SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission File Number 1-5721
LEUCADIA NATIONAL CORPORATION
(Exact name of registrant as specified in its Charter)
New York 13-2615557
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
315 Park Avenue South, New York, New York 10010-3607
(Address of principal executive offices) (Zip Code)
(212) 460-1900
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
----------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
------- -------
Indicate by check mark whether the registrant is 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
---- ------
APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding
of each of the issuer's classes of common stock, at May 1, 2007: 216,583,237.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
March 31, 2007 and December 31, 2006
(Dollars in thousands, except par value)
March 31, December 31,
2007 2006
------------- -----------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 700,438 $ 287,199
Investments 600,990 903,973
Trade, notes and other receivables, net 114,725 69,822
Prepaids and other current assets 140,844 105,215
------------ -----------
Total current assets 1,556,997 1,366,209
Non-current investments 1,785,939 1,465,849
Notes and other receivables, net 19,055 24,999
Intangible assets, net and goodwill 63,453 59,437
Deferred tax asset, net 1,024,221 978,415
Other assets 431,798 401,689
Property, equipment and leasehold improvements, net 234,523 234,216
Investments in associated companies 908,382 773,010
------------ -----------
Total $ 6,024,368 $ 5,303,824
============ ===========
LIABILITIES
Current liabilities:
Trade payables and expense accruals $ 149,303 $ 127,739
Deferred revenue 61,876 --
Other current liabilities 9,836 5,688
Debt due within one year 190,385 184,815
Income taxes payable 49 8,411
------------ -----------
Total current liabilities 411,449 326,653
Other non-current liabilities 93,780 90,268
Long-term debt 1,475,843 974,646
------------ -----------
Total liabilities 1,981,072 1,391,567
------------ -----------
Commitments and contingencies
Minority interest 23,865 18,982
------------ -----------
SHAREHOLDERS' EQUITY
Common shares, par value $1 per share, authorized 300,000,000 shares;
216,580,237 and 216,351,466 shares issued and outstanding, after deducting
56,884,989 and 56,881,489 shares held in treasury 216,580 216,351
Additional paid-in capital 528,339 520,892
Accumulated other comprehensive income (loss) 105,380 (4,726)
Retained earnings 3,169,132 3,160,758
------------ -----------
Total shareholders' equity 4,019,431 3,893,275
------------ -----------
Total $ 6,024,368 $ 5,303,824
============ ===========
See notes to interim consolidated financial statements.
2
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
For the three months ended March 31, 2007 and 2006
(In thousands, except per share amounts)
(Unaudited)
2007 2006
---- ----
Revenues and Other Income:
Manufacturing $ 96,594 $ 119,391
Telecommunications 32,771 --
Investment and other income 51,899 133,503
Net securities gains 15,921 38,714
----------- ----------
197,185 291,608
----------- ----------
Expenses:
Cost of sales:
Manufacturing 80,747 98,513
Telecommunications 27,607 --
Interest 20,076 17,150
Salaries and incentive compensation 19,140 14,898
Depreciation and amortization 6,180 4,914
Selling, general and other expenses 52,231 44,594
----------- ---------
205,981 180,069
----------- ----------
Income (loss) from continuing operations before income taxes and equity
in income of associated companies (8,796) 111,539
Income taxes (3,732) 42,679
----------- ----------
Income (loss) from continuing operations before equity in income of
associated companies (5,064) 68,860
Equity in income of associated companies, net of taxes 12,925 13,729
----------- ----------
Income from continuing operations 7,861 82,589
Income (loss) from discontinued operations, net of taxes 222 (1,433)
Gain (loss) on disposal of discontinued operations, net of taxes 291 (463)
----------- ----------
Net income $ 8,374 $ 80,693
=========== ==========
Basic earnings (loss) per common share:
Income from continuing operations $ .04 $ .38
Income (loss) from discontinued operations -- (.01)
Gain (loss) on disposal of discontinued operations -- --
------- ------
Net income $ .04 $ .37
======= ======
Diluted earnings (loss) per common share:
Income from continuing operations $ .04 $ .37
Income (loss) from discontinued operations -- (.01)
Gain (loss) on disposal of discontinued operations -- --
------- ------
Net income $ .04 $ .36
======= ======
See notes to interim consolidated financial statements.
3
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the three months ended March 31, 2007 and 2006
(In thousands)
(Unaudited)
2007 2006
---- ----
Net cash flows from operating activities:
Net income $ 8,374 $ 80,693
Adjustments to reconcile net income to net cash provided by operations:
Deferred income tax provision 4,666 44,923
Depreciation and amortization of property, equipment and leasehold improvements 7,862 9,047
Other amortization (1,463) (4,375)
Share-based compensation 3,384 347
Excess tax benefit from exercise of stock options (554) (197)
Provision for doubtful accounts (69) 508
Net securities gains (15,921) (38,714)
Equity in income of associated companies (22,451) (22,385)
Distributions from associated companies 26,866 40,248
Net gains related to real estate, property and equipment, and other assets (1,835) (86,265)
(Gain) loss on disposal of discontinued operations (505) 755
Investments classified as trading, net 39,097 (1,197)
Net change in:
Trade, notes and other receivables (2,967) 97,475
Prepaids and other assets (7,779) (6,452)
Trade payables and expense accruals (6,291) (39,311)
Other liabilities 1,264 1,136
Income taxes payable (4,201) 5,684
Other (1,151) 6,804
----------- ----------
Net cash provided by operating activities 26,326 88,724
----------- ----------
Net cash flows from investing activities:
Acquisition of property, equipment and leasehold improvements (9,330) (7,650)
Acquisitions of and capital expenditures for real estate investments (9,973) (20,683)
Proceeds from disposals of real estate, property and equipment, and other assets 13,392 166,818
Acquisitions, net of cash acquired (87,814) --
Net change in restricted cash (10,000) --
Advances on notes and other receivables (6,126) (10,000)
Collections on notes, loan and other receivables 8,742 700
Investments in associated companies (156,428) (56,020)
Capital distributions from associated companies 2,950 --
Purchases of investments (other than short-term) (463,030) (1,240,765)
Proceeds from maturities of investments 166,668 331,588
Proceeds from sales of investments 436,833 735,611
Other 384 552
----------- ----------
Net cash used for investing activities (113,732) (99,849)
----------- ----------
Net cash flows from financing activities:
Issuance of long-term debt 494,704 74,757
Reduction of long-term debt (780) (32,881)
Issuance of common shares 3,840 1,080
Excess tax benefit from exercise of stock options 554 197
Other 2,317 745
----------- ----------
Net cash provided by financing activities 500,635 43,898
----------- ----------
Effect of foreign exchange rate changes on cash 10 16
----------- ----------
Net increase in cash and cash equivalents 413,239 32,789
Cash and cash equivalents at January 1, 287,199 386,957
----------- ----------
Cash and cash equivalents at March 31, $ 700,438 $ 419,746
=========== ==========
See notes to interim consolidated financial statements.
