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, 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
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(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
315 Park Avenue South
New York, New York 10010
(212) 460-1900
(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
-------------------------------------- ------------------------
Common Shares, par value $1 per share New York Stock Exchange
7-3/4% Senior Notes due August 15, 2013 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, a non-accelerated filer, or a smaller reporting company. See
definitions of "large accelerated filer," "accelerated filer," and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [x] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [ ]
(Do not check if a smaller reporting company)
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, 2007 (computed by reference to the
last reported closing sale price of the Common Shares on the New York Stock
Exchange on such date): $5,753,522,000.
On February 14, 2008, the registrant had outstanding 222,575,940 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
2008 annual meeting of shareholders of the registrant are incorporated by
reference into Part III of this Report.
1
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, telecommunications, property management and
services, gaming entertainment, real estate activities, medical product
development and winery operations. The Company also owns equity interests in
operating businesses and investment partnerships which are accounted for under
the equity method of accounting, including a broker-dealer engaged in making
markets and trading of high yield and special situation securities, land based
contract oil and gas drilling, real estate activities and development of a
copper mine in Spain. 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 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
$5,570,500,000 at December 31, 2007, equal to a book value per common share of
the Company (a "common share") of negative $.04 at December 31, 1978 and $25.03
at December 31, 2007. Shareholders' equity and book value per share amounts have
been reduced by the $811,900,000 special cash dividend paid in 1999.
In March 2007, the Company's 75% owned subsidiary, STi Prepaid, LLC ("STi
Prepaid"), acquired the assets of Telco Group, Inc. and its affiliates ("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.
In June 2007, the Company completed the acquisition of ResortQuest
International, Inc. ("ResortQuest") for a purchase price of $11,900,000,
including expenses and working capital adjustments. ResortQuest is engaged in
offering property management and other services to vacation properties in beach
and mountain resort locations in the continental U.S.
The Company's manufacturing operations are conducted through Idaho
Timber, LLC ("Idaho Timber") and Conwed Plastics, LLC ("Conwed Plastics").
Acquired in May 2005, Idaho Timber is headquartered in Boise, Idaho and
primarily remanufactures dimension lumber and remanufactures, packages and/or
produces other specialized wood products. Conwed Plastics manufactures and
markets lightweight plastic netting used for a variety of purposes including,
among other things, building and construction, erosion control, packaging,
agricultural, carpet padding, filtration and consumer products.
The Company's gaming entertainment operations are conducted through its
controlling interest in Premier Entertainment Biloxi, LLC ("Premier"), which is
the owner of the Hard Rock Hotel & Casino Biloxi ("Hard Rock Biloxi"), located
in Biloxi, Mississippi. The Hard Rock Biloxi was severely damaged by Hurricane
Katrina on August 29, 2005 just prior to its originally scheduled opening; upon
completion of reconstruction the Hard Rock Biloxi opened for business on June
30, 2007.
The Company's domestic real estate operations include a mixture of
commercial properties, residential land development projects and other
unimproved land, all in various stages of development and all available for
sale.
The Company's medical product development operation is conducted through
Sangart, Inc. ("Sangart"), which became a majority-owned subsidiary of the
Company in 2005. Sangart is developing a product called Hemospan(R), which is a
form of cell-free hemoglobin that is designed for intravenous administration to
treat a wide variety of medical conditions, including use as an alternative to
red blood cell transfusions.
2
The Company's winery operations consist of Pine Ridge Winery in Napa
Valley, California and Archery Summit in the Willamette Valley of Oregon, and a
vineyard development project in the Columbia Valley of Washington. The wineries
primarily produce and sell wines in the ultra premium and luxury segments of the
premium table wine market.
In April 2007, the Company and Jefferies & Company, Inc. ("Jefferies"),
expanded and restructured the Company's equity investment in Jefferies Partners
Opportunity Fund II, LLC ("JPOF II") and formed Jefferies High Yield Holdings,
LLC ("JHYH"). Through its wholly-owned subsidiary, JHYH makes markets in high
yield and special situation securities and provides research coverage on these
types of securities.
The Company's land based contract oil and gas drilling investment is
conducted by Goober Drilling, LLC ("Goober Drilling"), in which the Company has
a 50% voting and equity interest at December 31, 2007. The Company has also made
secured loans to Goober Drilling aggregating $171,000,000, at various interest
rates, to finance new equipment purchases and construction costs, repay existing
debt and finance working capital needs.
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 11.6% of Inmet's current
outstanding common shares. CLC expects to begin commercial production at the
mine in the fourth quarter of 2008.
In August 2006, pursuant to a subscription agreement with Fortescue
Metals Group Ltd ("Fortescue") and its subsidiary, FMG Chichester Pty Ltd
("FMG"), the Company invested in Fortescue's Pilbara iron ore and infrastructure
project in Western Australia. In July 2007, Fortescue sold new common shares and
the Company exercised its pre-emptive rights to maintain its ownership position.
Fortescue is a publicly traded company on the Australian Stock Exchange (Symbol:
FMG). The Company also owns a $100,000,000 note of FMG that matures in August
2019; interest on the note is calculated as 4% of the revenue, net of government
royalties, invoiced from the iron ore produced from two specified project areas.
Fortescue expects to begin shipping ore in May 2008. The Company's total cash
investment in Fortescue aggregates $452,200,000; the market value of the
Fortescue common shares owned by the Company was $1,824,700,000 at December 31,
2007.
The Company and certain of its subsidiaries have substantial net
operating loss carryforwards ("NOLs") of approximately $5,400,000,000 at
December 31, 2007. For more information, see Note 16 of Notes to the
Consolidated Financial Statements.
As used herein, the term "Company" refers to Leucadia National
Corporation, a New York corporation organized in 1968, and its subsidiaries,
except as the context otherwise may require.
Investor Information
The Company is subject to the informational requirements of the
Securities Exchange Act of 1934 (the "Exchange Act"). Accordingly, the Company
files periodic reports, proxy statements and other information with the
Securities and Exchange Commission (the "SEC"). Such reports, proxy statements
and other information may be obtained by visiting the Public Reference Room of
the SEC at 100 F Street, N.E., 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 15, 2007,
certifying that he is not aware of any violations by the Company of NYSE
corporate governance listing standards.
3
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 the operating units
identified above, which offer different products and services and are managed
separately. At acquisition, the Company's investment in Premier was reported as
a consolidated subsidiary in the other operations segment; however, it was
deconsolidated and classified as an investment in an associated company upon the
filing of voluntary petitions for reorganization under chapter 11 of title 11 of
the United States Bankruptcy Code in September 2006. While in bankruptcy Premier
was classified as an investment in an associated company and its operating
results were not reported in the gaming entertainment segment. Upon its
emergence from bankruptcy in August 2007, Premier was once again consolidated by
the Company and has been reported as an operating segment since that date. Other
operations primarily consist of the Company's wineries and energy projects.
Associated companies include equity interests in other entities that the
Company accounts for on the equity method of accounting. Investments in
associated companies include HomeFed Corporation ("HomeFed"), a corporation
engaged in real estate activities, JHYH, Goober Drilling and CLC. The Company
also has made non-controlling investments in entities that are engaged in
investing and/or securities transactions activities which are accounted for as
investments in associated companies including Pershing Square IV, L.P.
("Pershing Square"), Highland Opportunity Fund, L.P. ("Highland Opportunity"),
HFH ShortPLUS Fund, L.P. ("Shortplus"), RCG Ambrose, L.P., ("Ambrose"),
EagleRock Capital Partners (QP), LP ("EagleRock") and Wintergreen Partners Fund,
L.P. ("Wintergreen").
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 include the Company's investments
in Fortescue and Inmet. Corporate assets, revenues, overhead expenses and
interest expense are not allocated to the operating units.
Conwed Plastics has manufacturing facilities located in Belgium and
Mexico, STi Prepaid has a customer care unit located in the Dominican Republic
and other operations includes a small Caribbean-based telecommunications
provider. These are the only foreign operations with non-U.S. revenue or assets
that the Company consolidates, and are not material. Unconsolidated non-U.S.
based investments include 38% of Light and Power Holdings Ltd., the parent
company of the principal electric utility in Barbados, the 30% ownership of CLC
and the investments in Fortescue and Inmet. 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 is presented in
the following table. Consolidated subsidiaries are reflected as of the date of
acquisition, which was June 2007 for ResortQuest, March 2007 for STi Prepaid,
November 2005 for Sangart and May 2005 for Idaho Timber. As discussed above,
Premier is reflected as a consolidated subsidiary from May 2006 until it was
deconsolidated in September 2006; Premier once again became a consolidated
subsidiary in August 2007. Associated Companies are only reflected in the table
below under identifiable assets employed.
4
2007 2006 2005
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(In millions)
Revenues and other income (a):
Manufacturing:
Idaho Timber $ 292.2 $ 345.7 $ 239.0
Conwed Plastics 105.4 106.4 93.6
Telecommunications 363.2 -- --
Property Management and Services 81.5 -- --
Gaming Entertainment 38.5 -- --
Domestic Real Estate 13.4 86.7 29.9
Medical Product Development 2.1 .7 .1
Other Operations (b) 53.6 42.8 59.0
Corporate (c) 205.0 280.4 268.3
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Total consolidated revenues and other income $ 1,154.9 $ 862.7 $ 689.9
========= ========= =========
Income (loss) from continuing operations before income taxes and equity in in
income (losses) of associated companies:
Manufacturing:
Idaho Timber $ 9.1 $ 12.0 $ 8.2
Conwed Plastics 17.4 17.9 14.2
Telecommunications 18.4 -- --
Property Management and Services (6.5) -- --
Gaming Entertainment (9.3) -- --
Domestic Real Estate (8.2) 44.0 4.1
Medical Product Development (31.5) (21.1) (1.4)
Other Operations (b) (17.2) (14.4) 7.5
Corporate (c) (29.3) 95.4 101.8
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Total consolidated income (loss) from continuing operations before
income taxes and equity in income (losses) of associated
companies $ (57.1) $ 133.8 $ 134.4
========= ========= =========
Identifiable assets employed:
Manufacturing:
Idaho Timber $ 129.5 $ 132.3 $ 162.7
Conwed Plastics 88.8 83.6 81.9
Telecommunications 81.9 -- --
Property Management and Services 62.8 -- --
Gaming Entertainment 300.6 -- --
Domestic Real Estate 306.3 198.1 182.7
Medical Product Development 36.5 12.2 7.0
Other Operations 255.5 257.8 245.0
Investments in Associated Companies 1,362.9 773.0 375.5
Corporate 5,501.8 3,846.8 4,062.0
Assets of discontinued operations -- -- 144.1
--------- --------- ---------
Total consolidated assets $ 8,126.6 $ 5,303.8 $ 5,260.9
========= ========= =========
(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) Other operations includes pre-tax losses of $13,900,000, $8,300,000 and
$1,600,000 for the years ended December 31, 2007, 2006 and 2005,
respectively, for investigation and evaluation of various energy related
projects. There were no material operating revenues or identifiable assets
associated with these activities in any period; however, other income
includes $8,500,000 in 2007 related to the termination of a joint
development agreement with another party.
5
(c) Net securities gains for Corporate aggregated $92,700,000, $116,600,000 and
$199,500,000 during 2007, 2006 and 2005, respectively, which primarily
resulted from the sale of publicly traded debt and equity securities that
had been classified as available for sale securities. In 2007, security
gains include a gain of $37,800,000 from the sale of Eastman Chemical
Company ("Eastman"). In 2006, security gains include a gain of $37,400,000
from the sale of 115,000,000 common shares of Level 3 Communications, Inc.
("Level 3"), which were received in December 2005 in connection with Level
3's purchase of WilTel Communications Group, LLC ("WilTel"). In 2005,
security gains include a gain of $146,000,000 from the sale of White
Mountains Insurance Group, Ltd. ("WMIG"). For 2007, 2006 and 2005, security
gains include provisions of $36,800,000, $12,900,000 and $12,200,000,
respectively, to write down investments in certain available for sale
securities and, in 2007, an investment in a non-public security.
(d) For the years ended December 31, 2007, 2006 and 2005, income (loss) from
continuing operations reflects depreciation and amortization expenses of
$54,200,000, $39,500,000 and $32,600,000, respectively; such amounts are
primarily comprised of Corporate ($12,700,000, $11,600,000 and $10,700,000,
respectively), manufacturing ($18,000,000, $17,500,000 and $14,200,000,
respectively), gaming entertainment ($6,300,000 and $900,000 in 2007 and
2006, respectively), domestic real estate ($3,800,000, $3,300,000 and
$2,000,000, respectively), property and management services ($3,100,000 in
2007) and other operations ($9,000,000, $5,600,000 and $5,700,000,
respectively). Depreciation and amortization expenses for other segments
are not material.
(e) For the years ended December 31, 2007, 2006 and 2005, income (loss) from
continuing operations reflects interest expense of $111,500,000,
$79,400,000 and $65,500,000, respectively; such amounts are primarily
comprised of Corporate ($110,800,000, $70,900,000 and $63,200,000,
respectively), gaming entertainment ($500,000 and $8,000,000 in 2007 and
2006, respectively) and other operations ($1,200,000 in 2005). Interest
expense for other segments is not material.
At December 31, 2007, the Company and its consolidated subsidiaries had 4,057
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 dimension lumber;
remanufacturing, bundling and bar coding of home center boards for large
retailers; and production of 5/4" radius-edge, pine decking. Idaho Timber also
manufactures and/or distributes a number of other specialty wood products. Idaho
Timber has over 25 years of operating experience in its industry. The Company's
investment in Idaho Timber was $123,700,000 at December 31, 2007.
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. Production
takes place in owned plants in Idaho and Montana. Idaho Timber also operates a
sawmill in Arkansas to produce its 5/4" radius-edge, pine decking products.
Idaho Timber performs traditional sawmill processes (cutting, drying and
planing) to manufacture these products.
Idaho Timber's profitability is dependent upon its ability to manage
manufacturing costs and process efficiency, minimize capital expenditures
through the purchase and cost-effective maintenance of used, lower-cost
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 spreads; however, during
periods of declining product demand and reduced selling prices, supply price
declines may lag behind resulting in lower spreads.
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 941,000 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 2007
actual shipments averaged approximately 57 million board feet per month.
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. 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 92% of that product line. The
combined revenue of these two customers in this product line was 19% of Idaho
Timber's total revenue for the year ended December 31, 2007. The customer base
for the dimension lumber business is much less concentrated; no customer
accounts for more than 9% of revenue. Idaho Timber's sales are somewhat
concentrated in regions where its facilities are located, with the largest being
Florida, 21%; North Carolina, 17%; and Texas, 10%.
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 active 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. In October 2006, the trade dispute was resolved and a new Softwood
Lumber Agreement between Canada and the U.S. became effective. The agreement has
a seven year term and may be extended for an additional two years. Currently,
restrictions on Canadian imports are not significantly adversely affecting Idaho
Timber's operations; however, if tariffs continue or further import limitations
are imposed in the future, it is possible that raw material costs could increase
or supplies could be constrained. During 2007, the export tax was at the maximum
level for the entire year. Idaho Timber is examining alternative sources of
supply to increase its raw material purchasing flexibility.
7
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, Idaho Timber could be exposed to
product liability claims if it can be demonstrated its products are
inappropriately rated.
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.
Plastics Manufacturing
Business Description
Through Conwed Plastics, which was acquired in March 1985, the Company
manufactures and markets lightweight plastic netting used for a variety of
purposes including, among other things, building and construction, erosion
control, packaging, agricultural, carpet padding, filtration and consumer
products. These products are primarily used for containment purposes,
reinforcement of other products, packaging for produce and meats, various types
of filtration and erosion prevention. Conwed Plastics believes it is a market
leader in netting products used in carpet cushion, turf reinforcement, erosion
control and packaging. Agricultural, erosion control and building and
construction markets tend to be seasonal, with peak periods in the second and
third quarters of the calendar year. Packaging is seasonal with the second
quarter being the slowest period in this market. Carpet padding, filtration and
consumer product markets are not usually subject to seasonal fluctuations
resulting in sales that tend to be evenly spread throughout the year. The
Company's investment in Conwed Plastics was $73,200,000 at December 31, 2007.
Certain products of Conwed Plastics 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 its operations.
Sales and Marketing
Conwed Plastics' manufacturing revenues and other income were
$105,400,000, $106,400,000 and $93,600,000 for the years ended December 31,
2007, 2006 and 2005, respectively. Products are marketed both domestically and
internationally with approximately 20.4% of 2007 revenues generated by customers
from Europe, Latin America, Japan and Australia. Products are sold primarily
through an employee sales force, located in the United States and Europe. Conwed
Plastics emphasizes development of new products and new applications of existing
products to sustain revenue growth. New product development focuses on market
niches where proprietary technology and expertise can lead to sustainable
competitive economic advantages. In addition, revenues have grown as a result of
acquisitions that provide synergies with existing customers, manufacturing
capacity, processes and technology, and/or raw material needs. Conwed Plastics
has completed eight acquisitions since 2004 and continues to look for additional
acquisition opportunities.
Approximately half of Conwed Plastics' revenues are generated on a make
to order basis. The remainder of Conwed Plastics' sales requires a more
substantial investment in inventory that is stored at various locations to
service customers with short lead time requirements. In the aggregate, inventory
is turned over between 6 and 8 times per year. The top 10 customers with
multiple locations represent approximately 30% - 37% of total sales. The largest
single customer typically represents 5% - 8% of total sales; for the year ended
December 31, 2007, the largest single customer represented 6% of total sales.
Order backlog generally ranges from 6% - 12% of annual sales throughout the
year.
8
Competition
Conwed Plastics is subject to domestic and international competition,
generally on the basis of price, service and quality. Conwed Plastics has 3 to 5
competitors in most of its market segments but the size and type of its
competition varies by market segment. 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 115% from 2002. Conwed Plastics has been able to raise prices
to its customers during this period to offset some of the increase in 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.
Telecommunications
Business Description
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. The
remaining Telco assets were contributed to STi Prepaid by the former owners in
exchange for a 25% interest in STi Prepaid.
STi Prepaid, headquartered in Flushing, New York, is a facilities-based
provider of long-distance wireline and wireless telecommunications services. STi
Prepaid's principal product line is prepaid international long distance calling
cards; STi Prepaid also generates revenues by providing carrier wholesale
services and selling prepaid wireless products and related services.
Prepaid international calling cards represent STi Prepaid's largest
telecommunication service. From acquisition through December 31, 2007, calling
card sales accounted for approximately 88% of STi Prepaid's revenues. Consumers
located in the U.S. who make international phone calls often use calling cards
because they provide lower rates than those offered by traditional long distance
providers. Through its portfolio of calling cards, STi Prepaid provides
international service to over 200 destinations. STi Prepaid currently offers
over 250 different calling cards in various denominations, which are sold
through a wide variety of retail stores and on the Internet, targeted to appeal
to a wide variety of consumers. STi Prepaid's calling cards are primarily
marketed to ethnic communities in urban areas.
To activate a card and initiate a call, a card customer will dial either
a local access or toll-free telephone number which accesses STi Prepaid's
interactive voice response unit on its network. Once a card is activated, calls
are routed to one of STi Prepaid's termination vendors, then ultimately to the
consumer's dialed party. STi Prepaid's switching network currently handles over
55 million outbound calls and over 600 million minutes per month. STi Prepaid
operates a customer care center in the Dominican Republic with over 100
operators to support its prepaid business.
STi Prepaid's next largest telecommunication service is carrier
wholesale, which is a business-to-business service. STi Prepaid enters into
wholesale service agreements with other telecommunication service providers
pursuant to which STi Prepaid becomes the terminating vendor for international
calls. Services provided to other carriers are highly automated and do not
require much support labor since calls simply pass through the Company's
switches and utilize excess capacity.
STi Prepaid operates its prepaid mobile business as a Mobile Virtual
Network Operator ("MVNO"). MVNOs are entities that do not own their own wireless
network; rather they enter into agreements to resell minutes from an established
facilities based wireless carrier such as Sprint or Verizon Wireless. However,
unlike wireless resellers that simply earn commissions for selling the products
of large facilities based wireless companies, MVNO operators have their own
brand name and directly maintain customer relationships including activities
related to rate plans, billing, and general customer service. STi Prepaid's
brand name for this product is STi Mobile.
9
Sales and Marketing
STi Prepaid distributes its prepaid calling cards primarily through
distributors who resell the cards to retailers throughout the U.S. A significant
portion of the calling cards are marketed to ethnic communities that shop at
small retailers or smaller chains that do not receive attention from large
telecommunication providers. STi Prepaid's relationships with its distributors
are critical to serving these market segments and maintaining and growing
prepaid calling card market share. The company also sells prepaid calling cards
through its website, www.stiphonecard.com. The website allows customers to
search for calling cards by state of origination and call destination.
The carrier wholesale business sales group focuses on establishing
relationships with leading telecommunication carriers. STi Prepaid markets its
STi Mobile wireless products and services through national, regional and local
retail outlets in the U.S., internet resellers and the division's website,
www.stimobile.com. STi Mobile provides prepaid wireless services to consumers
who may not have the credit rating required to qualify for a post-paid plan,
prefer to pay as they go in order to control expenses or do not use sufficient
minutes to justify the cost of a post-paid plan.
Competition
Prepaid calling cards are marketed by a wide range of telecommunication
providers from large national inter-exchange carriers to small local and
regional resellers. STi Prepaid's calling card products compete in markets where
consumers' decisions are primarily based on price and service quality. The
emergence and growth of wholesale carriers using voice over internet protocol,
privatization and deregulation has contributed to a decline in international
call pricing which is likely to continue. STi Prepaid will need to rely on its
network operation expertise and quality of service to continue to effectively
compete in the markets it serves.
Government Regulation
STi Prepaid 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 it changes
regularly 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 any
adverse changes may have on Sti Prepaid's 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 Federal Communications Commission ("FCC") has jurisdiction over STi
Prepaid's facilities and services to the extent those facilities are used in the
provision of interstate telecommunications services (services that originate and
terminate in different states). State regulatory commissions generally have
jurisdiction over facilities and services to the extent the facilities are used
in intrastate telecommunications services.
The Communications Act of 1934. The Communications Act of 1934, as
amended (the "Communications Act") grants the FCC authority to regulate
interstate and foreign communications by wire or radio. The Telecommunications
Act of 1996 (the "1996 Act") establishes a framework for fostering competition
in the provision of local and long distance telecommunications services. STi
Prepaid is regulated by the FCC as a non-dominant interstate and international
telecommunication provider and is therefore subject to less comprehensive
regulation than dominant carriers under the Communications Act. The FCC reviews
its rules and regulations from time to time, and STi Prepaid may be subject to
those new or changed rules.
STi Prepaid has registered with the FCC as a provider of domestic
interstate long distance services. STi Prepaid believes that it is in material
compliance with applicable federal laws and regulations, but cannot guarantee
that the FCC or third parties will not raise issues regarding its compliance
with applicable laws or regulations.
10
Universal Service. Pursuant to the 1996 Act, in 1997 the FCC established
a significantly expanded universal service regime to subsidize the cost of
telecommunications services to high-cost areas, to low income customers, and to
qualifying schools, libraries and rural health care providers. Providers of
interstate and international telecommunications services, and certain other
entities, must pay for these programs by contributing to a Universal Service
Fund (the "Fund"). The rules concerning which services are considered when
determining how much an entity is obligated to contribute to the Fund are
complex; however, many of the services sold by STi Prepaid are included in the
calculation. Current rules require contributors to make quarterly and annual
filings reporting their revenues, and the Universal Service Administrative
Company issues monthly bills for the required contribution amounts, based on a
quarterly contribution factor approved by the FCC. STi Prepaid also contributes
to other funds mandated by the FCC including Interstate Telecommunication
Service Provider Regulatory Fees, Telecommunication Relay Service and Local
Number Portability. STi Prepaid and other contributors to the Fund may recover
their contribution costs through their end-user rates or billing line item.
Customer Propriety Network Information (CPNI). CPNI is defined as
information that relates to the quantity, technical configuration, type,
destination, location, and amount of use of a telecommunications service
subscribed to by any customer of a telecommunications carrier, and that is made
available to the carrier by the customer solely by virtue of the
carrier-customer relationship. Section 222 of the 1996 Act requires
telecommunications carriers to take specific steps to ensure that CPNI is
adequately protected from unauthorized disclosure. In 2007, the FCC issued its
Report and Order and Further Notice of Proposed Rulemaking strengthening these
privacy rules by adopting additional safeguards to protect customers' CPNI. The
Company believes that it has developed policies that meet the FCC's requirements
to protect CPNI.
State Regulation of Telecommunications Services. STi Prepaid is certified
to provide telecommunication services in 49 states. State public utility
commissions ("PUC's") are permitted to regulate the Company's telecommunication
services to the extent that such services originate and terminate within the
same state. The PUC's may also impose tariff and filing requirements, consumer
protection measures and obligations to contribute to state universal service and
other funds.
Property Management and Services
Business Description
In June 2007, the Company acquired ResortQuest for $11,900,000, including
expenses and working capital adjustments finalized subsequent to the closing
date. Headquartered in Fort Walton Beach, Florida, ResortQuest's principal
service offering is providing vacation rental management services to vacation
properties in beach and mountain resort locations, and it also offers homeowner
association management to resort communities and real estate brokerage services
for the residential property market in resort locations. The Company's
investment in the property management and services segment was $13,900,000 at
December 31, 2007.
Vacation rental management service for homeowners is ResortQuest's
largest service offering representing 95% of ResortQuest's 2007 revenue (since
acquisition). ResortQuest contracts with each property owner to market and
manage the rental of their vacation property, generally for a percentage of the
rent and/or fees collected. Services provided include marketing to potential
guests, performing routine maintenance, providing housekeeping services and
providing guests access to additional activities such as golf, tennis or skiing.
ResortQuest provides services in Northwest and Southwest Florida, Delaware,
North and South Carolina, Colorado, Idaho and Utah. ResortQuest's rental
management services are somewhat geographically concentrated in the Northwest
Florida market, which accounts for 35% of its rental management services revenue
(since acquisition).
ResortQuest's primary means of attracting new guests is via the Internet,
through referrals and advertising in publications. ResortQuest's business is
seasonal with beach areas reaching their peak in the summer months and ski areas
reaching their peak in the winter months. Since ResortQuest's properties are in
markets that guests must travel to get to, high fuel prices and poor weather
conditions can have an unfavorable impact on its business.
ResortQuest's real estate brokerage services are concentrated in the
Northwest Florida market, which accounted for 65% of the aggregate real estate
brokerage revenue earned by ResortQuest during 2007 (since acquisition).
ResortQuest provides real estate brokerage services to resort developers on new
construction projects, and also represents other sellers and buyers in the
residential resale market. ResortQuest's revenues from these activities tend to
be cyclical, and experience the same volatility that residential real estate and
new construction markets experience. Since acquisition, the residential real
estate market in Northwest Florida and elsewhere in the U.S. has suffered from
oversupply and declining prices which have adversely affected ResortQuest's
business.
11
ResortQuest is in the services business with minimal working capital
needs, minimal investment in property, plant and equipment and relatively little
expenditures required for technology. The vast majority of ResortQuest's
expenses relates to employees' compensation and benefits, or to service
providers when ResortQuest chooses to outsource to a vendor. As of December 31,
2007, ResortQuest had approximately 1,400 full-time employees.
Sales and Marketing
ResortQuest serves five types of customers: owners of individual vacation
rental homes, guests staying in those homes, owners selling their homes, clients
buying homes and homeowner association boards. ResortQuest markets homeowner
properties via the internet, direct mail and publications. Marketing includes
promoting ResortQuest as a provider of quality management services and promoting
the homeowners' properties as attractive places to vacation. Marketing to rental
property guests and potential home buyers occurs at local, regional and national
levels depending on the location. Community presence and reputation are also an
important part of ResortQuest's marketing programs.
Competition
ResortQuest's competition is fragmented and varies by service and
location. Vacation rental management competitors include other homeowner
vacation rental management companies similar to ResortQuest, developers that
manage their own resort properties and homeowners that market their property
directly to the consumer. When residential real estate market conditions change,
the composition of ResortQuest's competition can also change. In some locations
developers have opted out of the vacation rental business providing greater
opportunities for ResortQuest. In other locations market conditions have
encouraged new competitors to enter the market, including the direct homeowner
rental management business which allows homeowners to market their own homes on
websites. These types of websites provide a low cost of entry to market rental
properties and relative ease in handling a potential guest. Real estate
brokerage service competitors are national, regional and local real estate
brokerage companies and developers that market their own projects.
Gaming Entertainment
Acquisition
During 2006, the Company indirectly acquired a controlling voting
interest in Premier for an aggregate purchase price of $90,800,000, excluding
expenses. The Company owns approximately 56% of the common units of Premier and
all of Premier's preferred units, which accrue an annual preferred return of
17%. The Company also acquired Premier's junior subordinated note due August
2012, and during 2007 provided Premier with a $180,000,000 senior secured credit
facility to partially fund Premier's bankruptcy plan of reorganization
(discussed below). At December 31, 2007, the Company's investment in Premier was
$267,600,000. At acquisition, the Company consolidated Premier as a result of
its controlling voting interest; during the pendency of bankruptcy proceedings
Premier was deconsolidated and accounted for under the equity method.
Plan of Reorganization
Premier owns the Hard Rock Hotel & Casino Biloxi, located in Biloxi,
Mississippi, which opened to the public on June 30, 2007. The Hard Rock Biloxi
was scheduled to open to the public on August 31, 2005; however, two days prior
to opening, Hurricane Katrina hit the Mississippi Gulf Coast and severely
damaged the hotel and related structures and completely destroyed the casino. On
September 19, 2006, Premier and its subsidiary filed voluntary petitions for
reorganization under chapter 11 of title 11 of the United States Bankruptcy Code
before the United States Bankruptcy Court for the Southern District of
Mississippi, Southern Division. Premier filed its petitions in order to seek the
court's assistance in gaining access to Hurricane Katrina-related insurance
proceeds (an aggregate of $161,200,000) which had been denied to Premier by its
pre-petition secured bondholders.
12
Premier filed an amended disclosure statement and plan of reorganization
on February 22, 2007 which provided for the payment in full of all of Premier's
creditors, including payment of principal and accrued interest due to the
holders of Premier's 10 3/4% senior secured notes at par (the "Premier Notes").
