SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 2005
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from ___________ to
___________
Commission file number: 1-5721
LEUCADIA NATIONAL CORPORATION
(Exact Name of Registrant as Specified in its Charter)
New York 13-2615557
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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
(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
7-3/4% Senior Notes due August 15, 2013 New York Stock Exchange
7-7/8% Senior Subordinated Notes due October 15, 2006 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None.
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [x] No [ ]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [x]
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [x].
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large Accelerated Filer [x] Accelerated Filer [ ] Non-Accelerated Filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [x]
Aggregate market value of the voting stock of the registrant held by
non-affiliates of the registrant at June 30, 2005 (computed by reference to the
last reported closing sale price of the Common Shares on the New York Stock
Exchange on such date): $3,130,796,000.
On February 23, 2006, the registrant had outstanding 108,072,508 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
2006 annual meeting of shareholders of the registrant are incorporated by
reference into Part III of this Report.
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 manufacturing, healthcare services, telecommunications,
real estate activities, winery operations and residual banking and lending
activities that are in run-off. The Company also owns equity interests in
investment partnerships and in operating businesses which are accounted for
under the equity method of accounting, including development of a copper mine in
Spain, real estate activities and property and casualty reinsurance operations.
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 out of favor or troubled 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
$3,661,900,000 at December 31, 2005, equal to a book value per common share of
the Company (a "common share") of negative $.07 at December 31, 1978 and $33.90
at December 31, 2005. The significant increase in shareholders' equity during
2005 reflects both profitable results of operations and the recognition of
$1,135,100,000 of the deferred tax asset that was deemed to be realizable.
Shareholders' equity and book value per share amounts have also been reduced by
the $811,900,000 special cash dividend paid in 1999.
In December 2005, the Company sold its largest telecommunications
subsidiary, WilTel Communications Group, LLC ("WilTel"), to Level 3
Communications, Inc. ("Level 3") for aggregate cash consideration of
$460,300,000 (net of estimated working capital adjustments) and 115,000,000
newly issued shares of Level 3 common stock (valued at $339,300,000 on the
closing date). In connection with the sale, the Company retained certain assets
and liabilities of WilTel that were not purchased by Level 3, which assets and
liabilities had a net book value of $254,000,000 on the closing date. The
retained assets included all of WilTel's right to receive certain cash payments
from SBC Communications Inc. ("SBC") totaling $236,000,000, of which $37,500,000
had been received prior to closing. In the aggregate, the Company received value
of $833,500,000 from the sale of WilTel, including the consideration paid by
Level 3 and the net book value of the retained assets and liabilities, but
reduced by a $220,000,000 capital contribution made to WilTel in 2005 to enable
WilTel to repay its debt obligations. The Company recorded a pre-tax gain on the
sale of WilTel of $243,800,000. For more information, see Note 5 of Notes to
Consolidated Financial Statements.
The agreement with Level 3 requires that all parties make the appropriate
filings to treat the purchase of WilTel as a purchase of assets for federal,
state and local income and franchise tax purposes. As a result, WilTel's net
operating tax loss carryforwards ("NOLs"), as well as any tax losses generated
by the sale, remained with the Company. As of December 31, 2005, the Company has
approximately $5,100,000,000 of NOLs, which are available to reduce the federal
income taxes that would otherwise be payable on that amount of pre-tax income in
the future (a potential federal tax savings of approximately $1,800,000,000).
The amount and availability of the NOLs are subject to certain qualifications,
limitations and uncertainties as discussed in Note 16 of Notes to Consolidated
Financial Statements and Item 7, Management's Discussion and Analysis of
Financial Condition and Results of Operations.
During 2005, the Company recorded net security gains of approximately
$208,800,000, principally from the sale of publicly traded debt and equity
securities that had been classified as available for sale securities. Net
security gains include $146,000,000 from the sale of the Company's entire equity
interest in White Mountains Insurance Group, Ltd. ("WMIG"). The Company acquired
the 375,000 common shares of WMIG in a private transaction in 2001 for
$75,000,000.
2
The manufacturing operations are conducted through Idaho Timber
Corporation ("Idaho Timber") and the Company's plastics manufacturing segment.
In May 2005, the Company acquired Idaho Timber for total cash consideration of
$133,600,000, including working capital adjustments and expenses. Idaho Timber
is headquartered in Boise, Idaho and primarily remanufactures dimension lumber
and remanufactures, packages and/or produces other specialized wood products.
The Company's plastics 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 plastics manufacturing segment increased its product offerings and customer
base through the purchase of the assets of NSW, LLC U.S. ("NSW") for
$26,600,000, including working capital adjustments.
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 and speech therapy services, healthcare staffing services and
Medicare consulting services.
The Company's telecommunications operations are principally conducted
through ATX Communications, Inc. ("ATX"). Upon the effectiveness of its
bankruptcy plan in April 2005, ATX became a majority owned subsidiary of the
Company and has been consolidated since that date. ATX is an integrated
communications provider that offers telephone, data, Internet and other services
principally to small to medium sized businesses in the Mid-Atlantic region of
the United States. The aggregate purchase price for ATX was $56,300,000, which
includes the cost of claims purchased prior to its bankruptcy filing, all
financing provided to ATX by the Company and acquisition expenses.
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. In May 2005, the Company sold its 716-room Waikiki Beach hotel for net
cash proceeds of approximately $73,000,000 and recorded a pre-tax gain of
$56,600,000 (reflected in gain on disposal of discontinued operations).
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.
During 2005, the Company's banking and lending operations sold its
remaining customer deposits and surrendered its national bank charter. Residual
operating activities are concentrated on collecting and servicing the remaining
loan portfolio.
The Company owns 30% of Cobre Las Cruces, S.A. ("CLC"), a former
subsidiary of the Company that holds the exploration and mineral rights to the
Las Cruces copper deposit in the Pyrite Belt of Spain. During 2005, the Company
sold a 70% interest in CLC to Inmet Mining Corporation ("Inmet"), a
Canadian-based global mining company, in exchange for 5,600,000 newly issued
Inmet common shares, representing approximately 11.7% of the outstanding Inmet
common shares immediately following completion of the transaction. The Inmet
shares were recorded at their fair value at the time of the transaction of
approximately $78,000,000, and the Company recorded a pre-tax gain on the sale
of $10,500,000.
During 2005, the Company sold its non-controlling equity interests in an
office complex located on Capitol Hill in Washington, D.C. Including repayment
of its mortgage loans at closing, the Company's share of the net proceeds was
$73,200,000, and the Company recognized a pre-tax gain of $72,300,000.
The Company's property and casualty reinsurance equity investment is
conducted through its 20% common stock interest in Olympus Re Holdings, Ltd.
("Olympus"), a Bermuda reinsurance company primarily engaged in the property
excess, marine and aviation reinsurance business. During 2005, Olympus recorded
significant losses from hurricanes Katrina, Rita and Wilma; the sum of the
Company's share of Olympus' losses under the equity method of accounting plus an
impairment loss aggregated $123,800,000 during 2005. In early 2006, Olympus
raised new equity capital (in which the Company did not participate), that will
dilute the Company's interest such that it will not apply the equity method of
accounting for this investment subsequent to December 31, 2005.
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.
3
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 (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, 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 17, 2005,
certifying that he is not aware of any violations by the Company of NYSE
corporate governance listing standards.
The Company's website address is 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.
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
manufacturing operations are conducted through Idaho Timber and its plastics
manufacturing segment. Idaho Timber primarily remanufactures, manufactures
and/or distributes wood products. The Company's plastics manufacturing
operations manufacture and market lightweight plastic netting used for a variety
of purposes. The Company's healthcare services operations provide physical,
occupational and speech therapy services, healthcare staffing services and
Medicare consulting services. The Company's telecommunications operations are
principally conducted through ATX, an integrated communications provider that
offers a wide range of telecommunication services in the Mid-Atlantic region of
the United States. 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 the Company's wineries and
residual banking and lending activities that are in run-off.
Associated companies include equity interests in entities that the
Company accounts for on the equity method of accounting. Investments in
associated companies include 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"), EagleRock
Capital Partners (QP), LP ("EagleRock"), CLC and Olympus. 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, which is the only foreign operation
with non-U.S. revenue or assets that the Company consolidates, and it is not
material. In addition to its investment in Bermuda-based Olympus, the Company
owns 36% of Light and Power Holdings Ltd., the parent company of the principal
electric utility in Barbados, and an interest, through its 30% ownership of CLC,
in a copper deposit in Spain. 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.
Certain information concerning the Company's segments for 2005, 2004 and
2003 is presented in the following table. Consolidated subsidiaries are
reflected as of the date of acquisition, which was September 2003 for Symphony,
April 2005 for ATX and May 2005 for Idaho Timber. Associated Companies are only
reflected in the table below under identifiable assets employed.
4
2005 2004 2003
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(In millions)
Revenues and other income (a):
Manufacturing:
Idaho Timber $ 239.0 $ -- $ --
Plastics 93.6 64.4 54.1
Healthcare Services 239.9 258.4 71.1
Telecommunications 111.4 -- --
Domestic Real Estate 29.8 63.5 50.4
Other Operations 59.1 70.8 95.6
Corporate (b) 268.3 180.9 42.5
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Total consolidated revenues and other income $ 1,041.1 $ 638.0 $ 313.7
========= ========= =========
Income (loss) from continuing operations before income taxes, minority expense
of trust preferred securities and equity in income (losses) of associated
companies:
Manufacturing:
Idaho Timber $ 8.2 $ -- $ --
Plastics 14.2 7.9 4.4
Healthcare Services 3.3 5.1 (2.3)
Telecommunications (1.9) -- --
Domestic Real Estate 4.1 20.7 18.1
Other Operations 6.1 18.6 9.1
Corporate (b) 101.9 59.6 (37.5)
Elimination (c) 2.3 -- --
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Total consolidated income (loss) from continuing operations before
income taxes, minority expense of trust preferred securities and
equity in income (losses) of associated companies $ 138.2 $ 111.9 $ (8.2)
========= ========= =========
Identifiable assets employed:
Manufacturing:
Idaho Timber $ 162.7 $ -- $ --
Plastics 81.9 50.4 50.8
Healthcare Services 55.5 65.6 54.6
Telecommunications 88.6 -- --
Domestic Real Estate 182.7 253.2 275.8
Other Operations 252.0 403.7 505.8
Investments in Associated Companies 375.5 460.8 430.9
Corporate 4,062.0 2,070.1 1,456.9
Assets of discontinued operations -- 1,496.6 1,622.4
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Total consolidated assets $ 5,260.9 $ 4,800.4 $ 4,397.2
========= ========= =========
5
(a) Revenues and other income for each segment include amounts for services
rendered and products sold, as well as segment reported amounts classified
as investment and other income and net securities gains on the Company's
consolidated statements of operations.
(b) Net securities gains for Corporate aggregated $199,500,000, $123,100,000
and $10,100,000 during 2005, 2004 and 2003, respectively, which primarily
resulted from the sale of publicly traded debt and equity securities that
had been classified as available for sale securities. Security gains in
2005 include a gain from the sale of WMIG of $146,000,000. For 2005 and
2004, security gains include provisions of $12,200,000 and $4,600,000,
respectively, to write down investments in certain available for sale
securities. For 2003, security gains include a provision of $6,500,000 to
write down investments in certain available for sale securities and an
investment in a non-public security. The write downs of the available for
sale securities resulted from declines in market value determined to be
other than temporary.
(c) Eliminates services purchased by ATX from WilTel and recorded as a cost of
sales by ATX.
(d) For the years ended December 31, 2005, 2004 and 2003, income (loss) from
continuing operations has been reduced by depreciation and amortization
expenses of $41,300,000, $29,400,000 and $29,100,000, respectively; such
amounts are primarily comprised of Corporate ($10,700,000, $11,400,000 and
$11,700,000, respectively), manufacturing ($14,200,000, $5,200,000 and
$4,700,000, respectively), other operations ($5,500,000, $6,900,000 and
$7,800,000, respectively) and telecommunications ($7,500,000 in 2005).
Depreciation and amortization expenses for other segments are not material.
(e) For the years ended December 31, 2005, 2004 and 2003, income (loss) from
continuing operations has been reduced by interest expense of $68,400,000,
$62,700,000 and $37,900,000, respectively; such amounts are primarily
comprised of Corporate ($63,200,000, $55,300,000 and $26,000,000,
respectively), healthcare services ($2,800,000, $2,200,000 and $600,000,
respectively) and banking and lending, which is included in other
operations ($1,100,000, $2,700,000 and $8,800,000, respectively). Interest
expense for other segments is not material.
At December 31, 2005, the Company and its consolidated subsidiaries had
3,969 full-time employees.
Manufacturing
Idaho Timber
Business Description
In May 2005, the Company acquired Idaho Timber for total cash
consideration of $133,600,000, including working capital adjustments and
expenses. Idaho Timber is headquartered in Boise, Idaho and is engaged in the
manufacture and/or distribution of various wood products. Idaho Timber's
principal product lines include remanufacturing of dimension lumber;
remanufacturing, bundling and bar coding of home center boards for large
retailers; and producing of 5/4" radius-edge, pine decking. Idaho Timber also
manufactures or distributes a number of other specialty wood products. Idaho
Timber has over 25 years of operating experience in its industry.
Remanufactured dimension lumber is Idaho Timber's largest product line.
Dimension lumber is used for general construction and home improvement,
remodeling and repair projects, the demand for which is normally a function of
housing starts and home size. All dimension lumber is assigned a quality grade,
based on the imperfections in the wood, and higher-grade lumber is sold at a
higher price than lower-grade lumber. Idaho Timber purchases low-grade dimension
lumber from sawmills located in North America and Europe and upgrades it into
higher-grade dimension lumber products. The remanufacturing process includes
ripping, trimming and planing lumber to reduce imperfections and produce a
variety of lumber sizes. These products are produced at plants located in
Florida, North Carolina, Texas, Kansas, Idaho and New Mexico. Each plant
distributes its product primarily by truck to lumber yards and contractors
within a 300 mile shipping radius from the plant site.
6
Idaho Timber's next largest product line is home center board products,
which are principally sold to large home improvement retailers. Idaho Timber
purchases high-grade boards from sawmills in the western United States, South
America and New Zealand (primarily pine but other wood species are also used),
performs minor re-work on those boards to upgrade the quality, and then packages
and bar codes those boards according to customer specifications. Services
provided include managing delivery to off-site inventory positions at
customer-owned distribution centers near retail locations so that adequate stock
is available for the customers to draw upon when needed. Production takes place
in owned plants in Idaho and Montana, and goods are shipped nationwide by rail
and truck to customer-owned distribution centers. The sale is not completed and
revenue is not recognized until the customer takes the product from the
distribution center.
Idaho Timber also operates a sawmill in Arkansas that produces 5/4"
radius-edge, pine decking cut to a variety of lengths. Rights to cut timber are
purchased from private land owners located near the sawmill, known as timber
deeds, and Idaho Timber employs third-party contractors to cut the timber and
transport the logs to the sawmill. Logs are also acquired in the spot market
(gate logs) when trucks loaded with logs arrive at the sawmill, are inspected
for quality and purchased if an agreement can be reached on price. Idaho Timber
performs traditional sawmill processes (cutting, drying and planing) to
manufacture the final product. The product is shipped to various regions
throughout the central and eastern parts of the United States via truck and rail
to lumber treaters and others for resale to the final consumer.
Idaho Timber's profitability is dependent upon its ability to manage
manufacturing costs and process efficiency, minimize capital expenditures
through the purchase of used, lower-cost equipment and repairing its existing
equipment, and effective management of the spread between what it pays for
dimension lumber and boards and the selling prices of the remanufactured
products. Selling prices for remanufactured products may rise quicker than
supplier prices in strong markets creating greater spread; however, during
periods of declining product demand and reduced selling prices, supply price
declines may lag behind resulting in lower spreads. Idaho Timber's business is
generally not seasonal, except in those locations that have weather related
construction slowdowns.
The dimension lumber product does not require significant build up of
inventory to cover peak periods of activity, nor are there any other unusually
significant needs for working capital. Home center board products experience a
longer cycle to convert raw material to product sales due to cross country
shipping and consignment inventory programs, resulting in an investment in
working capital. Working capital requirements are greater for the sawmill
operation. In addition to cash outlays for timber deeds, the sawmill will have a
seasonal build up of log inventory.
Idaho Timber owns nine plants, one sawmill that principally produces
decking products and one sawmill that produces split-rail fencing. These eleven
facilities in the aggregate have approximately 939,000 square feet of
manufacturing and office space, covering approximately 230 acres. Two plants are
principally dedicated to home center board products and the remaining plants
principally produce remanufactured dimension lumber products. All plant
locations can produce and distribute specialty wood products. Idaho Timber has
the capacity to ship approximately 70 million board feet per month; during 2005
actual shipments averaged approximately 62 million board feet per month.
Idaho Timber believes that its diverse remanufacturing, sawmill, and
distribution operations provide it with purchasing power to secure sources of
supply from multiple suppliers while minimizing freight costs. Idaho Timber's
diverse geographic footprint also mitigates geographic concentration risk.
7
Sales and Marketing
Idaho Timber primarily markets to local, regional and national lumber
retailers for its dimension lumber products, home improvement centers for its
home center board products and decking treaters for its sawmill product, and
other resellers of home construction materials. Demand for its products is
dependent, in part, upon the strength of the U.S housing market and the
do-it-yourself home improvement market which are subject to cyclical
fluctuations. Its success in attracting and retaining customers depends in large
part on its ability to provide quicker delivery of specified customer products
than its competitors. For dimension lumber products, sales are primarily
generated at each of the plants, with a dedicated sales force located in the
same geographic region as the customers the plant serves. Board and decking
products are sold and managed centrally. The home center board product is
heavily dependent on two customers, Lowe's and The Home Depot, which account for
approximately 90% of that product line. The combined revenue of these two
customers was 14% of Idaho Timber's total revenue for the period from
acquisition to December 31, 2005. The customer base for the dimension lumber
business is much less concentrated; no customer accounts for more than 5% of
revenue. Idaho Timber's sales are somewhat concentrated in regions where its
facilities are located, with the largest being Florida, 27%; North Carolina,
16%; and Texas, 13%.
Competition
Idaho Timber sells commodity products, and operates in an industry that
is currently oversupplied and very competitive. Idaho Timber competes against
domestic and foreign sawmills and intermediate distributors for its dimension
lumber and decking products. In some cases, Idaho Timber competes on a limited
basis with the same sawmills that are a source of supply of low-grade dimension
lumber. Foreign suppliers have been growing their sales in the U.S. market,
particularly European competitors, which has added to the current oversupply
condition in the industry and may continue to do so. The home center board
business has many competitors, and suppliers to large home centers are always
under pressure to reduce prices.
Idaho Timber also competes for raw material purchases needed for its
remanufactured dimension lumber and home center board products, and in the past
the availability and pricing of certain raw materials has been adversely
affected by import duties (tariffs) imposed on Canadian imports, the largest
source of these supplies. A decades old trade dispute between the U.S. and
Canada resurfaced with the expiration of the Softwood Lumber Agreement on March
31, 2001. The dispute involves claims that lumber from government-owned land in
Canada is subsidized and sold into the U.S. market for less than fair value, the
effect of which is to injure or threaten to injure U.S. competitors. In the
past, the U.S. has argued for the right to impose extra duties to prevent cheap
Canadian wood from harming U.S. manufacturers. However, the North American Free
Trade Agreement ("NAFTA") review panel rejected claims that U.S. lumber
producers had suffered damage as a result of Canadian imports. On September 10,
2004, the U.S. International Trade Commission complied with the NAFTA ruling and
issued a statement saying that the U.S. lumber industry is not threatened by
Canadian softwood imports; however, the Commission expressed some disagreement
with the panel's decision. There have been a number of challenges and appeals
made through various channels attempting to reverse NAFTA's decision. Currently,
restrictions on Canadian imports are not adversely affecting Idaho Timber's
operations; however, if tariffs increase or import limitations are imposed in
the future, it is possible that raw material costs could increase or supplies
could be constrained. Idaho Timber is examining alternative sources of supply to
increase its raw material purchasing flexibility.
Idaho Timber's manufacturing process is very labor intensive, and its
labor force is not unionized. Idaho Timber's low cost labor force allows it to
be competitive and flexible in its operating activities; however, its labor
force is in high demand in its own industry and also from non-industry
employers. If Idaho Timber is unable to continue to attract and retain a cost
efficient labor force, sales volumes and profitability could suffer.
Government Regulation
Lumber and decking are identified at Idaho Timber facilities with a grade
stamp that shows the grade, moisture content, mill number, species and grading
agency. All lumber is graded in compliance with the National Grading Rule for
Dimension Lumber, which is published by the U.S. Department of Commerce. Idaho
Timber facilities are subject to regular inspection by agencies approved by the
American Lumber Standards Committee. Idaho Timber believes that its procedure
for grading lumber is highly accurate; however, the company could be exposed to
product liability claims if it can be demonstrated its products are
inappropriately rated. Currently, Idaho Timber does not have any material
product liability claims outstanding.
Since Idaho Timber's sawmills do not treat its wood with chemicals, and
since timber deeds purchased from private land owners do not impose a
re-planting obligation, Idaho Timber does not have any unusual environmental
compliance issues.
8
Plastics Manufacturing
Business Description
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.
In February 2005, the Company acquired the assets of NSW for
approximately $26,600,000, thereby increasing its mix of products and customer
base. NSW has a manufacturing and distribution facility in Roanoke, Virginia,
and has generated revenues of approximately $17,500,000 for the period from
acquisition to December 31, 2005. Although the Company has integrated 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.
Certain of the division's products are proprietary, protected by patents
and/or trade secrets. 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.
Sales and Marketing
Plastics manufacturing revenues were $93,300,000, $64,100,000 and
$53,300,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
Products are marketed both domestically and internationally, with approximately
11% of 2005 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. 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 is now also 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.
Competition
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 85% from 2002. The
division has been able to raise prices to its customers during this period but
the contribution margin percentage has dropped by 6% as a result of higher raw
material costs. 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 few years.
The plastics division has had excess manufacturing capacity, principally
in its Belgium facility which became operational during 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. However,
operating results at the facility have improved, as sales grew 67% in 2005 as
compared to 2003 and the business achieved positive cash flow during 2004. In
addition, manufacturing production for customers in Australia and Asia has been
moved away from domestic facilities to the Belgium facility, thereby enabling
the domestic facilities to meet sales growth. In October 2005, the plastics
division acquired the manufacturing assets of a competitor for approximately
$4,300,000, and relocated and installed the equipment in the Belgium facility.
The asset acquisition is expected to increase sales in the filtration, packaging
and agricultural markets at the Belgium facility.
9
Healthcare Services
Business Description
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 1,650 locations through its
employee workforce of approximately 2,900 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, NurseWorks and Polaris Group. The Company has consolidated
Symphony in its financial statements since it was acquired in September 2003.
The principal services offered by Symphony are described below.
o Contract Therapy Services - Physical therapy, occupational
therapy and speech pathology 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 ("CMS"). 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.
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.
10
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 CMS 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 a Medicare Part A prospective
payment system for skilled nursing facilities based on the category of patient
care under the resource utilization group classifications ("RUGs") established
by CMS. The 2006 Prospective Payment System and Consolidated Billing for Skilled
Nursing Facilities Final Rule refined the RUGs system to more appropriately
reimburse providers for patients requiring extensive nursing and rehabilitative
services. Nine new categories were added and the nursing case-mix index was
shifted such that the nursing component of the per diem increased, while the
rehab component (the services Symphony provides) remained unchanged. To the
extent that Symphony's customer contracts link billing for services with the
RUGs classification, revenues could be adversely impacted even though a patient
may require the same level of care. Although Symphony has successfully
renegotiated many of its contracts with respect to this matter, Part A revenues
for certain customers could decline.
On January 1, 2006, most Medicare Part B therapy services became subject
to an annual limitation per beneficiary of $1,740 for physical therapy and
speech-language pathology and $1,740 for occupational therapy services. However,
the Deficit Budget Reconciliation Act that was enacted in February 2006 mandated
the development of an exception process to permit services above these
limitations for services deemed medically appropriate, retroactive to January 1,
2006. On February 17, 2006, CMS published three Change Request Transmittals
("Guidance"), which detail the process by which beneficiaries may obtain
exceptions to the cap limitation. The process is to be fully implemented no
later than March 13, 2006. Under the Guidance CMS published, the majority of
Symphony's patients will qualify for an automatic exception to the therapy cap
limits. Those who do not qualify for the automatic exception are still eligible
to obtain a manual exception, subject to CMS approval. While the exception
process was under development, it created uncertainty among Symphony's staff and
customers which limited Symphony's services to Part B patients. Symphony is
currently training operating and clinical staff on the new exception process, so
that services can be provided when medically necessary.
11
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. Symphony is currently in compliance with these standards.
Telecommunications
Acquisition
The Company purchased all of ATX's debt obligations under its senior
secured credit facility for $25,000,000 in December 2003, and ATX commenced a
voluntary Chapter 11 case to reorganize its financial affairs shortly
thereafter. The bankruptcy plan (the "Plan") of ATX was confirmed by the
Bankruptcy Court for the Southern District of New York and became effective on
April 22, 2005. As contemplated by the Plan, in exchange for its investment in
the credit facility the Company received approximately 90% of the new common
stock of the reorganized ATX, a new $25,000,000 senior secured 10% note, and the
Company provided ATX with $30,000,000 of additional financing. The aggregate
purchase price for ATX was $56,300,000, which includes all the financing
provided by the Company and acquisition expenses. The Company has consolidated
ATX since the effective date of the Plan.
Business
ATX is an integrated communications provider that offers customers a full
range of communications services, including local and long distance telephone
services, data and Internet services, web development, collocation and managed
services. Additionally, ATX provides conference calling, travel services,
enhanced fax and Web-based billing. ATX's target market is small to medium sized
enterprises located in the Mid-Atlantic region of the U.S.
The Telecommunications Act of 1996 (the "Telecom Act") established a
framework for creating competition in the local and long distance
telecommunications markets. At that time, most local markets received services
from one dominant local service provider, known as the Incumbent Local Exchange
Carrier ("ILEC"), who typically owned the entire infrastructure necessary to
provide local telecommunication services to businesses and consumers. As a
result of the Telecom Act, ATX and others were able to use or purchase various
components of an ILEC's network and infrastructure, referred to as Unbundled
Network Elements ("UNE"s), Unbundled Network Element Platform ("UNE-P") and
enhanced extended loops ("EEL"s), at favorable cost-based rates that were
subject to the jurisdiction of the Federal Communications Commission ("FCC").
UNE-P is a combination of a loop (the part of an ILEC's telephone network that
connects their central office to a customer), local switching and transport.
EELs are typically a combination of UNEs, loops and local transport that ATX
uses to provide service to its customers. ATX, which is known as a Competitive
Local Exchange Carrier ("CLEC"), would not be able to provide existing local
services to its customers without the right and ability to purchase UNEs and
EELs from the ILEC at reasonable rates.
ATX owns certain equipment and facilities which enable it to reduce the
cost of the components it would otherwise have to purchase from an ILEC. ATX
currently owns and operates five carrier class switches in Philadelphia,
Pennsylvania and Herndon, Virginia that provide a combination of local, long
distance, and Voice-over-Internet Protocol ("VoIP") services, which connect
calls to the public switched telephone network. These switches are connected via
transport purchased from an ILEC or other competitive network providers. ATX
connects its network to the networks of the ILEC and other third party providers
through collocations, which gives it the ability to service customers inside of
its immediate network area via ATX's switches.
ATX's principal products and services include the following:
CoreConnect. CoreConnect provides ATX's business customers dedicated
local, long distance, toll, data and Internet access services bundled
over a multi-purpose broadband connection. Through this integrated
product, ATX is also able to offer additional products and services.
Local Telephone Services. Local telephone services include local dial
tone and a set of custom calling features that customers can tailor to
meet their needs. Calling features include automatic callback, busy line
transfer, call blocking, call forwarding, call waiting, caller ID with
name, multi-ring service, repeat dialing, remote access call forwarding,
and speed calling.
12
Long Distance Telephone Services. Long distance telephone services
include inbound/outbound service, international, toll free service and
calling card telephone service. ATX currently provides intrastate and
interstate long distance services nationwide and international
termination.
Network/Internet Services. ATX provides high-speed network/Internet
connectivity products to its customers.
Web Services/E-commerce. Web services include Web design, development and
hosting, electronic commerce, Intranet development, database integration,
Internet security, and collocation.
Consulting and Managed Network Services. ATX assists in the design,
construction, implementation and management of local and wide area
networks. Consulting services include wide area network architecture,
router and customer premise equipment configuration and virtual private
network design and implementation.
Wireless Services. ATX offers wireless services primarily as a customer
retention tool, consisting of both cellular and paging service.
CoreConnect, local and long distance telephone services currently account
for approximately 86% of ATX's revenues. For the period from acquisition to
December 31, 2005, ATX's revenues were concentrated in certain states,
principally Pennsylvania, 45%; New Jersey, 31%; Maryland, 6%; Virginia and
Washington D.C., 6%; and Delaware, 5%.
Some of ATX's telecommunication services are not connected to its network
or switches. For these services ATX may simply be a reseller of the ILECs
services, or a seller of UNE-P services. ATX typically provides these services
to customers in areas where ATX does not maintain network facilities or where
customers do not have sufficient line needs to qualify for CoreConnect. ATX's
margins for these services are typically lower than services provided on its
network. Recent regulatory action has increased the rates that ILECs can charge
for these services, which has forced ATX to raise its prices, adversely
impacting ATX's ability to remain competitive for these products. ATX expects
that its revenues for UNE-P and reseller services will decline over time. For
the period from acquisition through December 31, 2005, these services accounted
for approximately 22% of ATX's revenues.