4
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders' Equity
For the three months ended March 31, 2007 and 2006
(In thousands, except par value)
(Unaudited)
Common Accumulated
Shares Additional Other
$1 Par Paid-In Comprehensive Retained
Value Capital Income (Loss) Earnings Total
-------- ----------- ------------- -------- -----
Balance, January 1, 2006 $216,058 $501,914 $ (81,502) $ 3,025,444 $3,661,914
----------
Comprehensive income:
Net change in unrealized gain (loss) on
investments, net of taxes of $9,039 15,932 15,932
Net change in unrealized foreign exchange
gain (loss), net of taxes of $484 854 854
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $52 (92) (92)
Net income 80,693 80,693
----------
Comprehensive income 97,387
----------
Share-based compensation expense 347 347
Exercise of options to purchase common shares,
including excess tax benefit 122 1,155 1,277
-------- -------- ---------- ----------- ----------
Balance, March 31, 2006 $216,180 $503,416 $ (64,808) $ 3,106,137 $3,760,925
======== ======== ========== =========== ==========
Balance, January 1, 2007 $216,351 $520,892 $ (4,726) $ 3,160,758 $3,893,275
----------
Comprehensive income:
Net change in unrealized gain (loss) on
investments, net of taxes of $61,997 109,264 109,264
Net change in unrealized foreign exchange
gain (loss), net of taxes of $263 462 462
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $50 87 87
Net change in minimum pension liability and
postretirement benefits, net of taxes of $167 293 293
Net income 8,374 8,374
---------
Comprehensive income 118,480
----------
Share-based compensation expense 3,384 3,384
Exercise of options to purchase common shares,
including excess tax benefit 232 4,162 4,394
Purchase of common shares for treasury (3) (99) (102)
-------- -------- ---------- ----------- ----------
Balance, March 31, 2007 $216,580 $528,339 $ 105,380 $ 3,169,132 $4,019,431
======== ======== ========== =========== ==========
See notes to interim consolidated financial statements.
5
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Notes to Interim Consolidated Financial Statements
1. The unaudited interim consolidated financial statements, which reflect all
adjustments (consisting of normal recurring items or items discussed
herein) that management believes necessary to present fairly results of
interim operations, should be read in conjunction with the Notes to
Consolidated Financial Statements (including the Summary of Significant
Accounting Policies) included in the Company's audited consolidated
financial statements for the year ended December 31, 2006, which are
included in the Company's Annual Report filed on Form 10-K, as amended, for
such year (the "2006 10-K"). Results of operations for interim periods are
not necessarily indicative of annual results of operations. The
consolidated balance sheet at December 31, 2006 was extracted from the
audited annual financial statements and does not include all disclosures
required by accounting principles generally accepted in the United States
of America ("GAAP") for annual financial statements.
Effective January 1, 2007, the Company adopted Financial Accounting
Standards Board Interpretation No. 48, "Accounting for Uncertainty in
Income Taxes - an Interpretation of FASB Statement No. 109" ("FIN 48"),
which prescribes the accounting for and disclosure of uncertainty in income
tax positions. FIN 48 specifies a recognition threshold that must be met
before any part of the benefit of a tax position can be recognized in the
financial statements, specifies measurement criteria and provides guidance
for classification and disclosure. The Company was not required to record
an adjustment to its financial statements upon the adoption of FIN 48.
The Company's accounting policy for recording interest and penalties, if
any, with respect to uncertain tax positions is to classify interest and
penalties as components of income tax expense. As of the date of adoption
of FIN 48, the aggregate amount of unrecognized tax benefits reflected in
the Company's consolidated balance sheet was $14,000,000 (including
$3,500,000 for interest); if recognized, such amounts would lower the
Company's effective tax rate. Unrecognized tax benefits were not materially
different at March 31, 2007. The statute of limitations with respect to the
Company's federal income returns has expired for all years through 2001.
The Company's New York State and New York City income tax returns are
currently being audited for the 1999 to 2002 period.
In September 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 157, "Fair Value
Measurements" ("SFAS 157"), which defines fair value, establishes a
framework for measuring fair value and expands disclosures about fair value
measurements. SFAS 157 is effective for fiscal years beginning after
November 15, 2007. In February 2007, the FASB issued Statement of Financial
Accounting Standards No. 159, "The Fair Value Option for Financial Assets
and Financial Liabilities - Including an amendment of FASB Statement No.
115" ("SFAS 159"), which permits entities to choose to measure many
financial instruments and certain other items at fair value. SFAS 159 is
effective for fiscal years beginning after November 15, 2007. The Company
is currently evaluating the impact of adopting SFAS 157 and SFAS 159 on its
consolidated financial statements.
Certain amounts for prior periods have been reclassified to be consistent
with the 2007 presentation.
2. Results of operations for the Company's segments are reflected from the
date of acquisition, which was March 2007 for the telecommunications
business conducted by the Company's 75% owned subsidiary STi Prepaid, LLC
("STi Prepaid"). The primary measure of segment operating results and
profitability used by the Company is income (loss) from continuing
operations before income taxes and equity in income of associated
companies.
Certain information concerning the Company's segments for the three month
periods ended March 31, 2007 and 2006 is presented in the following table.
6
2007 2006
---- ----
(In thousands)
Revenues and other income (a):
Manufacturing:
Idaho Timber $ 72,517 $ 92,538
Conwed Plastics 24,178 27,162
Telecommunications 32,844 --
Domestic Real Estate 4,294 62,048
Medical Product Development 271 92
Other Operations 10,555 8,960
Corporate 52,526 100,808
---------- ----------
Total consolidated revenues and other income $ 197,185 $ 291,608
========== ==========
Income (loss) from continuing operations before income taxes and equity in
income of associated companies:
Manufacturing:
Idaho Timber $ 4,229 $ 7,227
Conwed Plastics 3,364 5,227
Telecommunications 2,905 --
Domestic Real Estate (1,497) 47,821
Medical Product Development (8,367) (5,663)
Other Operations (5,010) (1,059)
Corporate (4,420) 57,986
---------- ----------
Total consolidated income (loss) from continuing operations before
income taxes and equity in income of associated companies $ (8,796) $ 111,539
========== ==========
(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.
For the three month periods ended March 31, 2007 and 2006, income (loss)
from continuing operations has been reduced by depreciation and
amortization expenses of $10,700,000 and $8,900,000, respectively; such
amounts are primarily comprised of Corporate ($2,900,000 for each period),
manufacturing ($4,600,000 and $4,200,000, respectively) and other
operations ($2,100,000 and $900,000, respectively). Depreciation and
amortization expenses for other segments are not material.
For the three month periods ended March 31, 2007 and 2006, income (loss)
from continuing operations has been reduced by interest expense of
$20,100,000 and $17,200,000, respectively; such amounts are primarily
comprised of Corporate ($20,100,000 and $17,000,000, respectively).
Interest expense for other segments is not material.