On July 30, 2007, the court entered an order confirming the plan, subject to a
modification which Premier filed on August 1, 2007; Premier emerged from
bankruptcy and once again became a consolidated subsidiary of the Company on
August 10, 2007. The plan was funded in part with the $180,000,000 senior
secured credit facility provided by a subsidiary of the Company. The credit
facility matures on February 1, 2012, bears interest at 10 3/4%, is prepayable
at any time without penalty, and contains other covenants, terms and conditions
similar to those contained in the indenture governing the Premier Notes.
The holders of the Premier Notes argued that they were entitled to
liquidated damages under the indenture governing the Premier Notes, and as such
are entitled to more than the principal amount of the notes plus accrued
interest that was paid to them at emergence. Although the Company does not agree
with the position taken by the Premier noteholders, in order to have the plan
confirmed so that Premier could complete reconstruction of its property and open
its business without further delay, the Company agreed to fund an escrow account
to cover the Premier noteholders' claim for additional damages in the amount of
$13,700,000, and a second escrow account for the trustee's reasonable legal fees
and expenses in the amount of $1,000,000. Entitlement to the escrows is expected
to be determined by the bankruptcy court during 2008. The Company believes it is
probable that the court will approve payment of legal fees and expenses and has
fully reserved for that contingency. However, the Company does not believe it is
probable or remote that the bankruptcy court will find in favor of the Premier
noteholders with respect to the additional damages escrow, and any potential
loss can not be reasonably estimated. Accordingly, the Company has not accrued a
loss for the additional damages contingency.
Business Description
The Hard Rock Hotel & Casino is located on an 8.5 acre site on the
Mississippi Gulf Coast and has over 1,300 slot machines, 50 table games, six
live poker tables, five restaurants (including a Hard Rock Cafe and Ruth's Chris
Steakhouse), a full service spa, a 5,200 square foot pool area, 3,000 square
feet of retail space, an eleven-story hotel with 318 rooms and suites and a Hard
Rock Live! entertainment venue with a capacity of 1,500 persons. At December 31,
2007, Premier had approximately 1,100 full-time employees.
Premier's marketing strategy is to position the resort as a full service
gaming, boutique hotel and entertainment resort catering to the Mississippi Gulf
Coast marketplace and the southern region of the U.S. The Mississippi Gulf Coast
region is located along the Interstate 10 corridor and is within a ninety minute
drive from the New Orleans metropolitan area, Mobile, Alabama and the Florida
panhandle. Premier's primary means of marketing utilizes its database of
customers for direct mail campaigns and promotional giveaways designed to reward
customers and generate loyalty and repeat visits. In addition, Premier benefits
from the "Hard Rock" brand name which appeals to a broad range of customers and
from its superior location which is within walking distance of the Beau Rivage,
an MGM Mirage property and the largest hotel and casino in the Mississippi Gulf
Coast market.
Hurricane Katrina completely destroyed the Hard Rock Biloxi's casino,
which was a facility built on floating barges, and caused significant damage to
the hotel and related structures. The new casino was constructed over water on
concrete pilings that greatly improved the structural integrity of the facility;
however, the threat of hurricanes remains a risk to the repaired and rebuilt
facilities. Premier's current insurance policy was bound on April 20, 2007, and
provides up to $263,700,000 in coverage for damage to real and personal property
including up to $84,100,000 in business interruption coverage. The coverage is
led by Underwriters at Lloyds and is comprised of a $20,000,000 primary layer
and six excess layers. The coverage is syndicated through several insurance
carriers, each with an A.M. Best Rating of A- (Excellent) or better. Although
the insurance policy is an all risk policy, weather catastrophe occurrence
(WCO), which is defined to include damage caused by a named storm, is limited to
$130,000,000 with a deductible of $13,200,000. The WCO coverage is subject to
mandatory reinstatement of limits for an additional pre-determined premium.
13
Competition
Premier faces significant competition primarily from nine other gaming
operations in the Mississippi Gulf Coast gaming market and secondarily from
gaming operations in Baton Rouge and New Orleans, Louisiana. Other competition
comes from gaming operations in Lake Charles, Bossier City and Shreveport,
Louisiana; Tunica and Philadelphia, Mississippi; Tampa and Hollywood, Florida
and other states. The Hard Rock Biloxi also competes with riverboats and Native
American gaming ventures, state-sponsored lotteries, off-track wagering, card
parlors, racinos, internet gaming and other forms of gaming in the U.S., as well
as with gaming on cruise ships and international gaming operations.
The Hard Rock Biloxi was the last gaming operation to open in Biloxi
following Hurricane Katrina. The Hard Rock Biloxi is still in the early stages
of establishing its customer database and instituting customer loyalty programs
and has not yet achieved a market share of the local gaming market commensurate
with the size of its facility and the gaming choices it offers. Since its
competitors in the Mississippi Gulf Coast gaming market have been in operation
longer than Premier they have more established gaming operations and customer
databases. Many are larger and have greater financial resources than Premier.
Government Regulation
The gaming industry in Mississippi is highly regulated. Premier, its
ownership and management are subject to findings of suitability reviews by the
Mississippi Gaming Commission. In addition, the laws, rules and regulations of
state and local governments in Mississippi require Premier to hold various
licenses, registrations and permits and to obtain various approvals for a
variety of matters. In order to continue operating, Premier must remain in
compliance with all laws, rules and regulations and pay gaming taxes on its
gross gaming revenues. Failure to maintain such approvals or obtain renewals
when due, or failure to comply with new laws or regulations or changes to
existing laws and regulations would have an adverse effect on Premier's
business. Premier believes it is currently in compliance with all governmental
rules and regulations.
Domestic Real Estate
At December 31, 2007, the Company's domestic real estate properties had a
book value of $225,400,000. 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. During 2007, the Company completed the sale of WilTel's former
headquarters building that was not sold to Level 3. The building was sold for
net cash proceeds of $53,500,000 which resulted in a small gain.
Certain of the Company's other real estate investments and their
respective carrying values as of December 31, 2007 include: approximately 104
acres of land located in Myrtle Beach, South Carolina, a nearly completed large
scale mixed-use development project with various residential, retail and
commercial space ($111,400,000); approximately 76 acres of land located on the
island of Islesboro, Maine and approximately 120 acres of land located in
Rockport, Maine, each of which have submitted plans for residential subdivisions
($34,700,000 in the aggregate); a 15 acre, unentitled air rights parcel above
the train tracks behind Union Station in Washington, D.C. ($10,100,000); an
operating shopping center on Long Island, New York that has 71,000 square feet
of retail space ($10,000,000); 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 540 acre
parcel is located near Mountain Village, Colorado, a ski resort bordering
Telluride, Colorado. As of December 31, 2007, non-recourse indebtedness secured
by the company's real estate projects was $27,800,000, all of which was incurred
in connection with the Myrtle Beach project.
In October 2007, the Company entered into an agreement with the Panama
City-Bay County Airport and Industrial District of Panama City, Florida to
purchase approximately 708 acres of land which currently houses the Panama
City-Bay County International Airport. The Company has placed $56,500,000 into
escrow; the transaction will close and title to the land will pass only after
the city completes construction of a new airport and moves the airport
operations to its new location. Prior to closing, all interest earned on the
escrow account is for the benefit of the Company and may be withdrawn at any
time. If construction on the new airport has not begun by October 2009, or if
construction is not completed by April 2012, the Company has the right to
terminate the agreement and receive a full refund of the escrowed funds. If the
transaction closes, the Company intends to develop the property into a mixed use
community with residential, retail, commercial, educational and office sites.
14
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 6.6% and 8.2% 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 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, 2007, its investment had a carrying value of
$47,200,000, which is included in investments in associated companies. HomeFed
is a public company traded on the NASD OTC Bulletin Board (Symbol: HOFD); at
December 31, 2007, the market value of the Company's investment was
$153,400,000.
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.
Medical Product Development
Business
At December 31, 2007, the Company owned approximately 87% of Sangart, a
biopharmaceutical company principally engaged in developing an oxygen transport
agent for various medical uses. From 2003 through December 31, 2007, the Company
invested an aggregate of $97,700,000 in Sangart, principally to help fund
Sangart's ongoing product development activities (as a development stage
company, Sangart does not have any revenues from product sales). Since
inception, the Company has recorded Sangart losses of $73,900,000, resulting
from product development expenses and Sangart's overhead costs. The Company
expects to invest up to an additional $48,500,000 in 2008 upon its exercise of
existing warrants, which would increase its ownership interest up to
approximately 91%. Sangart became a consolidated subsidiary of the Company in
2005; the book value of the Company's investment in Sangart was $23,800,000 at
December 31, 2007.
In 2002, Sangart commenced human clinical trials of its current product
candidate, Hemospan(R), a form of cell-free hemoglobin administered
intravenously to treat a variety of medical conditions, including use as an
alternative to red blood cell transfusions. A principal function of human blood
is to transport oxygen throughout the body, the absence of which can cause organ
dysfunction or death. The basis for Sangart's technology is the result of more
than 20 years of research in the understanding of how hemoglobin (the oxygen
carrier in red blood cells) functions outside of red blood cells in a cell-free
environment. Hemospan offers universal compatibility with all blood types and,
as compared to red blood cell transfusions, reduced risk of infectious disease
transmission and a longer storage life. Hemospan is made from human hemoglobin
that is extracted from outdated human blood obtained from accredited blood
centers, which is then combined with polyethylene glycol using Sangart's
proprietary processes. Sangart's manufacturing process is able to generate
approximately three units of Hemospan using a single unit of blood, which serves
to expand the supply of donated blood. Sangart owns or exclusively licenses
thirteen U.S. patents and has more than thirty applications pending worldwide
covering product composition, manufacturing or methods of use.
Sangart has previously completed five Phase I and Phase II human clinical
studies designed to assess product safety and gather early indications of the
product's effectiveness. In February 2007, Sangart commenced two Phase III
clinical trials that are designed to demonstrate Hemospan's safety and
effectiveness in preventing and treating low blood pressure during surgery and
in reducing the incidence of operative and postoperative complications. The
Phase III studies are being conducted in six countries in Europe and will
involve a total of 830 patients. Patient enrollment is expected to be completed
in early 2008. Following completion of the Phase III trials, Sangart plans to
prepare and submit an application for marketing approval to the appropriate
regulatory authorities in Europe in early 2009, with a U.S. application to
follow.
The outcome of the Phase III trials will determine how broad initial
marketing approval for Hemospan will be, although the Company can not provide
assurance that any approval will be received. If initial marketing approval is
for a relatively narrow subset of elective surgery procedures, subsequent
clinical trials may be required to evaluate and demonstrate the safety and
effectiveness of Hemospan in additional elective surgeries, trauma care, and
other circumstances in which delivery of oxygen to tissue provides clinical
benefit (e.g., sickle cell disease, strokes and heart attacks). Sangart cannot
control either the length of time required for regulatory approval or whether
expanded or additional clinical trials will be required. Delays and additional
studies could result in additional development cost expenditures.
15
Substantially all of the funding needed for Hemospan development has come
from sales of Sangart's equity securities. The additional investment the Company
expects to make upon the exercise of warrants in 2008, along with additional
investment from minority shareholders, would provide Sangart with $50,000,000
which is projected to be sufficient to fund activities through the filing of the
application for regulatory approval in Europe. Thereafter, additional funding
will be needed prior to regulatory approval and commercial launch; the source of
such funding has not as yet been determined.
Competitive Environment
Hemospan is intended to address the needs of the blood market. Currently
there are more than 14,000,000 units of packed red blood cells transfused each
year in the U.S., the majority of which are used in treating trauma and elective
surgery patients for whom Hemospan may be an alternative. Currently there are no
similar products approved for sale in the U.S. or the European Union; however,
other companies are developing products that could potentially compete with
Hemospan.
Any successful commercialization of Hemospan will depend on an adequate
supply of raw materials, principally blood and polyethylene glycol, at an
acceptable quality, quantity and price. Sangart is currently working with
potential suppliers of raw materials; however, commitments from suppliers of
blood and polyethylene glycol to support a commercial launch are not yet in
place and competitors may seek commitments from the same blood suppliers.
Sangart leases a 56,700 square foot combination office and manufacturing
facility that currently produces Hemospan for its clinical trials. Sangart
believes that its current manufacturing facility would have more than enough
capacity to support a commercial launch, but significant capital improvements
and engineering designs would be required. Alternatively, Sangart may conclude
it is more efficient or operationally effective to outsource its manufacturing
operations for a commercial launch. In addition to obtaining requisite
regulatory approvals and increasing manufacturing capacity for the manufacture
and sale of Hemospan, Sangart would have to create sales, marketing and
distribution capabilities prior to any commercial launch of this product, either
directly or in partnership with a service provider.
Government Regulation
As a product intended for medical use, clinical trials, marketing
approval, manufacturing and distribution of Hemospan is highly regulated. An
application for marketing approval may only be made after the safety and
effectiveness of the product has been demonstrated, including through human
clinical trial data. In the U.S., the U.S. Food and Drug Administration
regulates medical products, including the category known as "biologics", which
includes Hemospan. The Federal Food, Drug and Cosmetic Act and the Public Health
Service Act govern the testing, manufacture, safety, effectiveness, labeling,
storage, record keeping, approval, advertising and promotion of Hemospan.
In Europe, each country has its own agency that regulates clinical
trials. However, the Committee for Medicinal Products for Human Use ("CHMP"),
which is administered by the European Agency for the Evaluation of Medicinal
Products, is an EU-wide regulatory body. Following completion of clinical
trials, marketing approval can be granted either by a centralized application
through CHMP, or on a decentralized basis by one or more selected countries.
Sangart is currently considering which path will best fit its needs and
objectives.
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 229 acres of vineyards in Napa Valley, California and 116 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, 2007, the Company's combined net investment in these
wineries was $70,000,000. The wineries sold approximately 68,000 9-liter
equivalent cases of wine generating revenues of $18,500,000 during 2007 and
81,000 9-liter equivalent cases of wine generating revenues of $19,500,000
during 2006. Additionally, in 2005 and 2006, the Company acquired an aggregate
of 611 acres of land in the Horse Heaven Hills of Washington's Columbia Valley,
of which approximately 85 acres are currently undergoing vineyard development.
At December 31, 2007, the Company's total investment in the Washington property
was $5,900,000.
16
These wineries primarily produce and sell wines in the very competitive
ultra premium and luxury segments of the premium table wine market. The
Company's wines are primarily sold to distributors, who then sell to retailers
and restaurants. 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 2007, direct sales to consumers represented 25% of case
sales and 52% of wine revenues. Sales of the Company's wines in California
(excluding direct sales to consumers) amounted to approximately 9% of 2007 wine
revenues.
The Company's wines compete with small and large producers in the U.S.,
as well as with imported wines, and the ultimate consumer has many choices.
Demand for wine in the ultra premium and luxury market segments can rise and
fall with general economic conditions, and is also significantly affected by
grape supply. While the Company's current vineyard holdings in the Napa and
Willamette valleys will continue to be the most significant source for its wine
products in the immediate future, the Company plans to supplement certain brands
with purchased fruit to meet demand for its products and to provide the raw
materials for the launch of new products. The demand for the Company's wines is
also affected by the ratings given the Company's wines in industry and consumer
publications.
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 2005, the
U.S. Supreme Court decided that such discriminatory state direct shipment laws
violated the Commerce Clause of the U.S. Constitution. As a result, many 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. Overall, these changes have improved the
Company's ability to sell wine directly to consumers.
Energy Projects
During the past few years, the Company has been incurring costs to
investigate and evaluate the development of a number of large scale domestic
energy projects. Certain of the large scale projects employ gasification
technology to convert different types of low grade fossil fuels into clean
energy products. The Company has also invested in certain energy projects that
do not employ gasification technologies, one of which is described below. The
Company has expensed costs to investigate and evaluate its various energy
projects of $22,400,000, $8,300,000 and $1,600,000 during the years ended
December 31, 2007, 2006 and 2005, respectively.
Although there are a number of large scale projects the Company is
currently investigating, the Company is not obligated to develop any of the
projects, and no assurance can be given that the Company will be successful in
fully developing any of these projects. Any project that the Company might
develop would likely require a significant equity investment by the Company, the
acquisition of substantial non-recourse borrowings to build the projects (total
development costs for these types of projects range from $1 billion to $3
billion), the procurement of purchase commitments for long-term supplies of
feedstock, long-term commitments from purchasers of the output, and significant
technological and engineering expertise to implement. The investigation,
evaluation and financing of these large scale projects take years to complete.
Other than as described below, the Company does not expect that any of the
projects it is currently working on would reach the financing stage in the next
12 to 18 months, if ever.
The Company is currently evaluating a gasification project, which would
be built in Louisiana. The initial feasibility work has been completed; however,
the continued investigation and possible development of this project is
dependent upon the issuance of $1,000,000,000 principal amount of tax exempt
bond financing by a Louisiana state agency and the satisfaction of certain other
conditions. The bonds have been allocated to the Company's project but have not
as yet been issued. In addition, significant additional financing will have to
be raised from third parties and a significant equity contribution from the
Company would be required.
17
A subsidiary of the Company has acquired a leasehold interest and
certain permits to construct and operate an onshore liquefied natural gas
("LNG") receiving terminal and associated facilities on the Skipanon Peninsula
near the confluence of the Skipanon and Columbia Rivers in Warrenton, Clatsop
County, Oregon. The project includes construction of an offshore slip and berth
for offloading LNG carriers, onshore facilities to receive and store up to
480,000 cubic meters of LNG and vaporizers to regasify LNG at a baseload rate of
1 billion standard cubic feet per day ("bscfd") with a peak rate of 1.5 bscfd.
The current plan includes construction of an approximate 120 mile long 36-inch
diameter natural gas pipeline to transport regasified natural gas to the U.S.
natural gas transmission grid, which in turn will interconnect with other
natural gas pipelines, including the interstate transmission system of Williams
Northwest Pipeline at the Molalla Gate Station. Numerous regulatory permits and
approvals and acquisition of rights of way for the pipeline will be required
before project construction can commence; construction of the receiving terminal
and associated facilities is expected to begin in the fourth quarter of 2009 and
construction of the pipeline is expected to begin in the fourth quarter of 2010.
Completion of the project is also subject to obtaining significant financing
from third parties; the current estimated project cost is $1,300,000,000.
Other Investments
Jefferies High Yield Holdings, LLC ("JHYH")
During 2007, the Company and Jefferies formed JHYH, a newly formed
entity, and the Company and Jefferies each committed to invest $600,000,000. The
Company has invested $250,000,000 in cash plus its $100,000,000 investment in
JPOF II; its remaining $250,000,000 commitment will be funded at the sole
discretion of Jefferies. JHYH owns Jefferies High Yield Trading, LLC ("JHYT"), a
registered broker-dealer that is engaged in the secondary sales and trading of
high yield securities and special situation securities, including bank debt,
post-reorganization equity, public and private equity, equity derivatives,
credit default swaps and other financial instruments. JHYT makes markets in high
yield and distressed securities and provides research coverage on these types of
securities. JHYT does not invest or make markets in sub-prime residential
mortgage securities.
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. The organizational documents also permit passive investors to invest
up to $800,000,000. Jefferies also received additional JHYH securities entitling
it to 20% of the profits. The voting and non-voting interests are entitled to a
pro rata share of the profits of JHYH, and are mandatorily redeemable in 2013,
with an option to extend up to three additional one-year periods. Under
generally accepted accounting principles ("GAAP"), JHYH is considered a variable
interest entity that is consolidated by Jefferies, since Jefferies is the
primary beneficiary. The Company accounts for its investment in JHYH under the
equity method of accounting. At December 31, 2007, JHYH had total assets of
$1,200,000,000 and reported net income of $14,400,000. The Company's share of
JHYH's net income was $4,300,000 during 2007.
For the period from January 1, 2007 through March 31, 2007, and for the
years ended December 31, 2006 and 2005, the Company recorded income under the
equity method of accounting from its investment in JPOF II of $3,000,000,
$26,200,000 and $23,600,000, respectively, all of which was distributed to the
Company shortly after the end of each period. Over the seven years the Company
had its investment in JPOF II, the weighted average return on investment was
approximately 20% per year.
Fortescue
The Company has invested an aggregate of $452,200,000 in Fortescue's
Pilbara iron ore and infrastructure project in Western Australia, including
expenses. In exchange for its cash investment, the Company has received
277,986,000 common shares of Fortescue (split adjusted), representing
approximately 9.9% of the outstanding Fortescue common stock, and a $100,000,000
note of FMG that matures in August 2019. Interest on the note is calculated as
4% of the revenue, net of government royalties, invoiced from the iron ore
produced from the project's Cloud Break and Christmas Creek areas. The note is
unsecured and subordinate to the project's senior secured debt referred to
below. Fortescue is a publicly traded company on the Australian Stock Exchange,
and the shares acquired by the Company may be sold without restriction on the
Australian Stock Exchange or in accordance with applicable securities laws. The
Company's investment in the Fortescue common shares is classified as a
non-current available for sale investment and carried at market value as of each
balance sheet date. At December 31, 2007, the market value of the Fortescue
common shares was $1,824,700,000.
18
For accounting purposes, the Company allocated its initial Fortescue
investment to the common shares acquired (based on the market value at
acquisition), a 13 year zero-coupon note and a prepaid mining interest. The
zero-coupon note was recorded at an estimated initial fair value of $21,600,000,
representing the present value of the principal amount discounted at 12.5%. The
prepaid mining interest of $184,300,000 has been classified with other
non-current assets, and will be amortized to expense as the 4% of revenue is
earned. Cash interest payments on the note may lag the period interest is earned
due to covenants contained in the project's senior secured debt. Any interest
that is not paid when accrued will earn simple interest at 9.5%.
The project information presented in the paragraphs below was obtained
from Fortescue's website, (http://www.fmgl.com.au/), which contains substantial
additional information about Fortescue and the project. In April 2006, Fortescue
announced a proved reserve estimate of 121 million metric tons of iron ore and a
probable reserve estimate of 932 million metric tons of iron ore, in accordance
with the Australasian Joint Ore Reserves Committee code. This reserve estimate
is solely for the Cloud Break and Christmas Creek mining tenements, which cover
an area of approximately 770 square kilometers. Fortescue has additional
tenements in the Pilbara region of Western Australia, and in November 2007
announced an additional 1 billion metric tons of inferred resources in the
Solomon area. Although Fortescue has received all major approvals required under
the various governmental, environmental, and native title processes for the
Cloud Break and Christmas Creek tenements, it does not possess the approvals or
financing necessary for mining activities at its other tenements. Mining
revenues derived from the Solomon area or other tenements do not increase the
interest payable to the Company on the FMG note.
Fortescue's initial feasibility study was commissioned to identify a
quantity and quality of iron ore that would support an initial mine plan that
produces 45 million metric tons per annum ("mtpa") for a 20 year period.
Fortescue has since launched an optimization program and increased its base
mining plan to 55 mtpa. Fortescue has announced agreements with third parties,
including relationships with the largest Chinese steel mills, which intend to
purchase all of the initial 45 mtpa production as well as an additional 50 mtpa
of expansion tonnage. These agreements reference the "benchmark price" for
premium Pilbara iron ore which is set annually based on the first negotiated
price between any of the world's largest steel mills and one of the world's
three largest iron ore producers. As of February 14, 2008, the benchmark price
for the year beginning in April 2008 had not yet been set; however, a
substantial increase is expected.
In addition to the Company's investment and equity investments from
other parties, Fortescue raised $2,051,000,000 of senior secured debt to fund
the construction of the project, which includes a 260 kilometer railroad, port
and related port infrastructure at Port Hedland, Australia, as well as a
crushing and screening plant, access roads and other infrastructure at the mine
site. At the end of 2007, Fortescue announced that construction on the rail,
port, and mine site was approximately 80% complete and that it expects to begin
shipping ore in May 2008. The forecasted final cost for the infrastructure
associated with the mine, rail and port, which is reported monthly, aggregates
A$2,765,000,000 ($2,494,000,000 at exchange rates in effect on February 14,
2008).
Goober Drilling
During 2006, the Company acquired a 30% limited liability company
interest in Goober Drilling for aggregate consideration of $60,000,000,
excluding expenses, and agreed to lend to Goober Drilling, on a secured basis,
up to $126,000,000 to finance new rig equipment purchases and construction costs
and to repay existing debt. During 2007 the Company increased its equity
interest to 50% for additional payments aggregating $45,000,000. In addition,
the credit facility was amended to increase the borrowing capacity to
$138,500,000 and the interest rate to LIBOR plus 5%, the Company provided Goober
Drilling with an additional secured credit facility of $45,000,000 at an
interest rate of LIBOR plus 10%, and the Company provided another secured credit
facility of $15,000,000 at an interest rate at the greater of 8% or LIBOR plus
2.6%. At December 31, 2007, the aggregate outstanding loan amount was
$171,000,000 excluding accrued interest. The additional funding was required due
to increased raw material and labor costs to construct the new rigs and working
capital needs due to delays in rig construction.
Goober Drilling is a land based contract oil and gas drilling company
based in Stillwater, Oklahoma that provides drilling services to oil and natural
gas exploration and production companies in the Mid-Continent Region of the
U.S., primarily in Oklahoma and Texas. The majority of wells drilled are natural
gas wells. Goober Drilling, which has been in business since 1991, typically
generates revenues through drilling contracts based on daily rates, footage
(charged by depth of the well) or based on a turnkey contract (fixed price to
drill a well). In 2007, the majority of drilling services were performed on a
"day work" or daily rate basis. Goober Drilling supplies the drilling rig and
all ancillary equipment and drilling personnel.
19
Goober Drilling's business volume and profitability is significantly
affected by the actual and anticipated price of natural gas and levels of
natural gas in storage. The natural gas exploration and production industry is
cyclical and the level of exploration and production activity has historically
been very volatile. During periods of lower levels of drilling activity, price
competition for drilling services tends to increase which may result in reduced
revenues and profitability; conversely, during periods of increased drilling
activity drilling rigs are in demand often resulting in higher prices and
contractual commitments from customers to obtain exclusive use of a particular
rig for a longer term. Seasonality does not significantly impact Goober
Drilling's business or operations. During 2007, profitability was adversely
impacted by mixed views of future natural gas prices, an oversupply of rigs in
the marketplace and the construction and other delays experienced in getting new
rigs into the marketplace.
As of December 31, 2007, Goober Drilling had 36 drilling rigs, of which
17 are under contract for a 1 to 3 year term, 2 are operating under term
contracts which will expire within the next 12 months, 8 are under well-to-well
contracts with specific customers, 7 are "floaters" or rigs that are made
available on the spot market and 2 are small older rigs not currently in use. In
addition, the company has committed to purchase one additional rig which will be
made available on a spot basis until a contract is secured. Goober Drilling
expects that the one remaining purchased rig, which has yet to be delivered,
will be operational during the first quarter of 2008.
The contract drilling business is highly competitive. Customers award
contracts to contract drillers based on factors such as price, rig availability,
quality of service, proximity to the well site, experience with the specific
geological formation, condition and type of equipment, reputation, safety of
operations and customer relationships. Contracts for drilling services may be
awarded based solely on price.
CLC
CLC is a Spanish company that holds the exploration and mineral rights to
the Las Cruces copper deposit in the Pyrite Belt of Spain. It was a consolidated
subsidiary of the Company from its acquisition in September 1999 until August
2005, at which time the Company sold a 70% interest to Inmet, a Canadian-based
global mining company traded on the Toronto stock exchange (Symbol: IMN). Inmet
acquired the interest in CLC in exchange for 5,600,000 newly issued Inmet common
shares, representing approximately 11.6% of Inmet's current outstanding common
shares. Although the Inmet shares have registration rights, they may not be sold
until the earlier of August 2009 or the date on which the Company is no longer
obligated under the guarantee discussed below. The Inmet shares are reflected on
the Company's consolidated balance sheet at their fair value on the date they
were received of approximately $78,000,000; at December 31, 2007, the market
value of the Inmet shares was $451,800,000. The Company retains a 30% interest
in CLC.
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, 2007, approximately $126,900,000 was
outstanding under the senior secured credit facility and (euro)24,000,000 was
outstanding under the senior secured bridge credit facility. The Company and
Inmet have also committed to provide financing to CLC which is currently
estimated to be (euro)239,000,000 ($350,000,000 at exchange rates in effect on
February 14, 2008), of which the Company's share will be 30% ($80,000,000 of
which has been loaned as of December 31, 2007). CLC's senior secured credit
facilities restrict CLC's ability to make distributions to Inmet and the
Company; assuming CLC achieves its mining plan the Company would not expect to
receive distributions before 2010.
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)463,000,000 ($678,000,000 at exchange rates in effect on
February 14, 2008), including working capital, land purchases, and
contingencies, but excluding reclamation bonding requirements, inflation,
interest during construction, cost overruns and other financing costs. The
capital cost estimate assumed mine production would commence April 1, 2008;
however, due to a variety of factors CLC now expects to begin commercial
production in the fourth quarter of 2008 and reach full mine production in early
2009. For each month mine production is delayed after April 1, 2008, capital
costs are expected to increase by approximately (euro)4,000,000 until production
begins. Cash operating costs per pound of copper produced over the life of the
mine are expected to average (euro)0.49 per pound ($0.72 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.
20
Other
In June 2007, the Company invested $200,000,000 to acquire a 10% limited
partnership interest in Pershing Square, a newly-formed private investment
partnership whose investment decisions are at the sole discretion of Pershing
Square's general partner. The stated objective of Pershing Square is to create
significant capital appreciation by investing in Target Corporation. For the
period from investment to December 31, 2007, the Company recorded losses of
$85,500,000 from this investment under the equity method of accounting,
principally resulting from declines in the market value of Target Corporation's
common stock. At December 31, 2007, the book value of the Company's investment
in Pershing Square was $114,500,000.
In January 2007, the Company invested $74,000,000 in Highland
Opportunity, a limited partnership which principally invests through a master
fund in mortgage-backed and asset-backed securities. During 2007, the Company
recorded pre-tax losses from this investment under the equity method of
accounting of $17,600,000; at December 31, 2007, the book value of the Company's
investment in Highland Opportunity was $57,400,000.
In January 2007, the Company invested $25,000,000 in Shortplus, a limited
partnership which principally invests through a master fund in a short-term
based portfolio of asset-backed securities. During 2007, the Company recorded
pre-tax income from this investment under the equity method of accounting of
$54,500,000; at December 31, 2007, the book value of the Company's investment in
Shortplus was $79,500,000.
