815 2,258,653
----------- -----------
Total $ 4,757,261 $ 4,800,403
=========== ===========
See notes to interim consolidated financial statements.
2
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
For the three months ended March 31, 2005 and 2004
(In thousands, except per share amounts)
(Unaudited)
2005 2004
---- ----
Revenues and Other Income:
Telecommunications $ 421,495 $ 380,979
Healthcare 67,438 63,227
Manufacturing 20,874 13,382
Finance 101 8,485
Investment and other income 50,822 34,385
Net securities gains 55 9,272
--------- ---------
560,785 509,730
--------- ---------
Expenses:
Cost of sales:
Telecommunications 303,019 286,777
Healthcare 56,464 51,786
Manufacturing 14,709 9,696
Interest 24,809 20,870
Salaries 44,767 43,140
Depreciation and amortization 46,516 62,600
Selling, general and other expenses 78,412 70,055
--------- ---------
568,696 544,924
--------- ---------
Loss from continuing operations before income taxes and equity
in income of associated companies (7,911) (35,194)
Income taxes 624 258
--------- ---------
Loss from continuing operations before equity in income of
associated companies (8,535) (35,452)
Equity in income of associated companies, net of taxes 11,148 23,981
--------- ---------
Income (loss) from continuing operations 2,613 (11,471)
Loss from discontinued operations, net of taxes -- (481)
--------- ---------
Net income (loss) $ 2,613 $ (11,952)
========= =========
Basic earnings (loss) per common share:
Income (loss) from continuing operations $ .02 $(.11)
Loss from discontinued operations -- --
----- -----
Net income (loss) $ .02 $(.11)
===== =====
Diluted earnings (loss) per common share:
Income (loss) from continuing operations $ .02 $(.11)
Loss from discontinued operations -- --
----- -----
Net income (loss) $ .02 $(.11)
===== =====
See notes to interim consolidated financial statements.
3
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the three months ended March 31, 2005 and 2004
(In thousands)
(Unaudited)
2005 2004
---- ----
Net cash flows from operating activities:
Net income (loss) $ 2,613 $ (11,952)
Adjustments to reconcile net income (loss) to net cash provided by operations:
Depreciation and amortization of property, equipment and leasehold improvements 48,410 64,434
Other amortization (187) 683
Provision for doubtful accounts 1,715 982
Net securities gains (55) (9,272)
Equity in income of associated companies, net of taxes (11,148) (23,981)
Distributions from associated companies 16,323 20,382
Gain on disposal of real estate, property and equipment, and other assets (17,045) (10,429)
Investments classified as trading, net (17,189) 8,371
Net change in:
Trade, notes and other receivables 70,174 29,610
Prepaids and other assets (4,430) (4,689)
Trade payables and expense accruals (18,161) (27,432)
Other liabilities (3,980) 21,878
Deferred revenue 343 (6,562)
Income taxes payable (3,486) 2,661
Other (1,347) 672
--------- ---------
Net cash provided by operating activities 62,550 55,356
--------- ---------
Net cash flows from investing activities:
Acquisition of property, equipment and leasehold improvements (35,516) (18,182)
Acquisitions of and capital expenditures for real estate investments (2,898) (2,839)
Proceeds from disposals of real estate, property and equipment, and other assets 21,650 17,055
Principal collections on loan receivables 433 29,093
Acquisition of NSW (26,791) --
Advances on notes receivables (100) --
Collections on notes receivables 416 26,462
Investments in associated companies (2,284) (51,000)
Purchases of investments (other than short-term) (561,317) (287,498)
Proceeds from maturities of investments 426,917 185,060
Proceeds from sales of investments 326,950 205,730
--------- ---------
Net cash provided by investing activities 147,460 103,881
--------- ---------
Net cash flows from financing activities:
Net change in customer banking deposits (2,647) (26,342)
Issuance of long-term debt 2,969 --
Reduction of long-term debt (2,820) (2,682)
Issuance of common shares 222 1,224
--------- ---------
Net cash used for financing activities (2,276) (27,800)
--------- ---------
Effect of foreign exchange rate changes on cash (1,079) (31)
--------- ---------
Net increase in cash and cash equivalents 206,655 131,406
Cash and cash equivalents at January 1, 486,948 214,390
--------- ---------
Cash and cash equivalents at March 31, $ 693,603 $ 345,796
========= =========
See notes to interim consolidated financial statements.
4
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders' Equity
For the three months ended March 31, 2005 and 2004
(In thousands, except par value)
(Unaudited)
Common Accumulated
Shares Additional Other
$1 Par Paid-In Comprehensive Retained
Value Capital Income (Loss) Earnings Total
----- ------- ------------- -------- -----
Balance, January 1, 2004 $106,235 $577,863 $152,251 $1,297,812 $2,134,161
----------
Comprehensive income:
Net change in unrealized gain (loss) on
investments, net of taxes of $0 22,235 22,235
Net change in unrealized foreign exchange
gain (loss), net of taxes of $0 (1,029) (1,029)
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $0 588 588
Net loss (11,952) (11,952)
----------
Comprehensive income 9,842
----------
Exercise of options to purchase common shares 72 1,152 1,224
-------- -------- -------- ---------- ----------
Balance, March 31, 2004 $106,307 $579,015 $174,045 $1,285,860 $2,145,227
======== ======== ======== ========== ==========
Balance, January 1, 2005 $107,600 $598,504 $136,138 $1,416,411 $2,258,653
----------
Comprehensive loss:
Net change in unrealized gain (loss) on
investments, net of taxes $0 (16,537) (16,537)
Net change in unrealized foreign exchange
gain (loss), net of taxes of $0 (5,087) (5,087)
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $0 951 951
Net income 2,613 2,613
----------
Comprehensive loss (18,060)
----------
Exercise of options to purchase common shares 14 208 222
-------- -------- -------- ---------- ----------
Balance, March 31, 2005 $107,614 $598,712 $115,465 $1,419,024 $2,240,815
======== ======== ======== ========== ==========
See notes to interim consolidated financial statements.
5
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Notes to Interim Consolidated Financial Statements
1. The unaudited interim consolidated financial statements, which reflect all
adjustments (consisting of normal recurring items or items discussed
herein) that management believes necessary to present fairly results of
interim operations, should be read in conjunction with the Notes to
Consolidated Financial Statements (including the Summary of Significant
Accounting Policies) included in the Company's audited consolidated
financial statements for the year ended December 31, 2004, which are
included in the Company's Annual Report filed on Form 10-K, as amended by
Form 10-K/A, for such year (the "2004 10-K"). Results of operations for
interim periods are not necessarily indicative of annual results of
operations. The consolidated balance sheet at December 31, 2004 was
extracted from the audited annual financial statements and does not include
all disclosures required by accounting principles generally accepted in the
United States of America ("GAAP") for annual financial statements.
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's results of operations would not have been materially different
from that reported.
In April 2005, the Securities and Exchange Commission amended the effective
date of Statement of Financial Accounting Standards No. 123R, "Share-Based
Payment" ("SFAS 123R"), from the first interim or annual period after June
15, 2005 to the beginning of the next fiscal year that begins after June
15, 2005. The Company is currently evaluating the impact of SFAS 123R on
its consolidated financial statements.