3. The following tables provide summarized data with respect to significant
investments in associated companies accounted for under the equity method
of accounting for the periods the investments were owned by the Company.
The information is provided for those investments whose relative
significance to the Company could result in the Company including separate
audited financial statements for such investments in its Annual Report on
Form 10-K for the year ended December 31, 2007 (in thousands).
7
March 31, March 31,
2007 2006
----------- ---------
EagleRock Capital Partners (QP), LP ("EagleRock"):
Total revenues $ 8,700 $ 13,400
Income from continuing operations before extraordinary items 8,600 13,100
Net income 8,600 13,100
The Company's equity in net income 6,400 9,500
Jefferies Partners Opportunity Fund II, LLC ("JPOF II"):
Total revenues $ 4,700 $ 9,300
Income from continuing operations before extraordinary items 4,100 8,300
Net income 4,100 8,300
The Company's equity in net income 2,900 5,600
The Company and Jefferies & Company, Inc. ("Jefferies") have entered into
an agreement to expand and restructure the Company's equity investment in
JPOF II, one of several entities managed by Jefferies that invested capital
in Jefferies' high yield trading business. The Company has committed to
invest $600,000,000 in a newly formed entity, Jefferies High Yield
Holdings, LLC ("JHYH"), Jefferies has committed to invest the same amount
as the Company, and passive investors may invest up to $800,000,000 in the
aggregate over time. Jefferies will also receive additional JHYH securities
entitling it to 20% of the profits. Jefferies and the Company each have the
right to nominate two of a total of four directors to JHYH's board, and
each own 50% of the voting securities. JHYH owns a registered broker-dealer
engaged in the secondary sales and trading of high yield securities and
specialized situation securities formerly conducted by Jefferies, including
bank debt, post-reorganization equity, equity, equity derivatives, credit
defaults swaps and other financial instruments. It commits capital to the
market by making markets in high yield and distressed securities and
invests in and provides research coverage on these types of securities. In
April 2007, after regulatory approval for the new venture was received, the
Company contributed $250,000,000 to JHYH along with its investment in JPOF
II. The Company expects that its remaining $250,000,000 commitment will be
contributed before the end of the year.
The Company will account for its investment in JHYH under the equity method
of accounting. Under GAAP, JHYH is considered to be a variable interest
entity that will be consolidated by Jefferies, since Jefferies is the
primary beneficiary.
4. A summary of investments at March 31, 2007 and December 31, 2006 is as
follows (in thousands):
March 31, 2007 December 31, 2006
------------------------------ --------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
--------- ---------- -------- ----------
Current Investments:
Investments available for sale $ 529,515 $ 529,782 $ 803,034 $ 809,927
Trading securities 56,071 58,359 79,526 80,321
Other investments, including accrued interest income 12,849 12,849 13,725 13,725
---------- ---------- --------- ----------
Total current investments $ 598,435 $ 600,990 $ 896,285 $ 903,973
========== ========== ========== ==========
Non-current Investments:
Investments available for sale $1,270,920 $1,600,869 $1,131,198 $1,283,261
Other investments 185,070 185,070 182,588 182,588
---------- ---------- --------- ----------
Total non-current investments $1,455,990 $1,785,939 $1,313,786 $1,465,849
========== ========== ========== ==========
Non-current available for sale investments include 26,400,000 common shares
of Fortescue Metals Group Ltd ("Fortescue"), representing approximately
9.99% of the outstanding Fortescue common stock. Fortescue is a publicly
traded company on the Australian Stock Exchange (Symbol: FMG), and the
shares acquired by the Company may be sold without restriction. The
Fortescue shares have a cost of $202,100,000 and market values of
$431,000,000 and $276,300,000 at March 31, 2007 and December 31, 2006,
respectively.
8
Non-current other investments include 5,600,000 common shares of Inmet
Mining Corporation ("Inmet"), a Canadian-based global mining company traded
on the Toronto stock exchange (Symbol: IMN), which have a cost and carrying
value of $78,000,000 at March 31, 2007 and December 31, 2006. As more fully
discussed in the 2006 10-K, the Inmet shares are restricted and may not be
sold until August 2009 or earlier under certain specified circumstances.
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 March 31, 2007, the market
value of the Inmet shares is $308,100,000.
5. A summary of intangible assets, net and goodwill at March 31, 2007 and
December 31, 2006 is as follows (in thousands):
March 31, December 31,
2007 2006
------------ ----------
Intangibles:
Customer relationships, net of accumulated amortization of $13,600 and $11,768 $ 49,709 $ 46,967
Trademarks and tradename, net of accumulated amortization of $268 and $227 2,592 1,642
Patents, net of accumulated amortization of $336 and $298 1,994 2,032
Other, net of accumulated amortization of $1,875 and $1,727 1,007 645
Goodwill 8,151 8,151
-------- --------
$ 63,453 $ 59,437
======== ========
As a result of the acquisition of STi Prepaid during the first quarter of
2007, intangibles increased by $4,300,000; see Note 17 for further
information concerning this acquisition. Intangible assets also increased
by $1,800,000 during the first quarter of 2007 related to an acquisition by
Conwed Plastics.
Amortization expense on intangible assets was $2,100,000 and $1,700,000 for
the three month periods ended March 31, 2007 and 2006, respectively. The
estimated aggregate future amortization expense for the intangible assets
for each of the next five years is as follows (in thousands): 2007 (for the
remaining nine months) - $5,600; 2008 - $7,300; 2009 - $6,800; 2010 -
$6,500; and 2011 - $6,200.
All of the goodwill in the above table relates to Conwed Plastics.
6. A summary of accumulated other comprehensive income (loss), net of taxes at
March 31, 2007 and December 31, 2006 is as follows (in thousands):
March 31, December 31,
2007 2006
------------- -----------
Net unrealized gains on investments $ 147,070 $ 37,806
Net unrealized foreign exchange gains 1,340 878
Net unrealized losses on derivative instruments (1,145) (1,232)
Net minimum pension liability (42,647) (42,960)
Net postretirement benefit 762 782
---------- ---------
$ 105,380 $ (4,726)
========== =========
7. Investment and other income includes changes in the fair values of
derivative financial instruments of $(100,000) and $1,000,000 for the three
month periods ended March 31, 2007 and 2006, respectively.
9
8. Pension expense charged to operations for the three month periods ended
March 31, 2007 and 2006 related to defined benefit pension plans included
the following components (in thousands):
2007 2006
------- -------
Interest cost $ 2,956 $ 2,970
Expected return on plan assets (2,667) (2,032)
Actuarial loss 413 634
------- -------
Net pension expense $ 702 $ 1,572
======= =======
The Company did not make any contributions to its defined benefit pension
plans during the first quarter of 2007.
Several subsidiaries provide certain healthcare and other benefits to
certain retired employees under plans which are currently unfunded. The
Company pays the cost of postretirement benefits as they are incurred.
Amounts charged to expense were not material in each of the three month
periods ended March 31, 2007 and 2006.