Sales and Marketing
ATX's sales model is based on a consultative approach. Each sale begins
with a consultation that evaluates the needs of the prospective customer. ATX
then designs a tailored, integrated and cost-effective solution that addresses
the specific customer's communications needs. The average sales cycle is
approximately 90 days for customers with extensive and/or complex needs, and
approximately 30 days for smaller customers.
ATX has approximately 18,000 customers. ATX's customers are billed on a
single, consolidated invoice, delivered by traditional means. It does not depend
upon any single customer for any significant portion of its revenue. Neither
ATX's business nor the telecommunications industry is generally characterized as
having a material seasonal element and it does not expect the business or the
industry to become seasonal in the future.
Competition
The telecommunications industry is highly competitive, and is impacted by
regulatory changes, product substitution, technological advances, excess network
capacity and the entrance of new competitors. Competition for products and
services is based on price, quality, network reliability, service features and
responsiveness to customers' needs.
13
ATX faces competition from regional Bell operating companies such as
Verizon Communications, Inc. and AT&T, Inc., as well as other providers of
wireline telecommunications services, wireless telephone companies and VoIP
providers. In the local telephone markets, ATX's principal competitor is the
ILEC, which is usually Verizon. Verizon is also ATX's principal supplier of
UNEs, UNE-P and EELs. Wireless telephone companies have been taking market share
from providers of wireline voice communications. Cable television companies that
offer high-speed Internet access are expanding their offerings to voice based
telephone services.
Many facilities-based CLECs have committed substantial resources to
building their networks or to purchasing other industry participants with
complementary facilities. By building or purchasing a network or entering into
interconnection agreements or resale agreements with ILECs or long distance
carriers, a provider can offer a single source for local and long distance
services similar to those offered by ATX. Many of ATX's competitors have
substantially greater financial, personnel and other resources, with greater
flexibility and a lower cost structure than ATX. The completion of large mergers
within the telecommunications industry during the past year could result in
improved cost structures for ATX's competitors, which could result in
competitors offering lower prices.
Government Regulation
ATX is subject to significant federal, state and local 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 changes in response
to technological developments, competition, government policies and judicial
proceedings. 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 regulatory
authorities will not raise material issues regarding its compliance with
applicable laws and regulations.
The FCC has jurisdiction over ATX's facilities and services to the extent
those facilities are used to provide interstate telecommunications services.
State regulatory commissions generally have jurisdiction over facilities and
services to the extent the facilities are used in intrastate telecommunications
services. 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.
The implementation of the Telecom Act, the emergence of new technologies
and the financial distress of many in the telecommunications industry have
involved numerous industry participants, including ATX, in disputes, lawsuits,
proceedings and arbitrations before state and federal regulatory commissions,
private arbitration organizations, and federal and state courts. These issues
include the interpretation and enforcement of existing interconnection
agreements, the terms of new interconnection agreements, inter-carrier
compensation, access rates applicable to different categories of traffic, the
jurisdiction of traffic for inter-carrier compensation purposes, the services
and facilities available to ATX, the price that ATX will pay for those services
and facilities and the regulatory treatment of new technologies and services.
ATX anticipates that it will continue to be involved in various disputes,
lawsuits, arbitrations and proceedings over these and other material issues,
although no material litigation is currently pending. ATX anticipates that
further legislative initiatives and regulatory rulemaking will occur. Rulings
adverse to ATX, adverse legislation, new regulations or changes in governmental
policy on issues material to ATX could have a material adverse effect on ATX's
financial condition or results of its operations.
As a CLEC, the availability of services and facilities purchased from
ILECs and the rates ILECs can charge have a significant impact on ATX's
profitability. The enactment of the Telecom Act enabled ATX to purchase ILEC
services at favorable rates; however, certain subsequent regulatory action has
resulted in more flexibility for ILECs in determining what products and services
it provides and the rates it can charge. In certain instances, regulatory action
is shifting the determination of these rates from regulatory jurisdiction
towards commercial negotiation between the parties, generally resulting in ILEC
price increases. Some of these developments are discussed below.
14
The FCC Triennial Review Order
On August 21, 2003, the FCC released its Triennial Review Order ("TRO")
addressing the remand on UNEs and its statutorily mandated comprehensive
evaluation of UNEs, which was generally favorable to CLECs. In a portion of the
TRO, the FCC held that CLECs such as ATX could order new combinations of UNEs
and EELs, which in combination are the same elements that comprise higher priced
special access facilities. The TRO also held that CLECs could commingle UNEs and
UNE combinations with other wholesale services, including special access
services, and resold services. On March 2, 2004, the Court of Appeals issued a
decision reversing a substantial portion of the TRO. The Court vacated the FCC's
decision to order unbundling of mass market switches, special access facilities
and dark fiber dedicated transport. The Court found reasonable the specific EEL
eligibility standards pursuant to which CLECs may obtain high capacity EELs.
However, given the availability of special access, the Court expressed
skepticism that carriers using special access circuits to provide competitive
local exchange services were impaired without access to EELs, and remanded this
and other matters to the FCC for further consideration.
The FCC Triennial Review Remand Order
On remand, in February 2005, the FCC issued its Triennial Review Remand
Order ("TRRO") and adopted new rules, effective March 11, 2005. The FCC's TRRO
and rules govern the obligations of ILECs to provide access to certain of their
network elements, if at all, and the cost of such access. The TRRO for the most
part required that ILECs continue to provide competitors access to the high
capacity loops and UNEs that ATX uses. However, as discussed below the new rules
placed new conditions and limitations on the ILECs' obligation to unbundle these
elements. Moreover, the TRRO may have a material impact on ATX's future business
plans and operations, which can not be fully assessed until the new rates are
determined.
High Capacity Loops and Transport
The TRRO reduced the ILECs' obligation to provide high-capacity loops
within, and dedicated transport facilities between, certain ILEC central offices
that are deemed to be sufficiently competitive, based upon various factors such
as the number of fiber-based collocators and/or the number of business access
lines within such locations. In addition, certain caps are imposed regarding the
number of UNE facilities that a company, like ATX, may have on a single route or
into a single building. Where the central office conditions or the caps are
exceeded, the TRRO eliminated the ILECs' obligation to provide these
high-capacity circuits to competitors at the discounted rates historically
received under the Telecom Act. The rates charged by ILECs for ATX's
high-capacity circuits in place on March 11, 2005 that were affected by the
FCC's new rules were increased 15% for one year until March 2006, although the
scope of this increase is uncertain because the new FCC rules are subject to
interpretation by state regulatory agencies. In addition, by March 10, 2006, ATX
will be required to transition those existing circuits to alternative
arrangements, such as other competitive facilities or the higher priced special
access services offered by the ILECs, unless another rate has been negotiated.
Since March 11, 2005, any new circuits ATX orders were subject to the ILECs'
higher special access pricing in ILEC central offices that are deemed to be
sufficiently competitive, or that exceed the caps, subject to any contractual
protections under ATX's existing interconnection agreements. These rules will
increase the cost of new circuits in central offices meeting these criteria from
31% to 147%, depending upon the size of the circuit ordered and its location.
Entrance Facilities
On June 20, 2005, Verizon, which is ATX's principal ILEC supplier,
notified ATX and other CLECs of its intent, pursuant to the TRO and TRRO, to
eliminate its offering of Entrance Facilities at incremental cost-based pricing,
effective September 18, 2005. Entrance Facilities are used by ATX to obtain
access to unbundled elements it purchases from Verizon. In its notice Verizon
indicated that it would begin billing for Entrance Facilities at higher special
access rates if ATX has not re-provisioned the UNE Entrance Facilities to
alternative arrangements by September 18, 2005 (i.e., Verizon special access
term plans or alternative carriers). On July 13, 2005, ATX sent a letter to
Verizon indicating that it disagreed with Verizon's position and that the issue
was before Public Utility Commissions as part of the TRRO mandated arbitrations
to implement the FCC's new TRRO rules. ATX indicated that Entrance Facilities
could not be eliminated under the TRRO until March 11, 2006, and took the
position that Verizon was not permitted to eliminate the Entrance Facilities
prior to the conclusion of the arbitrations. ATX also argued that under the
TRRO, it was entitled to continue to use Entrance Facilities to purchase UNEs
until March 11, 2006, at existing UNE rates plus 15%.
15
On August 25, 2005, Verizon responded to ATX's letter stating that it
disagreed with ATX's position. In its letter, Verizon stated that it intended to
carry out its threat to discontinue Entrance Facilities effective September 18,
2005 and begin billing ATX for Entrance Facilities at Special Access rates,
although it provided a small exception for stand-alone dedicated transport in
Delaware and Maryland. To date, Verizon has not billed ATX at special access
rates but has indicated that it will back-bill ATX once its billing system is
capable of billing the changes.
On September 29, 2005, the Pennsylvania Public Utility Commission
("PAPUC") rejected Verizon's attempts to implement a tariff eliminating Entrance
Facilities. The PAPUC suspended operation of Verizon's tariff for six months or
until at least March 11, 2006, unless it acts on the matter in the arbitrations
prior to that time. This ruling is of particular importance to ATX because
approximately 60% of ATX's Entrance Facilities are located in Pennsylvania.
Verizon has appealed the PAPUC decision in federal court.
ATX and Verizon have been attempting to negotiate a resolution of this
dispute, but it is uncertain whether such a negotiated resolution will be
possible. ATX believes it has adequately accrued for any unbilled amounts and
has taken appropriate steps to eliminate its dependency on Verizon's Entrance
Facilities in the future.
Unbundled Local Switching
The TRRO determined that ILECs will no longer be required to provide
access to unbundled circuit switching capabilities, which previously allowed
CLECs to serve their customers by purchasing UNE-P at incremental cost-based
rates. The TRRO permitted ATX to continue purchasing existing UNE-P arrangements
for a period of one year after March 11, 2005, after which it has to either
convert the customers to other arrangements or discontinue serving them.
ATX began negotiations during 2005 with Verizon to establish an
alternative arrangement to provide service to its customers previously served
via UNE-P subsequent to March 2006. On December 21, 2005, ATX entered into a
wholesale contract with Verizon for its principal local service territory, which
will permit it to continue to provide service to its existing UNE-P customer
base, as well as provide service to new customers. The terms of the contract
will permit ATX to serve its customers previously served utilizing UNE-P with an
arrangement nearly identical to UNE-P; however, the contract required ATX to
begin paying increased charges per line to Verizon for the service retroactively
beginning September 1, 2005. At the end of the three-year term of the contract
rates will automatically go to higher resale rates unless a new contract is
established, and there is no assurance that ATX will be able to negotiate a new
contract on acceptable terms.
Interconnection Agreements
ATX has agreements for the interconnection of its networks with the
network of Verizon and other ILECs and the purchasing of UNEs covering each
market in which ATX provides local services. As the existing interconnection
agreements expire, ATX will be required to negotiate extension or replacement
agreements. ATX's interconnection agreement with Verizon is currently on a
month-to-month basis; agreements with other ILECs are also for short-term
periods. There are ongoing proceedings in most states to implement the TRO and
the TRRO that will likely result in amendments to ATX's interconnection
agreements with Verizon and the other ILECs. There can be no assurance that ATX
will successfully negotiate, arbitrate or otherwise replace or amend its
interconnection agreements on terms and conditions acceptable to ATX.
Domestic Real Estate
At December 31, 2005, the Company's domestic real estate assets had a
book value of $166,200,000. 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 owns a 15 story, 740,000 square foot office building located
in downtown Tulsa, Oklahoma that was formerly WilTel's headquarters building,
but which was not sold to Level 3. The building is currently 44% occupied by
Level 3 and another tenant under short-term leases; however, Level 3 has the
right to vacate one floor every six months commencing June 2006. The property
has a book value of approximately $54,100,000 and is being marketed for sale.
16
Certain of the Company's other real estate investments and their
respective carrying values as of December 31, 2005 include: a 90% interest in 8
acres of unimproved land in Washington, D.C. that was sold in 2006
($61,100,000); approximately 87 acres of land located in Myrtle Beach, South
Carolina, which is fully entitled for a large scale mixed-use development of
various residential, retail and commercial space ($16,800,000); an operating
shopping center on Long Island, New York that has 71,000 square feet of retail
space ($9,300,000); approximately 76 acres of land located on the island of
Islesboro, Maine, for which plans have been submitted for a residential
subdivision ($9,200,000); and an approximate 540 acre parcel located in San
Miguel County, Colorado which the Company is attempting to have re-zoned into a
mixture of estate lots, cabins and a lodge site ($5,700,000).
The Company owns approximately 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 7.7% 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,
2005, its investment had a carrying value of $44,100,000 which is included in
investments in associated companies. HomeFed is a public company traded on the
NASD OTC Bulletin Board (Symbol: HOFD).
In May 2005, the Company sold its 716-room Waikiki Beach hotel and
related assets for an aggregate purchase price of $107,000,000, before closing
costs and other required payments. After satisfaction of mortgage indebtedness
on the hotel at closing, the Company received net cash proceeds of approximately
$73,000,000, and recorded a pre-tax gain of $56,600,000 (reflected in gain on
disposal of discontinued operations). The Company's interest in the unimproved
land in Washington, D.C. was sold in February 2006, and the Company received net
cash proceeds of approximately $75,700,000 after satisfaction of mortgage
indebtedness on the property and other closing payments; the Company expects to
record a pre-tax gain of approximately $48,900,000.
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 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 and Willamette
Valleys. At December 31, 2005, the Company's combined net investment in these
wineries was $71,000,000. The wineries sold approximately 81,200 9-liter
equivalent cases of wine generating wine revenues of $17,800,000 during 2005,
and 63,600 9-liter equivalent cases of wine generating wine revenues of
$13,200,000 during 2004.
17
These wineries primarily produce and sell wines in the luxury segment of
the premium table wine market. 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 and luxury table wines of other producers 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 2005, direct sales to consumers
represented 19% of case sales and 40% of wine revenues. Sales of the Company's
wines in California (excluding direct sales to consumers) amounted to
approximately 12% of 2005 wine revenues.
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 and consumer
publications. Wines are rated on a 1 to 100 numerical scale for each vintage and
each type of wine. During the past year, ratings for some of the Company's wines
have increased or stayed the same while ratings for other Company wines have
declined relative to previous vintages. Future ratings are impossible to
predict; however, the Company expects ratings for newly released wines will
continue to reflect the specific wine quality of the Company's wineries and the
overall perceived quality of the vintage in the Napa and Willamette valleys.
At the beginning of 2005, inventory levels of the Company's wines held by
the Company and its distributors were too high, resulting in the need to hold
prices for certain varietals and increase spending on promotional, sales and
marketing programs to sell more wine. These efforts account for the increase in
case sales in 2005 as compared to the prior year, and the wineries have
significantly reduced the excess inventory levels. In particular, Pine Ridge had
been producing too much Merlot for its historical sales volume, and it has
reduced 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.
The wineries' production, sales and distribution activities are subject
to regulation by agencies of both federal and state governments. Many states
have historically prohibited or restricted sales of wine direct to consumers by
producers that are located in another state, even though the same states may
permit in-state producers to ship direct to in-state consumers. In a case that
was decided by the U.S. Supreme Court during 2005, such discriminatory state
direct shipment laws were held to violate the Commerce Clause of the U.S.
Constitution. As a result of the Court's decision, some states have revised
their laws to allow both in-state and out-of-state wineries to ship directly to
consumers. Other states have prohibited direct-to-consumer sales by in-state and
out-of-state wineries. Although the Company is unable to predict the action that
each state will take to comply with the Court's decision, the Company expects
that this decision will increase its ability to market and sell wine direct to
the consumer.
Antilles Crossing Group
The Company owns approximately 75% of entities comprising the Antilles
Crossing Group ("ACG"), a startup venture that is constructing a sub-sea fiber
optic cable system in the western Caribbean. The remaining interest is
principally owned by Light & Power Holdings Ltd., in which the Company holds a
36% interest.
ACG has entered into a construction contract with a third-party to
build a sub-sea fiber system from St. Croix to Barbados with a link to St.
Lucia. In St. Croix, capacity agreements have been purchased to access sub-sea
fiber systems to carry ACG customer traffic to and from the United States,
Canada, the United Kingdom, and the rest of the world. The system will be only
the second to be built to Barbados and St. Lucia and is expected to alleviate
much of the currently restricted bandwidth supply to those islands. The only
other system reaching those islands is controlled by the current sole provider.
Competitive international telecommunications and data service was first licensed
in each island in 2005. ACG has received licenses and permits to construct and
operate the system; however, certain additional authorizations have not been
received and are in the process of being obtained.
18
Once completed, the system will allow ACG to begin providing competitive
carrier telecommunications and data services to the islands of Barbados and St.
Lucia. In addition, the Company is building an on-island fiber and wireless
communications network on Barbados with the intention of providing data and
voice services to businesses operating in Barbados. The Company expects
construction of the sub-sea and on-island systems to be completed during 2006
and operating activities will commence thereafter. The estimated cost of the
project is approximately $37,000,000.
Banking and Lending
Historically, banking and lending operations made collateralized consumer
loans consisting principally of personal automobile instalment loans to
individuals who had difficulty obtaining credit. Over the past few years, the
Company has been shrinking its banking and lending operations. Operating
activities have been concentrated on maximizing returns on its investment
portfolio, collecting and servicing its remaining loan portfolios and
discharging deposit liabilities as they come due. During 2005, the Company's
banking and lending subsidiary filed a formal plan with the Office of the
Comptroller of the Currency to liquidate its operations, sold its remaining
customer deposits and surrendered its national bank charter. Net outstanding
loans were $3,000,000 and $4,300,000 as of December 31, 2005 and 2004,
respectively. Pre-tax income for the banking and lending operations was
$1,400,000, $22,000,000 and $8,400,000 for the years ended December 31, 2005,
2004 and 2003, respectively.
Other Investments
CLC
In August 2005, the Company consummated the merger with its then 72.1%
owned subsidiary, MK Resources Company ("MK"), whereby the Company acquired the
remaining outstanding MK common shares. The acquisition cost consisted of
approximately 216,000 of the Company's common shares (valued at $8,300,000), and
estimated cash amounts ($4,500,000 has been accrued) that will be paid to former
MK stockholders who perfected appraisal rights. As a result of the merger, MK is
now a wholly-owned subsidiary of the Company, and MK's securities are no longer
publicly traded.
Immediately following the merger, the Company sold to Inmet, a
Canadian-based global mining company traded on the Toronto stock exchange
(Symbol: IMN), a 70% interest in CLC, a Spanish company that holds the
exploration and mineral rights to the Las Cruces copper deposit in the Pyrite
Belt of Spain. Inmet acquired the interest in CLC in exchange for 5,600,000
newly issued Inmet common shares, representing approximately 11.7% of the
outstanding Inmet common shares immediately following completion of the
transaction. The Inmet shares were recorded at their fair value of approximately
$78,000,000, and the Company recorded a pre-tax gain on the sale of $10,500,000.
CLC entered into an agreement with third party lenders for project
financing consisting of a ten year senior secured credit facility of up to
$240,000,000 and a senior secured bridge credit facility of up to
(euro)69,000,000 to finance subsidies and value-added tax. The Company and Inmet
have guaranteed 30% and 70%, respectively, of the obligations outstanding under
both facilities until completion of the project as defined in the project
financing agreement. At December 31, 2005, no amounts were outstanding under the
facilities. The Company and Inmet have also committed to provide financing to
CLC which is estimated to be $159,000,000, of which the Company's share will be
30% ($14,300,000 of which has been loaned as of December 31, 2005). For the year
ended December 31, 2005, the Company recorded $1,600,000 of pre-tax losses from
this investment under the equity method of accounting.
A May 2005 technical report prepared by Pincock, Allen & Holt, an
independent engineering company, indicated proven and probable reserves at the
Las Cruces deposit of approximately 16 million metric tons of copper ore at an
average grade of 6.6% copper. The capital costs to build the project have been
estimated at (euro)290,000,000 ($345,000,000 at exchange rates in effect on
February 13, 2006), including working capital, land purchases, and
contingencies, but excluding reclamation bonding requirements, inflation,
interest during construction, cost overruns and other financing costs. CLC
expects to reach full mine production by the middle of 2008. Cash operating
costs per pound of copper produced are expected to average (euro)0.33 per pound
($.39 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 are
currently based on the U.S. dollar. In order to minimize its exposure to
currency fluctuations, CLC has entered into an agreement to swap
(euro)171,000,000 of euro denominated debt into $215,000,000 of U.S. dollar
denominated debt once construction of the mine is complete.
19
Berkadia
The Company is a member of 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 addition, 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.
Olympus
At December 31, 2005, the book value of the Company's 20% equity interest
in Olympus had been written down to zero, and its net cash investment was
$48,000,000. Olympus was formed in 2001 to take advantage of the lack of
capacity and favorable pricing in the reinsurance market. It entered into a
quota share reinsurance agreement with Folksamerica Reinsurance Company, an
affiliate of WMIG, and has also entered into reinsurance transactions with other
parties. During 2005, Olympus recorded significant losses as a result of
estimated insurance claims from hurricanes Katrina, Rita and Wilma. In early
2006, Olympus raised a significant amount of new equity to replace some, but not
all of the capital that was lost as a result of the 2005 hurricanes. Since the
Company did not invest additional capital in Olympus, its equity interest will
be diluted (to less than 4%) such that it will no longer apply the equity method
of accounting for this investment subsequent to December 31, 2005. For the years
ended December 31, 2005, 2004 and 2003, the Company recorded $(120,100,000),
$9,700,000 and $40,400,000, respectively, of pre-tax income (loss) from this
investment under the equity method of accounting.
Other
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 generally accepted accounting principles ("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, 2005, INTL had total assets of $105,100,000, which are reflected as
investments in the Company's consolidated balance sheet, and its liabilities
were not material. For the years ended December 31, 2005 and 2004, the Company
recorded pre-tax income relating to INTL of $9,900,000 and $2,200,000,
respectively. The Company has included INTL in its Corporate segment.
20
At December 31, 2005, the book value of the Company's equity investment
in JPOF II, a registered broker-dealer, was $123,600,000. 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, 2005, 2004 and 2003, the
Company recorded $23,600,000, $16,200,000 and $14,800,000, 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, 2005, the book value of the Company's equity
investment in EagleRock was $75,500,000, which excludes $16,600,000 that was
received in January 2006 and is classified as a receivable as of December 31,
2005. In August 2005, the Company notified EagleRock that it determined to
withdraw its entire interest on January 1, 2006. Discussions are ongoing as to
the timing and manner in which the Company's capital will be remitted by
EagleRock to the Company. Pre-tax income (losses) of $(28,900,000), $29,400,000
and $49,900,000 for the years ended December 31, 2005, 2004 and 2003,
respectively, were recorded from this investment under the equity method of
accounting.
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, 2005, 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 February 23, 2006 (determined in accordance with Rule 13d-3 of the
Securities Exchange Act of 1934): Level 3 (14.1%), FINOVA (25%), HomeFed
(29.9%), International Assets Holding Corporation (18.6%), Jordan Industries,
Inc. ("JII") (10.1%), and ParkerVision, Inc. (5.9%). 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
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 6.6% equity interest),
and a total of 19 other companies. At December 31, 2005, these investments are
carried in the Company's consolidated financial statements at $95,800,000, of
which $63,800,000 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 1A. Risk Factors.
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Our business is subject to a number of risks. You should carefully
consider the following risk factors, together with all of the other information
included or incorporated by reference in this Report, before you decide whether
to purchase our common stock. The risks set out below are not the only risks we
face. If any of the following risks occur, our business, financial condition and
results of operations could be materially adversely affected. In such case, the
trading price of our common stock could decline, and you may lose all or part of
your investment.
Future acquisitions and dispositions of our operations and investments
are possible, and if unsuccessful could reduce the value of our common shares.
We continuously evaluate the retention and disposition of our existing
operations and investigate possible acquisitions of new businesses. Any future
acquisitions or dispositions may result in significant changes in the
composition of our assets and liabilities. Consequently, our financial
condition, results of operations and the trading price of our common shares may
be affected by factors different from those affecting our financial condition,
results of operations and trading price at the present time.
21
Future acquisitions and investments may expose us to risks to which we
are not currently subject. Future acquisitions and investments may expose us to
risks such as:
o the possibility that future acquisitions and investments may not
immediately, if ever, add value to our Company;
o diversion of management's attention from our existing businesses;
and
o the possibility that the acquired businesses or investments will
generate insufficient profits to offset the increased expenses
associated with the acquisitions.
Our ability to make future acquisitions and investments successfully
depends on a range of factors, including our ability to identify and compete
with others for potential acquisition targets, the acquisition price, terms and
conditions of any completed acquisitions, and the future profitability of any
new acquisitions and investments.
We are dependent on certain key personnel. We are dependent on the
services of Ian M. Cumming and Joseph S. Steinberg, our Chairman of the Board
and President, respectively. Messrs. Cumming's and Steinberg's employment
agreements with us expire June 30, 2015. These individuals are also significant
shareholders of our Company. As of February 23, 2006, Messrs. Cumming and
Steinberg and their respective families (excluding certain private charitable
foundations) beneficially owned approximately 11.5% and 12.6% of our outstanding
common shares, respectively. Accordingly, Messrs. Cumming and Steinberg could
exert significant influence over all matters requiring approval by our
shareholders, including the election or removal of directors and the approval of
mergers or other business combination transactions.
We operate in a variety of industries and market sectors, certain of
which may be more susceptible to economic downturns than others. The industries
in which we operate may be subject to the effects of national or local economic
cycles, increased competition and changes in demographic conditions, any of
which may adversely affect our businesses and are beyond our control. Changes in
economic conditions in the United States or internationally can cause
fluctuation in prices and sales volumes which could adversely affect the
Company's operating results. A worsening of general economic or market
conditions may result in lower valuations for our businesses or investments or
have a negative impact on the credit quality of our assets.
Changes in the U.S. housing market could reduce Idaho Timber's revenues
and profitability. Idaho Timber's revenues benefit from continued strong new
housing starts and the strong home improvement market in the U.S. Any decline in
the U.S. housing market, which could result from local, regional, national or
international economic changes, or from other factors, including increases in
mortgage interest rate levels, would likely reduce demand for Idaho Timber's
products and lower revenue.
Changes in telecommunications laws and regulations could adversely
affect ATX. ATX operates in a highly competitive and regulated industry. ATX
would not be able to provide many of its services to its customers without the
ability to purchase services from its competitors, which is a right ATX and
others currently have pursuant to government laws promoting competition in local
telephone markets. Recent changes in government regulations have either limited
the ability of ATX to purchase certain services, or increased the cost of those
services to ATX. Future regulatory changes could have an adverse impact on ATX's
ability to sell its products, to sell its products at a competitive price or to
acquire the services it needs at a cost effective rate. In addition, ATX incurs
substantial expenses complying with various local, state and federal
regulations, and changes in these regulations could increase the cost of
compliance.
We are subject to risks associated with the increased volatility in raw
material prices and the availability of key raw materials. We purchase
significant amounts of raw materials from third parties for use in our plastics
manufacturing and Idaho Timber businesses. The price for polypropylene, the
principal raw material used by the plastics manufacturing segment, tends to
fluctuate with the price of oil and as a result has risen significantly over the
past couple of years. To the extent this trend continues and we are unable to
pass these price increases to our customers, our results of operations will be
negatively impacted. A significant portion of Idaho Timber's raw material
purchases are from foreign suppliers, and the availability of that supply can be
adversely impacted by trade disputes. In addition, raw material prices at Idaho
Timber will not always rise and fall in proportion to selling prices of Idaho
Timber's products, which can have a negative impact on operating results.
22
Compliance with government laws and regulations require the expenditure
of funds and adversely affect the profitability of our real estate development
projects. Our real estate development business requires numerous governmental
approvals, licenses and permits, which we must obtain before we can begin
development and construction. This approval process can be delayed by
withdrawals or modifications of preliminary approvals, by litigation and appeals
challenging development rights and by changes in prevailing local circumstances
or applicable laws that may require additional approvals. Adverse regulatory
changes or failure to obtain approvals could delay real estate development
projects or make them more costly to complete.
Changes in mortgage interest rate levels or changes in consumer lending
practices could reduce consumer affordability and demand for some of our real
estate development projects. Certain of our real estate development projects are
dependent upon the availability and cost of mortgage financing for potential
homebuyers. Any significant increase in the prevailing low mortgage interest
rate environment or decrease in available credit could reduce consumer demand
for housing, which in turn could lead to fewer home sales or lower selling
prices.
A decrease in consumer spending or general increases in the cost of
living could adversely impact sales at our wineries. Our wineries primarily
produce and sell wines in the luxury segment of the premium table wine market,
and are significantly dependent on the level of consumer spending. Consumer
spending habits are influenced by a number of factors beyond our control,
including the general state of the economy, increases in the cost of living,
federal and state income tax rates, deductibility of business entertainment
expenses under federal and state law and consumer confidence in future economic
conditions.
Adverse regulatory developments and healthcare reform legislation
impacting Medicare reimbursement levels could reduce Symphony's revenues and
reduce our operating profits. Changes in the reimbursement policies of the
Medicare or Medicaid programs as a result of budget cuts by federal and state
governments or other legislative and regulatory actions could have an adverse
effect on our healthcare business. Government payment programs are subject to
statutory and regulatory changes, retroactive rate adjustments, administrative
orders and funding restrictions, all of which could decrease program payments to
us or to our customers. In recent years, there have been numerous discussions at
federal and state levels for comprehensive reforms of the country's healthcare
system. Regulatory action affecting the level of funding for Medicare and
Medicaid programs, the reimbursement regulations of CMS, greater regulatory
flexibility, additional operational requirements or failure to obtain relief
from the recently imposed Medicare Part B caps could adversely affect us.