In March 2005, the Financial Accounting Standards Board issued FASB
Interpretation No. 47, "Accounting for Conditional Asset Retirement
Obligations" ("FIN 47"), which is effective for fiscal years ending after
December 15, 2005. FIN 47 clarifies that the term conditional asset
retirement obligation as used in FASB Statement No. 143, "Accounting for
Asset Retirement Obligations", refers to a legal obligation to perform an
asset retirement activity in which the timing and/or method of settlement
are conditional on a future event that may or may not be within the control
of the entity. Under FIN 47, an entity is required to recognize a liability
for the fair value of a conditional asset retirement obligation if the fair
value of the liability can be reasonably estimated. The fair value of a
liability for the conditional asset retirement obligation should be
recognized when incurred--generally upon acquisition, construction, or
development and/or through the normal operation of the asset. The Company
is currently evaluating the impact of FIN 47 on its consolidated financial
statements, but does not expect that the impact will be material.
Certain amounts for prior periods have been reclassified to reflect as
discontinued operations a commercial real estate property and the Company's
geothermal power business, which were sold during the fourth quarter of
2004.
2. In accordance with Financial Accounting Standards No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), the Company
evaluates its long-lived assets for impairment whenever events or changes
in circumstances indicate, in management's judgment, that the carrying
value of such assets may not be recoverable. When testing for impairment,
the Company groups its long-lived assets with other assets and liabilities
at the lowest level for which identifiable cash flows are largely
independent of the cash flows of other assets and liabilities (or asset
group). The determination of whether an asset group is recoverable is based
on management's estimate of undiscounted future cash flows directly
attributable to the asset group as compared to its carrying value. If the
carrying amount of the asset group is greater than the undiscounted cash
flows, an impairment loss would be recognized for the amount by which the
carrying amount of the asset group exceeds its estimated fair value.
6
Notes to Interim Consolidated Financial Statements, continued
As more fully described in the 2004 10-K, on January 31, 2005, SBC
Communications Inc. ("SBC") announced that it would buy AT&T Corp., and
announced its intention to migrate the services provided by WilTel to the
AT&T network. Since SBC is WilTel's largest customer, accounting for 70% of
the Network segment's 2005 telecommunications revenues, the Company
concluded that the SBC announcement is an event which requires the Company
to assess the carrying value of WilTel's long-lived assets for impairment,
principally property and equipment. Since the event which gave rise to the
impairment review occurred on January 31, 2005, and is not reflective of a
condition that existed as of December 31, 2004, the assessment of
impairment was performed as part of the preparation of the Company's
financial statements for the first quarter of 2005. Based on the
assumptions described below, the Company concluded that an impairment
charge was not required for the first quarter of 2005.
The Company determined that WilTel's fiber optic communications network is
the lowest level for which identifiable cash flows are largely independent
of the cash flows of other assets and liabilities. The asset group is
primarily composed of fiber optic cable, conduit, rights of way, optronics
and certain buildings and related improvements. These assets are used
together to generate joint cash flows. The Company has determined that the
primary asset of the group is fiber optic cable, which has a remaining
weighted average useful life of 16 years. The fiber optic cable is
considered to be the primary asset of the group as it is the most
significant component of the group, the principal asset from which the
asset group derives its cash flow generating capacity, would cost the most
to replace and without which most of the assets in the group would not have
been acquired. The determination of the primary asset of the asset group is
significant because estimated cash flows used to test for recoverability
are based on the estimated remaining useful life of the primary asset. The
carrying value of the asset group that was tested for impairment was
approximately $920,000,000.
The Company utilized WilTel's internal estimates of future cash flows from
all of its customers over the remaining useful life of the primary asset.
These assumptions reflect estimated future operating results and consider
all relevant facts and circumstances. The economics and term of WilTel's
future relationship with SBC are the most significant assumptions in the
analysis. These assumptions are based upon the best information available,
although WilTel does not know with certainty when SBC will receive
regulatory approval to acquire AT&T and following such approval how long it
will take to transition SBC's traffic to the AT&T network. Negotiations are
ongoing with SBC to enter into a new contract for this period and to settle
all outstanding matters between SBC and WilTel. No agreement has been
reached as to the term of such an agreement or the revenue that such an
agreement might generate and over what period of time. In the event no
agreement is reached, WilTel will continue to provide SBC services
according to the terms of its existing contract. If the actual amount of
revenues and cash flows to be received from SBC are less than the Company's
current assumptions, the Company would have to reconsider its impairment
analysis and may then conclude that this asset group is impaired.
WilTel and SBC have agreed to use a fixed price for voice transport
services (the substantial majority of WilTel's SBC generated revenue)
through May 31, 2005. As discussed above, WilTel is currently engaged in
negotiations with SBC with respect to a transition pricing agreement and
other matters that will enable WilTel to continue to provide services to
SBC beyond May 31, 2005. If the parties fail to reach agreement on pricing,
any disputes as to pricing methodology are to be resolved through binding
arbitration.
SBC's announcement is considered an event which could reasonably be
expected to have a "material adverse effect" as defined in WilTel's amended
credit facility, and while WilTel can no longer access its $25,000,000
revolving credit facility it has no impact on the $358,700,000 of term
loans under the agreement. However, the credit agreement provides for an
event of default if there is any amendment, supplement, modification or
termination of any WilTel contract or agreement that has had or could
reasonably be expected to result in a material adverse effect on WilTel (as
defined in the credit agreement). If WilTel's current negotiations with SBC
with respect to a transition pricing agreement and other matters are
successfully concluded, it may or may not be deemed an event of default
under the WilTel credit agreement. WilTel intends to enter into discussions
with its lenders before entering into any new definitive agreement with
SBC.
7
Notes to Interim Consolidated Financial Statements, continued
3. Results of operations for the Company's segments are reflected from the
date of acquisition. 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
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 GAAP measure, which is
used for all other reportable segments, for the first quarter of 2005 and
2004 (in thousands):
2005 2004
----------------------- ------------------------
Network Vyvx Network Vyvx
------- ---- ------- ----
Segment profit from operations (1) (2) $ 48,839 $ 7,002 $ 14,459 $ 6,351
Depreciation and amortization expense (41,096) (1,132) (54,545) (2,288)
Interest expense, net of investment income (3) (4) (5,257) 1,219 (6,555) (556)
Other non-operating income (expense), net (3) (5) (243) (24) 3,004 20
--------- -------- --------- --------
Income (loss) from continuing operations before income taxes
and equity in income of associated companies $ 2,243 $ 7,065 $ (43,637) $ 3,527
========= ======== ========= ========
(1) See note (c) to segment information below.
(2) For Network in 2005, includes gains of $12,600,000 from sales of
operating assets, principally undersea cable assets.
(3) If items in these categories cannot be directly attributed to a
particular WilTel segment, they are allocated to each segment based
upon a formula that considers each segment's revenues, property and
equipment and headcount.
(4) For Vyvx in 2005, includes a bankruptcy claim distribution of
$1,600,000 received for a security with no book value.
(5) For the 2004 period, includes a pre-tax gain of $2,800,000 related to
cash and securities received in excess of the book value of secured
claims in a customer's bankruptcy.
Certain information concerning the Company's segments for the three month
periods ended March 31, 2005 and 2004 is presented in the following table.