In September 2007, the Company invested $75,000,000 in Ambrose, a limited
partnership which principally invests through a master fund in anticipated
corporate transactions including mergers, acquisitions, recapitalizations and
similar events. During 2007, the Company recorded pre-tax losses from this
investment under the equity method of accounting of $1,100,000; at December 31,
2007, the book value of the Company's investment in Ambrose was $73,900,000.
The Company has invested $50,000,000 in Wintergreen, a limited
partnership that invests in domestic and foreign debt and equity securities. The
Company recorded pre-tax income from this investment under the equity method of
accounting of $14,000,000, $11,000,000 and $500,000 for the years ended December
31, 2007, 2006 and 2005, respectively. At December 31, 2007, the book value of
the Company's investment in Wintergreen was $75,500,000.
In 2004, the Company invested $75,000,000 in INTL Consilium Emerging
Market Absolute Return Fund, LLC ("INTL"), a limited liability company that is
invested in a master fund which primarily invests in emerging markets debt and
equity securities. INTL and the master fund are managed and controlled by an
investment manager who has full discretion over investment and operating
decisions. Under GAAP, INTL is considered a variable interest entity and the
Company is the primary beneficiary; as a result, the Company accounts for its
investment in INTL as a consolidated subsidiary. The Company has included INTL
in its Corporate segment. The Company recorded pre-tax income from this
investment of $13,900,000, $5,100,000 and $9,900,000 for the years ended
December 31, 2007, 2006 and 2005, respectively. At December 31, 2007, the book
value of the Company's investment in INTL was $56,100,000.
The Company owns approximately 38% 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, 2007, the Company's investment of $18,800,000 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 14, 2008 (determined in accordance with Rule 13d-3 of the
Securities Exchange Act of 1934): AmeriCredit Corp. ("ACF") (25%), The FINOVA
Group Inc. ("FINOVA") (25%), HomeFed (29.9%) and International Assets Holding
Corporation (16.5%). In addition to the Company's equity interests in Fortescue
and Inmet discussed above, the Company also owns a 7% equity interest in JZ
Equity Partners PLC, a British company traded on the London Stock Exchange.
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.
21
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.
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.
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 14, 2008, Messrs. Cumming and
Steinberg and trusts for the benefit of their respective families (excluding
certain private charitable foundations) beneficially owned approximately 11.3%
and 12.5% of our outstanding common shares, respectively. Accordingly, Messrs.
Cumming and Steinberg 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, all of which
are very competitive and susceptible to economic downturns and would be
adversely affected by a recession. 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.
Declines in the U.S. housing market have reduced revenues and
profitability of the manufacturing businesses and may continue to do so.
Our manufacturing operations are subject to risks associated with
increased volatility in raw material prices and availability of key raw
materials. If the price for our raw materials continues to increase and we are
not able to pass these price increases to our customers, or we are unable to
obtain key raw materials, our results of operations will be negatively impacted.
STi Prepaid may not be able to obtain sufficient or cost-effective
termination capacity to particular destinations. This could result in an
inability to fulfill customer demands or in higher costs, which could adversely
affect revenues and margins.
Pricing on STi Prepaid's prepaid phone card business is highly sensitive
to price declines and subject to intense competition. 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.
STi Prepaid relies on independent distributors to generate revenues, who
may not devote sufficient efforts to promote and sell our products rather than
the products of our competitors.
The Hard Rock Biloxi is a new business with no operating history, and
Premier does not have any experience operating a gaming facility. If Premier is
unable to manage the risks inherent in the establishment of a new business
enterprise, it would negatively impact operating results.
Increases in mortgage interest rate levels or decreases in available
consumer credit could reduce consumer demand for certain of our real estate
development projects.
The Company's current and future investment in Sangart is subject to
certain regulatory risks and costs, as well as risks associated with the
operation of a new business without a proven track record. Sangart's activities
are subject to extensive government regulation and Sangart cannot generate any
revenue without regulatory approval of its products. Sangart is also subject to
all of the risks inherent in establishing a new business.
22
Sangart's Hemospan product is subject to competition from other products
under development. There are other companies developing products for the same
market that Sangart is targeting, and if they are successful in bringing their
product to market before Sangart it may significantly impair Sangart's ability
to compete in the same market segment.
Sangart's success depends on its ability to obtain, maintain and defend
patent protection for its products and technologies, preserve trade secrets and
operate without infringing the intellectual property rights of others. The
patent positions of biopharmaceutical companies, such as Sangart, are generally
uncertain and involve complex legal and factual questions. If Sangart's
intellectual property positions are challenged, invalidated, circumvented or
expire, or if Sangart fails to maintain its third-party intellectual property
licenses in good standing, its ability to successfully bring Hemospan to market
would be adversely affected, it could incur monetary liabilities or be required
to cease using the technology or product in dispute.
Goober Drilling's revenues and profitability are impacted by natural gas
supplies and prices and the supply of drilling rigs in the marketplace. During
periods of decreased demand for natural gas, Goober Drilling's rig utilization
will decline and its competitors may also have excess capacity in the
marketplace, which would adversely impact Goober Drilling's revenues and
profitability.
The Company has a substantial investment in ACF, a company that makes
automobile loans to sub-prime and other borrowers. If ACF's loan losses increase
or its ability to make new loans and grow its business is impaired, its revenues
and profits would decline, adversely affecting the value of the Company's
investment.
The Company has substantial investments in Fortescue, Inmet and CLC,
entities which are engaged in the mining of base metals (principally iron ore
and copper), the prices of which have recently been at record levels. If these
prices decline or delays occur in bringing the mines into production, the value
of the Company's investments would decline.
We could experience significant increases in operating costs and reduced
profitability due to competition for skilled management and staff employees in
our operating businesses.
From time to time we are subject to litigation, for which we may be
unable to accurately assess our level of exposure and which if adversely
determined, may have a material adverse effect on our consolidated financial
condition or results of operations. The Company and its subsidiaries are or may
become 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. However, adverse determinations in
specific legal matters could have a material adverse impact on the Company's
consolidated financial position or results of operations.
We may not be able to generate sufficient taxable income to fully
realize our deferred tax asset. At December 31, 2007, we have recognized a
deferred tax asset of $1,138,100,000. 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.
We may not be able to insure certain risks economically. 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. If an uninsured loss or a loss in excess of insured
limits should occur, results of operations could be adversely affected.
We may reduce or cease to pay dividends on our common shares. On a split
adjusted basis, we paid cash dividends of $0.25 per common share in 2007 and
2006 and $0.125 per common share in 2005. 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.
23
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.
Item 1B. Unresolved Staff Comments.
------- -------------------------
Not applicable.
Item 2. Properties.
------ ----------
Real estate investments that are part of the Company's Domestic Real
Estate segment are described in Item 1 of this Report. Idaho Timber's plants and
sawmills, which are the principal properties used in its business are described
in Item 1 of this Report.
Through its various subsidiaries, the Company owns and utilizes office
space in Salt Lake City, Utah for corporate and other activities (totaling
approximately 31,900 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), facilities and land in
California, Oregon and Washington used for winery operations (totaling
approximately 110,800 square feet and 1,007 acres, respectively) and facilities
and land in Florida and South Carolina used for property management and services
(totaling approximately 60,600 square feet and 13 acres, respectively).
Premier's Hard Rock Hotel & Casino facility is approximately 592,000
square feet and is located on an 8.5 acre site which includes land that is owned
by Premier and adjacent water bottom which is leased from the State of
Mississippi.
The Company and its subsidiaries lease numerous manufacturing,
warehousing, office and headquarters facilities. The facilities vary in size and
have leases expiring at various times, subject, in certain instances, to renewal
options. A subsidiary of the Company also leases space in New York, New York for
corporate and other activities (approximately 29,800 square feet). 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.
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 14, 2008, 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:
24
Name Age Position with Leucadia Office Held Since
---- --- ---------------------- -----------------
Ian M. Cumming 67 Chairman of the Board June 1978
Joseph S. Steinberg 64 President January 1979
Thomas E. Mara 62 Executive Vice President May 1980
Joseph A. Orlando 52 Vice President and January 1994;
Chief Financial Officer April 1996
Barbara L. Lowenthal 53 Vice President and April 1996
Comptroller
Justin R. Wheeler 35 Vice President October 2006
Joseph M. O'Connor 32 Vice President May 2007
Rocco J. Nittoli 49 Vice President and September 2007;
Treasurer May 2007
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. Cumming is also an alternate director of Fortescue should Mr. Steinberg be
unavailable to vote on Fortescue board matters.
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 HomeFed since August 1998 (Chairman since December 1999) and
FINOVA since August 2001. He has served as a director of Fortescue since August
2006.
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 from January 1993 to May
2007. 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. Wheeler joined the Company in March 2000, and has served in a variety
of capacities in the Company's subsidiaries and as Vice President of the Company
since October 2006.
Mr. O'Connor joined the Company in August 2001 and has served as Vice
President of the Company since May 2007.
Mr. Nittoli joined the Company in September 1997, and has served in a
variety of capacities in the Company's subsidiaries and as Treasurer of the
Company since May 2007, and as Vice President of the Company since September
2007.
25
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.
Common Share
------------
High Low
---- ---
2006
----
First Quarter $29.93 $23.26
Second Quarter 32.62 27.67
Third Quarter 29.31 25.07
Fourth Quarter 29.35 25.52
2007
----
First Quarter $30.27 $26.61
Second Quarter 36.87 29.33
Third Quarter 49.14 35.78
Fourth Quarter 51.62 42.77
2008
----
First Quarter (through February 14, 2008) $47.92 $39.53
As of February 14, 2008, there were approximately 2,537 record holders of
the common shares.
On a split adjusted basis, the Company paid cash dividends of $0.25 per
common share in 2007 and 2006 and $0.125 per common share in 2005. 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.
The Company's purchases of its common shares during the fourth quarter of
2007 were as follows:
26
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
------------- --------- --------- -----------
October 1 to October 31 1,215 $49.55 -- $ --
------------ ------------
Total 1,215 --
============ ============
(1) Consists of common shares received from an employee to exercise stock
options. Shares were valued at the market price at the date of the option
exercise.
The Board of Directors from time to time has authorized acquisitions of
the Company's common shares. In March 2007, the Company's Board of Directors
increased to 12,000,000 the maximum number of shares that the Company is
authorized to purchase. At December 31, 2007, the Company is authorized to
purchase 11,995,285 common shares.
Stockholder Return Performance Chart
------------------------------------
Set forth below is a chart comparing the cumulative total stockholder
return on our common shares against the cumulative total return of the Standard
& Poor's 500 Stock Index and the Standard & Poor's 1500 Industrial Conglomerates
Index for the period commencing December 31, 2002 to December 31, 2007. Index
data was furnished by Standard & Poor's Compustat Services, Inc. The chart
assumes that $100 was invested on December 31, 2002 in each of our common stock,
the S&P 500 Index, and the S&P 1500 Industrial Conglomerates Index and that all
dividends were reinvested.
Total Return To Shareholders
(Includes reinvestment of dividends)
ANNUAL RETURN PERCENTAGE
Years Ending
Company / Index Dec03 Dec04 Dec05 Dec06 Dec07
---------------- ----- ----- ----- ----- -----
Leucadia National Corporation 24.23 51.53 3.00 19.89 67.91
S&P 500 Index 28.68 10.88 4.91 15.79 5.49
S&P 1500 Industrial Conglomerates 34.88 19.15 -3.70 8.69 4.27
INDEXED RETURNS
Base Years Ending
Period
Company / Index Dec02 Dec03 Dec04 Dec05 Dec06 Dec07
--------------- ------ ------ ------ ------ ------ ------
Leucadia National Corporation 100 124.23 188.24 193.89 232.46 390.32
S&P 500 Index 100 128.68 142.69 149.70 173.34 182.86
S&P 1500 Industrial Conglomerates 100 134.88 160.71 154.77 168.22 175.40
27
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,
------------------------------------------------------------------
2007 2006 2005 2004 2003
---- ---- ---- ---- ----
(In thousands, except per share amounts)
SELECTED INCOME STATEMENT DATA: (a)
Revenues and other income (b) $1,154,895 $ 862,672 $ 689,883 $ 379,566 $ 242,614
Expenses 1,211,983 728,852 555,448 272,742 248,525
Income (loss) from continuing operations before income
taxes, minority expense of trust preferred securities
and equity in income (losses) of associated companies (57,088) 133,820 134,435 106,824 (5,911)
Income from continuing operations before equity in income
(losses) of associated companies 502,683 92,049 1,265,473 127,368 25,695
Equity in income (losses) of associated companies, net of
taxes (21,875) 37,720 (45,133) 76,479 76,947
Income from continuing operations (c) 480,808 129,769 1,220,340 203,847 102,642
Income (loss) from discontinued operations, including
gain on disposal, net of taxes 3,486 59,630 415,701 (58,347) (5,588)
Net income 484,294 189,399 1,636,041 145,500 97,054
Year Ended December 31,
----------------------------------------------------------------
2007 2006 2005 2004 2003
---- ---- ---- ---- ----
Per share:
Basic earnings (loss) per common share:
Income from continuing operations $2.20 $ .60 $5.66 $ .96 $ .56
Income (loss) from discontinued operations, including
gain on disposal .02 .28 1.93 (.28) (.03)
----- ----- ----- ----- -----
Net income $2.22 $ .88 $7.59 $ .68 $ .53
===== ===== ===== ===== =====
Diluted earnings (loss) per common share:
Income from continuing operations $2.09 $ .60 $5.34 $ .93 $ .55
Income (loss) from discontinued operations, including
gain on disposal .01 .25 1.80 (.26) (.03)
----- ----- ----- ----- -----
Net income $2.10 $ .85 $7.14 $ .67 $ .52
===== ===== ===== ===== =====
At December 31,
-----------------------------------------------------------------
2007 2006 2005 2004 2003
---- ---- ---- ---- ----
(In thousands, except per share amounts)
SELECTED BALANCE SHEET DATA: (a)
Cash and investments $ 4,216,690 $ 2,657,021 $ 2,687,846 $ 2,080,309 $ 1,403,619
Total assets 8,126,622 5,303,824 5,260,884 4,800,403 4,397,164
Debt, including current maturities 2,136,550 1,159,461 1,162,382 1,131,922 682,135
Shareholders' equity 5,570,492 3,893,275 3,661,914 2,258,653 2,134,161
Book value per common share $25.03 $18.00 $16.95 $10.50 $10.05
Cash dividends per common share $ .25 $ .25 $ .13 $ .13 $ .08
(a) Subsidiaries are reflected above as consolidated entities from the date of
acquisition as follows: ResortQuest, June 2007; STi Prepaid, March 2007;
Sangart, November 2005; and Idaho Timber, May 2005. As discussed above,
Premier is reflected as a consolidated subsidiary from May 2006 until
September 2006; it once again became a consolidated subsidiary in August
2007. For additional information, see Note 3 of Notes to Consolidated
Financial Statements.
28
(b) Includes net securities gains of $95,641,000, $117,159,000, $208,816,000,
$136,564,000 and $9,928,000 for the years ended December 31, 2007, 2006,
2005, 2004 and 2003, respectively.
(c) During 2007 and 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, $542,700,000 in 2007 and
$1,135,100,000 in 2005 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 $2,300,000 for 2007,
$8,000,000 for 2006, $27,300,000 for 2004 and $24,400,000 for 2003.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
------ -----------------------------------------------------------------------
The purpose of this section is to discuss and analyze the Company's
consolidated financial condition, liquidity and capital resources and results of
operations. This analysis should be read in conjunction with the consolidated
financial statements and related notes which appear elsewhere in this Report.
Liquidity and Capital Resources
Parent Company Liquidity
Leucadia National Corporation (the "Parent") is a holding company whose
assets principally consist of the stock of its direct subsidiaries, cash and
cash equivalents and other non-controlling investments in debt and equity
securities. The Parent continuously evaluates the retention and disposition of
its existing operations and investments and investigates possible acquisitions
of new businesses in order to maximize shareholder value. Accordingly, 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.
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 December 31, 2007, the sum of these amounts aggregated
$4,216,700,000. However, since $447,900,000 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 $3,768,800,000 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 investment in Fortescue common shares
discussed below). 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.
The Parent's only long-term cash requirement is to make principal
payments on its long-term debt ($1,923,200,000 principal outstanding as of
December 31, 2007), of which $475,000,000 is due in 2013, $350,000,000 is due in
2014, $500,000,000 is due in 2015, $500,000,000 is due in 2017 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, except as
disclosed in this Report, 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 $100,000,000 that matures in 2011 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 one level below investment grade by Standard & Poor's and Fitch
Ratings. Ratings issued by bond rating agencies are subject to change at any
time.
29
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. 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 $98,600,000.
In March 2007, the Company invested an additional $48,500,000 in Sangart
(increasing its ownership interest to approximately 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 approximately 91%. The Company expects to exercise the
warrants in 2008.
In June 2007, the Company completed the acquisition of ResortQuest for
$11,900,000, including expenses and working capital adjustments finalized
subsequent to the closing date.
As discussed above, on August 10, 2007, Premier emerged from chapter 11
bankruptcy proceedings and once again became a consolidated subsidiary of the
Company. Premier was initially accounted for as a consolidated subsidiary when
it was acquired during 2006; however, Premier was deconsolidated on September
19, 2006, when it filed voluntary petitions for reorganization under the
bankruptcy code, before the United States Bankruptcy Court for the Southern
District of Mississippi, Southern Division. Premier filed its petitions in order
to seek the court's assistance in gaining access to Hurricane Katrina-related
insurance proceeds which had been denied to Premier by its pre-petition secured
bondholders. While in bankruptcy proceedings the Company's investment and loans
to Premier were accounted for as an investment in an associated company
($125,600,000 as of December 31, 2006).
Premier's plan was funded in part with a $180,000,000 senior secured
credit facility provided by a subsidiary of the Company. The credit facility
matures on February 1, 2012, bears interest at 10 3/4%, is prepayable at any
time without penalty, and contains other covenants, terms and conditions similar
to those contained in the indenture governing the Premier Notes. Since the plan
did not result in any change in ownership of the voting interests in Premier,
the Company did not apply "fresh start" accounting and did not treat the
reconsolidation of Premier as the acquisition of a business that, under the
purchase method of accounting, requires the measurement of assets and
liabilities at fair value. Accordingly, the Company reconsolidated the assets
and liabilities of Premier upon its emergence from bankruptcy using its
historical basis in Premier's assets and liabilities.
The plan provided for the payment in full of all of Premier's creditors,
including payment of principal and accrued interest due to the holders of
Premier's 10 3/4% senior secured notes at par (the "Premier Notes"). The holders
of the Premier Notes argued that they were entitled to liquidated damages under
the indenture governing the Premier Notes, and as such are entitled to more than
the principal amount of the notes plus accrued interest that was paid to them at
emergence. Although the Company does not agree with the position taken by the
Premier noteholders, in order to have the plan confirmed so that Premier could
complete reconstruction of its property and open its business without further
delay, the Company agreed to fund an escrow account to cover the Premier
noteholders' claim for additional damages in the amount of $13,700,000, and a
second escrow account for the trustee's reasonable legal fees and expenses in
the amount of $1,000,000. Entitlement to the escrows is expected to be
determined by the court during 2008. The Company believes it is probable that
the court will approve payment of legal fees and expenses and has fully reserved
for that contingency. However, the Company does not believe it is probable or
remote that the court will find in favor of the Premier noteholders with respect
to the additional damages escrow, and any potential loss can not be reasonably
estimated. Accordingly, the Company has not accrued a loss for the additional
damages contingency.
Hurricane Katrina completely destroyed the Hard Rock Biloxi's casino,
which was a facility built on floating barges, and caused significant damage to
the hotel and related structures. The new casino was constructed over water on
concrete pilings that greatly improved the structural integrity of the facility;
however, the threat of hurricanes remains a risk to the repaired and rebuilt
facilities. Premier's current insurance policy was bound on April 20, 2007, and
provides up to $263,700,000 in coverage for damage to real and personal property
including up to $84,100,000 in business interruption coverage. The coverage is
led by Underwriters at Lloyds and is comprised of a $20,000,000 primary layer
and six excess layers. The coverage is syndicated through several insurance
carriers, each with an A.M. Best Rating of A- (Excellent) or better. Although
the insurance policy is an all risk policy, WCO, which is defined to include
damage caused by a named storm, is limited to $130,000,000 with a deductible of
$13,200,000. The WCO coverage is subject to mandatory reinstatement of limits
for an additional pre-determined premium.
30
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. During the three year
period ended December 31, 2007, the only common shares acquired by the Company
were from employees in connection with the employees' exercise of stock options.
As of February 14, 2008, the Company is authorized to repurchase 11,995,285
common shares.
In March 2007, the Company sold $500,000,000 principal amount of its
newly authorized 7 1/8% Senior Notes due 2017 in a private placement
transaction. Net proceeds after payment of underwriting fees were $490,000,000.
Pursuant to an exchange offer, these notes were subsequently exchanged for a new
issue of debt securities registered under the Securities Act, with terms
identical to those of the 7 1/8% Senior Notes (except for provisions relating to
transfer restrictions and payment of additional interest).
In September 2007, the Company sold $500,000,000 principal amount of its
newly authorized 8 1/8% Senior Notes due 2015 at an issue price of 98.307%. Net
proceeds after payment of underwriting fees were $481,700,000.
In September 2007, the Company completed the issuance and sale of
5,500,000 of its common shares at a price of $45.50 per share. Net proceeds
after payment of underwriting fees were $242,000,000.
During 2007, the Company increased its equity interest in Goober Drilling
to 50% for additional payments aggregating $45,000,000. In addition, the senior
secured credit facility was amended to increase the borrowing capacity to
$138,500,000 and the interest rate to LIBOR plus 5%, the Company provided Goober
Drilling with an additional secured credit facility of $45,000,000 at an
interest rate of LIBOR plus 10%, and the Company provided another secured credit
facility of $15,000,000 at an interest rate at the greater of 8% or LIBOR plus
2.6%. At December 31, 2007, the aggregate outstanding loan amount was
$171,000,000 excluding interest. The additional funding was required due to
increased raw material and labor costs to construct the new rigs and working
capital needs due to delays in rig construction. The Company's investment in
Goober Drilling is classified as an investment in an associated company.
In April 2007, the Company and Jefferies expanded and restructured 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 committed to invest $600,000,000 in a newly formed entity, JHYH,
Jefferies 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 $100,000,000 investment in JPOF
II; the timing of the Company's remaining $250,000,000 contribution is at the
sole discretion of Jefferies. The Company's investment in JHYH is classified as
an investment in an associated company.
The Company has invested an aggregate of $452,200,000 in Fortescue's
Pilbara iron ore and infrastructure project in Western Australia ($44,200,000 in
2007 and $408,000,000 in 2006), including expenses. In exchange for its cash
investment, the Company has received 277,986,000 common shares of Fortescue
(split adjusted), representing approximately 9.9% of the outstanding Fortescue
common stock, and a $100,000,000 note of FMG that matures in August 2019.
Interest on the note is calculated as 4% of the revenue, net of government
royalties, invoiced from the iron ore produced from the project's Cloud Break
and Christmas Creek areas. The note is unsecured and subordinate to the
project's senior secured debt. Fortescue is a publicly traded company on the
Australian Stock Exchange, and the shares acquired by the Company may be sold
without restriction on the Australian Stock Exchange or in accordance with
applicable securities laws. The Company's investment in the Fortescue common
shares is classified as a non-current available for sale investment and carried
at market value as of each balance sheet date. At December 31, 2007, the market
value of the Fortescue common shares was $1,824,700,000.
31
Over the past few years, the Company has invested in various limited
partnerships or limited liability companies that are engaged in investing and/or
securities transactions activities whose investment decisions are at the sole
discretion of the entity's general partner or managing member. These investments
include Pershing Square ($200,000,000 in 2007), Ambrose ($75,000,000 in 2007),
Highland Opportunity ($74,000,000 in 2007), Shortplus ($25,000,000 in 2007) and
Wintergreen (a total of $50,000,000 invested during 2006 and 2005), each of
which is classified as an investment in associated companies.
As of February 25, 2008, the Company had acquired or had the right to
acquire 25.6% of the outstanding voting securities of ACF, a company listed on
the NYSE (Symbol: ACF), for aggregate cash consideration of $373,900,000
($70,100,000 was invested as of December 31, 2007). ACF is an independent auto
finance company that is in the business of purchasing and servicing automobile
sales finance contracts, predominantly to consumers who are typically unable to
obtain financing from other sources. ACF has historically funded its auto
lending activities through the transfer of loans in securitization transactions.
The Company also has the right to vote certain shares owned by another party; in
total, the Company has acquired or has the right to acquire the ability to vote
26.5% of ACF's outstanding voting securities. In February 2008, with the
acquisition of sufficient ACF shares that gave the Company the ability to
exercise significant influence, the Company elected to account for its
investment in ACF on a fair value basis pursuant to 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."
The Company and certain of its subsidiaries have substantial NOLs and
other tax attributes. The amount and availability of the 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. For more information about the NOLs and other tax
attributes, see Note 16 of Notes to Consolidated Financial Statements.
Consolidated Statements of Cash Flows
As discussed above, the Company relies on the Parent's available
liquidity to meet its short-term and long-term needs, and to make acquisitions
of new businesses and investments. Except as otherwise disclosed herein, the
Company's operating businesses do not generally require material funds from the
Parent to support their operating activities, and the Parent does not depend on
positive cash flow from its operating segments to meet its liquidity needs. The
components of the Company's operating businesses and investments change
frequently as a result of acquisitions or divestitures, the timing of which is
impossible to predict but which often have a material impact on the Company's
consolidated statements of cash flows in any one period. Further, the timing and
amounts of distributions from certain of the Company's investments in
partnerships accounted for under the equity method are generally outside the
control of the Company. As a result, reported cash flows from operating,
investing and financing activities do not generally follow any particular
pattern or trend, and reported results in the most recent period should not be
expected to recur in any subsequent period.
Net cash of $18,400,000 was used for operating activities during 2007 as
compared to $91,500,000 of net cash provided by operating activities during
2006. The change reflects decreased collections of receivables and distributions
of earnings from associated companies, increased income tax payments and greater
corporate overhead expenses. 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. During 2006, cash provided by operating activities reflects the
collection of the balance of certain receivables from AT&T Inc. ($198,500,000).
The AT&T receivables resulted from a termination agreement entered into between
the Company's former telecommunications subsidiary, WilTel, and its largest
customer during 2005. In 2007, distributions from associated companies
principally include earnings distributed by JPOF II ($29,200,000) and EagleRock
($15,000,000). In 2006, distributions from associated companies principally
include earnings distributed by JPOF II ($23,600,000) and EagleRock
($48,200,000). Contributions to the defined benefit pension plans were
$50,100,000 in 2006; no material contributions were made in 2007.
32
Funds used for operating activities during 2007 include the results of
companies acquired during 2007, STi Prepaid and ResortQuest, for the period they
were owned by the Company, and the results of Premier following its
reconsolidation in the third quarter of 2007. STi Prepaid's telecommunications
operations generated funds from operating activities of $26,700,000 and the
Company's property management and services segment generated funds of
$3,700,000. While it was a consolidated subsidiary, Premier used funds of
$38,500,000 in 2007 and $25,900,000 in 2006. Funds provided by the Company's
manufacturing segments decreased to $25,300,000 in 2007 as compared to
$45,300,000 in 2006, reflecting reduced profitability. Funds used by Sangart, a
development stage company, increased to $24,800,000 during 2007 from $19,400,000
during 2006. Funds provided by operating activities for 2006 also include
$9,100,000 of funds used by discontinued operations.
Net cash provided by operating activities decreased by $229,600,000 in
2006 as compared to the prior year, due principally to no 2006 cash flows from
WilTel, which was sold in December 2005, reduced distributions of earnings from
associated companies, reduced funds generated from activity in the trading
portfolio, payment of incentive compensation and increased defined benefit
pension plan contributions. In addition, funds provided by operating activities
during 2006 reflect a $19,400,000 use of funds by Sangart, a development stage
company which became a subsidiary in November 2005. During 2006, cash provided
by operating activities reflect the collection of the balance of certain
receivables from AT&T discussed above. WilTel's cash flow from operating
activities for the 2005 period prior to its sale was $278,500,000. In 2006,
distributions from associated companies principally include earnings distributed
by EagleRock ($48,200,000) and JPOF II ($23,600,000). In 2005, distributions
from associated companies principally resulted from JPOF II ($16,200,000) and
the sale of Union Square, two entities in which the Company had non-controlling
equity interests. In May 2005, these entities sold their respective interests in
an office complex located on Capitol Hill in Washington, D.C.; the Company's
share of the net proceeds was $73,200,000. Contributions to the defined benefit
pension plans were $50,100,000 in 2006 as compared to $21,800,000 in 2005. The
current status of the Company's frozen defined benefit pension plans is more
fully discussed below.
Net cash flows used for investing activities were $957,400,000 in 2007
and $186,200,000 in 2006; net cash flows provided by investing activities were
$22,600,000 in 2005. During 2007, acquisitions, net of cash acquired principally
include assets acquired by STi Prepaid ($85,400,000) and ResortQuest
($9,700,000) and cash acquired upon the reconsolidation of Premier
($17,300,000). During 2006, acquisitions, net of cash acquired principally
include the acquisition of Premier ($105,700,000). During 2005, acquisitions,
net of cash acquired principally include ATX Communications, Inc. ("ATX")
($12,500,000), Idaho Timber ($133,500,000) and NSW, LLC U.S. ("NSW"), an
acquisition by Conwed Plastics ($26,600,000). During 2006, proceeds from the
disposal of discontinued operations net of expenses and cash sold were
$120,200,000, principally reflecting the sale of Symphony Healthcare Services,
LLC ("Symphony") and ATX and the resolution of WilTel's working capital
adjustment relating to the December 2005 sale of WilTel. During 2005, proceeds
from the disposal of discontinued operations net of expenses and cash sold
principally reflect the sales of WilTel ($357,100,000) and the Waikiki Beach
hotel ($95,200,000). During 2007, funds provided by the disposal of real estate,
property and equipment and other assets include the sale of WilTel's former
headquarters building for $53,500,000. During 2006, funds provided by the
disposal of real estate, property and equipment and other assets include the
sale 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 ($56,400,000). Investments in associated
companies include JHYH ($250,000,000), Pershing Square ($200,000,000), Goober
Drilling ($108,000,000), Ambrose ($75,000,000), Highland Opportunity
($74,000,000), Shortplus ($25,000,000), CLC ($53,500,000) and Premier
($160,500,000) in 2007, Goober Drilling ($188,000,000), Safe Harbor Domestic
Partners L.P. ("Safe Harbor") ($50,000,000), Wintergreen ($30,000,000) and CLC
($12,100,000) in 2006, and Wintergreen ($20,000,000) in 2005. Capital
distributions from associated companies principally include Goober Drilling
($33,200,000) and Safe Harbor ($25,000,000) in 2007.