9. For the three months ended March 31, 2007 and 2006, salaries and incentive
compensation expense included $3,400,000 and $300,000, respectively, for
share-based compensation expense relating to grants made under the
Company's senior executive warrant plan and fixed stock option plan. No
grants were made during the 2007 period.
10. Basic earnings (loss) per share amounts are calculated by dividing net
income (loss) by the sum of the weighted average number of common shares
outstanding. To determine diluted earnings (loss) per share, the weighted
average number of common shares is adjusted for the incremental weighted
average number of shares issuable upon exercise of outstanding options and
warrants, unless the effect is antidilutive. In addition, the calculations
of diluted earnings (loss) per share assume the 3 3/4% Convertible Notes
are converted into common shares and earnings increased for the interest on
such notes, net of the income tax effect, unless the effect is
antidilutive. The number of shares used to calculate basic earnings (loss)
per share amounts was 216,409,000 and 216,112,000 for the three month
periods ended March 31, 2007 and 2006, respectively. The number of shares
used to calculate diluted earnings (loss) per share amounts was 216,779,000
and 231,765,000 for the three month periods ended March 31, 2007 and 2006,
respectively. The denominators for dilutive per share computations reflect
the effect of dilutive options and, for 2006, the 3 3/4% Convertible Notes.
For the three month period ended March 31, 2007, the 3 3/4% Convertible
Notes, which are convertible into 15,239,490 common shares, were not
included in the computation of diluted earnings per share as the effect was
antidilutive.
11. Cash paid for interest and income taxes (net of refunds) was $25,300,000
and $5,700,000, respectively, for the three month period ended March 31,
2007 and $24,900,000 and $300,000, respectively, for the three month period
ended March 31, 2006.
12. Debt due within one year includes $186,500,000 and $181,800,000 as of March
31, 2007 and December 31, 2006, respectively, relating to repurchase
agreements. At March 31, 2007, these fixed rate repurchase agreements have
a weighted average interest rate of approximately 5.3%, mature at various
dates through June 2007 and are secured by non-current investments with a
carrying value of $191,000,000.
13. In March 2007, the Company sold $500,000,000 principal amount of its newly
authorized 7 1/8% Senior Notes due 2017 (the "Notes") in a private
placement transaction. The Company and the initial purchasers of the Notes
entered into a registration rights agreement pursuant to which the Company
agreed to file an exchange offer registration statement with the Securities
and Exchange Commission for the purpose of exchanging the Notes for Senior
Notes with substantially identical terms that may be publicly traded.
14. In March 2007, the Board of Directors increased the number of the Company's
common shares that the Company is authorized to purchase. As a result, the
Company is authorized to purchase up to 12,000,000 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 notice.
10
15. In January 2007, the Company increased its equity interest in Goober
Drilling, LLC ("Goober") to 42% for an additional equity investment of
$25,000,000. In addition, the Company's existing $126,000,000 secured loan
to Goober was amended to increase the interest rate to LIBOR plus 5%, and
the Company agreed to provide Goober with an additional secured credit
facility for up to $45,000,000 at an interest rate of LIBOR plus 10%. As of
March 31, 2007, no loans were outstanding under this additional facility.
The additional funding was required primarily due to increased raw material
and labor costs to construct new drilling rigs and working capital needs
due to delays in rig construction. The Company's investment in Goober is
classified as an investment in an associated company; for the period ended
March 31, 2007, the Company recorded $2,700,000 of pre-tax income from this
investment under the equity method of accounting.
16. At December 31, 2006, the Company owned approximately 69% of Sangart, Inc.
("Sangart"), a biopharmaceutical company principally engaged in developing
an oxygen transport agent for various medical uses. In March 2007, the
Company invested an additional $48,500,000 in Sangart (increasing its
ownership interest to 87%) principally to fund Sangart's ongoing product
development activities. As more fully discussed in the 2006 10-K, Sangart
is a development stage company without any product sales and is currently
conducting clinical trials of its current product candidate, Hemospan(R), a
form of cell-free hemoglobin administered intravenously to treat a variety
of medical conditions. The Company also received warrants for the right
(but not the obligation) to invest up to an additional $48,500,000 on the
same terms, which if fully invested would increase its ownership interest
to 90%. The Company expects that the amount invested in Sangart will be
expensed as Sangart uses the funds to pay operating expenses and conduct
research and development activities.
The effective acquisition of a portion of the non-controlling interests in
Sangart was accounted for under the purchase method. Under the purchase
method, the purchase price is allocated to Sangart's individual assets and
liabilities based on their relative fair values; in Sangart's case, a
portion of the fair value of assets acquired is initially allocated to
research and development. However, since under GAAP the Company is not
permitted to recognize research and development as an asset under the
purchase method, any amounts initially allocated to research and
development are immediately expensed. For the three months ended March 31,
2007, the Company expensed acquired research and development of $4,000,000,
which is included in the caption selling, general and other expenses in the
consolidated statement of operations.
17. In March 2007, STi Prepaid purchased 75% of the assets of Telco Group, Inc.
and its affiliates (collectively, "Telco") for an aggregate purchase price
of $121,800,000 in cash, including expenses. The remaining Telco assets
were contributed to STi Prepaid by the former owners in exchange for a 25%
interest in STi Prepaid. STi Prepaid is a provider of international prepaid
phone cards and other telecommunications services in the U.S.
The acquisition cost was principally allocated to components of working
capital and to deferred tax assets. In connection with the acquisition, the
Company revised its projections of future taxable income and reassessed the
required amount of its deferred tax valuation allowance. As a result of the
reassessment, the Company concluded that it was more likely than not that
it could realize additional deferred tax assets in the future; accordingly,
a reduction to the deferred tax valuation allowance of $107,400,000 was
recognized in the purchase price allocation (in addition to certain
acquired deferred tax assets). The Company will not finalize its allocation
of the purchase price until an independent third-party appraisal of the
fair value of the assets acquired is completed. When finalized, any changes
to the preliminary purchase price allocation could result in changes to
inventory, deferred tax assets, property and equipment, identifiable
intangible assets and/or goodwill.
Revenues from sales of prepaid phone cards are deferred when the cards are
initially sold. Deferred revenues are recognized in the statement of
operations when the cards are used by the consumer and/or administrative
fees are charged in accordance with the cards terms, resulting in a
reduction of STi Prepaid's outstanding obligation to the customer. STi
Prepaid's cost of sales primarily consists of origination, transport and
termination of telecommunications traffic, and connectivity costs paid to
underlying service providers.
11
Unaudited pro forma operating results for the Company, assuming the
acquisition had occurred as of the beginning of each period presented below
are as follows (in thousands, except per share amounts):
For the Three Month
Period Ended March 31,
-----------------------------
2007 2006
----- ------
Revenues $289,900 $406,200
Income before extraordinary items and cumulative
effect of a change in accounting principles $ 12,100 $ 87,900
Net income $ 12,100 $ 87,900
Per Share:
Basic $.06 $.41
Diluted $.06 $.39
The amounts above reflect the historical operating results of Telco for
periods prior to the asset purchase, which include a $3,300,000 charge to
write-down certain inventory in 2007. The unaudited pro forma data is not
indicative of future results of operations or what would have resulted if
the acquisition had actually occurred as of the beginning of the periods
presented.