2005 2004
---- ----
(In thousands)
Revenues and other income (a):
Network (b) $ 413,082 $ 362,175
Vyvx 30,588 27,963
Healthcare Services 67,878 63,247
Banking and Lending 1,398 8,707
Manufacturing 21,023 13,401
Domestic Real Estate 9,454 16,357
Other Operations 6,496 7,639
Corporate 15,046 14,732
Intersegment elimination (c) (4,180) (4,491)
---------- ----------
Total consolidated revenues and other income $ 560,785 $ 509,730
========== ==========
8
Notes to Interim Consolidated Financial Statements, continued
2005 2004
---- ----
Income (loss) from continuing operations before income taxes
and equity in income of associated companies:
Network (c) $ 2,243 $ (43,637)
Vyvx (c) 7,065 3,527
Healthcare Services 1,356 2,383
Banking and Lending (1) 5,314
Manufacturing 2,348 926
Domestic Real Estate (588) 7,895
Other Operations (2,719) 153
Corporate (17,615) (11,755)
---------- ----------
Total consolidated loss from continuing operations
before income taxes and equity in income
of associated companies $ (7,911) $ (35,194)
========== ==========
(a) Revenues and other income 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 on the Company's consolidated statements of operations.
(b) For the three month periods ended March 31, 2005 and 2004, includes
services provided to SBC of $279,100,000 and $238,400,000,
respectively.
(c) Eliminates intersegment revenues billed from Network to Vyvx. However,
the intersegment revenues are included in the calculation to determine
segment profit from operations and income (loss) from continuing
operations for each of Network and Vyvx.
For the three month periods ended March 31, 2005 and 2004, income (loss)
from continuing operations has been reduced by depreciation and
amortization expenses of $49,700,000 and $65,300,000, respectively; such
amounts are primarily comprised of Corporate ($2,600,000 and $3,300,000,
respectively), and amounts related to WilTel's segments, which are
disclosed above. Depreciation and amortization expenses for other segments
are not material.
For the three month periods ended March 31, 2005 and 2004, income (loss)
from continuing operations has been reduced by interest expense of
$24,800,000 and $20,900,000, respectively; such amounts are primarily
comprised of Corporate ($15,600,000 and $10,100,000, respectively), banking
and lending ($400,000 and $1,100,000, respectively) and amounts related to
WilTel's segments ($7,400,000 and $8,500,000, respectively). Interest
expense for other segments is not material.
4. The following tables provide summarized data with respect to significant
investments in associated companies accounted for under the equity method
of accounting for the periods the investments were owned by the Company.
The information is provided for those investments whose relative
significance to the Company could result in the Company including separate
audited financial statements for such investments in its Annual Report on
Form 10-K for the year ended December 31, 2005 (in thousands).
9
Notes to Interim Consolidated Financial Statements, continued
March 31, March 31,
2005 2004
------------ ------------
Olympus Re Holdings, Ltd.:
Total revenues $ 128,600 $ 134,100
Income from continuing operations before extraordinary items 35,700 50,300
Net income 35,700 50,300
The Company's equity in net income 7,100 8,300
EagleRock Capital Partners (QP), LP:
Total revenues $ (6,100) $ 5,300
Income (loss) from continuing operations before extraordinary items (6,500) 5,100
Net income (loss) (6,500) 5,100
The Company's equity in net income (loss) (4,900) 4,300
Jefferies Partners Opportunity Fund II, LLC:
Total revenues $ 10,400 $ 7,000
Income from continuing operations before extraordinary items 9,600 6,400
Net income 9,600 6,400
The Company's equity in net income 6,400 4,400
5. A summary of investments at March 31, 2005 and December 31, 2004 is as
follows (in thousands):
March 31, 2005 December 31, 2004
-------------------------------- ------------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
---- ---------- ---- ----------
Current Investments:
Investments available for sale $ 768,437 $ 767,260 $ 939,175 $ 939,313
Trading securities 172,446 180,054 148,602 159,616
Other investments, including accrued interest income 6,161 6,161 7,393 7,393
--------- ---------- ---------- -----------
Total current investments $ 947,044 $ 953,475 $1,095,170 $1,106,322
========= ========== ========== ==========
Non-current Investments:
Investments available for sale $ 418,299 $ 647,674 $ 432,207 $ 676,051
Other investments 50,734 50,734 50,731 50,731
--------- ---------- ---------- -----------
Total non-current investments $ 469,033 $ 698,408 $ 482,938 $ 726,782
========= ========== ========== ===========
6. A summary of intangible assets (which are included in other assets in the
consolidated balance sheets) at March 31, 2005 and December 31, 2004 is as
follows (in thousands):
March 31, December 31,
2005 2004
----------- -----------
Customer relationships, net of accumulated amortization of $716 and $491 $ 7,317 $ 1,472
Trademarks and tradename, net of accumulated amortization of $13 1,447 --
Patents, net of accumulated amortization of $25 2,305 --
Other intangible assets, net of accumulated amortization of $12 348 --
------- -------
$11,417 $ 1,472
======= =======
10
Notes to Interim Consolidated Financial Statements, continued
The customer relationship intangible assets relate to acquisitions made by
the manufacturing segment during 2004 and 2005, and are being amortized on
a straight-line basis over their average useful lives. In February 2005,
the manufacturing segment acquired the assets of NSW, LLC U.S. ("NSW") for
a purchase price of approximately $26,800,000, subject to working capital
adjustments, and recorded an aggregate of $10,200,000 of intangible assets
and $8,300,000 of goodwill. The NSW intangible assets will be amortized on
a straight-line basis over the following average useful lives: customer
relationships - 16 years, trademarks and tradename - 19 years, patents - 15
years and other intangible assets - 5 years.
The pro forma effect of the NSW acquisition on the Company's operating
results is not material.
Amortization expense on intangible assets was $300,000 and $500,000,
respectively, for the three month periods ended March 31, 2005 and 2004.
The estimated aggregate future amortization expense for the intangible
assets for each of the next five years is as follows (in thousands): 2005
(for the remaining nine months) - $1,000,000; 2006 - $1,300,000; 2007 -
$800,000; 2008 - $700,000; and 2009 - $700,000.
7. A summary of accumulated other comprehensive income (loss), net of taxes at
March 31, 2005 and December 31, 2004 is as follows (in thousands):
March 31, December 31,
2005 2004
---------- ------------
Net unrealized gains on investments $ 136,659 $ 153,196
Net unrealized foreign exchange gains 9,222 14,309
Net unrealized losses on derivative instruments (2,804) (3,755)
Net minimum pension liability (27,612) (27,612)
---------- ---------
$ 115,465 $ 136,138
========== =========
8. Investment and other income includes changes in the fair values of
derivative financial instruments of $1,100,000 and $(1,200,000) for the
three month periods ended March 31, 2005 and 2004, respectively.
9. Pension expense charged to operations for the three month periods ended
March 31, 2005 and 2004 related to the defined benefit pension plan (other
than WilTel's plan) included the following components (in thousands):
2005 2004
------ ------
Interest cost $ 511 $ 532
Expected return on plan assets (228) (448)
Actuarial loss 208 144
Amortization of prior service cost 1 1
------- -------
Net pension expense $ 492 $ 229
======= =======
WilTel's pension expense charged to operations for the three month periods
ended March 31, 2005 and 2004 related to the defined benefit pension plan
included the following components (in thousands):
2005 2004
------ -------
Interest cost $ 2,051 $ 1,612
Service cost 965 863
Expected return on plan assets (1,326) (960)
Actuarial loss 12 --
------- -------
Net pension expense $ 1,702 $ 1,515
======= =======
Employer contributions to WilTel's defined benefit pension plan were
$1,000,000 during the first quarter of 2005.
11
Notes to Interim Consolidated Financial Statements, continued
Several subsidiaries provide certain healthcare 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 month
periods ended March 31, 2005 and 2004.