As a result of the sale of WilTel, the Company's use of funds for
property, equipment and leasehold improvements declined significantly in 2007
and 2006; funds used for WilTel's acquisition of property, equipment and
leasehold improvements totaled $96,100,000 in 2005. During 2007, the change in
restricted cash principally results from the $56,500,000 escrow deposit made in
connection with the Panama City real estate project. Pursuant to the indenture
governing the Premier Notes, Premier was required to put insurance proceeds it
collected into restricted accounts, which is the principal reason for the net
change in restricted cash during 2006. Premier's cash flow activity is reflected
in the Company's 2006 consolidated statement of cash flows only during the
period it was a consolidated subsidiary (April through September 2006).
33
Net cash provided by financing activities was $1,145,500,000 in 2007 and
net cash used for financing activities was $5,200,000 in 2006 and $442,700,000
in 2005. During 2007, issuance of debt, net of expenses, includes $500,000,000
principal amount of 7 1/8% Senior Notes and $500,000,000 principal amount of 8
1/8% Senior Notes. Issuance of debt during 2006 and 2005 principally relates to
repurchase agreements, which are discussed below. During 2005, funds were used
to retire customer banking deposits of the Company's former banking and lending
operations (which have been run-off) as they became due and the remaining
deposits were sold. The reduction of debt during 2007 principally relates to the
repurchase agreements. The reduction of debt during 2006 includes the repayment
of debt of Square 711 ($32,000,000), which was sold, and the maturity of the
Company's 7 7/8% Senior Subordinated Notes ($21,700,000). The reduction of debt
during 2005 includes the repayment of $442,500,000 of debt of operations sold
(WilTel and Waikiki Beach hotel) and the maturity of the Company's 8 1/4% Senior
Subordinated Notes ($19,100,000).
Issuance of common shares for 2007 principally reflects the issuance and
sale of 5,500,000 of the Company's common shares as discussed above and the
exercise of employee stock options. Issuance of common shares for 2006 and 2005
principally reflects the exercise of employee stock options.
Debt due within one year includes $125,000,000 and $181,800,000 as of
December 31, 2007 and 2006, 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 5.1%, mature in January 2008 and
are secured by non-current investments with a carrying value of $129,100,000 at
December 31, 2007.
During 2001, a subsidiary of the Company borrowed $53,100,000 secured by
certain of its corporate aircraft, of which $39,200,000 is currently
outstanding. Capital leases of another subsidiary aggregating $8,700,000 consist
of a sale-leaseback transaction related to other corporate aircraft. The Parent
company has guaranteed these financings.
The Company's senior note indentures contain covenants that restrict its
ability to incur more Indebtedness or issue Preferred Stock of Subsidiaries if
the Company fails to maintain a specified ratio of Consolidated Debt to
Consolidated Tangible Net Worth, limit the ability of the Company and Material
Subsidiaries to incur, in certain circumstances, Funded Debt or Liens, and
contain other terms and restrictions all as defined in the senior note
indentures. The Company's bank credit agreement also contains covenants and
restrictions which are generally more restrictive than the senior note
indentures; however, the Company has the ability to terminate the bank credit
agreement if no amounts are outstanding. 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 require that collateral be provided to the lender;
principally as a result of such requirements, the assets of subsidiaries which
are subject to limitations on transfer of funds to the Company were
approximately $303,800,000 at December 31, 2007. For more information, see Note
12 of Notes to Consolidated Financial Statements.
As shown below, at December 31, 2007, the Company's contractual cash
obligations totaled $3,684,024,000.
Payments Due by Period (in thousands)
------------------------------------------------------------------------
Less than 1
Contractual Cash Obligations Total Year 1-3 Years 4-5 Years After 5 Years
---------------------------- ----- ---------- --------- --------- -------------
Debt, including current maturities $ 2,136,550 $ 132,405 $ 49,550 $ 35,112 $ 1,919,483
Estimated interest expense on debt 1,105,836 146,097 275,095 266,523 418,121
Capital commitment to JHYH 250,000 250,000 -- -- --
Estimated payments related to derivative
financial instruments 13,248 5,321 7,271 656 --
Planned funding of pension and
postretirement obligations 26,033 4,345 19,259 771 1,658
Operating leases, net of sublease
income 126,127 11,839 19,219 15,615 79,454
Asset purchase obligations 1,330 582 643 105 --
Other 24,900 1,200 2,700 3,000 18,000
------------ ---------- --------- --------- -----------
Total Contractual Cash Obligations $ 3,684,024 $ 551,789 $ 373,737 $ 321,782 $ 2,436,716
============ ========== ========= ========= ===========
34
The estimated interest expense on debt includes estimated interest
related to variable rate debt which the Company determined using rates in effect
at December 31, 2007. Estimated payments related to a currency swap agreement
are based on the currency rate in effect at December 31, 2007. Amounts related
to the Company's consolidated pension liability ($22,400,000) are included in
the table primarily during the 1-3 year period; however, the exact timing of the
cash payments is uncertain. The above amounts do not include liabilities for
unrecognized tax benefits as the timing of payments, if any, is uncertain. Such
amounts aggregated $13,300,000 at December 31, 2007; for more information, see
Note 16 of Notes to Consolidated Financial Statements.
At December 31, 2007, the Company had recorded a liability of
$22,400,000 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 rates.
Although the Company did not make any significant pension plan
contributions during 2007, the Company does expect to make substantial
contributions to the segregated trust accounts in the future to reduce its plan
liabilities and reduce administrative and insurance costs associated with the
plans. The tax deductibility of these contributions is not a primary
consideration, principally due to the availability of the Company's NOLs to
otherwise reduce taxable income. The timing and amount of additional
contributions are uncertain; however, the Company believes it will make
substantial contributions over the next few years to reduce, but not to entirely
eliminate, its defined benefit pension 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, 2007, certain amounts for these plans are reflected
separately in the table below (dollars in thousands):
The Company's WilTel's
Plans Plans
----- -----
Projected benefit obligation $51,759 $ 168,541
Funded status - balance sheet liability at December 31, 2007 4,556 17,803
Deferred losses included in other comprehensive income 14,468 7,095
Discount rate used to determine the projected benefit obligation 5.20% 6.30%
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 2008.
Holding all other assumptions constant, a 0.25% change in these discount rates
would affect pension expense by $600,000 and the benefit obligation by
$7,800,000.
35
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 $10,700,000 at
December 31, 2007 for all plans. A portion of these excess deferred losses will
be amortized to expense during 2008, 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, 2007, the Company's off-balance sheet arrangements
consist of guarantees and letters of credit aggregating $76,000,000. 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, 2007, the amount of outstanding bonds was $12,100,000, which
expires at various times through 2010. Subsidiaries of the Company have
outstanding letters of credit aggregating $15,300,000 at December 31, 2007,
principally to secure various obligations. Substantially all of these letters of
credit expire before 2012.
As discussed above, the Company has also guaranteed 30% of the amounts
outstanding under CLC's $240,000,000 senior secured credit facility and CLC's
(euro)69,000,000 senior secured bridge credit facility. At December 31, 2007,
$126,900,000 was outstanding under the senior secured credit facility and
(euro)24,000,000 was outstanding under the senior secured bridge credit
facility; as a result, the Company's outstanding guaranty at that date was
$38,100,000 and (euro)7,200,000 ($10,500,000 at exchange rates in effect on
February 14, 2008), respectively.
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
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.
36
During 2007 and 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, $542,700,000 in 2007 and $1,135,100,000 in
2005 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
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, and also takes into consideration unrealized gains in its
investment portfolio. 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, estimates apportionment factors for state and
local taxing jurisdictions 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
December 31, 2007, the balance of the deferred tax valuation allowance was
approximately $299,800,000.
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 2007 or 2006; however, 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 in connection with the sale of WilTel to Level 3
(classified with gain on disposal of discontinued operations). WilTel's former
headquarters building, including the adjacent parking garage, was not included
in the sale to Level 3 and was 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. During 2007, the building was
sold for net cash proceeds of $53,500,000, which resulted in a small gain.
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, the ability and intent to
hold investments to maturity, 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
$36,800,000, $12,900,000 and $12,200,000 for the years ended December 31, 2007,
2006 and 2005, 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 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
37
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.
Use of Fair Value Estimates - Substantially all of the Company's
investment portfolio is classified as either available for sale or as trading
securities, both of which are carried at estimated fair value in the Company's
consolidated balance sheet. The estimated fair values are principally based on
publicly quoted market prices, which can rise or fall in reaction to a wide
variety of factors or events, and as such are subject to market-related risks
and uncertainties. The Company also invests in limited partnerships or limited
liability companies which are accounted for under the equity method of
accounting. These investees hold investments in publicly and non-publicly traded
securities, and as such are also subject to market-related risks and
uncertainties and the risks inherent in estimating the fair values of such
securities. Since changes in the fair value of all of these investments are
recognized in the Company's consolidated balance sheet, and with respect to
trading securities or securities owned by equity method investees also in the
Company's consolidated statement of operations, the Company is exposed to
volatility in securities markets.
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, 2007, the Company's accrual
for contingent losses was not material.
Results of Operations
General
Substantially all of the Company's operating businesses sell products or
services that are impacted by general economic conditions in the U.S. and to a
lesser extent internationally. Poor general economic conditions can reduce the
demand for products or services sold by the Company's operating subsidiaries
and/or result in reduced pricing for products or services. Troubled industry
sectors, like the residential real estate market, can have an adverse direct
impact not only on the Company's real estate and property management and
services segments, but also can have an adverse indirect impact on some of the
Company's other operating segments, including manufacturing and gaming
entertainment. The discussions below concerning revenue and profitability by
segment consider current economic conditions and the impact such conditions have
on each segment; however, should general economic conditions worsen and/or if
the country experiences a recession, the Company believes that all of its
businesses would be more adversely impacted than currently anticipated.
The Company does not have any operating businesses that are participants
in the sub-prime real estate lending sector, though a tightening in consumer
lending standards has and will have a direct or indirect negative impact on
certain of the Company's operations. The Company's investment portfolio includes
mortgage-backed securities of $319,500,000 at December 31, 2007; however, all of
these securities are rated investment grade and issued by United States
Government agencies or U.S. Government-Sponsored Enterprises. The Company has
also invested in certain investment partnerships (classified as investments in
associated companies) that invest in securities whose values are directly
affected by the sub-prime lending crisis. The Company's exposure to changes in
their values is limited to the net book value of its investment in such
partnerships. At December 31, 2007, the aggregate book value of the Company's
investments in such partnerships was approximately $140,000,000.
38
Manufacturing - Idaho Timber
Revenues and other income for Idaho Timber for the years ended December
31, 2007 and 2006 and from the date of acquisition (May 2005) through December
31, 2005 were $292,200,000, $345,700,000 and $239,000,000, respectively; gross
profits were $25,100,000, $30,000,000 and $22,000,000, respectively; salaries
and incentive compensation expenses were $7,800,000, $9,400,000 and $6,300,000,
respectively; depreciation and amortization expenses were $4,600,000, $4,900,000
and $4,200,000, respectively; and pre-tax income was $9,100,000, $12,000,000 and
$8,200,000, respectively.
Idaho Timber's revenues for 2007 continued to reflect the weak demand
resulting from reductions in housing starts and the abundant supply of
high-grade lumber in the marketplace. Although shipment volume increased
throughout much of 2007 as compared to the last quarter of 2006, the full year
shipment volume in 2007 declined by 3.5% as compared to 2006. In addition,
average selling prices for 2007 declined almost 12% as compared to 2006. Idaho
Timber expects that the abundance of existing homes available for sale in the
market will continue to negatively impact housing starts and Idaho Timber's
revenues during 2008. Until housing starts begin to increase, dimension lumber
shipping volume may remain flat or could decline further. Curtailment of
production at primary sawmills due to their operating losses could reduce excess
supply to some degree; however, spread (as discussed below) may not improve
since demand and pricing for low-grade lumber may increase if supplies are
reduced.
Idaho Timber's revenues weakened during 2006, reflecting lower average
selling prices and reduced shipment volume. This decline was principally due to
weakening demand resulting from reductions in housing starts and the abundant
supply of lumber in the marketplace. In October 2006, the trade dispute between
the U.S. and Canada over Canadian lumber imports was resolved and a new Softwood
Lumber Agreement became effective that restricts and imposes a tax on Canadian
lumber imports. Prior to the effective date of that agreement, imports from
Canada increased, which added to the oversupply in the market.
Raw material costs, the largest component of cost of sales (approximately
82% of cost of sales), declined during 2007 as compared to 2006 principally due
to the same market conditions that have negatively impacted revenues. However,
raw material costs gradually increased throughout 2007, reflecting less
availability of low-grade lumber due to increased shipments to Asia and Europe
and lower Canadian lumber imports. 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 declined throughout 2007, and were lower by approximately 8% for the
full year as compared to 2006. 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 $17,400,000, $17,900,000 and
$14,200,000 for the years ended December 31, 2007, 2006 and 2005, respectively.
Its manufacturing revenues and other income were $105,400,000, $106,400,000 and
$93,600,000, and gross profits were $31,300,000, $34,400,000 and $28,900,000 for
the years ended December 31, 2007, 2006 and 2005, respectively. Revenues were
largely unchanged in 2007 as compared to 2006 and increased by 14% in 2006 as
compared to 2005.
The slowdown in housing starts and a slow start in road construction due
to weather conditions were principally responsible for the revenue decline in
most of Conwed Plastics' markets during 2007. Markets that are impacted by the
slowdown in the housing industry, which began in the second half of 2006,
include the carpet cushion, building and construction, erosion control and turf
reinforcement markets. In addition, increased competition in the erosion control
market caused a decline in revenues during 2007. Revenues also declined due to
the removal of netting as a component of a customer's bedding product. Conwed
Plastics did realize increased revenues of $7,000,000 from its packaging market,
principally due to acquisitions in May 2006, and in February, July and October
of 2007. Conwed Plastics expects revenues to continue to be adversely impacted
in those markets related to housing, which may offset continued growth in the
packaging market.
The increase in revenues in 2006 as compared to 2005 reflects $5,400,000
of increased revenues from the acquisitions of NSW in February 2005 and Polynet
in May 2006, which increased the segment's product offerings and customer base.
In addition, 2006 revenues reflect increases in the erosion control, carpet
cushion and turf reinforcement markets, partially reduced by a decline in the
consumer products market due to lower demand for certain products. These changes
resulted from a variety of factors including the impact of price increases
implemented in 2005, increased road construction and using a new distributor for
certain products. While the carpet cushion market continued to benefit from the
previously strong housing market through the first half of 2006, it experienced
a reduction in sales volume during the second half of the year resulting from a
slowdown in housing starts.
39
Raw material costs increased by approximately 13% in 2007 as compared to
2006 and by approximately 4% in 2006 as compared to 2005. The primary raw
material in Conwed Plastics' products is a polypropylene resin, which is a
byproduct of the oil refining process, whose price tends to fluctuate with the
price of oil. In addition to managing resin purchases, Conwed Plastics has
improved its ability to reduce and/or reuse scrap and continues to seek further
improvements in order to increase raw material utilization.
Gross margins declined in 2007 as compared to 2006, primarily due to
product mix, increased raw material costs and greater depreciation and
amortization expense related to acquisitions and equipment upgrades. Gross
margins increased in 2006 as compared to 2005 despite the increase in raw
material costs, as the segment was able to increase selling prices in most
markets, and increase sales and production volumes. Gross margin and pre-tax
results for 2007 and 2006 reflect $800,000 and $1,100,000, respectively, of
greater amortization expense on intangible assets resulting from acquisitions
and depreciation expense.
Pre-tax results for 2007 reflects $2,200,000 of lower salaries and
incentive compensation expense as compared to 2006 principally due to lower
pre-tax profits and the conversion of certain European management employees from
salaried employees to contract based professionals. Pre-tax results for 2006
reflect $1,900,000 of higher salaries and incentive compensation expense than
2005, principally due to greater pre-tax profits and increased headcount.
Telecommunications
The telecommunications business of STi Prepaid has been consolidated by
the Company since March 2007. For the period from the asset acquisition through
December 31, 2007, STi Prepaid's telecommunications revenues and other income
were $363,200,000, telecommunications cost of sales were $309,000,000, salaries
and incentive compensation expenses were $8,100,000, selling, general and other
expenses were $27,000,000, and STi Prepaid had pre-tax income of $18,400,000.
Historically, STi Prepaid's revenue volumes have not declined during
periods of generally poor economic conditions, as customers have found prepaid
calling cards to be an attractive alternative to other, higher priced long
distance services. However, STi Prepaid's revenues have declined, as business
was lost to existing competitors and new entrants into the market, which have
been offering low entry pricing to gain market share which STi Prepaid believes
is not sustainable. In addition, during the period STi Prepaid was transitioning
from being a private company to a subsidiary of the Company, it lost some
distributors, which negatively impacted revenues. STi Prepaid has refocused its
efforts at maintaining strong and frequent contact with its distributors, which
was lacking at times during 2007, in an effort to rebuild those relationships
and grow revenue.
Property Management and Services
The property management and services operations of ResortQuest have been
consolidated by the Company since June 2007. For the period from its acquisition
through December 31, 2007, property management and services revenues and other
income were $81,500,000, direct operating expenses were $66,000,000, salaries
and incentive compensation expenses were $4,000,000, depreciation and
amortization expenses were $3,100,000, selling, general and other expenses were
$14,900,000 and pre-tax losses were $6,500,000.
Although revenue trends since acquisition have been consistent with
pre-acquisition periods, the vacation rental component of the property
management business could be negatively impacted by poor economic conditions in
the U.S., including the impact of higher fuel prices and less disposable income.
Slowdowns might be more acutely felt in the fly to markets like ski areas,
rather than drive to markets like Northwest Florida. Even if overall
reservations do not decrease, the number of advance bookings could decline as
consumers wait to decide closer to travel dates whether and where they will
vacation. ResortQuest has initiated a number of promotions to entice repeat
customers into booking their reservations well in advance of arrival. The real
estate brokerage business has been and will continue to be negatively impacted
by the depressed real estate market.
40
Gaming Entertainment
As more fully discussed above, Premier was accounted for as a
consolidated subsidiary when acquired during 2006; however, while in bankruptcy
proceedings from September 19, 2006 to emergence on August 10, 2007, Premier was
accounted for under the equity method of accounting. Premier's casino and hotel
operations opened to the public on June 30, 2007; prior to opening, Premier's
activities principally consisted of rebuilding and repairing the hotel and
casino facilities that were severely damaged by Hurricane Katrina and its
bankruptcy proceedings.
For the period from emergence from bankruptcy (date of reconsolidation)
through December 31, 2007, Premier's revenues and other income were $38,500,000
and its pre-tax losses were $9,300,000. Premier's results for this 2007 period
include direct operating expenses of $37,800,000, interest expense of $500,000,
salaries and incentive compensation expenses of $1,400,000, depreciation and
amortization expenses of $6,300,000, and selling, general and other expenses of
$1,800,000. For the period from date of acquisition (April 2006) through its
filing for bankruptcy in September 2006, Premier's pre-tax losses were not
material.
The Hard Rock Biloxi was the last gaming operation to open in Biloxi
following Hurricane Katrina. The Hard Rock Biloxi is still in the early stages
of establishing its customer database and instituting customer loyalty programs
and has not yet achieved a market share of the local gaming market commensurate
with the size of its facility and the gaming choices it offers. Although Premier
expected it would take some time to build its business, its revenue growth since
it opened has been slower than expected. Its competitors in the Mississippi Gulf
Coast gaming market have been in operation longer than Premier and have more
established gaming operations, marketing programs and customer databases.
The Company's share of Premier's net loss under the equity method of
accounting from January 1, 2007 to the date of emergence from bankruptcy was
$22,300,000 and not material during 2006.
Domestic Real Estate
Pre-tax income (loss) for the domestic real estate segment was
$(8,200,000), $44,000,000 and $4,100,000 for the years ended December 31, 2007,
2006 and 2005, 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, pre-tax results for this segment for any particular year are not
predictable and do not follow any consistent pattern.
The Company did not have any major real estate sales during 2007,
resulting in significantly lower pre-tax profits than in 2006. During 2007, real
estate revenues and other income include $3,900,000 of charges related to the
accounting for the mark-to-market value of an interest rate derivative relating
to the Myrtle Beach project's debt obligation. Pre-tax results for 2007 include
$1,600,000 of incentive compensation accruals related to the Company's real
estate development project in Myrtle Beach, South Carolina. During 2006 pre-tax
income includes the sale by Square 711, which resulted in a pre-tax gain of
$48,900,000, and the sale of other land parcels in Utah for a pre-tax gain of
$11,200,000. In addition, the Company recognized pre-tax profit related to its
95-lot development project in South Walton County, Florida of $3,600,000 and
$6,600,000 for the years ended December 31, 2006 and 2005, respectively. Such
amounts principally result from the completion of certain required improvements
to land previously sold. Pre-tax results for 2006 reflect $8,100,000 of
incentive compensation accruals related to the Company's real estate development
project in Myrtle Beach, South Carolina.
Medical Product Development
Pre-tax losses (net of minority interest) for Sangart for the years ended
December 31, 2007 and 2006 and from the date of acquisition (November 2005)
through December 31, 2005 were $31,500,000, $21,100,000 and $1,400,000,
respectively. Sangart's losses for these periods reflect research and
development costs of $22,100,000, $16,500,000 and $600,000, respectively, and
salaries and incentive compensation expenses of $8,800,000, $6,400,000 and
$1,000,000, respectively.
41
As more fully discussed above, 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(R), and is currently
conducting two Phase III clinical trials in Europe. It does not expect to
complete those clinical trials until 2008, and if they are successful it will
then seek approval with the appropriate regulatory authorities to market its
product. Sangart also recently completed a smaller Phase II clinical trial in
the U.S., data from which is still being compiled. 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 expects to invest up to an additional $48,500,000 in 2008
upon its exercise of existing warrants which will continue to fund Sangart's
research and development costs and which will be expensed by the Company over
time. The Company is unable to predict with certainty when, if ever, it will
report operating profits for this segment.
When the Company increases its investment in Sangart, the additional
investment is accounted for under the purchase method of accounting. Under the
purchase method, the price paid 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 was initially allocated to research and
development. However, since under current 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. The Company expensed acquired research and development of $4,100,000
and $7,500,000 for the years ended December 31, 2007 and 2006, 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, including the need to
increase Hemospan production for the clinical trials.
Corporate and Other Operations
Investment and other income decreased in 2007 as compared to the same
periods in 2006. Investment and other income during 2006 includes $34,700,000
related to the sales of two associated companies; investment and other income
during 2007 includes the receipt of escrowed proceeds from one of those sales of
$11,400,000 that had not been previously recognized. In addition, investment and
other income for 2006 includes $7,400,000 from the recovery of bankruptcy
claims. Interest income also declined by $22,400,000 in 2007 as compared to 2006
principally due to the sale of interest bearing securities to generate cash to
purchase Fortescue's securities and interests in associated companies. For 2007,
investment and other income includes $8,500,000 related to the termination of a
joint development agreement with another party. The amount recorded in other
income substantially reimbursed the Company for its prior expenditures, which
were fully expensed as incurred. Investment and other income for 2007 also
includes $4,200,000 of foreign exchange gains. Investment and other income
includes income (charges) of $(1,900,000), $1,200,000 and $1,700,000 for the
years ended December 31, 2007, 2006 and 2005, respectively, related to the
accounting for mark-to-market values of Corporate derivatives.
Investment and other income increased in 2006 as compared to 2005
primarily due to greater interest income of $54,400,000, reflecting a larger
amount of invested assets and higher interest rates, $34,700,000 related to the
sales of two associated companies and $7,400,000 from the recovery of bankruptcy
claims. Investment and other income in 2005 includes a gain of $10,500,000 on
the sale of 70% of the Company's interest in CLC to Inmet.
Net securities gains for Corporate and Other Operations aggregated
$95,600,000, $117,200,000 and $208,800,000 for the years ended December 31,
2007, 2006 and 2005. 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 and unrealized gains on
trading securities. Included in net securities gains for 2007 is a gain of
$37,800,000 from the sale of Eastman. Included in net securities gains for 2006
is a gain of $37,400,000 from the sale of Level 3 common stock. Included in net
securities gains for 2005 is a gain of $146,000,000 from the sale of 375,000
shares of WMIG common stock. Net securities gains for 2007, 2006 and 2005
include provisions of $36,800,000, $12,900,000 and $12,200,000, respectively, to
write down the Company's investments in certain available for sale securities
and, in 2007, an investment in a non-public security.
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.
42
The increase in interest expense during 2007 as compared to 2006
primarily reflects interest expense relating to the 7 1/8% Senior Notes issued
in March 2007, the 8 1/8% Senior Notes issued in September 2007 and the fixed
rate repurchase agreements. Interest expense during 2006 also include interest
on $21,700,000 principal amount of 7 7/8% Subordinated Notes, which matured in
the third quarter of 2006, and interest expense relating to Premier prior to its
deconsolidation of $8,000,000. The increase in interest expense during 2006 as
compared to 2005 primarily reflects interest expense relating to Premier prior
to its deconsolidation and the fixed rate repurchase agreements.
Salaries and incentive compensation expense decreased by $4,900,000 in
2007 as compared to 2006, principally due to a reduction in incentive bonus
expense and less share-based compensation expense. Salaries and incentive
compensation expense did not significantly change in 2006 as compared to 2005.
As a result of the adoption of SFAS 123R in 2006, the Company recorded
share-based compensation expense relating to grants made under the Company's
senior executive warrant plan and the fixed stock option plan of $11,200,000 in
2007 and $15,200,000 in 2006. The decrease in share-based compensation expense
in 2007 largely related to grants made under the warrant plan in 2006 for which
a portion vested upon issuance. This decrease was partially offset by increased
expenses in 2007 relating to the stock option plan due to the accelerated
vesting of stock options of an officer of the Company who resigned. Salaries and
incentive compensation expense for 2006 also reflects lower bonus expense as
compared to 2005.
The increase in selling, general and other expenses of $32,900,000 in
2007 as compared to 2006 primarily reflects higher professional fees and other
costs, which largely relate to analyses of potential and existing investments
and projects, and increased legal fees, including those incurred in connection
with litigation related to MK Resources. This litigation was settled during
2007, and selling, general and other expenses include a charge of $7,500,000 for
that settlement. Selling, general and other expenses related to Energy Projects
were $19,700,000, $8,300,000 and $1,600,000 for the years ended December 31,
2007, 2006 and 2005, respectively.
The increase in selling, general and other expenses of $8,800,000 in
2006 as compared to 2005 primarily reflects increased corporate aircraft
expenses, higher professional fees and other costs, which largely relate to
potential investments and projects and existing investments, and greater
employee benefit costs including pension costs relating to WilTel's retained
pension plan. In addition, 2005 reflects an impairment loss (described below)
for the remaining book value of Olympus Re Holdings, Ltd. ("Olympus") of
$3,700,000.
As more fully discussed above, during 2007 and 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,
$542,700,000 in 2007 and $1,135,100,000 in 2005 of the deferred tax valuation
allowance was reversed as a credit to income tax expense. The Company adjusted
the valuation allowance since it believes it is more likely than not that it
will have future taxable income sufficient to realize that portion of the net
deferred tax asset. The income tax provision reflects the reversal of tax
reserves aggregating $2,300,000 and $8,000,000 for the years ended December 31,
2007 and 2006, respectively, as a result of the favorable resolution of various
state and federal income tax contingencies.
Associated Companies
Equity in income (losses) of associated companies includes the following
for the years ended December 31, 2007, 2006 and 2005 (in thousands):
43
2007 2006 2005
---- ---- ----
Pershing Square $ (85,500) $ -- $ --
Shortplus 54,500 -- --
Highland Opportunity (17,600) -- --
Wintergreen 14,000 11,000 500
EagleRock (11,800) 16,400 (28,900)
Goober Drilling 13,600 2,000 --
HomeFed 1,500 2,900 5,800
JPOF II 3,000 26,200 23,600
JHYH 4,300 -- --
Ambrose (1,100) -- --
Union Square -- -- 72,800
Premier (22,300) (300) --
Safe Harbor 1,800 (7,600) --
CLC 4,000 3,800 (1,600)
Olympus -- -- (120,100)
Other 10,400 5,700 3,500
---------- -------- ---------
Equity in income (losses) before
income taxes (31,200) 60,100 (44,400)
Income tax (expense) benefit 9,300 (22,400) (700)
---------- -------- ---------
Equity in income (losses),
net of taxes $ (21,900) $ 37,700 $ (45,100)
========== ======== =========
In June 2007, the Company acquired a 10% limited partnership interest in
Pershing Square, a newly-formed private investment partnership whose investment
decisions are at the sole discretion of Pershing Square's general partner. The
stated objective of Pershing Square is to create capital appreciation by
investing in Target Corporation. Losses recorded by Pershing Square principally
result from a decline in the market value of Target Corporation's common stock.
Shortplus, Highland Opportunity, Wintergreen, EagleRock, Ambrose and Safe
Harbor are investment partnerships or limited liability corporations whose
investment decisions are at the sole discretions of their respective general
partners or managing members. These entities invest in a variety of debt and
equity securities.
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.
In April 2007, the Company and Jefferies expanded and restructured the
Company's equity investment in JPOF II, and formed JHYH. The Company contributed
$250,000,000 to JHYH along with its investment in JPOF II; the Company is
committed to contribute an additional $250,000,000 the timing of which is at the
sole discretion of Jefferies. The Company's share of JPOF II's earnings was
distributed to the Company shortly after the end of each period.
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.
44
The Company accounted for Premier under the equity method of accounting
while it was in bankruptcy (September 2006 to August 2007).
The Company's equity in losses from Olympus for 2005 reflects its share
of Olympus 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 no longer applies the equity method of
accounting. The book value of the Company's investment in Olympus was written
down to zero in 2005.
