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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, 2004
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 of (I.R.S. Employer Identification No.)
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 [ ].
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, 2004 (computed by reference to the
last reported closing sale price of the Common Shares on the New York Stock
Exchange on such date): $2,575,756,000.
On March 4, 2005, the registrant had outstanding 107,613,828 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
2005 annual meeting of shareholders of the registrant are incorporated by
reference into Part III of this Report.
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PART I
Item 1. Business.
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The Company
The Company is a diversified holding company engaged in a variety of
businesses, including telecommunications, healthcare services, manufacturing,
banking and lending, 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 maximize long-term shareholder value.
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
$2,258,700,000 at December 31, 2004, equal to a book value per common share of
the Company (a "common share") of negative $.07 at December 31, 1978 and $20.99
at December 31, 2004. The December 31, 2004 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
16,734,690 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.
SBC Communications Inc. ("SBC"), a major communications provider in the
U.S., is WilTel's largest customer, accounting for 70% of the Network segment's
2004 operating revenues. On January 31, 2005, 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. For more information about SBC see Item 1,
"Business-Telecommunications" below.
The Company's healthcare services operations are conducted by
subsidiaries of Symphony Health Services, LLC ("Symphony"), which was acquired
in September 2003. Symphony is engaged in the provision of physical,
occupational, speech and respiratory therapy services, healthcare staffing
services and Medicare consulting services.
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 February 2005, the manufacturing
segment increased its product offerings and customer base though the purchase of
the assets of NSW, LLC U.S. ("NSW") for approximately $28,000,000.
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,
the Company stopped originating subprime automobile loans in September 2001 and
all other consumer loans in January 2003. During 2004, the Company sold 97% of
its remaining outstanding loans to a third party for aggregate cash proceeds of
$149,000,000. Current operating activities at this segment are concentrated on
maximizing returns on its investment portfolio, collecting and servicing its
remaining loan portfolios and discharging deposit liabilities as they come due.
The Company's banking and lending subsidiary intends to ultimately surrender its
national bank charter.
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 72.1%
interest in MK Resources Company ("MK Resources") (formerly MK Gold Company), a
public company traded on the NASD OTC Bulletin Board (Symbol: MKRR).
The Company's property and casualty reinsurance business is conducted
through its 19% 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 Note 15 of "Notes to the Consolidated Financial Statements" and
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations."
On December 31, 2004, the Company effected a three-for-two stock split of
the Company's common shares in the form of a 50% stock dividend (the "Stock
Split"). The stock dividend was paid to holders of record of the Company's
common shares at the close of business on December 23, 2004. All amounts in this
Report have been adjusted to give retroactive effect to the Stock Split.
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 has submitted to the NYSE a certificate of the Chief Executive Officer
of the Company, dated May 11, 2004, certifying that he is not aware of any
violations by the Company of NYSE corporate governance listing standards.
The Company's website address is http://www.leucadia.com. The Company
makes available, without charge, through its website 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, as soon as reasonably practicable after such reports
are filed with or furnished to the SEC.
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, manufacturing, banking and lending and domestic
real estate. Healthcare services include the provision of physical,
occupational, speech and respiratory therapy services, healthcare staffing
services and Medicare consulting services. Manufacturing operations manufacture
and market lightweight plastic netting used for a variety of purposes. Banking
and lending operations historically made collateralized personal automobile
instalment loans to individuals who had difficulty obtaining credit, at interest
rates above those charged to individuals with good credit histories. The banking
and lending segment has ceased originating any new loans and in 2004 sold 97% of
its remaining outstanding loans to a third party. 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 accounts for on the equity method of accounting. Prior to the
acquisition of the outstanding common stock of WilTel that it did not 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 Resources,
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. These
are the only entities with non-U.S. revenues or assets that the Company
consolidates, and they are not material. In addition to its investment in
Bermuda-based Olympus, the Company also owns 36% of the electric utility in
Barbados. From time to time the Company invests in the securities of non-U.S.
entities or in investment partnerships that invest in non-U.S. securities.
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 accounting
principles generally accepted in the United States ("GAAP"), which is used for
all other reportable segments, for the year ended December 31, 2004 and for the
period from November 6, 2003 through December 31, 2003 (in millions):
4
For the period from
For the year ended November 6, 2003 to
December 31, 2004 December 31, 2003
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Network Vyvx Network Vyvx
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Segment profit from operations (1) $ 117.8 $ 30.3 $ 13.3 $ 4.1
Depreciation and amortization expense (197.4) (9.1) (37.2) (2.0)
Interest expense, net of investment income (2) (26.0) (2.1) (4.0) (.1)
Other non-operating income, net (2) 27.2 2.7 1.8 .5
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Income (loss) from continuing operations before
income taxes, minority expense of trust preferred
securities and equity in income (losses) of
associated companies (3) $ (78.4) $ 21.8 $ (26.1) $ 2.5
========= ======= ======== =======
(1) See note (d) to segment information below.
(2) 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.
(3) For 2004, includes income of $18,500,000 related to the settlement of
litigation for less than amounts reserved, income of $6,000,000 related to
the sale of an equity security which had a zero book value, gains of
$3,500,000 related to cash and securities received in excess of the book
value of secured claims in customers' bankruptcies and income of $2,300,000
related to the reversal of excess reserves for long-term commitments.
5
Certain information concerning the Company's segments for 2004, 2003 and
2002 is presented in the following table. Consolidated subsidiaries are
reflected as of the date of acquisition, which for WilTel's segments was
November 2003 and for Symphony's healthcare services segment was September 2003.
Associated Companies are only reflected in the table below under identifiable
assets employed.
2004 2003 2002
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(In millions)
Revenues and other income (a):
Network (b) $ 1,518.9 $ 218.4 $ --
Vyvx 123.6 21.2 --
Healthcare Services 258.4 71.1 --
Banking and Lending 30.8 62.3 95.9
Manufacturing 64.4 54.1 51.0
Domestic Real Estate 63.5 50.4 47.2
Other Operations 40.0 33.3 45.8
Corporate (c) 180.9 42.5 (4.7)
Intersegment elimination (d) (18.4) (4.3) --
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Total consolidated revenues and other income $ 2,262.1 $ 549.0 $ 235.2
========= ========= ========
Income (loss) from continuing operations before income taxes, minority expense
of trust preferred securities and equity in income of associated companies:
Network (d) $ (78.4) $ (26.1) $ --
Vyvx (d) 21.8 2.5 --
Healthcare Services 5.1 (2.3) --
Banking and Lending 22.0 8.4 1.9
Manufacturing 7.9 4.4 3.1
Domestic Real Estate 20.7 18.1 16.3
Other Operations (3.4) .7 14.5
Corporate (c) 59.6 (37.5) (74.9)
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Total consolidated income (loss) from continuing operations before
income taxes, minority expense of trust preferred
securities and equity in income of associated companies $ 55.3 $ (31.8) $ (39.1)
========= ========= ========
Identifiable assets employed:
Network $ 1,554.4 $ 1,628.8 $ --
Vyvx 57.3 115.5 --
Healthcare Services 65.6 54.6 --
Banking and Lending 151.1 252.4 481.5
Manufacturing 50.4 50.8 51.5
Domestic Real Estate 148.6 165.0 106.8
Other Operations 252.6 253.4 193.7
Investments in Associated Companies:
WilTel -- -- 340.6
Other Associated Companies 460.8 430.9 397.1
Corporate 2,059.6 1,445.8 970.6
--------- --------- --------
Total consolidated assets $ 4,800.4 $ 4,397.2 $2,541.8
========= ========= ========
6
(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 (losses) on the
Company's consolidated statements of operations.
(b) For 2004 and the period from November 6, 2003 (date of acquisition) through
December 31, 2003, includes services provided to SBC of $1,032,800,000 and
$141,700,000, respectively.
(c) Net securities gains for Corporate aggregated $123,100,000 during 2004,
which primarily resulted from the sale of publicly traded debt and equity
securities that had been classified as available for sale securities. For
2004, includes a provision of $4,600,000 to write down investments in
certain available for sale securities. 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.
(d) 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.
(e) For the years ended December 31, 2004, 2003 and 2002, income (loss) from
continuing operations has been reduced by depreciation and amortization
expenses of $235,900,000, $61,400,000 and $18,500,000, respectively; such
amounts are primarily comprised of Corporate ($11,400,000, $11,700,000 and
$8,700,000, respectively), and amounts related to WilTel's segments, which
are disclosed above. Depreciation and amortization expenses for other
segments are not material.
(f) For the years ended December 31, 2004, 2003 and 2002, income (loss) from
continuing operations has been reduced by interest expense of $96,800,000,
$43,000,000 and $33,000,000, respectively; such amounts are primarily
comprised of Corporate ($55,300,000, $26,000,000 and $13,100,000,
respectively), banking and lending ($2,700,000, $8,800,000 and $18,100,000,
respectively), and amounts related to WilTel's segments, which are
disclosed above. Interest expense for other segments is not material.
At December 31, 2004, the Company and its consolidated subsidiaries had
5,324 full-time employees.
Telecommunications
Acquisition
During the fourth quarter of 2002, the Company acquired 47.4% of the
outstanding common stock of WilTel for an aggregate cash purchase price of
$353,900,000, including expenses. In November 2003, the Company consummated an
exchange offer and merger pursuant to which WilTel became a wholly-owned
subsidiary of the Company and former WilTel public stockholders received an
aggregate of 16,734,690 common shares of the Company. The aggregate purchase
price for the 2003 acquisition was approximately $425,300,000, consisting of
$422,800,000 of the Company's common shares (based on a price of $25.27 per
share) and cash expenses of $2,500,000. Following completion of the merger, the
Company 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. At
December 31, 2004, the Company's consolidated balance sheet includes total
WilTel assets of $1,611,700,000 and total WilTel liabilities of $1,118,300,000
(which are non-recourse to the Company), resulting in a net investment of
$493,400,000.
Certain telecommunications terms used throughout this section are defined
under "Telecommunications Glossary" below.
7
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. Historically,
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
27,677 is currently in service;
- local fiber-optic cable networks within 40 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, Illinois 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 18,027 17,416 123
Fiber routes through dark fiber rights (1) 10,884 10,261 17
------ ------
Total 28,911 27,677
====== ======
(1) Network has obtained rights in dark fiber and conduits of approximately
10,884 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 approximately 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.
8
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 25 switches as of December 31, 2004, including
twenty three domestic switches, four of which are Voice over Internet Protocol
capable, 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 WilTel's 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, 2004, Network was providing services on local networks
in 40 U.S. cities. These cities are: Anaheim, CA; Atlanta, GA; Bakersfield, CA;
Baltimore, MD; Boston, MA; Buffalo, NY; Chicago, IL; Columbus, OH; Dallas, TX;
Denver, CO; Fresno, CA; Houston, TX; Indianapolis, IN; 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; Stamford, CT; 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"). 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,
Ethernet Transparent LAN, Internet Protocol ("IP") transport and IP virtual
private networks. These services are billed on a flat rate or usage basis.
9
Private line products. Network provides customers with fixed amounts of
point-to-point capacity at various speeds on a protected or unprotected service
level. A protected service level provides restoration on the customer's circuit
under a variety of network outage conditions and is priced higher than
unprotected service. These services are billed as fixed monthly fees, regardless
of usage.
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 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. Network also owns capacity positions on
five major undersea cable systems.
Customers
Network offers services to both carrier and enterprise markets, and its
customers currently include Regional Bell Operating Companies, ("RBOCs") 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, financial
institutions, international carriers and other communications services providers
who desire high-capacity and high-speed products on a carrier services basis.
SBC
Sales to SBC accounted for 70% of Network's 2004 operating revenues. On
January 31, 2005, 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. SBC
indicated that it expects to close its acquisition of AT&T in the first half of
2006.
Once SBC completes the migration of its business from WilTel's network to
the AT&T network and terminates the existing preferred provider agreements
between WilTel and SBC (scheduled to extend until 2019), SBC will be required to
pay WilTel up to $200,000,000 for all costs WilTel incurs in connection with
such termination, including increased costs of the network facilities remaining
with WilTel due to the loss of SBC traffic (defined as "Transition Costs" in the
provider agreements). WilTel anticipates that a migration of services from its
network to AT&T would not begin until after the appropriate regulatory agencies
approve SBC's acquisition of AT&T. WilTel expects it will take anywhere from two
to three years from now for SBC to migrate all of its traffic off of WilTel's
network, and anticipates that it will continue to provide some level of service
to SBC into 2007.
Pursuant to the preferred provider agreements, the price for products and
services, 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 April 1, 2005.
10
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 SBC with a high level of service after April 1, 2005. If the
parties fail to reach agreement on pricing, any disputes as to pricing
methodology are to be resolved through binding arbitration. The Company is also
evaluating the impact of SBC's intended acquisition of AT&T on WilTel's
operations and financial condition, including the potential adverse impact on
the carrying values of Network's assets. Under GAAP, the SBC announcement is
considered to be an event requiring the Company to assess the recoverability of
Network's assets (principally property and equipment) during the first quarter
of 2005. For more information about the process the Company expects to use to
assess the recoverability of Network's assets, see Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
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. WilTel expects it will evaluate and implement
cost reduction strategies, investigate sales of assets and minimize capital
expenditure outlays to help offset the loss of SBC's business. However, given
the current economic condition of the telecommunications industry as a whole,
where telecommunications capacity far exceeds actual demand and the marketplace
is characterized by fierce price competition, and the limited growth of non-SBC
business over the past few years, 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. However, no assurance can be given that the
Company will be successful in these efforts.
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, 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.
11
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 customers, Network
competes primarily with AT&T, MCI, Sprint, Qwest, Level 3, Global Crossing and
Broadwing. In the market for enterprise customers, Network competes primarily
with AT&T, MCI, and Sprint. 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. In
addition, many larger industry participants (SBC, Verizon and Sprint) have
announced agreements to acquire other industry participants in transactions that
may further intensify the competitive environment. 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 sixteen 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.
Vyvx also distributes advertising spots 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.
12
Advertising Distribution Services. These services include:
Audio Distribution. Vyvx sends radio spots to stations via
electronic and physical distribution. Spots are distributed to over 10,500
stations in North America via the Internet using no proprietary hardware.
Video Distribution. Vyvx has the capability to deliver video
content electronically and physically to television stations, broadcast networks
and cable networks across the United States. Its electronic reach covers more
than 1,450 destinations.
Storage. Vyvx offers secure storage of media components in Vyvx's
climate-controlled storage facilities located in Burbank, Chicago and Newark,
Delaware.
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
62% of Vyvx's 2004 operating revenue 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 18% of Vyvx's operating revenues and TimeWarner, Inc. accounted
for 16% of Vyvx's operating revenues.
Sales and Marketing
Vyvx has sales personnel located in eight states and the District of
Columbia to provide service to its domestic and international customers. The
largest sales offices are in New York, New York and Burbank, California, 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's products.
13
Telecommunications Glossary
- ---------------------------
Access - a long distance carriers use of local exchange facilities to originate
or terminate long distance traffic or of leased lines for dedicated facilities.
Asynchronous transfer mode (ATM) - a Layer 2 high-speed multiplexing and
switching protocol 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.
Ethernet - a local area network used for connecting computers, printers,
workstations, terminal, servers, etc. within the same building or campus.
Ethernet Transparent LAN - a network with Ethernet interfaces that can carry any
Layer 3 protocol, giving the LANs it connects the appearance of complete
transparency, as though they were connected directly across an Ethernet cable.
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 - a Layer 2 switching and multiplexing protocol that places data in
frames of varying size and allows transmission of data with efficient error
correction.
Gateway switch - a switch that allows signals to cross from one network to
another.
High Definition (HD) - a system standard for transmitting a TV signal with far
greater resolution.
Internet Protocol (IP) - the Layer 3 communications protocol standard used for
delivering individual data packets to their destinations by tracking the
Internet addresses of the sender and receiver.
Layer 2 - a data communications standard (such as ATM, Frame Relay, or Ethernet)
that establishes a fixed, pre-determined path for the data stream. In the event
of a network outage, the switches work together to re-route traffic to
facilities not impacted by the outage.
Layer 3 - a data communications standard (such as IP) that does not create a
fixed path through the network, but makes an individual routing decision for
each data packet received based upon real-time updates of network congestion.
Because of this additional computation burden, Layer 3 networks tend to have
more latency that is less predictable, but are also less susceptible to major
network outages.
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, higher speed
signal that is transmitted to a receiver. The receiver then decomposes the
signal into its original 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 physical
path to a destination.
14
Virtual private network (VPN) - private, secure switched voice or data network
between two or more sites that functions as a dedicated or private line facility
while using public network segments.
Voice over IP - telephone calls using IP.
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.
The Federal Communications Commission ("FCC") has jurisdiction over
WilTel's facilities and services to the extent those facilities are used to
provide 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.
15
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 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. 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 an
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.
The Section 272 separate subsidiary requirement for two of WilTel's
largest customers, Verizon in New York, Massachusetts, Pennsylvania and Rhode
Island and SBC in Texas, Oklahoma, Kansas, Arkansas and Missouri 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 approximately 75% of WilTel's Network revenues, the RBOC's ability to offer
long distance voice and data services poses risks to WilTel's business in the
future. For information about SBC (Network's largest customer) and its plan to
acquire AT&T and migrate its traffic to AT&T's network, see Item 1,
"Business-Telecommunications" above.
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.
In March 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. In response, the FCC
issued interim rules requiring regional local telephone companies to continue
opening their networks to competitors at reasonable rates until the earlier of
such time as the FCC issues permanent rules or September 13, 2005 (with
increased rates and reduced availability effective March 13, 2005). The FCC
released permanent rules on February 3, 2005. As a result, competing telephone
companies will be charged higher rates by local telephone companies to use parts
of their networks on certain routes, or incur costs to purchase and install
their own networks in order to offer local phone service. Although WilTel's
wholesale carrier market segment is not likely to be materially affected by
these actions, its enterprise market segment could experience a short-term cost
disadvantage with competitors who have cheaper access to local telephone company
networks. In addition, certain of WilTel's customers could be significantly
affected by these changes.
16
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. The FCC issued an order on
July 10, 2003 on remand readopting the substance of the disputed aspects of the
CALLS order, and the remand order was not appealed.
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. This 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 local calls exchanged between
them). The FCC's proposal seeks comments on a transition to a "bill and keep"
system 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. Several groups of industry participants, seeking to develop an
industry consensus to present to the FCC, have submitted proposals for broad
reform to the FCC, and on February 10, 2005, the FCC announced the adoption of a
further notice of proposed rulemaking in which it would seek comment on these
various proposals. 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.
In a May 2004 ruling, the FCC clarified that whenever traffic originates
and terminates on the public switched telephone network, long distance carriers
(such as WilTel) that carry such traffic must pay access charges, but the FCC
has not yet addressed whether traffic originating on broadband networks is
subject to such charges. RBOCs have attempted to recover unpaid access charges
from long distance carriers who were following business practices not consistent
with the FCC ruling. Although WilTel had been actively seeking clarification
from the FCC concerning this matter, WilTel's policy has been to accrue access
charges in a manner that it believes is consistent with the FCC's ruling. The
FCC's ruling is not expected to have a material impact on WilTel; however,
certain of WilTel's customers and competitors may be adversely affected.
17
On November 12, 2004, the FCC granted the request of Vonage Holdings
Corporation to preempt the Minnesota Public Utility Commission from regulating
Vonage's broadband-originated services as a telecommunications service subject
to full state regulation. WilTel believes that the FCC's ruling provides the FCC
with authority to create uniform rules applicable to Voice-over-IP. The FCC's
Vonage decision has been appealed by several state public utility commissions.
Several other Voice-over-IP petitions have also been filed. During 2004,
both Level 3 Communications and SBC filed petitions seeking FCC rulings on the
regulatory framework for Voice-over-IP related offerings. Other local exchange
carriers have filed similar petitions, and the FCC has requested comments on
developing comprehensive rules to cover Voice-over-IP. Absent FCC action on
these matters, some state public utility commissions and private parties
(through agreements) have begun addressing important issues such as the amount
of compensation companies must pay for termination of Voice-over-IP traffic on
the public switched telephone network. Decisions on the Level 3 and SBC
petitions are expected during the first or second quarter 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.
However, assuming the same volume of voice minutes, WilTel believes that
revenues and profitability for Voice-over-IP services may be less than
traditional voice transport products.
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 health care 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 2005 of 10.7% have been increased from 8.7% in the
fourth quarter of 2004. 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, 2004, WilTel was assessed approximately $6,600,000 by the Fund.
On December 13, 2002, the FCC issued revised universal service rules and
proposed further changes to the universal service contribution methodology.
Under one of the proposed changes, the FCC would begin assessing contributions
to the Fund based on working telephone numbers and connections to telephone
company customers, as opposed to the existing mechanism that requires
contributions based on end user revenues. The FCC is expected to adopt this
proposal during 2005. Although any FCC changes to the methodology could result
in WilTel paying a larger percentage of its revenues to the Fund, WilTel is
unable to determine what changes will occur and what impact those changes will
have on its business.
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.
18
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 appealed that decision, and the U.S. Supreme Court is scheduled to hear the
case during 2005. 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 how the U.S. Supreme Court will rule on
the Ninth Circuit decision, and whether such action will impact WilTel's
business.
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.
19
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.
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.
20
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 including 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 46 states, providing services at
approximately 2,000 locations through its employee workforce of approximately
3,200 part-time and full-time skilled healthcare professionals (excluding
temporary personnel). The businesses owned by Symphony operate under the names
RehabWorks, VTA Management Services, VTA Staffing Services, Symphony Respiratory
Services, NurseWorks and Polaris Group. At December 31, 2004, the Company's
consolidated balance sheet includes total Symphony assets of $65,600,000 and
total Symphony liabilities of $60,200,000 (which are non-recourse to the
Company), resulting in a net investment of $5,400,000.
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 to 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, where fixed fee schedules are set
by the Center for Medicare and Medicaid Services ("CMMS"). 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 offered by Symphony and its
competitors.
21
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 these
services. The managed inpatient units and outpatient programs are in highly
competitive markets and compete for patients with other hospitals and skilled
nursing facilities.
There is a significant shortage of skilled healthcare professionals who
provide Symphony's services, and Symphony's revenues are dependent on its
ability to attract, develop and retain qualified 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, 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 CMMS 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 Medicare Part
A prospective payment system for skilled nursing facilities and units based on
the category of patient care under resource utilization group classifications
established by the CMMS. 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. The proposed 2006 federal budget includes
a provision to refine the resource utilization group system to more
appropriately account for certain high cost cases, but no assurance can be given
that such changes will be implemented. Under the Medicare Part B payment system,
reimbursement for outpatient therapy services is based on the lesser of the
provider's actual charge for such services or the applicable Medicare physician
fee schedule amount also established by the CMMS. As part of the Balanced Budget
Act of 1997, the outpatient therapy benefit was capped at $1,590 per beneficiary
per year, but the implementation of the cap has been delayed a number of times
through legislation. Most recently, a two year moratorium expiring on December
31, 2005, was placed on implementation of the cap. Absent specific action by
Congress the moratorium will expire and the benefit cap will go into place on
January 1, 2006.
22
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. Symphony is in compliance with the privacy and electronic
transmission provisions and believes that it will be in compliance with the
security rule.
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. The plastics division is a market
leader in netting products used in carpet cushion, 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 2004
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 $64,100,000, $53,300,000
and $50,700,000 for the years ended December 31, 2004, 2003 and 2002,
respectively. At December 31, 2004, the Company's consolidated balance sheet
includes total manufacturing assets of $50,400,000 and total manufacturing
liabilities of $21,100,000, resulting in a net investment of $29,300,000.
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. 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. The cost of the principal raw material used in its
products, polypropylene, has increased by approximately 80% since the beginning
of 2004. High oil and natural gas prices along with high capacity utilization in
the polypropylene industry are expected to keep raw material costs higher than
historical levels for the next two years. The division was able to raise prices
to its customers during 2004 to offset the increase in polypropylene costs.
The plastics division currently has excess manufacturing capacity,
principally in its Belgium facility which became operational in the third
quarter of 2001. Utilization of this capacity has taken longer than anticipated
primarily due to the loss of a major customer for whom the facility was expected
to produce products. A new general manager was hired at the facility in 2004 to
develop and implement marketing and sales initiatives directed at generating
revenue growth. Operating results at the facility have improved during 2004 as
sales grew 20% compared to 2003 and the business achieved positive cash flow.
New customer acquisitions must continue in order for the facility to reach
profitability.
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.
As mentioned above, in February 2005 the Company acquired the assets of
NSW for approximately $28,000,000, thereby increasing its mix of products and
customer base. 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. Although the Company plans to integrate certain of
NSW's operating activities into its own, principally in the administration and
raw materials purchasing areas, NSW's manufacturing facility will continue as a
stand-alone operation. Products manufactured by NSW include produce and
packaging nets, header label bags, case liners and heavy weight nets for
drainage and erosion control purposes.
23
Banking and Lending
Business Description
Over the past few years, the Company has been shrinking its banking and
lending operations. Historically, this segment made collateralized consumer
loans consisting principally of personal automobile instalment loans to
individuals who had difficulty obtaining credit. The Company's other consumer
lending programs primarily consisted of marine, recreational vehicle, motorcycle
and elective surgery loans. These lending activities were conducted through
American Investment Bank, N.A. ("AIB"), a national bank subsidiary, and American
Investment Financial, a Utah industrial loan corporation which merged into AIB
in 2004.
The segment's current operating activities are concentrated on
maximizing returns on its investment portfolio, collecting and servicing its
remaining loan portfolios and discharging deposit liabilities as they come due.
In September 2001, the Company stopped originating subprime automobile loans as
a result of increasing loss experience and the increasingly difficult
competitive environment. In January 2003, the Company stopped originating all
consumer loans. In May 2004, the Company sold its subprime automobile and
collateralized consumer loan portfolios, which represented 97% of banking and
lending's total outstanding loans (net of unearned finance charges). The Company
received aggregate cash proceeds of $149,000,000 and reported a pre-tax gain of
$8,700,000, which is reflected in investment and other income. In September
2004, the Company sold certain loan portfolios that had been substantially
written-off and reported a pre-tax gain of $7,600,000, which is reflected in
investment and other income.
Certain information with respect to the Company's banking and lending
segment is as follows for the years ended December 31, 2004, 2003 and 2002
(dollars in thousands):
2004 2003 2002
---- ---- ----
Average loans outstanding $57,097 $282,986 $440,810
Interest income earned on loans $10,037 $ 53,944 $ 86,018
Average loan yield 17.6% 19.1% 19.5%
Average deposits outstanding $73,260 $251,031 $454,497
Interest expense on non-demand deposits $ 2,394 $ 8,553 $ 18,035
Average rate on non-demand deposits 3.3% 3.4% 3.9%
Net yield on interest-bearing assets 5.3% 12.1% 11.5%
Investments held by the banking and lending segment are primarily U.S.
Government agencies and mortgage-back securities.
24
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, 2004, the allowance for loan losses for the Company's
entire loan portfolio was $950,000 or 22% of the net outstanding loans, compared
to $24,200,000 or 11.8% of net outstanding loans at December 31, 2003.
Government Regulation
The Company's principal banking and lending operations are subject to
supervision by federal 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 regulation and
supervision by, among others, the Office of the Comptroller of the Currency (the
"OCC") and the FDIC.
In 2003, AIB entered into a formal agreement with the OCC, pursuant to
which the OCC approved AIB's strategic plan for exiting its existing lending
businesses. AIB also agreed to initiate a regulatory process by January 31,
2005, which would result in the eventual surrender of its national bank charter.
In November 2004, AIB submitted an application to the state of Utah to convert
its current national charter to a Utah state commercial bank charter. AIB is not
able to surrender its national bank charter while it still has deposits
outstanding, unless it is able to convert its charter to a Utah state commercial
bank charter. However, in January 2005 the state of Utah notified AIB that it
was suspending the application to convert AIB's charter until such time as AIB
has the operational structure in place that is necessary to begin loan
originations. AIB does not intend to make these changes. In February 2005, the
OCC denied AIB's prior request to extend the deadline to begin the regulatory
process to surrender the national charter, and required AIB to begin the
regulatory process to surrender the national charter within 30 days from the
date of the OCC's denial. Since AIB's application to convert the charter was not
approved, and since the OCC did not approve AIB's request for an extension, AIB
will file a plan with the OCC that will ultimately result in the surrender of
its national bank charter. No assurance can be given that the OCC will approve
AIB's plan of voluntary liquidation or that it will not take other adverse
regulatory action.
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.
25
Domestic Real Estate
At December 31, 2004, the Company's domestic real estate assets had a
book value of $131,200,000. 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 and has a book value of $57,600,000 at December 31, 2004. 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 716-room hotel located on Waikiki
Beach in Hawaii that has a book value of $39,400,000 at December 31, 2004. The
hotel was fully renovated during 2001 and 2002, and for 2004 had an occupancy
rate of approximately 66% and a net average daily room rate of $109.05. The
Company secured non-recourse financing for these two projects, which aggregated
$42,400,000 as of December 31, 2004.
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 9.5% 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 current development projects
consist of two master-planned communities located in San Diego County,
California: San Elijo Hills, which it purchased from the Company in 2002, and a
portion of the larger Otay Ranch planning area. The Company accounts for its
investment in HomeFed under the equity method of accounting. At December 31,
2004 its investment had a carrying value of $39,500,000 which is included in
investments in associated companies. HomeFed is a public company traded
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, 2004 include: approximately 88
acres of land located in Myrtle Beach, South Carolina, which is fully entitled
for a large scale mixed-use development of various residential and commercial
space ($12,900,000); and an operating shopping center on Long Island, New York
that has 60,000 square feet of retail space ($7,100,000).
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
Wineries
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. Since acquisition, the Company's
investment in winery operations has grown, principally to fund the 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. The
Company controls 224 acres of vineyards in the Napa Valley, California and 115
acres of vineyards in the Willamette Valley of Oregon, substantially all of
which are owned and producing grapes. The Company believes that its vineyards
are located in some of the most highly regarded appellations of the Napa Valley.
At December 31, 2004, the Company's combined net investment in these wineries
was $58,000,000. During 2004, the wineries sold approximately 63,600 9-liter
equivalent cases of wine generating wine revenues of $13,200,000.
These wineries primarily produce and sell wines in the luxury segment of
the premium table wine market; however, approximately 7% of the wineries' wine
revenues and 19% of case sales were derived from a wine that is not in the
luxury segment and is made from purchased grapes. The Company's wines are
primarily sold to distributors, who then sell to retailers and restaurants. The
distributors used by the Company also offer premium table wines of other
companies that directly compete with the Company's products. As permitted under
federal and local regulations, the wineries have also been placing increasing
emphasis on sales direct to consumers, which they are able to do through the
internet, wine clubs and at the wineries' tasting rooms. During 2004, direct
sales to consumers represented 21% of case sales and 41% of wine revenues. Sales
of the Company's wines in California and Oregon (excluding direct sales to
consumers) amounted to approximately 11% of 2004 wine revenues.
26
The luxury segment of the wine industry is intensely competitive. The
Company's wines compete with small and large producers in the U.S., as well as
with imported wines. Demand for wine in the luxury market segment can rise and
fall with general economic conditions, and is also significantly affected by
available supply. At present, there is a worldwide oversupply of luxury wine
which may last for a few years. The demand for the Company's wines is also
affected by the ratings given the Company's wines in industry publications.
During the past year, ratings for some of the Company's wines have increased or
stayed substantially the same while ratings for other varietals have declined.
Although future ratings are impossible to predict, the Company would not
normally expect that all of its wines would be similarly rated at the same time.
In the past year wine sales have declined and inventory levels of the
Company's wines held by the Company and its distributors have grown, which
resulted in the need to hold, or for certain varietals reduce prices. In
particular, Pine Ridge has been producing too much Merlot for its historical
sales volume, and it expects to reduce future production through re-budding and
re-planting activities. The Company's wineries have also been focused on
improving wine quality. Wine quality improvements are principally being made by
reducing the amount of grape clusters grown on each grapevine (resulting in
yield reduction) to further concentrate flavor, and investing in new winemaking
equipment. Luxury wines available for sale in any given year are also dependent
upon harvest yields of earlier periods, which can fluctuate from harvest to
harvest depending on weather patterns, insects and other non-controllable
circumstances.
Certain of the wineries' production, sales and distribution activities
are subject to regulation by agencies of both federal and state governments.
There is currently a case pending before the U.S. Supreme Court concerning
interstate wine shipments that could change the ability of wineries to sell wine
directly to consumers in various states. The Company is unable to predict the
eventual outcome of this litigation.
MK Resources
The Company has a 72.1% interest in MK Resources, whose principal
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 feasibility study for the project was prepared by DMT-Montan
Consulting GmbH and Outokumpu Technology Group, which incorporates the
requirements of various local regulatory authorities. The feasibility study was
reviewed by Pincock, Allen & Holt, an independent engineering company, and
includes a proven and probable ore reserve calculation prepared by DMT. Pincock,
Allen & Holt made minor adjustments to the ore reserve calculations in
connection with its review. Including these adjustments, proven and probable
reserves are approximately 16 million metric tons of copper ore at an average
grade of 6.62% copper. As of December 31, 2004, the carrying value of the
Company's investment in mining properties, plant and mine development was
$85,400,000 substantially all of which related to Cobre Las Cruces.
Based on the study, the capital costs to build the project are estimated
at 281 million euros ($372,000,000 at exchange rates in effect on March 4,
2005), including working capital, land purchases, and contingencies, but
excluding reclamation bonding requirements, inflation, interest during
construction, cost overruns and other financing costs. Cash operating costs per
pound of copper produced are expected to average 0.33 euros per pound ($.44 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. The appreciation of the euro against the U.S. dollar
during the past few years has significantly increased the U.S. dollar cost to
build the project; however, the price of copper in U.S. dollars has also
increased significantly, which would offset the increase in capital costs.
However, there can be no assurance that the relationship between the U.S. dollar
price of copper and the euro will stay the same in the future.
Development of the Las Cruces project is subject to obtaining required
permits, obtaining both debt and equity financing for the project, engineering
and construction. Environmental approval of the project has been obtained from
the Spanish and Andalusian government agencies. The mining concession was
received during 2003, and the four principal water permits that are required
were received during 2003 and 2004. The approvals, permits and concessions that
have been received to date are significant to the successful development of the
project; however, additional licenses and permits will have to be obtained.
Cobre Las Cruces has filed applications with the appropriate regulatory
authorities seeking approval for certain of these matters, while others cannot
be filed until additional engineering work or other steps are completed. Cobre
Las Cruces has also been granted government subsidies of 47.5 million euros
($62,900,000); however, the grants require it to make certain capital
expenditures by March 27, 2005, a deadline that it will not be able to meet
principally because of delays in obtaining permits. Cobre Las Cruces has filed a
request to further extend the deadline, but has been informed that the
government will not act on the extension request prior to the current
expiration. Although MK Resources believes that the extension will be granted,
no assurance can be given that an extension will actually be received. A loss of
the subsidies would adversely impact the economic viability of the project.
27
To date, the Company has been the sole source of funding for the Las
Cruces project. The amount of equity capital and third party financing that can
be obtained for the project and its related cost will be significantly affected
by the assessment of potential investors and lenders of the current and expected
future market price of copper, as well as current market conditions for this
type of investment. MK Resources has not yet determined whether the debt
financing for the project will be denominated in euros or dollars or some
combination of both. During 2004, MK Resources was unsuccessful in raising
equity capital for the project, due to unfavorable market conditions at the
time. Assuming required permits and financing are obtained in a timely manner,
MK Resources anticipates that final design will begin in 2005, followed by
construction and mine development thereafter, with copper production to begin
during 2007. Although MK Resources believes the necessary permitting and
financing will be obtained, no assurances can be given that MK Resources will be
successful, or if successful, when permitting and financing will be obtained.