10. The Company did not record any federal income tax expense (benefit) on
income (loss) from continuing operations or other components of
comprehensive income (loss) due to the availability of WilTel tax
attributes that have been fully reserved for in the valuation allowance.
Income tax expense principally relates to state income taxes.
11. Per share amounts were calculated by dividing net income (loss) by the sum
of the weighted average number of common shares outstanding and, for
diluted earnings (loss) per share, the incremental weighted average number
of shares issuable upon exercise of outstanding options and warrants for
the periods they were outstanding. In addition, the calculations of diluted
earnings (loss) per share assume the 3 3/4% Convertible Notes had been
converted into common shares for the period they were outstanding and
earnings increased for the interest on such notes, net of the income tax
effect. The number of shares used to calculate basic earnings (loss) per
share amounts was 107,609,000 and 106,272,000 for the three month periods
ended March 31, 2005 and 2004, respectively. The number of shares used to
calculate diluted earnings (loss) per share amounts was 107,880,000 and
106,272,000 for the three month periods ended March 31, 2005 and 2004,
respectively. For 2004, options and warrants to purchase approximately
931,000 weighted average shares of common stock were outstanding but were
not included in the computation of diluted loss per share, as those options
and warrants were antidilutive. Additionally, for the three month period
ended March 31, 2005, the 3 3/4% Convertible Notes, which are convertible
into 7,619,745 common shares were outstanding but were not included in the
computation of diluted earnings per share, as these Notes were
antidilutive.
12. Cash paid for interest and net income taxes paid (refunded) was $32,500,000
and $300,000, respectively, for the three month period ended March 31, 2005
and $27,600,000 and $(28,000,000), respectively, for the three month period
ended March 31, 2004.
13. In April 2005, the Company entered into an agreement to sell its 716-room
Waikiki Beach hotel and related assets for an aggregate purchase price of
$107,000,000, before closing costs and other required payments. The
agreement requires the Company to close during the second quarter; however,
if the buyer does not close then the Company's sole recourse is to retain
the buyer's $5,000,000 non-refundable deposit. If the sale closes, after
satisfaction of mortgage indebtedness on the hotel of $22,000,000 at
closing, the Company would receive net cash proceeds of approximately
$70,000,000, and would record a pre-tax gain of approximately $53,000,000
(reflected in discontinued operations). Historical operating results for
the hotel have not been material.
14. In March 2005, an entity in which the Company has a non-controlling equity
interest entered into an agreement to sell its interest in an office
complex located on Capitol Hill in Washington, D.C. The Company expects the
transaction to close during the second quarter of 2005, and the Company's
share of the net proceeds and the pre-tax gain on the sale is expected to
be approximately $70,000,000. The gain will be reported in the caption
equity in income of associated companies.
15. The bankruptcy plan (the "Plan") of ATX Communications, Inc. and certain of
its affiliates (collectively "ATX") was confirmed by the Bankruptcy Court
for the Southern District of New York and became effective on April 22,
2005. 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.
12
Notes to Interim Consolidated Financial Statements, continued
In December 2003, the Company purchased all of ATX's debt obligations under
its senior secured credit facility for $25,000,000. As contemplated by the
Plan, in exchange for its investment in the credit facility the Company
received 94.4% of the new common stock of the reorganized ATX and a new
$25,000,000 senior secured note which bears interest at 10%. In addition,
the Company provided ATX $5,000,000 of debtor-in-possession financing and
$25,000,000 of exit financing to fund bankruptcy related payments and
working capital requirements. On behalf of ATX, the Company also obtained
cash collateralized letters of credit totaling $14,700,000 issued for the
benefit of one of ATX's vendors. The Company will consolidate ATX as of the
effective date of the Plan.
16. In May 2005, the Company acquired Idaho Timber Corporation and certain
affiliated entities ("ITC") for total cash consideration of $132,000,000,
excluding expenses and working capital adjustments. ITC was a privately
held corporation that is headquartered in Boise, Idaho, which
"remanufactures" dimensional lumber, home center boards, 5/4" radius-edge
decking and a number of specialized products. ITC operates ten facilities
located throughout the United States, and its revenue is principally
derived from the purchase of bundles of low-grade lumber on the spot
market, and the conversion of that lumber into higher-grade lumber through
sorting and minor rework. The Company will consolidate ITC as of the date
of acquisition.
17. In May 2005, the Company's 72.1% owned subsidiary, MK Resources Company
("MK"), entered into a share purchase agreement with the Company and Inmet
Mining Corporation ("Inmet"), a Canadian-based global mining company, that
provides for Inmet's acquisition of 70% of MK's interest in Cobre Las
Cruces, S.A. ("CLC"), a Spanish wholly-owned subsidiary of MK that holds
the exploration and mineral rights to the Las Cruces copper deposit in the
Pyrite Belt of Spain. Inmet will acquire the interest in CLC in exchange
for 5,600,000 of Inmet common shares. The Inmet shares have the benefit of
a registration rights agreement; however, the shares may not be transferred
or sold to a third party until the earlier of four years from the closing
date or the date on which the Company is no longer obligated under the
guarantee discussed below. Although the Company does not currently believe
it will record any loss on the sale at closing, any gain or loss recorded
by the Company would be based upon the fair value of the Inmet stock on the
date it is received.
Closing of the transaction is subject to a number of conditions, including
the Company's acquisition of the outstanding MK common shares that it
doesn't already own, the execution of project financing commitments with
third parties to provide for no less than $255,000,000 (including interest
during construction), a 66 million euro bridge facility and other customary
closing conditions. The Company has entered into a merger agreement with MK
to acquire the remaining MK common shares for aggregate merger
consideration of approximately 333,500 of the Company's common shares. The
Company and Inmet have also committed to provide financing to CLC which is
estimated to be $159,000,000, of which the Company's share will be 30%
($32,300,000 of which has already been loaned), and has agreed to provide a
payment guarantee for 30% of the third party project financing until such
time as the completion tests to be specified under the project financing
have been achieved.
13
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations.
The following should be read in conjunction with the Management's Discussion and
Analysis of Financial Condition and Results of Operations included in the 2004
10-K.
Liquidity and Capital Resources
For the three month period ended March 31, 2005, net cash was provided by
operations principally as a result of the collection of a receivable related to
a former partnership interest, as discussed below, and distributions from
associated companies. For the three month period ended March 31, 2004, net cash
was provided by operations principally as a result of distributions from
associated companies, the pre-funding by SBC of certain of WilTel's capital
expenditures and the refund of excess federal income tax payments.
As of March 31, 2005, the Company's readily available cash, cash equivalents and
marketable securities, excluding amounts held by its regulated subsidiary and
non-regulated subsidiaries that are parties to agreements which restrict the
payment of dividends, totaled $1,720,600,000. This amount is comprised of cash
and short-term bonds and notes of the United States Government and its agencies
of $1,066,100,000 (62.0%), the equity investment in White Mountains Insurance
Group, Ltd. of $228,200,000 (13.3%) (which 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 $426,300,000 (24.7%).
As of March 31, 2005, WilTel had aggregate cash and investments of $265,700,000,
an increase of $26,000,000 from December 31, 2004. The increase during this
period reflects WilTel's positive operating results, reduced by WilTel's capital
expenditures of $22,000,000. 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 ($358,700,000 outstanding as of March 31,
2005) and its mortgage debt ($60,100,000 outstanding at March 31, 2005).