Discontinued Operations
Healthcare Services
In July 2006, the Company sold Symphony for $107,000,000 and classified
its historical operating results as a discontinued operation. After satisfaction
of Symphony's outstanding credit agreement by the buyer ($31,700,000 at date of
sale) and certain sale related obligations, the Company realized net cash
proceeds of $62,300,000. Pre-tax income of Symphony was $200,000 and $3,300,000
for the years ended December 31, 2006 and 2005, respectively. Gain on disposal
of discontinued operations for 2006 includes a pre-tax gain on the sale of
Symphony of $53,300,000 ($33,500,000 after tax).
Telecommunications - ATX
In September 2006, the Company sold ATX for $85,700,000 and classified
its historical operating results as a discontinued operation. Pre-tax losses of
ATX were $1,200,000 and $1,900,000 for the years ended December 31, 2006 and
2005, respectively. Gain on disposal of discontinued operations for 2006
includes a pre-tax gain on the sale of ATX of $41,600,000 ($26,100,000 after
tax).
WilTel
The Company sold WilTel to Level 3 in December 2005, recognized a pre-tax
gain on disposal of $243,800,000 ($243,800,000 after tax) and classified its
historical operating results as a discontinued operation. The calculation of the
gain on sale included: (1) the cash proceeds received from Level 3 of
$460,300,000, which was 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 AT&T cash payments that had not been
previously accrued prior to closing ($175,900,000); (4) an impairment charge for
WilTel's headquarters building of $42,400,000; and (5) the net book value of the
net assets sold and estimated expenses and other costs related to the
transaction. WilTel's pre-tax income from discontinued operations was
$116,000,000 for the year ended December 31, 2005.
Gain on disposal of discontinued operations for 2007 includes a pre-tax
gain of $800,000 ($500,000 after tax) from the resolution of a sale-related
contingency. Gain on disposal of discontinued operations during 2006 includes
$2,400,000 of pre-tax gains ($1,500,000 after tax) principally for the
resolution of certain sale-related contingencies and obligations and working
capital adjustments.
Real Estate
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. The Company recorded a pre-tax gain of
$56,600,000 ($56,600,000 after tax), which is reflected in gain on disposal of
discontinued operations.
45
Other
Gain on disposal of discontinued operations for 2007 includes a pre-tax
gain of $4,000,000 ($2,800,000 after tax) related to the collection of
additional amounts from the sale of the Company's interest in an Argentine shoe
manufacturer in 2005 that had not been previously recognized (collectibility was
uncertain). Although there was no material gain or loss on disposal in 2005,
results of discontinued operations during 2005 include a pre-tax loss of
$4,400,000 related to this investment.
In 2006, the Company sold its gas properties and recorded a pre-tax loss
on disposal of discontinued operations of $900,000. Income (loss) from
discontinued operations for 2006 includes $2,900,000 of pre-tax losses related
to these gas properties; amounts for 2005 were not material.
In 2006, the Company received $3,000,000 from a former insurance
subsidiary which, for many years, had been undergoing liquidation proceedings
controlled by state insurance regulators. The Company reflected the amount
received as a gain on disposal of discontinued operations. For income tax
purposes, the payment is treated as a non-taxable distribution paid by a
subsidiary; as a result, no tax expense has been recorded.
Recently Issued Accounting Standards
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 2008, the FASB deferred for one year the effective date of SFAS 157
only with respect to nonfinancial assets and nonfinancial liabilities that are
recognized or disclosed at fair value in the financial statements on a
nonrecurring basis, and removed certain leasing transactions from the scope of
SFAS 157. The Company does not believe that the adoption of SFAS 157 will have a
material impact on its consolidated financial statements; however, fair value
measurements for new assets or liabilities, and fair value measurements for
existing nonfinancial assets and nonfinancial liabilities, may be materially
different under SFAS 157.
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 does not intend to apply the
provisions of SFAS 159 to those items addressed by the standard and held as of
January 1, 2008. However, for financial instruments and other items addressed by
the standard acquired or entered into after January 1, 2008, the Company will
make an assessment at such time as to whether to apply the provisions of SFAS
159.
In December 2007, the FASB issued Statement of Financial Accounting
Standards No. 141R, "Business Combinations" ("SFAS 141R") and Statement of
Financial Accounting Standards No. 160, "Noncontrolling Interests in
Consolidated Financial Statements" ("SFAS 160"). SFAS 141R will change how
business combinations are accounted for and will impact financial statements
both on the acquisition date and in subsequent periods. SFAS 160 will change the
accounting and reporting for minority interests, which will be recharacterized
as noncontrolling interests and classified as a component of equity. SFAS 141R
and SFAS 160 are effective for fiscal years beginning after December 15, 2008.
The Company is currently evaluating the impact of adopting SFAS 141R and SFAS
160 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.
46
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.
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 and equity
price risk.
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 35% of the Company's total investment portfolio at
December 31, 2007. 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 2.4 years at December 31, 2007. 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, 2006, fixed income securities comprised approximately 57% of the Company's
total investment portfolio and had an estimated weighted average remaining life
of 2.5 years.
Also included in the Company's available for sale investment portfolio
are equity securities, which are recorded on the balance sheet at an aggregate
fair value of $2,198,500,000 (aggregate cost of $533,000,000), and which
comprised approximately 58% of the Company's total investment portfolio at
December 31, 2007. The majority of this amount consists of two publicly traded
securities, the largest of which is the investment in Fortescue common shares,
which is carried at fair value of $1,824,700,000. In addition, the Company's
investment portfolio includes its investment in ACF, which is carried at fair
value of $71,500,000 at December 31, 2007. The Company's investment portfolio
also includes its investment in Inmet, which is carried at cost of $78,000,000
at December 31, 2007. Although the Company is currently restricted from selling
the Inmet common shares, the investment is subject to price risk. The market
value of this investment is $451,800,000 at December 31, 2007. As discussed more
fully above in Management's Discussion and Analysis of Financial Condition and
Results of Operations, the Company evaluates its investments for impairment on a
quarterly basis.
At December 31, 2007 and 2006, the Company's portfolio of trading
securities was not material to the total investment portfolio.
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.
47
For additional information, see Notes 6, 12 and 21 of Notes to
Consolidated Financial Statements.
Expected Maturity Date
----------------------
2008 2009 2010 2011 2012 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
(Dollars in thousands)
Rate Sensitive Assets:
Available for Sale Fixed
Income Securities:
U.S. Government and agencies $ 747,305 $ 24,522 $ 4,761 $ 3,393 $ 2,456 $ 8,930 $ 791,367 $ 791,367
Weighted Average
Interest Rate 4.09% 3.90% 5.96% 5.99% 6.01% 6.00%
U.S. Government-
Sponsored Enterprises $ 217,583 $ 42,383 $ 32,387 $ 25,634 $ 20,796 $ 103,761 $ 442,544 $ 442,544
Weighted Average
Interest Rate 4.88% 6.71% 6.73% 6.74% 6.74% 6.71%
Other Fixed Maturities:
Rated Investment Grade $ 1,328 $ 717 $ -- $ 6,567 $ -- $ 22,396 $ 31,008 $ 31,008
Weighted Average
Interest Rate 1.22% 4.13% -- .81% -- 2.99%
Rated Less Than Investment
Grade/Not Rated $ 1,064 $ 6,639 $ 1,619 $ 3,178 $ 1,847 $ 39,945 $ 54,292 $ 54,292
Weighted Average Interest
Rate 7.63% 10.57% 8.25% 8.50% 9.00% 11.56%
Rate Sensitive Liabilities:
Fixed Interest Rate Borrowings $ 130,291 $ 5,370 $ 12,161 $ 1,059 $ 1,174 $1,919,483 $ 2,069,538 $ 2,464,944
Weighted Average
Interest Rate 5.23% 8.30% 7.87% 12.18% 12.20% 6.87%
Variable Interest Rate
Borrowings $ 2,114 $ 29,905 $ 2,114 $ 32,879 $ -- $ -- $ 67,012 $ 67,012
Weighted Average
Interest Rate 6.60% 6.74% 8.28% 8.39% -- --
Rate Sensitive Derivative
Financial Instruments:
Euro currency swap $ 2,085 $ 2,085 $ 522 $ -- $ -- $ -- $ 4,692 $ (2,862)
Average Pay Rate 5.89% 5.89% 5.89% -- -- --
Average Receive Rate 7.60% 7.60% 7.60% -- -- --
Pay Fixed/Receive Variable
Interest Rate Swap $ 2,114 $ 29,905 $ 2,114 $ 32,879 $ -- $ -- $ 67,012 $ (5,380)
Average Pay Rate 5.04% 5.04% 5.01% 5.01% -- --
Average Receive Rate 3.64% 3.50% 4.28% 4.39% -- --
Off-Balance Sheet Items:
Unused Lines of Credit $ -- $ -- $ -- $ 100,000 $ -- $ -- $ 100,000 $ 100,000
Weighted Average
Interest Rate 4.51% 4.79% 5.15% 5.28% -- --
48
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, 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 December 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 December
31, 2007, 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.
49
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, 2007. 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 STi Prepaid and ResortQuest, each of which was acquired by the
Company during 2007. In the aggregate, these entities represent approximately 2%
of consolidated assets at December 31, 2007 and 38% of 2007 consolidated
revenues.
Based on our assessment and those criteria, management concluded that, as
of December 31, 2007, the Company's internal control over financial reporting
was effective.
The effectiveness of the Company's internal control over financial
reporting as of December 31, 2007 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 2008 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.
------- --------------------------------------------------------------
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. Independent Accounting Firm Fees.
-------- --------------------------------
The information to be included under the caption "Independent Accounting
Firm Fees" in the Proxy Statement is incorporated herein by reference.
50
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, 2007 and 2006.................................. F-3
Consolidated Statements of Operations for the years ended December 31, 2007,
2006 and 2005........................................................................... F-4
Consolidated Statements of Cash Flows for the years ended December 31, 2007,
2006 and 2005........................................................................... F-5
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 2007, 2006 and 2005........................................................ F-7
Notes to Consolidated Financial Statements................................................. F-8
Financial Statement Schedule:
Schedule II - Valuation and Qualifying Accounts............................................ F-46
(3) Executive Compensation Plans and Arrangements. See Item 15(b)
below for a complete list of Exhibits to this Report.
1999 Stock Option Plan, as amended April 5, 2006 (filed as Annex
C to the Company's Proxy Statement dated April 17, 2006 (the
"2006 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")).
Form of Amendment No. 1 to the Amended and Restated Shareholders
Agreement dated as of June 30, 2003 (filed as Exhibit 10.6 to the
Company's Quarterly Report on Form 10-Q for the fiscal quarter
ended June 30, 2006 (the "2nd Quarter 2006 10-Q")).
Leucadia National Corporation 2003 Senior Executive Annual
Incentive Bonus Plan, as amended May 16, 2006 (filed as Annex A
to the 2006 Proxy Statement).
Leucadia National Corporation 2006 Senior Executive Warrant Plan
(filed as Annex B to the 2006 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).
51
(b) Exhibits.
We will furnish any exhibit upon request made to our Corporate Secretary,
315 Park Avenue South, New York, NY 10010. We charge $.50 per page to cover
expenses of copying and mailing.
3.1 Restated Certificate of Incorporation (filed as Exhibit 5.1 to
the Company's Current Report on Form 8-K dated
July 14, 1993).*
3.2 Certificate of Amendment of the Certificate of Incorporation
dated as of May 14, 2002 (filed as Exhibit 3.2 to the
2003 10-K).*
3.3 Certificate of Amendment of the Certificate of Incorporation
dated as of December 23, 2002 (filed as Exhibit 3.2 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2002 (the "2002 10-K")).*
3.4 Amended and Restated By-laws as amended through December 17,
2007 (filed as Exhibit 3.1 to the Company's Current Report on
Form 8-K dated December 17, 2007).*
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 (filed as Exhibit 3.5 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2005 (the "2005 10-K")).*
3.7 Certificate of Amendment of the Certificate of Incorporation
dated as of May 15, 2007.
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, as amended April 5, 2006 (filed as
Annex A to the 2006 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 Services Agreement, dated as of January 1, 2004, between the
Company and Ian M. Cumming (filed as Exhibit 10.37 to
the 2005 10-K).*
10.5 Services Agreement, dated as of January 1, 2004, between the
Company and Joseph S. Steinberg (filed as Exhibit 10.38
to the 2005 10-K).*
10.6 Leucadia National Corporation 2003 Senior Executive Annual
Incentive Bonus Plan, as amended May 16, 2006 (filed as
Annex A to the 2006 Proxy Statement).*
10.7 Employment Agreement made as of June 30, 2005 by and between
the Company and Ian M. Cumming (filed as Exhibit 99.1
to the July 13, 2005 8-K).*
10.8 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).*
52
10.9 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")).*
10.10 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).*
10.11 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).*
10.12 Information Concerning Executive Compensation (filed as
Exhibit 10.1 to the Company's Current Report on Form 8-K
dated January 11, 2007).*
10.13 Form of Unit Purchase Agreement, dated as of April 6, 2006, by
and among GAR, LLC, the Company, AA Capital Equity Fund, L.P.,
AA Capital Biloxi Co-Investment Fund, L.P. and HRHC Holdings,
LLC (filed as Exhibit 10.1 to the 2nd Quarter 2006 10-Q).*
10.14 Form of Loan Agreement, dated as of April 6, 2006, by and
among Goober Drilling, LLC, the Subsidiaries of Goober
Drilling, LLC from time to time signatory thereto and the
Company (filed as Exhibit 10.2 to the 2nd Quarter 2006 10-Q).*
10.15 Form of First Amendment to Loan Agreement, dated as of June
15, 2006, between Goober Drilling, LLC, the Subsidiaries of
Goober Drilling, LLC from time to time signatory thereto and
the Company (filed as Exhibit 10.3 to the 2nd Quarter 2006
10-Q).*
10.16 Form of First Amended and Restated Limited Liability Company
Agreement of Goober Drilling, LLC, dated as of June 15, 2006,
by and among Goober Holdings, LLC, Baldwin Enterprises, Inc.,
the Persons that become Members from time to time, John
Special, Chris McCutchen, Jim Eden, Mike Brown and Goober
Drilling Corporation (filed as Exhibit 10.4 to the 2nd Quarter
2006 10-Q).*
10.17 Form of Purchase and Sale Agreement, dated as of May 3, 2006,
by and among LUK-Symphony Management, LLC, Symphony Health
Services, LLC and RehabCare Group, Inc. (filed as Exhibit 10.5
to the 2nd Quarter 2006 10-Q).*
10.18 Form of Amendment No. 1, dated as of May 16, 2006, to the
Amended and Restated Shareholders Agreement dated as of June
30, 2003, by and among Ian M. Cumming, Joseph S. Steinberg and
the Company (filed as Exhibit 10.6 to the 2nd Quarter 2006
10-Q).*
10.19 Form of Credit Agreement, dated as of June 28, 2006, by and
among the Company, the various financial institutions and
other Persons from time to time party thereto and JPMorgan
Chase Bank, National Association (filed as Exhibit 10.7 to the
2nd Quarter 2006 10-Q).*
10.20 Form of Subscription Agreement, dated as of July 15, 2006, by
and among FMG Chichester Pty Ltd, the Company, and Fortescue
Metals Group Ltd (filed as Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 2006 (the "3rd Quarter 2006 10-Q")).*
10.21 Form of Amending Agreement, dated as of August 18, 2006, by
and among FMG Chichester Pty Ltd, the Company and Fortescue
Metals Group Ltd (filed as Exhibit 10.2 to the 3rd Quarter
2006 10-Q).*
53
10.22 Compensation Information Concerning Non-Employee Directors
(filed under item 1.01 of the Company's Current Report on
Form 8-K dated May 22, 2006).*
10.23 Leucadia National Corporation 2006 Senior Executive Warrant
Plan (filed as Annex B to the 2006 Proxy Statement).*
10.24 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, STiPrepaid & Co., STi Prepaid Distributors &
Co. and ST Finance, LLC (filed as Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 2007 (the "1st Quarter 2007 10-Q")).*
10.25 Registration Rights Agreement, dated as of March 8, 2007,
among STi Prepaid, LLC and ST Finance, LLC (filed as
Exhibit 10.2 to the 1st Quarter 2007 10-Q).*
10.26 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 (filed as Exhibit 10.3 to the
1st Quarter 2007 10-Q).*
10.27 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 (filed as Exhibit 10.4 to the 1st Quarter 2007
10-Q).*
10.28 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 (filed as Exhibit 10.5 to the 1st
Quarter 10-Q).*
10.29 Stock Purchase Agreement by and among BEI-RZT Corporation,
Gaylord Hotels, Inc. and Gaylord Entertainment Company
(Mainland Agreement), dated June 1, 2007 (filed as Exhibit
10.1 to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 2007).*
21 Subsidiaries of the registrant.
54
23.1 Consent of PricewaterhouseCoopers LLP with respect to the
incorporation by reference into the Company's Registration
Statements on Form S-8 (No. 333-51494), Form S-8
(No. 333-143770), and Form S-3 (No. 333-145668).
23.2 Consent of PricewaterhouseCoopers, with respect to the
inclusion in this Annual Report on Form 10-K of 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. 333-51494), Form S-8
(No. 333-143770), and Form S-3 (No. 333-145668).**
23.3 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. 333-51494), Form S-8 (No.
333-143770), and Form S-3 (No. 333-145668).**
23.4 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.
333-51494), Form S-8 (No. 333-143770), and Form S-3 (No.
333-145668).**
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 Pershing Square IV, L.P. and with
respect to the incorporation by reference in the Company's
Registration Statements on Form S-8 (No. 333-51494), Form S-8
(No. 333-143770), and Form S-3 (No. 333-145668). **
23.6 Consent of independent auditors from PricewaterhouseCoopers
LLP, with respect to the inclusion in this Annual Report on
Form 10-K of the financial statements of Premier Entertainment
Biloxi, LLC and with respect to the incorporation by reference
in the Company's Registration Statements on Form S-8 (No.
333-51494), Form S-8 (No.333-143770), and Form S-3
(No. 333-145668). **
23.7 Consent of independent auditors from PricewaterhouseCoopers
LLP, with respect to the inclusion in this Annual Report on
Form 10-K of the financial statements of HFH ShortPLUS Fund,
L.P. and HFH ShortPLUS Master Fund, Ltd. and with respect to
the incorporation by reference in the Company's Registration
Statements on Form S-8 (No.333-51494), Form S-8
(No. 333-143770), and Form S-3 (No. 333-145668). **
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.***
55
(c) Financial statement schedules.
(1) Olympus Re Holdings, Ltd. consolidated financial
statement for the year ended December 31, 2005.**
(2) EagleRock Capital Partners (QP), LP financial
statements as of December 31, 2007 and 2006 and for the
years ended December 31, 2007, 2006 and 2005 and
EagleRock Master Fund, LP financial statements as of
December 31, 2007 and 2006 and for the years ended
December 31, 2007, 2006 and 2005.**
(3) Jefferies Partners Opportunity Fund II, LLC financial
statements as of and for the period ended March 31,
2007 (unaudited), as of and for the year ended December
31, 2006 (unaudited), and as of and for the year ended
December 31, 2005 (audited). **
(4) Pershing Square IV, L.P. financial statements as of
December 31, 2007 and for the year ended December 31,
2007. **
(5) Premier Entertainment Biloxi, LLC financial statements
as of and for the year ended December 31, 2006
(unaudited) and as of August 9, 2007 and for the period
from January 1, 2007 through August 9, 2007 (audited).**
(6) HFH Highland ShortPLUS Fund, L.P. financial statements
as of December 31, 2007 and for the year ended December
31, 2007 and HFH ShortPLUS Master Fund, Ltd. financial
statements as of December 31, 2007 and for the year
ended December 31, 2007. **
----------------------------
* 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.
56
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
February 29, 2008 By: /s/ Barbara L. Lowenthal
------------------------
Barbara L. Lowenthal
Vice President and Comptroller
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated, on the date set forth above.
Signature Title
--------- -----
/s/ Ian M. Cumming Chairman of the Board
---------------------------------- (Principal Executive Officer)
Ian M. Cumming
/s/ Joseph S. Steinberg President and Director
---------------------------------- (Principal Executive Officer)
Joseph S. Steinberg
/s/ Joseph A. Orlando Vice President and Chief
---------------------------------- Financial Officer
Joseph A. Orlando (Principal Financial Officer)
/s/ Barbara L. Lowenthal Vice President and Comptroller
---------------------------------- (Principal Accounting Officer)
Barbara L. Lowenthal
/s/ Paul M. Dougan Director
----------------------------------
Paul M. Dougan
/s/ Lawrence D. Glaubinger Director
----------------------------------
Lawrence D. Glaubinger
/s/ Alan J. Hirschfield Director
----------------------------------
Alan J. Hirschfield
/s/ James E. Jordan Director
----------------------------------
James E. Jordan
/s/ Jeffrey C. Keil Director
----------------------------------
Jeffrey C. Keil
/s/ Jesse Clyde Nichols, III Director
----------------------------------
Jesse Clyde Nichols, III
57
Report of Independent Registered Public Accounting Firm
To the Board of Directors and
Shareholders of Leucadia National Corporation:
In our opinion, the consolidated financial statements listed in the accompanying
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, 2007 and 2006, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2007 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. Also in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2007, based on criteria established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Company's management is
responsible for these financial statements and financial statement schedule, for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting,
included in "Management's Report on Internal Control Over Financial Reporting"
appearing under Item 9A. Our responsibility is to express an opinion on these
financial statements, on the financial statement schedule, and on the Company's
internal control over financial reporting based on our integrated audits. We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audits of the financial statements included 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.
Our audit of internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, and testing and evaluating the design and
operating effectiveness of internal control based on the assessed risk. Our
audits also included performing such other procedures as we considered necessary
in the circumstances. We believe that our audits provide a reasonable basis for
our opinions.
As discussed in Note 2 and Note 13 to the consolidated financial statements, the
Company changed the manner in which it accounts for share-based compensation in
2006.
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.
F-1
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 ResortQuest International and STi Prepaid,
LLC from its assessment of internal control over financial reporting as of
December 31, 2007 because those entities were acquired by the Company during
2007. We have also excluded ResortQuest International and STi Prepaid, LLC from
our audit of internal control over financial reporting. ResortQuest
International and STi Prepaid, LLC are consolidated subsidiaries whose total
assets and total revenues represent approximately 2% and 38%, respectively, of
the related consolidated financial statement amounts as of and for the year
ended December 31, 2007.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
New York, New York
February 28, 2008
F-2
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2007 and 2006
(Dollars in thousands, except par value)
2007 2006
----------- ----------
ASSETS
------
Current assets:
Cash and cash equivalents $ 456,970 $ 287,199
Investments 983,199 903,973
Trade, notes and other receivables, net 133,765 69,822
Prepaids and other current assets 146,199 105,215
----------- -----------
Total current assets 1,720,133 1,366,209
Non-current investments 2,776,521 1,465,849
Notes and other receivables, net 16,388 24,999
Intangible assets, net and goodwill 79,506 59,437
Deferred tax asset, net 1,113,925 978,415
Other assets 544,432 401,689
Property, equipment and leasehold improvements, net 512,804 234,216
Investments in associated companies 1,362,913 773,010
----------- -----------
Total $ 8,126,622 $ 5,303,824
=========== ===========
LIABILITIES
-----------
Current liabilities:
Trade payables and expense accruals $ 229,560 $ 127,739
Deferred revenue 86,993 --
Other current liabilities 10,992 5,688
Debt due within one year 132,405 184,815
Income taxes payable -- 8,411
----------- -----------
Total current liabilities 459,950 326,653
Other non-current liabilities 71,061 90,268
Long-term debt 2,004,145 974,646
----------- -----------
Total liabilities 2,535,156 1,391,567
----------- -----------
Commitments and contingencies
Minority interest 20,974 18,982
----------- -----------
SHAREHOLDERS' EQUITY
--------------------
Common shares, par value $1 per share, authorized 600,000,000 and 300,000,000
shares; 222,574,440 and 216,351,466 shares issued and outstanding, after
deducting 56,886,204 and 56,884,989 shares held in treasury 222,574 216,351
Additional paid-in capital 783,145 520,892
Accumulated other comprehensive income (loss) 975,365 (4,726)
Retained earnings 3,589,408 3,160,758
----------- -----------
Total shareholders' equity 5,570,492 3,893,275
----------- -----------
Total $ 8,126,622 $ 5,303,824
=========== ===========
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, 2007, 2006 and 2005
(In thousands, except per share amounts)
2007 2006 2005
---- ---- ----
REVENUES AND OTHER INCOME:
Manufacturing $ 397,113 $ 450,835 $ 332,253
Telecommunications 361,742 -- --
Property management and service fees 80,892 -- --
Gaming entertainment 38,042 -- --
Investment and other income 181,465 294,678 148,814
Net securities gains 95,641 117,159 208,816
----------- ----------- -----------
1,154,895 862,672 689,883
----------- ----------- -----------
EXPENSES:
Cost of sales:
Manufacturing 340,703 386,466 281,451
Telecommunications 309,045 -- --
Direct operating expenses:
Property management and services 65,992 -- --
Gaming entertainment 37,772 -- --
Interest 111,537 79,392 65,523
Salaries and incentive compensation 88,269 89,501 71,884
Depreciation and amortization 35,238 22,105 18,070
Selling, general and other expenses 223,427 151,388 118,520
----------- ----------- -----------
1,211,983 728,852 555,448
----------- ----------- -----------
Income (loss) from continuing operations before income taxes and
equity in income (losses) of associated companies (57,088) 133,820 134,435
----------- ----------- -----------
Income tax (benefit) provision:
Current 155 (4,902) 4,062
Deferred (559,926) 46,673 (1,135,100)
----------- ----------- -----------
(559,771) 41,771 (1,131,038)
----------- ----------- -----------
Income from continuing operations before equity in income
(losses) of associated companies 502,683 92,049 1,265,473
Equity in income (losses) of associated companies, net of taxes (21,875) 37,720 (45,133)
----------- ----------- -----------
Income from continuing operations 480,808 129,769 1,220,340
Income (loss) from discontinued operations, net of taxes 159 (3,960) 115,329
Gain on disposal of discontinued operations, net of taxes 3,327 63,590 300,372
----------- ----------- -----------
Net income $ 484,294 $ 189,399 $ 1,636,041
=========== =========== ===========
Basic earnings (loss) per common share:
Income from continuing operations $2.20 $ .60 $5.66
Income (loss) from discontinued operations -- (.02) .54
Gain on disposal of discontinued operations .02 .30 1.39
----- ----- -----
Net income $2.22 $ .88 $7.59
===== ===== =====
Diluted earnings (loss) per common share:
Income from continuing operations $2.09 $ .60 $5.34
Income (loss) from discontinued operations -- (.02) .50
Gain on disposal of discontinued operations .01 .27 1.30
----- ----- -----
Net income $2.10 $ .85 $7.14
===== ===== =====
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, 2007, 2006 and 2005
(In thousands)
2007 2006 2005
---- ---- ----
Net cash flows from operating activities:
-----------------------------------------
Net income $ 484,294 $ 189,399 $ 1,636,041
Adjustments to reconcile net income to net cash provided by (used for) operations:
Deferred income tax provision (benefit) (567,864) 99,990 (1,135,100)
Depreciation and amortization of property, equipment and leasehold improvements 41,216 35,884 186,428
Other amortization 1,227 (11,884) 3,068
Share-based compensation 11,176 15,164 --
Excess tax benefit from exercise of stock options (4,022) (456) --
Provision for doubtful accounts 566 1,089 6,181
Net securities gains (95,641) (117,159) (212,299)
Equity in (income) losses of associated companies 31,218 (60,056) 44,403
Distributions from associated companies 55,769 75,725 90,280
Net gains related to real estate, property and equipment and other assets (30,040) (109,107) (29,386)
Gain on disposal of discontinued operations (4,748) (99,456) (300,372)
Investments classified as trading, net 45,128 4,469 18,022
Net change in:
Restricted cash 22,799 8,690 (11,871)
Trade, notes and other receivables 11,989 183,263 20,850
Prepaids and other assets (588) (2,914) (18,107)
Trade payables and expense accruals 835 (73,342) 54,344
Other liabilities (1,267) (47,230) (36,427)
Deferred revenue (16,356) -- 10,553
Income taxes payable (10,834) (6,628) (2,537)
Other 6,774 6,081 (2,961)
----------- ----------- -----------
Net cash provided by (used for) operating activities (18,369) 91,522 321,110
----------- ----------- -----------
Net cash flows from investing activities:
-----------------------------------------
Acquisition of property, equipment and leasehold improvements (37,700) (39,021) (136,260)
Acquisitions of and capital expenditures for real estate investments (97,393) (71,505) (26,053)
Proceeds from disposals of real estate, property and equipment, and other assets 81,247 188,836 33,722
Proceeds from disposal of discontinued operations, net of expenses and
cash of operations sold 4,245 120,228 459,094
Acquisitions, net of cash acquired (90,269) (105,282) (170,516)
Collection of Premier Entertainment Biloxi, LLC's insurance proceeds -- 109,383 --
Net change in restricted cash (65,715) (90,959) --
Advances on notes and other receivables (20,172) (31,518) (100)
Collections on notes, loans and other receivables 38,868 29,823 3,312
Investments in associated companies (1,010,211) (313,152) (34,466)
Capital distributions from associated companies 69,543 4,845 2,644
Investment in Fortescue Metals Group Ltd (44,217) (408,030) --
Purchases of investments (other than short-term) (5,759,504) (3,661,421) (3,350,651)
Proceeds from maturities of investments 688,355 1,149,123 1,262,577
Proceeds from sales of investments 5,286,321 2,933,601 1,979,288
Other (757) (1,127) --
----------- ----------- -----------
Net cash provided by (used for) investing activities (957,359) (186,176) 22,591
----------- ----------- -----------
(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, 2007, 2006 and 2005
(In thousands)
2007 2006 2005
---- ---- ----
Net cash flows from financing activities:
----------------------------------------
Net change in customer banking deposits $ -- $ -- $ (24,565)
Issuance of debt, net of issuance costs 1,017,852 96,676 82,753
Reduction of debt (75,509) (66,223) (477,360)
Issuance of common shares 253,441 3,838 3,689
Purchase of common shares for treasury (163) (187) (167)
Excess tax benefit from exercise of stock options 4,022 456 --
Dividends paid (55,644) (54,085) (27,008)
Other 1,461 14,313 --
----------- ---------- ---------
Net cash provided by (used for) financing activities 1,145,460 (5,212) (442,658)
----------- ---------- ---------
Effect of foreign exchange rate changes on cash 39 108 (1,034)
----------- ---------- ---------
Net increase (decrease) in cash and cash equivalents 169,771 (99,758) (99,991)
Cash and cash equivalents at January 1, 287,199 386,957 486,948
----------- ---------- ---------
Cash and cash equivalents at December 31, $ 456,970 $ 287,199 $ 386,957
=========== ========== =========
Supplemental disclosures of cash flow information:
-------------------------------------------------
Cash paid during the year for:
Interest $ 90,640 $ 82,072 $ 96,958
Income tax payments, net $ 11,078 $ 6,707 $ 3,486
Non-cash investing activities:
-----------------------------
Common stock issued for acquisition of MK Resources Company $ -- $ -- $ 8,346
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, 2007, 2006 and 2005
(In thousands, except par value and per share amounts)
Common Accumulated
Shares Additional Other
$1 Par Paid-In Comprehensive Retained
Value Capital Income (Loss) Earnings Total
----- ------- ------------- -------- -----
Balance, January 1, 2005 $ 215,201 $490,903 $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 $0 (27,611) (27,611)
Net income 1,636,041 1,636,041
----------
Comprehensive income 1,418,401
----------
Issuance of common shares on acquisition of
minority interest in MK Resources Company 432 7,914 8,346
Exercise of options to purchase common shares 432 3,257 3,689
Purchase of common shares for treasury (7) (160) (167)
Dividends ($.13 per common share) (27,008) (27,008)
--------- -------- -------- ---------- ----------
Balance, December 31, 2005 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 $34,149 60,187 60,187
Net change in unrealized foreign exchange
gain (loss), net of taxes of $2,137 3,768 3,768
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $128 (224) (224)
Net change in minimum pension liability,
net of taxes of $6,958 12,263 12,263
Net income 189,399 189,399
----------
Comprehensive income 265,393
----------
Share-based compensation expense 15,164 15,164
Adjustment to initially apply SFAS 158, net of
taxes of $444 782 782
Exercise of options to purchase common shares,
including excess tax benefit 300 3,994 4,294
Purchase of common shares for treasury (7) (180) (187)
Dividends ($.25 per common share) (54,085) (54,085)
--------- -------- -------- ---------- ----------
Balance, December 31, 2006 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 $549,415 959,872 959,872
Net change in unrealized foreign exchange
gain (loss), net of taxes of $3,512 6,126 6,126
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $87 168 168
Net change in pension liability and
postretirement benefits, net of taxes of $7,843 13,925 13,925
Net income 484,294 484,294
----------
Comprehensive income 1,464,385
----------
Share-based compensation expense 11,176 11,176
Issuance of common shares 5,500 236,500 242,000
Exercise of options to purchase common shares,
including excess tax benefit 728 14,735 15,463
Purchase of common shares for treasury (5) (158) (163)
Dividends ($.25 per common share) (55,644) (55,644)
--------- -------- -------- ---------- ----------
Balance, December 31, 2007 $ 222,574 $783,145 $975,365 $3,589,408 $5,570,492
========= ======== ======== ========== ==========
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, telecommunications, property management and services,
gaming entertainment, real estate activities, medical product development and
winery operations. The Company also owns equity interests in operating
businesses and investment partnerships which are accounted for under the equity
method of accounting, including a broker-dealer engaged in making markets and
trading of high yield and special situation securities, land based contract oil
and gas drilling, real estate activities and development of a copper mine in
Spain. 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, LLC ("Idaho
Timber") and Conwed Plastics, LLC ("Conwed Plastics"). Idaho Timber's principal
product lines include remanufacturing dimension lumber; remanufacturing,
bundling and bar coding of home center boards for large retailers; and
production of 5/4" radius-edge, pine decking. Idaho Timber also manufactures
and/or distributes a number of other specialty wood products. Idaho Timber
operates eleven facilities located throughout the United States.