18. As more fully discussed in the 2006 10-K, the Company is a defendant in
Special Situations Fund III, L.P., et al. v. Leucadia National Corporation,
et al, a consolidated action involving a petition for appraisal and a class
action pending in the Delaware Chancery Court related to the Company's 2005
acquisition of the minority interest in MK Resources Company ("MK
Resources"). In May 2007, the parties reached an agreement in principle to
settle these lawsuits for, among other terms, complete releases and a
dismissal with prejudice in exchange for an aggregate settlement payment by
the Company of approximately $13,800,000. The proposed settlement has been
memorialized in a Memorandum of Understanding but is subject to, among
other things, documentation in a formal settlement agreement and court
approval. During the first quarter of 2007, the Company increased its
accrual to the expected settlement amount and recorded an additional
expense of $7,500,000.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations.
The following should be read in conjunction with the Management's Discussion and
Analysis of Financial Condition and Results of Operations included in the 2006
10-K.
Liquidity and Capital Resources
In addition to cash and cash equivalents, the Company also considers investments
classified as current assets and investments classified as non-current assets on
the face of its consolidated balance sheet as being generally available to meet
its liquidity needs. Securities classified as current and non-current
investments are not as liquid as cash and cash equivalents, but they are
generally easily convertible into cash within a short period of time. As of
March 31, 2007, the sum of these amounts aggregated $3,087,400,000. However,
since $533,800,000 of this amount is pledged as collateral pursuant to various
agreements, represents investments in non-public securities or is held by
subsidiaries that are party to agreements which restrict the Company's ability
to use the funds for other purposes (including the Inmet shares), the Company
does not consider those amounts to be available to meet the Parent's liquidity
needs. The $2,553,600,000 that is available is comprised of cash and short-term
bonds and notes of the U.S. Government and its agencies, U.S.
Government-Sponsored Enterprises and other publicly traded debt and equity
securities, including the Company's investment in Fortescue. The investment
income realized from the Parent's 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.
In January 2007, the Company increased its equity interest in Goober to 42% for
an additional equity investment of $25,000,000. In addition, the Company's
existing $126,000,000 secured loan to Goober was amended to increase the
interest rate to LIBOR plus 5%, and the Company agreed to provide Goober with an
additional secured credit facility for up to $45,000,000 at an interest rate of
LIBOR plus 10%. As of March 31, 2007, no loans were outstanding under this
additional facility.
In January 2007, the Company invested $74,000,000 in Highland Opportunity Fund,
L.P. ("Highland Opportunity"), a limited partnership which principally invests
through a master fund in mortgage-backed and asset-backed securities, and
$25,000,000 in HFH ShortPLUS Fund, L.P. ("Shortplus"), a limited partnership
which principally invests through a master fund in a short-term based portfolio
of asset-backed securities.
In March 2007, the Company invested an additional $48,500,000 in Sangart
(increasing its ownership interest to 87%) principally to fund Sangart's ongoing
product development activities. The Company also received warrants for the right
(but not the obligation) to invest up to an additional $48,500,000 on the same
terms, which if fully invested would increase its ownership interest to 90%.
In March 2007, STi Prepaid purchased 75% of the assets of Telco for an aggregate
purchase price of $121,800,000 in cash, including expenses. STi Prepaid is a
provider of international prepaid phone cards and other telecommunications
services in the U.S. The acquisition cost was principally allocated to
components of working capital and to deferred tax assets, including a reduction
to the Company's deferred tax valuation allowance of $107,400,000.
In March 2007, the Company sold $500,000,000 principal amount of its newly
authorized 7 1/8% Notes due 2017 in a private placement transaction. The Company
and the initial purchasers of the Notes entered into a registration rights
agreement pursuant to which the Company agreed to file an exchange offer
registration statement with the Securities and Exchange Commission for the
purpose of exchanging the Notes for Senior Notes with substantially identical
terms that may be publicly traded.
In March 2007, the Board of Directors increased the number of the Company's
common shares that the Company is authorized to purchase. As a result, the
Company is authorized to purchase up to 12,000,000 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 notice.
13
As discussed above, the Company and Jefferies have entered into an agreement to
expand and restructure the Company's equity investment in JPOF II, one of
several entities managed by Jefferies that invested capital in Jefferies' high
yield trading business. The Company has committed to invest $600,000,000 in a
newly formed entity, JHYH, Jefferies has committed to invest the same amount as
the Company, and passive investors may invest up to $800,000,000 in the
aggregate over time. In April 2007, after regulatory approval for the new
venture was received, the Company contributed $250,000,000 to JHYH along with
its investment in JPOF II. The Company expects that its remaining $250,000,000
commitment will be contributed before the end of the year. The Company will
account for its investment in JHYH under the equity method of accounting.
Consolidated Statements of Cash Flows
Net cash provided by operating activities decreased by $62,400,000 in the three
month period ended March 31, 2007 compared to the same period in 2006
principally due to decreased collections of receivables, decreased distributions
of earnings from associated companies and increased income tax payments. The
change in operating cash flows also reflects increased funds generated from
activity in the trading portfolio, decreased payment of incentive compensation
and decreased defined benefit pension plan contributions. Funds provided by
operating activities reflect funds used by Sangart, a development stage company,
of $5,100,000 and $3,400,000 during 2007 and 2006, respectively. During 2006,
cash provided by operating activities reflects the collection of the balance of
certain receivables from AT&T Inc. ($67,300,000). The AT&T receivables resulted
from a termination agreement entered into between the Company's former
telecommunications subsidiary, WilTel Communications Group, LLC ("WilTel"), and
its largest customer during 2005. In 2007, distributions from associated
companies principally include earnings distributed by JPOF II ($26,200,000). In
2006, distributions from associated companies principally include earnings
distributed by JPOF II ($23,600,000) and EagleRock ($16,600,000). Contributions
to the defined benefit pension plans were $3,500,000 in 2006; no contributions
were made in 2007.
Net cash flows used for investing activities were $113,700,000 in the first
quarter of 2007 and $99,800,000 in the first quarter of 2006. During 2007,
acquisitions, net of cash acquired principally include assets acquired by STi
Prepaid ($84,600,000). During 2006, funds provided by the disposal of real
estate and other assets include the sales of 8 acres of unimproved land in
Washington, D.C. by 711 Developer, LLC ("Square 711"), a 90% owned subsidiary of
the Company, ($75,700,000) and the sale of two associated companies. The Company
received aggregate cash proceeds of $56,400,000 from the sale of the Company's
equity interest in, and loan repayment by, two associated companies. Investments
in associated companies include Goober ($25,000,000), Highland Opportunity
($74,000,000), Shortplus ($25,000,000), Cobre Las Cruces, S.A. ("CLC")
($4,000,000) and others ($28,400,000) in 2007 and Safe Harbor Domestic Partners
L.P. ($50,000,000) in 2006.