Further, there may be other political and economic circumstances that could
prevent or delay development of Las Cruces.
Other Investments
In 2004, the Company invested $75,000,000 in INTL Consilium Emerging
Market Absolute Return Fund, LLC ("INTL"), a limited liability company that is
invested in a master fund which primarily invests in emerging markets debt and
equity securities. INTL and the master fund are managed and controlled by an
investment manager who has full discretion over investment and operating
decisions. Under GAAP, INTL is considered a variable interest entity and the
Company is the primary beneficiary; as a result, the Company accounts for its
investment in INTL as a consolidated subsidiary. INTL plans to sell additional
membership interests in the future, which if accomplished could result in the
Company no longer accounting for INTL as a consolidated subsidiary. The Company
can generally withdraw its capital account interest upon 90 days notice, subject
to the manager's ability to liquidate security positions in an orderly manner.
At December 31, 2004, INTL had total assets of $79,600,000, which are reflected
as investments in the Company's consolidated balance sheet, and its liabilities
were not material. For the year ended December 31, 2004, the Company recorded
$2,200,000 of pre-tax income relating to INTL. The Company has included INTL in
its Corporate segment.
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 (collectively "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. For
the year ended December 31, 2004, ATX reported total revenues of approximately
$251,000,000.
As contemplated at the time of the Company's purchase, in January 2004,
ATX commenced a voluntary Chapter 11 case in order to reorganize its financial
affairs. During 2004, the Company provided debtor-in-possession financing to ATX
of $5,000,000. This financing is secured by liens on substantially all of ATX's
assets, and is expected to be repaid upon ATX's emergence from bankruptcy. In
January 2005, ATX filed its First Amended Joint Plan of Reorganization (the
"Plan") and related disclosure statement. The Plan was filed after agreements
were reached with major stakeholders and/or the representatives of major
stakeholders in the bankruptcy case. The Plan contemplates that the Company will
convert its current investment in the ATX credit facility into 95% 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 will provide up to
$25,000,000 of exit financing to ATX to fund bankruptcy related payments and
working capital requirements, which includes the repayment of the Company's
$5,000,000 debtor-in-possession financing. The Plan is subject to the approval
of the bankruptcy court and creditors. Assuming that ATX is reorganized as
contemplated in the Plan, the Company will consolidate ATX as of the date the
Plan becomes effective.
28
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, 2004, the book value of the Company's 19% equity interest
in Olympus was $124,400,000. 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. For the years ended December 31, 2004, 2003 and 2002, the Company
recorded $9,700,000, $40,400,000 and $24,100,000, respectively, of pre-tax
income from this investment under the equity method of accounting. During 2004,
Olympus' results, and accordingly, the Company's equity in Olympus' earnings,
were adversely affected by property damage claims caused by severe hurricanes.
At December 31, 2004, the book value of the Company's equity investment
in JPOF II, a registered broker-dealer, was $116,200,000. 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 years ended December 31, 2004, 2003 and 2002, the
Company recorded $16,200,000, $14,800,000 and $15,200,000, respectively, of
pre-tax income from this investment under the equity method of accounting, all
of which was distributed to the Company shortly after the end of each year.
In December 2001, the Company invested $50,000,000 in EagleRock, a
limited partnership that invests and trades in securities and other investment
vehicles. At December 31, 2004, the book value of the Company's equity
investment in EagleRock was $121,100,000. Pre-tax results of $29,400,000,
$49,900,000 and $(4,500,000) for the years ended December 31, 2004, 2003 and
2002, respectively, were recorded from this investment under the equity method
of accounting. During 2004, EagleRock distributed $3,700,000 to the Company.
29
The Company owns 375,000 common shares that represent approximately 3.5%
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, 2004, the Company's
investment had a market value of $242,300,000.
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. At
December 31, 2004, 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 4, 2005 (determined in accordance with Rule 13d-3 of the
Securities Exchange Act of 1934): FINOVA (25%), HomeFed (30%), International
Assets Holding Corporation (16.5%), Jordan Industries, Inc. ("JII") (10.1%), and
ParkerVision, Inc. (6.2%). The Company also owns 20.3% of JII's Senior
Subordinated Discount Debentures due 2009 ($19,300,000 aggregate principal
amount, for which the Company paid $9,100,000) and 22.8% of JII Holdings Senior
Secured Notes due 2007 ($39,500,000 aggregate principal amount, for which the
Company paid $36,500,000).
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 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 24 other companies. At December 31, 2004, these investments are
carried in the Company's consolidated financial statements at $108,900,000, of
which $81,800,000 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; the majority of its rights
of way agreements extend through at least 2018. WilTel owns or leases office
space and points of presence sites (point of presence are locations where WilTel
has transmission, routing and switching equipment) in approximately 120 U.S.
cities and towns. These facilities primarily range in size from 2,000 square
feet to 750,000 square feet and total approximately 3,700,000 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 396 acres, respectively).
30
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.
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 4. Submission of Matters to a Vote of Security Holders.
- ------ ---------------------------------------------------
Not applicable.
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 4, 2005, 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 64 Chairman of the Board June 1978
Joseph S. Steinberg 61 President January 1979
Thomas E. Mara 59 Executive Vice President May 1980;
and Treasurer January 1993
Joseph A. Orlando 49 Vice President and January 1994;
Chief Financial Officer April 1996
Barbara L. Lowenthal 50 Vice President and April 1996
Comptroller
H.E. Scruggs 47 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. 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 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 Resources since February 2000 and
President of MK Resources 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.
31
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
---- ---
2003
----
First Quarter $ 25.73 $ 21.73
Second Quarter 26.29 23.86
Third Quarter 26.27 24.22
Fourth Quarter 30.79 25.19
2004
----
First Quarter $ 35.97 $ 30.69
Second Quarter 37.74 30.03
Third Quarter 37.78 32.23
Fourth Quarter 47.00 37.50
2005
----
First Quarter (through March 4, 2005) $ 46.65 $ 32.40
As of March 4, 2005, there were approximately 2,800 record holders of the
common shares.
The Company paid cash dividends of $0.25 per common share in 2004 and
$.167 per common share in 2003. 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 Company's tax attributes, 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, 2024,
(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.
32
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. Amounts have been
adjusted to give retroactive effect to the Stock Split.
Year Ended December 31,
------------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(In thousands, except per share amounts)
SELECTED INCOME STATEMENT DATA: (a)
Revenues and other income (b) $ 2,262,111 $ 548,971 $ 235,157 $ 369,553 $ 489,566
Expenses 2,206,826 580,724 274,301 297,478 288,413
Income (loss) from continuing operations before income
taxes, minority expense of trust preferred securities
and equity in income (losses) of associated companies 55,285 (31,753) (39,144) 72,075 201,153
Income from continuing operations before minority
expense of trust preferred securities and equity in
income (losses) of associated companies (c) 75,447 11,689 104,931 83,799 133,019
Minority expense of trust preferred securities, net of
taxes -- (2,761) (5,521) (5,521) (5,521)
Equity in income (losses) of associated companies, net
of taxes 76,479 76,947 54,712 (15,974) 19,040
Income from continuing operations 151,956 85,875 154,122 62,304 146,538
Income (loss) from discontinued operations, including
gain (loss) on disposal, net of taxes (6,456) 11,179 7,501 (70,223) (30,530)
Cumulative effect of a change in accounting principle -- -- -- 411 --
Net income (loss) 145,500 97,054 161,623 (7,508) 116,008
Per share:
Basic earnings (loss) per common share:
Income from continuing operations $1.42 $ .94 $1.85 $ .75 $1.76
Income (loss) from discontinued operations,
including gain (loss) on disposal (.06) .12 .09 (.85) (.37)
Cumulative effect of a change in accounting principle -- -- -- .01 --
----- ----- ----- ----- -----
Net income (loss) $1.36 $1.06 $1.94 $(.09) $1.39
===== ===== ===== ===== =====
Diluted earnings (loss) per common share:
Income from continuing operations $1.40 $ .93 $1.83 $ .75 $1.76
Income (loss) from discontinued operations,
including gain (loss) on disposal (.06) .12 .09 (.85) (.37)
Cumulative effect of a change in accounting principle -- -- -- .01 --
----- ------ ----- ----- -----
Net income (loss) $1.34 $1.05 $1.92 $(.09) $1.39
===== ===== ===== ===== =====
33
At December 31,
---------------------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(In thousands, except per share amounts)
SELECTED BALANCE SHEET DATA: (a)
Cash and investments $ 2,320,052 $ 1,602,495 $ 1,043,471 $ 1,080,271 $ 998,892
Total assets 4,800,403 4,397,164 2,541,778 2,469,087 2,417,783
Debt, including current maturities 1,551,741 1,178,834 233,073 252,279 190,486
Customer banking deposits 24,591 145,532 392,904 476,495 526,172
Shareholders' equity 2,258,653 2,134,161 1,534,525 1,195,453 1,204,241
Book value per common share $20.99 $20.09 $17.16 $14.41 $14.52
Cash dividends per common share $ .25 $ .17 $ .17 $ .17 $ .17
(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 16,734,690 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). Symphony is reflected as a consolidated subsidiary since its
acquisition in September 2003. For additional information, see Note 3 of
Notes to Consolidated Financial Statements.
(b) Includes net securities gains (losses) of $142,936,000, $9,953,000,
$(37,066,000), $28,450,000 and $124,964,000 for the years ended December
31, 2004, 2003, 2002, 2001 and 2000, 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 $27,300,000 for 2004, $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.
As of December 31, 2004, the Parent'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 $1,756,600,000. This amount is
comprised of cash and short-term bonds and notes of the United States Government
and its agencies of $1,087,800,000 (61.9%), the equity investment in WMIG of
$242,300,000 (13.8%) (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
$426,500,000 (24.3%). 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 and corporate overhead
expenses.
34
The Parent's only long-term cash requirement is to make principal
payments on its long-term debt ($964,000,000 outstanding as of December 31,
2004), of which $40,800,000 is due before 2013, $475,000,000 is due in 2013,
$350,000,000 is due in 2014 and $98,200,000 is due in 2027. Historically, the
Parent has used its available liquidity to make acquisitions of new businesses
and other investments, but the timing of any future investments and the cost can
not be predicted. Should the Company require additional liquidity for an
investment or any other purpose, the Parent also has an unsecured bank credit
facility of $110,000,000 that matures in 2007 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. During 2004, Moody's Investors
Services and Standard & Poor's each downgraded the Parent's debt obligations,
and in early 2005, the Parent was also downgraded by Fitch Ratings. The Parent's
senior debt obligations are rated two levels below investment grade by Moody's
Investors Services and Standard & Poor's, and one level below investment grade
by Fitch Ratings. Ratings issued by bond rating agencies are subject to change
at any time.
In April 2004, the Parent sold $100,000,000 principal amount of its 7%
Senior Notes due 2013 in a private placement transaction at 102.191% of the
principal amount. The net cash proceeds from the sale of the notes are being
used for general corporate purposes. The Parent completed a registered exchange
offer pursuant to which each holder of the privately placed senior notes
exchanged those notes for publicly registered notes.
Also in April 2004, the Parent sold $350,000,000 principal amount of its
3 3/4% Convertible Senior Subordinated Notes due 2014 in a private placement
transaction. The notes are convertible into the Parent's common shares at $45.93
per share at any time before their maturity, subject to certain restrictions
contained in the notes, at a conversion rate of 21.7707 shares per each $1,000
principal amount of notes, subject to adjustment (an aggregate of 7,619,745
shares). The net cash proceeds from the sale of the notes are being used for
general corporate purposes. The Parent has a currently effective shelf
registration statement in respect of the notes and the common shares issuable
upon conversion of the notes.
In January 2004, the Company exercised an option to sell two of its older
corporate aircraft for total proceeds of $38,800,000. The option was received in
connection with the purchase of two new corporate aircraft during 2003. The
Company completed the sales in July 2004, and reported a pre-tax gain of
$11,300,000.
In 2004, the Company invested $75,000,000 in INTL, a limited liability
company that is invested in a master fund which primarily invests in emerging
markets debt and equity securities. INTL and the master fund are managed and
controlled by an investment manager who has full discretion over investment and
operating decisions. Under GAAP, INTL is considered a variable interest entity
and the Company is the primary beneficiary; as a result, the Company accounts
for its investment in INTL as a consolidated subsidiary. INTL plans to sell
additional membership interests in the future, which if accomplished could
result in the Company no longer accounting for INTL as a consolidated
subsidiary. The creditors of INTL have recourse only to the assets of INTL and
do not have recourse to any other assets of the Company. The Company can
generally withdraw its capital account interest upon 90 days notice, subject to
the manager's ability to liquidate security positions in an orderly manner. At
December 31, 2004, all of INTL's assets were classified as investments and its
liabilities were not material.
WilTel became a member of the Company's consolidated federal income tax
return as of November 6, 2003. WilTel joined the Company's tax return with
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 generates substantial deductions (primarily depreciation
deductions), some of which are also available to offset the federal taxable
income of the Company and its other subsidiaries. Although the amount of these
deductions that can be used to offset the federal taxable income of other
members of the Company's consolidated tax group is dependent upon a number of
factors, including 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.
35
The amount and availability of the Company's NOLs and other tax
attributes 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, 2024, (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.
As of March 4, 2005, the Company is authorized to repurchase 3,733,148
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. Except in connection with employees using common shares to pay the
exercise price of employee stock options, the Company has not repurchased any
common shares during the three year period ended December 31, 2004.
At December 31, 2004, no amounts were available to the Parent as
dividends from its regulated subsidiary without regulatory approval. Cash and
investments aggregating $241,000,000 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.
Consolidated Liquidity
In 2004, net cash was provided by operating activities, principally as a
result of distributions from associated companies, the pre-funding by SBC of
certain of WilTel's capital expenditures, the refund of excess federal income
tax payments and an increase in accounts payable due to the timing of payments.
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.
At December 31, 2004, WilTel had aggregate cash and investments of
$239,700,000 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 ($359,400,000 outstanding as of December 31, 2004) and its
mortgage debt ($60,300,000 outstanding at December 31, 2004).
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 amount is reflected as a liability on the December 31, 2004
consolidated balance sheet. During 2004, WilTel expended all of these funds for
the equipment specified in the pricing agreement. 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, during the first quarter of 2005
WilTel will recognize the full amount as other income.
In September 2004, WilTel refinanced its existing $375,000,000 credit
agreement debt by entering into an amended credit agreement consisting of a
$240,000,000 first lien term loan facility, a $120,000,000 second lien term loan
facility and a $25,000,000 revolving credit facility (which it can no longer
draw upon, as discussed below). WilTel also used $90,000,000 of its cash and
investments to repay in full one of the two mortgage notes that was secured by
its headquarters building ($54,600,000 including accrued interest), reduce the
amount outstanding under its credit agreement ($15,000,000), reduce the amount
outstanding under the other note that is secured by its headquarters building
($13,300,000) and pay expenses. The amended credit agreement has not been
guaranteed by the Company and is not secured by any of the Company's assets
other than the assets of WilTel.
36
The first lien term loan facility requires quarterly principal payments
of approximately $632,000 commencing December 31, 2004 through June 30, 2009,
and quarterly principal payments of $57,000,000 thereafter until final maturity
on June 30, 2010. The second lien term loan facility matures on December 31,
2010. However, if WilTel does not refinance its obligations under its
outstanding mortgage debt prior to October 1, 2009, then the first lien term
loan facility will mature on October 1, 2009, and if such mortgage debt is not
refinanced by January 1, 2010, then the second lien term loan facility will
mature on January 1, 2010. Loans under the credit agreement bear interest at a
variable rate based upon either the prime rate or LIBOR, at WilTel's option,
plus a specified margin for each loan. WilTel's obligations under its amended
credit agreement are secured by substantially all of its assets other than those
assets securing its headquarters building, for which the amended credit
agreement lenders have a second priority lien, and its aircraft capital leases.
Pursuant to the terms of WilTel's amended credit agreement, SBC's
announcement to migrate its IP-based and long distance services to the AT&T
network is considered an event which could reasonably be expected to have a
"material adverse effect" as defined in the facility, and as a result WilTel can
no longer access its $25,000,000 revolving credit facility. WilTel does not
anticipate needing the $25,000,000 revolving credit facility to meet its present
requirements. The announcement does not have any impact on the $360,000,000 of
term loans under WilTel's credit 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.
WilTel's mortgage debt (which is non-recourse to the Company), has an
interest rate of 7% and requires annual principal payments escalating from
approximately $700,000 in 2005 to approximately $1,000,000 in 2009; a final
payment of approximately $56,000,000 is due at maturity in April 2010.
The WilTel amended 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 agreement
also prohibits WilTel from paying dividends to the Company. The Company
currently expects that WilTel will be able to meet the operating targets
required by its credit agreement through 2006; however, compliance with the
operating targets thereafter is uncertain because of SBC's announced intention
to migrate its traffic to AT&T's network.
While WilTel has no material contractual commitments for capital
expenditures, it may 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 uses its available
cash resources and operating profits to fund its capital expenditure needs.
During 2004, WilTel spent approximately $73,200,000 for capital expenditures,
including amounts that were pre-funded by SBC and that will be retained by
WilTel.
WilTel is a party to various legal actions and claims, and has reserved
$21,500,000 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. During 2004, WilTel
settled litigation for a cash payment of $5,000,000; the $18,500,000 excess of
the reserved amount over the amount paid was recognized as other income.
As mentioned above, in February 2005 the Company's manufacturing division
acquired the assets of NSW for approximately $28,000,000, thereby increasing its
mix of products and customer base. The funds for the acquisition were provided
from the Company's readily available cash resources.
37
The Company's consolidated banking and lending operations had outstanding
loans (net of unearned finance charges) of $4,300,000 and $205,500,000 at
December 31, 2004 and 2003, respectively. These loans were primarily funded by
deposits generated by the Company's deposit-taking facilities and by brokers,
which totaled $24,600,000 and $145,500,000 at December 31, 2004 and 2003,
respectively. The cash flows generated from the collections on and sales of its
loan portfolios have been used to retire these deposits as they matured. During
2004, the Company sold its subprime automobile and collateralized consumer loan
portfolios for aggregate cash proceeds of $149,000,000, and sold certain loan
portfolios that had been substantially written-off for aggregate cash proceeds
of $8,100,000. The banking and lending segment is no longer making loans.
Operating activities at the banking and lending segment are currently
concentrated on maximizing returns on its investment portfolio, collecting and
servicing its remaining loan portfolios and discharging deposit liabilities as
they come due. In 2004, AIB submitted an application to the state of Utah to
convert AIB's current national charter to a Utah state commercial bank charter.
However, in January 2005 the state of Utah notified AIB that it was suspending
the application to convert AIB's charter until such time as AIB has the
operational structure in place that is necessary to begin loan originations. AIB
does not intend to make these changes. Since AIB's application to convert the
charter was not approved, and since the OCC is requiring AIB to begin the
regulatory process to surrender its national charter, AIB will file a plan with
the OCC that will ultimately result in the surrender of its national bank
charter. No assurance can be given that the OCC will approve AIB's plan of
voluntary liquidation or that it will not take other adverse regulatory action.
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.
38
As shown below, at December 31, 2004, the Company's contractual cash
obligations totaled $3,030,611,000.
Payments Due by Period (in thousands)
--------------------------------------------------------------------
Less than 1
Contractual Cash Obligations Total Year 1-3 Years 4-5 Years After 5 Years
- ---------------------------- ----- ---- --------- --------- -------------
Customer banking deposits $ 24,591 $ 18,472 $ 6,095 $ 24 $ --
Long-term debt 1,530,400 46,896 87,367 143,306 1,252,831
Estimated interest expense on long-term
debt 790,840 95,139 180,700 172,421 342,580
Estimated payments related to derivative
financial instruments 31,900 6,315 11,776 10,599 3,210
Planned funding of pension and post-
retirement obligations 25,991 22,210 913 904 1,964
Operating leases, net of sublease
income 537,922 58,821 101,064 78,745 299,292
Asset purchase obligations 1,857 905 952 -- --
Operations and maintenance obligations 66,944 15,388 19,174 7,674 24,708
Other long-term contractual
obligations 20,166 3,433 6,133 3,400 7,200
------------ -------- ---------- --------- -----------
Total Contractual Cash Obligations $ 3,030,611 $267,579 $ 414,174 $ 417,073 $ 1,931,785
============ ======== ========= ========= ===========
The estimated interest expense on long-term debt includes estimated
interest related to variable rate debt which the Company determined using rates
in effect at December 31, 2004. Estimated payments related to a currency swap
agreement are based on the currency rate in effect at December 31, 2004.
Material contractual obligations that are not included in the table above are
the Company's deferred revenue obligations ($213,800,000) and the consolidated
pension liability ($83,900,000). Deferred revenue obligations do not require the
expenditure of material incremental cash; however, they do require WilTel to
maintain its network for the benefit of itself and the other contracting party.
Except for expected funding of $21,700,000 in 2005, the pension liability is
excluded from the table because the timing of cash payments, if any, cannot be
predicted.
Off-Balance Sheet Arrangements
At December 31, 2004, the Company's off-balance sheet arrangements
consist of guarantees and letters of credit aggregating $73,300,000. 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 for
the benefit of the City of San Marcos, California and other government agencies,
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, 2004, the amount of outstanding bonds was $28,200,000,
$27,700,000 of which expires in 2005, $400,000 in 2006 and the remainder in
2009. Subsidiaries of the Company have outstanding letters of credit aggregating
$25,100,000 at December 31, 2004, principally to secure various obligations. All
of these letters of credit expire during 2005. The Company's remaining guarantee
at December 31, 2004 is a $20,000,000 indemnification given to a lender to a
certain real estate property. The amount borrowed under this real estate
financing is reflected as long-term debt in the Company's consolidated balance
sheet.
39
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.
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 based
on the Company's assessment of the probability of successfully sustaining its
tax filing positions.
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 offset 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, before the Company can recognize a net
deferred tax asset, it 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.
During each of the last three years, the Company has adjusted its reserve
for contingent tax liabilities and reduced income tax expense upon the
conclusion of audits by various taxing jurisdictions or upon the expiration of
the statute of limitations for the examination of the Company's tax returns. The
adjustments have been material, reflecting the inherent difficulty of accurately
estimating and accruing for the ultimate resolution of tax contingencies. The
Company expects that adjustments to the valuation allowance for deferred income
taxes and contingent tax liabilities could be made in the future and, if such
adjustments are made, they could be material.
Impairment of Long-Lived Assets - 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
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 a long-lived asset (or asset group) is recoverable is based on
management's estimate of undiscounted future cash flows attributable to the
asset as compared to its carrying value. If the carrying amount of the asset (or
asset group) is greater than the undiscounted cash flows, the carrying amount of
the asset is considered to be not recoverable. The amount of the impairment
recognized would be determined by estimating the fair value for the asset (or
asset group) and recording a provision for the excess of the carrying value over
the fair value.
40
As of December 31, 2004, the carrying amount of the Company's investment
in the mineral rights and mining properties of MK Resources was approximately
$85,400,000. The recoverability of this asset is entirely dependent upon the
success of MK Resource'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. In addition, the actual price of copper, the operating cost of the
mine and the capital cost (in U.S. dollars) to build the project and bring the
mine into production will affect the recoverability of this asset. The Las
Cruces project has been granted government subsidies of 47.5 million euros
($62,900,000); however, the grants require MK Resources to make certain capital
expenditures by March 27, 2005, a deadline that it will not be able to meet
principally because of delays in obtaining permits. Las Cruces has filed a
request to further extend the deadline, but has been informed that the
government will not act on the extension request prior to the current
expiration.
To date, the Company has been the sole source of funding for the Las
Cruces project. The amount of equity capital and third party financing that can
be obtained for the project and its related cost will be significantly affected
by the assessment of potential investors and lenders of the current and expected
future market price of copper, as well as current market conditions for this
type of investment. During 2004, MK Resources was unsuccessful in raising equity
capital for the project, due to unfavorable market conditions at the time. MK
Resources continues to explore financing possibilities. Based on the current
status of the project, MK Resource's estimate of future cash flows and its
assessment of financing possibilities, 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, is unable to obtain financing for the project or the capital cost of
the project changes significantly, it is likely that this investment will be
impaired.
At December 31, 2004, the carrying amount of the Company's investment in
its manufacturing facility located in Belgium was approximately $17,900,000. 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 to develop and implement marketing and sales
initiatives directed at generating revenue growth. Operating results at the
facility improved during 2004 as sales grew significantly compared to 2003 and
the business achieved positive cash flow. However, new customer acquisitions
must continue in order for the facility to reach profitability. Based on the
current business plan, which includes estimates of revenue growth, the Company
believes that its investment in the Belgium facility is recoverable. However, if
the estimated revenue growth is not achieved, the carrying amount of the
facility is likely to be impaired.
As discussed above, on January 31, 2005, SBC announced that it would buy
AT&T Corp., and announced its intention to migrate the services provided by
Network to the AT&T network. Since SBC is WilTel's and Network's largest
customer, accounting for 70% of Network's 2004 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 will be performed as part
of the preparation of the Company's financial statements for the first quarter
of 2005, and does not effect the carrying amount of the Company's assets as of
December 31, 2004. The carrying value of WilTel's property and equipment is
approximately $1,054,700,000 at December 31, 2004.
The Company will have to make numerous assumptions and estimates about
the future to prepare its impairment analysis. The process of estimating future
cash flows is subjective and inherently inaccurate because precise information
about the future is not available, and in this case is exacerbated by the
volatility that the telecommunications industry has experienced over the past
few years. The economics of WilTel's future relationship with SBC, including its
term, is also uncertain, which will be one of the most significant variables in
the analysis. WilTel is currently engaged in negotiations with SBC concerning
this and other pricing matters. WilTel will also have to make assumptions
concerning its ability to retain existing customers, attract new customers,
reduce expenses and participate in potential consolidation opportunities as part
of the analysis. The Company is not currently able to determine whether the
carrying amounts of WilTel's long-lived assets are impaired.
41
Acquisition of WilTel - In connection with accounting for the acquisition
of WilTel, significant judgments and estimates were made to determine the fair
values of certain liabilities, including liabilities for net unfavorable
long-term commitments and deferred revenue, many of which required the Company
to make assumptions about the future. 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 WilTel to provide future services. The Company also
assumed WilTel would continue to perform its contractual obligations through the
term of its contracts. Revenue is 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 WilTel 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 December 31, 2004, the amount reflected in the consolidated
balance sheet for deferred revenue was $213,800,000.
The Company evaluated the fair value of long-term commitments that were
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. The accrued liability is
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. At December 31, 2004, the
amount reflected in the consolidated balance sheet for unfavorable long-term
commitments was $44,900,000.
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.
Accruals for Access Costs - WilTel's access costs primarily include
variable charges paid to vendors to originate and/or terminate switched voice
traffic, which are based on actual usage at negotiated or regulated contract
rates, and fixed charges for leased lines for dedicated facilities. At the end
of each reporting period, WilTel's estimated accrual for incurred but not yet
billed costs is based on internal usage reports. The accrual is subsequently
reconciled to actual invoices as they are received, which is a process that can
take several months to complete. This process includes an invoice validation
procedure that normally identifies errors and inaccuracies in rate and/or volume
components of the invoices resulting in numerous invoice disputes. It is
WilTel's policy to adjust the accrual for the probable amount it believes will
ultimately be paid on disputed invoices, a determination which requires
significant estimation and judgment. Due to the number of different negotiated
and regulated rates, constantly changing traffic patterns, uncertainty in the
ultimate resolution of disputes, the period of time required to complete the
reconciliation and delays in invoicing by access vendors, changes in these
estimates should be expected.
42
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, 2004, the Company's consolidated balance sheet includes
litigation reserves of $21,500,000, 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
income (loss) from continuing operations before income taxes for the year ended
December 31, 2004 and for the period from November 6, 2003 (when WilTel became a
consolidated subsidiary) through December 31, 2003. Prior to November 6, 2003,
the Company accounted for its 47.4% share of WilTel's results under the equity
method of accounting. Audited financial statements of WilTel for the period from
January 1, 2003 to November 5, 2003 are filed as financial statement schedules
to this Report. 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.
For the year November 6, 2003
ended December 31, 2004 through December 31, 2003
---------------------------------------- ---------------------------------------
Network Vyvx Total WilTel Network Vyvx Total WilTel
------- ---- ------------ ------- ---- ------------
(In thousands)
Operating revenues (1) $ 1,462,400 $ 120,500 $ 1,582,900 $ 211,300 $ 20,600 $231,900
=========== ========= ============ ========= ========= ========
Segment profit from
operations $ 117,800 $ 30,300 $ 148,100 $ 13,300 $ 4,100 $ 17,400
Depreciation and
amortization expense (197,400) (9,100) (206,500) (37,200) (2,000) (39,200)
Interest expense, net of
investment income (2) (26,000) (2,100) (28,100) (4,000) (100) (4,100)
Other non-operating
income, net (2) 27,200 2,700 29,900 1,800 500 2,300
----------- --------- ------------ --------- --------- --------
Pre-tax income (loss) $ (78,400) $ 21,800 $ (56,600) $ (26,100) $ 2,500 $(23,600)
=========== ========= ============ ========= ========= ========
(1) Excludes intersegment revenues from amounts billed by Network to Vyvx of
$18,400,000 and $4,300,000, respectively, for 2004 and for the 2003 period.
(2) If items in these categories can not 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.
Network's revenues include services provided to SBC of $1,032,800,000 and
$141,700,000 for the 2004 and 2003 periods, respectively, representing
approximately 70% and 66%, respectively, of Network's operating revenues.
Network's revenues from SBC have continued to grow throughout 2003 and 2004,
principally related to voice products, for which SBC and WilTel have agreed to
use a fixed price through April 1, 2005. The growth in voice revenue resulted
from, in part, SBC's continued growth in long distance services in various
states, including California, Michigan, Indiana, Ohio, Illinois and Wisconsin.
Revenues attributable to other RBOCs were approximately 6% and 5% of Network's
operating revenues for the 2004 and 2003 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. In 2004, WilTel's Network segment began
to sell into the enterprise business market, although revenues have not been
material to date.
43
As discussed above, SBC's announcement to migrate its business from
Network to the AT&T network is expected to have a significant impact on WilTel's
future revenues and profitability. SBC indicated that it expects to close its
acquisition of AT&T in the first half of 2006. WilTel expects it will take
anywhere from two to three years from now for SBC to migrate all of its traffic
off of WilTel's network, and anticipates that it will continue to provide some
level of service to SBC into 2007. WilTel expects it will evaluate and implement
cost reduction strategies, investigate sales of assets and minimize capital
expenditure outlays to help offset the loss of SBC's business. However, given
the current economic condition of the telecommunications industry as a whole,
where telecommunications capacity far exceeds actual demand and the marketplace
is characterized by fierce price competition, and the limited growth of non-SBC
business over the past few years, 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.
Network's cost of sales has increased in line with revenue growth
throughout 2003 and 2004, 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. The price Network pays for these
services has been declining, generally in line with declines experienced by
Network in its pricing of its own services to customers. Network's gross margin
percentage has been adversely affected by a larger mix of voice transport
business, principally resulting from SBC's growth, which has a lower gross
margin as compared to some of Network's other products and services. In
addition, Network cost of sales in 2004 includes 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 salaries were $121,000,000 and $16,300,000 for the 2004 and
2003 periods, respectively, and selling, general and other expenses were
$155,500,000 and $24,000,000 for the 2004 and 2003 periods, respectively.
Selling, general and other expenses in 2004 include a reduction of $4,100,000 to
the provision for doubtful accounts, principally due to the collection of
previously reserved accounts receivable which had been in dispute. The provision
for doubtful accounts also includes a charge of $2,700,000 to fully reserve for
another customer's accounts receivable which is not expected to be collected.
Selling, general and other expenses in 2004 include $5,000,000 for estimated
repair costs for WilTel's headquarters building. The need for repair work arose
after the building was damaged in a severe storm. While insurance recovery is
deemed probable for some repairs to the building, the accrual relates to repairs
for which insurance recovery is not assured, as they are necessitated by
underlying design flaws in the building. WilTel will seek to obtain
reimbursement from the responsible parties; however, no recovery has been
accrued. Network's salaries expense and selling, general and other expenses for
2004 reflect lower headcount, higher costs of performance-based compensation,
greater personnel retention costs and greater vendor contract maintenance costs
for the network.
Vyvx operating revenues were $120,500,000 and $20,600,000 for the 2004
and 2003 periods, respectively. Revenues in 2004 were slightly lower due in part
to fewer hockey game broadcasts due to the National Hockey League labor dispute
and customers switching to lower cost Vyvx products. Although the lower priced
products result in less revenue, the costs to provide these products and related
selling, general and other expenses is also lower, which results in increased
segment profits. Approximately 62% of Vyvx's 2004 operating revenue was derived
from its top 10 customers. Fox and its parent company, The News Corporation
Limited, through their various news, sports and entertainment businesses,
accounted for approximately 18% of Vyvx's 2004 revenues and TimeWarner, Inc.
accounted for 16% of Vyvx's 2004 revenues. These percentages were not
significantly different during the 2003 period. Approximately 65% of Vyvx's 2004
revenues are from the sale of fiber optic and satellite video transport services
and the remaining 35% of revenues are from the sale of advertising distribution
services.
44
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
$18,600,000 and $3,000,000, respectively, and selling, general and other
expenses of $15,900,000 and $3,700,000, respectively, for the 2004 and 2003
periods.
For 2004, WilTel's other non-operating income includes income of
$18,500,000 related to the settlement of litigation for less than amounts
reserved, income of $6,000,000 related to the sale of an equity security which
had a zero book value, gains of $3,500,000 related to cash and securities
received in excess of the book value of secured claims in customers'
bankruptcies, and income of $2,300,000 related to the reversal of excess
reserves for long-term commitments.
Healthcare Services
Pre-tax income (loss) of the healthcare services segment was $5,100,000
for the year ended December 31, 2004 and $(2,300,000) for the four month period
from acquisition through December 31, 2003. For the 2004 and 2003 periods,
healthcare services revenues were $257,300,000 and $71,000,000, respectively,
and cost of sales, which primarily consist of salaries and employee benefits,
were $216,300,000 and $61,300,000, respectively.
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. The ability
of Symphony to continue to grow its business depends heavily upon its ability to
attract, develop and retain qualified therapists. There is a current shortage of
qualified therapists industry-wide, and Symphony has open positions to provide
service to new customers, provide additional service offerings for existing
customers and through normal employee turnover. The tight labor market causes
Symphony and others in its industry to hire, at times, independent contractors
to perform required services, which may increase costs and reduce margins, and
can also result in lost revenue opportunities.
During 2004, Symphony performed an evaluation of its customer base, in
order to identify those customers and markets where Symphony can deliver the
highest level of service and that should be the focus of customer retention
efforts, as well as identifying those customers that should be terminated. In
addition, Symphony has restructured its corporate management and field
operations organization, resulting in a more efficient organization with reduced
costs. Symphony is also seeking to grow its profitable businesses, which
includes expanding its service offerings to existing customers. Symphony may
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.
45
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%. As a result,
Symphony's average quarterly 2004 revenues for these therapy services increased
by approximately 44% as compared to the fourth quarter of 2003, comparing only
those locations that were operating during all periods. Symphony also added new
customers during 2004; however, certain low margin and non-profitable accounts
were cancelled, resulting in a slight decrease in total locations serviced.