Conwed Plastics manufactures and markets lightweight plastic netting used for a
variety of purposes including, among other things, building and construction,
erosion control, packaging, agricultural, carpet padding, filtration and
consumer products. Conwed Plastics manufacturing segment has four domestic
manufacturing facilities, and it owns and operates manufacturing and sales
facilities in Belgium and Mexico.
The telecommunications business is conducted by the Company's 75% owned
subsidiary, STi Prepaid, LLC ("STi Prepaid"). STi Prepaid is a provider of
international prepaid phone cards and other telecommunications services in the
United States.
The property management and services business is conducted through ResortQuest
International, Inc. ("ResortQuest"). ResortQuest is engaged in offering
management services to vacation properties in beach and mountain resort
locations in the continental United States, as well as in real estate brokerage
services and other rental and property owner services in resort locations.
The gaming entertainment business is conducted through Premier Entertainment
Biloxi, LLC ("Premier"). Premier owns the Hard Rock Hotel & Casino Biloxi ("Hard
Rock Biloxi") located in Biloxi, Mississippi.
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 Company's medical product development operations are conducted through
Sangart, Inc. ("Sangart"), which became a majority-owned subsidiary of the
Company in 2005. Sangart is developing a product called Hemospan(R), which is a
form of cell-free hemoglobin that is designed for intravenous administration to
treat a wide variety of medical conditions, including use as an alternative to
red blood cell transfusions.
The winery operations consist of two wineries, Pine Ridge Winery in Napa Valley,
California and Archery Summit in the Willamette Valley of Oregon, and a vineyard
development project in the Columbia Valley of Washington. The wineries primarily
produce and sell wines in the ultra premium and luxury segments of the premium
table wine market.
Certain amounts for prior periods have been reclassified to be consistent with
the 2007 presentation.
F-8
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 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. See Note 16 for more
information.
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.
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 Communications Group, LLC's
("WilTel"), 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
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, the ability and intent to
hold investments to maturity, 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
$36,800,000, $12,900,000 and $12,200,000 for the years ended December 31, 2007,
2006 and 2005, respectively.
F-9
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 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.
Use of Fair Value Estimates - Substantially all of the Company's investment
portfolio is classified as either available for sale or as trading securities,
both of which are carried at estimated fair value in the Company's consolidated
balance sheet. The estimated fair values are principally based on publicly
quoted market prices, which can rise or fall in reaction to a wide variety of
factors or events, and as such are subject to market-related risks and
uncertainties. The Company also invests in limited partnerships or limited
liability companies which are accounted for under the equity method of
accounting. These investees hold investments in publicly and non-publicly traded
securities, and as such are also subject to market-related risks and
uncertainties and the risks inherent in estimating the fair values of such
securities. Since changes in the fair value of all of these investments are
recognized in the Company's consolidated balance sheet, and with respect to
trading securities or securities owned by equity method investees also in the
Company's consolidated statement of operations, the Company is exposed to
volatility in securities markets.
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, 2007, the Company's accrual for contingent
losses was not material. See Note 18 for more information.
(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. The Company considers special
allocations of cash flows and preferences, if any, to determine amounts
allocable to minority interests. All intercompany transactions and balances are
eliminated in consolidation.
Associated companies are investments in equity interests that are accounted for
on the equity method of accounting. These include investments in corporations
that the Company does not control but has the ability to exercise significant
influence and investments in limited partnerships in which the Company's
interest is more than minor.
F-10
(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
$303,200,000 and $158,100,000 at December 31, 2007 and 2006, 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 publicly 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 Conwed Plastics
upon shipment of goods. Revenues from sales of prepaid phone cards are deferred
when the cards are initially sold and are recognized 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 the outstanding obligation to the
customer. ResortQuest typically receives cash deposits on advance bookings of
its vacation properties that are recorded as deferred revenue. Property
management revenues are recognized ratably over the rental period based on
ResortQuest's proportionate share of the total rental price of the property.
Real estate brokerage revenues are recorded when the transactions are complete.
Gaming entertainment revenues consist of casino gaming, hotel, food and
beverage, and entertainment revenues. Casino gaming revenue is the aggregate of
gaming wins and losses, reduced for the cash value of rewards earned by
customers based on their level of play on slot machines. Hotel, food and
beverage, and entertainment revenues are recognized as services are performed.
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, a portion of revenues are deferred and recognized under
the percentage of completion method of accounting.
(g) Cost of Sales: Manufacturing inventories are stated at the lower of cost or
-------------
market, with cost determined under the first-in-first-out method. Manufacturing
cost of sales principally includes product and manufacturing costs, inbound and
outbound shipping costs and handling costs. STi Prepaid's cost of sales
primarily consists of origination, transport and termination of
telecommunications traffic, and connectivity costs paid to underlying service
providers.
Direct operating expense for property management and services includes expenses
relating to housekeeping, maintenance, reservations, marketing, and other costs
associated with rental and management. Direct operating expenses also include
the cost of sales and operating expenses related to food and beverage sales.
Direct operating expense for gaming entertainment includes expenses relating to
casino gaming, hotel, food and beverage, and entertainment, which primarily
consists of employees' compensation and benefits, cost of sales related to food
and beverage sales, marketing and advertising, gaming taxes, insurance and
supplies.
(h) Research and Development Costs: Research and development costs are expensed
------------------------------
as incurred.
(i) Income Taxes: The Company provides for income taxes using the liability
------------
method. The Company records interest and penalties, if any, with respect to
uncertain tax positions as components of income tax expense.
F-11
(j) 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 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. Amounts recorded as income (charges) in investment and other income were
$(5,800,000), $1,200,000 and $1,700,000 for the years ended December 31, 2007,
2006 and 2005, respectively; net unrealized losses were $1,100,000 and
$1,200,000 at December 31, 2007 and 2006, respectively.
From time to time the Company may also make speculative investments in
derivative financial instruments which are classified as trading securities; see
Note 6 for more information.
(k) Translation of Foreign Currency: Foreign currency denominated investments
-------------------------------
and financial statements are translated into U.S. dollars at current exchange
rates, except that revenues and expenses are translated at average exchange
rates during each reporting period; resulting translation adjustments are
reported as a component of shareholders' equity. Net foreign exchange
transaction gains (losses) were $4,100,000 for 2007, and $(2,700,000) for each
of 2006 and 2005. Net unrealized foreign exchange translation gains (losses)
were $7,000,000, $900,000 and $(2,900,000) at December 31, 2007, 2006 and 2005,
respectively.
(l) Share-Based Compensation: Effective January 1, 2006, the Company adopted
------------------------
Statement of Financial Accounting Standards No. 123R, "Share-Based Payment"
("SFAS 123R"), using the modified prospective method. SFAS 123R requires that
the cost of all share-based payments to employees, including grants of employee
stock options and warrants, be recognized in the financial statements based on
their fair values. The cost is recognized as an expense over the vesting period
of the award. Prior to adoption of SFAS 123R, no compensation cost was
recognized in the statements of operations for the Company's share-based
compensation plans; the Company disclosed certain pro forma amounts as required.
The fair value of each award is estimated at the date of grant using the
Black-Scholes option pricing model.
(m) Recently Issued Accounting Standards: 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 2008, the FASB deferred for one year the
effective date of SFAS 157 only with respect to nonfinancial assets and
nonfinancial liabilities that are recognized or disclosed at fair value in the
financial statements on a nonrecurring basis, and removed certain leasing
transactions from the scope of SFAS 157. The Company does not believe that the
adoption of SFAS 157 will have a material impact on its consolidated financial
statements; however, fair value measurements for new assets or liabilities, and
fair value measurements for existing nonfinancial assets and nonfinancial
liabilities, may be materially different under SFAS 157.
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 does not intend to apply the provisions of SFAS 159 to
those items addressed by the standard and held as of January 1, 2008. However,
for financial instruments and other items addressed by the standard acquired or
entered into after January 1, 2008, the Company will make an assessment at such
time as to whether to apply the provisions of SFAS 159.
In December 2007, the FASB issued Statement of Financial Accounting Standards
No. 141R, "Business Combinations" ("SFAS 141R") and Statement of Financial
Accounting Standards No. 160, "Noncontrolling Interests in Consolidated
Financial Statements" ("SFAS 160"). SFAS 141R will change how business
combinations are accounted for and will impact financial statements both on the
acquisition date and in subsequent periods. SFAS 160 will change the accounting
and reporting for minority interests, which will be recharacterized as
noncontrolling interests and classified as a component of equity. SFAS 141R and
SFAS 160 are effective for fiscal years beginning after December 15, 2008. The
Company is currently evaluating the impact of adopting SFAS 141R and SFAS 160 on
its consolidated financial statements.
F-12
3. Acquisitions:
------------
STi Prepaid
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.
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 $98,600,000 was recognized in the purchase
price allocation (in addition to certain acquired deferred tax assets). Based
upon its allocation of the purchase price, the Company has recorded STi Prepaid
intangible assets of $4,400,000.
ResortQuest
In June 2007, the Company completed the acquisition of ResortQuest for
$11,900,000, including expenses and working capital adjustments finalized
subsequent to the closing date.
Unaudited pro forma operating results for the Company, assuming the acquisitions
of STi Prepaid and ResortQuest had occurred as of the beginning of each year
presented below, are as follows (in thousands, except per share amounts):
2007 2006
---------- ----------
Revenues $1,310,000 $1,545,100
Income before extraordinary items and cumulative effect
of a change in accounting principles $ 482,200 $ 214,000
Net income $ 482,200 $ 214,000
Per Share:
Basic $2.21 $.99
Diluted $2.09 $.96
The amounts above reflect the historical operating results of Telco and
ResortQuest for periods prior to the purchase transactions. Telco's 2007
historical results include a $3,300,000 charge to write down certain inventory.
ResortQuest's 2006 historical results include $4,900,000 of revenue relating to
the full settlement of its claim under its insurance policies as a result of
hurricanes.
Pro forma adjustments principally reflect the allocation of the purchase price
to the difference between 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, resulting in increased
amortization expense. The unaudited pro forma data is not indicative of future
results of operations or what would have resulted if the acquisitions had
actually occurred as of the beginning of the periods presented. Unaudited
acquisition balance sheets are not included as amounts were not material.
Premier
During 2006, the Company indirectly acquired a controlling voting interest in
Premier for an aggregate purchase price of $90,800,000, excluding expenses. The
Company owns approximately 56% of the common units of Premier and all of
Premier's preferred units, which accrue an annual preferred return of 17%. The
Company also acquired Premier's junior subordinated note due August 2012, and
during 2007 provided Premier with a $180,000,000 senior secured credit facility
to partially fund Premier's bankruptcy plan of reorganization (discussed below).
As of December 31, 2007, the Company's investment in Premier was $267,600,000.
At acquisition, the Company consolidated Premier as a result of its controlling
voting interest; during the pendency of bankruptcy proceedings Premier was
deconsolidated and accounted for under the equity method.
Premier owns the Hard Rock Biloxi, which opened to the public on June 30, 2007.
The Hard Rock Biloxi was scheduled to open to the public on August 31, 2005;
however, two days prior to opening, Hurricane Katrina hit the Mississippi Gulf
Coast and severely damaged the hotel and related structures and completely
destroyed the casino. On September 19, 2006, Premier and its subsidiary filed
voluntary petitions for reorganization under the bankruptcy code, before the
United States Bankruptcy Court for the Southern District of Mississippi,
Southern Division. Premier filed its petitions in order to seek the court's
assistance in gaining access to Hurricane Katrina-related insurance proceeds (an
aggregate of $161,200,000) which had been denied to Premier by its pre-petition
secured bondholders.
F-13
Premier filed an amended disclosure statement and plan of reorganization on
February 22, 2007 which provided for the payment in full of all of Premier's
creditors, including payment of principal and accrued interest due to the
holders of Premier's 10 3/4% senior secured notes at par (the "Premier Notes").
On July 30, 2007, the court entered an order confirming the plan, subject to a
modification which Premier filed on August 1, 2007; Premier emerged from
bankruptcy and once again became a consolidated subsidiary of the Company on
August 10, 2007. The plan was funded in part with the $180,000,000 senior
secured credit facility provided by a subsidiary of the Company. The credit
facility matures on February 1, 2012, bears interest at 10 3/4%, is prepayable
at any time without penalty, and contains other covenants, terms and conditions
similar to those contained in the indenture governing the Premier Notes. Since
the plan did not result in any change in ownership of the voting interests in
Premier, the Company did not apply "fresh start" accounting and did not treat
the reconsolidation of Premier as the acquisition of a business that, under the
purchase method of accounting, requires the measurement of assets and
liabilities at fair value. Accordingly, the Company reconsolidated the assets
and liabilities of Premier upon its emergence from bankruptcy using its
historical basis in Premier's assets and liabilities.
See Note 18 for information concerning contingencies related to Premier.
NSW, LLC U.S. ("NSW")
In February 2005, Conwed Plastics 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. For more information concerning
intangible assets and goodwill, see Note 8.
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.
4. Investments in Associated Companies:
-----------------------------------
The Company has investments in several Associated Companies. The amounts
reflected as equity in income (losses) of associated companies in the
consolidated statements of operations are net of income tax provisions
(benefits) of $(9,300,000), $22,400,000 and $700,000 for the years ended
December 31, 2007, 2006 and 2005, respectively. Included in consolidated
retained earnings at December 31, 2007 is approximately $24,100,000 of
undistributed earnings of the associated companies.
Goober Drilling, LLC ("Goober Drilling")
In the second quarter of 2006, the Company acquired a 30% limited liability
company interest in Goober Drilling for aggregate consideration of $60,000,000,
excluding expenses, and agreed to lend to Goober Drilling, on a secured basis,
up to $126,000,000 to finance new rig equipment purchases and construction costs
and to repay existing debt. Goober Drilling is a land based contract oil and gas
drilling company based in Stillwater, Oklahoma that provides land based drilling
services to oil and natural gas exploration and production companies in the
Mid-Continent Region of the U.S., primarily in Oklahoma and Texas. During 2007,
the Company increased its equity interest to 50% for additional payments
aggregating $45,000,000. In addition, the credit facility was amended to
increase the borrowing capacity to $138,500,000 and the interest rate to LIBOR
plus 5%, the Company provided Goober Drilling with an additional secured credit
facility of $45,000,000 at an interest rate of LIBOR plus 10%, and the Company
provided another secured credit facility of $15,000,000 at an interest rate at
the greater of 8% or LIBOR plus 2.6%. At December 31, 2007, the aggregate
outstanding loan amount was $171,000,000 excluding accrued interest. The
additional funding was required due to increased raw material and labor costs to
construct the new rigs and working capital needs due to delays in rig
construction. For the years ended December 31, 2007 and 2006, the Company
recorded $13,600,000 and $2,000,000, respectively, of pre-tax income from this
investment under the equity method of accounting.
F-14
The Company's investment in Goober Drilling exceeds the Company's share of its
underlying net assets by approximately $48,000,000 at December 31, 2007. This
excess is being amortized over a three to fifteen year period.
Cobre Las Cruces, S.A. ("CLC")
CLC is a Spanish company that holds the exploration and mineral rights to the
Las Cruces copper deposit in the Pyrite Belt of Spain. It was a consolidated
subsidiary of the Company from its acquisition in September 1999 until August
2005, at which time the Company sold a 70% interest to Inmet Mining Corporation
("Inmet"), a Canadian-based global mining company traded on the Toronto stock
exchange (Symbol: IMN). Inmet acquired the interest in CLC in exchange for
5,600,000 newly issued Inmet common shares, representing approximately 11.6% of
Inmet's current outstanding common shares. 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. The Company retains a 30% interest in CLC.
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, 2007 approximately $126,900,000 was outstanding under the senior
secured credit facility and (euro)24,000,000 was outstanding under the senior
secured bridge credit facility. The Company and Inmet have also committed to
provide financing to CLC which is currently estimated to be (euro)239,000,000
($350,000,000 at exchange rates in effect on February 14, 2008), of which the
Company's share will be 30% ($80,000,000 of which has been loaned as of December
31, 2007). For the years ended December 31, 2007, 2006 and 2005, the Company
recorded pre-tax income (losses) of $4,000,000, $3,800,000 and $(1,600,000),
respectively, from this investment under the equity method of accounting.
HomeFed Corporation ("HomeFed")
During 2002, the Company sold one of its real estate subsidiaries, CDS Holding
Corporation ("CDS"), to HomeFed for a purchase price of $25,000,000, consisting
of $1,000,000 in cash and 2,474,226 shares of HomeFed's common stock, which
represented approximately 30% of HomeFed's outstanding common stock. For the
years ended December 31, 2007, 2006 and 2005, the Company recorded $1,500,000,
$2,900,000 and $5,800,000, 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 6.6% and 8.2% 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.
Jefferies Partners Opportunity Fund II, LLC ("JPOF II") and Jefferies High Yield
Holdings, LLC ("JHYH")
During 2000, the Company invested $100,000,000 in the equity of JPOF II, a
limited liability company, which is a registered broker-dealer. JPOF II was
managed by Jefferies & Company, Inc. ("Jefferies"), a full service investment
bank to middle market companies. JPOF II invested in high yield securities,
special situation investments and distressed securities and provides trading
services to its customers and clients. For the period from January 1, 2007
through March 31, 2007 (date of termination), and for the years ended December
31, 2006 and 2005, the Company recorded pre-tax income from this investment
under the equity method of accounting of $3,000,000, $26,200,000 and
$23,600,000, respectively. These earnings were distributed by JPOF II as
dividends shortly after the end of each period.
F-15
During 2007, the Company and Jefferies formed JHYH, a newly formed entity, and
the Company and Jefferies each committed to invest $600,000,000. The Company has
invested $250,000,000 in cash plus its $100,000,000 investment in JPOF II; its
remaining $250,000,000 commitment will be funded at the sole discretion of
Jefferies. JHYH owns Jefferies High Yield Trading, LLC ("JHYT"), a registered
broker-dealer that is engaged in the secondary sales and trading of high yield
securities and special situation securities formerly conducted by Jefferies,
including bank debt, post-reorganization equity, public and private equity,
equity derivatives, credit default swaps and other financial instruments. JHYT
makes markets in high yield and distressed securities and provides research
coverage on these types of securities. JHYT does not invest or make markets in
sub-prime residential mortgage securities.
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. The
organizational documents also permit passive investors to invest up to
$800,000,000. Jefferies also received additional JHYH securities entitling it to
20% of the profits. The voting and non-voting interests are entitled to a pro
rata share of the profits of JHYH, and are mandatorily redeemable in 2013, with
an option to extend up to three additional one-year periods. Under GAAP, JHYH is
considered a variable interest entity that is consolidated by Jefferies, since
Jefferies is the primary beneficiary. The Company's share of JHYH's net income
was $4,300,000 during 2007.
Wintergreen Partners Fund, L.P. ("Wintergreen")
The Company has invested an aggregate of $50,000,000 in Wintergreen, a limited
partnership that invests in domestic and foreign debt and equity securities. For
the years ended December 31, 2007, 2006 and 2005, the Company recorded
$14,000,000, $11,000,000 and $500,000, respectively, of pre-tax income from this
investment under the equity method of accounting. At December 31, 2007, the book
value of the Company's investment in Wintergreen was $75,500,000.
EagleRock Capital Partners (QP), LP ("EagleRock")
During 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, 2007, the book value of the Company's equity investment in
EagleRock was $33,500,000; the Company received distributions of $15,000,000 and
$48,200,000 from EagleRock in 2007 and 2006, respectively. Pre-tax income
(losses) of $(11,800,000), $16,400,000 and $(28,900,000) for the years ended
December 31, 2007, 2006 and 2005, respectively, were recorded from this
investment under the equity method of accounting.
Highland Funds
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. For the year ended December 31, 2007, the Company
recorded $(17,600,000) and $54,500,000 of pre-tax income (losses) for Highland
Opportunity and Shortplus, respectively.
Pershing Square IV, L.P. ("Pershing Square")
In June 2007, the Company invested $200,000,000 to acquire a 10% limited
partnership interest in Pershing Square, a newly-formed private investment
partnership whose investment decisions are at the sole discretion of Pershing
Square's general partner. The stated objective of Pershing Square is to create
significant capital appreciation by investing in Target Corporation. For the
year ended December 31, 2007, the Company recorded $85,500,000 of pre-tax losses
from this investment under the equity method of accounting, principally
resulting from declines in the market value of Target Corporation's common
stock.
F-16
RCG Ambrose, L.P. ("Ambrose")
In September 2007, the Company invested $75,000,000 in Ambrose, a limited
partnership which principally invests through a master fund in anticipated
corporate transactions including mergers, acquisitions, recapitalizations and
similar events. For the year ended December 31, 2007, the Company recorded
$1,100,000 of pre-tax losses 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 for the
year ended December 31, 2005.
Olympus Re Holdings, Ltd. ("Olympus")
During 2001, the Company invested $127,500,000 for a 25% common stock interest
in Olympus, a newly formed Bermuda reinsurance company primarily engaged in the
property excess, marine and aviation reinsurance business. In 2003, the Company
sold a portion of its common shares of Olympus back to Olympus for total
proceeds of $79,500,000 as part of an issuer tender offer available to all of
its shareholders.
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 was diluted (to
less than 4%) such that it no longer applied the equity method of accounting for
this investment subsequent to December 31, 2005. For the year ended December 31,
2005 the Company recorded $120,100,000 of pre-tax losses from this investment
under the equity method of accounting. In addition, during 2005, the Company
recorded an impairment loss of $3,700,000 to reduce the book value of its
investment to zero.
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, 2007. (Amounts are in
thousands.)
2007 2006
------------ ------------
Assets $ 5,761,200 $ 3,553,900
Liabilities 1,446,500 1,980,500
----------- ------------
Net assets $ 4,314,700 $ 1,573,400
============ ============
The Company's portion of the reported net assets $ 1,175,700 $ 770,800
============ ============
2007 2006 2005
------------ ------------ -----------
Total revenues $ 158,900 $ 640,400 $ 984,400
Income (loss) from continuing operations before extraordinary items $ (625,100) $ 214,600 $ (484,200)
Net income (loss) $ (625,100) $ 214,600 $ (484,200)
The Company's equity in net income (loss) $ (31,200) $ 60,100 $ (44,400)
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.
F-17
5. Discontinued Operations:
-----------------------
Symphony Health Services, LLC ("Symphony")
In July 2006, the Company sold Symphony for approximately $107,000,000. After
satisfaction of Symphony's outstanding credit agreement by the buyer
($31,700,000 at date of sale) and certain sale related obligations, the Company
realized net cash proceeds of $62,300,000 and recorded a pre-tax gain on sale of
discontinued operations of $53,300,000 ($33,500,000 after tax).
ATX Communications, Inc. ("ATX")
In September 2006, the Company sold ATX for aggregate cash consideration of
approximately $85,700,000 and recorded a pre-tax gain on sale of discontinued
operations of $41,600,000 ($26,100,000 after tax).
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 included (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
AT&T Inc. (formerly SBC Communications Inc.) totaling $236,000,000, of which
$37,500,000 was received prior to closing and the balance was 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 required 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 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
($243,800,000 after tax). 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 AT&T 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.
WilTel's former headquarters building, including the adjacent parking garage,
was not included in the sale to Level 3 and was 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; 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.
During 2007, the facility was sold for net cash proceeds of $53,500,000 which
resulted in a small gain.
F-18
Gain on disposal of discontinued operations for 2007 includes a pre-tax gain of
$800,000 ($500,000 after tax) from the resolution of sale-related contingencies.
Gain on disposal of discontinued operations during 2006 includes $2,400,000 of
pre-tax gains ($1,500,000 after tax) principally for the resolution of certain
sale-related contingencies and obligations and working capital adjustments.
Real Estate
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
($56,600,000 after tax) reflected in discontinued operations for the year ended
December 31, 2005. Historical operating results for the hotel were not material.
Other
Gain on disposal of discontinued operations for 2007 includes a pre-tax gain of
$4,000,000 ($2,800,000 after tax) related to the collection of additional
amounts from the sale of the Company's interest in an Argentine shoe
manufacturer in 2005 that had not been previously recognized (collectibility was
uncertain). Although there was no material gain or loss on disposal in 2005,
results of discontinued operations during 2005 include a pre-tax loss of
$4,400,000 related to this investment.
In 2006, the Company sold its gas properties and recorded a pre-tax loss on
disposal of discontinued operations of $900,000. Income (loss) from discontinued
operations for 2006 includes $2,900,000 of pre-tax losses related to these gas
properties; amounts for 2005 were not material.
In 2006, the Company received $3,000,000 from a former insurance subsidiary
which, for many years, had been undergoing liquidation proceedings controlled by
state insurance regulators. The Company reflected the amount received as a gain
on disposal of discontinued operations. For income tax purposes, the payment is
treated as a non-taxable distribution paid by a subsidiary; as a result, no tax
expense has been recorded.
A summary of the results of discontinued operations is as follows for the two
year period ended December 31, 2006 (in thousands):
2006 2005
---------- ------------
Revenues and other income:
Telecommunications revenues $ 118,987 $ 1,855,130
Healthcare revenues 110,370 239,046
Investment and other income 2,790 116,006
Net securities gains -- 3,483
--------- ------------
232,147 2,213,665
--------- ------------
Expenses:
Telecommunications cost of sales 72,231 1,290,409
Healthcare cost of sales 95,628 203,149
Interest 1,321 30,389
Salaries 26,889 180,348
Depreciation and amortization 10,018 171,395
Selling, general and other expenses 29,888 222,679
--------- ------------
235,975 2,098,369
--------- ------------
Income (loss) from discontinued operations before income
taxes (3,828) 115,296
Income tax provision (benefit) 132 (33)
--------- ------------
Income (loss) from discontinued operations, net of taxes $ (3,960) $ 115,329
========= ============
Results of discontinued operations for 2007 were not material.