Net cash provided by financing activities was $500,600,000 in 2007 and
$43,900,000 in 2006. Issuance of long-term debt for the 2007 period reflects the
issuance of $500,000,000 principal amount of the Company's 7 1/8% Notes and for
the 2007 and 2006 periods reflects the increase in repurchase agreements of
$4,700,000 and $74,800,000, respectively. The reduction of long-term debt during
the three month period ended March 31, 2006 includes the repayment of debt of
Square 711 ($32,000,000), which was sold. Issuance of common shares for the
three month periods ended March 31, 2007 and 2006 principally reflects the
exercise of employee stock options.
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.
14
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 in the
future the Company were to determine that it would be able to realize its
deferred tax asset in excess of its net recorded amount, an adjustment would
increase income in such period or, if such determination were made in connection
with an acquisition, an adjustment would be made in connection with the
allocation of the purchase price to acquired assets and liabilities. If in the
future the Company were to determine that it would not be able to realize all or
part of its deferred tax asset, 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.
The Company's conclusion that a portion of the deferred tax asset is more likely
than not to be realized is strongly influenced by its historical ability to
generate significant amounts of taxable income and its projections of future
taxable income. The Company's estimate of future taxable income considers all
available evidence, both positive and negative, about its current operations and
investments, includes an aggregation of individual projections for each material
operation and investment, and includes all future years that the Company
estimated it would have available net operating losses. 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
March 31, 2007, the balance of the deferred valuation allowance was
approximately $804,400,000.
Impairment of Long-Lived Assets - In accordance with Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets", 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. The Company did not recognize any
impairment losses on long-lived assets during the three month periods ended
March 31, 2007 and 2006.
Impairment of Securities - Investments with an impairment in value considered to
be other than temporary are written down to estimated fair value. The
write-downs 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 $100,000 and $900,000 for the three month periods ended March 31,
2007 and 2006, respectively.
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.
15
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.
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 March 31, 2007, the Company's accrual for contingent
losses was not material.
16
Results of Operations
Three Months Ended March 31, 2007 Compared to the Three Months Ended
March 31, 2006
Manufacturing - Idaho Timber
Revenues and other income for Idaho Timber for the three months ended March 31,
2007 and 2006 were $72,500,000 and $92,500,000, respectively; gross profit was
$9,000,000 and $11,800,000, respectively; salaries and incentive compensation
expenses were $2,300,000 and $2,600,000, respectively; depreciation and
amortization expenses were $1,200,000 in each period; and pre-tax income was
$4,200,000 and $7,200,000, respectively.
Idaho Timber's revenues declined during the first quarter of 2007 as compared to
the comparable period in the prior year, reflecting both reduced shipment
volumes and lower average selling prices. While shipment volume increased in
2007 as compared to the fourth quarter of 2006, average selling prices continued
to decline. Idaho Timber continues to experience weakening demand resulting from
reductions in housing starts and the abundant supply of lumber in the
marketplace.
Raw material costs, the largest component of cost of sales (approximately 81%),
have declined during 2007 principally due to the same market conditions that
have negatively impacted revenues. 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.
Spreads improved for the first quarter of 2007 as compared to the fourth quarter
of 2006, but were lower than those for the first quarter of 2006. With the
continued oversupply in the market, Idaho Timber intends to continue to focus on
developing new higher margin products, diversifying its supply chain, improving
cost control and solidifying customer and supplier relationships, in an effort
to maximize gross margins and pre-tax results.
Manufacturing - Conwed Plastics
Pre-tax income for Conwed Plastics was $3,400,000 and $5,200,000 for the three
months ended March 31, 2007 and 2006, respectively. Its manufacturing revenues
were $24,200,000 and $27,200,000 and gross profits were $6,800,000 and
$9,000,000 for the three months ended March 31, 2007 and 2006, respectively. The
slowdown in housing starts and a slow start in road construction due to weather
conditions were principally responsible for the declines in revenue in most of
Conwed Plastics' markets, particularly carpet cushion, building and
construction, erosion control and turf reinforcement. In addition, revenues
declined due to the removal of netting as a component of a customer's bedding
product. Conwed Plastics did realize increased revenues from its packaging
market, principally due to the acquisition of Polynet Inc. in May 2006.
The decline in gross margin in the first quarter of 2007 as compared to the same
period in 2006 primarily reflects the lower sales volume and product mix. In
addition, gross margin and pre-tax results for 2007 reflects $400,000 of greater
amortization expense on intangible assets resulting from acquisitions and
depreciation expense than for 2006.
Telecommunications
The telecommunications business of STi Prepaid has been consolidated by the
Company since March 2007. For the period from the asset acquisition through
March 31, 2007, STi Prepaid's telecommunications revenues and other income were
$32,800,000, telecommunications cost of sales were $27,600,000, salaries and
incentive compensation expenses were $400,000, selling, general and other
expenses were $1,800,000 and STi Prepaid had pre-tax income of $2,900,000.
17
Domestic Real Estate
Pre-tax income (loss) for the domestic real estate segment was $(1,500,000) and
$47,800,000 for the three months ended March 31, 2007 and 2006, respectively.
Pre-tax income for 2006 principally reflects the sale by Square 711, which
resulted in a pre-tax gain of $48,900,000.
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, pre-tax income for
this segment for any particular period is not predictable and does not follow
any consistent pattern or trend.
Medical Product Development
Pre-tax losses (net of minority interest) for Sangart for the three month
periods ended March 31, 2007 and 2006 were $8,400,000 and $5,700,000,
respectively. Sangart's losses for 2007 and 2006 reflect research and
development costs of $5,900,000 and $4,600,000, respectively, and salaries and
incentive compensation expenses of $2,000,000 and $1,300,000, respectively. When
the Company increased its investment in Sangart in March 2007, the additional
investment was accounted for under the purchase method of accounting. Under the
purchase method, the price paid was allocated to Sangart's individual assets and
liabilities based on their relative fair values; in Sangart's case, a portion of
the fair value of assets acquired was initially allocated to research and
development. However, since under GAAP the Company is not permitted to recognize
research and development as an asset under the purchase method, any amounts
initially allocated to research and development are immediately expensed. For
the three month periods ended March 31, 2007 and 2006, the Company expensed
acquired research and development of $4,000,000 and $3,400,000, respectively,
which is included in the caption selling, general and other expenses in the
consolidated statement of operations. The increase in salaries and incentive
compensation in 2007 as compared to 2006 was due to increased headcount in
connection with the commencement of the Phase III trials.