During 2004, one customer accounted for approximately 16% of Symphony's
revenues. Symphony's margins for 2004 also reflect higher hourly wages and
benefits paid to attract and retain its therapists, and increased costs to hire
independent contractors as a result of hiring needs for both full-time and
part-time professionals. In order to maintain and improve margins in the
challenging labor market in which Symphony operates, Symphony is focused on
obtaining sufficient pricing for new and renewal business, as well as cost
effective employee retention programs. Pre-tax results for 2004 also reflect
approximately $3,300,000 from the collection of receivables in excess of their
carrying amounts, a decrease in estimated liabilities for employee health
insurance costs and other third party claims of approximately $1,700,000, and a
gain of $1,000,000 from the sale of certain property. In addition, pre-tax
results for 2004 reflect approximately $3,900,000 of costs, principally
severance for Symphony's former chief executive officer and others due to
reorganizing and consolidating certain field operations and closing offices.
The moratorium on legislative caps for Part B Medicare therapy is
scheduled to expire on December 31, 2005. While there is some congressional
support for an extension of the moratorium, there is also concern regarding the
cost of an extension. Symphony is unable to predict what the ultimate outcome
will be; however, any re-introduction of the legislative caps or other
methodology that reduces fees for Part B Medicare therapy could significantly
reduce Symphony's revenues.
Manufacturing
Pre-tax income for the manufacturing segment was $7,900,000, $4,400,000
and $3,100,000 for the years ended December 31, 2004, 2003 and 2002,
respectively. Manufacturing revenues were $64,100,000, $53,300,000 and
$50,700,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
Revenues increased by 20% in 2004 and by 5% in 2003, while they declined by 5%
in 2002 as compared to the prior year.
Manufacturing revenues in 2004 increased in substantially all of the
division's markets. The Company believes that these increases result from a
variety of factors including an improved economy, new product development and
the acquisition in the first quarter of 2004 of customer receivables and
inventory of a competitor that was exiting certain markets. Although raw
material costs increased significantly in 2004, the division increased selling
prices in most markets, that along with increased sales and production volumes
enabled it to maintain its gross profit margins. The primary raw material in the
division's products is a polypropylene resin, which is a byproduct of the oil
refining process, whose price tends to increase and decrease with the price of
oil. There is relatively little direct labor or other raw material costs in the
division's products. In addition to managing resin purchases, the division also
has initiatives to reduce and/or reuse scrap thereby increasing raw material
utilization.
As a result, the division's gross profit and gross profit margins
increased in 2004 as compared to 2003. Pre-tax results for 2004 also reflect
greater salaries expense, due to higher bonuses attributable to the division's
improved performance. During 2005, the division will seek to gain additional
cost efficiencies resulting from its acquisition of NSW, principally in
administration and overhead expense and raw material purchasing. In addition,
the division will look to make other strategic acquisitions of smaller entities
that serve the same markets as NSW, primarily those that supply package netting
and filtration products.
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 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 that is discussed below reduced pre-tax results in 2002.
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 did not expect would 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 determined that the
cost of these lines were no longer recoverable from other business.
46
Banking and Lending
As stated previously, 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 included in the Company's consolidated statements of operations are
reflective of the continuing decrease in the size of the loan portfolio. In
addition, as described earlier in this Report, during 2004, the Company sold its
subprime automobile and collateralized consumer loan portfolios representing
approximately 97% of its total outstanding loans (net of unearned finance
charges) and certain loan portfolios that had been substantially written-off for
aggregate pre-tax gains of $16,300,000, which is reflected in investment and
other income. Pre-tax income for the banking and lending segment was
$22,000,000, $8,400,000 and $1,900,000 for the years ended December 31, 2004,
2003 and 2002, 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 $57,100,000, $283,000,000 and
$440,800,000 during 2004, 2003 and 2002, respectively. Although finance revenues
decreased in 2004 as compared to 2003, pre-tax results increased due to gains
from the loan portfolios sales, a decline in the provision for loan losses of
$24,700,000, reductions in interest expense of $6,000,000 principally resulting
from reduced customer banking deposits, less interest paid on interest rate
swaps and lower salaries expense and operating costs resulting from the
segment's restructuring efforts. All of these changes reflect the ongoing
reduction in the amount of loan assets under management, including as a result
of the loan portfolios sales.
Although finance revenues decreased in 2003 as compared to 2002 for the
reasons described above, 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.
The reduction in the provision for bad debts resulted from the decrease in the
size of the consumer loan portfolios. However, 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 of
$3,100,000 and $3,500,000 for the years ended December 31, 2003 and 2002,
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.
47
Domestic Real Estate
Pre-tax income for the domestic real estate segment was $20,700,000,
$18,100,000 and $16,300,000 for the years ended December 31, 2004, 2003 and
2002, 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 for this segment increased in 2004 as
compared to 2003, primarily due to the sale of 92 lots at the Company's 95-lot
development project in South Walton County, Florida for aggregate sales proceeds
of approximately $50,000,000 for which the Company recognized pre-tax profits of
$15,800,000, net of minority interest. The Company will be required under the
sale agreements to make significant improvements to the property, including
infrastructure and certain amenities, which it expects to complete in 2005. The
Company estimates it will recognize additional pre-tax profit of $10,200,000
related to this project. In addition, revenues during 2004 reflect the sale of
certain unimproved land for cash proceeds of $8,800,000, which resulted in a
pre-tax gain of $7,600,000. Revenues during 2004 also reflect decreased gains
from property sales at the Company's other residential and commercial project in
the Florida panhandle as the lots have largely been sold, and less amortization
of deferred gains from sales of real estate in prior years. Pre-tax results for
2004 also reflect due diligence expenses for a real estate development project
that the Company decided not to develop.
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. During 2003, the Company also recognized
$11,100,000 of deferred gains from sales of real estate in prior years.
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. 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 increased in 2004 as compared to 2003
primarily due to the pre-tax gain from the sale of two of the Company's older
corporate aircraft, discussed above, greater dividend and interest income of
$12,400,000 and miscellaneous other income. Available corporate cash is
generally invested on a short-term basis until such time as investment
opportunities require an expenditure of funds. Investment and other income for
2003 included $5,300,000 of income related to a refund of foreign taxes not
based on income.
48
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 as a result of lower interest rates in 2003 and
foreign exchange gains recorded in 2002. 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 $5,300,000 of income
related to a refund of foreign taxes not based on income. In addition, revenues
from the Company's gas operations increased in 2003 principally due to increased
production and prices.
Net securities gains (losses) for Corporate and Other Operations
aggregated $136,100,000, $10,600,000 and $(31,300,000) for the years ended
December 31, 2004, 2003 and 2002, respectively. During 2004, substantially all
of the Company's net securities gains reflect realized gains from the sale of
publicly traded debt and equity securities that had been classified as Corporate
available for sale securities. Net securities gains (losses) for 2004, 2003 and
2002 include provisions of $4,600,000, $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 Company's decision to sell securities and realize security gains or
losses is generally based on its evaluation of an individual security's value at
the time and the prospect for changes in its value in the future. The decision
can also be influenced by the status of the Company's tax attributes but in
recent years has not been influenced by liquidity needs. Therefore, the timing
of realized security gains or losses is not predictable and does not follow any
pattern from year to year.
The increase in interest expense during 2004 as compared to 2003
primarily reflects interest expense relating to the $375,000,000 aggregate
principal amount of the 7% Senior Notes issued during 2003 and 2004, the
issuance of $350,000,000 principal amount of its 3 3/4% Convertible Senior
Subordinated Notes in 2004 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. The increase in interest
expense during 2003 as compared to 2002 principally results from the issuance of
$275,000,000 aggregate principal amount of the 7% Senior Notes that were issued
in 2003 and dividends accrued on its trust issued preferred securities.
The increase in selling, general and other expenses of $19,700,000 in
2004 as compared to 2003 primarily reflects greater professional and other fees
of $8,500,000, which largely relate to due diligence expenses for potential
investments, greater professional fees for existing investments and fees
relating to the implementation of the Sarbanes-Oxley Act of 2002, and $3,600,000
of expenses related to the proposed public offering of MK Resources' equity that
did not go forward due to unfavorable market conditions. In addition, the
increase reflects greater employee benefit expenses, higher insurance costs and
greater amortization of debt issuance costs related to the 7% Senior Notes and
3 3/4% Convertible Notes.
Selling, general and other expenses also include additions to cost of
goods sold of the winery operations of $3,900,000, $4,300,000 and $2,100,000 for
the years ended December 31, 2004, 2003 and 2002, respectively. The winery
operations, which account for inventory under the LIFO method of accounting,
recorded adjustments to cost of goods sold based upon the results of its annual
harvest. The additional expenses recorded in each of the last three years were
due primarily to a lower yield than had been previously estimated.
The income tax provision reflects the reversal of tax reserves
aggregating $27,300,000, $24,400,000 and $120,000,000 for the years ended
December 31, 2004, 2003 and 2002, respectively, as a result of the favorable
resolution of various state and federal income tax contingencies. In addition,
in 2004 the tax provision reflects a benefit to record a federal income tax
carryback refund of $3,900,000.
49
In 2003, 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 needs 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 the deferred tax asset.
Subsequent to the acquisition of WilTel, any benefit realized from WilTel's
deferred tax asset reduces 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 various components of comprehensive income include an
aggregate federal income tax provision of $22,300,000 in 2004 and $22,500,000 in
2003 (for the period subsequent to the acquisition of WilTel), even though no
federal income tax for those periods was due. During 2004, the effect of
recording this tax provision and the resulting reduction to the valuation
allowance was to reduce the carrying amount of the acquired non-current
intangible assets 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.
Now that the non-current intangible assets have been 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.
Associated Companies
Equity in income of associated companies includes the following for the
years ended December 31, 2004, 2003 and 2002 (in thousands):
2004 2003 2002
---- ---- ----
Berkadia $ 800 $ 79,200 $ 65,600
WilTel -- (52,100) (13,400)
Olympus 9,700 40,400 24,100
EagleRock 29,400 49,900 (4,500)
HomeFed 10,000 16,200 400
JPOF II 16,200 14,800 15,200
Pershing Square, L.P. 21,300 -- --
Other 4,100 (1,400) 4,000
---------- ---------- ----------
Pre-tax 91,500 147,000 91,400
Income tax expense (15,000) (70,100) (36,700)
---------- ---------- ----------
Equity in income, net of taxes $ 76,500 $ 76,900 $ 54,700
========== ========== ==========
Since the Berkadia loan was fully repaid during the first quarter of
2004, the Company will no longer have any income related to the Berkadia loan in
the future. The Company's income from this investment is expected to be limited
to its share of the annual management fee received from FINOVA while such fee
remains in effect, which is $4,000,000. The Company has received total net cash
proceeds of $91,200,000 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 decline in the Company's share of its earnings in 2004 as compared
to 2003 reflects the impact of property damage claims caused by severe
hurricanes. The Company's share of its earnings increased in 2003 as compared to
the prior year, reflecting the growth in Olympus' premium revenues during its
second year of operation. As a result of redemptions of other investors' equity
interests in the first half of 2004, the Company's percentage interest in
Olympus increased from approximately 16% to 19%.
50
The equity in income (losses) of EagleRock results from both realized and
changes in unrealized gains (losses) in its portfolio. In 2004, $3,700,000 was
distributed by the partnership to the Company.
In January 2004, the Company invested $50,000,000 in Pershing Square,
L.P. ("Pershing"), a limited partnership that is authorized to engage in a
variety of investing activities. The Company redeemed its interest as of
December 31, 2004, and the total amount due from Pershing of $71,300,000 (which
was paid during the first quarter of 2005) is included in trade, notes and other
receivables, net in the Company's consolidated balance sheet.
As more fully described above, the Company acquired its investment in
HomeFed in the fourth quarter of 2002. During 2004, HomeFed reported lower
earnings from sales of real estate as compared to the prior year principally at
the San Elijo Hills project.
As discussed above, WilTel became a consolidated subsidiary in November
2003 and the Company ceased applying the equity method of accounting at that
time. For 2003, the Company's share of WilTel's results of operations included
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. 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.
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. 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.
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 on disposal of discontinued operations of $11,500,000. The vesting criteria
for the remaining warrants were satisfied during 2004, and the Company recorded
$2,200,000 as gain on disposal of discontinued operations (net of minority
interest), which represented the estimated fair value of the warrants. Due to
WebLink's large net operating loss carryforwards, these gains were not reduced
for any federal income tax expense.
During the fourth quarter of 2004, WebLink exercised all of its warrants
and subsequently tendered all of its Metrocall shares as part of a merger
agreement between Metrocall and Arch Wireless, Inc. WebLink received cash of
$19,900,000 and 675,607 common shares of the new parent company (USA Mobility,
Inc., which had a fair market value of $25,000,000 when received), resulting in
a pre-tax gain of $15,800,000 that is included in net securities gains of
continuing operations. The Company's investment in the shares of USA Mobility at
December 31, 2004 are classified as a non-current investment.
In return for the Company's $19,000,000 investment in WebLink, the
Company has received cash and securities aggregating $48,400,000, based on the
market price of USA Mobility as of December 31, 2004. Such amount has been
reduced for the minority interest and liabilities of WebLink which remain to be
paid.
51
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.
Domestic Real Estate
In the fourth quarter of 2004, the Company sold a commercial real estate
property and classified it as a discontinued operation. During the second
quarter of 2004, the Company recorded a non-cash charge of $7,100,000 to reduce
the carrying amount of this property to its estimated fair value. The Company
recorded an additional pre-tax loss from the sale of $600,000, principally
relating to mortgage prepayment penalties incurred upon satisfaction of the
property's mortgage at closing. Operating results for this property were not
material in prior years.
Other Operations
In the fourth quarter of 2004, the Company sold its geothermal power
generation business for $14,800,000, net of closing costs, and recognized a
pre-tax gain of $200,000. For the years ended December 31, 2004, 2003 and 2002,
the Company recorded pre-tax losses from discontinued operations relating to
this business of $1,500,000, $2,300,000 and $2,800,000, respectively.
Recently Issued Accounting Standards
In November 2004, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 151, "Inventory Costs--An
Amendment of ARB No. 43, Chapter 4" ("SFAS 151"), which is effective for fiscal
years beginning after June 15, 2005. SFAS 151 amends the guidance in ARB No. 43
to clarify the accounting for abnormal amounts of idle facility expense,
freight, handling costs, and wasted material (spoilage). Among other provisions,
SFAS 151 requires that items such as idle facility expense, excessive spoilage,
double freight, and rehandling costs be recognized as current-period charges
regardless of whether they meet the criterion of "so abnormal" as stated in ARB
No. 43. In addition, SFAS 151 requires that allocation of fixed production
overheads to the costs of conversion be based on the normal capacity of the
production facilities. The Company is currently evaluating the impact of SFAS
151 on its consolidated financial statements.
52
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123R, "Share-Based Payment" ("SFAS 123R"), which replaces SFAS 123
and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees".
SFAS 123R requires that the cost of all share-based payments to employees,
including grants of employee stock options, be recognized in the financial
statements based on their fair values. That cost will be recognized as an
expense over the vesting period of the award. The pro forma disclosures
previously permitted under SFAS 123 no longer will be an alternative to
financial statement recognition. In addition, the Company will be required to
determine fair value in accordance with SFAS 123R. SFAS 123R is effective for
reporting periods beginning with the first interim or annual period after June
15, 2005, with early adoption encouraged, and requires the application of a
transition methodology for stock options that have not vested as of the date of
adoption. The Company is currently evaluating the impact of SFAS 123R on its
consolidated financial statements.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 153, "Exchanges of Nonmonetary Assets--An Amendment of APB Opinion
No. 29" ("SFAS 153"), which is effective for fiscal periods beginning after June
15, 2005. SFAS 153 eliminates the exception from fair value measurement for
nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB
Opinion No. 29, "Accounting for Nonmonetary Transactions," and replaces it with
an exception for exchanges that do not have commercial substance. SFAS 153
specifies that a nonmonetary exchange has commercial substance if the future
cash flows of the entity are expected to change significantly as a result of the
exchange. The adoption of SFAS 153 will not have any material effect on the
consolidated financial statements; however, SFAS 153 could impact the accounting
for future transactions, if any, within its scope.
Cautionary Statement for Forward-Looking Information
Statements included in this Report 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 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.
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;
53
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 replace the revenues generated by SBC, which if lost
as a result of SBC's proposed acquisition of AT&T will have a significant
adverse 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;
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;
54
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
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;
The inability to obtain necessary financing for the Las Cruces copper
mining project, 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 Company's mineral rights in Spain;
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, 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 Report or to reflect the occurrence of unanticipated events.
55
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 available for sale investment portfolio are fixed income securities,
which comprised approximately 69% of the Company's total investment portfolio at
December 31, 2004. 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 1.1 years at December 31, 2004. 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 $242,300,000. This investment is approximately 13% 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, 2003, fixed
income securities comprised approximately 70% of the Company's total investment
portfolio and had an estimated weighted average remaining life of 2.0 years. At
December 31, 2004 and 2003, 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.
As previously discussed in this Report, the Company's banking and
lending operations stopped originating all loans in 2003, and in 2004, sold the
vast majority of its outstanding loans. Cash generated from the collections on
and sales of its loan portfolios were used to retire customer deposits as they
matured. The Company's banking and lending operations currently are not
accepting new consumer or brokered deposits. The Company's banking and lending
operations are subject to risk primarily resulting from interest rate
fluctuations in its investment portfolio, which is classified as available for
sale, repurchase agreements and customer deposits. The investment portfolio
primarily consists of investments in mortgage-backed securities for which the
underlying assets are adjustable rate mortgages with a weighted average
repricing of approximately seven months. The Company's banking and lending
operations employ leverage to enhance the investment returns; these fixed rate
borrowings, comprised by the repurchase agreements, have an average term as of
December 31, 2004 of approximately fifteen days. 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. 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.
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 rates at the reporting date. For money market deposits
that have no contractual maturity, the table presents principal cash flows based
on management's judgment. For interest rate swaps, the table presents notional
amounts by contractual maturity date.
56
For additional information, see Notes 6, 11 and 20 of Notes to
Consolidated Financial Statements.
Expected Maturity Date
----------------------
2005 2006 2007 2008 2009 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
(Dollars in thousands)
The Company, Excluding
Banking and Lending:
Rate Sensitive Assets:
Available for Sale Fixed
Income Securities:
U.S. Government $ 870,046 $ 8,456 $ -- $ -- $ -- $ -- $ 878,502 $ 878,502
Weighted Average
Interest Rate 1.75% 2.35% -- -- -- --
Other Fixed Maturities:
Rated Investment Grade $ 21,900 $ 6,226 $ 2,616 $ 1,918 $ -- $ 7,610 $ 40,270 $ 40,270
Weighted Average
Interest Rate 2.16% 6.09% 5.90% 2.63% -- 2.43%
Rated Less Than Investment
Grade/Not Rated $ 47,367 $ 17,699 $ 77,338 $ 48,535 $ 10,921 $ 2,505 $ 204,365 $ 204,365
Weighted Average Interest
Rate 4.58% 8.04% 11.55% 5.86% 11.52% 11.95%
Rate Sensitive Liabilities:
Fixed Interest Rate
Borrowings $ 22,256 $ 27,057 $ 3,525 $ 19,418 $ 1,870 $ 983,839 $1,057,965 $1,171,615
Weighted Average
Interest Rate 6.26% 6.31% 7.07% 6.63% 7.44% 6.18%
Variable Interest Rate
Borrowings $ 24,640 $ 42,330 $ 14,455 $ 4,640 $ 117,378 $ 268,992 $ 472,435 $ 472,435
Weighted Average
Interest Rate 7.21% 7.88% 8.20% 8.60% 8.91% 9.93%
Rate Sensitive Derivative
Financial Instruments:
Euro currency swap $ 2,085 $ 2,085 $ 2,085 $ 2,085 $ 2,085 $ 522 $ 10,947 $ (5,800)
Average Pay Rate 5.89% 5.89% 5.89% 5.89% 5.89% 5.89%
Average Receive Rate 7.60% 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 $ 34,992 $ 45,562 $ (2,342)
Average Pay Rate 5.01% 5.01% 5.01% 5.01% 5.01% 5.01%
Average Receive Rate 3.51% 3.92% 4.28% 4.64% 5.00% 5.42%
Off-Balance Sheet Items:
Unused Lines of Credit $ -- $ -- $110,000 $ -- $ -- $ -- $ 110,000 $ 110,000
Weighted Average
Interest Rate 5.01% 5.42% 5.49% -- -- --
Banking and Lending:
Rate Sensitive Assets:
Variable Interest Rate
Securities $ 31,463 $ 28,586 $ 20,139 $ 14,454 $ 9,228 $ 37,728 $ 141,598 $ 141,598
Weighted Average
Interest Rate 4.79% 4.97% 4.99% 4.98% 5.00% 4.99% 4.94%
Fixed Interest Rate Loans $ 1,539 $ 278 $ 109 $ 5 $ 1 $ -- $ 1,932 $ 1,932
Weighted Average
Interest Rate 16.95% 14.23% 16.16% 18.49% 19.99% -- 16.51%
Variable Interest Rate
Loans $ 496 $ 235 $ 219 $ 208 $ 197 $ 1,017 $ 2,372 $ 2,372
Weighted Average
Interest Rate 6.26% 6.68% 6.68% 6.67% 6.67% 6.53% 6.53%
Rate Sensitive Liabilities:
Money Market Deposits $ 6,836 $ -- $ -- $ -- $ -- $ -- $ 6,836 $ 6,836
Weighted Average
Interest Rate .90% -- -- -- -- -- .90%
Time Deposits $ 11,636 $ 2,933 $ 3,162 $ 24 $ -- $ -- $ 17,755 $ 18,073
Weighted Average
Interest Rate 5.51% 4.93% 4.60% 1.00% -- -- 5.24%
Fixed Interest Rate
Borrowings $ 21,341 $ -- $ -- $ -- $ -- $ -- $ 21,341 $ 21,341
Weighted Average
Interest Rate 2.40% -- -- -- -- -- 2.40%
Off-Balance Sheet Items:
Unused Lines of Credit $ -- $ -- $ -- $ -- $ -- $ 17,000 $ 17,000 $ 17,000
Weighted Average
Interest Rate -- -- -- -- -- 2.34% 2.34%
57
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.
Item 9A. 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 December 31, 2004. 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, 2004.
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 December
31, 2004, that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
Management's Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting as defined in Rules 13a-15(f)
or 15d-15(f) promulgated under the Securities Exchange Act of 1934. Internal
control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles and includes those policies and procedures that:
o Pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and disposition of the
assets of the Company;
o Provide reasonable assurance that transactions are recorded as necessary
to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and
expenditures of the Company are being made only in accordance with
authorizations of management and directors of the Company; and
o Provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the Company's assets that
could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
The Company's management assessed the effectiveness of the Company's
internal control over financial reporting as of December 31, 2004. In making
this assessment, the Company's management used the criteria established in
Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
Based on our assessment and those criteria, management concluded that, as
of December 31, 2004, the Company's internal control over financial reporting
was effective.
Our management's assessment of the effectiveness of the Company's
internal control over financial reporting as of December 31, 2004 has been
audited by PricewaterhouseCoopers LLP, an independent registered public
accounting firm, as stated in their report which appears herein.
58
Item 9B. Other Information.
- ------- -----------------
Not applicable.
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 2005 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, 2004. 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 1,277,430 $32.72 175,575
Equity compensation
plans not approved
by security holders -- -- --
--------- ------ ---------
Total 1,277,430 $32.72 175,575
========= ====== =========
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.
59
PART IV
Item 15. Exhibits and Financial Statement Schedules.
(a)(1)(2) Financial Statements and Schedules.
Report of Independent Registered Public Accounting Firm..................................... F-1
Financial Statements:
Consolidated Balance Sheets at December 31, 2004 and 2003.................................. F-3
Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and
2002.................................................................................... F-4
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and
2002.................................................................................... F-5
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 2004, 2003 and 2002........................................................ F-7
Notes to Consolidated Financial Statements................................................. F-8
Financial Statement Schedules:
Schedule I - Condensed Financial Information of Registrant................................ F-55
Schedule II - Valuation and Qualifying Accounts............................................ F-60
(3) Executive Compensation Plans and Arrangements. See Item 15(b)
below for a complete list of Exhibits to this Report.
1999 Stock Option Plan (filed as Annex A to the Company's Proxy
Statement dated April 9, 1999 (the "1999 Proxy Statement")).
Form of Grant Letter for the 1999 Stock Option Plan.
Amended and Restated Shareholders Agreement dated as of June 30,
2003 among the Company, Ian M. Cumming and Joseph S. Steinberg
(filed as Exhibit 10.5 to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 2003 (the "2003
10-K")).
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).
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).
60
(b) Exhibits.
We will furnish any exhibit upon request made to our Corporate
Secretary, 315 Park Avenue South, New York, NY 10010. We
charge $.50 per page to cover expenses of copying and mailing.
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 (filed as Exhibit 3.2 to the 2003
10-K).*
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
(filed as Exhibit 3.4 to the 2003 10-K).*
3.5 Certificate of Amendment of the Certificate of Incorporation
dated as of May 13, 2004.
4.1 The Company undertakes to furnish the Securities and Exchange
Commission, upon written 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(a) Fiber Lease Agreement, dated April 26, 2002, between Williams
Communications, LLC ("WCL") and Metromedia Fiber National
Network, Inc. ("MFNN") (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")).*
10.3(b) First Amendment, dated October 10, 2002, to Fiber Lease
Agreement, dated April 26, 2002, among WCL, MFNN and Metromedia
Fiber Network Services, Inc. ("MFNS") (filed as Exhibit 10.3(b)
to the Company's Annual Report on Form 10-K/A for the fiscal
year ended December 31, 2003 (the "2003 10-K/A")).*
10.3(c) Second Amendment, dated February 14, 2003, to Fiber Lease
Agreement, dated April 26, 2002, among WCL, MFNN and MFNS (filed
as Exhibit 10.48 to the WilTel 10-K).*
61
10.3(d) Colocation and Maintenance Agreement, dated April 26, 2002,
between WCL and MFNN (filed as Exhibit 10.48 to the WilTel
10-K).*
10.3(e) First Amendment, dated October 10, 2002, to Colocation and
Maintenance Agreement, dated April 26, 2002, among WCL, MFNN and
MFNS (filed as Exhibit 10.48 to the WilTel 10-K).*
10.3(f) Second Amendment, dated February 14, 2003, to Colocation and
Maintenance Agreement, dated April 26, 2002, among WCL, MFNN and
MFNS (filed as Exhibit 10.48 to the WilTel 10-K).*
10.4 Form of Grant Letter for the 1999 Stock Option Plan.
10.5 Amended and Restated Shareholders Agreement dated as of June 30,
2003 among the Company, Ian M. Cumming and Joseph S. Steinberg
(filed as Exhibit 10.5 to the 2003 10-K).*
10.6 Form of Amended and Restated Revolving Credit Agreement (the
"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 Amendment, dated as of March 31, 2004, to the Revolving Credit
Agreement.
10.8 Amendment, dated as of June 29, 2004, to the Revolving Credit
Agreement.
10.9 Leucadia National Corporation 2003 Senior Executive Annual
Incentive Bonus Plan (filed as Annex A to the 2003 Proxy
Statement).*
10.10 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).*
10.11 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).*
10.12 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).*
10.13 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).*
10.14 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
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2000).*
10.15 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).*
62
10.16 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).*
10.17 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")).*
10.18 Investment Agreement, dated as of July 26, 2002, by and among
the Company, WCG and, for purposes of Section 7.4 only, WCL
(filed as Exhibit 99.4 to the WCG July 31, 2002 8-K).*
10.19 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")).*
10.20 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).*
10.21 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).*
10.22 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).*
10.23 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).*
10.24 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).*
10.25 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).*
10.26 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).*
10.27 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).*
10.28 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).*
10.29 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).*
10.30 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).*
63
10.31 Master Alliance Agreement between SBC Communications Inc. and
Williams Communications, Inc. dated February 8, 1999 (filed as
Exhibit 10.10 to WCG's Equity Registration Statement, Amendment
No. 1, dated May 27, 1999).*
10.32 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).*
10.33 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")).*
10.34 Copy of WCG's agreement with TWC (filed as Exhibit 10.2 to the
WCG April 22, 2002 8-K). *
10.35 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).*
10.36 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).*
10.37 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).*
10.38 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).*
10.39 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).*
10.40 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).*
10.41 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).*
10.42 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).*
64
10.43 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).*
10.44 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).*
10.45 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).*
10.46 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).*
10.47 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).*
10.48 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).*
10.49 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).*
10.50(a) Fiber Lease Agreement, dated April 26, 2002, between
Metromedia Fiber Network Services, Inc. ("MFNS") and WCL
(filed as Exhibit 10.47 to the WilTel 10-K).*
10.50(b) First Amendment, dated October 10, 2002, to Fiber Lease
Agreement, dated April 26, 2002, between MFNS and WCL (filed
as Exhibit 10.55(b) to the 2003 10-K/A).*
10.50(c) Colocation and Maintenance Agreement, dated April 26, 2002,
between MFNS and WCL (filed as Exhibit 10.47 to the WilTel
10-K).*
65
10.50(d) First Amendment, dated October 10, 2002, to Colocation and
Maintenance Agreement, dated April 26, 2002, between MFNS and
WCL (filed as Exhibit 10.47 to the WilTel 10-K).*
10.50(e) Lease Agreement #2, dated April 26, 2002, between MFNS and WCL
(filed as Exhibit 10.47 to the WilTel 10-K).*
10.50(f) First Amendment, dated October 10, 2002, to Lease Agreement
#2, dated April 26, 2002, between MFNS and WCL (filed as
Exhibit 10.55(f) to the 2003 10-K/A).*
10.51 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.
(filed as Exhibit 10.56 to the 2003 10-K/A).*
10.52 Third Amended and Restated Credit And Guaranty Agreement,
dated as of September 8, 1999, as amended and restated as of
April 25, 2001, as further amended and restated as of October
15, 2002, and as further amended and restated as of September
24, 2004, among WilTel, WilTel Communications, LLC, certain of
its domestic subsidiaries, as loan parties, the several banks
and other financial institutions or entities from time to time
parties thereto as lenders, Credit Suisse First Boston, acting
through its Cayman Islands branch, as administrative agent, as
first lien administrative agent and as second lien
administrative agent, and Wells Fargo Foothill, LLC, as
syndication agent (filed as Exhibit 99.1 to the Company's
Current Report on Form 8-K dated September 24, 2002 (the
"Company's September 24, 2002 8-K")).*
10.53 Second Amended and Restated Security Agreement, dated as of
April 23, 2001, as amended and restated as of October 15,
2002, and as further amended and restated as of September 24,
2004, among WilTel, WilTel Communications, LLC, and the
additional grantors party thereto in favor of Credit Suisse
First Boston, acting through its Cayman Islands branch, as
administrative agent, as first lien administrative agent and
as second lien administrative agent (filed as Exhibit 99.2 to
the Company's September 24, 2002 8-K).*
10.54 Exhibit 1 to the Agreement and Plan of Reorganization between
the Company and TLC Associates, dated February 23, 1989 (filed
as Exhibit 3 to Amendment No. 12 to the Schedule 13D dated
December 29, 2004 of Ian M. Cumming and Joseph S. Steinberg
with respect to the Company).*
10.55 Letter Agreement, dated February 3, 2005, between the Company
and Jefferies & Company, Inc.
66
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),
Form S-3 (File No. 333-118102) and Form S-3 (File No.
333-122047).
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), Form S-3 (File No.
333-118102) and Form S-3 (File No. 333-122047).
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), Form S-3 (File No.
333-118102) and Form S-3 (File No. 333-122047).**
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), Form S-3 (File No.
333-118102) and Form S-3 (File No.333-122047).**
23.5 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, LP 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), Form S-3 (File No.
333-118102) and Form S-3 (File No. 333-122047).
23.6 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),
Form S-3 (File No. 333-118102) and Form S-3 (File No. 333-
122047).
67
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. ***
(c) Financial statement schedules.
(1) Berkadia LLC financial statements as of December 31, 2004
and 2003 and for the years ended December 31, 2004, 2003 and
2002. **
(2) Olympus Re Holdings, Ltd. consolidated financial statements
as of December 31, 2004 and 2003 for the years ended
December 31, 2004, 2003 and 2002.
(3) The FINOVA Group Inc. and subsidiaries consolidated
financial statements as of December 31, 2004 and 2003 and
for the years ended December 31, 2004, 2003 and 2002.**
(4) EagleRock Capital Partners (QP), LP financial statements as
of December 31, 2004 and 2003 and for the years ended
December 31, 2004, 2003 and 2002 and EagleRock Master Fund,
LP financial statements as of December 31, 2004 and 2003 and
for the years ended December 31, 2004 and 2003 and for the
period from May 1, 2002 (commencement of operations) to
December 31, 2002.
(5) WilTel Communications Group, Inc. consolidated financial
statements as of November 5, 2003 (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 (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.
68
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 14, 2005 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
Joseph A. Orlando (Principal Financial Officer)
/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/ Alan J. Hirschfield Director
- -------------------------------------
Alan J. Hirschfield
/s/ James E. Jordan Director
- -------------------------------------
James E. Jordan
/s/ Jeffrey C. Keil Director
- -------------------------------------
Jeffrey C. Keil
/s/ Jesse Clyde Nichols, III Director
------------------------------------
Jesse Clyde Nichols, III
69
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 (filed as Exhibit 3.2 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2003 (the "2003 10-K")).*
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
(filed as Exhibit 3.4 to the 2003 10-K).*
3.5 Certificate of Amendment of the Certificate of Incorporation
dated as of May 13, 2004.
4.1 The Company undertakes to furnish the Securities and Exchange
Commission, upon written 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 Company's
Proxy Statement dated April 9, 1999 (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(a) Fiber Lease Agreement, dated April 26, 2002, between Williams
Communications, LLC ("WCL") and Metromedia Fiber National
Network, Inc. ("MFNN") (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")).*
10.3(b) First Amendment, dated October 10, 2002, to Fiber Lease
Agreement, dated April 26, 2002, among WCL, MFNN and
Metromedia Fiber Network Services, Inc. ("MFNS") (filed as
Exhibit 10.3(b) to the Company's Annual Report on Form 10-K/A
for the fiscal year ended December 31, 2003 (the "2003
10-K/A")).*
10.3(c) Second Amendment, dated February 14, 2003, to Fiber Lease
Agreement, dated April 26, 2002, among WCL, MFNN and MFNS
(filed as Exhibit 10.48 to the WilTel 10-K).*
10.3(d) Colocation and Maintenance Agreement, dated April 26, 2002,
between WCL and MFNN (filed as Exhibit 10.48 to the WilTel
10-K).*
10.3(e) First Amendment, dated October 10, 2002, to Colocation and
Maintenance Agreement, dated April 26, 2002, among WCL, MFNN
and MFNS (filed as Exhibit 10.48 to the WilTel 10-K).*
10.3(f) Second Amendment, dated February 14, 2003, to Colocation and
Maintenance Agreement, dated April 26, 2002, among WCL, MFNN
and MFNS (filed as Exhibit 10.48 to the WilTel 10-K).*
70
10.4 Form of Grant Letter for the 1999 Stock Option Plan.
10.5 Amended and Restated Shareholders Agreement dated as of June
30, 2003 among the Company, Ian M. Cumming and Joseph S.
Steinberg (filed as Exhibit 10.5 to the 2003 10-K).*
10.6 Form of Amended and Restated Revolving Credit Agreement (the
"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 Amendment, dated as of March 31, 2004, to the Revolving Credit
Agreement.
10.8 Amendment, dated as of June 29, 2004, to the Revolving Credit
Agreement.