The healthcare industry is heavily regulated by the government, which
requires our compliance with a variety of laws. The services Symphony provides
are subject to periodic reviews, investigations and audits by governmental
authorities to ensure that we are complying with standards established for
continued licensure under state law, certification for participation under the
Medicare and Medicaid programs and compliance with laws governing the
transmission and privacy of patient healthcare information. We could be
adversely affected if we fail to meet these standards or if the standards change
and we experience delays or incur additional costs in meeting the new standards.
Our failure to obtain, retain or renew any required regulatory approvals,
licenses or certificates could prevent us from being reimbursed for certain of
our services. Symphony incurs substantial administrative costs complying with
government laws and regulations. Symphony is also subject to potential lawsuits
under a federal whistleblower statute designed to combat fraud and abuse in the
healthcare industry.
We could experience significant increases in operating costs due to
continued intense competition for qualified staff in our healthcare business.
Our inability to attract and retain highly skilled personnel would make it
difficult to conduct our healthcare business. Due to shortages in qualified
professionals in the healthcare industry, competition for these employees is
intense and Symphony's competitors may offer more attractive wage and benefit
packages than we do. In addition to the wage pressures inherent in this
environment, the cost of training new employees amid high turnover rates has
increased our costs. Continued industry-wide shortages of qualified healthcare
professionals will affect our ability to attract and maintain adequate staffing
levels, which could adversely affect our results of operations.
23
Our various businesses are dependent on the proper functioning of our
information systems. Our operations are dependent on the proper functioning of
our information systems. Additionally, we rely on our information systems in
managing our accounting and financial reporting. Hardware and software is
protected by various forms and levels of security, and certain of our
information technology functions have backup processing capabilities. However,
these systems are still vulnerable to fire, storm, flood, power loss,
telecommunications failures, physical or software break-ins and similar events.
In the event that critical information systems are unavailable, these functions
would have to be accomplished manually, which could temporarily impair our
ability to identify business opportunities quickly, maintain billing and
clinical records reliably, bill for services efficiently or maintain our
accounting and financial reporting effectively.
We face intense competition in the operation of our businesses. The
industries in which we operate are highly competitive. There are numerous
competitors who operate in our markets, many of which have advantages over us,
such as more favorable locations, greater financial and other resources and may
be more established in their respective communities than we are. Competitors may
offer newer or different products or services that our customers may find more
attractive.
We may not be able to generate sufficient taxable income to fully
realize our deferred tax asset. We and certain of our subsidiaries have
significant NOLs and other tax attributes. At December 31, 2005, we have
recognized a deferred tax asset of $1,135,100,000 in respect of these tax
attributes. If we are unable to generate sufficient taxable income, we will not
be able to fully realize the recorded amount of the deferred tax asset.
Weather related conditions and significant natural disasters, including
hurricanes, tornadoes, windstorms, earthquakes and hailstorms could adversely
affect our business. The occurrence of natural disasters may impact our
wineries, real estate holdings and manufacturing operations, interfere with our
ability to obtain raw materials, sell our products and provide service or
realize income from our operations. Any shortage of reliable water and energy
resources or a drop in consumer confidence in the dependability of such
resources in areas where we operate or own land may adversely affect our
business operations, the values of our properties and/or result in government
restrictions that curtail operations.
We may not be able to insure certain risks economically. We may
experience economic harm if any damage to our properties is not covered by
insurance. We cannot be certain that we will be able to insure all risks that we
desire to insure economically or that all of our insurers or reinsurers will be
financially viable if we make a claim. We may suffer losses that are not covered
under our insurance or reinsurance policies. If an uninsured loss or a loss in
excess of insured limits should occur, results of operations would be adversely
affected.
We may reduce or cease to pay dividends on our common shares. We paid
cash dividends of $0.25 per common share in 2005 and 2004. However, we cannot
assure you that we will pay dividends on our common shares in the future or, if
we do, the amount of such dividends. The payment of dividends on our common
shares in the future is subject to the discretion of our Board of Directors and
will depend upon general business conditions, the availability of our NOLs,
legal and contractual restrictions on the payment of dividends and other factors
that our 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 our common shares, we are required to comply
with certain restrictions contained in certain of our debt instruments.
Our common shares are subject to transfer restrictions. We and certain of
our subsidiaries have significant 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 result in limitations on the use of the tax attributes, our
certificate of incorporation contains provisions that generally restrict the
ability of a person or entity from acquiring ownership (including through
attribution under the tax law) of 5% or more of our common shares and the
ability of persons or entities now owning 5% or more of our common shares from
acquiring additional common shares. The restriction will remain until the
earliest of (a) December 31, 2024, (b) the repeal of Section 382 of the Internal
Revenue Code (or any comparable successor provision) and (c) the beginning of
our taxable year to which these tax attributes may no longer be carried forward.
The restriction may be waived by our Board of Directors. Shareholders are
advised to carefully monitor their ownership of our common shares and consult
their own legal advisors and/or us to determine whether their ownership of our
common shares approaches the proscribed level.
24
Item 1B. Unresolved Staff Comments.
- ------- -------------------------
Not applicable.
Item 2. Properties.
- ------ ----------
Idaho Timber's plants and sawmills, which are the principal properties
used in its business are described in Item 1 of this Report. ATX leases
approximately 130,000 square feet of office space, and approximately 13,000
square feet used for network operations.
Through its various subsidiaries, the Company owns and utilizes office
space in Salt Lake City, Utah for corporate and other activities (totaling
approximately 31,800 square feet). Subsidiaries of the Company own facilities
primarily used for plastics manufacturing located in Georgia, Virginia and Genk,
Belgium (totaling approximately 457,300 square feet) and facilities and land in
California and Oregon used for winery operations (totaling approximately 123,300
square feet and 396 acres, respectively).
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 or
liquidity.
On October 6, 2005, purported stockholders of MK filed a purported class
action entitled Special Situations Fund III, L.P., et al, v. Leucadia National
Corporation, et al, (Civil Action No. 1692-N) against the Company, MK and the
former directors of MK. The complaint, which was filed in the Court of Chancery
for the State of Delaware alleges breach of fiduciary duty in connection with
the merger of MK into the Company, that unfair and inadequate consideration was
paid to minority stockholders of MK, and that the process by which the merger
was considered and approved was controlled by the Company and was unfair to the
minority stockholders of MK. The complaint seeks rescission of the merger,
damages in an unspecified amount, and attorneys' fees. On February 2, 2006,
plaintiffs in this action filed a Stipulation and Proposed Order of
Consolidation which proposes, among other things, to consolidate this action
with another purported class action entitled Weinberg v Joklik, et al., (Civil
Action No. 1455-N filed June 24, 2005) (which raises claims that are
substantially similar to the claims raised in the Special Situations Fund
complaint) and, for discovery purposes, with an appraisal action entitled
Special Situations Fund III, L.P., et al, v. Leucadia National Corporation and
MK Resources Company (Civil Action No. 1598-N, filed August 30, 2005) (from
which the Company was dismissed as a respondent in December 2005), both of which
were filed in the Court of Chancery for the State of Delaware in connection with
the merger of MK into the Company. On March 1, 2006, the Court granted the
plaintiffs' proposed order.
The Company believes that the material allegations of the complaints are
without merit and intends to defend these actions vigorously and does not
believe that any of the foregoing 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 February 23, 2006, 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:
25
Name Age Position with Leucadia Office Held Since
- ---- --- ---------------------- -----------------
Ian M. Cumming 65 Chairman of the Board June 1978
Joseph S. Steinberg 62 President January 1979
Thomas E. Mara 60 Executive Vice President May 1980;
and Treasurer January 1993
Joseph A. Orlando 50 Vice President and January 1994;
Chief Financial Officer April 1996
Barbara L. Lowenthal 51 Vice President and April 1996
Comptroller
H.E. Scruggs 48 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) and FINOVA since August 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 and Chief Executive Officer of FINOVA
since September 2002, and as a director of Inmet since August 2005.
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.
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 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.
26
Common Share
------------
High Low
---- ---
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 $46.65 $32.40
Second Quarter 41.21 32.91
Third Quarter 44.91 37.80
Fourth Quarter 49.28 40.09
2006
----
First Quarter (through February 23, 2006) $54.10 $46.52
As of February 23, 2006, there were approximately 2,860 record holders of
the common shares.
The Company paid cash dividends of $0.25 per common share in 2005 and
2004. 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. 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 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 result in 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 acquiring ownership (including through attribution under the tax law) of
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.
27
The Company's purchases of its common shares during the fourth quarter of
2005 were as follows:
ISSUER PURCHASES OF EQUITY SECURITIES
-------------------------------------
Total Number of
Shares Purchased Approximate
as Part of Dollar Value of
Publicly Shares that May
Total Number Average Announced Plans Yet Be Purchased
of Shares Price Paid or under the Plans
Purchased (1) Per Share Programs or Programs
------------- ---------- -------------- -----------
November 1 to November 30 3,671 $45.49 -- $ --
------------- ---------
Total 3,671 --
============= =========
(1) Consists of common shares received from employees to exercise stock
options. Shares were valued at the market price at the time of the option
exercise.
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. At December 31, 2005, the Company is authorized to
repurchase 3,729,477 common shares.
Item 6. Selected Financial Data.
- ------ -----------------------
The following selected financial data have been summarized from the
Company's consolidated financial statements and are qualified in their entirety
by reference to, and should be read in conjunction with, such consolidated
financial statements and Item 7, Management's Discussion and Analysis of
Financial Condition and Results of Operations of this Report.
Year Ended December 31,
---------------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(In thousands, except per share amounts)
SELECTED INCOME STATEMENT DATA: (a)
Revenues and other income (b) $ 1,041,147 $ 637,962 $ 313,679 $ 235,157 $ 369,553
Expenses 902,984 526,084 321,897 274,301 297,478
Income (loss) from continuing operations before income
taxes, minority expense of trust preferred securities
and equity in income (losses) of associated companies 138,163 111,878 (8,218) (39,144) 72,075
Income from continuing operations before minority
expense of trust preferred securities and equity in
income (losses) of associated companies (c) 1,269,245 132,070 26,956 104,931 83,799
Minority expense of trust preferred securities, net of
taxes -- -- (2,761) (5,521) (5,521)
Equity in income (losses) of associated companies, net
of taxes (45,133) 76,479 76,947 54,712 (15,974)
Income from continuing operations 1,224,112 208,549 101,142 154,122 62,304
Income (loss) from discontinued operations, including
gain (loss) on disposal, net of taxes 411,929 (63,049) (4,088) 7,501 (70,223)
Cumulative effect of a change in accounting
principle -- -- -- -- 411
Net income (loss) 1,636,041 145,500 97,054 161,623 (7,508)
28
Year Ended December 31,
---------------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(In thousands, except per share amounts)
Per share:
Basic earnings (loss) per common share:
Income from continuing operations $ 11.36 $ 1.95 $ 1.10 $ 1.85 $ .75
Income (loss) from discontinued operations,
including gain (loss) on disposal 3.82 (.59) (.04) .09 (.85)
Cumulative effect of a change in accounting
principle -- -- -- -- .01
------- ------ ------ ------ -----
Net income (loss) $ 15.18 $ 1.36 $ 1.06 $ 1.94 $(.09)
======= ====== ====== ====== =====
Diluted earnings (loss) per common share:
Income from continuing operations $ 10.71 $ 1.90 $ 1.09 $ 1.83 $ .75
Income (loss) from discontinued operations,
including gain (loss) on disposal 3.56 (.56) (.04) .09 (.85)
Cumulative effect of a change in accounting
principle -- -- -- -- .01
------- ------ ------ ------ -----
Net income (loss) $ 14.27 $ 1.34 $ 1.05 $ 1.92 $(.09)
======= ====== ====== ====== =====
At December 31,
------------------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(In thousands, except per share amounts)
SELECTED BALANCE SHEET DATA: (a)
Cash and investments $ 2,687,846 $ 2,080,309 $ 1,403,619 $ 1,043,471 $1,080,271
Total assets 5,260,884 4,800,403 4,397,164 2,541,778 2,469,087
Debt, including current maturities 1,162,382 1,131,922 682,135 233,073 252,279
Customer banking deposits -- 24,591 145,532 392,904 476,495
Shareholders' equity 3,661,914 2,258,653 2,134,161 1,534,525 1,195,453
Book value per common share $33.90 $20.99 $20.09 $17.16 $14.41
Cash dividends per common share $ .25 $ .25 $ .17 $ .17 $ .17
(a) Subsidiaries are reflected above as consolidated entities from the date of
acquisition as follows: Idaho Timber, May 2005; ATX, April 2005; and
Symphony, September 2003. For additional information, see Note 3 of Notes
to Consolidated Financial Statements.
(b) Includes net securities gains (losses) of $208,816,000, $136,564,000,
$9,928,000, $(37,066,000) and $28,450,000 for the years ended December 31,
2005, 2004, 2003, 2002 and 2001, respectively.
(c) During 2005, the Company's revised projections of future taxable income
enabled it to conclude that it is more likely than not that it will have
future taxable income sufficient to realize a portion of the Company's net
deferred tax asset; accordingly, $1,135,100,000 of the deferred tax
valuation allowance was reversed as a credit to income tax expense. 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.
29
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
subsidiaries.
As of December 31, 2005, the Parent's readily available cash, cash
equivalents and marketable securities, excluding amounts held by subsidiaries
that are parties to agreements which restrict the payment of dividends, totaled
$2,370,500,000. This amount is comprised of cash and short-term bonds and notes
of the United States Government and its agencies of $1,198,700,000 (50.6%), U.S.
Government-Sponsored Enterprises of $261,300,000 (11.0%), the equity investment
in Level 3 of $330,100,000 (13.9%), and other publicly traded debt and equity
securities aggregating $580,400,000 (24.5%). This amount does not include common
shares the Company owns in Inmet, which are subject to resale restrictions as
discussed below. Pursuant to a registration rights agreement entered into with
Level 3, Level 3 has filed a registration statement covering the Level 3 shares
and is required to keep the registration statement effective for the shorter of
two years (or a longer period as set forth in the agreement), or until the
distribution of the shares is completed. The Level 3 common stock is subject to
a transfer restriction that limits the number of shares the Company can sell
(with certain exceptions) on any given day until May 22, 2006; thereafter there
is no restriction. The investment income realized from the Parent's readily
available cash, cash equivalents and marketable securities 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.
The Parent's only long-term cash requirement is to make principal
payments on its long-term debt ($944,900,000 outstanding as of December 31,
2005), of which $21,700,000 is due in 2006, $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. 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 December 2005, the Company sold WilTel to Level 3 for aggregate cash
consideration of $460,300,000 (net of estimated working capital adjustments),
and 115,000,000 newly issued shares of Level 3 common stock. In connection with
the sale, the Company retained certain assets and liabilities of WilTel that
were not purchased by Level 3. The retained assets include (i) WilTel's
headquarters building located in Tulsa, Oklahoma, (ii) cash and cash equivalents
in excess of $100,000,000, (iii) corporate aircraft and related capital lease
obligations, and (iv) marketable securities. In addition, the Company retained
all of WilTel's right to receive certain cash payments from SBC totaling
$236,000,000, of which $37,500,000 was received prior to closing, and the
balance is due to be received during 2006. Prior to the closing, WilTel repaid
its long-term debt obligations using its funds, together with $220,000,000 of
funds advanced by the Company. The retained liabilities also include WilTel's
defined benefit pension plan and supplemental retirement plan obligation and
certain other employee related liabilities. The Company has reclassified
WilTel's balance sheet amounts in prior years to assets and liabilities of
discontinued operations.
30
In the aggregate, the Company received value of $833,500,000 from the
sale of WilTel, including the consideration paid by Level 3 and the net book
value of the retained assets and liabilities, but reduced by the funds advanced
to WilTel in 2005. In addition, the agreement with Level 3 requires that all
parties make the appropriate filings to treat the purchase of WilTel as a
purchase of assets for federal, state and local income and franchise tax
purposes. As a result, WilTel's NOLs, as well as any tax losses generated by the
sale, remained with the Company. For more information about the Company's NOLs
and tax attributes, see Note 16 of Notes to Consolidated Financial Statements.
In June 2005, the Company's 8 1/4% Senior Subordinated Notes, which had
an outstanding principal amount of $19,100,000, matured. The Company repaid
these notes and the related accrued interest with available cash resources.
In February 2005, the plastics manufacturing segment acquired the assets
of NSW for approximately $26,600,000, including working capital adjustments. In
April 2005, the Company acquired ATX upon the effectiveness of its bankruptcy
plan for approximately $56,300,000, including expenses, of which $25,300,000 was
spent in 2005 and the balance was spent during 2003 and 2004. In May 2005, the
Company acquired Idaho Timber for total cash consideration of $133,600,000,
including working capital adjustments and expenses. The plastics manufacturing
segment also acquired certain assets of a competitor in October 2005 for
approximately $4,300,000. Each of these acquisitions is reflected in the
Company's consolidated financial statements from the date of acquisition. In the
aggregate, the purchase price allocation for these acquisitions resulted in the
recognition of amortizable intangible assets of $78,400,000 and goodwill of
$14,000,000, which is not subject to amortization. For more information
concerning these acquisitions, see Notes 3 and 8 of Notes to Consolidated
Financial Statements. The funds for these acquisitions were provided from the
Company's available cash resources.
In May 2005, the Company sold its 716-room Waikiki Beach hotel and
related assets for an aggregate purchase price of $107,000,000 (before closing
costs and other required payments). After satisfaction of mortgage indebtedness
on the hotel of $22,100,000 at closing, the Company received net cash proceeds
of approximately $73,000,000.
Union Square, two entities in which the Company had non-controlling
equity interests, sold their respective interests in an office complex located
on Capitol Hill in Washington, D.C. in May 2005. Including repayment of its
mortgage loans at closing, the Company's share of the net proceeds was
$73,200,000.
In August 2005, the Company consummated the merger with MK, its then
72.1% owned subsidiary, whereby the Company acquired the remaining outstanding
MK common shares. The acquisition cost consisted of approximately 216,000 of the
Company's common shares (valued at $8,300,000), and estimated cash amounts
($4,500,000 has been accrued) that will be paid to former MK stockholders who
perfected appraisal rights.
Immediately following the merger, the Company sold to Inmet, a
Canadian-based global mining company, a 70% interest in CLC, a Spanish company
that holds the exploration and mineral rights to the Las Cruces copper deposit
in the Pyrite Belt of Spain. Inmet acquired the interest in CLC in exchange for
5,600,000 newly issued Inmet common shares, representing approximately 11.7% of
the outstanding Inmet common shares immediately following completion of the
transaction.
CLC has entered into an agreement with third party lenders for project
financing consisting of a ten year senior secured credit facility of up to
$240,000,000 and a senior secured bridge credit facility of up to
(euro)69,000,000 to finance subsidies and value-added tax. The Company and Inmet
have guaranteed 30% and 70%, respectively, of the obligations outstanding under
both facilities until completion of the project as defined under the project
financing. At December 31, 2005, no amounts were outstanding under the
facilities. The Company and Inmet have also committed to provide financing to
CLC which is estimated to be $159,000,000, of which the Company's share will be
30% ($14,300,000 of which has been loaned as of December 31, 2005).
The Inmet shares have the benefit of a registration rights agreement;
however, the shares may not be sold until the earlier of August 2009 or the date
on which the Company is no longer obligated under the guarantee of CLC's credit
facilities. At acquisition, the fair value of the Inmet common stock
($78,000,000) was determined to be approximately 90% of the then current trading
price as a result of these transferability restrictions. The Inmet shares will
be carried at the initially recorded value (unless there is an other than
temporary impairment) until one year prior to the termination of the transfer
restrictions. At December 31, 2005, the market value of the Inmet shares is
approximately $142,100,000.
31
In the fourth quarter of 2005, Square 711, a 90% owned subsidiary of the
Company, entered into an agreement to sell its interest in 8 acres of unimproved
land in Washington, D.C. for aggregate cash consideration of $121,900,000; the
sale closed in February 2006. The land was acquired by the Company in September
2003 for cash consideration of $53,800,000. After satisfaction of mortgage
indebtedness on the property of $32,000,000 and other closing payments, the
Company received net cash proceeds of approximately $75,700,000, and expects to
record a pre-tax gain of approximately $48,900,000.
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 acquiring ownership (including through attribution under
the tax law) of 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 February 23, 2006, the Company is authorized to repurchase
3,729,477 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,
2005.
Consolidated Liquidity
In 2005, net cash was provided by operating activities as a result of the
collection of a receivable related to a former partnership interest,
distributions from associated companies and a decrease in the Company's
investment in the trading portfolio. 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.
Symphony has a $50,000,000 revolving credit facility, of which
$27,100,000 and $37,700,000 was outstanding at December 31, 2005 and 2004,
respectively. This financing, which is secured by all of Symphony's assets (with
an aggregate book value of $55,500,000) but otherwise is non-recourse to the
Company, matures in 2006 and bears interest based on LIBOR plus 3%. At December
31, 2005, the interest rate on this facility was 7.39%.
Debt due within one year includes $92,100,000 and $21,000,000 as of
December 31, 2005 and December 31, 2004, respectively, relating to repurchase
agreements of one of the Company's subsidiaries. These fixed rate repurchase
agreements have a weighted average interest rate of approximately 3.95%, mature
at various dates through April 2006 and are secured by investments with a
carrying value of $95,100,000.
During 2001, a subsidiary of the Company borrowed $53,100,000 secured by
certain of its corporate aircraft, of which $43,400,000 is currently
outstanding. Capital leases of another subsidiary aggregating $9,900,000 consist
of a sale-leaseback transaction related to other corporate aircraft. The Parent
company has guaranteed these financings.
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 of such subsidiaries to pay
dividends to the Company and/or provide collateral to the lender. Principally as
a result of such restrictions, the assets of subsidiaries which are subject to
limitations on transfer of funds to the Company were approximately $289,700,000
at December 31, 2005. For more information, see Note 12 of Notes to Consolidated
Financial Statements.
32
As shown below, at December 31, 2005, the Company's contractual cash
obligations totaled $1,836,612,000.
Payments Due by Period (in thousands)
------------------------------------------------------------------------
Less than 1
Contractual Cash Obligations Total Year 1-3 Years 4-5 Years After 5 Years
- ---------------------------- ----- ---- --------- --------- -------------
Long-term debt $ 1,162,382 $175,664 $ 17,639 $ 6,106 $ 962,973
Estimated interest expense on long-term
debt 577,088 65,445 120,548 118,982 272,113
Estimated payments related to derivative
financial instruments 23,670 5,540 10,288 7,158 684
Planned funding of pension and post-
retirement obligations 33,014 29,494 853 845 1,822
Operating leases, net of sublease
income 38,216 8,274 13,218 8,862 7,862
Asset purchase obligations 1,361 783 578 -- --
Operations and maintenance obligations 881 881 -- -- --
------------ -------- --------- --------- -----------
Total Contractual Cash Obligations $ 1,836,612 $286,081 $ 163,124 $ 141,953 $ 1,245,454
============ ======== ========= ========= ===========
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, 2005. Estimated payments related to a currency swap
agreement are based on the currency rate in effect at December 31, 2005. Except
for expected funding of $29,100,000 in 2006, the Company's consolidated pension
liability is excluded from the table because the timing of cash payments is
uncertain.
At December 31, 2005, the Company had recorded a liability of
$102,800,000 on its consolidated balance sheet for its unfunded defined benefit
pension plan obligations. This amount represents the difference between the
present value of amounts owed to current and former employees (referred to as
the projected benefit obligation), and the market value of plan assets set aside
in segregated trust accounts. Since the benefits in these plans have been
frozen, future changes to the benefit obligation are expected to principally
result from benefit payments, differences between actuarial assumptions and
actual experience and interest costs.
In recent years, the Company's determination to make contributions to the
pension trust accounts in excess of minimum required amounts was influenced by
the tax deductibility of the contribution, a consideration that is no longer
important because of the Company's NOLs. The Company is currently analyzing the
administrative and insurance costs associated with these plans and will make
substantial contributions to the segregated trust accounts to reduce its plan
liabilities. The timing and amount of additional contributions are uncertain;
however, the Company believes it will make substantial additional contributions
over the next few years to reduce, but not to entirely eliminate, its defined
pension benefit plan liability.
The Company maintained defined benefit pension plans covering certain
operating units prior to 1999, and WilTel also maintained defined pension
benefit plans that were not transferred in connection with the sale of WilTel.
As of December 31, 2005, certain amounts for these plans are reflected
separately in the table below (dollars in thousands):
33
The Company's WilTel's
Plans Plans
----- -----
Projected benefit obligation $58,123 $186,054
Funded status - balance sheet liability at December 31, 2005 14,647 88,149
Deferred losses included in other comprehensive income 21,828 40,739
Discount rate used to determine the projected benefit obligation 4.87% 5.40%
Calculations of pension expense and projected benefit obligations are
prepared by actuaries based on assumptions provided by management. These
assumptions are reviewed on an annual basis, including assumptions about
discount rates, interest credit rates and expected long-term rates of return on
plan assets. For the Company's plans, a discount rate was selected to result in
an estimated projected benefit obligation on a plan termination basis, using
current rates for annuity settlements and lump sum payments weighted for the
assumed elections of participants. For the WilTel plans, the timing of expected
future benefit payments was used in conjunction with the Citigroup Pension
Discount Curve to develop a discount rate that is representative of the high
quality corporate bond market, adjusted for current rates which might be
available for annuity settlements.
These discount rates will be used to determine pension expense in 2006.
Holding all other assumptions constant, a 0.25% change in these discount rates
would affect pension expense by $2,000,000 and the benefit obligation by
$10,000,000.
The deferred losses in other comprehensive income primarily result from
changes in actuarial assumptions, including changes in discount rates, changes
in interest credit rates and differences between the actual and assumed return
on plan assets. Deferred losses are amortized to expense if they exceed 10% of
the greater of the projected benefit obligation or the market value of plan
assets as of the beginning of the year; such amount aggregated $36,700,000 at
December 31, 2005 for all plans. A portion of these excess deferred losses will
be amortized to expense during 2006, based on an amortization period of twelve
years.
The assumed long-term rates of return on plan assets are based on the
investment objectives of the specific plan, which are more fully discussed in
Note 17 of Notes to Consolidated Financial Statements. Differences between the
actual and expected rates of return on plan assets have not been material.
Off-Balance Sheet Arrangements
At December 31, 2005, the Company's off-balance sheet arrangements
consist of guarantees and letters of credit aggregating $85,100,000. 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, 2005, the amount of outstanding bonds was $29,500,000, $800,000
of which expires in 2006, $27,300,000 in 2007 and the remainder in 2009.
Subsidiaries of the Company have outstanding letters of credit aggregating
$23,600,000 at December 31, 2005, principally to secure various obligations.
Substantially all of these letters of credit expire before 2009. The Company's
remaining guarantee at December 31, 2005 is a $32,000,000 indemnification given
to a lender to a certain real estate property. The property was sold in early
2006 and the Company was released from its indemnification obligation.
As discussed above, the Company has also guaranteed certain amounts under
CLC's credit facilities; however, no amounts were borrowed by CLC at December
31, 2005.
34
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 tax asset to the amount that is more likely than not to be realized. If
the Company were to determine that it would be able to realize its deferred tax
asset 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 deferred tax asset in the
future, an adjustment would be charged to income in such period. The
determination of the amount of the valuation allowance required is based, in
significant part, upon the Company's projection of future taxable income at any
point in time. 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.
During 2005, as a result of the consummation of certain transactions and
ongoing operating profits, the Company prepared updated projections of future
taxable income. The Company's revised projections of future taxable income
enabled it to conclude that it is more likely than not that it will have future
taxable income sufficient to realize a portion of the Company's net deferred tax
asset; accordingly, $1,135,100,000 of the deferred tax valuation allowance was
reversed as a credit to income tax expense.
The Company's conclusion that a portion of the deferred tax asset was
more likely than not to be realizable was strongly influenced by its historical
ability to generate significant amounts of taxable income. The Company's
estimate of future taxable income considered all available evidence, both
positive and negative, about its current operations and investments, included an
aggregation of individual projections for each material operation and
investment, and included all future years that the Company estimated it would
have available NOLs. Over the projection period, the Company assumed that its
readily available cash, cash equivalents and marketable securities would provide
returns generally equivalent to the returns expected to be provided by the
Company's existing operations and investments, except for certain amounts
assumed to be invested on a short-term basis to meet the Company's liquidity
needs. The Company believes that its estimate of future taxable income is
reasonable but inherently uncertain, and if its current or future operations and
investments generate taxable income greater than the projected amounts, further
adjustments to reduce the valuation allowance are possible. Conversely, if the
Company realizes unforeseen material losses in the future, or its ability to
generate future taxable income necessary to realize a portion of the deferred
tax asset is materially reduced, additions to the valuation allowance could be
recorded. At December 31, 2005, the balance of the deferred valuation allowance
was $804,800,000.