F-19
6. Investments:
-----------
A summary of investments classified as current assets at December 31, 2007 and
2006 is as follows (in thousands):
2007 2006
------------------------------ ------------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
---- ---------- ---- -------------
Investments available for sale $ 897,470 $ 899,053 $ 803,034 $ 809,927
Trading securities 47,180 71,618 79,526 80,321
Other investments, including accrued interest income 12,528 12,528 13,725 13,725
--------- ---------- --------- ----------
Total current investments $ 957,178 $ 983,199 $ 896,285 $ 903,973
========= ========== ========= ==========
The amortized cost, gross unrealized gains and losses and estimated fair value
of available for sale investments classified as current assets at December 31,
2007 and 2006 are as follows (in thousands):
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- --------- ---------- -----------
2007
----
Bonds and notes:
United States Government and agencies $ 735,721 $ 1,634 $ 189 $ 737,166
U.S. Government-Sponsored Enterprises 159,365 138 8 159,495
All other corporates 2,384 17 9 2,392
--------- -------- ------- -----------
Total fixed maturities $ 897,470 $ 1,789 $ 206 $ 899,053
========= ======= ======= ===========
2006
----
Bonds and notes:
United States Government and agencies $ 440,375 $ 99 $ 155 $ 440,319
U.S. Government-Sponsored Enterprises 192,357 2 100 192,259
All other corporates 165,396 5,202 56 170,542
--------- ------- ------- -----------
Total fixed maturities 798,128 5,303 311 803,120
--------- ------- ------- -----------
Equity securities:
Industrial, miscellaneous and all other 4,906 1,901 -- 6,807
--------- ------- ------- -----------
Total equity securities 4,906 1,901 -- 6,807
--------- ------- ------- -----------
Total $ 803,034 $ 7,204 $ 311 $ 809,927
========= ======= ======= ===========
F-20
Trading securities is comprised of other investments, principally INTL Consilium
Emerging Market Absolute Return Fund, LLC's investment in a master fund, and at
December 31, 2007 includes an investment in credit default swaps carried at fair
value of $22,000,000. Net security gains include $19,500,000 of unrealized gains
related to these derivative financial investments for the year ended December
31, 2007. The Company's objective in making this speculative investment is to
realize capital appreciation.
A summary of non-current investments at December 31, 2007 and 2006 is as follows
(in thousands):
2007 2006
------------------------------ ----------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
----------- ----------- ----------- ------------
Investments available for sale $ 951,988 $ 2,618,648 $ 1,131,198 $ 1,283,261
Other investments 157,873 157,873 182,588 182,588
----------- ----------- ----------- -----------
Total non-current investments $ 1,109,861 $ 2,776,521 $ 1,313,786 $ 1,465,849
=========== =========== =========== ===========
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, 2007 and 2006.
Although the Inmet shares have registration rights, they 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, 2007, the market value
of the Inmet shares is approximately $451,800,000.
In August 2006, pursuant to a subscription agreement with Fortescue Metals Group
Ltd ("Fortescue") and its subsidiary, FMG Chichester Pty Ltd ("FMG"), the
Company invested an aggregate of $408,000,000, including expenses, in
Fortescue's Pilbara iron ore and infrastructure project in Western Australia. In
exchange for its cash investment, the Company received 26,400,000 common shares
of Fortescue, representing approximately 9.99% of the outstanding Fortescue
common stock, and a $100,000,000 note of FMG that matures in August 2019. In
July 2007, Fortescue sold new common shares in an underwritten public offering
to raise additional capital for its mining project and to fund future growth. In
connection with this offering, the Company exercised its pre-emptive rights to
maintain its ownership position and acquired an additional 1,398,600 common
shares of Fortescue for $44,200,000. Non-current available for sale investments
include 277,986,000 (reflecting a 10 for 1 split in December 2007) and
26,400,000 common shares of Fortescue, representing approximately 9.9% of the
outstanding Fortescue common stock at December 31, 2007 and 2006, respectively.
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 on
the Australian Stock Exchange or in accordance with applicable securities laws.
The Fortescue shares have a cost of $246,300,000 and $202,100,000 and market
values of $1,824,700,000 and $276,300,000 at December 31, 2007 and 2006,
respectively.
Interest on the FMG note is calculated as 4% of the revenue, net of government
royalties, invoiced from the iron ore produced from the project's Cloud Break
and Christmas Creek areas. The note is unsecured and subordinate to the
project's senior secured debt. For accounting purposes, the Company recorded its
2006 investment in Fortescue's common shares at the market price on the date of
acquisition, and bifurcated its remaining Fortescue investment into a 13 year
zero-coupon note and a prepaid mining interest. The zero-coupon note was
recorded at an estimated initial fair value of $21,600,000, representing the
present value of the principal amount discounted at 12.5%. The prepaid mining
interest of $184,300,000 has been classified with other non-current assets, and
will be amortized to expense as the 4% of revenue is earned.
The amortized cost, gross unrealized gains and losses and estimated fair value
of non-current investments classified as available for sale at December 31, 2007
and 2006 are as follows (in thousands):
F-21
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------- ---------- ---------- ---------
2007
----
Bonds and notes:
United States Government and agencies $ 54,148 $ 457 $ 404 $ 54,201
U.S. Government-Sponsored Enterprises 286,204 293 3,448 283,049
States, municipalities and political subdivisions 3,442 -- -- 3,442
All other corporates 75,162 5,403 1,099 79,466
----------- ---------- ------- ----------
Total fixed maturities 418,956 6,153 4,951 420,158
----------- ---------- ------- ----------
Equity securities:
Preferred stocks 7,849 -- -- 7,849
Common stocks:
Banks, trusts and insurance companies 99,716 33,863 1,133 132,446
Industrial, miscellaneous and all other 425,467 1,638,196 5,468 2,058,195
----------- ---------- ------- ----------
Total equity securities 533,032 1,672,059 6,601 2,198,490
----------- ---------- ------- ----------
$ 951,988 $1,678,212 $11,552 $2,618,648
=========== ========== ======= ==========
2006
----
Bonds and notes:
United States Government and agencies $ 61,098 $ -- $ 850 $ 60,248
U.S. Government-Sponsored Enterprises 337,397 612 4,366 333,643
States, municipalities and political subdivisions 50 -- - 50
All other corporates 153,175 6,508 291 159,392
----------- ---------- ------- ----------
Total fixed maturities 551,720 7,120 5,507 553,333
----------- ---------- ------- ----------
Equity securities:
Preferred stocks 8,331 35 -- 8,366
Common stocks:
Banks, trusts and insurance companies 12,340 9,744 -- 22,084
Industrial, miscellaneous and all other 558,807 142,876 2,205 699,478
----------- ---------- ------- ----------
Total equity securities 579,478 152,655 2,205 729,928
----------- ---------- ------- ----------
$ 1,131,198 $ 159,775 $ 7,712 $1,283,261
=========== ========== ======= ==========
The amortized cost and estimated fair value of non-current investments
classified as available for sale at December 31, 2007, 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 $ 35,083 $ 38,278
Due after five years through ten years 6,276 7,360
Due after ten years 54,953 54,981
---------- ----------
96,312 100,619
Mortgage-backed securities 322,644 319,539
---------- ----------
$ 418,956 $ 420,158
========== ==========
Net unrealized gains (losses) on investments were $997,700,000, $37,800,000 and
$(22,400,000) at December 31, 2007, 2006 and 2005, respectively.
Reclassification adjustments included in comprehensive income for the three year
period ended December 31, 2007 are as follows (in thousands):
F-22
2007 2006 2005
---------- ----------- -----------
Net unrealized holding gains arising during the period, net of
taxes of $561,743, $48,799 and $0 $ 981,411 $ 86,004 $ 12,707
Less: reclassification adjustment for net gains included in net
income, net of taxes of $12,328, $14,650 and $0 (21,539) (25,817) (188,284)
---------- ---------- -----------
Net change in unrealized gains (losses) on investments, net of taxes
of $549,415, $34,149 and $0 $ 959,872 $ 60,187 $ (175,577)
========== ========== ===========
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,
2007 (in thousands):
Unrealized
Description of Securities Fair Value Losses
------------------------- ---------- ---------
United States Government and agencies $ 293,236 $ 189
U.S. Government-Sponsored Enterprises 20,092 8
Mortgage-backed securities 104,298 1,216
Corporate bonds 19,080 788
Marketable equity securities 37,396 5,558
---------- ---------
Total temporarily impaired securities $ 474,102 $ 7,759
========== =========
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 considered to be minor (approximately .1%, less than .1% and
1.2%, respectively). The unrealized losses on the securities issued by the
United States Government and agencies relate to 7 securities which were
purchased in 2007 and mature in 2008. The unrealized loss on the U.S.
Government-Sponsored Enterprises relates to 1 security which was purchased in
2007 and which matures in 2008. 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 51 securities substantially all of
which were purchased in 2007. The unrealized losses related to the corporate
bonds and marketable equity securities 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, the ability and intent to hold
investments to maturity, and other factors specific to the individual
investment.
At December 31, 2007, the Company's investments which have been in a continuous
unrealized loss position for 12 months or longer are comprised of 74 securities
which had aggregate gross unrealized losses of approximately $4,000,000 and an
aggregate fair value of approximately $162,000,000. 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, 2007 and 2006, the aggregate carrying amount of the Company's
investment in securities that are accounted for under the cost method totaled
$157,900,000 and $182,600,000, respectively. 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.
Securities with book values of $12,500,000 and $12,400,000 at December 31, 2007
and 2006, respectively, collateralized certain swap agreements.
F-23
7. Trade, Notes and Other Receivables, Net:
---------------------------------------
A summary of current trade, notes and other receivables, net at December 31,
2007 and 2006 is as follows (in thousands):
2007 2006
---------- -----------
Trade receivables $ 66,101 $ 25,745
Receivables related to securities 13,678 24,962
Receivables related to associated companies 19,276 --
Receivables relating to real estate activities 5,934 6,591
Other 30,800 14,145
---------- ----------
135,789 71,443
Allowance for doubtful accounts (2,024) (1,621)
---------- ----------
Total current trade, notes and other receivables, net $ 133,765 $ 69,822
========== ==========
8. Intangible Assets, Net and Goodwill:
-----------------------------------
A summary of these assets at December 31, 2007 and 2006 is as follows (in
thousands):
2007 2006
---------- ----------
Intangibles:
Customer relationships, net of accumulated amortization of $19,472
and $11,768 $ 52,362 $ 46,967
Licenses, net of accumulated amortization of $361 and $0 11,527 --
Trademarks and tradename, net of accumulated amortization of $403 and $227 1,886 1,642
Patents, net of accumulated amortization of $453 and $298 1,907 2,032
Other, net of accumulated amortization of $2,048 and $1,727 3,673 645
Goodwill 8,151 8,151
--------- ----------
$ 79,506 $ 59,437
========= ==========
As a result of the acquisitions of STi Prepaid and ResortQuest during 2007,
intangibles increased by $10,000,000 which are amortized over their estimated
useful lives; see Note 3 for further information concerning these acquisitions.
Intangible assets also increased by $3,600,000 and $3,200,000 during 2007
related to acquisitions by Conwed Plastics and within the Other Operations
segment, respectively. These intangible assets are being amortized on a
straight-line basis over their estimated useful lives. The increase in licenses
during 2007 relates to the reconsolidation of Premier, which is more fully
discussed in Note 3.
Amortization expense on intangible assets was $8,600,000, $7,700,000 and
$5,800,000 for the years ended December 31, 2007, 2006 and 2005, respectively.
The estimated aggregate future amortization expense for the intangible assets
for each of the next five years is as follows: 2008 - $9,300,000; 2009 -
$8,800,000; 2010 - $8,500,000; 2011 - $8,100,000; and 2012 - $7,700,000.
At December 31, 2007 and 2006, all of the goodwill in the above table relates to
Conwed Plastics.
9. Other Assets:
------------
A summary of non-current other assets at December 31, 2007 and 2006 is as
follows (in thousands):
2007 2006
---------- ---------
Real Estate $ 225,409 $ 176,728
Unamortized debt expense 33,447 16,216
Restricted cash 93,556 20,603
Prepaid mining interest 184,315 184,315
Other 7,705 3,827
---------- ----------
$ 544,432 $ 401,689
========== ==========
F-24
In October 2007, the Company entered into an agreement with the Panama City-Bay
County Airport and Industrial District of Panama City, Florida to purchase
approximately 708 acres of land which currently houses the Panama City-Bay
County International Airport. At December 31, 2007, restricted cash included
$56,500,000 that has been placed into escrow pursuant to this agreement; the
transaction will close and title to the property will pass only after the city
completes construction of a new airport and moves the airport operations to its
new location within specified timeframes. In addition, restricted cash at
December 31, 2007 includes $14,700,000 of escrowed funds relating to the Premier
noteholders' claims; see Note 18 for further information.
The Company's prepaid mining interest relates to its investment in Fortescue,
which is more fully explained in Note 6.
10. Property, Equipment and Leasehold Improvements, Net:
---------------------------------------------------
A summary of property, equipment and leasehold improvements, net at December 31,
2007 and 2006 is as follows (in thousands):
Depreciable
Lives
(in years) 2007 2006
---------- ----------- -----------
Buildings and leasehold improvements 3-45 $ 359,801 $ 131,122
Machinery and equipment 3-25 157,692 101,104
Network equipment 5-15 32,294 30,587
Corporate aircraft 10 87,981 87,981
Computer equipment and software 2-5 14,455 3,921
Furniture and fixtures 2-10 23,549 7,131
Construction in progress N/A 10,498 3,291
Other 3-7 3,300 5,144
----------- -----------
689,570 370,281
Accumulated depreciation and amortization (176,766) (136,065)
----------- -----------
$ 512,804 $ 234,216
=========== ===========
11. Trade Payables, Expense Accruals, Other Current Liabilities and Other
Non-Current Liabilities:
---------------------------------------------------------------------
A summary of trade payables and expense accruals at December 31, 2007 and 2006
is as follows (in thousands):
2007 2006
--------- ---------
Trade payables $ 41,877 $ 16,061
Due to telecommunication carriers 31,289 --
Payables related to securities 4,712 15,883
Accrued compensation, severance and other employee benefits 46,722 42,320
Accrued legal and professional fees 19,224 8,973
Accrued clinical trial expenses 6,648 434
Taxes other than income 3,481 1,684
Accrued interest payable 41,348 20,739
Other 34,259 21,645
--------- ---------
$ 229,560 $ 127,739
========= =========
F-25
A summary of other non-current liabilities at December 31, 2007 and 2006 is as
follows (in thousands):
2007 2006
--------- ---------
Postretirement and postemployment benefits $ 5,704 $ 6,078
Pension liability 18,430 40,351
Liabilities related to real estate activities 4,141 4,015
Other 42,786 39,824
--------- ---------
$ 71,061 $ 90,268
========= =========
12. Indebtedness:
-------------
The principal amount, stated interest rate and maturity date of outstanding debt
at December 31, 2007 and 2006 are as follows (dollars in thousands):
2007 2006
----------- -----------
Parent Company Debt:
Senior Notes:
Bank credit facility $ -- $ --
7 3/4% Senior Notes due 2013, less debt discount of $312 and $355 99,688 99,645
7% Senior Notes due 2013, net of debt premium of $793 and $904 375,793 375,904
7 1/8% Senior Notes due 2017 500,000 --
8 1/8% Senior Notes due 2015, less debt discount of $8,266 and $0 491,734 --
Subordinated Notes:
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 124,977 181,763
Aircraft financing 39,221 41,335
Capital leases due 2008 through 2015 with a weighted average
interest rate of 11.6% 10,194 9,418
Other due 2008 through 2011 with a weighted average interest
rate of 6.9% 46,743 3,196
------------ ----------
Total debt 2,136,550 1,159,461
Less: current maturities (132,405) (184,815)
------------ ----------
Long-term debt $ 2,004,145 $ 974,646
============ ==========
Parent Company Debt:
In June 2006, the Company entered into a new credit agreement with various bank
lenders for a $100,000,000 unsecured credit facility that matures in five years
and bears interest based on the Eurocurrency rate or the prime rate. At December
31, 2007, no amounts were outstanding under this bank credit facility.
In March 2007, the Company sold $500,000,000 principal amount of its newly
authorized 7 1/8% Senior Notes due 2017 in a private placement transaction. Net
proceeds after payment of underwriting fees were $490,000,000. Pursuant to an
exchange offer, these notes were subsequently exchanged for a new issue of debt
securities registered under the Securities Act with terms identical to those of
the 7 1/8% Senior Notes (except for provisions relating to transfer restrictions
and payment of additional interest).
F-26
In September 2007, the Company sold $500,000,000 principal amount of its newly
authorized 8 1/8% Senior Notes due 2015 at an issue price of 98.307%. Net
proceeds after payment of underwriting fees were $481,700,000.
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
$22.97 per share at any time before their maturity, subject to certain
restrictions contained in the notes, at a conversion rate of 43.5414 shares per
each $1,000 principal amount of notes subject to adjustment (an aggregate of
15,239,490 shares).
The Company's senior note indentures contain covenants that restrict its ability
to incur more Indebtedness or issue Preferred Stock of Subsidiaries if the
Company fails to maintain a specified ratio of Consolidated Debt to Consolidated
Tangible Net Worth, limit the ability of the Company and Material Subsidiaries
to incur, in certain circumstances, Funded Debt or Liens, and contain other
terms and restrictions all as defined in the senior note indentures. The
Company's bank credit agreement also contains covenants and restrictions which
are generally more restrictive than the senior note indentures; however, the
Company has the ability to terminate the bank credit agreement if no amounts are
outstanding. As of December 31, 2007, cash dividends of approximately
$1,316,500,000 would be eligible to be paid under the bank credit agreement; the
senior note indentures do not restrict the payment of dividends.
Subsidiary Debt:
Debt due within one year includes $125,000,000 and $181,800,000 as of December
31, 2007 and 2006, respectively, relating to repurchase agreements. At December
31, 2007, these fixed rate repurchase agreements have a weighted average
interest rate of approximately 5.1%, mature in January 2008 and are secured by
non-current investments with a carrying value of $129,100,000.
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, 2007 was 9.2%. 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 $1,500,000 and
$300,000 at December 31, 2007 and 2006, 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; the lease term expires in 2015.
Other subsidiary debt principally includes Premier's equipment financing
($18,700,000) and debt secured by a real estate development project
($27,800,000). With respect to the real estate development project, the
subsidiary entered into an interest rate swap agreement, which fixed the
interest rate at approximately 5.1%. The subsidiary would have paid $3,900,000
at December 31, 2007 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.
At December 31, 2007, $303,800,000 of other assets (primarily investments, real
estate and property) are pledged for indebtedness aggregating $221,100,000.
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, 2012 are as follows: 2008 - $132,400,000; 2009 -
$35,300,000; 2010 - $14,300,000; 2011 - $33,900,000; and 2012 - $1,200,000.
The weighted average interest rate on short-term borrowings (consisting of
repurchase agreements) was 5.1 % and 5.3% at December 31, 2007 and 2006,
respectively.
F-27
13. Common Shares, Stock Options and Preferred Shares:
-------------------------------------------------
In September 2007, the Company completed the issuance and sale of 5,500,000 of
its common shares at a net price of $45.50 per share. Net proceeds after payment
of underwriting fees were $242,000,000.
The Board of Directors from time to time has authorized acquisitions of the
Company's common shares. In March 2007, the Company's Board of Directors
increased to 12,000,000 the maximum number of shares that the Company is
authorized to purchase. During the three year period ended December 31, 2007,
the Company acquired 18,617 common shares at an average price of $27.73 per
common share, all in connection with stock option exercises. At December 31,
2007, the Company is authorized to repurchase 11,995,285 common shares.
Effective January 1, 2006, the Company adopted SFAS 123R using the modified
prospective method. As a result of the adoption of SFAS 123R, compensation cost
increased by $11,200,000 and $15,200,000 for the years ended December 31, 2007
and 2006, respectively, and net income decreased by $8,100,000 and $9,800,000
for the years ended December 31, 2007 and 2006, respectively. Had the Company
used the fair value based accounting method for 2005, compensation cost would
have been higher by $1,600,000. As of December 31, 2007, total unrecognized
compensation cost related to nonvested share-based compensation plans was
$22,000,000; this cost is expected to be recognized over a weighted-average
period of 1.3 years.
As of December 31, 2007, the Company has two share-based plans: a fixed stock
option plan and a senior executive warrant plan. The fixed stock option plan
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 that may be acquired through
the exercise of options or rights under this plan cannot exceed 2,519,150. 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 granted to employees under this plan are intended to qualify as
incentive stock options to the extent permitted under the Internal Revenue Code
and become exercisable in five equal annual instalments starting one year from
date of grant. Options granted to non-employee directors become exercisable in
four equal annual instalments starting one year from date of grant. No stock
appreciation rights have been granted. As of December 31, 2007, 1,567,350 shares
were available for grant under the plan.
The senior executive warrant plan provides for the issuance, subject to
shareholder approval, of warrants to purchase up to 2,000,000 common shares to
each of the Company's Chairman and President at an exercise price equal to 105%
of the closing price per share of a common share on the date of grant. On March
6, 2006, the Company's Board of Directors approved, subject to shareholder
approval, the grant of warrants to purchase 2,000,000 common shares to each of
the Company's Chairman and President at an exercise price equal to $28.515 per
share (105% of the closing price per share of a common share on that date). In
May 2006, shareholder approval was received and the warrants were issued. The
warrants expire in 2011 and vest in five equal tranches with 20% vesting on the
date shareholder approval was received and an additional 20% vesting in each
subsequent year. At December 31, 2007, 4,000,000 warrants were outstanding and
1,600,000 were exercisable with aggregate intrinsic values of $74,300,000 and
$29,700,000, respectively. Both the outstanding and exercisable warrants had a
weighted-average remaining contractual term of 3.2 years. No warrants were
exercised or forfeited during 2007.
A summary of activity with respect to the Company's stock options for the three
years ended December 31, 2007 is as follows:
F-28
Common Weighted- Weighted-Average
Shares Average Remaining Aggregate
Subject Exercise Contractual Intrinsic
to Option Prices Term Value
--------- ------ -------------- -------------
Balance at December 31, 2004 2,554,860 $16.36
Granted 12,000 $18.03
Exercised (431,600) $ 8.55 $ 5,200,000
=============
Cancelled (180,000) $21.75
---------
Balance at December 31, 2005 1,955,260 $17.60
Granted 1,037,000 $27.42
Exercised (300,010) $12.79 $ 4,400,000
=============
Cancelled (34,000) $23.40
---------
Balance at December 31, 2006 2,658,250 $21.90
Granted 12,000 $33.50
Exercised (727,689) $15.72 $ 18,400,000
=============
Cancelled (63,200) $23.52
---------
Balance at December 31, 2007 1,879,361 $24.31 3.9 years $ 42,800,000
========= ========= =============
Exercisable at December 31, 2007 243,861 $17.87 2.1 years $ 7,100,000
========= ========= =============
The following summary presents the weighted-average assumptions used for
grants made during each of the three years in the period ended December 31,
2007:
2007 2006 2005
----------- ----------------------------- --------
Options Options Warrants Options
------- ------- -------- -------
Risk free interest rate 4.57% 4.47% 4.95% 3.77%
Expected volatility 21.71% 22.85% 23.05% 23.58%
Expected dividend yield .75% .90% .41% .69%
Expected life 4.3 years 4.0 years 4.3 years 4.3 years
Weighted-average fair value per grant $8.03 $6.25 $9.39 $4.29
The expected life assumptions were based on historical behavior and incorporated
post-vesting forfeitures for each type of award and population identified. The
expected volatility was based on the historical behavior of the Company's stock
price.
At December 31, 2007 and 2006, 3,446,711 and 4,174,400, respectively, of the
Company's common shares were reserved for stock options, 15,239,490 of the
Company's common shares were reserved for the 3 3/4% Convertible Senior
Subordinated Notes and 4,000,000 of the Company's common shares were reserved
for warrants.
At December 31, 2007 and 2006, 6,000,000 of preferred shares (redeemable and
non-redeemable), par value $1 per share, were authorized and not issued.
F-29
14. Net Securities Gains:
--------------------
The following summarizes net securities gains for each of the three years in the
period ended December 31, 2007 (in thousands):
2007 2006 2005
--------- --------- ---------
Net realized gains on securities $ 109,356 $ 129,734 $ 222,258
Write-down of investments (a) (36,834) (12,940) (12,230)
Net unrealized gains (losses) on trading securities 23,119 365 (1,212)
--------- --------- ---------
$ 95,641 $ 117,159 $ 208,816
========= ========= =========
(a) Consists of provisions to write down investments in certain available for
sale securities and, in 2007, an investment in a non-public security.
During 2007, the Company sold all of its common stock holdings in Eastman
Chemical Company and recognized a net security gain of $37,800,000. During 2006,
the Company sold all of its shares of Level 3 common stock received in
connection with the sale of WilTel (see Note 5) for total proceeds of
$376,600,000 and recorded a pre-tax gain of $37,400,000. During 2005, the
Company sold all 375,000 common shares of White Mountains Insurance Group, Ltd.
that it owned, and recorded a security gain of $146,000,000.
Proceeds from sales of investments classified as available for sale were
$5,286,100,000, $2,932,800,000 and $1,979,300,000 during 2007, 2006 and 2005,
respectively. Gross gains of $99,000,000, $134,200,000 and $204,600,000 and
gross losses of $5,500,000, $3,200,000 and $2,400,000 were realized on these
sales during 2007, 2006 and 2005, respectively.
15. Other Results of Operations Information:
---------------------------------------
Investment and other income for each of the three years in the period ended
December 31, 2007 consists of the following (in thousands):
2007 2006 2005
---------- --------- ----------
Interest on short-term investments $ 18,121 $ 10,909 $ 7,537
Dividend income 13,290 12,019 6,817
Interest on fixed maturity investments 64,787 91,634 46,440
Interest on notes receivable 566 927 1,880
Other investment income 3,509 3,703 977
Gains on sale of real estate and other assets, net of costs 11,607 75,729 25,366
Income related to sale of associated companies 11,441 34,673 --
Recovery of bankruptcy claims -- 7,371 --
Income on termination of joint development agreement 8,490 -- --
Rental income 5,723 7,023 11,870
Winery revenues 20,091 20,822 18,868
Other 23,840 29,868 29,059
---------- ---------- ----------
$ 181,465 $ 294,678 $ 148,814
========== ========== ==========
In February 2006, 711 Developer, LLC ("Square 711"), a 90% owned subsidiary of
the Company, completed the sale of 8 acres of unimproved land in Washington,
D.C. for aggregate cash consideration of $121,900,000. The land was acquired by
Square 711 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 $75,700,000, and
recorded a pre-tax gain of $48,900,000.
Taxes, other than income or payroll, amounted to $10,400,000, $3,900,000 and
$3,200,000 for the years ended December 31, 2007, 2006 and 2005, respectively.
Advertising costs amounted to $9,700,000, $900,000 and $900,000 for the years
ended December 31, 2007, 2006 and 2005, respectively.
Research and development costs charged to expense were $22,300,000 and
$16,500,000 for the years ended December 31, 2007 and 2006, respectively; such
costs were not material for the year ended December 31, 2005.
F-30
16. Income Taxes:
------------
The principal components of deferred taxes at December 31, 2007 and 2006 are as
follows (in thousands):
2007 2006
-------------- -----------
Deferred Tax Asset:
Securities valuation reserves $ 40,473 $ 46,550
Property and equipment -- 28,741
Other assets 45,089 25,397
NOL carryover 1,972,901 1,899,654
Other liabilities 48,829 51,009
------------ -----------
2,107,292 2,051,351
Valuation allowance (299,775) (911,777)
------------ -----------
1,807,517 1,139,574
------------ -----------
Deferred Tax Liability:
Unrealized gains on investments (626,364) (65,507)
Depreciation (18,536) (22,131)
Other (24,535) (60,063)
------------ -----------
(669,435) (147,701)
------------ -----------
Net deferred tax asset $ 1,138,082 $ 991,873
============ ===========
As of December 31, 2007, the Company had consolidated federal NOLs of
$722,000,000, 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 $4,719,000,000 of federal NOLs that are only available
to offset the taxable income of certain subsidiaries. None of these expire prior
to 2017. Foreign NOLs of $6,000,000 are not reflected in the table since the
Company does not expect it will be able to use those carryforwards before they
expire. The Company also has various state NOLs that expire at different times,
which are reflected in the above table to the extent the Company estimates its
future taxable income will be apportioned to those states. 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.
During 2007 and 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, $542,700,000 in 2007 and $1,135,100,000 in 2005 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 is more likely
than not to be realized was strongly influenced by its historical ability to
generate significant amounts of taxable income and its projections of future
taxable income, and also takes into consideration unrealized gains in its
investment portfolio. 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, estimates apportionment factors for state and
local taxing jurisdictions and includes all future years that the Company
estimated it would have available NOLs. 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.
F-31
The increase in the valuation allowance during 2006 is principally due to the
utilization of previously unrecognized capital losses in the Company's 2005
federal income tax return, which resulted in a larger NOL than previously
estimated.
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, 2007 was as follows, excluding amounts allocated to
equity in associated companies and discontinued operations (in thousands):
2007 2006 2005
----------- ---------- -----------
State income taxes $ 4,176 $ 3,682 $ 3,848
Resolution of state tax contingencies (1,475) (8,000) --
Federal income taxes:
Current (1,958) 1,721 --
Deferred (17,925) 44,203 --
Reversal of valuation allowance (542,686) -- (1,135,100)
Currently payable foreign income taxes 97 165 214
----------- --------- -----------
$ (559,771) $ 41,771 $(1,131,038)
=========== ========= ===========
The table below reconciles the expected statutory federal income tax to the
actual income tax provision (benefit) (in thousands):
2007 2006 2005
----------- --------- -----------
Expected federal income tax $ (19,981) $ 46,837 $ 47,052
State income taxes, net of federal income tax benefit 2,714 2,393 2,501
Reversal of valuation allowance (542,686) -- (1,135,100)
Resolution of tax contingencies (1,475) (8,000) --
Permanent differences 824 434 --
Recognition of acquired WilTel federal tax benefits -- -- (46,951)
Discontinued operations tax loss benefit -- -- 1,321
Other 833 107 139
----------- --------- -----------
Actual income tax provision (benefit) $ (559,771) $ 41,771 $(1,131,038)
=========== ========= ===========
Reflected above as 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.
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.
F-32
The following table reconciles the total amount of unrecognized tax benefits as
of the beginning and end of the period presented (in thousands):
Unrecognized
Tax Benefits Interest Total
------------ -------- ----------
As of January 1, 2007, date of adoption of FIN 48 $ 10,500 $ 3,500 $ 14,000
Additions to unrecognized tax benefits 400 100 500
Additional interest expense recognized -- 800 800
Audit payments (300) (200) (500)
Reductions as a result of the lapse of the statute of limitations
and completion of audits (1,000) (500) (1,500)
--------- ------- ---------
Balance, December 31, 2007 $ 9,600 $ 3,700 $ 13,300
========= ======= =========
If recognized, the total amount of unrecognized tax benefits reflected in the
table above would lower the Company's effective income tax rate. Over the next
twelve months, the Company believes it is reasonably possible that the aggregate
amount of unrecognized tax benefits will decrease by an additional $3,500,000
upon the expiration of the statute of limitations. The statute of limitations
with respect to the Company's federal income tax 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 2003 to 2005 period.