10.9 Leucadia National Corporation 2003 Senior Executive Annual
Incentive Bonus Plan (filed as Annex A to the Company's Proxy
Statement dated April 17, 2003).*
10.10 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")).*
10.11 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")).*
10.12 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).*
10.13 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).*
10.14 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
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2000).*
10.15 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).*
10.16 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).*
71
10.17 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")).*
10.18 Investment Agreement, dated as of July 26, 2002, by and among
the Company, WCG and, for purposes of Section 7.4 only, WCL
(filed as Exhibit 99.4 to the WCG July 31, 2002 8-K).*
10.19 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")).*
10.20 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).*
10.21 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).*
10.22 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).*
10.23 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).*
10.24 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).*
10.25 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).*
10.26 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).*
10.27 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).*
72
10.28 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).*
10.29 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).*
10.30 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).*
10.31 Master Alliance Agreement between SBC Communications Inc. and
Williams Communications, Inc. dated February 8, 1999 (filed as
Exhibit 10.10 to WCG's Equity Registration Statement,
Amendment No. 1, dated to May 27, 1999).*
10.32 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).*
10.33 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")).*
10.34 Copy of WCG's agreement with TWC (filed as Exhibit 10.2 to the
WCG April 22, 2002 8-K).*
10.35 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).*
10.36 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).*
10.37 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).*
10.38 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).*
10.39 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).*
73
10.40 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).*
10.41 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).*
10.42 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).*
10.43 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")).*
10.44 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).*
10.45 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).*
10.46 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).*
10.47 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).*
10.48 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).*
74
10.49 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).*
10.50(a) Fiber Lease Agreement, dated April 26, 2002, between
Metromedia Fiber Network Services, Inc. ("MFNS") and WCL
(filed as Exhibit 10.47 to the WilTel 10-K).*
10.50(b) First Amendment, dated October 10, 2002, to Fiber Lease
Agreement, dated April 26, 2002, between MFNS and WCL (filed
as Exhibit 10.55(b) to the 2003 10-K/A).*
10.50(c) Colocation and Maintenance Agreement, dated April 26, 2002,
between MFNS and WCL (filed as Exhibit 10.47 to the WilTel
10-K).*
10.50(d) First Amendment, dated October 10, 2002, to Colocation and
Maintenance Agreement, dated April 26, 2002, between MFNS and
WCL (filed as Exhibit 10.47 to the WilTel 10-K).*
10.50(e) Lease Agreement #2, dated April 26, 2002, between MFNS and WCL
(filed as Exhibit 10.47 to the WilTel 10-K).*
10.50(f) First Amendment, dated October 10, 2002, to Lease Agreement
#2, dated April 26, 2002, between MFNS and WCL (filed as
Exhibit 10.55(f) to the 2003 10-K/A).*
10.51 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.
(filed as Exhibit 10.56 to the 2003 10-K/A).*
10.52 Third Amended and Restated Credit And Guaranty Agreement,
dated as of September 8, 1999, as amended and restated as of
April 25, 2001, as further amended and restated as of October
15, 2002, and as further amended and restated as of September
24, 2004, among WilTel, WilTel Communications, LLC, certain of
its domestic subsidiaries, as loan parties, the several banks
and other financial institutions or entities from time to time
parties thereto as lenders, Credit Suisse First Boston, acting
through its Cayman Islands branch, as administrative agent, as
first lien administrative agent and as second lien
administrative agent, and Wells Fargo Foothill, LLC, as
syndication agent (filed as Exhibit 99.1 to the Company's
Current Report on Form 8-K dated September 24, 2002 (the
"Company's September 24, 2002 8-K")).*
75
10.53 Second Amended and Restated Security Agreement, dated as of
April 23, 2001, as amended and restated as of October 15,
2002, and as further amended and restated as of September 24,
2004, among WilTel, WilTel Communications, LLC, and the
additional grantors party thereto in favor of Credit Suisse
First Boston, acting through its Cayman Islands branch, as
administrative agent, as first lien administrative agent and
as second lien administrative agent (filed as Exhibit 99.2 to
the Company's September 24, 2002 8-K).*
10.54 Exhibit 1 to the Agreement and Plan of Reorganization between
the Company and TLC Associates, dated February 23, 1989 (filed
as Exhibit 3 to Amendment No. 12 to the Schedule 13D dated
December 29, 2004 of Ian M. Cumming and Joseph S. Steinberg
with respect to the Company).*
10.55 Letter Agreement, dated February 3, 2005, between the Company
and Jefferies & Company, 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),
Form S-3 (File No. 333-118102) and Form S-3 (File
No.333-122047).
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), Form S-3 (File No.
333-118102) and Form S-3 (File No.333-122047).
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), Form S-3 (File No.
333-118102) and Form S-3 (File No. 333-122047).**
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), Form S-3 (File No.
333-118102) and Form S-3 (File No. 333-122047).**
76
23.5 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, LP 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), Form S-3 (File No.
333-118102) and Form S-3 (File No. 333-122047).
23.6 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),
Form S-3 (File No. 333-118102) and Form S-3 (File No.
333-122047).
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.***
77
(c) Financial statement schedules.
(1) Berkadia LLC financial statements as of December 31, 2004
and 2003 and for the years ended December 31, 2004, 2003 and
2002. **
(2) Olympus Re Holdings, Ltd. consolidated financial statements
as of December 31, 2004 and 2003 for the years ended
December 31, 2004, 2003 and 2002.
(3) The FINOVA Group Inc. and subsidiaries consolidated
financial statements as of December 31, 2004 and 2003 and
for the years ended December 31, 2004, 2003 and 2002.**
(4) EagleRock Capital Partners (QP), LP financial statements as
of December 31, 2004 and 2003 and for the years ended
December 31, 2004, 2003 and 2002 and EagleRock Master Fund,
LP financial statements as of December 31, 2004 and 2003 and
for the years ended December 31, 2004 and 2003 and for the
period from May 1, 2002 (commencement of operations) to
December 31, 2002.
(5) WilTel Communications Group, Inc. consolidated financial
statements as of November 5, 2003 (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 (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.
78
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
-------------------------------------------------------
To the Board of Directors and
Shareholders of Leucadia National Corporation:
We have completed an integrated audit of Leucadia National Corporation's 2004
consolidated financial statements and of its internal control over financial
reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated
financial statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Our opinions, based on our audits,
are presented below.
Consolidated financial statements and financial statement schedules
- -------------------------------------------------------------------
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of
Leucadia National Corporation and its subsidiaries at December 31, 2004 and
2003, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2004 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 accompanying index
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 other auditors. We conducted our audits of these statements in accordance
with the standards of the Public Company Accounting Oversight Board (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 of financial statements 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 provide a reasonable basis for our opinion.
Internal control over financial reporting
- -----------------------------------------
Also, in our opinion, management's assessment, included in "Management's Report
on Internal Control Over Financial Reporting", in Part II, Item 9A of this
Report, that the Company maintained effective internal control over financial
reporting as of December 31, 2004 based on criteria established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), is fairly stated, in all
material respects, based on those criteria. Furthermore, in our opinion, the
Company maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2004 based on criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Company's management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express opinions on management's assessment
and on the effectiveness of the Company's internal control over financial
reporting based on our audit. We conducted our audit of internal control over
financial reporting in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. An audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial reporting,
evaluating management's assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other
procedures as we consider necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinions.
F-1
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
PricewaterhouseCoopers LLP
New York, New York
March 11, 2005
F-2
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2004 and 2003
(Dollars in thousands, except par value)
2004 2003
---- ----
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 486,948 $ 214,390
Investments 1,106,322 714,363
Trade, notes and other receivables, net 414,552 372,104
Prepaids and other current assets 52,127 49,506
------------ ------------
Total current assets 2,059,949 1,350,363
Non-current investments 726,782 673,742
Notes and other receivables, net 16,906 193,459
Other assets 203,096 223,970
Property, equipment and leasehold improvements, net 1,332,876 1,524,718
Investments in associated companies 460,794 430,912
------------ ------------
Total $ 4,800,403 $ 4,397,164
============ ============
LIABILITIES
- -----------
Current liabilities:
Trade payables and expense accruals $ 407,350 $ 377,473
Deferred revenue 52,632 47,311
Other current liabilities 94,956 89,390
Customer banking deposits due within one year 18,472 103,331
Debt due within one year 68,237 23,956
Income taxes payable 17,690 15,867
------------ ------------
Total current liabilities 659,337 657,328
Long-term deferred revenue 161,206 156,582
Other non-current liabilities 213,309 234,446
Non-current customer banking deposits 6,119 42,201
Long-term debt 1,483,504 1,154,878
------------ ------------
Total liabilities 2,523,475 2,245,435
------------ ------------
Commitments and contingencies
Minority interest 18,275 17,568
------------ ------------
SHAREHOLDERS' EQUITY
- --------------------
Common shares, par value $1 per share, authorized 150,000,000 shares;
107,600,403 and 106,235,253 shares issued and outstanding, after
deducting 42,399,597 shares held in treasury 107,600 106,235
Additional paid-in capital 598,504 577,863
Accumulated other comprehensive income 136,138 152,251
Retained earnings 1,416,411 1,297,812
------------ ------------
Total shareholders' equity 2,258,653 2,134,161
------------ ------------
Total $ 4,800,403 $ 4,397,164
============ ============
The accompanying notes are an integral part of
these consolidated financial statements.
F-3
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2004, 2003 and 2002
(In thousands, except per share amounts)
2004 2003 2002
---- ---- ----
REVENUES AND OTHER INCOME:
- --------------------------
Telecommunications $ 1,582,948 $ 231,930 $ -
Healthcare 257,262 71,039 -
Manufacturing 64,055 53,327 50,744
Finance 10,037 55,091 87,812
Investment and other income 204,873 127,631 133,667
Net securities gains (losses) 142,936 9,953 (37,066)
------------ ------------ ------------
2,262,111 548,971 235,157
------------ ------------ ------------
EXPENSES:
- ---------
Cost of sales:
Telecommunications 1,129,248 167,653 -
Healthcare 216,333 61,280 -
Manufacturing 45,055 38,998 33,963
Interest 96,787 43,002 32,975
Salaries 187,880 58,394 41,814
Depreciation and amortization 226,080 57,297 16,253
Selling, general and other expenses 305,443 154,100 149,296
------------ ------------ ------------
2,206,826 580,724 274,301
------------ ------------ ------------
Income (loss) from continuing operations before income taxes, minority
expense of trust preferred securities and equity in income of
associated companies 55,285 (31,753) (39,144)
------------ ------------ ------------
Income tax (benefit) provision:
Current (27,434) (19,692) (116,027)
Deferred 7,242 (23,750) (28,048)
------------ ------------ ------------
(20,192) (43,442) (144,075)
------------ ------------ ------------
Income from continuing operations before minority expense
of trust preferred securities and equity in income of
associated companies 75,477 11,689 104,931
Minority expense of trust preferred securities, net of taxes - (2,761) (5,521)
Equity in income of associated companies, net of taxes 76,479 76,947 54,712
------------ ------------ ------------
Income from continuing operations 151,956 85,875 154,122
Income (loss) from discontinued operations, net of taxes (8,269) 3,681 2,989
Gain on disposal of discontinued operations, net of taxes 1,813 7,498 4,512
------------ ------------ ------------
Net income $ 145,500 $ 97,054 $ 161,623
============ ============ ============
Basic earnings (loss) per common share:
Income from continuing operations $ 1.42 $ .94 $ 1.85
Income (loss) from discontinued operations (.08) .04 .04
Gain on disposal of discontinued operations .02 .08 .05
--------- --------- ---------
Net income $ 1.36 $ 1.06 $ 1.94
========= ========= =========
Diluted earnings (loss) per common share:
Income from continuing operations $ 1.40 $ .93 $ 1.83
Income (loss) from discontinued operations (.08) .04 .04
Gain on disposal of discontinued operations .02 .08 .05
--------- --------- ---------
Net income $ 1.34 $ 1.05 $ 1.92
========= ========= =========
The accompanying notes are an integral part of
these consolidated financial statements.
F-4
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2004, 2003 and 2002
(In thousands)
2004 2003 2002
---- ---- ----
Net cash flows from operating activities:
- -----------------------------------------
Net income $ 145,500 $ 97,054 $ 161,623
Adjustments to reconcile net income to net cash provided by (used for)
operations:
Deferred income tax provision (benefit) 7,242 (23,847) (28,048)
Depreciation and amortization of property, equipment and leasehold improvements 232,600 65,723 21,624
Other amortization 3,316 (4,624) (5,427)
Provision for doubtful accounts (5,366) 20,098 36,248
Net securities (gains) losses (142,936) (9,953) 37,066
Equity in income of associated companies, net of taxes (76,479) (76,947) (54,712)
Distributions from associated companies 23,878 25,359 43,807
Gain on disposal of real estate, property and equipment, loan receivables and
other assets (60,866) (23,429) (35,051)
Gain on disposal of discontinued operations (1,813) (7,498) (4,512)
Investments classified as trading, net (68,612) (8,133) 48,990
Net change in:
Trade, notes and other receivables 19,578 (18,306) 10,681
Prepaids and other assets 11,491 (10,687) (1,021)
Trade payables and expense accruals 19,654 (10,996) 11,936
Other liabilities (52,250) (18,931) (4,243)
Deferred revenue 9,945 2,045 -
Income taxes payable 1,823 (14,276) (137,327)
Other 1,732 (3,158) 2,934
Net change in net assets of discontinued operations - (3,994) (5,384)
------------ ------------ ------------
Net cash provided by (used for) operating activities 68,437 (24,500) 99,184
------------ ------------ ------------
Net cash flows from investing activities:
- -----------------------------------------
Acquisition of property, equipment and leasehold improvements (97,412) (84,665) (17,106)
Acquisition of and capital expenditures for real estate investments (23,022) (67,925) (20,748)
Proceeds from disposals of real estate, property and equipment, and other assets 123,302 111,134 108,146
Investment in WilTel, Symphony and WebLink, net of cash acquired - 114,524 -
Proceeds from disposal of discontinued operations, net of expenses 22,311 - 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)
Principal collections on loan receivables 41,862 138,259 174,718
Proceeds from sale of loan receivables 157,134 - -
Advances on notes receivables (400) (2,279) (2,390)
Collections on notes receivables 27,789 14,176 4,373
Investments in associated companies (69,398) (22,350) (375,307)
Capital distributions from associated companies 5,632 7,174 -
Purchases of investments (other than short-term) (2,534,404) (1,655,294) (1,143,361)
Proceeds from maturities of investments 869,707 555,148 657,487
Proceeds from sales of investments 1,460,181 683,752 548,249
------------ ------------ ------------
Net cash used for investing activities (16,718) (215,793) (100,327)
------------ ------------ ------------
(continued)
The accompanying notes are an integral part of
these consolidated financial statements.
F-5
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
For the years ended December 31, 2004, 2003 and 2002
(In thousands)
2004 2003 2002
---- ---- ----
Net cash flows from financing activities:
- -----------------------------------------
Net change in customer banking deposits $ (120,516) $ (245,845) $ (82,351)
Issuance of long-term debt, net of issuance costs 438,393 304,509 6,145
Reduction of long-term debt (92,454) (7,002) (13,265)
Issuance of convertible preferred shares - - 47,507
Issuance of common shares 22,006 1,293 102,535
Purchase of common shares for treasury - (61) (115)
Dividends paid (26,901) (17,706) (13,841)
----------- ----------- -----------
Net cash provided by financing activities 220,528 35,188 46,615
----------- ----------- -----------
Effect of foreign exchange rate changes on cash 311 895 (94)
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 272,558 (204,210) 45,378
Cash and cash equivalents at January 1, 214,390 418,600 373,222
----------- ----------- -----------
Cash and cash equivalents at December 31, $ 486,948 $ 214,390 $ 418,600
=========== =========== ===========
Supplemental disclosures of cash flow information:
- ------------------------------------------------
Cash paid during the year for:
Interest $ 89,707 $ 40,856 $ 34,681
Income tax payments (refunds), net $ (26,024) $ (5,098) $ 17,314
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-6
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the years ended December 31, 2004, 2003 and 2002
(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, 2002 $ - $ 82,977 $ 27,132 $ 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 $724 (1,343) (1,343)
Net income 161,623 161,623
------------
Comprehensive income 202,986
------------
Issuance of convertible preferred shares 47,507 47,507
Issuance of common shares 4,361 97,132 101,493
Exercise of options to purchase common shares 69 973 1,042
Purchase of stock for treasury (4) (111) (115)
Dividends ($.17 per common share) (13,841) (13,841)
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2002 47,507 87,403 125,126 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 $7,345 (13,639) (13,639)
Net income 97,054 97,054
------------
Comprehensive income 193,280
------------
Issuance of common shares on acquisition of
WilTel Communications Group, Inc. 16,735 406,095 422,830
Conversion of convertible preferred shares into
common shares (47,507) 2,022 45,485 -
Exercise of options to purchase common shares 79 1,214 1,293
Purchase of stock for treasury (4) (57) (61)
Dividends ($.17 per common share) (17,706) (17,706)
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2003 - 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 (8,592) (8,592)
Net change in unrealized foreign exchange
gain (loss), net of taxes of $0 6,807 6,807
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $0 (355) (355)
Net change in minimum pension liability, net
of taxes of $0 (13,973) (13,973)
Net income 145,500 145,500
------------
Comprehensive income 129,387
------------
Exercise of warrants to purchase common shares 1,200 17,960 19,160
Exercise of options to purchase common shares 165 2,681 2,846
Dividends ($.25 per common share) (26,901) (26,901)
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2004 $ - $ 107,600 $ 598,504 $ 136,138 $ 1,416,411 $ 2,258,653
============ ============ ============ ============ ============ ============
The accompanying notes are an integral part of
these consolidated financial statements.
F-7
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, manufacturing, banking and
lending, 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 continuously evaluates the retention and
disposition of its existing operations and frequently investigates the
acquisition of new businesses. Changes in the mix of the Company's owned
businesses and investments should be expected.
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 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 banking and lending operations have historically consisted of
making collateralized instalment loans primarily funded by customer banking
deposits to individuals who had difficulty obtaining credit. However, as a
result of increased loss experience and declining profitability, the Company has
ceased originating all loans. The segment's current operating activities are
concentrated on maximizing returns on its investment portfolio, collecting and
servicing its remaining loan portfolio and discharging deposit liabilities as
they come due. The Company's banking and lending subsidiary intends to
ultimately surrender its national bank charter.
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 72.1% interest in MK Resources Company ("MK Resources") (formerly MK Gold
Company), a public company traded on the NASD OTC Bulletin Board (Symbol: MKRR).
2. Significant Accounting Policies:
-------------------------------
(a) Critical Accounting Estimates: The preparation of financial statements in
conformity with accounting principles generally accepted in the United States
("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-8
2. Significant Accounting Policies, continued:
--------------------------------
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 based on the
Company's assessment of the probability of successfully sustaining its tax
filing positions.
Subsequent to the acquisition of all of the outstanding common stock of WilTel,
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 offset the future taxable income of other members
of the Company's consolidated federal 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). Before the Company can recognize a net deferred tax
asset, it 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.
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 a long-lived asset (or asset group) is recoverable is
based on management's estimate of undiscounted future cash flows attributable to
the asset as compared to its carrying value. If the carrying amount of the asset
(or asset group) is greater than the undiscounted cash flows, then the carrying
amount of the asset is considered to be not recoverable. The amount of the
impairment recognized would be determined by estimating the fair value for the
asset (or asset group) and recording a provision for the excess of the carrying
value over the fair value.
As of December 31, 2004, the carrying amount of the Company's investment in the
mineral rights and mining properties of MK Resources was approximately
$85,400,000. The recoverability of this asset is entirely dependent upon the
success of MK Resource'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. In addition, the actual price of copper, the operating cost of the
mine and the capital cost (in U.S. dollars) to build the project and bring the
mine into production will affect the recoverability of this asset. The Las
Cruces project has been granted government subsidies of 47.5 million euros
($62,900,000); however, the grants require MK Resources to make certain capital
expenditures by March 27, 2005, a deadline that it will not be able to meet
principally because of delays in obtaining permits. Las Cruces has filed a
request to further extend the deadline, but has been informed that the
government will not act on the extension request prior to the current
expiration.
To date, the Company has been the sole source of funding for the Las Cruces
project. The amount of equity capital and third party financing that can be
obtained for the project and its related cost will be significantly affected by
the assessment of potential investors and lenders of the current and expected
future market price of copper, as well as current market conditions for this
type of investment. During 2004, MK Resources was unsuccessful in raising equity
capital for the project, due to unfavorable market conditions at the time. MK
Resources continues to explore financing possibilities. Based on the current
status of the project, MK Resource's estimate of future cash flows and its
assessment of financing possibilities, 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, is unable to obtain financing for the project or the capital cost of
the project changes significantly, it is likely that this investment will be
impaired.
F-9
2. Significant Accounting Policies, continued:
--------------------------------
As of December 31, 2004, the carrying amount of the Company's investment in its
manufacturing facility located in Belgium was approximately $17,900,000. 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 to develop and implement marketing and sales
initiatives directed at generating revenue growth. Operating results at the
facility improved during 2004 as sales grew significantly compared to 2003 and
the business achieved positive cash flow. However, new customer acquisitions
must continue in order for the facility to reach profitability. Based on the
current business plan, which includes estimates of revenue growth, the Company
believes that its investment in the Belgium facility is recoverable. However, if
the estimated revenue growth is not achieved, the carrying amount of the
facility is likely to be impaired.
Acquisition of WilTel - In connection with accounting for the acquisition of
WilTel, significant judgments and estimates were made to determine the fair
values of certain liabilities, including liabilities for net unfavorable
long-term commitments and deferred revenue, many of which required the Company
to make assumptions about the future. 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 is 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 December 31, 2004, the amount reflected in the consolidated
balance sheet for deferred revenue was $213,800,000.
The Company evaluated the fair value of long-term commitments that were 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. The accrued liability is 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. At December 31, 2004, the
balance relating to those unfavorable long-term commitments was $44,900,000.
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.
F-10
2. Significant Accounting Policies, continued:
--------------------------------
Accruals for Access Costs - WilTel's access costs primarily include variable
charges paid to vendors to originate and/or terminate switched voice traffic,
which are based on actual usage at negotiated or regulated contract rates, and
fixed charges for leased lines for dedicated facilities. At the end of each
reporting period, WilTel's estimated accrual for incurred but not yet billed
costs is based on internal usage reports. The accrual is subsequently reconciled
to actual invoices as they are received, which is a process that can take
several months to complete. This process includes an invoice validation
procedure that normally identifies errors and inaccuracies in rate and/or volume
components of the invoices resulting in numerous invoice disputes. It is
WilTel's policy to adjust the accrual for the probable amount it believes will
ultimately be paid on disputed invoices, a determination which requires
significant estimation and judgment. Due to the number of different negotiated
and regulated rates, constantly changing traffic patterns, uncertainty in the
ultimate resolution of disputes, the period of time required to complete the
reconciliation and delays in invoicing by access vendors, changes in these
estimates should be expected.
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, 2004, the Company's consolidated balance sheet includes litigation
reserves of $21,500,000, 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.
(b) Consolidation Policy: The consolidated financial statements include the
accounts of the Company, all variable interest entities of which the Company or
a subsidiary is the primary beneficiary, and all majority-controlled entities
that are not variable interest entities. All intercompany transactions and
balances are eliminated in consolidation.
Associated companies are investments in equity interests that are accounted for
on the equity method of accounting. These include investments in corporations
that the Company does not control but has the ability to exercise significant
influence and investments in limited partnerships in which the Company's
interest is more than minor.
Certain amounts for prior periods have been reclassified to be consistent with
the 2004 presentation.
(c) Stock Split: On December 31, 2004, a three-for-two stock split was effected
in the form of a 50% stock dividend that was paid to shareholders of record on
December 23, 2004. The financial statements (and notes thereto) give retroactive
effect to the stock split for all periods presented.
(d) 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
$302,900,000 and $79,100,000 at December 31, 2004 and 2003, respectively.
(e) 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.
F-11
2. Significant Accounting Policies, continued:
--------------------------------
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.
(f) 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.
(g) 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 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 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.
Manufacturing revenues are recognized when title passes, which is generally upon
shipment of goods. 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. Revenue from the sale of real estate is generally
recognized when title passes;
F-12
2. Significant Accounting Policies, continued:
--------------------------------
however, if the Company is obligated to make improvements to the real estate
subsequent to closing, revenues are deferred and recognized under the percentage
of completion method of accounting.
(h) 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.
(i) 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.
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 and $(1,700,000) for the years ended December 31, 2003 and
2002, respectively, and not material for 2004. Net unrealized losses on
derivative instruments were $3,800,000 and $3,400,000 at December 31, 2004 and
2003, respectively.
(j) 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
transaction gains were $2,500,000 for 2002 and not material for 2004 and 2003.
Net unrealized foreign exchange translation gains were $14,300,000 and
$7,500,000 at December 31, 2004 and 2003, respectively.
(k) 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 $1,000,000, $800,000 and $600,000 in
2004, 2003 and 2002, respectively.
(l) Recently Issued Accounting Standards: In November 2004, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards No. 151, "Inventory Costs--An Amendment of ARB No. 43, Chapter 4"
("SFAS 151"), which is effective for fiscal years beginning after June 15, 2005.
SFAS 151 amends the guidance in ARB No. 43 to clarify the accounting for
abnormal amounts of idle facility expense, freight, handling costs, and wasted
material (spoilage). Among other provisions, SFAS 151 requires that items such
as idle facility expense, excessive spoilage, double freight, and rehandling
costs be recognized as current-period charges regardless of whether they meet
the criterion of "so abnormal" as stated in ARB No. 43. In addition, SFAS 151
requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities. The
Company is currently evaluating the impact of SFAS 151 on its consolidated
financial statements.
F-13
2. Significant Accounting Policies, continued:
--------------------------------
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 123R, "Share-Based Payment" ("SFAS 123R"), which replaces SFAS 123 and
supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees". SFAS
123R requires that the cost of all share-based payments to employees, including
grants of employee stock options, be recognized in the financial statements
based on their fair values. That cost will be recognized as an expense over the
vesting period of the award. Pro forma disclosures previously permitted under
SFAS 123 (which are shown above) no longer will be an alternative to financial
statement recognition. In addition, the Company will be required to determine
fair value in accordance with SFAS 123R. SFAS 123R is effective for reporting
periods beginning with the first interim or annual period after June 15, 2005,
with early adoption encouraged, and requires the application of a transition
methodology for stock options that have not vested as of the date of adoption.
The Company is currently evaluating the impact of SFAS 123R on its consolidated
financial statements.
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 153, "Exchanges of Nonmonetary Assets--An Amendment of APB Opinion No. 29"
("SFAS 153"), which is effective for fiscal periods beginning after June 15,
2005. SFAS 153 eliminates the exception from fair value measurement for
nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB
Opinion No. 29, "Accounting for Nonmonetary Transactions," and replaces it with
an exception for exchanges that do not have commercial substance. SFAS 153
specifies that a nonmonetary exchange has commercial substance if the future
cash flows of the entity are expected to change significantly as a result of the
exchange. The adoption of SFAS 153 will not have any material effect on the
consolidated financial statements; however, SFAS 153 could impact the accounting
for future transactions, if any, within its scope.
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 WilTel became a wholly-owned subsidiary of the Company and
former WilTel public stockholders received an aggregate of 16,734,690 common
shares of the Company. The merger agreement also provided that WilTel
stockholders receive contingent sale rights which entitled WilTel stockholders
to additional Leucadia common shares under certain circumstances; such
contingent sale rights expired in 2004 without payment of any additional
consideration. 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 execution of the merger agreement on August 21, 2003
created a measurement date for accounting purposes that 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, $25.27 per share, was used to calculate the
aggregate value of the Leucadia common shares issued.
F-14
3. Acquisitions, continued:
-------------
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, had been subsequently reduced by $65,400,000, representing
the Company's share of WilTel's losses under the equity method of accounting.
The 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 243,400
Prepaids and other current assets 62,200
-------------
Total current assets 497,100
Non-current investments 30,600
Property and equipment 1,214,900
Intangible assets 47,000
Other assets 38,800
-------------
Total assets 1,828,400
-------------
Liabilities:
Current liabilities:
Trade payables and expense accruals 235,900
Deferred revenue 47,400
Other current liabilities 119,100
Long-term debt due within one year 4,000
-------------
Total current liabilities 406,400
Long-term deferred revenue 154,500
Other non-current liabilities 138,100
Long-term debt 502,700
-------------
Total liabilities 1,201,700
-------------
626,700
Allocation to consolidated deferred income taxes 87,100
-------------
Net investment in WilTel $ 713,800
=============
Of the $47,000,000 of acquired intangible assets, $10,100,000 was related to
Vyvx's tradename (with a weighted-average useful life of approximately fifteen
years) and $36,900,000 was related to customer relationships (with a
weighted-average useful life of approximately thirteen years), primarily Vyvx
customers. The net carrying amount of these intangible assets increased
$8,200,000 during 2004 (which is reflected in the balance sheet above), due to
the completion of the analyses used to allocate the purchase price to the
individual assets acquired, which also resulted in a reduction in the amount
initially allocated to property and equipment. See Note 8 for more information
concerning intangible asset activity subsequent to the acquisition.
F-15
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 $ 1,730,800 $ 1,440,400
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 $ .71 $(3.26)
Dilutive $ .71 $(3.26)
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, that reduced the Company's 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-16
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 (collectively "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.
As contemplated at the time of the Company's purchase, in January 2004, ATX
commenced a voluntary Chapter 11 case in order to reorganize its financial
affairs. During 2004, the Company provided debtor-in-possession financing to ATX
of $5,000,000. This financing is secured by liens on substantially all of ATX's
assets, and is expected to be repaid upon ATX's emergence from bankruptcy. In
January 2005, ATX filed its First Amended Joint Plan of Reorganization (the
"Plan") and related disclosure statement. The Plan was filed after agreements
were reached with major stakeholders and/or the representatives of major
stakeholders in the bankruptcy case. The Plan contemplates that the Company will
convert its current investment in the ATX credit facility into 95% 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 will provide up to
$25,000,000 of exit financing to ATX to fund bankruptcy related payments and
working capital requirements, which includes the repayment of the Company's
$5,000,000 debtor-in-possession financing. The Plan is subject to approval by
the bankruptcy court and creditors. Assuming that ATX is reorganized as
contemplated in the Plan, the Company will consolidate ATX as of the date the
Plan becomes effective.
In July 2004, the Company invested $50,000,000 in INTL Consilium Emerging Market
Absolute Return Fund, LLC ("INTL"), a limited liability company that is invested
in a master fund which primarily invests in emerging markets debt and equity
securities. INTL and the master fund are managed and controlled by an investment
manager who has full discretion over investment and operating decisions. In
accordance with FASB Interpretation No. 46R, "Consolidation of Variable Interest
Entities", INTL is a variable interest entity and the Company is currently the
primary beneficiary; as a result, the Company accounts for its investment in
INTL as a consolidated subsidiary. In October 2004, the Company invested an
additional $25,000,000 in INTL. INTL plans to sell additional membership
interests in the future, which if accomplished could result in the Company no
longer accounting for INTL as a consolidated subsidiary. At December 31, 2004,
INTL had total assets of $79,600,000, which are reflected as investments in the
Company's consolidated balance sheet, and its liabilities were not material.
The creditors of INTL have recourse only to the assets of INTL and do not have
recourse to any other assets of the Company. The Company can generally withdraw
its capital account interest upon 90 days notice, subject to the manager's
ability to liquidate security positions in an orderly manner. For the year ended
December 31, 2004, the Company recorded $2,200,000 of pre-tax income relating to
INTL. The Company has included INTL in its Corporate segment.
4. Investments in Associated Companies:
-----------------------------------
The Company has investments in several Associated Companies. The amounts
reflected as equity in income of associated companies in the consolidated
statements of operations are net of income tax provisions of $15,000,000,
$70,100,000 and $36,700,000 for the years ended December 31, 2004, 2003 and
2002, respectively. Included in consolidated retained earnings at December 31,
2004 is approximately $124,000,000 of undistributed earnings of the
associated companies.
JPOF II
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, 2004, 2003 and 2002, the Company recorded $16,200,000,
F-17
4. Investments in Associated Companies, continued:
------------------------------------
$14,800,000 and $15,200,000, 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.
Olympus
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%.
Although the Company's equity interest declined below 20%, the Company continued
to account for its investment under the equity method of accounting because of
its ability to exercise significant influence. As a result of redemptions of
other investors' equity interests in the first half of 2004, the Company's
percentage interest in Olympus has increased to 19%. For the years ended
December 31, 2004, 2003 and 2002, the Company recorded $9,700,000, $40,400,000
and $24,100,000, respectively, of pre-tax income from this investment under the
equity method of accounting.
EagleRock
In December 2001, the Company invested $50,000,000 in EagleRock Capital Partners
(QP), LP ("EagleRock"), a limited partnership that invests and trades in
securities and other investment vehicles. Pre-tax results of $29,400,000,
$49,900,000 and $(4,500,000) for the years ended December 31, 2004, 2003 and
2002, respectively, were recorded from this investment under the equity method
of accounting. The results reported by the partnership since its inception
include both realized and changes in unrealized gains and losses in its
portfolio. In 2004, $3,700,000 was distributed by EagleRock to the Company.
HomeFed
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, 2004 and 2003, the deferred gain on
this sale was $6,800,000 and $7,900,000, 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 years ended December 31, 2004 and 2003,
the Company recorded $10,000,000 and $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 public traded
company traded on the NASD OTC Bulletin Board (Symbol: HOFD).
As a result of a 1998 distribution to all of the Company's shareholders,
approximately 9.4% and 9.5% of HomeFed is owned by the Company's Chairman and
President, respectively. Both are also directors of HomeFed and the Company's
President serves as HomeFed's Chairman.
Pershing
In January 2004, the Company invested $50,000,000 in Pershing Square, L.P.
("Pershing"), a limited partnership that is authorized to engage in a variety of
investing activities. The Company redeemed its interest as of December 31, 2004,
and the total amount due from Pershing of $71,300,000 (which was paid during the
first quarter of 2005) is included in trade, notes and other receivables, net in
the Company's consolidated balance sheet.
F-18
4. Investments in Associated Companies, continued:
------------------------------------
Other
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, 2004, except for Berkadia
LLC ("Berkadia") and WilTel which are separately summarized below. (Amounts are
in thousands.)
2004 2003
---- ----
Assets $ 2,247,000 $ 2,062,300
Liabilities 969,200 812,600
------------ -------------
Net assets $ 1,277,800 $ 1,249,700
============ =============
The Company's portion of the reported net assets $ 440,200 $ 411,900
============ =============
2004 2003 2002
---- ---- ----
Total revenues $ 914,500 $ 890,900 $ 479,200
Income from continuing operations before extraordinary items $ 221,000 $ 374,700 $ 133,400
Net income $ 221,000 $ 374,700 $ 136,600
The Company's equity in net income $ 90,700 $ 119,900 $ 39,200
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 investment.
Berkadia
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. 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). 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 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 even
though the Berkadia Loan has been repaid.
F-19
4. Investments in Associated Companies, continued:
------------------------------------
Under the agreement governing Berkadia, the Company and Berkshire Hathaway
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, was
shared 90% to Berkshire Hathaway and 10% 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,
in exchange for 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 reflected as
a discount from the face amount of the Berkadia Loan. The discount was amortized
to income over the life of the Berkadia Loan under the effective interest
method.
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.