The Company is required to record the adjustment to the deferred tax
asset valuation allowance under GAAP. While the adjustment significantly
increases the Company's net worth, there is no current cash benefit to the
Company. The adjustment will also result in the recording of material federal
income tax expense in the future, even though no material cash expenditure for
federal income taxes is expected. Further, while the adjustment results from the
projection of taxable income over a long period of time, under GAAP the expected
future tax savings are not discounted. As a result, this adjustment increases
the Company's net worth attributable to tax savings before the Company has
generated the taxable income necessary to realize those tax savings; when the
tax savings are actually realized over time, net worth will be reduced by the
recording of a deferred tax provision. Reflecting tax savings before the tax is
actually saved results in the Company's balance sheet being less conservative
than the Company would want it to be. However, this accounting policy is
mandated by GAAP.
35
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
whenever events or changes in circumstances indicate, in management's judgment,
that the carrying value of such assets may not be recoverable. When testing for
impairment, the Company groups its long-lived assets with other assets and
liabilities at the lowest level for which identifiable cash flows are largely
independent of the cash flows of other assets and liabilities (or asset group).
The determination of whether an asset group is recoverable is based on
management's estimate of undiscounted future cash flows directly attributable to
the asset group as compared to its carrying value. If the carrying amount of the
asset group is greater than the undiscounted cash flows, an impairment loss
would be recognized for the amount by which the carrying amount of the asset
group exceeds its estimated fair value.
As discussed above, WilTel's former headquarters building, including the
adjacent parking garage, was not included in the sale to Level 3 and has been
retained by the Company. The Company concluded that the change in the manner in
which the asset was being used, from a headquarters facility of an operating
subsidiary to a property held for investment, was a change in circumstances
which indicated that the carrying amount of the facility might not be
recoverable. On the closing date of the sale to Level 3, the carrying amount of
the facility was $96,500,000; based on the assumptions discussed below the
Company concluded that the carrying amount was not recoverable, and an
impairment loss of $42,400,000 was recorded reducing the gain on disposal of
discontinued operations. At December 31, 2005, the new cost basis and carrying
amount of the facility is $54,100,000.
The facility is a fifteen story, 740,000 square foot office building
located in downtown Tulsa, Oklahoma for which construction was substantially
completed in 2001, with a total of approximately 640,000 rentable square feet.
Approximately 260,000 square feet of the rentable space is leased to Level 3
under short-term leases that expire at the end of 2007, subject to Level 3
renewal options. Level 3 also has the right to vacate approximately 44,000
square feet every six months commencing July 1, 2006. Approximately 23,500
square feet are leased to another tenant also under a short-term lease that is
subject to renewal options. The building is considered to be Class A office
space, and the Company believes that the best value for the building would be
obtained by selling the building to an owner/occupant. The facility is being
marketed for sale at a gross selling price of $80,000,000, including furniture,
fixtures and equipment.
The Company utilized a discounted cash flow technique to determine the
fair value of the facility. In order to estimate the amount which could
ultimately be realized upon the sale of the facility, the Company had a market
analysis prepared of sales and leasing activity for the downtown Tulsa market.
The analysis identified the range of historical selling prices for properties of
comparable quality, including the age, size and occupancy rates of the
properties sold, properties currently available for sale or lease, current
market occupancy rates and recent leasing rates. Since the facility is being
marketed to an owner/occupant, the cash flow estimates reflect that it may take
from two to five years before a buyer is identified and the facility can be
sold. The cash flow estimates assume that Level 3 will only fulfill its minimum
rental commitment; the Company did not assume that space which is currently
vacant will be leased, which results in negative operating cash flow prior to
sale. The Company's cash flow estimates reflect a range of possible outcomes
since the timing of the sale and the ultimate price that the Company will
realize for the facility is uncertain.
The Company does not believe that there is any set of reasonable
assumptions it could have made resulting in a conclusion that the facility was
not impaired. However, since the amount of the impairment recorded is greatly
impacted by the estimated range of selling prices and the timing of the sale,
the actual gain or loss recognized upon ultimate disposition of the facility is
uncertain. If the market for this type of property declines in the future or the
Company lowers its estimate of the future cash flows for other reasons, further
reductions to the carrying amount of the facility could be required.
Impairment of Securities - 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 in the consolidated
statements of operations. The Company evaluates its investments for impairment
on a quarterly basis.
The Company's determination of whether a security is other than
temporarily impaired incorporates both quantitative and qualitative information;
GAAP requires the exercise of judgment in making this assessment, rather than
the application of fixed mathematical criteria. The Company considers a number
of factors including, but not limited to, the length of time and the extent to
which the fair value has been less than cost, the financial condition and near
term prospects of the issuer, the reason for the decline in fair value, changes
in fair value subsequent to the balance sheet date, and other factors specific
to the individual investment. The Company's assessment involves a high degree of
judgment and accordingly, actual results may differ materially from the
Company's estimates and judgments. The Company recorded impairment charges for
securities of $12,200,000, $4,600,000 and $6,500,000 for the years ended
December 31, 2005, 2004 and 2003, respectively.
36
Business Combinations - At acquisition, the Company allocates the cost of
a business acquisition to the specific tangible and intangible assets acquired
and liabilities assumed based upon their relative fair values. Significant
judgments and estimates are often made to determine these allocated values, and
may include the use of independent appraisals, consider market quotes for
similar transactions, employ discounted cash flow techniques or consider other
information the Company believes relevant. The finalization of the purchase
price allocation will typically take a number of months to complete, and if
final values are materially different from initially recorded amounts
adjustments are recorded. Any excess of the cost of a business acquisition over
the fair values of the net assets and liabilities acquired is recorded as
goodwill which is not amortized to expense. Recorded goodwill of a reporting
unit is required to be tested for impairment on an annual basis, and between
annual testing dates if events or circumstances change that would more likely
than not reduce the fair value of a reporting unit below its net book value.
Subsequent to the finalization of the purchase price allocation, any
adjustments to the recorded values of acquired assets and liabilities would be
reflected in the Company's consolidated statement of operations. Once final, the
Company is not permitted to revise the allocation of the original purchase
price, even if subsequent events or circumstances prove the Company's original
judgments and estimates to be incorrect. In addition, long-lived assets like
property and equipment, amortizable intangibles and goodwill may be deemed to be
impaired in the future resulting in the recognition of an impairment loss;
however, under GAAP the methods, assumptions and results of an impairment review
are not the same for all long-lived assets. The assumptions and judgments made
by the Company when recording business combinations will have an impact on
reported results of operations for many years into the future.
Purchase price allocations for all of the Company's recent acquisitions
have been finalized. Adjustments to the initial purchase price allocations were
not material.
Accruals for Access Costs - ATX'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. At
the end of each reporting period, ATX'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 ATX'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, these estimates may
change.
Contingencies - The Company accrues for contingent losses when the
contingent loss is probable and the amount of loss can be reasonably estimated.
Estimates of the likelihood that a loss will be incurred and of contingent loss
amounts normally require significant judgment by management, can be highly
subjective and are subject to material change with the passage of time as more
information becomes available. As of December 31, 2005, the Company's accrual
for contingent losses was not material.
Results of Operations
Manufacturing - Idaho Timber
Revenues and other income for Idaho Timber from the date of acquisition
(May 2005) through December 31, 2005 were $239,000,000; gross profit was
$22,000,000, salaries and incentive compensation expenses were $6,300,000,
depreciation and amortization expenses were $4,200,000, and pre-tax income was
$8,200,000. Idaho Timber's revenues reflect an oversupply in its dimension
lumber and home center board markets, resulting partially from increased foreign
imports and an easing of transportation bottlenecks that existed in the past.
The increased supply to the U.S. market has resulted in lower selling prices;
however, Idaho Timber's shipment volume of 500 million board feet remained level
with the comparable pre-acquisition period in the prior year. The steady demand
was due in part to continued strong housing and home improvement markets during
2005.
37
Selling prices declined during 2005; however, reductions in raw material
costs, the largest component of cost of sales (approximately 85% of cost of
sales), generally lagged behind the reduction in selling prices. The difference
between Idaho Timber's selling price and raw material cost per thousand board
feet (spread) is closely monitored, and the rate of change in pricing and cost
is typically not the same. During 2005, spread compressed from the very high
level achieved in the prior year, negatively impacting gross profits and pre-tax
results. With the current oversupply in the market, Idaho Timber intends to
focus on developing new higher margin products, diversifying its supply chain,
improving cost control and solidifying customer relationships, in an effort to
maximize gross margins and pre-tax results.
Manufacturing - Plastics
Pre-tax income for the plastics manufacturing segment was $14,200,000,
$7,900,000 and $4,400,000 for the years ended December 31, 2005, 2004 and 2003,
respectively. Its revenues were $93,300,000, $64,100,000 and $53,300,000, and
gross profits were $28,900,000, $19,000,000 and $14,300,000 for the years ended
December 31, 2005, 2004 and 2003, respectively. Revenues increased by 46% in
2005, 20% in 2004 and 5% in 2003, each as compared to the prior year.
The increase in revenues in 2005 reflects NSW's revenues since
acquisition of $17,500,000, and increases in most of the segment's markets.
Sales increases result from a variety of factors including the strong housing
market, new products developed late in 2004, and the impact of price increases
implemented during the second half of 2004 and in the first and fourth quarters
of 2005.
Raw material costs increased by approximately 19% in 2005 as compared
to the same period in 2004; however, the segment was able to increase selling
prices in most markets, which along with increased sales and production volumes
resulted in greater gross margins than in 2004. 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. Gross margins also reflect $1,300,000 of greater amortization
expense on intangible assets resulting from acquisitions.
Pre-tax results for 2005 include higher salaries, incentive compensation
expense and sales commissions primarily related to NSW. During 2005, the
division realized cost efficiencies resulting from its acquisition of NSW,
principally in administration and overhead expense and raw material purchasing.
In the future, 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. Pre-tax results for 2005 also reflect a
charge of $200,000 resulting from the sale of certain assets related to a former
product line of NSW.
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, this was more than offset by
increased selling prices, sales and production volumes in most markets,
resulting in increased gross profit and gross profit margins 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, and include
a gain of $300,000 resulting from the sale of certain assets related to a former
product line.
Healthcare Services
Pre-tax income (loss) of the healthcare services segment was $3,300,000
and $5,100,000 for the years ended December 31, 2005 and 2004, respectively, and
$(2,300,000) for the four month period from acquisition through December 31,
2003. For the 2005, 2004 and 2003 periods, healthcare services revenues were
$239,000,000, $257,300,000 and $71,000,000, respectively, and cost of sales,
which primarily consist of salaries and employee benefits, were $203,100,000,
$216,300,000 and $61,300,000, respectively. For the 2005, 2004 and 2003 periods,
pre-tax results reflect aggregate interest, depreciation and amortization
expenses of $4,000,000, $2,800,000 and $700,000, respectively.
38
As described above, regulatory changes that went into effect on January
1, 2006 concerning Medicare reimbursement for therapy services are likely to
have some negative impact on Symphony's future revenues and profitability,
particularly in 2006. The Medicare Part A prospective payment system was changed
to add new categories of services which effectively shifted the allocation of
reimbursable services away from the services that Symphony provides. To the
extent that Symphony's customer contracts are linked to these categories of
services, revenues and gross margins will decline unless Symphony is successful
in renegotiating its customer contracts to address this regulatory change.
Although Symphony has successfully renegotiated many of its contracts with
respect to this matter, Part A revenues for certain customers could decline.
With respect to Medicare Part B therapy services, most of these services became
subject to an annual limitation per beneficiary of $1,740 for physical therapy
and speech-language pathology and $1,740 for occupational therapy services,
subject to an exception process developed by CMS for services deemed medically
appropriate. The CMS exception process is retroactive to January 1, 2006, and is
to be fully implemented no later than March 13, 2006. Under the guidance CMS
published, the majority of Symphony's patients will qualify for an automatic
exception to the therapy cap limits. Those who do not qualify for the automatic
exception are still eligible to obtain a manual exception, subject to CMS
approval. While the exception process was under development, it created
uncertainty among Symphony's staff and customers which limited Symphony's
services to Part B patients. Symphony is currently training operating and
clinical staff on the new exception process, so that services can be provided
when medically necessary, and expects that once training is complete revenues
for Medicare Part B therapy services will increase. However, Symphony does not
expect that revenues for Part B Medicare therapy services will increase to the
level that they would have been absent implementation of the caps.
Beginning in 2004, Symphony performed an evaluation of its customer base
to identify those customers and markets where Symphony could 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. Symphony is also
seeking to grow its profitable businesses, which includes expanding its service
offerings to existing customers. The ability of Symphony 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 as a result of normal
employee turnover. The tight labor market causes Symphony and others in its
industry to, at times, hire independent contractors to perform required
services, which may increase costs and reduce margins, and can also result in
lost revenue opportunities if skilled independent contractors are not available
at an acceptable cost.
The decrease in healthcare revenues in 2005 as compared to 2004
principally resulted from Symphony's termination of certain underperforming
customers, customer attrition and the sale of Symphony's respiratory line of
business in the second quarter of 2005. During the 2005, 2004 and 2003 periods,
one customer accounted for approximately 14%, 16% and 14%, respectively, of
Symphony's revenues.
Gross margins declined in 2005 as compared to 2004, which reflects the
revenue changes discussed above, higher hourly wages and benefits paid to
attract and retain therapists and greater amounts incurred for independent
contractors, both due to a shortage of licensed therapists in the marketplace,
partially offset by improved therapist efficiency and reduced field management
costs. Pre-tax results for 2005 also reflect higher borrowing costs, greater
professional fees for certain outsourced services and expenditures for hiring,
training and automation, which Symphony hopes will help offset the increase in
the costs of therapists, and higher depreciation expense. Pre-tax results also
reflect aggregate gains of $800,000 from the sale of certain property and the
respiratory line of business.
Excluding charges for depreciation, amortization and interest expense,
profits for the fourth quarter of 2005 were approximately $1,900,000 despite a
16% decline in revenues from the comparable period in the prior year and
industry-wide labor cost increases. Symphony is beginning to realize the
benefits of its efforts to invest in automation to improve efficiency and reduce
expenses, and to enhance its service offerings and terminate unprofitable
contracts.
Symphony's margins for 2004 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. 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.
39
Telecommunications - ATX
ATX has been consolidated by the Company since April 22, 2005, the
effective date of its bankruptcy plan. From acquisition through December 31,
2005, ATX telecommunications revenues and other income were $111,400,000,
telecommunications cost of sales were $69,600,000, salaries and incentive
compensation expense was $17,700,000, depreciation and amortization expenses
were $7,500,000, selling, general and other expenses were $18,400,000 and ATX
had a pre-tax loss from continuing operations of $1,900,000. ATX's cost of sales
in 2005 reflects the migration of portions of its network to lower cost
providers, the favorable resolution of an access cost dispute and a favorable
rate change for unbundled local circuits; however, these cost reductions were
offset by UNE-P and Entrance Facility rate increases from Verizon. ATX had a
pre-tax loss from discontinued operations of $200,000 in 2005.
As discussed above, ATX's ability to provide quality services at
competitive prices to its customers is significantly dependent upon its ability
to use or purchase various components of an ILEC's network and infrastructure.
However, ATX does own certain equipment and facilities that help mitigate its
reliance upon ILECs and reduce its costs. The enactment of the Telecom Act
enabled ATX to purchase ILEC services at favorable rates; however, certain
subsequent regulatory action has resulted in more flexibility for the ILEC in
determining what products and services it provides and the rates it can charge.
In certain instances, regulatory action is shifting the determination of these
rates from regulatory jurisdiction towards commercial negotiation between the
parties, generally resulting in ILEC price increases. For some stand-alone
product lines, in particular local telephone services, ATX does not expect it
will be able to offer a competitive product because its charges from the ILEC
have risen, resulting in a price increase for ATX's customers. ATX has been and
continues to restructure its operations to meet the changing competitive and
regulatory environment and increased cost of services; however, ATX's future
profitability is uncertain.
Domestic Real Estate
Pre-tax income for the domestic real estate segment was $4,100,000,
$20,700,000 and $18,100,000 for the years ended December 31, 2005, 2004 and
2003, 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.
In 2005, the Company sold its 716-room Waikiki Beach hotel and related
assets for an aggregate purchase price of $107,000,000, before closing costs and
other required payments. The Company recorded a pre-tax gain of $56,600,000,
which is reflected in gain on disposal of discontinued operations. Historical
operating results for the hotel have not been material.
In 2004, the Company sold 92 lots of its 95-lot development project in
South Walton County, Florida for aggregate sales proceeds of approximately
$50,000,000, recognized pre-tax profits of $15,800,000 and deferred recognition
of pre-tax profits of $10,200,000. During 2005, the Company recognized
$7,000,000 of the deferred profit related to this project, upon completion of
certain required improvements to the property.
Revenues and pre-tax results for this segment increased in 2004 as
compared to 2003, primarily due to the South Walton County project sale
discussed above. 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 had 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.
During 2003, the Company recognized $11,100,000 of deferred gains from
sales of real estate in prior years.
40
Banking and Lending
As stated previously, the Company's banking and lending operations have
been in run-off, and during 2005 the Company's banking and lending subsidiary
filed a formal plan with the Office of the Comptroller of the Currency to
liquidate its operations, sold its remaining customer deposits and surrendered
its national bank charter. As a result, revenues and expenses included in the
Company's 2005 consolidated statements of operations are not material and are
not discussed below. Pre-tax results for banking and lending of $1,400,000,
$22,000,000 and $8,400,000 for the years ended December 31, 2005, 2004 and 2003,
respectively, have been classified with other operations.
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. Finance revenues of $10,000,000 in
2004 and $55,100,000 in 2003 reflect this decreasing level of consumer
instalment loans. 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 reflected the ongoing reduction in the amount of loan assets under
management, including as a result of the loan portfolios sales.
Pre-tax results for the banking and lending segment include income of
$3,100,000 for the year ended December 31, 2003, resulting from mark-to-market
changes on interest rate swaps. The Company had used interest rate swaps to
manage the impact of interest rate changes on its customer banking deposits; all
of the interest rate swap agreements matured in 2003.
Corporate and Other Operations
Investment and other income increased in 2005 as compared to 2004
primarily due to the $10,500,000 gain on the sale of 70% of the Company's
interest in CLC to Inmet, greater investment income of $24,200,000 reflecting a
larger amount of invested assets and higher interest rates, and increased sales
at the wineries of $5,000,000. 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 increased in 2004 as compared to 2003
primarily due to the pre-tax gain of $11,300,000 from the sale of two of the
Company's older corporate aircraft, greater dividend and interest income of
$12,400,000 and miscellaneous other income. Investment and other income for 2003
included $5,300,000 of income related to a refund of foreign taxes not based on
income.
Net securities gains for Corporate and Other Operations aggregated
$208,800,000, $136,100,000 and $10,600,000 for the years ended December 31,
2005, 2004 and 2003, respectively. During 2005 and 2004, the Company's net
securities gains largely reflect realized gains from the sale of publicly traded
debt and equity securities that had been classified as Corporate available for
sale securities. Included in net securities gains for the 2005 periods is a gain
of $146,000,000 from the sale of 375,000 shares of WMIG common stock. Net
securities gains for 2005, 2004 and 2003 include provisions of $12,200,000,
$4,600,000 and $6,500,000, respectively, to write down the Company's investments
in certain available for sale securities and an investment in a non-public
security in 2003. 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
could also be influenced by the status of the Company's tax attributes or
liquidity needs; however, sales in recent years have not been influenced by
these considerations. Therefore, the timing of realized security gains or losses
is not predictable and does not follow any pattern from year to year.
41
The increase in interest expense during 2005 as compared to 2004
primarily reflects interest expense relating to $100,000,000 principal amount of
7% Senior Notes and $350,000,000 principal amount of 3 3/4% Convertible Senior
Subordinated Notes issued in April 2004. The increase in interest expense during
2004 as compared to 2003 primarily reflects the issuance of the bonds in 2004,
interest expense relating to $275,000,000 aggregate principal amount of 7%
Senior Notes issued during 2003, 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).
Salaries and incentive compensation expense increased by $31,300,000 in
2005 as compared to 2004, and by $2,400,000 in 2004 as compared to 2003,
principally due to increased bonus expense.
Selling, general and other expenses increased by $14,600,000 in 2005 as
compared to 2004, primarily due to higher minority interest expense relating to
MK prior to its merger of $4,200,000, greater foreign exchange losses of
$2,700,000, higher professional fees of $4,400,000 that principally relate to
due diligence expenses for potential investments and investment management fees,
an impairment loss for the remaining book value of the investment in Olympus of
$3,700,000, greater employee benefit expenses and operating expenses of a
subsidiary engaged in the development of a new medical product.
Selling, general and other expenses increased by $19,700,000 in 2004 as
compared to 2003, primarily due to 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's 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.
As more fully discussed above, during 2005 the Company's revised
projections of future taxable income enabled it to conclude that it is more
likely than not that it will have future taxable income sufficient to realize a
portion of the Company's net deferred tax asset; accordingly, $1,135,100,000 of
the deferred tax valuation allowance was reversed as a credit to income tax
expense.
The income tax provision reflects the reversal of tax reserves
aggregating $27,300,000 and $24,400,000 for the years ended December 31, 2004
and 2003, 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.
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 valuation allowance was required because, on a pro
forma combined basis, the Company was not able to demonstrate that it is more
likely than not that it would be able to realize the deferred tax asset.
Subsequent to the acquisition of WilTel, during 2004 and 2003 any benefit
realized from WilTel's deferred tax asset reduced the valuation allowance for
the deferred tax asset; however, that reduction was first applied to reduce the
carrying amount of the acquired non-current intangible assets of WilTel rather
than to 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.
42
Associated Companies
Equity in income (losses) of associated companies includes the following
for the years ended December 31, 2005, 2004 and 2003 (in thousands):
2005 2004 2003
---- ---- ----
Olympus $ (120,100) $ 9,700 $ 40,400
EagleRock (28,900) 29,400 49,900
HomeFed 5,800 10,000 16,200
JPOF II 23,600 16,200 14,800
Union Square 72,800 1,300 100
Pershing Square, L.P. -- 21,300 --
Berkadia -- 800 79,200
WilTel -- -- (52,100)
Other 2,400 2,800 (1,500)
---------- ---------- ----------
Equity in income (losses) before
income taxes (44,400) 91,500 147,000
Income tax expense (700) (15,000) (70,100)
---------- ---------- ----------
Equity in income (losses), net of taxes $ (45,100) $ 76,500 $ 76,900
========== ========== ==========
The Company's equity in losses from Olympus for 2005 reflects its share
of Olympus' estimated losses from hurricanes Katrina, Rita and Wilma. Effective
January 1, 2006, Olympus received new capital which reduced the Company's equity
interest to less than 4%. As a result, the Company will not apply the equity
method of accounting for this investment in the future. At December 31, 2005,
the book value of the Company's investment in Olympus had been written down to
zero.
As described above, the Company owns approximately 30% of HomeFed, a
California real estate development company, which it acquired in 2002. The
Company's share of HomeFed's reported earnings fluctuates with the level of real
estate sales activity at HomeFed's development projects.
The Company's share of JPOF II's earnings was distributed to the Company
shortly after the end of each year.
The equity in income (losses) of EagleRock results from both realized and
changes in unrealized gains (losses) in its portfolio. The partnership
distributed $16,600,000 to the Company in 2006 and $3,700,000 in 2004.
Union Square, two entities in which the Company had non-controlling
equity interests, sold their respective interests in an office complex located
on Capitol Hill in Washington, D.C. during 2005. Including repayment of its
mortgage loans at closing, the Company's share of the net proceeds was
$73,200,000, and the Company recognized a pre-tax gain of $72,300,000.
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 effective
December 31, 2004; $71,300,000 was distributed to the Company in early 2005.
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 ($4,000,000) of the annual management fee received from FINOVA
while such fee remains in effect. The Company does not believe that its share of
the FINOVA common stock will ever result in any cash value, and is reflected at
a zero book value. The Company has received total net cash proceeds of
$95,200,000 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 table above includes amounts related to WilTel prior to consolidation
in November 2003 when it was accounted for under the equity method of
accounting.
43
Discontinued Operations
WilTel
As discussed above, the Company sold WilTel to Level 3 in December 2005
and recognized a pre-tax gain on disposal of $243,800,000. The calculation of
the gain on sale included: (1) the cash proceeds received from Level 3 of
$460,300,000, which is net of estimated working capital adjustments of
$25,500,000; (2) the fair value of the Level 3 common shares of $339,300,000,
based on the $2.95 per share closing price of Level 3 common stock immediately
prior to closing; (3) the amount of the SBC cash payments that had not been
previously accrued prior to closing ($175,900,000); (4) an impairment charge for
WilTel's headquarters building of approximately $42,400,000; and (5) the net
book value of the net assets sold and estimated expenses and other costs related
to the transaction. The Company reclassified WilTel's consolidated historical
results of operations prior to the sale to income (loss) from discontinued
operations. WilTel's income (loss) from discontinued operations was
$116,000,000, $(56,600,000) and $(15,300,000) for the years ended December 31,
2005, 2004 and 2003, respectively.
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 USA Mobility shares were sold during 2005.
In return for the Company's $19,000,000 investment in WebLink, the
Company received aggregate cash proceeds of $48,900,000, net of minority
interest and residual liabilities.
Domestic Real Estate
As discussed above, in 2005 the Company sold its 716-room Waikiki Beach
hotel and related assets and recorded a pre-tax gain of $56,600,000, which is
reflected in gain on disposal of discontinued operations.
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 of $600,000 when the sale closed,
principally relating to mortgage prepayment penalties incurred upon satisfaction
of the property's mortgage. Operating results for this property were not
material in prior years.
Other Operations
In December 2005, the Company sold its interest in an Argentine shoe
manufacturer that had been acquired earlier in the year. Although there was no
material gain or loss on disposal, results of discontinued operations during
2005 include an operating loss of $4,400,000.
44
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 and 2003, the
Company recorded pre-tax losses from discontinued operations relating to this
business of $1,500,000 and $2,300,000, respectively.
Recently Issued Accounting Standards
In April 2005, the SEC amended the effective date of Statement of
Financial Accounting Standards No. 123R, "Share-Based Payment" ("SFAS 123R"),
from the first interim or annual period after June 15, 2005 to the beginning of
the next fiscal year that begins after June 15, 2005. 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 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;
the Company intends to use the modified prospective method. The Company does not
expect that SFAS 123R will have a material impact on its consolidated financial
statements with respect to currently outstanding options.
In May 2005, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 154, "Accounting Changes and
Error Corrections-a replacement of APB Opinion No. 20 and FASB Statement No. 3"
("SFAS 154"), which is effective for accounting changes and corrections of
errors made in fiscal years beginning after December 15, 2005. SFAS 154 applies
to all voluntary changes in accounting principles, and changes the accounting
and reporting requirements for a change in accounting principle. SFAS 154
requires retrospective application to prior periods' financial statements of a
voluntary change in accounting principle unless doing so is impracticable. APB
20 previously required that most voluntary changes in accounting principle be
recognized by including in net income of the period in which the change occurred
the cumulative effect of changing to the new accounting principle. SFAS 154 also
requires that a change in depreciation, amortization, or depletion method for
long-lived, nonfinancial assets be accounted for as a change in accounting
estimate effected by a change in accounting principle. SFAS 154 carries forward
without change the guidance in APB 20 for reporting the correction of an error
in previously issued financial statements, a change in accounting estimate and a
change in reporting entity, as well as the provisions of SFAS 3 that govern
reporting accounting changes in interim financial statements. The Company does
not expect that SFAS 154 will have a material impact on its consolidated
financial statements.
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, development 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.
Factors that could cause actual results to differ materially from any
results projected, forecasted, estimated or budgeted or may materially and
adversely affect the Company's actual results include, but are not limited to,
those set forth in Item 1A. Risk Factors and elsewhere in this Report and in
the Company's other public filings with the Securities and Exchange Commission.
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.
45
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 and its borrowing activities.
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, 2005. These fixed income securities are primarily rated "investment
grade" or are U.S. governmental agency issued or U.S. Government-Sponsored
Enterprises. The estimated weighted average remaining life of these fixed income
securities was approximately 1.2 years at December 31, 2005. 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. At December
31, 2004, fixed income securities comprised approximately 68% of the Company's
total investment portfolio and had an estimated weighted average remaining life
of 1.1 years. At December 31, 2005 and 2004, the Company's portfolio of trading
securities was not material.
The Company's investment portfolio also includes its investment in
Level 3, carried at its aggregate market value of $330,100,000. This investment
is approximately 14% of the Company's total investment portfolio, and its value
is subject to change if the market value of the Level 3 stock rises or falls.
The Company's investment portfolio also includes its investment in Inmet, which
is carried at cost of $78,000,000 at December 31, 2005. Although the Company is
restricted from selling the Inmet common shares, the investment is subject to
price risk. The market value of this investment is $142,100,000 at December 31,
2005.
The Company is subject to interest rate risk on its long-term fixed
interest rate debt. Generally, the fair market value of debt securities with a
fixed interest rate will increase as interest rates fall, and the fair market
value will decrease as interest rates rise.
The 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 borrowings, the weighted average interest rates are based on implied
forward rates in the yield curve at the reporting date. For 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 additional information, see Notes 6, 12 and 21 of Notes to
Consolidated Financial Statements.