As more fully discussed in the 2006 10-K, Sangart is a development stage company
that does not have any revenues from product sales. Since inception, it has been
developing its current product candidate, Hemospan, and is currently conducting
clinical trials in the U.S. (a Phase II trial) and Europe (two Phase III
trials). It does not expect to complete its clinical trials until 2008, and if
they are successful it will then seek approval with the appropriate regulatory
authorities to market its product. Until such time, if ever, that Sangart
obtains regulatory approval for Hemospan, the Company will report losses from
this segment. U.S. or foreign regulatory agencies could also require Sangart to
perform more clinical trials, which could be both expensive and time consuming.
The Company is unable to predict with certainty when, if ever, it will report
operating profits for this segment.
Corporate and Other Operations
Investment and other income decreased in the three month period ended March 31,
2007 as compared to the three month period ended March 31, 2006. Investment and
other income for the 2006 period reflects $34,700,000 related to the sales of
two associated companies; investment and other income for the 2007 period
reflects the receipt of escrowed proceeds from one of those sales of $10,200,000
that had not been previously recognized. Investment and other income also
reflects (charges) income of $(100,000) and $1,000,000 for the 2007 and 2006
periods, respectively, related to the accounting for mark-to-market values of
Corporate derivatives.
Net securities gains for Corporate and Other Operations aggregated $15,900,000
and $38,700,000 for the three month periods ended March 31, 2007 and 2006,
respectively. Net securities gains for the 2007 and 2006 periods include
provisions of $100,000 and $900,000, respectively, to write down the Company's
investments in certain available for sale securities. The write down of the
securities resulted from a decline in market value determined to be other than
temporary.
The increase in interest expense during the three months ended March 31, 2007 as
compared to the same period in 2006 primarily reflects interest expense relating
to the 7 1/8% Notes issued in March 2007 and the fixed rate repurchase
agreements. The 2006 period also includes interest on the Company's 7 7/8%
subordinated notes, which subsequently matured in 2006.
18
Salaries and incentive compensation expense increased by $3,400,000 in the three
month period ended March 31, 2007 as compared to the same period in 2006
principally due to greater share-based compensation expense. Salaries and
incentive compensation expense included $3,400,000 and $300,000 for the three
month periods ended March 31, 2007 and 2006, respectively, relating to grants
made under the Company's senior executive warrant plan and fixed stock option
plan. The increase in share-based compensation expense in 2007 largely related
to grants made under the warrant plan in 2006 and the accelerated vesting of
stock options of an officer of the Company who resigned. Salaries and incentive
compensation expense for 2007 also reflected a decrease in estimated incentive
bonus expense as compared to the same period in 2006.
The increase in selling, general and other expenses of $12,100,000 in the three
month period ended March 31, 2007 as compared to the same period in 2006
primarily reflects a $7,500,000 accrual for the settlement of litigation related
to MK Resources, increased legal fees, including those incurred in connection
with the MK Resources litigation, and higher professional fees and other costs,
which largely relate to potential investments and projects and existing
investments.
For the three month periods ended March 31, 2007 and 2006, the Company's
effective income tax rate is higher than the federal statutory rate primarily
due to state income taxes.
Associated Companies
Equity in income (losses) of associated companies for the three month periods
ended March 31, 2007 and 2006 includes the following (in thousands):
2007 2006
-------- ----------
EagleRock $ 6,400 $ 9,500
Premier (6,900) --
JPOF II 2,900 5,600
HomeFed Corporation 200 700
Safe Harbor 4,400 1,200
Wintergreen 2,900 1,600
Shortplus 5,300 --
Goober 2,700 --
CLC (100) 1,500
Other 4,600 2,300
--------- ---------
Equity in income before income taxes 22,400 22,400
Income tax expense 9,500 8,700
--------- ---------
Equity in income, net of taxes $ 12,900 $ 13,700
========= =========
Discontinued Operations
Healthcare Services
As more fully discussed in the 2006 10-K, in July 2006 the Company sold Symphony
Healthcare Services, LLC and classified its historical operating results as a
discontinued operation. Pre-tax loss of the healthcare services segment was
$1,500,000 for the three month period ended March 31, 2006.
Telecommunications - ATX
As more fully discussed in the 2006 10-K, in September 2006 the Company sold ATX
Communications, Inc. and classified its historical operating results as a
discontinued operation. ATX reported a pre-tax loss of $100,000 for the three
month period ended March 31, 2006.
WilTel
Gain (loss) on disposal of discontinued operations for the 2007 period reflects
the resolution of a sale-related contingency related to WilTel, which was sold
in the fourth quarter of 2005, and for the 2006 period principally reflects
working capital adjustments and the resolution of certain sale-related
obligations related to WilTel.
19
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 the
following: potential acquisitions and dispositions of our operations and
investments could change our risk profile; dependence on certain key personnel;
economic downturns; changes in the U.S. housing market; changes in
telecommunications laws and regulations; risks associated with the increased
volatility in raw material prices and the availability of key raw materials;
compliance with government laws and regulations; changes in mortgage interest
rate levels or changes in consumer lending practices; a decrease in consumer
spending or general increases in the cost of living; proper functioning of our
information systems; intense competition in the operation of our businesses; our
ability to generate sufficient taxable income to fully realize our deferred tax
asset; weather related conditions and significant natural disasters, including
hurricanes, tornadoes, windstorms, earthquakes and hailstorms; our ability to
insure certain risks economically; reduction or cessation of dividend payments
on our common shares. For additional information see Part I, Item 1.A. Risk
Factors in the 2006 10-K and Part II, Item 1A. Risk Factors contained herein.
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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Information required under this Item is contained in Item 7A of the Company's
Annual Report on Form 10-K for the year ended December 31, 2006, and is
incorporated by reference herein.
Item 4. Controls and Procedures.
Evaluation of disclosure controls and procedures
(a) The Company's management evaluated, with the participation of the Company's
principal executive and principal financial officers, the effectiveness of
the Company's disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act")), as of March 31, 2007. Based on their
evaluation, the Company's principal executive and principal financial
officers concluded that the Company's disclosure controls and procedures
were effective as of March 31, 2007.
Changes in internal control over financial reporting
(b) There has been no change in the Company's internal control over financial
reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange
Act) that occurred during the Company's fiscal quarter ended March 31,
2007, that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
20
Part II - OTHER INFORMATION
Item 1. Legal Proceedings.
The Company and a subsidiary are defendants in Special Situations Fund III,
L.P., et al. v. Leucadia National Corporation, et al., a consolidated action
involving a petition for appraisal and a class action pending in the Delaware
Chancery Court related to our 2005 acquisition of the minority interest in MK
Resources. The appraisal proceeding seeks a judicial determination of the fair
value of 3,979,400 shares of MK Resources' common stock as of August 19, 2005,
the date of the merger of one of our subsidiaries into MK Resources (the "MK
Merger"). The class action alleges breach of fiduciary duty by the former MK
Resources directors and the Company and seeks compensatory damages in an
unspecified amount, costs, disbursements and any further relief that the court
may deem just and proper and, in the alternative, seeks rescissory damages, in
each case taking into account the $1.27 per share in Company stock paid in the
MK Merger to the minority stockholders of MK Resources who did not seek
appraisal. Based on discovery to date, we understand that the plaintiffs believe
that the fair value of each share of MK Resources common stock at the date of
the MK Merger ranged from $4.75 to $10.16 per share (with respect to all
10,520,000 minority shares), while we believe that the fair value of each MK
Resources share at such date was $0.57 per share.