Subsequent to acquisition, Berkadia accounted for its investment in the FINOVA
common stock under the equity method of accounting. During 2001, Berkadia
recorded its share of FINOVA's losses in an amount that reduced Berkadia's
investment in FINOVA's common stock to zero. Berkadia's recognition of any
future FINOVA losses was suspended at that time. Although the Company had no
cash investment in Berkadia, since it guaranteed 10% of the third party
financing provided to Berkadia, the Company recorded its share of any losses
recorded by Berkadia, up to the amount of the Company's guarantee. For the years
ended December 31, 2004, 2003 and 2002, the Company's equity in the income of
Berkadia consists of the following (in thousands):
2004 2003 2002
---- ---- ----
Net interest spread on the Berkadia Loan - 10% of total $ - $ 2,400 $ 6,100
Net interest savings 300 2,000 500
Amortization of Berkadia Loan discount related to cash fees -
50% of total 200 29,100 22,900
Amortization of Berkadia Loan discount related to FINOVA
stock - 50% of total 300 45,700 36,100
--------- --------- ---------
Equity in income of associated companies - Berkadia $ 800 $ 79,200 $ 65,600
========= ========= =========
The following table provides certain summarized data with respect to Berkadia at
December 31, 2003 and for the years ended December 31, 2004, 2003 and 2002.
Since Berkadia has distributed all of its cash to its members and the carrying
amount of its investment in FINOVA is zero, it has no assets or liabilities as
of December 31, 2004. (Amounts are in thousands.)
F-20
4. Investments in Associated Companies, continued:
------------------------------------
2003
----
Assets $ 526,400
Liabilities 525,600
------------
Net assets $ 800
============
2004 2003 2002
---- ---- ----
Total revenues $ 2,400 $ 198,800 $ 245,200
Income from continuing operations before extraordinary items
and cumulative effect of a change in accounting principle $ 2,200 $ 180,400 $ 180,900
Net income $ 2,200 $ 180,400 $ 180,900
WilTel
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 following table provides certain summarized data with respect to WilTel 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.)
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)
5. Discontinued Operations:
-----------------------
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. 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.
F-21
5. Discontinued Operations, continued:
------------------------
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 on disposal of discontinued operations of $11,500,000. The vesting criteria
for the remaining warrants were satisfied during 2004, and the Company recorded
$2,200,000 as gain on disposal of discontinued operations (net of minority
interest), which represented the estimated fair value of the warrants.
During the fourth quarter of 2004, WebLink exercised all of its warrants and
subsequently tendered all of its Metrocall shares as part of a merger agreement
between Metrocall and Arch Wireless, Inc. WebLink received cash of $19,900,000
and 675,607 common shares of the new parent company (USA Mobility, Inc., which
had a fair market value of $25,000,000 when received), resulting in a pre-tax
gain of $15,800,000 that is included in net securities gains of continuing
operations. The Company's investment in the shares of USA Mobility at December
31, 2004 are classified as a non-current investment.
In October 2004, the Company sold a commercial real estate property and
classified it as a discontinued operation. During the second quarter of 2004,
the Company recorded a non-cash charge of approximately $7,100,000 to reduce the
carrying amount of this property to its estimated fair value. The Company
recorded an additional loss of $600,000 in the fourth quarter of 2004 resulting
principally from mortgage prepayment penalties incurred upon satisfaction of the
property's mortgage at closing. Operating results for this property were not
material in prior years.
In the fourth quarter of 2004, the Company sold its geothermal power business
and classified it as a discontinued operation. This business had been included
in the Company's Other Operations segment. The Company received proceeds of
$14,800,000, net of closing costs, and recognized a pre-tax gain of $200,000.
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.
A summary of the results of discontinued operations is as follows for the three
year period ended December 31, 2004 (in thousands):
2004 2003 2002
---- ---- ----
Revenues and other income:
Wireless messaging revenues $ - $ 57,900 $ -
Investment and other income 6,441 7,670 19,552
Net securities losses - - (364)
--------- ---------- ---------
6,441 65,570 19,188
--------- ---------- ---------
Expenses:
Wireless messaging network operating expenses - 31,354 -
Interest 382 548 2,735
Salaries - 9,947 505
Selling, general and other expenses 14,328 20,782 11,178
--------- ---------- ---------
14,710 62,631 14,418
--------- ---------- ---------
Income (loss) before income taxes (8,269) 2,939 4,770
Income tax provision (benefit) - (742) 1,781
--------- ---------- ---------
Income (loss) from discontinued operations, net of taxes $ (8,269) $ 3,681 $ 2,989
========= ========== =========
F-22
6. Investments:
-----------
A summary of investments classified as current assets at December 31, 2004 and
2003 is as follows (in thousands):
2004 2003
------------------------------ ------------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
--------- -------------- ---------- ---------------
Investments available for sale $ 939,175 $ 939,313 $ 606,387 $ 623,570
Trading securities 148,602 159,616 74,923 86,392
Other investments, including accrued interest income 7,393 7,393 4,401 4,401
------------ ------------ ---------- -----------
Total current investments $ 1,095,170 $ 1,106,322 $ 685,711 $ 714,363
============ ============ ========== ===========
The amortized cost, gross unrealized gains and losses and estimated fair value
of available for sale investments classified as current assets at December 31,
2004 and 2003 are as follows (in thousands):
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ------------ ----------
2004
Bonds and notes:
United States Government and agencies $ 871,248 $ 10 $ 1,212 $ 870,046
All other corporates 67,927 1,666 326 69,267
---------- ---------- ---------- ----------
Total $ 939,175 $ 1,676 $ 1,538 $ 939,313
========== ========== ========== ==========
2003
Bonds and notes:
United States Government and agencies $ 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
========== ========== ========== ==========
Certain information with respect to trading securities at December 31, 2004 and
2003 is as follows (in thousands):
2004 2003
------------------------------ ------------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
--------- -------------- ---------- ---------------
Fixed maturities - corporate bonds and notes $ 67,629 $ 77,288 $ 69,923 $ 80,516
Equity securities 1,413 1,585 3,680 3,983
Other investments 79,560 80,743 1,320 1,893
---------- ---------- ---------- ----------
Total trading securities $ 148,602 $ 159,616 $ 74,923 $ 86,392
========== ========== ========== ==========
F-23
6. Investments, continued:
------------
A summary of non-current investments at December 31, 2004 and 2003 is as follows
(in thousands):
2004 2003
------------------------------ --------------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
--------- -------------- ---------- ---------------
Investments available for sale $ 432,207 $ 676,051 $ 420,947 $ 655,178
Other investments 50,731 50,731 18,564 18,564
---------- ---------- ---------- ----------
Total non-current investments $ 482,938 $ 726,782 $ 439,511 $ 673,742
========== ========== ========== ==========
The amortized cost, gross unrealized gains and losses and estimated fair value
of non-current investments classified as available for sale at December 31, 2004
and 2003 are as follows (in thousands):
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
2004
- ----
Bonds and notes:
United States Government and agencies $ 150,693 $ 51 $ 1,148 $ 149,596
States, municipalities and political subdivisions 7,610 - - 7,610
Foreign governments 1,507 79 - 1,586
All other corporates 125,020 41,568 416 166,172
---------- ----------- ---------- ----------
Total fixed maturities 284,830 41,698 1,564 324,964
---------- ----------- ---------- ----------
Equity securities:
Preferred stocks 993 - - 993
Common stocks:
Banks, trusts and insurance companies 91,154 194,620 - 285,774
Industrial, miscellaneous and all other 55,230 10,868 1,778 64,320
---------- ----------- ---------- ----------
Total equity securities 147,377 205,488 1,778 351,087
---------- ----------- ---------- ----------
$ 432,207 $ 247,186 $ 3,342 $ 676,051
========== =========== ========== ==========
F-24
6. Investments, continued:
------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ------------ ----------- ----------
2003
- ----
Bonds and notes:
United States Government and agencies $ 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
=========== =========== =========== ===========
The amortized cost and estimated fair value of non-current investments
classified as available for sale at December 31, 2004, 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 $ 133,191 $ 173,709
Due after five years through ten years 1,856 2,505
Due after ten years 7,610 7,610
----------- -----------
142,657 183,824
Mortgage-backed securities 142,173 141,140
----------- -----------
$ 284,830 $ 324,964
=========== ===========
The Company owns 375,000 common shares of White Mountains Insurance Group, Ltd.
("WMIG"), for which it paid $75,000,000. 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.
The Company's president is a director of WMIG. At December 31, 2004 and 2003,
the Company's investment in WMIG, which is reflected in non-current investments
available for sale, had a market value of $242,300,000 and $172,500,000,
respectively. The WMIG shares owned by the Company have the benefit of a
registration rights agreement with WMIG.
F-25
6. Investments, continued:
------------
Net unrealized gains on investments were $153,200,000, $161,800,000 and
$58,000,000 at December 31, 2004, 2003 and 2002, respectively. Reclassification
adjustments included in comprehensive income for the three year period ended
December 31, 2004 are as follows (in thousands):
2004 2003 2002
---- ---- ----
Unrealized holding gains (losses) arising during the period, net of
tax provision of $0, $56,896 and $12,558 $ (26,623) $ 105,861 $ 23,253
Less: reclassification adjustment for (gains) losses included in net
income, net of tax provision (benefit) of $0, $1,158 and $(1,657) 18,031 (2,085) 3,078
----------- ----------- ----------
Net change in unrealized gain on investments, net of tax provision
of $0, $55,738 and $14,215 $ (8,592) $ 103,776 $ 26,331
=========== =========== ==========
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,
2004 (in thousands):
Unrealized
Description of Securities Fair Value Losses
- ------------------------- ---------- -----------
United States Government and agencies $ 764,151 $ 1,274
Mortgage-backed securities 118,718 1,035
Corporate bonds 46,235 742
Marketable equity securities 32,484 1,778
----------- -----------
Total temporarily impaired securities $ 961,588 $ 4,829
=========== ===========
The unrealized losses on the securities issued by the United States Government
and agencies and the mortgage-backed securities were caused by interest rate
increases and were considered to be minor (approximately .2% and .9%,
respectively). The unrealized losses on the securities issued by the United
States Government and agencies relate to 48 securities which were primarily
purchased in 2004 and substantially all of which mature in 2005. The unrealized
losses on the mortgage-backed securities relate to 34 securities substantially
all of which were purchased in 2004. The unrealized losses related to the
corporate bonds are not considered to be an other than temporary impairment.
This determination is based on a number of factors, including the length of time
and the extent to which the market value has been less than cost and factors
specific to the individual investment. The unrealized losses on marketable
equity securities primarily relates to one security which the Company has owned
since November 2004 and which is in an unrealized gain position subsequent to
year-end.
At December 31, 2004, the Company's investments which have been in a continuous
unrealized loss position for 12 months or longer had aggregate gross unrealized
losses of approximately $50,000 and an aggregate fair value of approximately
$16,400,000. All of these securities were either issued by the United States
Government agencies or were mortgage-backed securities.
At December 31, 2004 and 2003, securities with book values aggregating
$7,100,000 and $26,300,000, respectively, were on deposit with various
regulatory authorities. Securities with book values of $12,100,000 and
$11,100,000 at December 31, 2004 and 2003, respectively, collateralized certain
swap agreements, and securities with a book value of $11,000,000 and $24,200,000
at December 31, 2004 and 2003, respectively, collateralized certain debt
obligations and a related letter of credit.
F-26
7. Trade, Notes and Other Receivables, Net:
-----------------------------------
A summary of trade, notes and other receivables, net at December 31, 2004 and
2003 is as follows (in thousands):
2004 2003
---- ----
Current trade, notes and other receivables, net:
Trade receivables $ 319,746 $ 300,659
Federal income tax receivable 3,858 25,648
Receivable from Pershing 71,294 -
Instalment loan receivables, net of unearned finance charges of
$112 at December 31, 2003 (a) 2,035 22,461
Receivables related to securities 5,999 2,451
Receivables relating to real estate activities 1,546 3,640
Other 20,998 22,568
---------- ----------
425,476 377,427
Allowance for doubtful accounts (10,924) (5,323)
---------- ----------
Total current trade, notes and other receivables, net $ 414,552 $ 372,104
========= =========
Non-current notes and other receivables, net:
Instalment loan receivables $ 2,269 $ 182,991
Receivables relating to real estate activities - 15,767
Other 15,281 16,279
---------- ----------
17,550 215,037
Allowance for doubtful accounts (644) (21,578)
---------- ----------
Total non-current notes and other receivables, net $ 16,906 $ 193,459
========== ==========
(a) Contractual maturities of instalment loan receivables at December 31, 2004
were as follows (in thousands): 2005 - $2,000; 2006 - $500; 2007 - $400; 2008 -
$200; and 2009 and thereafter - $1,200.
8. Other Assets:
------------
A summary of other assets at December 31, 2004 and 2003 is as follows (in
thousands):
2004 2003
---- ----
Real Estate $ 131,228 $ 144,273
Unamortized debt expense 30,457 8,804
Intangibles:
Tradename, net of accumulated amortization of $85 - 3,427
Customer relationships, net of accumulated amortization of $491 and $351 1,472 12,459
Deposits 24,975 39,719
Other 14,964 15,288
------------ ------------
$ 203,096 $ 223,970
============ ============
During 2004, the Company recorded $1,900,000 of customer relationship intangible
assets in connection with an acquisition made by its manufacturing segment. The
manufacturing segment's customer relationship intangible assets are being
amortized on a straight-line basis over an average useful life of approximately
three years.
F-27
8. Other Assets, continued:
-------------
The Company's total comprehensive income in 2004 and 2003 subsequent to the
acquisition of WilTel enabled it to realize certain 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 was
applied to reduce the recorded amount of WilTel's identifiable intangible assets
to zero.
Amortization expense on intangible assets was $2,300,000 for the year ended
December 31, 2004. The estimated aggregate future amortization expense for the
customer relationship intangible asset for each of the next five years is as
follows (in thousands): 2005 - $654; 2006 - $654; 2007 - $164; and thereafter -
$0.
As previously disclosed in the 2003 10-K, the Las Cruces mineral rights of MK
Resources had been classified as an intangible asset. Effective April 2004, the
FASB ratified the Emerging Issues Task Force's consensus that mineral rights
should be accounted for as tangible assets and classified as a component of
property and equipment. In accordance with this pronouncement, the Company has
reclassified this asset in the consolidated balance sheet as of December 31,
2003.
9. Property, Equipment and Leasehold Improvements, Net:
---------------------------------------------------
A summary of property, equipment and leasehold improvements, net at December 31,
2004 and 2003 is as follows (in thousands):
Depreciable
Lives
(in years) 2004 2003
------------ ------ ------
Fiber cable and conduit system 20 $ 489,451 $ 487,541
Network equipment 3-7 315,186 288,157
Right of way 20 91,591 95,813
Video satellite and microwave equipment 5-20 18,162 17,640
Buildings and leasehold improvements 5-30 369,886 383,040
Machinery and equipment 2-25 88,965 89,598
Corporate aircraft 5-10 85,871 140,033
Mining properties and mineral rights N/A 92,384 81,641
Computer equipment and software 2-5 57,605 58,304
General office furniture and fixtures 2-13 29,234 30,165
Construction in progress N/A 36,401 15,799
Other 3-10 8,414 9,728
--------------- -------------
1,683,150 1,697,459
Accumulated depreciation and amortization (350,274) (172,741)
--------------- -------------
$ 1,332,876 $ 1,524,718
=============== =============
In January 2004, the Company exercised an option to sell two of its corporate
aircraft for total proceeds of approximately $38,800,000. The option was
received in connection with the purchase of two new corporate aircraft. The
Company completed the sales in July 2004, and reported a pre-tax gain of
$11,300,000.
F-28
10. Trade Payables, Expense Accruals and Other Liabilities:
------------------------------------------------------
A summary of trade payables, expense accruals and other liabilities at December
31, 2004 and 2003 is as follows (in thousands):
2004 2003
---- ----
Trade payables and expense accruals:
Trade payables $ 162,448 $ 146,793
Payables related to securities 50,569 48,816
Accrued compensation, severance and other employee benefits 77,576 59,913
Taxes other than income 33,368 31,950
Accrued interest payable 22,993 20,833
Amount due on purchase of corporate aircraft - 17,000
Other 60,396 52,168
----------- -----------
$ 407,350 $ 377,473
=========== ===========
Other current liabilities:
Litigation reserves $ 21,494 $ 38,362
Customer deposit (a) 25,000 -
Unfavorable contract commitments 9,356 12,981
Liabilities related to real estate activities 18,935 -
Asset retirement obligations 1,728 1,017
Other 18,443 37,030
----------- -----------
$ 94,956 $ 89,390
=========== ===========
Other non-current liabilities:
Unfavorable contract commitments $ 35,524 $ 43,317
Asset retirement obligations 41,495 29,432
Postretirement and postemployment benefits 10,896 11,856
Pension liability 61,982 63,534
Liabilities related to real estate activities 6,841 9,117
Other 56,571 77,190
----------- -----------
$ 213,309 $ 234,446
=========== ===========
(a) In conjunction with a pricing agreement for certain voice services, in
January 2004 WilTel's largest customer, SBC Communications, Inc. ("SBC"), paid
WilTel $25,000,000 for pre-funding of certain capital expenditures (all the
funds were spent during 2004). 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, during the first quarter of 2005 WilTel will
recognize the full amount of this deposit as other income.
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.
F-29
10. Trade Payables, Expense Accruals and Other Liabilities, continued:
-------------------------------------------------------
The Company recorded WilTel's asset retirement obligation of $28,500,000 as of
the date the merger was consummated on November 6, 2003. The change in the
Company's asset retirement obligation during 2004 was primarily due to
additional liabilities incurred of $8,400,000 and accretion expense of
$4,500,000.
11. Indebtedness:
------------
The principal amount, stated interest rate and maturity of debt outstanding at
December 31, 2004 and 2003 are as follows (dollars in thousands):
2004 2003
---- ----
Parent Company Debt:
Senior Notes:
Bank credit facility $ - $ -
7 3/4% Senior Notes due 2013, less debt discount of $431 and $481 99,569 99,519
7% Senior Notes due 2013, net of debt (premium) discount of
$(1,105) and $1,016 376,105 273,984
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
$20 and $31 21,656 21,645
3 3/4% Convertible Senior Subordinated Notes due 2014 350,000 -
8.65% Junior Subordinated Deferrable Interest Debentures due 2027 98,200 -
Company-obligated mandatorily redeemable preferred securities of subsidiary
trust holding solely subordinated debt securities of the Company - 98,200
Subsidiary Debt:
WilTel Credit Agreement 359,368 375,000
One Technology Center ("OTC") Notes 60,268 119,125
Aircraft financing 45,562 47,675
Industrial Revenue Bonds (with variable interest) 9,815 9,815
Capital leases due 2005 through 2013 with a weighted average
interest rate of 11.9% 7,463 8,481
Other due 2005 through 2011 with a weighted average interest
rate of 5.7% 104,634 106,289
-------------- -------------
Total debt 1,551,741 1,178,834
Less: current maturities (68,237) (23,956)
-------------- -------------
Long-term debt $ 1,483,504 $ 1,154,878
============== =============
Parent Company Debt:
At December 31, 2004, 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 2007. At December 31, 2004, no amounts were outstanding
under this bank credit facility.
F-30
11. Indebtedness, continued:
-------------
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. In April 2004, the Company sold $100,000,000 principal amount
of its 7% Senior Notes due 2013 in a private placement transaction at 102.191%
of the principal amount. 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.
In April 2004, the Company sold $350,000,000 principal amount of its 3 3/4%
Convertible Senior Subordinated Notes due 2014 in a private placement
transaction. The notes are convertible into the Company's common shares at
$45.93 per share at any time before their maturity, subject to certain
restrictions contained in the notes, at a conversion rate of 21.7707 shares per
each $1,000 principal amount of notes subject to adjustment (an aggregate of
7,619,745 shares). The Company has a currently effective shelf registration
statement in respect of the notes and the common shares issuable upon conversion
of the notes.
In January 1997, the Company issued 8.65% trust issued preferred securities
("Trups") of its wholly-owned subsidiary, Leucadia Capital Trust I (the
"Trust"). As a result of the implementation of SFAS 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity", the
Company began classifying the Trups as liabilities on July 1, 2003, and
classifies dividends accrued for these securities as interest expense. SFAS 150
did not permit restatement of prior period amounts to reflect the new
classification. In 2004, the Company liquidated the Trust and distributed to the
Trups holders the 8.65% Junior Subordinated Deferrable Interest Debentures held
by the Trust in exchange for their Trups securities. The distribution had no
effect on the total debt of the Company.
Subsidiary Debt:
In September 2004, WilTel refinanced its existing $375,000,000 credit agreement
debt by entering into an amended credit agreement consisting of a $240,000,000
first lien term loan facility, a $120,000,000 second lien term loan facility and
a $25,000,000 revolving credit facility (which it can no longer draw upon, as
discussed below). WilTel also used $90,000,000 of its cash and investments to
repay in full one of the two mortgage notes that was secured by its headquarters
building ($54,600,000 including accrued interest), reduce the amount outstanding
under its credit agreement ($15,000,000), reduce the amount outstanding under
the other note that is collateralized by its headquarters building ($13,300,000)
and pay expenses. The amended credit agreement has not been guaranteed by the
Company and is not collateralized by any of the Company's assets other than the
assets of WilTel.
The first lien term loan facility requires quarterly principal payments of
approximately $632,000 commencing December 31, 2004 through June 30, 2009, and
quarterly principal payments of $57,000,000 thereafter until final maturity on
June 30, 2010. The second lien term loan facility matures on December 31, 2010.
However, if WilTel does not refinance its obligations under the remaining
promissory note that is secured by its headquarters building ($60,300,000
outstanding at December 31, 2004) prior to October 1, 2009, then the first lien
term loan facility will mature on October 1, 2009, and if such promissory note
is not refinanced by January 1, 2010, then the second lien term loan facility
will mature on January 1, 2010. Loans under the credit agreement bear interest
at a variable rate based upon either the prime rate or LIBOR, at WilTel's
option, plus a specified margin for each loan. At December 31, 2004, the amended
credit agreement had a weighted average interest rate of 6.7%. WilTel's
obligations under its amended credit agreement are secured by substantially all
of its assets other than those assets securing its headquarters building, for
which the amended credit agreement lenders have a second priority lien, and its
aircraft capital lease.
F-31
11. Indebtedness, continued:
-------------
As discussed in Note 24, in January 2005, SBC announced its intention to migrate
its IP-based and long distance services to the AT&T network. Pursuant to the
terms of WilTel's amended credit agreement, that announcement is considered an
event which could reasonably be expected to have a "material adverse effect" as
defined in the facility, and as a result WilTel can no longer access its
$25,000,000 revolving credit facility. WilTel does not anticipate needing the
$25,000,000 revolving credit facility to meet its present requirements. The
announcement does not have any impact on the $360,000,000 of term loans under
WilTel's amended credit 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 discussed above, WilTel is currently engaged in
negotations with SBC with respect with 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.
WilTel's amended credit agreement also permitted WilTel to obtain letters of
credit of which $21,000,000 was outstanding at December 31, 2004. However, as a
result of the SBC announcement WilTel will no longer be able to obtain new
letters of credit.
The WilTel amended 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 agreement also prohibits WilTel
from paying dividends to the Company. The Company currently expects that WilTel
will be able to meet the operating targets required by its credit agreement
through 2006; however, compliance with the operating targets thereafter is
uncertain because of SBC's announced intention to migrate its traffic to AT&T's
network.
The remaining OTC Note is fully recourse to WilTel, bears interest at 7% and is
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. The note requires annual principal payments escalating
from approximately $700,000 in 2005 to approximately $1,000,000 in 2009; a final
payment of approximately $56,000,000 is due at maturity in April 2010.
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, 2004 was 6.4%. 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 $2,300,000 and
$3,100,000 at December 31, 2004 and 2003, 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. 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. WilTel recorded a
capital lease obligation representing the present value of the future minimum
lease payments during the lease term.
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 $22,400,000 and $23,800,000 at
December 31, 2004 and 2003, 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.
F-32
11. Indebtedness, continued:
-------------
Symphony has a $50,000,000 revolving credit facility, of which $37,700,000 and
$34,200,000 was outstanding at December 31, 2004 and 2003, respectively, 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, 2004, the
interest rate on this facility was 6.25%. At 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 suspended application of
the covenant until March 31, 2004. Symphony is currently in compliance with the
covenant and expects it will continue to be in compliance in the future.
Included in other subsidiary debt are fixed rate borrowings of the Company's
banking and lending operations of $21,300,000 and $16,600,000 at December 31,
2004 and 2003, respectively. These borrowings are primarily comprised of
repurchase agreements, that at December 31, 2004 have an average term of
approximately 15 days and a weighted average interest rate of 2.4%, and are
secured by mortgage-backed securities that have a book value of $22,100,000 at
December 31, 2004.
Other subsidiary debt also includes a mortgage financing of $20,000,000 obtained
in 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, 2004, the interest rate on this facility was 5.4%.
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, 2004, cash dividends of approximately
$620,900,000 would be eligible to be paid under the most restrictive covenants.
Substantially all of WilTel's assets (with an aggregate book value of
$1,611,700,000) are pledged as collateral under WilTel's debt agreements. All of
Symphony's assets (with an aggregate book value of $65,600,000) are pledged as
collateral under Symphony's debt agreement. Property, equipment and leasehold
improvements of the manufacturing division (with a net book value of $5,400,000)
are pledged as collateral for Industrial Revenue Bonds; and $195,800,000 of
other assets (primarily property) are pledged for other indebtedness aggregating
$112,600,000. In addition, the Industrial Revenue Bond obligation is
collateralized by a letter of credit which is fully collateralized by securities
with a book value of $11,000,000.
Interest rate swap 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.
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, 2009 are as follows (in thousands): 2005 - $68,200; 2006 -
$69,400; 2007 - $18,000; 2008 - $24,100; and 2009 - $119,200.
F-33
11. Indebtedness, continued:
-------------
At December 31, 2004, customer banking deposits include $8,600,000 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 4.6%
and 3.4% at December 31, 2004 and 2003, 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, 2004,
the Company acquired 7,371 common shares at an average price of $23.89 per
common share, all in connection with employees exercising stock options. At
December 31, 2004, the Company is authorized to repurchase 3,733,148 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 $23.50, to
mutual fund clients of Franklin Mutual Advisers, LLC, including the funds
comprising the Franklin Mutual Series Funds. The Company issued 4,361,399 of the
Company's common shares and newly authorized Series A Non-Voting Convertible
Preferred Stock, that were converted into 2,021,580 common shares in March 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 450,000 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 1,800,000. 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 600,000 common shares were issued to each of the Company's Chairman and
President. The warrants were exercisable through May 15, 2005 at an exercise
price of $15.97 per common share (105% of the closing price of a common share on
the date of grant). In June 2004, Joseph S. Steinberg, President of the Company,
sold all of his warrants to Jefferies & Company, Inc. ("Jefferies") based on the
value of $33.33 per Leucadia share. In September 2004, Ian M. Cumming, Chairman
of the Board of the Company, and others (principally family members) sold
warrants to purchase 361,500 of the Company's common shares to Jefferies based
on a value of $36.67 per Leucadia share. Jefferies exercised all of the warrants
during 2004. Additionally, in September 2004, Mr. Cumming and others
(principally family members) exercised warrants to purchase 238,500 shares at an
exercise price of $15.97 per share. During 2004, the Company filed two
registration statements covering the shares owned by Jefferies and each were
effective for a thirty day period.
F-34
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, 2004 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, 2002 489,600 $15.18 87,995 1,276,125
Granted 468,750 $20.53 ========= ==========
Exercised (69,045) $15.08
Cancelled (59,700) $16.10
----------
Balance at December 31, 2002 829,605 $18.14 122,318 867,075
Granted 6,000 $25.69 ========= ==========
Exercised (78,525) $16.46
Cancelled (27,900) $19.10
----------
Balance at December 31, 2003 729,180 $18.35 228,912 888,975
Granted 727,500 $43.35 ========= =========
Exercised (165,150) $17.25
Cancelled (14,100) $19.92
----------
Balance at December 31, 2004 1,277,430 $32.72 254,430 175,575
---------- ========== =========
The weighted-average fair value of the options granted was $8.29 per share for
2004, $6.29 per share for 2003 and $5.27 per share for 2002 as estimated on the
date of grant using the Black-Scholes option-pricing model with the following
assumptions: (1) expected volatility of 19.1% for 2004, 29.9% for 2003 and 30.3%
for 2002; (2) risk-free interest rates of 3.3% for 2004, 2.3% for 2003 and 3.5%
for 2002; (3) expected lives of 3.7 years for 2004, 4.0 years for 2003 and 3.7
years for 2002; and (4) dividend yields of .4% for 2004, .6% for 2003 and .8%
for 2002.
The following table summarizes information about fixed stock options outstanding
at December 31, 2004:
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
- --------------- ----------- ---------------- --------- ----------- ----------
$15.08 - $15.21 198,180 1.3 years $15.10 137,130 $15.10
$20.49 336,000 3.5 years $20.49 110,550 $20.49
$22.09 4,875 1.4 years $22.09 3,375 $22.09
$23.49 5,250 2.4 years $23.49 2,250 $23.49
$25.69 5,625 3.4 years $25.69 1,125 $25.69
$31.12 9,000 4.4 years $31.12 - $31.12
$43.51 718,500 6.0 years $43.51 - $43.51
F-35
12. Common Shares, Stock Options and Preferred Shares, continued:
-------------------------------------------------
At December 31, 2004 and 2003, 1,453,005 and 1,618,155, respectively, of the
Company's common shares were reserved for stock options, at December 31, 2004,
7,619,745 of the Company's common shares were reserved for the 3 3/4%
Convertible Senior Subordinated Notes, and at December 31, 2003, 1,200,000 of
the Company's common shares were reserved for warrants.
At December 31, 2004 and 2003, 6,000,000 of preferred shares (redeemable and
non-redeemable), par value $1 per share, were authorized and not issued.
13. Net Securities Gains (Losses):
-----------------------------
The following summarizes net securities gains (losses) for each of the three
years in the period ended December 31, 2004 (in thousands):
2004 2003 2002
---- ---- ----
Net realized gains (losses) on securities $ 146,953 $ 15,762 $ (1,126)
Write-down of investments (a) (4,589) (6,485) (37,053)
Net unrealized gains on trading securities 572 676 1,113
--------- ---------- -----------
$ 142,936 $ 9,953 $ (37,066)
========= ========== ===========
(a) Includes a provision to write down investments in certain available for sale
securities in 2004, 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
$1,460,200,000, $683,700,000 and $649,000,000 during 2004, 2003 and 2002,
respectively. Gross gains of $142,300,000, $17,700,000 and $20,500,000 and gross
losses of $1,600,000, $2,100,000 and $21,000,000 were realized on these sales
during 2004, 2003 and 2002, respectively.
F-36
14. Other Results of Operations Information:
---------------------------------------
Investment and other income for each of the three years in the period ended
December 31, 2004 consists of the following (in thousands):
2004 2003 2002
---- ---- ----
Interest on short-term investments $ 4,974 $ 3,171 $ 7,626
Dividend income 10,592 3,411 3,436
Interest on fixed maturities 26,023 13,700 17,604
Interest on notes receivable 989 4,692 5,102
Other investment income 2,717 3,641 4,864
Gains on sale and foreclosure of real estate and other assets,
net of costs 46,878 24,347 39,320
Gains on sale of loan portfolios 16,304 - -
Income related to the settlement of litigation for less than amounts
reserved 18,549 - -
Rental income 23,176 20,123 15,211
MK Resources product and service income 993 1,441 4,841
Refund of foreign taxes, not based on income, including accrued
interest - 5,295 -
Winery revenues 13,840 13,839 16,433
Other 39,838 33,971 19,230
----------- ----------- -----------
$ 204,873 $ 127,631 $ 133,667
=========== =========== ===========
Taxes, other than income or payroll, amounted to $23,900,000, $6,600,000 and
$3,400,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
Advertising costs amounted to $5,400,000, $2,100,000 and $1,400,000 for the
years ended December 31, 2004, 2003 and 2002, respectively.
F-37
15. Income Taxes:
------------
The principal components of deferred taxes at December 31, 2004 and 2003 are as
follows (in thousands):
2004 2003
---- ----
Deferred Tax Asset:
Securities valuation reserves $ 42,712 $ 116,449
Property and equipment 591,788 680,039
Deferred revenue 79,305 78,666
Other assets 87,083 88,126
NOL carryover 1,456,870 1,296,156
Other liabilities 79,311 114,765
------------- -------------
2,337,069 2,374,201
Valuation allowance (2,185,275) (2,237,753)
------------- -------------
151,794 136,448
------------- -------------
Deferred Tax Liability:
Unrealized gains on investments (82,662) (85,253)
Depreciation (24,293) (25,273)
Other (44,839) (25,922)
------------- -------------
(151,794) (136,448)
------------- -------------
Net deferred tax liability $ - $ -
============= =============
As of December 31, 2004, the Company had consolidated federal NOLs of
$356,000,000, none of which expire prior to 2023, that may be used to offset the
taxable income of any member of the Company's consolidated tax group. WilTel has
$3,549,000,000 of federal NOLs, none of which expire prior to 2019, $45,000,000
of capital loss carryforwards, which expire in 2005 through 2007, and
$28,000,000 of foreign NOLs and various state NOLs that expire in various years.
The potential benefit from the capital loss carryforwards and the foreign NOLs
are not reflected in the table above, since the Company does not expect it will
be able to use them before they expire. In addition, at December 31, 2004,
WebLink had $140,000,000 of federal NOLs, none of which expire prior to 2023.
All of WilTel's and WebLink's NOLs and capital loss carryforwards are only
available to offset the federal taxable income of WilTel and WebLink and each of
their respective subsidiaries. However, WilTel also has substantial other tax
attributes and substantial deductions (primarily depreciation deductions), some
of which are also available to offset the federal taxable income of the Company
and its other subsidiaries. Uncertainties that may affect the utilization of the
Company's tax attributes include future operating results, tax law changes, the
amount of WilTel deductions that are available to offset the income of other
members of the Company's consolidated tax return, 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 the deferred tax asset.
Subsequent to the acquisition of WilTel, any benefit realized from WilTel's
deferred tax asset reduces the valuation allowance for the deferred tax asset;
however, that reduction is first applied to reduce the carrying
F-38
15. Income Taxes, continued:
-------------
amount of the acquired non-current intangible assets of WilTel rather than
reduce the income tax provision of any component of total comprehensive income.
During 2004, $22,300,000 of the reduction in the valuation allowance reduced the
carrying amount of WilTel's non-current intangible assets to zero. The remaining
reduction in the valuation allowance results from a federal income tax carryback
refund of $3,900,000 and the Company's use of WilTel's tax attributes to offset
the federal income tax provision that would have otherwise been recorded during
2004.
In future periods, 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.
Under certain circumstances, the ability to use 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, 2004 was as follows, excluding amounts allocated to
equity in associated companies, trust preferred securities and discontinued
operations (in thousands):
2004 2003 2002
---- ---- ----
State income taxes $ 3,418 $ (940) $ 686
Federal income taxes:
Current (31,143) (18,925) (116,763)
Deferred 7,242 (23,750) (28,048)
Foreign income taxes (currently payable) 291 173 50
------------ ------------ -------------
$ (20,192) $ (43,442) $ (144,075)
============ ============ =============
The table below reconciles the expected statutory federal income tax to the
actual income tax benefit (in thousands):
2004 2003 2002
---- ---- ----
Expected federal income tax $ 19,350 $ (11,114) $ (13,700)
State income taxes, net of federal income tax benefit 2,222 545 446
Resolution of tax contingencies (27,300) (24,407) (119,778)
Recognition of additional tax benefits - (6,998) (9,360)
Permanent differences (5,700) - -
Federal income tax carryback refund (3,858) - -
Recognition of acquired WilTel federal tax benefits (6,481) - -
Other 1,575 (1,468) (1,683)
------------ ------------ -------------
Actual income tax benefit $ (20,192) $ (43,442) $ (144,075)
============ ============ =============
F-39
15. Income Taxes, continued:
-------------
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 2000 has expired.