46
Expected Maturity Date
----------------------
2006 2007 2008 2009 2010 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
(Dollars in thousands)
Rate Sensitive Assets:
Available for Sale Fixed
Income Securities:
U.S. Government and
agencies $ 830,235 $ 7,875 $ 5,483 $ 3,840 $ 2,706 $ 6,816 $ 856,955 $ 856,955
Weighted Average
Interest Rate 3.04% 5.37% 5.36% 5.35% 5.34% 5.30%
U.S. Government-
Sponsored Enterprises $ 229,696 $ 23,815 $ 18,640 $ 14,788 $ 11,769 $ 39,905 $ 338,613 $ 338,613
Weighted Average
Interest Rate 3.97% 5.33% 5.33% 5.34% 5.35% 5.40%
Other Fixed Maturities:
Rated Investment Grade $ 169,224 $ 2,509 $ 2,791 $ - $ 406 $ 783 $ 175,713 $ 175,713
Weighted Average
Interest Rate 4.31% 5.90% 3.96% - 6.38% 3.27%
Rated Less Than Investment
Grade/Not Rated $ 19,824 $ 81,364 $ 49,095 $ 29,136 $ 12,030 $ 18,078 $ 209,527 $ 209,527
Weighted Average Interest
Rate 7.01% 10.69% 8.83% 10.21% 9.75% 9.04%
Rate Sensitive Liabilities:
Fixed Interest Rate
Borrowings $ 114,442 $ 963 $ 2,633 $ 886 $ 992 $930,095 $1,050,011 $1,101,933
Weighted Average
Interest Rate 4.43% 10.76% 8.47% 11.92% 11.97% 6.06%
Variable Interest Rate
Borrowings $ 61,222 $ 11,929 $ 2,114 $ 2,114 $ 2,114 $ 32,878 $ 112,371 $ 112,371
Weighted Average
Interest Rate 7.51% 7.97% 8.81% 8.91% 9.00% 9.01%
Rate Sensitive Derivative
Financial Instruments:
Euro currency swap $ 2,085 $ 2,085 $ 2,085 $ 2,085 $ 522 $ - $ 8,862 $ (2,546)
Average Pay Rate 5.89% 5.89% 5.89% 5.89% 5.89% -
Average Receive Rate 7.60% 7.60% 7.60% 7.60% 7.60% -
Pay Fixed/Receive Variable
Interest Rate Swap $ 2,114 $ 2,114 $ 2,114 $ 2,114 $ 2,114 $ 32,878 $ 43,448 $ (677)
Average Pay Rate 5.01% 5.01% 5.01% 5.01% 5.01% 5.01%
Average Receive Rate 4.77% 4.73% 4.81% 4.91% 5.00% 5.01%
Off-Balance Sheet Items:
Unused Lines of Credit $ - $ 110,000 $ - $ - $ - $ - $ 110,000 $110,000
Weighted Average
Interest Rate 6.27% 6.25% - - - -
47
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.
- ------ ---------------------
None.
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, 2005. Based on their
evaluation, the Company's principal executive and principal financial officers
concluded that the Company's disclosure controls and procedures were effective
as of December 31, 2005.
Changes in internal control over financial reporting
(b) There has been no change in the Company's internal control over
financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) that occurred during the Company's fiscal quarter ended December
31, 2005, 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, 2005. 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).
As permitted by the SEC, the Company has excluded from this assessment of
internal control over financial reporting the internal control over financial
reporting of Idaho Timber, ATX and NSW, each of which was acquired by the
Company during 2005. In the aggregate, these entities represent 5.2% of
consolidated assets at December 31, 2005 and 35.3% of 2005 consolidated
revenues.
48
Based on our assessment and those criteria, management concluded that, as
of December 31, 2005, 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, 2005 has been
audited by PricewaterhouseCoopers LLP, an independent registered public
accounting firm, as stated in their report which appears herein.
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 2006 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, 2005. 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 977,630 $35.19 259,575
Equity compensation
plans not approved
by security holders -- -- --
-------- ------ -------
Total 977,630 $35.19 259,575
======== ====== =======
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.
49
PART IV
Item 15. Exhibits and Financial Statement Schedule.
- -------- ------------------------------------------
(a)(1)(2) Financial Statements and Schedule.
Report of Independent Registered Public Accounting Firm..................................... F-1
Financial Statements:
Consolidated Balance Sheets at December 31, 2005 and 2004.................................. F-3
Consolidated Statements of Operations for the years ended December 31, 2005,
2004 and 2003........................................................................... F-4
Consolidated Statements of Cash Flows for the years ended December 31, 2005,
2004 and 2003........................................................................... F-5
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 2005, 2004 and 2003........................................................ F-7
Notes to Consolidated Financial Statements................................................. F-8
Financial Statement Schedule:
Schedule II - Valuation and Qualifying Accounts............................................ F-49
(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 (filed as
Exhibit 10.4 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2004 (the "2004 10-K").
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, as amended May 17, 2005 (filed as Annex A to
the Company's Proxy Statement dated April 22, 2005 (the "2005
Proxy Statement")).
Employment Agreement made as of June 30, 2005 by and between the
Company and Ian M. Cumming (filed as Exhibit 99.1 to the Company's
Current Report on Form 8-K dated July 13, 2005 (the "July 13, 2005
8-K")).
Employment Agreement made as of June 30, 2005 by and between the
Company and Joseph S. Steinberg (filed as Exhibit 99.2 to the July
13, 2005 8-K).
(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).*
50
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 (filed as Exhibit
3.5 to the Company's 2004 10-K).*
3.6 Certificate of Amendment of the Certificate of
Incorporation dated as of May 17, 2005.
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 Form of Grant Letter for the 1999 Stock Option Plan (filed
as Exhibit 10.4 to the Company's 2004 10-K).*
10.3 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).*
10.4 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).*
10.5 Amendment, dated as of March 31, 2004, to the Revolving
Credit Agreement (filed as Exhibit 10.7 to the Company's
2004 10-K).*
10.6 Amendment, dated as of June 29, 2004, to the Revolving
Credit Agreement (filed as Exhibit 10.8 to the Company's
2004 10-K).*
10.7 Leucadia National Corporation 2003 Senior Executive Annual
Incentive Bonus Plan, as amended May 17, 2005 (filed as
Annex A to the 2005 Proxy Statement).*
10.8 Employment Agreement made as of June 30, 2005 by and
between the Company and Ian M. Cumming (filed as Exhibit
99.1 to the Company's July 13, 2005 8-K).*
10.9 Employment Agreement made as of June 30, 2005 by and
between the Company and Joseph S. Steinberg (filed as
Exhibit 99.2 to the July 13, 2005 8-K).*
10.10 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).*
10.11 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).*
10.12 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).* 51
10.13 First Amended Joint Chapter 11 Plan of Reorganization of
Williams Communications Group, Inc. ("WCG") and CG Austria,
Inc. filed with the Bankruptcy Court as Exhibit 1 to the
Settlement Agreement (filed as Exhibit 99.3 to the Current
Report on Form 8-K of WCG dated July 31, 2002 (the "WCG
July 31, 2002 8-K")).*
10.14 Tax Cooperation Agreement between WCG and The Williams
Companies Inc. 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).*
10.15 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")).*
10.16 First Amendment to Third Amended and Restated Credit And
Guaranty Agreement, dated September 2, 2005, by and among
WilTel Communications, LLC, WilTel Communications Group
LLC, the Subsidiary Guarantors (as defined), and the First
Lien Administrative Agent, the Second Lien Administrative
Agent and the Administrative Agent for the Lenders (filed
as Exhibit 99.1 to the Company's Current Report on Form 8-K
dated September 2, 2005).*
10.17 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).*
10.18 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).*
10.19 Letter Agreement, dated February 3, 2005, between the
Company and Jefferies & Company, Inc. (filed as Exhibit
10.55 to the Company's 2004 10-K).*
10.20 Information Concerning Executive Compensation (filed as
Exhibit 10.1 to the Company's Current Report on Form 8-K
dated January 9, 2006).*
10.21 Compensation of Non-Employee Directors.
10.22 Hotel Purchase Agreement, dated as of April 6, 2005, by and
between HWB 2507 Kalakaua, LLC and Gaylord Entertainment
Co. (filed as Exhibit 10.2. to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended March
31, 2005 (the "1st Quarter 2005 10-Q")).*
10.23 Stock Purchase Agreement, dated as of May 2, 2005, by and
among the Company and the individuals named therein (filed
as Exhibit 10.4 to the Company's 1st Quarter 2005 10-Q).*
10.24 Purchase Agreement, dated as of October 30, 2005, among the
Company, Baldwin Enterprises, Inc., Level 3 Communications,
LLC and Level 3 Communications, Inc. ("Level 3") (filed as
Exhibit 10.1 to the Company's Current Report on Form 8-K
dated October 30, 2005).*
52
10.25 Registration Rights and Transfer Restriction Agreement,
dated as of December 23, 2005, by and among Level 3, the
Company and Baldwin Enterprises, Inc. (filed as Exhibit
10.2 to Level 3's Current Report on Form 8-K dated December
23, 2005).*
10.26 Purchase and Sale Agreement ("Square 711 Purchase and Sale
Agreement"), dated as of November 14, 2005, between Square
711 Developer, LLC and Walton Acquisition Holdings V,
L.L.C., a Delaware limited liability company.
10.27 First Amendment to Square 711 Purchase and Sale Agreement,
dated as of December 14, 2005.
10.28 Share Purchase Agreement, dated May 2, 2005, between Inmet
Mining Corporation, the Company and MK Resources Company
(filed as Exhibit 2 to Amendment No. 10 to the Schedule 13D
dated May 2, 2005 of the Company with respect to MK
Resources Company (the "MK 13D")).*
10.29 Agreement and Plan of Merger, dated as of May 2, 2005,
among the Company, Marigold Acquisition Corp. and MK
Resources Company (filed as Exhibit 3 to the MK 13D).*
10.30 Voting Agreement, dated as of May 2, 2005, between the
Company and Inmet Mining Corporation (filed as Exhibit 4 to
the MK 13D).*
10.31 Letter Agreement, dated March 30, 2005 between SBC
Services, Inc. ("SBC Services") and WilTel Communications,
LLC ("WCLLC") (filed as Exhibit 10.1 to the Company's 1st
Quarter 2005 10-Q).*
10.32 Letter Agreement, dated April 27, 2005 between SBC Services
and WCLLC (filed as Exhibit 10.3 to the Company's 1st
Quarter 2005 10-Q).*
10.33 Letter Agreement, dated May 25, 2005 between SBC Services
and WCLLC (filed as Exhibit 10.1 to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended June 30,
2005).*
10.34 Master Services Agreement dated June 15, 2005 among WilTel
Communications Group ("WCGLLC"), WilTel Local Network, LLC,
SBC Services. and SBC Communications Inc. ("SBC") (filed as
Exhibit 99.1 to the Company's Current Report on Form 8-K/A
dated June 15, 2005 (the "June 15, 2005 8-K/A")).*
10.35 Termination, Mutual Release and Settlement Agreement dated
June 15, 2005 among the Company, WCGLLC, WCLLC, SBC, SBC
Operations, Inc. and SBC Long Distance, LLC (filed as
Exhibit 99.2 to the Company's June 15, 2005 8-K/A).*
10.36 Debtors' Modified Second Amended Joint Plan of
Reorganization under chapter 11 of the Bankruptcy Code,
dated as of April 13, 2005, of ATX Communications, Inc.
(filed as Exhibit 99.1 to ATX Communication's Current
Report on Form 8-K dated April 20, 2005).*
10.37 Services Agreement, dated as of January 1, 2004, between
the Company and Ian M. Cumming.
10.38 Services Agreement, dated as of January 1, 2004, between
the Company and Joseph S. Steinberg.
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 (No. 2-84303), Form S-8 and S-3 (No.
33-6054), Form S-8 and S-3 (No. 33-26434), Form S-8 and S-3
(No. 33-30277), Form S-8 (No. 33-61682), Form S-8 (No.
33-61718), Form S-8 (No. 333-51494) and Form S-3 (No.
333-118102). 53
23.2 Consent of independent auditors from Ernst & Young LLP with
respect to the inclusion in this Annual Report on Form 10-K
of the financial statements of Berkadia LLC and with
respect to the incorporation by reference in the Company's
Registration Statements on Form S-8 (No. 2-84303), Form S-8
and S-3 (No. 33-6054), Form S-8 and S-3 (No. 33-26434),
Form S-8 and S-3 (No. 33-30277), Form S-8 (No. 33-61682),
Form S-8 (No. 33-61718), Form S-8 (No. 333-51494) and Form
S-3 (No. 333-118102).**
23.3 Consent of PricewaterhouseCoopers, with respect to the
inclusion in this Annual Report on Form 10-K the financial
statements of Olympus Re Holdings, Ltd. and with respect to
the incorporation by reference in the Company's
Registration Statements on Form S-8 (No. 2-84303), Form S-8
and S-3 (No. 33-6054), Form S-8 and S-3 (No. 33-26434),
Form S-8 and S-3 (No. 33-30277), Form S-8 (No. 33-61682),
Form S-8 (No. 33-61718), Form S-8 (No. 333-51494) and Form
S-3 (No. 333-118102). **
23.4 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) and Form
S-3 (No. 333-118102). **
23.5 Consent of independent auditors from Ernst & Young LLP with
respect to the inclusion in this Annual Report on Form 10-K
of the financial statements of WilTel Communications Group,
Inc. and with respect to the incorporation by reference in
the Company's Registration Statements on Form S-8 (No.
2-84303), Form S-8 and S-3 (No. 33-6054), Form S-8 and S-3
(No. 33-26434), Form S-8 and S-3 (No. 33-30277), Form S-8
(No. 33-61682), Form S-8 (No. 33-61718), Form S-8 (No.
333-51494) and Form S-3 (No. 333-118102).
23.6 Independent Auditors' Consent from KPMG LLP, with respect
to the inclusion in this Annual Report on Form 10-K of the
financial statements of Jefferies Partners Opportunity Fund
II, LLC and with respect to the incorporation by reference
into the Company's Registration Statements on Form S-8 (No.
2-84303), Form S-8 and S-3 (No. 33-6054), Form S-8 and S-3
(No. 33-26434), Form S-8 and S-3 (No. 33-30277), Form S-8
(No. 33-61682), Form S-8 (No. 33-61718), Form S-8 (No.
333-51494) and Form S-3 (No. 333-118102). **
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. ***
54
(c) Financial statement schedules.
(1) Berkadia LLC financial statements for the years ended December 31,
2004 and 2003. **
(2) Olympus Re Holdings, Ltd. consolidated financial statements as of
December 31, 2005 and 2004 and for the years ended December 31,
2005, 2004 and 2003. **
(3) EagleRock Capital Partners (QP), LP financial statements as of
December 31, 2005 and 2004 and for the years ended December 31,
2005, 2004 and 2003 and EagleRock Master Fund, LP financial
statements as of December 31, 2005 and 2004 and for the years
ended December 31, 2005, 2004 and 2003. **
(4) WilTel Communications Group, Inc. consolidated financial
statements for the period from January 1, 2003 through November 5,
2003.
(5) Jefferies Partners Opportunity Fund II, LLC financial statements
as of December 31, 2005 and for the year ended December 31, 2005.
**
-----------------------------
* 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.
55
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 8, 2006 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
Barbara L. Lowenthal Officer)
/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
56
Report of Independent Registered Public Accounting Firm
To the Board of Directors and
Shareholders of Leucadia National Corporation:
We have completed integrated audits of Leucadia National Corporation's December
31, 2005 and 2004 consolidated financial statements and of its internal control
over financial reporting as of December 31, 2005, and an audit of its 2003
consolidated financial statements in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Our opinions, based on our
audits and the report of other auditors, are presented below.
Consolidated financial statements and financial statement schedule
In our opinion, based on our audits and the report of other auditors, the
consolidated financial statements listed in the index appearing under Item 15(a)
(1) (2) present fairly, in all material respects, the financial position of
Leucadia National Corporation and its subsidiaries at December 31, 2005 and
2004, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2005 in conformity with accounting
principles generally accepted in the United States of America. In addition, in
our opinion, the financial statement schedule listed in the index appearing
under Item 15(a) (1) (2) presents 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 schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
financial statement schedule 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 and the report of other auditors 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" appearing under Item 9A, that the
Company maintained effective internal control over financial reporting as of
December 31, 2005 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,
2005, based on criteria established in Internal Control - Integrated Framework
issued by the 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.
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.
As described in "Management's Report on Internal Control Over Financial
Reporting", management has excluded Idaho Timber, ATX and NSW from its
assessment of internal control over financial reporting as of December 31, 2005,
because those entities were acquired by the Company during 2005. We have also
excluded Idaho Timber, ATX and NSW from our audit of internal control over
financial reporting. Idaho Timber, ATX and NSW are consolidated subsidiaries
whose total assets and total revenues represent 5.2% and 35.3%, respectively, of
the related consolidated financial statement amounts as of and for the year
ended December 31, 2005.
PricewaterhouseCoopers LLP
New York, New York
March , 2006
F-2
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2005 and 2004
(Dollars in thousands, except par value)
2005 2004
---- ----
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 386,957 $ 277,238
Investments 1,323,562 1,084,745
Trade, notes and other receivables, net 377,216 160,234
Prepaids and other current assets 140,880 27,850
Current assets of discontinued operations -- 509,882
----------- -----------
Total current assets 2,228,615 2,059,949
Non-current investments 977,327 718,326
Notes and other receivables, net 22,747 16,906
Intangible assets, net and goodwill 85,083 1,472
Deferred tax asset, net 1,094,017 --
Other assets 240,601 272,867
Property, equipment and leasehold improvements, net 237,021 283,330
Investments in associated companies 375,473 460,794
Non-current assets of discontinued operations -- 986,759
----------- -----------
Total $ 5,260,884 $ 4,800,403
=========== ===========
LIABILITIES
- -----------
Current liabilities:
Trade payables and expense accruals $ 259,778 $ 167,864
Other current liabilities 23,783 27,044
Customer banking deposits due within one year -- 18,472
Debt due within one year 175,664 64,799
Income taxes payable 15,171 17,690
Current liabilities of discontinued operations -- 363,468
----------- -----------
Total current liabilities 474,396 659,337
Other non-current liabilities 121,893 121,675
Long-term debt 986,718 1,067,123
Non-current customer banking deposits -- 6,119
Non-current liabilities of discontinued operations -- 669,221
----------- -----------
Total liabilities 1,583,007 2,523,475
----------- -----------
Commitments and contingencies
Minority interest 15,963 18,275
----------- -----------
SHAREHOLDERS' EQUITY
- --------------------
Common shares, par value $1 per share, authorized 300,000,000 and 150,000,000
shares; 108,029,008 and 107,600,403 shares issued and outstanding, after
deducting 42,377,843 and 42,399,597 shares
held in treasury 108,029 107,600
Additional paid-in capital 609,943 598,504
Accumulated other comprehensive income (loss) (81,502) 136,138
Retained earnings 3,025,444 1,416,411
----------- -----------
Total shareholders' equity 3,661,914 2,258,653
----------- -----------
Total $ 5,260,884 $ 4,800,403
=========== ===========
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, 2005, 2004 and 2003
(In thousands, except per share amounts)
2005 2004 2003
---- ---- ----
REVENUES AND OTHER INCOME:
- --------------------------
Manufacturing $ 332,253 $ 64,055 $ 53,327
Healthcare 239,046 257,262 71,039
Telecommunications 111,192 -- --
Investment and other income 149,840 180,081 179,385
Net securities gains 208,816 136,564 9,928
----------- ---------- ----------
1,041,147 637,962 313,679
----------- ---------- ----------
EXPENSES:
- ---------
Cost of sales:
Manufacturing 281,451 45,055 38,998
Healthcare 203,149 216,333 61,280
Telecommunications 67,266 -- --
Interest 68,376 62,710 37,902
Salaries 102,236 48,334 39,094
Depreciation and amortization 26,767 19,625 18,132
Selling, general and other expenses 153,739 134,027 126,491
----------- ---------- ----------
902,984 526,084 321,897
----------- ---------- ----------
Income (loss) from continuing operations before income taxes, minority
expense of trust preferred securities and equity in income (losses) of
associated companies 138,163 111,878 (8,218)
----------- ---------- ----------
Income tax (benefit) provision:
Current 4,018 (27,434) (11,424)
Deferred (1,135,100) 7,242 (23,750)
----------- ---------- ----------
(1,131,082) (20,192) (35,174)
----------- ---------- ----------
Income from continuing operations before minority expense of trust
preferred securities and equity in income (losses) of associated
companies 1,269,245 132,070 26,956
Minority expense of trust preferred securities, net of taxes -- -- (2,761)
Equity in income (losses) of associated companies, net of taxes (45,133) 76,479 76,947
----------- ---------- ----------
Income from continuing operations 1,224,112 208,549 101,142
Income (loss) from discontinued operations, net of taxes 111,557 (64,862) (11,586)
Gain on disposal of discontinued operations, net of taxes 300,372 1,813 7,498
----------- ---------- ----------
Net income $ 1,636,041 $ 145,500 $ 97,054
=========== ========== ==========
Basic earnings (loss) per common share:
Income from continuing operations $11.36 $ 1.95 $ 1.10
Income (loss) from discontinued operations 1.03 (.61) (.12)
Gain on disposal of discontinued operations 2.79 .02 .08
------ ------ ------
Net income $15.18 $ 1.36 $ 1.06
====== ====== ======
Diluted earnings (loss) per common share:
Income from continuing operations $10.71 $ 1.90 $ 1.09
Income (loss) from discontinued operations .96 (.58) (.12)
Gain on disposal of discontinued operations 2.60 .02 .08
------ ------ -------
Net income $14.27 $ 1.34 $ 1.05
====== ====== =======
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, 2005, 2004 and 2003
(In thousands)
2005 2004 2003
---- ---- ----
(Revised)
Net cash flows from operating activities:
- -----------------------------------------
Net income $ 1,636,041 $ 145,500 $ 97,054
Adjustments to reconcile net income to net cash provided by (used for)
operations:
Deferred income tax provision (benefit) (1,135,100) 7,242 28,960
Depreciation and amortization of property, equipment and leasehold improvements 186,428 232,600 65,723
Other amortization 3,068 3,316 (4,624)
Provision for doubtful accounts 6,181 (5,366) 20,098
Net securities gains (212,299) (142,936) (9,953)
Equity in (income) losses of associated companies 44,403 (91,546) (146,989)
Distributions from associated companies 90,280 23,878 25,359
Net gains related to real estate, property and equipment, loan receivables and
other assets (29,386) (60,866) (23,429)
Gain on disposal of discontinued operations (300,372) (1,813) (7,498)
Investments classified as trading, net 18,022 (68,612) (8,133)
Net change in:
Trade, notes and other receivables 20,850 19,578 (18,086)
Prepaids and other assets (29,978) 11,491 (6,559)
Trade payables and expense accruals 54,344 19,654 (23,489)
Other liabilities (36,427) (52,250) (22,165)
Deferred revenue 10,553 9,945 9,854
Income taxes payable (2,537) 16,890 2,959
Other (2,961) 1,732 (2,344)
----------- ----------- ---------
Net cash provided by (used for) operating activities 321,110 68,437 (23,262)
----------- ----------- ---------
Net cash flows from investing activities:
- -----------------------------------------
Acquisition of property, equipment and leasehold improvements (136,260) (97,412) (85,717)
Acquisition of and capital expenditures for real estate investments (26,053) (23,022) (67,925)
Proceeds from disposals of real estate, property and equipment, and other assets 33,722 123,302 111,134
Acquisitions, net of cash acquired (170,516) -- 114,524
Proceeds from disposal of discontinued operations, net of expenses and
cash of operations sold 459,094 22,311 (4,466)
Advances on loan receivables -- -- (2,981)
Principal collections on loan receivables 1,591 41,862 138,259
Proceeds from sale of loan receivables -- 157,134 --
Advances on notes receivables (100) (400) (2,279)
Collections on notes receivables 1,721 27,789 14,176
Investments in associated companies (34,466) (69,398) (22,350)
Capital distributions from associated companies 2,644 5,632 7,174
Purchases of investments (other than short-term) (3,350,651) (2,534,404) (1,655,480)
Proceeds from maturities of investments 1,262,577 869,707 555,148
Proceeds from sales of investments 1,979,288 1,460,181 683,752
----------- ----------- ---------
Net cash provided by (used for) investing activities 22,591 (16,718) (217,031)
----------- ----------- ---------
(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, 2005, 2004 and 2003
(In thousands)
2005 2004 2003
---- ---- ----
(Revised)
Net cash flows from financing activities:
- -----------------------------------------
Net change in customer banking deposits $ (24,565) $ (120,516) $ (245,845)
Issuance of long-term debt, net of issuance costs 82,753 438,393 304,509
Reduction of long-term debt (477,360) (92,454) (7,002)
Issuance of common shares 3,689 22,006 1,293
Purchase of common shares for treasury (167) -- (61)
Dividends paid (27,008) (26,901) (17,706)
---------- ---------- ----------
Net cash provided by (used for) financing activities (442,658) 220,528 35,188
---------- ---------- ----------
Effect of foreign exchange rate changes on cash (1,034) 311 895
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents (99,991) 272,558 (204,210)
Cash and cash equivalents at January 1, 486,948 214,390 418,600
---------- ---------- ----------
Cash and cash equivalents at December 31, $ 386,957 $ 486,948 $ 214,390
========== ========== ==========
Supplemental disclosures of cash flow information:
- --------------------------------------------------
Cash paid during the year for:
Interest $ 96,958 $ 89,707 $ 40,856
Income tax payments (refunds), net $ 3,486 $(26,024) $ (5,098)
Non-cash investing activities:
- -----------------------------
Common stock issued for acquisition of MK Resources Company in 2005 and
WilTel Communications Group, Inc. in 2003 $ 8,346 $ -- $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, 2005, 2004 and 2003
(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, 2003 $ 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 $7,345 (13,639) (13,639)
Net income 97,054 97,054
----------
Comprehensive income 193,280
----------
Issuance of common shares on acquisition of
WilTel Communications Group, Inc. 16,735 406,095 422,830
Conversion of convertible preferred shares into
common shares (47,507) 2,022 45,485 --
Exercise of options to purchase common shares 79 1,214 1,293
Purchase of common shares for treasury (4) (57) (61)
Dividends ($.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
---------
Comprehensive income:
Net change in unrealized gain (loss)
on investments, net of taxes of $0 (175,577) (175,577)
Net change in unrealized foreign exchange
gain (loss), net of taxes of $0 (17,199) (17,199)
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $0 2,747 2,747
Net change in minimum pension liability, net
of taxes of $0 (27,611) (27,611)
Net income 1,636,041 1,636,041
---------
Comprehensive income 1,418,401
---------
Issuance of common shares on acquisition of
minority interest in MK Resources Company 216 8,130 8,346
Exercise of options to purchase common shares 216 3,473 3,689
Purchase of common shares for treasury (3) (164) (167)
Dividends ($.25 per common share) (27,008) (27,008)
-------- --------- --------- -------- ----------- ----------
Balance, December 31, 2005 $ -- $ 108,029 $ 609,943 $(81,502) $ 3,025,444 $3,661,914
======== ========= ========= ======== =========== ==========
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 manufacturing, healthcare services, telecommunications, real estate
activities, winery operations and residual banking and lending activities that
are in run-off, principally in markets in the United States. The Company also
owns equity interests in investment partnerships and in operating businesses
which are accounted for under the equity method of accounting. These equity
investments include development of a copper mine in Spain, real estate
activities and property and casualty reinsurance operations. The Company
continuously evaluates the retention and disposition of its existing operations
and investments and frequently investigates the acquisition of new businesses.
Changes in the mix of the Company's owned businesses and investments should be
expected.
The manufacturing operations are conducted through Idaho Timber Corporation
("Idaho Timber") and the Company's plastics manufacturing segment. Idaho Timber
primarily remanufactures dimension lumber, remanufactures and packages home
center boards to customer specifications, produces 5/4 inch radius-edge, pine
decking and manufactures or distributes a number of specialized wood products.
Idaho Timber operates ten facilities located throughout the United States, and
its remanufacturing business is principally derived from the purchase of bundles
of low-grade lumber on the spot market, and the conversion of that lumber into
higher-grade lumber through sorting and minor rework.
The plastics manufacturing operations manufacture and market lightweight plastic
netting used for a variety of purposes including, among other things, building
and construction, erosion control, agriculture, packaging, carpet padding,
filtration and consumer products. The plastics manufacturing segment has three
domestic manufacturing facilities, and it owns and operates a manufacturing and
sales facility in Belgium.
The 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 telecommunications operations are principally conducted through ATX
Communications, Inc. ("ATX"). ATX is an integrated communications provider that
offers local and long distance telephone services, data and Internet services,
and web development, collocation and managed services, principally to small to
medium sized businesses in the Mid-Atlantic region of the United States.
The 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 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.
During 2005, the banking and lending operations sold its remaining customer
deposits and surrendered its national bank charter. The remaining operating
activities are concentrated on collecting and servicing its remaining loan
portfolio.
F-8
1. Nature of Operations, continued:
--------------------
On December 23, 2005, the Company completed the sale of its largest
telecommunications subsidiary, WilTel Communications Group, LLC ("WilTel"), and
has reclassified WilTel as a discontinued operation in the Company's
consolidated financial statements, including the reclassification of prior
years' balance sheets. The Company has reclassified its prior years' balance
sheets because WilTel's balance sheets for the prior periods comprised a
significant portion of the Company's consolidated balance sheets. For more
information concerning the sale and the Company's other discontinued operations,
see Note 5.
Certain amounts for prior periods have been reclassified to be consistent with
the 2005 presentation.
The 2003 consolidated statement of cash flows was revised to combine the cash
flows from discontinued operations with cash flows from continuing operations.
The Company had previously reported the cash flows from discontinued operations
as a single line item.
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.