As more fully described in the 2004 10-K, SBC's announcement in January 2005 to
migrate its business from WilTel's network is considered an event which could
reasonably be expected to have a "material adverse effect" as defined in
WilTel's amended credit facility, and while WilTel can no longer access its
$25,000,000 revolving credit facility it has no impact on the $358,700,000 of
term loans under the agreement. However, the credit agreement provides for an
event of default if there is any amendment, supplement, modification or
termination of any WilTel contract or agreement that has had or could reasonably
be expected to result in a material adverse effect on WilTel (as defined in the
credit agreement). As mentioned above, WilTel is currently engaged in
negotiations with SBC with respect to a transition pricing agreement and other
matters which, if successfully concluded, may or may not be deemed an event of
default under the WilTel credit agreement. WilTel intends to enter into
discussions with its lenders before entering into any new definitive agreement
with SBC.
As more fully discussed in the 2004 10-K, WilTel plans to modify its operations
in light of the anticipated loss of its major customer, including expanding its
customer base and evaluating opportunities for consolidation. However, given the
current economic condition of the telecommunications industry as a whole, WilTel
does not believe it will be able to fully replace the revenues and profits
generated by the SBC agreements in the near future, if ever. The Company
believes there may be opportunities to increase Network's value through
consolidation opportunities, and it is actively investigating those
possibilities.
WilTel is a party to various legal actions and claims, and has reserved
$21,000,000 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.
14
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
In February 2005, the Company's manufacturing segment acquired the assets of NSW
for approximately $26,800,000, subject to working capital adjustments. NSW has a
manufacturing and distribution facility in Roanoke, Virginia, and for its year
ended December 31, 2004 generated annual sales of approximately $20,000,000.
Products manufactured by NSW include produce and packaging nets, header label
bags, case liners and heavy weight nets for drainage and erosion control
purposes. The funds for the acquisition were provided from the Company's readily
available cash resources.
As more fully described in the 2004 10-K, current operating activities at the
banking and lending segment have been concentrated on maximizing returns on its
investment portfolio, collecting and servicing its remaining loan portfolios and
discharging deposit liabilities as they come due. During 2005, the Company's
banking and lending subsidiary filed a formal plan with the Office of the
Comptroller of the Currency to liquidate its operations and surrender its
national bank charter. The banking and lending segment expects to surrender its
charter during the third quarter of 2005. As of March 31, 2005, the banking and
lending segment had outstanding loans of $3,900,000 and deposit liabilities of
$21,900,000.
As of December 31, 2004, the Company redeemed its interest in Pershing Square,
L.P. ("Pershing"), a limited partnership that is authorized to engage in a
variety of investing activities. The total amount due from Pershing of
$71,300,000 was included in trade, notes and other receivables, net in the
Company's consolidated balance sheet at December 31, 2004. Such amount was
received in cash during the first quarter of 2005.
In April 2005, the Company entered into an agreement to sell its 716-room
Waikiki Beach hotel and related assets for an aggregate purchase price of
$107,000,000 (before closing costs and other required payments). The agreement
requires the Company to close during the second quarter; however, if the buyer
does not close then the Company's sole recourse is to retain the buyer's
$5,000,000 non-refundable deposit. If the sale closes, after satisfaction of
mortgage indebtedness on the hotel of $22,000,000 at closing, the Company would
receive net cash proceeds of approximately $70,000,000.
In March 2005, an entity in which the Company has a non-controlling equity
interest entered into an agreement to sell its interest in an office complex
located on Capitol Hill in Washington, D.C. The Company expects the transaction
to close during the second quarter of 2005, and the Company's share of the net
proceeds is expected to be approximately $70,000,000.
In May 2005, the Company acquired ITC for total cash consideration of
$132,000,000, excluding expenses and working capital adjustments. The Company
will consolidate ITC as of the date of acquisition. The funds for the
acquisition were provided from the Company's readily available cash resources.
In May 2005, MK entered into a share purchase agreement with the Company and
Inmet, a Canadian-based global mining company, which provides for Inmet's
acquisition of 70% of MK's interest in CLC, a Spanish wholly-owned subsidiary of
MK that holds the exploration and mineral rights to the Las Cruces copper
deposit in the Pyrite Belt of Spain. Inmet will acquire the interest in CLC in
exchange for 5,600,000 of Inmet common shares. The Inmet shares have the benefit
of a registration rights agreement; however, the shares may not be transferred
or sold to a third party until the earlier of four years from the closing date
or the date on which the Company is no longer obligated under the guarantee
discussed below.
Closing of the transaction is subject to a number of conditions, including the
Company's acquisition of the outstanding MK common shares that it doesn't
already own, the execution of project financing commitments with third parties
to provide for no less than $255,000,000 (including interest during
construction), a 66 million euro bridge facility and other customary closing
conditions. The Company has entered into a merger agreement with MK to acquire
the remaining MK common shares for aggregate merger consideration of
approximately 333,500 of the Company's common shares. The Company and Inmet have
also committed to provide financing to CLC which is estimated to be
$159,000,000, of which the Company's share will be 30% ($32,300,000 of which has
already been loaned), and has agreed to provide a payment guarantee for 30% of
the third party project financing until such time as the completion tests to be
specified under the project financing have been achieved.
15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
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. In its 2004 10-K, the Company identified certain areas 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. On an
on-going basis, the Company evaluates all of these estimates and assumptions.
Impairment of Long-Lived Assets - In accordance with SFAS 144, the Company
evaluates its long-lived assets for impairment whenever events or changes in
circumstances indicate, in management's judgment, that the carrying value of
such assets may not be recoverable. When testing for impairment, the Company
groups its long-lived assets with other assets and liabilities at the lowest
level for which identifiable cash flows are largely independent of the cash
flows of other assets and liabilities (or asset group). The determination of
whether an asset group is recoverable is based on management's estimate of
undiscounted future cash flows directly attributable to the asset group as
compared to its carrying value. If the carrying amount of the asset group is
greater than the undiscounted cash flows, an impairment loss would be recognized
for the amount by which the carrying amount of the asset group exceeds its
estimated fair value.
As discussed above, on January 31, 2005, SBC announced that it would buy AT&T
and announced its intention to migrate the services provided by WilTel to the
AT&T network. Since SBC is WilTel's largest customer, accounting for 70% of the
Network segment's 2005 telecommunications revenues, the Company concluded that
the SBC announcement is an event which requires the Company to assess the
carrying value of WilTel's long-lived assets for impairment, principally
property and equipment. Since the event which gave rise to the impairment review
occurred on January 31, 2005, and is not reflective of a condition that existed
as of December 31, 2004, the assessment of impairment was performed as part of
the preparation of the Company's financial statements for the first quarter of
2005. Based on the assumptions described below, the Company concluded that an
impairment charge was not required for the first quarter of 2005.
The Company determined that WilTel's fiber optic communications network is the
lowest level for which identifiable cash flows are largely independent of the
cash flows of other assets and liabilities. The asset group is primarily
composed of fiber optic cable, conduit, rights of way, optronics and certain
buildings and related improvements. These assets are used together to generate
joint cash flows. The Company has determined that the primary asset of the group
is fiber optic cable, which has a remaining weighted average useful life of 16
years. The fiber optic cable is considered to be the primary asset of the group
as it is the most significant component of the group, the principal asset from
which the asset group derives its cash flow generating capacity, would cost the
most to replace and without which most of the assets in the group would not have
been acquired. The determination of the primary asset of the asset group is
significant because estimated cash flows used to test for recoverability are
based on the estimated remaining useful life of the primary asset. The carrying
value of the asset group that was tested for impairment was approximately
$920,000,000.