Prior to May 2001, WilTel was included in the consolidated federal income tax
return of its former parent, The Williams Companies Inc. ("Williams"). Pursuant
to a tax settlement agreement between WilTel and Williams, WilTel has no
liability for any audit adjustments made to Williams' consolidated tax returns;
however, adjustments to Williams' prior years tax returns could affect certain
of WilTel's tax attributes that impact the calculation of alternative minimum
taxable income.
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 its investment strategies, assumptions and results
are significantly different than those of the Company.
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 2004 and 2003 is as follows (in thousands):
2004 2003
---- ----
Projected Benefit Obligation:
Projected benefit obligation at January 1, $ 55,079 $ 52,482
Interest cost (a) 3,173 3,299
Actuarial loss 5,263 4,536
Benefits paid (5,229) (5,238)
----------- ----------
Projected benefit obligation at December 31, $ 58,286 $ 55,079
=========== ==========
Change in Plan Assets:
Fair value of plan assets at January 1, $ 52,444 $ 45,905
Actual return on plan assets 555 1,891
Employer contributions - 10,000
Benefits paid (5,229) (5,238)
Administrative expenses (127) (114)
----------- ----------
Fair value of plan assets at December 31, $ 47,643 $ 52,444
=========== ==========
Funded Status $ (10,643) $ (2,635)
Unrecognized prior service cost 50 53
Unrecognized net loss from experience differences and
assumption changes 20,651 15,253
----------- ----------
Net amount recognized $ 10,058 $ 12,671
=========== ==========
(a) Includes charges to expense of $800,000 and $1,100,000 for 2004 and 2003,
respectively, relating to discontinued operations obligations.
F-40
16. Pension Plans and Postretirement Benefits, continued:
------------------------------------------
As of December 31, 2004 and 2003, $20,700,000 and $15,300,000, respectively, of
the net amount recognized in the consolidated balance sheet was reflected as a
charge to accumulated other comprehensive income and $10,600,000 and $2,600,000,
respectively, 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
2005 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):
2004 2003 2002
---- ---- ----
Interest cost $ 2,191 $ 2,247 $ 2,361
Expected return on plan assets (1,019) (1,947) (1,947)
Actuarial loss 652 258 76
Amortization of prior service cost 3 3 3
---------- ---------- ----------
Net pension expense $ 1,827 $ 561 $ 493
========== ========== ==========
At December 31, 2004, the plan's assets consist of U.S. government and agency
bonds (43%), investment grade bonds (28%) and cash equivalents (29%). At
December 31, 2003, the plan's assets consisted of U.S. government and agencies
bonds (72%), investment grade bonds (26%) and cash equivalents (2%).
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, and a final average maturity target for the
portfolio of one and one-half years and a one year maximum duration.
To develop the assumption for the expected long-term rate of return on plan
assets, the Company considered the following underlying assumptions: 2% current
expected inflation, 1% real rate of return for risk-free investments (primarily
U.S. government and agency bonds) for the target duration and .25% default risk
premium for the portion of the portfolio invested in non-U.S. government and
agency bonds. The combination of these underlying assumptions resulted in the
selection of the 3.25% expected long-term rate of return assumption for 2004.
Because pension expense includes the cost of expected plan administrative
expenses, the 3.25% assumption is not reduced for such expenses.
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, 2004.
F-41
16. Pension Plans and Postretirement Benefits, continued:
------------------------------------------
A summary of activity with respect to the Company's postretirement plans for
2004 and 2003 is as follows (in thousands):
2004 2003
---- ----
Accumulated postretirement benefit obligation at January 1, $ 4,422 $ 5,250
Interest cost 277 289
Contributions by plan participants 155 168
Actuarial (gain) loss 732 (30)
Benefits paid (871) (871)
Plan amendments - (384)
-------- ---------
Accumulated postretirement benefit obligation at December 31, 4,715 4,422
Unrecognized prior service cost 476 588
Unrecognized net actuarial gain 922 1,757
-------- ---------
Accrued postretirement benefit obligation $ 6,113 $ 6,767
======== =========
The Company expects to spend $400,000 on postretirement benefits during 2005. At
December 31, 2004, the assumed health care cost trend rate for 2005 used in
measuring the accumulated postretirement benefit obligation is 10% and, at
December 31, 2003, such rate for 2004 was 11.5%. At December 31, 2004 and 2003,
the assumed health care cost trend rates were assumed to decline to an ultimate
rate of 5.0% by 2013. If the health care cost trend rates were increased or
decreased by 1%, the accumulated postretirement obligation as of December 31,
2004 would have increased or decreased by $200,000. The effect of these changes
on interest cost for 2004 would be immaterial.
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
---------------- --------------
2004 2003 2004 2003
---- ---- ---- ----
Discount rate used to determine
benefit obligation at December 31, 5.25% 5.75% 5.25% 6.00%
Weighted-average assumptions used
to determine net cost for years ended
December 31:
Discount rate 5.75% 6.50% 6.00% 6.50%
Expected long-term return on plan assets 3.25% 6.50% N/A N/A
The following benefit payments are expected to be paid (in thousands):
Pension Benefits Other Benefits
---------------- --------------
2005 $ 4,002 $ 446
2006 4,359 459
2007 4,203 454
2008 4,426 450
2009 4,552 454
2010 - 2014 21,224 1,964
F-42
16. Pension Plans and Postretirement Benefits, continued:
------------------------------------------
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 for 2004 and for the period from November 6, 2003 (date of acquisition)
through December 31, 2003 is as follows (in thousands):
November 6, 2003
2004 to December 31, 2003
---- --------------------
Projected Benefit Obligation:
Projected benefit obligation at beginning of period $ 129,912 $ 120,151
Interest cost 7,829 1,075
Service cost 3,980 575
Actuarial loss 9,112 8,661
Benefits paid (2,945) (550)
------------ ------------
Projected benefit obligation at December 31, $ 147,888 $ 129,912
============ ============
Change in Plan Assets:
Fair value of plan assets at beginning of period $ 67,761 $ 65,126
Actual return on plan assets 6,002 3,185
Employer contributions 3,783 -
Benefits paid (2,945) (550)
------------ ------------
Fair value of plan assets at December 31, $ 74,601 $ 67,761
============ ============
Funded Status $ (73,287) $ (62,151)
Unrecognized net actuarial loss 14,572 6,117
------------ ------------
Net amount recognized $ (58,715) $ (56,034)
============ ============
The accumulated benefit obligation for WilTel's defined benefit plan was
$147,600,000 and $129,500,000 at December 31, 2004 and 2003, respectively. As of
December 31, 2004 and 2003, $14,300,000 and $5,700,000, respectively, of the net
amount recognized in the consolidated balance sheet was reflected as a charge to
accumulated other comprehensive income and $73,000,000 and $61,700,000,
respectively, was reflected as accrued pension cost.
Employer contributions expected to be paid to the plan in 2005 are $21,700,000.
WilTel's pension expense for 2004 and 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):
November 6, 2003
2004 to December 31, 2003
---- --------------------
Interest cost $ 7,829 $ 1,075
Service cost 3,980 575
Expected return on plan assets (5,391) (640)
Actuarial loss 46 -
---------- ----------
Net pension expense $ 6,464 $ 1,010
========== ==========
F-43
16. Pension Plans and Postretirement Benefits, continued:
------------------------------------------
WilTel's plans' assets consist of equity securities (71%), debt securities (19%)
and cash equivalents (10%) at December 31, 2004. At December 31, 2003, the
plans' assets consisted of equity securities (77%), debt securities (17%) and
mutual funds (6%).
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 Long-term
Target Target
------ ------
Equity securities:
Large cap stocks 36% 40%
Small cap stocks 18% 10%
International stocks 21% 20%
----- -----
Total equity securities 75% 70%
Fixed income/bonds 25% 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% for large to medium equities and 8% for
small to medium equities.
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 securities that are
currently paying interest, receiving principal, do not contain
leverage and are limited to 10% of the market value of the portfolio.
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 for 2004 and 2003.
A summary of activity with respect to WilTel's postretirement plans for 2004 and
for the period from November 6, 2003 (date of acquisition) through December 31,
2003 is as follows (in thousands):
F-44
16. Pension Plans and Postretirement Benefits, continued:
------------------------------------------
November 6, 2003
2004 to December 31, 2003
---- --------------------
Accumulated postretirement benefit obligation at beginning of period $ 1,784 $ 1,442
Interest cost 87 13
Service cost 92 18
Contributions by plan participants 17 3
Actuarial (gain) loss (239) 315
Benefits paid (137) (7)
--------- ----------
Accumulated postretirement benefit obligation at December 31, 1,604 1,784
Unrecognized net actuarial loss (76) (315)
--------- ----------
Accrued postretirement benefit obligation $ 1,528 $ 1,469
========= ==========
WilTel's postretirement benefit expense was not material for 2004 and for the
period from date of acquisition through December 31, 2003.
WilTel's cash cost for its postretirement plan during 2005 is not expected to be
material.
The health care cost trend rate assumed for 2005 is 8.8% to 10.8% and 2004 is
12%, declining to an ultimate rate of 5% by 2013. If the health care cost trend
rates were increased or decreased by 1%, WilTel's accumulated postretirement
obligation as of December 31, 2004 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 2004 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 2004 and
2003 are as follows:
Pension Benefits Other Benefits
---------------- --------------
Weighted-average assumptions used to determine 2004 2003 2004 2003
- ---------------------------------------------- ---- ---- ---- ----
Weighted-average assumptions used to determine
benefit obligation at December 31:
Discount rate 5.75% 6.00% 5.75% 6.00%
Rate of compensation increase 3.50% 3.50% N/A N/A
Weighted-average assumptions used to determine net
cost for the period ended December 31:
Discount rate 6.00% 6.25% 6.00% 6.25%
Expected long-term return on plan assets 7.00% 7.00% N/A N/A
Rate of compensation increase 3.50% 3.50% N/A N/A
The following pension benefit payments, which reflect expected future service,
as appropriate, are expected to be paid (in thousands):
2005 $ 2,151
2006 2,555
2007 2,730
2008 2,385
2009 2,881
2010 - 2014 19,601
F-45
16. Pension Plans and Postretirement Benefits, continued:
------------------------------------------
The expected benefit payments for its post retirement plan during that ten year
period are not expected to be material.
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 $7,200,000, $2,200,000 and $1,600,000 for the years
ended December 31, 2004, 2003 and 2002, respectively.
17. Commitments:
-----------
The Company and its subsidiaries rent office space and office equipment under
noncancellable operating leases with terms varying principally 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 and unfavorable contract
amortization) was $85,800,000 in 2004, $14,000,000 in 2003 and $5,200,000 in
2002. Future minimum annual rentals (exclusive of month-to-month leases, real
estate taxes, maintenance and certain other charges) under these leases at
December 31, 2004 are as follows (in thousands):
2005 $ 60,400
2006 53,500
2007 50,800
2008 44,000
2009 36,200
Thereafter 299,300
------------
544,200
Less: sublease income (6,300)
------------
$ 537,900
============
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 for the benefit of the City of
San Marcos, California and other government agencies 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, 2004,
$28,200,000 was outstanding under these bonds, $27,700,000 of which expires in
2005 and the remainder thereafter.
Sales to SBC accounted for 70% of 2004 and 66% of 2003 Network operating
revenues included in the Company's consolidated statement of operations. See
Note 24 for further information with respect to WilTel's relationship with SBC.
WilTel is prohibited and Symphony is limited by debt agreements in the amount of
dividends and other transfers of funds that are available to the Company. The
banking and lending subsidiary is 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 $599,100,000 at December 31, 2004.
F-46
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
$21,500,000 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. During 2004, WilTel
settled litigation for a cash payment of $5,000,000; the $18,500,000 excess of
the reserved amount over the amount paid was recognized as other income.
19. Earnings (Loss) Per Common Share:
--------------------------------
For the year ended December 31, 2004, the numerators for basic and diluted per
share computations for income from continuing operations were $152,000,000 and
$158,200,000, respectively. The calculation for diluted earnings (loss) per
share assumes the 3 3/4% Convertible Notes had been converted into common shares
for the periods they were outstanding and earnings increased for the interest on
such notes, net of the income tax effect ($6,200,000).
For the years ended December 31, 2003 and 2002, there were no differences in the
numerators for the basic and diluted per share computations for income from
continuing operations. These numerators were $85,900,000 and $154,100,000 for
2003 and 2002, respectively. The denominators for basic per share computations
were 106,692,000, 91,896,000 and 83,501,000 for 2004, 2003 and 2002,
respectively. The denominators for diluted per share computations reflect the
dilutive effect of 779,000, 656,000 and 524,000 options and warrants for 2004,
2003 and 2002, respectively (the treasury stock method was used for these
calculations), and 5,275,000 shares related to the 3 3/4% Convertible Notes for
2004. 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.
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.
F-47
20. Fair Value of Financial Instruments, continued:
------------------------------------
(d) Loan receivables of banking and lending subsidiaries: At December 31, 2004,
the carrying amount approximates fair value. At December 31, 2003, 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.
The carrying amounts and estimated fair values of the Company's financial
instruments at December 31, 2004 and 2003 are as follows (in thousands):
2004 2003
---- ----
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
Financial Assets:
Investments:
Current $ 1,106,322 $ 1,106,322 $ 714,363 $ 714,363
Non-current 726,782 726,782 673,742 673,742
Cash and cash equivalents 486,948 486,948 214,390 214,390
Notes receivable:
Current 1,697 1,697 2,283 2,283
Non-current - - 16,142 16,142
Loan receivables of banking and lending
subsidiaries, net of allowance:
Current 1,733 1,733 19,803 21,086
Non-current 1,625 1,625 161,413 174,376
Financial Liabilities:
Customer banking deposits:
Current 18,472 18,658 103,331 104,904
Non-current 6,119 6,251 42,201 44,004
Debt:
Current 68,237 68,639 23,956 23,988
Non-current 1,483,504 1,596,752 1,154,878 1,158,701
Securities sold not owned 50,569 50,569 48,816 48,816
Derivative Instruments:
Interest rate swaps (2,342) (2,342) (3,079) (3,079)
Foreign currency swaps (5,878) (5,878) (4,943) (4,943)
F-48
21. Concentration of Credit Risk:
----------------------------
As of December 31, 2004 and 2003, accounts receivable due from SBC, WilTel's
largest customer, represented approximately 28.9% and 32.2%, respectively, of
the Company's trade receivables. For 2004 and for the period from date of
acquisition of WilTel through December 31, 2003, telecommunications revenues
relating to SBC represented approximately 46% and 26%, respectively, of the
Company's total revenues and other income.
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, manufacturing, banking and lending and domestic
real estate. Healthcare services primarily include the provision of physical,
occupational, speech and respiratory therapy services, healthcare staffing
services and Medicare consulting services. Manufacturing operations manufacture
and market lightweight plastic netting used for a variety of purposes. Banking
and lending operations historically made collateralized personal automobile
instalment loans to individuals who had difficulty obtaining credit, at interest
rates above those charged to individuals with good credit histories. The banking
and lending segment has ceased originating any new loans and in 2004 sold 97% of
its remaining outstanding loans to a third party. 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
accounts 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, HomeFed,
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 Resources,
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. These
are the only entities with non-U.S. revenue or assets that the Company
consolidates, and they are not material. In addition to its investment in
Bermuda-based Olympus, the Company owns 36% of the electric utility in Barbados.
From time to time the Company invests in the securities of non-U.S. entities or
in investment partnerships that invest in non-U.S. securities.
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 GAAP measure which is used for
all other reportable segment for the year ended December 31, 2004 and for the
period from November 6, 2003 through December 31, 2003 (in millions):
F-49
22. Segment Information, continued:
--------------------
For the period from
For the year ended November 6, 2003 to
December 31, 2004 December 31, 2003
----------------- -----------------
Network Vyvx Network Vyvx
------- ---- ------- ----
Segment profit from operations (1) $ 117.8 $ 30.3 $ 13.3 $ 4.1
Depreciation and amortization expense (197.4) (9.1) (37.2) (2.0)
Interest expense, net of investment income (2) (26.0) (2.1) (4.0) (.1)
Other non-operating income, net (2) 27.2 2.7 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 (3) $ (78.4) $ 21.8 $ (26.1) $ 2.5
========= ========= ========= =========
(1) See note (d) to segment information below.
(2) 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.
(3) For 2004, includes income of $18,500,000 related to the settlement of
litigation for less than amounts reserved, income of $6,000,000 related to
the sale of an equity security which had a zero book value, gains of
$3,500,000 related to cash and securities received in excess of the book
value of secured claims in customers' bankruptcy, and income of $2,300,000
related to the reversal of excess reserves for long-term commitments.
Certain information concerning the Company's segments for 2004, 2003 and 2002 is
presented in the following table. Consolidated subsidiaries are reflected as of
the date of acquisition, which for WilTel's segments was November 2003 and for
Symphony's healthcare services segment was September 2003. Associated Companies
are only reflected in the table below under identifiable assets employed.
F-50
22. Segment Information, continued:
--------------------
2004 2003 2002
---- ---- ----
(In millions)
Revenues and other income (a):
Network (b) $ 1,518.9 $ 218.4 $ -
Vyvx 123.6 21.2 -
Healthcare Services 258.4 71.1 -
Banking and Lending 30.8 62.3 95.9
Manufacturing 64.4 54.1 51.0
Domestic Real Estate 63.5 50.4 47.2
Other Operations 40.0 33.3 45.8
Corporate (c) 180.9 42.5 (4.7)
Intersegment elimination (d) (18.4) (4.3) -
------------ ------------ ------------
Total consolidated revenues and other income $ 2,262.1 $ 549.0 $ 235.2
============ ============ ============
Income (loss) from continuing operations before income taxes, minority expense
of trust preferred securities and equity in income of associated companies:
Network (d) $ (78.4) $ (26.1) $ -
Vyvx (d) 21.8 2.5 -
Healthcare Services 5.1 (2.3) -
Banking and Lending 22.0 8.4 1.9
Manufacturing 7.9 4.4 3.1
Domestic Real Estate 20.7 18.1 16.3
Other Operations (3.4) .7 14.5
Corporate (c) 59.6 (37.5) (74.9)
------------ ------------ ------------
Total consolidated income (loss) from continuing operations before income
taxes, minority expense of trust preferred
securities and equity in income of associated companies $ 55.3 $ (31.8) $ (39.1)
============ ============ ============
Identifiable assets employed:
Network $ 1,554.4 $ 1,628.8 $ -
Vyvx 57.3 115.5 -
Healthcare Services 65.6 54.6 -
Banking and Lending 151.1 252.4 481.5
Manufacturing 50.4 50.8 51.5
Domestic Real Estate 148.6 165.0 106.8
Other Operations 252.6 253.4 193.7
Investments in Associated Companies:
WilTel - - 340.6
Other Associated Companies 460.8 430.9 397.1
Corporate 2,059.6 1,445.8 970.6
------------ ------------ ------------
Total consolidated assets $ 4,800.4 $ 4,397.2 $ 2,541.8
============ ============ ============
F-51
22. Segment Information, continued:
--------------------
(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 (losses) on the
Company's consolidated statements of operations.
(b) For 2004 and the period from November 6, 2003 (date of acquisition) through
December 31, 2003, includes services provided to SBC Communications Inc. of
$1,032,800,000 and $141,700,000, respectively, pursuant to long-term
preferred provider agreements.
(c) Net securities gains for Corporate aggregated $123,100,000 during 2004,
which primarily resulted from the sale of publicly traded debt and equity
securities that had been classified as available for sale securities. For
2004, includes a provision of $4,600,000 to write down investments in
certain available for sale securities. 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.
(d) 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.
(e) For the years ended December 31, 2004, 2003 and 2002, income (loss) from
continuing operations has been reduced by depreciation and amortization
expenses of $235,900,000, $61,400,000 and $18,500,000, respectively; such
amounts are primarily comprised of Corporate ($11,400,000, $11,700,000 and
$8,700,000, respectively), and amounts related to WilTel's segments, which
are disclosed above. Depreciation and amortization expenses for other
segments are not material.
(f) For the years ended December 31, 2004, 2003 and 2002, income (loss) from
continuing operations has been reduced by interest expense of $96,800,000,
$43,000,000 and $33,000,000, respectively; such amounts are primarily
comprised of Corporate ($55,300,000, $26,000,000 and $13,100,000,
respectively), banking and lending ($2,700,000, $8,800,000 and $18,100,000,
respectively), and amounts related to WilTel's segments, which are
disclosed above. Interest expense for other segments is not material.
F-52
23. Selected Quarterly Financial Data (Unaudited):
---------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(In thousands, except per share amounts)
2004:
- -----
Revenues and other income $ 509,730 $ 569,547 $ 633,593 $ 549,241
=========== =========== =========== ===========
Income (loss) from continuing operations $ (11,471) $ 36,371 $ 74,897 $ 52,159
=========== =========== =========== ===========
Loss from discontinued operations, net of taxes $ (481) $ (4,633) $ (333) $ (2,822)
=========== =========== =========== ===========
Gain (loss) on disposal of discontinued operations, net of taxes $ - $ 2,237 $ - $ (424)
=========== =========== =========== ===========
Net income (loss) $ (11,952) $ 33,975 $ 74,564 $ 48,913
=========== =========== =========== ===========
Basic earnings (loss) per common share:
Income (loss) from continuing operations $ (.11) $ .34 $ .70 $ .49
Loss from discontinued operations - (.04) - (.03)
Gain (loss) on disposal of discontinued operations - .02 - -
----------- ----------- ----------- -----------
Net income (loss) $ (.11) $ .32 $ .70 $ .46
=========== =========== =========== ===========
Number of shares used in calculation 106,272 106,320 106,717 107,404
=========== =========== =========== ===========
Diluted earnings (loss) per common share:
Income (loss) from continuing operations $ (.11) $ .34 $ .67 $ .47
Loss from discontinued operations - (.04) - (.03)
Gain (loss) on disposal of discontinued operations - .02 - -
----------- ----------- ----------- -----------
Net income (loss) $ (.11) $ .32 $ .67 $ .44
=========== =========== =========== ===========
Number of shares used in calculation 106,272 112,948 115,072 115,560
=========== =========== =========== ===========
2003:
- -----
Revenues and other income $ 55,105 $ 65,527 $ 74,387 $ 353,952
=========== =========== =========== ===========
Income (loss) from continuing operations $ (13,660) $ 11,883 $ 54,894 $ 32,758
=========== =========== =========== ===========
Income (loss) from discontinued operations, net of taxes $ (126) $ 3,534 $ 1,196 $ (923)
=========== =========== =========== ===========
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 $ (.15) $ .13 $ .62 $ .33
Income (loss) from discontinued operations - .04 .01 (.01)
Gain on disposal of discontinued operations - - - .08
---------- ---------- ---------- ----------
Net income (loss) $ (.15) $ .17 $ .63 $ .40
========== ========== ========== ==========
Number of shares used in calculation 89,427 89,445 89,463 97,419
========== ========== ========== ==========
Diluted earnings (loss) per common share:
Income (loss) from continuing operations $ (.15) $ .13 $ .61 $ .33
Income (loss) from discontinued operations - .04 .01 (.01)
Gain on disposal of discontinued operations - - - .08
----------- ----------- ----------- -----------
Net income (loss) $ (.15) $ .17 $ .62 $ .40
=========== =========== =========== ===========
Number of shares used in calculation 89,427 90,104 90,107 98,179
=========== =========== =========== ===========
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 $27,300,000 for the
third quarter of 2004 and $13,900,000 for the fourth quarter of 2003. In
addition, the fourth quarter of 2004 reflects a benefit to record a federal
income tax carryback refund of $3,900,000.
In 2004 and 2003, the totals of quarterly per share amounts do not equal annual
per share amounts because of changes in outstanding shares during the year.
F-53
24. Subsequent Event:
----------------
On January 31, 2005, 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.
SBC indicated that it expects to close its acquisition of AT&T in the first half
of 2006.
Once SBC completes the migration of its business from WilTel's network to the
AT&T network and terminates the existing preferred provider agreements between
WilTel and SBC (scheduled to extend until 2019), SBC will be required to pay
WilTel up to $200,000,000 for all costs WilTel incurs in connection with such
termination, including increased costs of the network facilities remaining with
WilTel due to the loss of SBC traffic (defined as "Transition Costs" in the
provider agreements). WilTel anticipates that a migration of services from its
network to AT&T would not begin until after the appropriate regulatory agencies
approve SBC's acquisition of AT&T. WilTel expects it will take anywhere from two
to three years from now for SBC to migrate all of its traffic off of WilTel's
network, and anticipates that it will continue to provide some level of service
to SBC into 2007.
Pursuant to the preferred provider agreements, the price for products and
services, 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 April 1, 2005. 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 after
April 1, 2005. If the parties fail to reach agreement on pricing, any disputes
as to pricing methodology are to be resolved through binding arbitration.
Since SBC is WilTel's largest customer, accounting for 70% of Network's 2004
operating 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 will be performed as part of the preparation of the Company's
financial statements for the first quarter of 2005. The carrying value of
WilTel's property and equipment is approximately $1,054,700,000 at December 31,
2004.
As more fully described in Note 11, 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
$360,000,000 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.
F-54
Schedule I - Condensed Financial Information of Registrant
LEUCADIA NATIONAL CORPORATION
BALANCE SHEETS
December 31, 2004 and 2003
(Dollars in thousands, except par value)
2004 2003
---- ----
ASSETS
- ------
Cash and cash equivalents $ 124,773 $ 53,957
Investments 597,442 880,695
Trade, notes and other receivables, net 18,683 42,001
Prepaids and other assets 24,295 10,483
Investments in associated companies and investments in and advances
to/from subsidiaries, net 2,574,253 1,788,127
----------- ------------
Total $ 3,339,446 $ 2,775,263
=========== ============
LIABILITIES
- -----------
Trade payables and expense accruals $ 37,406 $ 31,391
Other liabilities 63,735 81,107
Debt, including current maturities 964,631 512,449
Income taxes payable 15,021 16,155
----------- ------------
Total liabilities 1,080,793 641,102
----------- ------------
Commitments and contingencies
SHAREHOLDERS' EQUITY
- --------------------
Common shares, par value $1 per share, authorized 150,000,000 shares;
107,600,403 and 106,235,253 shares issued and outstanding, after
deducting 42,399,597 shares held in treasury 107,600 106,235
Additional paid-in capital 598,504 577,863
Accumulated other comprehensive income 136,138 152,251
Retained earnings 1,416,411 1,297,812
----------- ------------
Total shareholders' equity 2,258,653 2,134,161
----------- ------------
Total $ 3,339,446 $ 2,775,263
=========== ============
See notes to this schedule.
F-55
Schedule I - Condensed Financial Information of Registrant, continued
LEUCADIA NATIONAL CORPORATION
STATEMENTS OF OPERATIONS
For the years ended December 31, 2004, 2003 and 2002
(In thousands, except per share amounts)
2004 2003 2002
---- ---- ----
REVENUES AND OTHER INCOME:
- --------------------------
Investment and other income $ 29,637 $ 19,854 $ 14,771
Intercompany investment income 11,594 17,872 6,996
Net securities gains (losses) 77,466 800 (31,504)
----------- ----------- -----------
118,697 38,526 (9,737)
----------- ----------- -----------
EXPENSES:
- ---------
Interest 53,181 24,651 11,481
Intercompany interest expense 31,844 27,667 26,474
Salaries 14,068 11,559 11,695
Other expenses 29,485 24,436 21,332
----------- ----------- -----------
128,578 88,313 70,982
----------- ----------- -----------
Loss from continuing operations before income taxes, minority expense of
trust preferred securities and equity in income of
associated companies and subsidiaries (9,881) (49,787) (80,719)
Income tax benefit 34,529 41,832 148,030
----------- ----------- -----------
Income (loss) from continuing operations before minority expense of trust
preferred securities and equity in income of associated
companies and subsidiaries 24,648 (7,955) 67,311
Minority expense of trust preferred securities, net of taxes - (2,761) (5,521)
Equity in income of associated companies and subsidiaries,
net of taxes 127,308 96,591 92,332
----------- ----------- -----------
Income from continuing operations 151,956 85,875 154,122
Equity in income (loss) from discontinued operations, net of taxes (8,269) 3,681 2,989
Equity in gain on disposal of discontinued operations, net of taxes 1,813 7,498 4,512
----------- ----------- -----------
Net income $ 145,500 $ 97,054 $ 161,623
=========== =========== ===========
Basic earnings (loss) per common share:
Income from continuing operations $ 1.42 $ .94 $ 1.85
Income (loss) from discontinued operations (.08) .04 .04
Gain on disposal of discontinued operations .02 .08 .05
----------- ----------- -----------
Net income $ 1.36 $ 1.06 $ 1.94
=========== =========== ===========
Diluted earnings (loss) per common share:
Income from continuing operations $ 1.40 $ .93 $ 1.83
Income (loss) from discontinued operations (.08) .04 .04
Gain on disposal of discontinued operations .02 .08 .05
----------- ----------- -----------
Net income $ 1.34 $ 1.05 $ 1.92
=========== =========== ===========
See notes to this schedule.
F-56
Schedule I - Condensed Financial Information of Registrant, continued
LEUCADIA NATIONAL CORPORATION
STATEMENTS OF CASH FLOWS
For the years ended December 31, 2004, 2003 and 2002
(In thousands)
2004 2003 2002
---- ---- ----
Net cash flows from operating activities:
- -----------------------------------------
Net income $ 145,500 $ 97,054 $ 161,623
Adjustments to reconcile net income to net cash used for operations:
Other amortization (1,280) (432) (2,406)
Net securities (gains) losses (77,466) (800) 31,504
Equity in earnings of associated companies and subsidiaries (120,852) (107,770) (99,833)
Distributions from associated companies 1,581 1,271 643
Gain on sale of other assets (1,604) (1,532) -
Net change in:
Miscellaneous receivables 20,204 1,902 2,180
Prepaids and other assets (1,173) 84 (757)
Trade payables and expense accruals 6,015 6,405 6,627
Other liabilities (23,036) (14,213) (1,229)
Income taxes payable (1,134) (18,155) (136,850)
Other (157) (459) 4,860
------------ ------------ ------------
Net cash used for operating activities (53,402) (36,645) (33,638)
------------ ------------ ------------
Net cash flows from investing activities:
- ----------------------------------------
Dividends received from subsidiaries 2,000 2,500 11,782
Investment in and advances to/from subsidiaries (51,358) (108,045) 97,936
Proceeds from sale of other assets - 79,460 1,000
Advances on notes receivables - (1,470) -
Collections on notes receivables 1,125 10,000 2,000
Investments in associated companies - (11,070) (354,091)
Purchases of investments (other than short-term) (2,264,170) (1,355,282) (882,710)
Proceeds from maturities of investments 728,912 384,901 609,521
Proceeds from sales of investments 1,275,192 520,774 404,053
------------ ------------ ------------
Net cash used for investing activities (308,299) (478,232) (110,509)
------------ ------------ ------------
(continued)
See notes to this schedule.
F-57
Schedule I - Condensed Financial Information of Registrant, continued
LEUCADIA NATIONAL CORPORATION
STATEMENTS OF CASH FLOWS, continued
For the years ended December 31, 2004, 2003 and 2002
(In thousands)
2004 2003 2002
---- ---- ----
Net cash flows from financing activities:
- -----------------------------------------
Issuance of long-term debt, net of issuance costs $ 437,412 $ 267,865 $ -
Issuance of convertible preferred shares - - 47,507
Issuance of common shares 22,006 1,293 102,535
Purchase of common shares for treasury - (61) (115)
Dividends paid (26,901) (17,706) (13,841)
----------- ----------- ----------
Net cash provided by financing activities 432,517 251,391 136,086
----------- ----------- ----------
Net increase (decrease) in cash and cash equivalents 70,816 (263,486) (8,061)
Cash and cash equivalents at January 1, 53,957 317,443 325,504
----------- ----------- ----------
Cash and cash equivalents at December 31, $ 124,773 $ 53,957 $ 317,443
=========== =========== ==========
Supplemental disclosures of cash flow information:
- -------------------------------------------------
Cash paid during the year for:
Interest $ 47,652 $ 21,566 $ 11,420
Income tax payments (refunds), net $ (27,058) $ (6,232) $ 17,072
Non-cash investing activities:
- ------------------------------
Common stock issued for acquisition of WilTel Communications Group, Inc. $ - $ 422,830 $ -
Investments contributed to subsidiary $ 674,088 $ - $ -
Investments transferred from subsidiary $ 45,691 $ - $ -
See notes to this schedule.
F-58
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 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
$27,300,000, $24,400,000 and $120,000,000 for 2004, 2003 and 2002,
respectively, and a benefit of $3,900,000 to recognize a federal income
tax carryback refund for the year ended December 31, 2004.
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, 2009 are as follows (in thousands): 2005 -
$19,100; 2006 - $21,700; 2007 - $0; 2008 - $0; and 2009 - $0.
F-59
Schedule II - Valuation and Qualifying Accounts
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
For the years ended December 31, 2004, 2003 and 2002
(In thousands)
Additions Deductions
---------------------------------- ------------------------------------
Charged
Balance at to Costs Balance
Beginning and Write Sale of at End
Description of Period Expenses Recoveries Other Offs Receivables Other of Period
----------- --------- -------- ---------- ----- ---- ---------- ----- ---------
2004
----
Loan receivables of
banking and lending
subsidiaries $ 24,236 $ (8,301) $ 11,215 $ - $ 11,331 $ 14,873 $ - $ 946
Trade, notes and other
receivables 2,665 2,935 9,629 - 4,607 - - 10,622
----------- ---------- --------- ---------- ---------- --------- ---------- ------------
Total allowance for
doubtful accounts $ 26,901 $ (5,366) $ 20,844 $ - $ 15,938 $ 14,873 $ - $ 11,568
=========== ========== ========= ========== ========== ========= ========== ============
Deferred tax asset
valuation allowance $2,237,753 $ - $ - $ - $ - $ - $ 52,478(a) $ 2,185,275
=========== ========== ========= ========== ========== ========= ========== ============
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
=========== ========== ========= ========== ========== ========= ========== ============
Deferred tax asset
valuation allowance $ 49,551 $ - $ - $2,229,709(b) $ - $ - $ 41,507(c) $ 2,237,753
=========== ========== ========= ========== ========== ========= ========= ============
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
=========== ========== ========= ========== ========== ========= ========== ============
Deferred tax asset
valuation allowance $ 49,103 $ - $ - $ 448 $ - $ - $ - $ 49,551
=========== ========== ========= ========== ========== ========= ========== ============
(a) Principally results from the recognition of acquired tax benefits, of which
$22,300,000 was applied to reduce the carrying amount of WilTel's acquired
non-current intangible assets to zero, $3,900,000 resulted from a carryback
refund claim and $6,500,000 resulted from the use of WilTel's tax
attributes to offset the federal income tax provision that would have
otherwise been recorded during 2004.
(b) Additions represent acquired tax benefits, principally WilTel's tax
benefits, for which the Company established a full valuation allowance at
acquisition since the Company was not able to demonstrate that it was more
likely than not that it will be able to realize such tax benefits.
(c) Principally results from the recognition of acquired tax benefits of
$22,500,000, which was applied to reduce the carrying amount of WilTel's
acquired non-current intangible assets and a reclassification to other
liabilities.
F-60
OLYMPUS RE HOLDINGS, LTD.