Income Taxes - The Company records a valuation allowance to reduce its deferred
tax asset to the amount that is more likely than not to be realized. If the
Company were to determine that it would be able to realize its deferred tax
asset 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 deferred tax asset in the
future, an adjustment would be charged to income in such period. The
determination of the amount of the valuation allowance required is based, in
significant part, upon the Company's projection of future taxable income at any
point in time. 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.
During 2005, as a result of the consummation of certain transactions and ongoing
operating profits, the Company prepared updated projections of future taxable
income. The Company's revised projections of future taxable income enabled it to
conclude that it is more likely than not that it will have future taxable income
sufficient to realize a portion of the Company's net deferred tax asset;
accordingly, $1,135,100,000 of the deferred tax valuation allowance was reversed
as a credit to income tax expense.
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
whenever events or changes in circumstances indicate, in management's judgment,
that the carrying value of such assets may not be recoverable. When testing for
impairment, the Company groups its long-lived assets with other assets and
liabilities at the lowest level for which identifiable cash flows are largely
independent of the cash flows of other assets and liabilities (or asset group).
The determination of whether an asset group is recoverable is based on
management's estimate of undiscounted future cash flows directly attributable to
the asset group as compared to its carrying value. If the carrying amount of the
asset group is greater than the undiscounted cash flows, an impairment loss
would be recognized for the amount by which the carrying amount of the asset
group exceeds its estimated fair value.
F-9
2. Significant Accounting Policies, continued:
-------------------------------
As more fully discussed in Note 5, during 2005 an impairment loss of $42,400,000
was recorded to reduce the carrying amount of WilTel's former headquarters
facility to its estimated fair value.
Impairment of Securities - 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 in the consolidated statements of
operations. The Company evaluates its investments for impairment on a quarterly
basis.
The Company's determination of whether a security is other than temporarily
impaired incorporates both quantitative and qualitative information; GAAP
requires the exercise of judgment in making this assessment, rather than the
application of fixed mathematical criteria. The Company considers a number of
factors including, but not limited to, the length of time and the extent to
which the fair value has been less than cost, the financial condition and near
term prospects of the issuer, the reason for the decline in fair value, changes
in fair value subsequent to the balance sheet date, and other factors specific
to the individual investment. The Company's assessment involves a high degree of
judgment and accordingly, actual results may differ materially from the
Company's estimates and judgments.
Business Combinations - At acquisition, the Company allocates the cost of a
business acquisition to the specific tangible and intangible assets acquired and
liabilities assumed based upon their relative fair values. Significant judgments
and estimates are often made to determine these allocated values, and may
include the use of independent appraisals, consider market quotes for similar
transactions, employ discounted cash flow techniques or consider other
information the Company believes relevant. The finalization of the purchase
price allocation will typically take a number of months to complete, and if
final values are materially different from initially recorded amounts
adjustments are recorded. Any excess of the cost of a business acquisition over
the fair values of the net assets and liabilities acquired is recorded as
goodwill which is not amortized to expense. Recorded goodwill of a reporting
unit is required to be tested for impairment on an annual basis, and between
annual testing dates if events or circumstances change that would more likely
than not reduce the fair value of a reporting unit below its net book value.
Purchase price allocations for all of the Company's recent acquisitions have
been finalized. Adjustments to the initial purchase price allocations were not
material.
Accruals for Access Costs - ATX'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. At
the end of each reporting period, ATX'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 ATX'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, these estimates may
change.
Contingencies - The Company accrues for contingent losses when the contingent
loss is probable and the amount of loss can be reasonably estimated. Estimates
of the likelihood that a loss will be incurred and of contingent loss amounts
normally require significant judgment by management, can be highly subjective
and are subject to material change with the passage of time as more information
becomes available. As of December 31, 2005, the Company's accrual for contingent
losses was not material.
(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.
F-10
2. Significant Accounting Policies, continued:
-------------------------------
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.
(c) Cash Equivalents: The Company considers short-term investments, which have
----------------
maturities of less than three months at the time of acquisition, to be cash
equivalents. Cash and cash equivalents include short-term investments of
$295,600,000 and $93,300,000 at December 31, 2005 and 2004, respectively.
(d) Investments: At acquisition, marketable debt and equity securities are
-----------
designated as either i) held to maturity, which are carried at amortized cost,
ii) trading, which are carried at estimated fair value with unrealized gains and
losses reflected in results of operations, or iii) available for sale, which are
carried at estimated fair value with unrealized gains and losses reflected as a
separate component of shareholders' equity, net of taxes. Equity securities that
do not have readily determinable fair values are carried at cost. The cost of
securities sold is based on average cost.
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.
(e) Property, Equipment and Leasehold Improvements: Property, equipment and
----------------------------------------------
leasehold improvements are stated at cost, net of accumulated depreciation and
amortization. Depreciation and amortization are provided principally on the
straight-line method over the estimated useful lives of the assets or, if less,
the term of the underlying lease.
(f) Revenue Recognition: Revenues are recognized when the following conditions
-------------------
are met: (1) collectibility is reasonably assured; (2) title to the product has
passed or the service has been rendered and earned; (3) persuasive evidence of
an arrangement exists; and (4) there is a fixed or determinable price.
Manufacturing revenues are recognized when title passes, which for Idaho Timber
is generally upon the customer's receipt of the goods and for the plastics
segment upon shipment of goods. Revenue from the sale of real estate is
generally recognized when title passes; 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.
(g) Cost of Sale: Manufacturing cost of sales principally includes product and
------------
manufacturing costs, inbound and outbound shipping costs and handling costs.
Telecommunications cost of sales includes access costs paid to other
telecommunications providers, repairs and maintenance, rent, utilities and
property taxes of the telephone, Internet and data network, and salaries and
related expenses of network personnel. Telecommunications cost of sales are
recognized during the period in which revenue is recognized. Healthcare cost of
sales principally consists of employment costs and independent contractor costs
of the therapists providing the service. Any product installation costs of the
Company's operating subsidiaries are expensed when incurred.
(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: 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 GAAP, and
therefore are not accounted for as hedges.
F-11
2. Significant Accounting Policies, continued:
-------------------------------
Amounts recorded as income to investment and other income as a result of
accounting for its derivative financial instruments were $1,700,000 and
$3,500,000 for the years ended December 31, 2005 and 2003, respectively, and not
material for 2004. Net unrealized losses on derivative instruments were
$1,000,000 and $3,800,000 at December 31, 2005 and 2004, 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 losses were $2,700,000 for 2005 and not material for 2004 and 2003.
Net unrealized foreign exchange translation gains (losses) were $(2,900,000),
$14,300,000 and $7,500,000 at December 31, 2005, 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 $1,600,000, $1,000,000 and $800,000
in 2005, 2004 and 2003, respectively.
(l) Recently Issued Accounting Standards: In April 2005, the Securities and
------------------------------------
Exchange Commission amended the effective date of Statement of Financial
Accounting Standards No. 123R, "Share-Based Payment" ("SFAS 123R"), from the
first interim or annual period after June 15, 2005 to the beginning of the next
fiscal year that begins after June 15, 2005. 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 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; the Company
intends to use the modified prospective method. The Company does not expect that
SFAS 123R will have a material impact on its consolidated financial statements
with respect to currently outstanding options.
In May 2005, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 154, "Accounting Changes and Error
Corrections-a replacement of APB Opinion No. 20 and FASB Statement No. 3" ("SFAS
154"), which is effective for accounting changes and corrections of errors made
in fiscal years beginning after December 15, 2005. SFAS 154 applies to all
voluntary changes in accounting principles, and changes the accounting and
reporting requirements for a change in accounting principle. SFAS 154 requires
retrospective application to prior periods' financial statements of a voluntary
change in accounting principle unless doing so is impracticable. APB 20
previously required that most voluntary changes in accounting principle be
recognized by including in net income of the period in which the change occurred
the cumulative effect of changing to the new accounting principle. SFAS 154 also
requires that a change in depreciation, amortization, or depletion method for
long-lived, nonfinancial assets be accounted for as a change in accounting
estimate effected by a change in accounting principle. SFAS 154 carries forward
without change the guidance in APB 20 for reporting the correction of an error
in previously issued financial statements, a change in accounting estimate and a
change in reporting entity, as well as the provisions of SFAS 3 that govern
reporting accounting changes in interim financial statements. The Company does
not expect that SFAS 154 will have a material impact on its consolidated
financial statements.
F-12
3. Acquisitions:
-------------
NSW, LLC U.S. ("NSW")
In February 2005, the plastics manufacturing segment acquired the assets of NSW
for a purchase price of approximately $26,600,000; based upon its allocation of
the purchase price the Company recorded an aggregate of $10,200,000 of
intangible assets and $8,200,000 of goodwill. NSW has a manufacturing and
distribution facility in Roanoke, Virginia, which manufactures a variety of
products including produce and packaging nets, header label bags, case liners
and heavy weight nets for drainage and erosion control purposes. The NSW
customer relationship intangible assets will be amortized on an accelerated
basis, and other intangible assets on a straight-line basis, over the following
average useful lives: customer relationships - 12 years, trademarks and
tradename - 15 years, patents - 15 years and other intangible assets - 5 years.
ATX
In December 2003, the Company purchased all of ATX's debt obligations under its
senior secured credit facility for $25,000,000, and ATX commenced a voluntary
Chapter 11 case to reorganize its financial affairs shortly thereafter. The
bankruptcy plan (the "Plan") of ATX was confirmed by the Bankruptcy Court for
the Southern District of New York and became effective on April 22, 2005, and
the Company has consolidated ATX since that date. As contemplated by the Plan,
in exchange for its investment in the credit facility the Company received
approximately 90% of the new common stock of the reorganized ATX and a new
$25,000,000 senior secured note which bears interest at 10%. In addition, the
Company provided ATX with $5,000,000 of debtor-in-possession financing and
$25,000,000 of exit financing to fund bankruptcy related payments and working
capital requirements. On behalf of ATX, the Company also obtained cash
collateralized letters of credit totaling $14,700,000 issued for the benefit of
one of ATX's vendors. The requirement to provide the letters of credit will
decline over a period of years, commencing in 2006. The aggregate purchase price
for ATX was $56,300,000, which includes all the financing provided to ATX by the
Company and acquisition expenses.
Based upon its allocation of the purchase price, the Company has recorded ATX
intangible assets of $19,400,000 and goodwill of $5,800,000. The customer
relationship intangible assets will be amortized on an accelerated basis, and
other intangible assets on a straight-line basis, over the following average
useful lives: trademarks - 10 years, customer relationships - 7 years, software
- - 5 years, and other intangibles - 2 years.
Idaho Timber
In May 2005, the Company acquired Idaho Timber for total cash consideration of
$133,600,000, including working capital adjustments and expenses, and has
consolidated Idaho Timber from the date of acquisition. Based upon its
allocation of the purchase price, the Company recorded Idaho Timber intangible
assets of $45,100,000. The intangible assets will be amortized on a
straight-line basis over the following average useful lives: customer
relationships - 10 years, and other intangibles - 1 year.
Symphony
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.
Unaudited pro forma operating results for the Company, assuming the acquisitions
of ATX and Idaho Timber had occurred as of the beginning of each year presented
below are as follows (in thousands, except per share amounts):
F-13
3. Acquisitions, continued:
------------
2005 2004
---- ----
Revenues $ 1,213,800 $ 1,210,000
Income before extraordinary items and cumulative
effect of a change in accounting principles $ 1,643,200 $ 175,700
Net income $ 1,643,200 $ 175,700
Per Share:
Basic $15.25 $1.65
Diluted $14.33 $1.61
Pro forma adjustments principally reflect the preliminary allocation of the
purchase price to the difference between the fair value and book value of
property and equipment, resulting in increases or decreases to historical
depreciation expense, and the allocation to identifiable intangible assets
discussed above, resulting in increased amortization expense. For ATX, the pro
forma adjustments also include the elimination of net reorganization items,
which principally resulted from a gain recognized upon the discharge of ATX
indebtedness in bankruptcy, fresh start accounting adjustments and bankruptcy
related professional fees, and the reversal of historical interest expense
related to indebtedness that was discharged in bankruptcy. The increase or
(decrease) to historical income from the pro forma adjustments is as follows (in
thousands):
2005 2004
---- ----
Depreciation and amortization expenses $ (6,000) $ (13,400)
Reorganization items $ (300) $ 24,300
The unaudited pro forma data is not indicative of future results of operations
or what would have resulted if the acquisitions of ATX and Idaho Timber had
actually occurred as of the beginning of the periods presented. Unaudited pro
forma income statement data for NSW and Symphony is not included as the amounts
were not material. Unaudited acquisition balance sheets are not included as
amounts were not material.
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, 2005,
INTL had total assets of $105,100,000 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. The Company
recorded $9,900,000 and $2,200,000 of pre-tax income relating to INTL for the
years ended December 31, 2005 and 2004, respectively.
F-14
4. Investments in Associated Companies:
-----------------------------------
The Company has investments in several Associated Companies. The amounts
reflected as equity in income (losses) of associated companies in the
consolidated statements of operations are net of income tax provisions of
$700,000, $15,000,000 and $70,100,000 for the years ended December 31, 2005,
2004 and 2003, respectively. Included in consolidated retained earnings at
December 31, 2005 is approximately $42,800,000 of undistributed earnings of the
associated companies.
Cobre Las Cruces, S.A. ("CLC")
In August 2005, the Company consummated the merger with its then 72.1% owned
subsidiary, MK Resources Company ("MK"), whereby the Company acquired the
remaining outstanding MK common shares. The acquisition cost consisted of
approximately 216,000 of the Company's common shares (valued at $8,300,000), and
estimated cash amounts ($4,500,000 has been accrued) that will be paid to former
MK stockholders who perfected appraisal rights. As a result of the merger, MK is
now a wholly-owned subsidiary of the Company, and MK's securities are no longer
publicly traded.
Immediately following the merger, the Company sold to Inmet Mining Corporation
("Inmet"), a Canadian-based global mining company traded on the Toronto stock
exchange (Symbol: IMN), a 70% interest in CLC, a Spanish company that holds the
exploration and mineral rights to the Las Cruces copper deposit in the Pyrite
Belt of Spain. Inmet acquired the interest in CLC in exchange for 5,600,000
newly issued Inmet common shares, representing approximately 11.7% of the
outstanding Inmet common shares immediately following completion of the
transaction. The Inmet shares were recorded at their fair value of approximately
$78,000,000, and the Company recorded a pre-tax gain on the sale of $10,500,000,
which is reflected in the caption investment and other income. For more
information on the Inmet shares, see Note 6.
CLC has entered into an agreement with third party lenders for project financing
consisting of a ten year senior secured credit facility of up to $240,000,000
and a senior secured bridge credit facility of up to (euro)69,000,000 to finance
subsidies and value-added tax. The Company and Inmet have guaranteed 30% and
70%, respectively, of the obligations outstanding under both facilities until
completion of the project as defined in the project financing agreement. At
December 31, 2005, no amounts were outstanding under the facilities. The Company
and Inmet have also committed to provide financing to CLC which is estimated to
be $159,000,000, of which the Company's share will be 30% ($14,300,000 of which
has been loaned as of December 31, 2005). For the year ended December 31, 2005,
the Company recorded a pre-tax loss of $1,600,000 from this investment under the
equity method of accounting.
Union Square
Union Square, two entities in which the Company had non-controlling equity
interests, sold their respective interests in an office complex located on
Capitol Hill in Washington, D.C. during 2005. Including repayment of its
mortgage loans at closing, the Company's share of the net proceeds was
$73,200,000, and the Company recognized a pre-tax gain of $72,300,000.
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, 2005, 2004 and 2003, the Company recorded $23,600,000, $16,200,000
and $14,800,000, 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.
F-15
4. Investments in Associated Companies, continued:
----------------------------------
Olympus
In December 2001, the Company invested $127,500,000 for a 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 during 2004 and 2005, the Company's percentage
interest in Olympus increased to 20.1% as of December 31, 2005.
During 2005, Olympus recorded significant losses as a result of estimated
insurance claims from hurricanes Katrina, Rita and Wilma. In early 2006, Olympus
raised a significant amount of new equity to replace some, but not all of the
capital that was lost as a result of the 2005 hurricanes. Since the Company did
not invest additional capital in Olympus, its equity interest will be diluted
(to less than 4%) such that it will no longer apply the equity method of
accounting for this investment subsequent to December 31, 2005. For the years
ended December 31, 2005, 2004 and 2003, the Company recorded $(120,100,000),
$9,700,000 and $40,400,000, respectively, of pre-tax income (loss) from this
investment under the equity method of accounting. In addition, the Company
recorded an impairment loss of $3,700,000 to reduce the book value of its
investment to zero.
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. At December 31, 2005, the book value
of the Company's equity investment in EagleRock was $75,500,000, which excludes
$16,600,000 that was received in January 2006 and is classified as a receivable
as of December 31, 2005. In August 2005, the Company notified EagleRock that it
determined to withdraw its entire interest on January 1, 2006. Discussions are
ongoing as to the timing and manner in which the Company's capital will be
remitted by EagleRock to the Company. Pre-tax income (losses) of $(28,900,000),
$29,400,000 and $49,900,000 for the years ended December 31, 2005, 2004 and
2003, 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, 2005 and 2004, the deferred gain on
this sale was $4,200,000 and $6,800,000, 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, 2005, 2004 and
2003, the Company recorded $5,800,000, $10,000,000 and $16,200,000,
respectively, 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 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 7.7% 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.
F-16
4. Investments in Associated Companies, continued:
-----------------------------------
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 at
December 31, 2004 in the Company's consolidated balance sheet.
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, 2005, except for Berkadia
LLC ("Berkadia") which is separately summarized below, and except for WilTel
which was sold as discussed in Note 5. (Amounts are in thousands.)
2005 2004
---- ----
Assets $ 2,750,800 $ 2,247,000
Liabilities 1,873,300 969,200
----------- ------------
Net assets $ 877,500 $ 1,277,800
=========== ============
The Company's portion of the reported net assets $ 379,100 $ 440,200
=========== ============
2005 2004 2003
---- ---- ----
Total revenues $ 984,400 $ 914,500 $ 890,900
Income (loss) from continuing operations before
extraordinary items $ (484,200) $ 221,000 $ 374,700
Net income (loss) $ (484,200) $ 221,000 $ 374,700
The Company's equity in net income (loss) $ (44,400) $ 90,700 $ 119,900
Except for its investment in CLC, 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 addition, FINOVA entered into a ten-year management agreement with the
Company, for which the Company receives an annual fee of $8,000,000, which is
shared equally with Berkshire. The management agreement remains in effect even
though the Berkadia Loan has been repaid.
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.
F-17
4. Investments in Associated Companies, continued:
----------------------------------
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. Berkadia
distributed all of its cash to its members during 2004 and has had no financial
statement activity since that distribution. For the years ended December 31,
2004 and 2003, the Company's equity in the income of Berkadia consists of the
following (in thousands):
2004 2003
---- ----
Net interest spread on the Berkadia Loan - 10% of total $ -- $ 2,400
Net interest savings 300 2,000
Amortization of Berkadia Loan discount related to cash fees -
50% of total 200 29,100
Amortization of Berkadia Loan discount related to FINOVA
stock - 50% of total 300 45,700
-------- --------
Equity in income of associated companies - Berkadia $ 800 $ 79,200
======== ========
The following table provides certain summarized data with respect to Berkadia
for the years ended December 31, 2004 and 2003. (Amounts are in thousands.)
F-18
4. Investments in Associated Companies, continued:
-----------------------------------
2004 2003
---- ----
Total revenues $ 2,400 $198,800
Income from continuing operations before extraordinary items
and cumulative effect of a change in accounting principle $ 2,200 $180,400
Net income $ 2,200 $180,400
5. Discontinued Operations:
-----------------------
WilTel
In December 2005, the Company sold WilTel to Level 3 Communications, Inc.
("Level 3") for aggregate cash consideration of $460,300,000 (net of estimated
working capital adjustments of approximately $25,500,000), and 115,000,000 newly
issued shares of Level 3 common stock. In connection with the sale, the Company
retained certain assets and liabilities of WilTel that were not purchased by
Level 3. The retained assets include (i) WilTel's headquarters building
(including the adjacent parking garage) located in Tulsa, Oklahoma, (ii) cash
and cash equivalents in excess of $100,000,000, (iii) corporate aircraft and
related capital lease obligations, and (iv) marketable securities. In addition,
the Company retained all of WilTel's right to receive certain cash payments from
SBC Communications Inc. ("SBC") totaling $236,000,000, of which $37,500,000 was
received prior to closing and the balance is due to be received during 2006.
Prior to the closing, WilTel repaid its long-term debt obligations using its
funds, together with $220,000,000 of funds advanced by the Company. The retained
liabilities also include WilTel's defined benefit pension plan and supplemental
retirement plan obligation and certain other employee related liabilities. The
agreement with Level 3 requires that all parties make the appropriate filings to
treat the purchase of WilTel as a purchase of assets for federal, state and
local income and franchise tax purposes. As a result, WilTel's net operating tax
loss carryforwards ("NOLs"), as well as any tax losses generated by the sale,
remained with the Company. For more information on the Company's NOLs, see Note
16.
The Company recorded a pre-tax gain on disposal of WilTel of $243,800,000. The
calculation of the gain on sale included: (1) the cash proceeds received from
Level 3, net of estimated working capital adjustments; (2) the fair value of the
Level 3 common shares of $339,300,000, based on the $2.95 per share closing
price of Level 3 common stock immediately prior to closing; (3) the amount of
the SBC cash payments that had not been previously accrued prior to closing
($175,900,000); (4) an impairment charge for WilTel's headquarters building
described below; and (5) the net book value of the net assets sold and estimated
expenses and other costs related to the transaction.
The Company concluded that the change in the use of WilTel's former headquarters
facility to a property held for investment was a change in circumstances which
indicated that the carrying amount of the facility might not be recoverable. On
the closing date of the sale to Level 3, the carrying amount of the facility was
$96,500,000; based on the assumptions discussed below the Company concluded that
the carrying amount was not recoverable, and an impairment loss of $42,400,000
was recorded reducing the gain on disposal of discontinued operations. At
December 31, 2005, the new cost basis and carrying amount of the facility
reflected in other assets is $54,100,000.
The facility is a fifteen story, 740,000 square foot office building located in
downtown Tulsa, Oklahoma for which construction was substantially completed in
2001, with a total of approximately 640,000 rentable square feet. Approximately
260,000 square feet of the rentable space is leased to Level 3 under short-term
leases that expire at the end of 2007, subject to Level 3 renewal options. Level
3 also has the right to vacate approximately 44,000 square feet every six months
commencing July 1, 2006. Approximately 23,500 square feet are leased to another
tenant also under a short-term lease that is subject to renewal options. The
building is considered to be Class A office space, and the Company believes that
the best value for the building would be obtained by selling the building to an
owner/occupant. The facility is being marketed for sale at a gross selling price
of $80,000,000, including furniture, fixtures and equipment.
F-19
5. Discontinued Operations, continued:
-----------------------
The Company utilized a discounted cash flow technique to determine the fair
value of the facility. In order to estimate the amount which could ultimately be
realized upon the sale of the facility, the Company had a market analysis
prepared of sales and leasing activity for the downtown Tulsa market. The
analysis identified the range of historical selling prices for properties of
comparable quality, including the age, size and occupancy rates of the
properties sold, properties currently available for sale or lease, current
market occupancy rates and recent leasing rates. Since the facility is being
marketed to an owner/occupant, the cash flow estimates reflect that it may take
from two to five years before a buyer is identified and the facility can be
sold. The cash flow estimates assume that Level 3 will only fulfill its minimum
rental commitment; the Company did not assume that space which is currently
vacant will be leased, which results in negative operating cash flow prior to
sale. The Company's cash flow estimates reflect a range of possible outcomes
since the timing of the sale and the ultimate price that the Company will
realize for the facility is uncertain.
During 2002, the Company acquired 47.4% of the outstanding common stock of
WilTel for aggregate cash consideration of $353,900,000, including expenses. In
November 2003, the Company consummated an exchange offer and merger agreement
pursuant to which 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 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.
Prior to the merger, during 2003 the Company recorded its share of WilTel's
losses under the equity method of accounting in the amount of $52,100,000; such
amount is reflected in the 2003 statement of operations in the caption equity in
income (losses) of associated companies.
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 was 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.
Waikiki Beach Hotel
In May 2005, the Company sold its 716-room Waikiki Beach hotel and related
assets for an aggregate purchase price of $107,000,000, before closing costs and
other required payments. After satisfaction of mortgage indebtedness on the
hotel of $22,100,000 at closing, the Company received net cash proceeds of
approximately $73,000,000, and recorded a pre-tax gain of $56,600,000 (reflected
in discontinued operations). Historical operating results for the hotel are not
material.
WebLink Wireless, Inc. ("WebLink")
In December 2002, the Company entered into an agreement to purchase certain debt
and equity securities of 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.
F-20
5. Discontinued Operations, continued:
-----------------------
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 is classified as a non-current investment.
Other
In December 2005, the Company sold its interest in an Argentine shoe
manufacturer that had been acquired earlier in the year. Although there was no
material gain or loss on disposal, results of discontinued operations during
2005 include a pre-tax loss of $4,400,000.
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 pre-tax loss of $600,000 when the sale closed, resulting
principally from mortgage prepayment penalties incurred upon satisfaction of the
property's mortgage. 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. 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, 2005 (in thousands):
2005 2004 2003
---- ---- ----
Revenues and other income:
Telecommunications revenues $ 1,743,938 $ 1,582,948 $ 231,930
Wireless messaging revenues -- -- 57,900
Investment and other income 114,980 41,270 11,007
Net securities gains 3,483 6,372 25
-------------- ------------ -----------
1,862,401 1,630,590 300,862
-------------- ------------ -----------
Expenses:
Telecommunications cost of sales 1,223,143 1,129,248 167,653
Wireless messaging network operating expenses -- -- 31,354
Interest 27,536 34,459 5,648
Salaries 150,000 139,546 29,247
Depreciation and amortization 162,694 207,829 41,642
Selling, general and other expenses 187,460 184,370 45,914
-------------- ------------ -----------
1,750,833 1,695,452 321,458
-------------- ------------ -----------
Income (loss) before income taxes 111,568 (64,862) (20,596)
Income tax provision (benefit) 11 -- (9,010)
-------------- ------------ -----------
Income (loss) from discontinued operations, net of taxes $ 111,557 $ (64,862) $ (11,586)
============== ============ ===========
F-21
6. Investments:
-----------
A summary of investments classified as current assets at December 31, 2005 and
2004 is as follows (in thousands):
2005 2004
------------------------------ ------------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
---- ---------- ---- ----------
Investments available for sale $ 1,206,973 $ 1,206,195 $ 917,840 $ 918,064
Trading securities 103,978 105,541 148,602 159,616
Other investments, including accrued interest income 11,826 11,826 7,065 7,065
----------- ----------- ----------- -----------
Total current investments $ 1,322,777 $ 1,323,562 $ 1,073,507 $ 1,084,745
=========== =========== =========== ===========
The amortized cost, gross unrealized gains and losses and estimated fair value
of available for sale investments classified as current assets at December 31,
2005 and 2004 are as follows (in thousands):
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
2005
- ----
Bonds and notes:
United States Government and agencies $ 818,967 $ 107 $ 597 $ 818,477
U.S. Government-Sponsored Enterprises 199,030 17 377 198,670
Foreign governments 1,503 17 -- 1,520
All other corporates 187,473 476 421 187,528
----------- ------- ------- -----------
Total $ 1,206,973 $ 617 $ 1,395 $ 1,206,195
=========== ======= ======= ===========
2004
- ----
Bonds and notes:
United States Government and agencies $ 736,529 $ 10 $ 935 $ 735,604
U.S. Government-Sponsored Enterprises 113,384 -- 191 113,193
All other corporates 67,927 1,666 326 69,267
----------- ------- ------- -----------
Total $ 917,840 $ 1,676 $ 1,452 $ 918,064
=========== ======= ======= ===========
Certain information with respect to trading securities at December 31, 2005 and
2004 is as follows (in thousands):
2005 2004
------------------------------ -------------------------------
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
Equity securities -- -- 1,413 1,585
Other investments 103,978 105,541 79,560 80,743
----------- -------- --------- ---------
Total trading securities $ 103,978 $105,541 $ 148,602 $ 159,616
=========== ======== ========= =========
Other investments classified as trading securities principally include INTL's
investment in a master fund.
A summary of non-current investments at December 31, 2005 and 2004 is as follows
(in thousands):
F-22
6. Investments, continued:
-----------
2005 2004
------------------------------ -------------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
--------- ---------- --------- ----------
Investments available for sale $ 762,178 $ 825,716 $ 423,687 $ 667,595
Other investments 151,611 151,611 50,731 50,731
---------- ---------- ---------- ----------
Total non-current investments $ 913,789 $ 977,327 $ 474,418 $ 718,326
========== ========== ========== ==========
Other non-current investments include 5,600,000 common shares of Inmet, which
have a cost and carrying value of $78,000,000 at December 31, 2005. The Inmet
shares have the benefit of a registration rights agreement; however, the shares
may not be sold until the earlier of August 2009 or the date on which the
Company is no longer obligated under the guarantee of CLC's credit facilities.
At acquisition, the fair value of the Inmet common stock was determined to be
approximately 90% of the then current trading price as a result of these
transferability restrictions. The Inmet shares will be carried at the initially
recorded value (unless there is an other than temporary impairment) until one
year prior to the termination of the transfer restrictions. At December 31,
2005, the market value of the Inmet shares is approximately $142,100,000.