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:
-----------------------------------------
In September 2006, the FASB issued Statement of Financial Accounting Standards
No. 158, "Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and
132(R)" ("SFAS 158"), which requires companies to recognize on their balance
sheet a net liability or asset for the funded status of their defined benefit
pension and other postretirement plans, recognize changes in funded status
through comprehensive income and provide additional footnote disclosures. SFAS
158 was effective for publicly traded calendar year-end companies as of December
31, 2006. In addition, SFAS 158 requires companies to measure the funded status
of their plans as of the date of its fiscal year-end, with limited exceptions,
effective for fiscal years ending after December 15, 2008. The incremental
effect on the Company's consolidated balance sheet as a result of the adoption
of SFAS 158 was to decrease total liabilities by $1,200,000, decrease deferred
tax assets by $400,000 and increase accumulated other comprehensive income by
$800,000.
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 2007 and 2006 is as follows (in thousands):
F-33
2007 2006
---------- ----------
Projected Benefit Obligation:
Projected benefit obligation at January 1, $ 54,876 $ 58,123
Interest cost (a) 2,565 2,668
Actuarial gain (1,587) (1,200)
Benefits paid (4,095) (4,715)
---------- ----------
Projected benefit obligation at December 31, $ 51,759 $ 54,876
========== ==========
Change in Plan Assets:
Fair value of plan assets at January 1, $ 47,653 $ 43,476
Actual return on plan assets 3,786 2,022
Employer contributions -- 7,000
Benefits paid (4,095) (4,715)
Administrative expenses (141) (130)
---------- ----------
Fair value of plan assets at December 31, $ 47,203 $ 47,653
========== ==========
Funded Status at end of year $ (4,556) $ (7,223)
========== ==========
(a) Includes charges to expense of $700,000 and $800,000 for 2007 and 2006,
respectively, relating to discontinued operations obligations.
As of December 31, 2007 and 2006, $14,500,000 and $19,100,000, respectively, of
the net amount recognized in the consolidated balance sheet was reflected as a
charge to accumulated other comprehensive income and $4,600,000 and $7,200,000,
respectively, was reflected as accrued pension cost. The Company is currently
evaluating whether to make any contributions to the Company's defined benefit
pension plan in 2008.
Pension expense related to the defined benefit pension plan charged to
operations included the following components (in thousands):
2007 2006 2005
--------- --------- ---------
Interest cost $ 1,838 $ 1,916 $ 2,045
Expected return on plan assets (1,238) (1,052) (905)
Actuarial loss 813 905 848
Amortization of prior service cost 3 3 3
--------- --------- ---------
Net pension expense $ 1,416 $ 1,772 $ 1,991
========= ========= =========
At December 31, 2007, the plan's assets consisted of U.S. Government and
agencies bonds (12%), U.S. Government-Sponsored Enterprises (55%), investment
grade bonds (27%) and cash equivalents (6%). At December 31, 2006, the plan's
assets consisted of U.S. Government and agencies bonds (32%), investment grade
bonds (60%), cash equivalents (7%) and other (1%).
The defined benefit pension plan assets are invested in short-term investment
grade fixed income investments in order to maximize the value of its invested
assets by minimizing exposure to changes in market interest rates. This
investment strategy provides the Company with more flexibility in managing the
plan should interest rates rise and result in a decrease in the discounted value
of benefit obligations. The current investment strategy 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.
F-34
To develop the assumption for the expected long-term rate of return on plan
assets, the Company considered the following underlying assumptions: 2.5%
current expected inflation, 1.5% 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 4.25% expected long-term rate of return
assumption for 2007. Because pension expense includes the cost of expected plan
administrative expenses, the 4.25% 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, 2007.
A summary of activity with respect to the Company's postretirement plans for
2007 and 2006 is as follows (in thousands):
2007 2006
------- --------
Accumulated postretirement benefit obligation at January 1, $ 4,281 $ 4,773
Interest cost 236 229
Contributions by plan participants 162 145
Actuarial gain (111) (321)
Benefits paid (485) (545)
------- -------
Accumulated postretirement benefit obligation at December 31, $ 4,083 $ 4,281
======= =======
The Company expects to spend $400,000 on postretirement benefits during 2008. At
December 31, 2007, the assumed health care cost trend rate for 2008 used in
measuring the accumulated postretirement benefit obligation is 9.5% and, at
December 31, 2006, such rate for 2007 was 9.5%. At December 31, 2007 and 2006,
the assumed health care cost trend rates were assumed to decline to an ultimate
rate of 5% by 2015. If the health care cost trend rates were increased or
decreased by 1%, the accumulated postretirement obligation as of December 31,
2007 would have increased by $300,000 or decreased by $200,000. The effect of
these changes on interest cost for 2007 would be immaterial.
At December 31, 2007 and 2006, the amounts in accumulated other comprehensive
income relating to the Company's defined benefit pension plan and other benefits
plans that have not yet been recognized in net periodic benefit cost are as
follows (in thousands):
2007 2006
---------------------------------- ----------------------------------
Other Other
Pension Plan Benefits Plans Pension Plan Benefits Plans
------------ -------------- ------------ --------------
Net loss (gain) $ 14,425 $ (947) $ 19,008 $ (903)
Prior service cost (credit) 43 (264) 45 (323)
--------- ---------- --------- ---------
$ 14,468 $ (1,211) $ 19,053 $ (1,226)
========= ========= ========= =========
Changes in the Company's plan assets and benefit obligations recognized in other
comprehensive income (loss) for the year ended December 31, 2007 are as follows
(in thousands):
Pension Plan Other Benefits Plans
------------ --------------------
Net gain arising during period $ 3,447 $ 112
Recognition of amortization in net periodic benefit cost:
Prior service cost (credit) 3 (59)
Actuarial loss (gain) 1,134 (68)
-------- -------
Total $ 4,584 $ (15)
======== =======
The estimated net loss for the defined benefit pension plan that will be
amortized from accumulated other comprehensive income into net periodic benefit
cost in 2008 is $800,000; such amount for the prior service cost is not
material. The estimated net gain and prior service credit for the other benefits
plans that will be amortized from accumulated other comprehensive income into
net periodic benefit cost in 2008 are $100,000 and $100,000, respectively.
F-35
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
------------------ -------------------
2007 2006 2007 2006
----- ----- ----- -----
Discount rate used to determine benefit
obligation at December 31, 5.20% 4.90% 6.10% 5.75%
Weighted-average assumptions used to determine
net cost for years ended December 31,:
Discount rate 4.90% 4.87% 5.75% 5.25%
Expected long-term return on plan assets 4.25% 4.00% N/A N/A
The discount rate for pension benefits 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 discount rate for other benefits was based on the expected
future benefit payments in conjunction with the Citigroup Pension Discount
Curve.
The following benefit payments are expected to be paid (in thousands):
Pension Benefits Other Benefits
---------------- --------------
2008 $ 4,262 $ 415
2009 4,660 422
2010 3,896 408
2011 3,931 402
2012 3,938 369
2013 - 2017 20,095 1,658
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 2007 and 2006
is as follows (in thousands):
2007 2006
---------- ----------
Projected Benefit Obligation:
Projected benefit obligation at beginning of period $ 176,724 $ 186,054
Interest cost 10,163 9,856
Actuarial gain (12,573) (11,502)
Benefits paid (5,773) (7,684)
---------- ----------
Projected benefit obligation at December 31, $ 168,541 $ 176,724
========== ==========
Change in Plan Assets:
Fair value of plan assets at beginning of period $ 143,590 $ 97,905
Actual return on plan assets 14,490 11,976
Employer contributions 68 43,052
Benefits paid (5,773) (7,684)
Administrative expenses (1,637) (1,659)
---------- ----------
Fair value of plan assets at December 31, $ 150,738 $ 143,590
========== ==========
Funded Status at end of year $ (17,803) $ (33,134)
========== ==========
F-36
As of December 31, 2007 and 2006, $7,100,000 and $24,300,000, respectively, of
the net amount recognized in the consolidated balance sheet was reflected as a
charge to accumulated other comprehensive income and $17,800,000 and
$33,100,000, respectively, was reflected as accrued pension cost.
The Company anticipates funding and distributing the benefits of WilTel's
supplemental employee retirement plan in 2008. Accordingly, the Company has
classified the anticipated distribution ($3,900,000) as a current liability.
Other than the supplemental employee retirement plan, the Company is currently
evaluating whether to make any contributions to the WilTel plan in 2008.
Pension expense for the WilTel plans charged to results of continuing operations
in 2007 and 2006 and to results of discontinued operations in 2005 included the
following components (in thousands):
2007 2006 2005
---------- ---------- ----------
Interest cost $ 10,163 $ 9,856 $ 9,410
Service cost -- -- 4,612
Expected return on plan assets (9,363) (6,954) (6,509)
Actuarial loss 1,136 1,579 2,953
---------- ---------- ----------
Net pension expense $ 1,936 $ 4,481 $ 10,466
========== ========== ==========
At December 31, 2007, the plans' assets consisted of equity securities (58%),
debt securities (39%) and cash equivalents (3%). At December 31, 2006, the
plans' assets consisted of equity securities (57%), debt securities (21%) and
cash equivalents (22%). 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 having frozen 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.
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.
F-37
o Fixed income securities will all be rated BBB- or better at the time
of purchase, there will be no more than 8% at market in any one
security (U.S. government and agency positions excluded), no more than
a 30-year maturity in any one security and investments in standard
collateralized mortgage obligations are limited to securities that are
currently paying interest, receiving principal, do not contain
leverage and are limited to 10% of the market value of the portfolio.
To develop the assumption for the expected long-term rate of return on plan
assets, the Company considered the following underlying assumptions: 2.5%
current expected inflation, 2% real rate of return for risk-free investments,
..3% inflation risk premium (considering the long-term nature of plan
investments), .9% default risk premium for the portion of the portfolio invested
in corporate bonds, and 2.25% to 2.6% in equity risk premium (depending on asset
class) in excess of corporate bond returns. The Company then weighted these
assumptions by the long-term target allocations and assumed that investment
expenses were offset by expected returns in excess of benchmarks, which resulted
in the selection of the 7.5% expected long-term rate of return assumption for
2007.
At December 31, 2007 and 2006, the accumulated other comprehensive income
relating to WilTel's plans that has not yet been recognized in net periodic
benefit cost consists of cumulative losses of $7,100,000 and $24,300,000,
respectively.
Changes in plan assets and benefit obligations recognized in other comprehensive
income (loss) related to WilTel's pension plans for the year ended December 31,
2007 are as follows (in thousands):
Net gain arising during period $ 16,064
Recognition of amortization of actuarial loss in
net periodic benefit cost 1,135
----------
Total $ 17,199
==========
The estimated net loss for the defined benefit pension plan that will be
amortized from accumulated other comprehensive income into net periodic benefit
cost in 2008 is $1,800,000.
The measurement date for WilTel's plans is December 31. The assumptions used for
2007 and 2006 are as follows:
Pension Benefits
-----------------------
2007 2006
---- ----
Weighted-average assumptions used to determine
benefit obligation at December 31,:
Discount rate 6.30% 5.70%
Weighted-average assumptions used to determine
net cost for the period ended December 31,:
Discount rate 5.70% 5.40%
Expected long-term return on plan assets 7.50% 7.50%
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.
F-38
The following pension benefit payments are expected to be paid (in thousands):
2008 $ 6,146
2009 3,260
2010 3,156
2011 4,103
2012 4,161
2013 - 2017 40,833
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
$2,900,000, $2,000,000 and $1,700,000 for the years ended December 31, 2007,
2006 and 2005, respectively.
18. Commitments and Contingencies:
-----------------------------
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) was $12,900,000 in
2007, $5,700,000 in 2006 and $4,400,000 in 2005. Future minimum annual rentals
(exclusive of month-to-month leases, real estate taxes, maintenance and certain
other charges) under these leases at December 31, 2007 are as follows (in
thousands):
2008 $ 13,139
2009 11,235
2010 8,728
2011 8,204
2012 7,740
Thereafter 79,690
---------
128,736
Less: sublease income 2,609
---------
$ 126,127
=========
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, 2007,
$12,100,000 was outstanding under these bonds, $9,900,000 of which expires in
2008 and the remainder thereafter.
As more fully discussed in Note 4, CLC has entered into an agreement with third
party lenders 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. The Company has guaranteed 30% of the obligations outstanding
under both facilities until completion of the project as defined in the project
financing agreement. At December 31, 2007, $126,900,000 was outstanding under
the senior secured credit facility and (euro)24,000,000 was outstanding under
the senior secured bridge credit facility; as a result, the Company's
outstanding guaranty at that date was $38,100,000 and (euro)7,200,000
($10,500,000 at exchange rates in effect on February 14, 2008), respectively.
The Company has also committed to provide financing to CLC which is currently
estimated to be (euro)239,000,000 ($350,000,000 at exchange rates in effect on
February 14, 2008), of which the Company's share will be 30% ($80,000,000 of
which has been loaned as of December 31, 2007).
F-39
The holders of the Premier Notes argued that they were entitled to liquidated
damages under the indenture governing the Premier Notes, and as such are
entitled to more than the principal amount of the notes plus accrued interest
that was paid to them at emergence. Although the Company does not agree with the
position taken by the Premier noteholders, in order to have Premier's bankruptcy
plan confirmed so that Premier could complete reconstruction of its property and
open its business without further delay, the Company agreed to fund an escrow
account to cover the Premier noteholders' claim for additional damages in the
amount of $13,700,000, and a second escrow account for the trustee's reasonable
legal fees and expenses in the amount of $1,000,000. Entitlement to the escrows
is expected to be determined by the court during 2008. The Company believes it
is probable that the court will approve payment of legal fees and expenses and
has fully reserved for that contingency. However, the Company does not believe
it is probable or remote that the court will find in favor of the Premier
noteholders with respect to the additional damages escrow, and any potential
loss can not be reasonably estimated. Accordingly, the Company has not accrued a
loss for the additional damages contingency.
Hurricane Katrina completely destroyed the Hard Rock Biloxi's casino, which was
a facility built on floating barges, and caused significant damage to the hotel
and related structures. The new casino was constructed over water on concrete
pilings that greatly improved the structural integrity of the facility; however,
the threat of hurricanes remains a risk to the repaired and rebuilt facilities.
Premier's current insurance policy was bound on April 20, 2007, and provides up
to $263,700,000 in coverage for damage to real and personal property including
up to $84,100,000 in business interruption coverage. The coverage is led by
Underwriters at Lloyds and is comprised of a $20,000,000 primary layer and six
excess layers. The coverage is syndicated through several insurance carriers,
each with an A.M. Best Rating of A- (Excellent) or better. Although the
insurance policy is an all risk policy, weather catastrophe occurrence (WCO),
which is defined to include damage caused by a named storm, is limited to
$130,000,000 with a deductible of $13,200,000. The WCO coverage is subject to
mandatory reinstatement of limits for an additional pre-determined premium.
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, but any
amounts paid could be material to results of operations for the period.
20. Earnings (Loss) Per Common Share:
--------------------------------
For the year ended December 31, 2007, the numerators for basic and diluted per
share computations for income from continuing operations were $480,800,000 and
$489,600,000, respectively. For the year ended December 31, 2006, the numerators
for basic and diluted per share computations for income from continuing
operations were $129,800,000 and $138,600,000, respectively. For the year ended
December 31, 2005, the numerators for basic and diluted per share computations
for income from continuing operations were $1,220,300,000 and $1,234,500,000,
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, net
of the income tax effect, unless the effect is antidilutive.
The denominators for basic per share computations were 218,361,000, 216,233,000
and 215,531,000 for 2007, 2006 and 2005, respectively. The denominators for
diluted per share computations reflect the dilutive effect of 1,053,000, 412,000
and 504,000 options and warrants for 2007, 2006 and 2005, respectively (the
treasury stock method was used for these calculations), and 15,239,000 shares
related to the 3 3/4% Convertible Notes for each of 2007, 2006 and 2005.
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:
F-40
(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 securities that are accounted for
under the cost method (aggregating $79,900,000 and $104,600,000 at December 31,
2007 and 2006, respectively) 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) Long-term and other indebtedness: The fair values of non-variable rate debt
are estimated using quoted market prices and estimated rates that 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.
(e) Swap agreements: The fair values of the interest rate swap and currency rate
swap agreements are based on rates currently available for similar agreements.
The carrying amounts and estimated fair values of the Company's financial
instruments at December 31, 2007 and 2006 are as follows (in thousands):
2007 2006
---- ----
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ ----------- ------------ ------------
Financial Assets:
Investments:
Current $ 983,199 $ 983,199 $ 903,973 $ 903,973
Non-current 2,776,521 3,150,321 1,465,849 1,687,611
Cash and cash equivalents 456,970 456,970 287,199 287,199
Notes receivable:
Current 2,053 2,053 6,633 6,633
Non-current 200 200 2,244 2,244
Financial Liabilities:
Debt:
Current 132,405 133,364 184,815 185,867
Non-current 2,004,145 2,398,592 974,646 1,135,117
Securities sold not owned 2,603 2,603 5,697 5,697
Swap agreements:
Interest rate swaps (5,380) (5,380) (268) (268)
Foreign currency swaps (2,862) (2,862) (2,430) (2,430)
F-41
22. Segment Information:
--------------------
The Company's reportable segments consist of its operating units, which offer
different products and services and are managed separately. Idaho Timber
primarily remanufactures, manufactures and/or distributes wood products. Conwed
Plastics manufactures and markets lightweight plastic netting used for a variety
of purposes. The Company's telecommunications segment is conducted through STi
Prepaid, a provider of international prepaid phone cards and other
telecommunication services in the U.S. The property management and services
business is conducted through ResortQuest, which offers management services to
vacation properties in beach and mountain resort locations in the continental
United States, as well as real estate brokerage services and other rental and
property owner services. The Company's gaming entertainment segment is conducted
through Premier, which owns the Hard Rock Biloxi. 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. The Company's medical product
development segment is conducted through Sangart, which became a majority-owned
subsidiary in November 2005. Other operations primarily consist of the Company's
wineries and energy projects.
At acquisition in 2006, the Company's investment in Premier was reported as a
consolidated subsidiary in the other operations segment; however, it was
deconsolidated and classified as an investment in an associated company upon its
filing of voluntary petitions for reorganization under chapter 11 of title 11 of
the United States Bankruptcy Code in September 2006. While in bankruptcy Premier
was classified as an investment in an associated company and its operating
results were not reported as the gaming entertainment segment. Upon its
emergence from bankruptcy in August 2007, Premier was once again consolidated by
the Company and has been reported as an operating segment since that date.
Associated companies include equity interests in other entities that the Company
accounts for on the equity method of accounting. Investments in associated
companies include HomeFed, JHYH, Goober Drilling and CLC. The Company also has
made non-controlling investments in entities that are engaged in investing
and/or securities transactions activities which are accounted for as investments
in associated companies including Pershing Square, Highland Opportunity,
Shortplus, Ambrose, EagleRock and Wintergreen.
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 include the Company's investments in
Fortescue and Inmet. Corporate assets, revenues, overhead expenses and interest
expense are not allocated to the operating units.
Conwed Plastics has manufacturing facilities located in Belgium and Mexico, STi
Prepaid has a customer care unit located in the Dominican Republic and other
operations includes a small Caribbean-based telecommunications provider. These
are the only foreign operations with non-U.S. revenue or assets that the Company
consolidates, and are not material. Unconsolidated non-U.S. based investments
include 38% of Light and Power Holdings Ltd., the parent company of the
principal electric utility in Barbados, the 30% ownership interest in CLC and
the investments in Fortescue and Inmet. 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 is presented in the
following table. Consolidated subsidiaries are reflected as of the date of
acquisition, which was June 2007 for ResortQuest, March 2007 for STi Prepaid,
November 2005 for Sangart and May 2005 for Idaho Timber. As discussed above,
Premier is reflected as a consolidated subsidiary from May 2006 until it was
deconsolidated in September 2006; Premier once again became a consolidated
subsidiary in August 2007. Associated Companies are only reflected in the table
below under identifiable assets employed.
F-42
2007 2006 2005
--------- --------- ---------
(In millions)
Revenues and other income (a):
Manufacturing:
Idaho Timber $ 292.2 $ 345.7 $ 239.0
Conwed Plastics 105.4 106.4 93.6
Telecommunications 363.2 -- --
Property Management and Services 81.5 -- --
Gaming Entertainment 38.5 -- --
Domestic Real Estate 13.4 86.7 29.9
Medical Product Development 2.1 .7 .1
Other Operations (b) 53.6 42.8 59.0
Corporate (c) 205.0 280.4 268.3
--------- --------- ---------
Total consolidated revenues and other income $ 1,154.9 $ 862.7 $ 689.9
========= ========= =========
Income (loss) from continuing operations before income taxes
and equity in income (losses) of associated companies:
Manufacturing:
Idaho Timber $ 9.1 $ 12.0 $ 8.2
Conwed Plastics 17.4 17.9 14.2
Telecommunications 18.4 -- --
Property Management and Services (6.5) -- --
Gaming Entertainment (9.3) -- --
Domestic Real Estate (8.2) 44.0 4.1
Medical Product Development (31.5) (21.1) (1.4)
Other Operations (b) (17.2) (14.4) 7.5
Corporate (c) (29.3) 95.4 101.8
--------- --------- ---------
Total consolidated income (loss) from continuing operations
before income taxes and equity in income (losses) of
associated companies $ (57.1) $ 133.8 $ 134.4
========= ========= =========
Identifiable assets employed:
Manufacturing:
Idaho Timber $ 129.5 $ 132.3 $ 162.7
Conwed Plastics 88.8 83.6 81.9
Telecommunications 81.9 -- --
Property Management and Services 62.8 -- --
Gaming Entertainment 300.6 -- --
Domestic Real Estate 306.3 198.1 182.7
Medical Product Development 36.5 12.2 7.0
Other Operations 255.5 257.8 245.0
Investments in Associated Companies 1,362.9 773.0 375.5
Corporate 5,501.8 3,846.8 4,062.0
Assets of discontinued operations -- -- 144.1
--------- --------- ---------
Total consolidated assets $ 8,126.6 $ 5,303.8 $ 5,260.9
========= ========= =========
(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.
F-43
(b) Other operations includes pre-tax losses of $13,900,000, $8,300,00 and
$1,600,000 for the years ended December 31, 2007, 2006 and 2005,
respectively, for investigation and evaluation of various energy related
projects. There were no material operating revenues or identifiable assets
associated with these activities in any period; however, other income
includes $8,500,000 in 2007 related to the termination of a joint
development agreement with another party.
(c) Net securities gains for Corporate aggregated $92,700,000, $116,600,000 and
$199,500,000 during 2007, 2006 and 2005, 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
include a gain from the sale of Eastman Chemical Company of $37,800,000 in
2007, a gain from the sale of Level 3 of $37,400,000 in 2006 and a gain
from the sale of White Mountains Insurance Group, Ltd. of $146,000,000 in
2005. For 2007, 2006 and 2005, security gains include provisions of
$36,800,000, $12,900,000 and $12,200,000, respectively, to write down
investments in certain available for sale securities and, in 2007, an
investment in a non-public security.
(d) For the years ended December 31, 2007, 2006 and 2005, income (loss) from
continuing operations reflects depreciation and amortization expenses of
$54,200,000, $39,500,000 and $32,600,000, respectively; such amounts are
primarily comprised of Corporate ($12,700,000, $11,600,000 and $10,700,000,
respectively), manufacturing ($18,000,000, $17,500,000 and $14,200,000,
respectively), gaming entertainment ($6,300,000 and $900,000 in 2007 and
2006, respectively), domestic real estate ($3,800,000, $3,300,000 and
$2,000,000, respectively), property and management services ($3,100,000 in
2007) and other operations ($9,000,000, $5,600,000 and $5,700,000,
respectively). Depreciation and amortization expenses for other segments
are not material.
(e) For the years ended December 31, 2007, 2006 and 2005, income (loss) from
continuing operations reflects interest expense of $111,500,000,
$79,400,000 and $65,500,000, respectively; such amounts are primarily
comprised of Corporate ($110,800,000, $70,900,000 and $63,200,000,
respectively), gaming entertainment ($500,000 and $8,000,000 in 2007 and
2006, respectively) and other operations ($1,200,000 in 2005). Interest
expense for other segments is not material.
F-44
23. Selected Quarterly Financial Data (Unaudited):
---------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(In thousands, except per share amounts)
2007:
-----
Revenues and other income $ 197,185 $ 344,004 $ 331,149 $ 282,557
========== ========= ========= =========
Income from continuing operations $ 7,861 $ 26,315 $ 2,087 $ 444,545
========== ========= ========= =========
Income (loss) from discontinued operations, net of taxes $ 222 $ (13) $ 98 $ (148)
========== ========= ========= =========
Gain (loss) on disposal of discontinued operations, net of taxes $ 291 $ (3) $ 1,703 $ 1,336
========== ========= ========= =========
Net income $ 8,374 $ 26,299 $ 3,888 $ 445,733
========== ========= ========= =========
Basic earnings (loss) per common share:
Income from continuing operations $ .04 $ .12 $ .01 $ 2.00
Income (loss) from discontinued operations -- -- -- --
Gain (loss) on disposal of discontinued operations -- -- .01 --
----- ----- ----- -----
Net income $ .04 $ .12 $ .02 $2.00
===== ===== ===== =====
Number of shares used in calculation 216,409 216,596 218,071 222,494
======= ======= ======= =======
Diluted earnings (loss) per common share:
Income from continuing operations $ .04 $ .12 $ .01 $ 1.87
Income (loss) from discontinued operations -- -- -- --
Gain (loss) on disposal of discontinued operations -- -- .01 --
----- ----- ----- -----
Net income $ .04 $ .12 $ .02 $ 1.87
===== ===== ===== ======
Number of shares used in calculation 216,779 217,229 219,411 239,483
======= ======= ======= =======
2006
----
Revenues and other income $ 291,608 $ 224,426 $ 170,243 $ 176,395
========== ========= ========= =========
Income from continuing operations $ 82,589 $ 36,375 $ 3,740 $ 7,065
========== ========= ========= =========
Income (loss) from discontinued operations, net of taxes $ (1,433) $ 280 $ (2,717) $ (90)
========== ========= ========= =========
Gain (loss) on disposal of discontinued operations, net of taxes $ (463) $ 365 $ 59,454 $ 4,234
========== ========= ========= =========
Net income $ 80,693 $ 37,020 $ 60,477 $ 11,209
========== ========= ========= =========
Basic earnings (loss) per common share:
Income from continuing operations $ .38 $ .17 $ .02 $ .03
Income (loss) from discontinued operations (.01) -- (.01) --
Gain (loss) on disposal of discontinued operations -- -- .27 .02
----- ----- ----- -----
Net income $ .37 $ .17 $ .28 $ .05
===== ===== ===== =====
Number of shares used in calculation 216,112 216,201 216,291 216,334
======= ======= ======= =======
Diluted earnings (loss) per common share:
Income from continuing operations $ .37 $ .17 $ .02 $ .03
Income (loss) from discontinued operations (.01) -- (.01) --
Gain (loss) on disposal of discontinued operations -- -- .26 .02
----- ----- ----- -----
Net income $ .36 $ .17 $ .27 $ .05
===== ===== ===== =====
Number of shares used in calculation 231,765 231,777 231,906 216,707
======= ======= ======= =======
Income from continuing operations includes a credit to income tax expense of
$542,700,000 in the fourth quarter of 2007, resulting from the reversal of a
portion of the deferred tax valuation allowance.
In 2007 and 2006, the totals of quarterly per share amounts do not equal annual
per share amounts because of changes in outstanding shares during the year.
F-45
Schedule II - Valuation and Qualifying Accounts
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
For the years ended December 31, 2007, 2006 and 2005
(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
----------- --------- -------- ---------- ----- ----- ----------- ----- ---------
2007
----
Loan receivables of
banking and lending
subsidiaries $ 306 $ (228) $ 121 $ -- $ 111 $ -- $ -- $ 88
Trade, notes and other
receivables 1,467 794 26 -- 296 -- -- 1,991
---------- --------- ------ -------- ------- -------- ---------- ----------
Total allowance for
doubtful accounts $ 1,773 $ 566 $ 147 $ -- $ 407 $ -- $ -- $ 2,079
========== ========= ====== ======== ======= ======== ========== ==========
Deferred tax asset
valuation allowance $ 911,777 $ -- $ -- $ 29,311(a) $ -- $ -- $ 641,313(b) $ 299,775
========== ========= ====== ======== ======= ======== ========== ==========
2006
----
Loan receivables of
banking and lending
subsidiaries $ 536 $ (166) $ 66 $ -- $ 130 $ -- $ -- $ 306
Trade, notes and other
receivables 14,896 1,255 128 -- 6,395 8,417 -- 1,467
---------- --------- ------ -------- ------- -------- ---------- ----------
Total allowance for
doubtful accounts $ 15,432 $ 1,089 $ 194 $ -- $ 6,525 $ 8,417 $ -- $ 1,773
========== ========= ====== ======== ======= ======== ========== ==========
Deferred tax asset
valuation allowance $ 804,829 $ -- $ -- $106,948(c) $ -- $ -- $ -- $ 911,777
========== ========= ====== ======== ======= ======== ========== ==========
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(b) $ 804,829
========== ========= ====== ======== ======= ======== ========== ==========
(a) In connection with the filing of the 2006 income tax return and with a
subsidiary joining the Company's consolidated income tax return during
2007, additional deferred tax assets were recognized but were fully
reserved.
(b) During 2007 and 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, $542,700,000 in
2007 and $1,135,100,000 in 2005 of the deferred tax valuation allowance
was reversed as a credit to income tax expense. In 2007, also reflects
the allocation of the purchase price for STi Prepaid in the amount of
$98,600,000.
(c) The increase in the valuation allowance is principally due to the
utilization of previously unrecognized capital losses in the Company's
2005 federal income tax return, which resulted in a larger NOL than
previously estimated.
(d) Amounts in the schedule include activity related to discontinued
operations.
F-46