(Incorporated in Bermuda)
Consolidated Financial Statements
DECEMBER 31, 2004, 2003 AND 2002
(expressed in U.S. dollars)
PRICEWATERHOUSECOOPERS
- --------------------------------------------------------------------------------
PriceWaterhouseCoopers
Chartered Accountants
Dorchester House
7 Church Street
Hamilton
Bermuda HM 11
Telephone +1 (441) 295 2000
Facsimile +1 (441) 295 1242
January 26, 2005
REPORT OF INDEPENDENT AUDITORS
TO THE SHAREHOLDERS OF
OLYMPUS RE HOLDINGS, LTD.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated 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, 2004 and 2003, and the results of
its operations and its cash flows for the years ended December 31, 2004, 2003
and 2002 in conformity with accounting principles generally accepted in the
United States of America. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits. We
conducted our audits of these consolidated statements 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 consolidated financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall consolidated 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.
Consolidated Balance Sheets
AS OF DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
2004 2003
$ $
-------------------------------------------
ASSETS
Cash and cash equivalents (note 3) 50,929,556 36,083,597
Investments (note 3) 839,138,959 764,622,198
Investment income due and accrued 9,262,091 8,367,373
Premiums receivable 179,417,972 167,458,000
Deferred acquisition costs 48,406,242 46,732,324
Other assets 288,897 259,518
-------------------------------------------
1,127,443,717 1,023,523,010
===========================================
LIABILITIES
Loss and loss adjustment expense reserves (note 4) 301,021,728 114,317,141
Unearned premiums 156,827,274 142,792,737
Accounts payable and accrued expenses 424,940 591,308
Advisory fees payable (note 5) 15,758,183 47,017,307
-------------------------------------------
474,032,125 304,718,493
-------------------------------------------
SHAREHOLDERS' EQUITY
Common voting shares (3,716,378 in 2004 and 4,385,714
in 2003 shares issued and outstanding) (note 7) 37,164 43,857
Additional paid-in capital (note 7) 371,600,636 438,527,543
Accumulated other comprehensive income 2,978,377 11,515,650
Retained earnings 278,795,415 268,717,467
-------------------------------------------
653,411,592 718,804,517
-------------------------------------------
1,127,443,717 1,023,523,010
===========================================
APPROVED BY THE BOARD OF DIRECTORS
Director Director
- ----------------------------- -----------------------------
The accompanying notes are an integral part of these
consolidated financial statements
OLYMPUS RE HOLDINGS, LTD.
Consolidated Statements of Income
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
2004 2003 2002
$ $ $
---------------------------------------------------------------
REVENUES
Gross premiums written 521,031,407 523,178,240 298,522,087
---------------------------------------------------------------
Net premiums written 521,031,407 523,178,240 298,522,087
Net change in unearned premiums (14,034,538) (68,427,525) (74,365,214)
---------------------------------------------------------------
Net premiums earned 506,996,869 454,750,715 224,156,873
---------------------------------------------------------------
Net investment income 25,373,016 20,897,961 18,002,285
Net realized gains on investments 1,005,365 5,130,298 2,969,859
---------------------------------------------------------------
TOTAL REVENUES 533,375,250 480,778,974 245,129,017
===============================================================
EXPENSES
Losses and loss expenses (note 4) 296,732,651 104,344,698 57,901,965
Commissions 160,686,894 165,860,912 78,078,362
Premium taxes and fees 4,419,724 4,141,391 2,184,366
Other underwriting expenses 3,070,531 3,629,805 750,726
General and administrative expenses 2,336,496 2,059,983 1,236,605
---------------------------------------------------------------
TOTAL EXPENSES 467,246,296 280,036,789 140,152,024
---------------------------------------------------------------
NET INCOME FOR THE YEAR 66,128,954 200,742,185 104,976,993
===============================================================
The accompanying notes are an integral part of these
consolidated financial statements
OLYMPUS RE HOLDINGS, LTD.
Consolidated Statements of Shareholders' Equity
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
ACCUMULATED
ADDITIONAL OTHER RETAINED TOTAL
COMMON VOTING PAID-IN COMPREHENSIVE EARNINGS SHAREHOLDERS'
SHARES CAPITAL INCOME (DEFICIT) EQUITY
$ $ $ $ $
------------------------------------------------------------------------------------
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
Net income for the year - - - 66,128,954 66,128,954
Change in unrealized appreciation
(depreciation) on marketable investments - - (8,537,273) - (8,537,273)
Repurchase of common voting shares (note 7) (6,693) (66,926,907) - (56,051,006) (122,984,606)
------------------------------------------------------------------------------------
BALANCE AS OF DECEMBER 31, 2004 37,164 371,600,636 2,978,377 278,795,415 653,411,592
====================================================================================
The accompanying notes are an integral part of these
consolidated financial statements
OLYMPUS RE HOLDINGS, LTD.
Consolidated Statements of Comprehensive Income
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
2004 2003 2002
$ $ $
---------------------------------------------------------------
NET INCOME FOR THE YEAR 66,128,954 200,742,185 104,976,993
OTHER COMPREHENSIVE INCOME
Change in unrealized appreciation (depreciation) on
marketable investments (8,537,273) (4,589,630) 16,105,280
---------------------------------------------------------------
COMPREHENSIVE INCOME FOR THE YEAR 57,591,681 196,152,555 121,082,273
===============================================================
The accompanying notes are an integral part of these
consolidated financial statements
OLYMPUS RE HOLDINGS, LTD.
Consolidated Statements of Cash Flows
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
2004 2003 2002
$ $ $
---------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income for the year 66,128,954 200,742,185 104,976,993
Adjustments to reconcile net income to net cash provided
by operating activities
Gain on sale of investments (1,005,365) (5,130,298) (2,969,859)
Net amortization of premium/discount on fixed maturities 5,337,495 5,936,259 3,087,459
Investment income due and accrued (894,718) (1,682,462) (6,664,862)
Incorporation cost payable - - (7,883,231)
Premiums receivable (11,959,972) (90,968,391) (76,489,609)
Deferred acquisition costs (1,673,918) (23,414,237) (23,318,087)
Other assets (29,379) (101,330) (158,188)
Loss and loss adjustment expense reserves 186,704,587 69,609,547 44,707,594
Unearned premiums 14,034,537 68,427,523 74,365,214
Accounts payable and accrued expenses (166,368) 10,019 551,289
Investment trades pending settlement - (2,455,041) 2,455,041
Advisory fees payable (31,259,124) 21,847,079 25,170,228
---------------------------------------------------------------
Cash provided by operating activities 225,216,729 242,820,853 137,829,982
---------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments (698,087,800) (735,713,760) (1,066,976,281)
Proceeds from sales and maturities of investments 610,701,636 564,819,740 483,840,192
---------------------------------------------------------------
Cash used in investing activities (87,386,164) (170,894,020) (583,136,089)
---------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Purchase of common shares (122,984,606) (99,999,995) -
Proceeds to satisfy subscriptions - - 150,000
---------------------------------------------------------------
Cash provided by (used in) financing activities (122,984,606) (99,999,995) 150,000
---------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 14,845,959 (28,073,162) (445,156,107)
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 36,083,597 64,156,759 509,312,866
---------------------------------------------------------------
CASH AND CASH EQUIVALENTS - END OF YEAR 50,929,556 36,083,597 64,156,759
===============================================================
The accompanying notes are an integral part of these
consolidated financial statements
OLYMPUS RE HOLDINGS, LTD.
Notes to Consolidated Financial Statements
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
(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 (see note 2(h)).
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, 2004, this was through two main sources, quota share
reinsurance agreements with a U.S. reinsurance company (see note 6) and
two underwriting advisory contracts. The purpose of these quota share
agreements is to produce primarily property reinsurance. Olympus Re's
underwriting advisory contracts are with non-U.S. advisors (see note 5)
to recommend excess property and marine reinsurance business and consult
on the quota share agreements. The non-U.S. advisors are related to the
previously mentioned U.S. reinsurance company through common ownership.
2. SIGNIFICANT ACCOUNTING POLICIES
These consolidated 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) CONSOLIDATION
The consolidated financial statements include the financial
statements of the Company and its wholly-owned subsidiary Olympus
Re. All significant inter-company balances and transactions have
been eliminated on consolidation.
(b) PREMIUMS AND UNEARNED PREMIUMS
The Company records premiums based on cession statements received.
Premiums are earned 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.
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.
(1)
OLYMPUS RE HOLDINGS, LTD.
Notes to Consolidated Financial Statements
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
(c) 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.
(d) 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.
(e) 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.
(f) 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.
(2)
OLYMPUS RE HOLDINGS, LTD.
Notes to Consolidated Financial Statements
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
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.
(g) 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.
(h) NEW ACCOUNTING PRONOUNCEMENTS
In December 2003, the FASB issued a FASB Interpretation No. 46,
Consolidation of variable interest entities - an interpretation of
ARB No. 51 (revised December 2003) ("FIN 46R"). FIN 46R clarifies
the accounting and reporting for certain entities in which equity
investors do not have the characteristics of a controlling
financial interest.
Olympus Re's Board of Directors, who are elected as described in
note 1, 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
financial statements of the Company were previously presented on a
combined basis, rather than on a consolidated basis, in accordance
with ARB No. 51.
The Company adopted FIN 46R during 2004, the impact of which is to
present the financial statements as consolidated rather than
combined. This has not had any impact on the Company's net income
or net shareholders' equity as presented in these financial
statements.
3. INVESTMENTS
GROSS GROSS 2004
UNREALIZED UNREALIZED ESTIMATED
COST GAIN LOSS FAIR VALUE
$ $ $ $
-----------------------------------------------------------------------------------------
U.S. Government 146,969,861 1,605,351 1,125,641 147,449,571
U.S. Government-Sponsored Enterprises 347,715,100 1,919,481 762,368 348,872,213
Corporate 300,062,897 2,729,585 1,180,976 301,611,506
Mortgage-backed securities 41,412,724 23,962 231,017 41,205,669
-----------------------------------------------------------------------------------------
836,160,582 6,278,379 3,300,002 839,138,959
=========================================================================================
(3)
OLYMPUS RE HOLDINGS, LTD.
Notes to Consolidated Financial Statements
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
GROSS GROSS 2003
UNREALIZED UNREALIZED ESTIMATED
COST GAIN LOSS FAIR VALUE
$ $ $ $
-----------------------------------------------------------------------------------------
U.S. Government 172,534,991 1,243,158 - 173,778,149
U.S. Government-Sponsored Enterprises 326,656,609 4,613,114 - 331,269,723
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
=========================================================================================
The estimated fair value of fixed interest securities is based on quoted
market values.
The Company did not have any investments in a single corporate security
which exceeded 1.6% of total fixed interest securities as of December 31,
2004 and 2003.
The following table sets forth certain information regarding the
investment ratings of the company's fixed interest securities portfolio
as of December 31, 2004 and 2003.
2004 2003
------------------------------------------- -----------------------------------------
RATINGS AMORTIZED AMORTIZED
COST COST
$ % $ %
---------------------------------------------------------------------------------------
U.S. Government 146,969,861 18 172,534,991 23
U.S. Government-Sponsored Enterprises 347,715,100 41 326,656,609 43
AAA 64,265,227 8 46,743,994 6
AA 45,157,940 5 87,868,424 12
A 227,941,843 27 119,302,530 16
BBB 4,110,611 1 - -
---------------------------------------------------------------------------------------
836,160,582 100 753,106,548 100
---------------------------------------------------------------------------------------
The amortized cost and estimated fair value amounts for fixed interest
securities held at December 31, 2004 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.
(4)
OLYMPUS RE HOLDINGS, LTD.
Notes to Consolidated Financial Statements
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
AMORTIZED ESTIMATED FAIR
COST VALUE
$ $
-------------------------------------------
Due within one year 64,662,883 64,651,505
Due after one year through five years 712,992,476 715,862,799
Due after five years through ten years 17,092,499 17,418,986
-------------------------------------------
794,747,858 797,933,290
Mortgage-backed securities 41,412,724 41,205,669
-------------------------------------------
836,160,582 839,138,959
===========================================
The following table shows the unrealized losses and fair value of the
Company's investments with unrealized losses that are not deemed to be
other than temporarily impaired, aggregated by investment category and
length of time that individual securities have been in a continuous
unrealized loss position, at December 31, 2004:
LESS THAN 12 MONTHS 12 MONTHS OR GREATER TOTAL
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
$ $ $ $ $ $
-------------------------------------------------------------------------------------------------------
U.S. Government 118,983,575 1,125,641 - - 118,983,575 1,125,641
U.S. Government-Sponsored
Enterprises 196,934,402 750,502 17,958,600 11,866 214,893,002 762,368
Corporate 140,644,309 1,180,976 - - 140,644,309 1,180,976
Mortgage-back securities 37,850,700 231,017 - - 37,850,700 231,017
-------------------------------------------------------------------------------------------------------
Total 494,412,986 3,288,136 17,958,600 11,866 512,371,586 3,300,002
=======================================================================================================
The unrealized losses on the Company's investment portfolio are the
result of changes in general market conditions and interest rate
increases, rather than credit concerns related to these securities. It is
believed that the issuers of these securities will continue, to meet the
contractual obligations to the Company, including full repayment on
principal as contractually obligated. The Company has the ability to hold
these securities until a market price recovery, or until maturity, and
does not consider these investments to be other than temporarily impaired
at December 31, 2004.
(5)
OLYMPUS RE HOLDINGS, LTD.
Notes to Consolidated Financial Statements
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
The components of net investment income are as follows:
2004 2003 2002
$ $ $
------------------------------------------------------------
Interest on fixed maturities 30,403,659 27,758,971 20,691,286
Net amortization of premium/discount on fixed maturities (5,337,495) (5,936,259) (3,087,459)
Interest on cash and cash equivalents 1,047,368 557,713 1,592,238
------------------------------------------------------------
26,113,532 22,380,425 19,196,065
Net investment expenses (740,516) (1,482,464) (1,193,780)
------------------------------------------------------------
25,373,016 20,897,961 18,002,285
============================================================
During 2004, 2003 and 2002, proceeds from sales of available-for-sale
securities were $610,701,636, $564,819,740 and $483,840,192 respectively.
Gross realized gains were $2,990,444, $5,548,574 and $3,361,350 and gross
realized losses were $1,985,079, $418,276 and $391,491 for the years end
December 31, 2004, 2003 and 2002 respectively.
White Mountain Advisors, LLC, the Company's investment advisors, receive
a management fee at an annual rate of 0.1% of net invested assets. In
2003 and 2002 the annual rate was 0.2%.
In the normal course of business, the Company provides collateral in
accordance with certain reinsurance agreements. The Company has cash
equivalents of $2,840,794 and $54,453 and investments of $287,839,361 and
$201,128,202 in trusts, as of December 31, 2004 and 2003, respectively,
provided as collateral.
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.
(6)
OLYMPUS RE HOLDINGS, LTD.
Notes to Consolidated Financial Statements
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
Reserve activity for loss and loss expenses is summarized below:
2004 2003
$ $
-------------------------------------------------
BALANCE - BEGINNING OF YEAR 114,317,141 44,707,594
-------------------------------------------------
Net claims and claims expenses incurred for the year related to:
Current year 306,534,301 110,104,123
Prior year (9,801,650) (5,759,425)
-------------------------------------------------
296,732,651 104,344,698
-------------------------------------------------
Net paid claims and claims expenses for the year related to:
Current year 38,156,364 17,069,797
Prior year 71,871,700 17,665,354
-------------------------------------------------
110,028,064 34,735,151
-------------------------------------------------
BALANCE - END OF YEAR 301,021,728 114,317,141
=================================================
The December 31, 2004 and 2003 year end balance is comprised of
provisions for reported claims of $115,474,945 and $33,300,789 and
provisions for claims incurred but not reported of $185,546,783 and
$81,016,352, 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 and White
Mountains Underwriting (Bermuda) Limited, (collectively White Mountains
Underwriting) for all business on which they advise.
6. MAJOR CUSTOMERS
During the years ended December 31, 2004, 2003 and 2002, the Company
derived 86%, 90% and 99%, respectively, of its premiums written from
Folksamerica Reinsurance Company ("Folksamerica") for which the Company
pays an override commission. During the years ended December 31, 2004 and
2003, the Company derived 9% and 8% respectively, of its premiums written
from business recommended by White Mountains Underwriting for which the
Company pays an override commission. No significant business was written
through White Mountains Underwriting in 2002. Folksamerica and White
Mountains Underwriting 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 White Mountain
Advisors, LLC. Included in premiums receivable for the years ended
December 31, 2004 and 2003 were amounts of $166,798,822 and $157,980,421,
respectively, due from Folksamerica.
(7)
OLYMPUS RE HOLDINGS, LTD.
Notes to Consolidated Financial Statements
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
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 SHARES
At December 31, 2004 and 2003, the total issued and outstanding
common shares of the Company were 3,716,378 and 4,385,714,
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.
The Company's Bye-laws provide that the shareholders have an
annual put option to request that the Company repurchase any or
all of their shares. Such repurchase is subject to capital
adequacy of the Company under the Act and the approval of the
Board of Directors of the Company. At December 31, 2004 the
Company had received requests to repurchase 197,088 shares which
will cost the Company approximately $34.8 million at year end net
asset value. The repurchase of these shares is subject to approval
by the Board of Directors at their first meeting in 2005.
In the years ended December 31, 2004 and 2003, the Company used
$122,984,606 and $99,999,995 to repurchase a total of 669,336 and
714,286 shares respectively.
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.
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
$260,515,704, $261,589,120 and $149,261,044 at December 31, 2004, 2003
and 2002 respectively. Olympus Re's statutory capital and surplus was
$602,649,109, $668,937,898 and $593,312,822 at December 31, 2004, 2003
and 2002 respectively.
(8)
OLYMPUS RE HOLDINGS, LTD.
Notes to Consolidated Financial Statements
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
(expressed in U.S. dollars)
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 under
the Act, which was met for the years ended December 31, 2004, 2003 and
2002.
(9)
APPENDIX 1
FINANCIAL STATEMENTS CONTROL SHEET
====================================================================
THIS SHEET IS TO REMAIN WITH THE MOST CURRENT COPY.
ALL PERSONS TYPING IN THE STATEMENTS - INITIAL AND DATE THIS SHEET.
====================================================================
- -------------------------------------------------------------------------------- --------------------------------------------------
FULL CLIENT NAME: OLYMPUS RE HOLDINGS, LTD. DOCUMENT TITLE: FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------- --------------------------------------------------
CLIENT CODE/TA FILE NUMBER: 46624 YEAR/PERIOD END: DECEMBER 31, 2004, 2003 AND
2002
- -------------------------------------------------------------------------------- --------------------------------------------------
SPELLING: [X] AMERICAN [ ] BRITISH GAAP: US
- -------------------------- ----------------------------------------- ----------- --------------------------------------------------
FINALS DISTRIBUTION: DISTRIBUTED TO: DATE: FINALS PRINTED: FEBRUARY 25, 2005
- -------------------------- ----------------------------------------- ----------- --------------------------------------------------
BOUND COPIES: TEAM LEADER: TOM MILLER
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10 TEAM MANAGER: DARREN GREENWAY
- -------------------------- ----------------------------------------- ----------- --------------------------------------------------
SENIOR(S): ZAHEER ST.CLAIR
- -------------------------- ----------------------------------------- ----------- --------------------------------------------------
UNBOUND COPIES:
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DRAFTS FINALS
TYPED DRAFTS TO BE RETURNED TO: ZAHEER ST.CLAIR PRINTED FINALS TO BE RETURNED TO: ______________________
---------------
INITIALS DATE DATE/TIME REQUIRED: _________________________________
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CALL CHECKED BY/TO: INITIALS DATE
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ADDS/CROSS ADDS/CALCS BY:
CROSS REF. VERIFIED BY: ADDS/CROSS ADDS/CALCS BY:
OVERALL QUALITY CONTROL BY: CROSS REF. VERIFIED BY:
TEAM MANAGER REVIEW: FORMATTING/QUALITY CONTROL BY:
TEAM LEADER REVIEW: FINAL SPELL CHECK BY:
DRAFTS TO CLIENT FOR REVIEW: TEAM MANAGER REVIEW/APPROVAL FOR PRINTING:
1ST DRAFT (date/time required: ) TEAM LEADER REVIEW/APPROVAL FOR PRINTING:
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Typed by: Karen Patterson Date: February 8, 2005
Checked by: Date:
PRINTED FINALS CHECKED FOR COMPILATION AND QUALITY
2ND DRAFT (date/time required: ) (MATCH TO TRANSMITTAL LETTER):
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Typed by: Edwina Arorash Date: February 9, 2005
Checked by: Date:
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EAGLEROCK CAPITAL
PARTNERS (QP), LP
FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2004
EAGLEROCK CAPITAL
PARTNERS (QP), LP
FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2004
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 10-13
EAGLEROCK MASTER FUND, LP 14
INDEPENDENT AUDITORS' REPORT 15
FINANCIAL STATEMENTS:
Statements of assets and liabilities 16
Condensed schedule of investments - December 31, 2004 17-22
Condensed schedule of investments - December 31, 2003 23-27
Statements of operations 28
Statements of changes in partners' capital 29
Statements of changes in net assets 30
Summary of business and significant accounting policies 31-34
Notes to financial statements 35-38
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,
2004 and 2003, and the related statements of operations, changes in partners'
capital, and changes in net assets for the three 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, 2004 and 2003, and the results of its operations,
changes in partners' capital and its changes in net assets for the three years
then ended, in conformity with accounting principles generally accepted in the
United States of America.
January 21, 2005
3
EAGLEROCK CAPITAL PARTNERS (QP), LP
STATEMENTS OF ASSETS AND LIABILITIES
- --------------------------------------------------------------------------------
December 31, 2004 2003
----------------------------------------------------------------------------------------------------------------------
ASSETS
Investment in EagleRock Master Fund, LP $163,520,126 $102,776,970
Cash 556 -
----------------------------------------------------------------------------------------------------------------------
163,520,682 102,776,970
LIABILITIES
Due to EagleRock Master Fund, LP (Note 2) 1,974,347 906,051
----------------------------------------------------------------------------------------------------------------------
NET ASSETS (PARTNERS' CAPITAL) $161,546,335 $101,870,919
======================================================================================================================
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, 2004 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------
INVESTMENT (LOSS) INCOME:
Net investment (loss) income allocated from
EagleRock Master Fund, LP:
Interest $ 4,326,725 $ 4,401,712 $ 3,455,501
Dividends 1,024,367 2,020,980 102,514
Expenses (7,186,079) (4,281,435) (1,246,441)
- ----------------------------------------------------------------------------------------------------------------------------
NET INVESTMENT (LOSS) INCOME FROM EAGLEROCK (1,834,987) 2,141,257 2,311,574
MASTER FUND, LP
Interest income 556 - 2,523,401
Dividend income - - 35,692
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT (LOSS) INCOME (1,834,431) 2,141,257 4,870,667
- ----------------------------------------------------------------------------------------------------------------------------
EXPENSES:
Interest - - 2,030,350
Management fee (Note 2) 1,068,296 584,522 489,495
Dividends - - 39,571
Other - - 19,704
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL EXPENSES 1,068,296 584,522 2,579,120
- ----------------------------------------------------------------------------------------------------------------------------
NET INVESTMENT (LOSS) INCOME (2,902,727) 1,556,735 2,291,547
NET REALIZED GAIN ON INVESTMENTS - - 19,651
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS ALLOCATED
FROM EAGLEROCK MASTER FUND, LP:
Net realized gain (loss) on investments 5,606,973 9,686,036 (598,006)
Net change in unrealized gain (loss) on investments 37,703,722 44,227,782 (6,284,778)
- ----------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) (NOTE 1) $40,407,968 $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
- --------------------------------------------------------------------------------
Three years ended December 31, 2004
- ----------------------------------------------------------------------------------------------------------------------------
General Limited
partner partners 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
Capital contributions - 23,000,000 23,000,000
Capital withdrawals - (3,732,552) (3,732,552)
Net income (Note 1):
Pro rata allocation 2,278,164 38,129,804 40,407,968
Performance allocation 4,427,330 (4,427,330) -
Profit participation allocation (581,663) 581,663 -
- ----------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2004 $12,552,896 $148,993,439 $161,546,335
============================================================================================================================
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, 2004 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS:
Net investment (loss) income $ (2,902,727) $ 1,556,735 $ 2,291,547
Net realized gain (loss) on investments 5,606,973 9,686,036 (578,355)
Net change in unrealized gain (loss) on investments 37,703,722 44,227,782 (6,284,778)
- ----------------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING 40,407,968 55,470,553 (4,571,586)
FROM OPERATIONS
- ----------------------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS RESULTING FROM CAPITAL
TRANSACTIONS:
Capital contributions 23,000,000 - 50,971,952
Capital withdrawals (3,732,552) - -
- ----------------------------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM
CAPITAL TRANSACTIONS 19,267,448 - 50,971,952
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INCREASE 59,675,416 55,470,553 46,400,366
NET ASSETS, BEGINNING OF YEAR 101,870,919 46,400,366 -
- ----------------------------------------------------------------------------------------------------------------------------
NET ASSETS, END OF YEAR $161,546,335 $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. The Partnership invests a
significant portion of its assets in EagleRock
Master Fund, LP. On May 1, 2002, the
Partnership contributed all of its net assets
to a related entity, EagleRock Master Fund, a
Delaware partnership, in exchange for a pro
rata share of equity in that partnership. On
November 1, 2004, EagleRock Master Fund
transferred its net assets and partnership
interests to EagleRock Master Fund, LP, a
Cayman Islands exempted partnership that became
the surviving master partnership. As a result
of the transfer, the Partnership received a pro
rata share of the Partnership interest in Eagle
Rock Master Fund, LP on that date. The
financial statements of EagleRock Master Fund,
LP are included elsewhere in this report and
should be read with the Partnership's financial
statements.
SIGNIFICANT ACCOUNTING POLICIES Investment in EagleRock Master Fund, LP
The investment in EagleRock Master Fund, LP 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, LP. Valuation of the
investments held by EagleRock Master Fund, LP
is discussed in the notes to the EagleRock
Master Fund, LP financial statements included
elsewhere in this report. The percentage of
EagleRock Master Fund, LP partners' capital
owned by the Partnership at December 31, 2004
and 2003 was approximately 72% and 91%,
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.
8
EAGLEROCK CAPITAL PARTNERS (QP), LP
SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
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 year. Actual results could differ
from those estimates.
Reclassifications
Certain amounts in 2003 and 2002 have been
reclassified to conform to the 2004
presentation.
9
EAGLEROCK CAPITAL PARTNERS (QP), LP
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. ALLOCATION OF NET INCOME
(LOSS) AND PERFORMANCE
ALLOCATION The net income (loss) for the three years ended
December 31, 2004 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.
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 one of the limited partners 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 years
ended December 31, 2004 and 2003, the
performance allocation was $4,427,330 and
$4,991,114, respectively. There was no
performance allocation for the year ended
December 31, 2002.
In consideration of one of the limited
partner's contribution, the limited partner is
entitled to receive 10% of any performance
allocation paid to the General Partner by the
Partnership and an affiliated partnership (the
"Profit Participation Allocation"). Prior to
June 1, 2003, the limited partner was entitled
to 5% of any performance allocation paid to the
General Partner by the Partnership. The General
Partner may, at its discretion, increase this
fee. For the years ended December 31, 2004 and
2003, the Profit Participation Allocation was
$581,663 and $521,806, respectively. There was
no profit participation allocation for the year
ended December 31, 2002.
10
EAGLEROCK CAPITAL PARTNERS (QP), LP
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2. DUE TO EAGLEROCK
MASTER FUND, LP Management Fees
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, LP and are discussed in the notes
to EagleRock Master Fund, LP's financial
statements included elsewhere in this report.
For one of the limited partners 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 years ended December
31, 2004, 2003 and 2002, the Partnership's
management fees were $1,068,296, $584,522 and
$489,495, respectively. As of December 31, 2004
and 2003 an aggregate amount of $1,974,347 and
$906,051, respectively, was due to EagleRock
Master Fund, LP.
11
EAGLEROCK CAPITAL PARTNERS (QP), LP
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
3. FINANCIAL HIGHLIGHTS The financial highlights table represents the
Partnership's financial performance for the
three years ended December 31, 2004 are as
follows:
Limited partner 2004 2003 2002
-------------------------------------------------------------------------------------------
Total return before performance 34.11% 119.51% (8.97)%
allocation and profit
participation allocation
Performance allocation, net of
profit participation allocation (3.45) (9.82) -
-------------------------------------------------------------------------------------------
Total return after 30.66% 109.69% (8.97)%
performance allocation and
profit participation
allocation (a)
===========================================================================================
Operating expense ratio (b) 3.19% 4.33% 1.93%
Performance allocation, net of
profit participation allocation 3.45 9.82 -
-------------------------------------------------------------------------------------------
Total expenses and 6.64% 14.15% 1.93%
performance allocation,
net of profit
participation allocation
-------------------------------------------------------------------------------------------
Net investment (loss) income (2.60)% 3.33% 4.46%
ratio (c)
===========================================================================================
-----------------
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 allocation, net of
profit participation allocation.
12
EAGLEROCK CAPITAL PARTNERS (QP), LP
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
-----------------
An individual partner's return may
vary from the above returns based on
participation in hot issues,
different management fee and
performance 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 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 arrangements and
the timing of capital transactions.
(c) The net investment (loss) income
ratio is calculated by dividing the
net investment (loss) income by the
net assets of a theoretical
investment made at the beginning of
year. The net investment (loss)
income ratio is based on the net
investment income allocated to a
limited partner prior to the effects
of a performance allocation, net of
profit participation allocation. The
net investment (loss) income ratio
attributable to an individual
partner's account may vary based on
timing of capital transactions.
13
EAGLEROCK MASTER FUND, LP
- --------------------------------------------------------------------------------
FINANCIAL STATEMENTS
TWO YEARS ENDED DECEMBER 31, 2004 AND
PERIOD FROM MAY 1, 2002 (COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 2002
14
INDEPENDENT AUDITORS' REPORT
The Partners
EagleRock Master Fund, LP
Grand Cayman, Cayman Islands
We have audited the accompanying statement of assets and liabilities, including
the condensed schedule of investments, of EagleRock Master Fund LP (formerly,
EagleRock Master Fund) as of December 31, 2004 and 2003, and the related
statements of operations, changes in partners' capital, and changes in net
assets for each of the two years in the period ended December 31, 2004 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 LP as of
December 31, 2004 and 2003, and the results of its operations, changes in
partners' capital and changes in net assets for each of the two years in the
period ended December 31, 2004 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.
January 21, 2005
15
EAGLEROCK MASTER FUND, LP
STATEMENTS OF ASSETS AND LIABILITIES
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
December 31, 2004 2003
- -----------------------------------------------------------------------------------------------------------------------------
ASSETS
Investments in securities, at fair value (cost $377,657,524 and $247,328,617)
(Notes 1 and 5) $468,825,344 $284,340,077
Dividends and interest receivable 1,144,386 1,003,483
Due from affiliates (Note 3) 2,302,938 954,130
Other 9,166 13,805
- -----------------------------------------------------------------------------------------------------------------------------
472,281,834 286,311,495
- -----------------------------------------------------------------------------------------------------------------------------
LIABILITIES
Securities sold, not yet purchased, at fair value (proceeds of sales $81,968,106
and $66,145,693) (Notes 1 and 5) 79,791,970 63,107,264
Due to broker (Note 1) 165,062,685 109,802,714
Dividends and interest payable 1,013,698 795,178
Accrued expenses and other liabilities (Note 3 and 4) 72,065 -
- -----------------------------------------------------------------------------------------------------------------------------
245,940,418 173,705,156
- -----------------------------------------------------------------------------------------------------------------------------
NET ASSETS (PARTNERS' CAPITAL) $226,341,416 $112,606,339
=============================================================================================================================
See accompanying summary of business and significant accounting
policies and notes to financial statements.
16
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
December 31, 2004
- ----------------------------------------------------------------------------------------------------------------------------------
Number of shares/face Description (% of net assets of $226,341,416) Fair value
- ----------------------------------------------------------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES:
Common stock (132.48%):
United States (127.90%):
Building materials (.51%) $ 1,161,807
Business services (2.48%) 5,627,465
Capital equipment (8.62%) 19,525,136
Chemicals (6.21%):
10,702,820 Solutia Inc. (5.53%) 12,522,299
Other (.68%) 1,529,712
Consumer products (15.36%):
2,831,639 Interstate Bakeries Corp. (8.01%) 18,122,490
Other (7.35%) 16,637,751
Electronics (6.82%) 15,428,788
Energy (2.99%) 6,777,288
Financial services (4.33%) 9,791,463
Food processing (8.22%):
4,267,101 Darling International Inc. (8.22%) 18,604,560
Other (0.00%) 2,306
Health & death care (5.99%) 13,550,291
Index (.05%) 110,396
Media, entertainment & leisure (8.72%) 19,743,377
Mining and metals (2.78%) 6,301,479
Packaging and containers (8.51%):
2,363,801 Constar International Inc. (8.06%) 18,248,544
Other (.45%) 1,008,018
Pharmaceuticals (.60%) 1,366,558
Retail (9.47%) 21,440,736
Software (16.06%) 36,347,918
Telecommunications (8.05%) 18,211,070
Transportation and defense (3.87%) 8,749,027
Utilities (4.15%) 9,387,387
Wireless Communications (4.11%) 9,299,492
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCK - UNITED STATES (COST $229,389,463) 289,495,358
- ----------------------------------------------------------------------------------------------------------------------------------
==================================================================================================================================
See accompanying summary of business and significant accounting
policies and notes to financial statements.
17
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
December 31, 2004
- -----------------------------------------------------------------------------------------------------------------------------------
Number of shares/face Description (% of net assets of $226,341,416) Fair value
- -----------------------------------------------------------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES (CONTINUED):
Common stock (132.48%) (continued):
Canada (.12%):
Transportation and defense (.12%) $ 267,653
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCK - CANADA (COST $150,554) 267,653
- -----------------------------------------------------------------------------------------------------------------------------------
China (1.40%):
Software (1.40%) 3,172,433
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCK - CHINA (COST $3,156,229) 3,172,433
- -----------------------------------------------------------------------------------------------------------------------------------
England (.07%):
Telecommunications (.07%) 160,844
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCK - ENGLAND (COST $229,485) 160,844
- -----------------------------------------------------------------------------------------------------------------------------------
France (.41%):
Chemicals (.41%) 936,249
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCK - FRANCE (COST $474,997) 936,249
- -----------------------------------------------------------------------------------------------------------------------------------
Germany (.72%):
Financial services (.68%) 1,543,000
Health & death care (.04%) 83,525
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCK - GERMANY (COST $1,489,915) 1,626,525
- -----------------------------------------------------------------------------------------------------------------------------------
Mexico (.08%):
Media, entertainment & leisure (.08%) 191,208
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCK - MEXICO (COST $178,388) 191,208
- -----------------------------------------------------------------------------------------------------------------------------------
Norway (.26%):
Energy (.26%) 578,516
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCK - NORWAY (COST $201,021) 578,516
- -----------------------------------------------------------------------------------------------------------------------------------
Russia (.56%):
Energy (.56%) 1,262,055
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCK - RUSSIA (COST $1,346,876) 1,262,055
- -----------------------------------------------------------------------------------------------------------------------------------
South Africa (.96%):
Mining and metals (.96%) 2,167,776
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCK - SOUTH AFRICA (COST $2,328,853) 2,167,776
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCK (COST $238,945,781) 299,858,617
- -----------------------------------------------------------------------------------------------------------------------------------
===================================================================================================================================
See accompanying summary of business and significant accounting
policies and notes to financial statements.