The amortized cost, gross unrealized gains and losses and estimated fair value
of non-current investments classified as available for sale at December 31, 2005
and 2004 are as follows (in thousands):
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- ----------
2005
- ----
Bonds and notes:
United States Government and agencies $ 39,037 $ 25 $ 584 $ 38,478
U.S. Government-Sponsored Enterprises 141,265 106 1,428 139,943
All other corporates 160,190 37,677 1,675 196,192
---------- ---------- ---------- ----------
Total fixed maturities 340,492 37,808 3,687 374,613
---------- ---------- ---------- ----------
Equity securities:
Preferred stocks 5,569 -- 118 5,451
Common stocks:
Banks, trusts and insurance companies 12,340 10,010 -- 22,350
Industrial, miscellaneous and all other 403,777 28,817 9,292 423,302
---------- ---------- ---------- ----------
Total equity securities 421,686 38,827 9,410 451,103
---------- ---------- ---------- ----------
$ 762,178 $ 76,635 $ 13,097 $ 825,716
========== ========== ========== ==========
2004
- ----
Bonds and notes:
United States Government and agencies $ 26,995 $ 19 $ 155 $ 26,859
U.S. Government-Sponsored Enterprises 115,178 28 925 114,281
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 276,310 41,694 1,496 316,508
---------- ---------- ---------- ----------
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
---------- ---------- ---------- ----------
$ 423,687 $ 247,182 $ 3,274 $ 667,595
========== ========== ========== ==========
F-23
6. Investments, continued:
-----------
The amortized cost and estimated fair value of non-current investments
classified as available for sale at December 31, 2005, 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 $ 140,861 $ 177,331
Due after five years through ten years 18,585 18,112
Due after ten years 744 749
---------- ----------
160,190 196,192
Mortgage-backed securities 180,302 178,421
---------- ----------
$ 340,492 $ 374,613
========== ==========
Non-current available for sale equity securities include 115,000,000 shares of
Level 3 common stock received in connection with the sale of WilTel (see Note
5), with a cost of $339,300,000 and an estimated fair value of $330,100,000 at
December 31, 2005. Pursuant to a registration rights agreement entered into with
Level 3, Level 3 has filed a registration statement covering the shares and is
required to keep the registration statement effective for the shorter of two
years (or a longer period as set forth in the agreement), or until the
distribution of the shares is completed. The Level 3 common stock is subject to
a transfer restriction that limits the number of shares the Company can sell
(with certain exceptions) on any given day until May 22, 2006; thereafter there
is no restriction.
During 2005, the Company sold all 375,000 common shares of White Mountains
Insurance Group, Ltd. ("WMIG") that it owned, and recorded a security gain of
$146,000,000. The Company purchased the shares in 2001 for $75,000,000; at
December 31, 2004 the investment in WMIG, which was classified as a non-current
available for sale security, had a market value of $242,300,000.
Net unrealized gains (losses) on investments were $(22,400,000), $153,200,000
and $161,800,000 at December 31, 2005, 2004 and 2003, respectively.
Reclassification adjustments included in comprehensive income for the three year
period ended December 31, 2005 are as follows (in thousands):
2005 2004 2003
---- ---- ----
Unrealized holding gains (losses) arising during the period, net of
tax provision of $0, $0 and $56,896 $ 12,707 $ (26,623) $ 105,861
Less: reclassification adjustment for (gains) losses included in net
income, net of tax provision of $0, $0 and $1,158 (188,284) 18,031 (2,085)
----------- ---------- ----------
Net change in unrealized gain on investments, net of tax provision
of $0, $0 and $55,738 $ (175,577) $ (8,592) $ 103,776
=========== ========== ==========
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,
2005 (in thousands):
F-24
6. Investments, continued:
-----------
Unrealized
Description of Securities Fair Value Losses
- ------------------------- ---------- ----------
United States Government and agencies $ 518,329 $ 597
U.S. Government-Sponsored Enterprises 135,021 359
Mortgage-backed securities 113,840 1,567
Corporate bonds 170,093 1,985
Marketable equity securities 334,490 9,410
------------- ---------
Total temporarily impaired securities $ 1,271,773 $ 13,918
============= =========
The unrealized losses on the securities issued by the United States Government
and agencies, the U.S. Government-Sponsored Enterprises and the mortgage-backed
securities were caused by interest rate increases and were considered to be
minor (approximately .1%, .3% and 1.4%, respectively). The unrealized losses on
the securities issued by the United States Government and agencies relate to 14
securities which were purchased in 2005 and all of which mature in 2006. The
unrealized losses on the U.S. Government-Sponsored Enterprises relate to 20
securities which were primarily purchased in 2005 and all of which mature in
2006. The unrealized losses on the mortgage-backed securities (all of which are
issued by U.S. Government agencies and U.S. Government-Sponsored Enterprises)
relate to 27 securities substantially all of which were purchased in 2005. 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, but not limited to, the length of time and extent to which
the fair value has been less than cost, the financial condition and near term
prospects of the issuer, the reason for the decline in the fair value, changes
in fair value subsequent to the balance sheet date, and other factors specific
to the individual investment. The unrealized losses on marketable equity
securities primarily relates to the Company's investment in Level 3 common stock
which was acquired in December 2005.
At December 31, 2005, the Company's investments which have been in a continuous
unrealized loss position for 12 months or longer are comprised of 16 securities
which had aggregate gross unrealized losses of approximately $600,000 and an
aggregate fair value of approximately $60,200,000. These securities are
primarily mortgage-backed securities (all of which are issued by U.S. Government
agencies and U.S. Government-Sponsored Enterprises).
At December 31, 2005, the aggregate carrying amount of the Company's investment
in equity securities that are accounted for under the cost method totaled
$151,600,000. Of this amount, $78,000,000 relates to the Company's investment in
the Inmet common shares, which had a market value in excess of the carrying
amount. The fair value of the remaining cost method securities was not estimated
as there were no identified events or changes in circumstances that may have a
significant adverse effect on the fair value and it was not practicable to
estimate the fair value of these investments.
At December 31, 2004, securities with book values aggregating $7,100,000 were on
deposit with various regulatory authorities. Securities with book values of
$12,300,000 and $12,100,000 at December 31, 2005 and 2004, respectively,
collateralized certain swap agreements, and securities with a book value of
$11,100,000 and $11,000,000 at December 31, 2005 and 2004, respectively,
collateralized certain debt obligations and a related letter of credit.
F-25
7. Trade, Notes and Other Receivables, Net:
----------------------------------------
A summary of current trade, notes and other receivables, net at December 31,
2005 and 2004 is as follows (in thousands):
2005 2004
---- ----
Current trade, notes and other receivables, net:
Trade receivables (a) $ 115,538 $ 73,639
Receivable from SBC (b) 198,500 --
Federal income tax receivable -- 3,858
Receivable from Pershing -- 71,294
Receivable from EagleRock 16,636 --
Instalment loan receivables 1,257 2,035
Receivables related to securities 39,387 5,999
Receivables relating to real estate activities 5,602 2,988
Other 15,393 8,211
---------- ---------
392,313 168,024
Allowance for doubtful accounts (15,097) (7,790)
---------- ---------
Total current trade, notes and other receivables, net $ 377,216 $ 160,234
========== =========
(a) Includes $10,700,000 and $10,500,000 as of December 31, 2005 and 2004,
respectively, from Symphony's largest customer.
(b) Represents amounts due from SBC of which $11,000,000 was paid on January 4,
2006 and the balance is payable in ten equal monthly installments in
January 2006 through October 2006. See Note 5 for more information.
8. Intangible Assets, Net and Goodwill:
-----------------------------------
A summary of these assets at December 31, 2005 and 2004 is as follows (in
thousands):
2005 2004
---- ----
Intangibles:
Customer relationships, net of accumulated amortization of $6,686
and $491 $ 58,911 $ 1,472
Trademarks and tradename, net of accumulated amortization of $268 4,140 --
Software, net of accumulated amortization of $701 4,399 --
Patents, net of accumulated amortization of $142 2,188 --
Other, net of accumulated amortization of $1,488 1,446 --
Goodwill 13,999 --
----------- --------
$ 85,083 $ 1,472
=========== =========
During 2005, in connection with the acquisitions of NSW, Idaho Timber and ATX,
the Company recorded customer relationship intangible assets and other
intangible assets which are being amortized over their estimated useful lives,
and goodwill which is not being amortized. See Note 3 for more information. In
addition, during October 2005 the plastics manufacturing segment acquired the
manufacturing assets of a competitor for approximately $4,300,000, and allocated
$2,900,000 of the purchase price to customer relationships and $300,000 to
trademarks. Such amounts are being amortized on a straight-line basis over 10
years. During 2004, the Company recorded $1,900,000 of customer relationship
intangible assets in connection with an acquisition made by the plastics
manufacturing segment, which are being amortized on a straight-line basis over
an average useful life of approximately three years.
F-26
8. Intangible Assets, Net and Goodwill, continued:
-----------------------------------
Amortization expense on intangible assets was $8,800,000 for the year ended
December 31, 2005. The estimated aggregate future amortization expense for the
intangible assets for each of the next five years is as follows: 2006 -
$11,100,000; 2007 - $9,500,000; 2008 - $8,600,000; 2009 - $8,200,000; and 2010 -
$7,000,000.
9. Other Assets:
-------------
A summary of non-current other assets at December 31, 2005 and 2004 is as
follows (in thousands):
2005 2004
---- ----
Real Estate $ 166,188 $ 234,123
Unamortized debt expense 17,993 19,863
Restricted cash, (principally to secure outstanding letters of credits
of $23,000,000 and $2,000,000) 27,018 6,436
Deposits 488 5,565
Other 28,914 6,880
----------- -----------
$ 240,601 $ 272,867
=========== ===========
In the fourth quarter of 2005, 711 Developer, LLC ("Square 711"), a 90% owned
subsidiary of the Company, entered into an agreement to sell its interest in 8
acres of unimproved land in Washington, D.C. for aggregate cash consideration of
$121,900,000; the sale closed in February 2006. The land was acquired by the
Company in September 2003 for cash consideration of $53,800,000. After
satisfaction of mortgage indebtedness on the property of $32,000,000 and other
closing payments, the Company received net cash proceeds of approximately
$75,700,000, and expects to record a pre-tax gain of approximately $48,900,000.
10. Property, Equipment and Leasehold Improvements, Net:
----------------------------------------------------
A summary of property, equipment and leasehold improvements, net at December 31,
2005 and 2004 is as follows (in thousands):
Depreciable
Lives
(in years) 2005 2004
---------- ---- ----
Buildings and leasehold improvements 4-45 $ 136,460 $ 127,363
Machinery and equipment 2-25 93,740 77,686
Network equipment 5-7 14,524 --
Corporate aircraft 8-10 87,981 85,871
Mining properties and mineral rights N/A -- 92,384
Computer equipment and software 2-7 9,520 4,795
General office furniture and fixtures 2-13 8,933 6,840
Construction in progress N/A 4,978 1,591
Other 3-10 7,645 7,960
----------- ----------
363,781 404,490
Accumulated depreciation and amortization (126,760) (121,160)
----------- ----------
$ 237,021 $ 283,330
=========== ==========
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-27
11. Trade Payables, Expense Accruals and Other Non-Current Liabilities:
-------------------------------------------------------------------
A summary of trade payables and expense accruals and other non-current
liabilities at December 31, 2005 and 2004 is as follows (in thousands):
2005 2004
---- ----
Trade payables and expense accruals:
Trade payables $ 26,080 $ 14,939
Payables related to securities 24,268 50,569
Accrued compensation, severance and other employee benefits 109,657 51,403
Taxes other than income 7,228 4,668
Accrued interest payable 21,997 20,572
Due to Level 3 25,490 --
Other 45,058 25,713
--------- ---------
$ 259,778 $ 167,864
========= =========
Other non-current liabilities:
Postretirement and postemployment benefits $ 8,165 $ 8,633
Pension liability 73,729 61,982
Liabilities related to real estate activities 4,334 6,841
Other 35,665 44,219
--------- ---------
$ 121,893 $ 121,675
========= =========
12. Indebtedness:
-------------
The principal amount, stated interest rate and maturity date of outstanding debt
at December 31, 2005 and 2004 are as follows (dollars in thousands):
2005 2004
---- ----
Parent Company Debt:
Senior Notes:
Bank credit facility $ -- $ --
7 3/4% Senior Notes due 2013, less debt discount of $395 and $431 99,605 99,569
7% Senior Notes due 2013, net of debt premium of $1,009 and $1,105 376,009 376,105
Subordinated Notes:
8 1/4% Senior Subordinated Notes due 2005 -- 19,101
7 7/8% Senior Subordinated Notes due 2006, less debt discount of $9 and $20 21,667 21,656
3 3/4% Convertible Senior Subordinated Notes due 2014 350,000 350,000
8.65% Junior Subordinated Deferrable Interest Debentures due 2027 98,200 98,200
Subsidiary Debt:
Repurchase agreements 92,094 21,012
Aircraft financing 43,448 45,562
Industrial Revenue Bonds (with variable interest) 9,815 9,815
Capital leases due 2006 through 2015 with a weighted average
interest rate of 12.1% 10,101 7,280
Symphony credit agreement 27,108 37,690
Other due 2006 through 2011 with a weighted average interest rate of 6.5% 34,335 45,932
---------- ------------
Total debt 1,162,382 1,131,922
Less: current maturities (175,664) (64,799)
---------- ------------
Long-term debt $ 986,718 $ 1,067,123
========== ============
F-28
12. Indebtedness, continued:
------------
Parent Company Debt:
At December 31, 2005, 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, 2005, no amounts were outstanding
under this bank credit facility.
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:
Debt due within one year includes $92,100,000 and $21,000,000 as of December 31,
2005 and 2004, respectively, relating to repurchase agreements. These fixed rate
repurchase agreements have a weighted average interest rate of approximately
3.95%, mature at various dates through April 2006 and are secured by investments
with a carrying value of $95,100,000.
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, 2005 was 8.4%. 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 $700,000 and
$2,300,000 at December 31, 2005 and 2004, 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
certain corporate aircraft originally entered into in May 2003, which was
amended in 2005 to among other matters extend the lease term through 2015.
Symphony has a $50,000,000 revolving credit facility, of which $27,100,000 and
$37,700,000 was outstanding at December 31, 2005 and 2004, respectively. 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 3.00%. At December 31, 2005, the interest rate on this facility was 7.39%.
Other subsidiary debt includes a mortgage financing related to Square 711 that
was repaid in connection with the sale of that property in February 2006. The
mortgage balance was $32,000,000 and $20,000,000 as of December 31, 2005 and
2004, respectively.
F-29
12. Indebtedness, continued:
------------
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, 2005, cash dividends of approximately
$556,600,000 would be eligible to be paid under the most restrictive covenants.
All of Symphony's assets (with an aggregate book value of $55,500,000) are
pledged as collateral under Symphony's revolving credit facility. Property,
equipment and leasehold improvements of the plastics manufacturing division
(with a net book value of $4,600,000) are pledged as collateral for Industrial
Revenue Bonds; and $229,600,000 of other assets (primarily property and
investments) are pledged for other indebtedness aggregating $178,100,000. 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
$11,100,000.
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 a
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, 2010 are as follows (in thousands): 2006 - $175,700; 2007 -
$12,900; 2008 - $4,700; 2009 - $3,000; and 2010 - $3,100.
The weighted average interest rate on short-term borrowings (consisting of
customer banking deposits (at December 31, 2004), repurchase agreements and
subsidiary revolving credit agreements) was 4.7% and 4.6% at December 31, 2005
and 2004, respectively.
13. Common Shares, Stock Options and Preferred Shares:
-------------------------------------------------
Pursuant to shareholder approval, during the second quarter of 2005 the
Company's authorized common shares were increased to 300,000,000.
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, 2005,
the Company acquired 6,071 common shares at an average price of $37.55 per
common share, all in connection with employees exercising stock options. At
December 31, 2005, the Company is authorized to repurchase 3,729,477 common
shares.
F-30
13. Common Shares, Stock Options and Preferred Shares, continued:
-------------------------------------------------
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.
A summary of activity with respect to the Company's stock options for the three
years ended December 31, 2005 is as follows:
Common Weighted Available
Shares Average Options For Future
Subject Exercise Exercisable Option
to Option Prices at Year-End Grants
--------- ------ ----------- ------
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
========= ===========
Granted 6,000 $36.05
Exercised (215,800) $17.09
Cancelled (90,000) $43.51
-----------
Balance at December 31, 2005 977,630 $35.19 181,580 259,575
=========== ========= ===========
The weighted-average fair value of the options granted was $8.58 per share for
2005, $8.29 per share for 2004 and $6.29 per share for 2003 as estimated on the
date of grant using the Black-Scholes option-pricing model with the following
assumptions: (1) expected volatility of 23.6% for 2005, 19.1% for 2004 and 29.9%
for 2003; (2) risk-free interest rates of 3.8% for 2005, 3.3% for 2004 and 2.3%
for 2003; (3) expected lives of 4.3 years for 2005, 3.7 years for 2004 and 4.0
years for 2003; and (4) dividend yields of .7% for 2005, .4% for 2004 and .6%
for 2003.
F-31
13. Common Shares, Stock Options and Preferred Shares, continued:
-------------------------------------------------
The following table summarizes information about fixed stock options outstanding
at December 31, 2005:
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 59,630 0.4 years $15.08 59,630 $15.08
$20.49 262,500 2.5 years $20.49 112,200 $20.49
$22.09 3,375 0.4 years $22.09 3,375 $22.09
$23.49 4,125 1.4 years $23.49 2,625 $23.49
$25.69 4,875 2.4 years $25.69 1,875 $25.69
$31.12 8,625 3.4 years $31.12 1,875 $31.12
$36.05 6,000 4.4 years $36.05 -- $36.05
$43.51 628,500 5.0 years $43.51 -- $43.51
At December 31, 2005 and 2004, 1,237,205 and 1,453,005, respectively, of the
Company's common shares were reserved for stock options and 7,619,745 of the
Company's common shares were reserved for the 3 3/4% Convertible Senior
Subordinated Notes. At December 31, 2003, 1,200,000 of the Company's common
shares were reserved for warrants.
At December 31, 2005 and 2004, 6,000,000 of preferred shares (redeemable and
non-redeemable), par value $1 per share, were authorized and not issued.
14. Net Securities Gains:
---------------------
The following summarizes net securities gains for each of the three years in the
period ended December 31, 2005 (in thousands):
2005 2004 2003
---- ---- ----
Net realized gains on securities $ 222,258 $ 140,581 $ 15,737
Write-down of investments (a) (12,230) (4,589) (6,485)
Net unrealized gains (losses) on trading securities (1,212) 572 676
--------- --------- ---------
$ 208,816 $ 136,564 $ 9,928
========= ========= =========
(a) Includes a provision to write down investments in certain available for
sale securities in 2005, 2004 and 2003 and an investment in a non-public
security in 2003.
Proceeds from sales of investments classified as available for sale were
$1,979,300,000, $1,435,900,000 and $681,900,000 during 2005, 2004 and 2003,
respectively. Gross gains of $204,600,000, $135,900,000 and $17,700,000 and
gross losses of $2,400,000, $1,600,000 and $2,100,000 were realized on these
sales during 2005, 2004 and 2003, respectively.
F-32
15. Other Results of Operations Information:
----------------------------------------
Investment and other income for each of the three years in the period ended
December 31, 2005 consists of the following (in thousands):
2005 2004 2003
---- ---- ----
Interest on short-term investments $ 7,537 $ 1,693 $ 2,835
Dividend income 6,817 9,279 2,859
Interest on fixed maturities 46,440 25,606 13,633
Interest on notes receivable 1,880 945 4,657
Other investment income 1,164 1,749 3,605
Gains on sale or foreclosure of real estate or other assets,
net of costs 26,136 46,279 24,347
Banking and lending, including gains on sale of loan portfolios
of $16,304 in 2004 293 26,341 55,091
Rental income 11,870 23,176 20,123
MK product and service income 112 993 1,441
Refund of foreign taxes, not based on income, including accrued interest -- -- 5,295
Winery revenues 18,868 13,840 13,839
Other 28,723 30,180 31,660
---------- ---------- ----------
$ 149,840 $ 180,081 $ 179,385
========== ========== ==========
Taxes, other than income or payroll, amounted to $3,600,000, $2,900,000 and
$3,300,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
Advertising costs amounted to $2,600,000, $2,100,000 and $1,100,000 for the
years ended December 31, 2005, 2004 and 2003, respectively.
16. Income Taxes:
------------
The principal components of deferred taxes at December 31, 2005 and 2004 are as
follows (in thousands):
2005 2004
---- ----
Deferred Tax Asset:
Securities valuation reserves $ 46,473 $ 18,614
Property and equipment 31,547 7,271
Other assets 35,224 20,450
NOL carryover 1,870,100 1,456,870
Other liabilities 60,622 44,469
Discontinued operations -- 789,395
------------ -----------
2,043,966 2,337,069
Valuation allowance (804,829) (2,185,275)
------------ -----------
1,239,137 151,794
------------ -----------
Deferred Tax Liability:
Unrealized gains on investments (21,947) (82,662)
Depreciation (30,241) (24,293)
Other (51,849) (44,839)
------------ -----------
(104,037) (151,794)
------------ -----------
Net deferred tax asset $ 1,135,100 $ --
============ ===========
F-33
16. Income Taxes, continued:
-------------
As of December 31, 2005, the Company had consolidated federal NOLs of
$600,000,000, 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. In
addition, the Company has $4,500,000,000 of federal NOLs, none of which expire
prior to 2015, that are only available to offset the taxable income of certain
subsidiaries. Capital loss carryforwards of $45,000,000, which expire in 2006
and 2007, and foreign NOLs of $6,000,000 are not reflected in the table since
the Company does not expect it will be able to use the carryforwards before they
expire. The Company also has various state NOLs that expire at different times.
Uncertainties that may affect the utilization of the Company's tax attributes
include future operating results, tax law changes, rulings by taxing authorities
regarding whether certain transactions are taxable or deductible and expiration
of carryforward periods.
As of December 31, 2004, the Company carried a valuation allowance that fully
reserved for its net deferred tax asset, because the Company could not
demonstrate it would have the future taxable income necessary to realize that
asset. During 2005, as a result of the consummation of certain transactions and
ongoing operating profits, the Company prepared updated projections of future
taxable income. The Company's revised projections of future taxable income
enabled it to conclude that it is more likely than not that it will have future
taxable income sufficient to realize a portion of the Company's net deferred tax
asset; accordingly, $1,135,100,000 of the deferred tax valuation allowance was
reversed as a credit to income tax expense. In future years the Company will
record income tax provisions equal to its effective income tax rate, unless
there is a further adjustment to the valuation allowance.
The Company's conclusion that a portion of the deferred tax asset was more
likely than not to be realizable was strongly influenced by its historical
ability to generate significant amounts of taxable income. The Company's
estimate of future taxable income considered all available evidence, both
positive and negative, about its current operations and investments, included an
aggregation of individual projections for each material operation and investment
and included all future years that the Company estimated it would have available
NOLs. Over the projection period, the Company assumed that its readily available
cash, cash equivalents and marketable securities would provide returns
equivalent to the returns expected to be provided by the Company's existing
operations and investments, except for certain amounts assumed to be invested on
a short-term basis to meet the Company's liquidity needs. The Company believes
that its estimate of future taxable income is reasonable but inherently
uncertain, and if its current or future operations and investments generate
taxable income greater than the projected amounts, further adjustments to reduce
the valuation allowance are possible. Conversely, if the Company realizes
unforeseen material losses in the future, or its ability to generate future
taxable income necessary to realize a portion of the deferred tax asset is
materially reduced, additions to the valuation allowance could be recorded.
The Company's total comprehensive income in 2004 and 2003 enabled it to realize
certain acquired deferred tax assets which had been fully reserved for at
acquisition. The resulting reduction in the valuation allowance for deferred tax
assets ($22,300,000 in 2004 and $22,500,000 in 2003) was applied to reduce the
recorded amount of identifiable intangible assets to zero.
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 that 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, 2005 was as follows, excluding amounts allocated to
equity in associated companies, trust preferred securities and discontinued
operations (in thousands):
F-34
16. Income Taxes, continued:
------------
2005 2004 2003
---- ---- ----
State income taxes $ 3,804 $ 3,418 $ (909)
Federal income taxes:
Current -- (31,143) (10,688)
Deferred -- 7,242 (23,750)
Reversal of valuation allowance (1,135,100) -- --
Currently payable foreign income taxes 214 291 173
------------- ---------- ----------
$ (1,131,082) $ (20,192) $ (35,174)
============= ========== ==========
The table below reconciles the expected statutory federal income tax to the
actual income tax benefit (in thousands):
2005 2004 2003
---- ---- ----
Expected federal income tax $ 48,357 $ 39,157 $ (2,876)
State income taxes, net of federal income tax benefit 2,473 2,222 545
Reversal of valuation allowance (1,135,100) -- --
Resolution of tax contingencies -- (27,300) (24,407)
Recognition of additional tax benefits -- -- (6,998)
Permanent differences -- (5,700) --
Federal income tax carryback refund -- (3,858) --
Recognition of acquired WilTel federal tax benefits (46,951) (6,481) --
Discontinued operations tax loss benefit -- (19,807) --
Other 139 1,575 (1,438)
------------- ---------- ----------
Actual income tax benefit $ (1,131,082) $ (20,192) $ (35,174)
============= ========== ==========
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 the Company's federal income returns
have expired for all years through 2001. 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, the Company 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 the Company's tax attributes that
impact the calculation of alternative minimum taxable income.
17. Pension Plans and Postretirement Benefits:
------------------------------------------
The information presented below for defined benefit pension plans is presented
separately for the Company's plans and the plans formerly administered by
WilTel. Pursuant to the WilTel sale agreement the responsibility for WilTel's
defined benefit pension plans was retained by the Company. The Company presents
the information separately since the WilTel plan's 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 2005 and 2004 is as follows (in thousands):
F-35
17. Pension Plans and Postretirement Benefits, continued:
-----------------------------------------
2005 2004
---- ----
Projected Benefit Obligation:
Projected benefit obligation at January 1, $ 58,286 $ 55,079
Interest cost (a) 2,951 3,173
Actuarial loss 2,314 5,263
Benefits paid (5,428) (5,229)
---------- ----------
Projected benefit obligation at December 31, $ 58,123 $ 58,286
========== ==========
Change in Plan Assets:
Fair value of plan assets at January 1, $ 47,643 $ 52,444
Actual return on plan assets 1,375 555
Employer contributions -- --
Benefits paid (5,428) (5,229)
Administrative expenses (114) (127)
---------- ----------
Fair value of plan assets at December 31, $ 43,476 $ 47,643
========== ==========
Funded Status $ (14,647) $ (10,643)
Unrecognized prior service cost 48 50
Unrecognized net loss from experience differences and
assumption changes 21,828 20,651
---------- ----------
Net amount recognized $ 7,229 $ 10,058
========== ==========
(a) Includes charges to expense of $900,000 and $800,000 for 2005 and 2004,
respectively, relating to discontinued operations obligations.
As of December 31, 2005 and 2004, $21,800,000 and $20,700,000, respectively, of
the net amount recognized in the consolidated balance sheet was reflected as a
charge to accumulated other comprehensive income and $14,600,000 and
$10,600,000, 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 employer
contributions are expected to be made in 2006 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):
2005 2004 2003
---- ---- ----
Interest cost $ 2,045 $ 2,191 $ 2,247
Expected return on plan assets (905) (1,019) (1,947)
Actuarial loss 848 652 258
Amortization of prior service cost 3 3 3
--------- --------- ---------
Net pension expense $ 1,991 $ 1,827 $ 561
========= ========= =========
At December 31, 2005, the plan's assets consist of U.S. government and agencies
bonds (43%), investment grade bonds (24%), cash equivalents (32%) and other
(1%). At December 31, 2004, the plan's assets consisted of U.S. government and
agencies bonds (37%), U.S. Government-Sponsored Enterprises (6%), investment
grade bonds (28%) and cash equivalents (29%).
F-36
17. Pension Plans and Postretirement Benefits, continued:
-----------------------------------------
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 substantially requires
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 2005.
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, 2005.
A summary of activity with respect to the Company's postretirement plans for
2005 and 2004 is as follows (in thousands):
2005 2004
---- ----
Accumulated postretirement benefit obligation at January 1, $ 4,715 $ 4,422
Interest cost 247 277
Contributions by plan participants 167 155
Actuarial loss 224 732
Benefits paid (580) (871)
------- -------
Accumulated postretirement benefit obligation at December 31, 4,773 4,715
Unrecognized prior service cost 387 476
Unrecognized net actuarial gain 640 922
------ ------
Accrued postretirement benefit obligation $ 5,800 $ 6,113
======= =======
The Company expects to spend $400,000 on postretirement benefits during 2006. At
December 31, 2005, the assumed health care cost trend rate for 2006 used in
measuring the accumulated postretirement benefit obligation is 9% and, at
December 31, 2004, such rate for 2005 was 10%. At December 31, 2005 and 2004,
the assumed health care cost trend rates were assumed to decline to an ultimate
rate of 5% by 2013. If the health care cost trend rates were increased or
decreased by 1%, the accumulated postretirement obligation as of December 31,
2005 would have increased or decreased by $200,000. The effect of these changes
on interest cost for 2005 would be immaterial.