The Company utilized WilTel's internal estimates of future cash flows from all
of its customers over the remaining useful life of the primary asset. These
assumptions reflect estimated future operating results and consider all relevant
facts and circumstances. The economics and term of WilTel's future relationship
with SBC are the most significant assumptions in the analysis. These assumptions
are based upon the best information available although Wiltel does not know
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
with certainty when SBC will receive regulatory approval to acquire AT&T and
following such approval how long it will take to transition SBC's traffic to the
AT&T network. Negotiations are ongoing with SBC to enter into a new contract for
this period and to settle all outstanding matters between SBC and WilTel. No
agreement has been reached as to the term of such an agreement or the revenue
that such an agreement might generate and over what period of time. The Company
believes it is in the best interests of both parties to reach an agreement to
ensure a smooth transition of SBC's traffic to AT&T. In the event no agreement
is reached, WilTel will continue to provide SBC services according to the terms
of its existing contract. If the actual amount of revenues and cash flows to be
received from SBC are less than the Company's current assumptions, the Company
would have to reconsider its impairment analysis and may then conclude that this
asset group is impaired.
The Company's conclusion that an impairment charge is not required at this time
does not mean that the Company believes the fair value of the network asset
group equals its current carrying value. Under FAS 144, an asset group is
considered recoverable (and no impairment charge is recorded) if management's
estimate of the direct cash flows that the asset group can generate is, on an
undiscounted basis, greater than the carrying value. However, since the
Company's estimate of the future cash flows is undiscounted and extends over 16
years, the determination of the fair value of the asset group would have to
include, among other factors, discounting the gross cash flows to their net
present value at an appropriate rate.
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. 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 based on the Company's assessment of the
probability of successfully sustaining its tax filing positions.
As more fully discussed in the 2004 10-K, at acquisition the Company established
and has continued to maintain a valuation allowance that reserved for
substantially all of WilTel's net deferred tax assets, because the Company could
not demonstrate it would have the future taxable income necessary to realize
that asset. The Company's projections of consolidated taxable income and its
assessment of the need for a full valuation allowance for the deferred tax asset
are significantly influenced by the fact that it has not yet generated positive
cumulative pre-tax income over a period of years on a pro forma combined basis
with WilTel, and the uncertainty of WilTel's relationship with SBC in the
future. In addition, during the second quarter of 2005 the Company acquired ITC
and ATX, which may have a significant impact on the Company's estimate of future
profitability. The Company will continue to reassess the need for a full
valuation allowance for the net deferred tax asset and may make adjustments in
future periods if supported by the facts and circumstances.
Results of Operations
Three Months Ended March 31, 2005 Compared to the Three Months
Ended March 31, 2004
Telecommunications
The following table reconciles WilTel's segment profit from operations to income
(loss) from continuing operations before income taxes for the three month
periods ended March 31, 2005 and 2004. 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.
17
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
2005 2004
------------------------------------ -----------------------------------
Network Vyvx Total Network Vyvx Total
------- ---- ----- ------- ---- -----
(In thousands)
Operating revenues (1) (2) $ 406,900 $ 28,800 $ 435,700 $ 353,100 $ 27,800 $ 380,900
--------- -------- --------- --------- -------- ---------
Segment profit from operations (2) $ 48,800 $ 7,000 $ 55,800 $ 14,500 $ 6,400 $ 20,900
Depreciation and amortization expense (41,100) (1,100) (42,200) (54,500) (2,300) (56,800)
Interest expense, net of investment income (3) (4) (5,300) 1,200 (4,100) (6,600) (600) (7,200)
Other non-operating income (expenses), net (3) (5) (200) -- (200) 3,000 -- 3,000
--------- -------- --------- --------- -------- ----------
Pre-tax income (loss) $ 2,200 $ 7,100 $ 9,300 $ (43,600) $ 3,500 $ (40,100)
========= ======== ========= ========= ======== =========
(1) Excludes intersegment revenues from amounts billed by Network to Vyvx of
$4,200,000 and $4,500,000, respectively, for the 2005 and 2004 periods.
(2) For Network in 2005, includes gains of $12,600,000 from sales of operating
assets, principally undersea cable assets.
(3) If items in these categories cannot be directly attributable to a
particular WilTel segment, they are allocated to each segment based upon a
formula that considers each segment's revenues, property and equipment and
headcount.
(4) For Vyvx in 2005, includes a bankruptcy claim distribution of $1,600,000
received for a security with no book value.
(5) For 2004, WilTel's other non-operating income includes a pre-tax gain of
$2,800,000 related to cash and securities received in excess of the book
value of secured claims in a customer's bankruptcy.
Network's revenues include services provided to SBC of $279,100,000 and
$238,400,000 for the 2005 and 2004 periods, respectively, representing
approximately 70% and 67%, respectively, of Network's telecommunications
revenues. Network's revenues from SBC have continued to grow, principally
related to voice products, for which SBC and WilTel have agreed to use a fixed
price through May 31, 2005. Revenues attributable to other RBOCs were
approximately 6% and 5% of Network's operating revenues for the 2005 and 2004
periods, respectively. Revenues and gross margins for non-SBC related business
continue to reflect the excess telecommunications capacity in the marketplace,
which has resulted in lower prices for WilTel and others in the industry, and
created a very competitive environment for acquiring new business.
Network's cost of sales reflects the level of revenues, and is comprised of
variable charges paid to access vendors to originate and/or terminate switched
voice traffic, and fixed charges for leased facilities and local off-net costs.
Network's cost of sales for the 2004 period also included a charge of $3,500,000
for international voice access costs, for which no revenue was recognized.
WilTel entered into a commitment for these access costs in order to provide
services for a specific customer; however, the customer defaulted under its
contract, and WilTel accrued the remaining amount of the commitment, but does
not expect to be able to recover from its customer. Network's gross margin
percentage has improved compared to the same period in 2004 primarily due to a
decline in the price of voice access costs.
Network's salaries were $28,800,000 and $27,600,000 for the 2005 and 2004
periods, respectively, and selling, general and other expenses were $40,400,000
and $38,300,000 for the 2005 and 2004 periods, respectively. Selling, general
and other expenses for the 2005 period included a charge of $1,700,000 for
repairs resulting from weather related fiber damage, higher sales commissions
resulting from increased revenues, increased advertising and legal expenses and
the amortization of costs relating to WilTel's 2004 debt refinancing of
$500,000. Selling, general and other expenses also reflect lower property taxes
of $1,200,000, principally due to favorable assessments. Selling, general and
other expenses for the 2004 period included a charge of $2,700,000 to the
provision for doubtful accounts to fully reserve for a customer's accounts
receivable.
18
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
In conjunction with a pricing agreement for certain voice services, in January
2004, SBC paid WilTel $25,000,000 for pre-funding of certain capital
expenditures. The Company reflected these funds as a liability on its
consolidated balance sheet upon receipt. The agreement required that WilTel
return the funds to SBC if, prior to January 31, 2005, WilTel and SBC entered
into an agreement for voice transport pricing through December 31, 2006. Since
such an agreement was not entered into, these funds are no longer contractually
refundable to SBC. However, these funds will continue to be reflected as a
liability on the Company's consolidated balance sheet until such time as
WilTel's current negotiations with SBC are concluded.
Vyvx operating revenues were $28,800,000 and $27,800,000 for the 2005 and 2004
periods, respectively. Revenues in 2005 were slightly higher due to increased
advertising distribution services relating to movies, partially offset by lower
fiber revenues due to fewer hockey game broadcasts as a result of the National
Hockey League labor dispute.