18
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
December 31, 2004
- -----------------------------------------------------------------------------------------------------------------------------------
Number of shares/face Description (% of net assets of $226,341,416) Fair value
- -----------------------------------------------------------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES (CONTINUED):
Long-term debt securities (64.08%):
United States (55.48%):
Building materials (1.03%) $ 2,329,875
Business services (1.49%) 3,380,600
Capital equipment (1.01%) 2,281,250
Chemicals (.96%) 2,187,000
Consumer products (.97%) 2,212,825
Electronics (.46%) 1,057,500
Energy (.83%) 1,870,750
Financial services (2.35%) 5,329,750
Index (.40%) 900,000
Media, entertainment & leisure (9.53%) 21,557,505
Mining and metals (11.33%):
26,100,000 WCI Steel Inc 10% 12/1/04 Sr Nts (8.65%) 19,575,000
Other (2.68%) 6,073,913
Packaging and containers (3.03%) 6,861,000
Pharmaceuticals (.33%) 740,000
Retail (1.45%) 3,270,306
Telecommunications (2.55%) 5,767,215
Transportation and defense (9.24%):
30,225,000 Delta Airlines 8.3% 12/15/29 (6.01%) 13,601,250
Other (3.23%) 7,298,638
Utilities (8.52%) 19,278,000
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL LONG-TERM DEBT SECURITIES - UNITED STATES (COST $98,068,993) 125,572,377
- -----------------------------------------------------------------------------------------------------------------------------------
Bermuda (3.60%):
Telecommunications (3.60%) 8,144,900
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL LONG-TERM DEBT SECURITIES - BERMUDA (COST $8,224,170) 8,144,900
- -----------------------------------------------------------------------------------------------------------------------------------
England (.87%):
Automotive (.85%) 1,929,375
Telecommunications (.02%) 50,000
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL LONG-TERM DEBT SECURITIES - ENGLAND (COST $1,236,855) 1,979,375
- -----------------------------------------------------------------------------------------------------------------------------------
===================================================================================================================================
See accompanying summary of business and significant accounting
policies and notes to financial statements.
19
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
December 31, 2004
- -----------------------------------------------------------------------------------------------------------------------------------
Number of shares/face Description (% of net assets of $226,341,416) Fair value
- -----------------------------------------------------------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES (CONTINUED): Long-term debt
securities (64.08%) (continued):
Italy (2.27%):
Consumer products (2.27%) $ 5,126,585
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL LONG-TERM DEBT SECURITIES - ITALY (COST $11,532,266) 5,126,585
- -----------------------------------------------------------------------------------------------------------------------------------
Mexico (.78%):
Wireless communications (.78%) 1,778,688
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL LONG-TERM DEBT SECURITIES - MEXICO (COST $1,654,435) 1,778,688
- -----------------------------------------------------------------------------------------------------------------------------------
Norway (1.08%):
Energy (1.08%) 2,435,543
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL LONG-TERM DEBT SECURITIES - NORWAY (COST $1,356,611) 2,435,543
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL LONG-TERM DEBT SECURITIES (COST $122,073,330) 145,037,468
- -----------------------------------------------------------------------------------------------------------------------------------
Preferred stock (7.32%):
United States (7.32%):
Building materials (2.86%) 6,480,000
Consumer products (.11%) 243,000
Electronics (1.22%) 2,750,000
Financial services (.61%) 1,378,000
Media, entertainment & leisure (1.43%) 3,235,255
Packaging and containers (.65%) 1,483,920
Transportation and defense (.28%) 648,659
Utilities (.16%) 352,568
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCK (COST $8,322,031) 16,571,402
- -----------------------------------------------------------------------------------------------------------------------------------
Options purchased (3.25%) (cost $8,316,382):
United States (3.25%) 7,357,857
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SECURITIES (COST $377,657,524) $468,825,344
===================================================================================================================================
See accompanying summary of business and significant accounting
policies and notes to financial statements.
20
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
December 31, 2004
- -----------------------------------------------------------------------------------------------------------------------------------
Number of shares/face Description (% of net assets of $226,341,416) Fair value
- -----------------------------------------------------------------------------------------------------------------------------------
SECURITIES SOLD, BUT NOT YET PURCHASED:
Common stock (8.19%):
United States (8.19%):
Automotive (.30%) $ 674,610
Capital equipment (1.52%) 3,447,267
Chemicals (.72%) 1,619,352
Consumer products (.35%) 789,654
Electronics (.74%) 1,671,917
Energy (.56%) 1,281,500
Financial services (1.14%) 2,571,204
Health & death care (.15%) 340,800
Index (.01%) 12,821
Mining and metals (1.14%) 2,589,750
Pharmaceuticals (.78%) 1,757,610
Retail (.69%) 1,559,000
Software (.02%) 34,842
Telecommunications (.03%) 77,412
Transportation and defense (.04%) 95,563
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCK - UNITED STATES (PROCEEDS $18,421,290) 18,523,302
- -----------------------------------------------------------------------------------------------------------------------------------
Preferred stock (.80%):
United States (.80%):
Building Materials (.80%) 1,800,000
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCK (PROCEEDS $1,990,073) 1,800,000
- -----------------------------------------------------------------------------------------------------------------------------------
===================================================================================================================================
See accompanying summary of business and significant accounting
policies and notes to financial statements.
21
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
December 31, 2004
- -----------------------------------------------------------------------------------------------------------------------------------
Number of shares/face Description (% of net assets of $226,341,416) Fair value
- -----------------------------------------------------------------------------------------------------------------------------------
SECURITIES SOLD, BUT NOT YET PURCHASED (CONTINUED):
Long-term debt securities (25.37%):
United States (25.37%):
Automotive (3.64%) $ 8,240,940
Capital equipment (3.24%) 7,325,750
Chemicals (2.30%) 5,197,500
Consumer products (2.11%) 4,767,750
Energy (.09%) 194,250
Financial services (.88%) 1,998,000
Mining and metals (6.24%) 14,120,250
Packaging and containers (4.06%) 9,189,188
Retail (.46%) 1,045,000
Transportation and defense (1.68%) 3,810,125
Utilities (.67%) 1,525,000
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL LONG-TERM DEBT SECURITIES (PROCEEDS $58,666,374) 57,413,753
- -----------------------------------------------------------------------------------------------------------------------------------
Options written (.91%) (proceeds $2,890,369):
United States (.91%): 2,054,915
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL SECURITIES SOLD, NOT YET PURCHASED (PROCEEDS $81,968,106) $79,791,970
===================================================================================================================================
See accompanying summary of business and significant accounting
policies and notes to financial statements.
22
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
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.
23
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
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.
24
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
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.
25
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
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.
26
EAGLEROCK MASTER FUND, LP
CONDENSED SCHEDULE OF INVESTMENTS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
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.
27
EAGLEROCK MASTER FUND, LP
STATEMENTS OF OPERATIONS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
Period from
May 1, 2002
(commencement of
Year ended December 31, operations) to
-------------------------------------------- December 31,
2004 2003 2002
- ---------------------------------------------------------------------------------------------------------------------------------
INVESTMENT INCOME:
Interest $ 5,053,958 $ 4,615,738 $ 3,479,481
Dividends, net of withholding taxes 1,159,591 2,119,247 103,225
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT INCOME 6,213,549 6,734,985 3,582,706
- ---------------------------------------------------------------------------------------------------------------------------------
EXPENSES:
Interest on securities sold, not yet purchased 4,526,696 2,449,318 741,658
Margin interest 2,486,380 1,357,321 337,766
Dividends on securities sold, not yet purchased 900,263 557,251 124,820
Other 473,715 125,723 50,847
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL EXPENSES 8,387,054 4,489,613 1,255,091
- ---------------------------------------------------------------------------------------------------------------------------------
NET INVESTMENT (LOSS) INCOME (2,173,505) 2,245,372 2,327,615
NET REALIZED GAIN (LOSS) ON INVESTMENTS 4,381,952 10,157,003 (602,156)
NET CHANGE IN UNREALIZED GAIN (LOSS) ON INVESTMENTS 52,979,588 46,378,281 (6,328,391)
- ---------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) (NOTE 2) $55,188,035 $58,780,656 $(4,602,932)
=================================================================================================================================
See accompanying summary of business and significant accounting
policies and notes to financial statements.
28
EAGLEROCK MASTER FUND, LP
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
Two years ended December 31, 2004 and period from May 1, 2002
(commencement of operations) to December 31, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
EagleRock Capital
EagleRock Capital EagleRock Capital Partners Offshore
Partners QP, L.P. Partners, L.P. Fund, Ltd. Total
- ------------------------------------------------------------------------------------------------------------------------------------
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
Transfer from EagleRock Capital Partners
Offshore Fund, Ltd. - - 10,100,017 10,100,017
Capital contributions 23,000,000 15,654,565 13,525,012 52,179,577
Capital withdrawals (3,732,552) - - (3,732,552)
Net income (Note 2):
Pro rata allocation 41,475,708 7,430,887 6,281,440 55,188,035
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2004 $163,520,126 $32,914,821 $29,906,469 $226,341,416
====================================================================================================================================
See accompanying summary of business and significant accounting
policies and notes to financial statements.
29
EAGLEROCK MASTER FUND, LP
STATEMENTS OF CHANGES IN NET ASSETS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
Period from
May 1, 2002
(commencement of
Year ended December 31, operations) to
-------------------------------------------- December 31,
2004 2003 2002
- -------------------------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS:
Net investment (loss) income $ (2,173,505) $ 2,245,372 $ 2,327,615
Net realized gain (loss) on investments 4,381,952 10,157,003 (602,156)
Net change in unrealized gain (loss) on investments 52,979,588 46,378,281 (6,328,391)
- -------------------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING
FROM OPERATIONS 55,188,035 58,780,656 (4,602,932)
- -------------------------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS RESULTING FROM CAPITAL
TRANSACTIONS:
Transfer from EagleRock Capital Partners Offshore
Fund, Ltd. 10,100,017 - -
Capital contributions 52,179,577 6,800,000 52,259,502
Capital withdrawals (3,732,552) (48,935) (581,952)
- -------------------------------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM CAPITAL
TRANSACTIONS 58,547,042 6,751,065 51,677,550
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL INCREASE 113,735,077 65,531,721 47,074,618
NET ASSETS, BEGINNING OF PERIOD 112,606,339 47,074,618 -
- -------------------------------------------------------------------------------------------------------------------------------
NET ASSETS, END OF PERIOD $226,341,416 $112,606,339 $47,074,618
===============================================================================================================================
See accompanying summary of business and significant accounting
policies and notes to financial statements.
30
EAGLEROCK MASTER FUND, LP
SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
BUSINESS EagleRock Master Fund, LP ("Partnership") is a
Cayman Islands exempted partnership that
invests and trades in securities and other
investment vehicles and instruments.
The Partnership is a successor of EagleRock
Master Fund, a Delaware partnership, which
transferred all of its net assets on November
1, 2004. As a result, the financial statements
are presented as if the entities were always
the same reporting entity.
In addition, the EagleRock Capital Partners
Offshore Fund, Ltd. transferred all of its net
assets to the Partnership in exchange for a pro
rata share of the Partnership interests based
on net assets contributed at that date and
became a feeder fund of the Partnership.
EagleRock Capital Partners, LP, EagleRock
Capital Partners (QP), LP and EagleRock Capital
Partners Offshore Fund, Ltd. (collectively
"Feeder Funds") are all entities under common
control and are the general and limited
partners of the Partnership. Mariel Capital
Management, LLC is also a general partner of
the Partnership and has no capital balance at
December 31, 2004.
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.
31
EAGLEROCK MASTER FUND, LP
SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
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 (for investments)
or ask (for investments sold, not yet
purchased) prices supplied by market making
broker-dealers at the close of business.
Certain long-term debt and other securities for
which quotations are not readily available are
valued at estimated fair value as determined in
good faith by the general partner. The values
assigned to such investments are based upon
available information and do not necessarily
represent amounts which might ultimately be
realized. Because of the inherent uncertainty
of valuation, those estimated fair values may
differ from the values that would have been
used had a ready market for the investments
existed and those differences could be
material. The resulting unrealized gains and
losses are reflected in the statements 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.
32
EAGLEROCK MASTER FUND, LP
SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
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 investments.
Foreign Currency
Investment securities and other assets and
liabilities denominated in foreign currencies
are translated into U.S. dollar amounts at the
date of valuation. Purchases and sales of
investment securities and income and expense
items denominated in foreign currencies are
translated into U.S. dollar amounts on the
respective dates of such transactions.
The Partnership does not isolate that portion
of the results of operations resulting from
changes in foreign exchange rates on
investments from the fluctuations arising from
changes in market prices of securities held.
Such fluctuations are included with the net
realized and unrealized gain or loss from
investments.
Income Taxes
The Partnership is exempt from all forms of
taxation in the Cayman Islands including
income, capital gains and withholding taxes. In
jurisdictions other than the Cayman Islands,
foreign taxes may be withheld on dividends and
interest received by the Partnership at rates
up to 30%. Capital gains derived by the
Partnership are generally exempt from foreign
income or withholding taxes at source. Dividend
income is recorded net of any such withholding
taxes.
33
EAGLEROCK MASTER FUND, LP
SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
Prior to November 1, 2004, there was no income
tax provision made in the accompanying
financial statements since the partners were
required to report their respective shares of
the Partnership's 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 2003 and 2002 have been
reclassified to conform to the 2004
presentation.
34
EAGLEROCK MASTER FUND, LP
NOTES TO FINANCIAL STATEMENTS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
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) 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. 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 three
Feeder Funds. As of December 31, 2004 and 2003,
due from limited partnerships were $2,302,938
and $954,130, respectively. In addition, the
Partnership has a payable to the Investment
Manager of $28,686 and $-0- as of December 31,
2004 and 2003, respectively, which is included
in accrued expenses and other liabilities.
4. ADMINISTRATION FEES Effective November 1, 2004, Butterfield Fund
Services (Cayman) Limited serves as the
administrator and registrar for the Partnership
and its Feeder Funds. Pursuant to an
Administrative and Services Agreement, the
Partnership pays an administration fee on a
monthly basis, in arrears based on the
Partnership's net assets. For the period from
November 1 to December 31, 2004, the
administration fee was $43,379 which was
payable at December 31, 2004 and included in
accrued expenses and other liabilities.
35
EAGLEROCK MASTER FUND, LP
NOTES TO FINANCIAL STATEMENTS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
5. 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.
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, 2004 and 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 $22,663,677 and
$29,528,151 of identical securities held both
long and short at December 31, 2004 and 2003,
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, 2004 and 2003.
36
EAGLEROCK MASTER FUND, LP
NOTES TO FINANCIAL STATEMENTS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
6. FINANCIAL HIGHLIGHTS The financial highlights table represents the
Partnership's financial performance for the
years ended December 31, 2004 and 2003 and the
period from May 1, 2002 (commencement of
operations) to December 31, 2002 are as
follows:
Partner 2004 2003 2002
-----------------------------------------------------------------------------------
Total return (a) 34.99% 120.81% (9.54)%
===================================================================================
Operating expense ratio (b) 2.17% 3.05% .73%
===================================================================================
Net investment (loss) income ratio (c) (1.60)% 7.66% 4.60%
===================================================================================
-----------------
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
period of a theoretical investment
made at the beginning of the period.
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 period. 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.
37
EAGLEROCK MASTER FUND, LP
NOTES TO FINANCIAL STATEMENTS
(EXPRESSED IN US DOLLARS)
- --------------------------------------------------------------------------------
-----------------
(c) The net investment (loss) income
ratio is calculated by dividing the
net investment income by the net
assets of a theoretical investment
made at the beginning of period. The
net investment (loss) income ratio
is based on the net investment
(loss) income allocated to a limited
partner. The net investment (loss)
income ratio attributable to an
individual partner's account may
vary based on timing of capital
transactions.
7. SUBSEQUENT CAPITAL
TRANSACTIONS From January 1, 2005 through January 21, 2005,
there were $1,000,000 in capital contributions.
There were no capital withdrawals.
38
Report of Independent Registered Public Accounting Firm
The Stockholder
WilTel Communications Group, Inc.
We have audited the accompanying consolidated balance sheet of WilTel
Communications Group, Inc. as of November 5, 2003 (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), and the period from January 1, 2002 to October 31, 2002
(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 of the Public
Company Accounting Oversight Board (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 (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), and the period from
January 1, 2002 to October 31, 2002 (Predecessor Company), in conformity with
U.S. generally accepted accounting principles.
Ernst & Young LLP
Tulsa, Oklahoma
February 20, 2004
1
WILTEL COMMUNICATIONS GROUP, INC.
CONSOLIDATED BALANCE SHEET
Successor Company
--------------------
As of
November 5,
2003
------------
(In thousands)
Assets
Current assets:
Cash and cash equivalents.............................................. ..$ 208,286
Receivables less allowance of $5,036,000.................................. 235,950
Notes receivable.......................................................... 425
Prepaid assets and other.................................................. 62,239
-------------
Total current assets........................................................ 506,900
Property, plant and equipment, net.......................................... 1,236,743
Other assets and deferred charges.......................................... 51,919
-------------
Total assets............................................................... $ 1,795,562
=============
Liabilities and stockholders' equity
Current liabilities:
Accounts payable.......................................................... $ 183,313
Deferred revenue.......................................................... 47,858
Accrued liabilities....................................................... 187,756
Long-term debt due within one year........................................ 4,021
------------
Total current liabilities................................................... 422,948
Long-term debt.............................................................. 502,746
Long-term deferred revenue................................................. 154,498
Other liabilities........................................................... 135,824
Minority interest in consolidated subsidiary................................ --
Contingent liabilities and commitments
Stockholders' equity:
WilTel common stock, $0.01 par value, 200 million shares
authorized, 50 million shares outstanding .............................. 500
Capital in excess of par value............................................ 749,500
Accumulated deficit....................................................... (169,795)
Accumulated other comprehensive income (loss)............................. (659)
------------
Total stockholders' equity.................................................. 579,546
------------
Total liabilities and stockholders' equity................................. $ 1,795,562
============
See accompanying notes.
2
WILTEL COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Successor Company Predecessor Company
------------------------------- ----------------
Period from
January 1, Two Months Ten Months
2003 through Ended Ended
November 5, December 31, October 31,
2003 2002 2002
------------ ----------- ------------
(In thousands, except per share amounts)
Revenues ...................................................$ 1,111,415 $ 191,656 $ 1,000,007
Operating expenses:
Cost of sales ............................................ 901,293 171,605 862,405
Selling, general and administrative....................... 145,580 27,712 179,321
Provision for doubtful accounts........................... 4,199 787 20,118
Depreciation and amortization............................. 208,480 44,294 460,989
Asset impairments and restructuring charges.............. -- 8,572 28,483
Other expense (income), net.............................. (1,298) (6,242) 19,182
-------------- ------------ -------------
Total operating expenses............................... 1,258,254 246,728 1,570,498
-------------- ------------ -------------
Loss from operations ....................................... (146,839) (55,072) (570,491)
Interest accrued............................................ (34,708) (7,221) (199,202)
Interest capitalized........................................ -- -- 3,600
Investing income (loss):
Interest and other ....................................... 4,010 511 20,327
Equity losses ............................................ -- -- (2,710)
Income (loss) from investments............................ -- -- 1,575
Minority interest in loss of consolidated subsidiary........ 2,378 802 12,530
Gain on sale of consolidated subsidiary..................... 21,089 -- --
Other income (loss), net.................................... 45,347 (66) 564
Reorganization items, net................................... -- -- 2,066,032
-------------- ------------ -------------
Income (loss) before income taxes........................... (108,723) (61,046) 1,332,225
Benefit (provision) from income taxes....................... (23) (3) (1,030)
-------------- ------------ -------------
Income (loss) before cumulative effect of change in
accounting principle...................................... (108,746) (61,049) 1,331,195
Cumulative effect of change in accounting principle......... -- -- (8,667)
-------------- ------------ -------------
Net income (loss)........................................... (108,746) (61,049) 1,322,528
Preferred stock dividends and amortization of preferred
stock issuance costs...................................... -- -- (5,473)
-------------- ------------ -------------
Net income (loss) attributable to common stockholders...... $ (108,746) $ (61,049) $ 1,317,055
============== ============ =============
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
Cumulative effect of change in accounting principle....... -- -- (.01)
-------------- ------------ -------------
Net income (loss) attributable to common stockholders... $ (2.17) $ (1.22) $ 2.65
============== ============ =============
Weighted average shares outstanding....................... 50,000 50,000 497,621
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, 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
2003 through Ended Ended
November 5, December 31, October 31,
2003 2002 2002
---- ---- ----
(In thousands)
Operating activities
Net income (loss).............................................. $ (108,746) $ (61,049) $1,322,528
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
Provision from deferred income taxes............................. -- -- 1,005
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 doubtful accounts.................................. 4,199 787 20,118
Equity losses.................................................... -- -- 2,710
Gain on sales of property and other assets....................... (1,502) -- (2,731)
Gain on sales of investments..................................... -- -- (666)
Minority interest in loss of consolidated subsidiary............. (2,378) (802) (12,530)
Gain on sale of consolidated subsidiary.......................... (21,089) -- --
Cash provided by (used in) changes in:
Receivables.................................................... (39,003) 9,001 204,344
Prepaid and other current assets............................... (37,686) 26,607 (30,489)
Accounts payable............................................... 16,766 18,091 (48,719)
Current deferred revenue....................................... (7,339) (9,536) 16,595
Accrued liabilities............................................ (26,288) (33,385) 103,297
Long-term deferred revenue..................................... (25,453) (2,986) (17,747)
Other.......................................................... (1,967) (3,181) (1,654)
---------- ------------- ----------
Net cash used in operating activities.............................. (42,006) (12,159) (122,364)
Financing activities
Proceeds from long-term debt....................................... -- -- 12,586
Payments on and purchase of long-term debt......................... (20,098) (3,900) (633,180)
Investment by Leucadia National Corporation........................ -- 150,000 --
Proceeds from issuance of common stock, net of expenses............ -- -- 9,452
Debt issue costs................................................... -- -- (531)
Preferred stock dividends paid..................................... -- -- (4,161)
---------- ------------- ----------
Net cash provided by (used in) financing activities................ (20,098) 146,100 (615,834)
5
WILTEL COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
Successor Company Predecessor Company
--------------------------- -------------
Period from
January 1, Two Months Ten Months
2003 through Ended Ended
November 5, December 31, October 31,
2003 2002 2002
---- ---- ----
(In thousands)
Investing activities
Property, plant and equipment:
Capital expenditures............................................. (47,530) (6,434) (76,903)
Proceeds from net tax refunds, settlements and sales............. 32,671 1,130 48,473
Changes in accrued liabilities................................... (12,533) (5,585) (82,484)
Proceeds from sale of consolidated subsidiary...................... 19,575 -- --
Restricted investments............................................. (13,081) -- --
Purchase of investments............................................ -- -- (220,209)
Proceeds from sales of investments................................. -- 630 1,121,796
Other.............................................................. -- -- (907)
---------- --------- ---------
Net cash provided by (used in) investing activities................ (20,898) (10,259) 789,766
---------- --------- ---------
Increase (decrease) in cash and cash equivalents................... (83,002) 123,682 51,568
Cash and cash equivalents at beginning of period................... 291,288 167,606 116,038
---------- --------- ---------
Cash and cash equivalents at end of period........................ $ 208,286 $ 291,288 $ 167,606
========== ========= =========
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 the
period prior to November 1, 2002 is 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 for the ten months ended October 31, 2002
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. 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
13
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Total Assets
-----------------
Successor Company
---------------
As of
November 5,
2003
-----------
(In thousands)
Network.................................. $1,433,578
Vyvx..................................... 54,246
Other.................................... 307,738
----------
Total assets........................... $1,795,562
==========
The following geographic area data includes revenues from external
customers based on origin of services rendered and long-lived assets based upon
physical location for the following periods.
Successor Company Predecessor Company
-------------------------------- ----------------
Period from
January 1, 2003 Two Months Ten
through Ended Months Ended
November 5, December 31, October 31,
2003 2002 2002
---------------- ------------ ------------
(In thousands)
Revenues from external customers:
United States..............................$ 1,062,387 $ 179,328 $ 943,451
Other....................................... 49,028 12,328 56,556
------------ ---------- ----------
Total.......................................$ 1,111,415 $ 191,656 $1,000,007
============ ========== ==========
Successor
Company
--------------
As of November 5,
2003
---------------
(In thousands)
Long-lived assets:
United States........................$ 1,230,613
Other................................ 6,130
------------
Total..................................$ 1,236,743
============
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.
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.
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.
4. Investing Income
Predecessor Company
Marketable equity securities
Certain marketable equity securities were sold for proceeds of $7.0 million
for the ten months ended October 31, 2002. Gross realized gains of $0.7 million
were recognized for the ten months ended October 31, 2002.
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 for the ten months ended
October 31, 2002.
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 $16.8 million of non-recurring, non-operating gains primarily related
to the termination of arrangements previously accrued as unfavorable commitments
in fresh start accounting and recoveries of various receivables previously
written off.
16
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7. Benefit (Provision) from Income Taxes
The benefit (provision) from income taxes includes:
Successor Company Predecessor Company
-------------------------------- ---------------
Period from
January 1, 2003 Two Months Ten
through Ended Months Ended
November 5, December 31, October 31,
2003 2002 2002
---------------- ------------ ------------
(In thousands)
Current:
Federal........................................$ -- $ -- $ --
State.......................................... (23) (3) (25)
------- ------- ---------
(23) (3) (25)
Deferred:
Federal........................................ -- -- (850)
State.......................................... -- -- (155)
------- ------- ---------
-- -- (1,005)
------- ------- ---------
Total provision from income taxes................$ (23) $ (3) $ (1,030)
======= ======= =========
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
November 5, December 31, October 31,
2003 2002 2002
---------------- ------------ ------------
(In thousands)
United States.................................. $(127,993) $ (60,625) $ 1,146,955
Foreign........................................... 19,270 (421) 185,270
--------- ---------- ------------
Total income (loss) before income taxes........ $(108,723) $ (61,046) $ 1,332,225
========= ========== ============
The Company's undistributed earnings from non U.S. subsidiaries in 2003
and 2002 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
November 5, December 31, October 31,
2003 2002 2002
---------------- ------------ ------------
(In thousands)
Benefit (provision) at statutory rate............$ 38,053 $ 21,366 $(466,279)
Increases (reductions) resulting from:
State income taxes............................. (15) -- (119)
Foreign operations............................. 6,745 (147) 64,845
Non-deductible reorganization expenses......... (1,750) (566) (11,736)
Valuation allowance adjustments................ (42,913) (19,920) (964,313)
Non-taxable gain on debt discharge, net........ -- -- 1,377,623
Other-- net................................... (143) (736) (1,051)
--------- ---------- ----------
Provision from income taxes......................$ (23) $ (3) $ (1,030)
========= ========== ==========
Significant components of deferred tax assets and liabilities are as follows:
Successor Company
--------------------
As of
November 5,
2003
----------
(In thousands)
Deferred tax assets:
Deferred revenues.................................................. $ 76,895
Property, plant and equipment, including impairments................. 633,820
Investments, including impairments................................... 90,104
Other asset impairments.............................................. 151,962
Reserves............................................................. 60,726
Net operating loss carryforward...................................... 1,281,030
Other................................................................ 6,136
-----------
2,300,673
-----------
Valuation allowance.................................................... (2,300,673)
-----------
Net ................................................................... $ --
============
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 $200,000.
WilTel also has an unfunded other postretirement benefit plan covering
employees who were employed prior to January 1, 1992. This health care plan is
contributory with participants' contributions adjusted annually. Benefits are
paid to eligible employees with 10 years of service and aged 55 years or older
when leaving the company.
Obligations and Funded Status
The following table presents the changes in benefit obligations and plan
assets for pension benefits and other postretirement benefits for the WilTel
Plans for the periods indicated. It also presents a reconciliation of the funded
status of these benefits to the amount recognized in the accompanying
consolidated balance sheet.
19
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Pension Benefits
----------------------
Successor Company
----------------------
Period from
January 1,
2003 through
November 5,
2003
----
Change in benefit obligation:
Benefit obligation at beginning of period.........................$ 97,812
Service cost...................................................... 5,090
Interest cost..................................................... 6,556
Actuarial (gain) loss............................................. 15,470
Benefits paid..................................................... (4,777)
----------
Benefit obligation at end of period................................. 120,151
----------
Change in plan assets:
Fair value of plan assets at beginning of period.................. 57,360
Actual return on plan assets...................................... 9,298
Employer contribution............................................. 3,245
Benefits paid..................................................... (4,777)
----------
Fair value of plan assets at end of period.......................... 65,126
----------
Funded status....................................................... (55,025)
Unrecognized net actuarial gain..................................... (818)
----------
Net accrued benefit cost............................................$ (55,843)
==========
Amounts recognized in the Consolidated Balance Sheet consist
of:
Accrued benefit cost $ (56,501)
Accumulated other comprehensive income (before tax) 658
----------
Net accrued benefit cost $ (55,843)
==========
Accumulated benefit obligation $ 119,797
==========
20
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Other Postretirement Benefits
------------------------------
Successor Company
---------------------
Period from
January 1,
2003 through
November 5,
2003
----
Change in benefit obligation:
Benefit obligation at beginning of period.........................$ 2,033
Service cost...................................................... 111
Interest cost..................................................... 92
Plan participants' contributions.................................. 15
Actuarial gain.................................................... (767)
Benefits paid..................................................... (42)
------------
Benefit obligation at end of period................................. 1,442
------------
Change in plan assets:
Employer contribution............................................. 27
Plan participants' contributions.................................. 15
Benefits paid..................................................... (42)
------------
Fair value of plan assets at end of period.......................... --
------------
Funded status....................................................... (1,442)
Unrecognized net actuarial gain..................................... (749)
------------
Net accrued benefit cost............................................$ (2,191
============
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
November 5, December 31, October 31,
2003 2002 2002
---------------- ------------ ------------
(In thousands)
Components of net period pension expense:
Service cost..............................................$ 5,090 $ 897 $ 4,535
Interest cost.............................................. 6,556 1,229 5,754
Expected return on plan assets............................. (3,688) (731) (6,404)
Amortization of prior service credit....................... -- -- 72
Recognized net actuarial gain.............................. -- -- 129
Curtailment charge (credit)................................ -- (2,727) 246
-------- ---------- ---------
Net periodic pension expense (income)................. 7,958 (1,332) 4,332
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
======== ========== =========
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
November 5, December 31, October 31,
2003 2002 2002
---------------- ------------ ------------
(In thousands)
Components of net periodic postretirement benefit expense:
Service cost..............................................$ 111 $ 18 $ 112
Interest cost............................................. 92 28 144
Amortization of prior service credit...................... -- -- 52
Recognized net actuarial (gain) loss...................... (18) -- 3
Curtailment charge (credit)............................... -- (554) 8
-------- --------- ---------
Net periodic pension expense........................... 185 (508) 319
Fresh start valuation adjustment......................... -- -- 274
-------- --------- ---------
Total postretirement cost..............................$ 185 $ (508) $ 593
======== ========= =========
Assumptions
The following are the weighted-average assumptions used to determine
pension benefit obligations as of the measurement date indicated:
Pension Benefit Obligation
--------------------------
Successor Company
---------------------
November 5,
2003
----
Discount rate................................................. 6.25%
Rate of compensation increase................................. 3.50%
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
November 5, December 31, October 31,
2003 2002 2002
---- ---- ----
Discount rate................................................. 6.75% 6.75% 7.50%
Expected return on plan assets................................ 7.00% 7.00% 9.50%
Rate of compensation increase................................. 3.50% 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
------------------------------
Successor Company
-----------------
Period from
January 1,
2003 through
November 5,
2003
----
Discount rate.................................................. 6.25%
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
November 5, December 31, October 31,
2003 2002 2002
---- ---- ----
Discount rate.....................................................6.75% 6.75% 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
November 5, December 31, October 31,
2003 2002 2002
---- ---- ----
Equity securities:
Large cap stocks.........................34% 25% 27%
Small cap stocks.........................23% 21% 20%
International stocks.....................21% 29% 29%
--- --- ---
Total equity securities................78% 75% 76%
Fixed income/bonds ..........................22% 25% 24%
--- --- ---
Total................................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 and $9.0 million for the period from January 1, 2003
through November 5, 2003, for the two months ended December 31, 2002 and for the
ten months ended October 31, 2002, 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
Depreciable November 5,
Lives* 2003
------ ----
(In years) (In thousands)
Network equipment (including fiber, optronics and
capacity IRUs)...................................................3-20 $ 958,077
Right-of-way...................................................... 20 127,439
Buildings and leasehold improvements............................10-30 140,915
Computer equipment and software..................................2-3 130,629
General office furniture and fixtures............................5-8 43,468
Construction in progress.....................................Not.applicable 28,949
Other...........................................................Various 48,555
-----------
1,478,032
Less accumulated depreciation and amortization................... (241,289)
-----------
$ 1,236,743
===========
*As of November 5, 2003
Depreciation expense of $205.6 million, $43.8 million and $461.0 million
was recorded for the period from January 1, 2003 through November 5, 2003, for
the two months ended December 31, 2002 and for the ten months ended October 31,
2002, 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 amount of these credit balances
included in accounts payable was $19.5 million as of November 5, 2003.
Accrued liabilities consisted of the following:
Successor Company
As of
November 5,
2003
-----------
(In thousands)
Litigation............................................................. $ 82,576
Employee costs......................................................... 27,076
Taxes, other than income taxes........................................ 30,870
Unfavorable contractual commitments................................... 18,702
Other.................................................................. 28,532
-----------
$ 187,756
===========
Other noncurrent liabilities consisted of the following:
Successor Company
As of
November 5,
2003
-----------
(In thousands)
Employee costs........................................................ $ 64,585
Unfavorable contractual commitments.................................. 39,246
Other................................................................ 31,993
-----------
$ 135,824
===========
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
November 5,
2003
----
(In thousands)
Beginning balance............................ $ 26,270
Liabilities incurred......................... 473
Liabilities settled.......................... (197)
Accretion expense............................ 2,886
Revisions in estimated cash flows............ (975)
-----------
$ 28,457
===========
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 ten months
ended October 31, 2002 would have been $2.5 million.
12. Debt
Long-term debt consisted of the following:
Weighted Successor Company
Average As of
Interest November 5,
Rate* 2003
----- ----
(In thousands)
Exit Credit Agreement....................................... 5.7% $ 375,000
OTC Notes................................................... 8.1% 119,249
Other, primarily capital leases............................. 10.8% 12,518
---------
506,767
Less current maturities..................................... (4,021)
---------
Long-term debt............................................. $ 502,746
=========
* 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 and $115.7 million for the period from January 1, 2003 through
November 5, 2003, for the two months ended December 31, 2002 and for the ten
months ended October 31, 2002, respectively. These payments include commitment
fees relating to the Company's credit facility of $1.1 million, $0.1 million and
$6.2 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 , 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 $42.9 million in 2002 as a result of this transaction.
As discussed in Note 19, pursuant to the terms of the Plan, all of WCG's
Class A common stock was cancelled and 50 million shares of WilTel common stock
was issued upon emergence from the chapter 11 proceedings. In addition, certain
transfer restrictions apply to transactions in WilTel common stock as discussed
in Note 19.
29
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
14. Accumulated Other Comprehensive Income
The table below presents changes in the components of accumulated other
comprehensive income (loss).
Unrealized Foreign
Appreciation Currency Minimum
(Depreciation) Translation Pension
of Securities Adjustments Liability Total
------------- ----------- --------- -----
(In thousands)
Predecessor Company:
Balance as of December 31, 2001............................$ 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)
=========== ========= =========== ==========
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 and $92.1
million for the period from January 1, 2003 through November 5, 2003, the two
months ended December 31, 2002 and the ten months ended October 31, 2002,
respectively. All other rent expense was $29.2 million, $6.4 million and $42.2
million for the period from January 1, 2003 through November 5, 2003, the two
months ended December 31, 2002 and the ten months ended October 31, 2002,
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 and 47 percent
of Network's revenues for the period from January 1, 2003 through November 5,
2003 and the year ended December 31, 2002, 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
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