The trial of these two cases currently is scheduled for July 16-20, 2007. While
there can be no assurance that the Company will prevail if the cases go to
trial, the Company believes that the material allegations of the complaints are
without merit. While the Company does not believe it is probable that a loss
will be incurred, if the Company were unsuccessful in this matter, an adverse
determination could be material.
The parties now have reached an agreement in principle to settle these lawsuits
for, among other terms, complete releases and a dismissal with prejudice in
exchange for an aggregate settlement payment by the Company of approximately
$13,800,000 (including a payment in the appraisal proceeding of approximately
$5,000,000 that the appraisal petitioners would have received (based on the
value at the merger date of Company shares issued in the merger) had they
participated in the MK Merger). The proposed settlement has been memorialized in
a Memorandum of Understanding but is subject to, among other things,
documentation in a formal settlement agreement and court approval.
Item 1A. Risk Factors.
The Company is adding to its risk factors the items listed below that are
specific to the STi Prepaid investment.
STi Prepaid may not be able to obtain sufficient or cost-effective termination
capacity to particular destinations. Substantially all of STi Prepaid's
telecommunications traffic is terminated through third-party providers. We may
not be able to obtain sufficient termination capacity from high-quality carriers
to particular destinations or may have to pay significant amounts to obtain such
capacity. This could result in our not being able to fulfill customer demands or
in our incurring higher costs, which could adversely affect our revenues and
margins.
Pricing on STi Prepaid's prepaid phone card products are highly elastic and
subject to intense competition. STi Prepaid faces significant competition from
both larger and smaller calling card providers who, from time to time, offer
international prepaid phone card rates substantially below our rates. We believe
in some instances our competitors offer or appear to offer rates to consumers
that are below their cost in order to gain market share. This type of pricing by
one or more of our competitors can adversely affect our revenues and profits.
21
STi Prepaid relies on independent distributors to generate revenues. STi
Prepaid's marketing and distribution efforts are principally conducted by
independent distributors. Many of these distributors also sell the products and
services of our competitors, and we can not be assured that our distributors
will devote sufficient efforts to promote and sell our products. Additionally,
we may not succeed in finding capable distributors in new markets that we may
enter. STi Prepaid's ability to maintain and grow its revenues is greatly
dependent on the performance of independent distributors.
Federal, state and local government regulations may reduce STi Prepaid's ability
to provide services or reduce its profitability. STi Prepaid is subject to
varying degrees of regulation by federal, state and local regulators, and is
subject to various taxes, fees, charges and audits which can result in the
imposition of unforeseen assessments. The implementation, modification,
interpretation and enforcement of these laws and regulations can limit our
ability to provide our services or make it more costly to do so.
Item 2. Issuer Purchases of Equity Securities.
The Company's purchases of its common shares during the first quarter
of 2007 were as follows:
Total Number
of Shares Approximate
Purchased as Dollar Value of
Part of Publicly Shares that May
Total Number Average Announced Yet be Purchased
of Shares Price Paid Plans or under the Plans
Purchased (1) Per Share Programs or Programs
------------- --------- --------------- ----------------
March 1 to March 31 3,500 $29.19 -- $ --
--------- ------ ----------
Total 3,500 --
========= ==========
(1) Consists of common shares received from employees to exercise stock
options. Shares were valued at the market price at the date of the option
exercise.
Item 6. Exhibits.
10.1 Asset Purchase and Contribution Agreement, dated as of January 23,
2007, by and among Baldwin Enterprises, Inc., STi Prepaid, LLC,
Samer Tawfik, Telco Group, Inc., STi Phonecard Inc., Dialaround
Enterprises Inc., STi Mobile Inc., Phonecard Enterprises Inc.,
VOIP Enterprises Inc., STi PCS, LLC, Tawfik & Partners, SNC, STi
Prepaid & Co., STi Prepaid Distributors & Co. and ST Finance, LLC.
10.2 Registration Rights Agreement, dated as of March 8, 2007, among
STi Prepaid, LLC and ST Finance, LLC.
10.3 Amended and Restated Limited Liability Company Agreement, dated as
of March 8, 2007, by and among STi Prepaid, LLC, BEI Prepaid, LLC
and ST Finance, LLC.
10.4 Master Agreement for the Formation of a Limited Liability Company,
dated as of February 28, 2007, among Jefferies Group, Inc.,
Jefferies & Company, Inc. and Leucadia National Corporation.
10.5 Amended and Restated Limited Liability Company Agreement of
Jefferies High Yield Holdings, LLC, dated as of April 2, 2007, by
and among Jefferies Group, Inc., Jefferies & Company, Inc.,
Leucadia National Corporation, Jefferies High Yield Partners, LLC,
Jefferies Employees Opportunity Fund LLC and Jefferies High Yield
Holdings, LLC.
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.
22
31.3 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chairman of the Board and Chief Executive Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of President pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.3 Certification of Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LEUCADIA NATIONAL CORPORATION
(Registrant)
Date: May 9, 2007 By: /s/ Barbara L. Lowenthal
--------------------------
Barbara L. Lowenthal
Vice President and Comptroller
(Chief Accounting Officer)
24
Exhibit Index
10.1 Asset Purchase and Contribution Agreement, dated as of January 23,
2007, by and among Baldwin Enterprises, Inc., STi Prepaid, LLC,
Samer Tawfik, Telco Group, Inc., STi Phonecard Inc., Dialaround
Enterprises Inc., STi Mobile Inc., Phonecard Enterprises Inc.,
VOIP Enterprises Inc., STi PCS, LLC, Tawfik & Partners, SNC, STi
Prepaid & Co., STi Prepaid Distributors & Co. and ST Finance, LLC.
10.2 Registration Rights Agreement, dated as of March 8, 2007, among
STi Prepaid, LLC and ST Finance, LLC.
10.3 Amended and Restated Limited Liability Company Agreement, dated as
of March 8, 2007, by and among STi Prepaid, LLC, BEI Prepaid, LLC
and ST Finance, LLC.
10.4 Master Agreement for the Formation of a Limited Liability Company,
dated as of February 28, 2007, among Jefferies Group, Inc.,
Jefferies & Company, Inc. and Leucadia National Corporation.
10.5 Amended and Restated Limited Liability Company Agreement of
Jefferies High Yield Holdings, LLC, dated as of April 2, 2007, by
and among Jefferies Group, Inc., Jefferies & Company, Inc.,
Leucadia National Corporation, Jefferies High Yield Partners, LLC,
Jefferies Employees Opportunity Fund LLC and Jefferies High Yield
Holdings, LLC.
31.1 Certification of Chairman of the Board and Chief Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of President pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.3 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chairman of the Board and Chief Executive Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of President pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.3 Certification of Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
25