Vyvx cost of sales reflects the level of revenue and is comprised primarily of
amounts billed by Network to Vyvx for transporting content over the WilTel
network, costs paid to other providers for local access and other off-net
services, transponder expenses and freight and overnight delivery costs. The
Company's consolidated statement of operations includes Vyvx salaries expense of
$4,500,000 and $4,200,000, respectively, and selling, general and other expenses
of $3,800,000 and $3,600,000, respectively, for the 2005 and 2004 periods. The
increase in Vyvx's gross margins for the 2005 period compared to the 2004 period
resulted primarily from the higher advertising distribution services revenue and
a greater percentage of those services being provided by electronic versus
physical distribution, for which the costs are lower.
Healthcare Services
Pre-tax income of the healthcare services segment was $1,400,000 and $2,400,000
for the three month periods ended March 31, 2005 and 2004, respectively. For the
2005 and 2004 periods, healthcare services revenues were $67,900,000 and
$63,200,000, respectively, and cost of sales, which primarily consist of
salaries and employee benefits, were $56,500,000 and $51,800,000, respectively.
The increase in healthcare revenues primarily resulted from an increase in the
amount of services provided and an increase in outpatient therapy rates. During
the first quarter of 2005 and 2004, one customer accounted for approximately 13%
and 16%, respectively, of Symphony's revenues. Despite the increase in revenues,
gross margins and pre-tax results declined, principally due to higher hourly
wages and benefits paid to attract and retain therapists and increased borrowing
costs and depreciation expense. Pre-tax results for the 2005 period also reflect
a gain of $400,000 from the sale of certain property.
Manufacturing
Pre-tax income for the plastics division was $3,300,000 and $900,000 for the
three month periods ended March 31, 2005 and 2004, respectively. The plastics
division's manufacturing revenues were $20,800,000 and $13,400,000 for the three
month periods ended March 31, 2005 and 2004, respectively.
The plastic division's manufacturing revenues increased by $7,400,000 in the
first quarter of 2005 as compared to the same period in 2004, reflecting NSW
revenues since acquisition of $2,400,000 and increases in most of the division's
markets. These increases result from a variety of factors including increased
prices, new product development and the acquisition in March 2004 of certain
assets of a competitor that exited certain markets. Although raw material costs
increased significantly in 2005, the division increased selling prices in most
markets during the first quarter, which along with increased sales and
production volumes enabled it to maintain its gross profit margins. Gross margin
for the 2005 period also reflects $300,000 of amortization expense on intangible
assets resulting from acquisitions. Pre-tax income for the 2005 period resulting
from the acquisition of NSW was not material.
19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
For the three month period ended March 31, 2005, the manufacturing segment also
includes a net loss of $900,000 related to Indular, an Argentine shoe
manufacturing company acquired in January 2005 in which the Company has an
effective 59% interest. Indular's revenues for the 2005 period were not
material.
Banking and Lending
As stated in the 2004 10-K, the current activities of the banking and lending
segment are concentrated on collecting and servicing its remaining loan
portfolio, maximizing returns on its investment portfolio and discharging
deposit liabilities as they come due. As a result, revenues and expenses for
this segment are reflective of the continuing decrease in the size of the loan
portfolio, particularly as a result of the loan portfolios sales during 2004.
Finance revenues, which reflect both the level and mix of consumer instalment
loans, and pre-tax results decreased in the three month period ended March 31,
2005 as compared to the similar period in 2004, as average loans outstanding
were $4,000,000 and $185,900,000 during the 2005 and 2004 periods, respectively.
Pre-tax income for the banking and lending segment was $5,300,000 for the three
month period ended March 31, 2004 and was essentially break-even for the three
month period in 2005.
Domestic Real Estate
Pre-tax income (loss) for the domestic real estate segment was $(600,000) and
$7,900,000 for the three month periods ended March 31, 2005 and 2004,
respectively. During the first quarter of 2005, the Company recognized $900,000
of previously deferred pre-tax profit related to its 95-lot development project
in South Walton County, Florida, upon completion of certain required
improvements to the property. The Company expects to recognize the balance of
the deferred pre-tax profits during 2005 (aggregating $9,300,000) from this
project as it completes the remaining improvements.
Revenues and pre-tax profit for this segment in the 2004 period reflected the
sale of certain unimproved land for cash proceeds of $8,800,000, which resulted
in a pre-tax gain of $7,600,000.
In April 2005, the Company entered into an agreement to sell its 716-room
Waikiki Beach hotel and related assets for an aggregate purchase price of
$107,000,000, before closing costs and other required payments. The agreement
requires the Company to close during the second quarter; however, if the buyer
does not close then the Company's sole recourse is to retain the buyer's
$5,000,000 non-refundable deposit. If the transaction closes, the Company would
record a pre-tax gain of approximately $53,000,000, which will be reflected in
discontinued operations. Historical operating results for the hotel have not
been material.
Corporate and Other Operations
Investment and other income increased in the three month period ended March 31,
2005 as compared to the three month period ended March 31, 2004 primarily due to
greater interest income of $6,900,000, reflecting a larger amount of invested
assets and higher interest rates. Investment and other income for the 2005
period also reflects income of $1,100,000 related to the accounting for
mark-to-market values of Corporate derivatives as compared to expense of
$1,200,000 for the comparable 2004 period.
Net securities gains for Corporate and Other Operations aggregated $100,000 and
$9,200,000 for the three month periods ended March 31, 2005 and 2004,
respectively. Net securities gains for the 2005 period include a provision of
$2,200,000 to write down the Company's investments in certain available for sale
securities. The write down of the securities resulted from a decline in market
value determined to be other than temporary.
20
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
The increase in interest expense during the three month period ended March 31,
2005 as compared to 2004 primarily reflects interest expense relating to
$100,000,000 aggregate principal amount of 7% Senior Notes and $350,000,000
principal amount of its 3 3/4% Convertible Senior Subordinated Notes issued in
April 2004.
The increase in selling, general and other expenses of $3,200,000 in the three
month period ended March 31, 2005 as compared to the same period in 2004
primarily reflects greater cost of goods sold of the winery operations and
higher professional fees, which largely relate to due diligence expenses for
potential investments and greater professional fees for existing investments,
and greater foreign exchange losses.
The Company did not record any federal income tax expense (benefit) on income
(loss) from continuing operations or other components of comprehensive income
(loss) due to the availability of WilTel tax attributes that have been fully
reserved for in the valuation allowance. Income tax expense principally relates
to state income taxes.
Associated Companies
Equity in income (losses) of associated companies for the three month periods
ended March 31, 2005 and 2004 includes the following (in thousands):
2005 2004
--------- ---------
Olympus Re Holdings, Ltd. $ 7,100 $ 8,300
EagleRock Capital Partners (QP), LP (4,900) 4,300
Jefferies Partners Opportunity Fund II, LLC 6,400 4,400
HomeFed Corporation -- 2,000
Pershing -- 2,900
Other 2,500 2,100
-------- ---------
Pre-tax 11,100 24,000
Income tax expense -- --
--------- ---------
Equity in income, net of taxes $ 11,100 $ 24,000
========= =========
As discussed above, the Company redeemed its interest in Pershing effective
December 31, 2004.
In March 2005, one of the Company's associated company investments entered into
an agreement to sell its interest in an office complex located on Capitol Hill
in Washington, D.C. The Company expects the transaction to close during the
second quarter of 2005, and the Company's share of the net proceeds and the
pre-tax gain on the sale is expected to be approximately $70,000,000.