F-37
17. Pension Plans and Postretirement Benefits, continued:
-----------------------------------------
The Company uses a December 31 measurement date for its plans. The assumptions
used relating to the defined benefit plan and postretirement plans are as
follows:
Pension Benefits Other Benefits
---------------- --------------
2005 2004 2005 2004
---- ---- ---- ----
Discount rate used to determine
benefit obligation at December 31, 4.87% 5.25% 5.25% 5.25%
Weighted-average assumptions used to determine
net cost for years ended December 31:
Discount rate 5.25% 5.75% 5.25% 6.00%
Expected long-term return on plan assets 3.25% 3.25% N/A N/A
The discount rate was selected to result in an estimated projected benefit
obligation on a plan termination basis, using current rates for annuity
settlements and lump sum payments weighted for the assumed elections of
participants.
The following benefit payments are expected to be paid (in thousands):
Pension Benefits Other Benefits
---------------- --------------
2006 $ 4,593 $ 427
2007 4,377 426
2008 4,567 427
2009 4,704 430
2010 4,054 415
2011 - 2015 21,547 1,822
WilTel:
Effective on the date of sale, the Company froze WilTel's defined benefit
pension plans. A summary of activity with respect to the plans for 2005 and 2004
is as follows (in thousands):
2005 2004
---- ----
Projected Benefit Obligation:
Projected benefit obligation at beginning of period $ 147,888 $ 129,912
Interest cost 9,410 7,829
Service cost 4,612 3,980
Actuarial loss 29,758 9,112
Curtailment gain (2,334) --
Benefits paid (3,280) (2,945)
---------- ----------
Projected benefit obligation at December 31, $ 186,054 $ 147,888
========== ==========
Change in Plan Assets:
Fair value of plan assets at beginning of period $ 74,601 $ 67,761
Actual return on plan assets 4,815 6,002
Employer contributions 21,769 3,783
Benefits paid (3,280) (2,945)
---------- ----------
Fair value of plan assets at December 31, $ 97,905 $ 74,601
========== ==========
Funded Status $ (88,149) $ (73,287)
Unrecognized net actuarial loss 40,739 14,572
---------- ----------
Net amount recognized $ (47,410) $ (58,715)
========== ==========
F-38
17. Pension Plans and Postretirement Benefits, continued:
-----------------------------------------
Since the Company froze the WilTel plans, the accumulated benefit obligation is
the same as the projected benefit obligation as of December 31, 2005. As of
December 31, 2004, the accumulated benefit obligation for the plan was
$147,600,000. As of December 31, 2005 and 2004, $40,700,000 and $14,300,000,
respectively, of the net amount recognized in the consolidated balance sheet was
reflected as a charge to accumulated other comprehensive income and $88,100,000
and $73,300,000, respectively, was reflected as accrued pension cost.
Employer contributions expected to be paid to the plan in 2006 are $29,100,000.
Pension expense for the WilTel plans charged to results of discontinued
operations included the following components (in thousands):
November 6, 2003
(date of acquisition)
2005 2004 to December 31, 2003
---- ---- --------------------
Interest cost $ 9,410 $ 7,829 $ 1,075
Service cost 4,612 3,980 575
Expected return on plan assets (6,509) (5,391) (640)
Actuarial loss 2,953 46 --
---------- -------- ---------
Net pension expense $ 10,466 $ 6,464 $ 1,010
========== ======== =========
The plans' assets consist of equity securities (70%), debt securities (28%) and
cash equivalents (2%) at December 31, 2005. At December 31, 2004, the plans'
assets consisted of equity securities (71%), debt securities (19%) and cash
equivalents (10%).
The investment objectives of the plans emphasize long-term capital appreciation
as a primary source of return and current income as a supplementary source.
In connection with freezing the plan, the Company is reviewing the target
allocation, which currently is as follows:
Target
Equity securities:
Large cap stocks 40%
Small cap stocks 10%
International stocks 20%
-----
Total equity securities 70%
Fixed income/bonds 30%
-----
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% for large to medium equities and 8% for
small to medium equities.
F-39
17. Pension Plans and Postretirement Benefits, 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 (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.
The assumption for the expected long-term rate of return on plan assets
considered historical returns and future expectations, including a more
conservative expectation of future returns and asset allocation targets as the
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 2005 and 2004.
The measurement date for WilTel's plans is December 31. The assumptions used for
2005 and 2004 are as follows:
Pension Benefits
----------------
2005 2004
---- ----
Weighted-average assumptions used to determine
benefit obligation at December 31:
Discount rate 5.40% 5.75%
Rate of compensation increase 3.50% 3.50%
Weighted-average assumptions used to determine
net cost for the period ended December 31:
Discount rate 5.75% 6.00%
Expected long-term return on plan assets 7.00% 7.00%
Rate of compensation increase 3.50% 3.50%
The timing of expected future benefit payments was used in conjunction with the
Citigroup Pension Discount Curve to develop a discount rate that is
representative of the high quality corporate bond market, adjusted for current
rates which might be available for annuity settlements.
The following pension benefit payments are expected to be paid (in thousands):
2006 $ 3,309
2007 2,926
2008 3,381
2009 2,911
2010 3,396
2011 - 2015 22,976
The Company and its consolidated subsidiaries 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
$1,700,000, $1,400,000 and $1,300,000 for the years ended December 31, 2005,
2004 and 2003, respectively.
F-40
18. 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. Rental expense (net of sublease rental income and unfavorable
contract amortization) was $8,100,000 in 2005, $7,600,000 in 2004 and $5,900,000
in 2003. Future minimum annual rentals (exclusive of month-to-month leases, real
estate taxes, maintenance and certain other charges) under these leases at
December 31, 2005 are as follows (in thousands):
2006 $ 10,415
2007 9,340
2008 7,127
2009 5,642
2010 3,615
Thereafter 7,862
---------
44,001
Less: sublease income (5,785)
---------
$ 38,216
=========
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, 2005,
$29,500,000 was outstanding under these bonds, $800,000 of which expires in 2006
and the remainder thereafter.
Symphony is limited by debt 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 subsidiaries which are subject to
limitations on transfer of funds to the Company were approximately $8,800,000 at
December 31, 2005.
19. 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 or liquidity.
20. Earnings (Loss) Per Common Share:
---------------------------------
For the year ended December 31, 2005, the numerators for basic and diluted per
share computations for income from continuing operations were $1,224,100,000 and
$1,238,300,000, respectively. For the year ended December 31, 2004, the
numerators for basic and diluted per share computations for income from
continuing operations were $208,500,000 and $214,800,000, respectively. The
calculations 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.
F-41
20. Earnings (Loss) Per Common Share, continued:
--------------------------------
For the year ended December 31, 2003, there were no differences in the
numerators for the basic and diluted per share computations for income from
continuing operations; the numerator was $101,100,000. The denominators for
basic per share computations were 107,765,000, 106,692,000 and 91,896,000 for
2005, 2004 and 2003, respectively. The denominators for diluted per share
computations reflect the dilutive effect of 252,000, 779,000 and 656,000 options
and warrants for 2005, 2004 and 2003, respectively (the treasury stock method
was used for these calculations), and 7,620,000 and 5,275,000 shares related to
the 3 3/4% Convertible Notes for 2005 and 2004, respectively.
21. 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. The fair value of the Company's investment
in the Inmet common shares, all of which are restricted as discussed in
Note 6, is based on quoted market prices. The fair values of the Company's
other equity securities that are accounted for under the cost method
(aggregating $73,600,000) were not practicable to estimate; the fair values
were assumed to be the carrying amount.
(b) Cash and cash equivalents: For cash equivalents, the carrying amount
approximates fair value.
(c) Notes receivables: The fair values of variable rate notes receivable are
estimated to be the carrying amount.
(d) Loan receivables of banking and lending subsidiaries: The carrying amount
approximates fair value.
(e) Customer banking deposits: At December 31, 2004, the fair value of customer
banking deposits is estimated using rates currently offered for deposits of
similar remaining maturities.
(f) Long-term and other indebtedness: The fair values of non-variable rate debt
are estimated using quoted market prices and estimated rates which would be
available to the Company for debt with similar terms. The fair value of
variable rate debt is estimated to be the carrying amount.
(g) Derivative instruments: The fair values of the interest rate swap and
currency rate swap agreements are based on rates currently available for
similar agreements.
F-42
21. Fair Value of Financial Instruments, continued:
------------------------------------
The carrying amounts and estimated fair values of the Company's financial
instruments at December 31, 2005 and 2004 are as follows (in thousands):
2005 2004
---- ----
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
Financial Assets:
Investments:
Current $ 1,323,562 $ 1,323,562 $ 1,084,745 $ 1,084,745
Non-current 977,327 1,041,446 718,326 718,326
Cash and cash equivalents 386,957 386,957 277,238 277,238
Notes receivable:
Current 6,413 6,413 1,697 1,697
Non-current 3,787 3,787 -- --
Loan receivables of banking and lending
subsidiary, net of allowance:
Current 1,056 1,056 1,733 1,733
Non-current 1,376 1,376 1,625 1,625
Financial Liabilities:
Customer banking deposits:
Current -- -- 18,472 18,658
Non-current -- -- 6,119 6,251
Debt:
Current 175,664 176,052 64,799 65,201
Non-current 986,718 1,038,252 1,067,123 1,180,371
Securities sold not owned 24,268 24,268 50,569 50,569
Derivative Instruments:
Interest rate swaps (677) (677) (2,342) (2,342)
Foreign currency swaps (2,546) (2,546) (5,878) (5,878)
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
manufacturing operations are conducted through Idaho Timber and its plastics
manufacturing segment. Idaho Timber primarily remanufactures, manufactures
and/or distributes wood products. The Company's plastics manufacturing
operations manufacture and market lightweight plastic netting used for a variety
of purposes. The Company's healthcare services operations provide physical,
occupational and speech therapy services, healthcare staffing services and
Medicare consulting services. The Company's telecommunications operations are
principally conducted through ATX, an integrated communications provider that
offers a wide range of telecommunication services in the Mid-Atlantic region of
the United States. 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 the Company's wineries and
residual banking and lending activities that are in run-off.
F-43
22. Segment Information, continued:
-------------------
Associated companies include equity interests in entities that the Company
accounts for on the equity method of accounting. Investments in associated
companies include CLC, 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, which is the only foreign operation
with non-U.S. revenue or assets that the Company consolidates, and it is not
material. In addition to its investment in Bermuda-based Olympus, the Company
owns 36% of the principal electric utility in Barbados, and an interest, through
its 30% ownership of CLC, in a copper deposit in Spain. 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.
Certain information concerning the Company's segments for 2005, 2004 and 2003 is
presented in the following table. Consolidated subsidiaries are reflected as of
the date of acquisition, which was September 2003 for Symphony, April 2005 for
ATX and May 2005 for Idaho Timber. Associated Companies are only reflected in
the table below under identifiable assets employed.
F-44
22. Segment Information, continued:
-------------------
2005 2004 2003
---- ---- ----
(In millions)
Revenues and other income (a):
Manufacturing:
Idaho Timber $ 239.0 $ -- $ --
Plastics 93.6 64.4 54.1
Healthcare Services 239.9 258.4 71.1
Telecommunications 111.4 -- --
Domestic Real Estate 29.8 63.5 50.4
Other Operations 59.1 70.8 95.6
Corporate (b) 268.3 180.9 42.5
--------- --------- --------
Total consolidated revenues and other income $ 1,041.1 $ 638.0 $ 313.7
========= ========= =========
Income (loss) from continuing operations before income taxes, minority expense
of trust preferred securities and equity in income (losses) of associated
companies:
Manufacturing:
Idaho Timber $ 8.2 $ -- $ --
Plastics 14.2 7.9 4.4
Healthcare Services 3.3 5.1 (2.3)
Telecommunications (1.9) -- --
Domestic Real Estate 4.1 20.7 18.1
Other Operations 6.1 18.6 9.1
Corporate (b) 101.9 59.6 (37.5)
Elimination (c) 2.3 -- --
--------- --------- ---------
Total consolidated income (loss) from continuing operations before income
taxes, minority expense of trust preferred
securities and equity in income (losses) of associated companies $ 138.2 $ 111.9 $ (8.2)
========= ========= =========
Identifiable assets employed:
Manufacturing:
Idaho Timber $ 162.7 $ -- $ --
Plastics 81.9 50.4 50.8
Healthcare Services 55.5 65.6 54.6
Telecommunications 88.6 -- --
Domestic Real Estate 182.7 253.2 275.8
Other Operations 252.0 403.7 505.8
Investments in Associated Companies 375.5 460.8 430.9
Corporate 4,062.0 2,070.1 1,456.9
Assets of discontinued operations -- 1,496.6 1,622.4
--------- --------- ---------
Total consolidated assets $ 5,260.9 $ 4,800.4 $ 4,397.2
========= ========= =========
F-45
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) Net securities gains for Corporate aggregated $199,500,000 and $123,100,000
during 2005 and 2004, respectively, which primarily resulted from the sale
of publicly traded debt and equity securities that had been classified as
available for sale securities. Security gains in 2005 include a gain from
the sale of WMIG of $146,000,000. For 2005 and 2004, security gains include
provisions of $12,200,000 and $4,600,000, respectively, to write down
investments in certain available for sale securities. For 2003, security
gains include a provision of $6,500,000 to write down investments in
certain available for sale securities and an investment in a non-public
security. The write downs of the available for sale securities resulted
from declines in market value determined to be other than temporary.
(c) Eliminates services purchased by ATX from WilTel and recorded as a cost of
sales by ATX.
(d) For the years ended December 31, 2005, 2004 and 2003, income (loss) from
continuing operations has been reduced by depreciation and amortization
expenses of $41,300,000, $29,400,000 and $29,100,000, respectively; such
amounts are primarily comprised of Corporate ($10,700,000, $11,400,000 and
$11,700,000, respectively), manufacturing ($14,200,000, $5,200,000 and
$4,700,000, respectively), other operations ($5,500,000, $6,900,000 and
$7,800,000, respectively) and telecommunications ($7,500,000 in 2005).
Depreciation and amortization expenses for other segments are not material.
(e) For the years ended December 31, 2005, 2004 and 2003, income (loss) from
continuing operations has been reduced by interest expense of $68,400,000,
$62,700,000 and $37,900,000, respectively; such amounts are primarily
comprised of Corporate ($63,200,000, $55,300,000 and $26,000,000,
respectively), healthcare services ($2,800,000, $2,200,000 and $600,000,
respectively) and banking and lending, which is included in other
operations ($1,100,000, $2,700,000 and $8,800,000, respectively). Interest
expense for other segments is not material.
F-46
23. Selected Quarterly Financial Data (Unaudited):
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(In thousands, except per share amounts)
2005:
Revenues and other income $ 121,295 $ 258,665 $ 343,265 $ 317,922
========== =========== ========= ==========
Income (loss) from continuing operations $ (6,695) $ 1,205,266 $ 47,229 $ (21,688)
========== =========== ========= ==========
Income from discontinued operations, net of taxes $ 9,308 $ 11,267 $ 56,755 $ 34,227
========== =========== ========= ==========
Gain on disposal of discontinued operations, net of taxes $ -- $ 54,578 $ 130 $ 245,664
========== =========== ========= ==========
Net income $ 2,613 $ 1,271,111 $ 104,114 $ 258,203
========== =========== ========= ==========
Basic earnings (loss) per common share:
Income (loss) from continuing operations $(.06) $11.20 $.44 $(.20)
Income from discontinued operations .08 .10 .53 .32
Gain on disposal of discontinued operations -- .51 -- 2.27
----- ----- ----- -----
Net income $ .02 $11.81 $.97 $2.39
===== ====== ===== =====
Number of shares used in calculation 107,609 107,652 107,797 107,983
======= ======= ======= =======
Diluted earnings (loss) per common share:
Income (loss) from continuing operations $(.06) $10.46 $ .44 $ (.20)
Income from discontinued operations .08 .10 .49 .32
Gain on disposal of discontinued operations -- .47 -- 2.27
----- ------ ----- ------
Net income $ .02 $11.03 $ .93 $ 2.39
===== ====== ===== ======
Number of shares used in calculation 107,609 115,513 115,664 107,983
======= ======= ======= =======
2004:
Revenues and other income $ 124,083 $ 173,009 $ 202,653 $ 138,217
========== =========== ========= =========
Income from continuing operations $ 23,438 $ 60,895 $ 78,601 $ 45,615
========== =========== ========= =========
Income (loss) from discontinued operations, net of taxes $ (35,390) $ (29,157) $ (4,037) $ 3,722
========== =========== ========= =========
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 from continuing operations $ .22 $ .57 $ .74 $ .43
Income (loss) from discontinued operations (.33) (.27) (.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 from continuing operations $ .22 $ .55 $ .70 $ .41
Income (loss) from discontinued operations (.33) (.25) (.03) .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
======= ======= ======= =======
Income from continuing operations includes credits to income tax expense of
$1,100,000,000 and $25,100,000 for the second and third quarters of 2005,
respectively, resulting from reversals of the deferred income tax valuation
allowance.
F-47
23. Selected Quarterly Financial Data (Unaudited), continued:
---------------------------------------------
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 in the
third quarter of 2004. In addition, the fourth quarter of 2004 reflects a
benefit to record a federal income tax carryback refund of $3,900,000.
In 2005 and 2004, the totals of quarterly per share amounts do not equal annual
per share amounts because of changes in outstanding shares during the year.
F-48
Schedule II - Valuation and Qualifying Accounts
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
For the years ended December 31, 2005, 2004 and 2003
(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
----------- --------- -------- ---------- ----- ----- ----------- ----- ---------
2005
Loan receivables of
banking and lending
subsidiaries $ 946 $ (323) $ 90 $ -- $ 177 $ -- $ -- $ 536
Trade, notes and other
receivables 7,488 7,995 144 5,215 5,701 245 -- 14,896
---------- -------- ------- ---------- ------- ------- ---------- ----------
Total allowance for
doubtful accounts $ 8,434 $ 7,672 $ 234 $ 5,215 $ 5,878 $ 245 $ -- $ 15,432
========== ======== ======= ========== ======= ======= ========== ==========
Deferred tax asset
valuation allowance $2,185,275 $ -- $ -- $ -- $ -- $ -- $1,380,446(a) $ 804,829
========== ========= ======= ========== ======= ======= ========== ==========
2004
Loan receivables of
banking and lending
subsidiaries $ 24,236 $ (8,301) $11,215 $ -- $11,331 $14,873 $ -- $ 946
Trade, notes and other
receivables 2,268 4,967 4,860 -- 4,607 -- -- 7,488
---------- -------- ------- ---------- ------- ------- ---------- ----------
Total allowance for
doubtful accounts $ 26,504 $ (3,334) $16,075 $ -- $15,938 $14,873 $ -- $ 8,434
========== ======== ======= ========== ======= ======= ========== ==========
Deferred tax asset
valuation allowance $2,237,753 $ -- $ -- $ -- $ -- $ -- $ 52,478(b) $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 3,319 123 -- 2,057 -- -- 2,268
---------- -------- ------- ---------- ------- ------- ---------- ----------
Total allowance for
doubtful accounts $ 32,731 $ 19,730 $12,298 $ -- $38,255 $ -- $ -- $ 26,504
========== ======== ======= ========== ======= ======= ========== ==========
Deferred tax asset
valuation allowance $ 49,551 $ -- $ -- $2,229,709(c)$ -- $ -- $ 41,507(d) $2,237,753
========== ======== ======= ============ ======== ======= ========== ==========
(a) During 2005, as a result of the consummation of certain transactions
and ongoing operating profits, the Company prepared updated
projections of future taxable income. The Company's revised
projections of future taxable income enabled it to conclude that it is
more likely than not that it will have future taxable income
sufficient to realize a portion of the Company's net deferred tax
asset; accordingly, $1,135,100,000 of the deferred tax valuation
allowance was reversed as a credit to income tax expense.
F-49
(b) Principally results from the recognition of acquired tax benefits, of
which $22,300,000 was applied to reduce the carrying amount of
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
acquired tax attributes to offset the federal income tax provision
that would have otherwise been recorded during 2004.
(c) Additions represent acquired 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.
(d) Principally results from the recognition of acquired tax benefits of
$22,500,000, which was applied to reduce the carrying amount of
acquired non-current intangible assets and a reclassification to other
liabilities.
F-50
Report of Independent Registered Public Accounting Firm
The Stockholder
WilTel Communications Group, Inc.
We have audited the accompanying consolidated statements of operations,
stockholders' equity (deficit), and cash flows of WilTel Communications Group,
Inc., for the period from January 1, 2003 to November 5, 2003. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with auditing standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated results of operations and cash flows
of WilTel Communications Group, Inc. for the period from January 1, 2003 to
November 5, 2003, in conformity with U.S. generally accepted accounting
principles.
Ernst & Young LLP
Tulsa, Oklahoma
February 20, 2004
1
WILTEL COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
Period from
January 1,
2003 through
November 5,
2003
------------
(In thousands, except per share amounts)
Revenues ...................................................$ 1,111,415
Operating expenses:
Cost of sales ............................................ 901,293
Selling, general and administrative....................... 145,580
Provision for doubtful accounts........................... 4,199
Depreciation and amortization............................. 208,480
Other income, net........................................ (1,298)
--------------
Total operating expenses............................... 1,258,254
--------------
Loss from operations ....................................... (146,839)
Interest accrued............................................ (34,708)
Interest and other investment income........................ 4,010
Minority interest in loss of consolidated subsidiary........ 2,378
Gain on sale of consolidated subsidiary..................... 21,089
Other income, net........................................... 45,347
--------------
Loss before income taxes.................................... (108,723)
Provision for income taxes.................................. (23)
--------------
Net loss.................................................... (108,746)
==============
Basic and diluted loss per share $ (2.17)
===============
Weighted average shares outstanding....................... 50,000
See accompanying notes.
2
WILTEL COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
Accumulated
Capital in Other
Common Excess of Accumulated Comprehensive
Stock Par Value Deficit Income (Loss) Total
----- --------- ------- ------------- -----
(In thousands)
Balance, January 1, 2003 .............................. 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.
3
WILTEL COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
Period from
January 1,
2003 through
November 5,
2003
----
(In thousands)
Operating activities
Net loss...........................................................$ (108,746)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization ................................... 208,480
Provision for doubtful accounts.................................. 4,199
Gain on sales of property and other assets....................... (1,502)
Minority interest in loss of consolidated subsidiary............. (2,378)
Gain on sale of consolidated subsidiary.......................... (21,089)
Cash provided by (used in) changes in:
Receivables.................................................... (39,003)
Prepaid and other current assets............................... (37,686)
Accounts payable............................................... 16,766
Current deferred revenue....................................... (7,339)
Accrued liabilities............................................ (26,288)
Long-term deferred revenue..................................... (25,453)
Other.......................................................... (1,967)
----------
Net cash used in operating activities.............................. (42,006)
Financing activities
Payments on and purchase of long-term debt......................... (20,098)
Net cash used in financing activities.............................. (20,098)
4
WILTEL COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS - (Continued)
Period from
January 1,
2003 through
November 5,
2003
----
(In thousands)
Investing activities
Property, plant and equipment:
Capital expenditures............................................. (47,530)
Proceeds from net tax refunds, settlements and sales............. 32,671
Changes in accrued liabilities................................... (12,533)
Proceeds from sale of consolidated subsidiary...................... 19,575
Restricted investments............................................. (13,081)
----------
Net cash used in investing activities.............................. (20,898)
----------
Decrease in cash and cash equivalents.............................. (83,002)
Cash and cash equivalents at beginning of period................... 291,288
----------
Cash and cash equivalents at end of period........................ $ 208,286
==========
See accompanying notes.
5
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 began to be 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
WilTel emerged from bankruptcy on October 15, 2002. Pursuant to the
provisions of Statement of Position ("SOP") 90-7, "Financial Reporting by
Entities in Reorganization under the Bankruptcy Code," WilTel adopted the
provisions of fresh start accounting on October 31, 2002. Under fresh start
accounting the net reorganization value of the Company was allocated among the
Company's individual assets and liabilities based on their relative fair value.
2003 Presentation
The financial statements presented for 2003 are for the period from January
1, 2003 through November 5, 2003, which represents the results of operations and
cash flows prior to the acquisition by Leucadia.
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 3).
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
6
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 income.
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.
7
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Depreciation Expense
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.
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.
Income taxes are provided based on the liability method of accounting.
Deferred income taxes are provided for the expected future tax consequences of
temporary differences between the basis of assets and liabilities reported for
financial and tax purposes.
Loss Per Share
The Company's basic loss per share is based on the sum of the average
number of common shares outstanding and deferred shares, if any. Diluted loss
per share includes any dilutive effect of stock options and convertible
preferred stock. For WilTel, the basic and diluted loss per share is the same as
it does not have any dilutive securities outstanding.
8
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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.
9
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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.
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
10
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following geographic area data includes revenues from external
customers based on origin of services rendered January 1, 2003 through November
5, 2003.
Revenues from external customers:
United States..............................$ 1,062,387
Other....................................... 49,028
------------
Total.......................................$ 1,111,415
============
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.
3. Gain on Sale of Consolidated Subsidiary
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.
4. 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 $16.8 million of non-recurring, non-operating gains primarily related
to the termination of arrangements previously accrued as unfavorable commitments
and recoveries of various receivables previously written off.
11
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
5. Provision for Income Taxes
The provision for income taxes includes:
Period from
January 1, 2003
through
November 5,
2003
----------------
(In thousands)
Current:
Federal........................................$ --
State.......................................... (23)
-------
(23)
Deferred:
Federal........................................ --
State.......................................... --
-------
--
-------
Total provision for income taxes............. ...$ (23)
=======
The U.S. and foreign components of loss before income taxes are as
follows:
Period from
January 1, 2003
through
November 5,
2003
----------------
(In thousands)
United States.................................. $(127,993)
Foreign........................................... 19,270
---------
Total loss before income taxes.................. $(108,723)
=========
The Company's undistributed earnings from non U.S. subsidiaries in 2003
have been accounted for as if fully repatriated.
Reconciliation of the benefit from income taxes at the federal statutory
rate to the provision for income taxes are as follows:
Period from
January 1, 2003
through
November 5,
2003
----------------
(In thousands)
Benefit at statutory rate........................$ 38,053
Increases (reductions) resulting from:
State income taxes............................. (15)
Foreign operations............................. 6,745
Non-deductible reorganization expenses......... (1,750)
Valuation allowance adjustments................ (42,913)
Other-- net................................... (143)
---------
Provision for income taxes.. ....................$ (23)
=========
12
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 was an
increase of $50.1 million.
If the Company had filed a separate federal income tax return for all
periods presented, the tax provision would have been unchanged.
6. 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 $200,000.
WilTel also has an unfunded other postretirement benefit plan covering
employees who were employed prior to January 1, 1992. This health care plan is
contributory with participants' contributions adjusted annually. Benefits are
paid to eligible employees with 10 years of service and aged 55 years or older
when leaving the company.
Components of Net Periodic Benefit Cost
The following tables present net pension expense and other postretirement
benefit expense for the WilTel Plans.
Period from
January 1, 2003
through
November 5,
2003
----------------
(In thousands)
Components of net period pension expense:
Service cost..............................................$ 5,090
Interest cost.............................................. 6,556
Expected return on plan assets............................. (3,688)
--------
Net periodic pension expense ......................... 7,958
--------
Total pension cost ...................................$ 7,958
========
Additional information:
Increase in minimum liability included in other
comprehensive income (before taxes) $ 658
========
13
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Period from
January 1, 2003
through
November 5,
2003
----------------
(In thousands)
Components of net periodic postretirement benefit expense:
Service cost..............................................$ 111
Interest cost............................................. 92
Recognized net actuarial (gain) loss...................... (18)
--------
Total postretirement cost..............................$ 185
========
Assumptions
The following are the weighted-average assumptions utilized to determine
net periodic pension benefit cost for the period ended November 5, 2003:
Net Periodic Pension Benefit Cost
---------------------------------
Discount rate..................................... 6.75%
Expected return on plan assets.................... 7.00%
Rate of compensation increase..................... 3.50%
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.
The following are the weighted-average assumptions utilized to determine
net periodic other postretirement benefit cost for the period ended November 5,
2003:
Other Post Retirement Benefits
Discount rate..............................................6.75%
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)
14
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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 Williams Companies"). The Company's costs related
to these plans were $5.3 million for the period from January 1, 2003 through
November 5, 2003.
7. Interest
Cash payments for interest, net of amounts capitalized, were $25.8 million,
for the period from January 1, 2003 through November 5, 2003. These payments
include commitment fees relating to the Company's credit facility of $1.1
million, for the period from January 1, 2003 through November 5, 2003.
8. Accumulated Other Comprehensive Income
The table below presents changes in the components of accumulated other
comprehensive income (loss).
Unrealized Foreign
Appreciation Currency Minimum
(Depreciation) Translation Pension
of Securities Adjustments Liability Total
------------- ----------- --------- -----
(In thousands)
Balance as of January 1, 2003.............................. -- 780 -- 780
Change for the period from January 1, 2003 through
November 5, 2003:
Pre-income tax amount.................................... -- (82) (658) (740)
Reclassification adjustment for net gains realized in
net loss............................................... -- (699) -- (699)
----------- --------- ----------- ----------
Balance as of November 5, 2003.............................$ -- $ (1) $ (658) $ (659)
=========== ========= =========== ==========
9. 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
===========
For the period from January 1, 2003 through November 5, 2003, total
capacity expense incurred from leasing from a third party's network (off-network
capacity expense) was $35.4 million and all other rent expense was $29.2
million.
15
WILTEL COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
10. 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. 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.
11. 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.
16
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.
17
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.
18
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 of Network's
revenues for the period from January 1, 2003 through November 5, 2003. 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.
19