Cautionary Statement for Forward-Looking Information
Statements included in this Management's Discussion and Analysis of Financial
Condition and Results of Interim Operations may contain forward-looking
statements. 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. Such forward-looking statements are made pursuant to the safe-harbor
provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are inherently subject to risks and uncertainties,
many of which cannot be predicted or quantified. When used in this Management's
Discussion and Analysis of Financial Condition and Results of Interim
Operations, 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.
21
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
The factors that could cause actual results to differ materially from those
suggested by any of these statements or which may materially and adversely
affect the Company's actual results 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, in particular, our Chairman and President, the
loss of whom 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;
WilTel's ability to negotiate a satisfactory transition services agreement
with SBC, which if not successful could impair WilTel's ability to meet its
obligations under its credit agreement, result in an asset impairment
charge and adversely impact results of operations;
WilTel's ability to replace the profits generated by SBC, which if lost as
a result of SBC's proposed acquisition of AT&T will have a significant
unfavorable impact on WilTel's results of operations;
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;
WilTel's dependence on a small number of suppliers and high-volume
customers, 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;
Adverse regulatory developments impacting Medicare, which could materially
reduce Symphony's revenues;
22
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
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 insure or reinsure certain risks economically, or the
ability to collect on insurance or reinsurance policies, which could result
in the Company having to self-insure business risks;
Changes in U.S. real estate markets and real estate collateral values,
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
Las Cruces copper mining project or which could result in increased costs
of bringing the project to completion and increased costs in financing the
development of the project;
The inability to obtain necessary financing for the Las Cruces copper
mining project, or the failure of the Inmet transaction to close, which
could delay or prevent completion of the project;
Decreases in world wide copper prices or weakening of the U.S. dollar
against the euro, which could adversely affect the commercial viability of
the Las Cruces copper mining project;
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;
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, competition from others for potential acquisition
targets, 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, which are applicable
only as of the date hereof. The Company undertakes no obligation to revise
or update these forward-looking statements to reflect events or
circumstances that arise after the date of this Management's Discussion and
Analysis of Financial Condition and Results of Interim Operations or to
reflect the occurrence of unanticipated events.
23
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Information required under this Item is contained in Item 7A of the Company's
Annual Report on Form 10-K for the year ended December 31, 2004, and is
incorporated by reference herein.
Item 4. Controls and Procedures.
Evaluation of disclosure 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 March 31, 2005. 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 March 31, 2005.
Changes in internal control over financial reporting
(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 March 31,
2005, that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
24
PART II - OTHER INFORMATION
Item 5. Other Information.
On January 7, 2005, the Compensation Committee of the Board of Directors of
the Company, in consultation with Ian M. Cumming and Joseph S. Steinberg,
Chairman of the Board and President, respectively, of the Company, increased the
annual salaries of (effective January 1, 2005) and awarded bonuses for 2004 to
the Company's executive officers who have been included as named executive
officers in the Company's 2005 proxy statement (other than Messrs. Cumming and
Steinberg).
Name and Title 2005 Salary 2004 Bonus*
-------------- ----------- -----------
Thomas E. Mara, $ 310,000 $ 1,000,000
Executive Vice President and Treasurer
Joseph A. Orlando, 258,000 750,000
Vice President and Chief Financial Officer
H.E. Scruggs, 216,000 600,000
Vice President
____________________
* Does not include annual year-end bonus, based on a percentage of salary,
paid to all employees.
As disclosed in the Company's proxy statement dated April 22, 2005, bonuses for
2004 for Messrs. Cumming and Steinberg will be considered by the Compensation
Committee at the Board of Directors meeting to be held following the 2005 annual
meeting of shareholders.
Item 6. Exhibits.
10.1 Letter Agreement, dated March 30, 2005, between SBC
Communications, Inc. and WilTel Communications Group, Inc.
10.2 Hotel Purchase Agreement, dated as of April 6, 2005, by and
between HWB 2507 Kalakaua, LLC and Gaylord Entertainment Co.
10.3 Letter Agreement, dated April 27, 2005, between SBC
Communications, Inc. and WilTel Communications Group, Inc.
10.4 Stock Purchase Agreement, dated as of May 2, 2005 by and among the
Company, Larry Williams, Marianne Williams, Cris Williams, Cory
Williams, Cari Groves, Mike Johnson, Paul Anderson, Stanley
Hopper, Ted Ellis, George Karr, Bryant Rudd, Jack Beverage, Rob
Luce, Gary Botts, Todd Featherly, Kevin Ramer, Rusty Yazdanpour,
Byron Cannon, Keith Larue, Greg Trail, Romney Ruder, Cliff Tevogh
and Gary Sutton.
10.5 Share Purchase Agreement, dated May 2, 2005, by and among the
Company, MK Resources Company and Inmet Mining Corporation (filed
as Exhibit 2 to Amendment No. 10 to the Company's Schedule 13D
regarding MK Resources Company (the "MK Schedule 13D")).*
10.6 Agreement and Plan of Merger, dated as of May 2, 2005, by and
among the Company, Marigold Acquisition Corp., and MK Resources
Company (filed as Exhibit 3 to the MK Schedule 13D).*
25
Item 6. Exhibits, continued.
10.7 Voting Agreement, dated as of May 2, 2005, between the Company and
Inmet Mining Corporation (filed as Exhibit 4 to the MK Schedule
13D).*
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 Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
_____________________
* Incorporated herein by reference.
26
SIGNATURES
Pursuant to the requirements 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
(Registrant)
Date: May 10, 2005
By: /s/ Barbara L. Lowenthal
-------------------------------
Barbara L. Lowenthal
Vice President and Comptroller
(Chief Accounting Officer)
27
Exhibit Index
10.1 Letter Agreement, dated March 30, 2005, between SBC
Communications, Inc. and WilTel Communications Group, Inc.
10.2 Hotel Purchase Agreement, dated as of April 6, 2005, by and
between HWB 2507 Kalakaua, LLC and Gaylord Entertainment Co.
10.3 Letter Agreement, dated April 27, 2005, between SBC
Communications, Inc. and WilTel Communications Group, Inc.
10.4 Stock Purchase Agreement, dated as of May 2, 2005 by and among the
Company, Larry Williams, Marianne Williams, Cris Williams, Cory
Williams, Cari Groves, Mike Johnson, Paul Anderson, Stanley
Hopper, Ted Ellis, George Karr, Bryant Rudd, Jack Beverage, Rob
Luce, Gary Botts, Todd Featherly, Kevin Ramer, Rusty Yazdanpour,
Byron Cannon, Keith Larue, Greg Trail, Romney Ruder, Cliff Tevogh
and Gary Sutton.
10.5 Share Purchase Agreement, dated May 2, 2005, by and among the
Company, MK Resources Company and Inmet Mining Corporation (filed
as Exhibit 2 to Amendment No. 10 to the Company's Schedule 13D
regarding MK Resources Company (the "MK Schedule 13D")).*
10.6 Agreement and Plan of Merger, dated as of May 2, 2005, by and
among the Company, Marigold Acquisition Corp., and MK Resources
Company (filed as Exhibit 3 to the MK Schedule 13D).*
10.7 Voting Agreement, dated as of May 2, 2005, between the Company and
Inmet Mining Corporation (filed as Exhibit 4 to the MK Schedule
13D).*
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 Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
_____________________
* Incorporated herein by reference.
28